A Program for Monetary Reform
Encyclopedia
A Program for Monetary Reform is a July 1939 first draft proposal to repair and rebuild the American economic system following the Great Depression
which began with the sudden, devastating collapse of US stock market
prices on October 29, 1929, known as Black Tuesday and after apparent recovery in the mid-1930s was followed by the Recession of 1937-1938. The program was sent to the most complete list of academic economists available at the time. General approval of the program was expressed by 235 economists from 157 universities and colleges; another 40 economists approved of it with some reservations; only 43 economists expressed disapproval.
Joe Bongiovanni, cofounder of The Kettle Pond Institute for Debt-Free Money recalled that a copy of the draft proposal had been maintained by his father, Joseph T. Bongiovanni (1910–2001), a monetary reform advocate who had testified several times before the United States Congress Joint Economic Committee
on his own proposal for a Socio-Economic National Growth Act (SENGA) premised upon sound money and economic democracy
. Sadly, Bongiovanni's was lost.
Ronnie J. Phillips, then a Professor of Economics at Colorado State University
, referenced the draft proposal in his book, The Chicago Plan & New Deal Banking Reform (1995). Phillips is currently a Senior Fellow at the Networks Financial Institute at Indiana State University. .
Copies of the draft proposal stamped on the bottom of the first and last page, “LIBRARY - COLORADO STATE COLLEGE OF A. & M. A. - FORT COLLINS COLORADO” surfaced at the 5th Annual American Monetary Institute
Monetary Reform Conference (2009) and one was acquired for the Kettle Pond Institute by cofounder Pete Young. With the help of Jane Clary, Professor of Economics at the College of Charleston
, the images were scanned for dispay on the institute's web site.
in 1921. Together with the mathematician Charles W. Cobb, he developed the Cobb-Douglas
production function
(1928). He authored Real Wages in the United States, 1890-1996 (1930), The Theory of Wages (1934) and Social Security in the United States (1936; 2nd ed. 1939). Douglas was a professor of economics at the University of Chicago
when he coauthored A Program for Monetary Reform (1939).
He later went into politics and was elected to the United States Senate
where he served from 1948 until 1966. Douglas had a reputation of being an unconventional liberal; he passionately supported civil rights
but was equally concerned about fiscal discipline. He was best known for his support of environmental protection
, public housing
, and truth in lending laws. While serving in the Senate, Douglas authored the Consumer Credit Protection Act
and Ethics in Government (1952). After leaving the Senate, he held a position at The New School
for Social Research.
professor of economics who is best known for his work on the quantity theory of money
. Fisher was a true celebrity and one of the major influences on Milton Friedman
's monetarism
. Friedman called Fisher "the greatest economist the United States has ever produced." The Fisher equation
, the Fisher hypothesis
, the international Fisher effect
, and the Fisher separation theorem
are all concepts named after him.
The stock market crash of 1929 and the subsequent depression cost Fisher much of his personal wealth and academic reputation. He famously predicted, a few days before the crash, "Stock prices have reached what looks like a permanently high plateau." Irving Fisher stated on October 21 that the market was "only shaking out of the lunatic fringe" and went on to explain why he felt the prices still had not caught up with their real value and should go much higher. On Wednesday, October 23, he announced in a banker’s meeting “security values in most instances were not inflated.” For months after the October 29 crash, he continued to assure investors that a recovery was just around the corner. Fisher was so discredited by his 1929 pronouncements and by the failure of a firm he had started that few people took notice of his debt-deflation analysis of the depression.
Fisher believed that deflation was the principal cause of the disastrous cascading insolvencies then plaguing the American economy. He said that deflation had increased the real value of debts fixed in dollar terms. Fisher was also convinced that unemployment was linked to the unstable buying power of the dollar. Fisher's influence as a coauthor is apparent in A Program for Monetary Reform (1939). Today, his views on debt-deflation as the cause of periodic recessions, depressions and unemployment are getting new attention.
professor of economics whose early papers influenced theories on international trade and general equilibrium. He coauthored A Program for Monetary Reform (1930) opposing the gold standard
. Graham supported a market basket
standard for currency which he believed would lead to full employment
. His theories are brought together in Social Goals and Economic Institutions (1948).
(1927–1944) when he coauthored A Program for Monetary Reform (1939). He was later a professor of economics at Northwestern University
(1944–1947) and the University of Chicago
(1947–1967), and was Distinguished Professor of Economic History at the State University of New York at Binghamton (1966–1969). He authored War and Prices in Spain, 1651-1800 (1947), served as editor of the Journal of Political Economy
(7 years) and was the president of the Economic History Association
(1951 to 1952).
in rural Nebraska. He attended and graduated from the University of Nebraska (1905) before receiving his PhD in Philosophy from the University of Wisconsin-Madison (1913). King moved to Washington, D.C.
and became a statistician with the United States Public Health Service
(1917–1920) and then an economist with the National Bureau of Economic Research
(1920–1927).
He left public service to become a professor of economics at New York University
(1927–1945). It was at this time that King coauthored A Program for Monetary Reform (1939). He opposed the New Deal
, instead advocating a sliding scale of wages based on production, currency expansion, and the reduction of taxes and regulations. He founded the Committee on Economic Accord (1933) and, after he retired, became chairman of the Committee for Constitutional Government, which sought to "uphold Constitutional principles and our system of free enterprise."
professor of economics.
Paul H. Douglas
University of Chicago
Irving Fisher
Yale University
Frank D. Graham
Princeton University
Earl J. Hamilton
Duke University
Willford I. King
New York University
Charles R. Whittlesey
Princeton University
”, work. No one can doubt that it is threatened. However, the danger lies less in the propaganda of autocratic Governments from abroad than in the existence, here in America, of ten millions of unemployed workers, sharecroppers living barely at subsistence level, and hundreds of thousands of idle machines. On such a soil fascist and communist propaganda
can thrive. With full employment
such propaganda would be futile.
The important objective, therefore, is to repair and rebuild our economic system
so that it will again employ our productive resources to the fullest practicable extent. A high scale of living
for our people will better protect our cherished American democracy than will all the speeches and writings in the world.
Our problems are not simple and we can offer no panacea to solve them. We believe, however, that certain fundamental adjustments in our economy are essential to any successful attempt to bring our idle men, materials, land and machines together. These fundamental adjustments would, we believe, be facilitated by the monetary reform
here proposed.
Throughout our history no economic problem has been more passionately discussed than the money
problem. Probably none has had the distinction of suffering so much from general misunderstanding – suffering from more heat than light. As a result, not only is our monetary system now wholly inadequate and, in fact, unable to fulfill its function; but the few reforms which have been adopted during the past three decades have been patchwork, leaving the basic structure still unsound.
In analyzing this problem, we concluded that it is preeminently the responsibility of American economists to present constructive proposals for its solution. But, before organizing a movement for monetary reform, we wished to determine how many of our colleagues agree with us. For this purpose we drew up “A Program for Monetary Reform” and sent this to the completest available list of academic economists which, we believe, comprise the essential features of what needs to be done in order to put our monetary system into working condition. Up to the date of writing (July, 1939) 235 economists from 157 universities and colleges have expressed their general approval of this “Program”; 40 more have approved it with reservations; 43 have expressed disapproval. The remainder have not yet replied.
We want the American people to know where we stand in this important matter. The following is the first draft of an exposition of our “Program”, and the part it may play in reconstructing America.
Paul H. Douglas
Irving Fisher
Frank D. Graham
Earl J. Hamilton
Willford I. King
Charles R. Whittlesey
July 1939
problem. It is intended to eliminate one recognized cause of great depressions, the lawless variability in our supply of circulating medium.*
No well informed person would pretend that our present monetary and banking machinery is perfect; that it operates as it should to promote an adequate and continuous exchange of goods and services
; that it enables our productive resources – our labor, materials
, and capital
– to be fully or even approximately employed. Indeed, the contrary is the fact. If the purpose of money and credit
were to discourage the exchange of goods and services, to destroy periodically the wealth produced, to frustrate and trip those who work and save, our present monetary system would seem a most effective instrument to that end.
Practically every period of economic hope and promise has been a mere inflation
ary boom, characterized by an expansion of the means of payment, and has been followed by a depression, characterized by a detrimental contraction of the means of payment. In boom times, the expansion of circulating medium accelerates the pace by raising prices, and creating speculative profits. Thus, with new money raising prices and rising prices conjuring up new money, the inflation proceeds in an upward spiral till a collapse occurs, after which the contraction of our supply of money and credit, with falling prices and losses in place of profits, produces a downward spiral generating bankruptcy, unemployment, and all the other evils of depression.
The monetary reforms here proposed are intended primarily to prevent these ups and downs in the volume of our means of payment with their harmful influences on business. No claim is made, however, that this will entirely do away with “business cycles”.
. Gold
is still, and may always remain, an important part of the machinery of foreign trade and exchange. But it is no longer, and probably never again will be, the sole reliance for determining the “internal value” of monetary units. Even those who advocate some degree of return toward the former gold standard are, as a rule, now convinced that it must be “managed” and never again left to work “automatically”.
Up to 1931, the great majority of the countries of the world were on the gold standard. The characteristics of the gold standards may be briefly summarized as follows:
(a) The dollar
, franc
, guilder, or other monetary unit was the equivalent of, and usually was redeemable in, a fixed amount of gold of a certain fineness
. For instance, the American dollar was a definite weight of gold (23.22 grains of fine gold). This made an ounce of gold 9/10 fine identical with $20.67. Conversely, $20.67 was convertible into an ounce of gold of this quality. In other words, “one dollar” was roughly a twentieth of an ounce of gold or precisely 100/2067ths of an ounce.
After the war, chiefly as a result of a shortage in gold reserves, some of the smaller nations changed their currencies by making them redeemable in some foreign currency which, in turn, was convertible into gold. This system was called the gold-exchange standard. For these small nations, our dollar, the pound sterling
and similar gold currencies, such as the Dutch guilder and the Swiss franc were “as good as gold”.
(b) Because every gold currency was redeemable in a fixed amount of gold, the exchange relationship of those currencies to each other was to all intents and purposed fixed: That is, the foreign exchange rates of gold-standard currencies were constant, or only varied within extremely narrow limits. A grandiose ideology has been built up on this so-called “stability” of gold-standard currencies. The public has been confused and frightened by the cry, “the dollar is falling” or “the French franc is falling”, which simply means falling with reference to gold; whereas it may well have been that the real trouble was that the value of gold was rising with reference to commodities. Indeed such was often the case. Yet the uninformed public never realized that the so-called “stability” of the golden money had little to do with any stability of buying power over goods and services
. In fact, the buying power of so-called “stable” gold currencies fluctuated quite violently, because the value of gold itself was changing. Perhaps the most vicious feature of the gold standard was that, so long as exchange rates – the price of gold in terms of gold – remained unchanged, the public had a false sense of security. In order to maintain this misleading “stability” of gold and exchange rates, the “gold bloc” nations periodically made terrific sacrifices which not only destroyed their prosperity, and indeed brought them to the brink of bankruptcy, but ultimately destroyed the gold standard itself.
(c) In order to assure the redemption of national currencies in gold, the central banks were accustomed to maintain, behind their note
issues, a reserve
of upwards of forty per cent in gold or gold exchange.
(d) The extent of gold movements under this system led the central banks to regulatory action. For instance, if large amounts of gold began to vanish from a central bank, either to pay for a surplus of commodity imports or by way of withdrawals for speculative purposes, the banks among other things raised interest rates in order to discourage borrowing from it and thus put a stop to gold withdrawals. Thus the disappearance of gold from the banks led them automatically to take deflationary action; for it curtailed the volume of bank credit outstanding. This feature of gold-standard machinery, in most cases, worked efficiently enough to its end. But it often brought depression as the price of maintaining a fixed gold unit.
When there was an excess of commodity exports from a given country, or a flight to it of gold from foreign countries, its central bank was similarly supposed to lower interest rates, thus stimulating lending, with a consequent withdrawal of gold from the bank. But after the war this automatic regulatory mechanism worked badly or not at all.
In September 1931 England
found it impossible to maintain her gold reserves and was forced off the gold standard. Since then, every other gold-standard nation has either been forced off gold or has abandoned it voluntarily. Those countries which bowed first to this pressure were also the first to recover from the depression. France
was among the last to abandon gold; and she is still suffering from her mistake in waiting so long.
The depression experience of all countries under the gold standard has shown that it is scarcely worthy of being called a “standard” at all. It has shown that the so-called “stability” of gold and of foreign exchange destroyed the stability of the buying power of money and thereby the stability of economic conditions generally. In fact, the effort to retain gold as a “standard” has had such disastrous results all over the world that, for the time being, international trade has been deprived of some of the useful services which gold might still render it.
It may be that America
cannot solve the problem of the function of gold in the monetary relations among nations without the cooperation of other nations. The Tri-Partite Agreement
, concluded in 1936 by England, France, and ourselves – at our initiative – may well serve as a first tentative step in the direction of such a solution. The point here, however, is that we need not wait for international agreements in order to attack our domestic monetary problems.
But now that the central banks no longer operate according to the old rules of the gold standard, how do they determine their monetary policies? What “standard” has replaced the gold standard?
In the determination of a nation’s monetary policy
, the needs of its domestic economy
have taken the place of the arbitrary rules of the gold standard. After the experience of the past decade, it is improbable that many countries will want to give their currencies arbitrary gold values at the cost of domestic deflation and depression. At present healthy domestic economic conditions are generally given precedence over the maintenance of a fixed money value of gold. This is a great step forward. The countries which have consistently followed this new line have more nearly solved their depression problems than have those that have sought to compromise by permitting considerations other than domestic welfare to determine their monetary policies. And for the United States stability in the domestic purchasing power of the dollar is certainly of far more importance than stability in its exchange value in terms of foreign monetary units.
(3) Some countries, especially the Scandinavian and others included in the so-called “Sterling Bloc”, have gone further than the United States in formulating and in carrying out these new monetary policies.
On abandoning the gold standard in 1931, the Scandinavian
countries took steps to maintain for the consumer a constant buying power for their respective currencies. Finland
’s central bank made a declaration to this effect. The Riksbank of Sweden
has done the same, and its action was officially confirmed by the Swedish Government. As a result, since then people of those fortunate lands have never lost confidence in their money. The buying power of their monetary units have been maintained constant within a few per cent since 1931. At the same time, these countries have made conscious use of monetary policy as an essential part of their efforts to promote domestic prosperity. They have been so successful as to have practically eliminated unemployment to have raised their production figures to new peaks and to have improved steadily the scale of living of their people.
(4) Our own monetary policy should likewise be directed toward avoiding inflation as well as deflation and attaining and maintaining as nearly as possible full production and employment.
There is ample evidence that the Roosevelt Administration
once had every intention of managing our money on these principles. As early as July 3, 1933, in his famous message to the London Economic Conference
, President Roosevelt
declared:
“…old fetishes of so-called international bankers are being replaced by efforts to plan national currencies with the objective of giving those currencies a continuing purchasing power which does not greatly vary in terms of commodities and the need of modern civilization.
“Let me be frank in saying that the United States seeks the kind of dollar which a generation hence will have the same purchasing and debt-paying power as the dollar value we hope to attain in the near future…”
This was definite notice to the assembled financial representatives of the world’s nations that the United States had abandoned the gold standard and adopted in its place a policy of dollar management designed to keep the dollar’s buying power constant. In several talks during 1933, the President reaffirmed this principle of a “managed currency
”. However, some people saw danger of arbitrary changes in the gold content of the collar and feared that the discretionary powers of the President would serve as a disturbing influence. Apparently the President was influenced by those views, hence after fixing the new gold content of the dollar on January 31, 1934, he has allowed it to remain unchanged. That is, while professing adherence to the doctrine of a dollar of stable domestic buying power, the Administration has compromised and, in effect, followed a policy of giving the dollar a fixed gold content, within certain limits, whenever it should seem to require such treatment.
The purchasing power of our dollar has therefore not been consistently stabilized. Neither, on the other hand, have we had a genuine gold standard – or even any standard. We have vacillated between the two rival systems of monetary stability: The internal and external. The very rigidity of our gold price has, however, exposed the dollar to the disturbing influences of “hot money” from abroad and has probably been an obstacle to recovery in this country.
So long as we have no law determining what our monetary policy shall be there will always be uncertainty as to the external and internal values of the dollar. Consequently, there is an ever-present danger of abuse of discretionary powers, not only the President
’s powers but those of others as well. The Secretary of Treasury, for instance, has discretionary power to issue silver certificates and, for that purpose, to buy silver
. He is also free to use, as he pleases, the two billion dollars in stabilization account and thus influence foreign exchange. The Board of Governors of the Federal Reserve System
may change the reserve requirements of banks, may buy or sell Government bonds in the open market, may change discount rate
s, and in other ways effect the volume of credit and so the purchasing power of the dollar. Even our gold miners, and still more the miners of gold abroad, may effect the volume of money in circulation in the United States, since fore every ounce of gold they turn over to the United States Mint
, the Treasury increases our volume of money
by $35. Lastly, our 15,000 commercial banks affect the value of the dollar by expanding
, or contracting
, the volume of demand deposits when they either make or liquidate loans, and when they purchase or sell securities.
Our monetary system is thus permeated with discretionary powers. But there is no unity about it, no control, and, worst of all, no proscribed policy. In a word, there is no mandate based on a definite principle.
Up to the present time Congress
has merely given our monetary agencies certain broad powers, with no explicit directions as to how those powers should be used. Today we have no clear and definite standard by which to measure success or failure and, consequently, there is no way by which we can tell clearly and definitely whether the divers agencies are giving us the best service the can.
For instance, our most powerful monetary agency, the Board of Governors of the Federal Reserve System, proceeds on the basis of a broad statement of general principles which it published in September, 1937. This is not the law, but merely and expression of opinion on the part of the members of the Board as to what they, at that particular time, thought they ought to do. There is no compulsion about it. It is not binding on the Board itself. It said:
“…The Board believes that economic stability
rather than price stability should be the general objective of public policy. It is convinced that this objective cannot be achieved by monetary policy alone, but that the goal should be sought through coordination of monetary and other major policies of the Government which influence business activity, including particularly policies with respect to taxation, expenditures
, lending, foreign trade, agriculture
and labor.
“It should be the declared objective of the Government of the United States to maintain economic stability and should be the recognized duty of the Board of Governors of the Federal Reserve System to use all its powers to contribute to a concerted effort by all agencies of the Government toward the attainment of this objective.”*
As mentioned before, the maintenance of a substantially constant buying power of the Swedish and Finnish currencies is not inconsistent with the establishment and maintenance of prosperous economic conditions. On the other hand, there is no record of any experience of sustained economic equilibrium
without some degree of price-level stability. In a general way, however, the Board’s declaration conformed to the general principles of monetary stability enunciated by President Roosevelt in 1933, although the President was much more specific than the Board in mentioning the objective of “stable buying power.” The Board declared emphatically what it believed it could not do. As to what is could do, or intended to do, it made, at best, only a vague statement. It may, at any time in the future, in order to justify an action or lack of action to which it many be inclined, interpret this statement as it pleases or repudiate it altogether. That is, the Board is now free to reserve to itself the widest possible discretion in the use of its powers under any circumstances that may arise. What certainty is there that it has not already changed its mind on the subject without having made another declaration? What obligation would a new member of the Board feel for the opinions expressed by his predecessors? What does the public know of the real aims of the Board?
Once Congress determines the criteria of monetary policy, many current erroneous beliefs in erratic varieties of “managed currency” as a cure-all for our economic ill may be replace by more rational views as to the many important things that need to be done outside the monetary field in order to put our economic system into working condition. Unless disturbing monetary factors have first been largely eliminated, the relative importance of other necessary measures cannot be determined.
(6) The criteria for monetary management adopted should be so clearly defined and safeguarded by law as to eliminate the need of permitting any wide discretion to our Monetary Authority
.
That is, unless we tell one single responsible Monetary Authority exactly what is expected of it, we can never call it to account for not giving us the kind of policy we wish. When there is no definite direction in the law, the Monetary Authority (or as matters are now, authorities) cannot possibly function as a united body, but will make decisions under the ever-varying domination of different interests and different personalities. This vacillation cannot be avoided, and, in the past, it has been one of the weak points in the operation of the Federal Reserve System. Mr. Adolph Miller, a member of the Federal Reserve Board for twenty years, brought this weakness to light on the occasion of a Congressional Hearing
:
“I have in mind, vaguely, whatever happens to be the dominant influence in the Federal Reserve System, and that is expressing itself in the line of policy undertaken. It may today be this individual or group; tomorrow it may be another. But wherever any important line of action or policy is taken there will always be found some one or some group whose judgment and whose will is the effective thing in bringing about the result. There’s the ear which does the hearing of the system.”*
This uncertain condition is one which a law could and should make impossible.
(a) Establish a constant-average-per-capita
supply or volume of circulating medium
, including both “pocket-book money” and “check-book money” (that is, demand deposits or individual deposits subject to check). One great advantage of this “constant-per-capita-money” standard is that it would require a minimum of discretion on the part of the Monetary Authority.
(b) Keep the dollar equivalent to an ideal “market basket
dollar”, similar to Sweden’s market basket krona
. This market basket dollar would consist of a representative assortment of consumer goods in the retail markets (so much food
, clothing
, etc.), thus constituting the reciprocal of an index
of the cost of living. Under this “constant-cost-of-living” standard the Monetary Authority would, however, as has been found in Sweden, have to observe closely the movements of other, more sensitive indexes, with a view to preventing the development of disequilibrium as between sensitive and insensitive prices.
Under the former of those two arrangements all the Monetary Authority would have to do would be to ascertain the amount of circulating medium in active circulation whatever amount of circulating medium seemed necessary to keep unchanged the amount of money per head of population. For this purpose, the statistical information regarding the volume of means of payment
should be improved. At present, we have on the weekly figures of leading banks and the semi-annual figures of the Federal Deposit Insurance Corporation
.
It is also evident that the Monetary Authority would have to be empowered to regulate the total money supply
, including demand deposits of commercial banks, which would have to furnish appropriate data every week. Thus, correct statistical information would, under this constant-per-capita-volume-of-money criterion, clearly prescribe the duties of the Monetary Authority, and automatically reduce to a minimum the possibility of a discretionary, hit-or-miss decision on a given occasion.
It is believed by some competent students that the annual money income of the nation tends to remain in a fairly constant ratio to the means of payment in circulation. This ratio is alleged to be approximately 3 of income to 1 of circulating medium. If this is true, a constant-per-capita volume of circulating medium would be substantially the equivalent of a constant per capita money income. In other words, we could keep per capita money income stable by keeping constant the per capita volume of circulating medium.
One consequence of this would be that technological improvements, resulting in an increase in the national real income
, would not change the national money income but, as real income increased, the price level would fall. Some authorities regard prices falling, to some extent at least, with technological improvements, as a proper result of a successful monetary policy.*
The experience of Sweden during the past eight years shows that, with the help of monetary management, it is possible to maintain at a substantially constant level the consumer buying power of a currency. This stability in Sweden has not prevented a readjustment in the prices of farm products, and other raw materials which had fallen to unduly low levels.
Violent changes in the volume of money affect not only the general price level, but also the relationship of prices to each other within the price structure. Conversely, a constant volume of money tends ultimately to stabilize not only the general price level, but the relations within the price structure. The retail prices involved in the cost-of-living index, being relatively “sticky
”, do not afford all the information necessary for regulating the volume of money. The Monetary Authority might therefore find it desirable to include in its standard some commodities having “sensitive” prices, in order to make its actions respond more quickly to the direction in which things are moving.
Under a “constant-cost-of-living” or “market-basket” dollar technological improvement would not find expression in a falling price level, but rather in a higher per capita money income
and larger money wage
for labor. With present labor policies, there would be a strong tendency for money wages to keep pace with technological progress. In fact one of the advantages of the “constant cost of living” standard is its easier comprehensibility and its presumably greater appeal to labor.
Other standards besides the two here mentioned might be proposed.
Whatever technical criterion of monetary stability is adopted, as mentioned under (4) above, the ultimate object of monetary policy should not be merely to maintain monetary stability. This monetary stability should serve as a means toward the ultimate goal of full production and employment and a continuous rise in the scale of living. Therefore, the Monetary Authority should study the movements of all available indicators of economic activity and prosperity with a view to determining just what collection of prices, if stabilized, would lead to the highest degree of stability in production and employment.
Essentially, however, the purpose of any monetary standard is to standardize the unit of value
– just as a bushel
standardizes the unit of quantity
, and an ounce
standardizes the unit of weight
. To furnish a dependable standard of value should therefore be the only requirement of monetary policy. It would be fatal if the public were led to believe that the Monetary Authority, solely through monetary manipulations, were able to assure the maintenance of prosperity
, and should therefore be made responsible for it. Any such assumption would probably mean the demise of the Monetary Authority in the first period of adversity.
should be enacted, embodying the following features:
(a) There should be constituted a “Monetary Authority” clothed with carefully defined powers over the monetary system of the country, including the determination of the volume of circulating medium.
That is, the “Monetary Authority” would become the agent of Congress in carrying out its function as set forth in the Constitution
, Article I
, Section 8, - “to coin money, regulate the value therof, and of foreign coin…” This Monetary Authority would receive all the powers necessary to “regulate” – in particular, the power to determine – the value of circulating medium and the domestic and foreign value of the dollar. All of the miscellaneous powers now scattered among the Federal Reserve Board, the Secretary of the Treasury, the President and others would have to be transferred to this one central Monetary Authority.
Not only would such a mandate cause the Monetary Authority to use all of its powers for the purpose of attaining the standard set by Congress; but it would also prevent the abuse of those powers. The Monetary Authority would then have a definite standard to attain and maintain.
Unless the Monetary Authority were free from the pressure of both the party politics
and selfish interests, there would be no guarantee that, in making its decisions, it would be guided solely by the mandate given to it by Congress.
One way to secure the requisite independence is by the exercise of great care in appointment of members, by paying them adequate salaries and by making provisions for retirement pensions. Politics as well as the pressure of interested financial groups should be ruled out so far as practically possible. The members should be selected solely on the basis of their fitness for the job and should be subject to removal by Congress for acting in opposition to the mandate laid down by it.
The Monetary Authority should, of course, have the widest possible discretion with respect to the methods it might find most suitable for attaining the objectives laid down in the mandate. That is, it should be absolutely free to use any or all of its powers over money and the banks according to its own best judgment; but, as has been stressed before, the Monetary Authority should not be free to deviate from the mandate given to it by Congress.
, should be transferred to the Monetary Authority.
However, in determining its course of action the Monetary Authority should take note of all other activities of the Government intended to affect or likely to affect economic conditions, and it should, when necessary, cooperate with other agencies of the Government.
In the emergency of 1933-34
, the absence of any permanent monetary agency capable of handling the situation was a valid reason for giving the President and the Secretary of the Treasury emergency powers over our monetary machine. Even now, so long as we have no single Monetary Authority specifically charged by Congress to carry out a defined policy, there is much reason for continuing these discretionary powers. But once Congress has established a Monetary Authority and given it a mandate, no other agency should then have any concurrent or conflicting powers.
There is less danger in giving to a Monetary Authority of the type described above any or all of the powers necessary to control our monetary system, than there is in the present system under which wide discretionary powers are assigned to several agencies with more or less conflicting interests and with inadequate instructions to any of them concerning the use of them.
The Monetary Authority should be instructed to cooperate with non-monetary agencies in its endeavors to promote stability. This policy should include, in particular, cooperation with the Secretary of the Treasury, but the independence of the Monetary Authority must be scrupulously safeguarded.
Some nine-tenths of our business is transacted, not with physical currency
, or “pocket-book money”, but with demand deposits subject to check, or “check-book money”. Demand deposits subject to check, though functioning like money in many respects, are not composed of physical money, but are merely promises by the bank to furnish such money on the demands of the respective depositors. Under ordinary conditions only a few depositors actually ask for real money; therefore, the banks are required to hold as a cash reserve only about 20 per cent of the amounts they promise to furnish. For every $100 of cash which a bank promises to furnish its depositors, it needs to keep as a reserve only about $20. And even this reserve is not actual cash on hand. It is nothing but a “deposit” with a Federal Reserve Bank, though any fraction of this may, in fact, be borrowed from the Reserve Banks themselves. Even this borrowed money is merely the Reserve Banks’ promise to pay money. In other words, the whole of the 20 per cent legal reserve is itself merely a promise by the Federal Reserve Bank to furnish money. Nevertheless, the banks’ promises to their demand depositors actually circulate as if they were real money, so that the bank, in fact, floats its non-interest bearing debt as money. The depositor checks against his balance in the bank as if it were really there, and the recipient of the check looks on it in the same way. So long as not too many depositors ask for money, the promises of the bank are thus able to perform all the functions of money.
The question which naturally occurs is: How do these demand deposits affect the volume of the circulating medium?
When a bank makes a loan or purchases bonds, it increases its own promises to furnish money on demand by giving to the borrower, or to the seller of the bond, a demand deposit credit. By so doing it increases the total volume of demand deposits in circulation. Conversely, when the loan is repaid to the bank, or the bond is sold by the bank, the demand deposits are reduced by that much. Thus bank loans first increase, and repayment later decreases, the total volume of the country’s circulating medium.
Ordinarily the increases and decreases roughly balance; but, in boom periods, the increases preponderate and thus drive the boom higher, whereas, in depression periods, the decreases preponderate and thus further intensify the depression. In booms, many are eager to borrow; in depressions, lenders are loath to lend money but eager to collect. It is this over-lend and over-liquidate factor that tends to accentuate booms and depressions, and it is the tie between the volume of bank loans and the volume of the circulating medium which is responsible. It is this system which permits and practically compels the banks to lend and owe five times as much money as they must have on hand if they are to survive in the competitive struggle which causes much of the trouble.
Despite these inherent flaws in the fractional reserve system, a Monetary Authority could unquestionably, by wise management, give us a far more beneficial monetary policy than the Federal Reserve Board has done in the past. But the task would be much simplified if we did away altogether with the fractional reserve system; for it is this system which makes the banking system so vulnerable.
With such a dollar-for-dollar backing, the money which the bank promised to furnish would actually be in the bank. That is, with the requirement of a 100% reserve, demand deposits subject to check would actually become deposits of money, and no longer be merely the bankers’ debts. If, today, those who think they have money in the bank should all ask for it, they would, of course, quickly find that the money is not there and that the banks could not meet their obligations. With 100% reserves, however, the money would be there; and honestly run banks could never go bankrupt as the result of a run on demand deposits.
The 100% reserve system
was the original system of deposit banking, but the fractional reserve system was introduced by private Venetian bankers not later than the middle of the Fourteenth century. Originally they merely accepted deposits of actual cash for safe keeping, the ownership of which was transferrable by checks or by a proto-type of what we now call checks
. Afterward, the bankers began to lend some this specie
, though it belonged not to them but to the depositors. The same thing happened in the public banks of deposit at Venice
, Amsterdam
, and other cities, and the London
goldsmith
s of the Seventeenth century found that handsome profits would accrue from lending out other people’s money, or claims against it – a practice which, when first discovered by the public, was considered to be a breach of trust. But what thus began as a breach of trust has now become the accepted and lawful practice. Nevertheless, the practice is incomparably more harmful today than it was centuries ago, because, with increased banking, and the increased pyramiding now practiced by banks, it results in violent fluctuations in the volume of the circulating medium and in economic activity in general.
(a) The simplest method of making the transition from fractional to 100% reserves would be to authorize the Monetary Authority to lend, without interest, to every bank or other agency carrying demand deposits, sufficient cash (Federal Reserve notes, other Federal Reserve credit, United States notes, or other lawful money) to make the reserve of each bank equal to its demand deposits.
The present situation would be made the starting point of the 100% reserve system by simply lending to the banks whatever money they might need to bring the reserves behind their demand deposits up to 100%. While this money might, largely be, newly issued for the occasion – for example, newly issued Federal Reserve notes – it would not inflate the volume of anything that can circulate. It would merely change the nature of the reserves behind the money which circulates. By making those reserves 100%, we would eliminate a main distinction between pocket-book money and check-book money. The bank would simply serve as a big pocket book to hold its depositors’ money in storage. If, for instance, new Federal Reserve notes were issued and stored in the banks, as the 100% reserve behind the demand deposits, a person having $100 on deposit would simply be the owner of $100 of Federal Reserve notes thus held in storage. He could either take his money out and make payments with it, or leave it in and transfer it by check. The $100 depositor would have $100. Furthermore, the bank could not inflate by lending out the $100 on deposit, for, under the 100% system, that $100 would not belong to the bank nor even be within the bank’s control.
The power of the banks either to increase or decrease, that, to inflate or deflate, our circulating medium would thus disappear over night. The banks’ so-called “excess reserves
” would disappear, and with them one of the most potent sources of possible inflation. At present, because of the fractional reserve system, the banks could conceivably, on the basis of their enormous excess reserves, inflate their demand deposits by about twenty billion dollars. The Federal Reserve Board’s present powers are inadequate fully to control this situation. The Board realized this danger when it stated, in its Annual Report for 1938:
“The ability of the banks greatly to expand the volume of their credit without resort to the Federal Reserve banks would make it possible for a speculative situation to get under way that would be beyond the power of the system to check or control. The Reserve System would, therefore, be unable to discharge the responsibility placed upon it by Congress or to perform the service that the country rightly expects form it.”
Moreover, the Board’s present machinery is so clumsy that almost any attempt to counteract a threat of inflation might produce deflation.
(b) A second method of making the transition would be to let each bank count as cash reserve up to a specified maximum, its United States Government bonds (reckoned at par
), and to provide for their conversion into cash by the Government on the demand of the bank. This method of transition would be particularly easy today, because the banks already hold nearly enough cash and Government bonds to fulfill the proposed 100% reserve requirement.
Thus, under the proposed arrangement, the banks would need only $3,7 billions of new cash or Government bonds to satisfy a 100% reserve requirement. We could, therefore, today introduce the 100% reserve system and stabilize our banking situation, without causing any very disturbing changes in bank earnings from interest on federal bonds. While, under the plan proposed, those new funds would be distributed among banks automatically, as needed, to raise reserves, in practice almost three-fourths of the required new money would be needed at this time by the large banks in New York
, which function as the “Bankers' bank
s” for the small country banks. For New York State alone “interbank deposits” exceeded “interbank balances” by $2,8 billions (December 31, 1938). A similar situation exists in the large banks in the rest of the country. The problem is thus largely one of putting interbank deposits on a 100% reserve basis. The Federal Reserve Board has repeatedly considered taking this stop, and it has often been discussed, particularly early in 1939.
The amount of Government bonds which the banks would be permitted to hold on their own volition, as part of their reserve behind demand deposits, should be limited to the amount they held on the day when the 100% reserve requirement went into effect. As to any future additions to that volume (or subtractions from it as the bonds matured) the Monetary Authority would decide from time to time solely on the basis of the legal criterion of stability under which it was operating. The banks would be permitted to sell their reserve bonds to the Monetary Authority at any time, thus converting their reserves into cash.
One of the main reasons why the Board of Governors of the Federal Reserve System is not able to carry out a more effective policy of increasing our volume of circulating medium, thus helping recovery, is that it has no direct and immediate control. Open-market purchases of Government bonds by the Board may merely increase bank reserves, and not increase the volume of money, because, as the Board said “it cannot make the people borrow
,” nor can it make the commercial banks invest. Under the 100% reserve system, however, such purchases of bonds by the Monetary Authority would directly and correspondingly increase the volume of circulating medium. Conversely the sale of such bonds by the Federal Reserve Banks would directly and correspondingly reduce the volume of circulating medium when that was desired.
The point is sometimes made, however, that, even under the 100% system, the availability of an increased volume of circulating medium would not necessarily assure a correspondingly increased use of money. For example, the banks might hold an excess of “free” cash and be either unable or unwilling to invest or lend it, with the result that production and employment could not be maintained.
In such a case, it would, of course, be imperative for the Monetary Authority to increase the volume of circulating medium still further. However, instead of purchasing more bonds from banks, or from others, who might not employ the funds thus obtained, it might buy bonds from the public. The circulating medium could be reduced by the converse process whenever this was necessary.
The profit to the Government from the creation of new circulating medium would be a fitting reward for supplying us with such increased means of payment as might become necessary to care for an increased volume of business.
As we have seen, the banks have often expanded the volume of the means of payment when it should have been contracted, and contracted it when it should have been expanded. For this, bankers are not to be blamed; the fault lies with the system which ties the creation of our means of payment to the creation of the debts to, and by, the banks. Moreover, this system has been advantageous to the banks only by fits and starts, chiefly during boom periods when the volume of loans was high. When crash and depression have arrived, the system has resulted in serious trouble for the banks. Thousands of banks failed primarily because of “frozen” assets due in large part to the fact that their demand deposits were based on slow assets like land and industrial equipment which could not yield cash when suddenly needed. This fact greatly aggravated the banks’ embarrassment from the fractional reserve system.
Moreover, the independent and uncoordinated operations of some 15,000 separate banks result in haphazard changes in the volume of money and make for instability, with periodic depressions and losses to the banks themselves as well as to others.
In the past, before bank reserves were greatly weakened, the banks made tremendous profits firstly by lending out bank notes at interest, and later by lending “deposits” both of which they had themselves created. But as time went on these bonanza profits on bank notes and demand deposits became smaller and smaller as the reserve ratios became weaker and weaker, and the banks’ ability to meet their demand liabilities became more and more precarious. Eventually, ruin ensued, both to business and banking not only because operating profits were less but even more because of the havoc played with the value of their capital assets. In the ten years from 1927 to 1937 more than ten thousand banks closed their doors, with enormous losses to the stockholders as well as to the depositors and the public in general.
The assumption by the Monetary Authority of the money-creating responsibility would incidentally benefit the Government, by reducing the interest-bearing public debt pari passu
with every dollar of new currency money put out. It would benefit both the public and the banks, by preventing panics and resulting failures; and it would benefit the public because of the greater stability of prices, employment, and profits.
In early times, the creation of money was the sole privilege of the kings or other sovereigns – namely the sovereign people, acting through their Government. The principle is firmly anchored in our Constitution and it is a perversion to transfer the privilege to private parties to use in their own real, or presumed, interest.
The founders of the Republic did not expect the banks to create the money they lend. John Adams
, when President, looked with horror upon the exercise of control over our money by the banks.
checking accounts.
Under the present fractional reserve system, if any actual money is deposited in a checking account, the bank has the right to lend it out as belonging to the bank and not to the depositor. The legal title to the money rests, indeed, in the bank. Under the 100% system, on the other hand, the depositor who had a checking account (i.e., a demand deposit) would own the money which he had on deposit in the bank; the bank would simply hold the money in trust for the depositor who had title to it. As regards time or savings deposits, on the other hand, the situation would, under the 100% system, remain essentially as it is today. Once a depositor had brought his money to the bank to be added to his time deposit
or savings account
, he could no longer us it as money. It would now belong to the bank, which could lend it out as its own money, while the depositor would hold a claim against the bank. The amount, in fact, ought no longer to be called a “deposit”. Actually it would be a loan to the bank.
Now let us see how, under the 100% system, the banks would be able to make loans, even though they could no longer us their customers’ demand deposits for that purpose.
There would be three sources of loanable funds. The first would be in the repayments to the banks of existing loans of circulating medium largely created by the banks in the past. Such repayments would release to the banks more cash than they would need to maintain 100% reserve behind demand deposits; and this “free” cash they would be able to lend out again. The banks would, therefore, suffer no contraction in their present volume of loans. They would have a “revolving fund” of approximately sixteen billions (as of December 31, 1938) of “Loans, Discounts and Overdraft
s (including Rediscount
s)” with which to operate under the 100% system. The banks could keep these sixteen billions of loans revolving indefinitely by lending them out or investing them as they were repaid.
The second sources of loans would be the banks own funds, capital
, surplus
, and undivided profits
which might be increased from time to time by the sale of new bank stock
.
The third source of loans would be new savings “deposited” in savings accounts or otherwise borrowed by the banks. That is, the banks would accept as time or savings deposits the savings of the community and lend such funds out again to those who could put them to advantageous use. In this manner, the banks might add without restraint to their savings, or time, deposits, but not to the total of their demand deposits and cash.
However, there would, of course, be a continuous moving of demand deposits from one bank to another, from one depositor to another and from demand deposits into cash and vice versa. To increase the total circulating medium would, nevertheless be the function of the Monetary Authority exclusively.
The Government ought, as soon as possible, to retire from the banking and money-lending business, into which the recent emergency has driven it. While depending on our banks to mint
our money, we have come more and more to depend upon Uncle Sam
to be our banker and source of loanable funds. The appropriate functions of each have thus been perverted to the other. Uncle Sam has been acting through the R.F.C.
, H.O.L.C.
, the F.S.C., the Commodity Credit Corporation
, the A.A.A., and other lending agencies. Between the Government as a banker and the commercial banks there is, however, an essential difference: The banks can create the money they lend, while the Government borrows this money in order to perform the appropriate function of the banks. The 100% reserve system would put an end to this pernicious reversal of functions. It would take the banks out of the money-creating business and put them back squarely into the money-lending business where they belong, and it would put the Government in the money-creating business, where it belongs, and take it out of the lending business, where it does not. The commercial banks would then be on a basis of parity
in short-term loans with lenders on long-term who have no power to create their own funds.
The question has been raised, whether, under the 100% system, the banks would not, through their loan policies, continue to exercise control over the volume of circulating medium. Might not the banks refuse to lend out their own money and the money saved by the community, and thus inevitably cause a shrinkage in the volume of actively circulating money? The answer is that, if such hoarding
should occur, the Monetary Authority could readily offset it by putting new money into circulation. But the likelihood that the banks would wish to hoard money on which they have to pay interest or dividends is not very great.
and withdrawal of checking deposits, withdrawals from time or savings deposits (including Postal Savings
) should be restricted and subject to adequate notice. Only thus may the bankers ever feel safe in long term investing.
Under the 100% reserve system, demand deposits of checking deposits, being the equivalent of cash, would be withdrawable or transferrable without any restrictions whatever. The cash would belong to the depositor, and ought to be ready at his beck and call. But savings or time deposits would, as at present, normally be covered only fractionally by cash reserves. They represent time loans to the banks and therefore should be withdrawable only upon adequate notice. Their character as loans is often overlooked.
The term “time deposits” is a misnomer – even more so than the term “demand deposits”. Demand deposits, when provided with 100% cash reserves, become, as we have seen, true deposits of physical money withdrawable on demand. But time deposits (i.e. the bank’s liability) cannot under any circumstances be true deposits of physical money. The actual “deposit” is a loan to the bank, drawing interest, and therefore not appropriately available as money to the depositor.
One reason why time deposits are sometimes thought of as money is that they are guaranteed loans – a peculiar form of investment. The owner of a time or savings account of $1,000 can, under the terms of his contract, sell it back to the bank for exactly $1,000 plus interest. Therefore he thinks he actually has $1,000 plus interest. With other investments this guarantee is seldom given. If, today, $1,000 is “put into” some bond
or stock
, there is no certainty that tomorrow it can be sold for exactly $1,000. It may bring more or it may bring less. The owner thinks of his property not as $1,000 of money but as a right in the bond or stock, worth what it will bring in the market. Only the financially ignorant think of a millionaire as possessing $1,000,000 in money stored away in his cellar. Yet one naive investor, who had put $500 into a new company, visited the company’s office a year later and said that he had changed his mind and wanted to “take his money out.” He imagined “his money” to be lying idle in the company’s safe. His case was very much like that of the saving-bank
depositor who pictures his money, once “put in”, as always “in”, because he is assured that he can always “take it out”. The truth is, of course, that, in mutual savings banks, the money put in is invested by the bank on behalf of the savings depositor while, in stock savings banks, it is borrowed, on term, by the bank from the depositor and gives him no right to consider it as money freely at his disposal at any time.
As already mentioned, if we could rename time “deposits” and call them “time loans”, the general public would gain much in its understanding of these matters. The word “deposit” could then be confined to “demand deposits.” The expression “money on deposit” would cease to be a mere figure of speech. As matters are now, the “money on deposit” is not really “money” and is not really a “deposit”.
In order to make a clear distinction between true deposits which serve as money and time loans, which are investments, we should also discourage the too easy conversion of these time “deposits” into cash. At present, time deposits seldom turn over as often as once a year; and the fact that they draw interest is, and would continue to be, a considerable safeguard against any attempt to make them function as a medium of exchange. Nevertheless, it is conceivable that abuses might creep in; for example, that the banks might encourage the savings “depositor” to circulate his “deposit” by providing him with some sort of certificates, in convenient denominations of say $1 or $5, as consideration for a lowering of the rate of interest paid to him. This subterfuge should be forbidden. It would obscure the sharp distinction that should always be maintained between money, a medium of exchange, that does not bear interest, and a time loan, which bears interest, but does not serve as a medium of exchange.
It has become customary to let savings depositors withdraw cash almost as readily as if they held checking accounts. Banks having “savings” departments are thus in constant danger of having to meet unreasonable demands for the withdrawal of such savings and the practice should be stopped. The savings “depositor” is not properly entitled to any such privilege.
Under the 100% system the savings and the time deposit departments of banks should be given ample opportunity to sell investment in order to be able to supply any reasonable cash demands made by their depositors. In practice, the banks might require a month’s notice before cash could be withdrawn from a savings account. Instead of issuing pass books, the banks might issue debentures with definite maturities after notice. Savings “depositors”, moreover, might, in case of need, be entitled to borrow, at low rates of interest, against their “deposits” as security. However, such regulations, though important, are only loosely related to the main change here proposed, that of introducing a dollar-for-dollar reserve behind demand deposits.
In this way, the 100% reserve system would lead to a complete separation, within each bank, of its demand deposit department from its time deposit department. This separation would help substantially toward a greater development of our savings bank system, particularly in small communities, many of which today lack these facilities, largely, perhaps, because savings banks are subject to unfair competition from commercial banks which can pyramid loans on the basis of any cash deposited with them on time account in a way which savings banks cannot do.
(15) The splitting of the two functions of lending and the creation of money supply would be much like that of 1844 in the Bank of England
which separated the Issue Department from the Banking Department. That split was made with substantially the same object as underlies the present proposal, but demand deposits, being then comparatively little used in place of bank notes, were overlooked. The £–for-£ reserve behind Bank of England notes then enacted was a 100% reserve system for pocket-book money. The present proposal merely extends the same system to check-book money.
The Bank Act of 1844
provided that, up to a specified maximum, reserves behind bank of England notes could be held in the form of securities, but required that, above that maximum, reserves must be held in cash, 100%. The present 100% proposal is merely that we follow up the job thus undertaken in 1844 by Sir Robert Peel
. In 1844, Sir Robert could scarcely be expected to foresee that demand deposits would in time supplant bank notes as the dominant circulating medium and so require similar treatment – a 100% reserve. Yet, only four years later John Stuart Mill
foresaw an increased use of checks and both Fullerton and Mill saw clearly that Peel’s reform might be frustrated by the use of checks instead of notes.
The Act of 1844 satisfactorily solved the problem of Bank of England notes
, but serious difficulties soon arose with respect to deposit currency. As early as 1847
, the Banking Department of the Bank of England was confronted with a run
, a pressing demand for cash – whereupon another step toward the 100% system was taken. With the approval of the British Government, though not at first by authority of law, the Banking Department borrowed cash from the Issue Department. This cash was new money specially manufactured for the emergency and transferred to the Banking Department in exchange for securities. This procedure was called a “Suspension of the Bank Act” (not to be confused with the Suspension of the Bank itself). The practice was soon validated by Parliament; and the same policy has regularly been followed in subsequent crises.
The success of these periodic gravitations toward a 100% reserve system has been so invariable that their essential nature has been but little analyzed. Both the permanent set-up of the bank of England Issue Department, and the emergency set-up of the Banking Department, are plans to strengthen reserves, one reserve being gold (now Government paper) behind the Bank’s note liabilities, the other reserve being notes behind the Bank’s deposit liabilities. The former is a legally required 100% reserve. The latter could readily be made so by a minor legal amendment. Had it been so specified and made applicable at all times and to all banks, it would have finished in England the task begun by Peel. In a word, it would have put the British banks substantially on a 100% reserve system.
Our own National Bank Act was similarly an attempt to put our banking system on a sounder reserve basis. A primary object was to prohibit wild-cat
issues of bank notes. Though we have stopped the issuance of these, the creation of demand deposits has circumvented the prohibition. The wild-cat is now represented by demand deposits. The 100% reserve system would give holders of deposits the same protection earlier given holders of bank notes.
With the new steadiness in supplying the nation’s increasing monetary needs, and with the consequent alleviation of severe depressions, the people’s savings would, in all probability, accumulate more rapidly and with less interruption than at present. Loans and investments would become larger and safer, thus swelling the total business of banks. (These new loans and investments would no longer be associated with demand deposits but only with time and savings deposits).
The banks would also get some revenue from the demand deposit business itself in the form of charges for their services in taking care of the checking business.
If the manufacture of money is thus made exclusively a Governmental function and the lending of money is left to become exclusively a banking or non-Governmental function, some of the vexatious regulations to which bankers are now subject could be abolished. Moreover, the Government could withdraw from the banking business and again leave this field entirely to the bankers.
Incidentally, there would no longer be any need of deposit insurance
on demand deposits. Moreover, the principal argument in favor of branch banking, which is often regarded as a way to stabilize banking but by eliminating the small banker, would be removed. Last, and most important, the disastrous effects of depression would be lessened.
As we have seen, if the banks were permitted to retain as earning assets what private and Government bonds and notes they now have as backing for their demands deposits, there would be no immediate change in the earnings of the banks. However, as business continued to increase, there would be greater demands for the services of commercial banks in the demand-deposit departments. The banks might then be pressed to find additional income to compensate them for the additional work required. They would presumably be able to obtain this income through service charges. According to the “Service Charge Survey of 1938” of the Bank Management Commission of the American Bankers Association
, service charges are “a first essential to safe and sound banking.” In this Survey, an analysis of earnings from service charges in 1937 reveals that, while those service charges amounted to only 4.5 per cent of the total gross earnings of commercial banks, yet, in a number of instances, they actually made all the difference between profit and loss. As to the soundness of this principle of service charges, the following may be quoted from the Survey:
“Principles of sound bank management justify service charges on checking accounts. The principle that adequate service charges constitute a necessary step in sound banking operation has been firmly established.”
Another important point is that, if the 100% system were adopted for demand deposits, the expenses of the demand-deposit branch of the business would be decreased, for it would become merely a business of warehousing cash and the Government bonds initially held and of recording the checking transactions.
As to federal regulation of the activities of commercial banks, what we need is not more, but less, of it. At present, banking operations are complicated and impeded by conflicting regulations and controls. Three separate Government agencies now send their examiners into banks. Deposit insurance is a heavy burden; and, even though it is an important protection to the small depositor, it does not afford full protection to the banks themselves. Their trade is still dangerous. The larger banks bear what is probably an unfairly large share of the burden of this insurance. The smaller banks, face an increasing trend towards more concentration of economic power in the hands of the big banks. Under the 100% system, the demand deposits of both the smallest and the largest banks would be absolutely secure. The pressure toward the concentration of banking and the establishment of branch banking would thus be greatly reduced.
These trends are manifestations of the basically fallacious set-up under which all banks, large and small, are now functioning. This cannot be remedied by merely multiplying the regulations or increasing the concentration of banking power, or by deposit insurance. What is needed is to put the system as a whole on a sound reserve basis. Under the 100% system, insurance of demand deposits would be superfluous. Since our small banks would be strengthened they could better perform their important function of directing the flow of circulating medium into appropriate channels.
Another important influence of the 100% system, not only for bankers but for the community as a whole, would be the effect on the rate of interest. The fractional reserve system distorts the rate of interest, making it sometimes abnormally high and sometimes abnormally low. Banks often lend money at nearly zero per cent when they can manufacture without cost the money they lend and are even forced to do so on some forms of loans when so many banks compete for this privilege, and when investment opportunities have been killed by depression conditions. When, on the other hand, the money lent has to be saved, the rate is a result of normal supply and demand and is much steadier.
Incidentally, abnormally low rates injure endowed institutions such as Universities, which derive their income from interest. Moreover these low rates greatly increase the savings necessary to provide a given amount of insurance and operate to reduce the independence of all holders of fixed interest securities.
On the other hand, if and when the present abnormally low rates of interest are succeeded by higher rates, two great perils will confront the banks and the country – unless the 100% plan is first put in force.
One of these perils is a drastic fall in the price of U. S. Government and other bonds. This may wreck many banks now holding large amounts of the bonds. Under 100% reserves, however, the banks would have a special need for the bonds as a sort of interest-bearing cash against their deposits and solely for the revenue they yield so that their value could not fall.
The other peril is that the three billions of “baby bonds” in the hands of the public, redeemable at par on demand, may be presented for redemption and embarrass the Government.
(a) Sort-term commercial loans and liquid bankable investments other than Government bonds are no longer adequate to furnish a basis for our chief medium of exchange (demand deposits) under the fractional reserve system. Capital loans are inappropriate for this purpose. As time goes on this inadequacy will grow far worse. Under the present fractional reserve system, the only way to provide the nation with circulating medium for its growing needs is to add continually to our Government’s huge bonded debt. Under the 100% reserve system the needed increase in circulating medium can be accomplished without increasing the interest bearing debt of the Government.
Under the Federal Reserve Act
our banking system, is supposed to function on the principle of “automatic expansion”: That is, as the volume of goods and services increases, means of payment are expected to expand automatically as a result of borrowing from the banks. The circulating medium thus created is expected again automatically to shrink whenever business repays its bank loans after being paid by its own customers. In this manner, the volume of our means of payment is supposed to expand and contract with the volume of short-term, self-liquidating, or “commercial”, loans. In other words, the banks are supposed to “monetize”, temporarily, the goods in process of production or distribution. But the volume of these commercial loans has never closely paralleled the increased needs of our expanding economy. Sometimes they have expanded too fast. At other times they have contracted drastically.
Moreover, the banks have “monetized
” not only self-liquidating commercial loans, but also long-term loans and investment. The funds, for long-term investments pre-eminently, ought to be provided out of voluntary savings. The banks have trespassed on that function and have thereby disturbed the rate of interest on long-term investments. Moreover, as mentioned before, by creating demand deposits based upon long-term loans, the banks have filled their portfolios with “slow assets” which have become “frozen” whenever they were supposed to be repaid during times of depression. The too easy monetization of securities has facilitated the sky-rocketing in the stock market and has provided the banks with inflated assets which have collapsed and broken the banks and the public when the stock boom collapsed. During the depression of the early 30’s the preceding monetization of long-term loans substantially contributed to the failure of thousands of banks.
In recent years, attempts have been made to press the banks into making loans on real estate and other slow assets. The banks being thoroughly frightened, have balked. They have been unwilling again to risk that sort of expansion – at least for the present. To get the banks to make such loans, the Government has been compelled to guarantee mortgages on homes. Even so, it appears doubtful that the demand for short-term or commercial, loans by banks will in the future increase rapidly enough, or soon enough, alone to furnish the volume of demand deposits requisite to the maintenance of the present price level. Business has developed methods of its own for financing its operations without benefit of banks. It has added to its cash reserves, and has obtained additional resources, not by borrowing from the banks, but by offering investments directly to the public. Hence the natural trend seems to be toward less and less, rather than more and more, commercial banks. Thus it seems that the bottom has been knocked out of the original basis underlying out circulating medium. In short, we cannot now depend on short-term bank loans for furnishing us the money we need.
(b) As already noted, a by-product of the 100% reserve system would be that it would enable the Government gradually to reduce its debt, through purchases of Government bonds by the Monetary Authority as new money was needed to take care of expanding business. Under the fractional reserve system any attempt to pay off the Government debt
, whether by decreasing Government expenditures or by increasing taxation, threatens to bring about deflation and depression.
Some competent observers think that the two forces above noted will eventually compel the adoption of the 100% plan, even if no other powerful forces should be at work.
A slow reduction of the Government debt might be made an incidental by-product of the Government method of increasing our circulating medium. But the fundamental consideration is that whatever increase in the circulating medium is necessary to accommodate national growth could be accomplished without compelling more and more people to go into debt to the banks, and without increasing the Federal interest-bearing debt.
(18) If the money problem is not solved in the near future, another great depression, as disastrous and that of 1929-1938, seems likely to overtake us within a few years. Then our opportunity of even partially solving the depression problem may be lost, and, as in France, Germany
, and other countries where this opportunity was lost, our country could expect, if not chaos and revolution, at least more and more regulation and regimentation of industry, commerce and labor – practically the end of free enterprise
as we have known it in America.
If we do not adopt the 100% reserve system, and if the present movement for balancing the budget succeeds without providing for an adequate money supply, the resulting reduction in the volume of our circulating medium may throw us into another terrible deflation and depression, at least as severe as that through which we have just been passing.
To the extent that monetary forces play a part in our great economic problems – as, for example the problems of full production and employment, and equitable prices for farm products – to that extent the monetary reforms here proposed are a part of our task to make our form of Government work and enable it to survive. When violent booms and depressions, in which fluctuations in the supply of money play so vital a part, rob millions of their savings and prevent millions from working, constitutions are likely to become scraps of paper. We have observed this phenomenon in other countries. It is probably no accident that the world depression coincided with the destruction of popular Government in many parts of the world. In most every case where liberal
government broke down, the money system, amongst other disturbing elements, had broken down first. That free exchange of goods and services on which people in industrial countries depend for their very existence had stopped functioning; and, in utter desperation, the people were willing to hand over their liberties for the promise of economic security.
In this manner the decline of democracy has set in elsewhere, and unless we take intelligent action, it may happen here.
found their way into the history books. Perhaps the most notable proposals were first put forward by economists at the University of Chicago in a six-page memorandum on banking reform which
was given limited and confidential distribution to about 40 individuals on March 16, 1933. A copy of the memorandum was sent to Henry A. Wallace
, then Secretary of Agriculture, with a cover letter signed by Frank Knight
. Paul Douglas was listed among the supporters of the plan.
During the period March to November, the Chicago economists received comments from a number of individuals on their proposal and in November 1933 another memorandum was prepared. The memorandum was expanded to thirteen pages, there was a supplementary memorandum on "Long-time Objectives of Monetary Management" (seven pages) and an appendix titled "Banking and Business Cycles" (six pages). Evidently written by Henry Simons the memorandum was again supported by Paul Douglas.
The collective recommendations of these memorandum have come to be known and the Chicago plan
. The memorandum generated much interest and discussion among lawmakers but the suggested reforms, such as the abolition of the fractional reserve system and imposition of 100% reserves on demand deposits, were set aside and replaced by watered down alternative measures. The Banking Act of 1935 institutionalized Federal deposit insurance and the separation of commercial and investment banking; it successfully restored the public's confidence in the banking system and ended discussion of banking reform until the Recession of 1937-1938.
The July 1939 draft proposal, coauthored by Paul Douglas and five others, resurrected proposals for banking and monetary reform from the Chicago plan but did not result in any new legislation.
, closely parallels these suggested reforms; it is being call the The American Monetary and Financial Security Act (aka Tha American Monetary Act).
Representative Dennis Kucinich
's 16-point plan for economic recovery includes The American Monetary Act. Kucinich recently addressed the need for and benefits of monetary reform at a session of the United States House of Representatives
.
There is not currently a high level of awareness or popular support for the reforms suggested in A Program for Monetary Reform (1939) or the The American Monetary and Financial Security Act (2009) among lawmakers, in the media or in the general public. Legislation has not yet been introduced to the United States House of Representatives
, but Dennis Kucinich has indicated that he will soon do so.
This may be because the recent financial crisis was caused more by global capital flows than fractional-reserve banking—essentially, credit creation between nations. Modern central banks match savings with investment by encouraging credit expansion, which they control via short-term interest rates. In essence, money is loaned into existence without limit, other than interest rates (carefully set by the central bank—usually via inflation targeting
).
Great Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
which began with the sudden, devastating collapse of US stock market
Stock market
A stock market or equity market is a public entity for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.The size of the world stock market was estimated at about $36.6 trillion...
prices on October 29, 1929, known as Black Tuesday and after apparent recovery in the mid-1930s was followed by the Recession of 1937-1938. The program was sent to the most complete list of academic economists available at the time. General approval of the program was expressed by 235 economists from 157 universities and colleges; another 40 economists approved of it with some reservations; only 43 economists expressed disapproval.
Background
Widely distributed among academic economists, the draft proposal for A Program for Monetary Reform (1939) was never published and did not lead to legislation. Some copies of the program found their way into university and college libraries or private collections.Joe Bongiovanni, cofounder of The Kettle Pond Institute for Debt-Free Money recalled that a copy of the draft proposal had been maintained by his father, Joseph T. Bongiovanni (1910–2001), a monetary reform advocate who had testified several times before the United States Congress Joint Economic Committee
United States Congress Joint Economic Committee
The Joint Economic Committee is one of four standing joint committees of the U.S. Congress. The committee was established as a part of the Employment Act of 1946, which deemed the committee responsible for reporting the current economic condition of the United States and for making suggestions...
on his own proposal for a Socio-Economic National Growth Act (SENGA) premised upon sound money and economic democracy
Economic democracy
Economic democracy is a socioeconomic philosophy that suggests a shift in decision-making power from a small minority of corporate shareholders to a larger majority of public stakeholders...
. Sadly, Bongiovanni's was lost.
Ronnie J. Phillips, then a Professor of Economics at Colorado State University
Colorado State University
Colorado State University is a public research university located in Fort Collins, Colorado. The university is the state's land grant university, and the flagship university of the Colorado State University System.The enrollment is approximately 29,932 students, including resident and...
, referenced the draft proposal in his book, The Chicago Plan & New Deal Banking Reform (1995). Phillips is currently a Senior Fellow at the Networks Financial Institute at Indiana State University. .
Copies of the draft proposal stamped on the bottom of the first and last page, “LIBRARY - COLORADO STATE COLLEGE OF A. & M. A. - FORT COLLINS COLORADO” surfaced at the 5th Annual American Monetary Institute
American Monetary Institute
The American Monetary Institute is a non-profit charitable trust organized in 1996 for the "independent study of monetary history, theory and reform."...
Monetary Reform Conference (2009) and one was acquired for the Kettle Pond Institute by cofounder Pete Young. With the help of Jane Clary, Professor of Economics at the College of Charleston
College of Charleston
The College of Charleston is a public, sea-grant and space-grant university located in historic downtown Charleston, South Carolina, United States...
, the images were scanned for dispay on the institute's web site.
Paul H. Douglas
Paul H. Douglas (1892–1976) was an American economist and politician. He earned a PhD in economics from Columbia UniversityColumbia University
Columbia University in the City of New York is a private, Ivy League university in Manhattan, New York City. Columbia is the oldest institution of higher learning in the state of New York, the fifth oldest in the United States, and one of the country's nine Colonial Colleges founded before the...
in 1921. Together with the mathematician Charles W. Cobb, he developed the Cobb-Douglas
Cobb-Douglas
In economics, the Cobb–Douglas functional form of production functions is widely used to represent the relationship of an output to inputs. Similar functions were originally used by Knut Wicksell , while the Cobb-Douglas form was developed and tested against statistical evidence by Charles Cobb and...
production function
Production function
In microeconomics and macroeconomics, a production function is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs...
(1928). He authored Real Wages in the United States, 1890-1996 (1930), The Theory of Wages (1934) and Social Security in the United States (1936; 2nd ed. 1939). Douglas was a professor of economics at the University of Chicago
University of Chicago
The University of Chicago is a private research university in Chicago, Illinois, USA. It was founded by the American Baptist Education Society with a donation from oil magnate and philanthropist John D. Rockefeller and incorporated in 1890...
when he coauthored A Program for Monetary Reform (1939).
He later went into politics and was elected to the United States Senate
United States Senate
The United States Senate is the upper house of the bicameral legislature of the United States, and together with the United States House of Representatives comprises the United States Congress. The composition and powers of the Senate are established in Article One of the U.S. Constitution. Each...
where he served from 1948 until 1966. Douglas had a reputation of being an unconventional liberal; he passionately supported civil rights
Civil rights
Civil and political rights are a class of rights that protect individuals' freedom from unwarranted infringement by governments and private organizations, and ensure one's ability to participate in the civil and political life of the state without discrimination or repression.Civil rights include...
but was equally concerned about fiscal discipline. He was best known for his support of environmental protection
Environmental protection
Environmental protection is a practice of protecting the environment, on individual, organizational or governmental level, for the benefit of the natural environment and humans. Due to the pressures of population and our technology the biophysical environment is being degraded, sometimes permanently...
, public housing
Public housing
Public housing is a form of housing tenure in which the property is owned by a government authority, which may be central or local. Social housing is an umbrella term referring to rental housing which may be owned and managed by the state, by non-profit organizations, or by a combination of the...
, and truth in lending laws. While serving in the Senate, Douglas authored the Consumer Credit Protection Act
Consumer Credit Protection Act
The Consumer Credit Protection Act, , composed of several titles relating to consumer credit, mainly title I, the Truth in Lending Act, title II related to extortionate credit transactions, title III related to restrictions on wage garnishment, and title IV related to the National Commission on...
and Ethics in Government (1952). After leaving the Senate, he held a position at The New School
The New School
The New School is a university in New York City, located mostly in Greenwich Village. From its founding in 1919 by progressive New York academics, and for most of its history, the university was known as the New School for Social Research. Between 1997 and 2005 it was known as New School University...
for Social Research.
Irving Fisher
Irving Fisher (1867–1947) was a celebrated American economist and Yale UniversityYale University
Yale University is a private, Ivy League university located in New Haven, Connecticut, United States. Founded in 1701 in the Colony of Connecticut, the university is the third-oldest institution of higher education in the United States...
professor of economics who is best known for his work on the quantity theory of money
Quantity theory of money
In monetary economics, the quantity theory of money is the theory that money supply has a direct, proportional relationship with the price level....
. Fisher was a true celebrity and one of the major influences on Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...
's monetarism
Monetarism
Monetarism is a tendency in economic thought that emphasizes the role of governments in controlling the amount of money in circulation. It is the view within monetary economics that variation in the money supply has major influences on national output in the short run and the price level over...
. Friedman called Fisher "the greatest economist the United States has ever produced." The Fisher equation
Fisher equation
The Fisher equation in financial mathematics and economics estimates the relationship between nominal and real interest rates under inflation....
, the Fisher hypothesis
Fisher hypothesis
In economics, the Fisher hypothesis is the proposition by Irving Fisher that the real interest rate is independent of monetary measures, especially the nominal interest rate. The Fisher equation isr_r = r_n - \pi^e....
, the international Fisher effect
International fisher effect
The International Fisher effect is a hypothesis in international finance that says that the difference in the nominal interest rates between two countries determines the movement of the nominal exchange rate between their currencies, with the value of the currency of the country with the lower...
, and the Fisher separation theorem
Fisher separation theorem
In economics, the Fisher separation theorem asserts that the objective of a corporation will be the maximization of its present value, regardless of the preferences of its shareholders. The theorem therefore separates management's "productive opportunities" from the entrepreneur's "market...
are all concepts named after him.
The stock market crash of 1929 and the subsequent depression cost Fisher much of his personal wealth and academic reputation. He famously predicted, a few days before the crash, "Stock prices have reached what looks like a permanently high plateau." Irving Fisher stated on October 21 that the market was "only shaking out of the lunatic fringe" and went on to explain why he felt the prices still had not caught up with their real value and should go much higher. On Wednesday, October 23, he announced in a banker’s meeting “security values in most instances were not inflated.” For months after the October 29 crash, he continued to assure investors that a recovery was just around the corner. Fisher was so discredited by his 1929 pronouncements and by the failure of a firm he had started that few people took notice of his debt-deflation analysis of the depression.
Fisher believed that deflation was the principal cause of the disastrous cascading insolvencies then plaguing the American economy. He said that deflation had increased the real value of debts fixed in dollar terms. Fisher was also convinced that unemployment was linked to the unstable buying power of the dollar. Fisher's influence as a coauthor is apparent in A Program for Monetary Reform (1939). Today, his views on debt-deflation as the cause of periodic recessions, depressions and unemployment are getting new attention.
Frank D. Graham
Frank D. Graham (1890–1949) was an American economist and Princeton UniversityPrinceton University
Princeton University is a private research university located in Princeton, New Jersey, United States. The school is one of the eight universities of the Ivy League, and is one of the nine Colonial Colleges founded before the American Revolution....
professor of economics whose early papers influenced theories on international trade and general equilibrium. He coauthored A Program for Monetary Reform (1930) opposing the gold standard
Gold standard
The gold standard is a monetary system in which the standard economic unit of account is a fixed mass of gold. There are distinct kinds of gold standard...
. Graham supported a market basket
Market basket
The term market basket or commodity bundle refers to a fixed list of items used specifically to track the progress of inflation in an economy or specific market....
standard for currency which he believed would lead to full employment
Full employment
In macroeconomics, full employment is a condition of the national economy, where all or nearly all persons willing and able to work at the prevailing wages and working conditions are able to do so....
. His theories are brought together in Social Goals and Economic Institutions (1948).
Earl J. Hamilton
Earl J. Hamilton (1899–1989) was an American economist and economic historian. He authored American Treasure and the Price Revolution in Spain, 1501-1650 (1934) and Money, prices and wages in Valencia, Aragon and Navarre, 1351-1500 (1936). He was a professor of economics at Duke UniversityDuke University
Duke University is a private research university located in Durham, North Carolina, United States. Founded by Methodists and Quakers in the present day town of Trinity in 1838, the school moved to Durham in 1892. In 1924, tobacco industrialist James B...
(1927–1944) when he coauthored A Program for Monetary Reform (1939). He was later a professor of economics at Northwestern University
Northwestern University
Northwestern University is a private research university in Evanston and Chicago, Illinois, USA. Northwestern has eleven undergraduate, graduate, and professional schools offering 124 undergraduate degrees and 145 graduate and professional degrees....
(1944–1947) and the University of Chicago
University of Chicago
The University of Chicago is a private research university in Chicago, Illinois, USA. It was founded by the American Baptist Education Society with a donation from oil magnate and philanthropist John D. Rockefeller and incorporated in 1890...
(1947–1967), and was Distinguished Professor of Economic History at the State University of New York at Binghamton (1966–1969). He authored War and Prices in Spain, 1651-1800 (1947), served as editor of the Journal of Political Economy
Journal of Political Economy
The Journal of Political Economy is an academic journal run by economists at the University of Chicago and published every two months by the University of Chicago Press. The journal publishes articles in both theoretical economics and empirical economics...
(7 years) and was the president of the Economic History Association
Economic History Association
Economic History Association is an organization founded in 1940, dedicated to "encourage and promote teaching, research, and publication on every phase of economic history, broadly defined"....
(1951 to 1952).
Willford I. King
Willford I. King (1880–1962) was a noted American statistician and economist. As a boy, he attended a one-room schoolOne-room school
One-room schools were commonplace throughout rural portions of various countries including the United States, Canada, Australia, New Zealand, United Kingdom, Ireland and Spain in the late 19th and early 20th centuries. In most rural and small town schools, all of the students met in a single room...
in rural Nebraska. He attended and graduated from the University of Nebraska (1905) before receiving his PhD in Philosophy from the University of Wisconsin-Madison (1913). King moved to Washington, D.C.
Washington, D.C.
Washington, D.C., formally the District of Columbia and commonly referred to as Washington, "the District", or simply D.C., is the capital of the United States. On July 16, 1790, the United States Congress approved the creation of a permanent national capital as permitted by the U.S. Constitution....
and became a statistician with the United States Public Health Service
United States Public Health Service
The Public Health Service Act of 1944 structured the United States Public Health Service as the primary division of the Department of Health, Education and Welfare , which later became the United States Department of Health and Human Services. The PHS comprises all Agency Divisions of Health and...
(1917–1920) and then an economist with the National Bureau of Economic Research
National Bureau of Economic Research
The National Bureau of Economic Research is an American private nonprofit research organization "committed to undertaking and disseminating unbiased economic research among public policymakers, business professionals, and the academic community." The NBER is well known for providing start and end...
(1920–1927).
He left public service to become a professor of economics at New York University
New York University
New York University is a private, nonsectarian research university based in New York City. NYU's main campus is situated in the Greenwich Village section of Manhattan...
(1927–1945). It was at this time that King coauthored A Program for Monetary Reform (1939). He opposed the New Deal
New Deal
The New Deal was a series of economic programs implemented in the United States between 1933 and 1936. They were passed by the U.S. Congress during the first term of President Franklin D. Roosevelt. The programs were Roosevelt's responses to the Great Depression, and focused on what historians call...
, instead advocating a sliding scale of wages based on production, currency expansion, and the reduction of taxes and regulations. He founded the Committee on Economic Accord (1933) and, after he retired, became chairman of the Committee for Constitutional Government, which sought to "uphold Constitutional principles and our system of free enterprise."
Charles R. Whittlesey
Charles R. Whittlesey (1900–1979) was an American economist and Princeton UniversityPrinceton University
Princeton University is a private research university located in Princeton, New Jersey, United States. The school is one of the eight universities of the Ivy League, and is one of the nine Colonial Colleges founded before the American Revolution....
professor of economics.
A Program for Monetary Reform
byPaul H. Douglas
University of Chicago
Irving Fisher
Yale University
Frank D. Graham
Princeton University
Earl J. Hamilton
Duke University
Willford I. King
New York University
Charles R. Whittlesey
Princeton University
Foreword
The great task confronting us today is that of making our American system, which we call “democracyDemocracy
Democracy is generally defined as a form of government in which all adult citizens have an equal say in the decisions that affect their lives. Ideally, this includes equal participation in the proposal, development and passage of legislation into law...
”, work. No one can doubt that it is threatened. However, the danger lies less in the propaganda of autocratic Governments from abroad than in the existence, here in America, of ten millions of unemployed workers, sharecroppers living barely at subsistence level, and hundreds of thousands of idle machines. On such a soil fascist and communist propaganda
Propaganda
Propaganda is a form of communication that is aimed at influencing the attitude of a community toward some cause or position so as to benefit oneself or one's group....
can thrive. With full employment
Full employment
In macroeconomics, full employment is a condition of the national economy, where all or nearly all persons willing and able to work at the prevailing wages and working conditions are able to do so....
such propaganda would be futile.
The important objective, therefore, is to repair and rebuild our economic system
Economic system
An economic system is the combination of the various agencies, entities that provide the economic structure that defines the social community. These agencies are joined by lines of trade and exchange along which goods, money etc. are continuously flowing. An example of such a system for a closed...
so that it will again employ our productive resources to the fullest practicable extent. A high scale of living
Standard of living
Standard of living is generally measured by standards such as real income per person and poverty rate. Other measures such as access and quality of health care, income growth inequality and educational standards are also used. Examples are access to certain goods , or measures of health such as...
for our people will better protect our cherished American democracy than will all the speeches and writings in the world.
Our problems are not simple and we can offer no panacea to solve them. We believe, however, that certain fundamental adjustments in our economy are essential to any successful attempt to bring our idle men, materials, land and machines together. These fundamental adjustments would, we believe, be facilitated by the monetary reform
Monetary reform
Monetary reform describes any movement or theory that proposes a different system of supplying money and financing the economy from the current system.Monetary reformers may advocate any of the following, among other proposals:...
here proposed.
Throughout our history no economic problem has been more passionately discussed than the money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
problem. Probably none has had the distinction of suffering so much from general misunderstanding – suffering from more heat than light. As a result, not only is our monetary system now wholly inadequate and, in fact, unable to fulfill its function; but the few reforms which have been adopted during the past three decades have been patchwork, leaving the basic structure still unsound.
In analyzing this problem, we concluded that it is preeminently the responsibility of American economists to present constructive proposals for its solution. But, before organizing a movement for monetary reform, we wished to determine how many of our colleagues agree with us. For this purpose we drew up “A Program for Monetary Reform” and sent this to the completest available list of academic economists which, we believe, comprise the essential features of what needs to be done in order to put our monetary system into working condition. Up to the date of writing (July, 1939) 235 economists from 157 universities and colleges have expressed their general approval of this “Program”; 40 more have approved it with reservations; 43 have expressed disapproval. The remainder have not yet replied.
We want the American people to know where we stand in this important matter. The following is the first draft of an exposition of our “Program”, and the part it may play in reconstructing America.
Paul H. Douglas
Irving Fisher
Frank D. Graham
Earl J. Hamilton
Willford I. King
Charles R. Whittlesey
July 1939
Introduction
The following suggested monetary program is put forth not as a panacea or even as a full solution of the depressionDepression (economics)
In economics, a depression is a sustained, long-term downturn in economic activity in one or more economies. It is a more severe downturn than a recession, which is seen by some economists as part of the modern business cycle....
problem. It is intended to eliminate one recognized cause of great depressions, the lawless variability in our supply of circulating medium.*
No well informed person would pretend that our present monetary and banking machinery is perfect; that it operates as it should to promote an adequate and continuous exchange of goods and services
Goods and services
In economics, economic output is divided into physical goods and intangible services. Consumption of goods and services is assumed to produce utility. It is often used when referring to a Goods and Services Tax....
; that it enables our productive resources – our labor, materials
Raw material
A raw material or feedstock is the basic material from which a product is manufactured or made, frequently used with an extended meaning. For example, the term is used to denote material that came from nature and is in an unprocessed or minimally processed state. Latex, iron ore, logs, and crude...
, and capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
– to be fully or even approximately employed. Indeed, the contrary is the fact. If the purpose of money and credit
Credit (finance)
Credit is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately , but instead arranges either to repay or return those resources at a later date. The resources provided may be financial Credit is the trust...
were to discourage the exchange of goods and services, to destroy periodically the wealth produced, to frustrate and trip those who work and save, our present monetary system would seem a most effective instrument to that end.
Practically every period of economic hope and promise has been a mere inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
ary boom, characterized by an expansion of the means of payment, and has been followed by a depression, characterized by a detrimental contraction of the means of payment. In boom times, the expansion of circulating medium accelerates the pace by raising prices, and creating speculative profits. Thus, with new money raising prices and rising prices conjuring up new money, the inflation proceeds in an upward spiral till a collapse occurs, after which the contraction of our supply of money and credit, with falling prices and losses in place of profits, produces a downward spiral generating bankruptcy, unemployment, and all the other evils of depression.
The monetary reforms here proposed are intended primarily to prevent these ups and downs in the volume of our means of payment with their harmful influences on business. No claim is made, however, that this will entirely do away with “business cycles”.
- This and the subsequent closely printed paragraphs are quoted with minor alterations from the mimeographed “Program for Monetary Reform”, circulated among economists as explained in the foreword.
The Gold Standard
(1) During the last ten years the world has largely given up the gold standardGold standard
The gold standard is a monetary system in which the standard economic unit of account is a fixed mass of gold. There are distinct kinds of gold standard...
. Gold
Gold
Gold is a chemical element with the symbol Au and an atomic number of 79. Gold is a dense, soft, shiny, malleable and ductile metal. Pure gold has a bright yellow color and luster traditionally considered attractive, which it maintains without oxidizing in air or water. Chemically, gold is a...
is still, and may always remain, an important part of the machinery of foreign trade and exchange. But it is no longer, and probably never again will be, the sole reliance for determining the “internal value” of monetary units. Even those who advocate some degree of return toward the former gold standard are, as a rule, now convinced that it must be “managed” and never again left to work “automatically”.
Up to 1931, the great majority of the countries of the world were on the gold standard. The characteristics of the gold standards may be briefly summarized as follows:
(a) The dollar
United States dollar
The United States dollar , also referred to as the American dollar, is the official currency of the United States of America. It is divided into 100 smaller units called cents or pennies....
, franc
Swiss franc
The franc is the currency and legal tender of Switzerland and Liechtenstein; it is also legal tender in the Italian exclave Campione d'Italia. Although not formally legal tender in the German exclave Büsingen , it is in wide daily use there...
, guilder, or other monetary unit was the equivalent of, and usually was redeemable in, a fixed amount of gold of a certain fineness
Millesimal fineness
Millesimal fineness is a system of denoting the purity of platinum, gold and silver alloys by parts per thousand of pure metal by mass in the alloy. For example, an alloy containing 75% gold is denoted as "750". Many European countries use decimal hallmark stamps Millesimal fineness is a system of...
. For instance, the American dollar was a definite weight of gold (23.22 grains of fine gold). This made an ounce of gold 9/10 fine identical with $20.67. Conversely, $20.67 was convertible into an ounce of gold of this quality. In other words, “one dollar” was roughly a twentieth of an ounce of gold or precisely 100/2067ths of an ounce.
After the war, chiefly as a result of a shortage in gold reserves, some of the smaller nations changed their currencies by making them redeemable in some foreign currency which, in turn, was convertible into gold. This system was called the gold-exchange standard. For these small nations, our dollar, the pound sterling
Pound sterling
The pound sterling , commonly called the pound, is the official currency of the United Kingdom, its Crown Dependencies and the British Overseas Territories of South Georgia and the South Sandwich Islands, British Antarctic Territory and Tristan da Cunha. It is subdivided into 100 pence...
and similar gold currencies, such as the Dutch guilder and the Swiss franc were “as good as gold”.
(b) Because every gold currency was redeemable in a fixed amount of gold, the exchange relationship of those currencies to each other was to all intents and purposed fixed: That is, the foreign exchange rates of gold-standard currencies were constant, or only varied within extremely narrow limits. A grandiose ideology has been built up on this so-called “stability” of gold-standard currencies. The public has been confused and frightened by the cry, “the dollar is falling” or “the French franc is falling”, which simply means falling with reference to gold; whereas it may well have been that the real trouble was that the value of gold was rising with reference to commodities. Indeed such was often the case. Yet the uninformed public never realized that the so-called “stability” of the golden money had little to do with any stability of buying power over goods and services
Goods and services
In economics, economic output is divided into physical goods and intangible services. Consumption of goods and services is assumed to produce utility. It is often used when referring to a Goods and Services Tax....
. In fact, the buying power of so-called “stable” gold currencies fluctuated quite violently, because the value of gold itself was changing. Perhaps the most vicious feature of the gold standard was that, so long as exchange rates – the price of gold in terms of gold – remained unchanged, the public had a false sense of security. In order to maintain this misleading “stability” of gold and exchange rates, the “gold bloc” nations periodically made terrific sacrifices which not only destroyed their prosperity, and indeed brought them to the brink of bankruptcy, but ultimately destroyed the gold standard itself.
(c) In order to assure the redemption of national currencies in gold, the central banks were accustomed to maintain, behind their note
Banknote
A banknote is a kind of negotiable instrument, a promissory note made by a bank payable to the bearer on demand, used as money, and in many jurisdictions is legal tender. In addition to coins, banknotes make up the cash or bearer forms of all modern fiat money...
issues, a reserve
Gold Reserve
Gold Reserve Inc. is a gold mining company with operations and mining property in Bolivar State, Venezuela.Founded in 1956, Gold Reserve Inc. is now headquartered in Spokane, Washington. The company has about ten employees at its Washington office and about 55 in Venezuela. Of these 55,...
of upwards of forty per cent in gold or gold exchange.
(d) The extent of gold movements under this system led the central banks to regulatory action. For instance, if large amounts of gold began to vanish from a central bank, either to pay for a surplus of commodity imports or by way of withdrawals for speculative purposes, the banks among other things raised interest rates in order to discourage borrowing from it and thus put a stop to gold withdrawals. Thus the disappearance of gold from the banks led them automatically to take deflationary action; for it curtailed the volume of bank credit outstanding. This feature of gold-standard machinery, in most cases, worked efficiently enough to its end. But it often brought depression as the price of maintaining a fixed gold unit.
When there was an excess of commodity exports from a given country, or a flight to it of gold from foreign countries, its central bank was similarly supposed to lower interest rates, thus stimulating lending, with a consequent withdrawal of gold from the bank. But after the war this automatic regulatory mechanism worked badly or not at all.
In September 1931 England
England
England is a country that is part of the United Kingdom. It shares land borders with Scotland to the north and Wales to the west; the Irish Sea is to the north west, the Celtic Sea to the south west, with the North Sea to the east and the English Channel to the south separating it from continental...
found it impossible to maintain her gold reserves and was forced off the gold standard. Since then, every other gold-standard nation has either been forced off gold or has abandoned it voluntarily. Those countries which bowed first to this pressure were also the first to recover from the depression. France
France
The French Republic , The French Republic , The French Republic , (commonly known as France , is a unitary semi-presidential republic in Western Europe with several overseas territories and islands located on other continents and in the Indian, Pacific, and Atlantic oceans. Metropolitan France...
was among the last to abandon gold; and she is still suffering from her mistake in waiting so long.
The depression experience of all countries under the gold standard has shown that it is scarcely worthy of being called a “standard” at all. It has shown that the so-called “stability” of gold and of foreign exchange destroyed the stability of the buying power of money and thereby the stability of economic conditions generally. In fact, the effort to retain gold as a “standard” has had such disastrous results all over the world that, for the time being, international trade has been deprived of some of the useful services which gold might still render it.
It may be that America
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
cannot solve the problem of the function of gold in the monetary relations among nations without the cooperation of other nations. The Tri-Partite Agreement
Tripartite Agreement of 1936
The Tripartite Agreement was an international monetary agreement entered into by the United States, France, and Great Britain in September 1936 to stabilize their nations' currencies both at home and in the exchange.-History:...
, concluded in 1936 by England, France, and ourselves – at our initiative – may well serve as a first tentative step in the direction of such a solution. The point here, however, is that we need not wait for international agreements in order to attack our domestic monetary problems.
But now that the central banks no longer operate according to the old rules of the gold standard, how do they determine their monetary policies? What “standard” has replaced the gold standard?
The Standard of Stable Buying Power
(2) Several of the leading nations now seek to keep their monetary units reasonably stable in internal value or buying power and to make their money supply fit the requirements of production and commerce.In the determination of a nation’s monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
, the needs of its domestic economy
Economy
An economy consists of the economic system of a country or other area; the labor, capital and land resources; and the manufacturing, trade, distribution, and consumption of goods and services of that area...
have taken the place of the arbitrary rules of the gold standard. After the experience of the past decade, it is improbable that many countries will want to give their currencies arbitrary gold values at the cost of domestic deflation and depression. At present healthy domestic economic conditions are generally given precedence over the maintenance of a fixed money value of gold. This is a great step forward. The countries which have consistently followed this new line have more nearly solved their depression problems than have those that have sought to compromise by permitting considerations other than domestic welfare to determine their monetary policies. And for the United States stability in the domestic purchasing power of the dollar is certainly of far more importance than stability in its exchange value in terms of foreign monetary units.
(3) Some countries, especially the Scandinavian and others included in the so-called “Sterling Bloc”, have gone further than the United States in formulating and in carrying out these new monetary policies.
On abandoning the gold standard in 1931, the Scandinavian
Scandinavians
Scandinavians are a group of Germanic peoples, inhabiting Scandinavia and to a lesser extent countries associated with Scandinavia, and speaking Scandinavian languages. The group includes Danes, Norwegians and Swedes, and additionally the descendants of Scandinavian settlers such as the Icelandic...
countries took steps to maintain for the consumer a constant buying power for their respective currencies. Finland
Finland
Finland , officially the Republic of Finland, is a Nordic country situated in the Fennoscandian region of Northern Europe. It is bordered by Sweden in the west, Norway in the north and Russia in the east, while Estonia lies to its south across the Gulf of Finland.Around 5.4 million people reside...
’s central bank made a declaration to this effect. The Riksbank of Sweden
Sweden
Sweden , officially the Kingdom of Sweden , is a Nordic country on the Scandinavian Peninsula in Northern Europe. Sweden borders with Norway and Finland and is connected to Denmark by a bridge-tunnel across the Öresund....
has done the same, and its action was officially confirmed by the Swedish Government. As a result, since then people of those fortunate lands have never lost confidence in their money. The buying power of their monetary units have been maintained constant within a few per cent since 1931. At the same time, these countries have made conscious use of monetary policy as an essential part of their efforts to promote domestic prosperity. They have been so successful as to have practically eliminated unemployment to have raised their production figures to new peaks and to have improved steadily the scale of living of their people.
(4) Our own monetary policy should likewise be directed toward avoiding inflation as well as deflation and attaining and maintaining as nearly as possible full production and employment.
There is ample evidence that the Roosevelt Administration
Roosevelt Administration
There have been two Presidents of the United States with the surname "Roosevelt":*Theodore Roosevelt Administration, the 26th President of the United States, 1901 - 1909*Franklin D. Roosevelt Administration, the 32nd President of the United States, 1933 - 1945...
once had every intention of managing our money on these principles. As early as July 3, 1933, in his famous message to the London Economic Conference
London Economic Conference
The London Economic Conference was a meeting of representatives of 66 nations from June 12 to July 27, 1933, at the Geological Museum in London. Its purpose was to win agreement on measures to fight global depression, revive international trade, and stabilize currency exchange rates.The Conference...
, President Roosevelt
Franklin D. Roosevelt
Franklin Delano Roosevelt , also known by his initials, FDR, was the 32nd President of the United States and a central figure in world events during the mid-20th century, leading the United States during a time of worldwide economic crisis and world war...
declared:
“…old fetishes of so-called international bankers are being replaced by efforts to plan national currencies with the objective of giving those currencies a continuing purchasing power which does not greatly vary in terms of commodities and the need of modern civilization.
“Let me be frank in saying that the United States seeks the kind of dollar which a generation hence will have the same purchasing and debt-paying power as the dollar value we hope to attain in the near future…”
This was definite notice to the assembled financial representatives of the world’s nations that the United States had abandoned the gold standard and adopted in its place a policy of dollar management designed to keep the dollar’s buying power constant. In several talks during 1933, the President reaffirmed this principle of a “managed currency
Fixed exchange rate
A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.A fixed exchange rate is usually used to...
”. However, some people saw danger of arbitrary changes in the gold content of the collar and feared that the discretionary powers of the President would serve as a disturbing influence. Apparently the President was influenced by those views, hence after fixing the new gold content of the dollar on January 31, 1934, he has allowed it to remain unchanged. That is, while professing adherence to the doctrine of a dollar of stable domestic buying power, the Administration has compromised and, in effect, followed a policy of giving the dollar a fixed gold content, within certain limits, whenever it should seem to require such treatment.
The purchasing power of our dollar has therefore not been consistently stabilized. Neither, on the other hand, have we had a genuine gold standard – or even any standard. We have vacillated between the two rival systems of monetary stability: The internal and external. The very rigidity of our gold price has, however, exposed the dollar to the disturbing influences of “hot money” from abroad and has probably been an obstacle to recovery in this country.
So long as we have no law determining what our monetary policy shall be there will always be uncertainty as to the external and internal values of the dollar. Consequently, there is an ever-present danger of abuse of discretionary powers, not only the President
President of the United States
The President of the United States of America is the head of state and head of government of the United States. The president leads the executive branch of the federal government and is the commander-in-chief of the United States Armed Forces....
’s powers but those of others as well. The Secretary of Treasury, for instance, has discretionary power to issue silver certificates and, for that purpose, to buy silver
Silver
Silver is a metallic chemical element with the chemical symbol Ag and atomic number 47. A soft, white, lustrous transition metal, it has the highest electrical conductivity of any element and the highest thermal conductivity of any metal...
. He is also free to use, as he pleases, the two billion dollars in stabilization account and thus influence foreign exchange. The Board of Governors of the Federal Reserve System
Federal Reserve System
The Federal Reserve System is the central banking system of the United States. It was created on December 23, 1913 with the enactment of the Federal Reserve Act, largely in response to a series of financial panics, particularly a severe panic in 1907...
may change the reserve requirements of banks, may buy or sell Government bonds in the open market, may change discount rate
Discount rate
The discount rate can mean*an interest rate a central bank charges depository institutions that borrow reserves from it, for example for the use of the Federal Reserve's discount window....
s, and in other ways effect the volume of credit and so the purchasing power of the dollar. Even our gold miners, and still more the miners of gold abroad, may effect the volume of money in circulation in the United States, since fore every ounce of gold they turn over to the United States Mint
United States Mint
The United States Mint primarily produces circulating coinage for the United States to conduct its trade and commerce. The Mint was created by Congress with the Coinage Act of 1792, and placed within the Department of State...
, the Treasury increases our volume of money
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
by $35. Lastly, our 15,000 commercial banks affect the value of the dollar by expanding
Expansionary monetary policy
In economics, expansionary policies are fiscal policies, like higher spending and tax cuts, that encourage economic growth. In turn, an expansionary monetary policy is monetary policy that seeks to increase the size of the money supply...
, or contracting
Contractionary monetary policy
Contractionary monetary policy is monetary policy that seeks to reduce the size of the money supply. In most nations, monetary policy is controlled by either a central bank or a finance ministry....
, the volume of demand deposits when they either make or liquidate loans, and when they purchase or sell securities.
Our monetary system is thus permeated with discretionary powers. But there is no unity about it, no control, and, worst of all, no proscribed policy. In a word, there is no mandate based on a definite principle.
The Criteria of Our Monetary Policy
(5) We should set up certain definite criteria according to which our monetary policy should be carried out.Up to the present time Congress
United States Congress
The United States Congress is the bicameral legislature of the federal government of the United States, consisting of the Senate and the House of Representatives. The Congress meets in the United States Capitol in Washington, D.C....
has merely given our monetary agencies certain broad powers, with no explicit directions as to how those powers should be used. Today we have no clear and definite standard by which to measure success or failure and, consequently, there is no way by which we can tell clearly and definitely whether the divers agencies are giving us the best service the can.
For instance, our most powerful monetary agency, the Board of Governors of the Federal Reserve System, proceeds on the basis of a broad statement of general principles which it published in September, 1937. This is not the law, but merely and expression of opinion on the part of the members of the Board as to what they, at that particular time, thought they ought to do. There is no compulsion about it. It is not binding on the Board itself. It said:
“…The Board believes that economic stability
Economic stability
Economic stability refers to an absence of excessive fluctuations in the macroeconomy. An economy with fairly constant output growth and low and stable inflation would be considered economically stable. An economy with frequent large recessions, a pronounced business cycle, very high or variable...
rather than price stability should be the general objective of public policy. It is convinced that this objective cannot be achieved by monetary policy alone, but that the goal should be sought through coordination of monetary and other major policies of the Government which influence business activity, including particularly policies with respect to taxation, expenditures
Government spending
Government spending includes all government consumption, investment but excludes transfer payments made by a state. Government acquisition of goods and services for current use to directly satisfy individual or collective needs of the members of the community is classed as government final...
, lending, foreign trade, agriculture
Agricultural policy
Agricultural policy describes a set of laws relating to domestic agriculture and imports of foreign agricultural products. Governments usually implement agricultural policies with the goal of achieving a specific outcome in the domestic agricultural product markets...
and labor.
“It should be the declared objective of the Government of the United States to maintain economic stability and should be the recognized duty of the Board of Governors of the Federal Reserve System to use all its powers to contribute to a concerted effort by all agencies of the Government toward the attainment of this objective.”*
As mentioned before, the maintenance of a substantially constant buying power of the Swedish and Finnish currencies is not inconsistent with the establishment and maintenance of prosperous economic conditions. On the other hand, there is no record of any experience of sustained economic equilibrium
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...
without some degree of price-level stability. In a general way, however, the Board’s declaration conformed to the general principles of monetary stability enunciated by President Roosevelt in 1933, although the President was much more specific than the Board in mentioning the objective of “stable buying power.” The Board declared emphatically what it believed it could not do. As to what is could do, or intended to do, it made, at best, only a vague statement. It may, at any time in the future, in order to justify an action or lack of action to which it many be inclined, interpret this statement as it pleases or repudiate it altogether. That is, the Board is now free to reserve to itself the widest possible discretion in the use of its powers under any circumstances that may arise. What certainty is there that it has not already changed its mind on the subject without having made another declaration? What obligation would a new member of the Board feel for the opinions expressed by his predecessors? What does the public know of the real aims of the Board?
Once Congress determines the criteria of monetary policy, many current erroneous beliefs in erratic varieties of “managed currency” as a cure-all for our economic ill may be replace by more rational views as to the many important things that need to be done outside the monetary field in order to put our economic system into working condition. Unless disturbing monetary factors have first been largely eliminated, the relative importance of other necessary measures cannot be determined.
- From the Bulletin of the Board of Governors of the Federal Reserve System, September, 1937.
(6) The criteria for monetary management adopted should be so clearly defined and safeguarded by law as to eliminate the need of permitting any wide discretion to our Monetary Authority
Monetary authority
Monetary authority is a generic term in finance and economics for the entity which controls the money supply of a given currency, and has the right to set interest rates, and other parameters which control the cost and availability of money...
.
That is, unless we tell one single responsible Monetary Authority exactly what is expected of it, we can never call it to account for not giving us the kind of policy we wish. When there is no definite direction in the law, the Monetary Authority (or as matters are now, authorities) cannot possibly function as a united body, but will make decisions under the ever-varying domination of different interests and different personalities. This vacillation cannot be avoided, and, in the past, it has been one of the weak points in the operation of the Federal Reserve System. Mr. Adolph Miller, a member of the Federal Reserve Board for twenty years, brought this weakness to light on the occasion of a Congressional Hearing
Congressional hearing
Congressional hearings are the principal formal method by which committees collect and analyze information in the early stages of legislative policymaking. Whether confirmation hearings — a procedure unique to the Senate — legislative, oversight, investigative, or a combination of these, all...
:
“I have in mind, vaguely, whatever happens to be the dominant influence in the Federal Reserve System, and that is expressing itself in the line of policy undertaken. It may today be this individual or group; tomorrow it may be another. But wherever any important line of action or policy is taken there will always be found some one or some group whose judgment and whose will is the effective thing in bringing about the result. There’s the ear which does the hearing of the system.”*
This uncertain condition is one which a law could and should make impossible.
- See page 165 of the Hearings on H.R. 11806, 1928.
Constant–per–Capita Standard
(7) Among the possible standards to which the dollar could be made to conform are those which could be obtained by the two following methods:(a) Establish a constant-average-per-capita
Per capita
Per capita is a Latin prepositional phrase: per and capita . The phrase thus means "by heads" or "for each head", i.e. per individual or per person...
supply or volume of circulating medium
Medium of exchange
A medium of exchange is an intermediary used in trade to avoid the inconveniences of a pure barter system.By contrast, as William Stanley Jevons argued, in a barter system there must be a coincidence of wants before two people can trade – one must want exactly what the other has to offer, when and...
, including both “pocket-book money” and “check-book money” (that is, demand deposits or individual deposits subject to check). One great advantage of this “constant-per-capita-money” standard is that it would require a minimum of discretion on the part of the Monetary Authority.
(b) Keep the dollar equivalent to an ideal “market basket
Market basket
The term market basket or commodity bundle refers to a fixed list of items used specifically to track the progress of inflation in an economy or specific market....
dollar”, similar to Sweden’s market basket krona
Swedish krona
The krona has been the currency of Sweden since 1873. Both the ISO code "SEK" and currency sign "kr" are in common use; the former precedes or follows the value, the latter usually follows it, but especially in the past, it sometimes preceded the value...
. This market basket dollar would consist of a representative assortment of consumer goods in the retail markets (so much food
Food
Food is any substance consumed to provide nutritional support for the body. It is usually of plant or animal origin, and contains essential nutrients, such as carbohydrates, fats, proteins, vitamins, or minerals...
, clothing
Clothing
Clothing refers to any covering for the human body that is worn. The wearing of clothing is exclusively a human characteristic and is a feature of nearly all human societies...
, etc.), thus constituting the reciprocal of an index
Cost-of-living index
Cost of living is the cost of maintaining a certain standard of living. Changes in the cost of living over time are often operationalized in a cost of living index. Cost of living calculations are also used to compare the cost of maintaining a certain standard of living in different geographic areas...
of the cost of living. Under this “constant-cost-of-living” standard the Monetary Authority would, however, as has been found in Sweden, have to observe closely the movements of other, more sensitive indexes, with a view to preventing the development of disequilibrium as between sensitive and insensitive prices.
Under the former of those two arrangements all the Monetary Authority would have to do would be to ascertain the amount of circulating medium in active circulation whatever amount of circulating medium seemed necessary to keep unchanged the amount of money per head of population. For this purpose, the statistical information regarding the volume of means of payment
Payment
A payment is the transfer of wealth from one party to another. A payment is usually made in exchange for the provision of goods, services or both, or to fulfill a legal obligation....
should be improved. At present, we have on the weekly figures of leading banks and the semi-annual figures of the Federal Deposit Insurance Corporation
Federal Deposit Insurance Corporation
The Federal Deposit Insurance Corporation is a United States government corporation created by the Glass–Steagall Act of 1933. It provides deposit insurance, which guarantees the safety of deposits in member banks, currently up to $250,000 per depositor per bank. , the FDIC insures deposits at...
.
It is also evident that the Monetary Authority would have to be empowered to regulate the total money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
, including demand deposits of commercial banks, which would have to furnish appropriate data every week. Thus, correct statistical information would, under this constant-per-capita-volume-of-money criterion, clearly prescribe the duties of the Monetary Authority, and automatically reduce to a minimum the possibility of a discretionary, hit-or-miss decision on a given occasion.
It is believed by some competent students that the annual money income of the nation tends to remain in a fairly constant ratio to the means of payment in circulation. This ratio is alleged to be approximately 3 of income to 1 of circulating medium. If this is true, a constant-per-capita volume of circulating medium would be substantially the equivalent of a constant per capita money income. In other words, we could keep per capita money income stable by keeping constant the per capita volume of circulating medium.
One consequence of this would be that technological improvements, resulting in an increase in the national real income
Real income
Real income is the income of individuals or nations after adjusting for inflation. It is calculated by subtracting inflation from the nominal income...
, would not change the national money income but, as real income increased, the price level would fall. Some authorities regard prices falling, to some extent at least, with technological improvements, as a proper result of a successful monetary policy.*
- Professors Douglas and King do not approve of this criterion.
Constant-Cost-of-Living-Standard
The constant-per-capita criterion for the volume of money is only one of several possible criteria. The alternative most often suggested is the “constant-cost-of-living”, or “market basket”, standard as outlined in (b) above.The experience of Sweden during the past eight years shows that, with the help of monetary management, it is possible to maintain at a substantially constant level the consumer buying power of a currency. This stability in Sweden has not prevented a readjustment in the prices of farm products, and other raw materials which had fallen to unduly low levels.
Violent changes in the volume of money affect not only the general price level, but also the relationship of prices to each other within the price structure. Conversely, a constant volume of money tends ultimately to stabilize not only the general price level, but the relations within the price structure. The retail prices involved in the cost-of-living index, being relatively “sticky
Sticky (economics)
Sticky, in the social sciences and particularly economics, describes a situation in which a variable is resistant to change. Sticky prices are an important part of macroeconomic theory since they may be used to explain why markets might not reach equilibrium right away. Nominal wages are often said...
”, do not afford all the information necessary for regulating the volume of money. The Monetary Authority might therefore find it desirable to include in its standard some commodities having “sensitive” prices, in order to make its actions respond more quickly to the direction in which things are moving.
Under a “constant-cost-of-living” or “market-basket” dollar technological improvement would not find expression in a falling price level, but rather in a higher per capita money income
Income
Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...
and larger money wage
Wage
A wage is a compensation, usually financial, received by workers in exchange for their labor.Compensation in terms of wages is given to workers and compensation in terms of salary is given to employees...
for labor. With present labor policies, there would be a strong tendency for money wages to keep pace with technological progress. In fact one of the advantages of the “constant cost of living” standard is its easier comprehensibility and its presumably greater appeal to labor.
Other standards besides the two here mentioned might be proposed.
Whatever technical criterion of monetary stability is adopted, as mentioned under (4) above, the ultimate object of monetary policy should not be merely to maintain monetary stability. This monetary stability should serve as a means toward the ultimate goal of full production and employment and a continuous rise in the scale of living. Therefore, the Monetary Authority should study the movements of all available indicators of economic activity and prosperity with a view to determining just what collection of prices, if stabilized, would lead to the highest degree of stability in production and employment.
Essentially, however, the purpose of any monetary standard is to standardize the unit of value
Value (economics)
An economic value is the worth of a good or service as determined by the market.The economic value of a good or service has puzzled economists since the beginning of the discipline. First, economists tried to estimate the value of a good to an individual alone, and extend that definition to goods...
– just as a bushel
Bushel
A bushel is an imperial and U.S. customary unit of dry volume, equivalent in each of these systems to 4 pecks or 8 gallons. It is used for volumes of dry commodities , most often in agriculture...
standardizes the unit of quantity
Quantity
Quantity is a property that can exist as a magnitude or multitude. Quantities can be compared in terms of "more" or "less" or "equal", or by assigning a numerical value in terms of a unit of measurement. Quantity is among the basic classes of things along with quality, substance, change, and relation...
, and an ounce
Ounce
The ounce is a unit of mass with several definitions, the most commonly used of which are equal to approximately 28 grams. The ounce is used in a number of different systems, including various systems of mass that form part of the imperial and United States customary systems...
standardizes the unit of weight
Weight
In science and engineering, the weight of an object is the force on the object due to gravity. Its magnitude , often denoted by an italic letter W, is the product of the mass m of the object and the magnitude of the local gravitational acceleration g; thus:...
. To furnish a dependable standard of value should therefore be the only requirement of monetary policy. It would be fatal if the public were led to believe that the Monetary Authority, solely through monetary manipulations, were able to assure the maintenance of prosperity
Prosperity
Prosperity is the state of flourishing, thriving, good fortune and/or successful social status. Prosperity often encompasses wealth but also includes others factors which are independent of wealth to varying degrees, such as happiness and health....
, and should therefore be made responsible for it. Any such assumption would probably mean the demise of the Monetary Authority in the first period of adversity.
Legislative Feature A
(8) In order that our monetary policy may be made to conform to the new standard and become the means of attaining a high degree of prosperity and stability, legislationLegislation
Legislation is law which has been promulgated by a legislature or other governing body, or the process of making it...
should be enacted, embodying the following features:
(a) There should be constituted a “Monetary Authority” clothed with carefully defined powers over the monetary system of the country, including the determination of the volume of circulating medium.
That is, the “Monetary Authority” would become the agent of Congress in carrying out its function as set forth in the Constitution
United States Constitution
The Constitution of the United States is the supreme law of the United States of America. It is the framework for the organization of the United States government and for the relationship of the federal government with the states, citizens, and all people within the United States.The first three...
, Article I
Article One of the United States Constitution
Article One of the United States Constitution describes the powers of Congress, the legislative branch of the federal government. The Article establishes the powers of and limitations on the Congress, consisting of a House of Representatives composed of Representatives, with each state gaining or...
, Section 8, - “to coin money, regulate the value therof, and of foreign coin…” This Monetary Authority would receive all the powers necessary to “regulate” – in particular, the power to determine – the value of circulating medium and the domestic and foreign value of the dollar. All of the miscellaneous powers now scattered among the Federal Reserve Board, the Secretary of the Treasury, the President and others would have to be transferred to this one central Monetary Authority.
Feature B
(b) Congress should give to this Monetary Authority a mandate specifying the monetary standard, to maintain which these powers would be exercised. The mandate should also define the part which monetary policy would play in attaining the objective of steadily increasing prosperity.Not only would such a mandate cause the Monetary Authority to use all of its powers for the purpose of attaining the standard set by Congress; but it would also prevent the abuse of those powers. The Monetary Authority would then have a definite standard to attain and maintain.
Feature C
(c) The Monetary Authority might be the Federal Reserve Board or another body associated therewith. It should be kept free from any political or other influences and interests which might tend to interfere with the performance of its functions. Its primary concern should be the maintenance of the monetary standard as defined by Congress. This standard and the means of maintaining it should be so narrowly defined by Congress as to leave only a minimum of discretion to the Monetary Authority.Unless the Monetary Authority were free from the pressure of both the party politics
Party Politics
Party Politics is a peer-reviewed academic journal that publishes papers in the field of Political Science. The journal's editors are David M Farrell and Paul Webb...
and selfish interests, there would be no guarantee that, in making its decisions, it would be guided solely by the mandate given to it by Congress.
One way to secure the requisite independence is by the exercise of great care in appointment of members, by paying them adequate salaries and by making provisions for retirement pensions. Politics as well as the pressure of interested financial groups should be ruled out so far as practically possible. The members should be selected solely on the basis of their fitness for the job and should be subject to removal by Congress for acting in opposition to the mandate laid down by it.
The Monetary Authority should, of course, have the widest possible discretion with respect to the methods it might find most suitable for attaining the objectives laid down in the mandate. That is, it should be absolutely free to use any or all of its powers over money and the banks according to its own best judgment; but, as has been stressed before, the Monetary Authority should not be free to deviate from the mandate given to it by Congress.
Feature D
(d) Neither the President nor the United States Treasury nor any other agency of the Government should have power to alter the volume of circulating medium. That is, none of them should have the power to issue green-backs, whether to meet the fiscal needs of the Government or for any other purpose. They should not have the power to change the price of gold or the weight of the gold dollar either to increase the cash or the Government or for any other purpose. Any discretionary powers along these lines now possessed by the President or the Secretary of the Treasury should be repealed and such of them as may be necessary for controlling the volume of money, including the power of gold storilizationGold Reserve
Gold Reserve Inc. is a gold mining company with operations and mining property in Bolivar State, Venezuela.Founded in 1956, Gold Reserve Inc. is now headquartered in Spokane, Washington. The company has about ten employees at its Washington office and about 55 in Venezuela. Of these 55,...
, should be transferred to the Monetary Authority.
However, in determining its course of action the Monetary Authority should take note of all other activities of the Government intended to affect or likely to affect economic conditions, and it should, when necessary, cooperate with other agencies of the Government.
In the emergency of 1933-34
Emergency Banking Act
The Emergency Banking Act was an act of the United States Congress spearheaded by President Franklin D. Roosevelt during the Great Depression. It was passed on March 9, 1933...
, the absence of any permanent monetary agency capable of handling the situation was a valid reason for giving the President and the Secretary of the Treasury emergency powers over our monetary machine. Even now, so long as we have no single Monetary Authority specifically charged by Congress to carry out a defined policy, there is much reason for continuing these discretionary powers. But once Congress has established a Monetary Authority and given it a mandate, no other agency should then have any concurrent or conflicting powers.
There is less danger in giving to a Monetary Authority of the type described above any or all of the powers necessary to control our monetary system, than there is in the present system under which wide discretionary powers are assigned to several agencies with more or less conflicting interests and with inadequate instructions to any of them concerning the use of them.
The Monetary Authority should be instructed to cooperate with non-monetary agencies in its endeavors to promote stability. This policy should include, in particular, cooperation with the Secretary of the Treasury, but the independence of the Monetary Authority must be scrupulously safeguarded.
The Fractional Reserve System
(9) A chief loose screw in our present American money and banking system is the requirement of only fractional reserves behind demand deposits. Fractional reserves give our thousands of commercial banks power to increase or decrease the volume of our circulating medium by increasing or decreasing bank loans and investments. The banks thus exercise what has always, and justly, been considered a prerogative of sovereign power. As each bank exercises this power independently without any centralized control, the resulting changes in the volume of the circulating medium are largely haphazard. This situation is a most important factor in booms and depressions.Some nine-tenths of our business is transacted, not with physical currency
Cash
In common language cash refers to money in the physical form of currency, such as banknotes and coins.In bookkeeping and finance, cash refers to current assets comprising currency or currency equivalents that can be accessed immediately or near-immediately...
, or “pocket-book money”, but with demand deposits subject to check, or “check-book money”. Demand deposits subject to check, though functioning like money in many respects, are not composed of physical money, but are merely promises by the bank to furnish such money on the demands of the respective depositors. Under ordinary conditions only a few depositors actually ask for real money; therefore, the banks are required to hold as a cash reserve only about 20 per cent of the amounts they promise to furnish. For every $100 of cash which a bank promises to furnish its depositors, it needs to keep as a reserve only about $20. And even this reserve is not actual cash on hand. It is nothing but a “deposit” with a Federal Reserve Bank, though any fraction of this may, in fact, be borrowed from the Reserve Banks themselves. Even this borrowed money is merely the Reserve Banks’ promise to pay money. In other words, the whole of the 20 per cent legal reserve is itself merely a promise by the Federal Reserve Bank to furnish money. Nevertheless, the banks’ promises to their demand depositors actually circulate as if they were real money, so that the bank, in fact, floats its non-interest bearing debt as money. The depositor checks against his balance in the bank as if it were really there, and the recipient of the check looks on it in the same way. So long as not too many depositors ask for money, the promises of the bank are thus able to perform all the functions of money.
The question which naturally occurs is: How do these demand deposits affect the volume of the circulating medium?
When a bank makes a loan or purchases bonds, it increases its own promises to furnish money on demand by giving to the borrower, or to the seller of the bond, a demand deposit credit. By so doing it increases the total volume of demand deposits in circulation. Conversely, when the loan is repaid to the bank, or the bond is sold by the bank, the demand deposits are reduced by that much. Thus bank loans first increase, and repayment later decreases, the total volume of the country’s circulating medium.
Ordinarily the increases and decreases roughly balance; but, in boom periods, the increases preponderate and thus drive the boom higher, whereas, in depression periods, the decreases preponderate and thus further intensify the depression. In booms, many are eager to borrow; in depressions, lenders are loath to lend money but eager to collect. It is this over-lend and over-liquidate factor that tends to accentuate booms and depressions, and it is the tie between the volume of bank loans and the volume of the circulating medium which is responsible. It is this system which permits and practically compels the banks to lend and owe five times as much money as they must have on hand if they are to survive in the competitive struggle which causes much of the trouble.
Despite these inherent flaws in the fractional reserve system, a Monetary Authority could unquestionably, by wise management, give us a far more beneficial monetary policy than the Federal Reserve Board has done in the past. But the task would be much simplified if we did away altogether with the fractional reserve system; for it is this system which makes the banking system so vulnerable.
The 100% Reserve System
(10) Since the fractional reserve system hampers effective control by the Monetary Authority over the volume of our circulating medium it is desirable that any bank or other agency holding deposits subject to check (demand deposits) be required to keep on hand a dollar of reserve for every dollar of such deposit, so that, in effect, deposits subject to check actually represent money held by the bank in trust for the depositor.With such a dollar-for-dollar backing, the money which the bank promised to furnish would actually be in the bank. That is, with the requirement of a 100% reserve, demand deposits subject to check would actually become deposits of money, and no longer be merely the bankers’ debts. If, today, those who think they have money in the bank should all ask for it, they would, of course, quickly find that the money is not there and that the banks could not meet their obligations. With 100% reserves, however, the money would be there; and honestly run banks could never go bankrupt as the result of a run on demand deposits.
The 100% reserve system
Full-reserve banking
Full-reserve banking, also known as 100% reserve banking, is a banking practice in which the full amount of each depositor's funds are kept in reserve, as cash or other highly liquid assets...
was the original system of deposit banking, but the fractional reserve system was introduced by private Venetian bankers not later than the middle of the Fourteenth century. Originally they merely accepted deposits of actual cash for safe keeping, the ownership of which was transferrable by checks or by a proto-type of what we now call checks
Cheque
A cheque is a document/instrument See the negotiable cow—itself a fictional story—for discussions of cheques written on unusual surfaces. that orders a payment of money from a bank account...
. Afterward, the bankers began to lend some this specie
Coin
A coin is a piece of hard material that is standardized in weight, is produced in large quantities in order to facilitate trade, and primarily can be used as a legal tender token for commerce in the designated country, region, or territory....
, though it belonged not to them but to the depositors. The same thing happened in the public banks of deposit at Venice
Venice
Venice is a city in northern Italy which is renowned for the beauty of its setting, its architecture and its artworks. It is the capital of the Veneto region...
, Amsterdam
Amsterdam
Amsterdam is the largest city and the capital of the Netherlands. The current position of Amsterdam as capital city of the Kingdom of the Netherlands is governed by the constitution of August 24, 1815 and its successors. Amsterdam has a population of 783,364 within city limits, an urban population...
, and other cities, and the London
London
London is the capital city of :England and the :United Kingdom, the largest metropolitan area in the United Kingdom, and the largest urban zone in the European Union by most measures. Located on the River Thames, London has been a major settlement for two millennia, its history going back to its...
goldsmith
Goldsmith
A goldsmith is a metalworker who specializes in working with gold and other precious metals. Since ancient times the techniques of a goldsmith have evolved very little in order to produce items of jewelry of quality standards. In modern times actual goldsmiths are rare...
s of the Seventeenth century found that handsome profits would accrue from lending out other people’s money, or claims against it – a practice which, when first discovered by the public, was considered to be a breach of trust. But what thus began as a breach of trust has now become the accepted and lawful practice. Nevertheless, the practice is incomparably more harmful today than it was centuries ago, because, with increased banking, and the increased pyramiding now practiced by banks, it results in violent fluctuations in the volume of the circulating medium and in economic activity in general.
How to Establish the 100% Reserve System
(11) The following are two of several methods of introducing, or rather reintroducing, the 100% reserve system:(a) The simplest method of making the transition from fractional to 100% reserves would be to authorize the Monetary Authority to lend, without interest, to every bank or other agency carrying demand deposits, sufficient cash (Federal Reserve notes, other Federal Reserve credit, United States notes, or other lawful money) to make the reserve of each bank equal to its demand deposits.
The present situation would be made the starting point of the 100% reserve system by simply lending to the banks whatever money they might need to bring the reserves behind their demand deposits up to 100%. While this money might, largely be, newly issued for the occasion – for example, newly issued Federal Reserve notes – it would not inflate the volume of anything that can circulate. It would merely change the nature of the reserves behind the money which circulates. By making those reserves 100%, we would eliminate a main distinction between pocket-book money and check-book money. The bank would simply serve as a big pocket book to hold its depositors’ money in storage. If, for instance, new Federal Reserve notes were issued and stored in the banks, as the 100% reserve behind the demand deposits, a person having $100 on deposit would simply be the owner of $100 of Federal Reserve notes thus held in storage. He could either take his money out and make payments with it, or leave it in and transfer it by check. The $100 depositor would have $100. Furthermore, the bank could not inflate by lending out the $100 on deposit, for, under the 100% system, that $100 would not belong to the bank nor even be within the bank’s control.
The power of the banks either to increase or decrease, that, to inflate or deflate, our circulating medium would thus disappear over night. The banks’ so-called “excess reserves
Excess reserves
In banking, excess reserves are bank reserves in excess of the reserve requirement set by a central bank. They are reserves of cash more than the required amounts. Holding excess reserves is generally considered costly and uneconomical as no interest is earned on the excess amount...
” would disappear, and with them one of the most potent sources of possible inflation. At present, because of the fractional reserve system, the banks could conceivably, on the basis of their enormous excess reserves, inflate their demand deposits by about twenty billion dollars. The Federal Reserve Board’s present powers are inadequate fully to control this situation. The Board realized this danger when it stated, in its Annual Report for 1938:
“The ability of the banks greatly to expand the volume of their credit without resort to the Federal Reserve banks would make it possible for a speculative situation to get under way that would be beyond the power of the system to check or control. The Reserve System would, therefore, be unable to discharge the responsibility placed upon it by Congress or to perform the service that the country rightly expects form it.”
Moreover, the Board’s present machinery is so clumsy that almost any attempt to counteract a threat of inflation might produce deflation.
(b) A second method of making the transition would be to let each bank count as cash reserve up to a specified maximum, its United States Government bonds (reckoned at par
Par value
Par value, in finance and accounting, means stated value or face value. From this comes the expressions at par , over par and under par ....
), and to provide for their conversion into cash by the Government on the demand of the bank. This method of transition would be particularly easy today, because the banks already hold nearly enough cash and Government bonds to fulfill the proposed 100% reserve requirement.
Thus, under the proposed arrangement, the banks would need only $3,7 billions of new cash or Government bonds to satisfy a 100% reserve requirement. We could, therefore, today introduce the 100% reserve system and stabilize our banking situation, without causing any very disturbing changes in bank earnings from interest on federal bonds. While, under the plan proposed, those new funds would be distributed among banks automatically, as needed, to raise reserves, in practice almost three-fourths of the required new money would be needed at this time by the large banks in New York
New York
New York is a state in the Northeastern region of the United States. It is the nation's third most populous state. New York is bordered by New Jersey and Pennsylvania to the south, and by Connecticut, Massachusetts and Vermont to the east...
, which function as the “Bankers' bank
Bankers' bank
A bankers' bank is a financial institution that provides financial services to community banks in the United States of America. Bankers' banks are owned by investor banks and may provide services only to community banks....
s” for the small country banks. For New York State alone “interbank deposits” exceeded “interbank balances” by $2,8 billions (December 31, 1938). A similar situation exists in the large banks in the rest of the country. The problem is thus largely one of putting interbank deposits on a 100% reserve basis. The Federal Reserve Board has repeatedly considered taking this stop, and it has often been discussed, particularly early in 1939.
The amount of Government bonds which the banks would be permitted to hold on their own volition, as part of their reserve behind demand deposits, should be limited to the amount they held on the day when the 100% reserve requirement went into effect. As to any future additions to that volume (or subtractions from it as the bonds matured) the Monetary Authority would decide from time to time solely on the basis of the legal criterion of stability under which it was operating. The banks would be permitted to sell their reserve bonds to the Monetary Authority at any time, thus converting their reserves into cash.
Government Creation of Money
(12) Under a 100% requirement, the Monetary Authority would replace the banks as the manufacturer of our circulating medium. As long as our population and trade continue to increase there will, in general, be a need for increasing the volume of money in circulation. The Monetary Authority might satisfy this need by purchasing and retiring Government bonds with new money. This process would operate to reduce the Government debt. This means that the Government would profit by manufacturing the necessary increment of money, much as the banks have profited in times past, though, they do not and cannot profit greatly now because of the costly depression, largely a result of their uncoordinated activities. That is, the governmental creation of money would now be profitable where the bankers’ creation of money can no longer be profitable, for lack of unified control.One of the main reasons why the Board of Governors of the Federal Reserve System is not able to carry out a more effective policy of increasing our volume of circulating medium, thus helping recovery, is that it has no direct and immediate control. Open-market purchases of Government bonds by the Board may merely increase bank reserves, and not increase the volume of money, because, as the Board said “it cannot make the people borrow
Borrow
Borrow or borrowing can mean: to receive from somebody temporarily, expecting to return it.*In finance, monetary debt*In language, the use of loanwords...
,” nor can it make the commercial banks invest. Under the 100% reserve system, however, such purchases of bonds by the Monetary Authority would directly and correspondingly increase the volume of circulating medium. Conversely the sale of such bonds by the Federal Reserve Banks would directly and correspondingly reduce the volume of circulating medium when that was desired.
The point is sometimes made, however, that, even under the 100% system, the availability of an increased volume of circulating medium would not necessarily assure a correspondingly increased use of money. For example, the banks might hold an excess of “free” cash and be either unable or unwilling to invest or lend it, with the result that production and employment could not be maintained.
In such a case, it would, of course, be imperative for the Monetary Authority to increase the volume of circulating medium still further. However, instead of purchasing more bonds from banks, or from others, who might not employ the funds thus obtained, it might buy bonds from the public. The circulating medium could be reduced by the converse process whenever this was necessary.
The profit to the Government from the creation of new circulating medium would be a fitting reward for supplying us with such increased means of payment as might become necessary to care for an increased volume of business.
As we have seen, the banks have often expanded the volume of the means of payment when it should have been contracted, and contracted it when it should have been expanded. For this, bankers are not to be blamed; the fault lies with the system which ties the creation of our means of payment to the creation of the debts to, and by, the banks. Moreover, this system has been advantageous to the banks only by fits and starts, chiefly during boom periods when the volume of loans was high. When crash and depression have arrived, the system has resulted in serious trouble for the banks. Thousands of banks failed primarily because of “frozen” assets due in large part to the fact that their demand deposits were based on slow assets like land and industrial equipment which could not yield cash when suddenly needed. This fact greatly aggravated the banks’ embarrassment from the fractional reserve system.
Moreover, the independent and uncoordinated operations of some 15,000 separate banks result in haphazard changes in the volume of money and make for instability, with periodic depressions and losses to the banks themselves as well as to others.
In the past, before bank reserves were greatly weakened, the banks made tremendous profits firstly by lending out bank notes at interest, and later by lending “deposits” both of which they had themselves created. But as time went on these bonanza profits on bank notes and demand deposits became smaller and smaller as the reserve ratios became weaker and weaker, and the banks’ ability to meet their demand liabilities became more and more precarious. Eventually, ruin ensued, both to business and banking not only because operating profits were less but even more because of the havoc played with the value of their capital assets. In the ten years from 1927 to 1937 more than ten thousand banks closed their doors, with enormous losses to the stockholders as well as to the depositors and the public in general.
The assumption by the Monetary Authority of the money-creating responsibility would incidentally benefit the Government, by reducing the interest-bearing public debt pari passu
Pari passu
Pari passu is a Latin phrase that literally means "with an equal step" or "on equal footing." It is sometimes translated as "ranking equally", "hand-in-hand," "with equal force," or "moving together," and by extension, "fairly," "without partiality."...
with every dollar of new currency money put out. It would benefit both the public and the banks, by preventing panics and resulting failures; and it would benefit the public because of the greater stability of prices, employment, and profits.
In early times, the creation of money was the sole privilege of the kings or other sovereigns – namely the sovereign people, acting through their Government. The principle is firmly anchored in our Constitution and it is a perversion to transfer the privilege to private parties to use in their own real, or presumed, interest.
The founders of the Republic did not expect the banks to create the money they lend. John Adams
John Adams
John Adams was an American lawyer, statesman, diplomat and political theorist. A leading champion of independence in 1776, he was the second President of the United States...
, when President, looked with horror upon the exercise of control over our money by the banks.
Lending Under the 100% Reserve System
(13) The 100% reserve requirement would, in effect, completely separate from banking the power to issue money. The two are now disastrously interdependent. Banking would become wholly a business of lending and investing pre-existing money. The banks would no longer be concerned with creating the money they lend or invest, though they would still continue to be the chief agencies for handling and clearingClearing (finance)
In banking and finance, clearing denotes all activities from the time a commitment is made for a transaction until it is settled. Clearing is necessary because the speed of trades is much faster than the cycle time for completing the underlying transaction....
checking accounts.
Under the present fractional reserve system, if any actual money is deposited in a checking account, the bank has the right to lend it out as belonging to the bank and not to the depositor. The legal title to the money rests, indeed, in the bank. Under the 100% system, on the other hand, the depositor who had a checking account (i.e., a demand deposit) would own the money which he had on deposit in the bank; the bank would simply hold the money in trust for the depositor who had title to it. As regards time or savings deposits, on the other hand, the situation would, under the 100% system, remain essentially as it is today. Once a depositor had brought his money to the bank to be added to his time deposit
Time deposit
A time deposit is a money deposit at a banking institution that cannot be withdrawn for a certain "term" or period of time...
or savings account
Savings account
Savings accounts are accounts maintained by retail financial institutions that pay interest but cannot be used directly as money . These accounts let customers set aside a portion of their liquid assets while earning a monetary return...
, he could no longer us it as money. It would now belong to the bank, which could lend it out as its own money, while the depositor would hold a claim against the bank. The amount, in fact, ought no longer to be called a “deposit”. Actually it would be a loan to the bank.
Now let us see how, under the 100% system, the banks would be able to make loans, even though they could no longer us their customers’ demand deposits for that purpose.
There would be three sources of loanable funds. The first would be in the repayments to the banks of existing loans of circulating medium largely created by the banks in the past. Such repayments would release to the banks more cash than they would need to maintain 100% reserve behind demand deposits; and this “free” cash they would be able to lend out again. The banks would, therefore, suffer no contraction in their present volume of loans. They would have a “revolving fund” of approximately sixteen billions (as of December 31, 1938) of “Loans, Discounts and Overdraft
Overdraft
An overdraft occurs when money is withdrawn from a bank account and the available balance goes below zero. In this situation the account is said to be "overdrawn". If there is a prior agreement with the account provider for an overdraft, and the amount overdrawn is within the authorized overdraft...
s (including Rediscount
Rediscount
Rediscount is a way of providing financing to a bank or other financial institution. Especially in the 19th century and early 20th century banks made loans to their customers by "discounting" the customer's note. The note is a paper document, in a specified form, where the borrower promises to...
s)” with which to operate under the 100% system. The banks could keep these sixteen billions of loans revolving indefinitely by lending them out or investing them as they were repaid.
The second sources of loans would be the banks own funds, capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
, surplus
Surplus
Surplus means when there is more supply than demand, as in extra resources.Surplus may refer to: dumd* "The Surplus", an episode of The Office* Surplus: Terrorized into Being Consumers, a documentary film...
, and undivided profits
Profit (economics)
In economics, the term profit has two related but distinct meanings. Normal profit represents the total opportunity costs of a venture to an entrepreneur or investor, whilst economic profit In economics, the term profit has two related but distinct meanings. Normal profit represents the total...
which might be increased from time to time by the sale of new bank stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
.
The third source of loans would be new savings “deposited” in savings accounts or otherwise borrowed by the banks. That is, the banks would accept as time or savings deposits the savings of the community and lend such funds out again to those who could put them to advantageous use. In this manner, the banks might add without restraint to their savings, or time, deposits, but not to the total of their demand deposits and cash.
However, there would, of course, be a continuous moving of demand deposits from one bank to another, from one depositor to another and from demand deposits into cash and vice versa. To increase the total circulating medium would, nevertheless be the function of the Monetary Authority exclusively.
The Government ought, as soon as possible, to retire from the banking and money-lending business, into which the recent emergency has driven it. While depending on our banks to mint
Mint (coin)
A mint is an industrial facility which manufactures coins for currency.The history of mints correlates closely with the history of coins. One difference is that the history of the mint is usually closely tied to the political situation of an era...
our money, we have come more and more to depend upon Uncle Sam
Uncle Sam
Uncle Sam is a common national personification of the American government originally used during the War of 1812. He is depicted as a stern elderly man with white hair and a goatee beard...
to be our banker and source of loanable funds. The appropriate functions of each have thus been perverted to the other. Uncle Sam has been acting through the R.F.C.
Reconstruction Finance Corporation
The Reconstruction Finance Corporation was an independent agency of the United States government, established and chartered by the US Congress in 1932, Act of January 22, 1932, c. 8, 47 Stat. 5, during the administration of President Herbert Hoover. It was modeled after the War Finance Corporation...
, H.O.L.C.
Home Owners' Loan Corporation
The Home Owners' Loan Corporation was a New Deal agency established in 1933 by the Home Owners' Loan Corporation Act under President Franklin D. Roosevelt. Its purpose was to refinance home mortgages currently in default to prevent foreclosure. This was accomplished by selling bonds to lenders in...
, the F.S.C., the Commodity Credit Corporation
Commodity Credit Corporation
The Commodity Credit Corporation is a wholly owned government corporation created in 1933 to "stabilize, support, and protect farm income and prices"...
, the A.A.A., and other lending agencies. Between the Government as a banker and the commercial banks there is, however, an essential difference: The banks can create the money they lend, while the Government borrows this money in order to perform the appropriate function of the banks. The 100% reserve system would put an end to this pernicious reversal of functions. It would take the banks out of the money-creating business and put them back squarely into the money-lending business where they belong, and it would put the Government in the money-creating business, where it belongs, and take it out of the lending business, where it does not. The commercial banks would then be on a basis of parity
Purchasing power parity
In economics, purchasing power parity is a condition between countries where an amount of money has the same purchasing power in different countries. The prices of the goods between the countries would only reflect the exchange rates...
in short-term loans with lenders on long-term who have no power to create their own funds.
The question has been raised, whether, under the 100% system, the banks would not, through their loan policies, continue to exercise control over the volume of circulating medium. Might not the banks refuse to lend out their own money and the money saved by the community, and thus inevitably cause a shrinkage in the volume of actively circulating money? The answer is that, if such hoarding
Hoarding (economics)
In economics, hoarding is the practice of buying up and holding resources so that they can be sold to customers for profit.-Definition:Under capitalist theory, if this is done so that the resource can be transferred to the customer or improved upon, then it is a standard business practice ;...
should occur, the Monetary Authority could readily offset it by putting new money into circulation. But the likelihood that the banks would wish to hoard money on which they have to pay interest or dividends is not very great.
The Protection of Banks
(14) While there would be no restrictions on the transferBalance transfer
A balance transfer is the transfer of the balance in an account to another account, often held at another institution.-Types of balance transfers:...
and withdrawal of checking deposits, withdrawals from time or savings deposits (including Postal Savings
United States Postal Savings System
The United States Postal Savings System was a postal savings system operated by the United States Postal Service from January 1, 1911 until July 1, 1967. The system paid depositors 2 percent annual interest. Depositors in the system were initially limited to hold a balance of $500, but this was...
) should be restricted and subject to adequate notice. Only thus may the bankers ever feel safe in long term investing.
Under the 100% reserve system, demand deposits of checking deposits, being the equivalent of cash, would be withdrawable or transferrable without any restrictions whatever. The cash would belong to the depositor, and ought to be ready at his beck and call. But savings or time deposits would, as at present, normally be covered only fractionally by cash reserves. They represent time loans to the banks and therefore should be withdrawable only upon adequate notice. Their character as loans is often overlooked.
The term “time deposits” is a misnomer – even more so than the term “demand deposits”. Demand deposits, when provided with 100% cash reserves, become, as we have seen, true deposits of physical money withdrawable on demand. But time deposits (i.e. the bank’s liability) cannot under any circumstances be true deposits of physical money. The actual “deposit” is a loan to the bank, drawing interest, and therefore not appropriately available as money to the depositor.
One reason why time deposits are sometimes thought of as money is that they are guaranteed loans – a peculiar form of investment. The owner of a time or savings account of $1,000 can, under the terms of his contract, sell it back to the bank for exactly $1,000 plus interest. Therefore he thinks he actually has $1,000 plus interest. With other investments this guarantee is seldom given. If, today, $1,000 is “put into” some bond
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
or stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
, there is no certainty that tomorrow it can be sold for exactly $1,000. It may bring more or it may bring less. The owner thinks of his property not as $1,000 of money but as a right in the bond or stock, worth what it will bring in the market. Only the financially ignorant think of a millionaire as possessing $1,000,000 in money stored away in his cellar. Yet one naive investor, who had put $500 into a new company, visited the company’s office a year later and said that he had changed his mind and wanted to “take his money out.” He imagined “his money” to be lying idle in the company’s safe. His case was very much like that of the saving-bank
Savings bank
A savings bank is a financial institution whose primary purpose is accepting savings deposits. It may also perform some other functions.In Europe, savings banks originated in the 19th or sometimes even the 18th century. Their original objective was to provide easily accessible savings products to...
depositor who pictures his money, once “put in”, as always “in”, because he is assured that he can always “take it out”. The truth is, of course, that, in mutual savings banks, the money put in is invested by the bank on behalf of the savings depositor while, in stock savings banks, it is borrowed, on term, by the bank from the depositor and gives him no right to consider it as money freely at his disposal at any time.
As already mentioned, if we could rename time “deposits” and call them “time loans”, the general public would gain much in its understanding of these matters. The word “deposit” could then be confined to “demand deposits.” The expression “money on deposit” would cease to be a mere figure of speech. As matters are now, the “money on deposit” is not really “money” and is not really a “deposit”.
In order to make a clear distinction between true deposits which serve as money and time loans, which are investments, we should also discourage the too easy conversion of these time “deposits” into cash. At present, time deposits seldom turn over as often as once a year; and the fact that they draw interest is, and would continue to be, a considerable safeguard against any attempt to make them function as a medium of exchange. Nevertheless, it is conceivable that abuses might creep in; for example, that the banks might encourage the savings “depositor” to circulate his “deposit” by providing him with some sort of certificates, in convenient denominations of say $1 or $5, as consideration for a lowering of the rate of interest paid to him. This subterfuge should be forbidden. It would obscure the sharp distinction that should always be maintained between money, a medium of exchange, that does not bear interest, and a time loan, which bears interest, but does not serve as a medium of exchange.
It has become customary to let savings depositors withdraw cash almost as readily as if they held checking accounts. Banks having “savings” departments are thus in constant danger of having to meet unreasonable demands for the withdrawal of such savings and the practice should be stopped. The savings “depositor” is not properly entitled to any such privilege.
Under the 100% system the savings and the time deposit departments of banks should be given ample opportunity to sell investment in order to be able to supply any reasonable cash demands made by their depositors. In practice, the banks might require a month’s notice before cash could be withdrawn from a savings account. Instead of issuing pass books, the banks might issue debentures with definite maturities after notice. Savings “depositors”, moreover, might, in case of need, be entitled to borrow, at low rates of interest, against their “deposits” as security. However, such regulations, though important, are only loosely related to the main change here proposed, that of introducing a dollar-for-dollar reserve behind demand deposits.
In this way, the 100% reserve system would lead to a complete separation, within each bank, of its demand deposit department from its time deposit department. This separation would help substantially toward a greater development of our savings bank system, particularly in small communities, many of which today lack these facilities, largely, perhaps, because savings banks are subject to unfair competition from commercial banks which can pyramid loans on the basis of any cash deposited with them on time account in a way which savings banks cannot do.
(15) The splitting of the two functions of lending and the creation of money supply would be much like that of 1844 in the Bank of England
Bank of England
The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694, it is the second oldest central bank in the world...
which separated the Issue Department from the Banking Department. That split was made with substantially the same object as underlies the present proposal, but demand deposits, being then comparatively little used in place of bank notes, were overlooked. The £–for-£ reserve behind Bank of England notes then enacted was a 100% reserve system for pocket-book money. The present proposal merely extends the same system to check-book money.
The Bank Act of 1844
Bank Charter Act 1844
The Bank Charter Act 1844 was an Act of the Parliament of the United Kingdom, passed under the government of Robert Peel, which restricted the powers of British banks and gave exclusive note-issuing powers to the central Bank of England....
provided that, up to a specified maximum, reserves behind bank of England notes could be held in the form of securities, but required that, above that maximum, reserves must be held in cash, 100%. The present 100% proposal is merely that we follow up the job thus undertaken in 1844 by Sir Robert Peel
Robert Peel
Sir Robert Peel, 2nd Baronet was a British Conservative statesman who served as Prime Minister of the United Kingdom from 10 December 1834 to 8 April 1835, and again from 30 August 1841 to 29 June 1846...
. In 1844, Sir Robert could scarcely be expected to foresee that demand deposits would in time supplant bank notes as the dominant circulating medium and so require similar treatment – a 100% reserve. Yet, only four years later John Stuart Mill
John Stuart Mill
John Stuart Mill was a British philosopher, economist and civil servant. An influential contributor to social theory, political theory, and political economy, his conception of liberty justified the freedom of the individual in opposition to unlimited state control. He was a proponent of...
foresaw an increased use of checks and both Fullerton and Mill saw clearly that Peel’s reform might be frustrated by the use of checks instead of notes.
The Act of 1844 satisfactorily solved the problem of Bank of England notes
Bank of England note issues
The Bank of England, which is now the Central Bank of the United Kingdom, has issued banknotes since 1694. Since 1970, its new series of notes have featured portraits of British historical figures. Of the eight banks authorised to issue banknotes in the UK, only the Bank of England can issue...
, but serious difficulties soon arose with respect to deposit currency. As early as 1847
Panic of 1847
The Panic of 1847 was started as a collapse of British financial markets associated with the end of the 1840s railway industry boom. As a means of stabilizing the British economy the ministry of Robert Peel passed the Bank Charter Act of 1844...
, the Banking Department of the Bank of England was confronted with a run
Bank run
A bank run occurs when a large number of bank customers withdraw their deposits because they believe the bank is, or might become, insolvent...
, a pressing demand for cash – whereupon another step toward the 100% system was taken. With the approval of the British Government, though not at first by authority of law, the Banking Department borrowed cash from the Issue Department. This cash was new money specially manufactured for the emergency and transferred to the Banking Department in exchange for securities. This procedure was called a “Suspension of the Bank Act” (not to be confused with the Suspension of the Bank itself). The practice was soon validated by Parliament; and the same policy has regularly been followed in subsequent crises.
The success of these periodic gravitations toward a 100% reserve system has been so invariable that their essential nature has been but little analyzed. Both the permanent set-up of the bank of England Issue Department, and the emergency set-up of the Banking Department, are plans to strengthen reserves, one reserve being gold (now Government paper) behind the Bank’s note liabilities, the other reserve being notes behind the Bank’s deposit liabilities. The former is a legally required 100% reserve. The latter could readily be made so by a minor legal amendment. Had it been so specified and made applicable at all times and to all banks, it would have finished in England the task begun by Peel. In a word, it would have put the British banks substantially on a 100% reserve system.
Our own National Bank Act was similarly an attempt to put our banking system on a sounder reserve basis. A primary object was to prohibit wild-cat
Wildcat banking
Wildcat banking refers to the unusual practices of banks chartered under state law during the periods of non-federally regulated state banking between 1816 and 1863 in the United States, also known as the Free Banking Era...
issues of bank notes. Though we have stopped the issuance of these, the creation of demand deposits has circumvented the prohibition. The wild-cat is now represented by demand deposits. The 100% reserve system would give holders of deposits the same protection earlier given holders of bank notes.
Banks Under the 100% Reserve System
(16) Lest anyone think that the 100% reserve system would be injurious to the banks, it should be emphasized that the banks would gain, quite as truly as the Government and the people in general. Government control of the money supply would save the banks from themselves – from the uncoordinated action of some 15,000 independent banks, manufacturing and destroying our check-book money in a haphazard way.With the new steadiness in supplying the nation’s increasing monetary needs, and with the consequent alleviation of severe depressions, the people’s savings would, in all probability, accumulate more rapidly and with less interruption than at present. Loans and investments would become larger and safer, thus swelling the total business of banks. (These new loans and investments would no longer be associated with demand deposits but only with time and savings deposits).
The banks would also get some revenue from the demand deposit business itself in the form of charges for their services in taking care of the checking business.
If the manufacture of money is thus made exclusively a Governmental function and the lending of money is left to become exclusively a banking or non-Governmental function, some of the vexatious regulations to which bankers are now subject could be abolished. Moreover, the Government could withdraw from the banking business and again leave this field entirely to the bankers.
Incidentally, there would no longer be any need of deposit insurance
Deposit insurance
Explicit deposit insurance is a measure implemented in many countries to protect bank depositors, in full or in part, from losses caused by a bank's inability to pay its debts when due...
on demand deposits. Moreover, the principal argument in favor of branch banking, which is often regarded as a way to stabilize banking but by eliminating the small banker, would be removed. Last, and most important, the disastrous effects of depression would be lessened.
As we have seen, if the banks were permitted to retain as earning assets what private and Government bonds and notes they now have as backing for their demands deposits, there would be no immediate change in the earnings of the banks. However, as business continued to increase, there would be greater demands for the services of commercial banks in the demand-deposit departments. The banks might then be pressed to find additional income to compensate them for the additional work required. They would presumably be able to obtain this income through service charges. According to the “Service Charge Survey of 1938” of the Bank Management Commission of the American Bankers Association
American Bankers Association
The American Bankers Association is an industry trade group and professional association representing the United States' banking industry...
, service charges are “a first essential to safe and sound banking.” In this Survey, an analysis of earnings from service charges in 1937 reveals that, while those service charges amounted to only 4.5 per cent of the total gross earnings of commercial banks, yet, in a number of instances, they actually made all the difference between profit and loss. As to the soundness of this principle of service charges, the following may be quoted from the Survey:
“Principles of sound bank management justify service charges on checking accounts. The principle that adequate service charges constitute a necessary step in sound banking operation has been firmly established.”
Another important point is that, if the 100% system were adopted for demand deposits, the expenses of the demand-deposit branch of the business would be decreased, for it would become merely a business of warehousing cash and the Government bonds initially held and of recording the checking transactions.
As to federal regulation of the activities of commercial banks, what we need is not more, but less, of it. At present, banking operations are complicated and impeded by conflicting regulations and controls. Three separate Government agencies now send their examiners into banks. Deposit insurance is a heavy burden; and, even though it is an important protection to the small depositor, it does not afford full protection to the banks themselves. Their trade is still dangerous. The larger banks bear what is probably an unfairly large share of the burden of this insurance. The smaller banks, face an increasing trend towards more concentration of economic power in the hands of the big banks. Under the 100% system, the demand deposits of both the smallest and the largest banks would be absolutely secure. The pressure toward the concentration of banking and the establishment of branch banking would thus be greatly reduced.
These trends are manifestations of the basically fallacious set-up under which all banks, large and small, are now functioning. This cannot be remedied by merely multiplying the regulations or increasing the concentration of banking power, or by deposit insurance. What is needed is to put the system as a whole on a sound reserve basis. Under the 100% system, insurance of demand deposits would be superfluous. Since our small banks would be strengthened they could better perform their important function of directing the flow of circulating medium into appropriate channels.
Another important influence of the 100% system, not only for bankers but for the community as a whole, would be the effect on the rate of interest. The fractional reserve system distorts the rate of interest, making it sometimes abnormally high and sometimes abnormally low. Banks often lend money at nearly zero per cent when they can manufacture without cost the money they lend and are even forced to do so on some forms of loans when so many banks compete for this privilege, and when investment opportunities have been killed by depression conditions. When, on the other hand, the money lent has to be saved, the rate is a result of normal supply and demand and is much steadier.
Incidentally, abnormally low rates injure endowed institutions such as Universities, which derive their income from interest. Moreover these low rates greatly increase the savings necessary to provide a given amount of insurance and operate to reduce the independence of all holders of fixed interest securities.
On the other hand, if and when the present abnormally low rates of interest are succeeded by higher rates, two great perils will confront the banks and the country – unless the 100% plan is first put in force.
One of these perils is a drastic fall in the price of U. S. Government and other bonds. This may wreck many banks now holding large amounts of the bonds. Under 100% reserves, however, the banks would have a special need for the bonds as a sort of interest-bearing cash against their deposits and solely for the revenue they yield so that their value could not fall.
The other peril is that the three billions of “baby bonds” in the hands of the public, redeemable at par on demand, may be presented for redemption and embarrass the Government.
The 100% Reserve System May Be Inevitable
(17) There are two forces now at work which are tending silently but powerfully to compel the adoption of the 100% reserve plan:(a) Sort-term commercial loans and liquid bankable investments other than Government bonds are no longer adequate to furnish a basis for our chief medium of exchange (demand deposits) under the fractional reserve system. Capital loans are inappropriate for this purpose. As time goes on this inadequacy will grow far worse. Under the present fractional reserve system, the only way to provide the nation with circulating medium for its growing needs is to add continually to our Government’s huge bonded debt. Under the 100% reserve system the needed increase in circulating medium can be accomplished without increasing the interest bearing debt of the Government.
Under the Federal Reserve Act
Federal Reserve Act
The Federal Reserve Act is an Act of Congress that created and set up the Federal Reserve System, the central banking system of the United States of America, and granted it the legal authority to issue Federal Reserve Notes and Federal Reserve Bank Notes as legal tender...
our banking system, is supposed to function on the principle of “automatic expansion”: That is, as the volume of goods and services increases, means of payment are expected to expand automatically as a result of borrowing from the banks. The circulating medium thus created is expected again automatically to shrink whenever business repays its bank loans after being paid by its own customers. In this manner, the volume of our means of payment is supposed to expand and contract with the volume of short-term, self-liquidating, or “commercial”, loans. In other words, the banks are supposed to “monetize”, temporarily, the goods in process of production or distribution. But the volume of these commercial loans has never closely paralleled the increased needs of our expanding economy. Sometimes they have expanded too fast. At other times they have contracted drastically.
Moreover, the banks have “monetized
Monetization
Monetization is the process of converting or establishing something into legal tender. It usually refers to the coining of currency or the printing of banknotes by central banks...
” not only self-liquidating commercial loans, but also long-term loans and investment. The funds, for long-term investments pre-eminently, ought to be provided out of voluntary savings. The banks have trespassed on that function and have thereby disturbed the rate of interest on long-term investments. Moreover, as mentioned before, by creating demand deposits based upon long-term loans, the banks have filled their portfolios with “slow assets” which have become “frozen” whenever they were supposed to be repaid during times of depression. The too easy monetization of securities has facilitated the sky-rocketing in the stock market and has provided the banks with inflated assets which have collapsed and broken the banks and the public when the stock boom collapsed. During the depression of the early 30’s the preceding monetization of long-term loans substantially contributed to the failure of thousands of banks.
In recent years, attempts have been made to press the banks into making loans on real estate and other slow assets. The banks being thoroughly frightened, have balked. They have been unwilling again to risk that sort of expansion – at least for the present. To get the banks to make such loans, the Government has been compelled to guarantee mortgages on homes. Even so, it appears doubtful that the demand for short-term or commercial, loans by banks will in the future increase rapidly enough, or soon enough, alone to furnish the volume of demand deposits requisite to the maintenance of the present price level. Business has developed methods of its own for financing its operations without benefit of banks. It has added to its cash reserves, and has obtained additional resources, not by borrowing from the banks, but by offering investments directly to the public. Hence the natural trend seems to be toward less and less, rather than more and more, commercial banks. Thus it seems that the bottom has been knocked out of the original basis underlying out circulating medium. In short, we cannot now depend on short-term bank loans for furnishing us the money we need.
(b) As already noted, a by-product of the 100% reserve system would be that it would enable the Government gradually to reduce its debt, through purchases of Government bonds by the Monetary Authority as new money was needed to take care of expanding business. Under the fractional reserve system any attempt to pay off the Government debt
Government debt
Government debt is money owed by a central government. In the US, "government debt" may also refer to the debt of a municipal or local government...
, whether by decreasing Government expenditures or by increasing taxation, threatens to bring about deflation and depression.
Some competent observers think that the two forces above noted will eventually compel the adoption of the 100% plan, even if no other powerful forces should be at work.
A slow reduction of the Government debt might be made an incidental by-product of the Government method of increasing our circulating medium. But the fundamental consideration is that whatever increase in the circulating medium is necessary to accommodate national growth could be accomplished without compelling more and more people to go into debt to the banks, and without increasing the Federal interest-bearing debt.
(18) If the money problem is not solved in the near future, another great depression, as disastrous and that of 1929-1938, seems likely to overtake us within a few years. Then our opportunity of even partially solving the depression problem may be lost, and, as in France, Germany
Germany
Germany , officially the Federal Republic of Germany , is a federal parliamentary republic in Europe. The country consists of 16 states while the capital and largest city is Berlin. Germany covers an area of 357,021 km2 and has a largely temperate seasonal climate...
, and other countries where this opportunity was lost, our country could expect, if not chaos and revolution, at least more and more regulation and regimentation of industry, commerce and labor – practically the end of free enterprise
Free enterprise
-Transport:* Free Enterprise I, a ferry in service with European Ferries between 1962 and 1980.* Free Enterprise II, a ferry in service with European Ferries between 1965 and 1982....
as we have known it in America.
If we do not adopt the 100% reserve system, and if the present movement for balancing the budget succeeds without providing for an adequate money supply, the resulting reduction in the volume of our circulating medium may throw us into another terrible deflation and depression, at least as severe as that through which we have just been passing.
To the extent that monetary forces play a part in our great economic problems – as, for example the problems of full production and employment, and equitable prices for farm products – to that extent the monetary reforms here proposed are a part of our task to make our form of Government work and enable it to survive. When violent booms and depressions, in which fluctuations in the supply of money play so vital a part, rob millions of their savings and prevent millions from working, constitutions are likely to become scraps of paper. We have observed this phenomenon in other countries. It is probably no accident that the world depression coincided with the destruction of popular Government in many parts of the world. In most every case where liberal
Liberalism
Liberalism is the belief in the importance of liberty and equal rights. Liberals espouse a wide array of views depending on their understanding of these principles, but generally, liberals support ideas such as constitutionalism, liberal democracy, free and fair elections, human rights,...
government broke down, the money system, amongst other disturbing elements, had broken down first. That free exchange of goods and services on which people in industrial countries depend for their very existence had stopped functioning; and, in utter desperation, the people were willing to hand over their liberties for the promise of economic security.
In this manner the decline of democracy has set in elsewhere, and unless we take intelligent action, it may happen here.
Historical Significance
Many of the efforts made by economists to reform the banking system in the wake of the Great DepressionGreat Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
found their way into the history books. Perhaps the most notable proposals were first put forward by economists at the University of Chicago in a six-page memorandum on banking reform which
was given limited and confidential distribution to about 40 individuals on March 16, 1933. A copy of the memorandum was sent to Henry A. Wallace
Henry A. Wallace
Henry Agard Wallace was the 33rd Vice President of the United States , the Secretary of Agriculture , and the Secretary of Commerce . In the 1948 presidential election, Wallace was the nominee of the Progressive Party.-Early life:Henry A...
, then Secretary of Agriculture, with a cover letter signed by Frank Knight
Frank Knight
Frank Hyneman Knight was an American economist who spent most of his career at the University of Chicago, where he became one of the founders of the Chicago school. Nobel laureates James M. Buchanan, Milton Friedman and George Stigler were all students of Knight at Chicago. Knight supervised...
. Paul Douglas was listed among the supporters of the plan.
During the period March to November, the Chicago economists received comments from a number of individuals on their proposal and in November 1933 another memorandum was prepared. The memorandum was expanded to thirteen pages, there was a supplementary memorandum on "Long-time Objectives of Monetary Management" (seven pages) and an appendix titled "Banking and Business Cycles" (six pages). Evidently written by Henry Simons the memorandum was again supported by Paul Douglas.
The collective recommendations of these memorandum have come to be known and the Chicago plan
Chicago plan
The Chicago plan was a collection of banking reforms suggested by University of Chicago economists in the wake of the Great Depression. A six-page memorandum on banking reform was given limited and confidential distribution to about 40 individuals on March 16, 1933. The plan was supported by such...
. The memorandum generated much interest and discussion among lawmakers but the suggested reforms, such as the abolition of the fractional reserve system and imposition of 100% reserves on demand deposits, were set aside and replaced by watered down alternative measures. The Banking Act of 1935 institutionalized Federal deposit insurance and the separation of commercial and investment banking; it successfully restored the public's confidence in the banking system and ended discussion of banking reform until the Recession of 1937-1938.
The July 1939 draft proposal, coauthored by Paul Douglas and five others, resurrected proposals for banking and monetary reform from the Chicago plan but did not result in any new legislation.
Current Significance
With the advent of what is being called the Great Recession beginning in 2007, some economic reform advocates are revisiting the proposals embodied in the memorandum of March 1933 and November 1933 and the draft proposal of July 1939. One proposal put forward by Stephen Zarlenga and the American Monetary InstituteAmerican Monetary Institute
The American Monetary Institute is a non-profit charitable trust organized in 1996 for the "independent study of monetary history, theory and reform."...
, closely parallels these suggested reforms; it is being call the The American Monetary and Financial Security Act (aka Tha American Monetary Act).
Representative Dennis Kucinich
Dennis Kucinich
Dennis John Kucinich is the U.S. Representative for , serving since 1997. He was furthermore a candidate for the Democratic nomination for President of the United States in the 2004 and 2008 presidential elections....
's 16-point plan for economic recovery includes The American Monetary Act. Kucinich recently addressed the need for and benefits of monetary reform at a session of the United States House of Representatives
United States House of Representatives
The United States House of Representatives is one of the two Houses of the United States Congress, the bicameral legislature which also includes the Senate.The composition and powers of the House are established in Article One of the Constitution...
.
There is not currently a high level of awareness or popular support for the reforms suggested in A Program for Monetary Reform (1939) or the The American Monetary and Financial Security Act (2009) among lawmakers, in the media or in the general public. Legislation has not yet been introduced to the United States House of Representatives
United States House of Representatives
The United States House of Representatives is one of the two Houses of the United States Congress, the bicameral legislature which also includes the Senate.The composition and powers of the House are established in Article One of the Constitution...
, but Dennis Kucinich has indicated that he will soon do so.
This may be because the recent financial crisis was caused more by global capital flows than fractional-reserve banking—essentially, credit creation between nations. Modern central banks match savings with investment by encouraging credit expansion, which they control via short-term interest rates. In essence, money is loaned into existence without limit, other than interest rates (carefully set by the central bank—usually via inflation targeting
Inflation targeting
Inflation targeting is an economic policy in which a central bank estimates and makes public a projected, or "target", inflation rate and then attempts to steer actual inflation towards the target through the use of interest rate changes and other monetary tools.Because interest rates and the...
).
See also
- Great DepressionGreat DepressionThe Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
- Recession of 1937-1938
- Great Recession
- Business cycleBusiness cycleThe term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years...
- Credit cycleCredit cycleThe credit cycle is the expansion and contraction of access to credit over the course of the business cycle. Some economists, including Barry Eichengreen, Hyman Minsky, and other Post-Keynesian economists, and some members of the Austrian school, regard credit cycles as the fundamental process...
- Boom and bustBoom and bustA credit boom-bust cycle is an episode characterized by a sustained increase in several economics indicators followed by a sharp and rapid contraction. Commonly the boom is driven by a rapid expansion of credit to the private sector accompanied with rising prices of commodities and stock market index...
- Full employmentFull employmentIn macroeconomics, full employment is a condition of the national economy, where all or nearly all persons willing and able to work at the prevailing wages and working conditions are able to do so....
- MoneyMoneyMoney is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
- Monetary policyMonetary policyMonetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
- Full-reserve bankingFull-reserve bankingFull-reserve banking, also known as 100% reserve banking, is a banking practice in which the full amount of each depositor's funds are kept in reserve, as cash or other highly liquid assets...
- Criticism of fractional-reserve banking
- Gold Standard - Disadvantages
- Sound money