The First Bank of the United States, the Second Bank of the United States and the Federal Reserve System

Posted by PITHOCRATES - April 2nd, 2013

History 101

Merchants raise their Prices when the Monetary Authority depreciates the Currency

What is inflation?  A depreciation of the currency.  By adding more money into the money supply each piece of currency becomes less valuable.  Let’s assume our currency is whiskey.  In bottles.  Whiskey has value because people are willing to pay for it.  And because we are willing to pay for it we are willing to accept it as legal tender.  Because we can always trade it to others.  Who can drink it.  Or they can trade it with others.

Now let’s say the monetary authority wants to stimulate economic activity.  Which they try to do by expanding the money supply.  So there is more money available to borrow.  And because there is more money available to borrow interest rates are lower.  Hence making it easy for people to borrow money.  But the monetary authority doesn’t want to make more whiskey.  Because that is costly to do.  Instead, they choose an easier way of expanding the money supply.  By watering down the bottles of whiskey.

Now pretend you are a merchant.  And people are coming in with the new watered-down whiskey.  What do you do?  You know the whiskey is watered down.  And that if you go and try to resell it you’re not going to get what you once did.  For people typically drink whiskey for that happy feeling of being drunk.  But with this water-downed whiskey it will take more drinks than it used to take to get drunk.  So what do you as a merchant do when the money is worth less?  You raise your prices.  For it will take more bottles of lesser-valued whiskey to equal the purchasing power of full-valued whiskey.   And if they water down that whiskey too much?  You just won’t accept it as legal tender.  Because it will be little different from water.  And you can get that for free from any well or creek.  Yes, water is necessary to sustain life.  But no one will pay ‘whiskey’ prices for it when they can drink it from a well or a creek for free.

It was while in the Continental Army that Alexander Hamilton began thinking about a Central Bank

During the American Revolutionary War we had a very weak central government.  The Continental Congress.  Which had no taxing authority.  Which posed a problem in fighting the Revolutionary War.  Because wars are expensive.  You need to buy arms and supplies for your army.  You have to feed your army.  And you have to pay your army.  The Continental Congress paid for the Revolution by asking states to contribute to the cause.  Those that did never gave as much as the Congress asked for.  They got a lot of money from France.  As we were fighting their long-time enemy.  And we borrowed some money from other European nations.  But it wasn’t enough.  So they turned to printing paper money.

This unleashed a brutal inflation.  Because everyone was printing money.  The central government.  And the states.  Prices soared.  Merchants didn’t want to accept it as legal tender.  Preferring specie instead.  Because you can’t print gold and silver.  So you can’t depreciate specie like you can paper money.  All of this just made life in the Continental Army worse.  For they were hungry, half-naked and unpaid.  And frustrating for men like Alexander Hamilton.  Who served on General Washington’s staff.  Hamilton, and many other officers in the Continental Army, saw how the weakness of the central government almost lost the war for them.

It was while in the army that Hamilton began thinking about a central bank.  But that’s all he did.  For there was not much support for a central government let alone a central bank.  That would change, though, after the Constitutional Convention of 1787 created the United States of America.  And America’s first president, George Washington, chose his old aide de camp as his treasury secretary.  Alexander Hamilton.  A capitalist who understood finance.

Despite the Carnage from the Subprime Mortgage Crisis the Fed is still Printing Money

At the time the new nation’s finances were in a mess.  Few could make any sense of them.  But Hamilton could.  He began by assuming the states’ war debts.  Added them to the national war debt.  Which he planned on paying off by issuing new debt.  That he planned on servicing with new excise taxes.  And he would use his bank to facilitate all of this.  The First Bank of the United States.  Which faced fierce opposition from Thomas Jefferson and James Madison.  Who opposed it for a couple of reasons.  For one they argued it wasn’t constitutional.  There was no central bank enumerated in the Constitution.  And the Tenth Amendment of the Constitution stated that any power not enumerated to the new federal government belonged to the states.  And that included banking.  A central bank would only further consolidate power in the new federal government.  By consolidating the money.  Transferring it from the local banks.  Which they feared would benefit the merchants, manufacturers and speculators in the north.  By making cheap money available for them to make money with money.  Which is the last thing people who believed America’s future was an agrarian one of yeoman farmers wanted to do.

They fought against the establishment of the bank.  But failed.  The bank got a 20 year charter.  Jefferson and Madison would later have a change of heart on a central bank.  For it helped Jefferson with the Louisiana Purchase.  And like it or not the country was changing.  It wasn’t going to be an agrarian one.  America’s future was an industrial one.  And that required credit.  Just as Alexander Hamilton thought.  So after the War of 1812, after the charter of the First Bank of the United States had expired, James Madison signed into law a 20-year charter for the Second Bank of the United States.  Which actually did some of the things Jefferson and Madison feared.  It concentrated a lot of money and power into a few hands. Allowing speculators easy access to cheap money.  Which they borrowed and invested.  Creating great asset bubbles.  And when they burst, great depressions.  Because of that paper money.  Which they printed so much of that it depreciated the dollar.  And caused asset prices to soar to artificial heights.

Andrew Jackson did not like the bank.  For he saw it creating a new noble class.  A select few were getting rich and powerful.  Something the Americans fought to get away from.  When the charter for the Second Bank of the United States was set to expire Congress renewed the charter.  Because of their friends at the bank.  And their friends who profited from the bank.  But when they sent it to Andrew Jackson for his signature he vetoed the bill.  And Congress could not override it.  Sensing some blowback from the bank Jackson directed that they transfer the government’s money out of the Second Bank of the United States.  And deposited it into some state banks.  The president of the bank, Nicholas Biddle, did not give up, though.  For he could hurt those state banks.  Such as calling in loans.  Which he did. Among other things.  To try and throw the country into a depression.  So he could blame it on the president’s anti-bank policies.  And get his charter renewed.  But it didn’t work.  And the Second Bank of the United States was no more.

National banks versus local banks.  Hard money (specie) versus paper money.  Nobility versus the common people.  They’ve argued the same arguments throughout the history of the United States.  But we never learn anything.  We never learn the ultimate price of too much easy money.  Even now.  For here we are.  Suffering through the worst recession since the Great Depression.  Because our current central bank, the Federal Reserve System, likes to print paper money.  And create asset bubbles.  Their last being the one that burst into the subprime mortgage crisis.  And despite the carnage from that they’re still printing money.  Money that the rich few are borrowing to invest in the stock market.  Speculators.  Who are making a lot of money.  Buying and selling assets.  Thanks to the central bank’s inflationary policies that keep increasing prices.

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Without a Bill Clinton the Bursting of the Canadian Housing Bubble will be less Painful than in the US

Posted by PITHOCRATES - November 10th, 2012

Week in Review

The subprime mortgage crisis caused the Great Recession.  And bad government policy caused the subprime mortgage policy.  First with artificially low interest rates to encourage everyone to borrow money and take on enormous amounts of debt.  Then the Clinton administration took it up a notch.  By charging lenders with discrimination in their lending practices.  And if they didn’t find a away to qualify the unqualified for mortgages they would soon find themselves out of the mortgage business.  So they came up with subprime lending.  Adjustable rate mortgages (ARM).  No documentation mortgages.  Anything to get the government off of their backs.  And the government was so pleased with what they saw they started to buy (and/or guarantee) those toxic mortgages with their Government Sponsored Enterprises Fannie Mae and Freddie Mac.  Clearing those toxic mortgages from the lenders balance sheet by unloading them onto unsuspecting investors.  Clearing the way for even more toxic subprime lending.  The government was pleased.  And the bankers were making money with bad lending practices.  Something they normally would have avoided because it is very risky.  But when the government was transferring that risk to the taxpayer what did they have to lose?

Governments like a hot real estate market.  Because housing sales drives so much economic activity.  Because people put a lot of stuff into those houses.  Which is why governments are always quick to use their monetary authority to lower interest rates.  Which is what they did in the US.  Cheap money to borrow.  Lax lending practices thanks to the Clinton administration.  Creating a housing boom.  And a housing bubble.  It was a perfect storm brewing.  The only thing that it needed was a raise in the interest rates.  Which came.  Causing the subprime mortgage crisis as those ARMS reset at higher interest rates.  Leading to a wave of subprime mortgage defaults.  And the Great Recession.  Which raced around the world thanks to those toxic mortgages Fannie Mae and Freddie Mac unloaded on unsuspecting investors.

Canada did not suffer as much from the Great Recession.  Because they did not pressure their lenders to qualify the unqualified like Bill Clinton did in the US.  But they still used their monetary authority to keep interest rates artificially low.  So while they escaped the great damage the Americans suffered in their subprime mortgage they still have a housing bubble.  And it looks like it may be time for it to burst (see Analysis: Canada braces as housing slowdown takes hold by Andrea Hopkins posted 11/10/2012 on Reuters).

Long convinced the country’s housing boom would never end in a crash, Canadians have watched this autumn as a sharp slowdown in real estate spreads across the country, leaving would-be home buyers hopeful and sellers scared…

Signs are everywhere that Canada’s long run-up in house prices is over, hit by a combination of tighter mortgage lending rules and growing consumer reluctance to take on more debt. Sales of existing homes are down steeply, with condo sales hit especially hard, and some long-booming prices have started to fall…

Canadian households hold more debt than American families did before the U.S. housing bubble burst, which has led the government to tighten mortgage lending rules four times in four years…

Tal believes slower sales activity will be followed by falling prices in many cities. But he says Canadian lending standards have been higher, and borrowers more cautious, than in the United States before its crash, which will prevent large-scale mortgage defaults and plunging prices.

Mindful of what happened in the United States, the Canadian government has tightened mortgage rules to prevent home buyers from taking on too much debt. While interest rates are low and expected to stay low into 2013, the fear is that eventual rate hikes will drive borrowers out of their homes or into bankruptcy…

The last round of mortgage rule changes took effect in July, forcing home buyers to cut back on their budget and pushing many prospective first-time buyers out of the market entirely.

The Canadians may escape the damage the US suffered as Bill Clinton was an American and not a Canadian.  So they only have to suffer the effects of bad monetary policy.  Not the effects of government enforced bad lending practices.  So housing prices will fall in Canada.  And there will probably be a recession to correct those inflated real estate prices.  But housing prices probably will not fall as far as they did in the US.  For the Canadians were more responsible with their irresponsible monetary policy than the Americans were.

The lesson here is that when markets determine interest rates housing bubbles are smaller and recessions are less painful.  If you don’t believe that just ask an American with an underwater mortgage.

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