Thread by @NathanDallon

I am trying to learn what MMT is and how it works. From Warren Mosler's website, everything begins with understanding the fundamentals of sovereign currencies.

Namely, modern sovereign nations have a Common Monopoly over currency.

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I have decided to start with the first US national currency and review the history of the US Dollar.

Here is the thread as I learn.

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In 1775 the Continental Congress issued its own currency to pay for the war. These "Continentals" weren't backed by anything. The expectation was that FUTURE revenues would back the currency. Not surprisingly, the currency collapsed by 1779-1780.

investopedia.com/terms/c/contin…

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Alexander Hamilton recommended a quasi public quasi private bank be created to house loans of gold and sliver from France and the Netherlands. The first US charted bank was called The Bank of North America.

babel.hathitrust.org/cgi/pt?id=mdp.…

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The Bank of North America used fractional banking based on the gold/silver loans and had a hard time staying capitalized.

thebalance.com/what-is-fracti…

archive.org/stream/cu31924…

Some of the colonies allowed the notes to be used to pay taxes. Others did not.

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Hamilton replaces the Bank of North America with the First Bank of the United States which took the debts of the colonies, now states, and was used for money operations to fund the federal government.

en.wikipedia.org/wiki/First_Ban…

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The First Bank of the United states issued notes backed by a substantial gold reserve. All federal taxes had to be paid in Bank of the United States notes ("BotUS"). It was accepted in all the states. Each State maintained its own local currency.

federalreservehistory.org/essays/first_b…

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The Money Operations at the time was limited to "swap lines" with state banks and their currency AS WELL AS loans to citizens and other entities.

federalreservehistory.org/essays/first_b…

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Money Operations regarding the money supply worked like this.

BotUS would open accounts for local entities (private citizens, entities, and state governments) and make loans in BotUS notes AND exchange notes.

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"In the course of business, the Bank would accumulate the notes of the state banks and hold them in its vault. When it wanted to slow the growth of money and credit, it would present the notes to banks for collection in gold or silver...

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...thereby reducing state banks’ reserves and putting the brakes on their ability to circulate new banknotes."

philadelphiafed.org/-/media/public…

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That is how it all started. The First Bank of the United States didn't have its charter renewed in 1811 but the Second Bank of the United States appeared. Things get crazy until 1913 when THE FED IS BORN.

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The Fed came in response to the Panic of 1907.

federalreservehistory.org/essays/panic_o…

It seems that the Panic began in normal money operations.

Banks engaged in overnight lending through shadow banking. A group of private trust companies allowed for overnight loans.

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Overnight loans to banks allows banks to sit with small reserves on hand BUT STILL lend at a high clip.

en.wikipedia.org/wiki/Overnight….

Overnight lending encourages cheap credit AND the possibility of too many loans outstanding and not enough money in the bank's vault.

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"On October 16, 1907, two minor speculators ... suffered huge losses in a failed attempt to corner the stock of United Copper,"

federalreservehistory.org/essays/panic_o…

A risky bet went south in October (October seems to be a scary month for bank panics)

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The bust attempt at cornering a stock lead to a run on the banks that the speculators did business with. (Not surprising. A very public financial flop by two big investors shook confidence in their primary banks).

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The run on those banks started a tiny run on the shadow banking sector and overnight loans. "An upward spike in the call money interest rate" made daily banking nearly impossible in New York (and eventually the whole country).

federalreservehistory.org/essays/panic_o…

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The "panic" of people who hold money in the banks were worried that the Banks didn't have enough cash on hand to cover their financial obligations.

The news carries the local panic and soon thousands of people loss of confidence causes a "run on the banks."

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Important to note, the US financial system was not centralized at the time. Large city banks had some regulation requiring a Gold Standard, while smaller and country banks did not. (Often smaller currencies were backed by Large City Bank notes).

athenaeum.libs.uga.edu/handle/10724/2…

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The banking system was still fractional in its design. Certain amounts of gold/silver/notes were required to sit in the bank's vault, and currency lent into existence by the banks were backed by the reserves.

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However, a "run on the bank" or "panic" was still possible in that system. Lenders of last resort were independent financial titans, like JP Morgan (today a Buffet) or clearing houses.

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The panic of 1907 whipped up a progressive political movement to "to improve the nation’s chaotic banking system"

federalreservehistory.org/essays/before_…

The movement lead to the National Monetary Commission Study, Aldrich Plan, and the Federal Reserve Act of 1913

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There were a series a meetings on Jekyll Island, GA, where JP Morgan set up a meeting with a senator, three bankers, and the secretary of treasury. That meeting was a conspiracy.

marketplace.org/2015/10/20/how…

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The first draft of the Federal Reserve Act came out (called the Aldrich Plan, the Senator who went to the secret meeting) of the hush-hush meeting.

The plan outlined the basics of today's Federal Reserve System.

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"...a single central bank with fifteen branches across the country. Each branch would be governed by boards of directors elected by the member banks in each district, with larger banks getting more votes."

federalreservehistory.org/essays/jekyll_…

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Now, what are the basic purposes for creating the Federal Reserve Act of 1913?

The central bank is: the bank for the sovereign nation, a bank for bankers (lender of last resort), issuer of the common currency, clearing payments, and to regulate the private banks.

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The three critical theoretical developments came from the bank of England.

1) Since the sovereign nation backed the bank, a Central bank is viewed as more stable, increasing confidence.

2) Central banks issue common currency, allowing fiat currency to exist

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3) Tremendous capital holdings which allowed for market action (read manipulation) which other large banks couldn't match.

minneapolisfed.org/about-us/our-h…

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The 1913 Act did the following:

1) Created Federal Reserve Banks (regional)
2) New common currency
3) afford a means to rediscount commercial paper (banks solicit loans from private individuals)
4) Supervise private banks
5) "Other purposes"

papers.ssrn.com/sol3/papers.cf…

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The "other purposes" at the time principally meant act as a clearing house for checks between banks AND provide fiscal services to the US treasury (do bank like things for the federal government, like issue T Bills).

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In order to avoid one massive central bank, the Act created the regional federal reserve banks. The regional banks had members (the local private and state banks) who owned the "stock" of the Regional Reserve Bank.

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The private member banks elected the mangers of the Regional Federal Reserve Banks. The Federal Reserve Board (5 members appointed by the President, Secretary of the Treasury, and the Comptroller of the US) appointed the Directors to the Regional Federal Reserve Banks.

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*All of the above comes from the 1988 paper: "THE FEDERAL RESERVE ACT OF 1913 IN THE STREAM OF U.S. MONETARY HISTORY"

by James Parthemos - Fed Director Research in the Fed Reserve Bank of Richmond at the time.

papers.ssrn.com/sol3/papers.cf…

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And so it began. Common currency. Lender of last resort. Money operations.

All private banks were in on the cartel. The modern US monetary system was in place.
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One other important note, the new common currency was backed by 40% gold held at the reserves at the time of writing the 1913 Act.

Important to also note that in 1913 (February) the 16th Amendment was ratified. On December 23rd, 1913, the Fed was born.

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The new tax system would go hand in hand with the new Central Banking system.

To pay the new tax, you HAD TO have the new common currency issued by the Fed.

Where did that currency come from? It was issued by the Fed Reserve first.

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Once the new currency was issued, it was placed in the vaults of the commercial member banks in exchange for old currency and notes (which sat in the vaults and were probably burned at some point).

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Fed Reserve banks held gold, other currencies, and issued currency. Citizens had to pay their federal taxes in the new currency. They exchanged their currently held notes/gold/land into the new currency (US Dollars) at their local "member bank."

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One of the provisions that, at the time, was thought to be of little consequence was the "open-market" operations of the Federal Reserve banks. This provision allowed for the banks to purchase and sale securities (think bonds or real estate).

open.bu.edu/handle/2144/13…

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The original 1913 Act was a mere 30 pages long. THOSE WERE THE DAYS!!!!

The idea was to create a lending system that could handle the ebb and flow of credit needs.

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"Seasonal variations in need have been pronounced in the US due to the prominence of agriculture. The demand for currency and the deposit credit is greatest in the crop moving season, the autumn of the year..."

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"This yearly expansion explains the occurrence of panics in the late summer and fall."

open.bu.edu/handle/2144/13…

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The new Fed Banks could extend credit to private member banks by way of money operations. The member banks could rediscount (use an asset that is already used for a loan FOR A SECOND loan) with the Fed allowing more credit expansion beyond the assets the member bank held.

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The Fed could also suspend reserve requirements (get off the gold/note/other commodity standard) and lend away without restriction.

When a credit crunch hit, in theory, the 1913 Federal Reserve system could bend with the crunch and handle it.

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The downturn of October 1929 was the Federal Reserve's first chance to avoid a national banking panic. The Fed Reserve system was still new, 15 years is all, and it faced its first big test.

It failed that test AND made the situation worse.

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Recall that the policy purpose of the Fed Reserve system was to limit panics by creating a large central institution with massive capital holdings and lending capacity. That should help small private banks avoid runs since they had the Fed as a backstop.

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Beginning in 1928 the Fed Board began "tightening" lending standards to the Member banks. Why?

"A principal reason was the Board's ongoing concern about speculation on Wall Street. The Federal Reserve had long made the distinction between "productive" and "speculative"...

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...uses of credit, and the rising stock market and the associated increases in bank loans to brokers were thus a major concern."

federalreserve.gov/boarddocs/spee…

At the same time, the Fed interfered in the US Gold market, intentionally slowing gold outflows to France.

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Why would the Fed want to slow the flow of Gold out of the US into France? Well, the French economy had more or less recovered from WWI and had become a great investment opportunity for US investors. The Fed decided on its own that the outflow of Gold was too risky.

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These moves by the Fed started a chain reaction across the world of tighter credit WHEN THE ECONOMIES of those nations actually needed MORE, not less money.

bis.org/publ/work137.p…

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The Fed didn't stop there. They had tightened credit at a poor time, but things get worse.

In 1931, the United Kingdom went off the Gold Standard. The fear that the US may need to abandon the gold standard as well led to a run on gold in the US.

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Investors all over the world started exchanging their dollars for gold, drawing down gold reserves in US banks. There was both an external drain of gold as well as an internal drain of gold reserves in September and October 1931.

federalreserve.gov/boarddocs/spee…

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In an attempt to defend a "strong dollar" in foreign markets, the Fed raised its "rediscount rate" (reminder that a person's ability to get a bond/cash at a discount) to make the dollar "strong" meaning more expensive for foreign buyers of gold.

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Why defend the dollar? "Again, the logic is that a monetary policy change related to objectives other than the domestic economy--in this case, defense of the dollar against external attack--were followed by changes in domestic output and prices in the predicted direction."

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federalreserve.gov/boarddocs/spee…

The Fed ignored the domestic credit problems and instead tried to defend the Dollar abroad.

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The US and world economy were now into a full deflationary swing. Fueled by not enough money existing in the system to serve all the productive economic activity in the US and world economy. Why not? Where was the money? The Fed had chosen to slash credit/money creation.

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This is an important moment to highlight that money comes into existence through credit expansion. The US Treasury DOES NOT control the money supply. Every bank that can lend money, creates money. I will talk about this in more depth later.

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For the first time in April 1932, under pressure from Congress, the Fed purchased securities from the open market. It printed money itself AND BOUGHT securities (bond/stocks) from the open market.

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There was immediate relief to the US economy. Not a recovery, but evidence that the deflationary spiral stopped. The money printed by the Fed to but the bonds got badly needed cash into the economy. That cash went to productive places and slowed the deflation.

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The Fed hated this pressure and action. As soon as Congress recessed, the purchasing of bonds from the open market stopped. The money shortage relapsed.

Remember, the election of 1932 was in full swing, but FDR hadn't won yet. This is still the Hoover era.

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Between November 1932 and March 1933, there is financial carnage. FDR is elected in November of 32, but won't be inaugurated until March of 33. Many assumed that FDR would spend, devalue the dollar, and perhaps get off the gold standard all together.

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"However, from the President-elect's campaign statements and known propensities, many inferred (correctly) that Roosevelt might devalue the dollar or even break the link with gold entirely. Fearing the resulting capital losses...

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...both domestic and foreign investors began to convert dollars to gold, putting pressure on both the banking system and the gold reserves of the Federal Reserve System. Bank failures and the Fed's defensive measures against the gold drain...

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...further reduced the stock of money. The economy took its deepest plunge between November 1932 and March 1933, once more confirming the temporal sequence predicted by the monetary hypothesis."

federalreserve.gov/boarddocs/spee…

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What a mess. The Federal reserve triggers a run on the banks due to its own policies trying to defend rumour regarding the dollar AND by protecting its own gold reserves.

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The Fed, when it turns 20 years old, had closed HALF of US banks.

"During the Depression decade, something close to half of all U.S. commercial banks either failed or merged with other banks."

federalreserve.gov/boarddocs/spee…

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Not surprisingly, most of the banks that failed during this era were small community banks.

"The problem within the Fed was largely doctrinal: Fed officials appeared to subscribe to Treasury Secretary Andrew Mellon's infamous 'liquidationist' thesis...

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...that weeding out "weak" banks was a harsh but necessary prerequisite to the recovery of the banking system. Moreover, most of the failing banks were small banks (as opposed to what we would now call money-center banks) and not members of the Federal Reserve System."

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federalreserve.gov/boarddocs/spee…

Ben Bernanke says it brilliantly,

"Regarding the Great Depression. You're right, we did it. We're very sorry."

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