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California businessman contends the banking reforms of the 1930s have not removed the precarious danger inherent in our fractional banking system and that a return to 100% reserves -- as propounded by the late Irving Fisher -- is imperative. To save our free enterprise system, Mr. de Fremery also advocates giving to the government the exclusive right to issue money, making such money non-convertible, permitting all exchange rates to fluctuate freely, and overhauling our system of raising public revenue. The author finds no evidence that we can prevent another financial panic resulting from the "creation and lending of fictitious deposits," sees scant assurance in F.D.I.C., states our gold reserve is hopelessly inadequate, and believes our people mast first be told the truth in order to achieve reform.


When Paul M. Millians, Vice-President of Commercial Credit Company, spoke before the 40th International Consumer Credit Conference in San Francisco on July 19, 1954, he made the following revealing statement:

"Most of the 17 major depressions in American history have been money panics. …They were marked by a scramble of bank depositors to withdraw funds; restricted deposits; restricted credit; forced liquidation of bank loans; and forced liquidation of commodities."

A very similar statement was made by J. W. Gilbart -- one of the leading bankers in England during the latter half of the 19th Century:

"It has been remarked that panics recur at regular intervals of about ten years each; nor can this be wondered at, seeing that the years 1825, 1837, 1847, 1857, and 1866 have, from various causes, been marked by the catastrophes so named. Judging by this recurrence of disasters at an apparently fixed period, It is not surprising that in the popular mind there seems to be a belief that a cycle exists, fated to bring In its train ruin to the monetary world and to millions outside of it. The dominant causes of the panics of the years specified, and their distinguishing characters, differ in some essential particulars. In one feature, indeed, they are all alike -- the unreasoning fear which heralds, accompanies, accelerates and sometimes produces them." (J. W. Gilbart,The History, Principles, and Practice of Banking, Vol. 2, P. 334.)

These two men stated indisputable facts that are known to all who have a knowledge of business cycle theory. It is only the interpretation of those facts that leads to controversy among economists. One group claims that our banking system is basically sound and that panics are either due to causes originating outside the system or to abuses of that system. The other group claims that there is an inherent defect in our banking system that makes these panics inevitable. This latter group of economists has grown to such an extent that when the late Irving Fisher took a poll of the members of the American Economic Association in 1947 to determine how many of them favored reform of our banking system so as to remove the basic cause of bank panics, over 1,100 of them signified their approval -- many of them well-known economists and heads of their departments at their respective universities.

Main Cause for Bank Panics

It is difficult to understand why anybody should be in doubt as to the main cause of bank panics. When men engage in a "run on a bank," they do it for a very obvious reason. They are afraid their money isn't there. They're afraid that if they don't withdraw the money they have a right to withdraw, they may lose it altogether. And their fear is perfectly justified under a system of fractional reserve banking. Their money is not there -- nor is it anywhere. Only a small fraction of their money has an actual physical existence. All the rest of it is nothing but book entries against which the depositors can draw checks.

"How do the book entries come into existence?" you ask.

Our banks have the privilege of creating such book entries and lending them to the public so long as they maintain a certain minimum cash reserve. Hence, the name "fractional reserve banking." And in proportion as banks exercise this privilege of creating deposits and leading them, and as checks are drawn against these imaginary deposits to pay for goods and services and then deposited in other banks, the total amount of imaginary deposits grows. This means our banks become less and less liquid, i.e., less able to pay their depositors in cash if called upon to do so on a large scale. The more illiquid the banking system becomes -- the more inevitable it is that a loss of confidence will occur. When it finally occurs it takes either the form of a financial panic, or a contraction in business resulting from the fear that a panic or "credit crisis" may occur, or a combination of both as in the period 1929-33.

The fact that the National Bank Holiday didn't occur until 1933 has led many people to believe that the Great Depression which was heralded by the stock market crash in 1929 was not caused by the banking system. But as early as 1928 the financial advisers of some of our large corporations were getting increasingly uneasy about the weak condition of our banks. Faced with the likelihood of another financial crisis, the only sensible thing for them to do was to advise the curtailment of capital expenditures, a liquidation of inventories, and a reduction of indebtedness to the banking system. These very actions, of course, hastened the thing that was feared.

But the fears were certainly justified -- as later events proved: 1,352 banks suspended payments in 1930, and 2,294 suspended payments in 1931. Many of those who hadn't foreseen this financial trouble or who were lulled to sleep by Hoover's repeated assertions that the Federal Reserve System was panic proof, lost their businesses.

An economist for one of our largest banks, when confronted with the foregoing explanation of what it is that causes a loss of confidence at the height of each boom, attempted to disprove this theory with the following argument: The fact that our large corporations did not withdraw their bank deposits when they first began liquidating and curtailing operations is clear evidence they did not fear a collapse of the banking system. Had they feared such a collapse, he reasoned, the first thing they would have done is withdraw their deposits.

The answer to this is that for every dollar of bank deposits held by these corporations, there were hundreds of dollars in inventories that had to be liquidated. Their primary concern, therefore, was to liquidate their inventories before trouble with the banks developed. If they were so rash as to withdraw their bank deposits when they first anticipated trouble with the banks, they would have taken great losses because of their inability to liquidate large inventories produced at an inflated price and wage level.

Are Things Different Today?

Defenders of this unsound system of banking hasten to assure us today that things are different. They claim that the banking reforms made since 1933 have removed the possibility of another collapse such as we had in 1933. They point in particular to the Federal Deposit Insurance Corporation as a safeguard against wholesale bank failures. What they overlook, of course, is the fact that the basic weakness in our banking system still exists. We still operate on the assumption that the process of creating imaginary deposits is sound. The F.D.I.C. is nothing but a gimmick designed to bolster our confidence and trust in an untrustworthy system. Consider these facts: At the end of 1956, the savings and demand deposits of banks associated with the F.D.I.C. totaled over $218 billion. About $120 billion of this consisted of deposits that were under $10,000 and, therefore, insured by the F.DJ.C. Now, consider this: There was only about $30 billion in currency in the country -- much of it outside the banking system -- and the F.D.I.C. had less than $2 billion in assets, of which only $4,221,686 was in cash. (Statistics taken from the Report of the Federal Deposit Insurance Corporation, December, 1956.)

Of course the Federal Reserve System has the power to increase the amount of Federal Reserve Notes. But this power is limited by the amount of gold reserves held by the system. And gold, being an international commodity, has a way of flowing out of the country just when it is most needed ... in fact we have lost over $1% billion of that metal since Jan. 1, 1958.

Holds Gold Reserve Is Inadequate

Much nonsense has been written about the adequacy of our gold reserve. But as a matter of cold fact, our gold reserve is hopelessly inadequate should any trouble develop. In this connection it would be well for us to heed the warning contained in the June 27 bulletin issued by the Bankers Trust Co. This bulletin was devoted to an analysis of the gold outflow that has been taking place since the first of the year and still is taking place. Although they gave many reasons for believing we have nothing to worry about, all their soothing arguments were negated by the last two paragraphs which read as follows:

"One real hazard to the dollar could develop from the side of the Federal budget. Should this country enter an era of large and uncontrollable budget deficits, the inflationary implications for the domestic scene are very likely to be compounded by uncertainty abroad regarding tine ability and intent of the United States to maintain the international purchasing power of the dollar over the long run. Under such conditions, it is not inconceivable that foreign funds could be withdrawn from this country in greater amounts than seem likely under present circumstances, that the outflow could be enhanced by strong speculative movements, and that the consequent inroads of the gold reserve could assume disturbing proportions.

"Even if acute fiscal emergencies are avoided, the trend of recent years indicates yet another basic hazard over the long term, namely, that the rise in production costs in the United States may eventually price more and, more of our exports out of world mar kets. In the past, this prospect has been obscured by the parallel and generally more rapid progress of inflation among other leading nations. However, various countries abroad has recently demonstrated their determination to bring the inflationary boom under control and adjust their economies to the to the disciple of the balance of international payments. Should we fail to cope with rising costs and prices in the United States, our balance of payments could hardly escape deterioration over the years." (Italics added.)

Is there any doubt in anybody's mind as to whether we have entered "an era of large and uncontrollable budget deficits"? Senator Byrd has certainly made this point, clear. And the migration of capital that is being invested in foreign countries is certainly clear evidence that we're going to have steadily increasing trouble with our balance of payments. So there shouldn't be much doubt that the inroads on our gold reserve will assume "disturbing proportions."

Can We Prevent a Financial Panic?

How can any man acquainted with these facts -- and our largest corporations have such men on their staffs -- help but lose confidence in the future? Can you blame these men for advising the curtailment of capital expenditures and the liquidation of inventories as has been done in the last 18 months? As the law now stands, nothing can prevent another financial panic. We are just as prone to another financial, debacle as we were in 1929 when President Hoover begged us not to lose confidence in our banks. We were assured that the Federal Reserve System was designed to prevent a collapse of our banking system. We learned otherwise. And today we are being assured that the F.D.I.C. will prevent another collapse such as the one we had in 1933. But there is no sound basis for so believing.

The time has come for us to face the fact that there is no such thing as a sound method of insuring deposits in a banking system that operates on unsound principles. The creation and lending of fictitious deposits is not a sound method of banking.

Some people believe it is against the public interest to expose the inherent weakness of our banking system. I think it is against the public interest to keep people in ignorance of such things. Large financial interests have always been well aware of the defects in our banking system. They had to be to survive. They know how weak and unstable the system still is. Not only do they know how to protect, themselves from the economic fluctuations caused by our credit banking system but many of them know how to profit by these fluctuations. Should plain citizens be denied the same insight?

Reform by Telling the Truth

The only hope of reforming this basically unsound money mechanism is to let our citizens know the truth. They alone have the political strength to bring reform. Unless the voters learn the truth about our financial system, they will sanction ever-increasing government controls of our economy as it continues to break down because of an unreliable money.

I can be accused, of course, of shouting "Fire!" in a crowded theatre. But I am not shouting … and there is a fire. There is a blaze that has been steadily burning away the foundation of our free enterprise system for 300 years. The spread of Communism, which all thinking people rightly fear, has been fostered very largely by our failure to put out this fire. As a matter of fact, Marx's writings received their first prominence four years after England made a half-hearted attempt to correct the basic weakness in her banking system. Under the Bank Act of 1844, banks gave up the right to extend credit by issuing notes that, were not backed by gold. But they retained the right to extend credit by creating deposits against which checks could be drawn. Naturally the credit crises continued -- 1847, 1857, 1866 -- and in the meantime full blame for the continuing cycle of business activity was gradually shifted from the banking system to the business world itself.

Now it is time to complete the reform that was started in 1844. And that is the basic premise behind Professor Fisher's proposal which received the support of so many economists throughout our country in 1947. He suggested converting our present system of fractional reserve banking into a system of 100% reserves. This can be done by converting our billions of dollars of imaginary deposits into actual deposits. And to keep our banking system on this sound basis we would have to take away the bankers' privilege of creating any further imaginary deposits.

Only the Government to Issue Money

If more money is needed in our country, and we'll need more as our population expands, it should be the function of government -- and government alone -- to provide the new money -- not the function of a private banking system to provide us with imaginary deposits. Bankers should confine their lending activities to the lending of actual savings placed with them for that purpose and not subject to withdrawal during the period of the loan. They should no longer be allowed to lend their credit.

Having effected this reform, we need then only provide -- by Constitutional amendment -- that the supply of money per capita existing immediately after this reform has been made shall henceforth be maintained. When a further increase in our population necessitates a proportional increase in our supply of money, then Congress can authorize that increase as provided for in the amendment to our Constitution. In the words of Alexander Del Mar -- one of the most scholarly and astute monetary historians that ever lived: "The more exact the limits of the volume of money are defined in the law of each State the more equitable will it become in its operation upon prices and the dealings between man and man." (The Science of Money, P. 129.)

Those who would like a more detailed analysis of how our banking system can be put on a sound basis can get this in my acticle, "Banking and Monetary Reforms to Preserve Private Enterprise," (The Commercia land Financial Chronicle, June 7, 1956, P. 13).

Favors Going Off Gold

The question is often raised: "What about gold? Would our new money be convertible into gold at the request of our citizens and/or foreign bankers?"

Certainly not. The idea that our money has to be convertible into gold in order to maintain its value is a superstition foisted upon us by the vested interests in gold. And those who don't think such a vested interest exists should heed the following statement made by the National City Bank Bulletin for June, 1940:

"A second important reason why gold is unlikely to lose its value is that not only the United States, but other countries as well, have large vested interests in gold. The British Empire alone accounts for nearly half the gold output of the world, and in many other countries gold production is an important national asset. These countries would not look with favor upon the displacement of gold as a monetary metal; and even in the event of political changes resulting from the war these vested interests will remain though possibly shifted to other national jurisdictions." (p. 70.)

Another superstition foisted upon the public is that an expanding foreign trade among freedom-loving nations necessitates having currencies convertible into gold. Exactly the opposite is true. (One of the best books on this subject is International Monetary Issues by C. R. Whittlesey). The periodic breakdown of trade -- both national and international -- that has had such disastrous consequences on the political and economic development of all countries is a direct result of unstable currencies which, in turn, were an inevitable result of having currencies supposedly convertible into gold on demand when, in fact, that much gold didn't exist.

The greatest boon to the development of world trade would be to divorce all currencies from gold and allow all exchange rates to fluctuate freely so as to correctly reflect changes in the amount of imports and exports of each country.

Overhaul Our Reserve Raising System

Before closing, I would like to point out that banking reform alone will not save our free enterprise system. We also need a complete overhaul of our system of raising public revenue. Both of these reforms must eventually be made if freedom is to survive. Neither of these reforms is a panacea -- nor are both of them together a panacea. Our panacea is freedom. And a free economy cannot be expected to function properly without a sound monetary system and a sound method of raising public revenue.