Issuing an Existential Challenge to the Federal Reserve

Peter Conti-Brown has developed a cogent analysis of the constitutionality of the present-day Federal Reserve System’s ongoing operations.[1] His discussion of constitutional principles applied to the Fed’s contemporary monetary policy is both enlightening and logical. I learned from it, and I agree with his conclusions.

I wish to pursue in this comment the second constitutional issue that Conti-Brown emphasizes but does not treat: the question of the Fed’s original constitutionality—where it came from and the events and warped judgments that resulted in an omnipotent central bank. Just on the face of it, one cannot imagine that any of the Framers could have countenanced such an institution. To further my explanation, I refer to Supreme Court decisions on monetary laws and institutions that I analyzed in my recently published book, Constitutional Money.[2]

From the ratification of the Constitution in 1789 to the beginning of the Civil War in 1861, no one in the United States in any capacity ever imagined that the country’s monetary system could be based on anything except gold or silver. Businessmen, bankers, and government officials squirmed under its discipline, but they respected its constraints. The two metals made up what is now called ‘the monetary base,’ even though not so-labeled at that time.

Article 1, Section 10 of the Constitution provides for Congress to set up the rules for the operations of a bi-metallic, gold-silver, standard. It requires Congress to specify the precise relationship between the dollar—the unit of account—and the quantity and fineness for the coinage of each metal. From then on, the Law of Spontaneous Order determines the community’s ongoing quantity of money and the array of money prices for goods, services, and capital. Thousands of people making millions of decisions in hundreds of markets provide economic order and stability to this complex market system.

Unfortunately for society and the monetary system, the United States became embroiled in a Civil War in 1861. One of the wartime measures of the Union government was to pass laws for issuing full legal tender paper money—U.S. notes, or “greenbacks”–a paper money that was legal tender for all debts public and private. This currency was very similar to the “bills of credit” that the states had issued during the Revolutionary War. When the Civil War ended in 1865, near $400 million of this paper currency had replaced all the gold and silver, and had become the inflated monetary base of the U.S. monetary and banking system.

The post-war government then faced difficult monetary problems. For one thing, it wanted to retire the greenbacks, because common understanding recognized them as an unconstitutional currency for a peace-time economy. Second, it also had to retire the greenbacks in order to get the price level back down to near the pre-war level so that it could re-establish the pre-war “parity”—price—of gold that had become inflated with all other money prices. .

The post-war Republican governments found that the required deflationary monetary policy was difficult to sustain. What had gone up so facilely from the printing of paper money during the war came down slowly and with much social-economic friction.

Justifying the Legal Tender Acts

As would be expected, debtors tried to use the depreciated greenbacks to pay off debts they had incurred under the bi-metallic standard before the greenback inflation began. These efforts resulted in several state court cases and finally in a Supreme Court decision—Hepburn v. Griswold , 75 U.S. (8 Wall.).

The Court, made up of eight justices, decided 5-3 in 1869-70 that creditors could refuse to accept greenbacks to satisfy debt-contracts that had been initiated before the first issue of greenbacks in February, 1862. This judgment was eminently fair. It satisfied the just criterion of paying off a contract in the same medium that was current when the contract was signed. Any other arrangement would violate the reason-for-existence of contracts in the first place, and would allow any amount of repudiation offered by the decline in the real value of the dollar.

The issue, however, was not settled. The Grant Administration, alarmed and irritated, feared that the decision would increase the uncertainties of managing the greatly enlarged federal debt and ongoing deflation. It also believed that the decision was a political attempt to embarrass its post-war reputation.

At the time the Hepburn decision was announced in 1870, two vacancies existed on the Supreme Court. President Grant therefore had the opportunity to appoint two justices from state courts who, he knew, supported the legitimacy of the greenbacks. Under the expanded Court, now consisting of a majority of five “loyal” party-line Republicans appointed by Lincoln and Grant, two new cases, Knox v. Lee and Parker v. Davis, were brought before the Court to test the same legal tender question—the legitimacy of the greenbacks in paying off pre-war money-debts, as well as their legality for satisfying post-war debts. The new majority decided 5-4 in May, 1871 that the Legal Tender Acts were constitutional after all—that greenbacks were a tender for fulfilling all debt contracts, both public and private, no matter when the debts were incurred.[3]

The feature that the new majority justices brought into the argument had nothing to do with the facts of the cases they decided, but was their “discovery” of Sovereignty for the federal government. According to Justice William Strong, one of the two new justices, the “clause enabling Congress to coin money and regulate its value . . .confer[red] upon Congress that general power over the currency which has always been an acknowledged attribute of sovereignty in every other civilized nation than [sic] our own, especially when considered in connection with the other clause which denies to the states the power to coin money, emit bills of credit, or make anything but gold and silver coin a tender in payment of debts.”[4] The last legal tender decision in 1884, Juilliard v. Greenman, again emphasized this particularly fallacious misjudgment, with the would-be “sovereignty” of the federal government again the key feature.

In these decisions, justices Strong and Bradley in 1871, and Gray in 1884, reasoned by means of what could be described as subjunctive syllogism: First, they presumed that the federal government had unlimited sovereignty, contrary to what the Framers thought, said, and did. Congress, as the legislative agency of this sovereign government, they claimed, had the power to issue full legal tender currency because this power was “universally understood to belong to sovereignty [that existed] in Europe and America at the time of the framing and adopting of the Constitution.”[5] Therefore, the Framers—and here is the syllogism–would have known of their sovereign powers in 1787-89, and could have written a Constitution that would have included “the power to make the notes of the government a legal tender in payment of private debt.” Justice Gray, who furthered this absurd allegation in 1884, did not deign to notice that the Framers had not acknowledged any such “sovereignty.” The Constitution does not even use the term. Rather, Strong, Gray, and the other majority Republican justices re-constructed the meaning of the written, original, traditional, accepted Constitution into a useless placebo that could constrain nothing. Their presumed document, featuring “sovereignty,” could have sanctioned any arbitrary federal power.[6]

Following the momentous Court decisions of 1871 and 1884, however, no subsequent policies reflected this grant of power. Republican congresses and Executives continued to pursue policies limiting monetary excesses until resumption of the pre-war gold parity occurred in 1879. Then, the Cleveland Administrations and congresses in 1892-93 ended all excess (“cheap”) silver coinage. The stock of outstanding greenbacks also remained frozen at its 1878 level. Finally, Congress on March 14, 1900, passed the [Gold] Currency Act that declared gold the single legal tender metal.[7] All of these events (and non-events) emphasized that nothing in the monetary affairs of the country after 1871 and 1884 reflected in the slightest the “complete control over the monetary system” that the earlier Court decisions had ceded to Congress. Practically no one believed the legitimacy of the decisions, and no one tried to use them to promote any monetary policy. Their sheer absurdity seemed to be grooming them for the dust-bin of history.

Even more significant, if the decisions had had any credibility, they would have been heralded as the basis for the Federal Reserve Act of 1913. However, when Congress debated and passed that Act, no congressman argued that the Legal Tender decisions provided any support for passage of the Act. They were never mentioned. Rather, all the provisions of the Fed Act were treated on the merits of introducing a lender-of-last-resort institution for the banking system.[8]

Sovereignty and the Federal Reserve System

The Federal Reserve System of 1913 and after was not a central bank, but a regional institution with a very limited agenda. It never fulfilled this function to any degree. During World War I, the Treasury Department governed the operations of the Fed Banks. After the War, the Fed Bank of New York under Governor (President) Benjamin Strong instituted what amounted to a system-wide stable price level policy by means of the Fed Bank of New York’s control over the economy’s quantity of money. While Strong’s policy worked very well, it emphasized the fact that the New York Fed had co-opted the gold standard. The Federal Reserve System was no longer a Gold Standard Central Bank as originally designed.

Unfortunately, Strong’s policy opened the door to other discretionary policies that Fed opportunists might devise. The policy that appeared in 1929 (after Strong died) was initiated by the Fed Board. Never mind price level stability or helping needy banks, the primary problem that the economy faced, according to the new view from Washington, was speculation, particularly in the New York stock market. With this “problem” paramount, the Fed Board in 1929 instituted a policy of ‘direct pressure’ on the commercial banking system. This policy denied the member banks any lender-of-last-resort relief for any credit problems they suffered, if their operations had any taint of stock market speculation. This ‘cure’ was such a ‘success’ that it killed the patient. By early 1933 more than 9,000 banks had closed and the economy was in a shambles. No one knew what to do.

Federal Reserve spokesmen denied that the Fed was to blame. They alleged that the Gold Standard had been in charge, and that its “failure” became the monetary and banking system’s failure, in spite of their best efforts to “save” it. Everyone—laymen, bankers, and congressmen, especially, also presumed that if something did not work, it must have been the gold standard, because the monetary system was “based on it.” With this fiction in place, the Roosevelt Administration and a compliant Congress passed several acts that prohibited all private gold ownership and all transactions in gold. The new legislation called all monetary gold into Washington, melted it down, cast it into 27+ pound ingots, and buried it deep in the ground under heavy guard. Congress and the President also devalued the now banned gold dollar by 59 per cent, increasing the monetary value of the Treasury’s stock-piled gold, from $20.67 per ounce—the official price for 100 years—to $35.00 dollars per ounce.

Devaluation of the gold dollar meant that contracts that had included gold clauses, meant to protect the value of the medium in which the debt might be settled from inflation, would now be enhanced 59 per cent. Furthermore, prices had fallen for most of the post-war period after 1922, providing another feature that would further enrich the creditor. Both private debtors, such as railroads, and the government as a very large debtor objected, initiating court cases challenging the constitutionality of the gold clauses in their contracts.

The Gold Clauses cases came to the Supreme Court in 1934 and were decided in 1935. The Court faced an impossible dilemma: If it upheld the gold clauses, creditors would receive an “undeserved enrichment” because of the recent gold devaluation in addition to the sustained decline of prices. If the Court denied the contracts’ clear wording, their decision would violate the sanctity of contracts.

This dilemma was not solved by the 5-4 decision that concluded the case. The Court majority denied the primacy of the gold clauses, arguing that they interfered with a prior monetary policy of the federal government. The four-man minority, however, would have kept the specific provisions of the gold clauses, and allowed creditors to collect contracted dollars at the new gold value! Both majority and minority found and quoted the “complete control” decisions in the Legal Tender cases of 1871 and 1884, and both remarked that those decisions properly sanctioned Congress’s absolute monetary powers. They also agreed that the Federal Reserve System Congress had created in 1913 properly reflected such powers, not recognizing that Congress passed the Fed Act on very different grounds that had nothing at all to do with those remote Court decisions of 1871 and 1884. No justice in 1935 even questioned this false analysis, or even suggested a re-examination of those decisions. Had one done so, he would have found that Congress did not have such sweeping powers over the monetary system as the both sides presumed.

The solution was for the Court to deny Congress’s large-scale unprecedented and unconstitutional devaluation of the gold dollar that led to the litigation that the Court could not reconcile satisfactorily. The “complete control over the monetary system” that the Court decisions of 1871 and 1884 had granted Congress was invalid from beginning to end. This unconstrained “power” was a political fiction that the Courts of the time conjured up to satisfy the political preferences of the Executive. To return to traditional constitutional principles, Congress must limit its legislation to only the express monetary powers granted it under ARTICLE 1, Section 8. It has no further sovereignty. The additional banking and financial necessities for a working free enterprise economy will then be furnished by the “people” who are sovereign.

Even though at its beginnings in 1913 the Federal Reserve System might have been legitimate in the limited role espoused for it, it could not transmogrify into the “complete-control” central bank that the Gold Clause cases of 1934-35 presumed for it on the basis of the Legal Tender decisions of 1871 and 1884. Such a metamorphosis would have required a comprehensive analysis and review by all three branches of the federal government, with the “peoples” reactions included. Congress passed the [Central] Banking Act of 1935 in the mistaken belief that such monetary omnipotence was already established, but the bewilderment and confusion of the Fed’s managers thereafter emphasized the unconstitutionality of this Act in addition to its folly.

[1] Peter Conti-Brown, “Is the Fed Unconstitutional? And Who Decides?” The Liberty Fund, Law and Liberty website.

[2] Richard H. Timberlake, Constitutional Money, A Review of the Supreme Court’s Monetary Decisions. New York and Cambridge, England, Cambridge University Press and Cato Institute, 2013.

[3] See, Constitutional Money, chapter THIRTEEN, pp. 97-103. All five of the pro-greenback Republicans were appointed by Presidents Lincoln and Grant. In fact, Republican presidents throughout the post-war era, up to Wilson’s presidency, appointed almost all the justices. So the Court, from 1871 and after, was a “Republican” Court.

[4] Ibid., p. 103. My emphasis. Strong alleged here that because the power was denied the states, the Framers implied that the power be vested in the central government. Obviously, this presumption is a gross misrepresentation of the Framers words and thoughts. The power was explicitly denied the states, and implicitly denied the federal government.

[5] U.S., Wall pp.449-451.

[6] See Constitutional Money, pp. 222-223, from which I have paraphrased this section. See, particularly, the rigorous arguments of Justice Stephen Field who, as the last dissenter against this discretionary doctrine, futilely corrected the record for posterity. (1122)

[7] Gold became the single legal tender monetary commodity, while silver became a subsidiary currency similar to national bank notes—its monetary value preserved by its conversion into gold on fixed dollar terms.

[8] See, Richard H. Timberlake, Monetary Policy in the United States, An Intellectual and Institutional History. Chicago: University of Chicago Press, 1973, Chapter 15, “Advent of the Federal Reserve System,” pp.214-234.


goodwin eatwell three

Not Just Old White Males

Making sense of what happens when vast swathes of the electorates of liberal democracies feel ill-served by their political parties and institutions.