Dr. Lamborn is a professor in the Department of Economics at Boise State University in Idaho.

The most powerful individual in any organization is the person who controls the purse. The person controlling the keys to the vault where the cash is kept really has more power than many people who in an organizational sense should be in a position to order, or refuse to order, disbursement of funds.

In any attempt to control the Federal Government and the activities of the government we must first discover who is the keeper of the purse. Which branch, which person or which agency is actually in control. It does little good to look at an organizational chart—it will only confuse the issue. However, if we examine the actions of the Federal Government it soon becomes apparent that it is not the President, nor is it the Congress that is really in control, although both of these frequently announce that they are in charge. The real control is a semipublic agency known as the Federal Reserve System. Any person in control of the Federal Reserve really controls the system.

Governments have been successful in hiding the cost of many new programs because they have a monopoly in the creation and control of money. Because of this monopoly the government does not have to support new programs and other activities by taxation or the closing down of old programs. These new programs can be financed by the proper control of the money system. Nearly everyone thinks that this important activity must be run by and supervised by the government. It was thought to be so important that it was even written into the original United States Constitution, and it has remained there.

The Article is written “. . . shall have the power to coin money and regulate the value thereof.” It has been fairly easy for the government to discharge the responsibility to coin money, but this regulation of the “value thereof” is a bit more difficult.

Tied to Gold

Some want the money supply tied to some particular metal, the most popular of which has been gold and/or silver. The argument in its simple form is that the value of the money supply will be controlled automatically, and there seems to be a profound trust in anything that is automatic. But although it is automatic there is no assurance that the money supply will behave in such a way as to give us anything like a stable price level or full employment or any of many other things which we desire.

Under the gold or some metal standard whether or not your price level remains stable will depend on three factors: (1) the supply of goods, (2) the supply of money (gold), and (3) the price of the money—usually referred to as the price at which the government will buy and sell gold. Under conditions where the supply of goods and the supply of gold re main constant or change at the same rate, the price level will remain relatively stable. However, that would be a rather unique situation and has happened only a few times in history.

The factors that control the supply of goods in a general sense are not the same factors that control the supply of one particular good such as gold (and it won’t help much if the standard money is to be one, two or even three commodities). Witness what happened to the general price level following the discovery of gold in California in 1849, or the period from 1872-1896.

But the gold standard people have one ace in the hole. If things get too far out of balance they can always change the price of gold. However, this presents two problems:

(1) If the price is not changed quickly enough, we may have either deflation or inflation.

(2) This gives some government agency the power to control the money supply and thus control the price level and the change in the price level.

So it should be apparent, if we adopt or revert to the classical gold standard and then let it alone to operate in its automatic way, we will be subject to long periods of inflation or deflation and not stable prices at all. Whether we have inflation or deflation will depend upon the increase in supply of goods and services relative to the increase in the supply of money. Even this assumes we know something about money velocity (the number of times a unit of money is used in a given period of time).

The other alternative, of course, is changing the price of the money, and that supposes that some individual (or group of individuals in some government agency) is able to determine when and by how much the price of money should be changed. It is likely that the price of the metal that is used as money might be changed to help finance new pro grams in situations where it seems undesirable to increase taxes or to eliminate older programs. If a metal is selected as our money standard, the price of the metal should at least be allowed to change as market conditions change on a worldwide basis, which means that the price of money should be determined by supply and demand conditions on a worldwide market. Indeed, this might well be the second best solution to our money problem.

Some individuals who can see the need for some changes in the supply of money over time but sense the inherent weakness of the classical gold standard are willing to settle for a constant increase in the money supply. These people point out that the productive capacity of the country will no doubt increase over time, so some increase in the money supply is needed (the alternative being, of course, long term deflation). If the money increases at about the same rate as the production of goods and services the result will be stable prices. This, of course, assumes that the velocity of money does not change to any significant degree. This rather simple solution to a complex problem overlooks at least three rather basic problems:

(1) It is difficult to increase the money supply at some preannounced rate. Although we may want the money supply to increase at four per cent or five per cent or some other magic figure, it is necessary to control the actions of the commercial banks as well as the saving institutions to achieve this desired result.

(2) Short time fluctuations in the growth rate of either the money supply or of goods and services may cause serious periods of inflation or deflation. These periods of inflation and deflation will of course come to an end if we are willing to wait and do not give in to the third defect of the system.

(3) If the government or some agency of the government has the power to set the rate of increase in the money supply, they also have the power to alter the rate of increase, and the rate of increase can be changed to provide for inflation. That is the most serious defect of the system.

The Federal Reserve

We, in the United States, have tried to avoid the pitfalls of either the gold standard or fixed increase in the money supply. We have turned the control and operation of our monetary system over to a semipublic agency known as the Federal Reserve System. The Fed, as it has come to be called, is a rather large bureau and has become self-supporting, gaining its revenue from the services it sells to commercial banks and the interest on the government securities which it “owns.” The Federal Reserve also performs many services for the Federal Government, such as acting as its agent in the selling of bonds. However, the primary and most important function of the Federal Reserve is to control the monetary system. The Fed has been in existence since 1913 and is one of the most respected of all government agencies. However, when the Fed is measured against the yardstick of what it is supposed to be doing, the record is not only unimpressive—it looks like complete failure.

The best time to judge an institution is when it is working under stress, but when the Fed is placed under stress it fails to perform as we thought it would. This has been the case in every period of economic stress since 1913.

For example, during wars the government needs and uses large sums of money. The government really has only two ways to, obtain the needed funds: taxation or borrowing. In my opinion, taxation is the preferred method, but they have chosen in every war and “police action” to borrow large sums. This borrowing action has been handled by the Federal Reserve, and in order to get the large sums needed the money supply has been expanded at too rapid a rate, and the result has been higher prices.

The alternative to money expansion was for the Fed to bid the resources away from the private sector by raising the interest rate paid on government securities, but in the short run situation we in the United States seem to prefer inflation over high interest rates. Following World War II when the Federal Reserve complained about carrying this burden for the United States Treasury, the result was the “accord” signed in 1951 which officially relieved the Federal Reserve of this burden which they never really had in the first place. The Fed sometimes keeps the money supply expansion at too low a rate causing unemployment. However, the most usual error has been to expand the money supply at too fast a pace so that prices have risen. This has been especially true since 1950. The inflation rate has recently been above a figure that was completely unacceptable in 1955.

The Great Depression

The worst recession, or depression, that this country experienced was in 1929-33. At the time, few people understood what happened or the reasons for what happened. But after the smoke cleared it seemed apparent that the Federal Reserve was too busy getting the gold standard restored in England during the 1920s, which was a questionable objective for the United States Federal Reserve System. Then, when it appeared that we were to have a slight or minor recession, the Fed responded by actually forcing a reduction in the money supply. At the bottom of the depression the officials made the statement which by now has almost become a classic: “We could have stopped the recession except that we didn’t have enough power.” The Congress responded by giving them more power, and the Federal Reserve then used their new weapons to cause the recession of 1937-38. This recession was more severe but more short-lived than the recession of 1929-33. The short duration of the recession was due to the upcoming war in Europe and the fact that the Fed was shifting over to their new position of continuous inflation to help the Federal government finance the war effort.

There have been times when the Federal Reserve has done the right thing at the right time. But the more important question is, have their good decisions outweighed their bad decisions?

It is true that there were recessions before the creation of the Federal Reserve in 1913. It is also true that there were periods of inflation before 1913. The important question is, has the Federal Reserve been stabilizing or destabilizing? It seems to me that the Fed has been destabilizing. Monetary authorities that axe not government connected are coming to this same conclusion.

The problem is that although many are able to agree that the Federal Reserve System has worked less than perfectly, most want to keep the government involved in the monetary system in some fashion and try to correct the defects. However, it appears that the Federal Reserve has worked so poorly that any attempt to patch the system, which in most people’s minds means giving it more power, will not solve the problem. Everyone makes mistakes. Usually when a person makes mistakes he affects his own future and the future of people with whom he deals. When a government decision is a mistake it affects the people that deal with that agency. Everyone is affected by the monetary system, so this is one government agency that influences the lives of everyone.

The solution, then, is to repeal the act (actually it will be several acts) that created and expanded the Federal Reserve System, and then amend the Constitution of the United States so that the Federal Government no longer has the power or the responsibility “to coin money and regulate the value thereof.” This is drastic action, but drastic action is needed.

Mistakes Inevitable

Any government unit will make mistakes, but there are additional hazards with an agency that controls the money supply. Any government unit that wants to run continuous deficits over a period of time can do so only with the cooperation and aid of the people in control of the monetary system. Money is too important to the operation of the economy to trust the operation of the monetary system to government. It must be left in the hands of the people. The new system that will arise will handle our needs in better fashion, but of course the system will not be perfect.

The result of getting the government out of the money business will be chaos for awhile at least. After all, people for generations have been accustomed to the government controlling the monetary system. The point is that patching up the Federal Reserve, the gold standard, or any automatic monetary rule is not going to solve the problem. The problem is the government itself. A matter as important as money cannot be left to central government action.

Without government control there will be increased uncertainty, especially in the short run. After we have developed a new system the uncertainty will be at a minimum and the costs of operating the system will be no greater than the present costs—they might even be less. Remember that though the Federal Reserve operates without using money obtained from the Federal Treasury, they collect both for services rendered to commercial banks and interest on the securities that they own.

Cost of operating the new system will not be of major consideration. The cornerstone of the system will be that anyone who wants to can get into the production and sale of money. There is, of course, the problem of getting customers. This may be referred to as acceptability, but in the marketplace it is known as producing a product that consumers like.

Hopefully, under such a system the person or corporation that issued money would be interested in maintaining acceptability for that money. Some money would be worth more than others, and exchange rates would be established in the marketplace among the various monies offered. Some of these monies would become completely worthless. In time (and this time period would be years, not days, weeks or months) it is rather safe to assume that there would be only a few issuers of currency.

Advantages of a Market Monetary System

The important point is that under this system there would be no inflation. Individual issuers of currency would be interested in maintaining the value of their currency, or else it would not be used. There would, of course, be some fly-by-night operations. Some people would be taken in by worthless currency. These costs and the cost of operating the system would be less than the cost of operating the present Federal Reserve System, especially when inflation is assessed as one of the costs of the present system. The issuers of the currency would keep the system in operation, not because they are particularly public spirited, but because it would be in their own best interests.

Individual banks and/or other institutions would be free to make loans, collect interest and perform other monetary transactions. They would even be free to insure their deposits if they thought it was in their own best interest to do so. Some are apt to point to the Federal Deposit Insurance Corporation as a well-run government agency. Needless to say, its record is somewhat better than the record of the Federal Reserve, but then the FDIC has been operating as an insurance agent during a period of almost continuing inflation. Under these conditions there can be some bad debt, but one must wonder if the FDIC would be able to survive a situation such as existed in 1929-33. It would be better to have several insurers of deposits, and there is no reason why these could not be international in scope.

In summary, then, the thesis is that the government should take itself by Constitutional amendment out of the money business and turn it over to private interests. It is not that the private interests will operate the system in a perfect manner, because they will not. But the private sector can and would operate the system better than the government has during the period since 1913.