I was reading an article about the creation of the Federal Reserve Bank (boo, hiss) in 1913 and I came across this:
Faced with the supreme necessity of sustaining the national credit and providing a market for Government securities, the Secretary of the Treasury in 1863 passed a National Bank Act basing the issue of currency by the banks upon the purchase of an equal amount of Government bonds. That was a cardinal error which still remains uncorrected. It has entailed a vast locking-up of banking capital in Government bonds as security for notes, and it has made impossible a normal and elastic currency system based on commercial paper and similar assets and automatically adapting itself to the daily needs of business.
Cue utter confusion. For starters, why would a bank want to issue currency? Surely, a bank has all the money it wishes to lend out in the form of deposits. And what is meant here by currency? notes and coins or money in general?
…it has made impossible a normal and elastic currency system based on commercial paper and similar assets and automatically adapting itself to the daily needs of business.
This is really confusing. I can understand how notes work in a goldsmith system. Briefly, a depositor deposits some gold with the goldsmith and in return receives a receipt for that gold. The receipt, or note, is then capable of being used as money because it is literally “as good as gold”. I can see how government bonds might replace gold but it requires a depositor. And surely, once a depositor has deposited his bond the bank can issue its own receipts/notes rather than having anything to do with the government. Or maybe that’s illegal. Or maybe depositors would prefer to use government notes as they are accepted in more places.
“…a normal and elastic currency system”. What do they mean by “elastic”? Do they mean what modern-day Austrian economists mean i.e. inflationary? I doubt it because at the time the UK was on a gold standard which tends to be anti-inflationary [notwithstanding comments I have made about how there was some inflation at the time].
And what’s all this about commercial paper? The modern meaning is short-term business debt. I can kind of see how that would replace government bonds although presumably it would have to be extremely homogenous and what happens when the term is up?
And where, if anywhere, is the link with gold which, as I understand it, was one of the main issues in the 1896 presidential election?
Whatever the case may be it seems clear that the US monetary system was far from being a free market before the Fed came along.
One last thought: there are times when I think the confusion that monetary matters generate is deliberate rather than accidental.