THE LOST ART OF

COMMERCIAL BANKING

by

E. C. Harwood

ECONOMIC EDUCATION BULLETIN

AMERICAN INSTITUTE for ECONOMIC RESEARCH

Vol. XIV No. 6

ECONOMIC

EDUCATION

BULLETIN

June 1974

Published by

AMERICAN INSTITUTEfor

ECONOMIC RESEARCHGreat Barrington, Massachusetts 01230

The Lost Art of Commercial BankingThe evolutionary development of human culture

extended over millions of years. The written record ofwhat has occurred is relatively short, but we know notonly from the written record but also from the artifactsof earlier human societies that men acquired various artsor special skills only to lose them in subsequent centuries.

Perhaps in most instances loss of acquired arts was nota determining influence in the retrogressions, the declineand fall of an unknown number of civilizations. However,in the present century an art has been lost or nearly lost,and the consequences may have a significant influence onthe breakdown of Western civilization. This now nearlylost art is the art of commercial banking.

As has been true for many developments in humanculture, commercial banking evolved as men attempted tocope with their problems, in particular the exchangeproblems encountered in a world of rapidly increasingproduction, one result of the industrial revolution. Fromone point of view, the development of modern scienceand its technological application to production, forced themore or less parallel development of commercial banking.Although more and more men learned the procedures ofscientific inquiry that enabled them to create theamazingly productive modern industrial society, theynever did apply similarly scientific methods of inquiry tothe problem of effecting the tremendously augmentednumber of exchanges that characterized mass productionfor mass markets. Commercial banking evolved as an artby a succession of trials and errors just as many otherhuman arts have developed rather than as an outcome ofscientific inquiry.

Eventually the developing art of commercial bankingwas crudely described and in some degree understood byits practitioners. For about a hundred years it wassustained at an advanced level of development beforeretrogression began. More will be reported subsequentlyabout aspects of the retrogression; at this point we simplymention that almost no bankers and few money-crediteconomists today are familiar with significant aspects ofthis lost art. Even the most ardent advocates of soundmoney, of the gold standard, of a useful accounting unitseem not to realize that until the lost art of commercialbanking is revived and generally applied there can be nohope for the money-credit system of Western civilization.

Throughout the civilized world, inflating has becomethe great destroyer. The signs of pervasive economicdistortions leading to social disorder and retrogression areclearly evident. Some economists seem to believe thatrestoration of the gold standard or some other panaceacould remedy the situation. However, a return to the gold

standard or any other attempt to stabilize money-creditsystems would be short-lived and self-defeating withoutapplication of the lost art of commercial banking.

No doubt, other lost arts that once flourished seemeddurable and assured of perpetuity by those who practisedthem. But the fact is that arts once lost have not readilybeen recovered, even when to the earlier practitioners thearts had seemed so easily understood, so readilydiscoverable, that little trouble was taken to perpetuatethem.

In attempting to describe the lost art of commercialbanking we have at least two ways of proceeding. Onewould be to explore the evolutionary development,describe the failures and the successes, and thus finallyexhibit the art as practised for nearly a century. A secondway of proceeding would be to describe what objectivewas achieved by sound commercial banking and list indetail various aspects of the useful procedures. For thepurpose of this article, the second way of proceeding hasbeen chosen.

The Problem That Was Solved by Commercial BankingMedieval markets were like those existing today in the

more primitive societies. Things were produced on a smallscale, were brought to the public markets by theproducers or their families or friends, and exchanges wereeffected by barter in large part. Even in those earlymarkets where money was used, the money frequentlywas gold or silver coin, and the transactions more nearlyresembled primitive barter than the modern banking andexchange procedures now widely used.

However, as the industrial revolution developed throughthe eighteenth and nineteenth centuries, mass productionfor mass markets became commonplace. The flow ofthings to organized and continuous markets becamethousands of times the physical volume of thingsexchanged earlier. Today, as anyone who has observedmodern shopping centers, supermarkets, major discounthouses, and department stores can see for himself, theproblem of facilitating exchanges has become enormouscompared with the exchange problems of a village marketcenturies ago.

Today's problem may be summarized as follows:a. Coming to the markets of any country such as the

United States is a vast flow of merchandise, transportedin ships, freight cars, trucks, and airplanes, a flowcontinuously in movement day and night (with inter-missions for parts of the flow at times).

b. Millions of individuals and businesses obtainvarying portions of this flow, for consumption or perhapsfor facilitating the production of other things.

c. Clearly, one basic problem that must be solved, ifthe flow is to continue uninterrupted and without eitheraccumulations of surpluses or serious scarcities in themarkets, is to provide for potential claimants or buyersthe claim checks or purchasing media that will enablethem continuously to buy what is offered. Enough, butneither an excess nor a deficiency of claim checks, mustbe provided.

If you were suddenly confronted with such a problem,and had no experience with modern financial andexchange procedures, had never handled what you thinkof as money, the problem might well seem extraordinarilydifficult. Remember that innumerable items flow into themarkets: gold ingots from South Africa, manufacturedwatches, silver in many shapes and forms, diamonds andother precious gems, food in infinite variety from rawmaterial to precooked TV dinners, fabrics and clothingalso of seemingly unlimited variety, millions of auto-mobiles, all kinds of chemicals, medicines, householdappliances, etc.

Also, remember that practically all of the buyers in themarkets have, in some manner or another, participated inthe processing efforts that have resulted in this vast flowof things. Each is entitled to his share: this man has fittedthe wheels on each of thousands of cars; that woman hassewn the seams of hundreds of suits; this manager hascoordinated the efforts of a few hundred thousand peopleengaged in processing a flow of tires to market; anotherman has loaned his savings to a company that provideselectricity for all to use; still another, a barber, has* justperformed a service for Tom Jones and has received fromhim some of the claim checks earned by Tom during thepast week, so that, although a barber sends no things tomarket, he also obtains the means to buy.

Let us suppose that your problem is to provide for allthe potential sharers in the flow of things some means ofclaiming their shares in the markets. We shall not suggestthat you stumble down all the blind alleys where menwere frustrated in trying to solve this problem during thelong evolutionary development of useful commercialbanking. Instead we provide a summary description of themost advanced, most efficient stage of development thatwas reached in the decades before World War I.

We chose that stage of development because re-trogression began with World War I as will be described inmore detail later.

How a Useful Money-Credit System Functioned

One of the obvious requirements for solving theproblem as described is an accounting unit in terms ofwhich the exchange values of all things in the markets canbe determined. Clearly, claim checks valid in the marketsfor purchasing things being offered for sale must bedenominated in some unit of measure for exchangevalues. Thus, the claim checks can be anonymous andavailable for general use in claiming (buying) any thing.Unlike the situation in a baggage check room, those whowish to claim things offered in the markets want theirclaim checks to be valid for any item available, ratherthan valid for claiming only one thing. The buyer in amarket wishes to claim the number of units of exchangevalue to which he is entitled rather than the specific itemsthat he may have participated in producing or in bringingto the market.

Nevertheless, the market situation is in some respectslike that in a baggage checkroom. If claim checks forbaggage were counterfeited, or in some way were issuedwhen baggage had not actually been left in thecheckroom, people could be trying to claim more baggage

than there was baggage to claim. Conversely, if baggagechecks that had been issued properly as baggage wasreceived were either lost or destroyed, someeventually would remain unclaimed in the checkroom.

Similarly in a nation's markets, if the claim checks (orpurchasing media, or "money") were counterfeited or insome other ways amounts were issued to potential buyersin excess of the amounts required to represent values ofthings in the markets, buyers would have far more tospend than the usual market prices of things for sale. Intrying to use their excessive purchasing media, buyerswould bid for relatively scarce goods, and prices wouldrise.

In the reverse situation, that is, if claim checks(purchasing media) were not issued in sufficient amountto represent the values of things being offered in themarkets at the usual prices, prospective buyers would notbe able to claim all the things offered. Then merchantswould be forced to reduce prices in order to sell theirstocks of things before the continuing flow of goods tomarket exceeded the capacity of their storerooms.

The accounting unit finally chosen by all leadingindustrial nations was a specified amount of gold byweight and degree of purity. In some instances, differentweights of gold were designated as the accounting unit,and various names were applied by the different nationsto the weights of gold they selected, such as dollars,francs, pounds, etc. Nevertheless, because all the ac-counting units were gold all were freely exchangeablewith one another in the simple proportions of theirrelative weights of gold.

While these conditions prevailed, any specific numberof the accounting units designated so much gold byweight. One had no need to talk about a "price" of goldin terms of the various currencies, any more than onewould discuss the "price" of a bushel of potatoes interms of potatoes. One might talk about the weight of abushel of potatoes as being 60 pounds of potatoes; and insimilar fashion one might talk about 100 dollars as beinga specified amount of gold by weight, because a dollar bystatutory definition was approximately one-twentieth ofan ounce of gold in an alloy nine-tenths fine.

The fact that gold was the accounting unit chosenexplains neither how that choice came to be made norhow it facilitated the issue of claims for things in themarkets. As for how the choice happened to be made, weshall comment here only briefly.

As human culture evolved, men discovered theusefulness of gold as an exchange medium. This was not ascientific discovery in the usual sense involving laboratoryexperiments and analyses; it simply was the result ofunplanned experience. Men discovered the durability ofgold, which neither rots nor rusts; its comparativescarcity; the fact that its exchange value for other things(or rather for the average of other things over wide areasand prolonged times) was relatively stable, as comparedwith the relative exchange value of anything else; even itspleasing appearance to men and women; its easydivisibility; and possibly other attributes may have beentaken into consideration.

At this point we are focussing attention on some of thefacts and are not attempting to describe how those factscame to exist. These are aspects of the entire problemthat need not concern us here, however, interesting theymay be to students of economic history. The fact is thatgold was the unit of account for modern industrialcivilization.

We turn now to a description of the commercial

banking procedure that issued claim checks representingthings in the markets, retired those claim checks fromcirculation as things in the markets were sold, and issuednew claim checks to represent the new things coming intothe markets. These procedures had to occur in order tofacilitate the huge volume of exchanges essential to theorderly functioning of a modern industrial society.

At this point, one must first realize that gold held inthe banking system was one of the things continuallyoffered in a nation's markets. As gold was brought to thebanks, paper currency was issued to represent it, oradditions to individual checking accounts were made torepresent the gold; i.e., to the account of the man whodeposited gold was added, by a bookkeeping entry, theappropriate number of gold accounting units (in theUnited States, dollars). These purchasing media, i.e.,currency or checking accounts, could be used by theholders at any time to claim gold from the banks, that is,to buy the gold in that segment of the nation's markets.

The commercial banks also created claim checks(purchasing media consisting of currency and checkingaccounts or demand deposits) representing things beingshipped to and offered in the nation's markets. Theprocedure formerly more widely used is somewhat easierto understand.

As a manufacturer shipped completed things to market,he would prepare a document describing the shipment,take it to his bank, and borrow purchasing mediathat, in practical effect, represented the things enroute to market. The bank made the loan by creditingan appropriate amount to the checking account of themanufacturer, but this amount was not deducted fromother checking account liabilities of the bank. Thus,new purchasing media were created and were placed incirculation when the manufacturer used the addition tohis checking account to pay wages, salaries, suppliers,and other costs of processing the things sent tomarket. (As the things were sold, the receipts fromsales were used to repay the bank loan by having theamount deducted from the manufacturer's account.Thus the purchasing media created for temporary usewere withdrawn when their purpose had been served.)

Those who received the newly issued purchasingmedia from the manufacturer then could choose what-ever they wanted that the markets offered. Alsodemanding things in the markets were those individualswho had purchasing media representing gold in the banks.Everyone who had purchasing media at his disposal couldbuy anything he chose in the markets including the goldcontinually being offered by the banks as one segment ofthe entire market.

At all times some individuals and some businessesdesire to retain all or part of their available purchasingmedia for near-future use. Tom Jones, for example,prefers not to buy ordinary merchandise today but plansto buy tomorrow or next week. Therefore, he claims goldat the bank intending to hold it until later when he canuse it directly to buy other merchandise; or he mayredeposit it and use the currency or checking accountthat he thus obtains to buy later in other segments of themarket. Also, he may simply hoard currency or leave hischecking account inactive while Dick Smith who has anequal amount of purchasing media representing gold useshis currency or checking account to buy merchandisetoday. The result is the same as though Tom Jones hadsaid to Dick Smith, "Let me have your purchasing mediarepresenting gold in exchange for my purchasing mediarepresenting other merchandise, so that you can buy

general merchandise other than gold today and I can waituntil tomorrow (or next week)." However, because all thepurchasing media used is free of any tie to a particularproduct, such a conversation is unnecessary. The result isobtained without any need for Tom Jones to find andagree with Dick Smith.

A brief digression is necessary at this point, because theprocedure described above has been modified in recentdecades as mass production has developed on a broaderscale and now occurs almost continuously throughout theyear. For example, automobile manufacturers ship cars tomarket practically every business day except for the fewweeks each summer when plants are closed for thechangeover to new models. Preparing new sets ofdocuments nearly every day for all shipments for use as abasis for bank credits would be unnecessarily timeconsuming. Consequently, a different procedure has beendeveloped.

The automobile manufacturer arranges with commercialbanks for a "line of credit" and gives a promissory notethat may be paid off only once each year during themodel changeover period when no cars are en route tomarkets. Thus a series of borrowings continually beingrepaid as cars are sold is replaced by a single borrowingresulting in the creation of purchasing media that remainin circulation as long as the flow of cars to marketscontinues. Instead of using the receipts from today's salesof cars to pay off the note secured by the bill of ladingfor the shipment, the receipts from today's sales are usedby the manufacturer to finance his next shipment.(Whether the time intervals involved are daily, weekly, ormonthly depends in part on customary timing for thepayment of wages, salaries, dividends, bills for materials,etc.)

Clearly, the art of commercial banking requiresknowledge about many aspects of production andexchange. The banker must be an expert judge offinancial statements and must know the customaryproduction and shipping procedures of those for whom hecreates new purchasing media by discounting their notes.He also needs to have some knowledge of market prices,although much of this information is available in therecords of billings by the processors of things being sentto or in the markets.

The commercial banker must have some basis forjuäging prices. Inasmuch as gold by weight is theaccounting unit, when the gold standard is in general useas it was before World War I, prices of all things exceptgold are quoted in terms of gold. For example, at thattime, "dollar" was simply another and shorter name forabout one-twentieth of an ounce of pure gold in an alloynine-tenths fine. (Probably human beings are the onlyform of life on earth that can be persuaded to believethat a name such as "dollar," after having beenirrevocably severed from reality so that no longer is it aname for any tangible thing, nevertheless can be used asthough it still named something in the real world.)

Potential Errors in Judgment

From the summary description given above, one canrealize that possible errors by commercial bankers injudging the prices of things that are represented by newcredits, by newly created purchasing media, could havedisturbing repercussions. If, because of overoptimismabout prices generally, the bankers created so much newpurchasing media that prices in the United Statesincreased in relation to prices for similar things elsewherein the world, some potential buyers would buy in foreignmarkets. In that event, the banks would have had to send

HARWOOD INDEX OF INFLATING

1968 1969 1970 1971 1972 1973 1974

1914 '16 '18 '20 '22 2̀4 '26 '28 '30 3̀2 '34 '36

The actual developments that have led to the present situation arereflected in the charts on these two pages, which illustrate not sometheoretical or imagined relationships but the actual course ofmoney-credit events during recent decades.

The chart above shows the ratio of total purchasing media to theportion that is noninflationary (that is, represents gold or otherthings being offered in the markets). Clearly, the increasing creationof inflationary purchasing media in recent decades has resulted in aneven greater departure from sound commercial banking than that of1929.

The purchasing media available to the public in the United Statesinclude all coins, the paper currency (consisting largely of FederalReserve notes but including Treasury currency), and checkingaccounts (or, as the banks label them, demand deposits). Allpurchasing media in use, or that someone holds available for use,have come from one of the sources described in the paragraphs thatfollow. The purchasing media derived from these sources arerepresented by the areas on the other chart. The sources aredescribed in ascending order of these areas.

The first and an important source of purchasing media is thething chosen as the basic or standard purchasing medium. In thepresent industrial civilization, the money commodity is gold.

In spite of the so-called departure from the gold standard, goldis still the money commodity of modern civilization. Existing goldheld as reserves of the various banking systems actually is beingused as purchasing media, although it circulates in an altogetherdifferent form than the gold coins or gold certificates thatformerly were available.

When the Treasury acquires gold, the seller receives a checkdrawn on the Treasury's account; and the Treasury ordinarilycounter-balances these drafts against its checking account bydepositing certificates representing the gold with the FederalReserve banks.

By this means purchasing media equivalent in value to the goldsold to the Treasury are made available to the seller; and, when heuses the funds to buy some things desired, the purchasing mediapass on to someone else and thus remain in circulation.

A second source of purchasing media is the commercial lendingfunction of a commercial banking system. The borrower whosenote is discounted receives a bookkeeping credit to his checkingaccount that is not previously deducted from someone else'saccount. This action places at his disposal new purchasing media(in addition to those previously existing) that represent things thatthe borrower offers in the markets. Therefore, such purchasingmedia are not inflationary.

The third and fourth sources of purchasing media are also thecommercial banking system and also involve a bookkeeping creditto the borrower's checking account as in the commercial lendingmentioned above. However, purchasing media derived from thesesources do not represent things that the borrower offers in themarkets. The loans involved thus are investment-type assets of thecommercial banks. (The amounts of speculative inventory loans areestimates subject to revisions.)

The fifth sç>urce of purchasing media is the currency issued bythe Treasury in the form of United States notes, Treasury notesof I89OJ Federal Reserve banknotes, national banknotes, dollars,subsidiary coin, and minor coin. Because this kind of currency iscreated by the direct action of the Treasury and does not reflecteither an increase of gold or in other things coming to market, theTreasury currency is classified as inflationary purchasing media.

The sixth source of purchasing media is tne commercial bankingsystem's investment in Federal Government obligations to theextent that such investments exceed the capital and savingsaccounts of commercial banks that are available for that purpose.We refer to this source as "monetized Government debt," becausethe commercial banks create new purchasing media in exchangefor these Federal debt obligations.

The significant development reflected in the chart, whichlargely accounts for the present domestic money-credit chaos andthe virtual international bankruptcy confronting the United States,is the prolonged and marked inflating that has occurred during thepast three decades. This development is reflected in the hugeamount of inflationary purchasing media shown in the upper areasof the chart.

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gold abroad, because a foreign holder of U.S. purchasingmedia (or of claims on it) would buy the relativelycheapest thing available in U.S. markets, which would atthat time be gold.

The outflow of gold would reduce the purchasingmedia in the United States representing gold and thuswould reduce somewhat demand for other things. Pricesof most things would fall and the commercial bankers'error attributable to overoptimism perforce would becorrected. A cumulative distortion attributable to errorsof overoptimism would seem to be highly improbableprovided the basic principle of sound commercial bankingwere followed.

However, other major errors of a different type haveoccurred, of such nature as to create increasingly greaterdistortions leading to periodic breakdowns of themoney-credit system. How these errors occurred will nowbe described.

Savings and Investment

As commercial banking has developed, especially in theUnited States, two quite different functions haveperformed by the same institutions. In addition tocommercial banking as already described, most banks alsoaccept savings to be invested.

Savings are purchasing media that the original holderdecides not to spend himself but instead requests thebank to invest for him and pay him interest on his savingsaccount, sometimes called a time deposit. The bankinvests such purchasing media by lending it to a borrowerwho perhaps is buying equipment for his factory or to aborrower who may desire to buy a new car or for someother purchase. Thus, the purchasing media (currency orchecking account) are used by someone to buy things inthe markets although the original recipient of thosepurchasing media chose not to buy but to save. Heacquires a credit to his savings account or time deposit,which shows that he is the owner, indirectly, of whateverinvestments the bank has selected, such as bonds,mortgages, installment loans, etc.

The borrower from the bank in the savings-investmenttransaction is not at that time sending to or otherwiseoffering things of equal value in the markets to be sold.He does not desire purchasing media so that he maydistribute it to employees and suppliers who participatedin preparing things for the markets. His desire is to claimthings from the markets, either equipment for his factory,or a new car for personal use, or any of the multitudes ofother things available, such as new bricks for constructionof a factory, etc. Consequently, the bank should notcreate new purchasing media for such a borrower butshould lend him purchasing media already in existencethat some present owner or owners save and deposit inthe bank.

Probably because the same banks have been performingtwo functions, each of which involves lender-borrowertransactions and similar, often identical forms (such aspromissory notes) and related procedures, many bankershave confused the two functions. Extreme examples werenumerous in the late 1700's and early 1800's.

In the United States the so-called "wildcat banks,"usually small institutions in more or less remote areas, soinextricably confused their two primary functions thatthey not only created new deposits (by discounting notesand crediting the proceeds to checking accounts) fortypical commercial purposes but also they followed thesame procedure and created new checking accounts whendiscounting mortgage notes. In the first type ofprocedure, the new purchasing media created represented

the exchange value of things en route to or being offeredfor sale in the local markets, but in the second the newpurchasing media represented things (such as land,factories, or consumer goods not being offered by theborrowers for sale but on the contrary being removed bythem from the markets).

Perhaps the most easily confused examples of com-mercial vs. noncommercial banking are provided by thefinancing of automobiles in or en route to markets incontrast with consumer installment borrowing to purchasea new car. The important distinction that makes all thedifference between sound and unsound commercialbanking is:

a. When an automobile manufacturer borrows newlycreated purchasing media and distributes them amongemployees, suppliers, and others, he is arranging for thosepotential buyers to obtain their shares in dollar value, ofthings in or en route to markets.

b. When an installment buyer arranges to purchase acar, he is not claiming a share corresponding to hisparticipation in producing things for markets, he isclaiming someone else's share. James Brown can properlydo that provided John Doe is willing to lend to JamesBrown the share that Doe's purchasing media (currency orchecking account) proves he is entitled to claim. Such anarrangement usually is effected via the savings-investmentprocedures with a bank as intermediary. If the bankcreates new purchasing media for James Brown to useinstead of arranging a loan from John Doe or others, theresult will be more purchasing media available to potentialbuyers than the corresponding value of things in or enroute to markets.

c. Thus, one can see that a bank's lendingtransaction may reflect additional things offered in themarkets or it may not. If it does, creation of newpurchasing media (for use until retired by repayment ofthe loan by the seller) is sound commercial banking. Ifthe lending transaction does not reflect additionalofferings in the markets, it should be financed by thesavings-investment procedures.

When the borrowers from "wildcat banks" attemptedto buy, they discovered that merchandise was scarce; theybid prices higher and higher for the available things. Soon,those having purchasing media tried to buy more cheaplyin foreign or at least more distant markets. The sellers inthose markets did not wish to buy most things in thelocal markets but used their claims to demand gold fromthe "wilcat banks," which then were unable to meet theirobligations and collapsed.

This disastrous syndrome has been repeated again andagain in human experience. Another notorious instancewas that of the Scottish banks, of which a multitudecollapsed after similarly neglecting to apply what mightbe called the basic principle of sound commercialbanking.

Finally, the lesson was learned. For nearly a centuryprior to World War I, the leading English banks appliedthe basic principle of sound commercial banking most ofthe time with outstanding success. The basic principalbecame more widely understood and applied amongindustrial nations. Even the United States, which hadbeen one of the "slow learners," did embody this basicprinciple in the legislation that initiated the FederalReserve System in 1913. The Federal Reserve banksoriginally were permitted to rediscount for the memberbanks only commercial paper directly tied to the vohimeand value of things flowing to markets. Such widespreadapplication of the basic principle of sound commercial

banking marked the farthest advance achieved by thehuman race in the evolutionary development oí amoney-credit system that could serve a modern industrialsociety.

During World War I the prolonged evolutionarydevelopment ended, and retrogression began that hascontinued to date. Perhaps the decisive influence was thepolitical decision by each leading combatant to financethe war by inflating. This procedure was not justifiable oneconomic grounds (as Napoleon had demonstrated acentury earlier), but apparently it was politicallyexpedient. The basic principle of sound commercialbanking was simply disregarded when the governmentsused the various banking systems as means ofmonetizing government debt. Not only the centralbanks but also the commercial banks generally werestuffed with government paper (promissory notes ofshort and long duration, the latter called bonds), inexchange for credits to the checking accounts ofgovernments. What happened then and since issummarized below.

Developments During Recent Decades

In the last part of the 1800's and until World War I(1914), all of the leading industrial nations of the worldand many others used a common international monetarybase. All of their currency units were gold, althoughsome used different weights of gold than others did,and various names were used for the different unitweights, such as "dollar," "pound," "franc," "mark,"etc.

Because each currency unit was gold, each wasreadily exchangeable into any other, based on therelative gold contents of the unit. In practical effect,troy ounces of gold, or in the metric system grams ofgold, were the international unit for all currencies ofleading nations.

This situation, which included the advanced stage ofcommercial banking already described, represented thepeak of development for Western civilization inmonetary matters. It facilitated commerce and madepossible long-term accounting records that weremeaningful rather than fictitious. Not only commercebetween nations but also the great increase of usefulcapital was encouraged by the growth of savingsinstitutions, life insurance, and pension funds.

During World War I, the nations concerned inflatedby printing paper money and monetizing governmentdebt unrestrained or not limited by any relation tothe gold currency unit. The results were catastrophic:

a. In Germany, the money became worthless in1923, with complete loss of savings, life insurance,

pensions, and an economic breakdown with seriousdepression. A new gold monetary unit was adopted. Insome other countries the experience was similar.

b. In France, the loss of buying power of thecurrency was not so extreme as in Germany; but theFrench franc, by the time De Gaulle became presidentin 1958, would buy less than one two-hundredth ofwhat it bought in 1914.

c. In Great Britain the pound sterling lost muchof its buying power, but an effort was made in 1925to restore the prewar gold currency unit.

d. In the United States the consequences wereless serious, although a noticeable loss in the buyingpower of the dollar occurred.

Between World War I and World War II, an effortwas made to restore the pre-World War I monetarysituation. However, the procedure adopted facilitatedinflating again as some currencies, especially the dollarand the pound, were widely used as reserves in othercountries as though they were gold. The basic principle ofsound commercial banking was disregarded; and the in-flationary boom of the 1920's was the immediate resultfollowed by the Great Depression of the 1930's.

During World War II, the inflating procedures usedduring World War I again were applied, with similarlydisastrous consequences for many nations.

After World War II the leading nations joined inestablishing a new international monetary system basedon gold. However, once again they repeated the mistakeof the 1920's by providing that the currencies of somenations could be held instead of gold as the reserves ofother nations. In practical effect, this meant countinggold twice, once where it actually was held and again insome other countries whose central banks held claims ondollars, pounds, etc.

In the decades after World War I, the basic principle ofsound commercial banking was so far departed from thatit was largely forgotten. Also, during the 1930's, the yearsof the Great Depression, the economic notions of JohnMaynard Keynes became widely accepted as theremedy for depression difficulties. The "new"economic ideas (actually very old, but new to manyignorant of history) became virtually a new economic"religion" with fanatic followers in all the leadinguniversities of Western civilization.

To summarize, the new ideas involved perpetualinflating as a means of achieving perpetual prosperity.Dr. Keynes' ideas were embodied in the charter ofthe International Monetary Fund, created in194546. As was intended, it became a great engineof inflation, and thus functioned for nearly threedecades.

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The Situation Now ExistingThe results of forgetting the art of sound commercial

banking, of accepting almost universally the Keynesiansecular revelations, and of adopting perpetual inflatingas not-to-be-questioned government policy are becomingincreasingly apparent and increasingly unpleasant. Thatthe economic distortions created are disrupting socialorder hardly will be questioned by anyone who haseven a glimmer of understanding of the news behindthe news. Andrew Dickson White reported on inflationin France in the late 1700 's, commenting that all theworst characteristics found in human nature, avariciousembezzling, reckless speculation, betrayal of trust, andthe like, grew like "fungus on a muck heap." Whenone observes what has gone on in high corporatefinance, in banking, in government during recent years,one is impressed with the extreme fertility of theWestern civilization "dung heap." Most prominenttoday are not the characteristics of a lasting socialorder; at least one hopes that these characteristics willnot last. Unfortunately, however, present indicationsare that developments will be worse, much worse,before there is a lasting turn for the better.

Consider, for example, the 1973 meeting of theInternational Monetary Fund in Nairobi. Severalhundred of the world's leading bankers, governmentfinancial personnel, and economists solemnly met for afew days. With straight faces they discussed SpecialDrawing Rights, the so-called "paper gold." Not a manstood on his feet and declared, "Gentlemen, we arelaboring under the delusion that imposing names mustapply to something, but there is no reality to whichthe name 'paper gold' can be applied. The fruitlessefforts of our Group of Twenty should*be enough toconvince anyone. We are not so much making fools ofourselves as exhibiting the fact that we are anaggregation of monetary novices. Those of us inbanking are mere pawnbrokers in marble halls, most ofwhom never learned the art of commercial banking oreven know that there once was such an art. With theaid of ignorance, cupidity, and expediency on the partof our friends in governments, we are destroying acivilization. Let us stop and try to learn from thelessons of the past."

Now the point of this imagined comment is notto castigate the world's bankers and politicians,however well they may merit such castigation. Thepoint is that no single man in banking or in

government and no group of men is urging thedesirability of leaving the world of dreams andreturning to reality. The inescapable conclusion isthat there is little or no reason to hope thatinflating and the resulting destruction of socialorder will be stopped short of terrible disaster.

Even the advocates of a return to the goldstandard do not provide good reason to hope thata turn for the better can be achieved. Almostnone of them understands that application of thebasic principle of sound commercial banking isessential to make the gold standard, or for thatmatter any other monetary standard, useful in thelong run.

Among the gold standard advocates are found the100-percent-reserve proponents who would restrict thepurchasing media in use to gold and perhaps silver coinsor paper currency and to checking accounts directlyrepresenting these. They would go back to medieval timesbefore the earliest beginnings of sound commercialbanking. How they would cope with the flood ofproducts to be marketed in a modern industrialcivilization they do not suggest, nor do they seem torealize that a problem might exist.

Others among the gold-standard advocates offer asimplistic solution, raising the "price" of gold andrestoring convertibility of currencies to gold. They seemnot to realize that a huge volume of inflationarypurchasing media exists and is polluting the moneysupplies of the world just as would multiple billions ofcounterfeit currency. Few add to this simplistic solution aproposal for removing excess purchasing media fromcirculation (deflating) and thereafter prudently applyingthe basic principle of sound commercial banking.

An art that mankind once acquired has been lost. Thisassertion does not imply that the art in question had beendeveloped to perfection. Wise men do not hope to achieveperfection; they aim at solutions that work passably wellin the real world and try to improve upon them, morenearly to perfect the application of basic principlesdiscovered, and to preserve the best of what already hasbeen achieved while striving to achieve even better results.Until the art of commercial banking becomes a science,and like most of man's studies of human behavior that isa long way in the future, can we do better than revive thelost, but not entirely forgotten, procedures that onceworked so relatively well, in contrast with the inter-national monetary muddle we have today?

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