# A Primer on Money, Banking, and Gold  ## Metadata - Author: [[Peter L. Bernstein and Paul A. Volcker]] - Full Title: A Primer on Money, Banking, and Gold - Category: #books ## Highlights - During the late 1950s and the first half of the 1960s, people began to worry about inflation as they experienced a prosperity no one could have dreamed of in the early days after World War II, or surely during the 1930s. For many people, the inflation of World War II, with its associated price controls and rationing, remained a vivid memory. Its repetition under conditions of high prosperity seemed a logical development. I was not so sure about that. The great prosperity of the 1920s had been accompanied by a gently falling price level. Except for wartime, inflation in U.S. history all the way back to the early nineteenth century had never amounted to anything—until the late 1960s rolled around, just about the time the revised edition of the book was published. From the business cycle peak of 1957 to 1965, the cost of living had risen at an annual rate of only 1.9 percent, not such a surprise as unemployment averaged 5.7 percent during those years. But beginning with 1966, in large part due to an expansion of 60 percent in government spending for the war in Vietnam, the unemployment rate began a steep decline, reaching 3.5 percent at the end of 1969—a level not seen since the Korean War in the early 1950s. The impact on the cost of living was significant, as inflation more than doubled to an annual average of 4.3 percent over this period, reaching 6 percent at the end of 1969. ([Location 160](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=160)) - Tags: [[blue]] - Throughout history, people’s memories seem to be more influenced by the disasters of an era than by any positive changes that may have occurred. As a child of the depression, I continued to worry much more about too little output and employment in the 1960s than I worried about too much prosperity and inflation. ([Location 172](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=172)) - Tags: [[blue]] - Schwarz, A Monetary History of the United States, 1867-1960, had appeared in 1963 (I did not even peek into that fabulous book until 1984), and it was here that Friedman had originally laid out his theory of the supply of money as the dominant economic variable in the system. ([Location 185](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=185)) - Tags: [[blue]] - Another interesting passage in this book appears on page 207, where I wrote, with the italics in the original, “When all is said and done, the productivity of the American economy is the ultimate barrier to runaway inflation in our country.” I would still stand by that observation, and the extraordinary decade of the 1990s demonstrated its validity. Today, however, I would have to add an important qualifier, namely, “as long as monetary policy does not finance an inflationary spiral at levels approximating full employment.” ([Location 191](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=191)) - Tags: [[blue]] - Fed Chairman Paul Volcker’s blunt, painful, sustained, and courageous effort to bring the money supply under control during the turbulent years from August 1979 to August 1987 would manage to convince people inflation had to be licked and that no consideration for unemployment would be allowed to interfere with this overriding obligation. Volcker also broke away from long-standing traditions of purposely obfuscated Federal Reserve policy statements by making his intentions loud, clear, simple, and unqualified. He would bring the money supply under control, let short-term rates go where they would under the circumstances, and he would not let go until the job was done. ([Location 197](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=197)) - Tags: [[blue]] - Baron Rothschild was once heard to say that he knew of only two men who really understood gold—an obscure clerk in the Bank of France and one of the directors of the Bank of England. “Unfortunately,” he added, “they disagree.” Most people would share his sense of frustration on the subject. ([Location 225](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=225)) - Tags: [[blue]] - Put in its simplest terms, we want to be sure that we have enough money around so that we can buy everything that has been produced, but never so much that we try to buy more than has been produced. The problem that will concern us most is the difficulty of keeping the number of dollars spent in line with the quantity of goods produced. ([Location 248](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=248)) - Tags: [[blue]] - Despite the problems money causes, mankind invented it and sticks to it because it relieves us of the almost insurmountable difficulties of doing business through barter. For this reason, even the most primitive societies have tended to use some form of money, whether it be feathers or wampum or giant stones buried under the sea. As societies become more complex and people more specialized in the tasks they perform, money is even more necessary to enable one man to exchange his production for another’s. ([Location 251](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=251)) - Tags: [[blue]] - The entire accumulation of monetary gold over the centuries has brought the world’s gold hoard today to just about 40,000 tons; American industry pours 40,000 tons of steel in less than one hour ! ([Location 275](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=275)) - Tags: [[blue]] - We find repeated cases in which people seemed to have so little money that they were unable, or certainly reluctant, to buy everything that could be produced. As a result, prices fell, profits vanished, production shrank, and unemployment spread. Only when all prices and all wages had been pushed down so low that the formerly inadequate supply of money seemed sufficient to buy up all the goods and services offered for sale at bargain levels did the wheels finally begin to turn again and men go back to work. ([Location 280](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=280)) - Tags: [[blue]] - We can also find frequent examples of the opposite situation—the inflationary spiral in which the quantity of money outruns the supply of goods. When people want to buy more than has been produced, prices rise. Then some people lose out through being outbid in the marketplace. Those who suffer most are usually the ones who least deserve to be the losers—the frugal, the conservative, the prudent, together with the poor and unorganized who are unable to battle for the higher incomes they need to stay even with the rising prices. ([Location 284](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=284)) - Tags: [[blue]] - an increase in production or the sale of the same quantity of goods at higher prices simply cannot be sustained unless people are willing and able to lay out the extra money they will need to buy the additional goods or to pay the higher prices for the same quantity of goods. ([Location 299](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=299)) - Tags: [[blue]] - Take, for example, the case of a family that has been spending $6,000 a year on the basketful of goods and services it requires to maintain its living standards. Now let us assume that we enter into an inflationary phase and, as a result, the price of the same basketful rises from $6,000 to $6,600. To maintain its living standards, this family is now going to have to find an additional $600 every year.Where can they find it? The breadwinner in the family—most likely, the father—can go to his employer and demand an increase in wages. But then, of course, the employer has to find an additional $600 a year to keep his employee happy. This money must either come out of his own profits from the business (in which case he will have less money to spend) or he must raise his prices and ask his customers to pay it. In that case, the customers must find the additional $600, and we are right back where we started. If the father of the family is unable to obtain a raise from his employer, he still has several alternatives available to him. He can draw down money that he has accumulated in the past—the cookie jar can be emptied and its contents used to maintain the family’s standard of living. He can go to the savings bank and ask them to give him back the money he previously deposited—but then the savings bank has to be sure it has the money. He can borrow the money from friends or from a finance company, but they, too, must have the money available to lend him. And what if this family is unable to find the additional $600 it needs to carry on? Clearly, it will have to cut down on the quantity of goods and services it buys. If it can only afford to spend the same $6,000, approximately 10 percent of the things it bought before will now remain unsold. Retailers, finding that sales are falling below expectations and that inventories are piling up on their shelves, will cut down their orders from wholesalers. Wholesalers will tell manufacturers to ship a smaller quantity of goods. Manufacturers will then have to cut back on their production schedules; their employees will probably be laid off or will work fewer hours. In time, then, the inability to finance the purchase of goods at higher prices results in unemployment and excess productive capacity. ([Location 302](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=302)) - Tags: [[blue]] - The significance of this example is that the supply of money does set limits to how far business expansion can go and how high prices can rise. Both increased production and the same volume of production sold at higher prices involve a higher rate of spending by customers, and, when they have to pay out money, money is the only thing they can pay out. No bill can be paid with Government bonds or shares of stock or jewelry, or even a savings account or life insurance policy. Only a check or currency or coins will be acceptable for this purpose. ([Location 340](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=340)) - Tags: [[blue]] - although the supply of money can set the upper limit to a price inflation or to growth in production, we have no ready way of knowing where that limit may be. In fact, the number of dollars in our bank accounts and pockets is only an indirect, and frequently unsatisfactory, guide to the rate at which we are going to spend those dollars. And it is expenditure that counts—it is expenditure that comes into the marketplace to be matched against the supply of goods and services. ([Location 345](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=345)) - Tags: [[blue]] - When people spend more than they earn producing goods and services, the chances are that they will be trying to buy more than has been produced. This excess demand will then either stimulate an increase in production schedules or an increase in prices. ([Location 361](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=361)) - Tags: [[blue]] - the rate of spending can vary widely, even when the supply of money in the economy is relatively stable. Conversely, variations in the supply of money will not necessarily lead to corresponding changes in the sales of business firms. Sometimes people want to accumulate cash rather than spending it or making it available to others to spend; at other times, they are eager to spend their cash hoards or to borrow and spend the cash hoards of others. ([Location 363](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=363)) - Tags: [[blue]] - To recapitulate, we have seen that our main problem is to keep the rate of spending in line with the production of goods and services—neither so low that prices and demand collapse nor so high that an inflationary spiral begins. ([Location 367](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=367)) - Tags: [[blue]] - Most of us spend money at a rate different from the rate at which we earn it. If we should earn $15 a day and spend $15 a day, we would never have to hold money for more than a few hours. But since money comes in to most of us at regular intervals, whereas money is spent in amounts that may vary widely from day to day, we must have some funds available to finance our outlays during those periods when more is going out than is coming in. Most of the money we hold, then, is for this purpose. And the more we spend, the larger the cash balances we will need to finance these expenditures. This also means that the higher the level of business activity and the more active the volume of production and employment, the more each of us will need the money we have and the smaller the amount we will be able to make available to finance the expenditures of others. For these reasons, we frequently hear that money is “tight” (that is, in tight supply) when business is good and that money is “easy” (that is, easy to obtain) when business is slow. ([Location 377](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=377)) - Tags: [[blue]] - We will indeed put our excess cash out to work if the price is right—in other words, if the return we will earn from the person using our money is adequate to compensate us for the risk and inconvenience of giving up this cash. ([Location 395](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=395)) - Tags: [[blue]] - a more important and compelling reason for wanting to receive a high rate of interest is that, in addition to inconvenience, risk is involved in letting someone else use our excess cash. For one thing, he may not repay when he promised, and we therefore deserve some compensation for the credit risks involved. Furthermore, what happens if we want our money back before the time that the borrower has promised to return it? Will we be able to find another investor who will be willing to take this obligation off our hands and give us our money when we need it? Thus, time horizons are crucial in influencing our decisions to part with excess cash and in determining our attitudes as to whether any given rate of interest is, in fact, “adequate” for our purposes. ([Location 423](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=423)) - Tags: [[blue]] - Although many people consider low interest rates desirable because they make borrowing money more attractive to businessmen and will therefore stimulate business activity, history tells us that periods of high and rising interest rates, rather than low and falling interest rates, have been associated with vigorous and sustained prosperity. ([Location 448](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=448)) - Tags: [[blue]] - It is just these struggles for increased “liquidity”—for more cash on hand—that have led to repeated monetary crises in our history, of which the experience of 1929 to 1933 was a dramatic, but by no means isolated, example. In that panic, everyone was a seller and no one a buyer.These instances are the culmination of a long process that begins when people who need more cash are at first able to get it by offering higher rates of interest for it; ultimately, no one has any more extra cash to lend out at any price.The panic sets in when people recognize that he who parts with cash today will have a hard time getting it back tomorrow. ([Location 469](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=469)) - Tags: [[blue]] - When interest rates begin to move, that is a signal that the demand for money and the supply of it are out of kilter. Rising rates indicate that some people with too little cash are now willing to pay a higher price for the use of the other fellow’s money, whereas declining rates show that some people are holding more cash than they need and are now willing to take a lower price to put it to work. ([Location 475](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=475)) - Tags: [[blue]] - the money we use takes two forms—coin and currency that we can see and hold in our hands, and checking accounts, which have no tangible existence at all and are only bookkeeping entries at commercial banks. One passes readily from hand to hand; the other moves in a devious and mysterious process through bookkeeping machines and electronic computers. These two forms of money, one visible and the other invisible, come into existence in different ways and have differing impacts on the way in which the system operates. ([Location 492](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=492)) - Tags: [[blue]] - we might take a look at the famous stories about people running around with wheelbarrows full of currency during hyperinflations, such as the terrible experience of the Germans after World War I. There, as in the Confederacy during the American Civil War and in France during the Revolution, the Government did print and spend tremendous amounts of money. In those cases, however, the use of checking accounts was either non-existent or much less prevalent than it is today; currency and coin were the primary rather than the minor form in which money was handled. It was natural, therefore, that an increase in the total supply of money should have been reflected largely by an expansion in the amount of currency and coin in use. ([Location 515](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=515)) - Tags: [[blue]] - Who determines the amount of currency and coin in circulation? It is the public—the millions of individuals, business firms, and financial institutions that choose continuously between the use of currency on the one hand and checking accounts on the other.When people want to use more currency, as at Christmastime or when the company treasurer draws the payroll, the amount of currency in circulation goes up and bank deposits tend to go down. After Christmas, when the shopkeepers’ cash registers are bulging with currency, they put their excess cash back into the bank and their deposits go up. On payday afternoon or the day after, the workers will also put their excess currency into the bank in exchange for a deposit there. ([Location 529](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=529)) - Tags: [[blue]] - the Government prints and mints our currency and coin, but it has no lasting influence on how much of it we keep in circulation and how much of it we deposit in the bank. Of course, this does not mean that the Government has no influence on the supply of money—on the contrary, it has a profound influence on the total supply of money in the economy. But that is different from saying that it can determine the relative size of the parts. The choice between the use of currency and of checking accounts is made by the public and only by the public. ([Location 534](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=534)) - Tags: [[blue]] - In short, except for the very small amount that the Government issues directly as soldiers’ salaries and other payments of that type, all the currency that gets into circulation is withdrawn from bank accounts ( just as excess currency in circulation is redeposited in bank accounts). ([Location 539](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=539)) - Tags: [[blue]] - Anything not readily transferable or whose value is a matter of negotiation rather than instant agreement cannot function as money, because it will lack the general acceptability in payment that is the essential quality of the things we use as money. ([Location 552](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=552)) - Tags: [[blue]] - an increase in the supply of money can come only from an increase in the quantity of dollars in currency, coin, or checking accounts. Since we know that an increase in coin and currency comes through withdrawals from checking accounts, it follows that an increase in the supply of money must originally come about through a rise in checking accounts. ([Location 559](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=559)) - Tags: [[blue]] - the only way that somebody can increase his bank account without a transfer from somebody else—that is, the only way one man can have a receipt without another man’s making a payment—is if the money he receives comes from some source other than another member of the community. In other words, some mechanism outside the system is necessary if the supply of money is ever to change at all. ([Location 562](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=562)) - Tags: [[blue]] - Where, then, can we look for some source of money, someone in a position to pay out money, who is not already a depositor in the banking system? Indeed, to the banks themselves! The banks hold our deposits and therefore cannot be depositors in themselves. Thus, the man who receives the money that a bank has paid out for some purpose—say, because it has lent him money or bought a security he wanted to sell—will increase his bank balance without having taken money away from any other depositor. Since his larger balance has no offset in a smaller balance elsewhere, the total volume of deposits must be larger than it was before! ([Location 577](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=577)) - Tags: [[blue]] - All of this leads to a logical, but nonetheless unexpected, conclusion: it isn’t the Government that creates the money we use at all. Rather, the very largest part of the money in our bank accounts today, which we received yesterday and may be spending tomorrow, originally came into being when some commercial bank officer approved a loan to a customer or decided to invest in a marketable security. Of course, this does not mean that we all just borrowed this money or sold securities to a bank to get it; it does mean that, somewhere back along the line, most of the dollars we are now using were created by the lending and investing decisions of commercial bank officers. ([Location 586](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=586)) - Tags: [[blue]] - But what does the banker do with the money his depositors leave with him? When a bank begins to gain funds, when the sums being deposited exceed the amounts being withdrawn, the banker will at first simply hold some of that cash idle, earning no interest at all, just to be sure that what seems to be a net inflow does not soon reverse itself and turn into a net outflow. He will, in any case, want to have a pool of cash or of securities he could liquidate readily, to cover him in case money does begin to leave the bank. The cash that the banker holds to cover the possibility of net withdrawals by his depositors is called a reserve. This is a messy bit of nomenclature, because banks also have other kinds of reserves, such as reserves against losses on their loans. But when we are discussing the manner in which a bank meets the possibilities of net withdrawals by its depositors, the word “reserve” always refers to the cash that the bank holds to meet such contingencies. But just as the banker knows that all of his depositors are not going to ask for all of their money at the same moment, he also can feel reasonably certain that a large or protracted net outflow of funds will be spread over a period of time, not just concentrated into one or two days. He sees no necessity, therefore, to hold more cash than he might need to cover the first few days of a net outflow. Therefore, in order to supplement his cash reserve, he will carry what he likes to call a “secondary reserve.” This means that he will invest some of his available cash in a form that will permit him to turn it back into cash at little risk and on short notice. Very likely he will buy U.S. Treasury obligations that will be maturing in the near future; these will give him back his cash in a short time in any case and, if he needs the cash before maturity, he can readily find a buyer for these securities at a price close to what he paid for them. Such investments will earn some interest—more than he would get if he kept the funds in cash—but will still permit him to take care of a net outflow of funds as it begins to mount up.   Now the banker begins to consider what he might do with the money that he hopes and expects will remain with the bank for an extended period of time. Some of it will consist of funds that depositors keep in their accounts more or less indefinitely as a minimum working balance. A large part of it will consist of dollars whose ownership among the depositors may be shifting but whose total will tend to remain about the same—in other words, dollars that the banker can figure on having available on a long-term basis because he expects one customer’s deposit to offset another customer’s withdrawal to at least this amount. This is the basic pool of money on which the bank earns enough to cover its operating expenses and show a profit for its stockholders.10 But we must remember the banker’s conservative temperament. Although he thinks it probable that this money will remain… ([Location 616](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=616)) - Tags: [[blue]] - In deciding how to allocate his resources between marketable securities, on the one hand, and loans, on the other, the banker will consider three factors: liquidity, cost, and demand. ([Location 647](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=647)) - Tags: [[blue]] - the factor that distinguishes securities from loans in bank operations is that the former have a market where they can be bought from or sold to other investors, whereas the latter… ([Location 651](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=651)) - Tags: [[blue]] - the banking business is a constant struggle between the necessity to be liquid to meet net withdrawals and the desire to have money lent out and invested so that it will earn interest to show the bank a profit. ([Location 680](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=680)) - Tags: [[blue]] - From the viewpoint of the economy, however, the process is radically different. When the manufacturer borrows from a friend or an insurance company, the money he receives is transferred to him by the lender—he has more money, the lender has less, and the total amount of money is unchanged. But when he borrows from the commercial bank, he has more money but no one has any less! His deposit has been increased; nobody’s deposit has been reduced. Therefore, he has more money to spend, while no one else has any less. With the punch of a bookkeeping machine, the total amount of purchasing power in the economy has obviously been increased. ([Location 712](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=712)) - Tags: [[blue]] - All banks together are not limited by cash on hand. One bank’s loss is another bank’s gain. ([Location 784](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=784)) - Tags: [[blue]] - The intriguing aspect of this process is that the banker doesn’t make loans or buy securities because he wants to create money—he gives this little or no thought. Rather, his attention is simply directed to how much of his available cash resources he can lend or invest and still have enough on hand to cover his depositors’ demands for withdrawals—a very limited and parochial view of a process with a profound impact on the level of employment, production, and prices in the national economy. ([Location 833](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=833)) - Tags: [[blue]] - This leads to an even more asymmetrical view of things by the individual banker, on the one hand, and our view of the system as a whole, on the other. If the individual banker is to make loans and buy securities, his customers must first make deposits in his bank so that he has the cash available to lend or invest. But if money is to be circulating around so that his customers can make deposits in the first place, the banking system must be making loans and buying securities! In the individual bank, the loans and investments follow from the deposits; in the system as a whole, the deposits are created by the loans and investments. ([Location 842](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=842)) - Tags: [[blue]] - since this process goes on with each individual commercial bank looking out for its own self-interest, and since each bank wants to lend out and invest just as much as it can based on its judgment as to the probable demands of its depositors for withdrawals, some sort of control over this process is necessary. For example, has the public any assurance that the banks will, in fact, keep enough cash on hand to cover their withdrawals? What does the bank do when it has to meet withdrawals but the moment is a bad one for selling securities or saying no to creditworthy borrowers? What happens when one man’s withdrawal is not offset by another man’s deposit and when, as a result, not just one or two, but many banks are trying to sell securities to raise cash? If everyone is trying to sell, who will buy? And how can we be certain that the rate at which banks are creating new money is appropriate to the level of business activity in the national economy—neither so slow that expenditures are excessively difficult to finance nor so rapid that inflation can result? In short, how do things work out when we drop our simplifying assumption that money never leaves or enters the commercial banking system? All of these questions have spelled trouble for the American economy at one time or another in our history. Some of them still do. But at least we have developed a mechanism that attempts to deal with problems of this type—sometimes with more success, sometimes with less. That mechanism is known as the Federal Reserve System. ([Location 853](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=853)) - Tags: [[blue]] - The Federal Reserve System was established by Congress in 1913, following the banking crisis of 1907. All of the questions raised at the end of Chapter 6 had applied with a vengeance to the events of 1907, and this was only the most intense of a long sequence of similar crises. It was hoped that the Federal Reserve System would prevent a repetition of such disasters. Although unable to stem the cataclysmic worldwide breakdown of the early 1930s, the Federal Reserve has met most of the challenges for which its framers originally designed it. ([Location 869](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=869)) - Tags: [[blue]] - Membership in the System stipulates certain restrictions as to lending and investing policies. The banks are regularly examined by officials of the Federal Reserve Banks to make certain that the quality of their loans and investments meets the required standards. Equally important, and especially appropriate from our viewpoint here, member banks must carry a minimum amount of cash reserves in relation to their outstanding deposits, this minimum being set from time to time by the Board of Governors in Washington. Why should a bank submit to these restrictions? There are two major incentives for membership.15 First, prestige attaches to it: it implies that a member bank is a safer place in which to deposit money, precisely because the bank has submitted to the restrictions and rules on which the Reserve authorities insist. Thus, membership helps attract deposits. Second, member banks have the privilege of borrowing from the Federal Reserve Banks when they have insufficient cash to cover their depositors’ withdrawals—a privilege that gives our whole banking system much more flexibility than it would otherwise have. ([Location 894](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=894)) - Tags: [[blue]] - There is nothing complicated about the mechanics of Federal Reserve operations. In fact, we have only one thing to keep in mind: the Reserve Banks are bankers’ banks—that is, they function in relation to the member banks in precisely the same way that the commercial banks function in relation to the public. ([Location 911](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=911)) - Tags: [[blue]] - As the public holds most of its ready money in the form of deposits in commercial banks, so the commercial banks hold most of their cash resources in the form of deposits at the Federal Reserve Banks. ([Location 914](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=914)) - Tags: [[blue]] - As the commercial banks provide a convenient means for an individual or business firm to make payments by transferring funds to another individual or business firm through the use of checking accounts—that is, through simple bookkeeping procedures—so the Federal Reserve System provides a convenient way for one bank to transfer funds to another bank through bookkeeping procedures rather than through any physical transfer of cash. ([Location 916](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=916)) - Tags: [[blue]] - As the public deposits its excess currency holdings in checking accounts at commercial banks, where it is more conveniently spendable, and as the public also replenishes its supply of currency by withdrawals from checking accounts, so commercial banks will draw down their accounts at the Federal Reserve Banks when they need additional amounts of currency to satisfy the public. And so, also, the commercial banks will redeposit at the Federal Reserve excess currency that accumulates in their vaults. ([Location 919](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=919)) - Tags: [[blue]] - as a consequence of these other considerations, the granting of loans by the Federal Reserve Banks and their purchases of securities will result in an increase in member bank deposits at the Reserve banks, for the same reasons that commercial bank lending and investing will cause the volume of checking account money to increase. ([Location 923](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=923)) - Tags: [[blue]] - as the commercial banks are to the public, so the Federal Reserve Banks are a source of currency for the commercial banks on the one hand, and a depository for their excess currency supplies on the other. ([Location 985](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=985)) - Tags: [[blue]] - Take the case of Mr. Jones, who draws a check on the New York State Bank for $1,000 to pay his income tax. The Treasury will deposit that check in the Federal Reserve Bank of New York. The Federal Reserve Bank will increase the Treasury’s account by $1,000 and reduce the New York State Bank’s balance on its books by $1,000, after which the New York State Bank will also reduce Mr. Jones’s balance by $1,000. But note that this is a case where one bank’s loss is not another bank’s gain: the money withdrawn from the New York State Bank did not reappear as a deposit in some other commercial bank. The loss of reserves by the New York State Bank was a loss for the system as a whole. Nor can we say that the funds were gained by the Federal Reserve Bank, for the Federal Reserve Bank gained nothing—it merely transferred the credit balance of $1,000 on its books from the account of the New York State Bank to the account of the Treasury. But, of course, the opposite is also true when the Treasury is paying out money faster than it is depositing the receipts of taxes or new borrowings. While the Treasury will take in much more than it is paying out during tax time, and particularly during the middle of April, disbursements tend to exceed receipts during much of the remainder of the year. ([Location 1002](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1002)) - Tags: [[blue]] - we have now found one case (and we shall subsequently find others) in which the commercial banking system as a whole can gain or lose reserves. In such cases, the increase or decrease in the cash resources of one bank is not offset by decreases or increases in the cash resources of some other bank. Just as payments by commercial banks to the public are the mechanism that increases one man’s holding of money without decreasing another man’s, so payments in and out of the Federal Reserve Banks can change one bank’s reserve balance without offsetting changes in another’s. ([Location 1018](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1018)) - Tags: [[blue]] - Although the Federal Reserve authorities can do little or nothing to influence the rate at which money is spent, they do exercise significant control over the quantity of money available to be spent. They do this, in large part, by causing member bank reserve balances to go up or down and thereby enlarging or reducing the lending and investing capacity of the commercial banking system. But each individual commercial banker watches more than just the size of his cash assets; he also watches how they move in relation to the claims that his depositors may make upon him.Thus, the relationship between cash reserves and deposit liabilities is the principal point at which Federal Reserve policy attempts to regulate the quantity of money in the economy. ([Location 1027](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1027)) - Tags: [[blue]] - If the function of the Federal Reserve System can be summarized succinctly, we can say that it is to prevent both the occasion in which everyone is a seller and no one a buyer (the money panic just described) and also to prevent the occasion in which everyone is a buyer and no one a seller (which is what happens in an inflation). ([Location 1076](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1076)) - Tags: [[blue]] - Suppose, however, that the securities offered for sale by the bank short on reserves are bought, not by a depositor in another commercial bank, but by the Federal Reserve Banks. This can happen if the Reserve Banks are willing to outbid other buyers and thereby run up the prices of the securities. Now we have a deus ex machina. Just as before, the selling bank receives a check in payment for the securities it sold. Just as before, it deposits that check in its Federal Reserve account. Just as before, its cash position is restored to the desired level. What is different—and crucially so—is that no other bank in the system has lost any reserves; one bank’s gain is not offset by another bank’s loss. In effect, the Federal Reserve Banks, by buying the securities, have paid to the selling bank the additional reserves it needed, so that no other bank had to lose reserves to accommodate the situation. ([Location 1086](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1086)) - Tags: [[blue]] - By providing the commercial banks with additional reserves, the Federal Reserve either prevents a shortage of reserves from spreading throughout the system, thereby forcing a reduction in the supply of money as other banks are impelled to sell securities and retract loans, or it actually encourages an increase in the supply of money by creating additional reserves for the commercial banks.20 Furthermore, by coming into the bond markets as an additional (and substantial) buyer, the Federal Reserve pushes bond prices to a higher level than they would otherwise have reached. This is the same thing as saying that bond yields move lower. In short, then, purchases of securities by the Federal Reserve Banks make the financing of a business expansion both easier and less expensive; banks are more willing to provide new credits, and interest rates are lower than they would have been without Federal Reserve action. ([Location 1104](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1104)) - Tags: [[blue]] - Just as purchases of securities by the Federal Reserve raise bond prices and lower interest rates, so the sale of securities by the Federal Reserve will reduce bond prices and raise interest rates. ([Location 1122](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1122)) - Tags: [[blue]] - the Federal Reserve authorities can adjust their policies, not only to the general level of bond prices, but also to the level of particular segments of the bond markets. By buying or selling bonds of different maturities, they can influence the spread in interest yields on short-term bonds as compared with long-term bonds. ([Location 1128](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1128)) - Tags: [[blue]] - except under exceptional circumstances—and then only for limited periods of time—the Reserve Banks are prohibited from buying Government securities directly from the Treasury: they must buy and sell in the open market, trading there with all other investors who deal in Government securities. The purpose of this restriction is to deny the Treasury the temptingly easy method of financing itself by borrowing from a quasi-governmental institution—a path that has led to excessive monetary expansion in many other countries. Instead, the Treasury must compete with all other borrowers in the marketplace for the investment funds of individuals, corporations, and financial institutions. ([Location 1133](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1133)) - Tags: [[blue]] - the Federal Reserve can do more than step into the breach by buying securities when all banks are short on reserves. Just as the Federal Reserve will buy when no one else has sufficient cash available, so the Reserve Banks can make loans to member banks when no other bank has sufficient excess reserves to do so. The essential principle involved is the same. When one bank borrows from another, reserves are transferred from the lending bank to the borrowing bank; one has more, the other less; the two together have the same amount of reserves that they had to begin with. If one bank borrows from the Federal Reserve, however, the Federal Reserve will increase the balance on its books to the credit of that bank: the borrowing bank will have more, but no other bank will have less. No cash will leave the Federal Reserve as a result of this loan, for if the borrowing bank subsequently loses those reserves, either because it buys securities with them or because its depositors draw out more than they put in, the reserves lost by that bank will simply be transferred to some other bank. The sums on the books of the Federal Reserve to the credit of the various banks will shift from bank to bank, but no cash will be withdrawn from the Federal Reserve Banks. ([Location 1166](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1166)) - Tags: [[blue]] - The Federal Reserve Banks naturally charge interest for these loans, the interest rate being known as the “discount rate.” As a general rule, the Federal Reserve Banks almost never keep the discount rate far below the rate of return on short-term Treasury securities. This would encourage an excessive amount of borrowing, as banks would use the reserves borrowed at a low rate to invest in (or refrain from selling) securities earning a higher rate of return. As a matter of fact, the discount rate is usually just about equal to or higher than the yield on U.S. Treasury bills—highly liquid obligations of the U.S. Government, maturing every ninety days. The higher the discount rate relative to the bill rate, of course, the more reluctant the banks will be to borrow and the greater the frequency with which they will sell securities to replenish their reserve positions. ([Location 1186](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1186)) - Tags: [[blue]] - while an increase in member bank borrowings from the Federal Reserve shows that the banks are trying to maintain their lending and investing operations, and while a fall in member bank borrowings shows that the banks have accumulated more reserves than they need at that particular moment, Federal Reserve open-market operations reflect the initiative of the Federal Reserve authorities in attempting to influence the member banks to restrict or expand their loans and security holdings.The important difference is that the ebb and flow of member bank borrowings show the efforts of the banks to maintain the status quo, whereas Federal Reserve open-market operations are an effort to change it. ([Location 1208](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1208)) - Tags: [[blue]] - When the Reserve Banks go into the market and buy securities, they have to find someone who is willing to sell. In order to induce investors to sell securities, the Reserve Banks must offer to pay higher prices than those currently prevailing or must be willing to buy more than had previously been bid for at current prices. In either case, the initial effect of the Federal Reserve purchases is to persuade some investor to hold money instead of securities. At the same time, reserves will be gained by the banks in which the sellers of the securities maintain their checking accounts. Banks gaining reserves will tend to respond initially by going out and buying securities (or by refraining from selling some that they might otherwise have liquidated), so that further amounts of money will be substituted for the security holdings of individuals and corporations. What do the former holders of securities do with the money they have now received? Some of them perhaps sold their securities because they expected bond prices to decline in the future; others sold because they needed the money to finance their businesses or to pay for goods and services they wanted to buy. The first group, finding the banks eagerly bidding for securities, will see that their expectations of bond prices were mistaken and will probably use the money to make some fresh investment. As Government securities and other high-quality bonds rise in price, investors will begin to look at lower-quality bonds and at common stocks that appear relatively attractive now that the safest types of investments are more expensive than they were before. To use a technical term, the liquidity of the economy has increased: people are holding more money than they had been holding, and those who need cash find it easier to raise through selling securities or finding a willing lender. Although this situation in itself gives no assurance that individuals or business firms will use this additional liquidity to go out and buy more goods and services than they had been buying (which presumably was the objective that motivated the Federal Reserve open-market purchases in the first place), money ultimately does begin to burn a hole in most people’s pockets. Furthermore, any increased demand for goods and services that does develop can now be much more readily financed. ([Location 1216](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1216)) - Tags: [[blue]] - One of the major additions effected in the Banking Act of 1935 was the permanent grant to the Board of the power to vary member bank reserve requirements—to raise or to lower the amount that each bank had to keep in legal reserves in relation to the volume of deposits it has outstanding. The higher this requirement, the smaller the amount of any given level of cash resources that the banks can lend and invest; the lower the reserve requirement, the greater the amount of credit and new money that the member banks can create from a given volume of reserves. ([Location 1256](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1256)) - Tags: [[blue]] - Changes in reserve requirements have occurred much less frequently than changes in the discount rate or in open-market policy. An increase or decrease in reserve requirements is a blunt instrument: it hits all banks at once across the board, whether they have ample supplies of reserves or whether they are all loaned up. The use of discount rate changes or open-market operations, on the other hand, tends to facilitate adjustments at those banks that are short of reserves or have too much cash, without having those adjustments drain reserves away from other banks or flood other banks with an excessive amount of reserves. ([Location 1266](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1266)) - Tags: [[blue]] - Even if the banks attempt to lend out and invest every penny of excess reserves that they hold, and even if the Federal Reserve takes no steps to discourage or restrain them, we still have no idea of what will happen to the supply of money, for that ultimately depends upon the willingness of all the business firms and individuals and other depositors in the banks to increase their holdings of demand deposits and currency. If the public decides to use the additional liquidity to repay loans to the banks or to repurchase securities from the banks or—as we shall see in a later chapter—to hold more balances in time deposits rather than in demand deposits, the money supply will either fail to increase or will in any case fall short of the theoretical limit set by the reserve requirement ratio and the level of excess reserves. We must never forget that the willingness of the public to hold money rather than repaying debts to the banks or holding other types of liquid assets can set a practical limit to the supply of money that may be below the theoretical one. ([Location 1357](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1357)) - Tags: [[blue]] - Thus, when the Federal Reserve believes that member banks have too little in reserve over and above what is required (“too little” meaning that the authorities would like to see the supply of money increase), they will lower the discount rate and buy Government securities in the open market. When they believe that bank credit is advancing too rapidly and that the expanding money supply is financing an inflationary spiral, they may raise reserve requirements, thereby stipulating that a smaller amount of a given level of reserves is available for loans and investments, or they may raise the discount rate and sell Government securities. ([Location 1373](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1373)) - Tags: [[blue]] - the amount of currency in circulation is not set by the Government or by any other issuing agency; rather, it is determined by the choices and habits of the public in deciding how much of their money holdings to keep in the form of currency and how much in the form of checking accounts. No law can regulate these patterns. In fact, in a crisis, when the people completely lose confidence in the banks and want to convert all of their bank deposits into currency, the system simply breaks down. In 1933, all the banks were forced by the Government to close their doors until confidence was gradually restored. ([Location 1424](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1424)) - Tags: [[blue]] - what is the “backing” for checking accounts? The backing for checking accounts is to be found in the assets of the commercial banks in which we maintain these deposits. And what do they consist of ? At least three-quarters of these assets are loans to individuals and business firms and marketable obligations issued by corporations and governmental agencies. Their soundness rests upon the soundness of each individual borrower—but the ultimate soundness of the borrowers depends upon the level of prosperity and rate of economic growth throughout the American economy. The balance of the assets of the commercial banks is listed as cash—which means this same irredeemable currency plus deposits with the Federal Reserve Banks. But the deposits with the Reserve Banks are redeemable only in Reserve Notes again, so that the “cash” assets end up looking little more substantial than the loans and investments. In short, the money that we use every day, the money that we are all happy to accept in payment for goods sold, services rendered, and debts incurred, is intrinsically worthless: it has no tangible backing, in the strict sense of the word.Yet, though it has no value of its own, we nevertheless value it highly! We value it because of what we have to give up to get it—our labor and our possessions—and because of what we can buy with it. The real meaning of the value of our money, in other words, is how much a dollar can buy. ([Location 1479](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1479)) - Tags: [[blue]] - Tangible money is just as “worthless” as intangible money, when we really get right down to it. Men worship and treasure gold, but the Midas story reminds us that he who has only gold is truly poverty-stricken. If the young United States had been flooded with gold instead of with paper money after the Revolution in 1783, we would have been just as badly off as we were with the Continental currency, because there was so little available to buy and so much money around to spend. ([Location 1492](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1492)) - Tags: [[blue]] - The only real attraction of gold as a basis for a monetary system is that its supply is limited, or at least increases slowly, whereas only the judgments and fallibility of men can put a limit to the issuance of money based on credit and promises. The use of something like gold, in other words, will tend to prevent us from having too much money in relation to the supply of things we want to buy (although substantial inflations did in fact occur despite the existence of the old gold standard). However, it also may set too low the upper limit on the money supply, in which case we will have too little money and will be unable to finance business expansion and economic growth. ([Location 1496](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1496)) - Tags: [[blue]] - When we look back over the ground that we have covered and ask what the American dollar is really based upon, we would have to say that it consists essentially of promises and bookkeeping machines. If anyone were to set up such a system by decree or legislation, it would probably never work. Indeed, it is just as well that most people never stop to realize that the money they earn for their efforts is only a number in a bookkeeping machine or a piece of paper convertible into nothing more than another number in a bookkeeping machine. ([Location 1518](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1518)) - Tags: [[blue]] - until 1968, the volume of Federal Reserve Notes outstanding could not exceed four times Federal Reserve Bank holdings of gold certificates, a special form of currency backed 100 percent by gold actually held in the Treasury vaults at Fort Knox. For example, on September 30, 1967, Federal Reserve Notes outstanding amounted to $39.6 billion, against which the Reserve Banks were required to hold $9.9 billion in gold certificates; their actual gold certificate holdings on that date were $12.5 billion. This margin of $2.6 billion in excess gold certificates was shrinking rapidly, however, as currency in circulation was rising and America’s gold stock was shrinking. Thus, a year earlier, the gold certificate reserve had been $0.3 billion bigger and Federal Reserve Notes outstanding had been $2.0 billion smaller. In other words, we were rapidly approaching a point where we either had to deflate the money supply or change the law; we clearly chose the lesser of two evils and changed the law. ([Location 1528](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1528)) - Tags: [[blue]] - The original purpose of this legislation was to set an upper limit to the supply of money in the United States by setting a maximum to the volume of commercial bank reserves and to the amount of currency outstanding. Two factors explain its gradual abandonment. First, our levels of economic understanding and sophistication of monetary management are so much more advanced today than they were fifty or sixty years ago that arbitrary barriers of this nature are obsolete and can cause more problems than they solve. Second, the original authors of the Federal Reserve Act could hardly visualize the enormous expansion in the money supply that is needed to finance the operations of an economy as tremendous as ours in this day and age. The law has had to give way to the sheer necessity to have more dollars to finance trillions of dollars a year of expenditures. ([Location 1540](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1540)) - Tags: [[blue]] - the application of the gold certificate reserve to Federal Reserve Notes alone was hardly an effective way of restraining the money supply. As we have seen, Federal Reserve Notes are not “issued” in any active sense of the word—the public draws currency from the banks as they need it. They obtain the currency by cashing checks—that is, by drawing down their demand deposits. This means, in turn, that demand deposits tend to rise first, with an increased demand for currency following later on. Since the level of demand deposits is limited by the balances the banks carry at the Federal Reserve and since the 1964 legislation removed any restriction on the abilities of the Federal Reserve to expand member bank reserve balances, keeping the gold certificate reserve requirement against Notes alone was clearly an awkward and unsatisfactory way of trying to limit the supply of money. ([Location 1546](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1546)) - Tags: [[blue]] - Few people realize, however, that gold’s hegemony as the world’s sole monetary standard has been surprisingly brief. Britain was the first country to adopt gold as the single monetary standard in 1821, but only after ample supplies of it were discovered in the latter half of the nineteenth century did most other countries follow suit. Yet by merely 1937, only about fifty years after gold had reached its zenith, not one country in the entire world continued to maintain a fixed tie between its currency and the price of gold, and only a few any longer permitted free and unlimited convertibility of their currency into gold. ([Location 1626](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1626)) - Tags: [[blue]] - gold now plays a more subsidiary role and is on the defensive against substitutes whose supply can be more elastic for the settlement of international accounts. This was predicted more than thirty years ago by Keynes, in an eloquent passage from an essay entitled Auri Sacra Fames:   Almost throughout the world, gold has been withdrawn from circulation. It no longer passes from hand to hand, and the touch of the metal has been taken away from men’s greedy palms. The little household gods who dwelt in purses and stockings and tin boxes have been swallowed up by a single golden image in each country, which lives underground and is not seen. Gold is out of sight—gone back into the soil. But when gods are no longer seen in a yellow panoply walking the earth, we begin to rationalise them; and it is not long before there is nothing left. ([Location 1641](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1641)) - Tags: [[blue]] - But something is indeed amiss, and it is important to us. For, in recent years, our gold stock has not only been shrinking, but the claims that entitle foreign countries to ask for more of it have been increasing. If the claims grow too large or if our gold stock falls too low, our foreign friends may ask for gold from us, not because they need it to settle up their own international accounts, but simply because they want to be sure to get what is coming to them before we shut down the doors on it. Like all bankers, the United States is able to satisfy withdrawals by some of its depositors some of the time but cannot satisfy withdrawals by all of its depositors at the same time.   How did the richest country in the world, holding three quarters of the world’s stock of monetary gold at the end of World War II, ever get into such a position? The explanations for difficulties are easier to find than the cures: the United States has simply been paying out to foreigners more than foreigners have been paying to us. ([Location 1652](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1652)) - Tags: [[blue]] - the dollar has done a good job as an inexpensive substitute for gold. Since the United States has stood ready at all times to convert dollars into gold at $35 an ounce for foreign governments and central banks, the dollar in effect has been “good as gold.”∗ Holding assets in the form of gold is an expensive business in any case. It not only earns no interest, but is inflicted with a form of negative interest in that high fees have to be paid for its safekeeping, transfer, and shipment. ([Location 1719](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1719)) - Tags: [[blue]] - it is an overstatement to assert that foreigners have had no use for the dollars that they have accumulated. They must carry substantial amounts of dollars simply to finance their day-to-day financial dealings with and purchases from Americans. Moreover, a large and growing volume of business among foreigners themselves is transacted in dollars—or Eurodollars—rather than in sterling or francs or some other currency. This simple business reason is probably most important. In addition, however, many of these countries have been able to use the accumulation of excess dollars to make repayments on the money we lent them in the early postwar years, when they were desperately short of cash to pay for the enormous quantities of American goods and services so essential for the reconstruction of their economies. ([Location 1723](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1723)) - Tags: [[blue]] - Note: Eurodollars incentivized European countries to avoid converting their US dollars into gold. Hence, US dollars would leave the US system (deflating the currency) without a corresponding decrease in gold reserves. Similarly, dollars used in international trade today suck dollars out of the American system. The more that those dollars are used for trade between countries where both parties are NOT the US, the less likely they will be to ever return to the American system. So as long as a substantial proportion of international trade is conducted in dollars and the growth rate of internal economies & trade exceeds the growth in the need for the US to print more dollars, the inflation rate will remain low. The dollars will be printed, used to pay off government debt or fund services, and eventually those dollars will get suctioned off into international trade - the willingness of foreigners to hold dollars is more a compendium of hopes and fears than of cool economic calculations. Those countries with the largest claims on our gold—the Western Europeans and the Japanese—clearly enjoy some of our discomfiture over our present position, but they would probably hesitate to do anything that would bring down in ruins the structure of international cooperation that has been built up during the postwar years. International trade and finance are so much more important to their economies than to ours that they have really been forced to go along with our deteriorating position rather than risk a holocaust that would be even more ruinous to them. ([Location 1733](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1733)) - Tags: [[blue]] - That a period of chaos, panic, and uncertainty would follow upon the suspension of gold convertibility goes without saying. This is reason enough to try to avoid it. But ultimately, as the fundamental economic forces of trade and investment began to reassert themselves, clearer patterns would emerge. If a German could obtain dollars for 3 marks instead of 4 and if a Frenchman could buy them for 3 francs instead of 5, American goods and services would begin to appear extraordinarily inexpensive and attractive to them. The demand for dollars would thus begin to revive. Meanwhile, Americans, finding that they were receiving fewer marks and francs in exchange for their dollars, would buy more bourbon whiskey and California wine instead of Scotch and claret. In short, the foreign exchange value of the dollar would probably return to a level close to its present one, once the dust of the crisis had settled. ([Location 1786](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1786)) - Tags: [[blue]] - We know that interest rates reflect the interaction of the demand for and supply of money. With business activity rising so slowly, the need for cash to finance expanding production during the 1930s was obviously also growing at a slow rate. With ever-rising amounts of money in the checking accounts of individuals and corporations, those who held these idle dollars pressed to find some employment for them. Long-term yields on corporate bonds had been above 4 percent when Roosevelt took office in 1933; by 1938 they had fallen to little more than 3 percent and at Pearl Harbor were down to only 2¾ percent. At the same time, yields on short-term paper, which had run well above 4 percent before the crash in 1929, fell to nearly zero.29 ([Location 1828](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1828)) - Tags: [[blue]] - as a result of both a general sense of insecurity and of a basic reluctance to part with cash for such a small reward in interest, the fetish for liquidity during the 1930s was extraordinarily powerful—the simple creation of money (or receipt of money from abroad in the form of gold) was no guarantee that it would be spent. Some observers compared the stimulus of monetary policy with the effectiveness of pushing on a string. As a result, increasing interest and attention was focused on Government spending in excess of tax revenues—deficit financing, as it came to be called—in which the Government would borrow the idle dollars no one else wanted to use and spend them for things the community needed. ([Location 1846](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1846)) - Tags: [[blue]] - The Treasury was faced with a serious dilemma at this point. Out of total budget expenditures of $340 billion, $130 billion were raised by taxation. The rest (some $210 billion) had to be borrowed. But this enormous sum was five times greater than the total quantity of money held by the citizens and corporations and financial institutions in the United States in 1941. How, then, could the money be borrowed without sending interest rates to astronomical levels?31 The remarkable fact is that the Treasury was borrowing money in the summer of 1945 just as cheaply as in the months preceding Pearl Harbor! The answer, of course, is that the Treasury borrowed dollars that never existed before, that were held by no one until they came into the possession of the Treasury. There was no choice. If all the money could not be raised by taxation because of political obstacles, and if the remainder could not all be borrowed from holders of idle dollars because there were either insufficient idle dollars or because interest rates would have skyrocketed, then the necessary money had to be found elsewhere than in the taxpayer’s pocket or in an inactive checking account. In short, the Treasury borrowed about one-third of the money from the commercial banks. The checks the banks issued to pay for the Government bonds increased the Treasury’s bank account without decreasing any other depositor’s account. What the Treasury spent was new money, not a transfer to it of somebody else’s money. Of course, when the Treasury spent that money, it moved into the pockets and bank accounts of the soldiers and sailors and armament producers and farmers, who, in turn, either spent it for their own needs or (as was frequently the case) checked it back to the Government again as money paid for taxes or money paid for Government bonds. Out of total borrowings of $210 billion from the end of 1940 to the end of 1945, $70 billion were borrowed from the commercial banks. No wonder, then, that the war period was accompanied by a tremendous increase in the supply of money, from $40 billion at the beginning to more than $100 billion five years later. Since this was an even faster rate of expansion than the steep rise in the gross national product, more than enough money was created to finance the war effort. Thus, interest rates stayed at the low levels of the 1930s, even though Government debt more than quintupled. ([Location 1880](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1880)) - Tags: [[blue]] - With the end of the war and the rapid dismantling of all wartime controls, the great pool of money that had formerly been flowing into the Treasury now burst upon the marketplace for automobiles, homes, clothes, appliances, butter, and meat for which people had been yearning for so long. But it was not only consumers who stampeded into the marketplace; businessmen were eager to reequip their run-down productive facilities. Western Europe turned to us as well for assistance in the seemingly bottomless job of reconstruction, and countries that had prospered by staying out of the war also joined the queue of eager buyers. ([Location 1942](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1942)) - Tags: [[blue]] - Whereas the physical output of goods and services in the early postwar years was probably a little lower, and surely no bigger, than it had been at the high point of war production in 1944 (although, of course, its composition changed completely), the demand for goods and services was so voracious that businessmen had no hesitation in taking advantage of the seller’s market to raise prices. Workers, breaking out of the wartime wage-freeze, demanded and had little trouble in obtaining higher wages. No problems of definition arose in describing the first three postwar years: this was inflation. ([Location 1950](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1950)) - Tags: [[blue]] - Without the accumulation of cash and liquid assets during the war years, the inflation of 1945 to 1948 could never have taken place: no one could have afforded to pay the higher prices, no businessmen could have financed the rising cost of production. ([Location 1965](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1965)) - Tags: [[blue]] - As long as there was so much cash around, sellers of Government securities should have had no trouble in finding buyers. The difficulty was, however, that most investors were now looking for other types of assets that would provide a higher return. Furthermore, money that had been sitting during the war was now rapidly moving on the wing: the gross national product expanded by one-third from 1945 to 1950 on an increase of only 10 percent in the money supply. Another measure of the degree to which idle dollars were being put to active use is the sharp rise in debt among borrowers other than the Federal Government: These trends became the subject of profound concern. The economy had lived so long on low interest rates that low interest rates were considered a necessary condition for continued prosperity (especially in the construction industry). Any tendency toward higher interest rates thus appeared to be cause for alarm. Furthermore, aside from the pressures of the fundamental economic forces playing on the level of interest rates—the degree to which production was outpacing the supply of money—investor expectations also had to be considered. The fear arose that anticipation of higher interest rates would cause large-scale dumping of Government securities and that the millions of individuals who held more than $40 billion in Savings Bonds redeemable on demand would rush to the Treasury and ask for their cash. ([Location 1974](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=1974)) - Tags: [[blue]] - The real climax of this period came during the 13 percent expansion in gross national product from 1958 to 1960 accompanied by less than a 3 percent increase in the money supply. No wonder the interest yield on long-term bonds rose by nearly 50 percent at that time, as business firms and individuals needing cash desperately strove to pry it loose from those who held it. ([Location 2009](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=2009)) - Tags: [[blue]] - While member bank loans and investments expanded by about $100 billion from 1951 to 1963, total deposits in the member banks also increased by just about $100 billion over the same period. The rise in member bank loans and investments, in other words, led to an equivalent increase in deposits, just as the theory predicts they would. ([Location 2053](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=2053)) - Tags: [[blue]] - the fact remained that the banks were in an increasingly illiquid position and that the slightest pressure on the brakes by the Federal Reserve could change the pace suddenly and unmistakably. ([Location 2127](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=2127)) - Tags: [[blue]] - A dramatic rise in interest rates reflected the financial tensions surging throughout the economy. The yield on U.S.Treasury bills, which had fluctuated between 3½ and 4 percent during 1964 and 1965, zoomed from 4½ percent in April 1966 to 5½ percent in October.The interest rate that commercial banks charge their prime business borrowers, which had held unchanged at 4½ percent from the latter part of 1960 to the end of 1965, climbed rapidly to 6 percent during the first seven months of 1966. After more than five years of almost completely stable borrowing costs, top quality corporations were borrowing long-term funds in the bond market at the highest rates since 1920. Common stock prices fell sharply to a point where investors could buy stocks more cheaply in relation to their earnings than at any time since 1958. ([Location 2147](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=2147)) - Tags: [[blue]] - This experience taught the policymakers an important lesson. Tight money leaves most spenders and borrowers unscathed—they may have to pay more for money, but they can continue to get it. Where tight money hits, however, the impact is total. The events of 1966 left most individual and corporate borrowers in a position to finance all, or almost all of the expenditures they wished to make, but the residential construction industry was left in a state of disarray, marked both by bankruptcies among employers and a labor force scattered around in more promising occupations and almost impossible to reassemble in any short period of time. ([Location 2169](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=2169)) - Tags: [[blue]] - the tight money crisis of 1966 passed into history, but it left behind three important lessons. First, expectations as well as current needs play an important role in shaping the demand for money. Any tight money policy runs the danger of feeding on itself and creating a speculative demand for money that is almost impossible to satisfy. These consequences may be more catastrophic than the inflation the tight money policy is designed to avert. Second, excessive reliance on monetary policy in preference to fiscal policy as a means of restraining demand is dangerous and places the burden unfairly on limited sectors of the economy. A general tax increase takes at least something out of the pockets of everyone, so that everyone is forced to tighten his belt to some degree; the impact of tight money, however, is total in that it completely cuts off all access to financing from some sectors while, despite the higher cost, money continues to be readily available to others. Finally, our financial system is more closely interrelated and the American people are more sophisticated than the authorities realized. Long habits of using financial intermediaries to invest small savings can clearly be broken in a hurry when alternative means of investment begin to offer higher rates of return with no significant difference in safety or liquidity (and, indeed, some open market instruments have more safety and liquidity than savings deposits). The process of “disintermediation” that took place during 1966 caused dislocations far beyond anyone’s expectations and, in fact, raised dangers of failures and loss of confidence among savings institutions that might have touched off a crisis of 1931 to 1933 dimensions. ([Location 2208](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=2208)) - Tags: [[blue]] - At Christmas 1965, in the course of a speech to the American Economic Association, the Chairman of the President’s Council of Economic Advisors commented on the difficulties of policy determination for an economy at virtually full employment and full capacity with expansionary forces still at work. He was most concerned, he pointed out, that the margin of error for policymakers under these conditions was very much smaller than when they were simply trying to bring the economy from less than full employment up to its maximum. The twelve months that followed surely proved his point. ([Location 2222](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=2222)) - Tags: [[blue]] - Conservatives also believe that progress should come slowly, with plenty of time for trial and error, in order to avoid excesses and distortions that may lead to disaster. They know that providing too much money too fast will permit the financing of too many projects doomed to fail the inexorable tests of profitability. ([Location 2236](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=2236)) - Tags: [[blue]] - When all is said and done, the productivity of the American economy is the ultimate barrier to runaway inflation in our country. The catastrophic inflations of history—and many large, but less disruptive, inflations—have been the result of a real shortage of goods and a breakdown of the economy’s ability to produce and distribute, rather than of an excess of money. This was clearly the case in the Confederacy during the Civil War, and in the defeated countries of Europe and Asia after World War I and World War II. It has also been the case in the underdeveloped nations, where resources must be devoted to building roads and factories and power plants rather than to consumer goods while at the same time the demand for consumer goods is burgeoning. These types of problems simply do not exist in the American economy (or exist only very briefly), where, for most of the peacetime years in the twentieth century, our capacity to produce has exceeded our willingness to buy. ([Location 2266](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=2266)) - Tags: [[blue]] - If the economy is sufficiently liquid so that financing of expenditures is possible without the assistance of the commercial banks, monetary policy will be hard put to stop inflation in any case. If, on the other hand, financing is made so difficult that expenditures fall short of the desired level, men will be unemployed and machines will stand idle. This is especially likely if, as usually happens, prices and wages refuse to come down in the face of shrinking demand. In addition, we have no assurance that demand will be restricted in just those spots where it is excessive—it does no good to deny credit to the corner grocery store when large corporations accumulating raw materials are able to get all the credit they need: the lop-sided impact of tight money in 1966 is proof of this. ([Location 2285](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=2285)) - Tags: [[blue]] - the dangers inherent in too little demand may be greater than the dangers of too much. If business firms are operating below their full potential, we lose many of the economies of high-volume production. Instead of a risk-taking, enterprising economy running under a full head of steam, with production moving to ever higher levels and new products and new techniques the order of the day, we have an economy strangled in the rigidities and insecurities of an inadequate level of demand. Labor fights against automation and other types of progress that would improve productivity. Minority groups feel the impact of job discrimination even more intensely than usual. Overhead costs, spread over a smaller rather than a larger number of units of output, loom high and cut into profit margins. Finally, the evidence suggests that at least 6 percent (and probably a larger proportion) of the labor force must be unemployed if wage increases are to be kept in check—and this is a politically and socially intolerable level of unemployment. ([Location 2290](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=2290)) - Tags: [[blue]] - we have no basis for believing that stable prices are essential for economic growth and full employment, nor can we necessarily argue that, in the difficult business of matching demand to supply, we would do better to err on the side of too little demand than on the side of too much. ([Location 2306](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=2306)) - Tags: [[blue]] - The willingness of foreigners to accumulate dollars has indeed enabled us to pay out to them more than they have paid over to us, but their continued preference for holding dollars has required us on occasion to provide the economy with less liquidity and less fiscal stimulation than we might have found desirable under other conditions, while at the same time we have restricted the freedom of American businessmen and investors to accumulate highly profitable assets abroad. Thus, while giving up our position as a key currency would involve certain economic costs, they might well turn out to be smaller than the costs of preserving it. ([Location 2319](https://readwise.io/to_kindle?action=open&asin=B001FA0WUW&location=2319)) - Tags: [[blue]]