ISSUE: Spring 1941
During the six years from 1935 to 1941 the Federal government bought almost $17,000,000,000 worth of gold, of which all but $1,000,000,000 worth was purchased from abroad. Sixteen billion dollars is a lot of money to spend for foreign gold that we bury in a bombproof cave in Kentucky. It is more than twice as much as the Federal government spent for the army and navy during those same six years. Indeed, it is as much as the total Federal, state, and local expenditures for unemployment relief in that period.
Our huge stock of monetary gold represents the New Deal’s biggest blunder—the return to the gold standard in January, 1934. Gold imports since then have provided the means and the stimulus for a tremendous inflation of the money supply, and they afford no protection against a severe post-war deflation and depression. To pay for this huge sum of imported gold, the Treasury has printed $16,000,-000,000 of non-circulating paper money, which rests in the Federal Reserve banks. Today, with the Treasury holding over $22,000,000,000 of monetary gold and the private banks holding $18,000,000,000 of government bonds, our money supply (currency and checking accounts) amounts to $41,000,000,000, which is 50 per cent above the previous all-time peak in 1929. Despite such an expanded money supply, the member banks have $7,000,000,000 of reserves in excess of those they are required to hold, as a result of increased gold purchases.
The inflationary significance of such huge member-bank reserves is easy to see when one recalls that there are only three restraints on the expansion of checking accounts by the banking system: (1) gold exports to other gold-standard countries; (2) the internal drain of cash for transactions on a higher price level; and (3) the percentage reserve required by law for checking accounts. Because we are the only country on the gold standard and cash in circulation has increased by $4,000,000,000 since 1929, the first and second restraints are of comparatively little significance. Since but $1 of reserves is required for every $5 of checking accounts which the banks create by making loans, the banks could easily double our money supply and bring on the biggest inflation in the nation’s history.
The situation gets progressively more dangerous as gold continues to flow in and as bank loans and checking accounts expand with the growing credit demands of private business, stimulated by our big armament program. However, the rate of expansion of our gold stocks cannot continue to increase, for we had 80 per cent of the world’s stock of monetary gold at the end of 1940, and it is very possible that we shall have practically all of the world’s monetary gold within two or three years.
That is not all. Each dollar of checking accounts in 1939 and 1940 was passing from one person to another at the extremely low rate of about once a month, compared with an average turnover of twice a month in the 1920’s. If our productive resources were fully employed, an increase in the velocity of circulation of checking accounts to twice a month would tend to cause the level of prices to rise by 100 per cent. It was the increased speed of monetary circulation that helped to push up prices so rapidly during the inflation in Germany in the early 1920’s.
That the Federal Reserve authorities are alarmed by the inflationary elements in the present banking situation is indicated by the fact that, for the first time, a Special Report was submitted to Congress on December 31, 1940. The report explains “the present extraordinary situation” which makes the Federal Reserve system “unable effectively to discharge all its responsibilities.” As a means of forestalling “the development of inflationary tendencies attributable to defects in the machinery of credit control” and of combatting “the dangers of overexpansion of bank credit due to monetary causes,” this joint report recommends that Congress take steps:
(1) to increase the statutory reserve requirements for all banks to the following percentages of a bank’s checking accounts: 26 per cent for New York and Chicago banks, 20 per cent for banks in some 60 reserve cities, and 14 per cent for banks in other communities;
(2) to grant the Federal Reserve authorities the power to double these recommended reserve requirements if necessary to absorb excess reserves;
(3) to remove the power of the Secretary of the Treasury to issue $3,000,000,000 of greenbacks, and permit the power of the President to devalue the dollar to lapse;
(4) to cease further monetization of foreign silver;
(5) to prevent further growth in excess reserves and in deposits arising from future gold acquisitions.
The first step would wipe out about one-seventh of the excess reserves of member banks. The second proposal would give the Federal Reserve authorities the power to eliminate the present excess reserves completely, and, if proposals four and five were carried out, banks could acquire additional reserves only through a net reduction of cash in circulation arising from currency deposits or through an expansion of credit by the Federal Reserve banks. The purchase of gold is the important factor in the inflation of bank reserves and deposits, since less than $1,000,000,000 of foreign silver has been bought under the Silver Purchase Act of 1934. No one expects the above-mentioned powers of the Secretary of the Treasury and of the President to be used in the near future.
II
This program of the Federal Reserve authorities represents an attempt to patch and prop up a weak, old structure that is collapsing under the weight of enormous gold imports, It still would leave the control of our money supply largely in the hands of foreigners and the private banks. The Federal Reserve authorities do not propose that we abandon the gold standard, thereby putting a stop to free conversion of billions of dollars of foreign gold into newly-printed paper money. Such a step the Swedish authorities took during the first World War in order to prevent foreigners from increasing the Swedish money supply and inflating Swedish prices by means of gold imports. Neither do they suggest that private banks be prevented from manufacturing and destroying check-book money against the wishes of the Federal government. It was our private banks that stimulated a 120 per cent rise in the price level during the first World War by more than doubling our money supply and it was the banks that contributed to the great depression, with its 40 per cent decline in prices, by reducing their loans and destroying one-third of our money between 1929 and 1983. It is the threatened manufacture of money through loans or investments on a large scale by our private banks that lately has given the Federal Reserve authorities the inflation jitters.
It may come as a shock to some readers to learn that we are the only country on the gold standard, that since 1936 the United States Treasury has been the only agency offering to buy and sell gold in unlimited quantities at a fixed price. The conservatives, who induced the Roosevelt Administration to delay fundamental banking reform in 1983 and to return to gold in 1934, have confused the public by crying that inflation was just around the corner and demanding that gold be coined, that individuals be permitted to hoard gold, and that the President be prevented from changing the gold content of the dollar—the price at which the government stands ready to buy all gold and to sell it for industrial or professional purposes or for export in order to settle international balances. Although charged with being unorthodox in monetary matters, the Roosevelt Administration has been the only government in the whole world that was orthodox enough and foolish enough to return to the gold standard in the 1930’s.
Some people have difficulty in understanding that the more gold we get, the more unsafe our money becomes and the greater the danger of extreme inflation. They fail to appreciate that the Treasury pays out newly-manufactured dollars for all the imported gold that is bought by the government. That explains why we are threatened with a flood of “sound” money that may double the price level, as happened during the first World War, when we were on the gold standard and gold imports increased our stock of monetary gold by more than 50 per cent. In fact, our price level rose to a greater extent during the first World War, when the banks were paid to inflate the money by lending checking accounts, than it did in the North during the Civil War, which was partly financed by the issuance of greenbacks.
Let me make it clear that my fear of inflation is not of long standing. I am not one of those economists who have been crying “Inflation! Inflation!” continually for the past seven years. In fact, in an article published in January, 1985, I insisted that all the lessons of history indicated the improbability of a sharp rise in prices in the near future. At that time, however, our money supply was about half what it is today and all the excess reserves of Federal Reserve member banks could easily have been eliminated. In addition, we were deep in a depression with 12,000,000 unemployed workers and 20,000,000 persons on relief. Since then our money supply has been inflated by $15,000,000,000 of gold, industrial production has reached a new all-time high, and our idle resources are being re-employed so rapidly that shortages are occurring in many branches of industry.
One of the weakest parts of the program of the Federal Reserve authorities is their vague suggestion that “means should be found to prevent further growth in excess reserves and in deposits arising from future gold acquisitions.” Pre-sumably they are proposing that the Treasury “sterilize” the gold by issuing bonds and using the proceeds from the bonds to buy the new gold. Otherwise, the new gold could serve as the basis for the expansion of bank credit, since it would increase bank reserves. The Treasury did pursue such a policy in 1937 and early in 1938, but abandoned it because it found that interest on the bonds issued for sterilization purposes is costly, whereas gold purchases with paper money cost the Treasury nothing.
Such gold purchases have not, however, been costless to the country. Apparently two-thirds of the proceeds of their sales of gold to the Treasury has been used by foreigners to buy income-yielding investments or to acquire bank deposits, and the other third has been used to buy our goods. In so far as we have traded interest-bearing securities and commodities for barren gold, we have suffered a national economic loss. Since August, 1939, such a loss might be justified as aid in the defense of the British Empire, which accounts for over 55 per cent of the world’s annual gold production; but it cannot be justified, as some economists have recently suggested, on the ground that it has stimulated American exports and American employment. How much was American employment increased by purchases of foreign-produced gold, when, before the outbreak of the war, foreign sellers used only a small part of their gold sales to buy American goods? There are certainly better and more intelligent ways to stimulate domestic employment than by the purchase of foreign gold.
Part of the burden of the huge gold imports has been borne by bank customers. Since 1934 the reserves of commercial banks have increased fivefold through gold imports, yet the banks have been powerless to prevent this marked expansion in their non-earning assets. In order to maintain average profits of six or seven per cent, the banks have increased their service charges on deposit accounts. The amounts collected from such charges tripled between 1933 and 1940, and higher required bank reserves to offset gold imports will undoubtedly mean still larger service charges.
A more pernicious financial system than our present one is difficult to conceive. Not only do haphazard gold movements and ungovernable bank money threaten us with a wartime inflation but they promise to increase the severity of the post-war depression. In the deflation following the first World War, our money supply decreased by about one-fifth and our price level declined by two-fifths. During that deflation the drop in our money supply was cushioned by a 35 per cent increase in our gold stock from gold imports in order to help pay for American goods with which to feed and reconstruct Europe. On the other hand, gold will undoubtedly flow out of this country during the depression following the present war and thus aggravate the post-war deflation in this country.
There are a number of reasons why gold is likely to flow out of the country after the war: (1) withdrawal by foreigners of the billions of dollars they have temporarily deposited in American banks, some of which belong to the invaded countries and have already been “frozen” here by the Secretary of the Treasury; (2) the sale of foreign-held securities on our security markets as prices begin to fall; (8) the increase of remittances to European relatives and of expenditures by American tourists to the pre-war figures; and (4) American loans either to needy countries for post-war reconstruction or to countries desiring to return to the gold standard. Of course, if the Axis powers win the war, there will be no gold exports and we shall then own a huge pile of unwanted, if not useless, gold.
The Secretary of the Treasury warned us early in 1939 that, despite the existence of large excess reserves, a continuing loss of gold would tend to impair public confidence in the country’s currency. In order to avoid an adverse psy. chological reaction from large gold outflows, it is not unlikely that he will ban further gold exports, perhaps by freezing all foreign balances here. In that event we will have abandoned the gold standard and at last have terminated its baneful existence.
It is unfortunate indeed that the obvious defects in our monetary system were not remedied at the time of the banking holiday in 1933. Because we failed to establish a sensible monetary system in the early years of the New Deal, we find ourselves in the present predicament, with the Federal authorities proposing all sorts of makeshift measures to prevent monetary instability and financial disaster.
III
Experience during recent decades has clearly indicated that monetary instability is partly responsible for the roller-coaster movements in American business. The amount of money available for purchases in this country has fluctuated in a haphazard and perverse fashion. Generally it has fluctuated with the business cycle, so that a graph of changes in the amount of money in circulation resembles the fever chart of industrial production.
Control over our money supply must be taken out of the hands of gold producers, foreigners, and private bankers before it will behave in a sane manner and perform its proper function in our exchange economy. The amount of money in this country should be related to the output of American industry rather than to foreign gold production and shipments of gold from abroad. Private bankers should not be permitted to inflate and deflate our economy by creating and destroying a large part of the means of payment or purchasing power.
At present the total amount of spendable money is enlarged when the officers of our fifteen thousand independent banks decide that it is advantageous or profitable to increase bank loans and investments, and is reduced when bank loans and investments, for any reason, decline. If, for example, the Federal government should attempt to reduce its outstanding debt, almost half of which is held by the banks, our economy would be threatened by deflation and depression. If the government drew checks to pay off the bonds held by banks, the total amount of checking accounts would be reduced by a corresponding amount unless the banks made offsetting investments. Why our money supply should be tied up with the total loans and investments of private banks has never been satisfactorily explained. Such an unholy alliance between money and bank assets tends to cause vicious spirals in our economy. When prices and private expenditures start to decline, the banks tend to contract the means of payment through curtailed loans and investments, thus reducing monetary demand and causing a further decline in prices and private expenditures. From studies of world economic conditions in the early 1930’s, Professor James W. Angell, a well known monetary authority, concludes: “It is perhaps not even too rash to suggest that much of the decline in world economic activity between 1929 and 1933, possibly more than half, could have been avoided by stabilizing the quantity of money at around the 1928-1929 peaks.”
During the years 1931 to 1934 we witnessed the strange spectacle of two Presidents, Hoover and Roosevelt, pleading with the banks to make loans and investments so that the nation’s money supply might be restored and demand increased. In a money economy, demand is related to the money supply, for cash and checking accounts constitute the means for making purchases. Now we are witnessing the spectacle of the Federal Reserve authorities confessing that they are unable to discharge their responsibilities because they cannot prevent the banks from providing the increased money for a dangerous inflation.
In order to prevent private banks from changing the nation’s money supply on their own initiative, some five hundred economists have recently proposed a 100-per-cent-re-serve plan for checking accounts in banks. Under such a system the Federal authorities could keep the total sum of cash and checking accounts at any desired figure. Banks could not make loans and investments by writing up checking accounts nor reduce the volume of checking accounts by decreasing their loans and investments. The Federal Reserve authorities are moving in the direction of the 100-per-cent-reserve system, for they have already doubled the legal required reserves for banks and have asked for authority to double them again for checking accounts. However, such piecemeal changes are designed only to offset gold imports; they do not reduce the power of the private banks to create or destroy money. Until reserve requirements for checking accounts are raised to 100 per cent, the banks can continue to frustrate the monetary policies of the Federal authorities and to magnify the business cycle by varying the volume of money.
Although a 100-per-cent-reserve system would deprive the private banks of their control of the money supply, foreigners will continue to exert control over our money as long as we adhere to the gold standard. Hesitancy to abandon the gold standard seems partly due to a fear on the part of some people that our Federal authorities could not manage money as successfully as other nations have done—for example, England, Sweden, and Australia during the 1930’s. The Federal Reserve authorities apparently share such fears, for they have protested that they do not want full responsibility for control of the money supply or the price level. In recent statements the Board of Governors of the Federal Reserve System has argued that its “control of the amount of money is not complete and cannot be made complete,” that it does not and cannot have complete control over the rate of use or turnover of money, and that its monetary policies should be governed by the vague and ambiguous objective of “economic stability” rather than by such more definite and exact objectives as a constant money supply, a money supply increasing at a fixed rate, or a stable price level.
In the face of such objections to pure monetary management put forth by both “sound-money” advocates and those responsible for monetary management, a number of well known economists and business executives have formed a Committee for Economic Stability, which advocates a multiple-commodity standard for our money instead of the gold standard, Such a “goods” standard, it is argued, would give us a money supply related to our own production, would serve to stabilize a large section of the price level, would help to maintain the demand for American products, would stimulate expenditures and employment, and “would go a long way toward eliminating the paradox of ‘poverty in the midst of plenty’ in that it would prevent general surpluses of raw materials from demoralizing the price structure and intensifying depressions.” Nineteen years ago the inventor, Thomas A. Edison, proposed such a goods or commodities standard as much sounder and more favorable to business stability than the gold standard,
The essence of the proposal is to give to a composite unit made up of twenty or thirty commodities traded on organized commodity exchanges the same monetary status that gold enjoys under the free gold standard. The amount of each of the twenty or thirty storable commodities in a standard unit would depend on the relative importance of that commodity in the country’s economy. Mechanically the goods standard would operate just as the gold standard does. The government would stand ready to exchange dollars for commodity units and to redeem dollar bills in commodity units at a fixed price. In this way the price of the goods units would remain fixed as the price of gold does in gold standard countries. As long as free convertibility was maintained between goods units and the dollar, the price level (the weighted average of prices) of the commodities would be kept absolutely stable without pegging the price of any individual commodity. Price inflations and deflations, which have been so demoralizing for American business in the past, would be impossible under such a monetary standard.
The most important advantage of the goods standard is that it would regulate the money supply in a way that would help to stabilize business and maintain the domestic market for our basic products. Whenever private demand for our basic products fell off because of reduced spending, it would become profitable for people to exchange commodity units into dollars at the government’s conversion price. That would mean automatic government purchase of commodity units. Not only would such government purchases supplement a declining private demand, but the amount of money in private hands would be increased by a corresponding amount, and this additional purchasing power would tend to stimulate private demand. Under such circumstances, general overproduction of our basic commodities would be impossible just as overproduction of gold is impossible so long as countries remain on the gold standard. Since the government market would be a permanent one at the conversion price, business men could rely upon it in making their calculations.
When private demand revived and prices began to rise, it would become profitable for people to convert dollars into composite units, thus reducing the government’s store of commodities in warehouses and serving as an automatic check to inflation. The balanced stock of basic commodities that the government would have on hand would be far more valuable to us in time of war than gold, which we cannot use for military purposes and which foreign governments do not stand ready to buy in unlimited quantities. The cost of storing commodity units in commercial warehouses could be reduced through purchases of futures; in any case, it might be no greater than the present cost of storing and caring for our gold stock, especially if one includes the burden that gold imports have placed on the banks, bank depositors, and the government to the extent that it has attempted to “sterilize” such imports.
The goods standard for money would be automatic, impersonal, and non-political. It would not involve the fixing of individual prices, the regulation of production, the regimentation of industry, or government interference with business. Although 100-per-cent-reserve banking might be desirable in connection with such a goods standard, it could function under present banking arrangements. Even redemption of money in gold could be permitted within limits. Unlike the gold standard, a goods standard would relate our money supply to the production of basic American commodities and to American business conditions rather than to foreign gold production and to gold imports. By helping to solve the paradox of want induced by plenty or depression aggravated by abundance, it would greatly facilitate the readjustment of our economy to a peacetime basis at the end of present emergency.
If we fail to adopt financial reforms such as 100-per-cent banking or a goods standard for money, we shall undoubtedly be forced to take much more drastic measures in the midst of a wartime inflation or a post-war deflation. Government price-fixing and government control of industry and banking may be required to dampen a price inflation; government control of investment, a tax on idle money, a huge Federal borrowing-spending program, or nationalized banking may seem necessary in the next depression. In contrast to the monetary reforms already discussed, these more drastic measures would involve considerable government intervention in business, restrictions upon people’s freedom to use their money as they wish, and other large increases in the Federal debt for the spending programs now being suggested in Washington to prevent post-war unemployment.
As numerous writers have indicated, the essence of the Nazi financial program for eliminating unemployment has been to expand and control the money supply and to force persons and corporations with idle balances to invest them in business enterprise or in government bonds so that the government might spend money that otherwise would be idle. In Russia, unemployment was eliminated partly by expanding the money supply to such an extent that consumer demand, at government-stipulated prices, exceeded supply and rationing was necessary.
We shall never solve the problem of unemployment under a democratic, free enterprise system until we are able to prevent marked reductions in the money supply and marked reductions in the turnover of money because of hoarding, both of which diminish total expenditures and total incomes by a corresponding amount. Monetary stability is absolutely essential for economic stability. A goods standard for money does offer one means of preventing widespread unemployment and general overproduction by stimulating the demand for basic commodities, by increasing government expenditures in a business slump without piling up more and more Federal debt, and by eliminating two depression-accelerating factors, downward swings in the level of prices and reductions in bank-made money, that are stimulated by falling prices—the so-called spiral of deflation.
If we are to avoid financial catastrophe and Fascist economic controls in the days to come, we must adopt a sane and sensible monetary system. Recent experience has clearly indicated that we cannot continue to muddle through by adopting one makeshift measure after another.
