Americans look to John F. Kennedy as being one of the great heroes of the last century.  At a White House dinner honoring Nobel Prize winners on April 29, 1962, Jack Kennedy said:

"I think this is the most extraordinary collection of talent, of human knowledge, that has ever been gathered together at the White House, with the possible exception of when Thomas Jefferson dined alone."

Jefferson's intelligence was exercised in 1791, when President Washington requested the opinion of each of his cabinet members on the constitutionality of the First Bank of the United States, established by Congress in 1791 at the behest of Alexander Hamilton.

If Jefferson was considered brilliant by Kennedy 171 years later, he certainly should be considered brilliant in one of the most important papers he ever wrote concerning the Constitution. Below is an excerpt from that opinion; specifically on two key constitutional issues; one concerning the general welfare clause and the second concerning the necessary and proper clause. Any historian of constitutional law knows that the greatest extensions of federal power that have ever been made have been made through the interpretations of those two clauses.

Recognizing that Jefferson was so brilliant, read his opinion concerning those two clauses and try to reconcile it with the continued expansion of the federal government. Jefferson's quotes are right on point and are characteristically brilliant.  If either the general welfare clause or the necessary and proper clause meant what they have been expanded to mean over the last two hundred years, there would be no need for any of the rest of the constitution because congress could do anything it wanted by its interpretation of these clauses.  It is absurdity of the highest order to believe that the Framers of the Constitution meant for those clauses to be able to be interpreted so broadly.

Here we have shown you Jefferson's opinion to Washington on the establishment of the 1791 bank. In a future post, we will discuss why Jefferson did not make the Article 1, Section 8 argument against a bank's power to issue "paper money;" an evil of which the founders were well aware.

Here is the relevant excerpt from Jefferson's opinion on the constitutionality of the 1791 National Bank: or you can review Jefferson's full opinion.

II. Nor are they within either of the general phrases, which are the two following:

1. "To lay taxes to provide for the general welfare of the United States;" that is to say, to lay taxes for the purpose of providing for the general welfare: for the laying of taxes is the power, and the general welfare the purpose for which the power is to be exercised. They are not to lay taxes ad libitum, for any purpose they please; but only to pay the debts or provide for the welfare of the Union. In like manner, they are not to do anything they please to provide for the general welfare, but only to lay taxes for that purpose. To consider the latter phrase, not as describing the purpose of the first, but as giving a distinct and independent power to do any act they please, which might be for the good of the Union, would render all the preceding and subsequent enumerations of power completely useless; it would reduce the whole instrument to a single phrase, that of instituting a Congress with power to do whatever would be for the good of the United States; and, as they would be the sole judges of the good or evil, it would be also a power to do whatever evil they please.  (Emphasis Added.)  It is an established rule of construction, where a phrase will bear either of two meanings, to give it that which will allow some meaning to the other parts of the instrument, and not that which will render all the others useless.  Certainly no such universal power was meant to be given them. It was intended to lace them up straitly within the enumerated powers; and those without which, as means, those powers could not be carried into effect.

2. The second general phrase is, "to make all laws necessary and proper for carrying into execution the enumerated powers." But they can all be carried into execution without a bank. A bank, therefore, is not necessary, and, consequently, not authorized by this phrase. It has been much urged that a bank will give great facility or convenience, in the collection of taxes. Suppose this were true, yet the Constitution allows only the means which are "necessary," not those which are merely "convenient" for effecting the enumerated powers. If such a latitude of construction be allowed to this phrase as to give any non enumerated power, it will go to every one; for there is not one, which ingenuity may not torture into a convenience, in some way or other, to some one of so long a list of enumerated powers: it would swallow up all the delegated powers, and reduce the whole to one phrase, as before observed. (Emphasis Added)  Therefore it was that the constitution restrained them to the necessary means; that is to say, to those means, without which the grant of the power would be nugatory.

*  ad libitum - "at one's pleasure"

Our politicians on both sides of the aisle are constantly talking about taxes, spending, the deficit and the debt. What you rarely hear them discussing is the monetary system itself; the system that supports the government's ability to have unlimited spending and debt. Without the ability to monetize debt/print money, the government could not spend like it does. We are borrowing over forty cents for every dollar we spend, which equals a deficit of 1.65 trillion for 2011. All of the money we are borrowing is not coming from real borrowing. A good percentage of that money is coming from monetizing debt, which is similar to counterfeiting and is effectively taxing and stealing money from citizens without their realizing they are being robbed. For instance, how many times do you hear politicians discuss the increase in the oil prices and at the same time discuss that the dollar has been devalued by the Fed (which is a major cause for the increased price of oil!). No wonder the Arabs will not take $60 any more for a barrel of oil. Oil costs more because the dollar is worth less.

When we discuss the monetary system itself, we do not differentiate between the two basic schools of thought on the monetary system. One school of thought, developed in the 1890's by Irving Fisher and followed by Englishman John Maynard Keynes, believes that central banks printing money (to spend our way out of booms and busts) is the best way to handle a monetary system and to stimulate an economy. This method has been tried for almost ninety (90) years now and has failed dismally throughout that time. It is interesting that conservatives never label liberals Keynesians and attack that failed theory. They also seldom champion Von Mises or the Austrian School as being correct on economic matters since 1928. Both sides simply demagogue each other. There have been numerous books and articles written on the Austrian School. Von Mises, in 1928, predicted exactly what was going to happen in the 1929 crash but nobody wanted to listen. Irving Fisher, on the other hand, said at the same time that the economy was in excellent shape and prosperity would continue indefinitely. He said the same thing in 1932. He said the same thing in 1936, right before he died in poverty, living off his children. That is Keynes theory. The Austrian School of Economics has been correct. The Keynesian School has failed.

For a useful expansion of this subject, see this PDF of the article "The Great Depression: Mises vs. Fisher" by Mark Thornton from mises.org.

The precursor to modern day banking was a crime when it first began over a thousand years ago. Today, fractional reserve banking is preferred worldwide.

Fractional Reserve Banking requires a bank to only keep a fraction of its capital on hand to back deposits. Unfortunately, we know from the history of our great depression that there is no effective way of managing a fractional reserve banking system when the loans created using that system begin to fail.

To understand Fractional Reserve Banking, you must first learn about the four kinds of money. Once you have done that, come back here.

Reserve Ratio

Under the National Bank Act of 1863, the reserve ratio (fractional reserve requirement) was 25%. Under the 1913 Federal Reserve Act, it was reduced to 18%. By 1917 it was further reduced to 13% and today stands at 10%, although during the current crisis, many banks in America are closer to 7%. It is even lower elsewhere in the world.

What does this mean? A 10% reserve requirement means that for every $10 of deposits a bank has, it can loan $9. If the borrower then deposits the $9 in a bank, that bank can lend out all but 10% or $8.10 and so on. So the banking system can turn the original $10 deposit into $100 ($10 + $9 + $8.1 + $7.29 + ... = $100) at a 10% reserve requirement. That's $90 that is created out of thin air. The banks don't have it to loan. Nobody has it to loan. The lower the reserve ratio, the more money can be created from nothing. It is a franchise allowed by government for banks to create money.

"No one has a natural right to the trade of money lender, but he that has money to lend." ~ Thomas Jefferson

Bankers love Fractional Reserve Banking because they receive interest on money that does not exist. It is very profitable. Of course, it doesn't take a lot of thought to realize that it is also very risky. You will not be surprised to learn that banks get around the problem of very risky loans with the guarantee of bailouts from Congress through the mechanism of debt monetization through the Fed.

Increasing Reserves

When a bank is all loaned up, it can get more reserves in one of four ways. It can increase deposits, it can use bank profits, it can sell bank stock or it can borrow money from the Federal Reserve (go to the "discount window"). Typically, a bank will use commercial loans as collateral for the money it borrows from the Fed. But remember, those commercial loans were largely made with money the bank didn't have in the first place. When it borrows from the Fed, the bank has more reserves, which it can loan out at a 10% reserve requirement which creates more loans that it can use as collateral to borrow more money from the Fed (see above).

Risk

Banks are more likely to make large, risky loans and be satisfied with a low reserve ratio because they know Congress is there to bail them out. This is a major purpose of the Federal Reserve Act of 1913 and it works just as planned. Congress and the Fed have made loans to:

• Risky companies (Penn Central - later Amtrak, Lockheed, Chrysler)
• Risky banks (Unity Bank and Trust, Commonwealth Bank of Detroit, First Pennsylvania Bank, Continental Illinois Bank, Bank of Oklahoma)
• Risky governments (New York City, Panama, Mexico - 3 times, Russia, Brazil, Argentina)

The fact that fractional reserve banking is a problem is evidenced by a recent meeting in Switzerland that was held to increase the reserve ratio worldwide. The purpose was to "...prevent a repeat of the recent financial crisis," and financial markets responded the next day with a favorable increase in bank stock values. Clearly, markets and bankers know the score. Fractional reserve banking is extremely risky. Additionally, if you are interested in more information about bailouts, see this and this.

Definition of Money

Money serves three purposes. It is a medium of exchange, a store of value and a unit of account. It is used to pay debts, purchase goods and services and is accepted by the government for taxes. Legal Tender laws are enacted to require people to use the government's money in payment of lawful debts among private citizens.

There are Four Types of Money

1. Commodity Money

Commodity money started as barter. The exchange of cattle and sheep advanced to one of gold and silver because metals are not perishable, their purity and weight can be measured easily and they can be traded for any good or service. Unlike diamonds, metals can be melted down and reformed into smaller quantities for smaller purchases without losing value.

In 2100 BC, gold cubes were used in China. In 600 BC, the Lydians used precious metal coins in Asia Minor. In 400 BC the Greeks began minting coins. From about 300 AD to 1100 AD, the Byzantine empire (Eastern Holy Roman Empire) used a coin called the Solidus. One could not file or chip the coins or issue a false coin under the penalty of chopping off your hand. As a result, the Byzantines never bankrupted, never went into debt and never devalued the currency over a span of 800 years. The Byzantine Empire had a perfect monetary system: the best in history.

The Western Roman Empire, on the other hand, used every imaginable means to devalue their currency and plunder the people. As a result, it collapsed in 476 AD long before the Byzantines who eventually succumbed in 1453 AD for reasons having nothing to do with the stability of their currency.

Nota Bene: It should be noted here that the amount of gold in the world does not affect its ability to serve as money. As the world economy grows, only the quantity that will be used to measure any given transaction will change. After a time, it might take a very small amount of gold to buy something, but gold can be effectively traded in small quantities. In addition, transactions may also be accomplished with other metals such as silver, nickel or copper. We come to the startling truth that it does not matter how big the supply of real money (gold) is: Any supply will do. The free market will simply adjust by changing the value of gold. More money does not supply more capital, is not more productive and does not result in economic growth. Our "elastic" monetary system, based on fractional reserve banking is just a clever way for bankers to make money and Congress to take your money and spend it without your knowing about it.

2. Receipt Money

During the days of the Roman Empire, goldsmiths maintained vaults where they stored their gold. It followed logically that they might also store gold for other people for a fee. Thus, the first banks were born. The goldsmiths gave their depositors receipts for gold deposited and because the receipts could be redeemed by a bearer at any time, they had intrinsic value and were traded as money. Goldsmiths also loaned money from their reserves and collected interest just as is done today.

3. Fractional Money

Of course, goldsmiths quickly realized they only needed 10 to 15% of their stockpiles on hand for redeeming customer receipts for "their" gold. So it logically followed that to collect more interest, they could loan more money than they had on hand by using receipts backed by nothing except the goldsmith's knowledge that all their depositors would not come to collect their gold on any given day. Thus was born fractional receipt money, the precursor to our present day banking system. As long as these illegal and fraudulent loans were repaid, no one was the wiser. But if the loans failed (flood, drought), the goldsmith was caught short. This began a "run on the bank" and only the first in the door were made whole. The rest lost their money and "hung" the goldsmith. Without the crime of loaning more money in receipts than the goldsmith had on hand in real gold, there would never be a run on the bank to redeem the receipts. Of course, at the time this was considered a serious crime because it was recognized clearly as fraud. The money did not exist and everyone understood it.

4. Fiat Money

Fiat money is money that has value only because a government says it has value. It is not backed by anything. Fiat money has two characteristics. a) It does not represent anything of intrinsic value. b) It is decreed to be legal tender (laws that require everyone to use it in settlement of private debts). These two characteristics always go hand-in-hand because fiat money is worthless and it would be rejected by the public without the government's threat of fines or imprisonment for failure to accept it as money. A review of the history of money and banking shows that manipulation of fiat money by governments has failed every time it has been tried.

Today's Money

Fractional money partially backed by gold or silver is a hybrid between receipt money (honest money) and fiat money that has nothing to back it. When the fraction in fractional receipt money reaches zero, the fractional receipt money is then truly fiat money. Because we are on a Fiat Money system in the US today, all money (the M1 money supply) is created by debt, not by work. If all debts were paid, there would be no money.

Learn more about the History of Money and Banking.

An excellent video by Author Jeffrey A Tucker.

How Government is Unraveling Civilization by Force. The Delusion of Good Government.

Presented at "The Delusion of Good Government": the Mises Circle in Colorado Springs, Colorado; 18 September 2010. Sponsored by Pikes Peak Economics Club. Includes an introduction by Douglas French.

The first thing we think of when someone mentions inflation is increased prices. However, increased prices are a result of inflation, not the cause. Rather, the best definition of inflation is too much money chasing too few goods. Or to clarify how this works, on any given day there is some number of dollars in the monetary system. On that same day there are a set amount of goods and services available for those dollars to purchase. Monetizing is the process used by the government, through the Fed, that causes an excess of dollars in the system. When people have extra money, they bid up prices for goods. In other words, if the number of dollars is increased without a corresponding increase in the amount of goods and services available (or a corresponding increase in real value), then all that has occurred is that there are more dollars chasing the same number of goods and services. THAT is Inflation. Your money will buy less! The result of inflation is increased prices.

For example, do you believe prices are increasing? In the 1950s, you could buy a week's worth of groceries for $10, a car for $1000, a pack of cigarettes for $0.20 and a gallon of gasoline for $0.25. A stay in a hotel was $2 a night and a hospital stay was $15/day. The dollar today has a fraction of the purchasing power it once had. Those increased prices are a result of inflation.

Neither inflation nor deflation* are good for an economy. Both generate uncertainty which causes people to hold off on investment and purchasing decisions because they cannot predict what will happen to their investment. Most economists feel a slow steady rate of inflation is the preferred course. This is because deflation is harder to manage since while decreased prices are acceptable, wages are fairly inelastic in a downward direction, so rather than take that risk, they feel a little inflation is the better course. In our opinion, no inflation or deflation would be the preferred choice and with a better monetary system, we believe it is achievable.

* Deflation here is used in the sense of value being lost in the economy. Deflation is beneficial when considered as the natural decline in the prices of goods as they become less expensive to manufacture through productivity increases.
** Wages being inelastic means that, even though as prices decrease and purchasing power increases, employers cannot easily lower employee wages. What is more likely is that the employer's business fails because a more competitive business opens down the street paying employees lower wages. They can do this because the lower amount will be adequate since prices of goods and services are lower. The overall economy suffers as displaced workers must find new employment. Deflation in the 1930s was devastating.