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/ There are ten CHAPTERS and the original press release. Link to them here -- I • II • III • IV • V • VI • VII • VIII • IX • X • press release
CHAPTER 1 of "A Primer On Money"
MONEY AND SOCIETY
What is money’ Where does money come from? How is it created? By whom and for what purpose is money created?
Perhaps these questions will seem elementary to some readers. Yet they are questions which many people -- the usually well informed as well as others -- cannot answer. Money, it appears, is a very mysterious subject.
Other questions of equal importance can be asked. For example, who decides how much money shall be in use at anyone time? Or who decides how much will be paid for the use of money?These are questions which most of us never think about. Yet their answers lead directly to the Federal Government in Washington, which keeps constant watch over the amount of money available and the level of interest rates paid for its use. These quantities are no more matters of accident than, say, the number of automobiles produced in a given season. In the one case the government decides; in the other the managers of the automobile companies.
In other words, deciding what the money supply and the prevailing interest rate will be is as much a part of the public business as any other decision of Government. But in these decisions the general public participates little if at all. Indeed, relatively few people are even aware that these decisions are being made. This is unfortunate because, except for decisions about wars and foreign affairs, the Government makes no decisions more important to our pocketbooks, our jobs, or our businesses.
Consider, for example, what a large part interest charges play in the cost of living. All of us know, of course, that the amount the Nation pays to the farmers is important in the cost of living. Farmers supply all of our food, plus, of course, much of the fibers used for making our clothing. The total gross farm receipts from marketing in 1963 was about $36 billion. In the same year, personal income from interest alone ran almost as high, $33 billion. And then there are the billions of dollars paid in interest to financial institutions which show up in personal incomes as wagesand salaries, profits and dividends. Obviously, interest charges are closely linked to our cost of living.
This link is more easily seen by looking at business practice. All business firms have to borrow to conduct their operations -- some firms more than others. An increase in interest rates means then an increase in business costs. More money has to be paid out for use of operating credit. Mining companies, smelters, steel mills, manufacturers, distributors, wholesalers, retailers, all pay more for the use of credit which means that costs of the final product are pyramided at each stage of the production and distribution processes. Utility and transportation companies supplying the water, power, communications, and so on, and transporting the goods to market, also have their costs increased. These cost increases are passed on, at least in part, to the consumer.
So the cost of the goods consumers buy has an element of interest cost fitted in which must be included in prices for profitable operation. Interest is important enough simply as one of the costs of doing business,but is actually more than that. It is also a determining factor of the level of business activity. This is because interest rates affect the rate at which business firms invest in new plants, new equipment, and new inventory. Why do interest rates have this effect? Briefly, because some part of business’ annual investment is paid for with borrowed money. And, in the usual case, firms will only borrow this money if the rate of interest is low enough to yield them a profit after all costs, including interest, have been paid. Raise the rate of interest high enough and almost any investment can become a losing proposition. When interest rates are high, then, the incentive to invest is blunted; lower rates sharpen the incentive.
The rate of business investment, in turn, is a major determinant of economic activity. It is the third largest component of expenditure for the country’s annual output, ranking next after consumer buying and Government purchases. Interest rates by playing on the incentive to invest greatly influence the rate of total spending in the economy.
This second function of interest, as a lever which jacks business activity up and down -- and perhaps around, is perhaps even more relevant to everyday living than the first. Consider what happens, for example, when the Government is restricting credit -- interest rates rise as loans become difficult to obtain, even at the high rates. The high rates discourage investment in new plants, equipment, or inventory. Even firms willing to invest despite the high going rate find that banks and other financial institutions will not make the necessary funds available to them. Investment tumbles as firms postpone or cancel their planned outlays.
The small business sector is especially hard hit by such a turn of events. The scarcity of loan funds, more than the cost, plagues small business during a credit squeeze. Because they lack the bargaining power of their larger rivals in dealing with the lending institutions, small business firms cannot obtain their share of credit though willing to pay the going rate. Such firms, which would normally be adding to the country’s economic growth, not only cannot grow, but must retrench on their inventories, work forces, and so on, in order to adapt to the credit contraction. Not a few go bankrupt. Yet these are only the first effects of a credit squeeze. Others occur because of the fact that part of the country’s vast productive capacity is at all times geared to produce a certain flow of investment goods. When business brakes investment -- and the economy’s growth slows the investment goods industries find themselves over extended and react. For example, when business curtails the building of new plants, new retail stores, etc., the construction industry itself contracts. Construction workers lose jobs and so do the workers in industries supplying building materials. The so-called capital goods industries -- industries which produce machinery and the other goods purchased by producers -- slump. More workers are laid off. And there is a consequent drop in demand for basic raw materials of industry such as copper, steel, aluminum.
There is also a more subtle “cost” of high interest rates that is frequently forgotten. One of the important ways an economy grows is by becoming more efficient, that is by creating and adopting methods of producing and distributing more goods and services per given amount of labor. In fact, the modern standard of living was made possible only by the continuous increase in efficiency -- technically labeled “output per man-hour” - over the past 250 years.
Many things contribute to rising efficiency. One of the most important is the continual invention of new machinery, equipment, or instruments, and the ceaseless refinement of old production techniques. But these improvements are stillborn until business has invested in the new plants and new machinery incorporating the innovations.
Another way an economy grows is by adding to its capacity to produce; i.e., providing its workers with more tools to use in the production process. These additional tools -- new factories and new machinery -- equip new workers to produce as efficiently as those already employed and extend known efficiencies as far as possible.
(Significant changes were made in the next paragraph because I thought Patman’s words were not clear -- mrc) When high interest rates choke off investment spending, two things happen. (1) The rate of growth of output per man-hour is less than it might have been. And (2) the rate of growth of industrial capacity slackens. In other words, high interest rates today cause less full employment and output tomorrow, because, first, tomorrow’s labor has less equipment to work with than it might have had, and, second, this equipment is less efficient than it might have been. These results of a period of high interest are also a “cost,” though the cost this time is of lost opportunities to increase tomorrow’s income. But the cost is no less real. A smaller output from a given effort is a cost which appears as higher prices or smaller wages. The result is equivalent to a decision today to tax tomorrow’s production.
Notice, the payment of this “low growth” tax does not at all depend on the economy being plunged into a recession. Even when the economy is working at full-employment levels, high interest will dull the inducement to invest. Relatively fewer investments will be made, and the output “mix” will be shifted away from investment goods. Efficiency and industrial capacity will grow more slowly than with low interest rates. The economy will still, in this case, be bearing the cost of high interest, though the cost does not appear as falling income and production. It does appear as a production growth rate lower than the labor force growth and normal efficiency gains would have suggested. High interest, therefore, can tax away production by two different and not necessarily connected effects: one, the cutting down of today’s production, and two, changing the composition and not the amount of today’s output, but restricting the capacity available for producing tomorrow’s output.
What may appear, then, to be a simple decision to rein in the money supply and raise interest rates is, in fact, a simultaneous decision about the whole range of economic life -- the prices people pay, the incomes they earn, the level of prosperity and the dynamic thrust the economy is permitted to develop. The fallout extends even further. As interest rates rise, a transfer of income also takes place -- to the large holders of liquid assets and the large financial institutions. It is no accident that rising interest rates are accompanied by a boom in the market for stocks of banks and life insurance companies. The major owners of these institutions -- certainly concentrated among a tiny minority of families in the United States -- receive gratuitous additions to their personal wealth as the value of their stock increases. This only reflects the fact that there has been a shift of income away from the interest payers -- all of us in our role of consumers -- toward the substantial interest receivers -- only a relative handful.
Someone might ask, in view of the example, whether high interest is always a burden. The answer is both “yes” and “no.” As far as interest is a cost of production or a transfer of income, the answer is “yes.” It is always a burden. But there is one case, when the other “costs” of high interest are painless.
Consider the economy when it reached boom levels. Many firms find they were working all out, and an investment boom develops. In these circumstances it is possible that the capital goods producers will find they are unable to produce fast enough to meet the flow of new orders. Backlogs soar; capital goods prices start climbing. If the Government raises interest rates now and depresses investment, only the flow of new orders for capital goods is affected. There is no less of today’s production during the time the capital goods makers are working off their backlog. And there is no future loss from any failure to take advantage of any efficiency gains because the economy is producing as many machines and plants as it can with present capacity.
These conditions for a “painless” high interest policy -- painless only with respect to forfeited income -- are, of course, very special. They only occur during that part of a boom when the economy is running all out and unemployment has dropped to very low levels. And they last only until dwindling new orders start shrinking the bloated backlogs. With these costs and conditions of tight credit in mind it is possible to consider briefly the total effects of tight money on our economy. For the past 10 years interest rates have been in a broad general uptrend in the United States. What reasons have the Federal officials responsible for this policy given for burdening the economy with higher interest? The words differ as the years pass, but the policy lingers on. In the early years, the reason given was that “too many dollars were chasing too few goods.” In later periods, such as the prolonged credit squeeze of 1956-57, it was felt that business was building capacity more rapidly than consumer demand was increasing. In recent years, the balance-of-payments deficit was cited. Higher interest rates were necessary to prevent American capital from going overseas, lured by a favorable return on foreign short-term investments. And throughout this 10-year period there has been constant talk of “fighting inflation” by ever tighter credit restrictions.
Looking at this menu of necessities for tight money, the question has to be asked whether high interest rates were either the only or the least costly way of achieving the desired end. For tight money always costs something -- sometimes more than others. In general, the sustained high interest policy of the past decade does not pass the test. There were only two occasions when it could possibly be claimed that the economy reached those boom levels where tight money could operate with the least harmful side effects. There was a period during the Korean war and, perhaps, some parts of 1956. But even if tight money was the best way to deal with these periods, they passed, but high interest rates remained.
Otherwise there is little to be said for the high interest deadweight the economy has been dragging along. As a means of “fighting inflation” tight money is like using a cannon to kill a fly. If it doesn’t kill the insect it will at least do a great deal of damage to the surrounding tissue. The modern economy is just not an ideal patient for the tight money treatment for inflation.
As an inflation treatment, tight money is supposed to prevent price increases and maybe rock back some prices. How?
High interest works by cutting demand for goods and, indirectly, labor. But as everyone knows, prices in most sectors of the present day economy are simply not very responsive to fluctuations in demand, especially declines. Somewhat sluggish demand, as the steel industry made clear, is often insufficient to halt price rises, let alone force price cuts. And the same statement holds true for labor, which does not forgo wage demands simply because some workers are unemployed.
Tight money, therefore, can only hope to stop inflation -- and this means merely keeping prices level-by pressing down hard on demand and keeping significant numbers of people unemployed. With the economy stagnating -- and paying the full price of tight money -- prices may be kept from rising. They will not fall, because labor will fiercely resist any attempt to cut wages and modern management prefers to accept a fall in demand in preference to a fall in prices. Some sectors of the economy, such as farming, will experience a price slide, but they are exceptional. High interest can fight inflation, then, only by making the economy pay a very high price. In fact, the poor performance of our economy from the mid-1950’s to recent times is precisely what would be expected from a tight credit clamp. Investment has limped along both absolutely and relatively to the level of output. Tight money certainly contributed. The economy’s growth fell well below its “historic average”. And unemployment developed into a major problem again for the first time since the thirties. In a word, the economy stagnated during the prolonged credit contraction.
Of course, tight money was not the only cause of any of those developments. Other factors were also at work. How much of the lost incomes, profits, and jobs should be chalked up to high interest is, then, unknown. But that is not important. What matters is that tight money reinforced any tendency the economy had toward stagnation in recent years. Fighting the threat (not the reality) of inflation by raising interest rates made sure that the economy would operate for years well below full capacity. This is not to say that inflation should not be fought whenever price stability is truly threatened. Of course, it should and must be fought, but with the weapons appropriate to modern economic conditions. If the Federal officials responsible for credit policy take it on themselves to be the lonely army holding back a presumed inflation, then the economy is permanently committed to a state of semi-paralysis. Here is a case where the treatment is as bad as the illness. The economy is condemned to 5 to 6 even 7 percent of the labor force permanently unemployed. Costs are raised by pyramided higher interest charges. Opportunities for efficiency gains are permitted to slip by. Costs and prices, therefore, remain higher than necessary (under a policy of fighting inflation).
There is one more standpoint from which to view high interest -- that of the taxpayer. What does high interest mean to the taxpayers? High interest means that the Federal Government, as well as the State and local governments, have to pay out more money in interest costs. In one way or another this is money which must come from the taxpayers. The interest cost for carrying the Federal debt is particularly sensitive to a change in interest rates. A large portion of outstanding Government securities is constantly coming due and the Treasury is constantly “paying” these off by issuing new securities. In a period when interest rates are being raised, the Treasury is replacing securities issued at low interest rates with new securities bearing higher rates.
Over the past decade, interest costs for carrying the Federal debt have mounted by huge sums year after year. By fiscal year ‘63 the Federal Government was paying out almost $10 billion / year just in interest charges on the debt. This annual cost is about twice as large as it would have been if interest rates had been left at their ‘52 levels. Half of $10 billion, or an increased cost of $5 billion, amounts to $26.20 a year for every man, woman, child, and infant in the country. Or, if yours is an average family of five, your share of the increased interest charges amounts to $131.
Add to this the increased costs the average family is paying on interest charges on the State and local debts, increased charges on the home mortgage, increased interest charges for buying an automobile, TV set, kitchen or laundry appliance on time and we see that increased interest rates make a dent in the family budget.
Finally, and perhaps most important of all, the Government’s interest rate decisions vitally affect the future of our country in its race with the Communist world. Mr. Khrushchev boasts that the Soviet Union will be outproducing us within a few years and will “plow us under.” Though the Soviet Union has stumbled recently, the boast is not to be taken lightly. The Soviet Union has shown itself capable of rapid economic growth. According to estimates made by the U.S. Intelligence Service, the Soviet economy grew at a rate of between 7 and 10 percent a year during the past decade. The Russians will do everything possible to regain that rate of growth. Our economy, on the other hand, grew at less than 3% percent -- its long-term average during the last half of the fifties. It is pointless to argue about whether the Soviets will actually catch and surpass us in the foreseeable future. The point is that we are in a race that we most certainly do not want to lose, either 20 years from now, or 25 years from now, or ever.
Certainly then, there are good reasons why we should question the wisdom of our Government’s following a high interest policy when, as has been shown, one of its effects is to slow down our rate of economic growth.
In any case, in a democracy such as ours it is important that the general public know how its Government functions and who makes the decisions to follow one policy rather than another. The purpose of this book is to explain what money is and how it is created, how the money supply is controlled, and how interest rates are determined.