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CHAPTER II of "A Primer On Money" (continue to Chapter III)
WHAT IS MONEY?
Over the long span of human history, money has assumed many forms and shapes. Different societies, at different times, have been willing to exchange goods or services for: Seashells / Bricks / Whale’s teeth / Conuts Boar’s tusks Cocoa beans / Stones / Iron rings / Feathers Salt / Beaver pelts / Blankets / Bronze axes / Wheels.
In some of the South Pacific islands, great stone wheels served as money. Someone has said that those were the days when the men handled all the money. It took muscle to move a huge stone wheel. In ancient Greece oxen were money; one ox was the basic money unit. When the Greeks introduced coins of gold and silver, this unit remained the basis for metal money, with each of the various coins worth different fractions of an ox.
In ancient Rome different things circulated as money. When the emperors were firmly established, they issued coins of gold and silver, and, throughout the Empire their subjects used them. In addition, the Romans used pieces of bronze and copper that were not made into coins; Roman merchants had to weigh and test each piece every time they made a sale or purchase. In the early days of the Empire, however, Caesar paid his legionnaires in cakes of salt, not metal, and the Roman emperors did this again, in the later days of the Empire, when they began to run out of metal. This custom may be the origin of the saying -- that a person is -- or is not -- ”worth his salt.”
The point is this: Any number of different materials -- including paper I. O. U.’s -- may serve as money. How money functions, and what money represents, are the important aspects of money. What material the money is made of is not an important aspect at all In any society, people may use as money anything they wish, provided that they agree with other people throughout the society that the material they are using has the same meaning for all of them.
The question, “What is money?” can be answered briefly: Money is anything that people will accept in exchange for goods or services, in the belief that they may in turn exchange it, now or later, for other goods or services. Later, this book will discuss the various functions of money. Further, it will discuss the reasons why the kind of monetary system we have, and the ways in which it is managed, have profound effects on the amount of real wealth produced and distributed among different families in the country. Here, it is enough to say that an efficient, up-to-date monetary system, properly managed, is essential to a modern, industrial economy.
What did Americans use for money in earlier times?
In colonial times, the earliest settlers used “wampum” more than anything else for money. Wampum consisted of clamshells strung like beads; the settlers considered these beads very valuable, even though it may seem surprising to us that, in our own society, people could have considered clamshells valuable as money. In fact, it must have been surprising to them, too, for these settlers had come from western Europe where they had used and placed their faith in gold and silver, or claims to gold and silver. Nevertheless, the native Indians used wampum as money. When the settlers found that wampum was the most useful material they could have for trading with the Indians, they began to use it for trading among themselves. Wampum had the same meaning for both Indians and settlers: It was “money” for both.
So, in 1637 the government of Massachusetts made wampum legal tender, and fixed the exchange value between wampum of white clamshells and that made of black clamshells. And, in 1641, the New Amsterdam Council fixed the exchange value between wampum and Dutch money; New Yorkers continued to use wampum as their chief currency as late as 1672. As late as 1693, people could pay the ferry charge from New York to Brooklyn in wampum. It is interesting to note that since wampum beads were generally strung, various ordinances on the subject prescribed that they must be “well strung.” Since a string of wampum was a considerable amount of money for fairly large purchases, small purchases were frequently made by counting out loose shells. This may be why people even today say they are “shelling out” money. .
Nevertheless, since the colonists did not trade only with Indians, they also used the coins of England, Spain, and France both for trading among themselves and trading with foreign nations. As trade with Europe increased, these coins became their principal form of money circulating throughout the Colonies as if they were locally minted.
In addition, most of the Colonies began to create their own systems of money by minting coins, usually of gold or silver. Some of the Colonies also issued paper money notes, supposed to be “good” for gold or silver coins. This meant that the colonists presumed that their treasuries had in their possession a dollar’s worth of gold or silver to cover each dollar of paper money. Frequently, however, this was mere “wishful thinking” on the part of the colonists.
During the reign of George III, his government forbade the Colonies to mint coins -- or to issue any other kind of money. This policy, together with the fact that most of the foreign coinage the colonists had been using was eventually drawn away to help England finance the Napoleonic wars, ultimately created a severe shortage of coined or printed money in the Colonies. Some historians claim that the colonists’ resentment against this policy was one of the major reasons they finally issued their Declaration of Independence from England.
Thus, despite the fact that the colonists had been using various foreign coins, and despite the fact that they also had been minting their own coins, these forms of money became generally scarce throughout the colonial period. In response to this shortage during the colonial period, and even later, the colonists began to use other, less familiar, commodities as money: nails, beaver and coon skins, whisky, musket balls and flints, tobacco, corn, codfish, rice, timber, tar, or cattle.
For example, early in their history, the colonists of Virginia, Maryland, and North Carolina adopted tobacco as their money standard and made it legal tender. When plantation owners harvested their tobacco and placed it in the warehouses, to await sale, the warehouse operators issued the owners paper receipts for the tobacco. When the owners made these receipts transferable, they circulated as a principal currency throughout these States. In fact, some of the American people were still using such warehouse receipts to a small extent almost up to the year 1900, long after most Americans had become accustomed to using the lawful money, such as we use today.
The use of tobacco as the basis of money illustrates the difficulties a society faces when it tries to make any commodity - gold or anything else -- the basis of its money. When warehouse receipts for tobacco was the principal money in several of the early Colonies, tobacco production was an important economic activity in these Colonies. On the whole, tobacco money, though crude, did serve with reasonable efficiency considering the nature of the times.
But, as might be expected, what happened was that tobacco prices, which were determined in the markets of Europe, changed widely from season to season and year to year. This meant that the value of tobacco money changed relative to other commodities. Where long-term debts were contracted in terms of payment in tobacco money, neither the creditors nor the debtors could be sure what the value of the money would be when the debts were paid. These troubles, which inevitably increased as the economies of the Colonies grew more diverse and complicated, led to efforts on the part of the State legislators first to fix the price of tobacco in terms of European money, then to fix the price of other commodities in relation to tobacco.
What was the money system during the Revolutionary War?
With the Declaration of Independence, the colonists repudiated the rule of England, and with it, the right of King George and his government to regulate their coining or printing of money. To help finance the War of Independence, they permitted the Continental Congress to print and issue great quantities of paper money. But as the Revolutionary War went on, American trade with Europe was interrupted, creating a widespread shortage of almost all kinds of goods. Since the Congress continued issuing more and more “Continental dollars”, this paper money rapidly came to be worth less and less. By the end of the war, “Continentals” were so worthless that Americans began using an expression we still hear today. When people now say that something is “not worth a Continental,” they mean exactly what the ex-colonists meant: that something has no value in itself-and that there is nothing behind it, to give it value, even as a symbol.
The “Continental” became worthless, however, not only because there were shortages of commodities but also because it was easy to counterfeit, and the British did exactly that. Further, the Continental Congress actually had neither the power to declare what could be used to pay debts, nor the power to tax. Both of these powers remained with the individual States, until the Constitution was adopted. And the States refused to make good the Continental money.
What has been used for money since the end of the Revolutionary War?
With independence from England established, with the creation of the United States of America as a Nation under its own sovereign rule, and with the adoption of the Constitution as the law of the land, the American people were free also to create their own money system. They could now coin or print money as they saw fit-that is, they could permit their Government to do it for them. But, even after the new Government coined metals and printed paper currency, to some extent, Americans continued to use other things as money, even though they were not lawful tender. The use of tobacco receipts and other kinds of money died out only gradually.
But the Government was not the only printer of money. During the 19th century two other organizations were given the right to print money: State banks and, then, national banks.
What were State bank notes?
Before Abraham Lincoln’s administration, the private commercial banks were permitted to issue paper money, today called State bank notes. This meant that any private company that could obtain a charter to engage in the banking business from any one of the States could also print and issue currency, or notes, against the bank. And this was a time when most States followed the “free” banking principle; almost any group which desired to do so could open a bank, and issue notes. The terms and conditions under which these banks issued such notes, as well as the basis upon which they began to do business, depended only upon the requirements of the State where the bank was chartered and the notes issued. And, often the States had few or no formal requirements, to start a bank. Since the value of the notes of any State bank depended upon the reputation of the bank itself, and the reputation of a bank usually was not known outside the locality where it did business, many “frontier” or “wildcat” banks issued paper money with little or no value.
What happened to the State banknote?
The State bank notes disappeared shortly after the Government passed the National Bank Act of 1863. This act, passed at the request of President Lincoln, provided for a system of private banks which were to receive their charters from the Federal Government and operate under Federal Government regulation. The Federal Government authorized the new national banks to issue national bank notes, also under prescribed rules and regulations. In addition, in 1865 the Government imposed a 10-percent tax on notes issued by State banks which, for all practical purposes, made it impossible for them to issue notes any longer. At that time, President Lincoln said: ”Money is the creature of law, and the creation of the original issue of money should be maintained as an exclusive monopoly of the National Government. The privilege of creating and issuing money is not only the supreme prerogative of the Government, it is the Government’s greatest opportunity.”
Why did the Federal Government pass the National Bank Act?
The Federal Government intervened in the printing of currency by private banks because this had begun to cause the Nation a great deal of trouble. The United States was rapidly becoming industrialized; trade, once largely local, was fast growing nationwide in scope. Before the National Bank Act, there was no reliable money with a uniform value in every section of the country. Obviously, the unreliability of the money supply and its lack of uniformity were serious obstacles to nationwide trade. Moreover, the Nation was being transformed into a “money economy.” This means that even then Americans were moving into specialized occupations, in contrast to earlier times when most people lived on farms, and each family produced at home much of what It needed. In a more complex and diversified economy, people gradually began to realize that it would be an advantage to have the Federal Government provide a regulated national system supplying a reliable money to finance the increasing production and trade, in place of the State banks with their separate and unrelated note issues.
What happened to national bank notes?
When Woodrow Wilson set up the Federal Reserve System in 1913, the Government withdrew the national banks’ privilege of issuing banknote currency. A relatively small amount (about $37 million) of these notes, is still outstanding, however. People have either buried them away in private holdings, lost, or destroyed them. The U.S. Treasury will redeem them when they are turned in, at the banks.
What are the forms of money in use in the United States today?
Today, the American people use coins, currency (paper money), and commercial bank demand deposits (checkbook money).
Why are commercial bank deposits listed as money?
The reason is that with a checkbook -- and some money in an account, of course -- anyone can make purchases, pay bills, or instantaneously procure any of the other forms of money -- currency and coins. In other words, it is possible to do almost everything with a check that can be done with currency and coins. Not everything, however. People do not offer bus drivers checks when they want change. Only coins and paper money will do. Checks are not freely convertible everywhere into paper money and coins -- cashing a check is a problem away from the bank which holds the deposit. But a checking account is so very close to the other two forms of money-representing purchasing power which is immediately available -- that students of monetary affairs find it most convenient to include commercial bank demand deposits in the meaning of money. Savings deposits at commercial banks -- technically, “time” deposits-are not included. The purchasing power in a savings account cannot be transferred by check.
At the time the Constitution was adopted, bank checks were almost unknown. By 1850, about half of the Nation’s money was in the form of bank deposits. Today, about 80 percent of all money is in the form of commercial bank deposits. Currency and coin in circulation outside the Treasury, Federal Reserve System, and commercial bank deposits in commercial banks were as follows in the final week of February 1964:
................................................................................................................................Millions
Currency and coin ................................................................................................. $32,000
Demand deposits in commercial banks ................................................................ 119,700
Total ...................................................................................................................... 151,700
What is “legal tender” ?
Legal tender is any form of money which the U.S. Government declares to be legal tender; that is, good for payment of taxes and both public and private debts.
Why is our money valuable?
Our money is valuable, primarily, because people will accept it in exchange for goods and services, as mentioned earlier in the chapter. But why will people accept it ? And why don’t they accept Confederate notes or German marks as well? The answer is the legal status of the dollar. As legal tender, the dollar can be used to pay taxes -- it’s advisable not to use marks. And debtors can discharge their debts by paying dollars. This is what a court will order debtors to do if they are sued for nonpayment. This makes the dollar valuable to creditors because debtors, wishing to acquire dollars to pay debts, will exchange valuable commodities or services for it.
What are the coins in use today ?
Today, the U.S. Government mints pennies, nickels, dimes, quarters, and half-dollars. The pennies, or “coppers,” of course, are made of copper. The other coins, however, are made of alloys of metals, the most valuable of which is silver, and the actual metals in the coins are not worth as much as the coins themselves.
Before 1934, the Treasury minted and issued gold coins; it no longer does. The Government enacted a law in 1934 prohibiting the use of gold coins as money, and calling in all gold coins issued before that time, except for the few people have been allowed to keep as souvenirs.
Who issues coins?
In the United States, only the Federal Government may mint and issue coins. Specifically, the U.S. Treasury is the single institution that does so. The Treasury, however, issues coins through the Federal Reserve banks.
What is currency?
Currency is the paper money, or folding money, $1 bills, $5 bills, $10 bills, and the higher denominations. Americans use several different forms of currency today, although few of us notice any difference between them, and in practice, all forms of currency have the same value. At the end of February 1964, the amounts of each kind of currency “paper” money, in circulation were as follows:
Federal Reserve notes .......................................................... $31,107,000,000
Silver certificates and Treasury notes of 1890 .......................... 1,718,000,000
U.S. notes ..................................................................................... 312,000,000
Federal Reserve bank notes .......................................................... 75,000,000
National bank notes ....................................................................... 37,000,000
Total ........................................................................................ 33,249,000,000
The Government no longer issues Federal Reserve bank notes and national bank notes. When these obsolete notes are turned into the banks, the Government replaces them by one of the other notes or silver certificates, and it then destroys these old notes.
Who issues currency?
In the United States only the Federal Government may print currency. Specifically, the Federal Reserve banks issue Federal Reserve notes. As the table indicates, about 94 percent of all currency in circulation consists of Federal Reserve notes. However, the U.S. Treasury itself did issue some silver certificates and U.S. notes. The Treasury only recently ceased issuing silver certificates. For all practical purposes, only the Federal Reserve now issues paper money.
What backs the Treasury currency?
The Treasury currency in circulation today is largely silver certificates. By law, the Government requires the Treasury to keep on deposit a certain amount of silver to “back” silver certificates. The Treasury must do the same for the Treasury notes of 1890. This means that anyone holding silver certificates can obtain silver for them on demand. The Treasury’s legal reserve of silver amounts to about two thirds the value of the silver certificates in circulation.
What backs the Federal Reserve notes?
Behind the Federal Reserve notes is the credit of the U.S. Government. If you happen to have a $5, $10, or $20 Federal Reserve note, you will notice across the top of the bill a printed statement of the fact that the U.S. Government promises to pay, not that the Federal Reserve promises to pay. Nevertheless, most Americans don’t realize what the Government promises to pay: American citizens holding these notes cannot demand anything for them except (a) that they be exchanged for other Federal Reserve notes, or (b) that they be accepted in payment for taxes and all debts, public and private. Certain official or semiofficial foreign banks may exchange any “dollar credits” they may hold-that is, deposits with the commercial banks -- for an equal amount of the Treasury’s gold. Americans themselves may not exchange them for gold. But because, in commerce with foreign nations, Americans may pay in gold, gold actually “backs”
American dollars.
Who issues “checkbook money” ?
The private commercial banks issue “checkbook money.” The next chapter will show the mechanics of how they do it, and how the Federal Reserve controls the amount of “checkbook money” they may create. Right now, it is just necessary to see what is meant by saying that the commercial banks create demand deposits, which may be exchanged for currency or coin anytime the depositor wishes. Imagine there is only one bank in the country and that it has two private depositors, each with $50 in his checking account. Total bank demand deposits would then be $100. Suppose John Jones asked for a $50 loan from the bank, and the bank approved the loan. The bank would then lend the money to Mr. Jones by simply opening a checking account for him and depositing $50 in it. This is what ordinarily happens when anyone -- business or private individual -- borrows from a bank. The bank deposits the amount of the loan in the relevant checking account. In making the loan to Mr. Jones, the bank did not reduce anyone’s previous bank balance. It simply credited the Jones account with $50. The total amount held in bank demand deposits now becomes $150. Tho bank has, therefore, issued $50 in “checkbook money.” The natural question to ask is, Where does the bank get the additional $50 to issue and lend to Mr. Jones? The answer, as will become clear in the next chapter, is that the bank did not “get” the money at all. Money has been created. Of course, the bank’s power to create money is limited. And a later chapter will show that the Federal Reserve sets the limits of this power to create money.
Did the State banks stop creating their own money after the Federal Government passed the National Bank Act?
Although the State banks ceased issuing bank notes, they continued to create money, in the form of bank deposits, just as they do today. In fact, as “checkbook money” has become increasingly popular, State banks have continued to create money in this form. They now create more of this kind of money than before the Government passed the National Bank Act. This act merely stopped the State banks from printing and issuing currency.
Who should have the power to create money?
The power to create money is an inherent power of Government. As President Lincoln said:
The privilege of creating and issuing money is not only the supreme prerogative of the Government, it is the Government’s greatest opportunity.
During the past several centuries, various governments in the Western world have, at various times, delegated the money-creating power to private groups or had this power taken from them by default. In these situations, control of the Nation’s affairs has been not so much in the hands of the official head of state, but in the hands of the private groups controlling the money system. A famous British banker once summed up the matter this way: They who control the credit of the nation direct the policy of governments, and hold in their hands the destiny of the people. (Reginald McKenna, Chancellor of the Exchequer in Britain during the World War I period.)
As we look over human history, we find that the tribal chief, the king, the pharaoh, or the emperor has usually had direct or indirect control of the society’s money. In the modem, constitutional governments, one or another branch of the government is given responsibility for establishing and managing the money system. In the United States, the Constitution gives these powers to the Congress.
Does the Constitution, which mentions only the power to “coin” money, give Congress sole power over all money?
Yes. Article 1, section 8, paragraph 5, of the Constitution provides that “the Congress shall have power to coin money, regulate the value thereof, and of foreign coin.” It is generally agreed that only the word “coin” was used because there were no banks of issue in the country at the time the Constitution was written, and the Founding Fathers assumed that coins would always meet the needs for lawful money. Over the past century and a half, many questions about Congress powers over the Nation’s money system have arisen, and the Supreme Court has upheld the proposition that “whatever power there is over the currency is vested in the Congress.”
In McCulloch v. Maryland in 1819, the Supreme Court held that Congress has a right to establish the first “Bank of the United States,” to give it powers to issue currency, and that the States could not levy a tax on such an instrumentality of the Federal Government.
Years later the Supreme Court held, again, that Congress has the power to charter national banks and also the power to tax the notes issued by State banks ---- not merely because it was a means of raising revenue, but as an instrument to put out of existence such a circulation in competition with notes issued by the Government!
In the famous legal tender cases decided in the 1870’s, the Supreme Court held that the Congress has the power to determine what shall be “legal tender,” to make currency (that is, U.S. notes) legal tender, even though in so doing Congress overturned private contracts which had been entered into before the law was passed. In short, after Congress passed the Legal Tender Act, creditors were required to accept paper money (U.S. notes) in settlement of debts for which there were contracts calling for payment in gold. Finally, in the famous gold clause cases 2 of the 1930’s, the Supreme Court held that Congress has powers to change the gold value of money and to call the Nation’s monetary gold into the U.S. Treasury and to prohibit the circulation of gold money.
How does Congress exercise its power to create money and to regulate its value!
Congress has delegated this power in part to the Federal Reserve System and in part to the private commercial banks. Furthermore, it has delegated to the Federal Reserve System the power to determine how much money shall be created and to determine also -- within wide limits laid down in law -- what part of the total money supply shall be created by the Federal Reserve and what part by the private banks.
What “backs” the dollar?
As mentioned earlier, from one point of view gold can be considered as “backing” the dollar. Certain foreign banks may exchange their dollar holdings for gold, whenever they desire. If, then, in our commerce with other nations, foreigners receive dollars, they know that ultimately these dollars are backed by gold through the exchange rights of the designated foreign banks. (These foreign banks are “central” banks-a term which will be discussed in a later chapter.) But from a much more basic point of view, the dollar is backed by the credit of the U.S. Government, and, accordingly, by the credit and assets of all its citizens. There is no mystery about this. Most of the U.S. money in existence -- currency, coin, and demand deposits -- belong to citizens of the United States. They cannot exchange their dollars for gold or anything else. They can exchange them only for other dollars. Yet, as the Federal Reserve notes show, these dollars are obligations of the U.S. Government. The Government promises to pay. It has placed its credit behind the dollar.
1) Knox v. Lee 1870. p. 543.
2) Norts v. U.S., 1935; Norma v. Baltimore & Ohio R.R., 1935.
Does money need to ‘be “’backed” ‘by some specific commodity?
Because of the long experience of people in the Western World with money “backed” by a specific commodity, such as gold or silver, many people feel that money is good only if it can be exchanged for a given quantity of some specific commodity, usually a precious metal. The fact that a dollar can be exchanged for “many types of commodities, including gold in commercial forms, as well as for housing, professional services, and labor, does not always cure their uneasiness. Yet almost anyone who found a gold nugget, or somehow came into legal possession of gold bullion, would sell it. That is to say, he would exchange it for dollars because he could spend or invest the dollars, but not the gold. This raises the question whether it was the dollar which needs or needed to be exchanged into gold, or the opposite.
When was the U.S. dollar convertible into gold?
For almost 100 years prior to 1934, except for 18 years during and following the Civil War.
Did the gold dollar mean that all of the currency and bank deposits could be converted to gold?
Yes; but in theory only. Anybody who actually asked to have his dollars converted to gold would get his gold. But if everybody had demanded gold for his dollars, the story would have been different. There was never enough gold in the country at any time to supply gold in exchange for all of the dollars. For example, when the Federal Reserve was organized in 1914, commercial bank deposits and currency in circulation amounted to $20 billion, but there was only $1.6 billion of monetary gold in the country. In other words, the amount of money in existence was about 12 times the amount of gold in the country. A similar proportion holds today. (In December 1963, the money totaled $157.4 billion and the Treasury’s gold was $15.6 billion.)
Why does the 1934 law make it impossible for U.S. citizens to demand gold in exchange for their dollars?
This law gives us a better money system because it has made the money system easier to manage. In the United States, gold is not needed to carry on our economic activities. Legal tender money, that is, the paper dollar, will buy anything that gold bullion could buy, and more. And, because the Nation’s gold supply was scattered, and buried away in private hoards prior to 1933, the dollar was less reliable in foreign exchange and, hence, more subject to changes in value at home.
Has the United States actually gone off the gold standard?
Yes; except in its international transactions. The “gold standard” usually means that people may exchange their paper money for gold whenever they desire. Today, the dollar can be exchanged for gold only in international transactions, although we still define the dollar in terms of gold. In other words, when we owe foreigners money, they may collect it either in gold or in goods or services.
Did “going off the gold standard” change the basis of our money?
In reality, no. The action which Congress took in 1934 merely formalized what had been true all along, which is this: Checkbook money, which, as we have seen, accounts for about 80 percent of our money, was created on the basis of all kinds of valuable assets. When a bank makes a loan to a business firm, secured by inventories or machinery, it has, in effect, created a dollar based on those inventories or that machinery. Similarly, when a bank makes a loan to a farmer to finance a crop, it, in effect, creates money based on farm commodities. In practice, of course, banks frequently make loans secured not by any specific assets but only; by the general credit standing of the company or individual. If the loan is not repaid, the bank can sue and collect its money by forcing the sale of whatever valuable assets the company or the individual may have. This evolution in the basis of money had taken place long before Congress passed new laws, beginning In 1934, which called all of the monetary gold into the U.S. Treasury and made it impossible for U.S. citizens to convert their dollars to gold.
If we do not have a “gold dollar,” what kind of dollar do we have?
We have what is sometimes called a managed paper currency. The dollar is based on credit, and every dollar in existence represents a dollar of debt or a dollar of credit extended owed by an individual, a business firm, or a governmental unit. Some dollars have been created in exchange for a claim against such specific assets as the plant or the inventories of a business firm, others have been created in exchange for a claim against the general credit of an individual company or governmental unit. This paper money is said to be “managed,” however, because an agency of the Federal Government (this statement seems to be incorrect. Elsewhere Patman explains that Federal Reserve is not an agency of the Federal government. mrc) -- the Federal Reserve System consciously determines and controls at all times the maximum amount of money which may be created.
Is money wealth?
No. Money itself is not real wealth; it is only a claim to real wealth.
Why do we use money?
Many primitive societies produce only a limited range of goods and often hardly enough of these to meet their day-to-day wants. Such a society can get along without any money. Trade is carried on by barter -- that is, goods of one kind are simply swapped for goods of another kind. But in a modern, industrial economy, barter would be inconvenient, if not impossible. For example, a man working on an auto assembly line might be paid his weekly wages in auto parts. He would have great trouble finding a butcher, a landlord, a doctor, and so on, all of whom happened to need auto parts and would take them in exchange for the goods and services they have to offer. We use money because money makes it easier for a nation to produce and distribute goods and services.
When people accept their incomes in money, rather than in a portion of the goods they help produce, they accept claims to wealth rather than goods which they could neither use nor store and preserve for future use. Thus, money makes it possible for the individuals of a nation to save and for the nation to invest. Investing means, of course, that all of the nation’s current productive efforts do not go into producing goods for immediate consumption, but that a part of this effort goes into producing the tools and other things needed for
future production.
It is only because we have a store of tools and other laborsaving facilities accumulated from past labors that our Nation is able to produce a great amount of necessities and conveniences for each man and woman at work. It is only because our industries, our farms, and our various kinds of service establishments are constantly adding to their supply of producer equipment, and are constantly developing still more efficient producer equipment, that our output per man-hour constantly increases.
Why must money by managed?
“Money does not manage itself,” is a famous saying of British bankers. It is a saying which Chairman Martin, of the Federal Reserve Board, likes to quote, and it sums up the matter quite well.
Since the purpose of money is to make it easier for a nation to produce real goods and services, easier to divide the income from this production, and easier to save and invest for the future, the money system should be designed and controlled in ways which serve these purposes best. For example, it is very important to have the right amount of money available at all times. Too little money and too much money are both bad. Since the people, acting through their government, make all the important decisions about money, from what they will use to who will create it, they would indeed be foolish to select a monetary system which leaves the amount of money to chance, or to accidental discovery of gold.
Why is it important for the country to have the right amount of money?
The right amount of money is as important to the economic system as the right number of tickets is to the financial success of a theater performance. The theater has only a certain number of seats. If the manager prints and distributes a great many more tickets than seats, there will be a scramble for seats when the patrons arrive at the theater. And in the long run, of course, there would be a loss of confidence in the theater management and its tickets. On the other hand if the management prints fewer tickets than there are seats in the theater, there will be empty seats. When the Federal Reserve does not allow enough money to be created, there will be, in effect, empty seats n our economy. Plants do not operate at full capacity, some people cannot find jobs, and real wealth which might have been created is not created. Under these conditions, industry reduces its investment in new and more efficient productive facilities; and the search of scientists, experimenters, and technicians for new and better ways of doing things slows down. If the official money managers do not permit the amount of money to increase as rapidly as the monetary needs of a growing economy then growth will be stunted by monetary deficiency-high interest rates-and continuous unemployment looms. On the other hand an economy can suffer equally from too much money relative to its needs. An overabundance of money, by spurring demand presses the economy to produce beyond its capacity. When this occurs, the extra demand cannot bring about an increase in production, but only an increase in prices. Inflation erupts.
How is the “money supply” defined?
The “money supply” is most usually defined as the demand deposits in commercial banks of the country plus the currency and coin in circulation outside these banks. This is the definition which Federal Reserve officials and most professional economists use when they have in mind a question of how much money is “right” for any level of economic activity. Demand deposits in commercial banks, plus currency and coin, make up, in theory at least, the total amount of money which could be spent at any one time. Many of us have, of course, money deposited with savings and loan associations, in the hands of life insurance companies, in pension funds, and so forth. Why isn’t this money included in the “money supply”? It could be, or at least some of it could, and there are times when economists find it convenient to use a broader definition of money than the usual one. But a moment’s thought will show that these excluded types of money -- a savings and loan deposit, for example-are not immediately available to make a purchase. A savings and loan account is not a checking account and the depositor first has to withdraw the money from the bank before it can be used. In addition, all the money deposited with a savings and loan association eventually is redeposited in a commercial bank or remains in the form of currency and coin outside the commercial banks. So this money is already counted in the “money supply.” (the previous sentence is not logically correct. The money in a savings and loan is not counted into the money supply until it is deposited in a commercial bank -- mrc) The same is true for money going to an insurance company, pension fund or other non-commercial-bank financial institution. Individuals’ accounts with these institutions are not included in the “money supply”, then, to avoid counting the same money twice.