The new US $100 bill is out, as you may have seen this holiday season. Our dear old Uncle Ben is a technological wonder with a dozen different anti-counterfeiting devices on it. Since there are more $100 bills circulating outside of the United States than inside, the U.S. Government has to insure that counterfeiters are unable to replicate the government’s most treasured export. This raises the question, who was the greatest counterfeiter of all time?  

Government Counterfeiting

Although governments have done more to destroy their own currencies than all the counterfeiters in the history of mankind put together, the government is not the correct answer. Governments have debased their own currency for millennia. Historical examples of government-induced debasement include:

• The Roman Empire replacing its silver Denarii with billon Antonininii;
• The Khans of China creating the first paper inflation in the 1300s;
• The United States making its first currency, the Continental Dollar, worthless;
• Germany hyperinflating out of its debts by creating trillions of marks;
• Or the US Federal Reserve blowing up its balance sheet.

In holding governments accountable, we are also not talking about one government counterfeiting the currency of another government as the

• Barbarians did of the Roman gold Aureus
• British did of Continental Dollars and French Assignats during the 1700s
• Germans did of British Pounds during World War II in Operation Bernhard
• United States did of Japan’s Occupation currency of the Philippines
• North Koreans did of US Dollars, making them one of their principle exports.

Governments have consistently destroyed their own currency and those of other countries without ever being held accountable for their “crime” the way a counterfeiter is punished. No, we are not talking about governments; we are talking about individual counterfeiters. It is one thing for the government to expand the money supply in order to stimulate the economy and help the unemployed. It is quite another for counterfeiters to do the same –albeit on a much smaller scale– to benefit themselves. Counterfeiters provide competition to the government, and though government officials are applauded when they inflate the economy, counterfeiters are condemned to prison – when caught.  

A Classy Counterfeiter

Our vote for the greatest counterfeiter of all time goes to Artur Alves dos Reis whose story was recounted by Murray Teigh Bloom in The Man Who Stole Portugal. Reis was both smart and classy, and his criminal operation reflected these qualities. To my knowledge, Reis put together the most audacious counterfeiting scheme in history. He conceived his master plan while he was in jail in Oporto for embezzling the funds of a company he had taken over. Some criminals sit in jail and try to avoid repeating their misfortunes. Others, like Reis or Tony de Angelis, think-up bigger, more foolproof schemes. While he was sitting in his cell, Reis put together his master plan that would make him the richest, and possibly the most influential man in Portugal in only one year.Although you may not realize it, counterfeiting is a very complex operation. To be successful, (i.e. not get caught), be able to spend your money, and not receive free room and board from the government, you have to do three things successfully. First, you have to create counterfeit currency that can’t be detected. Second, you need a way of laundering the money and converting it into real assets so you can enjoy the fruits of your ill-begotten labors. Third, you must make sure that you avoid the triple curse of detection, arrest and conviction. Let’s see what Reis’s solution was to this age-old problem.  

Step One: Create an Undetectable Banknote

First, create a counterfeit that can’t be detected. During the 1920s, the Banco do Portugal had the exclusive right to print currency in Portugal. The bank used foreign printing companies with superior anti-counterfeiting technology to protect their banknotes. The English company, Waterlow & Sons, printed the 500 and 1000 Escudo notes (equal to about $25 and $50 in 1923) for the Banco do Portugal. So why not get Waterlow & Sons to print the notes for Reis as well?Reis was a natural-born forger. He forged his diploma as an engineer from Oxford as a “joke”, but this helped land him a job as a government railroad inspector in Angola at the age of twenty-two. In 1924, he forged $100,000 worth of checks and used the money to take over control of Ambaca, the Royal Trans-African railway Company of Angola. He then used the money in the company’s treasury to cover his own checks. He was arrested in July 1924 for embezzlement, but was released two months later when a court decided his was a civil and not a criminal case. It was during the two months he was the guest of the Oporto police that he conceived his infamous counterfeiting scheme. The key was to find someone with a respected name who could help him convince Waterlow & Sons to print banknotes secretly for Reis. He found three men of questionable repute, but with connections to help Reis: Jose Bandeira, Gustav Adolf Hennies and Karel Marang. Bandeira got his brother, the Portuguese Minister to the Netherlands, to give Marang a letter introducing him as a respected Dutch citizen who had a power-of-attorney for Alves Reis to negotiate the printing of the banknotes. Marang went to Waterlow & Sons in London, and presented his letter of introduction as the “Consul General of Persia” on forged Banco do Portugal stationary to Sir William Waterlow. Marang spun the story Reis had instructed him to give. A private syndicate was being formed to save the colony of Angola from its current dire financial condition with a $5,000,000 investment. In return for the loan, the syndicate would be allowed to print and circulate banknotes in Angola. Waterlow & Sons would print the banknotes for the syndicate, and once the notes reached Angola, the banknotes would be supercharged with the word ANGOLA so they wouldn’t be confused with notes from the mother country. The whole affair had to be kept secret lest Angola fall into further financial difficulties due to ill-placed rumors of pending economic ruin. Of course, Sir William knew that supercharging notes was normal practice for Portugal’s colonies, and that the Banco Ultramarino had the exclusive right to print banknotes for the Portuguese colonies. This was an opportunity for Waterlow & Sons to get this business away from Bradbury, Wilkinson & Co., the current printer of banknotes for the Banco Ultramarino in Angola. Marang asked Waterlow to print the 500 Escudo note with Vasco da Gama on it. The deal was signed on January 6, 1925, and for the printing cost of $7,200, Reis and his conspirators would receive $5,000,000 in banknotes, a 70,000 percent return on their investment. Bandeira picked up the first group of notes from Waterlow & Sons on February 10, and by March 20, they had 100 million Escudos ($5,000,000) in Portuguese banknotes. Bandeira used his orange diplomatic card to transport the bills in luggage marked the “Legation of Portugal” across the borders without detection. After the first step had been successfully completed, they placed an order for an additional 190 million Escudos in banknotes ($9,500,000). Of course, the banknotes never made it to Angola. 

The greatest risk in the scheme was having banknotes with duplicate numbers discovered, but this was the lesser of two evils. If Reis and Marang had requested banknotes outside the numerical range of the 500 Escudo notes, the spurious notes would have been quickly discovered. The lower risk lay in duplicating the existing serial numbers, and hoping the counterfeiters were able to successfully release all the banknotes before the law of large numbers caught up with them.  

Step Two: Laundering Money with Your Own Bank

Step One of the plan was complete, now for Step Two: laundering the money. A small-scale counterfeiter can pass bills through petty criminals, but the notes Reis and friends had were equal to almost 1% of Portugal’s GDP. This was the equivalent of over $150 billion if the same amount had been released in the United States today. Even if Reis hired every petty criminal in Lisbon and Oporto, he wouldn’t be able to unload a fraction of the banknotes.

 

Reis was going first class with his counterfeiting scheme, and he decided the only way to launder the money was to have his own bank. Reis used his newly printed banknotes to encourage corrupt Portuguese officials and politicians to grant him his bank charter, and on June 15, 1925, the Banco Angola e Metropole’s application was approved by the government. Of course, the bank would have multiple branches in Lisbon and Oporto to speed up the distribution of their treasure. Want to exchange foreign currency? The Banco Angola e Metropole provides the best rates. Want to borrow money for a business or mortgage? The Banco Angola e Metropole will be happy to extend you the loan in cash. Want high interest rates on your deposits? Go to the Banco Angola e Metropole? In the meantime, Reis, his wife, and their compatriots spent their money freely, buying jewelry, cars, real estate, and sending money abroad. Reis flooded Portugal with his freshly minted banknotes, and the economy of Portugal was booming. And as Reis would rationalize, how was this any different from what a real government did? Was there really any difference between Keynesianism and counterfeiting?  

Step Three: Avoid Detection (For a While)

Step Three and the most important of all was how to avoid detection, arrest and imprisonment. For this, Reis had a brilliant solution. Since they were counterfeiting Banco do Portugal banknotes, only the Bank could initiate proceedings to prosecute them. But what if –just what if– Reis controlled the shares in the Banco do Portugal? The bank had already exceeded its statutory banknote limit many times over and the directors of the Banco do Portugal had never been prosecuted, so why should they prosecute Reis? Or as Reis put it, “How can they arrest us when they’re us and we’re them?”Like most European countries, Portugal had suffered inflation after World War I. Prices had increased 48% per annum between 1919 and 1924, and the Escudo had depreciated by 87% against the Pound Sterling. Although the Banco do Portugal was only supposed to issue banknotes thrice its capital, it had, in fact, issued banknotes a hundred times its capital. By comparison with this, Reis’s monetary manipulations were minor by comparison. The chart below shows the depreciation of the Portuguese Escudo against the U.S. Dollar after World War I.

 

 

Reis began buying up as many shares of the Banco do Portugal as he could, so he could gain a controlling interest in the bank to protect himself. Should his scheme ever be detected, Reis would, quite naturally, refuse to prosecute himself. By November 1925, Reis controlled over 10,000 shares of Banco do Portugal stock. “Just another month” and Reis would have control of the Banco do Portugal. Then he could live in luxury for the rest of his life. As in all of these cases, whether it be counterfeiting currency, pumping and dumping, forging corporate books, hiding money in offshore accounts, or any of the other financial schemes that crooks are heir to, it was hubris and greed which undid Reis. He took part of his proceeds and invested them in a mineral and oil exploitation scheme in Angola hoping to increase his wealth even more. In December 1925, Reis and Hennies were on their way back to Portugal from Angola. Aboard the ship, they learned that the Banco do Portugal was doing an investigation of the 500 Escudo notes. A lowly, underpaid teller who worked part-time at a jeweler to help make ends meet had become suspicious of the Banco Angola e Metropole. The Escudo notes he received were never in numerical order (Reis’s plan to shuffle the banknotes to avoid detection actually caused detection), and the pages that recorded foreign exchange transactions at the bank were torn out. The teller alerted the Banco do Potugal, an investigation began, and soon duplicate banknotes were discovered. Hennies, sensing that the scheme was up, decided to sail on, but Reis disembarked in Lisbon. His goal was to lay the blame for the duplicate banknotes on officials at the Banco do Portugal by forging documents that the Governor of the Banco do Portugal was the originator of the whole plot.  

The Scam Exposed

The crisis broke on December 4, 1925 when the newspaper O Sêculo published an expose of the Banco Angola e Metropole. When one of its branches was closed, huge caches of duplicate 500 Escudo banknotes were discovered. Reis, his compatriots, and almost anyone associated with the Banco Angola e Metropole, (save Hennies who had sailed on), were arrested. Incredibly enough, the Governor and the Vice Governor of the Banco do Portugal were also arrested, so convincing were Reis’s forged documents. It was as if Ben Bernanke and Janet Yellen had been arrested for counterfeiting!The Banco do Portugal faced a tough decision. What should it do with all the 500 Escudo notes? It was impossible to differentiate between the original and the duplicate banknotes because they were printed by the same printer using the same plates. The Banco do Portugal came to the only conclusion possible. Every single Vasco da Gama 500 Escudo note would have to be withdrawn from circulation. People could exchange up to 200 of the Vasco da Gamas for 1000 Escudo notes until December 26. After that, they would be worthless. The revelation of the counterfeiting plot created a huge loss of confidence in the corrupt, democratic government. Military officers who were aggrieved over their pay failing to keep up with inflation, overthrew the democratic government on May 28, 1926. This eventually led to the dictatorship of Portugal by Dr. Antonio de Oliveira Salazar (who had been Portugal’s Finance Minister) in 1932. Salazar remained dictator of Portugal until his death in 1968. A scheme to counterfeit currency and make a forger rich had led, indirectly, to the downfall of a democracy which was followed by a forty-year dictatorship. Reis remained in jail and was found guilty on June 29, 1930 of falsely introducing 330,000 banknotes into Portugal. He was sentenced to twenty years in prison. His compatriots were found guilty as well, but received lesser sentences. Reis was released from prison on May 14, 1945, and died ten years later. Sir William Waterlow was sued by the Banco do Portugal for damages for printing the banknotes. Of course, Waterlow had no knowledge of the counterfeiting scheme and as his lawyers argued, no actual damage had been done to the bank by the banknotes. If anything, Portugal was better off as a result of Reis’s unconventional stimulus plan. Though Waterlow spent a million dollars on lawyers defending him, he lost the case and Waterlow & Sons was forced to pay of £610,392 (about $3,000,000) in damages. There must be a certain irony in the fact that as a result of the lawsuit, the main beneficiary of the scheme to counterfeit the banknotes was the Banco do Portugal itself. Sir William died of peritonitis in 1931 and the case was settled in April 1932. Reis was the last of the great counterfeiters. His scheme had style and panache, as did he. His story ripped through the papers just as his scam ripped through the economy. This case study should not be forgotten nor should we forget Reis and the ingenuity that rested behind his schemes. The piranha of Portugal may be gone, but there will always be a new Wolf on Wall Street attempting to profit at the expense of others.

When I think of Venice, I think about three things. I think about the first time I went to Europe with my dad. For an entire week before we got to Venice, all I heard about was his insistence on going on a gondola, and passing through the canals while the gondolier sang his Venetian songs. By the time we got to Venice, I was so sick of this that the first thing I did was take him to the place where you hired gondoliers so I would never have to hear about the canal ride again. My dad asked our potential gondolier how much the ride was, and when he found out it was the equivalent of $50 (this was a long time ago), he swore at the gondolier and said he wasn’t wasting $50 on a stupid boat ride. I was ready to kill my dad, but I didn’t cherish the idea of spending the rest of my life in a Venetian prison and having to pass over the Bridge of Sighs. Since I am an economist, the other two things I think about deal with finance. First, Venice was one of the three city-states in Italy (Florence in 1252, Genoa in 1253, and Venice in 1280) that reintroduced gold into the Italian peninsula eight centuries after the fall of Rome. The other important financial contribution that I associate with Venice are the prestiti: the government bonds Venice began issuing in the 1100s to fund its wars. The prestiti were the first Eurobonds and if Moody’s and S&P had been around in the 1300s, they would have been the first AAA-rated government bonds, though they eventually would have been downgraded.  

PRESTITI: THE FIRST AAA EUROBONDS

Venice was the first country to issue government bonds to its citizens in the same way governments currently issue government bonds. Before the Venetian prestiti, and even after, kings, queens, emperors and others borrowed money to fight wars or feed their royal megalomania. When the rulers were unable to pay back the loans, they simply defaulted, often bankrupting their creditors. Venice was different. Venice was the medieval equivalent of Athens, a democracy for the elites. In 726, the Venetians rebelled against their Roman/Byzantine rulers over the Iconoclast controversy and elected the first of 117 doges before Napoleon conquered the city in 1797. Venice became a city-state, expanding its commercial reach, and became an imperial power, eventually capturing and sacking Constantinople in 1204 during the Fourth Crusade. By the late thirteenth century, Venice was the most prosperous city in all of Europe. At the peak of its power and wealth, it had 36,000 sailors operating 3,300 ships, dominating Mediterranean commerce. Defending their empire meant wars with other Italian city-states, such as Florence and Genoa, and wars meant borrowing money.  

THE PRICE OF PRIZED PERPETUITIES

Venice introduced the prestiti in the twelfth century. Subscriptions were obligatory on wealthy citizens in proportion to their wealth, and the elites of Venice found forced loans preferable to outright taxation. In 1262, Venice lost control over Constantinople, and the outstanding loans, which had been considered temporary, were consolidated into one permanent fund called the monte vecchio. This move institutionalized the prestiti as long-term loans rather than short-term borrowings. The prestiti paid a nominal interest rate of 5% on the outstanding capital, two installments of 2.5% paid per annum. After 1377, interest rates were variable, and rates were reduced to 4% in the 1400s. In 1482 a new series of prestiti, the monte nuovo, was issued based upon a new kind of tax and the interest rate was restored to 5%. Another new series, the monte novissimo, was issued in 1509 during the war with the League of Cabrai, and finally the monte sussidio was introduced in 1526. The prestiti were perpetuities that had no specific maturity date. No physical bonds were issued, but all bonds were registered through the Loan Officers, the Ufficiali degli Prestiti. The claims on these bonds could be sold and transferred to others who then had all the rights of the original purchasers. When possible, the Venetian government repaid the principal. The prestiti became popular forms of investment for Venetian nobles. They were used as endowments for charities, and were used as dowries for daughters upon their marriage. Since the elites of Venice owned prestiti and were part of the government, this reduced the likelihood the city would default on its debts (though the government did forgo interest payments in 1379-1381, 1463-1479 and 1480). Owning prestiti was a privilege. Foreigners, who trusted the Venetian government more than their own, could only obtain prestiti through an act of the Council of Venice. The prestiti were fully paid off by the government of Venice in the late 1500s. As with any bond, as the price of the prestiti went down, the yield went up. During a war, the price of prestiti would fall as new bonds were issued and owners faced the risk of delays in payment of principal and interest. During peace time, the price rose as the risk diminished. Since the price of trades in prestiti was a matter of public record, potential purchasers could use these prices to determine the riskiness of their investment. Thus, the prestiti became a barometer of the Venetian Republic. When there was peace, the government would repay outstanding prestiti, sometimes by issuing new prestiti, rolling over old loans into new, but when Venice was at war, the government would issue new prestiti. The prestiti were exempt until 1378 from assessment of new forced loans if held by the original owner, and new assessments were levied largely on real estate. Venice was successful with the issue of prestiti because the right to transfer the bonds through the Ufficiali degli Prestiti made the bonds liquid and fungible. The Venetian government established a long record of regular payment of interest even when war and disaster threatened the state, assuring investors that they would not lose their money from a royal default. As Venice prospered, confidence in payments rose. The government was under a legal obligation to pay the prestiti, and payment was not left to the whim of the king. During peace time, extra revenues were directed to repayment of the prestiti, rather than setting aside money for the Venetian war chest or expanding services. The government had a deliberate policy of repurchasing prestiti whenever their price fell. In short, the prestiti were the AAA bonds of their day, and as Venice prospered, so did the city and its bondholders.  

THE VAGARIES OF WAR IMPACT THE PRESTITI

As all nations know, wars do not always go as planned. Sidney Homer, in his History of Interest Rates, provides historical data on the prices of prestiti, and you can see how the price of the bonds and their yield fluctuate in response to the fortunes of Venice. When Venice imposed large assessments, as in 1311-1314, the price of the prestiti fell, and when Venice made large repayments, as in 1344, the price could exceed 100. The worst decline in the fourteenth century came during the War of Chioggia between 1378 and 1381 with Genoa, during which Venice imposed very large assessments, suspended interest payments, made the prestiti no longer immune from tax levies, and expanded the debt 6 to 9 times its level in 1344. The price sank as low as 19 as a result. After the War of Chioggia ended, the prestiti fought their way back as confidence in the Venetian government returned, causing the price to rise to the 60 level. Unfortunately, the fifteenth century was one of ongoing wars in the Mediterranean. Venetian wars with Hungary in 1412, the Turks in 1416, Milan during the 1420s, and wars with both Florence and Milan in 1450 and the costs associated with these wars reduced confidence in the Venetian government’s ability to fund the prestiti. Emboldened by the fall of Constantinople in 1453, Sultan Mehmet II declared war on Venice, leading to a disastrous and protracted conflict between 1464 and 1479 which drove the price of prestiti back to the 20s. This led to the reissue of new prestiti as monte nuova in 1482. The graph below shows the yield on the prestiti from 1285 to 1502, assuming a 5% coupon (though in reality the prestiti paid a variable rate after 1377 and 4% during part of the 1400s). The impact of the War of the Chioggia in the 1370s and the wars with Milan and the Turks after 1420 are clearly seen. As the Venetian Republic’s empire shrank, holders of the prestiti suffered. Venetian bonds would definitely have been downgraded as the heavy impact of the Venetian wars had their effect on the city-state’s finances. Though Venice is no longer a city-state, it has left us a beautiful city which tourists cherish. It also leaves us an important financial legacy: a record of the first international government bonds which were used throughout Medieval Europe by investors who wanted a safe place to store their wealth. Today, U.S. Government Bonds play the same role in the twenty-first century that prestiti played in the fourteenth century. Let’s hope U.S. Government Bonds can continue to pay that role for the century to come.

H2O EXTRACTS GAS AND ATTRACTS MONEY

Born in Philadelphia on September 3, 1837, John Ernst Worrell Keely worked various jobs as a young man, as a member of a theatrical orchestra, a painter, a carpenter, a carnival barker, and as a mechanic. Then in 1872, he announced the discovery of a machine that could revolutionize the world. He said he had discovered a new physical force that could produce phenomenal power, never before heard of. Keely proposed to use the power of atoms in water to create perpetual motion. Since water covers more of the earth than land, the fuel for his machine would be cheap and readily available for all of mankind to benefit from. Keely’s basic idea, as he explained it to his awed listeners, was that atoms were in constant vibration, so all you had to do was to harness and channel the random vibrations of the atoms within water and you could produce unlimited energy. If you could get atoms to vibrate in unison, you could use their “etheric force” to run any motor of any size. To promote his discovery, Keely went on a speaking tour to share his great discovery with the world. At each engagement, someone in the audience would ask “How did you come to this great discovery?” Keely would explain to the audience that the revelation had hit him while he was playing a few notes on the violin. The notes on the instrument had set in motion harmonic vibrations, and in a moment of serendipitous inspiration, he had realized that the vibrations of atoms could be used to create energy just as the vibration of notes could be used to create music that could soothe the beast. Keely’s next stop was New York where he invited potential investors to the plush hotel he was staying at on Fifth Avenue. There, in his expansive suite with velvet chairs, chandeliers and extravagant mirrors, Keely explained his invention to potential investors while serving them delicacies to eat and liquor and champagne to savor and imbibe. Bankers, businessmen, engineers, lawyers, and other rich investors went to the hotel to invest in the sensation of the century. Soon after, with his first investment of $1 million in hand, he formed the Keely Motor Company. The corporation quickly grew to $5 million in capitalization. His investors wondered why the name of John Ernst Worrell Keely shouldn’t stand alongside that of Thomas Alva Edison and Alexander Graham Bell in the pantheon of great American inventors.  

ETHERIC DISINTERGRATION

Keely impressed potential investors with phrases such as “quadruple negative harmonics,” “etheric disintegration,” and “atomic triplets” when he revealed his ideas to eager listeners. Through the “liberator” which was a system of highly sensitive tuning forces, Keely would unleash the secret powers of the universe through his “hydro-pneumatic, pulsating vacuum energy” to solve the world’s energy problems forever. Keely demonstrated his machine to his guests, using his powers of prestidigitation to pour water into his vacuum engine and demonstrate his device. After a little bit, the engine gurgled, then rumbled, then came alive, providing a pressure of 50,000 psi to the amazed onlookers. As The New York Times wrote on June 11, 1875, the “generator” was reported to be about 3 feet in size, made of Austrian gunmetal in one piece, and held about ten or twelve gallons of water. Its inside was made up of cylindrical chambers connected by pipes and fitted with stopcocks and valves. The “receiver” or “reservoir” was about forty inches long by six inches in diameter and connected to the “generator” by a one inch diameter pipe. Keely claimed that his apparatus would generate his “vapor” from water solely by mechanical means without using any chemicals and claimed that it could produce 2,000 psi in five seconds. Whenever Keely demonstrated one of his machines, he would provide an elaborate explanation of how the engine worked, as illustrated by one of Keely’s exercises in eloquent embellishment from The New York Times on June 7, 1885: “It is an elaboration of interatomic ether by vibration. The atomic ether vibrates all around the molecules of matter. There is a magnetic force attached to it at the same time, and it assimilates with the molecular atomic aggregations – that is, assimilates with a certain attractive force that it is hard to tell what it is. I call it a vibratory negative. It doesn’t act like a magnet drawing metals toward it. There is a certain magnetic effect about it that causes it to adhere by vibratory rotation to different forms of matter – that is the molecular, atomic, etheric, and ether-etheric. The impulse is given by metallic impulses, the rotary power that is formed by etheric vibration – that is the force that holds it in position.” Even if you didn’t understand Keely’s theories, he had demonstrated to potential investors that his machine actually worked. What else mattered?  

A VIBRATING DEMONSTRATION

On November 10, 1874, Keely demonstrated the first full-scale version of his miracle machine at his laboratory at 1422 North Twentieth Street in Philadelphia, which he called the “etheric generator,” later to be called a “vibratory-generator.” The motor obtained its power from “intermolecular vibrations of ether” which allowed him to create a machine which he finally named the “hydro-pneumatic pulsating vacuo-motor engine.” The press simply called it a perpetual motion machine, though Keely never referred to it as such. With the prospect of investing in the greatest invention of all time, shareholders were eager to be part of the Keely Motor Co. The company showed no profits and paid no dividends because Keely invested all of his capital and proceeds in developing mankind’s greatest source of energy. During the 1880s and 1890s, other inventions came into use, Bell’s telephone, Edison’s electric lights and automobiles, but Keely continued to work on perfecting his wonder of the ages. When Keely was asked when he planned to apply to the Patent Office for his machine, he told his investors that he wasn’t going to file a patent lest the secrets of his motor be unveiled and others could steal his ideas. The best thing, he told shareholders, was to keep every aspect of his invention secret until the etheric forces could be unleashed in a machine that made money for the company’s investors. Otherwise, some unscrupulous and dishonest pirate could study his designs and introduce a machine similar to his, reducing the company’s profits. Keely would occasionally need new capital to continue developing and refine his machine. After all, in the later stages of development, the machine was becoming even more complex and required even more capital. Keely would call a board meeting, where the board would vote to issue more shares and raise additional capital. Old shareholders would purchase additional shares, and new investors would get the opportunity to share in the creation of the world’s first perpetual motion machine. Even John Jacob Astor invested in the Keely Motor Co.  

CONDUCTOR OF MUSIC, ELECTRICITY, AND STOCK

One of Keely’s biggest supporters was a widow by the name of Mrs. Clara Jessup Bloomfield-Moore, who not only invested $100,000 in the Keely Motor Co., but provided Keely with $2000 a month for personal expenses. When others began to lose faith in Keely because of the inevitable delays, Clara would invest more money and urge others to do the same. Ms. Bloomfield-Moore even wrote articles for prominent magazines of the day, praising Keely and his invention, saying that Keely’s etheric force was “like the sun behind the clouds, the source of all light though itself unseen. It is the latent basis of all human knowledge…” Whenever there were doubts that his engine would finally come to fruition, Keely would unveil his newest advancement in tapping the forces of nature. At one demonstration, he showed investors the “shifting resonator” which carried seven different kinds of vibration, each “being capable of infinitesimal division.” Keely would set the whole contraption going in a variety of ways; sometimes by playing a few notes on his violin, a zither, a harmonica, or even an ordinary tuning fork. Whatever the method, etheric force came forth, starting the motor and impressing the investors. The stock went public on the New York Stock Exchange in January 1890, the greatest place for venture capital in the United States. The stock traded steadily during the 1890s, neither shooting up in a bubble nor collapsing. With no profits and no dividends, there was no reason for the stock to skyrocket until the etheric vibrations were turned into a money-making machine for the company’s shareholders. If Keely wasn’t the greatest inventor of the nineteenth century, he was probably a greater escape artist other than Houdini. For over 25 years, from 1872 to 1898, Keely was able to convince investors that a workable machine that could make his investors millions would be available next year. Edison, Bell and Tesla produced real results; Keely produced promises. Despite law suits from his own company to reveal his secrets, inquiries by scientists, exposes by the Scientific American, pressure from Mrs. Clara Jessup Bloomfield-Moore, and even a court order that landed him in jail for three days for contempt of court, Keely was always able to wiggle out of the demands for a marketable machine. Every year, from 1872 to 1898, Keely was able to introduce a new variation on his engine to impress shareholders and potential investors with his “vaporic gun” or “hydro-pneumatic-pulsating-vacu-engine”.

Under the Affordable Care Act, you must have health insurance, or pay a fine. But what if you were arrested or jailed if you did not comply with the healthcare reform law? The website for the Affordable Care Act is now up and running again so Americans can enroll for health insurance. Obama has had problems making the Affordable Care Act a reality during the past few weeks. Millions of Americans have found out that their health care has been cancelled, despite promises to the contrary, because their plans didn’t meet the standards of the Affordable Care Act, and millions more have seen large jumps in their annual premiums. Other Americans could not sign up due to past website performance of an approximate 10% downtime so now the government is hoping the website will work and reverse their fortunes.

The problem is that given the increase in health care costs that will occur, many people will not be able to afford health care insurance and will face the prospect of paying fines for non-compliance. The whole process reminds me of what happened during the Roosevelt Administration and its ill-fated attempt to impose price controls on the economy during the 1930s.  

FINES FOR COMPETITION

After Roosevelt became President in 1933, he introduced the New Deal to bring the country out of the Great Depression. Manufacturing production was collapsing, trade was falling, people didn’t know where their next meal was coming from and unemployment lines were growing. As the chart below shows, unemployment had risen from around 1% in 1929 to 25% by 1933.

With any new legislation comes a new set of government rules, and the NRA created the inevitable regulatory nightmare. Raymond Clapper reported that between 4,000 and 5,000 business practices were prohibited by some 3,000 NRA orders that ran to over 10 million pages. Businesses that supported Roosevelt’s plan showed their support by putting up an NRA poster, which showed a blue eagle and the words “We Do Our Part” in their windows. If you watch an old movie, such as Gold Diggers of 1933, you can even see an NRA eagle that Busby Berkeley had his dancers form in the musical as a sign of Hollywood’s support for the NRA.  

BLACK MARKETS

As with any set of government regulations, you have to have enforcement. Black markets resulted from the NRA’s regulations and in some garment districts, enforcement police were used to make sure the rules were followed. Just as the Volstead Act was passed to enforce Prohibition, each state passed laws that administered the thousands of regulations created by the NRA. The New Jersey State Recovery Act was passed by that state’s legislature to make sure businessmen complied, regardless of whether they knew all the details or not. The biggest supporters of the price controls were big businesses which, as always, were better able to apply the regulations than small firms, and which could use the price controls to increase their profits and keep smaller, more efficient firms from competing against them. In the cleaners and dyers business in New Jersey, the industry set a “fair competition” price of 40 cents for pressing a suit. Before the Crash, tailors could charge 50 cents; now they were forced to charge 40 cents. Jacob Meged was a tailor of Polish descent who had a tailor shop at 138 Griffiths Street in Jersey City. He had a wife and four children and he needed money to feed his family. Other tailors were charging 40 cents, but he wanted to get more business, so he put a sign in his shop window advertising that he would press suits for 35 cents. After all, this was America where you were accustomed to being free to charge what you want. Beating the competition and being entrepreneurial was the American way, and he would be happy to press suits for 35 cents. Unfortunately, Jacob didn’t get more business and instead, he was arrested. J. Raymon Tiffany, Special Assistant Attorney General in charge of enforcing NRA codes in New Jersey took responsibility for prosecuting the tailor. When Jacob Meged was read the charges, he told Judge Kinkead that he was only vaguely aware of the existence of a code, but he pled guilty to the charge that he had violated the New Jersey State Recovery Act. Mr. Tiffany asked the court to impose a sentence stiff enough to warn other code violators that the law had teeth in it.  

UNSUITABLE JAIL SENTENCE

On Friday, April 20, 1934, Judge Robert V. Kinkead sentenced Jacob Meged to 30 days in the county jail, and he was ordered to pay a $100 fine. At 40 cents a suit, Meged would have to press 250 suits to cover his fine. That would be $100 he couldn’t use to feed his family, and in addition to this, he would lose a month’s earnings. As The New York Times put it, “He believed that the codes were designed to help the ‘little fellow’ and could not believe that by charging 35 cents instead of 40 cents to press a suit would put him behind bars. In court yesterday he stood as if in a trance when sentence was pronounced. He hoped that it was a joke.” It was no joke. Jacob Meged spent the weekend in jail, where he played checkers with fellow inmates. His case quickly became a cause célèbre, and although there is no record of it, over the weekend, political pressure was likely brought to bear upon Judge Kinkead to reverse the sentence. On Monday, Jacob Meged was called back before Judge Kinkead who remitted the fine and suspended sentence. Meged’s attorney explained that Meged had been ignorant of the meaning of the NRA, and now that the purpose of the NRA had been explained to him, he was anxious to comply. Judge Kinkead -who had no problem feeding his family, spoke to Meged like a father berating a little child. “I am glad you have come into court in a spirit of repentance…. The idea was to teach you a lesson. It never was the intention of this court that you pay the fine or be sent to prison. But there must be some way of impressing people who break the law that you did and it is necessary to demonstrate to people that the NRA State Act will be rigidly enforced.” The jocular judge even promised to be one of Meged’s customers if he raised his price to 40 cents for pressing a suit, though it is not known if Judge Kinkead ever followed up on his promise. Jacob Meged had an easy choice – shut up, do as you are told, comply, and you will be able to feed your family. Don’t comply and you could lose everything. So Jacob Meged did what he had to do. He went back to his shop. He took down the poster advertising his willingness to press a suit for 35 cents and replaced it with an NRA poster with the blue eagle on it. The photo of Jacob Meged at his shop, obviously staged, was published in newspapers with the caption: “The NRA is OK.” Jacob Meged also wired General Hugh Johnson, the head of the NRA, and let him know that he was “heartily in favor of it.” Meged was free from jail, but not free in spirit. He had to choose between his conscience and his family, and he chose his family. Although Jacob Meged’s incarceration was the most egregious result of the NRA, there were many other examples of the agency keeping people from competing freely in the market. As a result, in early 1935, the NRA announced that it would stop setting prices. The main supporters of the price controls had been the businessmen who ran the industries. According to Time Magazine, of the 2,000 businessmen that worked with the NRA, 90% opposed the chairman of the NRA’s decision to stop setting prices. Why compete with more agile, smaller firms when you can use the government to set up a cartel to protect you?  

FREED BUT NOT FREE

On May 27, 1935, in the court case of Schecter Poultry Corp. v. United States, the Supreme Court, in a unanimous decision, held that the mandatory codes section of the NRA was unconstitutional because it attempted to regulate commerce that was not interstate in character. They found that the codes represented an unacceptable delegation of power from the legislature to the executive. The Court held that the codes violated the United States Constitution’s separation of powers as an impermissible delegation of legislative power to the executive branch. The Court also held that the NIRA provisions were in excess of congressional power under the commerce clause. After the Supreme Court invalidated the NRA, Jacob Meged was free to speak his mind and indeed he did. When asked what he thought of the court’s ruling, he retorted . . . “[the] NRA never was any good and is no good now.” Nevertheless, the entire ordeal clearly took its toll on Jacob Meged. He became ill in 1938, went into the hospital on February 21, 1939 where he died at the young age of 54, only five years after initial arrest. Reviewing this misadventure of Joseph Meged, it makes you wonder about the unintended consequences of government interference in the marketplace. Who and when will be the next Joseph Meged? The government has proven it is able to enforce its writ regardless of the consequences, but I certainly hope that this time, the government will.