CHAPTER I

PREFACE

1. Who has the right to create money in the United States?
Under the Constitution, it is the right and duty of Congress to create money. It is left entirely to Congress.

2. To whom has the Congress delegated this money creating right?
To the banking system, that is, to the Federal Reserve System and to the commercial banks of the country.

3. Why is the money-creating power important?
Because, by creating money, banks provide the exchange media which the economy needs to prosper and grow. Since the growth and proper functioning of the U.S. economy require increasing amounts of money over the years, those who control the amount of money exercise great power over business activity, the incomes people earn and economic strength.

4. Why was the banking system given the right to create money?
The reasons are mainly historical. Still the banks do perform a service in creating money. For once the money and credit is created someone must decide whom to give the money and for what purposes. This the banks do. And bank earnings are the return for wise and proper placing of the money supply.

5. What is the Federal Reserve System?
The Federal Reserve System is the “central bank” of the country, composed of 12 regional Reserve banks, and the Federal Reserve Board in Washington and controls the ability of our commercial banks to create money and credit. The Federal Reserve also controls the level of interest rates.

6. Does Congress supervise Federal Reserve policymaking?
No. In practice the Federal Reserve is “independent” in its policymaking. The Federal Reserve neither requires nor seeks the approval of any branch of Government for its policies. The System itself decides what ends its policies are aimed at and then takes whatever action it sees fit to reach those ends.

7. What problems are raised by an “independent” Federal Reserve?
There are two major problems. One is the problem of political responsibility for the country’s economic policies. The other is the problem of final control over the Government’s actions in the economic sphere.

8. What is the problem of political responsibility?
Since the Federal Reserve is independent it is not accountable to anyone for the economic policies it chooses to pursue. But this runs counter to normally accepted democratic principles. The President and Congress are responsible to the people on election day for their past economic decisions. But the Federal Reserve is responsible, neither to the people directly nor indirectly through the people’s elected representatives. Yet the Federal Reserve exercises great power in controlling the money-creating activities of the commercial banks.

9. Why is final control of economic policy a problem?
Because with an “independent” Federal Reserve, Congress and the President can be moving in one direction while the Federal Reserve is moving in the other. The result is sometimes no policy at all. At other times, it leads to the Federal Reserve’s neutralizing the President’s economic policies. This very possibility caused President Johnson to request the Federal Reserve in his 1964 Annual Economic Report to Congress not to nullify his efforts to reduce unemployment and raise incomes. Should the President have to ask any Government agency to go along with his policy as approved by Congress? Obviously not.

10. Who really directs Federal Reserve operations?
Day-to-day operations in each of the 12 regional Federal Reserve banks are supervised by nine directors—six of them selected directly by privately owned commercial banks. The most important monetary decisions for the system as a whole are made by the Open Market Committee, which is composed of 12 members.

11. Do private bank interests influence Federal Reserve policy?
Yes. Of the 12 members of the Open Market Committee—the Committee which actually controls credit policy—5 are presidents of regional banks. These presidents are elected by the individual regional banks’ nine-man board of directors with its preponderance of private commercial bank representatives. Further, all 12 of the regional bank presidents participate an the Open Market Committee’s discussions, though only 5 can vote. The “discussion” Open Market Committee, then, has 19 members—12 regional bank presidents and the 7 members of the Federal Reserve Board.

12. Does it matter what amount of money is supplied the economy?
Yes, indeed. The money Supply helps determine the general level of interest rates paid for the use of money, employment, prices, and economic growth. Many economists believe the money supply is the most important determinant of these variables.

13. Who determines the money supply?
The Federal Open Market Committee of the Federal Reserve System.

14. Why are interest charges important?
For many reasons. First, interest plays a large part in the cost of living. All business firms borrow to conduct their operations—some more than others. These include firms at every stage of production. So interest is a charge which is added on at each link of the production chain. This is a cost which must eventually be paid by the consumer. If it is not paid by consumers, output cannot be sustained. Thus, interest rates also are a determining factor of the level of business activity. Additionally, interest rates influence production because interest rates influence the amount business spends for investment in plant and equipment, the third largest amount of spending for the country’s annual output. (Interest has this effect because a part of the country’s annual investment is financed by borrowing.)

15. Do interest rate changes and tight money have other effects?
Yes. Consider what happens when the Government is restricting money and credit. Firms find loans difficult to obtain and investment tumbles. Small business is especially hard hit because the larger firms tend to have their credit needs catered to first. Further, when investment falls, firms which produce machinery or build factories find their orders slumping and lay off workers while cutting their own orders for goods. The economy pays for high interest in incomes not earned and in output not produced.

16. What is the “efficiency cost” of high interest?
When investment is cut by high interest two things happen. (1) Business does not take as much advantage of the new, more efficient tools to produce goods as it might. (2) Industry slows down the rate of expansion of the total output capacity of the country’s factories. The result of these twin effects is that tomorrow’s workers work with less efficient machinery and fewer machines than they might. Having fewer and less efficient tools, tomorrow’s workers of course produce less than the could. In other words, the rate of growth output slackens when high interest prevails.

17. What has been the trend of interest rates from 1952 to 1964?
Interest rates in the United State increased in steps between 1952 to 1964; and each major step upward was followed by a recession.

18. What reasons have been given by the Federal officials responsible for the uptrend?
The reasons have differed as the years passed. In the early years, the official reason given was that “too many dollars were chasing too few goods,” causing inflation. In recent years, the deficit in our balance of payments was cited. High interest rates, it was argued, were necessary to keep American capital at home. At all times, there has been constant talk of “fighting inflation,” real or imagined.

19. Can anything be done to stop the trend toward ever-higher interest rates?
Yes. The period from late 1939 to 1951 was as violent and catastrophic as any in the entire history of the United States. At the beginning, of this period, millions were still unemployed from the Great Depression. A short time later, we were shooting away $250 million every day on the battlefield. Then the war ended and we reconverted to a peacetime economy with tremendous pent-up purchasing power and inflation. Then came the Korean conflict. Yet, during this entire period of economic stress and turmoil the interest rate on longterm Government bonds never exceeded 2½%. And these bonds never sold below par. This proves that the Fed can restrain higher interest rates, when and if it wants to. The Fed has the ability to set the interest rate at 2½% and keep it there.

20. How effective is high interest as an “inflation fighter”?
Well, if killing the patient is considered an “effective” treatment for an illness, then high interest is an effective anti-inflation tool. Of course plunging the country into a deep recession will cut labor’s wage demands and will cause some business firms to make price concessions. But the cost of this is economic stagnation. And even then prices overall will probably not fall and they may even rise. That is, in the modern economy, just lowering the demand for goods and labor somewhat will not necessarily stop a price push. The country learned this bitter lesson in 1958.

21. Does this mean there is no way to restrain inflation?
No. Although the modern economy has a built-in tendency toward inflation—not just in the United States but everywhere in the Western world—and no one has yet found the perfect answer, it is clear that moderation by big business and big labor in their price and wage policies can go a long way toward keeping prices stable. This country has experienced a 8-year upturn from 1961-64 with remarkable price stability as moderate wage-price policies were followed. This is proof that frequent recessions are unnecessary to stop inflation.