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THE MARQUETTE NATIONAL BANK
OF MINNEAPOLIS
MINNEAPOLIS, MINNE SOTA
February 16, 1944
Mr. Marriner S. Eccles
Chairman, Board of Governors
Washington, D. C,
Dear S i r j
During the decade or more in which radical and irresponsible critics of "banking have been harping upon the
claim that banks manufacture money out of nothing, and
at no substantial cost, and lend it to the public for
unearned interest, bankers and economists both appear
to have thought the notion was too silly to be worth
while answering, When a well educated and apparently
honest congressman gives respectability to this charge
by writing a book largely built around it, it would
seem that an answer is in order so I have thought it
would be fun to try to answer it.
You must have a waste basket big enough to accommodate
efforts of this sort.
Yours very truly,
RUM-Eh
end.
Comments on Mr, Jerry Voorhis* book entitled
"OUT OF DEBT OUT OF DANGER"
This is not, as one might guess from the title, primarily an indictment of government debt. It is mainly an indictment of the prevailing practice whereby the commercial banking
system is used by the Government to monetize its debt, and the
thing that apparently troubles Mr. Voorhis most is not the inflationary influence of the creation of this vast body of unneeded bank deposit currency but rather the notion that the banks
are being unjustly paid interest upon the government debt which
they monetize. Mr. Voorhis appears to feel that interest charged
by commercial banks for leans to their private customers can scarcely be justified, and that in the case of bonds sold to the banks
by the Government the payment of interest is wholly unjustified.
He recognizes the justice of the payment of interest by the Government to individuals and corporations who lend to the Government
their saved money income, and he doesnft seem to be greatly disturbed by the amount of this sort of government debt - debt for
which he recognizes that the Government has received full value.
The general view expressed by Mr, Voorhis is held by a
considerable body of bank critics, ranging all the way from the
holders of the wildest sort of notions clear through to men of
high intelligence and wholly honest purpose, like Mr. Voorhis himself.
It appears to be the opinion of most students of the bank-
ing process that these notions are based, in part at least, upon
fundamental fallacies. No one, however, so far as the writer knows,
has
undertaken to spell out the exact nature of these fallacies,
and he has, therefore, set himself that task,
Mr, Voorhis believes that banks manufacture money out
of nothing, and at no considerable cost, and then lend it for
interest which they do not earn. In this honest belief I think
he is neither wholly right nor wholly wrong.
Banks, speaking of
them collectively as a banking system, do manufacture one kind
of money, or at least a means of payment which performs the
function of money and, for the purpose of Mr. Yoorhis! book and
of this discussion may perfectly properly be included in the
definition of money.
It is the kind of money that is perhaps
more accurately described as bank deposit currency or bank money.
It consists in balances transferable by check standing to the
credit of bank depositors on bank ledgers. In the main these
credit balances are created by transactions which take the familiar
form of loans and investments but are,in fact, the first steps in
the monetization of credit. In an entirely sound banking scheme
monetization would be limited to current producer credit to be used
to implement the economic process of creating useful goods and
services and distributing them amongst the participants in that
process.
Such implementation of the economic process is the prime
function of money.
Banks manufacture this money just as legitimately and
just as usefully as tailors manufacture clothes and millers manufacture flour. Banks do not manufacture bank money out of nothing, however, any more than tailors manufacture clothes out of
nothing, or millers manufacture flour out of nothing, and banks
-3do not manufacture "bank money without substantial cost any more
than tailors or millers manufacture their products without substantial cost, and neither do they lend it at unearned interest.
This whole subject of the function of commercial banks,
and of a commercial banking system is pretty well enveloped in a
fog of popular misunderstanding, and even bankers and academic
students of banking have not always penetrated this fog. Bankers
have been slow to recognize the money creating effect of their
own operations, and many critics of banking who see clearly this
creative function of banks have been over-quick to conclude that
bank deposit money is made out of nothing and without substantial
cost.
The individual banker knows that his bank's ability to
make loans is limited hy the credit balances which his depositors
carry in their accounts - the deposits which they leave with the
bank. He knows that if his bank's deposits go up its loans and
investments oan expand, and if his bank's deposits go down its
loans and investments must contract. In the light of these obvious
facts it is not altogether strange that many bankers have scouted
the idea that their banks create money.
The close correspondence, however, between the enormous
purchases of government bonds by banks in recent years, and the
concomitant increase in the aggregate of their deposits subject to
check has been generally recognized by most thoughtful bankers as
a concrete and convincing example of the money creating function
of the commercial banking system, though they may not clearly under•
stand it.
The fact is that providing the oountry with a sound,
elastic and efficient currency is the prime function of a commercial banking system.
Incidentally, commercial banks perform
many other useful services, including the savings bank service
of receiving, on deposit, saved money income, and lending it to
persons, corporations, and municipalities for investment by
them in durable goods - homes, business buildings, and publio
improvements.
The one peculiar, significant, and exclusive function of commercial banks, however, is the operation of the banking process, and the banking process consists in the creation,
servicing, and extinguishment of bank deposit currency - bank money,
That currency is created by making bank "loans" and "investments".
It is serviced by the exchange, transfer, and account-
ing facilities and services of the banks, and it is extinguished
by the collection of loans and the liquidation of investments.
Banks manufacture bank money out of the sound credit of their
customers, much as grist millers once manufactured flour out of
the good wheat of their farmer customers, and the money so manufactured belongs, not to the bank but to the borrower, just as
the flour belonged not to the grist miller but to the farmer who
grew the wheat. To carry the analogy a little farther, the bank
retains a very small portion of the newly manufactured bank money
as a charge for its services in manufacturing or converting
its customer's credit into currency, just as the ancient grist
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miller retained a small part of the flour as his compensation
for manufacturing or converting the farmer^ wheat into flour*
This service charge made by the banks for monetizing the credit
of their customers is mistakenly called interest. This unfortunate application of the term "interest" to designate a service
charge for monetization arose no doubt from the fact that the
process of monetizing looks so much like the process of lending.
The use of the word "credit" to designate numerous concepts also
has befuddled our minds. Ihen used here to designate the material
out of which bank money is manufactured it has a very specific and
limited meaning• The sort of credit which banks are justified in
manufacturing into bank money (not the kind of credit which banks
sometimes do improperly manufacture into money) consists in the
binding obligations of solvent participants in the economic process.
Whether accompanied by lien instruments or not (l) these
obligations constitute valid claims against useful goods and
services in existence or in process of creation, and on their way
to market - current goods and services in which this bank money
will shortly be redeemed through the markets.
It is in fact these
valid self-liquidating claims against current goods and services
(collectively called current credit) which the banking system properly may convert or manufacture into bank money.
Banks convert this credit into bank money by giving it
the quality of currency or acceptability as a means of payment
and this process is called monetization. They give their customers' credit this quality of currency by several acts: first, by
(l) If these obligations are not accompanied by lien in-
-6-
sponsoring that credit and guaranteeing its soundness; second, by
undertaking to convert that credit into cash immediately upon demand; third, by providing the exchange machinery and services whereby this credit may be transferred by check from person to person
and place to place.
Let us see if a bank does these things without substantial cost, as Mr. Yoorhis alleges; Before a bank may vouch for
the genuineness and suitability of its customer's credit and
guarantee the soundness thereof, it must take the neoessary steps
to determine whether or not it is current credit; whether or not
this credit reflects the current creation of useful goods and
services, and whether or not the credit is sound. To do these
things the bank must avail itself of extensive information facilities and the mature judgment of trained and experienced bank officers
This is an expensive operation.
Moreover, the guaranteeing of
customer credit continually involves the exposure of the bank to
substantial risk which inevitably results in occasional losses.
These losses also are a part of the cost of monetizing customer
credit - manufacturing bank money.
Beside underwriting the soundness of its customers1
credit, the bank promises to convert that credit into cash immediately upon demand.
To insure its ability to make this promise
good the bank must continually hold large sums of cash idle and
ready for this purpose.
This also is a material element of cost.
Beside the cost of appraising customer credit and absorbing the losses which arise from failure of customer credit, and
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holding large sums of idle cash, the banks must also defray the
cost of maintaining expensive banking quarters centrally and,
therefore, expensively located. They must provide all the necessary "blanks, forms, and other supplies, and the necessary modern
calculating and recording machines, and employ the bookkeepers,
tellers, clerks, auditors, and administrative officers necessary
to accomplish the immense task of servicing this bank money.
In the days of relatively high rates of so-oalled
interest practically all of the cost of operating our commercial
banking system, which is in fact the cost of monetizing credit,
was levied upon the so-called "borrowers" and collected as
"interest,"
More recently increased costs of bank operation and
reduced "interest" rates have already made it necessary to collect
from the depositors a substantial part of the cost of servicing
bank money.
If banks were denied the right to collect service
charges (so-called interest) for monetizing their customers1 credit
they would be obliged to add to their present service charges
against depositors the amount which they are now collecting in
"interest" from their "borrowers" and no net saving to the
community would result.
There may be room for difference of opinion as to the
ratio in which banking service charges should be levied upon those
whose credit is monetized (borrowers) and those who currently own
this monetized credit ("depositors") but, manifestly, the aggregate of these charges must be sufficient to pay the full cost
of the service plus a reasonable profit or the service can
-8-
not be provided.
Bank stock is a risky and highly speculative
investment since it is its important function to provide a
cushion for the protection of depositors.
It is unthinkable that
the owners of capital will subject themselves to these well-known
hazards without the reasonable expectation of a fair reward. As
a matter of fact, earnings on bank capital are not and have not
been liberal when compared with the earnings of other equally
speculative investments.
ffhus far this discussion has dealt only with the monetization of customer credit, and it must be remembered that Mr.
Voorhis1 principal complaint is against the monetization of government credit through the banking process. Obviously, the monetization of government credit costs the banks less than does the
monetization of customer credit, because the expense of determining the soundness and suitability of the credit is eliminated, as
is also most of the bankfs risk.
(2) There remains, of course,
the cost of maintaining large reserves of idle cash, and the much
larger and continuing cost of providing the machinery of exchange
by which monetized government credit is transferred by check from
person to person and place to place, thus sustaining its quality
of currency.
This difference in monetization cost is reflected
in the very low rate of monetization charge (mistakenly called
interest) which the government pays. Here it must be remembered
that the banks do not hold the long-time government bonds which
pay as much as 2% and 2&/o; they hold, instead, the short-time
(2) This risk is not entirely eliminated, because government bonds are not demand obligations. They cannot always be sold for what they cost. Banks have sometimes
found it necessary to sell their government bonds at a
loss in order to provide funds to pay off deposit liability,
-9-
bonds and the average rate of the typical bank portfolio of
government bonds is around 1%» Surely this oannot be regarded
as an excessive charge for the monetization service which the
banks perform.
There are sound reasons why government credit
should not be monetized, but the modest charge paid to the banks
for their service is not one of them.
Mr, Voorhis apparently thinks that since governmant
credit is sound it requires no monetization by the banking process.
We have seen, however, that the guaranty of credit sound-
ness is only one of the less expensive of the several things which
are required to give the quality of currency to credit. Mr.
Voorhis proposes that the Government, instead of selling bonds with
a nominal interest rate to chartered banks, shall require the
Federal Reserve Banks to buy these bonds without interest, paying
the Government by crediting the amount of the non-interest bearing bonds on its checking accounts with one or more of the Federal
Reserve Banks•
Presumably, the Government would issue checks transferring this credit to its contractors and suppliers who would deposit the checks in the chartered banks, thus converting this
credit into bank money. The burden, then, of servicing this bank
money and thus maintaining its currency quality throughout the
whole life of the bonds would fall upon the chartered banks without compensation. The banks would then find it necessary to collect the whole cost of this monetization service from their depositors by additional servioe charges. There would be no net
saving
and all that would be accomplished would be an unjust shift
-10of the cost of monetizing government credit from the taxpayers
to the "bank depositors.
It is quite possible that the Govern-
ment, in its ardor for low interest rates, lias gone too far in
that direotion already.
It may be said that the Government, instead of monetizing its own credit through the Federal Reserve Banks and the
chartered banks, might issue paper money and count it out to its
contractors and suppliers. This would be a rather awkward performance in the first instance, but that is not the major difficulty. Paper money is not what the Government contractors and
suppliers require with which to transact their business, and the
recipients of this paper money would immediately convert it into
bank money by depositing it in their banks, and it would cost the
banks just as much to service this bank money manufactured out of
paper money as it would to service bank money manufactured out of
government bonds or out of customer credit. This cost would
simply be assessed against the depositors instead of against the
Government and again no net saving would be effected.
The advocates
of the issuance of paper money by the Government as a means of
saving interest persistently overlook the fact that paper money
is no longer the currency of commercef that nearly all of the
business of this country is transacted with bank money, and will
continue to be transacted with bank money because it is vastly
more convenient and efficient. Paper money, or gold and silver
for that matter, in excess of what people wish to carry about in
-11-
their pockets is almost immediately converted into bank money
by depositing it in chartered banks, and this bank money must
thereafter be serviced by the banking system just as other
bank money must be serviced. Here again the banks would be
compelled to collect the whole cost of monetizing the Government credit from their depositors, instead of collecting part
of it from the Government and part from the depositors, as is
the present practice.
There is a further practical and enormously important
objection which applies with equal force to large scale sale of
government bonds to Federal Reserve Banks, and to large scale issuance of government paper money. Either procedure would deluge
the chartered banks v/ith wholly unmanageable reserves. If thirty
billion dollars of government bonds (the approximate amount sold
to the chartered banks in the fiscal year 1943) were sold to the
Federal Reserve Banks, or if an equal amount of paper money were
issued, the reserves of the ohartered banks would be increased
by that prodigious amount. The pressure upon bank management to
find employment for these reserves (sufficient to support the
monetization of a hundred and fifty billion dollars of new credit)
would be an irresistable inflationary force.
Form'F. R. 511
TO
<nr.
FROM
REMARKS:
Could someone in your
Division
read this and give me a very brief memo
as to whether it is or is not a good
answer to Voorhis
etc.? The °hairman
asked me to pass this on to you for this
comment so he can reply tp^the letter.
CHAIRMAN'S OFFICE
©
RIR/EAG:rsd
March 4, 1944
Manuel vs. Voorhis
The criticism Mr. Manuel makes of Mr. Voorhis* "Out of Debt,
Out of Danger** shows that he does not grasp Mr. Voorhis1 ideas. The
major argument of Mr. Voorhis is that control of the money system should
be returned to the hands of the Government as is provided in the Constitution. He claims that this would require Government ownership of the
Federal Reserve System and 100 per cent reserves for the commercial banking system. This is the system that was popularized a number of years
ago as the Chicago Plan, but which gained other advocates such as Irving
Fisher and Lauchlin Currie. The idea of control is the major thesis of
Mr. Voorhis1 work but a minor and subordinate thesis is the saving of
interest on the public debt. Mr. Voorhis as a Congressman is inclined
to pursue arguments that are effective in Congressional debate, so that
his treatment of this subject is more polemic than academic. As a
result, he gets in some very effeotive licks concerning the interest
burden on the public debt.
Mr. Manuel never joins issue with the major thesis of Voorhis,
but spends most of his time in rebuttal of the interest charge argument.
On this limited point Mr. Manuel argues with good sense and with vastly
more understanding of the fundamental banking operations than most bankers
have. But the only place at which !'r. Manuel really touches on the major
thesis of Jsrry Voorhis is where he draws upon the now commonly discarded
commercial banking theory, i.e., that the extension of bank credit for
true commercial purposes can never inflate or deflate the economy sinoe
the credit is only called into being when real goods are available and
is automatically extinguished when the goods disappear.
The most effeotive reply to Mr. Voorhis was passed up altogether by Mr. Manuel. That argument consists of two simple parts:
(1) For all intent and purposes the Federal Reserve System
is now publicly controlled and the small element of private
ownership does not keep the System from acting as a public agency
in the broad public interest.
(2) So long as the reserve ratio isn't too low, control
over the total volume of payments is nearly as effeotive under
a fractional reserve system a? under a 100 per cent reserve plan.
The present average ratio—about 1 to 6—seems to be quite adequate.
In replying to Mr. Manuel, one might compliment him on the
caliber of his rebuttal (that can be done conscientiously because he jl£
intelligent), and then suggest the two points mentioned above. If he
would be interested (ana I suspect he is the sort of man that would be)
a reference to Angell!s discussion of the 100 per cent reserve proposal
might be helpful to him. It appeared in the Quarterly Journal of
Economics for November 1935..
\
March 7,
Mr. Ralph W. Manuel, President,
the Marquette National Bank,
Minneapolis, Minnesota.
Dear Mr. Manuel:
Your letter of February 16 enclosing your comments on Mr.
Voorhis1 book, entitled "Out of Debt, Out of Danger", did not go
into the wastebasket, but interested us here very much. As I understand it, the major argument of Mr. Voorhis is that in order to
assure to the Government absolute control of the money system as
provided in the Constitution, the Government should acquire ownership
of the Federal Reserve System and institute a hundred per cent reserve
requirement for the commercial banks. This idea was popularised some
years ago as the Chicago Plan and was vigorously promoted by Irving
Fisher, among others, fixe idea of unequivocal Government control is
the major thesis of the book, but a minor and subordinate thesis is
the saving of interest on the public debt. You have devoted yourself
largely to a rebuttal of his argument in regard to interest, and I
think you have done so most effectively and with a grasp of fundamental banking operations that unfortunately is only too rare among
the bankers.
X have debated this subject frequently in committee hearings
with Wright Pataaan, who is a well-informed and an able antagonist. I
have contended that the Federal Reserve System is now publicly controlled and that the incidental fact that member banks own stock in
the Reserve Banks does not keep the System from acting as a public
agency in the broad public interest* As to the hundred per cent reserve requirement, so long as the reserve ratio is not too low — it
is about one to six at present — control over the total volume of
payments is nearly as effective under a fractional reserve system as
it would be under a hundred per cent reserve plan.
In March of 19U1 I addressed a public letter to Mr. Patman
because it seemed to me that something ought to be said in answer to
his repeated speeches over the radio and on the floor of Congress in
advocacy of non-interest-bearing debt. I am enclosing a copy of this
letter because it occurred to me you might not have seen it and you
might be interested in reading it. I didn't go into the hundred per
Mr. Balph W. Manuel
-
(2)
March 7,
cent reserve question because he had not injected that into his
In regard to that question, you perhaps have read, but
if you have not you may want to look up, Professor James W. Angellfs
discussion of the hundred per cent reserve plan which appeared in
the Quarterly Journal of Hoonoiaics for Bovember, 1935*
You are to be complimented on the high caliber of your rebuttal, ahieh most favorably iispressed our economics division, as it
did ae«
With kind personal regards,
Sincerely yours,
M. S* Eccles,
Chairman.
Enclosure
THE MARQUETTE NATIONAL BANK
OF MINNEAPOLIS
MINNEAPOLIS, MINNESOTA
2
April 5, 1944
Mr, S&rriner 3. 3coles
Board of Governors
Washington, D. C.
My dear Chairman:
Thank you for your gracious letter of March 7, and for the copy of
your excellent letter to Mr, Battman, which I have enjoyed reading
again. During the years that you have been in Washington I have
read, with keen interest and great profit, everything of yours that
has come v/ithin my reaoh. It has been a liberal education in the
matters in which I am most interested. Certainly, no other man in
the Government has understood the nature of banking so well, and
discussed it so frankly. Incidentally, you have made it respectable, even among bankers, to talk about the banking process as it
is*
I have finally found time to dig up Dr. Angell's 1935 article and
read it again. I was interested to note that my reaction to his
proposal is no different now than it was nearly a decade ago. I
never have bothered much with the several techniques which these
men have proposed because I am wholly unsympathetic toward their
common objective of putting the banks out of the banking business,
and making them merely agencies for the loan of existing funds.
These plans all propose to replace our monetized credit currency
with a purely fiat currency.
Now, I am not one of those persons
who are disposed to insist upon a currency tied to gold, but I am
a firm believer in a currency tied to current goods and services
(the summum bonum of our material life).
I realize that the credit which our banks have monetized never has
been strictly limited to current producer credit (claims against
current goods and services on the way to market); that the emergency
of deep depression drove us still farther away from sound practice
in this respect, and that the emergency of war now has compelled
the creation of inflation currency almost to the exclusion of sound
currency, but it appears to me that the cure for this unhappy
situation is not to be had through the abandonment of the highly
useful banking process, but rather through reforming, improving and
perfecting it.
«.
Yours very truly,
U
http://fraser.stlouisfed.org/
RWM-Eh
Federal Reserve Bank of St. Louis
(jaAw~<s^^^^
April 11,
Mr. Ralph W. Manuel, President,
The Marquette National Bank,
Minneapolis 2, Minnesota.
Dear Mr. Manuel:
It seems to me that your views and mine in regard to banking and currency matters run along closely
parallel lines, and 1 wanted you to know that X very much
appreciate your generous personal references in your
letter of April 5.
From time to time over the past decade, X have
had the privilege of seeing material that has come from
your pen. Unfortunately, not many men in our profession
take the time and trouble to read and study as thoughtfully and extensively as you do. X am therefore the more
gratified to have your kind and encouraging letter.
Sincerely yours,
M. S. Eccles,
Chairman.
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@FedFRASER