David H Friedman I Bet You Thought
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'tied.an. David B.
I Bet rOQ Tboaqh~ ••• Federal Reserye Bank of
Dec 17 36p.
Pederal Beserve Bank 3 Liberty Street. Nev York, Nev rc~k
fublic Info· of lew fork 100115 Cfree)
BF01 Plus Postage. PC Hot Available fro. EDRS. Adult Educa~ion: .Sankinq; Concept Foraation: Credi~ (finance': Econa.1c Develop.ent: *Econoaic !ducation: Eoono.ics: Pederal ReqQlation: financial policy: .pinancial SeryiC8$: Governaent ~ole: Instructional laterials: .8oney ftenaqeaent: *soney Systeas: Purchaminq: secondary Education: Dnited States History .Federal Reserve syste.
The bocklet lists and di3pels 1ij economic myths thl. "1h a discussion of aoney. econoaic concepts, and ~he Federal Be~~·i.. "e Systea. 'rhe object ive is to help secondary stadents O!: adul ts undc'":..stand tbe econoaic svstea as relate~ to aone' and banking. Topics fOCQS cn aoney. bankinq, qold and silver, credit. qovern.ent role. financial concepts. and interest. For ~hese topics historical backQroand 1nforaatioD is provided, teras and concepts are defined, relationships between qovernaent and the banks are pointed out, Federal Reserve functiGDS and operations lre outlined. and various types of banks are co.pared. Sa.pIe mytha inclUde "Boney is si.ply - coin and paper currency." "Gold and silver are the only perfect .onies.- "Tbe Governaent reduces aoney's ,alue by printinq ~oo .nch currency." ·Checks are aoney." "Sanks are par~ of the Govern.ent." -Ill banks are the sa.e,- Niall Street banking interests established the federal Reserve and control aonetary policy," "The Federal Reserve controls the a.ount uf currency in circulat.ion." and "Banks borrow aonev fro. the Federal ~eserve at the discount ra~e and lend the funds at a hiqher rate tc .ake \:irofit.. fI Cartoon drav!ncrs illustrate the concept.s discu3sed. (CK)
•••••••••••••••••••••••••••••••••••••••• **•••••••••••••••••••• *.**••••• • Reproductions sdpplied by EDRS are the best that can be made * • fro. the o~iqinal Jocuaent. *
O'~AIU MI"TOt tHIALTH . ,auCAT ION & "AT'O"A L 'NITITU T' OF IOUCAT lON
THI~ DOCUME NT "A~ aEEN Ii EPIiO· OuCEO I_ACTL " AS IIECEIII EO FIlOM
THE PEIl!iON 011 ORGANI ZATION ORIGIN· ATING IT POINTSO F vIEw Oli OPINION S STATED DO NOT ""ECE~S ARIL" REPIIESfNT OFJtIC,A L NATIONA L INHITU TE OF IDUCAT ION POSITIO N 011 POLICY
'PERMIS SION TO ~t:PRLlllud !'~IS IN MICROf iCHE' ONLY
H~/;r0R~~J-;~~2 TO THf EDUCA T'ONAl R!.50UR l.t:S ~NFORM ATION CENHH \E:fN~\
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Public Information Department Federal R£!serve Bank of New York
33 Liberty Street New York. New York 10045
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P,.,.c. Most of us acqUire two types of knowledge"~ "001 knowledge" and 'fall< knowledge .' Folk knowledge IS information and "wisdom" passed from generation to goneratIon or aCQuired on the streets For example, were often tOld that sItting In a d,.aft will gIve us a cold SCIence tells uS the common cole results frorn a V1fUS Yet. stili we change our seat ;0 avoid a draft We may acknowledge that drafts only contribute to lowering our resistance to Infection but we 51111 blame the tJreeza rathAr than the bug So too most of us hold certain economic misconceptions folk knowledge cont8lnlng a germ of truth and a plague of misconcp.pliu n economiC myths picked up by mlsreadlngs or t"e acceptance off'lCls from a If lend or relative Few of us are Immune to (~conomIC myths Of misconceptions If yuu dunt ttllTlk so I bet you thought
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T..... of Contents Before readin g thIs bookle t. indIcat e whethe r
each statem ent below IS true or false After, check your answe rs and rate yourse lf
Tru~ Fal!;t' Answer on page
Simply cOin amI paper curren cy Onlv Calf! and curren cy dre real monIes bec been no as money It won, worl< well or Idst long unless It meanin gful dlstlnc tlun betwee n 'lcgi11 lelluer C,J1l also !)crve well a~ d standi:Hd and store 0' value, and other U S money since 1933, when Congres~ People 's wIllmg ness to accep t money In any made all cOins and curren CIes legal tender for lorm IS rooted no' In tr,e law hut in money 's all public and private debIs ablltty to effectI vely measu re anfJ hold value Regarc1Ie Congre ss Issu(!l1 paper money during the AmCrican Rp.volutlon bHcau se It lacked gold and Silver coms and the metal to make them In the 18705, the U S allowe d people to exchan ge Silver dollars for paper dollars becau se the weIght and size of the cOins made them unpop ular and httle used In tho late 19605. (Ising mdustf lal ,1emand forced Silver's ehmina hon from U S COinage Teday' s U S COIns don't contain preCIous rpetal The face value of our COinS IS greate r than the value of the rnHlal rn the COinS We accep t cems as "foken " or 'co,we nlence " money for the small fmanelal transa cllons of dativ life, such as vendin g fll,Jchm e purcha ses phone cdlls and lipS The use of paper curren cy grew dlfecfl y out of the proble ms of coms 1he InGonVE~nlence of carrYin g and safeke epmg large Quantities of corn cause d people In differe nt SOCieties 10 excha nge
paper recelp ls for cOins or bullIon hele1,n a natIOnal treasu ry or prIvate bank More Import ant. paper money was often used to overco me the scarcit y of ~rec,ous metal cOins Paper money , howev er also provm1 less than perfec t Thf? baSIC proble m conce rned ItS source When money was pre(1omlnantly gold and Silver COin govcrn ments were preven ted from ISSUIng more COin by the amoun t of melal In Ihelr treasur ies. dug out of thE~ ground or obtain ed for goods 501(110 other nal,ons Wlthoul srnHlar reslrlc llons on curren cy govern ments and banks coul(1o ver'ssu H ret1ucmg Ihe value of each note, and leopar fl1llng paper money 's dccep liib,llly by making curren cy a poor slore of value DlJflng the Amenc an Rel/olut,on, Congr ess so over Issued conI menIal curren cy Its value almost (1,sappea red Indeed , the expres sion not worth a contIn ental" was WIdely used then to conno te worthle ssness The colonis ts were so angere d that, after Indepe ndenc e. Congr ess dldn'l Issue paper money for over 70 years, even Ihough It had the C"nstl tutlona l power to'col n money ' and 'regula te" Its value Unlilth e Civil War, slate·c hartere d banks Issued Ihelf own curren cy In the early 1860s, as many as 10,000 differe nt bank nole Issues clfcula ted Banks were pledge d to redeem their notes for COin or bullton. but beCalJSe many banks had only a fractio n of the preCIous COin or melal neede d for repaym ent. and beca... se many were headq uartere d m remOle reglor1s Ihe value of thelf notes was suspe ct The result was a ChaotJc curren cy system In which people sometI mes accep ted bank notes at less than face value Unt,l after the eSlabl lshmen t of the Federa l Reserve System In Decem ber 1913, the U S dIdn't have an'ela stlc" curren cy, a curren cy whose supply could expan d or contra ct as buslf1ess acllvlty and publiC deman d chang ed
Gold "backing" Ilv...... do.Ia, Ita VI'u•. Unt,l 1968, US currency had to be parllally backed by gold However. gold never gave the dollar Its value The dollar's value always has been determined by the amount of goods and services It can buy . Its purchasing power Gold backmg was requIred through most of U S history as a means of restraining Government overlSSudnce of paper money and ImprovlMg pubhc confidence. and, therefore, the acceptability of paper money When the Federal Reserve was establIshed. Congress reqUIred the 12 Reserve Banks to tjack thel: currencV. known thefl a'S Feder al Reserve Bank notes and today as Federal Reserve notes, with 40 percent gOld and 100 percent 'eligible paper" (Short-term IOUs of busmesses and farmers) The eligible paper requirement was reduced to 60 pelcent In 1917 Gold WdS bought from the Treasury Eligible paper was obtained from commercial banks that pre5ented these cuSfomer IOUs as collateral for loans Essenhally, only thoSe IDUs representtng commerCial banI( loans made to expand manufactuflng or farm output were deSIgnated "eligible" as collateral by the Federal Reserve The backing reqUIrements on Federal Reserve notes were deSigned to regUlate currency issuance automatically to the pace of the ecrmomy's growth, smce only Increased bUSiness actiVity and bank lendmg could generate the collateral necessary fOf more note Issuance
Federal Reserve notes ate stili "backed" dollar-far-dollar by the assets of the Reserve Banks About 85 percent of Ihese assets conSist of Government securities the FtJderal Reserve purchased over the years The rerr.aln:ng 15 , 'rcent conSists of gold cerltf,rates representing ~. I?dges against the Treasury's gold supply Ht:serve Banks no longer have to use thelf gold certifIcates thIS way, but many sllU do Currency backing Isn! relevant In today's economy Currency can no! be . redeemed," or oxcrtanged for Treasury gOld or any other asset USf~(J as backing The questIon of Just what assets back' Federal Reserve notes has Iltlle but hookkeepmg significance Money's value, however IS highly relevant Maintaining the dolla(~ lIue means maintaining Its purchaSing power 11.Stng pr,ces-lMflatlon-reduce purchaSing power, stable pflces keep purchaSing power strong, Too mUC!1 money results In excess spending When consumers, bUSinesses and governments spend excessively, they compete for the available supply of goocs and services and force pflces up When prices flse. the purchaSing power of money falls To keep purchaSing power strong, then, the supply of money must not Increase too rapidly
Backing requirements were Itber ahzed and reduced over the years, as we gained better inSight Into how the aconomy works and how money should be regulated By the 1930s. Congress allowed Reserve Banks to use assets other than eligible paper, such as US Government secuntles, to back currency By the 19409, Congress slashed the gold requirement to 25 percent and In 1968 eliminated gold back1nt:, entirely 11
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TIle Govwnment reducn man.,'. v.SUe by
prlnUng too muctl currency. The Bureau of Engraving and Prinllng In Washinglon,O C, a unit of the Treasury. I!. responsible for printing the nahon's currency But its orders 10 print come from the '2 Federal Reserve Banks, not the President or Congress. The Reserve Banks, not Ihe Treasury, delermlne how much currency IS printed. based mainly on estimates of commercial bank and public cash demands Under this arrangement. the Government can't punt more Federal Reserve notes to pay its bIlls or debts. Since most U.S money IS checkbook money, the printing presses have liltle 10 do with the buying power of money. Maintaining money's value involves Ihe Federal Reserve's control over commerCial banks that create most checkbook balances. The Federal Reserve does this in three ways Flfst, the Federal Reserve Act requires commercial banks that are members of the System to keep "reserves" as COin and currency in their vaults or balances at their district Reserve Bank. By ralsmg the percentage of reserves thaI must be held, Ihe Federal Reserve reduces banks' ability to create more money Lowering reserve requirements increases banks' money creating ability.
Second. the Federal Reserve lends money. generllfly for only a day or two, to banks that belong to the Federal Reserve System It charges Ihem inlerest, called the "dIscount rate .. Changes in the Jtscounl rate have the effect of making Federal Reserve loans more or less attractive to member banks. The most important control IS open market operatlons-ouylnQ and selling U S Government securtties through a network of almost three dvzen privale dealer fIrms. When Ihe Federal Reserve sells securities from lIs $100 billion pl'Jr!follo. dealers pay with checkbook money that IS laken out of circulation when the checkbof)k funds are transferred from the dealer's bank to the Federal Res~rve. When the Federal Reserve buyt securifies. it pays with checKbook money, increasmQ money In Circulation
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CndIt card8 ..... ,... form of money.
CredIt cards aren't a form of money, bu' a "defer red payme nt" device , a m~ans a' :ltammg gOOds and services by promls mg 10 pa)' laler CredIt card transactIons are similar to loans When you use a credIt card, Ihe C\tendmg you credit for whIch you Will pay Interest after a short period Many people , however, pay theIr credit card bIlls within the month billed and aVOId Interest charge s Many credit cards carry a "credl t Ime," a maXimum amoun t the Issuer WIll lend you. A $1,000 credIt line allows you to accum ulate $1.000 In unpaId purcha ses or cash advan ces. CredIt lmes are prearr anged loans that becom e effecti ve when used. an arrang ement commo nly used by large companies. All bank lending depen ds on the availabIlIty of reserves whIch are determ ined by the Federal Reserve When the supply of reserves .s small and cred.t card users draw on their credit ltnes, banks have to reduce loans to other customers Comm ercial banks alone lent about $12 bIllIon throug h credIt cards and simIlar plans In 1976, about 10 percen t of thelf loans to IndlYlduals that year
Even though credIt cards aren't money. !hey affect 'he way we spend money and. in that sense, arf3 Important to unders tandin g people 's purcha sing behav ior For thiS reason, some econo mists beheve lines of credIt gIven on credit cards should be counte d as part of the nation's "mone y suppl y"-a techn,cal measure of the funds the public has avariabl3 for Immediate spend ing. They argue that many Important spend mg deciSions are based not lust on the amoun t of cash and checkb ook muney peo~le have on hand, but on indiViduals' holdIn gs of financial assets, such as savmgs depOSits, stocks and bonds , as well as the availabIlity of credIt
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ca.au •• IIIOIMY.
Checks aren't money in themselves. They are stmply Ofdel' forms instructing bank& to move checkbook deposits, which are money, from one account to another. Those checkbook depoSits are
numbers on banks' ledgers and In their computers.
BankS don't keep cash in "hecking accounts and don', transfer currency or coin when acting on a check's instructions. Checkbook deposits are transferred between accounts and banks as bookkeeplng entries only. tn 1917. the nation's 14,600 commercIal banks held about 5230 billion of checkbook deposits for individuals, businesses and governments.
CIIeckbook mone, I. "created" hu currency
Commercial banks create checl