A Primer on money, banking, and gold

Peter Bernstein
Chapter 1
we want to be sure that we have enough money around so that we can buy everything that has been
produced but never so much that we try to buy more and has been produced. The problem that will
concern us most is the difficulty of keeping the number of dollars spent in line with the quantity of
goods produced.
With the growing complexities of the marketplace and of the methods of production, we find that the
character of money changes. It becomes more and more abstract, until it reaches a highly sophisticated
form of our own money, which consists primarily of numbers on the lectures of the banks that maintain
our checking accounts. Though we still use some currency and some coins, most of the money we spend
it moves from buyer to seller through the writing of checks that ordered the banks to debit one account
on their books and to credit another. Thus most of our money has no real value and no tangible
existence: we can't see it or feel it or smell it. This is one of the reasons why it is quantity is so difficult to
regulate.
People who lose out in an inflationary spiral are those who least deserve to be the losers, the frugal
conservative the prudent together with the poor and unorganized who are unable to battle for the
higher incomes they need to stay even with the rising prices.
Chapter 2 and important conclusion is that an increase in production or the sale of the same quantity of
goods at higher prices simply cannot be sustained unless people are willing and able to lay out the extra
money they will need to buy the additional goods or to pay the higher prices for the same quantity of
goods.
In time, the inability to finance the purchase of goods at higher prices results in unemployment and
excess productive capacity. The forces of competition at work when businessmen could produce more
than they are able to sell will probably lead to the elimination of the price increase. Or if people are
willing to pay for the goods whose prices have been raised, they will have less money to spend on other
goods and services, so that unemployment will spread into those industries whose market power is
weakest.
A supply of money does set limits to how far business expansion can go and how high prices can rise.
Both increase production in the same volume of production sold at higher prices involved a higher rate
of spending by customers and when they had to pay out money, money is the only thing they can pay
out. No book can be paid with government bonds or shares of stock or jewelry, or even a savings
account or life insurance policy. Only a check or currency or coins will be acceptable for this purpose.
Nevertheless, although the supply of money can set the upper limit to a price inflation or two growth in
production, we have no ready way of knowing where that limit may be. In fact the number of dollars in
our bank accounts and pockets is only an indirect, and frequently unsatisfactory, guide to the rate at

which we are going to spend those dollars. And it is expenditure that counts, it is expenditure that
comes into the marketplace to be matched against a supply of goods and services.
In short some production may go unsold simply because individuals and businesses sit on their money
instead of spending it or making it available to others to spend.
When people spend more than they earn producing goods and services, the chances are that they will
be trying to buy more it has been produced. This excess demand will then either stimulate an increase in
production schedules or an increase in prices.
Variations in the supply of money will not necessarily lead to corresponding changes in the sales of
business firms.
Chapter 3
we frequently hear that money is tight when business is good and that money is easy when business is
slow. Tight means and tight supply and easy means easy to obtain.
About many people consider low interest rates desirable because they make Bahrain money more
attractive to businessmen and will therefore stimulate business activity, history tells us that appears of
high and rising interest rates, rather than low and falling interest rates, have been associated with
vigorous and sustained prosperity.
When all is said and done, the rate at which we spend our money doesn't make the total supply of it any
smaller or larger.
It is these struggles for increased liquidity, for more cash on hand, that have led to repeated monetary
crises in our history, of which the experience of 1929 through 1933 was a dramatic, but by no means
isolated, example. In that panic everyone was a seller and no one a buyer use instances are the
culmination of a long process that begins with people who need more cash are first able to get by
offering higher rates of interest for it; ultimately no one has any more extra cash to lend out at any
price. The panic sets in when people recognize that he who parts with cash today will have a hard time
getting it back tomorrow.
Chapter 4
what causes the supply of coin and currency in circulation to go up and down since coin and currency
are issued by the government, the obvious answer to the question must be that the government simply
coins more coins in print or currency and the issues them. But this isn't what happens at all.
In the past the use of checking accounts was either nonexistent or much less prevalent than it is today,
parenting and coin were the primary rather than the minor form in which money was handled. It was
natural therefore that an increase in the total supply of money should have been reflected largely by an
expansion in the amount of currency and coin in use.

Who determines the amount of currency and coin in circulation? It is the public, the millions of
individuals businesses and financial institutions that choose continuously between the use of currency
on the one hand and checking accounts on the other.
Of course this does not mean that the government has no influence on the supply of money on the
contrary, it has a profound influence on the total supply of money in the economy. But that is different
from saying that it can determine the relative size of the parts. The choice between the use of currency
and a checking account is made by the public and only the public.
On those occasions when one or currency and draw down our checking account, our total amount of
money is unchanged: we have more in hands and less in the bank but the total is neither more nor less
than before. And if we obtain our currency by drawing it from the bank, and the factors that determine
the amount of money we have in the bank in the first place will give us the real key to where our money
comes from.
First, an increase in the supply of money can come only from an increase in the quantity of dollars in
currency, coin, or checking accounts. Since you know that an increase in coin and currency comes
through withdrawals from checking accounts, it follows that an increase in the supply of money must
originally come about through a rise in checking accounts.
Second, the only way that somebody can increase his bank account without a transfer from somebody
else, that is, the only way one man can have a receipt without another man making a payment, is if the
money he receives comes from some source other than another member of the community. In other
words, some mechanism outside the system is necessary if the supply of money is ever to change at all.
Indeed, many of the myths and fears about government spending flooding the economy with too much
money go back to other times and other countries the government actually did cover its expenses by
paying out really pretty currency instead of by borrowing and taxing. But our government is both legally
and morally prohibited from financing its expenditures by printing the money to do it. The government
is in the same boat as the rest of us, it has to finance its expenditures by obtaining money from
somebody else. As it normally does by levying taxation on us or by borrowing money from us. But the
important point is that the government cannot spend money indefinitely without replenishing its big
thoughts. In other words all the government may spend more than it takes in taxes, it is unable to spend
more than it takes in in taxes and borrowings. Thus, the government surplus or deficit has such has no
effect on the whole amount of money in the economy, only on its distribution in the rate of
expenditure.
Chapter 5
Chapter 6
the unique characteristic of the commercial banks is that essentially no one asks them to make good.
Whatever we want to call them, checking accounts, demand deposits, claims on the commercial banking

system, the deposits serve as a substitute for currency or coin as a means of payment. There isn't
anything else that we use in this particular fashion.
Chapter 7
the focal point of all this machinery, the 12 Federal Reserve Banks, the board of governors, the rules and
regulations of membership, as the supply of member bank cash reserves relative to the volume of
deposits outstanding in the banks. Bus for control of the supply of member bank reserves, the Federal
Reserve authorities attempt to influence member banks to increase or decrease their credit operations
and thereby to expand or contract the quantity of money, the purchasing power and checking accounts.
As the public holds most of its ready money in the form of deposits and commercial banks, so the
commercial banks hold most of the cash resources in the form of deposits at the Federal Reserve Banks.
Member banks of the Federal Reserve are required to hold a stipulated minimum of cash reserves in
relation to the volume of the outstanding deposits, and the only cash reserve that satisfies this legal
requirement is the member's bank balance at the Federal Reserve Bank plus currency and coin the bank
has in its faults.
Just as payments by commercial banks to the public by the mechanism that increases one man's holding
of money without decreasing another man's, so payments in and out of the Federal Reserve Banks can
change one banks reserve balance without offsetting changes in another's.
Chapter 8
if business is booming, the excess liquidity resulting from a rapid expansion in commercial bank credit is
likely to stoke the fires of inflation, leading to speculation and distortions in the boom that will
ultimately bring about an economic crash.
If the function of the Federal Reserve system can be summarized simply, we can say that it is to prevent
both the location in which everyone is a seller and no one a buyer and also to prevent the occasion in
which everyone is a buyer and no one a seller.
One way a commercial bank can replenish its reserves is by selling securities, but we saw this only drains
cash away from other banks in which the buyers of the securities maintain their accounts. The problem
of overcoming a shortage of cash instantly transferred from the first bank to the others. One banks gain
is another banks loss, the total quantity of reserves available to the banking systems has remained
unchanged. Suppose however that the securities offered for sale by the bank short on reserves are
bought, not by a depositor or other commercial bank, but by the federal reserve banks. This can happen
if the reserve banks are willing to outbid other buyers and thereby run up the prices of the securities.
What is different and crucially so that no other banking system has lost any reserves; one banks gain is
not offset by another banks loss. In effect the federal reserve banks by buying the securities have paid to
the selling bank be additional reserves it needed, so that no other bank had to lose reserves to
accommodate the situation.

By providing the commercial banks with additional reserves, the Federal Reserve either but that's a
shortage of reserves from spreading throughout the system, thereby forcing a reduction in the supply of
money as other banks are impelled to sell securities and retract loans, or it actually encourages an
increase in the supply of money by creating additional reserves for the commercial banks. Furthermore
by coming into the bond market as an additional and substantial buyer, the Federal Reserve pushes
bond prices to a higher level than they would otherwise have to reached. This is the same thing as
saying that bond yields move lower.
When the reserve banks begin to sell, the quantity of bonds offer for sale will be greater than it was
before. In order to find buyers for these additional bonds, the reserve banks will have to offer the bond
at a price below the previous level at which bonds were trading. This means that the sale of securities by
the Federal Reserve makes the financing of business expansion more difficult, for a drains of reserves
from the commercial banks and limits their lending and investing capacity. It is also more expensive,
new borrowers and others seeking cash will have to sell the bonds at lower prices than they had
previously been able to sell them.
The reserve banks are prohibited from buying government securities directly from the treasury: they
must buy and sell in the open market, trading there with all other investors who deal in government
securities. The purpose of this restriction is to deny the treasury that temptingly easy method of
financing itself by borrowing from a qualified governmental institution, a path that has led to excessive
monetary expansion and many other countries. Instead the treasury must compete with all other
borrowers in the marketplace for the investment funds of individuals, corporations, and financial
institutions.
All that monetary policy can do is to put money into people's pockets or to persuade them to give up
money in exchange for securities; but people may be reluctant to spend the additional money or the
opposite case may still be able to finance their expenditures without too much trouble.
Chapter 9
rather than looking at the total reserves to see how much they bank might land and invest, we must
rather look only to the excess reserve at the bank has available over and above the amount stipulated
by the reserve authorities.
At any point when the bank has excess reserves, the potential expansion left will be equal to five times
the excess reserves, when the reserve requirement is 20%.
When excess reserves are greater than borrowings, is different is known as re-reserves; when
borrowings run above excess reserves, the difference is known as negative free reserves. The reason for
watching free reserves as a measure of likely bank decisions to lend or invest is that reserves gain by
banks to borrowing from the federal reserve banks are temporary in nature; they will probably be paid
off and disappear in the near future. A bank with a large debt to the Federal Reserve will be reluctant to
expand its loans and investments until it has gained sufficient reserves to bring itself out of bed.

Chapter 10
we have stated repeatedly that withdrawals from one bank are always deposited in some other banking
system, that one bank may lose reserves but the system never does. Exceptions that we have made to
the rule were in those cases where the Federal Reserve sells government securities in the open market,
or member banks repay their loans to the reserve banks, or where the government is taking in more
money than is pain now. In those cases one banks loss of reserves will not be a gain for some other
bank.
This brings us back to something we noted early in this discussion, namely that the amount of currency
in circulation is not set by the government or by any other issuing agency, rather it is determined by the
choices and habits of the public insight how much of their money holdings to keep in the form of
currency and how much in the form of checking accounts. No law can regulate these patterns. In fact in
a crisis and the people completely lose confidence in the banks and want to convert all of their bank
deposits into currency, the system simply breaks down. In 1933, all banks were forced by the
government to close their doors until confidence was gradually restored.
A necessary condition is that the physical supply of currency itself should be large enough to satisfy the
needs of the public. At the $18 billion in additional currency but unavailable during the war, the
experiences of our earlier history would have been repeated, in which currency actually circulated at a
premium one dollar in currency would buy more than one dollar paid by check.
The original Federal Reserve act in 1913 establish a form of paper currency called the federal reserve
note, which accounts for most of the money the reserve banks provide when called upon for currency.
The trick in the federal reserve notes is that the federal reserve banks lose when they pay out this
currency to the member banks. To put it briefly, they are an UBP mobile application issued by the
federal reserve banks.
Should it be more surprising than our willingness to use checking account as money to a much greater
extent than we use currency, for what is the backing for checking account?
The money we use every day is intrinsically worthless. Yet though it has no value of its own, we
nevertheless value it highly. We value it because of what we have to give up to get it, our labor and our
possessions, and because of what we can buy with it. The real meaning of the value of our money, in
other words, is how much a darkened by.
If the young United States had been flooded with gold instead of with paper money after the revolution
in 1783, we would have been just as badly off as we were with the Continental currency, because there
was so little available to buy and so much money around to spend. The only real attraction of gold as a
basis for a monetary system is that supply is limited, at least increases slowly, whereas only the
judgments and fallibility of man could put a limit to the issuance of money based on credit and
promises. The user something like gold will tend to prevent us from having to much money in relation to
the supply of things want to buy, although substantial inflation did in fact occur despite the existence of

the old gold standard. However it also may set to load the upper limit on the supply of money, in which
case we will have to little money and won't be unable to finance business expansion and economic
growth. The situation has often proved intolerable.
The American dollar is based essentially on promises and bookkeeping machines. If anyone were to set
up such a system by decree or legislation, it would probably never work. Indeed it is just as well that
most people never stop to realize that the money they earn for their efforts is only a number in a
bookkeeping machines or a piece of paper convertible into nothing more than another number in a
bookkeeping machines.
Chapter 11

Chapter 12
one nation cannot indefinitely pay out to foreigners more than it receives from them. This is as true of
nations as it is of individuals or corporations. You can't spend money you haven't got: nasty day of
reckoning somewhere along the line, and gold is what nations used by common consent on the day of
reckoning comes. Few people realize however that golds hegemony as the world's sole monetary
standard has been surprisingly brief. Britain was the first country to adopt gold as a single monetary
standard in 1821. Yet by merely 1937, only about 50 years after gold had reached its zenith, not one
country in the entire world continue to maintain a fixed tie between its currency and the price of gold
and only a few any longer permitted free and unlimited convertibility of the currency to gold.
What happened was the one thing that must never happen in a viable monetary system: everybody
rushed to ask for conversion. Because it's relatively fixed supply so rigorously set upper limits to any
expansion in the quantity of money, will now place a more subsidiary role and it is on the defensive
against substitute to supply could be more elastic for the settlement of international accounts.
Of course, it is impossible to point a finger at one element in our balance of payments and say that that
particular item is the cause of the deficit. If you love MR roles are on one side of the scale and 10 on the
other, one cannot say which marble on the heavier side is causing the guilty tip, in fact one just as well
say this scale is tipping because of the absence of a marble on the lighter side.
Chapter 13
indeed, the fetish for liquidity during the 1930s was extraordinarily powerful, simple creation of money
was no guarantee that it would be spent.
Chapter 14
conclusion
when all is said and done, the productivity of the American economy is the ultimate barrier to runaway
inflation in our country. The catastrophic inflations of history and many large but less disruptive

inflations, have been the result of a real shortage of goods and a breakdown of the economy's ability to
produce and distribute, rather than an excess of money.
Appendix reading the weekly Federal Reserve statement
reading the statement each week as one of the great detective gains in the financial world as the effort
is made to set normal operating procedures or random variations in the data from the intended changes
prompted by policy decisions on the part of the authorities.
As the Federal Reserve authorities have no direct control over the volume of deposits and member
banks and as they are reluctant to change the percentage reserve requirement, their only means of
influencing the member banks is to increase or reduce their loans and investments is by causing changes
to occur in the total quantity of member bank reserves.
Therefore in order to avoid erratic and excessive swings in the size of bank reserves from one day to day
or even from month to month, substantial part of the Federal Reserve open market operations what
nothing whatsoever to do with monetary policy but will be designed purely as steps to offset the
seasonal or happenstance variations and other factors that are causing member bank reserves to vary.
The table begins by showing Federal Reserve open market operations, purchases or sales of government
securities and repurchase agreements. Repurchase agreements are really short-term loans made by the
reserve Bank to a government security markets. The table then shows discounts and advances to
member banks, which reveals the extent to which member banks are borrowing reserves are repaying
their debts at the Federal Reserve Banks. Treasury currency outstanding refers to that part of our
currency and coin that is issued by the treasury read it rather than by the Federal Reserve. Currency in
circulation refers to all currency and coin held outside the Federal Reserve Banks. Deposits, other than
member bank reserves, help with Federal Reserve Banks, include accounts carried at the Federal
Reserve banks by the U.S. Treasury, by foreign governments and foreign central banks, and my nonmember commercial banks which are permitted to carry such accounts for clear purposes under certain
circumstances.
The best way to begin to look at the statement is by noting the direction of the changes in those not
policy factors that are likely to be large and erratic, particularly the change in the float, and currency in
circulation, and the treasury account at the Federal Reserve, and in required reserves of member banks.