Managing America- What is the Reserve Banking System?

Reserve banking is the practice of making loans in multiples of the gold deposits on hand in the hope that depositors won't make a run on the bank, all claiming their deposits at the same time. The English goldsmiths accepted gold deposits, earning money on the difference between what they paid for the gold and what they could get by lending it to borrowers.

How the English Reserve Banking System Created Wealth

William of Orange came to England from the Netherlands in 1688 to claim the English throne on behalf of his wife Mary. Parliament restricted the King's taxing power, leaving William without funds he needed to defend his crown.  He couldn't raise money by taxation and the King's credit was nonexistent. William's only hope lay in persuading the English Parliament to adopt a national banking system similar to that of his native Netherlands, that had inherited the practice of reserve banking from Venice.

William Patterson, a Scot, studied reserve banking and worked up a proposal for an English reserve national bank system. The survival of the King’s sovereignty depended on the implementation of Patterson's proposed white paper. The English goldsmiths were opposed to financing William's wars with debt-created currency. The proposed national bank would compete with their operations and, if given the power to deal in gold on behalf of the King, eliminate their profession altogether.

Patterson noting that currency circulates as an integral part of commerce, he reasoned that the panic resulting from the loss of confidence that drove depositors to demand their gold would not infect currency holders. He proposed creating a national bank that would lend money to the King in exchange for a note.

The King's note would then be used to back paper currency that the bank would lend into existence. The King would receive the value of all movies the bank lent into existence, with the national bank receiving interest from both the King and the loans created by its currency issuance.

The currency holders could not run on the national bank because the currency would be in perpetual circulation.

Bank of England was created over the active opposition of Parliament and the existing banking establishment, Charles Montagu, a member of William's party, tackled the task. Charles Montagu had befriended Isaac Newton, eventually taking Newton's niece as his lover.

He was interested in Newton for his practice of alchemy. Alchemy was the physics of the time. The public held a belief of alchemical accomplishments. Alchemy involved mixing three substances, an impure metal such as iron ore, a pure metal such as lead or mercury, and an organic acid together in a mortar.

The mixing could take months. The finished compound was slowly heated in a crucible and then dissolved in an acid under polarized light, the source of Newton's interest in optics. The distillate was oxidized using potassium nitrate, producing a rough form of gunpowder.

The sealed container was heated, and when cooled reportedly produced a powder known as the White Stone.

The White Stone could be used to transmute base metals into silver, allowing alchemists to stock their pantry with silverware made from iron.

Applying their knowledge of the hidden secrets of the universe, alchemists could then distill the White Stone into the Philosopher's Stone, which could transmute base metals into pure gold.

 Charles Montagu was interested in the Philosopher's Stone because of its reputed power to turn base metals into gold. He knew that the success of a reserve bank depended on its ability to withstand a run on its assets. He was aware that the ability to withstand a run would depend on the confidence the national bank's depositors had that their deposits were safe.

Montague understood that confidence in the safety of a national bank's deposits depended solely on perception, that depositors would not run a bank if their deposits appeared safe. He set out to exploit the widespread public belief in alchemy and its claim that the Philosopher's Stone could turn base metals into gold to establish the Bank of England, whose paper currency-purportedly representing an equal amount of silver on deposit-would be backed by nothing.

Montague wanted Newton close in case his alchemical reputation was needed to give the bank the appearance of having unlimited supplies of silver to back its paper currency. He didn't care whether Newton could turn base metals into gold and silver as long as the public believed he could.

The first step in making the public believe that Newton was, in fact, capable of such a feat was to promote Newton's universal gravitation as the discovery of the heretofore hidden secrets of the universe, the secrets the alchemist needed to produce the Philosopher's Stone.

Charles Montagu became the president of the Royal Society and used its influence to promote the Principia, with Newton's ideas of universal gravitation becoming drawing room talk throughout London. Montagu also tackled Tory control of Parliament, successfully unseating the Tories in favor of William's Whigs in 1694.

He immediately tacked a provision onto the annual Ways and Means bill securing legislative authorization for the Bank of England. The national   bank was organized with a loan of £1,200,000 to William.  He returned a note to the bank, which then lent pound sterling notes into public circulation.

The Recoinage Act of England

The goldsmiths, however, countered with a provision in the Recoinage Act requiring that old coins be surrendered for their face value rather than for the value of the silver remaining after clip-ping. England had introduced the milled coins invented by Pierre Blondeau in 1662, but failed to make any provision for retiring clipped coins.

The legislation that created the Bank of England empowered it to handle bullion transactions for England. Because the bank was now responsible for Recoinage Act, it would be forced to pay for retiring all of England's debased coinage at face value.

The Bank of England Challenged

The Recoinage Act was ordered to take effect February 1, 1697

However; in the summer of 1695, Montagu discovered that the goldsmiths were collecting clipped coins and cashing them in for their full value in the pound sterling notes the national bank had been issuing.

He realized that when the goldsmiths controlled enough of the pound sterling notes, they would demand their full value in silver, causing a public panic and a general rush on the bank to redeem all of its paper notes for silver the bank didn't have.

Montagu immediately started rumors that Sir Isaac Newton would be made master of the national mint in charge of the Recoinage Act. With the master alchemist, the man who had demonstrated intimate knowledge of the secrets of the universe, serving as master of the mint, the national bank would give the appearance of holding unlimited amounts of silver bullion. The appearance of unlimited wealth would eliminate the public's fear of collapse and stop a run on the national bank's assets.

Charles Montagu gave up trying to install Newton as master, instead moving the warden of the mint to Customs and installing Newton as the new warden on March 19, 1696-not a moment too soon. The goldsmiths, having amassed £30,000 in paper notes, made their run on the bank the week of May 4, 1696.

At this time, Sir John Houblon was the Lord Mayor of London, a large stockholder in and governor of the Bank of England was the official who, on that morning in 1696, met the angry mobs demanding their paper pound notes be traded for silver.

He told the mob, we can assume it had something to do with Newton being at the mint and whose genius put the Philosopher's Stone at the beck and call of the bank.

Question: What else would have sent the angry crowds home, never again to question the liquidity of the Bank of England?

Answer: The Bank of England’s claim it had possession of the Philosopher's Stone became irrelevant as the world came to realize that reserve banking is the money machine that buys an empire and England's enemies would never again question her ability to finance wars on the world stage.

A few years later, Sir Isaac Newton took over as head of the Bank of England. His new job gave him the power of life and death over counterfeiters. It was known that he in prosecuting his duties, enjoyed disguising himself in rough garb to carouse London bars in search of counterfeiters.

 With the Bank of England’s armed men close by, rogues attempting to pass counterfeit coins were arrested, and with Sir Isaac as the sole judge and jury, these men were slowly drawn and quartered, a practice he indulged in for the rest of his life.

“I am afraid the ordinary citizen will not like to be told that the banks can and do create money. And they who control the credit of the nation direct the policy of Governments and hold in the hollow of their hand the destiny of the people.” Reginald McKenna:  Chairman of the Midland Bank, addressing stockholders in 1924.

Questions: How does the Federal Reserve Banking System work in America?

               and

Is the U S Dollar backed by anything of value?

Mr. Martin Chekel, a noted international businessman and author of the thought provoking “Managing America” six book series and the retrospective eight book series “The Diary of American Foreign Policy 1938 – 1945” that laid the foundation for US foreign policy the past seventy-four years.