The Constitution and Money

In order to understand why I am writing this particular blog you will need to read the comments section in Longshots' blog, On Political Economy. (http://onpoliticaleconomy.blogspot.com/2010/11/more-thoughts-on-constitutional-money.html#comments)

I have heard many conservatives argue that the Federal Reserve system is unconstitutional and that paper money is illegal. Like so many conservative arguments, it is extremely difficult to imagine what would happen to this country if we tried to retreat to a coin-cash economy. Not only is a major portion of today's money supply in paper currency but the digital age has taken us far beyond a paper-cash economy. "Plastic money" (ATM cards, credit cards, and store-specific cards) backed up by "electronic banking" means that a person may rarely see or use cash of any kind. Exchange in our economy is based on "deposits" at banking institutions. These deposits act as legal tender as they are shifted back-and-forth, often within the same banking institution, between individuals.

Deposits can represent legal tender because they are backed by actual paper or coinage currency, which can be paid out at demand. As we all know, however, banks do not maintain enough currency to pay out on all their deposits; they loan portions of their deposit reserves. This is part of what economists call the "multiplier effect." The actual money supply is alway larger than the credit basis of the country lying in gold in some vault. The expansion of legal tender in this effect is necessary to facilitating commerce and generating our GNP.

If this entire system were taken down and if people were to demand coinage in payment, the economy would collapse. Is that really what conservatives want?

As to the Constitutional argument, Article I, uses the term "money" several lines before it grants Congress the power of making coin-money, and well before it denies that power for the states. Hence, "money" is the more primitive term. Congress was well aware of paper money because so-called "Continentals" already existed as a way of funding the Revolution. The Constitution guarantees that all outstanding obligations will be carried over into the new government (Article VI); hence, the Continentals will be backed by the new government. We have had paper money as long as we have had our Constitution.

It is interesting that the United States Treasury resides within the Executive branch of government and that the Secretary of the Treasury is a member of the President's cabinet. None of this is spelled out in Article II, which deals with the Executive. Indeed, Alexander Hamilton was the first Secretary and it was under Hamilton that the first central banking institution (The Bank of the United States) was established (1790), patterned after (of all things) the Bank of England. That began a long and complicated history of central banking institutions.

While people have raised Constitutional arguments about central banking and paper money throughout our history, these arguments have not succeeded except for brief periods of time.