Posts Tagged ‘technology’
Henry R. Nothhaft author of the book Great Again was interviewed on the Dylan Ratigan show on MSNBC and the Harvard Business Review blog radio. The Dylan Ratigan show focused on job creation and how all new jobs are created by startups not by small business or large corporations. Mr. Nothhaft argues thatWashington is forcing a once size fits all government on American businesses. He wants an immediate freeze on new regulations on startup business and a carve out from Sarbanes Oxley and Dodd Frank for companies with a market capitalization less than $500M. He explains that multinational companies have choices to create jobs in theUS or outside the US and suggests that large companies have decided to create jobs outside the US. While I think it is important to point out the current business climate in the US is causing companies to move overseas, the reality is that large corporations never produce large numbers of net new jobs and they are not the engine of innovation. The host attempts to argue that labor rates are the only reason that companies are relocating outside the US. Mr. Nothhaft explains that for high technology companies labor costs only represent 3% of their total expenses and it is the US tax and regulatory structure that are killing startups.
One of the panel members suggests that Google, Facebook, Twitter, etc show thatSilicon Valleyand innovation in the US are doing just fine. First of all, Google was started in the late 1990s before SOX, other regulatory burdens and before the patent system in this country was undermined. SOX and the changes to our patent system have destroyed the venture capital market in theUS. Second, social media companies have not driven the entire economy like the Internet did in the 1990s and the personal computer did in the 1980s. These companies and the social media industry are isolated islands of success that have little significance to the broader economy. If the panel member had any insight to the US economy he would known that the number of technology startups has declined precipitously. The Information Technology and Innovation Foundation index ranked the US dead last among 40 countries in the change in our rate of innovation last decade and many other indicators show the US is falling behind technologically.
The host of the show and the panel seemed to have no idea what Mr. Nothhaft was talking about. My guess is that the host and panel are all Wall Street experts who believe finance is the American economy. They believe in Keynesian economics in which manipulating the money supply and increasing demand by increasing government spending are all that matters. They have no idea what affects technology startups and they do not really believe they are important. They do not understand that technology startups create the inventions that increase our real per capita income.
The Harvard Business Review interview again focused on how startups create jobs. Mr. Nothhaft again argues for a two-tiered approach to SOX and other financial regulations. He argues that technology startups do not use leverage and do not pose a threat to the financial system of the US. He also points out that Lehman Brothers, AIG, Goldman Sacs, etc. were all SOX compliant going into the current financial crisis.
He later explains that the patent system has been undermined by the theft of user fees from the Patent Office by Congress to the tune of over $1B in the last two decades. Congress just stole another $100M from the Patent Office in the continuing resolution bill – See Stealing From Inventors.
The HBR interviewer is also ignorant of the US’s lack of innovation in the last decade. She does not understand that increases in technology are the only way to increase real per capita income. The host ends the interview with the condescending comment that it’s clearly a very complex issue. It is not complex! When the government interferes with property rights (particularly patents) and imposes absurd regulatory burdens (SOX, Dodd Frank) and the US has the highest corporate tax rate in the World it is straight forward that the result will be fewer businesses, fewer jobs, and a lower standard of living for all.
I respectfully disagree with Mr. Nothhaft’s two-tier approach to SOX and other financial regulation. First of all, Mr. Nothhaft points out that SOX failed to stop financial fraud and the 2008 financial meltdown. He points out that the companies he believes should be subject to SOX were all SOX compliant, but they were also the ones that caused the financial meltdown. So if SOX does not work, why have a two-tiered approach? SOX should be repealed – period. Second, laws that only apply to certain people or businesses are the essence of tyranny. A good law should apply to all people equally, much like a law of physics/nature. When Congress exempts itself from certain laws (e.g., antidiscrimination, Social Security, Obama Care, etc) and makes convoluted tax laws to help the politically connected at the expense of the rest of the country, you know that you are on the path to tyranny. Adding another law that only applies to certain businesses will only accelerate the US’s decline into despotism.
This intriguing question and its implications for US economic policy are tackled in the groundbreaking book Great Again, by Henry R. Nothhaft with David Kline. They answer the above query with a series of questions:
Could a twenty-year-old college dropout, just back from six months in an ashram somewhere, attract funding for a capital-intensive venture based on the manufacture (yes, the manufacture) and sale of a $2,500 consumer product unlike any that had ever been bought by consumers before? One whose potential uses were at best unknown, and possibly nonexistent? And one for which the total current market size was exactly zero?
Not only could Apple not get funded today, it probably could not go public. Nor would Apple have received its first patent (USPN 4,136,359) in only 20 months. The book asks “how many of today’s Apples are not getting a chance?”
The authors use the above example to make a broader point that theUSis failing economically and technologically because of the policies we are pursuing. They show that all net new jobs created in theUSsince 1977 (and possibly longer) were created by startups like Apple. All increases in real per capita income are due to new technologies and most revolutionary/disruptive technologies are created by startups and individual inventors. So what are the policies that have undermined our economy, by undermining technology startups?
The book examines five areas:
1.Role of regulations. The Authors show that our tax policies, Sarbanes Oxley and our indifferent (some might say arrogant) regulators’ application of well meaning regulations to startups is driving them either overseas or out of business.
2. Underfunding the patent office. This is costing theUS millions of jobs and billions in GDP. According to the authors, each issued patent is worth 3-5 jobs on average, particularly patents issued to startups.
3. Manufacturing policies in the US. Manufacturing is key, particularly in a world that does not respect property rights in inventions, to ensuring that theUS profits fromUS innovation and not other countries. TheUS is also losing the global battle for human talent.
4. Battle for global talent. Our restrictive immigration policies are depriving theUS of talented entrepreneurs such as Andy Grove, founder of Intel.
5. Funding for research. The book shows that our spending on basic science and engineering is not only declining as a percentage of GDP, but the system has become short-term oriented and bureaucratic.
While this book tackles complex issues, it is a quick easy read. It is full of interviews from entrepreneurs, venture capitalists, and technologists who built America’s technology startups over the last three decades. Great Again provides numerous real life examples to illustrate its points.
This pioneering book shows how the US can create jobs and increase per capita income. The policy prescriptions are based on solid science. Just cutting government spending (balancing the budget) will not cause theUSeconomy to grow vigorously, we need pro-growth policies. The authors are some of the few people that understand what policies are needed for the US to be GREAT AGAIN.
Great Again: Revitalizing America’s Entrepreneurial Leadership, by Henry R. Nothhaft and David Kline
The genesis of the non-obviousness standard (Inventive Step in Europe) was the Supreme Court’s decision in Hotchkiss v. Greenwood, 52 U.S. (11 How.) 248 (1851). This case first articulated the idea that the improvement that was the subject of a patent had to be more than “the work of the skilful mechanic.” The case involved making door and other knobs of all kinds of clay used in pottery, and of porcelain.The invention according to the patent holder was:
This improvement consists in making said knobs of potter’s clay, such as is used in any species of pottery; also of porcelain; the operation is the same as in pottery, by moulding, turning, and burning and glazing; they may be plain in surface and color, or ornamented to any degree in both; the modes of fitting them for their application to doors, locks, furniture, and other uses, will be as various as the uses to which they may be applied, but chiefly predicated on one principle, that of having the cavity in which the screw or shank is inserted, by which they are fastened, largest at the bottom of its depth, in form of a dovetail, and a screw formed therein by pouring in metal in a fused state.
The Supreme Court upon reviewing the case made the common error of pointing out that each of the elements in the invention were known.
But in the case before us, the knob is not new, nor the metallic shank and spindle, nor the dovetail form of the cavity in the knob, nor the means by which the metallic shank is securely fastened therein. All these were well known, and in common use, and the only thing new is the substitution of a knob of a different material from that heretofore used in connection with this arrangement.
All inventions are combinations of known elements since conservation of matter and energy means that you cannot create something from nothing, for more information see KSR: Supreme Ignorance by Supreme Court. As a result, this analysis by the Supreme Court is meaningless and sheds no light on whether the invention should have obtained a patent.
Based on this analysis the Supreme Court then reasons:
for unless more ingenuity and skill in applying the old method of fastening the shank and the knob were required in the application of it to the clay or porcelain knob than were possessed by an ordinary mechanic acquainted with the business, there was an absence of that degree of skill and ingenuity which constitute essential elements of every invention. In other words, the improvement is the work of the skillful mechanic, not that of the inventor. (underlining added)
This ruling states the well known idea that for an invention to be patentable, it must be more than just the work of a skillful mechanic. Today this is stated as the invention must have taken more than just the work of “one skilled in the art.”
There are a number of problems in the Supreme Court’s ruling in Hotchkiss v. Greenwood. First, where did the Supreme Court get the authority to add an additional requirement above novelty in order for an invention to obtain a patent? The statute at the time did not contain any such additional requirement. It was judicial activism to add a requirement not found in the statute. Another error in the Supreme Court’s reasoning is the use of hindsight. All inventions are obvious in hindsight and must be described in enough detail that they can be practiced by one skilled in the art (ordinary mechanic) to meet the requirement of the social contract of patents. Another error in the case was the failure to recognize that copying by competitors of the invention or success of the invention tend to show that it was non-obvious. Finally, the Supreme Court failed to understand the implications of the laws of physics as they apply to inventions, specifically that conservation of matter means all inventions are combinations of known elements.
Despite these errors, it is reasonable to ask did the Supreme Court’s judicial activism result in any lasting problems? According to Gale R. Peterson, Cox Smith Matthews in their paper, “Obviousness / Non-Obviousness Of The Novel Invention: Hotchkiss v. Greenwood to KSR v. Teleflex 35 U.S.C. § 103 – 1851 to 2006.”
The cases decided after Hotchkiss in 1851, both by the Supreme Court and the lower courts, were chaotic. There was no statute governing the additional hurdle an otherwise novel invention must cross before being deemed a patentable invention.
The Supreme Court’s decision in Hotchkiss v. Greenwood resulted in an unworkable standard of patentability, because it was inherently subjective. This increased the uncertainty whether an inventor would obtain a patent for their invention and increased the risk that their patent might be held invalid. It also caused the standard of patentability to vary in different Circuits and the Patent Office. Today this is widely understood to increase the cost of obtaining a patent and decrease the amount of resources invested in inventions. The Supreme Court’s judicial activism in Hotchkiss v. Greenwood resulted in numerous problems that haunt us today. Including the complete nonsense opined by the Supreme Court in the KSR v. Teleflex decision, see KSR: Supreme Ignorance by Supreme Court.
Is there any logical reason for the additional requirement of non-obviousness for patents? The definition of invention according to Free Dictionary online is “to produce or contrive (something previously unknown) by the use of ingenuity or imagination.” While Merriam Webster (online) defines invention as “a device, contrivance, or process originated after study and experiment.” I will ignore how and invention is created as a criteria and suggest the following definition, “to create something new” as a common sense definition. This definition differentiates production or manufacturing from invention. Production is creating something, but it is not creating something new it is creating something old. If you argue that it is creating something new, then the word new has no meaning in the definition. This definition does not do a good job of differentiating an invention from a new book or painting. It might be argued that a new book is not creating something new, but it is not the same as other books. So I believe this simple common sense definition has to be supplemented. Specifically, I suggest that invention is “to create something new that has an objective result.” By an objective result I mean that goal of an invention is an objective result that can be tested as opposed to a subjective result that is the result of a song being played or a book being read or a painting be viewed. An objective result distinguishes an invention from a new artistic creation.
So how does this common sense definition of invention, “to create something new that has an objective result,” match up with the requirements of patent law (101, 102, 103, 112)? This definition is generally consistent with section 35 USC 101, statutory subject matter. It excludes scientific and mathematical discoveries since these are not creations. Notably it clearly does not exclude software patents. A software enabled invention is clearly a new creation and it has an objective result. The same is true of business methods patents (for more on the nonsense associated with business method patent see – Bilski, Software Patents and Business Method Patents. This definition is clearly consistent with section 102 – new equals novel. Is this definition consistent with section 35 USC 103? No this definition is not consistent with section 103. There is nothing in the definition that suggests a standard above novelty or new. The general reason given for section 103 is that we do not want trivial inventions that just change the size or the weight or some other trivial feature of an existing invention to obtain a patent. If a change in size or weight or color does not make a difference in the objective result, it is not new and it is not an invention. So I believe the definition of invention I have offered covers this issue and therefore there is no reason for an addition standard above novelty. My suggested definition is neither consistent nor inconsistent with section 35 USC 112, since this section does not define what is an invention. Section 112 defines the requirements an inventor must meet to obtain a patent for their invention. Section 112 deals with the social contract between the inventor and society. Overall the common sense definition I suggested for invention fits nicely with patent law, but there is absolutely no logic for a nonobviousness criteria for patents based on this definition. The creation of the nonobviousness standard was judicial activism on the part of the Supreme Court without any statutory justification. The standard has proven to be completely unworkable and completely subjective. Only the CAFC’s jurisprudence before KSR provided any measure of a stability and logic to the section 103. The nonobviousness standard has resulted in increase costs to inventors without any benefit. It has increase the cost of ligation, helped technologies thieves to steal inventions, and decreased the amount invested in new technology.
I suggest the radical notion that logically the nonobviousness standard, 35 USC 103, should be repealed. If it is not repealed then we should demand a statutory definition that is as objective as possible. One objective solution would be to codify the CAFC’s teaching, suggestion, motivation (TSM) test. I have proposed an alternative standard for 35 USC 103 that I believe is even more objective, clearer, and more consistent with reality than the TSM test – see Obviousness Flow Chart . By adopting any of these solutions we will reduce the cost and uncertainty of obtaining a patent and litigating patents. This will increase the value of issued patents and increase the investment in new technologies, which are the only way to increase real per capita income – see The Source of Economic Growth.
As an interesting intellectual exercise I attempted to use ordinary definitions of novelty and obviousness to determine if the Supreme Court’s seminal decision in Graham v. Deere had any basis in logic and was in anyway consistent with the statutory language. The non-obviousness standard was added to U.S. patent law in the 1952 Patent Act. The Courts’ job is to interpret the statute. The key portion of the non-obviousness statute states:
A patent may not be obtained though the invention is not identically disclosed or described as set forth in section 102 of this title, if the differences between the subject matter sought to be patented and the prior art are such that the subject matter as a whole would have been obvious at the time the invention was made to a person having ordinary skill in the art to which said subject matter pertains. (underlining added)
While many lawyers will want to immediately jump to the legislative history to interpret the statute, this is only appropriate if the statute is not clear on it face. Based on the wording and the fact that section 103 was added later than the novelty requirement, logically 103 is intended to be an additional requirement above the novelty requirement. According to Dictionary.com, novelty means “of a new kind; different from anything seen or known before: a novel idea.” The nonobviousness requirement logically requires something more than an invention be novel. In order to understand what nonobvious means, lets find out what obvious means. Then anything that does not meet the definition of obvious is nonobvious. According to Dictionary.com obvious means, “easily seen, recognized, or understood; open to view or knowledge; evident.” It is axiomatic to patent law that whether an invention is nonobvious has to be determined at the time the invention was made, in other words before the invention was known. How can an invention that has not been made be easily seen, recognized, or understood; open to view or knowledge; evident (obvious)? Clearly, an invention that has not been made cannot be open to view and how can you have knowledge of something that does not exist. Evident means, according to Dictionary.com, plain or clear to the sight or understanding, which cannot be true of something that does not exist. Unfortunately, this line of examination does not lead to any useful results. No wonder the 1952 Statute has not lead to meaningful clarification of what is patentable!
 Hotchkiss v. Greenwood, 52 U.S. (11 How.) 248, 249 (1851)
 Ibid 250-251
 Ibid 266
 Ibid 268
 35 USC 112, first paragraph (Modern)
 Gale R. Peterson, Cox Smith Matthews, “Obviousness / Non-Obviousness Of The Novel Invention: Hotchkiss v. Greenwood to KSR v. Teleflex 35 U.S.C. § 103 – 1851 to 2006.” 11th Annual Advanced Patent Law Institute, October 26-27 2006.
 Ibid 3.
 KSR Int’l Co. v. Teleflex, Inc., 550 U.S. 398 (2007).
 http://www.thefreedictionary.com/inventor (6/16/10).
 http://www.merriam-webster.com/netdict/invention (6/16/10).
 Graham v. John Deere Co. of Kansas City, 86 S.Ct. 684 (1966)
Accounting rules for R&D result in companies and nations under investing in research and development. Since increases in real per capita income are the result of increases in our level of technology, this accounting error actually results in all of us being poorer. The point of R&D is to create inventions, whether products or processes, that are useful. R&D that does not result in inventions may be interesting intellectually, but does not increase our wealth- so the rest of the post will discuss investments in inventions as opposed to the more nebulous concept of R&D.
Creating an invention without obtaining legal title to the invention is like building an office building without obtaining title to the land and building. Without legal title to the office building, you cannot finance the building, sell the building, or lease the building. In other words, without legal title to the office building its economic value is significantly reduced. The same is true of inventions. Inventing something without obtaining legal title to the invention means that you cannot license (lease) the invention, cannot sell the invention, and cannot finance the invention.
There are couple of ways to obtain title to an invention. You can either obtain a patent on the invention or you can keep the invention a trade secret. Many inventions are not amenable to trade secret protection. As a society, it is better if people obtain patents instead of keeping their inventions a trade secret, since a patent allows other people access to the knowledge associated with the patent, allowing them to use this knowledge to build other inventions.
The present accounting rules for the costs in creating an invention and obtaining title to the invention result in an immediate expensing of these costs. While this may be helpful from a tax point of view, it causes these costs to appear superfluous. Note that the rest of this post is concerned with accounting as an accurate measurement tool for the operations of a business and is not concerned with tax law, which has caused so many perversions to accounting and business generally. Our present accounting systems never show internally funded inventions produce any value.
This excellent book by Pat Choate will both frighten and upset you. For instance, Dr. Choate relates the shocking tale of a woman from Alabama who received a counterfeit antibiotic for a routine infected ingrown toenail and almost died. Counterfeit medicines kill and injure people every year. The U.S. is not immune to counterfeit medicines entering our market as the story of the woman from Alabama shows. Counterfeiting medicines has become a major criminal enterprise. The reason for this, according to Choate, is the risk of getting caught counterfeiting legitimate medicines is significantly less than distributing and selling illegal drugs. In addition, the margin for counterfeit medicines is often higher than the profits obtained selling illegal drugs (and less dangerous).
The pharmaceutical industry is not unique in dealing with counterfeits. According to a FAA report, 176 aircraft accidents were the result of counterfeit parts between 1973-1996. Almost every industry in the U.S. is under attack by pirates making counterfeit products. The tales of counterfeit music, software, and movies are well known, but there isn’t a personal harm component. It is past time that we deal with piracy issues effecting our citizens’ security.
A number of these pirates operate with the tacit or even explicit support of their governments. Dr. Choate documents the long history of state supported industrial espionage. Often foreign governments target certain technologies that both increase their commercial and military might. Our government has not prioritized stopping commercial pirates or industrial spies and the United States citizens are all poorer for their negligence. In some cases, there is even domestic industry that profits from the pirates’ activities at the expense of our long term future. These domestic industries lobby hard for inaction on the part of our government. For instance, the retail industry often turns a blind eye to trademark and copyright violations and other forms of counterfeit products.
Perhaps most maddening though, is our government’s policy of giving away our technology. For instance, Dr. Choate shows that during the Clinton administration and continued in the Bush II administration, we failed to protect the technologies of our domestic inventors. Our government gave away many of the most important safeguards in our patent system to the Japan and Europe and received almost no concessions from them. For instance, we now publish our patent applications at 18 months for the whole world to see and providing the opportunity to steal our technology. We fought hard in the GATT trade negotiations to require other countries to strengthen their intellectual property laws and enforcement. In return, we significantly reduced our tariffs on textiles and apparel. This has decimated our textile and apparel industries; but these countries have not come into compliance with the requirements for strengthening their intellectual property systems. We could bring suit against these countries in the WTO (World Trade Organization) and force compliance, but for some reason we seem uninterested or unwilling to require these nations to uphold their part of the bargain. I am a strong believer in free trade, but stealing intellectual property is not free trade- it is just theft, pure and simple. Theft of real property results in underinvestment in real property. It follows that theft of intellectual property results in underinvestment in technology, making us poorer in the US, which in turn makes the whole world poorer.
An interesting point that becomes clear in Hot Property, is the Reagan Administration took intellectual property rights, particularly patent rights, more seriously than any subsequent administration. Reagan understood that our technological innovation has always been the key to our wealth.
Some people suggest that Venture Capital is just in a normal cyclical downturn. Not a single venture backed company went public in second quarter of 2008. This has not happen since 1978. This was followed up by no venture backed companies going public in second and third quarters of 2009. This is clearly not just a cyclical downturn.
Venture Capital is built on technology start-up companies whose main assets are inventions. The value of these inventions is determined not just by their technical merit, but the strength of title to the invention. If legal title to the invention is weak, then a great technical invention provides a very limited opportunity for the start-up company or its investors. This clearly reduces the value of the company and the chances of return for it investors. Since 2000 the U.S. has significantly weakened inventors’ title to their inventions.
A thriving Venture Capital ecosystem requires a viable exit market for start-up companies. This provides returns for the Venture Capital investors, founders, and key employees. While mergers and acquisition are one exit market, a viable public market is critical for start-ups to obtain reasonable valuations in M&A market. As discussed above, the public market is essentially closed to start-up companies.
The book, The Decline and Fall of the American Entrepreneur, by Dale B. Halling, explains:
How we have weakened inventors’ and start-up companies’ rights to their inventions;
How the capital markets have been foreclosed to technology start-up companies;
How the accounting rules have changed to limit start-up companies access to human talent; and
How these changes to our laws are killing the Venture Capital market.
Get your copy of The Decline and Fall of the American Entrepreneur today. Available on Amazon.com.
The first step in build a market dominating patent portfolio is to undertake a survey of the patent landscape in your marketplace. For more information on how to perform a prior art survey please see Competitive Analysis and Patent Portfolios . This analysis will show you where there are gaps in the prior art that can be exploited and also help stimulate your thinking about design options. Gary Boone, the inventor of the microcontroller, explains the advantage of surveying the prior art this way. “Most engineering design groups do not feel there is much to learn by reading patents. I feel that’s unfortunate, because there is a huge amount to learn from the accumulated five million issued patents, just picking up the U.S. patents alone.”
This post is the Introduction to my book, which should be available on Amazon.com in December of 2009.
This book started as a project based on my observations. I deal with technology start-up entrepreneurs everyday as a patent attorney. I noticed a difference between the sort of projects my clients were undertaking since the technology downturn of 2000-2001 and the 90s. Clients, in the 90s, would come into my office with plans to build businesses that were disruptive or revolutionary. The technologies underlying these companies held the potential to completely redefine a market. Some of these of these ideas would increase the available bandwidth by 10x for minimal costs or allow data searches that were 10-100x faster than existing technologies. It was extremely exciting talking with these entrepreneurs. Their energy was infectious and the potential implications of their work was mesmerizing. The technology downturn of 2000-2001 forced a reevaluation of these aggressive business plans. I expected that after a couple years of the technology market taking a breath, I would again be working with companies trying to change the world.
Most companies that generate enough patents to justify an in-house patent counsel have a Patent Review Committee. The Patent Review Committee determines if an invention described in an “Invention Disclosure Form” is worthy of obtaining patent protection. The committee is usually made up of a business/marketing person, one or more technical people, and one or more patent attorneys. An inventor usually makes a short presentation to the committee based on the Invention Disclosure Form. Here are the top five reasons why Patent Review Committees result in second rate patent portfolios, hurt innovation, and increase legal costs.
There are number of indications that the U.S. is losing its technological edge. In the second quarter of 2008, there were no public offerings of Silicon Valley venture capital-backed companies, a phenomenon not seen since 1978. U.S. venture capital firms are investing more of their funds overseas. Many U.S. trained, foreign national, scientists and engineers are leaving the U.S. and returning to their home countries. In 2001 (the most recent year for which data are available), US industry spent more on tort litigation than on research.
A number of scholars have suggested that the logical basis for property rights is scarcity. Property rights efficiently allocate these resources and avoid conflicts. These scholars argue that ideas and inventions are not subject to scarcity and therefore intellectual property rights should not exist. These arguments seem to be particularly prevalent among Libertarians, including the Cato Institute and Von Mises Institute, and the open source community.
None of these securities laws were able to prevent the stock market decline of 2000. Sarbanes Oxley was passed in 2002 in reaction to several corporate and accounting scandals including those affecting Enron, Tyco International, Adelphia, and WorldCom. The legislation set new or enhanced standards for all U.S. public company boards, management, and public accounting firms. The act contains 11 titles, or sections, ranging from additional corporate board responsibilities to criminal penalties, and requires the Securities and Exchange Commission (SEC) to implement rulings on requirements to comply with the new law.
Phoenix: Mythical Fed Chairman Muses on the Economic Growth of the 90s
The Federal Reserve Chairman was sitting in his office contemplating the fantastic problem that he and the other fed governors were trying to solve. The Federal Reserve, since its inception in 1913, had never faced such a dilemma. Huge federal budget surpluses were likely to wipe out the federal debt in the next couple of years and the fed chairman was concerned how the Federal Reserve was going to control the money supply. Buying and selling treasury notes was one of the major methods the Federal Reserve used to control the money supply. Controlling the money supply was necessary to control inflation, ease recessions and deal with banking crises, such as 1930’s style runs on banks. The Federal Reserve buys treasury bills when they want to increase the money supply and sells treasury bills when they want to decrease the money supply. If the federal deficit was paid off, then the Federal Reserve would have difficulty using open market operations to control the money supply. The Federal Reserve could still alter the discount rate or the required reserve ratio of banks to alter the money supply, but open market operations have a more immediate.
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