Basic Principles of the Money-Credit System
in the United States
Edward C. Harwood
[A "Special Bulletin" issued 19 September,
1952, by the American Institute for Economic Research, Great
Since the days of the earliest monetary economists, discussion of
money-credit problems has been hampered by semantic difficulties of
increasing complexity. As banking systems have evolved and modern
industrial societies have tremendously multiplied the number and types
of exchanges, early descriptions have become inadequate and later
reports on the monetary (and credit) facts of economic life have
become correspondingly complex as well as burdened with additional
The net result is that finding even two economists today who will
agree on an over-all report on the money-'credit facts of life as they
are found here in the United States, including complete agreement on
the word symbols used, is difficult, perhaps impossible.. Laymen who
consult economists on this subject soon discover that the "doctors
disagree"; and we all know who prescribes in that event. Any
plausible proponent of a pleasing panacea gains a hearing; and, if he
has the persuasive tongue of a John Law, gains an impressive, perhaps
even a politically dominant following.
The purpose of this brief paper is to present an out line report on
the money-credit system of the United States as it is today together
with tentative suggested word symbols that seem to be suitable for
scientific discussion. One group of experts and interested laymen has
found this material useful in an effort to reach a common
understanding. We hope that many others will find it helpful.
Functioning of the Money-Credit System
No attempt is made here to discuss either the technical details of
banking operations or the intricacies of Government monetary and
fiscal procedures. We are concerned herein only with the actual
functioning of the money-credit system, the principles involved, and
the results. The essential features can be seen more readily by
observing first the exchange operations of simpler societies than
One can-readily imagine that, in a primitive society where most
families produced much of the goods and services they- consumed, tie
percentage of goods exchanged in the; market places would be small.
Such a society, if it were beyond the stage of simple barter and were
using gold as an exchange medium, might readily effect its few
exchanges by the direct use of gold coins or gold by weight in
connection with each transaction.
A society somewhat more advanced in the scale of industrial progress
might effect some of its more numerous exchanges by transfers of gold
(coins or by weight) and effect other exchanges by direct barter of
some, goods produced for other goods. In numerous instances, the
sellers of shoes would want wheat and the sellers of wheat would want
shoes. Neither would personally have any need for gold in connection
with such transactions as long as direct barter could conveniently be
However, in many instances sellers of wheat would find more
convenient an exchange of their wheat for gold and subsequent exchange
of the gold for articles desired. Some sellers might want gold to hold
indefinitely for future purchases; some buyers might prefer to spend
gold previously accumulated. Thus we readily see that in such a
society there would be numerous exchanges involving gold with the
result that a market price in terms of gold (subject of course to
fluctuations) probably would be known to most individuals. No doubt,
many of the direct exchanges, as of shoes for wheat, would be
facilitated by the fact that both buyer and seller would know the
respective market prices in terms of the gold exchange unit (shall we
say ducats); thus they would have a "common denominator" of
exchange ratios or values that enabled them more readily to agree on
the ratio at which they would exchange wheat for shoes. The "haggling"
in the markets can be seen at first hand in primitive markets all over
the world today. And "haggling" similar in principle but on
a far more elaborate and precisely organized scale can he seen in all
the leading markets for commodities and commodity futures throughout
In the society just discussed, a producer of wheat (for example), a
Mr. A, might be one of many who had so need for gold at a particular
time. He might prefer to exchange his wheat directly for other goods
desired. However, carrying wheat from one shop to another would be a
laborious process. We therefore introduce in this society a. grain
elevator and its owner Mr. B. The producer of wheat then leaves his
load of grain with Mr. B, where the wheat is available in the market
place, and accepts from Mr. B a receipt for each of the six bushels
reading as follows:
This receipt entitles the bearer
to one bushel of wheat at Mr. B's elevator.
signed by B
The producer of wheat then can effect his purchases by offering the
receipts in exchange for the shoes, meat, another cqmmodities he may
The trader in gold in the simple society likewise conceives the
notion that those who are selling or buying gold also might prefer the
more convenient exchangeable receipts for gold, which were worded as
This is to certify that the bearer
is entitled to one gold ducat now on deposit in my possession.
signed by Mr. C
As this rather primitive society became more industrialized, Mr. C
(the banker) became a specialist in exchangeable receipts. He finally
conceived the notion of simplifying the exchange processes by issuing
certificates to Mr. A reading as follows:
This is to certify that Mr. A has
delivered to Mr. B one bushel of wheat having an exchange value of
one ducat, which is to be paid by Mr. B to Mr. C within 30 days and
thereafter will be paid by Mr. C to bearer on demand.
And Mr. A can use these exchangeable receipts for his purchases of
other goods and services desired.
Later, after Mr. C had found that Mr. A habitually reported
accurately what he had roduced and shipped to Mr. B, Mr. C accepted
Mr. A's promissory note when wheat had been shipped to Mr. B and
issued exchangeable certificates in this form:
This is to certify that Mr. A has
produced and sent to market one bushel of wheat having a market
value of one ducat payable by me ton demand.
signed Mr. C
Mr. C expected that, within the 30- or 60-day period specified in the
note, Mr. A would receive either ducats or similar exchangeable
certificates from the sale of the wheat so that ducats or their
equivalent in ducat's worth of certificates would be paid to him when
A's note fell due.
Finally, the banker further simplified the process by deleting from
the exchangeable certificates all reference to the commercial
transaction involved. Then the certificates issued in exchange for A's
promissory note read as follows:
This is to certify that the bearer
is entitled to one ducat payable by me on demand.
signed Mr. C
As long as all concerned are willing to accept at face value the
banker's (Mr. C's) promise to pay on demand, the banker will not be
required to pay out any actual ducats (gold coins) at all. From tune
to time, some holders of the bank's certificates may prefer actual
ducats, hut they, are readily accommodated.
Note also that, even if all concerned desire actual ducats for their
ducat's worth of certificates, the banker has ho difficulty. He simply
calls in his loans. Within a short period those who have borrowed are
eagerly seeking to obtain the exchangeable certificates in order to
repay their borrowings. As long as the banker limits the creation of
exchangeable certificates to those that represent current exchange
values of goods coming to market and gold all the loans are
automatically self-liquidating ; the process b in fact sound
Because we in the United States are accustomed to legal reserve
ratios, some readers may ask whether there is a limit to the banker's
operations, whether he should restrict the exchangeable certificates
(bank-note currency) to some definite multiple of the gold held by the
bank. There is no need to be concerned about this aspect of the
problem. The total ducat's worth of exchangeable certificates will
depend on the exchanges to be made in the market place. If most of
them are, in effect, exchanges of some type of goods for other types
of goods, that is, if most buyers are offering goods rather than gold
in exchange for what they wish to buy, and if most sellers want other
goods rather than gold for what they have.to sell, only a small
portion of all the exchanges will involve transfers of gold. In that
event, the total amount of exchangeable certificates issued may be
very large in relation to the gold in the banking system. For decades,
the commercial banks of England operated in this way. Why then, has a
fixed legal reserve ratio become customary in the United States?
In order to understand both what has happened in this country and the
actual situation now existing, we return to consideration of the
society last described. The commercial banker has been functioning in
the proper manner by creating convenient purchasing media (paper
certificates) that, in effect, represent the gold in the bank and the
goods produced and en route to or in the markets.
A Mr. D comes to the banker and offers his note for 100 ducats
payable in 1 year and secured by a mortgage on his valuable house. The
bankers considers the house excellent security for the loan and
creates and issues to Mr. D exchange certificates (bank-note currency)
as requested. Then Mr. D goes to the markets and buys the goods that
he desires. Is there some vital difference in this transaction from
those previously described?
Note that Mr. D's house is
not being offered on the market simultaneously with the
creation and use of the additional purchasing media. Unlike the
situation when manufacturers and other producers borrow for commercial
purposes, no goods are being offered on the supply side of the market
in this instance. Therefore, when Mr. D tries to buy goods that are in
the market, there will be more purchasing media offered for goods than
there are goods, and prices inevitably will rise. The exchange values
formerly existing will be disrupted.
Until Mr. D finally repays the loan, thereby withdrawing purchasing
media from circulation and returning it to the bank, the excess or, as
we should call it, inflationary purchasing media remain in circulation
as successive possessors use h to buy goods. Thus the inflationary
effects gradually spread throughout the markets for all goods.
For some reason the government of this society decides to spend more
than it is receiving in taxes, perhaps because a war has begun or
perhaps merely because the government chooses to build some pyramids.
Government bonds are printed and delivered to the banker with the
request that he lend to the government by giving in exchange for the
bonds some newly created bank-note currency. In the belief that the
loan (or investment) is sound, or perhaps because he dare not refuse,
the banker complies with the request. The bonds are placed in the
bank's vaults, and the government spends the funds thus, placed at its
As in the case of Mr. D who borrowed on a mortgage, the government
has produced no goods and is sending none to market. Therefore, when
the newly created purchasing media are spent by the government there
comes into the market additional demand. With no more goods on the
supply side but much more purchasing media on the demand side, prices
inevitably rise. Again, we should say that 'this is an effect of
inflation, and the inflationary process itself was the creation and
issue of purchasing media that did not represent either gold or goods
produced and en route to market
As banking has developed in the United States, commercial banking and
savings banking have become inextricably confused. American bankers
usually accept deposits of savings to be invested, that is, they
accept purchasing media that the owner does not wish to spend (either
for consumption or for investments directly), and invest the funds for
the benefit of the time or savings depositors concerned. When
acting in that capacity, bankers are justified in using such
purchasing media to lend on mortgages (a form of investment) or to
purchase government bonds, or for other investments. Then the
purchasing media, that the borrowers receive are not newly
created and in addition to the purchasing media previously created to
represent gold or goods in the markets; but they are a portion of the
purchasing media previously created that do represent gold or goods.
When those purchasing media are spent in the markets by the borrower
(or by the government), they are simply part of the purchasing media
already balanced by gold or or goods in the markets. Therefore, the
exchange values are not disrupted.
But American bankers, for the most part, never learned what
commercial banking was. Time and again in the Nation's history, the
supposedly commercial banks have created purchasing media for
borrowers speculating in western lands, railroads, Florida lots,
common stocks in general, etc. Congress has sought to limit the
successive inflations by establishing legal reserve requirements; that
is, by limiting the amount of purchasing media the banks could create
as a multiple of the gold held. This crude, rule-of-thumb method of
controlling the bankers has worked, after a fashion, in that it has
shortened the credit "rope." Great and irreparable disaster
has been averted at the cost of numerous small and some serious
disasters that have occurred when legal .expansion, limits were
reached and contraction became necessary. For a banking system whose
managers have not understood sound commercial banking, there
apparently is no other way to prevent the periodic destruction of die
entire system. Hence legal reserve requirements.
The Situation Today
Only one additional simple step need be understood by readers in
order for them to see the money-credit situation as it is today in the
United States. Heretofore, we have discussed purchasing media as
though bank-note currency and currency representing gold made up the
total. Now a bank note is a banker's promise to pay on demand, a
demand liability; and demand deposits or checking accounts are the
same type of demand liability. We might say that checking accounts, in
effect, are bank-note currency converted into a form such that the
owner can make them any denomination he pleases by writing a check.
Sometimes a borrower would prefer to have an addition to his checking
account rather than the bank-note currency in his hands or pocket.
Similarly, the depositor of gold may prefer to have it credited to his
checking account or demand deposit rather than receive bank notes
redeemable on demand.
Today in the United States, the demand liabilities of the banking
system that are used as purchasing media largely consist of checking
accounts (demand deposits); but from the viewpoint, of an over-all
understanding of the
principles and functions involved, we may regard bank-note
currency and demand deposits (or checking accounts) as essentially the
same. Which form any individual or business will use in any instance
is merely a matter of convenience.
The situation as it exists in the United States today (August 27,
1952) is as follows:
media in circulation
|and this may be
sub-divided as follows:
gold (the money commodity)
goods in or en route to markets
mortgages and other tangible investment type assets of the bank
Government promises to pay (bonds)
The total purchasing media in use may also be subdivided into two
principal types: demand deposits adjusted (checking accounts), and
currency (plus subsidiary coinage). As of August 27, 1952, about
$11,938,000,000 worth was circulating in the form of currency and
$95,940,000,000 worth was in the form of checking accounts. (Hoarded
currency is excluded.) As most readers know, each of these forms of
purchasing media can be exchanged for the other at the option of the
holder. The relative amounts of each in circulation reflect only the
customary buying and purchasing habits.
As will be apparent from the figures given for the various sources of
purchasing media, about half of the purchasing media in circulation
today are inflationary (do not represent either gold or goods in or en
route to markets). In other words, the total is about double the
noninflationary purchasing media. Also of interest is the fact that
wholesale commodity prices today are almost exactly double die
long-term trend adjusted for devaluation that we computed 15 years
Duration and Magnitude of the Effects of Inflation by Various
Based on their understanding of the views of various European
economists, some Americans as well as European observers contend that
inflationary purchasing media derived from Government debt7 tend to be
more permanent, more a fixture in the money-credit system, than
purchasing media derived from commercial loans. Apparently based on
this assumption, such individuals urge that a reduction in the weight
of the gold monetary unit is the only way of avoiding disaster. By
such means, they would create more gold monetary units and substitute
them as the basis for some, at least, of the purchasing media derived
from Government bonds in the commercial banks.
Although the record elsewhere and in much earlier times is obscure,
we do have a reasonably accurate record of developments during the
last three major inflations and subsequent deflations in the United
States. These periods include the following years: 1917, to 1921; 1922
to 1932; and 1933 to 1938. The pertinent data are summarized below.
in billions for the following periods
of inflationary purchasing media
inflationary purchasing media to total
change in commercial loans from time of maximum inflation to depth
change in inflationary purchasing media from time of maximum
inflation to depth of depression
Note: The foregoing percentage changes are reasonably
correct as to order of magnitude but are not assumed to be exact.
Also of interest in this connection is the experience from December
1945 to December 1948. At the beginning of that 3-year period, the
inflationary purchasing media approximated 60 billion dollars' worth
and was nearly two-thirds of the total. By December 1948 the
inflationary purchasing media had decreased to 52 billion dollars'
worth (a decrease of 13 percent) and was only a little more than half
the total. In the meantime, commercial loans approximately doubled.
(By December 1948, deflation was well under way and was reflected in
the 1948-49 recession of business activity and accompanying decline in
In the earliest of the three periods, the inflationary purchasing
media were derived from Government debt, in the second instance-almost
entirely from private debt, and in tie third about half from each of
Based on the foregoing, it would seem that inflationary purchasing
media, regardless of whether they represent mortgages etc. or
Government deficits, are by no means "frozen into" the
money-credit system as has been suggested.
The suggestion also has been made that commercial loans reflect high
prices rather than contribute to causing them. The record suggests
that this notion is partly correct and partly in error.
We should remember that the purchasing media derived from commercial
loans are used to facilitate the exchanges where the buyer is not
offering gold but, in effect, other goods he has produced and the
seller desires not gold but other goods than those he is selling. In
other words, the commercial banking system facilitates the large
portion of exchanges where gold is not involved. Therefore, under
normal circumstances of sound commercial banking, the purchasing media
representing goods in or en route to markets do not tend to cause a
rise in prices; the equilibrium between gold and goods remains
At first thought, the reader may believe that, during a period of
inflation, purchasing media derived from commercial loans will
increase. The usual argument to this effect points out that production
is increasing and that prices are rising so that manufacturers and
merchants must borrow more in order to do business. Plausible as this
argument seems, the available facts do not support it.
Specifically, from mid-1917 through early 1919, when inflationary
purchasing media derived from Government bonds in the commercial banks
were increasing rapidly and commodity prices rose about 30 percent,
commercial loans leveled off instead of increasing. In 1922 to 1928,
as the inflationary purchasing media steadily increased and prices
were sustained well above the 1914 level, commercial loans first
increased slightly for only 3 years and then decreased steadily. In
1933 to 1936. as the total of inflationary purchasing media increased
rapidly and prices rose nearly 20 percent, commercial loans decreased
almost steadily by nearly 35 percent.
An explanation for this seemingly paradoxical situation is not
difficult to imagine. When increasing amounts of inflationary
purchasing media are being placed in circulation, businesses generally
receive "windfall profits" that reflect the excessive demand
for goods in the markets. Most businesses thus have more cash coming
in than they bad expected and are able to reduce instead of
increase their commercial borrowings. Of course, when inflation is
followed by deflation, the reverse is true, losses replace
the-unexpected profits; cash does not come in as rapidly as was
expected and commercial borrowing increases unless the depression is
exceptionally severe and prolonged as in 1929-33. (Banks that operate
too extensively as pawnshops instead of commercial banks fail and
cannot increase their commercial loans.)
 The group referred to includes
representatives of several other groups interested in various aspects
of the Nation's money and credit problems. In a series of conferences,
an effort is being made to gain a mutual understanding, at least, and
perhaps reconcilement of widely divergent points of view on matters of
vital importance to the future of the United States and much of the
rest of the world. The names of the individuals and groups concerned
cannot be released at this time.
We remind readers that the vital point is whether or not the newly
created purchasing media constituting effective demand are balanced on
the supply side by additional goods in or coming to the markets. The
question is not whether the security for the loan was something
tangible like a house or something intangible like a government's
promise to pay at some future date (a bond), but whether the new
purchasing media do or do not represent gold or goods in the markets.
 Readers should note that time or savings deposits are simply the
banks' record of purchasing media that were first received by the
banks ami subsequently invested (spent for certain types of assets).
The time or savings deposits accounts are a means of recording the
names of the original savers and the extent of the beneficial interest
of each depositor in the investments acquired by the bank.
 There are various legal and technical differences that need not
concern us at this time. The more important differences in detail are
attributable in large part to ignorance of the principles herein
 Readers should note that we refer to$ worth rather than $; most
of the purchasing media in use purport to be exchangeable for dollars;
i.e., to be dollars worth, rather than dollars, (The United States
dollar is defined by statute as 1/35 of an ounce of gold 9/10 fine.)
In the interests of avoiding semantic confusion, dollars worth of
purchasing media should be differentiated from dollars in a discussion
such as this. Of course, for ordinary business purposes, such precise
differentiation ia unnecessary, but for anyone trying to discuss::
money-credit problems intelligently, such precision of reference in
using word symbols is essential.
 Formerly, some of the purchasing media that represented gold (the
gold certificates) could readily be recognized, and of course the gold
coins in circulation actually were the statutory dollars (or multiples
of them). Today, however, none of the purchasing media in circulation
reveal their true source: no one can tell by examining ft whether a
particular purchasing medium represents gold, or other goods in or en
route to markets, or mortgages, or government bends. (Minor exceptions
need not be discussed here.)
 Whether directly or through the more usual procedure, which
includes sale of Government bonds to the banking system in exchange
for newly created purchasing media, is not material to the issue, we
A Partial and Tentative List of Suggested Means of Avoiding
the Semantic Stumbling Blocks and Bobby Traps
A brief example will illustrate one of the semantic difficulties.
Some people prefer to use "money" as the word symbol for a
medium of final payment that has real substance and value in addition
to its use as a purchasing medium. Yet these same individuals
sometimes use the phrase "paper money." In using the symbol "money"
such individuals in the United States ordinarily would be referring to
the gold dollar (1/35 of an ounce of gold 9/10 fine); that is, the
referent for money would be a specific quantity of a metal. When such
individuals use the phrase "paper money," they presumably
are not intending to talk about paper metal, but that is what they are
doing unless they are shifting the referent of the symbol "money."
The subtle and frequently unrealized shifting of the referent makes
sane discussion almost impossible.
We should adhere to the rule "one and only one referent"
for each word symbol if we hope to avoid the semantic stumbling blocks
and booby traps. The following word symbols with the indicated
referents may be helpful.
||Description of Referent
||1/35 ounce of gold 9/10 fine
when used as a-standard of value, as a store of value, or as a
medium of exchange (all or any one of these uses).
||Pieces of paper purporting to be
claims to dollars' worth of value in the market place, for taxes,
||Those items of currency that not
only are pieces of paper purporting to be claims as above but that
also constitute warehouse receipts for silver at the rate of 1
ounce for each dollar's worth indicated. The bolder has a choice
of demanding either the specified silver of what he can get in the
|BANK NOTE CURRENCY
||Those items of currency issued
by banks (Federal Reserve banks in the United States). Like other
currency, they purport to be claims to dollars' worth of value in
the market place, for taxes, etc. Although they include the
statement that the United States will redeem them with "dollars"
on demand, the pledge has not been kept (for United States
citizens) since 1933. Foreign central banks and governments can
obtain "dollars" on demand as stated, but United States
|DEMAND DEPOSITS OR CHECKING ACCOUNTS
||These symbols are directly
substitutable either for the other, and they refer to bank records
of demand liabilities to,individuals, businesses, etc. These
records of demand liabilities are promises to deliver legal
currency (formerly dollars.) on demand.
||All subsidiary coins, currency,
and demand deposits that are immediately available for use in
their existing forms for purchases or payment of bills, that are
immediately acceptable to the sellers or potential recipients, and
that involve no continuing obligations for a more or less
protracted period after the payment is made.
|TIME OR SAVINGS DEPOSITS
||Bank records of liability or
obligation for purchasing media delivered to the bank by
individuals, corporations, etc., with the understanding that the
funds will be invested for the benefit of the depositor. The
banks' obligation is, in effect, a promise to pay the income from
the investment less expenses to the depositor or, if he so
requests, to sell or transfer the investments to the benefit of
others and return to the original depositor a corresponding
amount of purchasing media within a reasonable time.
Note: For the purpose of this discussion, other currency (United
States notes, Federal Reserve bank notes, and National Bank notes) and
the subsidiary coinage.
Note: Time or savings deposits are not purchasing media.
A Fundamental Difference Between a Measure of Value and a
Measure of Distance,Weight, Etc.
Gold is customarily regarded as a standard of value, and specific
quantities of gold therefore are referred to as measures of value. For
example, the statutory dollar, which is 1/35 of an ounce of gold 9/10
fine, is referred to as the unit of measure in measuring exchange
values in the United States.
In a somewhat similar way, the statutory yard is a measuring unit for
distance, the bushel for bulk, the pound for weight, etc. Because
there are similarities in the use of all measuring units, analogies
sometimes are offered that attempt to explain values much as the
yardstick is used for measuring distances.
Such analogies, although they may be helpful in some respects, also
may be dangerous, because they may tend to conceal rather than reveal
a fundamental difference between gold as a measure of value and the
yardstick as a measure of distance.
Most measuring units are conventional in that they are chosen by men.
Consequently, most such units or standards can be altered by men. The
yard today is a specified linear distance, but the statutory yard
could readily be made half as long. Similarly, the units of weight
called 1 pound could be altered so that it would contain more or less
lhan the presently specified quantity of water at sea level. Also
similarly, the statutory dollar could be made a different quantity of
gold than it now is.
However, all of these units of measure are fixed by statute, are
legal standards, and can be altered only by legislative action.
Congress has the power to alter any of them. Of course, there
presumably would be protracted discussion of proposals to change any
of these standard measures, but in the end Congress could act.
Nevertheless, there are important differences in the developments lo
be be expected both (luring the discussion period and after the
adoption of revised standards.
While Congress was debating an alteration in the standard yard, the
principal effect would be on those writing contracts in terms of yards
and on the makers of yardsticks. Presumably, the former would include
clauses protecting both parties against future alterations in the unit
of measure, and the latter would prepare 10 make yardsticks of a
different length, a minor modification in manufacturing procedures. No
one would attempt to hoard the existing yardsticks, or to noard space
measured in square or cubic yards of the old dimension in the hope
that he would profit in any way by the reduction in the length of the
On the other hand, while Congress was debating an alteration in the
statutory dollar, the effects surely would be striking. They would be
especially noteworthy if the decision were made to discard any
specific weight of the dollar for a time in order to see what would
happen. Almost certainly, those who could do so would attempt to hoard
gold. Only by effectively prohibiting the ownership of gold could
individuals be prevented from seeking protection against the
Government's actions; but the very denial of the freedom to hoard gold
would in itself be a powerful stimulant to black markets where the
exchange ratio between paper currency or credit and gold would rise
even more than it would in free markets.
In short, serious discussion of alterations in the gold content of
the dollar almost certainly will induce a speculative demand for gold.
(This is precisely what occurred in January and February 1933, when
rumors of Mr. Roosevelt's intentions began to come from credible
sources.) Under such circumstances, if a specific unit of value is
abandoned and the monetary unit is left to find its level in free
markets, the exchange ratios between gold and the monetary unit will
reflect primarily the optimism and greed of those who hope to gain and
the fears of those who expect to lose by the prospective establishment
of a new statutory dollar.
Turning now to consideration of developments after an alteration in a
statutory standard of measure has been effected, we also find e
difference between the measure of value and the measures of distance,
space, weight, etc. After a change in the yardstick, for example, to
half its former length, the principal effect would be that all
distances, immediately after the adoption of the revised standard,
would be twice as many yards as they formerly were.
The situation with reference to the measure of value would be
decidedly different, however, as we learned in 1934. Some of the more
naive of those who advocated devaluation in 1933 expected prices
generally to reflect automatically and immediately, or almost
immediately, the change in the unit of value measurements. However,
their expectations were not realized. Several years elapsed before
commodity prices generally reflected the full extent of the 1933-34
Therefore, those who expect that a second devaluation of the
statutory dollar, say from 1/35 to 1/50 of an ounce of gold,
would immediately or in a short period compensate for the existing
inflation and resulting high prices are as apt to be disappointed
as were the proponents of devaluation in 1933-34. Several years will
elapse before all the adjustments to the new unit will he made, and in
the meantime there is no assurance that a serious deflation will be
avoided. In fact, if the first reaction to another devaluation is a
flight from the dollar such as the scare buying of July 1950 and
January 1951 or worse, we may experience even more inflation that in a
few months will result in an even higher level of prices from which
there may be a disastrous nosedive into substantial deflation.
Elements of An Ideal Gold Standard
- A statutory unit of purchasing or exchange media constituting a
standard of value and capable of serving as a store of value that
consists of a specified weight and fineness of gold.
- A commercial banking system
a. All demand liabilities (checking accounts) of the
commercial banks to represent either gold or goods in or en
route to markets and all such demand liabilities to be payable
in the statutory gold units on demand.
b. No demand liabilities (purchasing media) to be created on
the basis of in vestment-type assets such as mortgages,
Government bonds, installment loans, term loans, or loans to
finance accumulations of excessive or speculative inventories by
business. (Note: Once the principles of commercial banking are
understood, legislation to exclude such loans probably would not
be necessary. Of course such loans would continue to be proper
investments for savings.)
- Both the Government and the commercial banks would be
authorized to issue gold certificates (warehouse receipts for
- Only the commercial banking system would be authorized to issue
currency in the form of bank notes, and such currency would be
redeemable on demand.
- Only the Government would be authorized to issue small
denomination coins and to coin gold.
- Interest rates to be determined at all times by free markets.
- Government deficits, if any (in war and in peace), to be
financed by bona fide savings from current incomes.