Does Money Matter?

Edward C. Harwood

[Reprinted from the Henry George News, March, 1956]

At the time this essay was published, Edward C. Harwood was director of the American Institute for Economic Research at Great Barrington, Massachusetts and a trustee of the Henry George School. He was a recognized monetary authority.

Important publications prepared by the Institute's staff of experts are: Cause Control of the Business Cycle, What Will Deflation or More Inflation Mean to You? Where Are We Going? and Reconstruction of Economics. The newest publication, soon to be released, is entitled Useful Economics.

Unfortunately, the label "money" is almost useless for economic discussions. The confusions involved in the current use of this word have become even greater than those described by Henry George 60 years ago.[1] We at the American Institute for Economic Research have concluded that those who would report on money-credit matters in a manner scientifically sound and therefore useful must avoid using the label or name "money" wherever practicable and must specify more precisely what they are talking about.

Most exchange transactions in a modern industrial society such as that in the United States involve the use of what may be called a purchasing medium. The principal purchasing media used in this country include silver and other coins, paper currency of various kinds, and demand deposits or checking accounts. The last named are transferred from one person to another by the familiar process of writing checks.

Nearly everyone has learned that the purchasing media called paper currency can be counterfeited. Those who remember their American history also know that genuine currency can be issued by a government in such great amounts that the exchange value rapidly decreases. Such was the situation with the Continental "shin-plasters" during the American Revolution and with the "greenbacks" during the Civil War. In many instances elsewhere in the world similar excessive issues of genuine paper currencies have continued to such an extent that the paper currencies have become nearly worthless. The old German mark was one example; the French franc, now worth less than 1 per cent of its 1914 exchange value, is another.

Perhaps few readers realize that demand deposits or checking accounts can be created by the banking system. Henry George asserted that the depositor in a bank" ... cannot draw money out until he has put money in."[2] This statement is erroneous, and Henry George himself was well on the way to correcting it when he left unfinished at his death the final portion of his book, The Science of Political Economy. (Unfortunately, some of Henry George's followers seem determined to regard all that he wrote as a kind of revealed truth, more or less analogous to a religious revelation, in spite of his own brilliant and nearly completed effort to report more adequately on economic matters.) The fact is that the commercial banking system creates huge totals of purchasing media in the form both of checking accounts and paper currency, purchasing media that no one ever deposited in the first place.

For example, during World War II, the nation's commercial banks monetized a large portion of the federal debt. The Treasury delivered bonds to the banks, which then literally created checking accounts of corresponding dollar amount against which the Treasury drew checks to pay for munitions, etc. The huge volume of newly created purchasing media made possible increased efiective demand for goods in the markets with a resulting bidding up of prices generally that continued long after the war.

More recently, the commercial banks have similarly created new demand deposits as they increased mortgage and installment loans. One result has been more inflationary purchasing media in circulation with further increases in prices and artificial stimulation of business activity.

Some of the banks' loans are secured by or represent goods produced and enroute to the nation's markets. Even though the borrowers in these instances also may receive newly created demand deposits (or checking accounts usable as purchasing media), as long as there are goods corresponding in value reaching the markets, effective demand and supply are in balance and no general price changes either up or down occur. Such newly created purchasing media are not inflationary.

Many people find it difficult to understand how banks create purchasing media in the form of checking accounts, but the process is simple. When a borrower gives the bank a promissory note, the equivalent amount (less interest if that is deducted in advance) is credited to his checking account precisely as though he had deposited paper currency or other purchasing media. Anyone who reflects on the matter and remembers that he has never been notified that his bank is lending part of his checking account to some borrower, should readily realize that the bank must create new checking accounts or additions to existing accounts for many borrowers. (The savings banks and the savings departments of the commercial banks function differently. They do not create checking accounts but loan to others purchasing media deposited in such banks by savers.)

A great and prolonged period of "prosperity" can be made possible by inflationary expansion of purchasing media. Of course, the aftermath always has been deflation and sudden descent of business activity to depression levels.

Nevertheless, while the inflationary prosperity continues (perhaps for several years as in 1922 to 1929 or 1946 to 1956), few people will believe that there are any serious underlying maladjustments such as those analyzed so well by Henry George. And when depression comes with widespread unemployment and bankruptcies, few will believe that Henry George's remedy would help.

That the mass misery of Asia is attributable in large part to fundamental economic relationships clearly described by Henry George, few adequately informed persons would doubt; that the widespread poverty in Europe similarly is explainable as Henry George explained it seems equally indisputable; but that the economic "laws" described by Henry George are inexorably operating here in the United States is far from clear to those deluded by the "money illusion," prolonged inflationary prosperity on the one hand and deflationary depressions on the other.

The basic question raised by Henry George in Chapter I of Progress and Poverty is, "Why, in spite of increase in productive power, do wages tend to a minimum which will give but a bare living?" Few people in the United States today believe that there is any such tendency; and fewer still have the economic understanding to realize that such a long-run tendency must be observed by comparing, for example, the average conditions of the 1920's and 1930's with the average conditions of the 1820's and 1830's.

The obvious fact is that the "money illusion" hides the operation of fundamental "laws" from all but the keenest and statistically skilled observers. Remedying the periodic abuses of the money-credit system would by no means even alleviate the long-run tendencies described by Henry George; but those long-run tendencies may never be recognized for what they are nor be correctly attributed to the basic cause, even by most intelligent citizens, as long as the veil of the "money illusion' is permitted to obscure the view. That is one important reason why money matters, and it is why Georgists in particular might find it advantageous to be far better informed in this respect than Henry George ever succeeded in being. Continuing to explore the monetary aspects of economics, as he was doing at the time of his death, would seem to be a more fruitful occupation for Georgists than clinging to the errors he was trying to correct.


  1. Henry George The Science Of Political Economy>/I>, Robert Schalkenbach Foundation, Book V, Chapter I. Chapter I.
  2. Henry George Progress and Poverty, Robert Schalkenbach Foundation, page 61.