Basic Principles of the Money-Credit System
in the United States

Edward C. Harwood

[A "Special Bulletin" issued 19 September, 1952, by the American Institute for Economic Research, Great Barrington, Massachusetts]


Since the days of the earliest monetary economists, discussion of money-credit problems has been hampered by semantic difficulties of increasing complexity. As banking systems have evolved and modern industrial societies have tremendously multiplied the number and types of exchanges, early descriptions have become inadequate and later reports on the monetary (and credit) facts of economic life have become correspondingly complex as well as burdened with additional semantic difficulties.

The net result is that finding even two economists today who will agree on an over-all report on the money-'credit facts of life as they are found here in the United States, including complete agreement on the word symbols used, is difficult, perhaps impossible.. Laymen who consult economists on this subject soon discover that the "doctors disagree"; and we all know who prescribes in that event. Any plausible proponent of a pleasing panacea gains a hearing; and, if he has the persuasive tongue of a John Law, gains an impressive, perhaps even a politically dominant following.

The purpose of this brief paper is to present an out line report on the money-credit system of the United States as it is today together with tentative suggested word symbols that seem to be suitable for scientific discussion. One group of experts and interested laymen has found this material useful in an effort to reach a common understanding.[1] We hope that many others will find it helpful.

Functioning of the Money-Credit System

No attempt is made here to discuss either the technical details of banking operations or the intricacies of Government monetary and fiscal procedures. We are concerned herein only with the actual functioning of the money-credit system, the principles involved, and the results. The essential features can be seen more readily by observing first the exchange operations of simpler societies than ours.

One can-readily imagine that, in a primitive society where most families produced much of the goods and services they- consumed, tie percentage of goods exchanged in the; market places would be small. Such a society, if it were beyond the stage of simple barter and were using gold as an exchange medium, might readily effect its few exchanges by the direct use of gold coins or gold by weight in connection with each transaction.

A society somewhat more advanced in the scale of industrial progress might effect some of its more numerous exchanges by transfers of gold (coins or by weight) and effect other exchanges by direct barter of some, goods produced for other goods. In numerous instances, the sellers of shoes would want wheat and the sellers of wheat would want shoes. Neither would personally have any need for gold in connection with such transactions as long as direct barter could conveniently be arranged.

However, in many instances sellers of wheat would find more convenient an exchange of their wheat for gold and subsequent exchange of the gold for articles desired. Some sellers might want gold to hold indefinitely for future purchases; some buyers might prefer to spend gold previously accumulated. Thus we readily see that in such a society there would be numerous exchanges involving gold with the result that a market price in terms of gold (subject of course to fluctuations) probably would be known to most individuals. No doubt, many of the direct exchanges, as of shoes for wheat, would be facilitated by the fact that both buyer and seller would know the respective market prices in terms of the gold exchange unit (shall we say ducats); thus they would have a "common denominator" of exchange ratios or values that enabled them more readily to agree on the ratio at which they would exchange wheat for shoes. The "haggling" in the markets can be seen at first hand in primitive markets all over the world today. And "haggling" similar in principle but on a far more elaborate and precisely organized scale can he seen in all the leading markets for commodities and commodity futures throughout the world.

In the society just discussed, a producer of wheat (for example), a Mr. A, might be one of many who had so need for gold at a particular time. He might prefer to exchange his wheat directly for other goods desired. However, carrying wheat from one shop to another would be a laborious process. We therefore introduce in this society a. grain elevator and its owner Mr. B. The producer of wheat then leaves his load of grain with Mr. B, where the wheat is available in the market place, and accepts from Mr. B a receipt for each of the six bushels reading as follows:

This receipt entitles the bearer to one bushel of wheat at Mr. B's elevator.
signed by B

The producer of wheat then can effect his purchases by offering the receipts in exchange for the shoes, meat, another cqmmodities he may desire.

The trader in gold in the simple society likewise conceives the notion that those who are selling or buying gold also might prefer the more convenient exchangeable receipts for gold, which were worded as follows:

This is to certify that the bearer is entitled to one gold ducat now on deposit in my possession.
signed by Mr. C

As this rather primitive society became more industrialized, Mr. C (the banker) became a specialist in exchangeable receipts. He finally conceived the notion of simplifying the exchange processes by issuing certificates to Mr. A reading as follows:

This is to certify that Mr. A has delivered to Mr. B one bushel of wheat having an exchange value of one ducat, which is to be paid by Mr. B to Mr. C within 30 days and thereafter will be paid by Mr. C to bearer on demand.

And Mr. A can use these exchangeable receipts for his purchases of other goods and services desired.

Later, after Mr. C had found that Mr. A habitually reported accurately what he had roduced and shipped to Mr. B, Mr. C accepted Mr. A's promissory note when wheat had been shipped to Mr. B and issued exchangeable certificates in this form:

This is to certify that Mr. A has produced and sent to market one bushel of wheat having a market value of one ducat payable by me ton demand.
signed Mr. C

Mr. C expected that, within the 30- or 60-day period specified in the note, Mr. A would receive either ducats or similar exchangeable certificates from the sale of the wheat so that ducats or their equivalent in ducat's worth of certificates would be paid to him when A's note fell due.

Finally, the banker further simplified the process by deleting from the exchangeable certificates all reference to the commercial transaction involved. Then the certificates issued in exchange for A's promissory note read as follows:

This is to certify that the bearer is entitled to one ducat payable by me on demand.
signed Mr. C

As long as all concerned are willing to accept at face value the banker's (Mr. C's) promise to pay on demand, the banker will not be required to pay out any actual ducats (gold coins) at all. From tune to time, some holders of the bank's certificates may prefer actual ducats, hut they, are readily accommodated.

Note also that, even if all concerned desire actual ducats for their ducat's worth of certificates, the banker has ho difficulty. He simply calls in his loans. Within a short period those who have borrowed are eagerly seeking to obtain the exchangeable certificates in order to repay their borrowings. As long as the banker limits the creation of exchangeable certificates to those that represent current exchange values of goods coming to market and gold all the loans are automatically self-liquidating ; the process b in fact sound commercial banking.

Because we in the United States are accustomed to legal reserve ratios, some readers may ask whether there is a limit to the banker's operations, whether he should restrict the exchangeable certificates (bank-note currency) to some definite multiple of the gold held by the bank. There is no need to be concerned about this aspect of the problem. The total ducat's worth of exchangeable certificates will depend on the exchanges to be made in the market place. If most of them are, in effect, exchanges of some type of goods for other types of goods, that is, if most buyers are offering goods rather than gold in exchange for what they wish to buy, and if most sellers want other goods rather than gold for what they have.to sell, only a small portion of all the exchanges will involve transfers of gold. In that event, the total amount of exchangeable certificates issued may be very large in relation to the gold in the banking system. For decades, the commercial banks of England operated in this way. Why then, has a fixed legal reserve ratio become customary in the United States?

In order to understand both what has happened in this country and the actual situation now existing, we return to consideration of the society last described. The commercial banker has been functioning in the proper manner by creating convenient purchasing media (paper certificates) that, in effect, represent the gold in the bank and the goods produced and en route to or in the markets.


A Mr. D comes to the banker and offers his note for 100 ducats payable in 1 year and secured by a mortgage on his valuable house. The bankers considers the house excellent security for the loan and creates and issues to Mr. D exchange certificates (bank-note currency) as requested. Then Mr. D goes to the markets and buys the goods that he desires. Is there some vital difference in this transaction from those previously described?

Note that Mr. D's house is not being offered on the market simultaneously with the creation and use of the additional purchasing media. Unlike the situation when manufacturers and other producers borrow for commercial purposes, no goods are being offered on the supply side of the market in this instance. Therefore, when Mr. D tries to buy goods that are in the market, there will be more purchasing media offered for goods than there are goods, and prices inevitably will rise. The exchange values formerly existing will be disrupted.

Until Mr. D finally repays the loan, thereby withdrawing purchasing media from circulation and returning it to the bank, the excess or, as we should call it, inflationary purchasing media remain in circulation as successive possessors use h to buy goods. Thus the inflationary effects gradually spread throughout the markets for all goods.

For some reason the government of this society decides to spend more than it is receiving in taxes, perhaps because a war has begun or perhaps merely because the government chooses to build some pyramids. Government bonds are printed and delivered to the banker with the request that he lend to the government by giving in exchange for the bonds some newly created bank-note currency. In the belief that the loan (or investment) is sound, or perhaps because he dare not refuse, the banker complies with the request. The bonds are placed in the bank's vaults, and the government spends the funds thus, placed at its disposal.

As in the case of Mr. D who borrowed on a mortgage, the government has produced no goods and is sending none to market. Therefore, when the newly created purchasing media are spent by the government there comes into the market additional demand. With no more goods on the supply side but much more purchasing media on the demand side, prices inevitably rise. Again, we should say that 'this is an effect of inflation, and the inflationary process itself was the creation and issue of purchasing media that did not represent either gold or goods produced and en route to market[2]

As banking has developed in the United States, commercial banking and savings banking have become inextricably confused. American bankers usually accept deposits of savings to be invested, that is, they accept purchasing media that the owner does not wish to spend (either for consumption or for investments directly), and invest the funds for the benefit of the time or savings depositors concerned.[3] When acting in that capacity, bankers are justified in using such purchasing media to lend on mortgages (a form of investment) or to purchase government bonds, or for other investments. Then the purchasing media, that the borrowers receive are not newly created and in addition to the purchasing media previously created to represent gold or goods in the markets; but they are a portion of the purchasing media previously created that do represent gold or goods. When those purchasing media are spent in the markets by the borrower (or by the government), they are simply part of the purchasing media already balanced by gold or or goods in the markets. Therefore, the exchange values are not disrupted.

But American bankers, for the most part, never learned what commercial banking was. Time and again in the Nation's history, the supposedly commercial banks have created purchasing media for borrowers speculating in western lands, railroads, Florida lots, common stocks in general, etc. Congress has sought to limit the successive inflations by establishing legal reserve requirements; that is, by limiting the amount of purchasing media the banks could create as a multiple of the gold held. This crude, rule-of-thumb method of controlling the bankers has worked, after a fashion, in that it has shortened the credit "rope." Great and irreparable disaster has been averted at the cost of numerous small and some serious disasters that have occurred when legal .expansion, limits were reached and contraction became necessary. For a banking system whose managers have not understood sound commercial banking, there apparently is no other way to prevent the periodic destruction of die entire system. Hence legal reserve requirements.

The Situation Today

Only one additional simple step need be understood by readers in order for them to see the money-credit situation as it is today in the United States. Heretofore, we have discussed purchasing media as though bank-note currency and currency representing gold made up the total. Now a bank note is a banker's promise to pay on demand, a demand liability; and demand deposits or checking accounts are the same type of demand liability. We might say that checking accounts, in effect, are bank-note currency converted into a form such that the owner can make them any denomination he pleases by writing a check. Sometimes a borrower would prefer to have an addition to his checking account rather than the bank-note currency in his hands or pocket. Similarly, the depositor of gold may prefer to have it credited to his checking account or demand deposit rather than receive bank notes redeemable on demand.

Today in the United States, the demand liabilities of the banking system that are used as purchasing media largely consist of checking accounts (demand deposits); but from the viewpoint, of an over-all understanding of the principles and functions involved, we may regard bank-note currency and demand deposits (or checking accounts) as essentially the same. Which form any individual or business will use in any instance is merely a matter of convenience.[4]

The situation as it exists in the United States today (August 27, 1952) is as follows:

Total purchasing media in circulation $107,870,000,000 worth[5]
and this may be sub-divided as follows:
Representing gold (the money commodity) $22,340,000,000 worth [6]
Representing goods in or en route to markets $28,659,000,000 worth
Representing mortgages and other tangible investment type assets of the bank $10,151,000,000 worth
Representing Government promises to pay (bonds) $46,720,000,000 worth

The total purchasing media in use may also be subdivided into two principal types: demand deposits adjusted (checking accounts), and currency (plus subsidiary coinage). As of August 27, 1952, about $11,938,000,000 worth was circulating in the form of currency and $95,940,000,000 worth was in the form of checking accounts. (Hoarded currency is excluded.) As most readers know, each of these forms of purchasing media can be exchanged for the other at the option of the holder. The relative amounts of each in circulation reflect only the customary buying and purchasing habits.

As will be apparent from the figures given for the various sources of purchasing media, about half of the purchasing media in circulation today are inflationary (do not represent either gold or goods in or en route to markets). In other words, the total is about double the noninflationary purchasing media. Also of interest is the fact that wholesale commodity prices today are almost exactly double die long-term trend adjusted for devaluation that we computed 15 years ago.

Duration and Magnitude of the Effects of Inflation by Various Means

Based on their understanding of the views of various European economists, some Americans as well as European observers contend that inflationary purchasing media derived from Government debt7 tend to be more permanent, more a fixture in the money-credit system, than purchasing media derived from commercial loans. Apparently based on this assumption, such individuals urge that a reduction in the weight of the gold monetary unit is the only way of avoiding disaster. By such means, they would create more gold monetary units and substitute them as the basis for some, at least, of the purchasing media derived from Government bonds in the commercial banks.

Although the record elsewhere and in much earlier times is obscure, we do have a reasonably accurate record of developments during the last three major inflations and subsequent deflations in the United States. These periods include the following years: 1917, to 1921; 1922 to 1932; and 1933 to 1938. The pertinent data are summarized below.

Dollar amounts in billions for the following periods 1917-21 1922-32 1933-38
Maximum amount of inflationary purchasing media $5 $6.5 $7.5
Percentage of inflationary purchasing media to total 25% 23% 25%
Percentage change in commercial loans from time of maximum inflation to depth of depression +33% -11% no change
Percentage change in inflationary purchasing media from time of maximum inflation to depth of depression -90% -70% -30%

Note: The foregoing percentage changes are reasonably correct as to order of magnitude but are not assumed to be exact.

Also of interest in this connection is the experience from December 1945 to December 1948. At the beginning of that 3-year period, the inflationary purchasing media approximated 60 billion dollars' worth and was nearly two-thirds of the total. By December 1948 the inflationary purchasing media had decreased to 52 billion dollars' worth (a decrease of 13 percent) and was only a little more than half the total. In the meantime, commercial loans approximately doubled. (By December 1948, deflation was well under way and was reflected in the 1948-49 recession of business activity and accompanying decline in commodity prices.)

In the earliest of the three periods, the inflationary purchasing media were derived from Government debt, in the second instance-almost entirely from private debt, and in tie third about half from each of these sources.

Based on the foregoing, it would seem that inflationary purchasing media, regardless of whether they represent mortgages etc. or Government deficits, are by no means "frozen into" the money-credit system as has been suggested.

The suggestion also has been made that commercial loans reflect high prices rather than contribute to causing them. The record suggests that this notion is partly correct and partly in error.

We should remember that the purchasing media derived from commercial loans are used to facilitate the exchanges where the buyer is not offering gold but, in effect, other goods he has produced and the seller desires not gold but other goods than those he is selling. In other words, the commercial banking system facilitates the large portion of exchanges where gold is not involved. Therefore, under normal circumstances of sound commercial banking, the purchasing media representing goods in or en route to markets do not tend to cause a rise in prices; the equilibrium between gold and goods remains undisturbed.

At first thought, the reader may believe that, during a period of inflation, purchasing media derived from commercial loans will increase. The usual argument to this effect points out that production is increasing and that prices are rising so that manufacturers and merchants must borrow more in order to do business. Plausible as this argument seems, the available facts do not support it.

Specifically, from mid-1917 through early 1919, when inflationary purchasing media derived from Government bonds in the commercial banks were increasing rapidly and commodity prices rose about 30 percent, commercial loans leveled off instead of increasing. In 1922 to 1928, as the inflationary purchasing media steadily increased and prices were sustained well above the 1914 level, commercial loans first increased slightly for only 3 years and then decreased steadily. In 1933 to 1936. as the total of inflationary purchasing media increased rapidly and prices rose nearly 20 percent, commercial loans decreased almost steadily by nearly 35 percent.

An explanation for this seemingly paradoxical situation is not difficult to imagine. When increasing amounts of inflationary purchasing media are being placed in circulation, businesses generally receive "windfall profits" that reflect the excessive demand for goods in the markets. Most businesses thus have more cash coming in than they bad expected and are able to reduce instead of increase their commercial borrowings. Of course, when inflation is followed by deflation, the reverse is true, losses replace the-unexpected profits; cash does not come in as rapidly as was expected and commercial borrowing increases unless the depression is exceptionally severe and prolonged as in 1929-33. (Banks that operate too extensively as pawnshops instead of commercial banks fail and cannot increase their commercial loans.)


[1] The group referred to includes representatives of several other groups interested in various aspects of the Nation's money and credit problems. In a series of conferences, an effort is being made to gain a mutual understanding, at least, and perhaps reconcilement of widely divergent points of view on matters of vital importance to the future of the United States and much of the rest of the world. The names of the individuals and groups concerned cannot be released at this time.

[2]We remind readers that the vital point is whether or not the newly created purchasing media constituting effective demand are balanced on the supply side by additional goods in or coming to the markets. The question is not whether the security for the loan was something tangible like a house or something intangible like a government's promise to pay at some future date (a bond), but whether the new purchasing media do or do not represent gold or goods in the markets.

[3] Readers should note that time or savings deposits are simply the banks' record of purchasing media that were first received by the banks ami subsequently invested (spent for certain types of assets). The time or savings deposits accounts are a means of recording the names of the original savers and the extent of the beneficial interest of each depositor in the investments acquired by the bank.

[4] There are various legal and technical differences that need not concern us at this time. The more important differences in detail are attributable in large part to ignorance of the principles herein discussed.

[5] Readers should note that we refer to$ worth rather than $; most of the purchasing media in use purport to be exchangeable for dollars; i.e., to be dollars worth, rather than dollars, (The United States dollar is defined by statute as 1/35 of an ounce of gold 9/10 fine.) In the interests of avoiding semantic confusion, dollars worth of purchasing media should be differentiated from dollars in a discussion such as this. Of course, for ordinary business purposes, such precise differentiation ia unnecessary, but for anyone trying to discuss:: money-credit problems intelligently, such precision of reference in using word symbols is essential.

[6] Formerly, some of the purchasing media that represented gold (the gold certificates) could readily be recognized, and of course the gold coins in circulation actually were the statutory dollars (or multiples of them). Today, however, none of the purchasing media in circulation reveal their true source: no one can tell by examining ft whether a particular purchasing medium represents gold, or other goods in or en route to markets, or mortgages, or government bends. (Minor exceptions need not be discussed here.)

[7] Whether directly or through the more usual procedure, which includes sale of Government bonds to the banking system in exchange for newly created purchasing media, is not material to the issue, we understand.


A Partial and Tentative List of Suggested Means of Avoiding the Semantic Stumbling Blocks and Bobby Traps

A brief example will illustrate one of the semantic difficulties. Some people prefer to use "money" as the word symbol for a medium of final payment that has real substance and value in addition to its use as a purchasing medium. Yet these same individuals sometimes use the phrase "paper money." In using the symbol "money" such individuals in the United States ordinarily would be referring to the gold dollar (1/35 of an ounce of gold 9/10 fine); that is, the referent for money would be a specific quantity of a metal. When such individuals use the phrase "paper money," they presumably are not intending to talk about paper metal, but that is what they are doing unless they are shifting the referent of the symbol "money." The subtle and frequently unrealized shifting of the referent makes sane discussion almost impossible.

We should adhere to the rule "one and only one referent" for each word symbol if we hope to avoid the semantic stumbling blocks and booby traps. The following word symbols with the indicated referents may be helpful.

Word Symbol Description of Referent
DOLLAR 1/35 ounce of gold 9/10 fine when used as a-standard of value, as a store of value, or as a medium of exchange (all or any one of these uses).
CURRENCY Pieces of paper purporting to be claims to dollars' worth of value in the market place, for taxes, etc.
SILVER CURRENCY Those items of currency that not only are pieces of paper purporting to be claims as above but that also constitute warehouse receipts for silver at the rate of 1 ounce for each dollar's worth indicated. The bolder has a choice of demanding either the specified silver of what he can get in the market.
BANK NOTE CURRENCY Those items of currency issued by banks (Federal Reserve banks in the United States). Like other currency, they purport to be claims to dollars' worth of value in the market place, for taxes, etc. Although they include the statement that the United States will redeem them with "dollars" on demand, the pledge has not been kept (for United States citizens) since 1933. Foreign central banks and governments can obtain "dollars" on demand as stated, but United States citizens cannot.
DEMAND DEPOSITS OR CHECKING ACCOUNTS These symbols are directly substitutable either for the other, and they refer to bank records of demand liabilities to,individuals, businesses, etc. These records of demand liabilities are promises to deliver legal currency (formerly dollars.) on demand.
PURCHASING MEDIA All subsidiary coins, currency, and demand deposits that are immediately available for use in their existing forms for purchases or payment of bills, that are immediately acceptable to the sellers or potential recipients, and that involve no continuing obligations for a more or less protracted period after the payment is made.
TIME OR SAVINGS DEPOSITS Bank records of liability or obligation for purchasing media delivered to the bank by individuals, corporations, etc., with the understanding that the funds will be invested for the benefit of the depositor. The banks' obligation is, in effect, a promise to pay the income from the investment less expenses to the depositor or, if he so requests, to sell or transfer the investments to the benefit of others and return to the original depositor a corresponding amount of purchasing media within a reasonable time.

Note: For the purpose of this discussion, other currency (United States notes, Federal Reserve bank notes, and National Bank notes) and the subsidiary coinage.

Note: Time or savings deposits are not purchasing media.


A Fundamental Difference Between a Measure of Value and a Measure of Distance,Weight, Etc.

Gold is customarily regarded as a standard of value, and specific quantities of gold therefore are referred to as measures of value. For example, the statutory dollar, which is 1/35 of an ounce of gold 9/10 fine, is referred to as the unit of measure in measuring exchange values in the United States.

In a somewhat similar way, the statutory yard is a measuring unit for distance, the bushel for bulk, the pound for weight, etc. Because there are similarities in the use of all measuring units, analogies sometimes are offered that attempt to explain values much as the yardstick is used for measuring distances.

Such analogies, although they may be helpful in some respects, also may be dangerous, because they may tend to conceal rather than reveal a fundamental difference between gold as a measure of value and the yardstick as a measure of distance.

Most measuring units are conventional in that they are chosen by men. Consequently, most such units or standards can be altered by men. The yard today is a specified linear distance, but the statutory yard could readily be made half as long. Similarly, the units of weight called 1 pound could be altered so that it would contain more or less lhan the presently specified quantity of water at sea level. Also similarly, the statutory dollar could be made a different quantity of gold than it now is.

However, all of these units of measure are fixed by statute, are legal standards, and can be altered only by legislative action. Congress has the power to alter any of them. Of course, there presumably would be protracted discussion of proposals to change any of these standard measures, but in the end Congress could act. Nevertheless, there are important differences in the developments lo be be expected both (luring the discussion period and after the adoption of revised standards.

While Congress was debating an alteration in the standard yard, the principal effect would be on those writing contracts in terms of yards and on the makers of yardsticks. Presumably, the former would include clauses protecting both parties against future alterations in the unit of measure, and the latter would prepare 10 make yardsticks of a different length, a minor modification in manufacturing procedures. No one would attempt to hoard the existing yardsticks, or to noard space measured in square or cubic yards of the old dimension in the hope that he would profit in any way by the reduction in the length of the yardstick.

On the other hand, while Congress was debating an alteration in the statutory dollar, the effects surely would be striking. They would be especially noteworthy if the decision were made to discard any specific weight of the dollar for a time in order to see what would happen. Almost certainly, those who could do so would attempt to hoard gold. Only by effectively prohibiting the ownership of gold could individuals be prevented from seeking protection against the Government's actions; but the very denial of the freedom to hoard gold would in itself be a powerful stimulant to black markets where the exchange ratio between paper currency or credit and gold would rise even more than it would in free markets.

In short, serious discussion of alterations in the gold content of the dollar almost certainly will induce a speculative demand for gold. (This is precisely what occurred in January and February 1933, when rumors of Mr. Roosevelt's intentions began to come from credible sources.) Under such circumstances, if a specific unit of value is abandoned and the monetary unit is left to find its level in free markets, the exchange ratios between gold and the monetary unit will reflect primarily the optimism and greed of those who hope to gain and the fears of those who expect to lose by the prospective establishment of a new statutory dollar.

Turning now to consideration of developments after an alteration in a statutory standard of measure has been effected, we also find e difference between the measure of value and the measures of distance, space, weight, etc. After a change in the yardstick, for example, to half its former length, the principal effect would be that all distances, immediately after the adoption of the revised standard, would be twice as many yards as they formerly were.

The situation with reference to the measure of value would be decidedly different, however, as we learned in 1934. Some of the more naive of those who advocated devaluation in 1933 expected prices generally to reflect automatically and immediately, or almost immediately, the change in the unit of value measurements. However, their expectations were not realized. Several years elapsed before commodity prices generally reflected the full extent of the 1933-34 devaluation.

Therefore, those who expect that a second devaluation of the statutory dollar, say from 1/35 to 1/50 of an ounce of gold, would immediately or in a short period compensate for the existing inflation and resulting high prices are as apt to be disappointed as were the proponents of devaluation in 1933-34. Several years will elapse before all the adjustments to the new unit will he made, and in the meantime there is no assurance that a serious deflation will be avoided. In fact, if the first reaction to another devaluation is a flight from the dollar such as the scare buying of July 1950 and January 1951 or worse, we may experience even more inflation that in a few months will result in an even higher level of prices from which there may be a disastrous nosedive into substantial deflation.


Elements of An Ideal Gold Standard

  1. A statutory unit of purchasing or exchange media constituting a standard of value and capable of serving as a store of value that consists of a specified weight and fineness of gold.
  2. A commercial banking system

    a. All demand liabilities (checking accounts) of the commercial banks to represent either gold or goods in or en route to markets and all such demand liabilities to be payable in the statutory gold units on demand.

    b. No demand liabilities (purchasing media) to be created on the basis of in vestment-type assets such as mortgages, Government bonds, installment loans, term loans, or loans to finance accumulations of excessive or speculative inventories by business. (Note: Once the principles of commercial banking are understood, legislation to exclude such loans probably would not be necessary. Of course such loans would continue to be proper investments for savings.)
  3. Both the Government and the commercial banks would be authorized to issue gold certificates (warehouse receipts for gold).
  4. Only the commercial banking system would be authorized to issue currency in the form of bank notes, and such currency would be redeemable on demand.
  5. Only the Government would be authorized to issue small denomination coins and to coin gold.
  6. Interest rates to be determined at all times by free markets.
  7. Government deficits, if any (in war and in peace), to be financed by bona fide savings from current incomes.