Full text of Committee on the History of the Federal Reserve System : Szymczak, M. S. (1950), Entry 168, Box 14, Folder 5

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SPEECHES OF

M. S. SZYMCZAK
MEMBER
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
MASHINGTOH, D. C.

RELATING TO

CREDIT CONTROL AND MONETARY POLICY
1936-1949

-1950WASNINGTOII, D. C.

CONTENTS
"Credit Control by the Federal Reserve System" •—
•Uarch 25, 1936
,.,.,..,.,......,.,

"The Federal. Reserve. System and Credit Control" April 29, 1936

"Credit Control" - June 13, 1936
"The Technique, of Credit Regulation" r
November 5, 1937
•

•

• • • • 25

"Credit and Our. Economy" - December. 28,,. 193.8............... .*............. . 33
"Brief Remarks on Certain Aspects, .of. Reserves". January 2k, 191*1

"Economic Defense" - Hay 18, 191*1

"Tightening up Credit" - October 5, 191*1

"Post Var Credit" - October 25, 191*5

"Our Uonetary Problems" - Hay 1, 19U6

"Outlook for Interest Rates" - June lU, 19l*6

"Our Current Inflation and Monetary Problem" October 20, 191*7

"The Changed Situation in Our Monetary and
Credit problems Today" - January 22, 19U8

"Our Present Financial Situation" - March 23, 191*8

•

"Current Credit Problems" - April 6, 191*8

105

"What About Money and Credit?" - May 7, 19l*8

Ill

"Our Present Economic Situation" - July 31, 19l*8

121

"Bank Reserves and Monetary Restraint" September 1, 19l*8

127

"Our Federal Reserve Policy Today" October 11, 191*8

137

"The Current Economic Situation" - October 27, 191*8
"The Credit Situation" - February 9, 191*9
"Contemporary Monetary Policy and Economic Stability" Uarch 9, 191*9...

Page
"The Problem of Post-War Monetary Policy" . Uarch 11,--19U9*
......•...../..•.

171

"The Current Economic situation" - June 21, 19k9.....••••••••••••• 179
"The Function of Bank Reserves" - August 31, 19U9

,• 187

"Monetary Management Abroad and at Home" - *

October 2fc, 19h9

••••

"What Does a Credit Uan Think About Today?" December 9* 19k9*;
i••
i
•
••Where Now?" - December 9, 19^9

197
207
217

Speech delivered before
Richmond Chapter, American Institute of Banking
Richmpnd, Virginia
March" 25, 1936
CREDITCONTROL BY THE FEDERAL RESERVE SYSTEM
There are five principal 1 means by" which credit control may be exercised in the Federal Reserve System. These are:
Discount Rates
Open Market Operations
Direct Action
Reserve Requirements
Margin. Requirements
Discount Rates
Under the original terms of the Federal Reserve.Act two principal
instruments of credit control were used. One of these was the discount
rate; the other was the rate on.bills,, or as they ere crlled In the j:ct,
"Acceptances". The Act specifically provided that ecch Federal Reserve
bank "establish from time to time, subject to review end determination
of the Board of Governors of the Federal Reserve System,rates,of discount to be charged by the Federal Reserve bank for each class of psper,
which shall be fixed with a view of accommodating commerce end business".
To this the Banking Act of 1935 added.the provision that such retes shall
be established "every .fourteen days, or ofterier if deemed necessary by
the Board". This does not mean that the rates have to be changed every
time, but" that they must be regularly end frequently reviewed. The Reserve banks usually take the initiative in eny action on rates.
The discount rates of the Federal Reserve banks' rre usually somewhere between bill rates, which are usually lower, and other short-tern
rates in the open market, which are usually higher * They ere also lower
than rates which benks charge their customers for loans. They, differ, .
therefore, from the discount rate of foreign central-banks, such es the
Bank of England, for example, whose discount rste is higher than the t
market rate. Since the Federal Reserve bank discount rate is lower than
the rates charged t>y member banks it has usually been possible for member
banks to borrow from the Reserve bank and relend at a profit. It has
not been the practice for them to do so, however, probably because they
are a.verse to having borrowings show up in their published statements. •
Consequently, member banks as a usual thing borrow of.the Reserve brnk
only when they have to. in order to replenish their reserves and ovoid the
penalty for deficiencies in their reserve accounts.
•
. •.
Although each Federal Reserve bank's rate is determined largely with
reference to local conditions, it is important, of course, not to fix -;
rates at any one Reserve bank without reference to the conditions to
which other Reserve banks are subject. The member banks in one district
cannot go to the Federal Reserve bank of another district, but nevertheless if rediscount rates in one district were noticeably lover than in
another it would be possible for funds to find their way through indirect
channels (such as .correspondent benks, for example) from the district
where rates were low to the district where rates vere high. Consequently,

general conditions as well as local have to be taken j n t o . a c c ? ™ * / " d e "
teraining vhat the rediscount rate, vrill be and vhat changes, should be
made.
The Federal Reserve Act formerly limited the classes of paper which
Federal Reserve banks could discount for member banks, on the principle
that a definite preference should be maintained for short-tenn credm
based on self-liquidating commercial transactions, The Reserve banKS
were, therefore, given the power to' discount only'short-term selfliquidating commercial paper, that is'notes, drafts, bills of exchange^
and bankers1 acceptances arising out of commercial, industrial and agricultural transactions, and to make advances to member banks on their
promissory notes backed ly. paper eligible for discount or purchase or
backed by United States Government obligations. It was a narrowly defined classification. Advances on a vide range of other assets which
made up an important part of the total earning assets of bsnks were not
authorized. These included advances on securities other than those of
the United States Government, on real estate loans, and on other loans
of considerable importance in the portfolios of banks.
As a result of many developments in our financial organization,
paper which qualified for borrowing from the Reserve banks has consti- .
tuted a constantly decreasing proportion of the totsl assets of member .
banks ever since the System was established. In 1929 it was only about
twelve percent of total loans and investments of such banks, and in
1934 it was but eight percent. Consequently, in 1931 and 1932 when the
great liquidation occurred, many banks with assets which were good but
technically ineligible for borrowing at Reserve banks, were obliged to
dump them on a falling market, suffering severe loss thereby end contributing to the deflation.in values, or to close their doors.
The new banking act increases the powers of the Federal Reserve
banks so that they may meet this situation. It authorizes the Reserve
banks to make advances to member banks for periods not exceeding four
months on any security satisfactory to the Reserve bank, at e rate of
interest e.t least one-half of one percent above the highest discount
rate in effect at the particular Reserve bank. This amendment modifies
and makes permanent the emergency legislation which was passed in 1932.
In addition to the foregoing general powers of discount and purchase the Federal Reserve banks have special powers with respect to
loans to commerce and industry for working capital purposes/ These
powers are granted by. Section 13b of the Act. Under this, section the
Reserve banks are authorized to discount loans me.de by member benks and
other financing institutions to established industrial end commercial
businesses for the purpose of supplying working capital.
These changes made by recent legislation enlarge very greetly the
kind of credit which the Federal Reserve banks may deal in directly,
and give the Reserve banks greater freedom of action in meeting requirements of the money market.
Open Market Operations
In addition to the discount rate and the bill rate, two other important means of credit control have been developed from Reserve System

experience, although they were not specifically contemplated in ti r• original Federal Reserve Act, These are open market operrtions r .c?
direct action. Open market operations consist of the purchase aid stle
by Reserve banks of certain classes of securities, chiefly Government
obligations. They hr.ve the effect of increasing or decreasing the
supply of credit available in the money market es a whole. They do not
leave control of the money market dependent upon the voluntary action
of member banks in seeking funds for the replenishment of their reserves,
but give to the Federal Reserve banks the initiative in influencing tee
market. By selling securities the .Reserve banks withdraw funds from the
market and less credit becomes available. By purchasing securities they
put funds into the market and tend to ease credit conditions. If pecirrities are sold they must be paid for, and in the process of paying fo-1
them the reserves of member banks are diminished, for every payment
means a debit sooner or later to some member bank's reserve account.
If the program is carried far enough the member banks will be forced to
restrict their extensions of credit or dispose of some of their assets
to the Federal Reserve banks either by sale or rediscount in order to
replenish their reserves. Uhen this happens, the member bonks have been
forced by the initiative of the Reserve banks to take action which they
would otherwise not have had to take. If, on the contrary, market conditions are such that member banks have gone into debt to the Federal Re- .
serve banks in order to replenish depleted reserves, the Federal Reserve
banks may relieve the situation end the tightness which exists in the
money market generally by buying securities on a large scale. The funds
which they release in payment for the securities which they buy flow one
way or another into the reserve accounts of the member banks and enable
the latter to pay off their obligations. If the purchases continue
beyond this point, they create excess reserves which it is likely the
member benks will try to put to some use.
By selling securities, therefore, the Federal Reserve banks iu£y enable themselves to give an effectiveness to a discount veto which it
would not have otherwise until such time as market conditions had stiffened and individual banks were forced by those conditions to go to the
Reserve banks for funds. Open market operations, therefore, enable the
Reserve banks to accelerate corrective action. They are especially
useful in view of the tradition which mskes banks refrain as much S G
possible from borrowing from the Federal Reserve banks. If member banks
felt no inhibitions about being in debt, end built up their reserves by
borrowings so that they might nake more loans, they would more generally
be smenable to control through the discount rate. As it is, hew ever,
the discount rate must depend for much of its effectiveness upon open
market operations.
The powers of the Reserve' banks to buy and sell securities in the
open market were granted in general terms in the original Federal Reserve
Act, but at the time were not generally considered to be of very greet
importance. It was not until 1922 that open market operations were conducted on a large enough scale to effect the money market. The first
operations were carried on by the Federal Reserve benks independently of
one another, but it wap soon found that action hrd to be coordinated,
for otherwise the banks would be buying or selling in competition with
one another and following different, and perhaps conflicting, policies.
a committee representing several of the reserve banks was
Digitized forConsequently,
FRASER

formed for the purpose of coordinating.their operations. About the
sane tine the purpose of the operations was clarified. For some time
there had been" a tendency to allow purchases end sales to be miluenced
by the objective of profit, but it yas eventually realized thst such en
objective was in conflict with that of moderrting si given condition ox
the noney market, and must, therefore, be .subordinated or even abcncloned.
This is in.line with the general policy of .central banks in conducting
open market operations; they do so .quite definitely /with the idea of
correcting credit conditions end.not for the purpose of larking darnings.
The Banking Act of 1933 gave specific recognition to open w r k e t
operations aid established a Federal Open Market Committee of twelve
members, one representing each Federal Reserve bank, to tcke the plr.ee
of the .former non-statutory committee. At the sane tine the lev adopted
substantially the statement of purpose vhich had alreedy governed open
market operations. The strtute provides that open msrket operations
"shell be governed vith a viev to accommodating commerce and business
and with regard to their bearing upon the general credit situation of
the country."
The Banking. Act of 1935 made further 'change by providing thrt the
Federal Open Market Committee should comprise, the nembers of the Boc-rd
of Governors of the Federal Reserve System and five representatives
chosen by the twelve Federal Reserve banks. The lev else ctekes the decisions of this committee obligatory upon the Federal Reserve bsnks end
provides that the record of the committee's actions shall be included
in the annual report of the Board submitted to Congress. Thus en
activity which was barely recognized in the original Federal Reserve
Act,. Mid which W P S grrdually developed in the process of sdninistrstion
of the System, hrs come to be emphasized in the law F S one of the System's most important activities.
Direct Action
I also mentioned direct action as e. nerns of credit control Direct action means individual effort by the Federal Reserve bphks'to
discourse credit policies of given member banks in given circumstrnces.
*or the correction of specific conditions, it is to be reguUriv reso-ted
to by the Reserve banks in their relations with member bunks.' Opportunity for it occurs on verious occesions, but particularly vhen the nember
bank is being exrained, raid when it is seeking'to rediscount some of its
paper. In this sense airect action is largely.tn individual ratter end
the form teken by it in any case. may. have little or no reference to reneral credit conditions. It may el s o have reference either to re^ion^
or country wide conditions, however, and may then be resorted toSf?r
the ;:urpose of enforcing general credit policy. The Dover to exercise
direct action against member banks lies pertly with the Federal Reserve
ne erve
banks end partly with the Board of Governors.
.'
•
°
The effectiveness of direct p'ction was specifically s
by the Ecnking Act of 1933 in.severrl particulars. *he£
that undue use of bank credit is being made for the ™ , ™

tion in securities,^ estate, or cLoditiel^or S S ? ^ ^

pose inconsistent with sound credit conditions, the f?cts a h m ? S \ T
reported by the Federal Reserve banks to theBoerd o f G o v e r n ^ of the

Federal Reserve System. The Board may in its discretion suspend y
member ;bank making such use.of credit from recourse to credit fu'.:i..it;.es
of the System.* Furthermore., authority has been given to the Borrd to
remove from office any officer or director of e member benk.who hes violated the lav governing the bank's operation or who has persisted in
unsafe end unsound practices in conducting the bank's business. The
Board also has power to limit for each Federal Reserve district the individual bank capital.and surplus which mcy be represented by loans
secured by stock or bond collateral.
•

••

•

It is to be presumed that these special powers will not often have
to.be used, in view, of other broad powers designed for control of credit
conditions, but in principle they are nevertheless significant, for
they indicate that the law definitely contemplates the exercise of considerable responsibility by the Federal Reserve banks end the Board.
Power to Change Reserve Requirements
Recent legislation has also established two other new forms of
general credit control, which previously did not exist. The first of
these is the power given the Board to. change the reserve requirements
imposed- upon member batiks by the statute. For most banks the requirement is and has been for yecrs that they have reserves on deposit with
the Federal Reserve bank equal to at least 7 percent of their demand
deposits, and 3 percent of their time deposits. The power to alter
these reserve requirements was. first given the Board by an amendment
to the Federal Reserve Act Hoy 12, 1933, but under limitations which
were.later removed by the Banking Act of 1935* The.Bocrd is nov authorized to change the reserve requirements
"in order to prevent injurious
credit expansion or contraction11, but it is not permitted to lower them
below the present requirements nor increase them to more then twice the
present requirements. .The effect of raising them, which is the only
action that could now be. taken, because the reserves are now at the
point of legal.requirement, would be to decrease the lending power of
member banks end consequently the available credit. The effect of subsequently lowering them would be, of course, to enlarge the lending
power and the amount of available credit. This meens of credit control
is one. of the most powerful and direct thet the law hes bestowed.
Margin Requirements

The second new form of general credit control recently authorized
pertains to margin accounts and loans made for the purpose of purchasing
or carrying listed securities. Authority for the Board to issue regulations in this field was granted by the Securities Exchange Act of 1934.
This grant of authority was in line with various provisions of the Federal Reserve Act, such as I have already referred to, aimed at restricting the use of credit for speculative purposes. In the language of the
Securities Exchange Act, the authority it bestows is to be exercised
with the object of preventing "the
excessive use of credit for. the purchase or carrying of securities11. The standard established in the Act
and adopted by the Board as an'initial regulation limits the loans vhich
a broker or dealer may make on a security, to whichever is higher of the
two following*ratios:

(a) Fifty-five percent of the current market price of the

security, or
(b) One hundred percent of the lowest market price of the security since July 1, 1933, but not more than seventy-five percent of the
current market price.
This standard permitted the extension of credit up to seventy-five
per cent of current market value on securities that had made little or
no advance from the lows of recent years, and up to-fifty-five percent
on securities that had made considerable advance. The Board, however,
was given authority to alter this initial standard, making it either
higher or lower as conditions might warrant, and it has recently changed
the fifty-five per cent limitation to forty-five per cent. The reason
for this action was realization of the possibility that recent increases
of stock market values might lead to such excesses as the law sought to
prevent.
The determination of margin requirements is designed to exert a
restraining influence on speculative trading. By imposing higher margin
requirements on securities that have had a repid rise, credit is made
less freely available for trading in speculative stocks. A limitation
is also imposed on the extent to which speculative profits on securities
can be used as margins for further speculation, a practice that is known
as pyramiding.
The power of the Board to raise margin requirements provides an
instrument for controlling the demand for credit from speculators in
the stock market without restricting the supply available for other borrowers. It differs from other means of credit control in thct it affects directly the demand for credit rather than the available supply
or cost. Through the use of this instrument it may be possible for the
Board to exert a restraining influence on the use of credit for speculation in the stock market before it has reached a stage at which the
general business and credit situation is unfavorably affected. The use •
of the instrument exercises a restraint on speculation without limiting
the supply or raising the cost of credit to agriculture, trade, and
industry.
The Securities Exchange Act specifically exempts from its provisions all obligations of the United States Government, of any state,
municipal, or other political subdivision, and of agencies or instrumentalities of a State or local government. Additional exemptions of
a similar nature are provided for.
Brokers and securitiesldealers subject to the Act are not permitted
by the Act to borrow from banks which are not members of the Federal Reserve System, unless such banks agree to comply with the same conditions
relating to the use' of credit to finance transactions in securities as
are imposed on member banks.
.
•
The foregoing provisions governing the credit activities of brokers
and dealers are covered in Regulation T of the Board of Governors;
Insofar as banks are concerned, the Board's authority relates to"
loans made for the purpose of purchasing or cariying securities registered on national securities exchanges. It does not apply, therefore

to. loans msde solely for" industrial, agricultural, or ccnunerciL'l purposes, regardless of the question whether these loans are secured or
unsecured, and, if secured, regardless of the character of the colicteral.
The determining factor is 'the purpose of the loan and not the nature of
the security offered. If a loan is made for the purpose of purchasing
or carrying securities registered on a national securities exchange, it
comes under this section of the act; if it is mt?.de for any other purpose — industrial, agricultural, or commercial -- then it is exempt.
It is also exempt if it is secured by certain types of collateral other
than stocks, such as bonds and. government obligations. In general, the
lav, insofar as it applies to control over banks, is intended, to prevent
the banks from being used for the purpose of circumventing the margin
requirements prescribed for loans extended by brokers to their customers, and to prevent undue expansion of bank credit in the securities
markets.
. .
.- .
The law imposes upon the Board no duties in connection with supervision of stock exchanges or prevention of undesirable practices among
members of such exchanges. Responsibility for these matters rests upon
the Securities and Exchange Commission.
Conclusion - Limitation on Means of Credit Control
Although the five meens I have discussed by which credit control
may be exercised - discount rates, open market operations, direct action^
reserve requirements, and margin requirements - appecr to be very comprehensive and powerful, it would be a mistake to convey the impression
that a perfect control of credit will be effected through them. In the
first place, their application cannot be mechanical nor governed by
simple unvarying rules. Credit and economic relationships ere extremely
intricate, and the circumstances under which the need for action crises
are always to some extent different and special. Let me mention c few
things that complicate the task of credit control.
In the first place, if there were a clear connection between given
extensions of credit end the uses to which the credit is ultimately put,
the control of credit would be simplified. This connection was formerly
assumed to exist and to afford an important meens of control. The
thought was that the Reserve bank could shut off speculation by refusing to discount the notes of speculators. That, of course, is f?.r from
the facts. A bank may borrow from the reserve bank on bills of lading
covering the sale of merchandise and at the some moment it may buy the
mortgage of a men who is speculating in industrial stocks. The extension of credit on bills of lading was specifically favored by the original Federal Reserve Act, yet in such an instance as I mention, it might
make possible a speculative activity directly opposed to the purposes
of the Act.
Another important fact is that more than half the banks of the
United States are not' members of the Federal Reserve System. The system has consequently only a partial and indirect influence on their
credit activities.
For another thing, there is always the important consideration
that
United
States Treasury activities must be taken into account.

These have to do in part with the operations of the Exchange Stabilization Fund and the issue of circulating media/ e.g., coins, silver certificates, and United States notes; and in part vith the public debt,
and the government's receipts and expenditures. These operations involve such large sums and so" intimately affect the banking and credit
situation that Federal Reserve policy and Treasury policy must always
be coordinated vith one another.
Finally there rre conditions that arise not only outside the System, but outside the country, and yet affect the domestic banking situation powerfully. There is, for example, the recent great movement of
gold to the United States from abroad - a movement that in the last twoyears has added over three billion dollars to the reserves of member
banks.

• . . .

These factors, among others, necessarily limit and modify the exercise of credit control.

Speech delivered before
The Economic Club of Chicago
The Primer House, Chicago, Illinois
April 29, 1936
• THE FEDERAL RESERVE SYSTEM AND CREDIT CONTROL
It is now nearly three years since I left Chicago to take up my
present duties in Washington. In those three years the sdaiinistrative organization and functions of the Federal Reserve System have
undergone important and interesting changes, mainly brought about by
the Banking Acts of 1933 and 1935.
In general terms, I think the most important accomplishr.ont of
recent legislation so far as the Federal Reserve System in concerned
is that it strengthened and clarified the lines of credit control. A
few changes affecting the organization and functions of the Federal Reserve banks were made, but they were not changes in essentials. The most
conspicuous of these changes was that the title of President was given
to the principal executive officer. Formerly his title was Governor.
The title of Vice President now replaces the former title of Deputy
Governor. As you know, the former titles, Governor and Deputy Governor,
were not mentioned in the Federal Reserve Act. The office of Governor
was originally created under the general authority which the Federal Reserve Act gave the directors of the Federal Reserve banks to arrange for
such officers as were necesssry for the administrative work of the banks.
Originally, the only office specifically mentiqned by the Act, other than
that of- director, was that of Federal Reserve Agent and Chairman, with
assistant agents and deputy chairmen. The Banking Act of 1935 in designating the President of the Federal Reserve bank vs its chief executive
officer merely recognized an arrangement that had developed under general
authority and that had proved itself desirable from the point of view of
Federal Reserve bank acLiini strati on.
The organization of the governing board of the System vss changed
considerably by the Banking Act of 1935. In the first place, the old
name "Federal Reserve Board" was changed to "Board of Governors of the
Federal Reserve System". At the same time, the chief executive officer
of the Board was- designated as Chairman. Furthermore, the number of members of the Board was changed from eight to seven end all of these members were made appointive. Formerly, as you know, the Secretary of the
Treasury and the Comptroller of the Currency were ex officio members of
the Board.
.
.
The term of office of the members of the Eoard was formerly 12 years.
Under the new law, the terms of members now in office range from 2 to 14years and their successors in office will have terms of 1U years so arranged that the term of one member will expire every 2 years. Since a
member who has served a full term of 14 years is not eligible for reappointment, there will be a regularly recurring change in membership; one
member leaving the Board and a new one being appointed every 2 years,
unless more frequent changes occur from deaths or resignations.
The most important changes effected by the 1935 Act, however, have
not to do with these matters of organization so much as with the function
and authority of the governing Board in the field of credit.

10
In the course of the twenty-two years that have elapsed since the
Federal Reserve banks were established much experience and knowledge have
been accumulated. Some problems which the System was devised to remedy
have now been settled and others have taken their place. At the same time
the conception of central banking functions has changed in ueny respects.
The net result is that the System presents in certain ways a different
aspect from what it did formerly.
Twenty-two years ago the ideas prevailed that the important functions
of the Federal Reserve .banks were to furnish an elastic currency, to lend
to member banks which were short of money some of the reserve funds accumulated by other member banks, and to curb the speculative use of credit by
rediscounting only paper representing self-liquidating commercial transactions. These ideas now appear quite inaccurate, or at least inadequate.
Furnishing currency is seen to be less important than it was thought to be,
because currency cuts a very small figure in the total of payments that are
made by people in their dealings with one another. IJhat they use for the
most part is bank credit in the form of deposits. The control of bank
credit as a whole is, therefore, of greater importance than the control
merely of the currency supply; it is also incomparably more difficult.
In the second place, the reserve banks do not depend on the deposits
which member banks maintain with them for the ability to make loans and
buy securities. They pay for such assets by entering deposit credits on
their books in favor of the member banks whose paper they discount or
whose investments they buy. If a member bank's reserves are deficient,
it can turn over some of its assets to the Reserve Bank and receive a
credit to its reserve account. The Reserve Bank.in such a transaction is
not lending to one bank what it owes to another; it is exercising the
familiar banking power of paying for assets by the entry of deposit credit.
In the third place, it is recognized that there is no necessary connection between the form in which credit is procured from a bank end the
form in which it is used. Money may be borrowed on acceptances end yet
be used in the stock market. It may be borrowed on a real estate mortgage
and yet be used to buy merchandise. It msy be borrowed on the security of
speculative stocks and yet be-used to finance the production and shipment
of commodities. Consequently, any discrimination for or against a certain
type of paper offered for discount does not mean that speculation is being
controlled or that credit is being supplied for the needs of commerce.
The task of controlling the use of credit is far more difficult than such
a supposition would imply.
Under various provisions of federal law there are five principal
means of credit control which the Federal Reserve banks or the Board of
Governors may use. These are:
Discounts
Open Market Operations
Direct Action
Reserve Requirements
Margin Requirements •
Discounts

The Federal Reserve

Act has fro* the beginning provided that each

11
Federal Reserve bank establish from time to time rates of discount to be
charged by it on various classes of pp.per; these rates to be subject to
review and determination by the Eoard of Governors of the Federal Reserve System, and to be fixed with a view of accommodating commerce and
business, - To this the Banking Act of 1935 added the new requirement
that such rates shall be established "every fourteen days, or oftener
if deemed necessary by the Board". This does not mean that the rates
must be changed every time, but that they must be regularly and frequently reviewed. In general the initiative in making changes in discount rates rests.with the Federal Reserve banks, but the Board has
authority to make changes on its own initiative if the public interest
demands.
T

.Jhen the Federal Reserve Act was adopted the prevailing idea seems
to have been that discount rates were not only the most definite means
of credit control but the most important. - This idea was apparently
based upon a belief that member banks would seize the opportunity to
borrow funds from the.Reserve banks at a low rate of interest, in order
to relend them to their own customers at a higher rate. This was a
logical supposition and it appears to be widely held even at the present
time. As a natter of fact, it has not worked out that way in practice
at all. Member banks rarely show a disposition to borrow from the Reserve banks for the purpose of relending. They do not like to borrow
and as a general thing they will not borrow unless they have to, no
matter how low the rediscount rate is. Custom appears to exercise a
very imperious control over them in this respect. As a consequence,
they borrow from the Reserve banks as e usual thing only when they have
to augment depleted reserves.
The Federal Reserve Act formerly limited the classes of paper which
Federal Reserve banks could discount for member banks, but the Banking
Act of 1935 eased these limitations. The principle followed in the
original provisions was that a definite preference should be maintained
for short-term credit based on self-liquidating commercial transactions*
The Reserve banks were, therefore, given the power to discount only such
paper, that is notes, drafts, bills of exchange and bankers1 acceptances
arising out of ccmmercial, industrial and ?i£ricultural transactions, or
paper becked by United States Government obligations. These were narrowly defined classifications. Advances on a wide range of other assets
vhich made up an important part of the total earning assets of benks
were not authorized.
Moreover, as a result of various financial and economic developments the classes of paper which could be used as a DPsis for borrowing
from the Reserve banks had for many years constituted a decreasing proportion of the assets of member banks. In 1929 it was only about twelve
percent of their total loans and investments, end in 1934- it was only
eight percent. Consequently, in 1931 and 1932 when the great liquidation occurred, many banks whose assets as a whole were good nevertheless
had very little that was technically eligible for use in borrowing at
the Reserve bank. They therefore had to dump their assets on a falling
market in order to raise the funds, they needed.
The new banking act increases the powers.of the Federal Reserve
banks
so that such a necessity may be avoided.- It authorizes advances

12
to be" made to member "banks for periods hot exceeding fourmonths on any
security satisfactory to the Reserve bank. - This ^ ^ J ^ ^ S : ^
makes permanent the emergency legislation which was. adopted a
Beside the foregoing general" powers of discount and purchase, speciil authority was given the Reserve banks in 1934 to discount loans^which
member banks'and'other financing institutions m y make to established industrial and commercial businesses .for the purpose of supplying them with
working capital.
These changes made fry recent legislation enlarge very greatly the
kind of credit which the Federal Reserve banks mey deal in directly, end
ellow greater freedom of action in meeting the requirements of the money
market.
Open Market Operations
Itrraust be obvious, however, that the power of a Federal Reserve
Bank to grant credit at predetermined rates of discount and interest can
be exercised-only when credit is asked for. Consequently, if the Reserve
bank had no other means of credit control than- the power to' discount the
paper of member banks at given rates, it might have to wait passively
and idly until .individual member banks decided that they would like to
borrow. Then only would it have opportunity to act and what it might
do 'then would be far from constituting real credit control. As a consequence of the need of meeting the Federal Reserve System's responsibilities more positively, two other means of credit control have been
developed. These are open market operations and direct action. Both
are outgrowths of experience, primarily.
Open market operations consist of the purchase and sale by the Reserve banks of certain classes of securities, mainly government obligations, for the purpose of increasing or decreasing the supply of credit
available in the money market as a whole. By selling securities the
Reserve banks withdraw funds from the market and less credit becomes
available. The reason for this is that in the process of paying for
the securities that are sold the reserve's of member bsnks become1 diminished, because every payment means a debit sooner or later to some member bank's reserve account. Arid as a member bank's reserves.decline
toward the legal minimum it is less able to make extensions of credit.
.
On the other hand, by purchasing securities the Reserve banks put
fuftds into the market and more credit becomes-available; because the
. funds which are released in payment flow directly or indirectly into the
preserve accounts of the member banks and enlarge then. .And as tfieir re( serves expand, they are in a position to< extend more and more credit*
'' In principle, therefore,.the Reserve banks can increase or decrease
.the funds available for .lending,, accordingly as they buy or sell securities." Of course, there are in practice many limitations-on the effectiveness of open market operations, biit their tendency is to enable the
Federal Reserve banks to take corrective action with..respect to abnormal
credit conditions on their own initiative
The powers of

the Reserve banks'to buy and sell-securities in the

13
open market were granted in general terms in the original Federal Reserve
Act, and at the time were not generally considered to be of very great
importance. The first operations were carried on by the Federal Reserve
banks independently of one another, but it was soon found that action
would have to be coordinated; otherwise the banks would be buying or selling in competition with one another and following different, and perhaps
conflicting, policies. To avoid this, a committee representing several
banks was formed for the purpose of directing the operations. About the
same time the purpose of the operations was clarified. For some time
purchases had been cade with the idea of providing income to meet expenses, but it was eventually realized that such an objective was in conflict with that of moderating a given condition of the money market, and
must, therefore, be subordinated or even abandoned.
The Banking Act of 1933 gave specific recognition to open market
operations as a System matter and established a Federal Open Market Committee of twelve members, one representing each Federal Reserve bank, to
take the place of the former non-statutory committee. At the same time
the law adopted substantially the statement of purpose which had already
governed open market operations. This was to the effect that they be
conducted "with a view to accommodating commerce and business and with
regard to their bearing upon the general credit situation of the country,11
The Banking Act of 1935 made a further change by providing that the
Federal Open Market Committee should comprise the members of the Board of
Governors of the Federal Reserve System and five representatives chosen
by the twelve Federal Reserve banks. The law also makes the decisions of
this committee obligatory upon the Federal Reserve banks and provides
that the record of the Committee's actions shall be included in the annual
report of the Board submitted to Congress. Thus an activity which was
barely recognized in the original Federal Reserve Act, end which was
gradually developed in the process of administration of the System* has
come to be emphasized in the law as one of the System's most important
functions.
Direct Action
I also mentioned direct action as a means of credit control. Direct
action means efforts by the Federal Reserve banks or the Board to discourage credit policies of given member banks in given circumstances.
Opportunity for it occurs on various occasions, but particularly when a
member bank is being examined, and when it is seeking to rediscount some
of its paper. In this sense, direct action is aimed at the correction of
specific conditions in particular bejiks. It may also be resorted to,
however, with reference to general conditions and for the purpose of enforcing general credit policy.
The effectiveness of direct action was specifically strengthened ty
the Banking Act of 1933 in several particulars. If a member bank makes
undue use of bank credit for any purposes inconsistent with sound credit
conditions, it may be suspended from recourse to credit facilities of the
Federal Reserve System. Furthermore, authority has been given to the
governing Board of the System to remove from office any officer or director of a member bank who continues to violate the law governing the bank's
operation or who has persisted in unsafe and unsound practices in conduct-

Ill
ing the bank*s business. The Board also has power to limit for each Federal Reserve district the individual bank capital and surplus which may
be represented by loans secured by stock or bond collateral.
Power to Change Reserve Requirements
Recent legislation has also established two other new forms of general credit control which previously did not exist. The first of these
is the power given the Board to change the reserve .requirements now imposed upon member banks by the statute. For iaost banks (chiefly those
outside the larger cities) the requirement is and has been for years that
they have reserves on deposit with the Federal Reserve bank equal to at
least 7 percent of their demand deposits, and 3 percent of their time deposits. The power to alter these reserve requirements was first given
the Board in 1933, but under limitations which were later raaoved by the
Banking Act of 1935. The Board is now authorized to change the reserve
requirements "in order to prevent injurious credit expansion or contraction", but it is not permitted to lower them below the present requirements nor increase them to more than twice the present requirements. The
result of raising them - which is the only action that could now be taken,
since the minimum is already in effect - would be to decrease the lending
power of member banks and consequently the amount of available credit.
The effect of lowering them Inter on would be,, of course, to enlarge the
lending power and the amount of available credit.
Margin Requirements

. . .

•

The second new form of general credit control recently authorized
pertains to margin accoi-ints and loans inade for the purpose of purchasing
or carrying registered securities. Authority for the board to issue regulations in this field was granted \y the Securities Exchange Act of
193A* This grant of authority was in line with various provisions of the
Federal Reserve Act, such as I have already referred.to, aimed at restricting the use of credit for speculative purposes.
Pursuant to these provisions the Board has issued twin Regulations, •
T and U. Regulation T, following Sections 7 and 8(a) of the Securities
Exchange Act of 1934-* governs the extension and maintenance of credit.bybrokers and dealers in securities for the purpose of purchasing or carrying securities. Regulation U, following Section 7(d) of the Act, governs
loans made by banks for the purpose of purchasing or carrying stocks registered on exchanges. In general, these regulations fix the maximum loan
value of securities subject to their provisions at 4-5 percent of their
current market value. This means a margin requirement of 55 percent.
This loan value applies erually to margin accounts with brokers and to
similar loans made by banks.
In the case of brokers who are financing other brokers in- order to
enable them to carry accounts of their customers - as may happen, for
example, when a large city broker is financing a correspondent broker in
a small comnunity - loan values of 60 percent are permitted. Special,
provision is also made to facilitate the financing of securities1 distribution.
.
The Board has authority to change the loan value percentages as
necessary in order to prevent, in the language of.the Act, "the excessivb
use of credit for the purchase or carrying of securities11. . .

The provisions of the law and of the regulations are too technical
and too numerous for me to discuss in detail, but I shall mention a few
distinctions end exceptions which are to be observed. To begin with,
Regulation U does not prevent a bank from taking collateral in addition
to that required by regulation-; it does not require a bank to have any
outstanding loan reduced or paid, nor additional collateral put up.
Neither regulation applies to loans on government obligations, nor on a
number of similar types of exempted securities. They do not apply to
loans, however secured, which were not made for the purpose of purchasing
or carrying registered securities. I wish to emphasize this last point.
Regulation U does not restrict the right of a bank to extend credit,
whether on securities or otherwise, for any commercial, agricultural or
industrial purpose, or for any other purpose except the purchasing and
carrying of stocks registered on a national securities exchange. In
other words, it does not interfere with the available supply of credit in
general. Instead, it achieves its purpose by imposing restrictions upon
the demand for credit from the speculative quarter.
For example, under the • regulation last issued, it is possible to
borrow $4-5 on each &100 of stocks, valued at. the market. That obviously
means a very definite restriction upon the extent to which speculators
can expand their holdings. If market prices nevertheless rise so that
the $100 worth of securities becomes worth £125, £150, or $200, at the
market, the emount that can be borrowed, namely 45 percent, becomes of
course progressively greater, until such time as the Board finds it advisable to reduce the ratio of loan value. As the Board reduces the
ratio, the effective demand is checked. In principle, therefore, the
Board has the power to prevent the use.of too much credit for speculation and to prevent an expansion dependent too largely upon the ease with
which money can be borrowed. Moreover it is enabled to do this without
making credit any the less available for commercial, agricultural or industrial purposes, and without raising its cost for such purposes. It
is not the function of the Board to attempt control of security prices
nor to do anything in conflict with the responsibilities of the Securities and Exchange Commission in its supervision of securities exchanges.
The function of the Board is confined to control of credit.
As you will recall, one of the conditions at which the original provisions of the Federal Reserve Act were aimed was the use of bank funds
to finance stock market speculation. It has always been clear that the
Act sought to maJce credit ample for commercial, .industrial, and agricultural purposes without encouraging its speculative usej but the -difficulty has been to make measures of control work in one field without producing corresponding but undesired results in the other. A discount rate
that was advantageous to agriculture was advantageous to speculation, and
a rate that was disadvantageous to speculation was disadvantageous to
agriculture. This difficulty in the way of discriminating between the
possible uses to which credit might be put was characteristic of attempts
to reach the objective ty control from the angle of supply. It appears
to be obviated in the new provisions, which, as I have said, attempt to
reach the objective from the angle of demand.
This is because the power which has been given the Board to impose

16
and relax restraints upon the demand for credit for speculative purposes
is definitely selective. It is aimed at a particular use of credit and
at the specific channels through which demand becomes effective. For
this purpose, it extends the powers of the Board outside the Federal Reserve System to reach direfctly brokers and nonmember banks. It differs
from powers of discount, because while these powers may be exercised to
discriminate against paper directly involved in speculative uses, they
cannot prevent the speculative use of funds procured by the discount of
paper not directly involved in speculation. Moreover, the discount "
power is not of effect until such time as individual banks make up their
minds to dispose of some of their assets.
Open Market Operations are even more general in their effect. They
influence the total amount of funds but not the uses to which they can
be put. The same thing is true of the power to alter reserve requirements. Direct action can be used to discriminate against the speculative use of credit, but only in individual cases. It cannot be applied
comprehensively, uniformly, end simultaneously in all relevant cases as
can the power to fix the loan values of securities.
In the case of margin accounts, the regulation is directed at an
unmistakable objective and cannot mis? -affecting the speculative use of
credit. In the case of loans by banks for. purposes of speculation it
may be felt that the objective is less distinct, since the purpose of
such loans may be disguised. This may appear especially possible since
Regulation U permits a bank to rely upon a signed statement, accepted
in good faith, as to the purpose of a given loan. Of course if means
of evasion develop, they will have to be dealt with, but the Eoard has
chosen to avoid imposing inquisitorial investigations in the absence
of reason for believing that evasions will be deliberate or of serious
consequence.
I have alluded to the exemptions from these new regulations; I
imagine they are of special interest to you and should be mentioned in
detail. The regulations covering brokers and dealers do not apply to.
United States Government obligations, State, county, and Municipal obligations, and such other securities as the Securities and Exchange
Commission may exempt. These regulations also do not apply to credit
extended by a broker for bona fide commercial or industrial purposes or
extended for limited periods to finance bona fide cash transactions in
securities.
In the case of the regulations covering bank loans made for the
purpose of purchasing or carrying stocks, the following are some of the
transactions to which the regulations are not applicable:
Any loan made for any agricultural or industrial purpose, even though the loan be collateraled by stocks.
Any loan for the purpose of purchasing or carrying
securities not registered on a national securities exchange.
Any temporary advance to finance the purchase or sale
of securities for prompt delivery which is to be repaid in
the ordinary course of business upon completion of the
transaction.

17
Any loan to a dealer to aid in the financing of the
distribution of securities to customers not through the
medium of a national securities exchange.
Any loan to a broker or dealer that is. made in exceptional circumstances in good faith to meet his emergency needs.
Conclusion - Limitation on Means of Credit ControlAlthough the*five means I have discussed cy which credit control
nay be exercised - discounts, open market operations, direct action, reoerve requirements, and margin requirements - appear to be very comprehensive and powerful, it would be a mistake' to convey the impression
that a perfect control of credit will be effected through them. In the
first place, their application cannot be mechanical nor governed by
simple unvarying rules. Credit and economic relationships are extremely
intricate, and the circumstances under which the need for action crises
are always to some extent different and special. Let me mention a few
things that complicate the task of credit control.
For ons thing, there has never been a time when the membership of
the Fadsral Reserve System included as many as h^lf the banks in the
country. It does not now. The majority of banks in the United States
are outside the System, Although it is true that the System includes
most of the large banks and that it, therefore, includes the bulk of the
banking business of the country, still from the point of view of the
coLimunities they serve and of relations with other banks, the importance
of the thousands of snail banks which are outside the System is not
negligible.
For another thing, there is always the important consideration that
United States Treasury activities must be taken into account. These
have to do in part with the operations of the Exchange Stabilization
Fund and the issue of circulating media, e.g., coins, silver certificates, and United States notes; and in part with the public debt, and
the government's receipts and expenditures. These operations involve
large sums and intimately affect" the banking and credit situation.
Finally there arc conditions that arise not only outside the System, but outside the countiy, end yet affect the domestic banking situation powerfully. There is, for example, the recent great movement of
gold to the United States from abroad - a movement that in the last two
years has added over three billion dollars to the reserves of member
banks and created a quite unprecedented credit situation.
These factors, among others, necessarily limit and modify the exercise of credit control.
In concluding I want to assure you how much I appreciate the opportunity you have given me to discuss these matters with you. In the first
place, it is particularly important to me because I am at home here. I
feel as if I were coming" back to report to friends who have more than a
formal interest in what I have to say; certainly in addressing you I feel
more than a formal interest in my subject matter.

18
In the second place, it is important to discuss matters with people
such as yourselves who have understanding and who are able to enlighten
others. I feel, as I have probably said before, that an administrative
agency cannot function properly without having behind it a well informed
and sympathetic public interest. Credit control unfortunately is a matter which bristles with technical difficulties and abstract ideasj but
it is nevertheless essential, if the important objectives of credit control are to be achieved, that at least their general purpose and philosophy be understood•

19
Speech delivered before
Oregon Bankers Association Convention.
Portland, Oregon
June 13. 1936'
CREDIT CONTROL
• Under various provisions of federal law there are five principal
.means of credit control which the Federal Reserve Banks or the Board of
Governors-may use. These are;
Discounts
Open Market Operations
Direct Action
. .
•Reserve Requirements
Margin Requirements
Discounts
The Federal Reserve Act provides that each Federal' Reserve Bank establish from time to time rates of discount, subject to review and determination by* the Board of Governors of the Federal Reserve System. To
this the Banking Act of 1935 added the new requirement that such rates
shall be established "every fourteen days, or oftener if deemed necessary
by the Board". This does not mean that the rates must be changeqt eveiy
time, but that" they must be regularly and frequently reviewed.
tfhen the1 Federal Reserve Act was adopted the prevailing idea seems
to have been that discount rates were the most important means of credit
control. This idea was apparently based upon a belief that'member banks
would borrow funds at a low rate of interest in order to relend at a "
higher rate. As a matter of fact, banks rarely borrow from the Reserve
Banks for the purpose of relending. They do not like to borrow and as a
general thing they will not borrow, no matter how low the rediscount
rate is, except when they have.to augment depleted reserves.
The Federal Reserve Act formerly limited the classes of ..paper which
Federal Reserve Banks could discount for member banks', on the principle .
that a definite preference should be maintained for short-term credit
based on self-liquidating commercial transactions.1 The Reserve Banks
were, therefore•> given- the power to discount
only paper 'arising out of
commercial^ industrial, and agricultural1 transactions, or paper backed
by United States Government obligations.
As a result of various financial and" economic" developments, the
classes of paper which could be ifeed as a basis for borrowing from the
Reserve Banks for many years constituted a decreasing proportion of. the
assets of member banks. In 1929 it was only about twelve percent of
their total loans and'investments, and in 1934 it was only eight percent.
Consequently, in 1931 and 1932 when the great liquidation occurred, many
banks whose assets as a whole were good nevertheless had very little that
"as technically eligible. They therefore had to dump their assets on a,
falling market in order to raise the funds they needed.
The new banking act increases the powers of the Federal Reserve
Banks so that advances may be made to member banks for periods" not ex-

20
ceeding four months on any security satisfactory to the Reserve Bank.This amendment modifies and makes permanent the emergency legislation
which was adopted in 1932,
Open Market Operations
If the Reserve Bank had no other means of credit control than the
power to discount the paper of member banks at given rates, it might have
to wait passively and idly until individual member banks decided that
they would like to borrow. As a consequence of the need of meeting responsibilities more positively, other means of credit control have been
developed.
Open market operations consist of the purchase end sale ty the Reserve Banks of securities, mainly government obligations, for the purpose of increasing or decreasing the supply of credit available in the
money market as a whole. By selling securities the Reserve banks withdraw funds from the market and less credit becomes available; because in
the process of paying for the securities that ere sold the reserves of
member banks become diminished. And as a member .bank's reserves decline
toward the legal minimum it is less able to make extensions of credit.
On the other hand, by purchasing securities the Reserve Banks put
funds into the market and more credit becomes available; because the
funds which are released in payment flow directly or indirectly into the
reserve accounts of the member banks end enlarge them. And as their reserves expand, they are in a position to extend more and more credit.
In principle, therefore, open market operations enable the Reserve
banks to increase or decrease the funds available for lending, by buying
or selling securities.. They enable the Federal Reserve banks to take corrective action with respect to abnormal credit conditions on their own
initiative.
The powers of the Reserve Banks to buy and sell securities in the
open market were granted in general terms in the original Federal Reserve
Act. The first operations were carried on by the Federe.1 Reserve Banks
independently of one another, but it was soon found that.action would have
to be coordinated; and a committee representing several banks was formed
for the purpose of directing the operations. For some time purchases had
been made with the idea of providing income to meet expenses, but it was
eventually realized that such an objective was in conflict with that of
moderating a given condition of the money market, and must, therefore, be
subordinated or even abandoned.
The Banking Act of 1933 geve specific recognition to open market operations and established a Federal Open Market Committee of twelve members, one representing each Federal Reserve Bank, to take the.place of
the former non-statutory committee. At the same time the law adopted substantially the statement of purpose which had already governed open market operations. This was to the effect that they be conducted "with a
view to accommodating commerce and business and with regard to their bearing upon the general credit situation of the countiy.11
. The Banking Act of 1935 nade a further change by providing that the

21
Federal Open Market Committee should consist of the members of the Board
of Governors of .the Federal Reserve System and"five -representatives
chosen by the twelve Federal Reserve Banks,
. . .
Direct Action
Direct action means efforts to discourage credit policies 6f givenmember banks in given circumstances. Opportunity for it occurs on vkrious occasions, but particularly when a member bank is being examined, or
when it is seeking to rediscount some of its paper. In this sense, direct action is aimed at the correction of specific conditions in particular banks. It may also be resorted to with reference to general conditions and for the purpose of enforcing general credit policy.'
The effectiveness of direct action was increased by the Banking Act
of 1933 in. several particulars. If a member bank mekes undue use of bank
credit for any.purposes inconsistent vith sound credit conditions, it'may
be suspended from recourse to credit facilities of the Federal Reserve "
System. Furthermore, authority has been given to remove any officer'or
director of a member bank/who continues to violate the-law governing the
bankls operation or 1 who has persisted in unsafe and unsound practices in
conducting the bank s.business,.
Power to Change Reserve Requirements
. Recent legislation has also given the Board power'to- change reserve.
requirements. For most banks (chiefly those outside thfe larger cities)
the requirement is and has been for years that they have reserves equal
to at least 7 percent of their demand deposits, and 3 percent of their
time deposits. The power to alter thesis requirements was first given the
Board in 1933, tut under limitations which' wfcre later removed by the •
Banking Act of 1935. The Board is how authorized to change" the reserve
requirements
"in order to prevent injurious credit expansion*or cbritraction11,1 but it is not permitted to lower them'below the present require-Jnents nor increase them to more than twice the present requirements'*; The
result of raising them would be to decrease the lending power of member
banks and consequently the amount of available credit. The effect of
lowering them later on would be, of course, to enlarge the lending power
rid the amount of available credit.
Margin Requirements
Another new form of general credit control recently authorized pertains to margin accounts and loans made for the purpose of purchasing or
carrying registered securities. Authority for the Board to issue regulations in this field was granted by the Securities Exchenge Act of 1934-

Pursuant to these provisions the Board has issued twin Regulations,
T and U. Regulation T, following Sections 7 and 8(a) of the Securities
Exchenge Act of 1934, governs the extension and maintenance of credit by
brokers and dealers in securities for the purpose of purchasing or carrying securities.. Regulation U, following Section 7(d) of the Act, governs
loans made by banks for the purpose of purchasing or-carrying stocks reg- •
istered on exchanges. In general, these regulations fix the maximum loan
value of securities subject to their provisions at 45 percent of their
current market value'. • This means a margin requirement of 55 percent.

22
This loan value applies equally to margin accounts with brokers and to similar loans made by banks.
In the case of brokers who sre financing other brokers in order to
enable them to carry accounts of their customers - as may happen, for example, when a large city broker is financing a correspondent broker in a
smaller community - loan values of 60 percent are permitted. Special provision is also made..to facilitate the financing of securities1 distribution.
The Board has authority to change the loan value percentages as necessary in order to prevent, in the language of the Act, "the excessive use
of credit for the purchase or carrying of securities."
For example, under the regulation last issued, it is possible to
borrow £45 on each &100 of stockb, valued at the market. If market prices
nevertheless rise so that the $100 worth of securities becomes worth $125 >
$150, or $200, at the market, the amount that ctn be borrowed, namely 45
percent, becomes of.course progressively greater, until such time as the
Board finds it advisable to reduce the ratio of loan value. As the Board
reduces the ratio, the effective demand is checked. In principle, therefore, the Board has the power to prevent the use of too much credit for
speculation end to prevent an expansion dependent too largely upon the
ease with which money can be borrowed. Moreover it is enabled to do this
without making credit any the less available for commercial, agricultural
or industrial purposes, and without raising its cost for such purposes,
•The power which has been given the Board to impose end relax restraints upon the demand for credit for speculative purposes is definitely
selective. It is aimed at a particular use of credit and.at the specific
channels through which demand becomes effective. For this purpose,, it extends the powers of the Board outside the Federal Reserve System to reach
directly brokers and nonmember.banks. It differs from powers of discount,
because while these powers may be exercised to discriminate against paper
directly involved in speculative uses, they cannot prevent the speculative
use of funds procured by the discount of paper not directly involved .in
speculation. It also differs from the power to conduct.open market operations which influence the total amount of funds but not the uses to which
they can be put. The same thing is true of the power to alter reserve'
requirements. Direct action can be used to discriminate against the speculative use of credit, but only in individual cases,
.
In the case of margin accounts, however,, the regulation is directed
at an unmistakable objective and cannot miss affecting the speculative use
of credit. In the case of loans by banks for purposes of" speculation it
may be felt that the objective is less distinct, since the purpose of such
loans may be disguised. This may appear especially possible since Regulation U permits a bank to rely upon a signed statement, accepted in good
faith, as to the purpose of a given loan. Of course if means of evasion
develop, they will have to be dealt with, but the Board has chosen .to avoid
imposing inquisitorial investigations in the absence of reason for believing that evasions will be deliberate or of serious consequence.
It is not the function of the Board to attempt control of security
prices
nor to do anything in conflict with the responsibilities of the

23
Securities and Exchange Commission in its supervision of securities exchanges.
Conclusion - Limitation on Means of Credit Control
Although the five means I have discussed by which credit control may
be exercised - discounts, open market operations, direct action, reserve
requirements, and margin requirements - appear to be very comprehensive
and powerful, it would be a mistake to convey the impression that a perfect control of credit will be effected through them. In the first place.,
their application cannot be mechanical nor governed by simple unvarying
rules. Credit and economic relationships are extremely intricate, and
the circumstances under which the need for action arises are always to
some extent different and special.
For one thing, there has never been a time when the membership of
the Federal Reserve System included as many as half the banks in the
country. Although it is true that the System includes most of the large
banks and that it, therefore, includes the bulk of the banking business
of the country, still from the point of view of the communities they
serve and of relations with other banks, the importance of the thousands
of small banks which are outside the System is not negligible.
For another thing, United States Treasury activities must be taken
into account. These have to do in part with the operations of the Exchange Stabilization Fund and the issue of circulating media, e.g., coins,
silver certificates, and United States notes; and in part with the public
debt, and the government's receipts and expenditures. These operations
involve large sums and intimately affect the banking and credit situation.
Finally there are conditions that arise not only outside the System,
but outside the country, and yet affect the domestic banking situation
powerfully. There is, for example, the recent great movement of gold to
the United States from abroad - a movement that in the last two years has
added over three billion dollars to the reserves of member bsnks and
created a quite unprecedented credit situation.
These factors, among others, necessarily limit and modify the exercise of credit control.
In concluding I want to assure you hov much I appreciate the opportunity you have given me to discuss these matters. I feel, as I have
probably said before, that an administrative agency cannot function properly without having behind it a well informed and sympathetic public interest. Credit control unfortunately is a matter which bristles with
technical difficulties and abstract ideas; but it is nevertheless essential, if the important objectives of credit control are to be achieved,
that at least their general purpose and philosophy be understood.

25
Speech delivered before
Eighth New England Bank Management Conference
Hotel Statler, Boston, Massachusetts
November 5, 19 37
THE TECHNIQUE OF CREDIT REGULATION
During the past year, the Federal Reserve System has adopted measures of unusual significance and interest. Some were the familiar measures of credit regulation. Others were quite new, and involved the exercise of powers only recently granted by Congress to the Federal Reserve
System and never before exercised.
These measures serve to illustrate the technique of credit regulation and I should like to review them with you as examples of. technique
rather than from the standpoint of policy. Let.me first restate the purposes end scope of credit regulation and also the general long range
policy that has been pursued by Federal Reserve authorities in the recent
past.
The basic purpose of what may be described broadly as central banking
powers, such as those vested in the Federal Reserve System, is aid in
stabilizing and equalizing monetaiy conditions so that the supply of
credit is neither inadequate for sound business activity nor so excessive
in amount that it invites speculative abuse. For the'achievement of this
purpose, the Federal Reserve banks, depend largely upon open market operations. That is, they may purchase investment securities in the open
market at times when the supply of funds in the money market needs to be
increased, or they may sell investment securities at times when an excess
of funds overhangs the money market and needs to be absorbed lest it stimulate speculation.
In addition there are other means of influencing credit, particularly
ty raising or lowering the discount rate and by advancing funds to such
individual member banks as apply for accommodation to replenish their reserves .
These means of credit technique are exercised by the banking authorities to implement policies which they believe the economic situation requires. At one time, they may feel that the situation requires a restraining policy, and to carry out that policy they may sell securities from
their portfolio, or they may raise rediscount rates, or do both. At another time, they may believe that the situation requires a policy of ease,
and to carry out that policy they may purchase securities in the open market - thereby supplying banks with additional reserves - end they may
lower the rediscount rates. Open market operations and changes in the discount rate are the two principal means of credit technique. They are
flexible instruments and they are general in their application. That is,
they affect the credit picture as a whole, rather than individual banks.
As you know, the Federal Reserve authorities have felt ond frequently
stated that an eagy money policy is essential to help promote economic recovery. Rather than speak of the considerations upon which this policy is
based, I wish to invite your attention to the various, technical steps whicl

26
have been taken and the several i:ieans employed in carrying out this broad
general policy during the past year or. so. A knowledge of the technique
employed to implement a particular policy seems to. me of practical importance and of interest irrespective of what that policy may be. In other
words, I wish to discuss how a given policy was effected rather thtin v?hy.
The measures I wish to review began with the increase in reserve requirements a year ago last August. This was not what I call a measure of
credit technique. It was instead intended as a basic, readjustment which
placed the System once again in a position to use its .traditional and
flexible credit instruments and to make them effective. It was adopted
because a situation had developed in which the ordinary means of credit
technique - namely, open market operations and rediscount rates - had
lost their efficacy. This situation arose primarily, as you know, from
the flow of gold into this country from abroad, as a result of which the
excess reserves of domestic banks swelled to such an extraordinary degree
that the customary instruments of credit policy were wholly ineffective.
If the Federal Reserve System had desired to have easy money conditions
regardless of the consequences that might ensue in case unsound and inflationary conditions developed, it could have adopted a policy of.doing
nothing at all. But it sought instead to reestablish the position it was
intended by law to occupy - a position in which it. could act promptly and
effectively either in the direction of easing the credit situation further,
or in the direction of restraint - whichever appeared to1 be in the public
interest.
Theoretically and historically, the technique of credit regulation
has been considered most efficient when member banks have had a minimum of
excess reserves and could expand the amount of credit outstanding when and
as steps are taken to increase their reserves. This can be most readily
effected by open market purchases, which have the effect of making funds
available to the money market and of making it unnecessary for most member
banks to apply to the Federal Reserve banks for advances. However, should
individual banks still require funds, they may borrow from the Federal Reserve bank and when they do so its discount rates can be reduced in conformity with a policy of ease, or conversely can be raised if an opposite
policy is adopted. But, of course, when the banks ere superabundantly sup.plied with reserve funds from an outside source and therefore have little,
if any, occasion to seek additional funds from the Federal Reserve banks,
the .discount rate, .like open market'operations, ceases to be applicable.
Under such circumstances, even if the Federal Reserve System were to sell
off its entire portfolio of government securities, the action would fail
to absorb the excess reserves. Moreover, by such action the System would
be. flinging away the possibility of conducting further .open market operations to any purpose, because subsequent purchases of securities that it
might make would.merely increase the excess of reserves again. The System
would be exhausting its principal means of influencing" credit conditions.
In other words, the situation would continue to be out of control.
The Board, in explaining its action at the time', said:
"For current adjustments of the reserve position of member banks to
changes in the credit situation the Reserve System should continue to rely on the traditional methods of credit control through discount policy
and particularly through open-market operations. By the present action

27
excess reserves will be reduced to within, the amount that could be ab-*
corbed through open-market operations, should such action'become desir• able. Conversely, should conditions develop .requiring expansion of reserves, they could be increased through open-market operations."
Subsequently, the Secretary of tfte Treasury announced that the
Treasury "proposes, whenever it is? .deemed advisable and in the public interest to do so> to take appropriate action with respect to net r.ddi- ,
tional acquisitions or releases of goid by the Treasury Department. This
will
be. accomplished by the sale of additional public-debt obligations,
the1 proceeds of which wili be used for the purchase of gold, and by the
.purchase or redemption of outstanding obligations in the case"of move- "
. ments in the. reverse direction."
The Treasury's purchases of gold pursuant to this "policy had" the"
effect of keeping the gold from getting into bank reserves, and swelling
them" to greater volume.
On Jantiery 30 the' Board announced final increases in.reserve re-'
quirements and pointed out in its statement made at the; time; that:ly: this
action- the System would be restored to "a position where-such" reduction
or expansion of member bank reserves as may be deemed" ill the public in^terest' may be effected through open-market operations, a more flexible '
instrument, better adapted for keeping the reserve position of membeir
banks currently in close adjustment to credit needs."
These measures - t h e increase in reserve requirements by the Federal
Reserve System and- the sterilization of gold by the Treasury:- Were ^unusual measures taken to offset an unusual condition, '.nfcnieiy," the £nar-..-...
moua inflow of capital and gold from abroad. They were eutside -the ^category bf" normal measures of .credit regulation. They were related to- ...
normal measures of credit regulation in somewhat the same way-that re^
ballasting a-ship is related .to its reguldf operation,' They were measures intended to neutralize the effect of major financial disturbances
originating abroad, and to keep the domestic "credit situation•amenable to
the established technique of .regulation.
As the Board emphasized at the time^1 these measures involved no abaivdonment of 'the* policy of monetary ease which the Board has consistently
pursued, "By using, as it announced that it would, 'the customary arid flexible instruments of open market, and rate policy.
At this point perhaps 1" should briefly restate the process by which
open-market operations achieve their purpose. In the first place, as you
know,- when'a-bank enlarges the amount of credit it has outstanding, either
by Additional loans to its customers'or by additional purchases-of investment securities, its" reserves tend to be reduced. • Consequently it
cannot enlarge the amount of-credit it has outstanding unless it has reserves in" excess of what it is required to have. On their own- initiative
banks may procure additional reserve funds either by borrowing or' "by selling securities.- Or the Federal,Reserve System on its initiative may supply banks- in general with additional reserve funds by opennaarket purchases of investment securities;; for as the Federal "Reserve tanks pay for
the securities they W > either by check" or by credit, the reserves of
member batiks are Increased. In ..April', the Federal Reserve banks, purchased

28
about $100,000,000 of securities and this amount immediately flowed into
member bank reserve accounts. It eased their position so that they would
have no lack of funds for continuing to .'extend -credit, whether in the form
of loans or in the form of investments. . Contrariwise, if the Federal Reserve System had sold securities, the process of paying for them, whether
purchased by member banks or by the customers of member banks, would have
reduced the reserves of member banks. Purchases by the System tend to
ease the money market, sales by the System tend to tighten it.
The ease produced by the System^ purchases in April, therefore, was
deliberately brought about* If need had arisen that condition, of ease
could have been as deliberately ended by a reversal of policy and the sale
of investments- The situation, in other words, was one that had been made
amenable to the normal measures for influencing credit.
In August and September a further step in pursuance of the System1 s
established policy was taken when the Federal Reserve bank rediscount rates
were lowered. In approving the first of these changes the Board stated
that its "approval was based upon the view that the reduction of discount
rates at this time would assist in carrying out the System's policy of
monetary ease and make Federal Reserve bank credit readily available to
member banks for the accommodation of commerce, business and agriculture,
without encouraging member banks to borrow outside of their districts or
to liquidate their portfolios in order to be in a position to meet the
needs of present or prospective borrowers,"
The Board went on to say "The reduction in discount rates, which
have had little or no practical effect during the period when excess reserves were abnormally large and widely distributed throughout the System,
brings the rates into closer relation with the interest rate structure
generally prevailing, and affords to member banks the benefit of rates,
on advances made by the Federal Reserve bank, which are in line with those
available in the money market. During the extended period when excess reserves of the banking system were between two and three billions of dollars, the occasion did not arise except in rare instances for member banks
to borrow from the Federal Reserve banks, and the discount rates were accordingly inoperative as a practical matter.
"As a result of the continued progress of the recovery movement, demands of agriculture, industry and commerce for bank accommodation have
steadily increased and at the present time are augmented by seasonal requirements, particularly with relation to crop movements „
"It is the Board's view, therefore, that at this time the Federal
Reserve System can best discharge its public responsibility and promote
the continuance of recovery by making it possible for member banks to obtain accommodation from Federal Reserve banks at rates which will encourage
them to employ their funds to meet the needs of agriculture, industry and
commerce."
Later in September, the Federal Open Market.Committee announced that
it had authorized purchase in the open market from time to time of "sufficient amounts of short-term United States Government obligations to provide funds to meet- se^sori^l withdrawals of. currency from the banks and
other seasonal requipments." It said further;

29
"Reduction of the additional holdings in the open merket portfolio
is contemplated when the seasonal influences ar.e -reversed or other circumstances make their retention unnecessary.
"The purpose of this action is to maintain at -member banks cm aggregate volume of excess reserves adequate for the continuation of the System's policy of monetary ease for.the furtherance of economic recovery.11
At the same time, the Committee announced that at the request of the
Board of Governors the Secretary of the Treasury had agreed to release that is, to desterilize - approximately £300,000,000 of gold from the
Treasury's inactive account. Accordingly, the Treasury was credited with
that amount on the books of the Federal Reserve banks which in the course
of regular Treasury disbursements found its way into the reserve accounts
of member banks and increased their available funds correspondingly.
This was an effective means of utilizing our monetary measures to maintair.
the policy of ease. The Committee's statement made at the time pointed
out that:
"This action is in conformity with the usual policy of the System to
facilitate the financing of orderly marketing of crops and of autumn
trade. Together with the recent reductions of discount rates at the several Federal Reserve banks, it will enable the brinks to meet readily any
increased seasonal demands for credit and
currency and contribute to the
continuation of easy credit conditions.11
As stated in the October Federal Reserve Bulletin, this action
toward augmentation of member bank reserves was taken to anticipate the
usual seasonal needs of member banks for currency and credit. The action
of the System in bringing about an increase of available funds.put banks
in a still easier position.to meet seasonal needs as well as increasing
demands for bunk credit. It was an exercise of credit technique under
normal and.typical conditions•
Before passing on to the latest measure, of credit technique taken
by the System, I want to mention a recent change in the regulations governing discounts by the Federal Reserve banks. This change was effected
by the issuance of Regulation A in revised form effective October 1. Its
significance lies in the fact that in determining the eligibility of paper
for discount, the form of the obligations to be discounted is considered
of less importance than it used to be. Originally the privilege of rediscount at the Federal Reserve banks hed been restricted to relatively,
short-term paper arising from certain commercial and agricultural activities. As you* know, the amount of such- paper .has tended in recent years to
constitute a smaller and smaller proportion of the total amount of paper
available to banks.' To the extent that banks were dependent on such paper
for discounts, the decrease in its amount meant in effect a curtailment
of the power of the Federal Reserve banks to extend credit. The Banking
Act of I933 and the Banking Act of 1935 both enlarged the classification
of paper upon which individual member banks might procure funds from the
Federal Reserve banks for the replenishment of their reserves, and Regulation A as recently issued by the Board carries out the purpose of these
changes in the law*
The new Regulation had been in preparation for a long period end the

30
time of its issuance had no special bearing with respect to the current
situation. It was rather a longer range measure. Moreover, its issuance
was not of course a measure of credit regulation, like open market operations or changes in the discount rate, but a liberalization of the conditions under which the regular means of credit regulation are exercised.
Let me emphasize that the term "credit regulation" is not altogether
satisfactory. I have taken care to avoid using the phrase "credit control", for that is far too strong. The technique which I have been describing "influences" rather than "controls".
The latest measure of credit regulation taken by the System was the
change in margin requirements announced a little over a week ago and effective last.Monday. The power to fix margin requirements is, as you
know, a. new and special responsibility imposed upon the Board by the Securities Exchange Act which*Congress adopted in 1934. Its effect is not
general upon the whole field of credit. In this respect, it differs from
other means of credit regulation, namely, open market operations and
changes in the discount rate. It is directed exclusively ot the use of
credit advanced ty brokers, dealers and by banks for the purpose of carrying registered securities. Theoretically, margin requirements can be
raised when it appears advisable to restrain speculative use of credit
and they can be lowered when it appears advisable to relax the restraints.
Because of the special nature of this particular power of credit
regulation, it can be exercised independently of other measures by which
the credit situation is influenced. Thus it is possible to pursue1 e restraining policy with respect to the use of credit for securities speculation at the ssme time that an easy money policy is being pursued with
respect to the use of credit for commerce, industry and agriculture. By
its most recent action the Board reduced margin requirements from 55 percent to 40 percent. This eased credit conditions so far s.s securities1
trading is concerned. It happens that this policy of ease in the special
field of stock market trading coincided with the policy of ease which
the Board has all along pursued in the general field of credit, but since
I am discussing the technique of credit regulation I wish to emphasize
the fact that conditions do not always call for a parallel policy by any
means. The peculiar character of the power to fix margin requirements
is that it makes it possible to influence credit conditions in a particular field independently, if necessary, of what is done in other fields.
It is evident that the exercise of Federal Reserve functions, like
those of any other organization, involves sometimes merely the use of
certain tools according to accepted procedure, and sometimes a change in
the tools themselves or in the conditions tinder which they are to be
used. Open market operations and changes in discount rates are the customary tools regularly employed in performance of Federal Reserve System
functions. They are practicable, flexible and tested tools, which can
be used to ease money conditions et one time and to tighten them at another. They can be made to accomplish their purposes without shock without violent and painful adjustments. They can be applied gradually
so that their effect is barely perceptible. If necessary, they con be
applied vigorously and.sweepingly.
It is time of any technique that its effectiveness is dependent
upon the conditions under which it is used. The inflow of gold .into this

31
country from abroad crested a condition under vhich the normal, fler'ble
credit tools had lost their effectiveness • Poising or lowering 4;he discount rate would mean nothing vhen bejnks had such a super-afcnndfince of
funds that they lied no occasion to look to Federal Reserve bankii for accommodation. Selling government securities vhen the excess reserves to
be absorbed were greater than the volume of securities available for
sale, would amount to throving away tools vhich are necessary If there
is to be any effective supervision to influence general credit policies
in the broad public interest.
There has been no change meanwhile in the basic policy of monetary
ease. Open market purchases of securities ard lowering of the rediscount
rates have been undertaken in pursuance of this sane fundamental policy, ,
And it is important to note that a situation has been restored vhore the
normal technique of credit regulation once more applies.
The functions and responsibilities I have been discussing aro not
peculiar to 'the Federal Reserve System, of cource. They are the functions &nd responsibilities of the central banking orgoiization of virtually every country. And as such they differ essentially from the functions and responsibilities of privately managed banks operated for profit,
A central banking organization makes loans find purchases securities not
for the purpose of making a profit, but for the purpose of increasing the
supply of credit available through privately managed banks. At the present time, for example, the twelve Federal Reserve banks hove CJ sh and
reserves of nearly nine and a half billion and earning assets of only tvp
and e hclf billion. Such a position, vhich is quite different from what
an enterprise operated for profit would choose to maintain, is entirely
normal for a central banking organization.
It appears, therefore, that during the period I have reviewed, the
System has consistently pursued a policy of monetary ease amenable to
regulation. The increase in reserve requirements and the sterilisation
of gold hnd amenability to regulation as their objectives. The open
market purchases, the reduction of discount rates, &nd the desterilization of a smell portion of the gold had further ease, as their objectives.
Each of these measures has been effective in its ovn way in helping to
achieve the combined objective. This series of measures is informative
and illuminating to those who are interested in the technique of central
banking, and I appreciate your kindness in giving me this opportunity to
review that technique with you.

33
Speech delivered before
Polish-American Luncheon Club of Metropolitan New York
George Washington Hotel,' Hew York, K. Y.
December 28, 1938
CREDIT AND OUR ECONOMY
The Federal Reserve System has been in existence exactly twenty-five
years and yet comparatively few people know what the Federal Reserve System really is, and still fewer know how it operates or the purpose for
which it was created by Congress in 1913. May I, therefore, begin with a
brief description of the general structure of the Federal Reserve System
as the basis for my discussion on Credit and Our Economy.
In the first pln.ce, the Federal Reserve System differs from many of
these other instrumentalities end agencies in that it is only in part n
governmental institution. The member banlcs of the Federal Reserve System—about 6,300 in number—are privately owned and privately managed coi>
porations in all parts of the United States. They are such banks as you
keep your checking accounts with. Many of them were in operations long
before the Federal Reserve System was organised. These banks that are
members of the System are in competition not only with one another but
with other banks that do not belong to the System. There are, in fact,
more banks outside the Federal Reserve System thpji there ore belonging to
it, but the nonmembers, as we call them, though very numerous are relatively small. Around 80 or 85 percent of the bonking business of the
country is done within the Federal Reserve System.
The country is divided into Federal Reserve districts and each member bank deals with the Federal Reserve bank in its district. It owns
stock in its Federal Reserve bank in proportion to its own capital and
surplus end it maintains its required reserves vith its Federal Reserve
bank. The twelve Federal Reserve banks perform many services for their
member banks and for the public, particularly in providing currency for
circulation and in facilitating the clearance and collection of checks.
The Federal Reserve banks also act as fiscal agents of the United States
government. They cariy the checking accounts of the United States government and do the servicing of the public debt. This meens handling subscriptions for issues of government securities, paying interest, redeeming matured issues, making conversions and such things.
The twelve Federal Reserve banks are regional institutions. Each of
them has a board of directors, representing not only the banking interests
of the district but its agricultural, industriel and commercial interests
as well.
Coordination of the activities of the twelve Federal Reserve banks is
effected through the Board of Governors in Washington. The Board consists
of seven members appointed ty the President of the United States with the
consent of the Senate. The Board, beside coordinating and supervising
the operations of the Federal Reserve banks, has important regulatory powers as the administrative head of the whole System.
The members of the Board together with five representatives chosen
ty the twelve Federal Reserve banks constitute the Federal Open Market
Committee. This committee directs the open market operations of the Fed
eral Reserve banks, which 1 shall explain later.

3U
Under the law, there are certain powers exercised directly by.the
Federal Reserve banks, there are certain ones exercised by the Board of
Governors, and there are certain ones exercised by the Federal Open Market Committee. For the sake of simplicity, I shall simply use the term
"Federal Reserve authorities" in speaking of the rowers exercised under
the Federal Reserve Act.
. I n order that they may perform, their duties properly, the Federal .
Reserve authorities require all the accurate information they can procure
as to the state of banicing and business not only in the United States but
in the world at large. Such information as relates to banking is secured
from examination reports and from reports of condition which member banks
themselves submit to the Reserve authorities. Much cf the essential financial information required is reflected in the operations of.the Federal Reserve banks, for no important monetary trend .can"fail to manifest
itself in one or more of the general accounts on the books of the Federal
Reserve banks. Certain financial movements will be reflected in increases
and decreases in the volume of the bank reserves which constitute the deposits of the Federal Reserve banks, Certain financial movements will be
reflected in increases and decreases in the amount of Federal Reserve notes
in circulation. Certain movements will be reflected in increases and decreases in the volume of Federal Reserve bank loans and investments. Close
observation and analysis of changes in Federal Reserve bank statements will
consequently yield important information as to monetaiy conditions in general.
From sources outside the Federal Reserve System, the Federal Reserve
authorities draw information as to industrial and economic production,
prices, international trade and exchange, domestic trade, payrolls, and
employment. Most of thi3 information is procured in cooperation with
other agencies.
Although the Federal Reserve authorities meke,every reasonable effort to procure such information as will guide them in determining monetaiy policy, it goes without saying that there are many facts about economic life that are inaccessible." Nobody knows how much inoney is going to
be spent by purchasers at next Christmas time; nobody knows what the
prices of commodities are going to be six months frcra now; nobody knows
exactly how many people are out of jobs at this moment. ' Vlith respect'to
all such conditions, approximate and generalized information is the best
that can be procured. Moreover, after the- information is procured, it
is not always possible to determine readily and" exactly what cours.e of
action it calls for. The parts of our economic life are so closely interrelated and the factors determining it are so numerous that the unexpected is always happening. Employment influences production and production influences employment. Demand influences supply and supply influences demand. Political and international conditions affect business and
business affects political and international conditions. Causes and effects are interwoven with one another so that the effect produced by one
cause becomes itself the cause of other effects.
Bearing in mind these easily recognizable difficulties in the way of
interpreting current information so as "to determine the proper policy, you
vill be able to understand under what conditions the Federal Reserve authorities exercise the powers that I now wish briefly to describe.

35
The first of these is the power to. conduct open market operations,
which I have already referred to. Open market operations enable the
Federal Reserve authorities by the purchase of securities in the open
market to supply banks and the money market in general with additional
reserve funds. Such purchases will be undertaken for the specific purpose of preventing tightness in the money market. At times such operations may be called for in order to increase.the available supply of
credit; at other times they may be called for merely to maintain a stable
condition. In a broad sense, the mechanism of these actions is very simple. Vihen investment securities are sold to the Federal Reserve banks,
the money paid for them by the Federal Reserve banks naturally increase
the funds available to the public.
On the other hand, vhen and if it appears that the volume of credit
is excessive, the Reserve authorities may by the sole of securities withdraw from the market some at least of the excess. This results simply
because the funds with which the securities are paid for when the Federal
Reserve bank sells them disappear from the banks and the money market as
they pass to the Federal Reserve banks*
In recent years the effectiveness of open market operations has been
greatly circumscribed by the enormous accumulation of excess reserves of
member banks. These excess reserves in turn have resulted from the movement of gold into the United States. Prior to the year 1934', the stock
of monetary gold in the United States had never amounted to much more
than four and one-half billion dollars. At the present time, it is more
than H billion dollars. Over 3 billions of this increase is accounted
for by revaluation, but a large part - perhaps the larger part - has come
to the United States largely because of disturbed political and economic
conditions elsewhere in the world. It has taken refuge here. It did not
come because it was needed and it so far exceeds the requirements of the
economic life of our people as to create a serious problem. More than
one half of the monetary gold in the world is now in our possession. Ve
have far more than we need and other countries have less than they need.
The effectiveness of any action that the Federal Reserve authorities
may take is conditioned by the presence of these enormous reserves. Member banks now have reserve balances with the Federal Reserve banks of 9
billion dollars. Of this about 5 and one-half billions represent required reserves and 3 and one-half represent excess reserves. Purchases
of securities by the Federal Reserve banks tend to maintain or increase
this excess. On the other hand, since the Federal Reserve banks own only
about 2 and one-half billion of securities, it is obvious that if they
sold the whole amount it would no where near absorb the excess.
Another important power of the Reserve authorities is that of
count. Uhen a member bank needs additional reserve fluids it. may borrow
them from its Federal Reserve bank. There have been times in the past
vhen member banks borrowed very heavily from the Federal Reserve banks,
but under present conditions, as I have just described them, member banks
in general have such a large volume of excess reserves that there is little occasion for them to borrow.
At times when there is an active demand for credit, the power of the
Federal Reserve authorities to set the discount rate may be of consider
able importance; a higher or lower rate will, of course, tend to influence

tHe'canount of borrowing. In recent years, the discount rates of the Federal Reserve banks have been extremely low. At present they range from 1
to 2 per cent. These are the rates at which member banks may borrow from
the Federal Reserve banks; they are not, you understand, rates on borrowing in general.
The monetary policies of the Federal Reserve authorities are one of
many important factors which help to make any given business situation
what it is. Not one of these factors can be neglected; not one of them
can be depended upon to accomplish all that is desired. In racent years,
the Federal Reserve authorities have pursued what is called en easy money
policy. They have endeavored to maintain such credit conditions as would
be most favorable for active business and increased enploymont.
When one speaks of credit, one must speak of the Federal Reserve System and its relation to the credit of the country. This, no doubt, is evident at this point of my discussion.
The economic prospects, so far as we can see then, are reasonably encouraging at the present time. A year ago activity in prices had been declining for several months, but we had not reached the end of the decline.
Quite naturally, therefore, many people were wondering whether the decline
was to be another long depression like the one which began in 1929 • Now,
however, we have seen not only a slowing down in the decline during the
first half of 1938, but a sharp advance in the business situation generally
during the second half of this year.
The total income payments are about the same now as they were at the
end of 1937* Hie decline in payrolls froma year ago is narrowing, but
work relief is higher.
In industrial production, the November adjusted index shows 103 per.
cent of the 1923-25 average and December will very likely.be higher. . The
same index a year ago for the month of December was 8£S. This, of course,
is an encouraging sign. There was during 1938 less decline in nondurable
manufactures such cs textiles and shoes than in durable goods, and their,
output has been above 1937 in the past few months. Output of durable goods
such as steel and automobiles has been lower for the year to date but has
shown sharp recovery in recent months and is now currently in excess of the
same time in 1937. Steel output for the current week is 52 per. cent of capacity .and, the average so far in December is 57 per cent as compared with
27 in. the corresponding period of last year. Automobile assemblies are now
around" 100,000 a week end they were about 85,000 during the. first part of
December of 1937. There is, of course, a smaller output of minerals which
did not decline much until after the end of 1937.
In building construction there has been a sharp reversal in movements
during the past year. Residential building was declining in the latter
part of 1937 and with incomes being reduced, many thought there would be
a .further reduction in 1938, but instead with prices of materials reduced
and down payments and current financing charges materially "lowered early
in 1938 \yy amendments to the Federal Housing Act, there was a more than
seasonal increase in the Spring and currently contracts for private work
of. this type were double those of a year ago. . Also, contracts on projects

37
of the United States Housing authority are now being awarded in increasing volume.
Nonresidential construction shows a marked .rise in public works
contracts. By December 16th work was started on FWA projects to cost
1 billion 200 million dollars and to be substantially completed by July,
1940. A large part, but of course not all of this, represents an increase over a year ago when many of the projects started under earlier
programs were being completed. There is, however, a continued low level
of contracts for factories, commercial building, and other private nonresidontial building.
'
In domestic retail trade, there was little decline until the end of
19.37, except for automobiles and house furnishings and the current level
in most lines is about the same as a year ago. There was considerable
decline in the first half of 1938 which was followed by an advance. Department stores1 Sc?.les by dollar volume heve been slightly smaller than
a year ago with prices somewhat lower, but indications are that the December figures will be close to, if not equal to, that of the 1937 month.
Mail order sales and sales at Variety Stores are about the same as at
the end of 1937, but retail automobile sales in the month of November of
1938 are above the sales of a year ago.
In foreign trade, during the month of October, the exports on a
value basis were lower than a year ago by about one-sixth and imports
were lower than a year ago by about a fifth. Export trr.de decline is
less than anticipated in some quarters and import decline stopped soon
after industrial recovery in this country began in 1938. Excess of exports is still unusually large end is around 100 million dollars per
month.
Inventories of consumers1 goods lowered considerably by the middle
of 1933, after a long period with trade reduced only moderotely, while
production was sharply curtailed. Inventories in other lines ere also
reduced and improvement in the inventory position generally contributed
much to the rise in orders and activity in the middle of 1938. Currently
stocks are substantially lower than at the end of 1937, but information
is not available to indicate just how much they are below the end of
1937. At department stores dollar volume of stocks is about 10 per cent
smaller than a year ago.
Commodity prices in general are moderately lower than a year ago
and the index is 77 per cent of the 1926 average as against 83 per cent
in 1937. There was a decline in commdoity prices in the early part of
1938 and since May there has been little change in the general index.
Some industrial materials currently are about the same as a year ago
after a marked rise in the middle of this year. Agricultural products
are lower than a year ago owing partly to increased carryovers, ample
crops and also owing to increased supplies of live stock and dairy products.
Including Government payments, farm income is estimated at 7 billion,
625 million dollars for the calendar year 1938. This is down by one bxllion dollars from 1937, which was the highest since 1929.

38
On the whole, therefore, there are signs of improvement. Of course,
I do not wish to darken the picture by going over the things which must
prevent us from being too optimistic. You know well enough just what
they are, tut I should like to emphasize the fact that just as the Federal
Reserve authorities cannot lay claim to having brought about the improvement mentioned through their sole effort, so also they can give no assurance that their policies only will make this improvement continue. Within
the province of monetary matters, the Federal Reserve authorities have as
their objective to maintain as favorable conditions as they can and business need feel no fear that sound and healthy activity will find any lack
of the bank credit necessary to support it.

Speech delivered at
"
Dinner given by Federal Reserve-Bank of Dallas
In honor of Board of Governors of .the Federal Reserve System
Baker Hotel, Dallas, Texas
January 24., 1941
BRIEF REMARKS ON CERTAIN ASPECTS OF RESERVES
There has been e great deal of talk about excess reserves. Some of
it has produced more heat than light. It seems important to me, therefore, to undertake to throw increased light on certain aspects of the
subject which is so important to you, to the Federal Reserve System, and
to the nation.
•
First: We have today the unprecedented amount of seven billion dollars in excess reserves. This excess can be used by the member bnnks of
the System to extend credit by means of loans and investments.
Second: On the basis of this enormous volume of excess reserves
the volume of deposits—now 60 billions—could be doubled. A volume of
deposits twice as large could do twice as much work and if the amount of
goods and services did not increase at the seme rate, there would be the
danger that prices would rise rapidly. This is not in the interest of a
stable economy.

Third: It may also be pointed out that the same result could be
achieved by doubling the use. of jgjcistinjg. deposits, namely, the sixty billions. In other words, at the present tine the velocity of deposits—
that is, the use or turnover of the present deposits—is about "thirteen".
There have been times in the past when this velocity was "twenty-six".
Therefore, if existing deposits should be used twice as actively as they
are now used, that too would represent a dangerous situation. This is
not in the interest of a stable economy.
Fourth: After deposits have once been created, there is little that
the Federal Reserve System con do about them. That has to be dealt with
by non-monetary means such as restricting of price advances, rationing,
etc. The Federal Reserve authorities can, if given sufficient power,
regulate the growth of deposits but they can not control the turnover of
existing deposTEST""
Fifth: To control the growth of deposits, however, the Federal Reserve System needs sufficient powers in sufficient tine to deal with the
existing excess reserves should occasion arise for the System to act in
the interest of a stable economy.
These facts are plain and simple. Let's now try to clarify the meaning of reserves.
• I have found in talking about reserves that one often encounters
misconceptions with regard to reserves and their functions. This is due
principally to the fact that often the individual thinks of Federal Reserve Bank operations in terms of commercial bank operations.

ko
An understanding of reserves requires more than that. It requires
that the point of view of the banking system as a whole be taken; that
the close inter-relation of- bank with bank in an organic system be.recognized as a fundamental condition' and that the essential problems of central banking action be understood.
For example, there are those who sincerely believe that financing of
Government deficits by banks increases excess reserves. This is not so,
as I have attempted to show on previous occasions. When.a bank buys a
Government obligation and pays for it, the banker's reserves at the Federal Reserve Bank are thereby diminished and the Governments deposits at
the Federal Reserve Banks are increased. On the other hand, when the Government later spends this money, the money goes into the hands of private
persons in various sections of -the country who pay their bills and the
money finds its way into banks, or vho themselves deposit the money in
banks. The banks in turn re-deposit the money with the Federal Reserve
Banks. The net result is that there has been no change in the total volume of member banks1 reserves but there has actually been an increase in
deposits. In other words purchasing Government securities by banks is
lending to the Government by a bank and has the same effect on the volume
of deposits as when a bank lends to anyone else. . The extension of credit
in either case increases deposits.
Incidentally, it may be mentioned again that Government deficit financing through the banks diminishes excess reserves. As deposits increase, required reserves, according to present percentages of reserve .
requirements, increase by roughly one seventh of the amount of the increase in deposits so that if the Government borrows a billion dollars
from the banks, it will increase deposits by about one billion dollars and
thus convert about one hundred and fifty million dollars of excess reserves
into required reserves«
For the reasons outlined it has been suggested.that a large part of
future Government financing (though of course'not all and certainly hot at
once) be accomplished, by drawing upon the existing large volume of deposits rather than by creating additional deposits through bank purchases
of Government securities. This can be done by offering a security that willbe desirable to and sought by the depositors, individuals, business corporations such as insurance companies and others. It has. likewise been suggested
that a means be provided for absorbing a large part of'the'existing excess
reserves so as not to make possible a further large increase in deposits.
The deposits are already large.
•
There is still another misconception. This .misconception is even more
widespread and has certain insidious .implications.
Some think and say that when the Federal Reserve Banks engage in open
market operations end are making discounts or advances to member banks the
funds they use are the reserves of the member banks, tihat is worse, some
even go so far as to say that the reason that the Federal Reserve System
has raised or may. in the future wish to raise reserve requirements is that
it would.have more funds to invest in Government securities. Of course
this is not true.
It is perfectly apparent that an increase in reserve requirements does

not necessarily result in an increase of reserve balances. The result is
a change in amount of reserves from one to the other of the two labels—
a larger amount on the books of the Federal Reserve Banks is labelled
"required reserves11 and a smaller amount on the books of the Federal Reserve Banks is labelled "excess reserves". The reserves. as such, at the
Federal Reserve Banks may remain the seme. The Federal Reserve System
does not acquire any funds whatever by the process of increasing reserve
requirements.
Furthermore the Federal Reserve Banks are not dependent on the member banks for their lending power* Let us look at our balance sheet.
At the present time the. Federal Reserve Bonks have, on the resources
side, twenty billion dollars of cash and two billion dollars of earning
assets and on the liabilities side they have sixteen billion dollars of
deposits and six billion dollars of Federal Reserve notes. If all the
deposits of the Federal Reserve Banks were withdrawn by the member banks
which, of course, could not happen, the result would be that the Federal
Reserve Banks would have the same assets as before but instead of having
sixteen billion dollars of deposits and six billion dollars of notes on
the liability side of the statement1, they would have no deposit liabilities but would have twenty-two billion dollars of note liability. There
would be no change in the ratio of the Federal Reserve Banks1 reserves to
their liabilities which is about ninety per cent and there would be no
substantial reduction in the Federal Reserve Banks1 lending powers. I
say substantial reduction—because as you know, the law requires the Federal Reserve Banks to hold a forty per cent reserve against notes—and
only a thirty-five per cent reserve against deposits.
The lending power of the Federal Reserve Banks is based in the first
instance on the power which Congress placed in the Federal Reserve Banks,
when it established them, to issue Federal Reserve notes and to create
deposits, holding forty per cent reserves against the notes and thirtyfive per cent reserves against the deposits. Therefore, the lending
power"does not originate with the member banks; it originates from the
Government granted power.
Since we have a practical situation in the Federal Reserve System
and not a theoretical one, I shall not take your time now to discuss
hypothetical and highly improbable situations, though I shall be pleased
to have you send me questions or ask them tonight—after this dinner.
Our actual situation is this:.
The liabilities of the Federal Reserve Banks—notes and
deposits—are used by the banks or the public continuously
because they need them in their business operations.
Everyone needs a certain amount of pocket cash to meet
certain kinds of expenditures. Therefore, Federal Reserve
notes are issued. These notes stay out because they meet a
public need and they stay out so long as this public need
exists. When the public no longer needs them, they are returned to the banks and from the banks to the Federal Reserve
Banks. If the need increases, the amount of notes increases
. and if the need decreases, the amount of notes decreases.
This mechanism works well and we have no trouble witii it.

As regards deposits, the member, banks want .their de- •
posits to be in the Federal Reserve Banks and they want them
there, not only because they are required-by law to hold reserves in that form, but also because it. is the most convenient way to clear with other banks and, finally, because the
banks want to feel that a certain amount of their.funds is -a
solutely intact and held in a public institution not operated
for profit but devoted to the purpose of regulating the volume
of bankccredit in the interest of economic stability.
This is the case even in foreign countries where there^
are no legal reserve requirements. In those foreign countries,
commercial banks maintain reserves with their central bank
even though they are not required to do so under law.
To point this up, let me state that the power of the. Federal Reserve
Banks to invest in Government securities or to distifcint for or make advances
to the member banks is based on the fact that Congress has given the Federal
Reserve System certain powers and back of these powers lies the fact that
modern economies have.found central banking mechanisms ah essential part of
modem life. The Federal Reserve Banks1 lending power, therefore, rests in
the final analysis on the fact that they perform necessary central banking
functions.
'
The Federal Reserve authority can therefore make" additional reserves
available when needed, quickly and in ample volume to meet all the credit
demands that go with economic activity. This authority is in the discount
powers, the powers of open market operations and the power to lower reserve
requirements. They have ample power to increase excess reserves should
conditions require an increase.
Finally, let me point out that not only do the Federal Reserve Banks
not depend on member bank deposits for their lending power, but, quite the
contrary, the Federal Reserve Banks under normal circumstances have the authority to regulate the lending power of member banks. When the Federal
Reserve Banks lend to the member banks or buy securities in the open market,
they create member bank reserves end, therefore-, increase the member banks1
lending powers. When Federal Reserve Banks are re-paid or when the 1Federal
Reserve Banks sell Government securities,
they diminish member banks reserves and reduce the member banks1 lending powers. It is, in fact, in this
power to influence member bank reserves and consequently to influence their
lending power that lies the principal.instrument of credit control possessed
by the Federal Reserve System and, therefore, since a large part of member
bank reserves is created through Federal Reserve purchases of Government
securities, it is absurd (isn't it) to say that the Federal Reserve Banks
use the member banks1 reserves. How can the Federal Reserve Banks be using.
member banks• reserves when the operation itself increases member banks'
reserves? It would be a case where the creature is supposed to be the creator of its creator.
I hope I have been helpful in throwing some light on the subject of
reserves.

•

••

We are all concerned with our national success. Our part—yours" and
mine—in national success is in the responsibility we have in connection

1*3
influencing credit to the end of economic stability. It is plain
common sense that to meet this responsibility, which is only one factor
in the broad field of economic influences, the time to get ready to solve
a national credit problem that may arise, is not when the problem is
right on the doorstep of an individual bank—your bank for example—for
then it may be too late.
Certainly too, everyone wishes to do his part in the program for
national defense. That program has its effect on our national economy,
now and later. You and I are in duty bound to be concerned with a
strong national credit defense in the interest of economic stability in
the United States. Economic stability makes for national success.

Speech delivered before
Alpha Chapter,.Pi Gamma Mu
Catholic University, Washington, D . C .
May 18'.' M A l
ECONOMIC DEFENSE
A colored fellow valked .into a drugstore and asked for a slug. He
walked, into the telephone booth - 16ft the door open, deposited th3
slug, got his number. The clerk overheard the following conversation:
"Does you all want a good man? A very good man who can keep your piece
very clean and work.all hours of. the day and night? What's that? You
all have a man, and you f re satisfied with hia? You don't want another
man? All right." He hung up, Started to walk out of the drugstore.
The clerk remarked, "I see you didn't get the job you called ior." "Oh,
boss - that's the.job I got. I just wanted to know how I stand."
So true. We all want to know, and particularly do we want to know
how we stand. Hore than that, we not only want to know, but we vant to
know why. Upon that principle is based all science.
We search for causes, reasons, principles.
In a world torn apart and depressed ty the baser instincts of man,
there is little light afforded to lead us in our search for causes,
reasons, principles. We are almost lost. To say the least, we are bewildered. Even more bewildered than was Father Staith when, as he said
himself tonight, he was asked to act as toastmaster.
And yet, it is during times such CLS these that greatness co/r.es to
the fore. Today's history will be written, and when it is, historians
will show, or at least attempt to show, who is responsible, and why.
Scientists will try to point to the causes, and politicians will make an
attempt to remove them so that there will be no repetition of the present condition. And yet human nature tells us that men learn very little
even from the most bitter of experiences. Therefore, is it all worth
while? Shouldn't .we just sit back and let events care for themselves?
Should we? The answer is "Positively NoI" For again human nature comes
to the fore and produces leaders. Bad leadership led us into this condition, and again, good leadership will lead us out of it.
A gentleman with an-excess' of avoirdupois is riding horseback - heis perspiring, and the horse Sweating* but on his chest are medals galore. He rides alone, stops, asks a passerby - "Did you see a parade go
by here?" The passerby answers', "Oh, yes, it's gone by two hours ago."
Response from the rider: "Oh, I must catch up. I just must catch up,
for ... for ... I'm their leader." That is not the kind of leadership
we speak of here. Thei-e must be order - logic in the thinking of our
leadership, else we have chaos.
Therefore, upon £ou rests a great responsibility, not only because
education enables you to think clearly, but also because you have the
added advantage so essential - the advantage of religion. Once the world
loses faith in God and in humanity, demagogs have. easy. prey. For the
raasses^are crying for something V anything1. - and. the demagogs seem to
provide that something or anything.
•

U6
In a democracy - a form of government adopted by pur United States the citizeniy must be especially informed in order to participate actively
in its responsibilities to attain the end sought by the 'State - complete
welfare.
Here, more than anywhere else in the world - because of our history,
because of our social and economic and political nature, the individual
must be constantly mentally alert to all of the processes of government.
Otherwise, through blindness.he is apt to be antagonistic at. a time vhen
he should be most cooperative. In other words, he i-iay be helping to
destroy the very thing that he cherishes and desires to preserve so
much - liberty. Tonight at the dinner table Dr. Patterson asked me
whether I knew the difference between the English expression "We muddle
through11 and the American expression, "Vie have the situation well in'
hand.11 I thought awhile and had to answer that I didn't. He looked
at me and said he had given it a lot of thought, and had finally come
to the conclusion that there was absolutely.no difference - they both
mean the same.
Our countiy is in the process of preparing its defenses. It is
logical that we should in a day such as this be strong in order to retain the liberty that we enjoy. But while we speak of "defense11 we
shouldn't limit it to militaiy and naval defense. That is a mistake
often made. Social, political and economic defense are likewise processes with which we should be much concerned.
On the economic side we have two questions: (1) the effect of
what is happening here and abroad on all of the factors that compose
our economic structure -. now; and (2) the effect of what is happening
now, here and abroad, on our economic structure later, after the defense preparation period is over.
The Federal Reserve System has many responsibilities. Among them
is the responsibility in connection with influencing credit to the end
of economic stability. To meet this responsibility it must cooperate
with and obtain the cooperation of other governmental agencies. Therefore, we are continuously, advising and being advised by others in the
government.
The uncertainties of the future are indeed tremendous. How long
and how extensive will be the war? Will our participation be belligerent or nonbelligerent. Will the victory be partial or complete; will the
peace be constructive or vengeful? However events may answer this question, we may be sure that the central banking functions of the Federal
Reserve Syste.n will be more and more essential to our economy. We shall
have more occasion than ever for a wise regulation of domestic credit,
so that it may be readily available for proper use, wherever and whenever needed, and so that it may not be available for harmful, speculative
use. This, therefore, requires that central banking responsibilities
be implemented in due course of time with effective powers, and not left
as at present with powers that the developments of recent years have rendered ineffective. We shall also have more occasion than ever for a
strict husbanding of our credit resources against the time when they can
be used for restoration of trade relations with other countries. It is
in this process, both for our own good and for that of the world at large,

hi
that the propfcr use of our gold stock must be found, and as the gold now
abnormally accumulated here is redistributed, the Federal Reserve bank
credit may be counted on to take the place of the gold withdrawn, if necessary, to prevent distrubance of the economic supply of credit.
As you know, the member banks * that is, the commercial banks which
are members of the Federal Reserve System - can borrow at the Federal Reserve Bsnic just as you borrow at.your bank.
Today, of course, the member banks are rot borrowing at the Federal
Reserve Bank because they have a large excess: reserve position. In
other yor,le, there are about.six billion cr iuO.ro in excess reserves that
the merdbw bar.ks can lend to their customers - to industry, commerce and
agriculture.

•

• " . . . • • . .

At the present time, likewise, the volume of deposits at banks, now
sixty billions, could be doubled, A volume of deposits twice as large
could be capable of doing twice as much work, and* if the amount of goods
and services 'in the country did not increase at the same rate, there
would be the danger that prices would rise rapidly. This, of course, is
not in the interest of a stable economy. Finally, let me point out that
the econoi^jr vould become unstable if the use of existing deposits were
doubled. In other words, at the present time the velocity of deposits that.is, the use or turnover of present deposits,* is about 13« There
have been times in the past when this velocity or turnover was 26. There. fore, if existing deposits should be used twice as actively as they are
now used, that too would, represent a dangerous situation. This, also,
therefore, is not in the interest of a stable econony.
After deposits have once been created, there is little that the Federal Reserve System can do about them, as that has to be dealt with by
non-monetary means, such as restricting of price advances, rationing, etc*
The Federal Reserve authorities, however, if given sufficient power by
Congress, can regulate the growth of deposits, but they cannot control
the turnover or velocity of existing deposits.
Therefore, the Federal Reserve System has advised Congress of the
fact that it needs sufficient powers in sufficient time to de^l vith the
existing excess reserves of six billion, should ever the occasion arise
f
or the System to act in the interest of a stable econony on the credit
side of our economic picture.
Of course I must point out at this juncture that credit is not overextended just now. But the time may come when action may have to be
taken because of the increased business activity in this country due
principally to the defense program, and to take effective action, the
Federal Reserve System must be in possession of powers to meet its responsibilities in this monetary field. . .
.
At the time that we issued our statement to Congress, vhich was on
the first day of January, this year, there was much concern expressed fcy
bankers and others about what was construed to be an unnecessary warning
a
gainst inflation - that is, overextension of credit. But we did try to
Point out, perhaps ineffectively, that we weren't asking for the powers
jn order to use them at once, but rather we were asking for. the powers to
Digitizedbe
for FRASER
in a position to use them should occasion arise for us to do so. ..For

timing, as you know, is the essence of proper monetary action.1 To revert
to the old saying - "You can't close the barn door after the horse has
been stolen" - it just won't do any good.
That is the one side of our responsibility. The other side is the
one that we are constantly concerning-ourselves with. This requires long
range studies. Eveiy part of our economic structure must be geared up to
an emergency tempo, and coordinated with one objective - our National
success.
• We envisage problems the solution of which is dependent upon the
studies of various aspects of our past, current and future econoipy. Our
central banking authorities - the"Federal Reserve System - are studying
and considering the following in order to be in a position to discharge
their particular duties wisely.
1. The magnitude and timing of the Defense Program.
2. The probable effect of the Defense Program upon the national income, employment and output.
3. The
and housing,
equipment at
cial studies

probable magnitude of private investment in plant, equipment
and the probable expenditures on automobiles and household
various income levels. In this connection we are making speof instalment credit control.

4. The probable volume of business profits; of corporate, institutional and individual savings at various income levels.
5. The probable magnitude of tax receipts (assuming different tax
structures) at various income levels.
6. The probable Federal expenditures and deficits under the Defense
Program.
•
7. The probable Federal borrowing from commercial banks, savings
institutions, corporations and individuals.
8- The prospect with respect to co;nmodity price inflation (industrial, agricultural and food prices) under varying conditions.
9. The danger of bottlenecks with special reference to steel, railway equipment and skilled labor.
10. The prospect with respect to wage increases and labor unrest.
11. Control of inflation: rationing, priorities and other direct
measures of control; consumption control; the so-called Keynes plan for
compulsory saving and deferred payment; excess reserves and direct monetary Controls.
12. The impact of the war on foreign trade and post-war trade policy.
13. Gold and exchange policy of the United States, especially in view
of Germany's access to the gold and foreign balances of virtually the entire
Digitized forEuropean
FRASER
continent.
. .

14. Problems relating: .to1 the post-defense slump, particularly
post-defense.Federal, budget,.,.the fiscal capacity of the States, the
Federal-State fiscal relations.'variable grents-in-aid, social security
programs (including old age, unemployment, food stamp plen, health, education), Federal .Y/orks .programs, housing.
And, finally, 15.. Long-range proposals with respect to expansion,
full utilization of resources, £Jiti-depression policy, flexible ttx
structure, flexible program of public works, a Fiscal Authority Planning
Agency.
This is a formidable list, and it challenges our best efforts in
study and research, and yet it is incomplete.
On the immediate side of our concern is the vast sum of money that
must be raised by the government in financing our rearmament program.
The question on that side is not put to us, directly, for the responsibility there is with Congress and the Treasury. . But since fiscal operations have an effect on our.-economic structure,we naturally are concerned
with a financing program. And we ask this question: Whet are the
basic aims to be considered in formulating a program to obtain this huge
sum for governmental expenditures?
Stated simply, th.e financing program must be or should be equitable
and efficient. By equitable we mean that each of us shall bear his fair
share of the burden, and by efficient we mean that the program should be
one that can be carried out with rapidity and vith the least possible
disruption of our economic activity now and in the post-war period.
To spend this money the Government must first obtain it. It obtains
it from two sources; first, by borrowing and second, by taxation. Both
borrowing and taxation affect our economy.
If we borrow, we can borrow from the banks or from the public, by
selling securities: bonds, notes and bills. Suppose we rely primarily .
on borrowing from the banks. t;hat about the equity and efficiency of
this method? Such a policy would have the effect of increasing the total
supply of purchasing power, to which I referred a few minutes ago namely, bank deposits would increase. For when the banks buy government
securities they give the government credit on their books, which credit
the government is then free to spend. Such an increase in the supply of
bank money or deposits, especially now when ve tre all likely to spend
our money more rapidly with better business conditions, is apt to lead
to rising prices - to what is generally called inflation. Therefore,
suppose we finance defense by borrowing from the public rather than the
banks? Vjhat difference would this make? The answer is that while borrowing from the banks increases the total supply of -purchasing power,
borrowing from private savers only transfers purchasing power from them
to
the government. In other words, when securities are sold to the publi
c, private savers give up so much purchasing power to the government,
^nd therefore do not retain those funds to compete with the government
in the market.
Thus the desire of the Treasury to sell as many of their securities
s possible to orivate investors is most desirable. Such a program of

Digitized afor FRASER

$0
course is by no means a guarantee-sgainst price rises for there ere or
may be many other causes1 of increased prices, but it does avoid-increasing the supply of bank deposits,which might prove a beL3isfor inflation.
'

•

Suppose we finance defense.by taxation. Here-the general effect is very
very much like borrowing from the public so f&r as inflation is concerned.
The effect is a transfer of purchasing power from private to governmental
hands, and there is no increase in total purchasing power*
• •
Taxes, however, must be equitable and efficient. And in the consideration of a tax program, we must give thought to the present tax burden.
And from our observation and study, we find that there is no justification
for substantially higher rates on- the middle income group, and probctoly
for a broadening of the income tax base below the $2,000 income for a family of two, assuming, of course, that new end different sales and excises
falling heavily upon the lower income groups are to be avoided. Heavy excess profits taxes in business income surely have a proper place in an
equitable defense taxation. Also on the efficiency side we must distinguish carefully between taxes as such and the effects of different, specific taxes, remembering all the while that froia an economic stability
point of view we must be in favor of taxation as the bcisic need to avoid
serious price inflation in the future. For the present, therefore, there
seems to be a strong case for the reliance on selected tax, aid on borrowing from the public if we wish to finance our defease program equitably and efficiently.
.
In a period such as this, too much emphasis is apt to be placed on
revenue alone, for revenue's sake, with little or no attention to the
problems of equity in avoidance of post-war disruptions*
The Federal Reserve System,' looking upon the economic picture as a
whole and as one of the responsible public agencies cooperating with
others, is giving its full energies to certain aspects of our economic
problems. Alone, however, we can do very little, We can only be effective when the public is enlightened, when the public is cooperating.
Again I wish to repeat that democracy necessarily rests on an educated and cooperative populace. And to revert to my introductory remarks, responsibility rests upon.the leadership of the country* Universities, therefore, play an important- part in thos whole defense program, .
for education is an effective part of-our.Hational Defense.
This is our program, just, as this is our'country1. "
And it was written, as you know; that !lit ain't the individual, nor"
the airoy as a whole, but the everlastin1 teamwork of every bloomin1 soull"

Broadcast over
Radio Station K-M-T-R, Los Angeles, Calif.
October 5, 1941
TIGHTENING UP CREDIT
You doubtless know why the anti-inflation battle is on - you know
that our country is spending enormous suias of money for defense - for
ourselves and the Allies; you know that more and more people are finding
jobs -. that there are not only more people working, but more money in
pay envelopes. A vast new stream of buying power.is thus pouring over
the nation, and at the same time supplies of many kinds of goods are
running short. Defense requirements not only need the materials from
which many of the goods that you and I are accustomed to buying are made,
but also more and more our industrial plants and our workers are being
turned from the production of civilian goods to the production of planes,
guns, munitions, ships, etc.
To emphasize this even more plainly, there are more and more buyers
in the market, and there are less, and less goods to go around* Therefore, only.one thing can heppen - the prices of the goods available will
be bid up to ever higher a,xxd higher levels, unless somebody does something about it, and does something about it in time. That "somebody11 is
the Government, for it represents us all, collectively. The Government
can (and it is already in action) draw off some of this swollen stream
of buying power by te-xation - particularly by income and excess profits
taxes, which are based on the equitable principle of the ability to pay.
It can draw off more potential buying power by borrowing savings of all
groups, big and little - hence, the Defense Savings 3onds, which enable
us to help pay for defense and to store up buying power for the future,
when our plants can again turn out goods for civilian use, and when we
shall have need for some.form of industrial activity to take the place
of our present defense activity - when we shall need to keep our plants
and our workers busy.
In other fields where there are acute shortages, the Government has
had to act as speedily as possible to fix prices, to determine priorities - which means deciding how to distribute the limited supply of
important but scarce metals and other materials according to the urgency
of the need for it - defense coming first of all, of course.
But one of the greatest economic fields is that of credit - credit
of all kinds - the kind you get or I get when we borrow at the bank or
at the finance company, or "when we buy goods on the instalment plan.
And it is easy to see that it isn't sufficient to draw off buying power
from the market place through Government taxes and through Government
borrowing if amounts thus drawn off can be offset, or more than offset,
by the creation of.new buying power through credit.
In this connection, therefore, the Federal Reserve System has
raised the reserve requirements of member banks. Vhile this does not
directly affect you, and while this of course is but a small step in
itself, .more important from a psychological than from an immediate practical standpoint, it does signify a trend toward dampening down excessive credit expansion by the banking system of the country. It means
that the banks must keep more of their funds with the Federal Reserve

B k
and this in turn means that the banks will not have quite so

much to lend, though of course they still have a great deal left for that
purpose.
When this action was taken, the statement was made that "The Treasury and the Board of Governors will continue to
watch the economic situation and to cooperate with other
agencies of the Government in their efforts, through
priorities, allocations, price regulation,, and otherwise,
to fight inflation."
" ' '
This includes recommendations of further action if necessary over bank
reserves.
.
.
Hot so long ago the Federal Keserve System was directed by Executive Order to put out (and it has put out) a Regulation to tighten instalment or consumer credit - to tighten up the terms on which you or I may
buy automobiles, refrigerators, radios, vacuum cleaners, and a limited
number of other articles - desirable articles that all of us like to
have and do not like to go without - but nevertheless, articles that
cannot be turned out and are not turned out during this emergency by
plants and workers in sufficient quantities to go around while we are
producing for defense.
It doesn!t mean, however, that you can no longer, buy on time. It
simply means that on certain articles - articles primarily that use
materials needed for defense - you and I.will have to make specified
down payments - a third in the case of an automobile - less in all
other cases under the present terms of the Regulation." ^nd you and I
must pay the rest in .18. months on all articles listed, and besides that,
on all cash instalment loans up to and including a thousand dollars, as
well as loans above a thousand dollars made for the purpose.of purchasing (and secured by) a listed article. Not very severe terms, to be
sure, but it is only fair to warn you that the terms may have to be
tightened and may have to cover more articles.
Naturally, there are some who will think it is rather hard not
to be able to buy on very easy terms at a time when, they have just
found a job and are now in a position to buy what they have for some
time needed or wanted. I know but one answer to th^t, and the answer,
is the same as you or I would make to any young man who complained . :
that it was unfair to ask him to serve in our armed forces just as he. ..
was preparing for a bright future. Yes, it is a sacrifice, and sacrifices are not - cannot be equally borne. We can only t r y - try to see
that the. sacrifices are distributed as equally a3 is humanly possible-.
We are all on exactly the same footing when it comes to cooperating in
combating inflation, for that, too, is a fight - aL fight against a
common enemy, the enemy that strikes hardest at those of small means the factory workers, the farmer, the breadwinner, the housewife - the
great masses of our population.
Let us consider for a moment what the alternative is-, if .there is
no damper put on this very important type of credit - consumer credit if it continues to grow rapidly, as it has been doing for many months.

Unless some check is put upon it, and other means of fighting inflation
are also brought into action, there is no escape from soaring prices,
and no thoughtful American wants to have that happen - wants to have the
millions of Americans who now have steady jobs, perhaps for the first
time in a long while - no one wants to see these workers exchange their
hard-earned money for fewer end fewer things. It doesn't make sense does it? - to earn good wages and have prices go up so high and so fast
that the wages buy fewer and fewer goods, food, clothing, necessities of
life - as well as the extras, father, if given the choice, every thoughtful citizen would prefer to save some of his income if in so doing - if
in cooperation with his fellow citizens, subject to the same Regulationshe can help ward off price inflation, - and he will have laid by something for the future, for a time when he and everybody else can buy good3
that can be produced in sufficient quantity to meet the demands. And
that will be when peace comes, when our plants end workers can be turned
back to normal activity producing things of peace instead of things of
war.
We are happy to live in a democracy, but for a democracy to operate
successfully, public understanding and cooperation are essential, and
they are essential if the Government's fight on inflation is to succeed.
Those of us whose task it is to work directly on the program welcome
the opportunity to report to you - to report on what we are doing. We
welcome questions that lead the way to an understanding of credit regulation, taxation, the sale of Defense Bonds, price control, and other
features of our effort. Vie are defending our democracy, and we wish to
defend it by democratic means. The strength of our nation lies in our
understanding and determination. Having these, we are invincible.

$5
Speech delivered before
Illinois.Association of Small Loan Companies
Edgewater Eeach Hotel, Chicago, Illinois
October 25.1945 •
POST WAR CREDIT
I was born and raised here. I worked here, Fron this very hotel I
made veek2.y radio broadcasts on current topics. I like it here. It's
always a pleasure to be back.
The war is over and here we are. Here we are—facing a new situation. Ue've faced so iiany situations together that this could easily be
called just mother situationj but this is more than that—at least
that's the way it appears to me, at this point of transition from war to
peace. It's worldwide, it's complicated, and we are in the forefront.
The entire world looks to the United States for leadership. Ue're a
creditor nation, greater than ever before.
And yet—our nation has emerged from the war in better shape than
sny najor nation.
VE-Day and VJ-Day did not permit finance to demobilize. Rather,
finance has moved up into the front line of the battle of peace. Our
nation, which yesterday was the world's main source of war materials and
armed men, is now looked upon as the world's pincipal source of peacetime goods and credit. The difficulties we have already overcome provide
assurance th^.t we can cope with those tiict lie ahead.
Ho one nan saw the entire stoiy of the credit problems of the war,
but we in the Federal Reserve System did have close contact with its main
theme. The System, as you know, is the central banking agency of the
nation, and its broad function is that of contributing its share to the
Government's purpose of maintaining economic stability. The Reserve
System's part is played by influencing the supply, cost and uses of
money and credit. Very early, with the approach of war, it became evident that the System's task, in the event of war, would center upon helping the Treasury to obtain all funds needed for the prosecution of the
war and, equally upon stabilizing the market for Government obligations.
That the nation was to absorb Government securities in excess of £220
billion on top of an existing national debt of #40 billion could not, of
course, be accurately foreseen, but even so early it was evident that the
demands upon investment would be vast and beyond all past experience. It
was apparent that market fluctuations must not be permitted to interfere
with Treasury offerings. But the necessity of supporting Treasury
financing was parallel to another responsibility of the Federal Reserve
System—that of fighting inflationary developments so far as possible by
means at its disposal in the -aonetary and credit field. A serious i n flation would have been vastly disruptive to our.war effort. Ve couldn't
afford to p e m i t the value of money to depreciate and thus to weaken the
will to save. 1-hile it was necessary to maintain credit ease for Treasury financing, it was a policy that could have been carried too far.
That is why credit restraints in fields such as consumer credit and stock
market credit were made operative.
Before the attack upon Pearl Harbor the Treasury and the System1 s
Open Market Committee decided, in the event we were drawn into the war,

to maintain a structure of yields on Government issues. The rates ranged
from 3/8 of 1 per cent on 3-nonth bills to 2-1/2 per cent on long-term
issues. Compared to those of the Uorld Uar I, these rates were moderate
indeed. Also, compared with the first world war, these rates did not increase as the war progressed. In fact, although the two terminal points
of the structure of yields were maintained, the yields on medium-tern
securities are actually lower now than they were at the beginning of the
war. The maintenance of such stability in rates nay well be regarded as
an unexampled feat in the annals of war financing. The principles that
were applied were, fundamentally, as simple as they were successful.
First was the principle of buying and selling Treasury issues to
steady the market. This was carried out through th& open-narket operations of the Federal Reserve System. There is no ^yctery about this:
when offerings of Government securities were in excess of demand, so that
the rate structure night be inclined to rise, the System bought those
issues in the open market in amounts sufficient to balance supply with
demand and to neutralize the upward pressure. Conversely, when the demand for individual issues was in excess of supply, so that the rate
structure might fall, the System made sufficiently substantial sales of
those iscues to satisfy the market. I do not wish to give the impression
that the application of this policy was as easy as falling off the proverbial log, for decisions have been difficult at times, but the record
of results remains,
" •
Second—in order to provide an adequate and continuous market for
Treasury offerings, it was necessary that the resources of the commercial
banks, which were fortunately at a high level, be released on a gradual
basis, as the situation might require. On the day after the Pearl Harbor
attack, the Board of Governors issued a statement to the banks calling
attention to their plentitude of funds, assuring them that the Federal
Reserve System would support them in full in their aid in financing of
the war, so far as that aid was required, and specifically stating that
the System 'stood ready to advance funds to banks on Governnent securities
. at par. This statement proved effectual. The Syster.: backed it up with
action. In November 19A2 the System, together with the Treasury, the
Comptroller of the Currency, the Federal Deposit Insurance Corporation,
and the executive committee of the Association of State Bank Supervisors,
issued a statement, assuring banks that the exaraination and supervisoiy
policy vould not deter bank investment in war securities with certain
restrictions as to kinds of securities banks can buy; also that these
supervisory authorities would not look with disfavor on loans up to 6
months rcade to the public for the' purpose of public buying of Government
securities.
.However, the stabilisation problem became not only one of sufficient
credit ease but also one of excessive ease. So rapidly were funds supplied to the Treasury and so rapidly did these funds begin to pervade*
the productive economy, through increases in dollars in circulation and
increases in bank deposits resulting from purchases of Treasury offerings
by banks, that member banks began to feel the need of replenishment of
their reserve position. The increasing demands for bank* credit by enterprises producing for war further increased the banks" requirement of re.serves.. It was a demand which .early in 194-3 passed the $3 billion nark
in loans outstanding, and rose to $3.5 billion by the end of the year.

It was, of course, encouraged by the guaranteeing of war production
loans under the Board's Regulation V.
Therefore, this condition called for an approach along several
lines. First, the Federal Reserve System so directed its open market
operations as to relieve some of the pressure upon bank.reserves; but,
nind you, not to release large and unnecessary amounts of excess reserves, but small and necessary c:.iounts as needed, Hext, the reserve requirements for central reserve city banks (New York and Chicago) wore reduced from 26 to 20 per cent. Borrowing by banks from Federal Reserve
Banks, which had been largely a discontinued practice in the period when
excess reserves were abundant, was encouraged through establishment by
the Systen of low discount rates. Iceserve Bank loans to meaber banks
reached the highest levels in both number and amount for n-any years.
The System in addition established the policy of buying Treasury
bills froia banks, under an option by which banks could repurchase them,
at 3/8 of 1 per cent. Also, Congress suspended reserve requirements
against war loan deposits for the period of the war. However, the System's policy watJ influenced by the general objective of selling as large
.amounts of Government securities as possible to buyers other than banks;
a policy that not only greatly helped to ease the pressure upon bank reserves but also absorbed idle funds that, otherwise, might have been
used to bid up prices to create uncontrollable inflation. Not only did
the Federal Reserve in its operations follow this guiding policy, but it
gave counsel to the Treasury and to the banks on this vital matter, in
pursuance of this policy.
By means of these various actions, and of others that vere taken
from time to time as the situation required, the largest scale financing
in history was accomplished without swamping the investment market or
undermining the dollar on which the entire operation was based. Ue inherit in this period of reconversion a credit responsibility carried over
from the war, and this is it.
I need not tell you that, because of the success in marketing and
maintaining the market for Government obligations, this type of investment is today of underlying importance in the financial structure of
banks, insurance companies, savings banks, and institutional investors of
every type; of business corporations large and small, of the very numerous unincorporated businesses, and of countless individual investors
like ourselves. I need not point out thc.t the value of this allpervading investment would be affected by inflation.
Of all our responsibilities, it seeias to ne, perhaps the greatest
continuing responsibility is thct of protecting our common investment
from a decline in its value; which is only another way of saying that we
must do our utmost to prevent inflation. l.re must protect our investment
in the victoiy that has been won.
Because I wanted its connection to this most fundamental of all
problems to be clear, I have omitted until now ray nention of one aspect
of Federal Reserve policy that nost nearly concerns you. I spoke of the
abundance of purchasing power in consumer hands, and the capacity of
that buying power, if not applied to aiding the war effort, to go in the

other direction, to burst the price ceilings, and, by reducing the worth
of the dollar, to operate to the detriment of the entire financing of the
war. This danger was especially serious because liquid funds^in the form
of currency and bank deposits have been and.are at .an unprecedented high
level. Dollar circulation increased to 027,804,000,000 on September 30,
1%5, and demand deposits of individuals, partnerships, and corporations
in1 insured banlcs rose from f?36.5 billion at.the end of 194-1 to more than
§64 billion at the end of 1944. '
•
Many consumer goods have been and still are in short supply. Obviously the danger of inflation from this cause still exists.
The classic effect exerted by inflation through a high cash buying
power against a short supply was subject to restraint by price ceilings,
. These were established, but the pressure against them was heavy, and it
was clear that the additional buying power which consumer credit could
supply could easily, added to the cash pressure, be the marginal factor,
however small, that could burst the ceilings and with them tlie war investment, market. In 1941 the President of the United States todccognisance of this possibility and "ay JScecutive Order Ho. 8343 enjoined
the Federal Reserve System to take action to discourage consumer credit.
The Board of Governors in response to that order issued Regulation II.
You are faniliar with the terms of that Regulation, and I need not recount them, except to call attention to the temperate language used by
the President in his iiieasage to Congress bearing upon the. order, an
attitude that was reflected in the Regulation itself:
"To keep the cost of living from spiralling upward, we
must discourage credit and installment buying, and encourage
the paying off of debts, mortgages and other obligations; for
this promotes savings, retards excessive buying and adds to
the amount available to the creditors for the purchase of
War Bonds."
The order, unprecedented as it was in this country, met with immediate response. Financing institutions at the tir-ie, 1941, were at
their all-time peak of consumer credit, especially installment financing. Those institutions tint were directly engaged in financing of
consumers might be conceived of as liaving two conflicting points of
view, their immediate interests appearing to run counter to their . long-time interest; their daily business to pull in one direction,
their stake in the war effort in another. If such were the case, then
the record shows that they chose the long-time point of view, for the
extent to which Regulation U has been self-enforcing on a voluntary
basis stands as clear evidence that those men most interested in the
financing of buying power were willing to help fight inflation at the
cost of reduced business to themselves.
Now, the record further shows, first, that the fight against inflation, while not completely won, has by no means been completely
lostj and further, that tho commercial banlcs felt the dislocating
effects of Regulation V more than did the small loan companies. I
understand that from about 1910, when States began to pass enabling
laws, to about 1934, the licensed small-loan companies had this field
fairly well to themselves except for some competition by .credit

-59
unions, industrial banks .-and receivable financing companies. About •••
1934-f the coirimercial banks- became active, in installment financing,.-and
in the ensuing 7-year period,, in which the total volume of installment
financing rose from about a half-billion to about- 2-1/2 billion outstanding, the small loan companies gained, in volume by about 115 per
cent, whereas the. outstandings of commercial "banks rose from less- than
050 million to about #780. million, or by a.much greater percentage.
However, the total volume, of outstandings declined by about 50 per cent
from 1941 to the early part of 1944. This was due to various factors:
The shortage of consumer durable goods resulted naturally in a limited
volume of new business^ and Regulation 1J ..tended to expedite the repayment of debts incurred, • Naturally those ;part3 of the consumer credit
business that were the most intimately tied to the market for consumer
durable goods suffered the greatest losses in volume. Tho discounting
of salea contracts for automobiles and similar goods declined more than
four-fifths and this effect was felt most keenly by cales fincnce .companies and banks. ..Cash installment loans were somewhat less severely
curtailed. Such loans at commercial banlcs declined by aluost one-half
from the peak of 1941 > by about two-fifths at credit unions and industrial banlcs, and by about one-third at -small loan companies. For saore
than a year now there has been relatively little cliange in consumer
credit volumes; such change as. has taken place lias been mainly a slight
increase*
I need not here discuss action taken by our Board to restrain uses
of stock market credit.- May it suffice to say that the present cash requirements are 75 per cent.
And so we come, to the situation, as it is today..
There is much conplexity and there are many contradictions in our
present situation; yet'I feel sure, there: is a virtually universal recognition of the fact that increased production, the greatest abundance of
production we can got and at the earliest date, is the primary key to
those.problems tint present themselves as-the most serious to finance.
On the one hand: The Office of Uar Mobilization and Reconversion,
in its report to the President on October first of this year, states
that
...
"5y next spring with demobilisation running at better
than a million a month, unemployment may rise to about 8
million. The total will depend on how fast reconversion and
expansion can be accomplished."
And again, in that sane report, Mr. Snyder, Director of Reconversion,
speaking of our1 vast purchasing power and.stifled war-tiue deniands, says
"Big as the backlog is, our.econoqy cannot,-carry on
out of accumulated savings alone... These savings.are
largely in the hands of middle and higher income groups.
There are millions*of families with little or no savings.
The steady.-market.that business and agriculture need, to
reach full:.employment, laust come chiefly from current1
wages and salaries.11.

60
Shrinkage of current income, "of course/is a deflationary element in-our
economic picture. -There are also other contributing deflationary features- in.the present situation which we need not detail now.
On the other hand: lie do not need theory to recognize that, -inmaintaining the stability- in a free economy, z nomal balance between the
supply of goods and the demand for goods is the main necessity. If the
supply-demand equation is over-balanced on the supply side, prices drop;
if "the equation is over-balanced on the demand side, prices rise.
At the immediate moment, production is far. in arrears; demand for
goods is enormous and urgent. There1-is a psychology that tells us that
the war is over, that we can put thfc-rifle in the corner and go home,
relax and enjoy life in its fullness. - Yet we need hardly to be told that
the poorest service we could render to our economy would be to let the
forces of a pent-up domestic and world demand be unleashed upon that
econoriy, without restraint and without safeguards to prevent.these forces
from having an inflationary instead of a-constructive, and stabilizing
influence.
The present unbalanced situation, we know, is temporary. In some
consumer lines, alleviation of shortages already appears. There is world
shortage of supply in lumber, paper and pulp, rubber, cotton and woolen
textiles, sugar, fats and oils, brick, lead, tin and other basic com' modities. Some of these shortages will be overcome sooner than others;
all will ultimately be overcome. There is a bright side of the picture,
too, in the fact that, generally speaking, American productive enterprise
is well equipped with funds for the internal financing of its reconversions, and in the fact that planning for individual reconversions is in
many cases complete. But we also know that the manufacture of new
machinery takes tine, labor-management adjustments take tine, proper tax
adjustments take time, and until a consistent flow, of needed raw materials and parts is assured, the mass-producing industries, especially,
cannot start their assembly lines. Some industries are beginning to revive and replenish the inventory shelves already, others will do so with
a considerable lag; it is a process of step-by-step reconversion,
paralleling the uneven previous process of conversion to war.
Looking at the demand side again, which remains the dangerous side
until shortages are renoved, we see not only the deferred domestic
demand, of which various high e stimates have been laade, but also the
demand of the devastated and impoverished foreign countries, as to which
no reliable estimate exists. Both demands will draw heavily upon the
producing capacity of the United States; the domestic demand because it
is here already, and the foreign demand because governments, relief
agencies and individual businesses in foreign countries nust have goods
of every type, and we are the best potential source of what they need.
Ife want to meet that foreign c.eiaand, not only for the sake of the trade
and an expanded business activity at hone or because of the friendly
international relations and a sense of moral obligation to share with
those who deserve our gratitude, but also because the prosperity of our
international environment directly affects our own prosperity and our
own economic•stability at a high level. The new international structures,
proper policies of our Export-Import • Bank operations-and other Government
lending and sound judgment in private lending and business investment

61
abroad can and doubtless will spread the impact of the foreign demand
upon our markets; international loans made and under consideration will
gradually revive foreign production and aid in-establishing a balanced
world economy essential to world stability; there is.a cood prospect
that the international effort to stabilize foreign currencies in terras of
our own will not be frustrated by the kind of price-bidding that causes
inflation in the world as at home. But here again'we seek balance— ."
balance of international payments. International credits, unlike domestic credits, involve transfers from one currency to another, and these
transfers can be made only if merchandise exports and imports, together
with other international transactions, are all in balance. The difficulties of making international transfers—particularly if major trade
barriers must be hurdled—have been much in our minds. It is a complex
question of great concern to our economy. Much can and doubtless will be
said about it, but this is not the time.
llhat we ourselves must concentrate upon in our domestic program is
the maximum acceleration of production; and until inventories are also
in balance, we must concentrate upon the maximum possible prevention of
inflationary purchasing, here at home.
In the encouragement of industry to speed production, various actions have been taken by Government. The Board of Governors lias taken
two actions which reflect the policy of balancing the supply-demand
equation as soon as possible by the use of credit. Uhile, generally
speaking, our productive enterprise is well equipped with funds, there
are and will be many exceptions in the reconversion of snail business,
depending on kind and size of enterprise as well as type of reconversion.
More than a year ago, therefore, in conformity with the forward-looking
recommendations of the Baruch-Hancock Report, the Board asked Congress to
amplify the powers of the Reserve Banks, under Section 13b of the Federal
Reserve Act, to underwrite the loan risks of commercial banks and other
private lending institutions in providing funds to business and industry
for reconversion purposes. The fora of underwriting thr.t is proposed is
the seme that has been tested by experience during the war under Regulation V, in guaranteeing some $10*4 billion of credit authorisations for
war production, and in fact was well tested prior to the war by Federal
Reserve Banks in guaranteeing bank loans under the commitment provisions
of the existing Section 13b. The guarantee is simply a "take-out agreement", by which a Federal Reserve Bunk contracts with the lending institution, in advance of each loan, to buy a participation up to ^ stipu-^
lated percentage of the loan at any future time, on denand of the lending
institution. For this assurance that it can in the future rid itself of
part of a transaction, should loss be threatened or occur, the commercial
lender pays a portion of its return on the transaction as a fee. The result is a net return, for the guaranteed loan generally represents new
business—typically, a technically troublesome loan, or one in which the
security is somewhat inadequate—which otherwise would have to be declined. The proposed guarantee plan nay apply to any type, purpose or
term of business*loan, and any type of lending institution may use it.
In practice, it appears that the plan will most greatly aid the nailer
businesses, whose"ability to supply loan collateral in proportion to
their credit needs is often deficient. Congress to date has.not adopted
this measure, known as the Uagner-Spence bill (S. 511 and II.R. 591) 5 the
measure which by its teras is intended only for the transition period, is
before the Banking and Currency Committees of the House and Senate, and

62
I comnend it "to your attention because it is a constructive measure that
would strengthen the national economy and thereby be of indirect benefit
to small loan companies.. It is a well-known fact that your business
expands as the national economy expands.
The second action taken by the Board of Governors is. more far.iliar .
to you, and indeed I"understand that there has been seme disappointment
in this connection. In its desire to release credit.as soon as possible
for purposes of production and employment, the Board on September 25, by
an order effective October 15, adjusted Regulation \J by exempting credits
for home repairs and improvements (for which a great social need exists),
and by lengthening from 12 to 18 aonths. the maturity limit on loans which
are not for the purpose of purchasing consumers1 durable goods. Production thus gets the green light, whereas, for reasons that I have tried to
explain, loans for financing the purchase of consumers1 durable goods
listed in Regulation II still remain under their former degree of partial
restriction. To emphasise the temporary nature of the present situation,
let me recall to you the language used by the Board inrackingthis initial
relaxation:
.
•
'
"Until consumers goods come on the market in sufficient gupply to neet demands, the Board believes .that the use of consumer
credit should be discouraged. Accordingly, the Board, after reviewing Regulation U now that the war has ended, has concluded
that the Regulation should not be substantially amended at the,
present time except in the two particulars specified•"
It is :ny understanding that you would like to have the latest amendment to Regulation M clarified in its application to outstanding nonpurpose loans made before October 15. It is also my understanding that
you would like- to have the regulation contain more explicit and nore
liberal provisions respecting consolidations, or what you call "new loans
to present borrowers". Both of these matters are now being worked on by
the Board and the Federal Reserve Banks and you nay be sure that, among
others, representatives of tlie small loan companies are being and will be
consulted with respect to any amendment that may be proposed.
It is indeed a matter of timing, and timing is of the essence of
the problems of credit that now exist. Trnirig of supply, so that it increases with the utmost rapidity in each given line, timing of demand so
that it does not prematurely swamp supply and postpone the day when the
supply-demnd equation ie. generally balanced.•" We linow our amazing productive capacity, and we know that the demands, of a devastated and
goods-hundiy world assure that capacity of abundant markets for a long
time to corae. IJhat we cannot be so sure of is that mistakes in details
may not be made;, that the impatience that everyone feels to confide the •
credit task to the free forces of a free economy may not result in
premature action at times. I am not a prophet.but, for what rny forecast
is worth, it is that as the restoration of production goes forward and
the national.peacetime economy expands, the total' volume of consumer
credit will increase again and in a few years will be vast, to say the
least, by aiy comparison. Ue hope the expansion will be orderly, will
not lead to excessive demands for goods, and will not be followed by
severe liquidation. Having, thus far held the line against inflation,
not perfectly> but vith a remarkable degree of success in view of the.

63
economic pressure thus far, we have no reasons for lack of confidence
that, with a more widespread understanding of how fundamental the value
of the dollar is to this nation and to the world, those who are on the
firing-line of the credit problem will obtain the necessary cooperation.
To summarize: The war is over* We won. Free enterprise is once
again on trial and credit is the blood and sinew of free enterprise,
Hill private credit meet the test by adjusting operations in the
transition period to the sound economic requirements of short and longterm reconversion of our country? in a world torn asunder by a total
war that has not only wrought destruction to property and manpower but
has changed the face of the earth economically as well as socially and
politically, this will not be easy. It will really take nore tlian
understanding; it will take bulldog tenacity and infinite patience• As
private lending meets the test, however, it will help not only to establish a sound peace but it will help assure the maintenance of our
economic system.
The Federal Reserve is aware of its responsibilities in the monetary
and credit field during the transition.
The situation is full of contradictions, but as these did not deter
us from winning the war together so they will not deter uc from winning
the peace together and, God willing, we shall have peaceI

Speech delivered before
Economic Club' of New York'
New York City
May 1, 1946
OUR MONETARY PROBLEMS
The monetary problems that we face today are largely a heritage of
the most tremendous war financing in history. This financing was successful because we" all'worked together to win .the war as quickly and as
effectively cs possible.
Now that the war is won, we need to work together again—this time,
to vin our fight against the immediate danger of inflation. Countless
irJLllions of Americans h?ive loyally supported the home front battle
.. against the inflationary forces generated by the war, . It.would be tragic
to lose"this battle at the eleventh hour by prematurely abolishing ;essen. tial price controls and the other remaining protective measures, irksome
though many of them may be and eager as we all are to be rid of such. .
restraints as soon as we can safely do so. If we were to permit inflation to demoralize our economy now it would place in jeopardy our justifiably high hopes for establishing an enduring prosperity at home.. And
a prosperous America is essential to a lasting peace abroad.
. A. solution of our monetary problems is a part of winning.that fight
against inflation. ' I should like to touch on some of these.monetary
matters "tonight.
At the outset we should admit that we can not solve our monetary
problems with some simple Single device, with some single, action, or for
all time. We must move cautiously, not abruptly, and;we must take the
problems as they" come—as objectively as we can. That.is .the economic.and
politic thing to do. There can be no easy nor quick way..
We do not live and work in a vacuum. We live and worlc..in an active
day-to-day economy under a free-enterprise system, which we propose to
preserve under our form, of 'Government. • This- Government, like our economy,
has many.parts, and these parts' have nlany departments ancl).divisions in
which responsibilities are not always exact and precise. -Solutions, to
national economic problems do-not lie in any one single part, department,
or division, nor in any one segment of our economy. The.solutions should
not result in favor of any single group or groups of our people. The'
solutions of our monetary problems must be considered with one fundamental
aimr-econ6mic stability at a high level of production.and employment.
That, goal can not be:reached through monetary and credit measures alone,
but it can not be achieved without appropriate monetary and credit
measures.
In peace time,, as has been said often before, the primary objective
of Federal Reserve pplicy is to provide monetary and credit conditions
favorabie to sustained sound economic activity in commerce, industry, and
agriculture. In war"time this objective continued to be of great importance but it was influenced by the special requirements imposed by : military necessity. In reconversion from war to peace, it is: influenced by

66
the special requirements imposed by the accumulated demands for goods
here and abroad, the short supply of certain goods, "the large purchasing
power in the hands of the public, and the interest cost "on the extra- •
ordinarily large public debt—all resulting from the war. The primary
problem, therefore, is to meet the accumulated demands for goods, needed
both at home and abroad, through an expansion of production that will
achieve as rapidly as possible a better balance between supply and demand
without, at the same time, causing a rapid inflationary rise in prices
that would end In deflationary, .collapse.
It is important to note right here that inflation .increases the cost
of Government as prices rise sharply • The increased cost ..would likely
continue during the subsequent collapse as the.Government would need to
make expenditures for recovery and relief.
To fight inflzvtion we need to encourage continued savings by the
public on a substantial scale.- The savings bond program is, therefore,
vitally important and deserving of support. We should exert every effort
to insure the balancing of our budget. Hence we should not reduce taxes
further, in the coming year and should hold Government expenditures to the
.minimum.
On the monetary side, as you are aware, individuals and businesses
have accumulated" huge amounts of liquid assets which are held in the form
of currency, bank deposits, and readily convertible Government securities.
The public,.even after paying greatly increased war-time taxes, had a
large excess of income relative to the supply of goods and services available for purchase. If the public had spent a larger part of .this excess
income,, the result would have been a ruinous inflation.
Notwithstanding the ..fact that taxes were increased heavily, arid that
tax receipts of 153'billion dollars comprised about 40 per cent"of all
funds raised during the war period, the public debt rose'from less than
50 billion dollars before the war to a peak of approximately .273. billion.
This increase in debt inevitably added tremendously to ..the liquid
assets of the public... Liquid assets—that .is* currency,, bank deposits,
and Government securities—held by individuals and businesses, exclusive
of^financial institutions, rose from about 80 billion dollars at the time
we entered the war to approximately 225. billion at the end of 1945—an
increase of some 145 billion dollars. This is.an inflationary potential
that dwarfs anything in our past.

••••••-...

• ..As, you know, it has been the policy of the Government to sell'the'
largest practicable anount of its securities to investors other.than'
commercial bamcs and to.induce these nonbank investors to hold their
securities. The purpose has been to channel as much as-"possible tp the
current income and idle funds of nonbank investors from the purchase of
scarce goods and services to investment in Government securities. This,
in"turn, has retarded the increase in bank deposits and thereby limited
the amount of' funds that were-in readily spendable form.for purehasings
goods and'services, either, during the war.or afterwisird'.". .You are familiar
with the devices-used to implement, tlds policy—war, loan drives,, payroll
savings plans, and issues of Government securities, whose .ownership, wast

general •> restricted, to nonbank investors*

67
In spite of this, a large part.of the Government securities vent to
the banks.
It is p.tten saia LnaL Lne casip cause or inflation is the Government
deficit.and the resulting borrowing from" banks that creates new money.
This is essentially true,.but the results" of;that situation now exist and
they can not be eliminated overnight. Mo country has ever bsen abie to
impose sufficient taxes to finance a war without borrowing or creating
new money in the form of bank deposits. Now that the war isl over, the
deficit has practically disappeared; it is no longer necessary to create
this new money by borrowing to finance the Government. Nevertheless,
.the money created during tho war still exists and might be expanded
through further transfers to thebanss of Government securities already
in the market. Until those funds are firmly invested" ;or until our .
economy has grown up to them, they are potential inflationary tinder.
These funds, in addition to current incomes that result from current
production of goods and services, are available for spending or investment in other .assets. Thus the potential spending power can continue
far in excess of the current flow of goods and services even though production should increase considerably. Expanding production would not
prevent or check inflation, if the public should attempt to s^end its
accumulated savings as well as current income. Nor can these accumulated
liquid assets be substantially reduced except by.debt retirement—at best
a slow process. We can hope that they will remain firmly held until, they
can be gradually invested in peace-time pursuits. In the neantime,1 controls of various sorts over goods in limited supply and over prices will
continue to be necessary.
Although, this background is familiar to you, it is so vital to any
discussion of our monetary problems that it bears repeating."
In the monetary" field the responsible authorities face a difficult
though not impossible dilemma. Under the existing structure of interest
rates, with its wide spread between short-term and long-term rates, there
is an incentive for both.commercial banks and rionbank investors to shift'
their holdings from short-term to longer-term securities.' By this means
they can obtain both the higher yield on the longer-term securities and
the profit that accrues as each issue, with the passage of time, automatically becomes shorter and consequently declines in yield and increases1 in price. For this reason there generally has been a supply of
short-term securities in the market and a de:cand for" longer-tern secur- •
ities." . The Federal Reserve is continuing, as it did during the war
period, to support present short-term rates by purchasing all of the
short-term securities that are offered in" the market at those rates. : On
the other hand, the Federal Reserve can not supply the market demand for
longer-term"securities, because it has already virtually exhausted its "
portfolio of these issues.
.
'
The result is that, so long as holders of Government securities want
to shift from short-term to longer-term securities, Federal Reserve
holdin-s increase. This increases member banfc reserve balances at the ='
Federal Reserve Banks; On the basis of these- increased 'reserve balances,
commercial banks as a group can expand credit for whatever purpose they •
choose .by six times the increase in reserve balances at the Federal

68
Reserve Banks. The expansion averages six times the increase in reserve
balances because on the average a given amount of reserve balances will
support six times that amount of deposits, Expressed the other way
around, present reserve requirements for the various reserve classes of
banks are at levels that equal, on the average for all member banks, onesixth of net demand deposits. To summarize, so long as present sliortterm rates can be maintained oaly by tederal Reserve purchases, there is
an inducement for bank credit to expand further. This increased bank
credit is available to the public for spending in addition to their current income.
You may &sk, ouite properly, at this point: "Why not use the methods thLt the Federal Reserve hLS employed in the past? V.'hy should not
the Federal.Reserve discontinue buying Government securities? Would not
this top the further expansion of bank credit? If the Federal Reserve
discontinued buyinr securities, would not this make it nore difficult and
more costly fornonbank investors to raise funds by selling Government
securities, by borrowing from banks, or, &s in the case of corporations,
for example, by the issuance of. their own new securities?"
I think the answer to these questions is that the present situation
is entirely different from anything in the past. The difference lies in
the large public debt, the large interest cost of that debt, the large
profits that commercial banks t*s a whole receive from Government securities, and the large holdings of Government securities by nenbank
investors.
If the Federal Keserve discontinued buying the securities, shortterm interest rates would no doubt increase. This, in turn, xvould increase the interest cost of the debt to the Treasury as maturing shortterm issues were refunded srt; higher short-term rates. The importance of
this interest cost is shown by the fact that, as e result of the war-time
expansion of the debt, it has increased fivefold from a billion dollars'
a year to about five billion a year. Who pays this interest .coat?* The
taxpayer. As you know, the public and the Government are in no mood to
increase the cost of servicing our tremendous public debt.
An increase in interest rotes also would unnecessarily add to" the
profits of commeriCLl banks. The importance of this consideration is
shov.n by the fact that, es a result of war-time purchases of Government
securities, commercial bank profits have more than doubled. You may sey
that, since an increase in bank profits w£s of no concern to the Government in the past, it should be of no concern nov:. I believe, however,
that the difference lies in the fact that in the past bank profits came :
principally from the public in the form of business.losns,'corporate securities, and like assets. At present, iiovever, a considerable p&rt
comes from the Government, which in the last analysis .means you and me
as taxpayers. More important still is the continuation of our free
enterprise system, and increasing the profits of coiomercial banks at this
time at the expense of the taxpayer is not a good "way. to preserve the '
system of free enterprise—or, to be inore specific,, to preserve pur private banking system.

I do not v;ant

to seem in any way to disparage either the need for

6$
the existence of a healthy coranercial banking system or the excellent
job that commercial banks did for their countiy during the wtr. Commercial banks vere an important factor in selling Government securities to
nonbank investors. Also, they purchased the Government securities that
the Treasury v;es unable to sell to nonbank investors. Thqrporformed many
other valuable functions in the v;ur effort. Always—in wtr'or in peace—
they are vital, useful institutions tnd as such they must etra sufficient
profits to maintain their existence. Also, in exceptional circumstances,
some individual banks or groups of banks heve not participated in the
general increase in profits but banks in general do not need to obtain
higher rates of interest, on Government securities to maintain their
existence.
There is a third reason for avoiding a rise in short-term interest
rates, in addition to the effect on the interest cost of the debt and on
commercial bank profits. It is said that a rise in-short-term rates
night result in liquidation of present holdings of Government securities
by nonbank investors. If this were to reach large proportions of a
flight from Government securities, it would h&ve inflationary consequences, . After interest rates have been prevented from increasing for
four years, the first break in the dike might possibly bring: on a flood.
For my part, I do not believe that this would be the result, but the
possibility at least indicates th&t v;e should proceed with caution, and
there are those who stress this point.
On the other hand, there is the long-run danger that lies . in the
fact, well.known to you, that as coiTiHiercial banks purchase Medium-term
bonds .from nonbank investors and the nonbank investors in turn bid
against ;e&ch other for long-term bonds not available to commercial banks
for purchase, yields on these bonds decre&se.. * decline in long-term
yield tends to result in such attractive premiums th&t holders of longterm bonds other than institutional investors are tempted to cell them at
those premiums, with profit, end to seek other employment for their
funds. The result is that the funds tend to shift to other marketsfirst to high grade corporate bonds depressing their yields to the point
where.they become unattractive, then into lov.er-grede bonds, stocks, real
estate, e t c , bidding up their prices and tending to accentuate speculation in such investments. ^ decline in long-term yields tends to reduce
the income, of insurance companies, savings banks, .and endoved institutions, which hold a large part of the savings of the public end perform
essential public services. It seems to me, therefore, that lov/er interest rates, especially at this tine, would not be desirable.^
• • What I have been spying up to this.point seems altogether negative.
There, is. something, however* on the positive side. ^K>st important is the
state of..the federal budget, ±n the first quarter of this year, the
Treasury had a small surplus of tax and other receipts over Government
expenditures. Receipts were larger and expenditures had been reduced
ftore rapidly then had been expected. The budget is close to a balance on
an annual .basis, -its long as inflationary pressures continue, however,
there is no justification for-further tux reductions and Government
expenditures should be held to the. minimum of public needs. I believe
that budgetary surpluses to retire public debt should be the order of the
day.
•

70
favorable trend In-the budget reeus thtt the Government deficit
is not nearly so large as it was and that there-has been a reduction in
the excess of the' public's income over the available supply of goods and
services. In addition, it netns that-the Government debt will not continue to increase.
In fact, the Government debt has already started to decrease be-""
cause the Treasury very wisely has been retiring maturing and called securities by usinp- part of the large cash balance not needed for current
•expenditures. Since the cosh balance is still Itrge, the Treasury is in
a position to continue to' retire debt. Since banks held a lar.-re proportion of the maturing and called issues, the result is a substantial reduction in bank credit• From i.iarch 1 through Llay 1, 1946, the Treasury
retired a total of 6.4 billion dollars of certificates, notes, and bonds.
Of this amount comrtorci&l banks held somewhat over 4 billion dollars end
Fecer&l Reserve banks 1.2 billion/
•
-toother new-1 factor- thfct may ret&rd the Lionetization of our public
debt is thst the yields-on the medium-term bonds that-cfoLTZLerciel b&nks
have been easer to purchase have declined to 1-3/8" per cent, compared
with 2 per cent only a little over a year a&o. The spread between these
bonds and the 7/8 per cent certificates consequently h&s been reducedfrom 1-1/8 per cent to. 1/3 per cent. The type of switching that iei/ds
to further expansion of bank credit is not nearly so profitable as1 itwas formerly, finally the debt retirement has reduced cor.^erciel bank
holdings of the shortest-term securities and consequently has lengthened
the averse maturity of their portfolios. This also tends to make them
a little hesitant to extend their maturities further by selling certificates end purchasing medium-term bonds. In fact, during recent weeks
commercial banks seem to have been shortening rtther than lengthening the
maturities of their Government securities.
-•
• •
In any event, because of this combination of circumstances, the '
situation looks much riore favorable than it did a few months -ago or at
the tine you invited me to speak here, '^he demand deposits of individuals and businesses-have stopped expending, and the total of bank loans
and investments has actually declined, 'i'otal loans and investments by
weekly-reporting member banks declined from 68 billion"dollars in February to 65.5 billion, dollars on ^pril 17. Whether this is a temporary
phenomenon or a major change, I* v:ould not undertake -to say, but I hope
it is a major change.

•

. - • • • •

In addition, a return flow of currency and gold imports, which
could have been a basis for' further expansion of bank- credit, has been
offset by a decline in .Government -securities held by the Federal' Reserve
Banks. Currency in circulation has declined by about 700 million dollars
from the v-ar-time peak of nearly 29,000 million" dollars reached 'last- •."
December, Gold imports in this period have amounted to about =200 million dollars". The effect of- these movements,. which isp to increase bank
reserves, has been more than offset by a decline in ^overnnent securities
held by the Federal Reservfe Banks. **s a result-of. the Government's" debt
retirement program tmd salies of securities in the market the Federal •
Reserve System's" portfolio has been reduced by 2 billion dollars-since
the first of the year. It is now 22 billion dollars.

71
... A S I- have indicated, there are serious obstacles under present day
circumstances to the use of the traditional monetary powers to implement
anti-inflationary policies in a way that vould increase interest rates.
Our.Board announced last v;eek Thursday that it "does not favor a higher
level of interest rates car United-States securities than the Government
is now paying.". • The problem of exerting further pressure to arrest unnecessary and.imdecirGble monetization of the public debt through the
conrierclal banking systeu may require Congressional study and legislation..
One perhaps relatively minor but certainly desirable step vms the
. ending o£ the y&r-tiine preferential discount rate of 1/2 per cent on
Government .securities due or callable in a year or less. This special
•rate v;as established, purely as &n emergency v<ar r-ioasure to help the
. Treasury in the successful s^le of its securites to obtain funds required to v:in the v,ar. It vas designed to enable coiamerciLl bunks to obtain ir:ore.re&dily the excess reserves needed to purchase Uovernruent securities that cpulfi not be sold4 to the public. To facilitate them in
adjustinr their reserve positions, end fintlly to encourage them to buy
short-terra rather than long-term securities.
-:":
This, rate not .only had pacsad its period of usefulness but had made
it possible for banks to borrow at 1/2 per cent in order to purchase
higher yielding.^pyerniiient securities, '^he magnitude of the possible
credit expansion if? several ti^es the cmount borrowed from- the Federal
Reserve because, as I have•blrcedy explained, the bank reserves created
by the additional Reserve, -bank credit provide the basis for a six-fold .
expansion of bank credit. The preferential rate also encouraged banks
to lend on "overnment securities at. low-rates, thus giving substantial
profits- to borrowers and encouraging speculation. - Although such loans
have declined .from the v/ar-time peak, they still exceed 3 billion dollars. The preferential rate has not been an important instrument of
inonetary policy and its elimination is merely a post-var adjustment in
conformity v/ith the Governments stabilization program.
Various other proposals concerning our monetary problems have cone
to my attention. lror example, to stop further expansion of bank credit
and a further decline in the long-torm yield and to do so without in- •
creasing the interest cost of the public debt and vdtliout increasing further the already lar^e profits of commercial banks, several suggestions
have been Made to require commercial banks to hold a certain minimum
amount of Treasury bills end certificates, or, following the example of
the Canadians, to prohibit the commercial banks from holding i;»ore than a
certain maximum amount of Treasury bonds.
It has likewise been proposed by some that the required reserves of
central reserve city banks be increased to 26 per cent against net demand deposits. They are nov: 20 per cent, the same as at reserve city
banks, vhile so-called country bonks are required to hold reserves of 14
per cent against their net defend deposits. That is the limit of our
authority. It hfcs also been proposed, therefore, thet the Federal Reserve bsk the Congress for some additional power to raise reserve requirements above the present maximum for each of the three classifications of member banks. It seems to me that whatever merit there may be
in the various proposals that have come to my attention, one thing is

72
'evident and that is thst they deserve very careful study for;- G S you know,
they have both' advantages and disadvantages •'
Sudden or drastic action v.dth.respect to our. monetary situation is
not advisable, economically or politically. We should move sl.ov:ly, cautiously, moderately— step by step—in the monetary field, givin.n; whatever
help re can to increased production, giving whatever help we c£.n to prevent inflation. Vfoat we do in the monetary field, while essential, is
only supplemental to the larger economic influences inherent in the" budget
and in debt retirement, for example. Monetary end credit policies can
help,:: but they can't do the whole economic job alone.
Forums such as this ere important and necess&ry to widen our. understanding of! the economic problems of the tines and to aid1 us in arriving
at the most satisfactory solutions* tone of the problems are complex &nd
not wiflely understood by the general public. I think we may justly •"••
classify the problems of debt nan&genent, of interest rates, and of monetary action through the commercial banking system as beinff.fciaongthe "
most complex and leest understood crenerally,
If you fe-jl thot I have debit in too wncral terms in sue^kini? about
some of1 these Monetary letters, 1 must confess thit-i have done so deliberately and, in part at letst, in the hope of•stimulating discussion
rather than assuming to krov; the final and best'enswers.to many of these
complex problems'today • V*e shall arrive at the ri^ht solutions by patient, open-minded study and .discussion—not by dogmatism or any narrow
consideration of our individual interests a'p^rt from the broader interests of the-nation as a whole. By your program-arid your presence here,
you signify your desire to hardier out the right '"answers 'on the anvil of
full and" free discussion. That, in essence, is democracy—and, by the •
sawe token, v;e shtll preserve our democracy and our economic system only
by such" "full, free, arid fair discussion, and debate.

Speech delivered before
Directors and Officers of
-'Savings Banks Trust Co;;:and Institutional Securities Corp.
•

New-York,-

H . Y ,

•

•-••••-••

June 'l£i 1946•

OUTLOOK FOR INTEREST RATES
Considering the size of the public debt and the great importance of
the interest cost of servicing the debt, few, if any, would be so bold
as to forecast;sharp increases in interest rates over the next several
years, I make no claim
as a forecaster, end as a member of the Board of
. Governors should notlplace•myself in" that position. However, I can dis. cuss with you some of the factors which will bear'importantly upon the
future cost of interest rates and some of the considerations which probably will influence public .policy in this matter.The War Situation
The demand for'arid the supply-of loans and investments hs.ve always
been the underlying factors determining-the rcourse"of interest rates, "
During 'the war, the conditions of demand and : supply in the security, i&ar"kets, as in eny other-sectors
of the economy, were of an altogether
unusual kind; From:Pearl Harbor" to -early this year'the public debt rose
..from 64 billion dollars to 280 billion- "This enormous increase in the
supply of securities vas-made necessary to pay for some 60 per cent of
the war* cost which1 was riot covered-bvt&xation.
At the same time, there was also a vast increase in funds available
for investment in Government securities- Uages, salaries, farm incomes
and "profits,"-after allowing for "deduction of income taxes rose from
an annual" rate of little over"90 •billion dollars to a rate of well over
H O billion. As the supply of civilian goods did not• increase during the
wax years and prices were held fairly stable, savings, and henco the demand 'for investments, rose sharply. As the economy moves along, these
factors keep changiiig with-it. Of the 216 billion dollar increase in the
debt, 'over'50 per cent-was absorbed by this investment demand outside the
banks. The remainder was absorbed -by the banking system. To adjust the
combined demand for securities to the requirements of war financing," the
commercial-banking system, for this purpose, was supplied with the necessary reserve funds,
Thui-we .-have for the war period a vast increase in the supply of
.securities,'accompanied by an equally sharp rise in demand. On balance, i
the two factors "tended to offset each other rjid it was possible to maintain interest rates at a fairly stable level. Rates on Government securities ranged from 3/8 per cent on 3-month Treasury bills to 2-1/2 per cent
on long-term marketable bonds. In fact, during the latter part of the
period there was strong market pressure for interest rates on medium-term
and .'long-term Government securities to decline. The spread between corporate and'other securities narrowed during this period as a result of
the decline in yields on corporate"securities;"interest rates on loans
also, declined.

The Transition Period
With the end of the war, there was a rapid.change in the financing
picture . The Federal budget has tumbled, from its wartime peak of annual
expenditures of over 100 billion to less than 40 billion:dollars. The
deficit has well nigh disappeared, and by the end of the year we should begin to have a cash surplus. The increase in the debt has stopped, and due
largely to the drawing down of Treasury balances it is being reduced at a
considerable rate. On the supply side- the situation has thus eased a great
deal. The problem which was one of rapid debt expansion has become one of
refunding anci retirement.
On the demand Side the change has been leas drastic. The level of
income has jreiaaineu extraordinarily high- Notwithstanding.strikes and
. other disruptions, our production record since V-E Day has belied the pessimists and surpassed most expectations. Production during the months before the coal strike was higher than ever beforq. in times of peace. ..If
we manage things at all well in the months ahead, finished products will
be flowing to the market at &n ever-increasing rate.
With incomes remaining high, the dollar volume of private savings
will continue at a high level. Although it is only natural to expect
that the rate of savings should-decline from its wartime peak, a substantial amount of current savings will continue to be available for investment in Government securities. Individual savings are now at an annual
rate of about 20 billion, as against 7 billion in 1940. The demand for
Government securities, similarly, should be sustained by. the existence of
the huge volume of liquid funds.which has been erected.in the course of
wartime borrowing from the commercial banking system* The voliuae of demand deposits (adjusted) end currency alone increased from -39 billion in
1940 to 130 billion by the end of April.
But here is where the inflation problem enters the picture. . Even
under the most favorable prospects, for. full production, the :supply of
goods for.some time is bound to remain scarce relative to demand. • Inflation pressures are bound to remain strong. If we can hold them in rein,
if we can avoid the vicious spiral of price and wage and price. increases,
there is every reason to hope that pressures, will, relax within a year'or
so. If, on the other hand,-we fail to do so, if we give the investor any
reason to fear that-the purchasing value, of his security holdings is
threatened by upward spiralling prices, the entire demand side" of the.
security market will be most seriously threatened. "Already, there is .on
overflow of funds into speculative investments, and capital, values in
many lines have reached inflationary levels. This is true especially in
the reel estate market, both for urban and residential real estate. The
prices of' ldwrcost houses are- generally 6j,per cent, and in many cases
100 per cent, over their 194-0 levels • A l s o , there has been a. steady inflow
of funds into the stock market and prices during the past 12 months have
increased by 30 per cent. All signs show that strong inflationary pressures will continue.
Lest this situation sholild get out of hand, we.must useiall our
powers to stem inflationary forces until production has time'to bring
about a reasonable-balence between.the factors .of supply !arid demand.
Monetary
policy and Federal Reserve policy ".has an' importanV.though sec
ondary
role
to play in preventing a further increase in," and. if possible

in reducing the money supply at this time. This means avoidance of
further increases in bank credit and, if possible, a reduction. The
Treasury in this connection has embarked upon a program of retiring
debt out of the large cash balances that were built up during the.
Victory Loan. The cash balance remains sufficiently large to continue
this debt retirement program over the next several months. The securities being retired are, of course,' short-term maturing issues, vhich
are largely held by commercial banks and the Federal Reserve Banks.
This will have a tightening effect upon bank reserves..
The Federal Reserve System also has announced the discontinuance of
the war-time preferential discount rate of 1/2 per" cent on.short-term
Government securities. At the same time the Board" stated that it does
not favor a higher level of interest rates on U. S. Government.securities then the Government is now paying. Assurances have h»een.given
that the rate of 7/8 per cent on one year certificates wGuid be maintained. In practice that means that the Federal Reserve from time to
time needs to purchase short-term securities in the market in order to
prevent short-term interest rates from rising above the level that the
Government is now paying. Medium-term and long-term rates are below the
coupon levels that the Government is now paying and consequently do not
need support. As the Federal Reserve purchases short-tern securities in
the market the reserve balances increase and commercial banks generally
can expand credit by several times the amount of the increase in reserve
balances. Since an expansion of bank credit is dangerous at this time
of inflationary pressures, some method should be devised to stop this
expansion. The orthodox methods of influencing the level of bank credit
cannot be used, however, because they would no doubt result in a higher
level of short-term interest rates. Some new instrument of credit policy, therefore, is needed.
Several "netnods nave been proposed and are being carefully studied.
Some would directly or indirectly increase commercial bank demand.for
short-term securities, either by requiring commercial banks to hold secondary reserves in. the form of these securities or by limiting the emamt
of bonds that they may hold. Another would offset Federal Reserve purchases of short-term securities by increasing the reserve requirements
of member banks. .These plans have disadvantages as well as advantages.
Hone" of them should be put into effect until we are sure that the advantages clearly outweigh the disadvantages. Congressional study and action is a prerequisite.
.:
In the meantime, retirement of Government" debt is anti-expansionary.
As long as this retirement continues, the problem of bank credit expansion becomes less urgent. This gives us a breathing spell in vhich to
study the problem. The development of a substantial budget surplus
would go a long way toward solving this problem, because it would permit
the Treasury to continue* to reduce the Government debt. While' I hope
that the inflationary problem on the monetary side can be solved without
the need for employing any new method that would restrict the operations
"of commercial banks, I believe that the prudent course would be to develop a new method of influencing bank credit aid have it ready for use
if the need for it should arise, prudence, caution, and proper timing
'
of the essence.

76
The Longer-Run Outlook
Over the longer-run, developments defy prediction. Assuming a high
level- of business activity, which we are all striving for,' savings tanks,
insurance companies and other savings institutions will have a-substantial accumulation of funds to invest. Over the war period
these funds
have found outlet in Government securities, vnd since ?the Government is
now embarking upon a debt retirement progran, this source for investments will not be available. The funds of these institutions, therefore,
will exert strong pressure on market yields of existing Government issues,
and will force a lowering of the long-term rate unless the- demand for longterm funds by corporations, the mortgage lending Held, the World B&nk,
the Export-Import Bank and others offset those pressures. It may be desirable in this connection to devise special long-term nonnegoti&ble
Government'issues, somewhat similar to tho F and G bends which vrill" attract theso institutional funds. In view of the backlog of demand for
goods both at home and abroad, and in view of the demand for housing, I
would venture an opinion that while there may be periods of fluctuations,
the demand and supply factors might be approximately in balance at the
present level of interest rates.
Conclusions
• So far, we have dealt with some of" the conditions of" demand and supply by which interest rates are determined. It remains to be emphasized
that these conditions do not'-represent a set of natural forces which are
beyond our reach cr influence. On the contrary. Debt End credit policy
have a very direct bearing on these conditions. The authorities in
charge of debt and credit policy have t very direct responsibility for
them. This w*;s obvious during the war vhen the vastly increased supply
of securities was balanced by a controlled increase of bank credit available for such investment. Because of this policy, which assured that
securities not sold outside the banking system would be absorbed by bank
purchases, it was possible to: finance the war debt at a low interest rate.
Now the problem is to prevent further additions to bank holdings of securities and hence to the country's money supply, and if possible to reduce
them, lie must""do so without raising the taxpayer's interest bill. IJhile
the problems have changed, they have not become simpler. The importance
of a wise credit and debt policy"has been greatly increased by the wartime
debt expansion.
An intelligent opinion concerning the outlook for interest rates,
therefore, involves the use of judgment as to the net effect on interest
rates of many policy problems that are confronting the Government's
authorities at the present time and of many crosscurrents and unpredictable' factors in the demand and supply aspect of"the problem. The only
conclusion of which we may be reasonably *sure at .this time is that rates
on short-term Government securities are not likely to rise, and as long
as short-tena rates stay down, it is unlikely that long-term rates will
increase to'any significant degree. Some of the wartime factors bringing
about declines in long-term rates no longer exist, but others remain. , I*
may be necessary to adopt new measures to avoid a further decline in longterm rates." With this exception therefore, I think it hazardous'to venture an opinion. I would be inclined to agree with the prevailing opinion that long-term interest rates over the next six months to a year

would
be less likely to increase than to remain stable.

77
Speech delivered before
District of Columbia Bankers Association
Mayflower Hotel, Washington, •D.* .-C.
October 20, 19U7
OUR CURRENT INFLATION AND MONETARY PROBLEM
With little pause after fighting and winning the most "costly war in
histozy, we are now facing a crucial battle against, inflation. This is
not altogether surprising* • It., was-, necessary for us "to create a huge
amount of money in order to finance the war and at the' same time to restrict the availability of goods and services for which the public would
customarily use"additional money.. •To•complicate our. domestic problem
there is the necessity of helping to restore the productive capacity bf
countries whose .populations and resources have been ravished by war.
My remarks to you this evening .are. addressed primarily to th.e domestic phases of our inflation problem. Some weeks ago, in a paper that' I
shall be glad to make available to you, I reviewed the international
phases of this-problem.v/ith particular, reference to Germany, a defeated
eneny country. Here it is sufficient to say that the present economic
difficulties of European democracy are inextricably entangled with our
own problem. It -would be. foolhardy to deny that aiding in their reconstruction will amplify our own inflatiQnary curve, but it would be equally foolhardy to assume that we can put our ov/n house in order while large
areas of the world are in chaos.
Without our-own volition, we have been catapulted into, a position of
world leadership, and in the interest, of our ov/n stability and welfare,
we must assume the.responsibilities of this leadership. The. greatest
single antidote for inflation is.increased production.- Our own productive capacity is already running at full speed and. the largest immediate
reservoir of" unused productive resources is in Europe. The answer to this
part of our problem is clearcut. . I know you will concur in ny belief that
we are qualified to take the measure of .this problem and, in cooperation
With1other nations,.to find constructive ways of helping devastated European, countries to helr> themselves*
This hydra-headed problem of inflation cannot be mastered for all s
time by any single device or any single approach. But with a proper combination of effective policies TO have reason to hope that we still can
establish a lasting prosperity at home and contribute to- enduring peace • .
in the world*
We have been' a little tardy in lining up our forces against inflation. . Weaiy of the disciplines .of war, we have been prone..to rest qn pur
oars and drift with the current. . Inequities have .already been worked on
the recipients of. fixed incomes by the arbitraiy • transfer of part, of their
purchasing power to classes benefiting immediately from rising prices.
This process must be. stopped .if we are to avoid the cataclysmic consequences of a run-a-w£or inflation.
Extent of price inflation'
During wartime, price' ahd*-other controls7kept our own ihflationaiy
forces under check, "'ifft'ofunder complete restraint, - It was nbt until

7'8
after the lapse of these controls in the earijr*summer of rl9ii6that inflation carried many commodity prices to new high levels. Essentially ..temporary shortages in supply have contributed greatly to successive spurts
in the prices of many goods. The rising cost of living has necessitated
widespread wage.and salary adjustments that have raised production costs
and justified many price increases. In many instances, however, price advances have exceeded increased costs, and have helped to generate record
profits.* The combination-of these factors has entangled the econony in
what appears to be an irresistible upward spiral of wages, costs, and
prices*
.... *
Let us compare some of our current prices with those prevailing before the war* Corn before 'the war was selling at U5 cents per bushel,
now it is #2.1*5. Hog prices were $6.75 per hundredweight, now they are
$29.50. Cotton was 9 cents a pound and is now 32 cents. Lead prices
were 5 cents a pound and now they are 15;cents. Southern pine lumber
prices were $22 per thousand and now they; are $80.
These are only examples of-important primary commodities that have
risen from 200 to 1*00 per cent since prewar days. In general, advances:j
in prices of primary commodities have been much greater since the outbreak of war in 1939 than they were between:19lU and the peak.of :the':
postv/ar inflationary period in 1920.
The average level of all viiolesale prices, including- primary commodities as well as manufactured goods, is now 110 per cent above the
prewar'level and the retail prices of many goods have risen by almost
the same proportion. Retail food prices have advanced by:'more than 100
per cent and clothing and housefurnishings are up 85 to 100 per cent.. •
Vfith rents up only 10 per cent, the rise in cost of living shown by the
consumers' price index is about 65 per cent.
Pricesvwere already high during the war and the early postwar period.
When price controls were dropped last year, prices rose considerably further. Since June 19U6 the average level of wholesale prices has risen 1*0
per cent and the cost of living 22 per cent. This spring prices showed- :
signs of downward readjustment, but domestic and foreign developments since
that-time have resulted-in another sharp upswing..
Inflation problems'
Our sharply inflated price levels are unstable elements/in the nation's
economic position and the higher prices rise, the more unstable they become.
This is because disparities among prices develop with inflation and become
greater and greater as inflation proceeds.. .Thus inflation begets inflation
and in the process produces economic dislocations and distortions that bear
the seed of ultimate collapse and widespread unemployment.
- Let us consider some of the critical tensions that attend current inflationary developments.
Prices are becoming more and more dependent, oh buyer's demands, "which
*Cotton.textile manufacturers, paper mills, lumber producers, automobile
dealers and. wheat; farmers,..to cite a. few examples, are making, several, times
Digitized forthe
FRASER
profit returns of prewar years.
"

in turn are. dependent on other'inflated prices.. 'Inequities and discon-'
"tent are multiplying.. Consumiptiori'in some*'directions is being curtailed
"because'the rise in prices is greater than the expansion in incomes.
Price increases are making the problem of financing foreign aid and recovery. particularly difficult/ Foreign-countries" with limited-dollar resources .are finding the loss- of purchasing porter"qf these dollars .a-serious handicap.
"While organized-labor- has: been able* to obtain wage increases, to cover
of the increase" in living costs,: the majority of consumers have
been" in >;'less favorable position; • 'Consumers with relatively fixed incomes, Especially those in the low income groups,**.are being forced to cuptail their purchases of goods, to reduce current saving, and to draw
heavily on'accumulated savings. In short, they are fighting a losing battle against the cost of living.
a11 part;

. It is. important to recognize that the present upward price spiral- re-*
fleets in part essentially transitory developments. These include the
persistence of wartime disruptions in* production and trade, deferred private demands "for investment and consumption, a rapid expansion in credit
extended by private prganizatioris: to business and consumers, arid: unusually
large Government expenditures for military purposes and foreign aid. Undoubtedly, too, the upward surge of prices' ii" being* pressed by speculative
forces, but the extent of this speculation" will only become evident -after
the cumulative force of these special transitory factors has been spent. '
The higher prices rise in an inflation, the more widespread and severe the subsequent readjustments are likely to be. Inevitable readjustments will, affect not only prices, but production, incomes, and employment
as .well. ..The uneven character of demand,' together.with the special and in
part temporary character, of supply, has already brought striking readjust-,
ments in price relationships.
The higher production costs generated by inflation are becoming imbedded in the price structure. This development foreshadows .an eventual
price level substantially higher than, -tfiat. prevailing before"the war.
Since inflations tend ultimately to end in collapse and deflation, it is
probable that the price level' established when the.liquidation of inflatipn is complete will be" sharply below peaks reached in the present upwaTd
spiral of prices.
Breaking the inflation circle
Clearly, a primary factor in the postwar price inflation is the increase of 160 billion dollars in money, and other,.liquid assets which occurred during the period of the war. This huge" accumulation of money and
liquid assets was the direct result; of Government borrowing to finance
w
ar It was Essential to .winning- thei war.
At the war's' end these monetary assets, represented an,enormous backof deferred demand' for goods of all types, but particularly durable.,
goods.;
ds.; As a consequence, demand•** current-prices
currentprice was. far & ™ " ; ° ?
t i p p l i f e j f / d tthat
h t -were.available
reavailable or could be ( llu l?< ?^ k ^> JiD ^^ e ^ 1 ^
y . sstipplifesjpf/goods
W e . .The result/.when wartime controls "were; removed, .was a. sharp rise
Digitized forPrices
FRASER "and'th<5 spiral of inflation *hat is still going on. The sooner

80
this spiral is broken, the better, off our; people and our economy will be..
Also,- the, nearer at hand willibe the goal" of. sustained high levels of production and employment.
Today, the country's aggregate stock of money and other liquid assets
exceeds 225 billion dollars, an amount rabout equal to the total national
product. Prior to the war, aggregate liquid' assets approximated only 65
billion dollars, or nearly one-third less than total product/ Since redundancy of money and liquid assets is a primary, factor, in.the present
inflationary spiral, attack on this strategic factor.is .an essential requirement for..breaking the. circle of rising" prices. The difficulty confronting any such attack, however, is that the existing supply of money,
and liquid assets" is based on public debt issued /to finance war.
V/e'can only reduce the volume of Federal, debt by having a budget surplus. With a Government debt of 260 billion dollars, it is clear that a
surplus in any one. year will not' greatly reduce the total... For the current
*fiscal year, the President, has recently estimated that we may have a budget
surplus of 5 billiori dollars that will be available for debt retirement• .
With the further rise in national income that we have been experiencing, "
the available surplus may exceed the President's estimate. But the new.
budget assumed no reduction in taxes. It also assumed ho increase in Government expenditures, such as may be necessary, to fulfill the nation's international obligations under the. proposed program for European relief and
recovery. Thus, the amount available for debt retirement this fiscal year
may actually be less than currently seems possible.
Reduction in public debt "through retirement from budget surpluses .
will be a slow process at best. Not every year will budget conditions be.
so favorable as this year. But it is urgent that we use debt retirement
whenever possible and that we continue to do so while we are confronted :.
by acute inflationary dangers. In the present situation, .this means, of. ;
course, that moderation should be the rule to" govern any immediate adjustments in our tax structure.
The problem of restraining further bank credit expansion
. Six months ago it appeared that postwar expansion in the money supply
had been effectively brought under control and that. our. answer to the inflation problem was to increase production to a level consistent' with ..the
existing volume of money. Since business was already operating near full
capacity, however, expansion of output appeared to be a .time-consuming
process. Some price rise, therefore, was a method of facilitating and
shortening the adjustment period, and could be viewed without alarm.,.
We attained this leveling off-in monetary expansion by. using large .
accumulated balances of the Treasury combined with .some surplus from the
Federal budget to retire Government securities. The .retirement program*
as you know, was directed particularly at Government obligations held by"
commercial banks and by the Federal Reserve Banks. Retirement of. obligations held by commercial banks reduced deposits directly, because Treasury deposits were exchanged for. maturing bank-held Government securities*
.Retirement of obligations held by Reserve Banks reduced' the',volume of both
ba^k deposits arid baink reserves. In this case,, funds 'were Shifted froiji
commercial banks to Federal Reserve Banks and" the. retirement of Government

81
securities held by Reserve Banks cancelled a corresponding volume of member bank reserve balances. It is true that commercial banks were still
free to restore reserve positions by selling other Government securities
in the open market at rates, kept stable by Federal Reserve System policy,
and this the banks did in limited degree. ' But in general the pressure
exerted was enough to keep further bank credit and monetary expansion under restraint.
Unfortunately, the control of postwar monetary expansion can no longer be affirmed. The total money supply is currently increasing at approximately 9 billion dollars, a year. " This increase in the money supply
is directly inflationary and is seriously accelerating the upward spiral
in prices.
The renewed expansion in the money supply is based in part on increased holdings of gold, largely received by this country- in payment
for
exports needed by other nations. So far this year, the country1 s gold
stock has increased by 1.8 billion dollars and imports of gold are still
adding to this stock* This new gold' has provided the banks with the reserves necessary to support additional deposit expansion notwithstanding
the fact that the Federal Reserve has brought some pressure on reserves
by selling some of its holdings of Government securities. Deposit expansion has gone on because of heavy" private demands for credit from business, property owners, consumers, and State and local governments. During
the first nine months of the year, bank loans increased by almost 5 billion dollars, or ty almost as much as they increased during the vhole of
last year. The increase is still going on and,-vdth the momentun being
gathered, credit/expansion can continue without check for some little time*
Therefore, our inflationary spiral problem is now not only a matter
of the wartime accumulation of money and other liquid assets, but also a
problem of renewed monetary expansion. Since we cannot rapidly reduce
the excessive money supply that is based so largely on public debt, the
least we -can do is to endeavor to restrain further monetary expansion
based on private d ebt creation.
There is unfortunately a:fundamental change in the financial situa~ ^
tioh -which handicaps suoh restraint. This fundamental change is the. ability of the-banking system to contineu credit expansion that the Federal-Reserve System is not in a position to offset because of its responsibility
for maintaining orderly and stable prices of Government securities.
The Board of Governors has given considerable thought ana SLuay to
the problem presented by this-fundamental change-in the banking picture
and has suggested several methods by which the Government securities market might be protected and traditional credit controls, reestablished.
These methods, which are discussed in the Board's Annual Reports to Congress 'for 19U5 and 19\\69 are to empower the Federal Reserve to increase
member bank reserve requirements (with the exception of raising reserve
requirements £rom 20 to 26 percent for banks in central reserve cities,
the Board of;Governors has already applied the present statutory maximum
reserve-requirements to member banks), to introduce by statute a secondary reserve requirement against demand deposits, or, lastly, to authorize the System to limit commercial bank holdings of long-term Government
securities. Chairman Eccles,in a recent speech before the National Association of Supervisors of State Banks, has underscored the importance of

82
our changed banking problem and the ".urgency, of .finding, an effective way of
meeting it*
In the absence of authority to deal with, the changed banking situation
through one or more of these methods, there has recently been some increase
in short-term rates of Government securities. But the rise in bill and
certificate rates has not as yet exerted an effective retarding influence
on cred.it/expansiont As.you are aware, the sheer size of the 260 billion
dollar public, debt; the problems .of refinancing large monthly maturities,
and the role of interest cost.in the Federal budget are among.the main.reasons v/hy short-term interest rates have-not been, allowed to rise more sharply. Secretary of the Treasury Snyder will announce soon action on the November 1st refunding.
The responsibility falling on the banks•
.. Although the Federal Reserve System, is handicapped by its present responsibilities, on the one hand, and by: the limited scope of its authority
in dealing with the present type of inflationary banking situation, on the
Qther hand, the System will do all it.can, directly and indirectly, .to restrain further credit expansion. Nevertheless, .a.:heavy responsibility devolves upon individual banks to submit to self-restraint. Under present *
conditions, banks are incurring large risks in private, credit expansion and
they should be constantly- aware of these risks. Banks that conserve their
credit resources and stubbornly maintain a high degree". of liquidity will have
m less to regret and fewer losses to write off than institutions that ride the
'crest of "the inflationary tide. This is particularly -true -for banks specializing in real estate and consumer credit, but it is also "true for banks
engaging in extensive business and agricultural lending*
A greater alertness on the part-of bankers regarding, the composite inflationary effects of their individual credit advances can do much to restrain the rate of current bank credit-and monetary expansion. It can also
do much to reduce the undesirable effects upon banks .when, inflation comes
to an end and is followed, as it inevitably will be, by deflation. To be
. sure, the business of banks is to make loans and. investments which accomnodate industry, commerce, and agriculture, and when they discontinue this .
activity they cease to be true banking institutions, I am not .urging banks
to deny themselves their proper sphere of .'activity. They can reasonably be
asked,* however, to recognizer common responsibility in times such as these
and in their self-interest to take double precautions to make loans and investments that are in every respect sound—not only sound in.individual
cases, but sound as related, to the present inflationary economic picture.
Debt management policy
If the present spiral of rising prices is to b e broken before serious
damage to the economy is done, every avenue of public financial policy must
be examined for whatever contribution it can make to meeting -this key problem. .Debt management policy is one of these avenues. Debt retirement,.operations in the present situation should be as anti-inflationary" as possible
This.means, of course, that any ..retirement, program made possible by the current, budget surplus should focus on the retirement of Government"securities
held by the commercial banks and the Federal Reserve.Banks.

83
As I have-said before, retirement of issues held.by the Reserve
Banks is more restrictive and, therefore, more anti^inflationary that retirement of issues held by commercial banks, (The Federal Reserve now
holds1"22" billion dollars of Government securities.) This process necessitates" the adjustment of reserve positions bjrmany banks. However, any
retirement of. Government securities held by banks is helpful" and in the
direction of restraining further credit expansion.
Another important phase of debt management policy;would be to increase the sale of*long-term bonds to investors and to use the proceeds
to retire part" of the debt held by banks. Important banking and other
groups have strongly urged such a program and recently the Treasury1 has
taken an important step-to. implement the suggested policy, • I refer, of
course, to the new Series A nonmarketable investment bonds. Further experience along these lines is desirable.
Maintenance of as high a level of sales of savings bonds as possible
will also need to.be an essential aspect of an effective debt program designed to help check the inflationary spiral* The vast majority of American families strongly-believe that regular-saving is'important,, and more
than half of all families think that saving is even more important now
than it was during the war. This is one of the significant findings of
the Board's recent surveys of consumer finances. It lends substance to
the belief, that a continuing flow of funds will be available, to the Treasury from sales of savings bonds in excess of redemptions, even though personal savings, are lower in volume than in war years. The amounts in any
one year will probably not be.large, but they will help to transfer securities from banks to nonbank investors in accordance with desirable debt
management policy. ; Again, consideration must be given to the use of these
funds to retire bank-held obligations in the way that will be most antiinflationary.
It is clear that debt management policy can serve constructively to
check the present price spiral by helping to restrict further monetary
expansion. It is clear too that the inflationary situation is serious
enough to warrant as much use of such policy as is feasible. The actual
working out of policy appropriate to current conditions, is, of course,
a highly technical matter. The subject is under continuing study by the
Board, the System1 s Open Market Committee, and the Treasury, and the effective liaison that exists between the authorities assures that every
suggestion or alternative will receive careful study and consideration.
Conclusions on domestic inflation and monetary policies
Economic stability at high levels of employment and output is seriously threatened by the current inflationary spiral. One of the main
causes of this inflationary condition is the excessive money supply created ty war finance. Expansion in the money supply under the pressure of
forces that are largely domestic, but to some extent international, in
origin is being resumed. Meanwhile, the demand for available supplies of
goods and services is driving prices higher. If the inflationary spiral
is to be broken, it is imperative that the world supply of goods and services be expanded as rapidly as possible. Today the greatest available
supply of unused resouces is in Europe and it should be developed without
delay.

8U
Fiscal, debt management,- and monetary policies .must.also be brought
to beat1 on the inflationary spiral.
At least, it is urgent to restrain further expansion in the money
supply". Maintenance of a large budgetary surplus is essential for this,
purpose. This can be accomplished, however, only by holding taxes up .and
governmental expenditures down so far as1 is-possible under existing conditions.
Monetary policies should be directed to keeping in check further bank
credit and -deposit expansion. Not much can be done through Federal Reserve
policies, however, in the existing situation. Therefore, individual banks
have "to assume A greater responsibility for.credit;expansion, to recognize
more fully the composite effects of their actions, and to take account more
directly of the abnormally high risks that are involved in current credit
extensions.
Public debt management policy should be as anti-inflationary as circumstances permit. Emphasis on retirement of bank-held Government securities is. essential and every feasible measure for transferring Government securities out of the banks into the hands of= nonbank investors should
be applied.
The task of breaking the present inflationary spiral through fiscal
debt management, and monetary policies may not prove insuperable. If successful, however, the attack will require the full cooperation with Government of all banks, financial institutions, and businesses.". And if it
is not successful, our private banking system may once more be the scapegoat in the eyes of the public. First, it may be held responsible for
having caused inflation. And second,, it may be accused of having caused
the collapse and deflation which, if history is any guide tc* future events,
will at some stage inevitably come unless prudent realistic measures are
applied in all quarters without delay.

Speech delivered before
Annual Stockholders1 Iieeting, Federal Home Loan Bank of Hew York
Valdorf-Astoria Hotel, New York City
January 22. 19A8
THE CHANGED SITUATION
IN
OUR MONETARY AND CREDIT PROBLEMS TODAY
Since the days when I was active in the operations of building and
loon associations, many changes have taken place—changes in the number
and size and activities of building and loan associations, and changes in
the operation of our economy and the organization of our society. The
problems which confront the central banking authorities with which I
have been associated are also reflected in the problens with which you
have to cope.
In 1 9 U the. United States was a debtor- nation; a substantial part of
national development had been and- was being financed abroad. Ue were in
the process of shifting from a predominantly agricultural nation to a
predoninantly industrial and urban nation. Our conventional patterns of
finance drew no distinction between the.fiscal position of Governuent and
that of individuals and businesses.
There were about 6,600 organizations of the type ve think of'as
building and loan or savings and loan associations, as compared with
about 6,000 today. These associations, through the thrift and saving of
their members, had accumulated total assets of 1,360 million dollars, as
compared yitfa about 11 billion dollars today. At the same tine, there
were about 26,000 commercial bankc with total deposits of about 17 billion dollars, compared with about 14,000 banks today with deposits of
140 billion dollars. The Federal debt was onlyl billion dollars. Today
it is 254 billion.
Our pre-Uorld Uar I economy was a composite of regional economies.
Perhaps the heart of our central banking problem at that stage of the
country's development was to reconcile the monetary and credit needs ol
major regions and to maintain a balance between these needs. It was
largely vith this end in.view that the Federal Reserve System was established. At that time there did not seem to be any necessity for separate
provision to balance special needs of the various regions ior mortgage
credit.
When the Federal Reserve Act was revised substantially two decades
later, between 1933 and 1935, the nation had becone a great creditor
country internationally and a great industrial economy domestically . O u r
monetary and credit problem had chenged from the problem of f^tributing
funds among regions-which had been solved fairly yell--to
.of controlling the total supply of money ana equating t m s
various national uses. In addition, the economy had S « ~ f ^ ^ , , ^
var, two great "booms", and two great "busts". The war, the "booms", and
the'«busts"?i Sere national in ramification. While regional
*^™»*?
economic organization still existed, the reality of regional interdependence was a more fully demonstrated fact than every before in our history.
During these two decades there were indications that ^ f ^ ^ S ^
of mortgage financing were not completely adequate. We had the notable

86
experiment with various kinds of nortgage bonds, mortgage participations,
and "guaranteed" mortgages, and we had the notable failure of traditional
mortgage financing methods in the Florida "boom" and crash.
Our great "bust" of 1929 had been particularly severe and its aftermath was widespread bankruptcy, unemployment, and poverty. Tine economy^
critical problem of that period vas "idle men, "idle machines, idle noney".
It was determined to solve the problem on a national basis. Fiscal policy
and central banking policy became, more directly than formerly, the instruments, of national economic policy. . Many new agencies were created to
complement these two major instruments of national policy. In mortgage .
credit, the Federal Home Loan. Banlc Systera was given the fona we know today,
and provision was made for chartering Federal savings and loan associations. The Hone Owners1 Loan Corporation was fomed to take over "slow"
mortgages and strengthen lending institutions, and the Federal Savings
and Loan Insurance Corporation was established to insure share accounts
in building and loan and sayings and loan associations. At the same tine,
under the Federal Housing Actiinistration, the program of mortgage insurance was inaugurated, -and this program made use of much.of the experience
with mortgage credit which load.been acquired by building and loan .associations in their many decades of operation..
Once more we find ourselves in a new period. \lo have again gone
through a great and devastating war. The war has changed our position in
international affairs,, and we find ourselves overwhelmingly a creditor.
The balance of power between capital and labor is different from what
it was in 1914- or 19359 and is still changing. The relationship between
creditor end debtor has also changed, in important part because better
financial arrangements and techniques have been worked but. Banks make
one kind of arrangement with farmers for the repayment of loans and a
different kind of arrangement with manufacturing concerns, each arrangement calculated to fit the operations of the borrowers*. Relatively little
mortgage credit is extended today for the short periods of one, three, or
five years which uced to be "conventional". Most mortgage lenders have
adopted the practice of writing long-term amortized loans which building
and loan associations were pioneering in 1914,.
The Government is no longer merely another borrower in the market.
It is by far the largest, borrower. The Federal debt accounts for nearly
three-fifths of the entire indebtedness of the country, and interest on
the debt is a major item in the Federal budget, amounting to more than 5
billion dollars ci year. In this situation, special arrangements have had
to be made for selling and managing the public debt. The Treasury and
the Federal Reserve work closely together in issuing, retiring, and refunding the debt. This greatly, increased importance of the public debt
is one of the major factors in the present inflation.
Why has this increase in the public debt contributed so strongly to
inflation? If we understand this point, we shall .understand why some of
the problems of the Federal Reserve System are so difficult to handle.
During the war, the Government spent more than twice as much as.it
collected in taxes, making up the difference by borrowing* Producersworkers, fanners, and business organizations—were paid for all the

87
production of the economy, but the taxes they paid vere less than half
the money spent by the Government for the goods and services needed to
win the weir. Producers, as consumers, therefore, vere left with more
noney to spend or save than the value of the goods and services they
could buy. To soaie extent, they used these excess funds to bid up
prices, but because we were at war, and because some goods, such as automobiles, were not available, controls were effective in spreading the
supply of goods and services and restraining price increases. People,
therefore, saved. Some of the savings were in currency, some in bank deposits, and seine in other liquid assets, particularly Government securities.
The country's aggregate money supply, as measured by currency in'
circulation and privately-held de:aand, time, and savings deposits, is
two and a half tines as large as at the beginning of the defense program,
about 170 billion dollars, compared with 66 billion in June 1940. In
addition, the general public, outside of banks, insurance companies, and
Government agencies, increased its holdings of Government securities to
105 billion dollars, or nearly seven times as much as in June of 194-0.
These Government securities in the hands of the public are practically
the equivalent of money because they are readily convertible into cash.
In sun total, this stock of purchasing power available to buy the current output of goods and services aaounts to almost 275 billion dollars,
compared with a stock of about SO billion in 1940.
Most of this expansion in the money supply and liquid assets in the
hands of the public occurred during the "World Var II period. However,
further expansion has taken place over the postwar period, and in recent
months the expansion has shown marked signs of acceleration. This recent acceleration of expansion largely resulted from very active bank
lending to' businesses and individuals.
Since the war, the economy has been operating vciy close to capacity
and the general public has shown a pronounced disposition to enjoy all
the things that were in short supply during the war, from shirts and
socks to automobiles and houses. People have been willing to spend, their
current incomes and dip into some of their accumulated savings. They
have also supplemented these funds by borrowing fron banks and other
lenders, and by buying on installment credit. As a result of these
strong demands for goods and services—demands in excess of supplies-. prices have risen, and we have had inflation. As long as the volume of
goods and services available, valued at current prices, remains less
than the amount of money being spent, inflation will persist. This condition, in fact, is the*essence of inflation.
Two other ffcetora are adding to inflationary forces. First, the addition of productive facilities to the economy is going on at a rapid
pace. Second, we have a large export surplus• On the first, producers
are paid now for turning out nachineiy and building warehouses, factories, and houses, and, on the second, producers are paid, for making the
goods which are being shipped abroad. But goods and services to match
these, incomes will be turned out by the machinery and buildings only
°ver q period of years, and it will also take some years for us to receive goods, and services from abroad in payment for our exports financed
Digitized forthrough
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loans.

Both expansion of productive capacity and. the export surplus have^
resulted in additions to the money supply through the creation of credit,
and by the use of funds previously held idle. An additional source of
increased money supply has been payment in gold for come of our exports
of goods.
This brings me to the problem which confronts the banking authorities and about which the Federal Reserve Board is deeply concerned, for
it shows clearly the changes which have taken place in the tasks of the
Federal Reserve System,
Taken as a whole, the commercial banking system is fundamentally a
mechanism for creating money—for. allowing borrowers to spend noney vhich
no one has saved. This is in .contrast to other types of lending—lending
such as your institutions, or savings banks, or insurance companies, or
individuals do—which is a matter of transferring savings frou those who
have them but do not wish to spend them to those who do wish to spend
them*
Limits are set to the amount of credit banks can create by the legal
requirements that they must hold cash reserves to the extent of some proportion of their deposits—which are themselves.largely the result of
loans and investments. Banks which" are members of the Federal Reserve
System, which hold 85 per cent of all comnercial bank deposits in this
country, must hold their reserves as deposits with the Federal Reserve
Banks, and no income is derived from these reserves. On the average, required reserves amount to about one-sixth of commercial bank deposits.
For every dollar.of reserves, credit can expand sixfold.
Reserves are the heart of commercial banking, and control over commercial bank credit has traditionally been exercised by control of these
reserves. Three techniques have been used to exercise this control: (1)
varying the rediscount rate, or the rate of interest at which member
commercial banks may borrow from the Reserve Banks; (2) open market
operations;. or the buying and selling of Government securities by the
Reserve System; and (3) varying the level of reserve requirements, that
is, the amountswhich member banks deposit with Federal Reserve Banks as
legally required reserves.
Two of these techniques for controlling bank reserves—discount
rates tnd open ru.rket operations—are not so effective as they once
were, while the third—varying the.level of reserve requirements—was exhausted under present law as a restraining weapon early in the recent
war, except for a relatively small percentage in central reserve citiesNew York and Chicago. The present limited effectiveness of available
credit control technique is due almost entirely to the sise and wide
distribution of the public debt largely inherited from the war. - Comnercial banks now hold 70 billion dollars of Government securities, an
amount equal to about 50 per cent of their total demand and time deposits, which they can sell in order to obtain additional reserves without borrowing from the Reserve Banks.
The traditional open market operation to reduce excess bank reserves is for the Federal Reserve System to sell Government securities,
thus drawing <k>\m private deposits at commercial banks. In turn, this

89
draws down the reserves of commercial banks by reducing their deposits
with the Federal Reserve Banks.
. .,Here? however, we come up;against the problem of management of our
huge public debt of 254 billion dollars.' If the* Reserve' System were to
sell enough Governnent securities to reduce bank reserves and curb credit
expansion, it would involve* great dangers for the entire economy. To
make possible this volume of sales/ the prices of Government securities
would have to be permitted to decline. With a marketable public debt
held by investors other than the Federal Reserve Banks amounting' to H 3
billion dollars, no one can say how great this decline in prices vould
have to be. As prices declined because of Federal Reserve sales, investors would suffer capital losses and in turn would be encouraged to
sell their holdings while their losses were still small, and these sales
would further drive prices downward. In brief, Federal Reserve open
market operation to reduce bank reserves might lead to a disruptive decline in Government security prices, which might spread to the prices of
other securities. This is a risk too serious to contemplate.
Traditional open market policy would also have serious consequences
for the Treasury. As prices of bonds decline, their yield, or effective
interest rate, rises, and, if Government securities were to fall seriously, all future Treasury financing would have to be done at higher interest rates, thus raising the cost of servicing the Government debt.
Also, in such a raarket, the price at which the Treasury and other borrowers could sell securities would be altogether uncertain, and this uncertainty would interfere with" the orderly management of the public debt
as well as the orderly financing of private corporate investment programs.
^ The Federal Reserve System through its open market and discount,
policy in close cooperation with the-Treasury, has already recognized
that interest rates have undergone an upward readjustment, probably in
response to temporary forces. • It has recognized this, first, by lowering
the support price (increasing the yield) on short-term Government securities, and second,, by lowering the support price on long-term obligations
(vith assurance, however, that support of the lowered levels vould be
aggressive and continued for the foreseeable future), and third, by the.
increase in discount rates frora 1 to 1-1/4- per cent. It seems much
better to us to permit interest rate changes in this luanner than to leave
the economy»s marketable debt to find its own interest level in a free
market, dominated by Government securities.
It should be apparent fron what l have said that the most important
change in the problem facing the central banking authorities is the
greatly increased influence of the public debt in our monetary and fiscal
affairs. After the First World War the public debt (26 billion dollars)
could be "looked on as merely another set of obligations—to be allowed to
find their ovn price level in a completely free market. This policy,
vhich was in. line with traditional attitudes, resulted in largo losses to
nany. individuals arid businesses, but these consequences were not nearly
as serious as those which would result from a similar policy now. The
Public debt today is a factor to be reckoned with in all public and private decisions. Both its size and its wide distribution have given it
great,
leverage in monetary policy and economic conditions. Moreover, the
f
act
that
the Treasury,- unlike other borrowers, must constantly refinance

90
its debt makes stability of the market for the public debt particularly
crucial.
The increased importance of the public debt is also, a factor in
another situation which has received relatively loss attention in' public
discussion. This is the shift which has taken place fron the hands of
the banking and fiscal authorities of a significant part of the control
over the supply of money, I have already nentioned the primaiy difference
between bank credit and credit, extended by other lender's—namely, that
nonbank" lenders lend only savings, which have been accumulated by savers,
while banks-also make, available to borrowers, funds created by the 6. to 1
expansion of deposits to which I have referred a.bove.
It has been customary and, in the nain, correct, to cay that loans .
made by nonbank.lenders add nothing to the money supply. Today.this is no
longer true. Before we. can say whether a loan by, for example, an insurance company or a savings bank or a. savings and loan association adds to
the money supply or not we must know where these funds were obtained •
Take an insurance company for example. In the first place, of course,
the insurance company obtained the funds fron its policyholders1 in the
form of insurance reserves on policies—that is, policyholders savings*
In this sense the funds were saved by the policyolders. But this is not
the .full answer. If the insurance company had these funds invested in
Government securities, and, in order to make a loan, it sold thesq securities indirectly to the Federal Reserve Banlcs, it added to the money, supply,
or at least to the potential money supply. Such an addition to the noney
supply results because when a nonbank investor sells Government securities,
their prices tend to fall, and if prices threaten to fall too far, the
Reserve System buys in order to preserve a relatively stable and orderly
market for these issues. This increases private deposits at commercial
banks, and the deposits of commercial banks at the Federal Reserve Banks,
thus increasing, bank reserves, and the capacity of the banks to lend. The
effect, in other words, may be just as inflationuiy as if commercial banks
had sold the securities. The insurance companies, the savings banlcs, and
the savings and loan associations are apostles of thrift and foes.of inflation and yet by selling Governr.ient securities to add to their currently
available funds for investment they are contributing to inflationary
pressures.
In the light of all these considerations, the Federal Reserve Board
has recommended to Congress the adoption of a plan which we feel would
restore some of the powers over the money supply which have been lost
because of the grea.t increase in the public debt. Very simply, this plan
involves a temporary increase in reserves which all banlcs would be required to hold, except that instead of being legally required to add to
their cash reserves, banks would be permitted to hold certain incomeproducing assets, namely short-tem Government obligations.
Ue could, of course, ask Congress-to raise the limits to which required cash reserves may be increased, but it now appears to the Board
that to increase required cash reserves by this means far enough to be
relatively certain of bank credit restriction, that will be required,
would mean reducing the earnings of banks below expenses and a "reasonable return on capital. This, however, in my.opinion, may become an

alternative to the special reserve plan groppsed by the Board*
We recognize that the Board's-proposal is no .cure-all and that it
would only deal with a part, of the ;inflationary problem. But.tho proposed measure-would constitute an important,"available.restraint, which
is nov lacking, on bank credit expansion, in the. present inflationary
situation*
• There is likely to be little need for the suggested special reserve
during the next three months because of the large amount of Treasury
surplus funds, taken ,from the market through taxes, which will be avail. able to retire bank-held public debt. . This will tenporarily exert pressure against.bank credit; expansion. If. inflationary*bank credit ex- .
pansion continues after this period,.,however,, and if further Treasuiy
surpluses are foregone in favor of tax reduction, the need for restraining: pressure will be urgent. It is better to have power to deal with the
situation when it develops• rather than to liave.it provided, if at all,
too late to be used*
The urgency for the Federal Be serve Board's proposal, or sone other
proposal to curb credit .expansion, .will be especially great if we relax
our current fiscal policy while.inflationary dangers, exist. Fiscal '•
policy, is by far the .most effective way to deai with-the demand side of
inflation just as production and partipularly nore production per man
hour is the most effective way. to deal-with it on the supply side. This
means, rigid Governnent .economy and deferment of all deferable expenditures. It also means as large a surplus of tax receipts as possible so
that dollars are removed from the spending, stream and -used- to retire
public debt held by. the Federal Reserve System. This takes dollars out
of the money supply, by an equivalent;.aniount and is a reversal of the wartime, process by which the money supply was expanded. The, classical • •
precept of sound, finance that-debt, should be paid.off in boon times has
peculiar .virtue in the case, of a public debt the size of ours, so much of
which is held.ty the banking system..
There -is -still another side to the credit picture.
As. you know, curbing.of inflationary pressures cannot be accomplished by monetary and fiscal policy alone. Among other necessary measures
are appropriate private decisions. You, for exanple, must ask yourselves whether, as a group, you are .extending mortgage credit on a sound
basis--credit which.will stand ,UR in.whatever storms are ahead of us. . In
this connection, I comiaend to your attention, as well.as to the attention
of .all bankers, the program fomulated several weeks ago by the American
Bankers Association/ and the joint statement on "Bank Credit Policy During the Inflation*1, issued November 24,v1947, by the Board of Governors
of the Federal Reserve System, the Comptroller .of the Currency, the Federal-Deposit Insurance Corporation, and the. 12x^cutive Committee of the
National Association of Supervisors of State Banks.
As you can see, I have.so far;spoken almost entirely about a fairly
technical side of the inflation problem which confronts the monetary and
fiscal authorities, that is, about how the supply of noney is being increased. . Another, and just'a? important, ..problem is how this large and
supply.of money is being used. Here, again, developments
Digitized forincreasing
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92
have removed a substantial measure of control over bank lending from the
hands of the banking authorities*
Banking authorities have always-exercised s'one measure of influence
over the kind of'loans and investments made1-toy banks as well as over the
total volume of their credit;; Such Influence has1 been "exercised by way
of statutory prohibitions or limitations,' byway of varied'privileges of
access to Federal Reserve credit, and t>y way of bank supervision. Statutory prohibitions and limitations have generally been quite inflexible.
Federal Reserve influence on: the kind of lending done by member banks has
usually been accomplished," therefore1,1 by keeping informed as to the credit
policies followed by member banks "and limiting the access to Reserve Bank
credit of those member banks, found to be following unsound policies. Bank
examination policy is also adapted, in cooperation-with other.-supervisoiy
authorities,, to" changing conditions.
Developments-over the past rirteen years, particularly in Government
programs, have modified the effectiveness of .the powers of • the central r.
banking authorities. This modification is particularly marked-in the case
of real estate loans* It would be rather difficult, for example, for the
Federal Reserve Board to- say that banks with large mortgage loan portfolios shall be denied the right to'borrow at the! Reserve Banks—even if
rediscounting had any significance today—when a large part of bank real
estate loans are guaranteed by the Federal Government,'either in.whole or
in part. Similarly, in these1-'conditions,:-a bank examiner might have some
difficulty in convincing bankers to reduce the volume = of- their guaranteed
real estate loans or to establish additional reserves-against them.
It is probably not correct to say :tliat-restraint or encouragement of
credit expansion tlirough central banlc credit arid supervisory policies ever
exercised a decisive influence oh the lending-activities.-of nonbank
lenders. It would be equally "incorrect, however,1 to say that such policies in the past exercised no influence; Central banking policy-gradually
came to exert a broad influence' over national1 credit conditions arid the
prudent nonbank lender took these conditions carefully into account in •
shaping his own lending program. Eut since the middle thirties, financial
developments, particularly those of wartime', have tended to reduce the
influence of central banking policy. In addition, the link between
important sectors of the credit market has b'een*weakened at several
points.
In the case or mortgage credit, for example, where this change is
most'pronounced; programs and practices instituted since 1932 have resulted in almost complete separation of this field of lending from general iredit policy. Even mortgage lending '"by commercial banks has been
largely sheltered from the influence of general credit conditions; Loans
underwritten by the Federal Housing Administration and the-Veterans
Administration are obviously difficult to'discourage by ordinary techniques of bank credit "control-when they-are being encouraged on social
grounds by other agencies .*
Your own organizations, the savings and loan^associations, are
adding to the problems of restraining-inflationary credit-developments,
again largely because of Federal programs developed since the passage,of
the original Federal Home Loan Bank Actfiril932. Let me'say here that-I

93
would not argue for one moment in-favor of returning the savings, and loan
business to the conditions' that existed.before that date. Then, there
were no" effective restraints oh savings and loan lending except the volume of capital available to associations, and you suffered severely as a
consequence. There was no effective means for transferring funds from
areas of oversupply to areas of scarcity,-and developments in real estate
vere uneven as a result; " There was riot sufficient, protection for shareholders; against either mismanagement: or unfavorable economic conditions—
arid1 many investors lost heavily through no fault, of their own.
Tiie savings ancl loan systen has been strengthened to perform its
functions, and that is a good thing. We must face the fact, however,
that this very strengthening, of the system has made it independent of
national credit policy, in a way it never was before. Funds are attracted to a savings and loan association as much by. the insurance of
share accounts as by an association's reputation for being a sound,.
well-managed institution.- The right of borrowing from the Home Loan
Banks makes it possible for associations to make more real estate loans
in a community tlian there are savings in the community available for
real estate lending. • The. capacity of the Home Loan Bank System to borrow in the general' money market makes it possible to channel the funds
available for investment in institutions sponsored by the Federal Government into the particular field of real estate. All of these conditions, arp.ong others, have given savings and loan lending a degree of independence. it never had in the days when the only resources of an association were the investments of its shareholders and depositors and loans
fron commercial banks.
Let me emphasize that the present condition is nuch sounder than the
earliar condition. Home-mortgage credit, accounting as it does for
al-nost a fifth of all private debt, is important.enough in the economy to
warrant "special" facilities operating under special legislation. Just
because it is so important,1 however, its general.policies need to. be related to and integrated with broad national policy in the credit and
fiscal areas. Mortgage credit can, and does, add to inflationary pressures at a time like the present. I know you realise that credit is
needed to finance the construction of houses, and you are making more and
more of your loans for this purpose. You are also aware that credit extended for the construction of more houses than can be built with the
materials and labor available drives prices upward and I am sure you are
Uniting your lending in such a way as to minimize these price pressures.
As experienced business men, you know not to lend money to Tom Jones just
so that he can pay more for a house than Hariy Smith can afford, because
that is the way bad loans are made, and bad loans seem to have a way of
staying on the books longer than good loans.
And now let me suinnarize and conclude ray remarks on this occasion.
Important changes have taken place in the structure of our economy
and in the organization of our society. As E. result, central banking and
fiscal policies have lost a large part of the influence they once exerted
over the supply of noney. The credit and monetary control thus lost has
not been placed in other hands, but has been diffused throughout all
financial sectors. At the sane time, national influence over the use to
which the money supply is put—never as strong as control of the supply

9h
itself—has been weakened*, partly by .these : same .-forces, partly also by
the independence'which particular credit prograjiis-have-had because they
are specially sanctioned.and encouraged by the.GoyerriKient-fbr social
reasons.
The Reserve Board has recoiriinended. adoption of a specip.1 reserve plan
which it believes would restore a desirable-degree, of control over the .
money supply. I suggest" that the
reconstruction and. strengthening of .
policy controls over the use to1 which tha-.credit supply, is put also requires careful and conscientious study. I do not suggest that we keep
reaching out for more power- and more controls, but I am aware of the fact
that in honestly and sincerely seeking to promote -economic stability at
a high level, new effective techniques, may perhaps be devised to meet the
changing situation* For many years the Board has been able to control,
the flow of bank credit-into the securities-.market, and during the war
it was given the task of. regulating consumer credit. The Board has recently asked Congress to renew this power, at least so far as installment
credit is concerned•
It ic possible that central.banking policy.will find the instruments
necessary to perform its tasks under the new • conditions which we face in
a combination of traditional controls over the supply of money and. selective controls over the use to which, credit is put. if this-bo so,
cooperation will be necessary between, the central banlcing authorities and
other agencies. For.example, the mortgage, credit field may be. one in'
•which such cooperation will be fruitful. .At. any; rate, this is "a question
that you and we should be studying at this time, both separately and
jointly.
The problems which monetary and credit policy must face today are
different from those of a few years ago. On our success in finding ways
to deal with these problems will depend in no small measure our success
in reaching the goal of sustained prosperity*.

95
Speech delivered before
Sociology Club, University of Maryland
College Park, Maryland
March 23, 1948.

OUR PRESENT FINANCIAL SITUATION.
. Before going into the discussion proper, I should like to spend a
few moments in making a brief sketch of certain background information
which will be helpful in our discuss ion'.
In 1914- the United States was a debtor nstionj a substantial part
of national development had been and was being financed abroed. Vie were
in the .process of shifting from.a predominantly industrial and urban
nation. Our conventional patterns of finance drew no distinction between
the fiscal position of Government and that of individuals and businesses.
At that time, there were about 26,000 commercial tenks with total
deposits of about 17 billion dollars, compared with about 14,000 banks
today with deposits of H O billion dollars. The Federal debt was only
1 billion dollars. Today it is 257 billion.
Our pre-World War I economy was a composite of regional economies.
Perhaps the heart of our central banking problem at that stage of the
country's development was to reconcile the monetary and credit needs of
major regions and to maintain a balance between these needs. It was
largely with this end in view that the Federal Reserve System was
established.
When the Federal Reserve Act was revised substantially two decades •
later, between 1933 and 1935, the nation had become a great creditor
country internationally and a great industrial economy domestically.
Our monetary and credit problem had changed from the problem of distributing funds among regions-.-which had been solved fairly well—to the
problem of controlling the total supply of money and equating this supply
to various national uses. In addition, the economy had gone through a
great war, two great "booms,11 and two great "busts.11 The-war, the
"booms," and the "busts" were national in ramification. While regional
differences in economic organization still existed, the reality of
regional interdependence was a more fully demonstrated fact than ever
before in dur history.
Our. great "bust" of .1929 had been particularly severe and its aftermath was widespread bankruptcy, unemployment, and poverty. The economy's
critical problem of that period was "idle men, idle machines, idle .
money." It was determined to solve the problem on a national basis.
Fiscal policy and central banking policy became, more directly than
formerly, the .instruments of national economic policy.
Once more we find ourselves in a new period. V:e have again gone
through a great and devastating war. The war has changed our position
in international affairs, and we find ourselves overwhelmingly a creditor.
The balance of power, between capital and labor is different from
what it was in i 9 U or 1935, and is still changing. The relationship

96
between creditor and debtor has also changed, in important part because
better financial arrangements and techniques have been worked out. Banks
make one kind of arrangement with farmers for the repayment of loans and
a different kind of arrangement with manufacturing concerns, each arrangement calculated to fit the operations of the borrowers.
•The Government is no longer mereiy another borrower in the market.
It is by far the largest borrower. l"he Federal debt accounts for nearly
three-fifths of the entire indebtedness of the country, and interest on"
the debt is a major item in the federal budget, amount ing to more than
5 billion dollars a year. In this situation, special arrangeJients have
had to be made for selling and managing the public,debt. The Treasury .
and the Federal Reserve work closely together in issuing, retiring, and
refunding the debt. This greatly increased importance of the public debt
is one of the major factors in the present inflation,
vJhy has this increase in the public debt contributed so strongly to
inflation? If we understand this point, we shall understand why some of
the problems of the Federal Reserve System are so difficult tc handle.
During the war, the Government spent more than twice as much as it
collected in taxes, making up the difference by borrowing. Producers—
workiers, farmers, and business organizations—were paid for all the
production of the economy, but 'the taxes they paid were less than half
the money spent by the Government for the goods and services needed to
win the war. Producers, as" consumers, therefore, were left with more
money to spend or save than the value of the goods and services they
could buy. To .some extent, they used these excess funds to bid up
prices, but because we were at war, and because some goods, such as
automobiles, were not available, controls were effective in spreading
the supply of goods &nd services and restraining price; increases.
People, therefore,' saved. Some of the savings were in currency, some
in bank deposits," and some in other liquid assets, particularly Government securities.
The country's aggregate money supply, as. measured by currency in .
circulation and privately-held demand, time, and savings deposits, is
tvo and a half timer, as large cs at the beginning of the defense program, about 170 billion dollars, compared with 66 billion in June 1940..
In addition, the general public, outside of commercial banKs,'mutual
savings banks, insurance companies, and Government agencies, increased
its holdings of Government securities to about 90 billion dollars, or
nearly six times as much as in June of 1940. These Government securities in the hands of the public are practically the equivalent of money
because they are readily convertible into cash. In sun total, this
stock of purchasing power available to buy the current output of goods
and services amounts to almost 260 billion dollars, compared with a
stock of about 80 billion in 1940. It is now more than three times
what it was in 1940.
Most of this expansion in "the money supply and liquid assets in
the hands of the public occurred during the>*orld War II period.
However, further expansion has taken place over.the.postwar period,

97
and in recent months the expansion has shown marked signs of acceleration... This recent acceleration "of expansion largely .resulted from very
active bank lending to businesses and .individuals.
Since the war, the economy has been operating very close to capacity
and the general public has shown a pronounced disposition to enjoy all '
the things that, were in short, supply during the war, from shirts and
socks to:automobiles and.houses. " The inflation.is continuing for one.
major reason—people have been willing'to" spend their current incomes
and dip into some of their accumulated savings. "They have also supplemented these funds by borrowing from banks and other lenders, and by
buying on installment credit... As s result of. these strong demands for
goods end services—demands in" excess of supplies—prices have risen,
and we. have. had. inflation..' As long as the volume- of goods and services
available, valued at. current, prices, remains", less than the amount of "
,money :being .spent,""- inflation, will, persist. This condition* in fact, is
the, essence of inflation.
Two other factors are adding to inflationary forces. First, the
addition of- productive, facilities is going on.at a rapid pace. This
has the effect of diverting scarce materials and. labor from the production of consumer goods to the.production of machines to make machines
to-make consiimer goods. This latter process "is. all to the .good in the
long run for.it is .prinarily .in this way 'that, we iricrease the productivity .of the nation and obtain the increasing'standard of living that is
both an American tradition and a goal. In the short, run/ however, it
adds to the bidding up .of prices .on scarce materials and manpower and
because producers are paid noy ..for turning out machinery, buildings,
warehouses, factories and inventory which will riot add to the' immediate
flow of consumer.goods. Therefore, not only are the. prices of scarce
materials and manpower.bid up by such.a process but producers1 income
generated in the process is added to the total cleinarid for the" existing
stock of consumer goods, already deficient. In addition, the supply of
money is expanded because to finance this expansion .in facilities,
businesses are. borrowing from.inar^y' sources, and particularly from
commercial banks.
Secondly, we have had a large ."commodity export surplus in our
international trade for Several years. International trade which results
in a commodity, balance is inherently anti-inflationary since it means
that emphasis is being.placed.on the production of those goods which can
be produced, the niosf efficiently and trading these for others which are
not so ."efficiently produced. A. commodity export surplus, on the other
.hand', is. essentially inflationary, for producers are paid for the production of goods sent elsewhere in greater volume than other goods are
received. .Production of this.excess of exports, moreover, may heve been
financed by inflationary bank .credit expansion. If the surpluses are
balanced by Government loans financed out of taxes which would otherwise
be. used by..the fiscal and" monetary authorities to reduce the excessive
money'supply, or by private lending to foreigners, the net result is
likewise inflationary. To the extent that export commodity surpluses
are paid for by imports of gold an added inflationary element is created
in the form of. increased deposits and reserves in the commercial banking
structure,

98
Both of these factors> then, expansion of productive :.capital; und •
the export surpluses, have resulted in additions to the .money supply,
through the expansion of credit, in the use of funds previously held
idle, and in additions to bank reserves growing out of the payment in
gold for sone of our export surpluses.
This" brings" me to the problem which confronts the banking authorities and" about which the Federal Reserve Board is deeply concerned, for
it shows clearly'the" changes which have taken piece in the tasks of the
Federal Reserve System..
Taken as a whole, the commercial banking system is fundamentally
a mechanism for creating money^-for allowing borrowers to • spend money
which no one has saved. This is in contrast to other types of lending—
such as lending by building and loan associations, or savings banks,.or•
insurance companies, or individuals. These institutions transfer savings
from those who have them but do not wish to spend them to those who do .
wish to spend them.
Limits are set to the amount of credit banks can- create by the
legal requirement that they must hold cash reserves to the extent of
some proportion of their deposits—which are themselves largely the
result "of loans and investments. Banks which are members of the Federal
Reserve System, which hold 85 per cent of all commercial bank deposits
in this country, must hold their reserves-as deposits with the Federal
Reserve Banks,'and no income is derived from these reserves. On the
average, required reserves amount to about one-sixth of commercial bank
deposits. For every dollar of reserves, credit can expand sixfold.
Reserves are tte heart of commercial banking, and control over
commercial bank credit has traditionally been exercised by control of
these reserves. Three techniques have been used to exercise this
control: (1) varying the rediscount rate, or the rate of interest at
which member commercial banks may borrow from the Reserve Banks; (2)
open market operations; or the buying and selling of Government securities by the Reserve System; and (3) varying the level of reserve requirements, that is, the amounts which member banks.deposit with
Federal Reserve Banks as legally required reserves.1
•Two of these techniques for controlling bank reserves—discount
rates and open market operations—are not so effective as they once
were, while the third—varying the level of reserve requirements—was
exhausted under present law as a restraining weapon early in the recent
war, except for a relatively small percentage in central reserve citiesNew York and Chicago. The'.present limited effectiveness of available
credit control technique is due almost entirely to the size and wide
distribution of the public debt largely inherited from the war.
Commercial banks now hold about 70 billion dollars of Government
securities, an amount equal to about 50 per cent of their total demand
and time deposits, which, they can.sell" in order, to obtain additional
reserves without borrowing from the Reserve Banks.
The traditional open market operation to reduce" excess bank rethe Federal Reserve System to sell Government securities,

serves is for

99
thus.arawing aown private deposits at. commercial banks. In turn, this
draws'down the reserves of"commercial'tanks by reducing their deposits
with, the Federal.Reserve Banks.
Here, however, we come up against the problem of i&anagement of our
huge public debt.of 257 billion dollars. If the Reserve System were to
sell enough Government securities to reduce bank reserves and curb credit
expansion, it would involve great dangers, for the entire economy. To
make possible this volume of sales, the prices of Government securities
would have to be permitted to decline. With a marketable public debt
held by investors other than the. Federal Reserve Banks amounting to 14.0
billion dollars,, no one can sey how great this decline in prices would
have to be.. As prices, declined because of Federal Reserve sales, in- •
vestors would suffer capital losses and in turn would be encouraged to"
sell their' holdings while their losses were still small, end these sales
would further drive prices, downward. In brief, Federal Reserve open
market operations to reduce bank reserves might lead to a disruptive
decline in Government security prices, which might spread to the prices
of other securities. This is a risk too serious to contemplate.
Traditional open market policy would-also have serious "consequences
for the Treasury. As prices of bonds decline, their yield, or effective interest rate, rises, and, if Government securities were to fall
seriously, all future; Treasury, financing11 would have to be done at higher
interest rates, thus raising" the cost- of servicing" the Government debt.
Also, in :such a market, the" price at which the Treasury and other
borrowers could" sell securities would be altogether uncertain, and this
uncertainty would interfere with the .orderly management of the public •
debt as well as the orderly financing of private corporate investment
programs.
. . The Federal Reserve System, iri close-cooperation with the Treasury,
has already recognized that interest -rates required an upward readjustment. .It," has recognized this through1 its" open market and discount policy,
first, by lowering the support price (increasing the yield) on shortterm Government securities, and second, by lowering the support price
on long-term obligations (with assurance, however> that support of the
lowered levels would be aggressive and continued for the foreseeable
future), and third, by the increase in discount rates from 1 to 1-1A
per cent v It seems much better to us to' permit interest rate changes in
this manner than to .leave the economy1 s marketable debt to find its own
interest level in.a free—-"bottbmlessn~market, dominated by Government
securities.
It should be apparent from what I have said that the most important
change in the problem-facing the central banking authorities is the
greatly increased influence of the-public debt in our monetary and fiscal
affairs.. After the ..First World War the public debt""(26 billion dollars)
couid be looked on as merely another set of obligations—to be allowed to
find their own price level .in a completely free market. This policy,
which was in line with.traditional attitudes, resulted in lerge losses
to many individuals and businesses, but these consequences were not
nearly as serious as those which would result from a similar policy now.
public debt today is a factor to be reckoned with in all public and
Digitized forThe
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100
private decisions. Both its size and its wide distribution have given it
great leverage.in monetary policy and economic conditions. Moreover, the
fact that the Treasury, "unlike other borrowers,.must constantly refinance
its debt makes stability of the market for the public debt particularly
crucial•
The increased importance.of the public debt is also a factor in
another situation vhich has. received relatively less attention, in public
discussions-This is the .shift, which lias taken place from the hands of
the banking and fiscal authorities of a significant part of the control
over the supply of money. I hsve already mentioned the primary difference between bank credit and. credit extended by other lenders—namely,
that nonbank lenders lend only savings which, have been accumulated by
savers, while banks also make.available to borrowers funds created by
the 6 to 1 expansion of deposits, to which I have referred above.
It has been customary and, in the main, correct, to say that
loans made by nonbank lenders add nothing to the 'money supply. Today
this is no longer true. Before we can say whether a loan by, for
example, an insurance company or a savings bank or a savings and loan
association adds to the money supply or not we must know where these
funds were" obtained.
Take an insurance company for example. In the first place, of
bowse, the insurance company obtained the funds from* its policyholders
in the form of insurance reserves on: policies—that is, policyholders1
savings. In this sense the funds were saved by the policyholders.'.
But this is not the full answer. . If the insurance.company had these"
funds invested in Government securities,, and, in order to make- a loan,
if sold these securities indirectly to the Federal Reserve Banks, it
added to the money supply, or at least to the potential money supply.
Such an addition to the money supply results because when a nonbank
investor sells Government securities, -their prices tend to.fall, and if
prices threaten to fall too far. the Reserve System buys in order to preserve a relatively, stable and orderly market for.these issues. This
increases private deposits at commercial banks, and the deposits of com-,
mercial banks at the Federal Reserve Banks, thus increasing bank reserves,
and the capacity of the banks to-lend.' The effect," in other words, may
be just as inflationary as if commercial banks had sold the securities..
The insurance companies, the savings banks, and the savings and ioe'n .
associations are apostles of thrift and foes of inflation.and yet byselling Government securities to add to their currently available funds
for investment they are contributing to inflationary pressures.
In the light of all these considerations, the Federal Reserve Board
has recommended to Congress the adoption of a plan which we feel would
restore some of the powers over the money supply which.have been lost •
because of the great increase in the public debt. Very simply, this plan
involves a temporary increase in reserves which all banks would be recuired to hold, except that instead of being legally required to add to
their cash reserves, t>anks would be permitted to hold- certain income-,
producing assets, namely short-term
Government obligations. ' The proposalhas come to be called the Board1 s special reserve plan*.

101
The Board has also asked Congress, as an alternative, to raise the
limits to which required cash or primary reserves may be increased.' To
increase required cash reserves far enough to be relatively certain of
effective bank ..credit restriction, however, would mean reducing the
earnings of banks below.expenses and a reasonable return on capital.
Notwithstanding thi3 certain effect, many bankers favor, this .method over
the Board's special reserve plan as a moans of dealing with the present
problem of too easy bank credit.
The need for bringing the money supply more definitely under control by providing additional authority for regulating the level of bank
reserves has .also raised, the problem of appropriateness of our. existing
system of reserve requirements. This scheme has long been recognized
as inequitable in certain respects; indeed the System has engaged in
many studies of methods to improve it. Ultimately, it will be desirable
to have our reserve requirements based on the type of banking business
conducted by a bank rather than on the basis of location, as is now the
case. .. but this is ..a. complicated matter, as matters of equity invariably
are, and will .take time-to remedy.
Meanwhile,.we confront a situation of an excessive and highly ex-.
pansionary monejr supply, and the problem is to find some way of regulating growth of bank credit in the public interest with the object of pre
venting recurrent outbreaks of inflation. Either the Board's special
reserve plan or authority to raise further existing reserve requirements
seems to be the most feasible,, available restraint for this purpose,
taking into account the over-shadowinr size of our pubiic debt.
There has been little need for increased reserve requirements
during the past
three months because of the Treasury's favorable fiscal
developments1, which have made possible a substantial retirement of bankheld public debt. ,Such retirement has temporarily exerted pressure. '.
against bank credit expansion. • But in the future this type of pressure
will not be.available in the same degree, and bank credit conditions may
become, unduly easy. If this should-happen, the need for soae special,
additional restraint will be urgent. It is better to h&ve authority to
deal with a situation as it develops than to have authority provided, if
at ally too late to be used.
The urgency for ..the Federal. Reserve .Board's proposal,-.or some other
proposal to curb credit-expansion, will be especially great if we relax
our current fiscal policy while inflationary dangers exist... Fiscal .
policy is by far. the. mo^t effective way to deal with the demand side.of
inflation just as production and particularly more production per man- .
hour is the most effective way to deal with it on the supply side. This
means rigid Government economy and deferment of all deferable expenditures. It also means as large a-surplus of tax receipts £s possible so
that dollars are removed from the spending stream and used to retire
public debt held by the Federal Reserve. System. This takes dollars out"
of the money supply by an equivalent amount and is a reversal of the wartime process by which the money.supply was expanded. The classical precept, of sound finance that debt should be paid off in boom times has
peculiar virtue in.the case of a public debt the size of ours, so much
of which is held by the banking system.

102
There is still another side to the credit picture.
- As you know, curbing of inflationary pressures cannot be accomplished
by monetary and fiscal policy alone. Among other necessary measures are
appropriate private decisions, ^ankers, for example,, must ask thenselves whether, as a group, they are, extending credit on a .sound basiscredit which will stand up in whatever.storms are ahead of us. • in this
connection, I commend to your attention,, as well as to the attention of
bankers, the program formulated some time ago by the American Bankers
association,
and the joint statement on "Bank Credit Policy during the
Inflation,11 issued November 24, 1947, :t?y the Board of Governors of the
Federal Reserve System, the-Comptroller of the Currency, the Federal
Deposit Insurance Corporation, and the Executive Committee of the National Association of Supervisors of State Banks.
As you can see, I have so far spoken almost entirely.about a.fairly
technical side of the inflation problem which confronts the monetary arri
fiscal authorities, that is, about how the supply of money, is being in-r
creased, /mother, and just as important, problem is how this large and
increasing supply of money is being used. Here, again, developments
have removed a substantial measure, of control over bank lending from
the hands of the banking'authorities.
Banking authorities heve always exercised some measure of in-.
fluence over the kind of loans and investments made by banks as well as
over the total volume of their credit. . Such ..influence has been exercised by way of statutory ^prohibitions or limitations, by way of. varied
privileges of access to Federal Reserve credit, and by way of bank
supervision. Statutory prohibitions and limitations have generally
been quite inflexible. Federal Reserve influence on the kind of lending done by member banks has usually been accomplished,-therefore, by
keeping informed as to the credit policies followed by member banks
and limiting the access to Reserve bank credit of those nember banks
found to be following unsound policies. Bank examination policy is
also adapted, in cooperation with other supervisory authorities, to
changing conditions.
Developments over the past fifteen years, particularly in Government programs, have modified the effectivness of the powers of" the
central banking authorities. This modification is particularly marked,
for example, in the case of real estate loans. It would be rather
difficult for the Federal Reserve Board, to 3£y that banks with large
mortgage loan portfolios shall be denied the right to borrow, at the
Reserve.Banks—even if rediscounting.had any significance today—when
a large part of bank real estate loans are guaranteed by the Federal
Government, either in whole or-inpart... Similarly,, in these conditions,
a bank examiner might have some difficulty in convincing bankers to .
reduce the volume of their guaranteed real estate loans or to establish
additional reserves against them.
It is probably not correct to say. that restraint or encouragement oi credit expansion through central bank credit and s u S r v i K r y
policies ever exercised a.decisive influence on the lendiS*activities
of nonbank lenders. It would be equally incorrect,. hoSe^r, to lay that

103
such policies in the past exercised no influence. Central banking policy
gradually came.to exert a broad influence over national credit condition*
and the prudent nonbank lender took these conditions carefully into•
account in shaping his own lending program. But since "the. Middle thirties, financial developments, particularly those of wartime, have tended
to reduce the influence of central banking policy. In addition, the
link between important sectors of the credit market has been weakened at
several points.
In the case of mortgage credit, for example, where this change is
most pronounced, programs and practices instituted since 1932 have resulted in almost complete separation of this field of lending from general credit policy. Even mortgage lending by commercial banks has been
largely sheltered from the influence of general credit conditions.
Loans underwritten by the Federal Housing Administration and the Veterans
Administration are obviously difficult to discourage by ordinary techniques of bank credit control when they are being encouraged on social
grounds by other agencies.
And now let me summarize and conclude my remarks on this occasion.
Important changes have taken place in the structure of our economy
and in the financial organization of our society. As e result, central
banking and fiscal policies have lost a large part of the influence they
once exerted over the supply of money. The credit and monetary control
thus lost has not been placed in other hands, but has been diffused
throughout all financial sectors• At the same time, national influence
over the use to which the money supply is put—never as strong as control
of the supply itself—has been weakened, partly by those same forces,
partly also by the independence which particular credit programs have
had because they are specially sanctioned and encouraged by the Government for social reasons.
The Reserve Board has recommended an increase in reserve requirements which it believes would restore a desirable degree of control^ over
the money supply. I suggest that the reconstruction and strengthening
of policy controls over the use to which the credit supply is put also
requires careful and conscientious study. I do not suggest that we keep
reaching out for more power and more controls, but I am aware of the fact
that in honestly and sincerely seeking to promote economic stability at
a high level, new effective techniques may perhaps be devised to meet the
changing situation. For many years the Board has been able to control
the folow of bank credit into the securities market, and during the war
it was given the task of regulating consumer credit. The Board has
recently asked Congress to renew this power, at least so far as installment credit is concerned.
It is possible that central banking policy will find the instruments
necessary to perform its tasks under the new conditions which we face in
a combination of traditional controls over the supply of money and selective controls over the use to which credit it put. If this be so, cooperation will be necessary between the central banking authorities and
other agencies.

101*
The problems which monetary and credit policy must face today are
different iron those of a few years ago. On our success in finding .-ways
to deal with these problems will depend in no small measure our success
in reaching the goal of sustained prosperity.

105
Speech delivered before
Northwest Town Kiwanis Club
Chicago, Illinois
April 6, 1948
CURRENT CREDIT PROBLEMS
Three years ago at this time we were all looking forward eagerly to
the end of the war, which in the European theater was only a month away.
It then seemed that if only the fighting would come to a stop, our
troubles would be over. But three years have passed and difficulties,
economic and political, are thick all around us. Ho matter what the
field of interest, uncertainties as to the future are weighing down
heavily and problems face us demanding solution tnrl K.t the saine time defying it. These problems are both domestic *\nd international.
The Board of Governors of the Federal Reserve System, of which I am
a member, is no better off in this respect thru sjiybody else. Difficulties are normal, of coursej we. always have them, and if it isn't one
thing it's another. But just now, Tx>tb in the field of bank supervision
end in the field of central banking, varied problems seeia to be pressing
on each other and crowding for attention to a degree I have seldom if
ever observed before. I should like to take this occasion to review some
of the things tha.t are of immediate interest to the Board—not nerely because they are of personal interest to me but because they ere of interest to you. They concern banking and banking in turn concerns all of us.
These matters all involve legislation, either pending or prospective, and
relate either to the supervisory or central banking responsibilities of
the Board.
The first of these is a measure proposed by the Board, ejid now.
pending in Congress, to provide more effective supervision and control
of bank holding companies. Bank holding companies, as you know, are organizations engaged in owning or controlling banks. There are a number
of such companies in various parts of the country which control substantial groups of banks and, in some instances, hr.ve major nontx.nking interests. In the Banking Act of 1933, Congress attempted to deal with the
problems presented by this development but experience has demonstrated
that the existing law is inadequate. In substimce, it merely forbids a
holding company to vote any stock it owns in a member bank unless it
first obtains a voting permit, A S a practical matter, submission to regulation is to a large degree voluntary and the regulatory powers which
can be exercised by the Board are very limited.
It is inherently dangerous to permit companies which are not subject
to regulation to dominate major portions of the banking facilities in
particular sections of the country and, particularly, to combine with
that activity the control or operation of businesses unrelated to banking
To deal with .this situation, the Boerd has recommended legislation which
would regulate all bank holding companies, treating them in much the same
manner as banks themselves and including provisions controlling their expansion and requiring them to divorce nonbanking activities. The proposed bill provides that bank holding companies meeting the prescribed
definition shall register with the Board and, having registered, shall be
automatically
subject*to all of the regulatory provisions of the statute.

1C6
In controlling expansion and requiring the separation of tanking and
nonb::nking cctivibics, the proposed legislation would bo applying to bank
holding companies accepted principles of bank regulation. Existing law
does not permit banks to establish additional offices without the api^roval
of supervisory authorities or permit then to engage in any business other
thrm banking; and there is no justification for permitting tank holding
companies to do so. The abuses resulting from unregulated group banking
and the potential dangers thereof continue and the noed for legislation is
urgent.
in the field of central.banking the Board has several proposals. One
of those is a recommendation to Congress that the Federal Reserve Banks be
authorized bo grant partial guarantees of loans made by chartered buiks to
business. The purpose of the guarantees would be to insure th«.t financial
assistance is wade"promptly available to small business firms that night
find financing otherwise difficult. The small individually-owned business
has a basic need for long-term funds, but it has not recourse to the machinery for raising such funds through the flotation of securities in the noney
markets th&t large scale business has. Federal Reserve Eank guarantees would te
subject to u charge proportionate to tho percentage of the loan gii&r&nteed.
A part of tiiis proposal is thc.t the existing previsions of law authorizing
direct loans by tho Federal Reserve Ean::s under terns of Section 13b of the
Federal Reserve iict be repealed.
These proposals of the Eo:ird are aiwed at making existing provisions
of the law simpler and ;:iorc effective by providing that the Federal Reserve BDJIICS should not xzke direct loans "to business but should guarantee
losns made by private banks to business. The changes proposed would remove the Federal Reserve Banks from any eppearence of competition with the
private? tonkins eystea. They would tend r&ther to enlarge the scope of
the private bcjik!s operations. They would provide a stund-by arrangement
to fall baci: on when the need for such credit ^rioes fit tines in the future.
At the nonent the provisions for guaranteed loans would not have luuch if
any occasion to be utilised, for our present problem is not at all one of
inadequate credit, when present conditions have passed, however, r.ccnsshould be ready to check recession by a ready extension of bank credit to
qualified borrowers.
Another measure in the central banking field is the regulation of
consumer credit, which was established as a war measure by executive order
and should have been continued, in the Board's opinion, as a means of restraining postwar inflation* Actually, Congress did not approve the
Board's recommendation tut instead terrainsted tho regulation last fall.
Inflation, however, was not terminated. The prices of goods are still
high, r.nd the purchasing pover of the dollar continues to shrink. In the
judgment of the Eo^rd, it is to the interest of.consumers to bo discouraged froi.i borrowing in order to pt:y high prices. In order to avoid
alternating booms*, and busts, it is also in the genercl interest that the
consuming capacity or buying power of the public be Maintained as evenly
as possible. Otherwise it tends to exhaust itself in competitive baying
as prices rise and to be suffocated beneath a mass of debt end unemployment when they fall.
Since the end of the war three years ago, the Board h*«s been preocdangerous surplus of money that the war left on our hands

with the
cupied

107
in the form of greatly expended bank deposits. This ic an inevitable
result of 1 war because in 1 wartime resources are diverted fron supplying
consumers and producers goods to supplying miiitr.ry materials, and
psople are paid large amounts for producing goods and providing services
vhich they can not purchase vith their incomes. In consequence, the
supply of money is everywhere excessive in comparison with the supply of
things to buy with it. This condition -light be corrected from either
side or, better still, from both. On the one hand, we need to produce
:nore goods but on the other we &L1SO need to restrr.in further expansion
of the money supply.
On the side of production, however, there is little prospect of immediate relief. We are producing at close to ncxiaxua volume. Industrial
production and employment remain far above all prior perscctine levels,
and employment is currently above the wartime peaks. But offsetting this
is a level of demand greatly in excess of prewar years. Our people need
nev cars, new houses, new equipment, ^nd on top of that there is the
need of Europe for the materials to restore her economic life. This is
not Europe's need clone. It is to our own direct self-interest that the
economies of Europe te restored to the point where they csn be useful and
self-dependent members of the world caamunity, buying our products and
contributing their chare to world production. Her disorganisation and
lack of productive power, which we are endeavoring to help her correct,
is a prime cause of the pressure we- are under. But help to th&t end can
not be given without sacrifice for the tine being on our p:crtj if we
furnish Europe the things she can not yet supply herself, ve must to that
extent forego having them ourselves.
Moreover, it is new apparent that we must also renew and expand our
military strength. This too will divert money, manpower, materials, and
equipment which might have been used for the production of concuiner and
producer goods. If we turned our backs on the international situation
and produced exclusively for our domestic requirements, we should for a
short time lighten the pressure of inflation and enjoy the comforts-of
increased consumption. But our interval of ease would be short and the
termination of it painful. No such course con be considered, end we have
already turned definitely from it.
In the face of these needs—economic ;..nd nilitLry—there is little
prospect, as I have just said, that production can expand enough to meet
the demands for domestic consumption end for export. The protiLsc is
largely & physical one—a problem of enough machines, enough material,
enough men to produce wtu:t the world now needs.
Aggravating this deficiency on the side of production, we have an
inflationary excess on the sice of purchasing power. Unless this excess
is reduced or ot least not permitted to increase, it will reeulu in higher prices and increased living costs. The one most effective v^y to reduce this excess purchasing power ic by reducing the Federal Reserve
Binks1 holdings of Government debt.
Liquidation of the public debt held by the Federal Reserve Banks is
*n effective curb on inflation because it involves not only a reduction
°f bank deposits but also of bank reserves. For vhen the taxpayers1

is used to pay a Government obligation held by a Federal Reserve

108
Bank, the payment reduces commercial bank deposits and dlso bank reserves.
Thuc it extinguichus existing purchasing poorer in the form of bank deposits and it tho 3P.:ne tine reduces the possibilities of renewed expansion
of those deposits. But though it is important accordingly that Federal
Reserve B:^nk holdings of Government debt be reduced, the difficulty is
that so long as the Reserve Banks stand by to purchase Government obligations in support of their market value, it is bard if not impossible for
reduction of their holdings to be cccomplishcu.-* .
But as taxes are reduced instead of public debt the problem is mc.de
nore difficult. For in the first place, to stop retiring the public debt
means abandoning the most effective Beans we have toti&y of restraining inflation. Reduction of taxes means sbill more: it means that we stimulate
inflation, because if the Government takes less money in taxes, then we
all have so much more money to spend, and the volume of purchasing power
forcing prices upward will be so much thu greater. Lvory dollsr not paid
to the Government will be available to bid for scarce goods. To each of
us individually the reduction of taxes ic welcome, of coursej but when we
think of the response of prices to the increased demand, it ic evident
that we Gtenci too good :.i chence of being worse off with tho money than
without it# For a dollar with prices at present levels may well be worth
more than a largex* sum with prices at still higher levels.
The tax reduction passed by Congress is C5 billions. In addition to
that v-e are now facing enlarged expenditures not only for F.urope*.n re- •
covery but for military purposes. It is said that approximately £•£ billion
will cc needed for such items as universal military training, a greater air
force, and an increase in thq authorized strength of the standing army.
So if we reduce taxes by &5 billion ind increase expenditures by £4. billion,
we shall lu'vc- about j,9 billion lees: with which to rcauce tho public debt
or contat inflation through fiscal policy. . The chances :ire rr-ther th^t
the :,,9 billion will feed inflation still further.
If fiscal policy can net be relied on, the need of credit controls
seems to me all the greater. Arid if inflated purchasing uotrer ctj\ not
otherwise be reduced to a reasonable par with the supply of goods, it nay
at least be pinned dovn temporarily by v measure which the Eonrd h*s already recommended to Congress. This is that banks be allowed to count
Treasury short-term obligations (billc, certificates, ::nd notes), gjid
cash, each itens, .inter-bcuik balancer., end excess reserve balances with
tho Federal Reserve Eanks as special reserves required to co held in addition to legal receives. This io in substance an increased requirement,
the additional reser/os to be held at tho bank's option, however, either •
in the fora of balances with the Reserve 3onk or in Treasuryobligations,
cash, etc.. Its effect would be to reduce the bi\sic of credit expansion.
These special reserves night reach c ..:axir.iua of 25 per cent of demand deposits and 10 per cent of time deposits; the requirements would be
imposed gradually at the discretion of the Board; aid they would apply to
all cornmcrcis.1 banks, •-whether members of the Federal Reserve System'or not*
The arrangement would not oblige banks to reduce the volume of their earnings assets, but it would restrain the further expansion of bank credit.
It would also give a fresh effectiveness to the traditional instruments
of credit control, namely, discount rates and open market operations. The
banks would still be able to meet the credit npeds of borrowers, and yet
Digitized the
for FRASER
responsible authorities would be in a position to act for protection

10?
of the economy from the inflationary evils of further credit expansion.
This is viewed as a temporary measure limited to a period of three
years. It would be helpful in stemming the tide and giving us ti^c to
study the new conditions th&t have sprung up around us. Our present
difficulties ere not only real but essentially unfamiliar. I think we
can not assume that they will quiet down of their own accord. Indeed,
wherever one looks conditions that tend to continue to intensify inflationary threats are evident, nowhere con one see cny automatic tendency
to mitigfction or cny material forces operating to bring it about. Kor
can we assume that the instruments and procedures we- have been accustomed to in the past will neet the needs of the future. But neither can
we postpone action till ve have everything figured out. Something needs
to be done now. Ue have a basic problem vhich at best :zast be the subject of long range planning; and we have in addition a mounting euergency. Present proposals insy not be perfect but they do c° ff.r to aeet
the iiifcediate need.
Our present reserve requirements have cone to be what they are by a
process of legislative changes that have never ctujjht up with the fpcts.
For e. long time this condition mode littlo difference, but we are now
getting to the point where an arrangement originating in Civil War times
is altogether too fur out of line for present day needs. The arrragenent I inean is that vhich determines the required reserves of benke on
the be.cis of their location. ;.s &. rr.atter of fact a bank1;; location is
under modern conditions a pretty poor criterion for deterziininj the reserves it should Liaintain/ The important thing is the kind of deposits,
no laatter vhere the bank ic, and I think that exploration for a more
sensible basir, for reserve requirements should be in that direction
without regard to location. The further objective should be a requirement administratively feasible, equitable, and ndr.pted to the Anerican
r,ystem of banking.
So far in considering this problem it has been argued, at one extreme, that deposits should not be classified at f.U or that requirements should be uniform against all classes of deposits. This was the
situation under the National Dank Act end is still the situation under
the banking lairs of half of the States, ^t the other extrene, it hes
been argued that a detailed classification should bo iacdu based on such
characteristics as turnover, volatility, size, ond economic activity^of
depositor—whether r..n individual or c business, whether local or national. Some classification is necoscuy, I believe, cat it should not be
too elaborate. Furthermore, the requirements should be subject to administrative chance, as at present, and they should trie account of
vault cc.sh end inter-bank balances.
But this search for a new ttsic system of requirements is : long
range affair vhich the immediate emergency ccn not wilt for; and 1 think
it would be wron^ for *e to lec.va you vith the thought thtt we are concentrating on the future* and comfortably leaving the present to take
care c f itself. On the contrary, we feel the need of covering coth
fronts at once. Ue feel the need of giving greater effectiveness to^
the peititnent inctruir.entG of credit control, but we a s o feel the neea
of powers to correct the BjalcdjuotnentF. that the war we thought we hna
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Federal Reserve Bank of St. Louis

110
I am glad to have had this opportunity to discuss with you these
measures which the Board believes its responsibilities call upon it to
recomnend. The public has a right to hecr frora the Hoard on the problems
that ens^Ce its attention and the Board feels very keenly the responsibility resting upon it to keep the public inferred, not only in the annual reports vhich it sutaits to Congress but in special reports from time
to tine. The measures I have been describing neod to be weighed in the
lif.;ht of present difficulties, economic end political, domestic end international. Thouph they involve technicalities end factors that seem remote
from the day-to-eLy problems of business, they have in reality & close
bearing on the future demand for your goody ;:.nd services .Ms business and
professional men, on tlie supply of goods end cervices you require, and on
the future value of your dollar. I hope thr-t rny f.ccount of them hes been
helpful in clarifying their relationship to your individual interests.
This much \re ell know, ve are living in most unusual aid uncertain
tines. T»;e therefore must be informed and prepared to ueet cny eventuality*

Ill
Speech delivered before
55th Annual Convention of the
Alabama Bankers Association
Birmingham, Alabama
May 7, 19/.8
WHAT ABOUT MONEY AND CREDIT?
The economic situation in which we find ourselves today 13 indeed
difficult. Instead of the happy security we hoped to enjoy after the wai
we are beset with fears, confusions, and discouragement. We are dangerously close to a process of turning around and heading back in the direc
tion from which we just came.
During the past winter we were making noticeable headway in the fight
against inflation. Although the underlying economic situation continued
to be basically inflationary, there were signs that the pressures of an
under supply of goods and an over supply of money were undergoing gradual,
cumulative abatement.
On the side of production, the output of goods was not only holding
up at maximum levels, tut' in seine areas wns catching up with demand. Crof
prospects to the world at large vere encouraging, and the. fall in the
prices of foods and other agricultural products was a desirable, corrective readjustment. The program of world aid recovery, then under consideration, seemed to hold promise of providing an effective basis on
which to reestablish lasting peace.
Recent Monetary Developments
On the monetary side, fiscal and monetary policies were having significant restrictive effects. The money supply, though still excessive,
was being sharply reduced by the Treasury's seasonal surplus of tax receipts over expenditures and by accelerated retirement of public debt
held by the Federal Reserve Banks and commercial banks. There had been
some rise in interest rates during the fall &nd early winter in response
to tightening credit conditions. At that juncture, the Government bank
supervisory authorities launched efforts to discourage further expansion
of bank credit, and these efforts were strongly reinforced by a nationwide program of voluntary restraint by the banking fraternity. Finally,
the credit situation was affected restrictively by successive Federal Reserve actions: first, the lowering of support levels for Governnent security prices at the end of December; second, the rise in discount rates
early in January; and third, the moderate increase in reserve requirement
for banks in Hew York and Chicago in February.
Despite a large inflow of gold, a heavy seasonal return of currency
from circulation, and large sales of Government securities by nonbank investors to the Federal Reserve during winter months, fiscal and monetary
operations kept bank reserves under unslackened restraint. Federal Reserve holdings of Government securities fell by about one and a half billion dollars? The combined effect of fiscal and monetary operations, too
was
to reduce the total money supply by nearly U billions. Considering
a
H of the circumstances, this was a notable anti-inflationary accomplish
ment.

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Government Budget Outlook
In view of these salutary developments, it came to be widely hoped
that inflationary pressures were finally under control and that taxes
could be safely reduced. The response of Congress to this belief was a
general reduction, taking away about 5 billion dollars per annum from the
revenue of the Government and adding this sum to the annual purchasing
power of the public. The effect of this action was to eliminate any further budgetary surplus and any anti-inflationary restraint the surplus
might have had on bank credit expansion, while at the same time unleashing new inflationary pressures through larger purchasing power.
While Congress was acting upon a tax program and a program of world
aid, the international situation commenced to displey alarming portents—
especially in Czechoslovakia and in Berlin. These portents put an entirely new face on our international position. They produced a program
of renewed military preparation that promises before it is completed to
add billions to the Federal budget. In undertaking such a preparedness
program, we must remember that our recently enacted program of world aid
for the coming year is only a part of a larger program covering several
years. It is, so to speak, a first instalment. I wish to underscore
this fact. It means that we are adding expanded military preparedness
on top of an already heavy budgetary load. We may shortly be confronted
by budgetary deficits; in fact, we may have some budget deficit as early
as this coming fiscal year. And this is only the beginning of developments for which no terminal point, as a matter of stark realism, can now
be set.
The elimination of the Government's budgetary surplus and the prospect of imminent budgetary deficits strike the economy before the fight
against postwar inflation has been decisively won. Prices of many products are still very high in comparison with prewar and wartime levels,
and many commodity and service prices, including wages, are still advancing. The total money supply, while reduced from last fall, continues
redundant in relation to the output of goods, and the public's 250 billion
dollar stock of available purchasing power—currency, bank deposits, and
Government securities—remains excessively large. Sustained high levels
of production and employment,- which are likely, will generate high levels
of consumer income, but supplies of goods for final consumption must be
diminished by amounts required for foreign aid, for military preparedness,
and for domestic capital maintenance and expansion.
Prospective Bank Credit Expansion
These conditions present a picture of continuing inflationary pressures. They al3o add up to a strong possibility that the financing needs
of the Federal Government, together with those of business, State and
local governments, home ovners, and consumers, will exceed the supply of
available savings. This possibility implies a large demand for financing
through the banks, repeating the type of bank credit development" which
occurred last year. Renewed expansion of bank credit and money could
only result in accentuating our inflationary pressures.
The commercial banks could readily accommodate any amount of demand
for
further
bank credit expansion. In all likelihood/ bank reserves will

113
be increased somewhat by an inflow of gold-from foreign sources, an<J also
by such purchases of Government securities from nonbank investors.-as the
Federal Reserve may make for the purpose of maintaining an orderly market
Finally, commercial banks, though obliged to sell some Government securities in recent months, still hold-about 66 billions of such investments,
which are readily convertible at the discretion of banks into reserves.
And as reserves from these various sources expand, they make possible,
for the banking system as a whole, a six-to-one inflationary expansion,
of bank credit and deposits.
. F^ced with these prospects, further bank credit expansion, which
will add to bur existing superfluity of money and liquid assets, will be
very difficult to keep in check. We must probably resign ourselves to
some credit expansion; we should certainly take every precaution, however, to keep it.within the bounds of the essential. I suggest as a
criterion of what is essential the expansion of bank credit required by
our current program of national preparedness and world aid. This means,
of course, priority for the bank financing of1 production related to these
programs and also for the financing of any Government deficits that may
result. It means, too, a rigorous avoidance of bank credit expansion foi
nonessential production, for speculation, and for consumption purposes.
Measures for Monetary Restraint
There is no simple or single way of accomplishing this task*.- It
will have to be' accomplished in a combination of ways—by general credit
controls and in particular areas by selective controls. Moreover, credit
controls alone cannot do the entire job. Banking and monetary policies
will need to supplement fiscal and other national policies—including,
if necessary, direct economic controls. I speak, however, only of the
factors lying in the field of money and credit; they are not the most
potent tut they are essential..
• The responsibility of the Federal Reserve System in this situation
is to conserve the nation's credit resources in the interest of the
longer-run stability of our democratic capitalism. In view of this responsibility, the System will be obliged to use its influence to restrair
unnecessary credit expansion. Its capacity to fulfill this responsibility,
is necessarily circumscribed, in part as a result of statutory authority,
and in part as a result of the nature of our banking system. •
Applicability of Interest Rate Policy
:

Taking these limitations into account, there are two lines of general
credit policy open to the System. The first of these alternatives,, which
is entirely within the System's existing statutory authority, is to permit a general rise in the level of interest rates. Such a program would
have a three-fold purpose: first, to strengthen the incentive for- savings; second, to meet increased financing needs; and, third, to discourage nonessential' borrowing. It is a program that would conform in
fcaj respects to the traditional'precepts of "orthodox" finance.
Yet it is a program that should not be accepted without careful coneffect of rising interest rates varies and may be the

for the
sideration}

opposite at one time of what it is at another. .Thus the initial effect
of * rising rates may be to encourage economic activity and they may not
become restrictive till an alarmingly high level has been reached. They
are first taken as harbingers of rising prices and active business. Un-'
der inflationary conditions, especially, rising rates would put businesses under a strong inducement to undertake expansion programs before
rates and costs went still higher; and they would hardly become deterrent until they had become extremely high. They would impel consumers
to avoid higher prices in the future by making credit purchases in the
present. They would draw out savings now held in bank deposits or in
savings bonds and add them to the volume of credit. But they would not
discourage Government borrowing, for the Government borrows not because
rates are low but because appropriations and tax legislation make borrowing necessary.
Still further aspects of a policy of higher interest rate levels
are the primary effects of such a policy upon the market prices of Government bonds and the secondary effects of lowered price levels for
Government bonds upon the soundness and the functioning of financial
institutions. It is one thing to contemplate higher interest rates on
a public debt of 25 billion dollars, such as we had at the end of World
War I; it is another thing to contemplate higher interest rates when
public debt amounts to 253 billion and exceeds the total of ell private
and other debt by nearly 50 per cent. We have also to keep in mind that
marketable public debt alone amounts to 162 billion, or approximately
75 per cent more than the value of all listed stocks and non-Government
bonds.
• The additional cost to the Government of a higher interest rate
program is another matter requiring thoughtful consideration, since a
maturing debt of 50 billion dollars this year and 100 billion in five
years would have to be refunded at higher rates. This aspect of the interest rate problem has a further implication. The Treasury might become a borrower at the higher"interest levels. This would raise the
knotty question of eo_uity with regard to present holders of Government
securities. The program'of financing participation in World War II, in
contrast to that of World War I, was geared to avoidance of this problem
by adherence to a stable pattern and level of interest rates.
These considerations with respect to the general level of interest
rates do not mean that the existing structure of interest rates should
remain rigid. Long-term interest rates reflect conditions in the capital
market—the supply of savings relative to the demand for investment.
Short-terra interest rates are more largely determined by liquidity preferences and other more transient money market factors. To the extent
possible without raising long-tern rates, short-term rates may be permitted more flexibility than they have had in recent years. In particular, short-term and discount rates somewhat higher than those now prevailing may help to encourage investment in short-term Government securities by banks and other holders of liquid funds and reduce the amounts
that need to be bought by the Federal Reserve. Such a policy may fce helpful in avoiding creation of additional bank reserves.

115
Proposals for Higher Required Reserves
In the light of these considerations, I think you will agree that
tnere are fairly clear practical limitations on the use of interest rate
policy to restrain further growth in bank reserves and accompanying bank
credit expansion. This leads me to the second alternative, namely, an
increase, m the reserve requirements of all commercial banks. This alternative would require legislation granting additional authority to the
Reserve System. The System still has unused power to increase the reserve requirements of member banks in New York and Chicago, but theie^rage to oe exerted through this authority would be relatively minor in relation to the problem that the banking system confronts. What is needed
is a more general authority which would apply, as a matter of equity as
well as economics, to all coimercial banks. To this end, the Federal Reserve Board has recently recommended to the Congress that authority of a
two-fold character be provided.
In the first place, the authority should make it possible for the
System to impose on all commercial banks a primary reserve requirement
up to 10 per cent of aggregate demand deposits and U per cent of aggregate time deposits, in addition to present requirements. If desired, tte
authority could be graduated by class of bank.' This measure would give
the Reserve System authority to increase total reserve requirements by a
maximum of about 12 billion dollars. It would enable the System, over
the next few years, to absorb and sterilize the credit expansion potential
occasioned by gold inflows and by Federal Reserve purchases of Government
securities from nonbank investors.
In the second place, the recommended legislation would enable the
system to impose on all commercial banks, under proper safeguards, a
special reserve requirement up to 25 per cent of aggregate demand deposits
£
nd 10 per cent of time deposits. This may be preferably described as an
optional reserve requirement, because the special reserve could be held,
at the option of the individual banks, in specified cash assets or in certain marketable short-term Government securities.
It seems to me at this time that perhaps the most desirable arrangement would be to package together the optional reserve plan and the proposal for authority to increase primary reserves made by the Board to
Congress in April. Provision might be made both for the optional reserve
and for an increase in primary reserves as proposed, with the general
^ t a t i o n that the total increase in required reserves that might be apPlied by the two types of authority taken together could not exceed 25
Per cent of aggregate demand deposits and 10 per cent of aggregate time
^posits.
At the special session of Congress last fall when the Board was asked
r° say what might be done in the monetary and credit field to deal with
lnf
lationary forces, its response was to recommend consideration of the
special reserve olan. The proposal attracted considerable attention,much
of
yhich was adverse. It was objected that the situation was not yet
serious enough to warrant such a measure, and that the Eoard already had
Jjough power anyway. As to the timing, the Board proposal was not that
r™" power be granted for instant application but that its use be author
e
d vhen necessary. The mere existence of such an authority would have

116
some effect, of course, for most bankers had rather act on their own
initiative than vait for a regulation to tell thorn what to do. Moreover
to wait till a situation is desperate before recommending appropriate
legislation is scarcely what one would call statesmanship. As ^or the
adequacy of Board powers, I think the point is whether the present powers
are applicable. The power to raise reserve requirements in New lork and
Chicago, for example—which the Board could do—is not very helpful waen
the problem largely lies elsewhere. Moreover, it is impracticable to exhaust powers before the moment of their greatest effectiveness and unfortunate to have to exhaust them without some power in reserve. Finally,
the Board was not seeking power but was responding to a request for suggestions at a time which was not of its own making or choice.
Some bankers have liked tho special reserve plan and some have not.
I have had doubts about it myself, and can sympathize with the doubts of
others. Yet I know of nothing better, and the plan has advantages, I
think, which have not been understood or appreciated.
Generally speaking, the optional or special reserve requirements
would be capable of accomplishing the "saiie restraints on bank credit expansion as a straight increase in primary reserve requirements, but it
would be considerably less onerous to the banks. As I have just said,
I sympathize with bankers who have questioned the desirability of the
special reserve plan and I think I understand their misgivings. Bankers
naturally resent being blamed .for everything. They did not bring on the
inflation and they do not like to feel that all the pressure to stop it
is being put on them. In reality, of course, restraint on the extension
of credit happens to be one of the effective ways of resisting inflation,
and we must not forget that we are speaking about it because banking is
the field of our responsibility and not because ve expect everything
that is done to be done in that field and nowhere else. I certainly do
not wish to give the impression that I have any patience with the tendency to take everything out on the bankers. I have a public duty to .
perform, but that duty is certainly not against the long-run interests
of bankers. One of its aims is the protection of banking through banking itself. It is in this spirit that I should like to clarify the optional reserve plan, for perhaps our explanations have not sufficiently
described the relative merits of the proposed measures.
Optional Reserve Plan
By way of preface it should be emphasized, as I noted earlier, that
banks now hold 66 billion dollars of Government securities. From the
standpoint of an individual bank and from the standpoint of the banking
system as a whole, these securities are virtually excess reserves. That
is, banks may sell Government securities in the market to obtain reserves
and unless other buyers appear, the Federal Reserve System must buy them
in support of orderly and stable market conditions. In the process new
bank reserves are created. As a matter of fact, nearly all large banks
and many medium-sized end small banks recognize this characteristic of
Government securities by adjusting their reserve positions continually
through purchases and sales.
Any plan to place restraint on the total volume of bank credit and
must recognize the potential reserve feature of the

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Government securities held by banks, or for that matter, of those held by
other investors. As a measure to reduce the volume of potential reserves,
it is as effective to immobilize a part of these securities in the port- '
folios of banks as it is to require banks to sell then to the Reserve
Banks in order to meet an increase in primary reserves • In fact, as a device for meeting the very special kind of situation that now confronts us,
the special or optional reserve plan has certain important advantages both
to banks and to the public generally.
In the first place the optional or special reserve requirement, if
imposed, would leave the banks with their holdings of Government securities intact. It would make possible an increase in bank required reserves
and at the same time avoid a considerable amount of banking readjustment,
as well as any serious adverse effect upon bank earnings. It would simply
immobilize a portion of commercial bank portfolios of Government securities and discontinue the treatment of these holdings as excess reserves,
i.e., as assets equivalent to cash and available for conversion into actual reserves at the bank's discretion through sale to the Federal Reserve.
The optional or special reserve, which would strengthen the demand
by banks for short-term Government securities and thus aid in the maintenance of relatively stable interest rates on Government securities,
would, on the other hand, make possible some increase in interest rates
on private borrowing, particularly on short-term and medium-tern borrowing. Any such rise would have the same restraining effects on inflationary borrowing as higher interest rates in general night have. More importantly, the plan would put pressure on the lender to ration scarce
bank credit among customers and to reduce voluntarily the bank credit
available for business expansion and consumer financing.
Furthermore, if Government deficit financing again becomes necessary
at some not too distant stage, the optional requirement would make it
possible to tie the deposits created'in deficit financing to the securities sold to the commercial banks and held as assets against the deposits.
Consequently, it would be much more adaptable in coping with the problems
of credit control incident to Government deficit financing than an increase in primary reserve requirements would be.
Lastly, the optional or special reserve authority would restore flexibility and effectiveness to the customary instruments of Federal Reserve
policy, i.e., open market operations and discount rates. In the traditional sense of their use for credit control purposes, these instruments
have become largely unusable because of the dominance of public debt in
the credit situation.
Criticism has been made of the special reserve plan that it would be
too restrictive and again that it would not be restrictive enough. Yet
as a device for meeting the serious problems of excessive credit expansion
the special reserve could be used with greater precision and with less
danger of adverse reaction than could an increase in primary requirements,
since the special reserve, as I said before, would involve fewer banking
adjustments". Moreover, safeguards against too rapid application of the
Requirements are an integral part of the plan.
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It has been said that the special reserve would not be restrictive
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118
still permit banks to sell longer-term securities to obtain reserves.
It is of course true that the plan would leave banks largely free to do
this. Banks would be deterred from doing this, however, because they
would be sacrificing a higher-yielding security, possibly at a book loss.
Further, since their short-term securities would be immobilized as special reserves, banks in practice would need to hold at least a portion
of their long-term Government securities as secondary operating reserves.
Should banks sell long-terra securities, moreover, buyers other than the
Reserve Banks might be attracted by theso higher-yielding iscue3, thus
avoiding the creation of new bank reserves through Reserve Bank purchases.
Some have criticized the special reserve plan because banks might
need to sell higher-yielding bonds to obtain sufficient short-term securities to meet requirements. The resulting loss in earnings, it has
been said, night cause banks to reach out for more risky, high-interest
loans and investments, with consequent expansion in private bank credit
end impairment of the condition of our bonks. I believe this criticism
does less than justice to the good common sense of the average banker as
well as to the effectiveness of our bank supervisory agencies. It also
does not take into account possible higher interest rates on sound private credit, and the increase in bank earnings from this source.
It is worth mention that a special reserve requirement, like an increase in primary requirements, would reduce the ratio of'multiple deposit expansion that could be built on new reserves that banks might
acquire from whatever source.
Supplementary Measures of Credit Restraint
My remarks thus for have been concerned with the major means of restraining redundant credit expansion. But there are also other measures
supplementary to general credit policy which should be restrictive in
particular credit areas and therefore helpful in controlling the aggregate volume of bonk credit. I refer to the areas of stock market credit,
consumer credit, and housing mortgage credit.
Credit to finance the purchase or carrying of listed stocks has
been restrained up to the present by the Federal Reserve Board's regulation of margin requirements; and in view of the dangerous inflationary
possibilities of the immediate future, it would be a grave mistake, in
my judgment, to ease those requirements at this time. 3
•• "
Regulation of down payments and maturities in the field of consumer
instalment credit is also needed, in my opinion. Re-establishment of
this control would help to dampen consumer demand, especially for durable
goods, financed on tine-payment plans. This would help to curb further
inflationary growth in consumer expenditures and to reduce the competition for available supplies of basic materials and manpower, on which
the national defense and world aid programs must draw heavily. An
auxiliary effect of this restraint would be some increase of savings,
encouragement of which may be put down as an essential element of any
program to. fight inflation in the period ahead.
The third area that I mentioned where selective credit control
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119
sa-ne time now has been one of the most inflationary factors in the current situation. Since early last winter, there have been mounting complaints—mainly from the building industry and veterans organizations" that residential mortgage credit is becoming tighter. Partly in response
to these complaints, consideration is being given by Congress to legislation designed to reverse this situation. You ere perhaps familiar vith
the proposals under consideration. They are, first, to continue on an
unsound basis the mortgage insurance program under Title VI of the National Housing Act; second, to create a Government financed secondary
market for mortgages already underwritten by the Government: and third,
to relax lending conditions under Titles I and II of the National Housing
Act. However, I am glad to say that, in this proposed legislation some
relevant economic facts have been faced; permissive interest rates on
guaranteed and insured mortgages have been placed one-half per cent
higher, and the pernicious "necessary current cost1' cost formula for
appraisal has been replaced by a "value" formula.
We are not at all sure that mortgage credit is getting tighter in
any real cense. Financial institutions, including commercial banks, are
still making mortgage leans at a substantial rate. Mortgage premiums,
bonuses, and fees offered by lenders are lower or have disappeared, but
loans are being placed. Borrowers are having a harder tine getting 100
per cent or 90 per cent loans, but thsre is no sound economic reason why
they should ever have had such loans- If recent anti-inflationary monetary and fiscal policies have been tightening residential mortgage credit
somewhat, that seems to me all to the good, and, considering the inflationary conditions that prevail in the housing market, entirely consistent
vith the objectives of those policies. There is no such thing as an effective program of over-all credit restraint that avoids restrictive effects in particular areas which have largo financial importance, such as
residential mortgage credit.
Even without a strongly inflationary outlook for domestic economic
developments, there would be very good reason for reconsidering and moderating any new program for the encouragement of mortgage lending. With
such an outlook, the need for reconsideration is urgent. It would be
better if we abandoned the program altogether, but at the least any further special encouragement of mortgage credit should be limited to rental
housing. We shall not succeed in overcoming the housing shortage by increasing the competitive pressures on scarce supplies of materials and
construction labor. What is needed is a continuing effort to keep the
volume of mortgage credit from pressing too powerfully against these important supplies.
The sale of savings bonds offers a positive check on inflation that
approaches the problem from a different angle. It withdraws money from
the spending stream, thus reducing the pressure of buyers on a scanty
^Pply of goods, and it substitutes private investment in Government securities for bank investment, thus reducing the volume of bank credit and
°f bank deposits.
Lastly, an over-all restrictive credit policy will needto be supplemented by vigilant watchfulness on the part of the supervisory authorities
by voluntary self-restraint on the part of individual bankers.
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^ believe that supervisory policy should vigorously maintain the
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120
soundness of credit extension by individual banks, and we have actively
cooperated with the American Bankers Association in its nationwide program of fostering banker-self-restraint. Rut the banks may expect continuing strong credit denunds from businesses and individuals, and they
are not in a positicn to refuse the sound credit demands of individual
customers in good credit standing. I think that banks can fairly be
asked to adhere strictly to conservative lending standards, and I believe that banks universally will respond to such requests. Fsut I do
not believe that they can extend credit competitively, as they must, in
the interests of their local communities, and at the same time refrain
from redundant credit expansion on a national basis—especially with
the basic factors present that are now stimulating credit expansion.
Financial Strength Essential
Before closing, I should like to stress the fact that there is
such a thing as a prudent, sound financial course for tn entire economy.
We are compelled by circumstances teyond our control to undertake commitments for world recovery and peace that no one till very recently
would have anticipated. These ccnmitTaents cone at a time of full utilization of our manpower and resources, of heavy current and deferred
peacetime demand by our own people, and of recent action to reduce our
heavy burden of Federal taxes. There is no financial sleight-of-hand
by which we can carry the unavoidable burden of our national program
and still avoid further serious inflation. We must raise from the public the money that has to be spent and there must be some restriction
on domestic demand for goods financed through bank credit.
These matters I have put before you are matters that it is the duty
of the Board to bring not only to the attention of Congress but also to
the attention of bankers and the public at large. Furthermore, it is
our duty to do so in sufficient time to allow Congressional and public
discussion and debate. And furthermore the powers the Eoard requires in
the discharge of its responsibilities must first be granted by Congress
in sufficient time for their exercise to be effective. Powers granted
too late serve no particular good.
I hope the suggestions we are offering will not be greeted with
the hackneyed comment that the Federal Reserve merely wants more power.
To make that comment is to beg the question. The Federal Reserve System
was set up nearly thirty-five years "ago to exercise certain authorised
functions in the public good. The world has nob stood still since then,
and presumably it will not stand still in the near future. We have had
two great wars in that time, the magnitude of business operations has
grown, and new forces have arisen. These developments make it necessary
to adapt and enlarge the powers that changed conditions have rendered
inadequate. I leave to your consideration the question vhat should be
done about it.

121
Broadcast over
Radio Station U-J-E, Detroit, Michigan
July 31, 191B
OUR PRESENT ECONOMIC SITUATION
Introduction: Governor Szyiaczak, as a member of the Board of Governors
of the Federal Reserve System over the past 15 years and with experience abroad in 1944 for the roreign Economic Administration and
again in 1946 EJTJ" 194-7 with the American Military Government for
Germany, has been in an unusually good position to watch economic
developments, both in this country and abroad. We are delighted to
have him discuss "Our Present Economic Situation".
Question: Governor, I think the economic problem uppermost in the minds
of many of us is the high cost of living. Can you tell us what
prices are so high? And why the chances are that they mifht come
down after a while?
Answer: That is a long story. Even so, I think we might first take a
look at how high the cost of living is now. According to the Bureau
of Labor Statistics index (which is to be used to adjust wage rates
under the new General Motors-United Automobile V/orkers contract),
consumer prices in May were 70 per cent higher than in 1939 and 9
per cent higher than a year ago.
Question: Wasn't there a sharp drop in grain prices early this year?
Answer: Yes, but it did not help the cost of living much. Food prices
dipped temporarily, but they are now somewhat above their January
peak and clothing prices have risen further. So have rents, but
in comparison with 1939 levels rents are up less than 20 per cent
while food and clothing are double what they were before the war.
Question:

Governor Szymczak, what about meat prices?

Answer: They, have risen considerably in the past few months and are now
about 20 per cent higher than a year ago end more than two and a
half times the pre-war level.
Question: You caid that since a year ago the total cost of living has
risen 9 per cent. Have any items come down?
Answer: Reductions in retr.il prices have been few and far between.
Radios and vacuum cleaners are cheaper than they weze a yehr ago.
Seme textiles and miscellaneous products have also been reduced.
Question:. That covers the main facts on the present cost of living;
plenty of housewives cr.n supply the details from their own experience, i^ow, can you tel3 uc what caused these high prices?
Answer: Chiefly the war. During thnt period a great deel of the world1 s
productive resources was diverted to war purposes. In this country,
at the peak of the war over two-fifths of all production was for
war uses. Abroad, factories were destroyed and trade wes disrupted
to.an extent not readily appreciated by those of us living at a dis
tance
from the scenes of actual warfare.

122
Question: So that for a. period of five'or* six years production for.
civilians was low and supplies of consumer goods were reduced?
Answer* Yes, and at the sane time incomes the world over were expanded tremendously because people were being paid for producing
munitions and waging war. The increased incomes were partly taken
away by. .Government taxes but people still had much more money to
buy goods thun there, were goods to.be bought. " Price rises were
United by controls. In this country the amount that people
saved out of their incomes increased very greatly duriftg the war
period.
Cuestion: And as a result of this people had more money in the bank
after the war?
Answer: More money in the bank, more cash in their pockets, and more
Government bonds. The total amount of these so-called "liquid
assets" held by individuals and corporations at the end of the
war was more than three times as great as before the war.
Cuestion: ^nd where die! all these liquid assets come from?
Answer: Less than half of the Government's expenditures during the war
was financed by taxes and the remaining amount was borrowed. Some
of this amount vas borrowed from savings and the rest was borrowed
from the banks. The Government paid the money out for war equipment, and the money was deposited in banks or held as currency.
The expansion, in these funds and increased holdings of redeemable
Government bonds resulted in a record supply of purchasing power.
Question: The main point, as I get it,, is' that people accumulated
money during the war, when many goods were not on the market; •
Then after the var they were able to pay high prices if necessary
for what they wanted urgently in the way of "food, automobiles, and
houses. Is that right?
•
Answer: Yes, people could back up their wishes vith more dollars than
ever before—dollars accumulated during the war and also dollars
received out of current incomes which generally continued high
after the war in spite of the curtailment of the war program.
There were plenty of jobs, immediately after the war and even more
now. In June employment reached a new record and wage rates have
advanced further.
Question:. .How much have wages risen?
Answer: ..At nanufacturing plants average hourly earnings are more than
-double prewar levels. This spring wage rates have risen less than
before as marked resistance developed" in leading industries.
Recent increases in eutoiaobile and electrical equipment" industries
have been within the general range of 5 to 15 cents an hour, which
has been characteristic this year where any increases st all have
been negotiated,
Question: Uow that you are discussing wages, Governor, I want to ask
you whether they are hij,h because prices are high or are prices

122
high because w&ges are high?
Answer: I am glad you asked that because there seems to be so much misunderstanding about it. Basically prices, wages, and profits are
all high because of heavy-demands for coeds. It needs to be remembered th&t wages are not the only business cost; that, particularly in times like these, many prices are not very closely related
to costs; and that consequently care should be taken in attributing
price increases to wage increases.
Question: But wage increases add to costs £.nd they add to incomes so
they must have some influence on price increases.
Answer: They most certainly do. Actually these things are all interrelated, which is one reason why we talk about the "inflationary
spiral". Such a spiral once under way is difficult to stop. In a
period of heavy demand and rising prices, increases in prices and
wages reinforce each other. Only those who receive fixed incomes
can claim that they do not contribute to the spiral.
Question: Governor, there is another question I would like to ask you in
this connection—has the tanking system contributed to the rise in
prices by expanding loans?
Answer: Earlier I mentioned thtxt during the war the banks loaned a great
deal of money to the Government, which the Government scent for war
purposes, and this resulted in an increase in the purchasing power
people held. In the last two yecrs the Government has raised more
in taxes than it has spent and with the surplus has paid back some
of these loans, which has tended to reduce the supply of money. But
bank loans to private business and to consumers have expanded
sharply since the war, tending to increase spending.
Question: Have bank loans continued to rise this year?
Answer: Loans for commercial and industrial purposes have not risen
since the beginning of the year, partly because of seasonal influences and partly because of substitution of other means of financing. Also, banks have shown some restraint in making loans. Loans
on real estate have continued to rise rapidly, despite some restrictive policies; and so also have consumer loans.
Question: Do you regard increases in losnc as a cause or a result of
rising prices?
Answer: Extension of credit since.the war has in some degree made possible more production, but borrowed funds have also been usea to
compete for'a limited supply of goods, thereby adding to the pressure on prices. Higher prices in turn have required larger loans to
finance a given physical volume of business•
Question: How about loans to foreign countries? Haven't they been sizeable and helped push up prices?

Answer: Yes, Federal loans and grants to foreign countries have been

12U
.large and they hcve contributed to increases in prices of domestic
commodities, but it is a cost that ve have willingly assumed in^
order to assist in relief and recovery abroad. 5vsn without United
States assistance, however, foreign demands would have been very
large relative to prewar because of wr.rtitne shortages of goods and
accumulations of gold and dollar balances.
Question: You have been discussing so far the influence or: prices of
various demands for goods, rtow, would you tell us something about
supplies? How large hsc production been?
Answer: Total physical production of goods end services has been about
two-thirds higher this year than in the 1935-39 period; output of
manufactured goods lias been dcuble the prewar average. Of course,
that period was quite a while ago and since then the population has
increased by 11 per cent. Also, there were many unemployed in the
1935-39 period. Even so, the present production level is very hijfcpractically at peacetime capacity with present equipment.
Question: You are emphasizing then that in spite of a very large volume
of output since the end of the war the pressure for price increases
has been very great.
Answer: Yes, and this pressure was particularly evident in the latter
part of 1946 when practically all price controls except those over
rents were removed. This action was taken partly with the hope
that production could thereby be increased. Since then, in the
past year and a half, production his increased, tut by only a
moderate amount because of capacity limitations, and prices have
advanced further.
Question: Has the high level of production since the war eased the
shortages of goods prevailing then?
Answer: Yes, quite a little. Merchants and manufacturers hove been
able to substantially increase their 3tocks of poods, l-lcie—
though not enough—housing accoiruT.odatio".tf have become available*
Consumers have satisfied some of their more urgent deferred
demands for goods not available in wartime. In some lines, as
in the shoe industry, supplies have exceeded demand and output has
been curtailed.
Question: Have there been any periods when supplies of goods generally
seemed to be catching up with or exceeding demand?
Answer: Such appeared to be the case for a time in the second quarter
of 1947 when hesitation was noticeable in E. nuaber of markets,
even reducing production in a number of lines for a short time;
but a new wave of buying and price rises occurred in the summer and
autumn, stimulated partly by short feed grain crops and new plans
for aid to Europe, and production later reached new peak levels.
Question: How about the situation since then?

125
Answer: Early this year there again was some hesitation in buying, as
grain prices declined sharply on prospects of excellent crops in
this country and abroad, but demand has since increased again owinp
in pert to the actual and anticipated effects of a reduction in
taxes, increased foreign aid, and the expanded armament program.
Generally, production has been close to capacity levels and supplies of some important products, such as steel, h w e continued to
fall short of demands. Upward pressures on prices and wages have
been strong.
Question: Can it be expected that prices, wares and profits* and the
volume of bank credit will go on expanding indefinitely?
Answer: That is a very basic question. The answer which economists
read from the pages of history is that booms come to an end, with
serious consequences for production, employment, financial assets,
and economic well being generally. The bigger the boom the more
likely it is that the bust will be disastrous. That is why efforts
should be made to check a boom and prevent the distortions in
prices, production, profits, and the like which lead to severe
reaction.

127
Speech delivered before
Evening Seminar Session,
School of Banking, University of Wisconsin
i.lauison, Wisconsin
September 1, 19 U8
BANK RESERVES AND MONETARY RESTRAINT
The present inflationary situation is so
description of it is necessary; certainly not
up 70 per cent over what they were in 1935 to
up 10 per cent vdthin the past year. On some
crease is much larger, for the figures I have

patent that no analysis or
here. Consumer prices are
1939, and they have {-one
items, of course, WIG inmentioned are averages.

Me are taught to think of an inflationary situation as one in wldch
there is a wide disparity between the available purchasing power of the
public and the available supply of goods and services. At tho present
time there is little, if any, productive capacity that is not at v.rork,
and we can not expect any great increase in production. There are, to
be sure, some points at which inflationary pressures are less strong
than they have been, but it is too early to say whether production is
catching up with demand. We can only note the fact that crop prospects
are extremely good and that a shortage in farm production should therefore not be a factor. The supply of certain nondurable goods, such as
shoes, appears to be catching up with demand. The same is true of
certain durable goods, such as radios. Despite these few signs, however,
the present outlook on the production side is still inflationary.
Turning to the other side of the picture we find that total commercial bank credit, other than credit extended to the United States
Government through purchases of its securities, has increased nearly
g20 billion since the middle of 19ii5. In this sane three-year period
privately owned deposits have increased about 27 billion. In the first
half of the present year bank loans have expanded ,#1.7 billion. This
recent growth is the net result of several different trends. The first
of these is that real estate loans and consumer loans have continued a
substantial growth, whereas business loans have declined slightly, loan
demand being seasonally slack during the first half of the year, [jost
of the mortgage loan expansion has occurred at country banks, v;here all
types of loans have shown an increase. City banks have increased their
real estate and consumer loans substantially, but this increase has been
partly offset by the decline in business loans. Total loans at city
banks, however, increased nearly a half billion dollars. Since the end
of June the current loan expansion has been accelerated, and at weekly
reporting banks, loans to businesses, and to real estate buyers have
been increasing at the rate of about -,100 million a week. This postwar
credit and deposit expansion is in addition to the large expansion of
purchasing power during the war. It has raised the volume of deposits
and currency in the hands of the public to over .-165 billion, more than
2-1/2 times as great as at the end of 1939Any attempt through the central banking mechanism to curb the expansion of bank credit than I have been describing brings up the
question of bank reserves immediately. Originally, as you know, bank
reserves were thought to be of importance because they were supposed to

128

insure the ability of banks to redeem their circulating notes. VJhen deposit liabilities cams to take the place of note liabilities, bank reserves wore conceived of as a merns of assuring the ability of banks to
pay their depositors, i!ow, however, our concept of the role of bank reserves has developed into a very different one. They r.o longer are thought
of merely as assets which banks maintain in readiness for instant use.
Being the assets upon which a bank's freedom of action depends, they have
coino to be the direct object of regulatory effort. The Federal Reserve
System can, under proper conditions, increase or decrease the volunc of
bank reserves. Hence, reserves now have their principal significance as
an instrument for influencing the supply of money.
At the present time a given addition to reserves makes possible about
a six-fold increase in bank deposits. A contraction in reserves of a fiven
amount tends to produce a six-fold contraction of deposits.
• The basic principle underlying this possible expansion and contraction
is that bank deposits have their mlncipal source in bank credit. If a
bank v;ere without any competitors to v;hich it might lose deposits, it could
expand its deposits indefinitely by making loans to its customers and placing the proceeds of the loans to their credit in their checking account.
The only limitation v;ould be the amount of reserves it had to maintain in
proportion to its deposits as a result either of its own rules or of legal
reserve requirements. At the present time member bank reserve requirements
are on demand deposits 2h per cent at central reserve city banks, 20 per
cent at reserve city banks, and llx per cent at country banics and on time
deposits 6 per cent at all classes of banks. These requirements average
about 15 per cent of deposits. Fifteen per cent reserves permit deposits
to expand about six and tv;o-third times. Thus, if there were but one
large co..i?.erclal bank serving the entire country and holding all the deposits of the people, its deposits could expand to ,,666 for each additional vlOO of reserves. This expansion could be effected by lending "
and investing, deposits beir:£, set*up on the bank's books in payment for
the loan and investment paper acquired. Being the only bank it would
not noed to fear loss of deposits and inability to honor the checks of
its depositors. It would, therefore, not be subject to the inhibition
that banks are under in actual competitive situations. Persons who receive checks on the bank would deposit them in the bank and the effect
would be a transfer of deposit ownership on the bank's bookc without aqy
actual transfer of deposits from the bank.
3ut we have approximately lU,000 cornrr-ercial banks. Therefore, in
the actual competitive situation that exists vtoere there are many banks
in existence, as in the United States, no bank dares to lend six and a
fraction times the amount of newly acquired reserves. It dare not do
so because bank customers do not borrow with the expectation of' leaving
the borrowed funds on deposit; they borrow in order* to expend, and the
iunds they borrow are more apt to be checked out to another bank than
to remain v,ith the bank which lent them. Actually, when a bank receives
a deposit of vlOO, it must put aside .£$ as a reserve against the deposit and it can lend ^85. This ,585 will probably be transferred in a
monetary payment to a depositor of a second bank. The second bank receiving the ^85 deposit must increase its reserves by 15 per cent of
Digitized forthe
FRASER
deposit; that is ,,12.75. It then has ,72.25 left which it can lord

129
and vAilch v.111 probably find its way through a monetary payment to a
third bank.
This process continues through a succession of banks, assuming
there is an aggressive demand for bank credit, until taking all the
banks together a result is reached v.hich is the same cs .v/ould be" reached
if there were only one bank. That is, all banks taken together constitute a system analogous to a single bank performing all tho banking
business. Deposits may shift from bank to bank but, as a general thing,
they do not leave the banking system. So, the process of lending and
r.;oving funds from bank to bank with resulting increases in deoo^.ts. and
in required reserves can continue through a succession of banks mit'll
the total of the new deposits, counting the original deposit of .JLO'A1 at
the first bank arid the successive deposits created through th-3 successive loans, .will anount to .L666# The reserves set aside by tho baiiKs
involved will anount to £00, which is the 15 per cent required against
the aggregate deposit of ;666.
Since the amount of deposits is keyed to the amount of bank reserves, control of the volume of bf.nic reserves and of the percentages of
reserves that must be hold against deposits gives tho Federal Reserve '
System power to restrain or encourage the expansion of bank deposits and
their adjustment to the needs of the economy. These controls over bank
reserves have been exercised traditionally in three different ways:
The first and basic means of control has been tlirouph changes in
tho rediscount rate, for these rates by being raised or lowered, respectively, discourage or encourage banks to borrow from the Reserve
System in order to obtain additional reserves.
The second moans of control has been through opon market operations,
the effects of which aro to decrease or increase bank reserves. This
instrument was partly used for making discount rate policy effective.
The third device is that of varying reserve requirements. Tho
generally accepted thought has been that this was .a device to be used
only occasionally to effect broad eeneral changes in the credit situation and to make the other instruments of control more sffoctive.
The poorer to change reserve requirements was first granted to the
Federal Reserve Board in 1933. Through a series of changes maximum
requirements gradually cai.-ie into effect in 1937 and in 193d they -.,ere .
slightly reduced. Subsequently tney have been raised. Before the
enactment of recent legislation allovang higher reoiiireiaents to be imposed, requirements under the earlier authorization were at a maximum
except for central reserve city banks, where requirements were 2U per
cent* against net demand deposits as compared vritli the possible maximum
of 26 per cent.
In what I have just said the traditional instruments of credit control have been described as they might operate under ideal conditions.
As you know, ideal conditions never exist, actually, the Board's freedom of action is constantly subject to conditions and limitations over

*hich
it has no control. Thus at the present time the Federal Reserve

130
System has the responsibility for maintaining orderly and stable conditions
in the Government security market. With this responsibility it is not possible to use aggressively the open market and rediscount power the Federal
Reserve System possesses to contract the volume of bank reserves.
If, for example, the Federal Reserve vdthdrew support from the Government securities market and undertook to sell Government securities in the
market to absorb bank reserves, long-term yields on Government securities
would rise until investors would find Treasury securities attractive as
compared with competing demands for.their funds. This balance would be
. reached at some yield level as the larger return on Government securities
..attracted funds out of hoards or from spending and as rates to private
borrowers rose to levels which would cause some of them to abandon their
less urgent expenditures. If (as pointed out recently by Mr, Allan Sproul,
President of the Hew York Federal Reserve Bank and Vice Chairman of the
Open Market Committee, in a letter to a President of an insurance company)
the level of long-term rates at which this would occur should be h per
cent, then the Treasury 2-1/2 per cent bonds of 1967-72 would need to decline to about 77- The shock of such a move on business and markets would
probably be severe. We would get results, but in the way of bringing about
a decline in production, a decline in employment, and a reduction in the
income of a large segment of thff consuming public. As it is, therefore,
open market operations under the support program must operate within the
framework of the support structure. The central bank authorities have,
in fact, little initiative; control of the situation being largely in
the hands of bank and nonbank investors.
The rediscount rate is also of very limited importance at the present, because banks generally adjust their reserve positions by sales in
the security market and not by borrowing from the Reserve Banks. An increase in the rediscount rate may effectively accompany a rise in shortterm rates but an increase in the rate by itself would be only psychological in its effect.
This leaves only the third device still available for use, especially since Congress has recently given the Board limited additional
authority over reserve requirements. However, if banks are required to
hold reserves in excess of what they now are required to hold they might
meet the situation by the sale of Government securities. If the Federal
Reserve Banks purchase these securities it would simply be providing the
additional reserves that it had just required; and thereby It might undo
with one hand what it did vdth the other.
These recent auditions to the Board's authority over reserve requirements do not by any means settle this country's central banking problem.
In its immediate aspects, this problem is one of helping control the current inflation. In its larger aspects it is the very old one of finding
more efficient means of credit control than have yet been devised. The
instruments we possess result from a long and rather haphazard history,
and the Board has for many years been seeking to develop ways of improving and strengthening them particularly vrith respect .to* reserve requirements, I wish now to describe to you some of the proposals that have
been given consideration in recent years.

131

Before goinf:: into these proposals, however, let me remind you that
vre have followed since the war a program of action which has generated a
moderate amount of credit restraint. The rate on short-term Government
securities has been permitted to rise from the wartime levels of 3/8 per
cent on 91 day bills and 7/8 per cent for one year certificates to about
1.1 per cent and l-l/U per cent, respectively. The rediscount rate has
been raised from 1/2 per cent to 1-1/2 per cent. Surplus Treasury funds,
particularly over the past year, have been used to retire securities held
by the Federal Reserve Banks, a process that drains away bank reserves.
I wish first to refer to the reserves to which the Reserve Ranks
themselves are subject, for the matter has been brought up frequ.cnay
of late.
As you know, the reserve Banks are required by lav/ to hold reserves
of gold certificates equal to 2J> per cent of their note and deyoait liabilities. The proposal has recently been made by the House Banking and
Currency Committee to increase this requirement to 35 per cent against
the deposit liabilities of the Federal Reserve Banks (that is, the reserve balances due their member banks) and hO per cent against their
note liabilities. The proposal, in other words, would restore the requirements that were in effect before the middle of V)hS when the present
requirements were adopted.
Restoration of the previous ratio of required gold certificate reserves held by Federal Reserve Banks of aO per cent against Federal Reserve notes and 35 per cent against Federal Reserve bank deposits would
make no contribution whatever to the fight against inflation. It would
not sterilize new acquisitions of gold nor would it give the Federal Reserve System any additional powers to curb inflationary expansion of bank
credit.
The present reserve requirements of the Federal Reserve banks stand
at a uniform level of 25 per cent. Congress established then at this
level in consequence of the wartime expansion of currency and Reserve
bank credit. The previous requirements of uO per cent against notes and
35 per cent against deposits, 'incorporated in the Federal Reserve Act of
1913, were largely arbitrary.
To restore the prewar levels now would only entail needless operating difficulties for some of the Federal Reserve banks. The combined
banks at oresent hold gold certificates amounting to 50.6 per cent of
their total note and deposit liabilities, or approximately -,6,000,000,000
in excess of the proposed higher requirements. Thus, they would not prohibit Reserve banks from providing member banks with additional funds on
which to base a considerable further expansion of bank credit.
Although the Reserve System as a whole has gold certificate reserves in excess of the proposed higher requirement, there is considerable variation among individual Federal Reserve banks. As a practical
operating matter, these banks cannot permit the ratios to go down to the
vanishing point and hence require a working margin of at least three
percentage points.

132
If the higher requirement were restored, some Federal Reserve banks
would have a substantial deficiency, others v/ould be below or close to
the necessary operating margin, while still others v:ould have a large
excess*
Reserve banks with a deficiency would be obliged to cell some of
their Government securities to or to borrow from Reserve banks which had
an excess. The reserve position of the individual Federal Reserve banks
is constantly changing with seasonal and other movements of funds in the
economy. Therefore, the proposal would entail operating difficulties and
constant inconvenience without accomplishing any useful purpose.
ixpansion or contraction of Reserve Bank credit should be determined
by the needs of the economy and not by the amount of gold certificates
which Reserve banks happen to have, which in turn is contingent upon international movements of gold.
The Reserve banks do not control the amount of currency v/hich the
public wishes to hold. It is the depositors of the banks and the recipients
of checks who determine the volume of outstanding currency. They create
the demand and member banks come to their respective Federal Reserve banks
to obtain such amounts of currency as their depositors or others presenting
checks may desire to have.
Next let me discuss with you reserves as they relate to member banks.
Firat anong these plans is the optional or special reserve proposal,which
was recommended to Congress in the Board's Annual iteport for V)h5 and
again was recommended to Congress in November 19U7. This proposal is that
for th-3 periou of this inflation emergency the Federal Reserve Hoard be
authorized to impose on all commercial banks, member and nonmember, a
special reserve requirement up to 25 per cent of aggregate demand deposits
and 10 per cent of time deposits.
This is called an optional requirement because the reserves required
could be held at the option of the individual bank either in specified
cash assets, that is vault each or interbank deposits, or in certain marketable short-term Government securities.
There are several important advantages in the plan. First, it v/ould
immobilize a portion or each bank's holdings of short-term Government
securities, instead of selling them, banks would have to sell their
higher yielding long-term issues if they wished to increase their reserves. Second, the plan would bring about a decrease in the ratio of
multiple credit expansion; for the higher the requirement the less the
ratio of expansion can be. Third, the plan would not reduce the amount
of earning assets from longs to shorts held by banks. Fourth, the rise
in interest rates consequent upon recourse to the plan would be limited
largely to the field of private credit. The effect would not be to increase the cost of carrying the public debt.
The plan to increase primary reserve requirements also was proposed
in the Board's Annual Report for V)kxJ> and again in April 19U8, the recommendation being that the maximum requirements authorized by lav/ be in
creased by 10 percentage points for demand deposits and h percentage

133
points for tir.e deposits. The recent increase in authority cranted bry
Congress in Aut*ust v;as in terms of this plan but the amount of authority
£iven was smaller and its application was limited, as you know, to .neniber banks and dees not include nonmembers.
The advantage of increased primary reserve requirements is t'mt it
is in line with traditional practice* Furthermore/ the increases can
be imposed as a means of mopping up additional reserves resulting from
the flow of gold into the country, which has amounted to about three
billion dollars last year and one billion thus far this year, fro.i; the
return of currency from circulation which over the last twelve months
has amounted to about .;-.300 million, or from the purchase of Govonniierit
securities by the Federal Reserve System in supporting the Govornneut
securities market. The power can also be used to force banks to sell
Government securities to the System and thereby reduce a source of
secondary reserves potentially convertible into primary reserves.
A disadvantage of this plan is that increased primary reserve requirements tend to diminish the earning assets of banks•
Next is the Uniform Reserve Plan, which is still in the study stage
and is subject to change,~and which is based on the consideration that
changes in reserve requirements may become our major instrument of
credit control, especially in view of the limitations imposed upon open
market operations and discount policy by the need of supporting the
Government security market. If this is so, changes should be made in
the present system of reserve requirements so as to uake the instrument
of changing reserve requirements more flexible and to eliminate inequities that would become burdensome as the requirements were increased.
There are six features of the Uniform Reserve Plan considered from
this point of view. First, central reserve city and reserve city designations would be abandoned. Second, the following initial reserve requirements would be prescribed against classes of deposits;
a. 30 per cent against interbank deposits
less cash items in process of collection.
b.

20 per cent against other demand deposits,
less cash items in process of collection.

c. 6 per cent against time deposits.
Third, banks would be permitted to deduct frora their required reserves a
percentage of balances due from other baaks equal to the percentage of
reserves required to be held by them against interbank deposits.
.Fourth, banks would be permitted to count vault cash as a part of required reserves. Fifth^ during a transition period the Federal Reserve
Board would be empowered to waive, by regulation, penalties for deficiencies in reserves resulting from increased requirements on the new
basis. Sixth, the Federal ueserve System would be empowered to increase
or decrease basic reserve requirements by some suitable percentage (say
a maximum of $0) in either direction as to any or all classes of deposits.

13U
The Uniform Reserve Flan has several advantages. To boyin vvith, it
would eliminate fundamental inequities in the present system which involve hicher reserves for some banks than for others sindlarly situated
simply because of the arbitrary classification of the communities in which
the respective banks arc located. Another advantage is that long standing
problems incident to reserve city designations v;ould be ended, Banks
whose business requires them to hold large amounts of vault cash would no
longer be under the disadvantage of having to maintain the same required
reserves at the Reserve Banks as other banks which have to carry little
vault cash. Furthermore, under the Uniform Reserve M a n , changes in the
volume of interbank deposits would no longer affect the volume of other
deposits that could be supported by a given aggregate volume of reserves.
Finally, increases could be made in reserve requireiaents, v.ith the sa;iie
advantages and disadvantages as attend a straight increase in reserve
requirements. The Uniform Plan is now getting further serious study
from the System.
There is another plan for reserve control which I should like to
present to you for your study at this tin:e. 1 am not recommending it
but am only submitting it. It has been named the Optional Ceiling Reserve plan. The effect of this plan would be to restore monetary control to the monetary authorities and at the same time permit continued
stabilization of the Government security market. The plan would ina4<e
this possible, moreover, without causing a sinple bank to undergo any
transition adjustments. The plan would not reduce bank earnings and it
would not prevent an individual bank from making as many loans as its
resources might, permit.
The features of the Optional Ceiling Reserve would be as follows:
1. At the Federal Reserve Bank two deposit accounts would be
set up for each member bank. One of these would be the
member bank's Reserve Account and the other its Clearing
Account.
2.

Sach member bank would start with an amount in a Reserve
Account equal to its reserve requirements at the time.
Any excess reserve (or deficiency) that it might have at
the time would be posted to its Clearing Account.

Only those funds in a bank's Reserve Account could be
used to satisfy basic reserve requirements,

U. All ordinary transfers of funds, including the clearing
of checks by the banks, would be effected with the funds
in Clearing Accounts. Thus, when a bank received from
one of its customers a check drawn on another bank, it
might send the check to its Reserve Bank for deposit to
its Clearing Account. The paying bank would in turn
have its Clearing Account reduced by the amount of the
check. Y;hen a member bank found itself in possession
of more currency than it needed and sent it for deposit to its Federal Reserve Bank, credit would be
given in its Clearing Account.

135
5. A bank night buy or sell Reserve Account deposits
in the market just as Federal funds are now" traded,
and such funds would be transferred from the Reserve Account of the selling bank to that of the
buying bank. As at present a bank might also borrow Reserve Account deposits from its Keserve Sank
at the discount rate set by the Reserve Bank. The
Reserve System might also buy or sell Reserve Account funds in the market.
6. Government securities bought in the market by the
System and securities sold by the System would be
paid for with funds drawn from the Clearing Account
deposit.
7. The computation of reserve positions under this
plan would be simple. For reserve city banks, for
example, Reserve Account requirements would equal
20 per cent of net demand deposits less Clearing
Account balances, and plus 6 per cjnt of time
deposits. Some of these Clearing Account balances
right be invested at the option of a bank in a
security issued by the Reserve System or perhaps
by the Treasury.
The Optional Ceiling Reserve plan that I have just described would
seem to make bank reserves independent of the influence of the erratic
haphazard factors that now tend to increase or decrease then. Theee are
principally the flow of gold into and out of the country, the movement
of currency in and out of circulation, fluctuations in Treasury working
balances, and fluctuations in foreign deposits at the Reserve Banks. The
volume of existing bank Reserve Account balances would be subject to increase or decrease by action of the Federal Reserve System in buying or
selling Reserve Account balances in the open market. These transactions
would be carried out in accordance vdth the needs of the economy.
It would be neither necessary nor desirable for the r-eserve iivn
to have authority to vary reserve requirements under this plan.. Individual member banks would adjust their reserve position as they rain
deposits either by buying Reserve Account balances in the market or by
exercising the option of holding larger Clearing Account balances or of
investing in Reserve Securities, When a bank lost deposits, its Clearing
Account balances would be reduced and if it vdshed to replenish them, it
could do so by cashing Reserve Securities, it would, also have sons excess Reserve Account balances to sell if it chose to do so.
Let me give you an example of how this plan would work. Suppose
the X Bank of Chicago has an increase in its demand deposits of $100,000
as a result of a favorable balance in its check clearings with other
banks. How would the bank adjust its reserve position? Under the
Optional Ceiling Reserve Plan the X Bank could send the balance to its
Reserve Bank for credit to its Clearing Account. The X Bank's Clearing
Account would be increased by ,£100,000 which would natch the increase in
its deposits, and its reserve needs would be fully met. Or, if it chose,

136
the X Bank could invest the jO.00,000 in interest bearing Reserve Bonds,
Again its reserve needs would be fully met. Or, third, the X Bank might
purchase, or borrow from another bank or from the Reserve Bank, a Reserve
Account deposit sufficient to meet the rise in its iieserve Account requirements implied by a ^100,000 increase in its demand deposits. With a 20 per
cent reserve requirement, this would mean that the X Dank would have to
acquire .^20,000*of Reserve Account deposits. Having done this, the X Rank
would then have the remainder of the newly acquired funds available for
lending or investment.
In adjusting to a ^100,000 demand deposit loss—a result of an unfavorable clearing balance, or a withdrawal of currency by depositors say
for Christmas or Easter shopping—the X Bank could again follow alternative
procedures. It could permit its Clearing Account balance or its holdings
of iieserve Bonds to decline by : J100,000. Since the decline in those items
would match the decline in deposits, the reserve position of the X Bank
would be unchanged and all reserve needs would be satisfied. Alternatively,
the X Sank might decide to keep the total of its Clearing Account balances
and holdings of Reserve Bonds intact, and provide funds to meet the deposit
loss by liquidating other assets, such as selling Government securities to
the Reserve Banks. In this case, the volume of Reserve Account deposits
that the bank would need to hold would automatically decline. T.lth the 20
per cent requirement, a ,J100,000 deposit loss would release ,^20,000 of Reserve Account deposits which could be sold in the open market established
for Reserve Account funds. The remainder could be raised through liquidation of other assets.
Yrtiat about a bank's lending operations under the Plan? l/hen a customer wishes to borrow money the X Bank might be able to accorcnodate him
out of funds received from repayment of other loans. If not, the bank
might need to liquidate other assets to make the loan, say short-tern
Government securities. Under the plan the sale of securities, which would
increase the bank's Clearing Account balances, would provide the reserve
offset needed to set up a deposit to the borrower in making the loan.
These clearing balances would be drawn upon as the loan deposit was checked
on by the borrower. Except for a difference in timing, the net result corresponds closely to the way that an individual bank meets its loan demand
now—that is, by selling Government securities to meet deposit losses that
may result from lending.
The crux of the Optional Ceiling Reserve Flan is that, from the standpoint of an individual bank, lending activities and operations might £° on
in about the same way as now. but taken as a whole, the banking system
would not have the multiple monetary expansion U, has today. I discussed
this multiple expansion oarly in my talk. As a system, banks could not
base
2 multiple deposit and credit expansion on a given volumo of new funds*
As I said before, I am not proposing the Optional Ceiling Reserve
Flan as my solution to the problem of monetary stability, I have told you
about the plan so as to set you thinking about it and more generally to
thinking about the broad problem of what we can do to establish our money
and banking systems on a sounder basis following the most costly war in
history.

137
Speech delivered before
Third Annual Federal Reserve Forma
iiicollet Hotel, Minneapolis, rliaaesota
October il 39AB
OUR FEDERAL RESERVE POLICY TODAY
Introduction
Our inflation is en offspring of the war. During the vt.r, resources had to be divei-ted from tha production of (roods rnd services fo?
civili-ms rr.d turned to the production of military necessities, flub
the fact tLat goods were not avnilable did not aean ttot ti-o uruuH for
thea automatically dissolved. Unsatisfied wants accunukteii, urvLti.y
the return of perce ana prosperity. Tod'iy the impuct of there t.c.wculi ted vunt>* is still being foit in almost every sector or our econcsy.
But the mo3t important aspect oi' the war fro* the point, of view of
explaining the present inflation is the wuy in which it was financed.
Fundamentally the Government had two sources upon which to draw for its
itanae: (1) the ^ocketbooks of individuals .ind business firms which it
couxd reach through taxation or borrowing; (2) the resources of tiie
banking system.
Taxation is, of course, a noninflationv.ry fora oJ1 finance. \'hen
toxes are imposed, the spending power of the public is rcducr-d by tho
anount that the Government's is increased, ho ex^nsion .in the total
spending power of the coacfiunity tc-kes plc-.ce. The t&x:icyer receives in
oxcli&ngo only ? tax receipt, vhich he cannot use to mrOc* purch'sses in
the niarket, either in i,he pz-otient or in the future.
No £ovonraent has ever succeeded in finrjicinj the total cost of was
throuih taxation, c-nd ours ws.s no exception. It is estlooted thut less
tlian half of the total funds zeised by the Treasury fro.n the raiddle of
1940 to the end of 1945 came from taxes. Now, there rue cerious practical obstacles thwt place a definite upper licit to the tox bu-don tha<
c&n be imposed in wartime vithout lieaperin^ the was- efi'ort itself. Jusl
where thai limit its cannot be detennined exactly. Bus it i3 certain
that we didn't reach it. te should heve done better, and i:ui we used
taxation more during tlie vcr, ini'l&bion would not be the problen that
it i3 today.
Another noninfictioruiry type of fin: nee, at least while vr.r is
goiag on, consisto in .bonowinc from the nonbank public. Since in
purchasing a Government security the individual £.ives over a portion of
his current spending power to the Government,, borrowing froa tno nonbenk public it: ia one aspect siailar to taxation. It has a basic difference from taxation, however, vhich is ell important for tho iiostwar
period. Holding a Government security is the next best thinf, to holding noney, so for as a resevoir of purctociinj pov:er is concerned. This
cunns tliat the loss of spending power involved in lending to the Government was not permanent, as with ta>aition, and tlict the pouer could be
reclaimed in the future pretty much £t the lender's de-aand. Vfe te.ve
been ceeing the effects of tiiis potentiality since the vi;r!a end. Thus,
while borrowinc instead of taxing helped to relieve current pressures

during the war, it w.s storirit up pressure trouble for the 1 .-osti.br era.

138
An outright inflationary *;ay to finance a var is through borrowing
frcm the cosaercicl banking system. When coiamercial banks lend to the
Govern/Krnt, vhich they do by netms of security purchases, b&nk deposits
are created and pluced at the disposal of the Treasury. Darin- th« wnr
this deposit creation typically took the form of additions to the Tres:;ury. During the var this1 deposit creation typically took the fora of
additions to the Treasury s w r loan accounts* Thus, by borrowing from
thetan*!?.,the Government increased its spending power through an expansion of credit and the aor:ey supply. There was not, as was the cy.se
for T.r.x\".tior. and borrowing fron the nonfcsnk public, an offsetting reduction in thy spending cower of the rest of the community. And when
the Government spent the" funds it acquired from the bunks, a general
rise of nouey incomes tooic ploce. With no commensurate incrcr.ee in the
supply of goods and services upon which the community could spend the
higher incomes, the result was an intensification of the upward pressure
on prices.
In this process of w&rtine borrowing from the bMu:s, trouble wrs
also beins stored up for the postwar ere*
Support of Government Securities
As you know, the pivotal vsrtine policy of the Federal Leserve was
the aaiiiteiK-nce of the longer-tern interest rate structure at 3p.i»roxi.nately the level existing fit the beginning of the war. As vus generally
kno;m at that time, this policy was inxenrted to serve several purposes:
to forestall delay by investors in purchasing securities, wuo might otherwise have owcited higher interest rates as during world Vr.r 1} to keep
down interest cost on the Government's var debt; and to prevent an undue
growth in tank and other investors1 earnings from their holdings of public debt, issued to fight a victorious war.
Another iraportnnt purpose of the policy was to facilitate necessary
ban* ^urchp.ses of Government securities. For though it was generally
recognised as desirable that the balance of expenditures not covered Iff
taxes should to borrowed out of the peopled savinrs, it vts also recognized thiit us a practical fact the Treasury would rely on the commercial tenking syswn for a fairly substantial portion of its funds.
The federal Feserve accepted as on over-riding obligation the necessity of assuring the availability tf whatever funds the Government
needed for the prosecution of var, even though it was constantly stressing the importance of sales of securities to the public rather than the
banks. About one-fourth of the tot&l funas raised by the Treasury during
the wcr cine from the tanking system. This v&s clearly excessive, even
in view of any prcctical difficulties of wartime finance. As the Board
of Governors pointed out in its 32nd Annual keport to Congress, in the
interest of a successful financing of a victorious war we committed the
double error in our wartime finance of taxing too little and expanding
bank credit too nuch.
From the point of view of the problem of postwar inflation control,
the chief consequence of the policy of maintaining the interest structure
on the Government debt is thtt it has seriously impaired the ccpacity of
the
Federal Reserve to perform at this tlao its chief central b t i n g

139
function: naiaely, the control of expansion of bonk credit *:nd the money
supply.
Expansion of bonk credit requires, of course, that banks have access bo an expanding volume of reserves. Consequently, ia exercising coi>trol over the totc-1 volume of money e.nd credit, traditional Fcderrl Reserve policies have had as their focal point the- reserve position of member be-rues. Through changes in the rediscount rate bunks were to be encouraged in, or discouraged from, borrowing, from the bescrve Systcc to
obtain additional reserves. Through changes in reserve rcquii-cnents the
to serve- System was to influence- the volume of credit thfct member tanks
were able to extend on the basin of any ^iven amount cf receives. Through
its open market operations the System was to be- able to bring about expansion or contraction in the volume of reserves itself — though aivays
of course within amounts set by the criterion of orderly security m;..rket
conditions.
Now, with the Federal Reserve cosrcitted to supporting the narket,
Government recur it ies in commercial bcrucs are essentially |-otentiaL legal
reserves. I!an2:s can cilw&ys count on liquidating their holdings of Government securities, in order to obtain reserves for credit expansion.
Furthermore — and this i3 a point th&t I think hus been frequently
overlooked in discussing the pioblers of crtdit control in the current
situation — so long as a support poiicy is In force, the Government
security holdings of financial institution.?, other than batiks must also
be classified as pert of the potential reserve base i'or credit expansion.
When these institutions sell Government securities to obtain funds for
loans to private borrowers, the effects aay be exactly the sc-.me as when
commercial banks sell securities to make private lo&ris. in the absence
of other buyers the securities must be absorbed by the Federal reserve
under the support program. Vhen the proceeds of the sale are then added
to the institution's bank account the legal reserves of the tank receiving
the deposit as veil as its deposits are increased. In othcz* words the
behavior of nonbe-nk lending institutions can be a factor that seriously
the problem of credit control.
As the portfolios of Government securities of member b&nzs themselves continued to swell throughout the war, so, in u sense, their reserve position bec&se stronger Mid stronger, and they bec&ae more and
sore insulated fron any restraining influence by the System. Except for
its psychologicnl impact, the rediscount rate lost nuch of its effectiveness as an instrument of control, since banks could generally adjust their
reserve position by sales of securities and not by borrowing fron the heserve Banks, irom 1941 forward, reserve requirements had been raised to
the prevailing legal maxima for country and reserve city banks, and the
increases still remaining for central reserve cities i.ere not innje. In
any event, moderate increases ia reserve requirements were not lixcly to
be very effective, since banks on the whole could neet the hirher requirements fairlv readily by selling Government securities- Finally, the
policy of support precluded the possibility of refusal by the System to
supoly tanks with reserves at their volition when they offered Government
seeitt-ltics for sale. Open market policy as an instrument of restraint
vas rendered essentially inoperative.

lliO
Money and Credit Supply
As a result, then, of our methods of wartime- finance, the nation1 s
money supply and the national debt experienced a tremendous growth.
Between December 1939 and December 1945, currency and bank deposits in
the hands of the public increased from 63 billion to 151 billion. The
increase in the gross national debt, other thnn that held by agencies
and trust funds of the Federal Government itself, amounted to 210
billion. Of this increase nearly 115 billion, or 55 per cent, was held
by nonbank investors; approximately 75 billion, or 35 per cent, vent
into the portfolios of commercial banks; and the remainder into the
holdings of the Federal Reserve Banks.
Thus the stage was set for postwar inflation. First, there was a
generally pent-up demand that would take several ye&rs to satisfy, even
with the economy operating at full capacity. Second, there was c huge
volume of liquid assets held by individuals and business firms which
could be drawn on to m?.ke demands effective in the market place.
And third, though by no means third in importance,,. there w-:-..s the
banking system, and other financial institutions as well, capable of
providing a huge supplementary flow of spending power through credit
expansion, and well insulated under existing powers from any restraining influence by the Federal Reserve. For it was clear that the policy
of System support of the Government securities market, inhibiting though
it was, could not be abandoned or suspended at the termination of hostiLities. The public debt had grown to tremendous proportions during the
war — five times its prewar peak. Its interest level had become
integrated into our whole asset and liability structure. Aside from
any considerations as to increased interest cost on the public debt,
withdrawal of support might well have a disastrous imp&ct on our whole
financial system. Perhaps never again, or at least not for a long tine
could public debt management be permitted to recede from its position
as a prime preoccupation of Federal Reserve policy.
Well| I do not need to remind any of you here tonight that on
that well-set stage a very vigorously acted-out play tooK place and
is still taking piace. The plot has been simple: an upward spiral of
wages, profits and prices. The only element of suspense has been, where
will they stop? And the great concern of us all has been, what is to
be the sequel? A leveling off into enduring prosperity is the great
hope; deflation and unemployment the great fear.
Restraints
Nevertheless, there have been a number of restraining elements in
the postwar situation to date, without which matters might h*ve been
much worse. Particularly since mid-1947, Treasury fiscal and debt
management policies, as well as Federal Reserve credit policies, have
had as a major objective generation of restraint on monetary and credit
expansion.
Perhaps most significant has been the restraining influence produced tjy the Treasury cash surplus. During the period between July 1

end Septenber 1948, receipts by the Treasury from taxes and other sources
exceeded expenditures by about 10 billion dollars.- This excess of receipts over expenditures has had the effect of directly reducing the
spending power of the co;7imu:i.i.ty. Further, by using the surplus substantially to retire debt held by the Reserve Banks, funds heve been
permanently withdrawn from the commercial banking • system as well ass from
the public. Thus pressure has been brought to bear on the reserve position of commercial banks.
To raise the cost of reserve funds to the banks, and also to encour
age the willingness of banks and nonbank investors to hold on. to the seem'
ties they owi rather than unload them onto the System, short-term market
rates and Federal Reserve discount rates have been permitted to rise.
Fates on Tre&sury bills have risen from 3/8 of 1 per cent in mid-1947 to
more than 1 per cent today. Yields on one-year certificates huve increased from 7/3 to 1-1/4- per cent, while the Federal heserve Banks have
raised their discount rates from 1 to l-l/* per cent.
Moderate pressure has also been brought- to be&r on the reserve position of member banks by increases in reserve requirements. Prior to the
legislation enacted in August, this was a possible course of action only
for the New York and Chicago banks, since for all other
classes of banks
requirements were at their legal limit. In January, *r.ind egain in June of
. this year, the Federal Koserve Board raised by 2 percentage points the
reserve requirements on net demand deposits fit Hew lork and Chicago banks.
On the b?.sis of the temporary authority granted by the Congress in August,
the Board raised reserve requirements by 2 percentage points on demand
deposits and I-l/i percentage points for time deposits. These new requirements became effective September 16 for country tenics, and September
£4 for central reserve and reserve city banks.
As a measure of direct restraint in en area in which credit expansion has been very rapid, the Board has re instituted controls on do\/n
payment and maturity terns of consumer installment credit.. First imposed
in 1941, these controls expired in November of 1947. They hrve been
revived under the temporary authority granted the Board in the August
legislation.
Today's Situation

•

Today the Board's responsibility for restraining the forces of inflation is perhaps greater ttan ever. Cert;:inly the general situation is
as volatile as it lias ever been. Yet the 1948 tax reduction act, calling
for an estimated reduction in revenue of around 5 billion dollars, and
expanded defense and foreign cid expenditures ha.ve cut deeply into the
Treasury surplus. ' Thereby one of the most important elements of inflatio:
restraint .in* the postwar period has been removed —. though I should perhaps point out that :I do not wean by this to suggest that the defense and
foreign aid expenditures are the cause of the present inflation. Rather,
they tre today a contributing factor, no different in this respect from
certain other forms of government expenditures, or from the expenditures
of consumers and business'firms, especially capital expenditures... No one
of these expenditure components is, alone, responsible for the present inflation* But all of them together-are responsible in the sense-that they

1U2
add to a totcl of spending thrt is excessive in relation to the total
volume of goods and services that can be made available. The even
greater responsibility then that today's situation imposes may confront
the central* banking authorities of the United States with *?. very real
dilemma: to seriously modify the policy of supporting the Government
securities market in the interest of credit control, and thereby risk
demoralization of our capitc-1 rarkets; or to adhere to the support
policy and'risk the possibility of a further serious inflation resulting from excessive expansion of bank credit.
Either horn of our dilrmaa would obviously be intolerable. Would
escape between them be possible?
To put the matter in another vay, it may be necessary to seek more
efficient means of credit control than the Bo£*rd now possesses — instruments that take into account the changed environment in which central
banking1 policy nu3t operate today, that would be the nature of such
instruments? Many proposals hf*ve been made, and I vould like at this
juncture to mention briefly to you some that h&ve been fjiven consideration.
Optional Plan
The first of these is the optional or special reserve proposal
which was recommended to Con^rc-ss in the Soard's Annual Report for 1945
and a pa in recordnended in November of 1947 trnd in April 1948. Under this
proposal the Board would be authorized to impose on £-.11 ccniEicrcic-l bunks,
member and nonuember, a special temporary requirement that could be met,
at the option of the individual bank, either"in specified cash assets
or certain marketable short-term Government securities. Uonmember banks
were included in the proposal since it V E S recognized that the responsibility for curbing inflationary credit expansion should be shared by
the whole banking co:d:nunity, end not only by mcribers of the Federal
Reserve System. It would be unfaii and inequitable to do otherwise.
An important advantage of the plan is that it would immobilize
a portion of each bank's holdings of short-term Government securities,
and thereby cut down the reserve potential of the banking system. At
the same tirae, however, the Ccrxrnin£ assets of the banics would not be
reduced, end any consequent rise in interest rates would be limited
largely to the field of private credit find would not be reflected in
an increase in the cost of carrying the public debt.
Further, the special requirement would automatically reduce the
increase in total deposits that could be supported by any new reserves
the banking system might acquire. At the present tine, member bank reserve requirements on the average work out to be about 17 per cent, or
1/6, of total deposits. Thus 0100 of new reserves can support an expansion in deposits pf 5600 of nev reserves can support an expansion
in deposits of i600. If the special requirement were to raise total
required reserves to, say, 25 per cent of total deposits, then v 100
of new reserves would permit an expansion of only£400 in deposits. For
the individual bank, the Imposition of the special reserve requirement
would mean that when it received a new deposit it would have to put

11*3
aside*en amount to meet primary reserve requirements as it does now, and
then an additional amount in the fora of assets eligible to meet the
special requirement. As a result, lesu would re.aain for new loans and
investments.
Uniform reserve Plan
It has also been proposed that if changes in reserve requirements
should become n major instrument of credit control modifications should
be made in the present system to elii:iin;:te inequities thr.t would become
more burdensome as requirements were increased. Essentially whot the
propose 1 — termed the Uniform Reserve Plan -- calls for is the abandonment of distinctions based upon central reserve and I'eserve city designations, so that reserve requirements would be based so.iely upon classes
of deposits &S such, regardless of the tank's physical location. Under
this plan, vault cash and interbank balances would be eligible for meeting reserve requirements.
Thus, under the Uniform Reserve Plc-n individual banks would no
longer be pieced at a disadvantage because of the arbitrary classification of the communities in which they are located, or because their
business requires tfc;t they hold a larger volume of vault cash. Power
to increase or decrease reserve requirements is part of this Uniform
Reserve Plan which is in process of a Federal heserve System study.
Dual Reserve Account Plan
Another pl*n involving n somewhat different approach to credit control policy has been named the Option-: 1 Ceiling Reserve Plan, or, alternatively end perhaps nore accurately, the Dual neserve Account Plan.
The plan calls for establishing tvo deposit accounts at the Federal
Reserve Banks: a Reserve Account and & Clearing Account.
Each member bank vould titart under the plan with an amount in its
Reserve Account euual to its existing reserve requirement at the time.
Any excess or deficiency of reserves would be posted to the Clearing
Account.
Reserve account balances could be bought or sold among banks in the
market just us federal Reserve funds ere traded now. But only the Open
Market Committee, through deliberate purchase or sale of Reserve Account
teposits, would be able to affect the total of Reserve Account balances
available to the banking system as a whole.
After the plan had been put into operation, the computation of Renerve Account requirements would be simple: For reserve city banks, for
example, Reserve account requirements would ecual 22 per cent of net
demand deposits less Clearing Account balances, plus 7-1/2 |-er cent of
time deposits. Ho changes in the Keserve Account requirements would be
necessary under the pien as & method of controlling credit expansion and
the money supply. For this purpose, any desirable change in the Reserve
Account position of the banks could be better achieved by use of the
nore refined method of Open Market Committee purchase or s^.le of Reserve
Digitized forAccount
FRASER deposits. However, the changes in requirements that would be

HiU
necessary to incorporate the cdventages of the Uniform Reserve
could, of course, be rc-rdily adopted at any time.
All new funds received by a bank from ordinary ti^nsfers or- from
such sources as c return flow of currency or gold infiov from abroad,
would expand only the bank's Clearing account balance and by jurt the
amount needed to cover the riee in deposits. Or, as a possible alternative that would protect bank earnings, new funds could be invested in a
special, interest-bearing Reserve Bond. In either case there would be
no excess to be used for loan expansion and further increases in deposits.
But more importent, funds received as a result of System purchases
of Government securities woald also affect only the Clearing Account and
not Kesorve account balances. Thus after the clan is installed a £100
purchase made by the System in supporting the Government securities
market vould provide the basis for no more than a £100 expansion in
total deposits, and not a #600 deposit expansion, as is the case today.
The conflict between the policy of market support and the need for
restraining the growth in the money supply would clearly be considerably
mitigated.
Finally, the plan could be introduced without causing a single br-nk
to undergo any transition adjustments. It would not reduce tank earnings, and while it would severely limit the mount of credit expansion
that could be produced by the banking system as a vhole, it would still
leave individual banks free to make loans on a basis essentially similar
to that which pievaiis today. This plan has no status in the Federal
Reserve Systeia and is being submitted here only for your study.
Conclusion
To reyeat, in view of current and foreseeable conditions, it may
be necessary to devise additional instruments of credit control of the
kind sugcesteci by these and other proposals. Not to do so aoy mean ih&t
the central banking authorities will hr-.ve to default on one or the
other oi their major responsibilities. And, as a cost of that default,
there ;aay cone new techniques of control much less compatible with the
framework of our free enterprise economy.

Speech delivered before
The Buffalo Chamber of Commerce
Hotel Statler, Buffalo, New York
October 27, U8

THE CURRENT ECONOMIC SITUATION
The years since the end of the war have been uneasy ones, economically as v/ell as politically. While we have attained the objective of
high levels of employment, there has nevertheless persisted widespread
uncertainty as to our ability to sustain these levels. In part, our fears
stem from our experience in the dismal thirties; in part, from the knowledge that recurrent boom and recession have always been characteristic of
our economy; but especially are we afraid that the inflation of the past
few years has set in motion forces that will eventually make a downturn
both inevitable and severe.
In this general anxiety, we are beset by conflicting interpretations
of the present and expectations of the future. On the one hand, every
dip in price and every slackening in sales—v/hatever the commodity may
be—is taken as proof that a general downturn is upon us. On the other
hand, we have the thesis that despite the distortions which have developed in recent years the economy is fundamentally so strong that full employment, production, and income will go on more or less indefinitely,
rolling over one difficulty today and another tomorrow—all the time approaching closer and closer to an equilibrium which is not defined. It
is clear that the current economic situation—whenever "current" may b e —
is not a figure or a combination of figures, but an interpretation which
looks both forwards and backwards•
Postwar Inflation in Retrospect
Looking backwards, we see that the war is largely responsible both
for the high levels of employment and for the inflation that characterized
the postwar years. During the war, about two-fifths of our gross national
product was devoted to prosecution of the war. The expenditures for war
goods created consumer and business incomes for which there was no matching supply of available goods.
A policy which financed all war expenditures through taxation would
have soaked up this excess of purchasing power and would have prevented
the large-scale increase in liquid assets. For a variety of reasons,
such a rigorous policy was not feasible, and the war was financed through
a combination of borrowing and increased taxes, with taxes accounting for
less than half the total amount raised. From December 1939 to December
1915 the national debt, other than that held by Federal agencies andtmst
funds, increased by 210 billion dollars. Of this increase, nearly 115
billion was accounted for by nonbank investors; about 75 billion was held
by commercial banks, and about 20 billion by the Federal Reserve Banks.
During the war, price and wage controls and rationing kept prices
remarkably stable, even if allowance is made for activity in black markets. But this stability was possible only because consumers and industry in general exercised remarkable restraint in the use of their income by saving voluntarily, rather than attempting to secure larger individual
portions of the limited civilian output. Thus, about one-fourth

11*6
of personal income after payment of taxes was-saved in: 19iih as compared
to less than 5 per cent in 1929 and to about 7 per cent today. A very
large share of these wartime savings took the form of liquid assets,
i.e. currency, bank.deposits, and government bonds. From the end of 1939
to the end of 1915, personal holdings of liquid assets more than tripled,
increasing from about 50 to over 150 billion dollars.
V.Tien the war ended, the econonQr had available for speeding not only
high current, incomes but the large accumulation of war savings as well as
exceptional access to credit. The incentives to spend were strong in view
of the great backlogs of demand for both consumer and producer goods. At
the same time, we had heavy responsibilities abroad both for relief and
reconstruction* It simply was not possible to increase production fast
enough to meet demand. Moreover, increasing production itself increases
current income correspondingly.
It was in such a war and postwar situation that inflation was bred.
Inflation means that effective demand—i.e. demand backed by purchasing
power—exceeds the current supply of goods and services at prevailing
prices. Unless controlled, prices advance in such a situation and each
advance breeds further advances without necessarily bringing supply and
demand into balance at a reasonable price level. Rising prices have resulted in rising incomes and expanding credit which have maintained a gap
between effective demand and supply. This now familiar spiral of increased
prices followed by increased income has been repeated again and again since
the end of the war. For example, since 1939 wholesale prices have increased
about 120 per cent, consumer prices 75 per cent, and personal income 190
per cent. A very large proportion of each of these increases has come after

1915.
Notwithatanding all the inflationary forces at the end of the war, v/e
removed prematurely such wartime controls as might have been used as transition safeguards. These, included controls over prices and wages, consumer credit, material allocations, and the excess profits tax. Furthermore,
for one reason or another we adopted policies which from a strictly economic
point of view were more suitable for inducing recovery from low levels of
activity than for curbing inflation. The extreme gravity of the housing
shortage led to easy mortgage financing. Generous provision was made for
veterans. The agricultural program resulted in price support for farm
products at levels which prevented large crops from having as deflationary
an effect as they might otherwise have had. Desires to grant taxpayers
some relief after the long years of high taxation brought tax reduction
at a time when incomes were already excessively high in relation to the
available supply of goods. In short, when a policy desirable for other
reasons came in conflict with price stability, stability frequently was
sacrificed. It should not be surprising, therefore, that prices are
veiy high.
Significance of Postwar International Situation
The problem of maintaining price stability would have been, difficult
in any event in the face of an unprecedently strong restocking and investment boom for new plant and equipment, inventories, construction, and
consumers1 durables and semi-durables with demand supported by large and
Digitized for widely
FRASER held liquid assets and high and rising incomes. In addition,

however, a disturbed postwar international situation has been superimposed on an already inflationary domestic one. Postwar has unfortunately
not meant peace. Defense expenditures v/ere cut drastically after the
termination of hostilities, but they nevertheless remained far above prewar levels. Liore recently, the intensification of international tension
has resulted in a substantially enlarged defense program, with adoption
of both a Selective Service program and plans for a 70 Group Air Force.
For fiscal 19h99 the expenditures for defense may run more than 1-1/2
billion dollars above those for the preceding year. The present program,
if fully carried out, will mean a further substantial increase in fiscal
1950. The President was recently quoted to the effect that he was recommending a budget of about lii-l/2 billion dollars for defense in fiscal
1950. At the same time, the President indicated that military leaders
had requested a budget of.23 billion dollars.
Furthermore, the war left a large part of the world desperately in
need of outside aid. This was true both of our allies and of our former
enemies. Our vast foreign aid programs for relief and reconstruction reflect not only humanitarian motives but also a desire for enhanced security. By the spring of 19li7* our exports of merchandise had risen to a
level close to that in wartime, which included lend-lease. S3 nee then,
exports have declined more or.less steadily, but are still at very high
levels, heanwhile, imports have continued to increase. As a result of
these divergent movements, the excess of exports of goods and services
has declined from its peak in the first half of 19 h7, but is still very
great, amounting to an annual rate of over 7 billion dollars in the second
quarter of I9I48. •
The continued excess of exports of goods and services has been financed in a variety of ways, but the most important has been aid furnished by the United States Government, This aid has taken the form of
both gifts and loans. It has included credits on sales of surplus property and ships, loans made by the Export-Import Bank, the British loan,
contributions to UNRRA and post UNRRA, civilian supplies for occupied
countries, interim aid to France, Italy and Austria, the Greek-Turkish
aid program, and most recently the European Recovery Program. Loans have
become relatively less important while gifts have become increasingly important. It is estimated" that this country will spend or lend more that
6 billion dollars on such aid in the current fiscal year, viiich is close
to the very high rate of the first half of 19hl. A large proportion of
this year's aid represents expenditures under the European Recovery Program.
Other major means of financing the export surplus have been liquidation of foreign holdings of gold and dollar assets (which were run down
by I1-1/2 billion dollars in 19li7 and by about 1 billion dollars in the
first half of 191*8), operations of the International Bank and the Monetary Fund, and gifts and loans from private sources in the United States.
Developments in 1948
The year 19lfi has in general witnessed a continued development of
postwar expansive forces. The first quarter was one of some business
hesitation, with gross national product showing no change over the fourth
Digitized quarter
for FRASER of 19ltf, and with prices of mary farm products breaking sharply

11*8
in February* In the second quarter, however, adoption of the enlarged defense program, the European Recovery Program, and tax reduction furnished
a strong upward push to the economy, and especially so since these actions
were taken in a situation still characterized by excessive over-all demand.
Expansive tendencies were further reinforced late in the second quarter by
the responsiveness of large mass-production companies to wage demands after
an .earlier show of strong resistance to a third-round wage increase. After
the signing of a two-year agreement between General Motors and the United
Auto Workers on May '29, new wage contracts wore soon negotiated elsewhere
in the automobile industry and in such other key industries as electrical
machinery, rubber, farm equipment, bituminous and anthracite coal, and steel.
Wage increases have since spread, and are still spreading, throughout the
economy generally. Although the increases this year have been more selective
and diverse than in preceding years, the average increase approximates the
rise in consumer prices during the last year.
After the first quarter, further increases occurred in retail sales
and consumer and wholesale prices. Gross national product and disposable
income (i.e., income of individuals after payment of personal taxes) reached
new peaks in the second and third quarters as business, government, and individuals all enlarged their expenditures. Unemployment has continued at a
low level, below 2 million persons. The index of industrial production which
had declined in July, recovered in August, ard t?y September v:as back to its
June level.
Ueanwhile, expansion in bank loans has continued to make a substantial
contribution to total spending power, though not on quite as large a scale
as last year. Loans of all banks are estimated to have increased 1.8 billion dollars between the second and third quarters, as compared to the 2
billion dollar expansion in the corresponding period last year. Though
somewhat smaller in total, the second-to-third quarter growth of loans this
year has followed a pattern not much different from that of last year. Increases have taken place in all three of the main loan categories—business,
real estate, and consumer loans. Present estimates do indicate, however,
that the somewhat smaller increase this year is chiefly to be accounted for
by a decline in the rate of growth an the business loan category.
Data from the latest survey of planned expenditures for nev/ plant and
equipment indicate some increase in outlays by manufacturers for the second
half of 19ii8 in comparison with planned expenditures reported in surveys
taken earlier this year. Moderate gains over the first* half of 19U8 are
also forecast by electric and gas utilities. All in all, on the basis of
reported intentions, total plant and equipment expenditures should amount
to about 18-1/2 billion dollars for all of 19L8. as compared to about 16
billion in 19ltf
Meanwhile, personal income continues to increase, both as a result of
increasing employment and of the spreading of third-round wage increases
throughout industry. Despite the sharp drop in prices of many crops, net
income of farm proprietors has been maintained at a level above the already
hifch level of last year. The price-support program combined v/ith the large
volume of marketings prevents substantial declines in farm incomes. Personal
holdings of liquid assets are still very large and are widely distributed,
despite some tendency to concentration in the hands of upper income groups.
Re-establishment
of Regulation X! has not precluded the further expansion of

Ik9
consumer credit.
These factors—high current income, large past savings, and ready
access to credit—reinforced by the continued backlog of demand for some
durables (e.g., automobiles) furnish a strong basis for continued high
levels of personal consumption.
Taken together, all these indicate a considerable degree of current
strength. Nevertheless, there are also evidences that in son:e important
areas supply is equalling or exceeding demand at current prices. These
products include not only some finished consumer goods but some raw materials as well. As these products tend to stabilize or fall in price,
they serve to relax somewhat other upward pressures on costs and prices
elsewhere in the economy. Probably the most important development of this
sort has been the record breaking crops of this year, which have resulted
in reduction of prices of wheat, corn, and cotton to support levels. The
effects of these large crops have not yet been materially reflected in
over-all retail food prices, however. Furthermore, meat prices have continued to rise until very recently, when they started to come down even
more sharply than in broad conformity with their usual seasonal pattern.
Reports of possible balance or even excess of supply at current
prices are also heard in connection with such products as cotton textiles,
shoes, men's clothing, liquor, housefurnishings, coal, paper and radios.
There have even been reports of more than seasonal weakness in prices of
new-used cars.
It may also be noted that wholesale prices in general have sho-.vn
smaller increases so far this year than in 191*7. Furthermore, considerable divergence has developed in price movements of various commodities.
Great strength has been shown by metals and moderate strength in such industries as building materials and fuels. On the other hand, prices of
some foods, hides and leather, textiles, paper and pulp, and chemicals are
close to or below their January levels.
Another possible symptom of general weakness may be read into the
fact that new housing starts declined in August to 83,000 units, a level
11,000 below July and 3,300 belovf August last year, A further decline
occurred in September. This behavior contrasts with that of 19ii7 v.'hen new
starts increased steadily to a yearly high of 9li,000 units in October.
The declines this year at this time may be interpreted as an indication
of some softening in the market, reflecting the facts that the most urgent demands for housing have been met, and that consumer resistance to
the extremely high prices charged for houses is becoming effective. Nevertheless, construction costs have continued to advance steadily and the
index of- viiolesale prices of building materials in early October was at
its peak.
Any signs of general weakness must be watched closely, because after
the great price increases of recent years, the economy is becoming increasingly vulnerable both to sharp price declines in particular areas and
to the effects of such declines on credit and on business and consumer
expectations generally.
On the other

hand, it is v/ell to remember that the postwar boom has

150
already over-ridden many deflationary forces and periods and that greater
strength in some lines may well continue to offset weakness in specific
lines. In the past two years, we have overcome the sharp break of stock
prices in.the fall of 19l|6, the weakness in nondurable goods and trade in
the first half of 19U7-, some reduction in new private construction in the
second quarter.of 19ltf> the sharp break in prices of many farm products
in February of this year, and the large Federal cash surplus in the first
quarter of this year and the use of much of this surplus to retire bank
held debt.
More important than all of these things in conditioning my thinking
about current economic trends is the continued state of tension in international affairs. Our defense requirements have precluded any reduction
in Federal expenditures. On the contrary, they are most likely to result
in further sharp increases in Federal expenditures during the remainder
of the fiscal year and well beyond that. The enlarged defense and foreign
aid programs adopted this spring are being carried out at an accelerating
rate. Their fall economic effects will not be felt until next year. But
who can say that the present programs will represent the peak of defense
and foreign assistance efforts? In recent weeks, there have been more and
more rumors in the press about the adoption of nalitary lend-lease. Under
the circumstances and with the continued threat of further deterioration
in the international situation, it would be dangerous to assume that inflationary forces have run their course. Vftiile the recent indications of
moderation of some inflationary pressures are hopeful signs, the direction
of most broad measures of economic activity is still upward* It is still
too early to be confident that our hopes for stability will not again be
disappointed.
Monetary Measures to Curb Inflationary Tendencies
Under these circumstances, what can the Federal Reserve System do to
curb inflationary tendencies? Traditional instruments of monetary control in a boom—increases in reserve requirements within existing laws and
in rediscount rates and sales of securities in the open market—have on3y
limited effectiveness because the banking system can obtain all the reserves
it needs by selling Government bonds to the Federal Reserve. This situation is a result of our war-created debt. Holders of these various debt
obligations—including commercial banks, insurance companies, other investment institutions, and individuals—feel free to sell their securities to
obtain funds for other purposes. Thus, the total volume of current expenditures can be expanded. The Federal Reserve System has to serve as the
residual buyer in the market for Government bonds in order to preserve
confidence in Government credit and to provide an orderly market for the
enormous refunding operations of the Treasury. Confidence in the stability
of Government security prices is essential to prevent a possible large
volume of selling of such securities. Aside from any considerations as
to increased interest cost on the public debt, withdrawal of support might
well have a disastrous impact on our whole financial system.
The Federal Reserve's support program keeps interest rates stable
and at the same time gives the banking system access to all the reserves
it needs with practically no deterrent. The banking system even obtains
reserves which it does not itself seek when the Federal Reserve purchases
bonds sold by nonbank investors. In recent months, unfortunately, nonbank

investors—notably insurance companies—have sold a substantial amount of
restricted bonds to the Federal Reserve System.
It is true that the Federal Reserve System would presumably be able
to curb credit and monetary inflation by withdrawing its support of the
Government bond market. But, as I have already indicated, this v/ould be
drastic action indeed, all the major consequences of which cannot be
foreseen. It therefore seems more desirable to make full use of less
drastic measures and to explore new legislative methods of credit control. Some additional powers have recently been made available to the
System through the restoration of consumer credit controls and the authority to increase reserve requirements• Use of these pov;ers is possibly exerting some moderating influence. In addition, there have recently
been further increases in short-tern interest rates and perhaps further .
. increases will be needed. The rediscount rate has been increased and in
due course will, if necessary, be increased again.
Another remedy vhich can be tried is enactment of legislation vhich
would prevent the ready conversion of Government securities into banking
reserves. One such proposal which v.ould restrain such conversion by commercial banks has been sponsored by the Federal Reserve Board. This
v/ould give the commercial baiks an option to hold special reserves in
cash or in the form of short-term Government securities. Since shortterm Government securities afford reasonable earnings—especially as
short-term rates increase—the likelihood is that a large part of bank
holdings of Government securities would be immobilized. Means to prevent the creation of reserves through the sale of bonds by institutions
and other holders outside the banking system should also be explored and
adopted. Also, some pressure would be placed on the reserve position of
commercial banks if the Treasury were to draw further on its Vvar Loan
Accounts at such banks and use the proceeds to retire debt held by the
Federal Reserve,
There are further important measures which lie beyond the control of
the commercial banks or of the Federal Reserve System. Host important of
these is the maintenance of the Federal budgetary surplus. But here we
run into the great conflict of this period between the need for economic
stability and the demands of national security. Government expenditures
cannot be reduced so long as the state of international relations is such
as to require a large and increasing defense effort and large commitments
for aid and reconstruction to foreign countries.
Our continuing inflationary pressures stem largely from our defense
requirements. It is clear then that confidence in the existence of an
enduring peace is the desperate need of our times from every point of
view.

153
Remarks before
Advertising Council of America
The Uhite House, Washington, D. C.
Februaiy 9, 1949
THE CREDIT SITUATION
On behalf of the #Board of Governors let me express my appreciation
of this opportunity to give you a resmae of what the Federal* Reserve System has sought to do and will tiy to do in performing its function of
influencing the volume of bank reserves and the supply of money. That
is the fundamental responsibility of a central bank—and ther Reserve System is a central banking organization. If it wore done cwa;. with sone
other nechanism of regulating the country's supply of money would have
to be set up in its place. A modern nation has to have »3e/..;c such machinery, most of all a nation that occupies a dominant role in the world
today. It follows that this mechanisia should be equipped and adapted to
perform its primary function under changing economic conditions.
Our System has not been and is not now adequately equipped. True it
has very great power. It could force a contraction oi1 credit and bring
about a severe, indeed a catastrophic, deflation. It could do that by
using its open market powers, that is, by withdrawing from the Governuent
bond E&rket, selling off System holdings of Government securities and
contracting the credit base and raising the discount rate, thus forcing
interest rates to rise. That would be the meat axe way of dealing with
an inflation. The Board and the Open Market Committee is of one mind in
rejecting such a course. It has been argued by some that small doses of
this strong medicine might have effected a cure for inflation. I shall
not burden you with the pros and cons of the argument which has been
widely aired until recently. The Beard has strongly believed that some
other means—other than a credit contraction forced through a breaking of
the Government securities itarket—should be found to influence the money
supply. If no other devices were available, it might be argued that this
deterrent should be used as a last resort. But whether in snail doses oi
not, the forced credit contraction and high interest r^te remedy, if it
is to bo effective, almost inevitably precipitates deflation. The first
objective of Government policy, as declared in the Employment Act of
1946, is to steer a middle course between inflation and deflation. Ue
are not prepared to admit that we nust founder on one or the other rock*
That is why, in search of alternative means of checking continued
growth of the money supply, the Board, in it3 annual reports to Congress
frou 1945 on, has suggested various other ways of meeting the situation.
That is wiiy the Board is united in support of the recommendations on the
credit front which are contained in the President's economic report to
this Congress.
There are two proposals on this front: First, that Congress give
the Reserve System continuing authority to require all insured banks—not
just members of the System—to hold a supplemental reserve requirement in
addition to whatever other reserves they may be obliged to hold under
State or Federal laws. Second, that Congress give the Board continuing
authority to regulate credit ten-is in the consumer instalment credit
Digitized forfield.
FRASER

Concerning the first proposal, itracyha recalled that the late
Senator Glass, en author and unfailing defender of the Reserve Act, Insisted In the Banking let of 1935 that all Insured banlcs, having deposits of a nillion dollars or more, should qualify for mambership in the
Eeser¥e System, The 1935 Act so provided. Had the date for entry into
the Syetera not toeen first postponed, then droppcd? Insured banks would
ha¥e been subjected to the cash reserve requirements which all rucmbcr
banks are now required to imve on deposit with their respective federal
Reserve Banks. That i/ould have been a much more drastic step than is
proposed In the President's economic report. This proposal does not require membership in the System and does not subject Insured Mules to the
cash reserve requirements required of member banks* It simply proposes
that If further—or siippleuentary—'requirements are imposed, the burden
shall be borne by all insured banlcs, not merely hj member banks. Henber
banks are today put at a very serious disadvantage as compared with nonmembers because of the relatively large percentage of their deposits vhich
they are obliged to keep on deposit with pyeserve Banks. It is an unfair
and inequitable state of affairs.
It is unfortunate, I think, that some other irord tlian "reserves11 i:as
not invented to describe these cash .requirements• They are not reserves
In the sense in which a banker or buainessuan thinks of reserves. They
are, rather, a required fund ianobilised so far as feeding further aonetary expansion is concerned. They are, IM effect, a protective fund
for the purpose of preventing continuing monetary Inflation• Si&ce preventing inflation protects the whole coiznunity, it is wholly Inequitable
to put the conraunity load on sone banks and to exenpt others* That is
why It is proposed that all Insured banks, sharing as they cio this governmental advantage, should share soiae of the burden of having their funds
Imotolllseci against over-expansion of the noney supply*
Authority to change member bank reserve requirements was first io-ide
an instrument of credit control in 1933• The Board vaa authorized, under
the so-called Thomas Anendiaent/ to raise reserve requirements la order to
prevent nn Injurious expansion of credit provided the President declared
the existence of an eaergeiicy and with approval of the Secretary of the
Treasuzy. Under the Banking Act of 1935," the emergency provision was removed, but the authority was Halted In that the reserve requirements
could not be nore than double the ratios stated In the law."
Excess reserves of neater banks rose considerably In 1934 and 1935
as a result of a substantial gold inflow. The Board decided in the simmer
of 1936 that It would be In accordance with the spirit of the law to raise
reserve requirements, which could be done without putting banks in debt,
and^thus prevent the large volume of excess resenres from becoming the
basis for a possible Injurious credit expansion. Bequireaents vex*6 raised
50 per cent effective In August 1936.
In early 1937 economic activity was Increasing rapidly. Inventories
were accumulating, a wave of buying iras In progress and prices of certain
were growing rapidly and prices of secmrltiee were at the highest levels
since the^early part of the Repression. In the light of these developments,
and in view of the large volume of excess'reserves held by banlcs,

the
Board
decided to raise reserve requirements in two steps to the lioi

permitted by law, that is, to double the basic amount stated in the law.
This action was not a reversal of the policy of Monetary ease pursued since the beginning of the depression. After meeting the requirements, benks still held large amounts of excess reserves• Interest
rates remained very low. The Board's action vus precautionary in
character and placed the System in a position to control an injurious
credit expansion by open market operations and discount policy, should
such an expansion occur.
In the spring of 1938, as a part of a general nove by the Government
to combat a rapid decline in business activity, the Board reduced somewhat the reserve requirements for member banks. Gold inflow in the late
•thirties was very large, however, and excess reserves increased rapidly.
In the fall of 1941 reserve requirements wore raised again to the legal
limits, a step which still left excess reserves at about 3-5 billion
dollars.
In order to facilitate financing of the war, reserve requirements at
banks in central reserve cities (New York City and Chicago) were lowered
in tliree steps over the late summer and early fall of 1942 to the sane
levels prevailing for banks in reserve cities.
As a part of the System's general program to place under restraint
the inflationary credit expansion of the postwar period, the Bo«-:rd in
February 19-48 and again in June 19AS increased by 2 percentage points the
reserve requirements of member banks in New York City and Chicago. Reserve requirements of other member banks could not be increased since
those were already ut the highest levels permitted by lav. In August
194.8 Congress granted the Reserve Board temporary authority to increase
reserve requirements of member banks only and the authority was limited
to 4. per cent on demand deposits and 1 1/2 per cent on time deposits. So
far, the board has not used 2 per cent of this authority affecting d&jand
deposits. Presumably the Eoard would have no occasion for applying the
additional reserve requirement authority when bank credit is not expanding, as has been the case in the past two months.
Increases in reserve requirements in 194-8 absorbed about 3 billion
dollars into required reserves of member banks. This vas somewhat more
than the total anount of new reserve funds banks obtained from gold inflow and return flow of currency from circulation during the year.
It is not suggested that the supplemental reserve now proposed—
which would amount, if fully used, to ten por cent of demand deposits and
four per cent of time deposits—is tlio last word, and the perfect solution for the problem of arming the monetary authorities with adequate
laeans of performing their primary function. It is to be hoped that possibly through another Monetary study Congress will arrive at a still
better long-range means of dealing with the question of bank reserves.
The pending proposal, however, is a necessary step in the right direction.
Together with other powers now available, it would equip the central
banking mechanism with authority to cope with overoxpancion of the money
supply in case that danger again threatens us. It is & workable substitute
for the now unusable discount rate and open-nnrket operation weapons.

Perhaps I should digress here long enough to point out that in speakring of opon-Lnrket operations I am referring,1 to their effects in increasing long-term interest rateo. As you are aware, it has been possible to
have come danpening effect on the creation of bank reserves by permitting
discount rates and short-tern Government interest rates to rise sauevhr-.t
and thereby encourage the banks and other investors to hold sliort-tona
Governments and to increase their holdings. Purchases of additional
holdings in this way can help to offset the credit expansion effects of
additional reserves supplied by Federal Reserve purchases of Government
bonds, by gold imports", or by inflows of currency from circulation,
I should like to quote the President's words, in this connection,
because they state, briefly, the fundamental principle that the country's
monetary authorities should be equipped at all times to deal with inflationary pressures on the one hand or deflationary forces on the other.
Monetary policy is not a one--./ay street. It must be flexible, and suited
to the changing economic situation.
"On previous occasions", — the President said, "I have
recommended that adequate means be provided in order that monetary authorities may at all times be in a posiLion to carry out
their traditional function of exerting effective restraint upon
excessive credit expansion in an inflationary period and conversely of easing credit conditions in a tine of deflationary
pressures."
So far as the recommendation relating to consumer instalment credit
regulation is concerned, this type of selective credit control, like the
statutoiy nargin requirements on listed stocks, is always a fruitful
source of debate. It can be said fairly, I think, that the Regulation is
exerting some effective pressure on instalment credit expansion. With
more than 8 billion dollars in instalment credit outstanding, it seems
to us desirable to have sone concern over the soundness of this credit
and over any further excessive growth of it. It is in the public interest,
too, to have competition in consumer markets takeolace in prices and in
quality of product rather than in credit terms. Recently, with the reimpositlon of consumer instalment credit regulation under authority granted
last summer, the inflationary credit and monetary expansion baaed on such
loans lias slackened considerably. The volume of consumer instalment
credit, which had been increasing at the rate of frau 180 to 200 Million
dollars a month through September 19-^3, shoved a much more moderate
growth (150 millions a month) over the last throe months of the year*
Available evidence suggests that in the major sector of instalment
credit—new passenger car financing, Regulation U has had the direct
effect of increasing average dovnpaymonts from 47 to 49 per cent and de- ^
creasing average maturities from 20 to 16 months. Average monthly payments
have apparently increased from 73 to 89 dollars. Differences in these
effects appear, of course, cjaong the various car-price classes.
Another impact in the automobile field, attributable in some part to
Regulation U, has been a sharp decline in the prices of usorl ccrs,
particularly prices of recent models. Premium"prices are still obtainable on many "used" new cars, especially in lover price brackets.

157
Retail sales of consider durables, particularly ci" household appliances and used cars, exhibited a marked weakening in the fourth quarter
of 194.8, and total retail sales shoved distinct signs of leveling off.
Levels of dollar sales, however, are substantially above prevar years.
With respect to ell categories of durable goods, dealers appear to face a
problem of maintaining sales volume at prevailing prices for the first
tine since the var.
Factory production of most consumer durable goods has continued at
high levels, but with recent flagging sales, there i-as probably been some
inventory accumulation at wholesale and retail levels. In 1948 output
of n few household lines was .Moderately below 1947.
Employment in consumer durable goods industries has also continued
at high levels, but there are currently more frequent reports of temporary lay-offs, actual or prospective. Generalization of" recent tendencies is difficult because of varying seasonal and other production conditions in the several industries.
Equity positions in the sales finance business wore under strain
prior to Regulation Yi and subsequent developments have brought only
slight, if any, improvement in financial positions. Partly under pressure of limited funds, some sr-.les finance companies have apparently been
placin-j greater emphasis on automobile financing, causing dealers in
appliance lines to rely more heavily upon their own resources und on bank
financing• Furniture dealers continue to rely on their resources supplemented by bank financing. Reports indicate thct sales finance companies
are especially concerned about the volume of funds they have tied
up in
dealer stocks, and are tending to limit the volume of "wholesale11 paper
they are willing to handle for individual dealers. Such policy "rationing" of dealer financing has an immediate impact on factory sales, cutput, and employment.
The Board's use of its authorities over listed stock margins has
also been a helpful moans for checking inflationary credit and monetary
expansion. Loans for purchasing and canying stock have not risen during
the postwar period. Ue have not, as in scne past boo:a periods, weakened
our economic position by allowing a speculative boon to develop in tlio
stock mcrket on the basis of an expansion of security loans.
In the Securities Exchange Act of 1924 the Congress directed the
Board to issue margin-requirenent regulations "for the purpose of preventing the excessive use of credit for the purchase or carrying of
securities." The Act does not define what use of this credit shall be
deened "excessive," but leaves this to be determined by the Board. The
context and legislative background indicate, however, that decisions to
change margin requirements should give consideration to the general
economic and credit situation, as well as to the e::tent of speculative
activity and credit inflation in the securities irarkets themselves.
In general, it may be said that the purpose of security margin requirements is to help prevent economic instability. The SecuritJ.es Exchange Act of 1934 was a result of the general public recognition that
stock speculation liad been a very important factor in the serious insta
bility of the economy in the late twenties and early thirties

According to the broad principles which ordinarily underlie the
Board's credit policy, margin requirements would presumably be raised or
lowered only when such ticbion appears to be called for both by developments in the general business situation, actual or impending, and by ^
developments in the stock market itself. The pertinent criteria which
indicate developments in the stock market itself relate primarily to the
degree of speculative activity in the markets. For this reason, the
level of the various market indices usually is given less consideration
in decisions to change margin requirements than is the rate of change of
these indices. Rapid changes, particularly in stock prices, may provide
a basis for a change in margin requirements that would not be justified
if the same anount of change were spread over a longer period.
Specific stock market criteria usually considered in connection with
a chanjje in margin requirements include the following: (1) The level and
rate of change ox conmon stock prices; (2) The amount of credit borrowed
by customers from brokers in margin accounts; (3) The number of shares
traded, and the extent of public or professional participation in the
market; (4) The volume and ease of flotation of new security issues.
Two points should be mentioned in connection with the torn "excessive use of credit" in the statutory mandate. This has been generally
interpretated in the past by the Board as applying not only to the
amount of credit in use but also to its turnover, that is, the extent to
which a given amount is being used. For instance, an active and sharply
rising market may1 in itself indicate an excessive use of credit even
though customers debit balances remain relatively stable. Furthermore,
studies by the Board's staff and others have indicated that uost of the
credit used in the stock market is not absorbed by the market but flows
into the general stream of spending for capital goods and consumer goois
throughout the economy. Consequently, the major question in tieueraining
whether or not a particular amount of stock irxirket credit is excessive
is whether economic stability would be promoted by en increase or by a
decrease in the quantity of credit noney- being spent generally in the
markets for goods and services.
Stock prices have been comparatively stable since 1946. For conditions of inflationary prosperity, however, they have maintained stability
at severely deflated levels in terms of current earnings, and dividends
and in relation to prices of fixed income securities and of real estate.
While the common stock price factor in itself does not suggest an urgent
need for a change in inargin requirements at this time, the current high
ratios of earnings and dividends to prices expose the requirements to continuing criticism as "unduly strict." However, a lowering of margin requirements could not be expected in itself to change public appraisal of
stock price earnings or dividend relationship.
There have been a few chort periods in the past year when considerable public participation in the market wa3 evident. In Hay 194-8, there
was heavy activity when volume averaged nearly 2-1/2 million shares in &
week of sharply rising prices. Again in November 194S, activity in the
market suggested considerable public liquidation as stock prices fell 10
per cent in a week after the election. On the whole, however, the market
has
been relatively inactive in the past two years, with little indication

of
any
http://fraser.stlouisfed.org/sustained bullish or bearish speculative participation at any stageFederal Reserve Bank of St. Louis

159
There has been a relatively snail volume of now stock issues ^n the
past^ycar in relation to the general business .level and corporate financing in general, but the present 75 per cent mrgin requirement has
been only ono factor in this situation. In 19/+6, when margin requirements were 100 per cent, there was a relatively large voluae of new
stock issues, compared with past years. The large supply of equity
money obtained through undistributed profits, and the sharply lower cost
of debt as compared with equity funds, were probably more important
factors than the level of margin requirements in influencing the low
volume of new stock issues in 1948.
In view of the present huge supply of money and other liquid assets,
rising Government expenditures, and the threat of resumed inflationary
tendencies, the desirability of substantial lowering of margin requirements at thic time, in order to expand the amount of stock market credit
and credit money generally flowing into commerce and industry, rany be
questioned. Inflationary tendencies have shown recent signs of abatement. Should further slackening of inflationary pressures materialize,
an economic case for a relaxing of. margin requirements would develop.
These two credit regulations that I have
credit and margin requirements—are flexible.
for a tine of inflation, scarce goods, and an
not appropriate for a time of deflation, when
effective purchasing power is not adequate,

just discussed—instalment
Terms that are appropriate
over-supply of i.ioney are
goods are in abundance and

I want to stress the point again that monetary measures must be
adapted to the times. Credit restraints must be eased in slack times,
just as they should be tightened in boom times. The president's economic
message broadly states the basic principle which should guide monetary
and credit policy. It does not operate in a vacuum. It needs to be
closely coordinated with other major economic policy, including notably
fiscal measures.
This point is especially important with respect to housing. As to
the need of housing and the importance of a housing program, it seems to
sie there can be no difference of opinion. Yet it is obvious that we have
to deal with two things here that are in direct conflict. Me can not,
that is, expand credit for a housing program with one hand and restrict
credit to combat inflation with the other. The time to stimulate
economic activity is not when it is over-stimulated already. Housing,
unless it is carefully tined, entails a demand for materials that will
drive prices up and intensify the inflationary condition that we are
trying to cure*. It is necessary, therefore, that Federal programs for
encouraging housing construction and re-development be so conducted as to
minimize inflationary pressures during periods of substantially full
employment and production. VJe must not frustrate policy by attempting to
do things simultaneously that are bound to interfere with each other.
Whatever we do must be timed not only to be effective itself but to
avoid rendering other measures ineffective.
What the present situation still calls for, in my opinion, is the
sort of corrective the President emphasized in his Economic Report. He
said:

160
"It is essential to sound fiscal policy to have a budget
surplus now. This is our most effective weapon against inflation. It will enable us to reduce our debt now; it would bo
much more difficult to do so in less prosperous times
"Increased taxation is only one of the means by which ve
can accumulate a budget surplus. The other is a careful limitation of Federal expenditures. It is essential that our
fiscal policy under present circumstances contemplate not only
a surplus of revenues over expenditures, but also a surplus
achieved at the lowest level of expenditures which is consistent with our needs.11
Finally, let no say a word about the downside of the cycle. The Reserve S/steiP. today is far better equipped than ever before to help offset
deflationary dangers. Apart from relaxing instalment credit and margin
requirement regulations, it has virtually unlimited means of supplying the
market with additional reserves through purchases of"Government securities. Under existing legislation with respect to gold reserve requirements—25 per cent of note and deposit liabilities—the Systen is not now
hampered by any crippling limitations on its ability to supply funds to
the market, should the need ariso. The Federal Reserve Banks have 023
billions of gold certificate reserves, only half of which is required by
the law. Accordingly, their note and deposit liabilities could be more
than double what they now are. The Systcjn is also in a position to sake
advances freely—that is, to lend on any assets of member banks acceptable
to the Reserve Banks as security. This greatly liberalised lending
authority was provided by the Banking Act of 1935. In addition the Reserve Banks are empowered to make direct loans for working capital
purposes to business and industry, in case other lenders are not available.
If the System is now armed by the new Congress with sufficient means
to deal with over-expansion of credit—just as it has been a m o d since the
mid-thirties with important powers to offset deflationary credit forces—
it will be equipped once more to play the role that central banking has to
play in a modern economy. The adequate equipping of this mechanism should
not be left for another emergency. The time to prepare for stormy economic
weather is before tho storn breaks. The President's recommendations are
adequate for the period ahead, and they are moderate.

161
Lecture delivered under the
Charles R« Walgreen Foundation for the Study of American Institutions
University of Cnicago, Chicago, Illinois
March 9, 19h9
CONTEMPORARY MONETARY POLICY AND ECONOMIC STABILITY
Those who have the task of making policy decisions sometimes admonish the academic economist to avoid theorizing in a vacuum. However
that may be, the policy maker himself must beware of making decisions in
a theoretical vacuum. Absorbed as he must be in day-to-Jay operations,
the policy maker can easily lose perspective*, If he fails to relate
each new problem to what has gone before aiod to what may come after, the
result vd.ll be inferior policy.
Let me take this opportunity to heed n&r ov/n warning and review contemporary monetary policy broadly in the light of experience in this
country with both theory and practice* In so doinc, I realize that I
may not say anything new. But iry purpose is to prcvide perspective for
consideration of more Immediate monetary issues, which I shall come to
in ny second lecture and in the seminar between the two lectures.
Gold Standard Background of Modern Monetary Policy
Our conception of the responsibilities of monetary policy has been
continuously evolving and broadening for the last half centruy or so.
During the nineteenth century and the early years of the twentieth century, the theory of the gold standard dominated most thinking about monetary affairs. This theory was preoccupied with the rigid stabilization
of the international exchanges, rather th^i with the ^ntornal stability
of the nations adhering to the gold standard* The domestic s.oney supply of
individual nations was thus assumed to be determined automatically by international market forces and the responsibilities of monetary policy
were relatively meager.
Under established gold standard rules, monetary or central banking
policy was regarded as largely passive. The primary function accorded
the monetary authorities was to facilitate the smooth operation of the
gold standard mechanism and the rules for action were simple and unambiguous. A net inflow of gold was a signal to ease monetary and credit
controls, a net outflow was a signal to tighten controls. Response to
both of these signals involved iirrnediate use of the discount rate, the
chief instrument of monetary policy. • It is a fair.generalization that
monetary policy under the gold standard was primarily expressed through
the discount activities of central banks.
Popular Basis of the Gold Standard System
The popularity of the gold standard system, in theory and in practice, was due to several factors. The impersonal and automatic fashion
in "which the gold standard nechanism was supposed to operate had an appealing elegance to the nineteenth century mind. It seemed to place the
mysteries of money natters in Olympian hands and to protect them from
erring mortals. Also, it fitted well into the mechanistic view of organized society which dominated scientific thought in the nineteenth
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162
The emphasis placed on the stability of international exchanges attracted support from all those who were especially impressed with the advantages of an expanding volume of international trade. Economists in
particular supported the gold standard because they saw in the development
of world markets the possibility of greater specialization in the use of
resources than rjouldbe possible within the limits of a national econoipy.
Active support also came from the commercially minded enterprisers who
were so influential in the nineteenth century, particularly in.England.
This group clearly saw the connection between national and individual
prosperity and the unhampered flow of international trade at stable exchange values.
Still another reason for the popularity of the gold standard was a
widespread fear of inflation. By the nineteenth century, as you know, the
civilized world had had many, many sad experiences with inflation. There
was comfort in the idea that fiat money could be avoided by maintaining a
constant relationship between the currency unit and a fixed quantity of
the scarce metal.
Finally, the wide acceptance of the gold standard theory reflected
the assumption of a high degree of flexibility in domestic prices and
wages. Whether such flexibility obtained in practice v;as little questioned.
The real fact was that people quite generally thought that prices and wages
were flexible and they regarded price and wage flexibility as a good thing.
Changing Role of Monetary Policy
The operation of the gold standard mechanism was not without its hardships# Gold standard countries experiencing a contraction in gold stocks
found themselves confronted with deflationary pressures. These harsh effects necessarily put the m l e s of the game to severe test. After a succession of such tests, it was inevitable that a more flexible concept of
monetary policy would emerge. It eventually became the practice of the
monetary authorities—that is, the central bankers, who after all had to
come into direct contact with the human problems of adjustment—to act
in a way that would mitigate some of the harsher effects of the gold flow
mechanism.
Little by little, such practices became the rationale of modern cen*tral banking. By 191U v.hen the Federal Reserve System was established,
the special contribution of central banking was conceived to be that of
preventing undesirable monetary and credit stringency during periods of
transient emergency, such as might arise from a temporary drain of gold
or from seasonal swings in commerce, industry, and agriculture. As a result, the originally narrow concept of monetary or central banking policy
under the gold standard theory had to be broadened to take more account
of internal consequences.
After the disruptive effects of World War I, the gold starriard never
regained the form it had had in the prewar era. In those countries vhere
its suspension had been considered only a wartime measure, its reestablishmentwas on substantially modified lines. In the new environment, monetary
authorities were acknowledged to have even more extensive and flexible responsibilities. As a matter of fact, they were assigned the double role

of functioning as an overt buffer against the upsetting consequences of

163
gold flows and as the means of continuously adjusting monetaiy and credit
conditions to the needs of domestic trade and industry. The Federal Reserve Board's Annual Report for 1923 is a classic example of the newer
thinking v/ith regard to monetary or central banking policy* At that time,
when gold was flowing to the United States, the Board indicated that the '
increasing gold ratio of the System was not a signal for an automatic easing of Reserve Bank credit* The report stated: "It is its (i.e., the
Federal Reserve's) responsibility to regulate the flows of new and additional credit from its reservoirs in accordance with solid indications
of the economic needs of tr^de and industry#"
In this climate of thought, stability of the international exchanges
as a primary preoccupation of monetary policy became definitely subordinate to domestic economic stability. Accordingly, during the Twenties,
major gold movements were interpreted as calling for deliberate measures
to counteract rather than to reinforce their effects. And to fulfill the
broader responsibilities of monetary policy more effectively, new policy •
techniques were developed—including, in our country, open-market operations, a more systematic bank supervisory policy, formally issued policy •
statements for public information, and the publicizing of relevant statistical facts.
V/ith this background of developing ideas about monetary management,
it was only to be expected that the great financial collapse of the late
Twenties and early Thirties would further change the character of monetar
policy• The breakdown of the gold standard internationally, involving
widespread depreciation and devaluation of currencies in relation to gold
put monetary policy in many countries into direct control over foreign
exchange transactions, particularly over capital movements. Subsequent
monetary reorganization brought about a position of more positive influence over the activities of banks and other financial institutions.
You are acquainted v/ith developments during this period in our own
country. V.e devalued the dollar and undertook a comprehensive overhauls
of our monetary machinery. Time does not permit a review of these fundamental reorganization measures. I want only to remind you that two new
techniques of continuing monetary policy were introduced at that t i m e —
authority to vary the level of reserve requirements of member banks and
control over the margins required on stock market loans * The reserve requirement authority provided a powerful new method of general monetary
policy, while the regulation of margins afforded a selective instrument
to influence credit conditions in a particular but important area. The
importance of these innovations, as well as of the inclusive reform of ou
monetary structure with which they were associated, is that they meant a
still more explicit commitment to active monetary policy focused on national economic stability.
During the Thirties, sheer necessity of depressed economic condition?
and widespread unemployment made reattainment of a satisfactorily high
level of business and consumption activity the principal preoccupation of
monetary and other public policy. You will recall the upsetting, though
not altogether novel, experience we had of reaching a cyclical peak in
business activity without approaching full levels of output and employmen
You will also recall that previously accepted notions as to the potency o
policy, fostered particularly in the Twenties, were seen to be
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16U
grossly exaggerated. To combat the powerful forces of maladjustment during this period, reliance had to be placed on other measures—notably fiscal policy. Even with the extensive use of other policy measures, largescale unemployment persisted until the outbreak of Ytorld War II.
Postwar Conception of Monetary Policy
The huge demands generated by war soon eliminated unemployment. But
the experience of the depressed Thirties had a lasting impact. How to
prevent the recurrence of large-scale unemployment was a dominant question
in all discussions of postwar policies. From these discussions it became
clear that public economic policy v/ould have to assume a great postwar responsibility for the maintenance of continuously high levels of employment.
There is no better testimony as to how intense was the concern over this
issue than the Employment Act of 19U6, which was passed, incidentally, by
a conservative Congress.
But the goal of high level employment was not to be pursued at all
costs. For example, "full employment" through inflation, was recognized
as an undesirable long-run solution. Resort to v/asteful, "make-work" projects was considered unacceptable. And, of course, all policy measures
were expected to meet the general requirement of consistency with a "free
private enterprise" system.
Not high employment alone, but stability at high levels of employment
and output; achieved within the framework of a free private enterprise
economy, became the emerging conception of the primary purpose of all public economic policy, including monetary or central banking policy. The
part which monetary policy was to play in realizing this conception was
not entirely clear. But that its responsibility was to be a large one,
there can be no dcubt.
I want to state at this point that wartime and early postwar thought
regarding the future role of monetary policy was not neglectful of the
international aspects of the money problem. It was recognized that some
mechanism had to be devised as a substitute, internationally, for the
former gold standard mechanism. The fruit of this thinking, as you are
aware, was the international agreement reached at Bretton Woods providing
for the establishment of an International Monetary Fund and an International Bank. It was felt that the first of these co-operative institutions—the lionetary Fund—could adequately assure relative stability of
international exchange values, and that the secooi agency—the Bank—could
contribute to the progressive expansion and balanced grovrth of vorld trade.
Both of these institutions were projected to function in a peaceful
world-in which member countries pursued national economic and monetary
policies designed to promote high levels of employment and real income
and to develop as fully as possible the productivity of their resources.
The new agencies were not expected to be final answers to the international monetary problem., On the other hand, there was a conviction that
success in the experiment of continuous international consultation and
cooperation through these organized channels vould give the v;or3da better
monetary mechanism internationally than had been provided by any former
gold standard system. A stable expansion of international trade, if a

favorable environment for such expansion could be established, would

165
progressively strengthen the nevj- international financial institutions
and permit them to perform their respective functions with increasing
effectiveness«
Such then is the postwar conception of the objectives of policy in
the management of money, and, as I have said, the goal of a stable but
progressive private enterprise econoiny puts aTEiy heavy responsibility
on monetary management.
Complex Structure of the Money Supply
For monetary policy to do its part, it must provide the economy at
all times with a supply cf money consistent with the needs of a stable anc
expanding economy. This is easier said than done, for the term "money
supply11, at least in our own country, is a highly complex concept. Our
particular money supply is not a quantity of readily identifiable and additive items. Rather, it is an amorphous mass.
V/e have currency money issued by the Treasury and the Federal Reserve Banks. \.-e have the demand deposit money created by the commercial
banks. We have a Irge amount of other liquid assets in the form of time
deposits and savings accounts, building and loan shares, and the cash
value of readily convertible insurance policies. We have an even larger
volume of other liquid assets in the form of Government securities, exchangeable into money at par, by redemption or sale. V/e have still othei
assets—e.g., corporate bonds and obligations of State and local governments—that are very high in liquidity, and therefore by nature close to
money. Some of our money, moreover, when lodged in the reserves of Federal Reserve Banks and commercial banks, possesses the property of multiplying through loans and investments into still more money. These bank
reserves have correctly been called high-pressure dollars.
The significance, from the standpoint of monetary policy, of this
complex money structure becomes even greater when we realize that the
ultimate concern of monetary policy is not with the money supply itself,
but with the flow of money through the economy. The active money flow ir.
the economy bears the impact of changes in the monqy supply and of the
activation or deactivation of existing money stocks. In our complex money system, both of these types of monetary change reflect the independent
decisions of many individuals and institutions, as well as the decisions
of the monetary authorities.
In vev/ of this complexity of monetary problems it is not surprising
that the total monetary* flow will at times reveal a tendency to become
excessive, producing the symptoms of a general price rise, or that at
other times it vail show an opposite tendency, producing price declines and
unemployment.
Ideally, monetary policy should completely forestall either tendency
and maintain a total monetary flow that is at all times perfectly adjusted
to the stability needs of the community. But the limitations on our
ability to forecast economic behavior is itself sufficient reason to suppose that such an ideal is impossible of attainment in the near future.
At present the most that we can feasibly aim for is to achieve and ap
proximation
to this ideal.

166
Need for Flexibility in Formulating Policies
Such an approximation is by no means an unambitious goal.. It inevitably requires all the foresight, knowledge, and judgment that we can muster.
One cardinal virtue to be cultivated is flexibility both in thought and in
action. No rigid policy, no matter how well thought out in advance, will
enable U3 to cope adequately vdth the problems of an uncertain future.
Nor can monetary authorities expect to avoid mistakes that will require
remedial action. Improvisation and reversibility should be indued in a
proper concept of flexibility.
lie must not overlook the risks of flexibility in the making of public
policy, not the least of which is that flexibility can itself become a
source of economic instability. A «rell functioning private economy requires stability in certain areas of public policy as much as it requires
flexibility in others. An important part of wise policy making, as I see
it, is to recognize and adhere to the boundaries of each of these areas.
The importance of this aspect of policy making is reflected, I think, in
the considerable recent popularity of what has been termed built-in^ or
automatic, flexibility—a concept to which I shall refer again in a few
minutes. Essentially, this concept undertakes to compromise the advantages of flexibility and stability in economic policy.
Strategic Factors in the money Flow
The major changes that do occur in the econony's money flow are heavily dependent on certain strategic forces such as capital formation by private business, consumer expenditures for durable goods and housing, and
international trade. To a greater or less degree each of these forces is
subject to influence by the monetary authorities through the terms and conditions on which new money is available to borrowers. However, their susceptibility to such influence is qualified by the fact that these forces
are in turn heavily dependent onnon-iaonetaiy factors.
The volume of business capital formation, for instance, is affected
by current expectations of future business activity, and investment plans
are subject to expansion, modification, postponement, or withdrawal as the
economic outlook changes. Demands for consumer durable goods stem from
wants that are now deeply imbedded in the American standard of life. The
state of international trade is a reflection of world political tensions
as well as the product of reciprocal needs among nations for goods and
services. In general, policies operating through the cost and availability of money—the major ways in v.hich the monetary authorities can influence developments—are apt to meet vdth greater success when it is a
matter of restraining rather than stimulating monetary expansion.
I might add at this juncture that the complexity of the money flow
process is the basic justification for such instruments of monetary policy
as margin requirements and consumer instalment credit regulation. By influencing credit conditions in selected areas, these instruments help to
keep the use of credit in balance as well as to maintain sound credit conditions in the sectors affected. They thus afford a means of keeping certain strategic non-monetary forces from having an undue influence on the
money supply and on the monetary flow through the economy. While they are
relatively new techniques of monetary poliry, in the brief period they

have been available they have had a helpful supplementary effect. The

167
extent to which they may be forerunners of a broader development of selective credit technique cannot be judged at this stage of monetary development. Much more experience than we have had to date will be necessary before the desirability of such a development can be judged.
Timing of Treasury Surpluses and Deficits
The monetary flow through the econory is also affected strategically
by Treasury surpluses and deficits. Whether considered within the scope
of monetary policy proper or viewed as a separate area of public poHcy,
the fiscal operations of Government play a significant role in monetary
affairs. They cannot be ignored in any consideration of contemporary
problems.
A current surplus on a cash basis means that the Government's out«
lays are running less than its income, and it is therefore having a contractive effect on the total money flow in the econoiry. A current cash
deficit means that outlays are running in excess of income, and that the
net effect of the Government's fiscal operations is to have an expansive
effect on the current monetary flow. Consequently, under a stabilizing
economic policy, surpluses should be accumulated whenever there is a
tendency for the monetary flow to become excessive, and deficits ought
never to arise except when it is desirable to expand the monetary flow.
This principle of fiscal policy is, or ought to be by now, a thoroughly elementary notion. Though I cannot speak with the authority of
one who is directly concerned with making fiscal policy, it seems to me
that a much more relevant and difficult problem is how to provide for
Government surpluses and deficits of the right amount at the right time.
In other words, to me, the really crucial problem in developing an adequately stabilizing economic policy is that of providing proper flexibility in Government finance.
Flexible Fiscal Policy
A certain anount of flexibility in Government fiscal policy can be
provided on an automatic basis, that is, without requiring deliberate
and specific action by either the Congress or the Executive. If the
structure of tax rates remains unchanged, revenues will rise as the monetary flow expands, tending to reduce a deficit or increase a surpluso As
the monetary* flow contracts, revenues vdll fall, tending to reduce the
surplus or create a deficit. With no opposing changes in expenditures,
this automatic ebb and flow of revenues will itself exercise a stabilizing influence on the monetary flow. Such stabilizing influence may be
supplemented, of course, by equally automatic fluctuation in the volume of
outlays made on behalf of such items as unemployment compensation.
A stabilizing fiscal policy achieved through automatic devices is an
undeniably appealing approach to the problem, and its potentialities are
well worth stressing. But I suspect that its potentialities can never
be great enourh to preclude entirely the need for specific tax or expenditure adjustments as well. Just what tax or expenditure adjustments
ought to be a part of a program of fiscal stability, I sm not prepared to
discuss in detail. In general, my preference is for relying on the tax
rather than the expenditure side of the budget. It is rry impression that

168
most expenditure items do not lend themselves readily to rapid expansion
or contraction; but such rapid changes v/ould be necessary if expenditure
adjustments are to be heavily relied on to promote economic stability.
Aside from the problem of workability, I an not sure that we ought to rely on changes in the volume of Government expenditures as a major means
for ironing out fluctuations in the economy. For the scope, of the Government's direct role in the market place is related primarily to the
size and nature of its expenditures on goeds and services. I think the
scope of this role is one of the elements that", in a free private enterprise econony, ought itself to be kept as stable as possible.
Long-Run "Neutrality" of Fiscal Policy
The problem of stability at high levels of employment, insofar as it
depends on fiscal policy, may involve resort to deficit financing, but only
on a temporary and not on a permanent basis . A belief in the need for a
chronic Government deficit to attain stability reflects, it seems to me,
a lack of confidence in the viability of our econony. The long-run fiscal
objective of budget neutrality—i.e., of a balanced budget—is, in ny outlook, entirely consistent vtith the achievement of stable aad high levels
of employment and output.
From the point of view of stabilization needs, our real danger may
be that v:e will lapse into an excessive use of deficit finance. If tension
in the international situation persists, no retrenchment from a huge military budget vail be possible. At the same time a considerable expansion
in the welfare activities of the Government is probable. This combination
of a welfare and garrison state means a large and growing volume of Government expenditures, implying in turn an average volume of Government revenues
equally large if in the long run we are to maintain a balanced budget. In
this situation, the temptation~and the danger—is to slip into a policy of
chronic deficit financing. Should we default on our fiscal-monetary obligations in this v/ay, the result may be to create a demand for comprehensive
direct controls in order to combat a chronic condition of inflationary
pressures.
Management of Surpluses and Deficits
The implications for monetary policy of a stabilizing program of Government finance are not confined alone to the timing of surpluses" and deficits. They extend also to the way in which a surplus is disposed of or a
deficit is financed. Differences in disposing of a surplus and in financing
a deficit vdll be reflected in different effects on the money supply. Broadly speaking, their significance will ciepend on such factors as the nature
and strength of the demand for investable funds and the reserve position "of
commercial banks*
To illustrate ny point, a surplus night be used to retire debt held by
the nonbank public In this case, the process of accumulating and disposing
of a surplus would not in itself result in any reduction in the money supply; it would only shift the ownership of money from taxpayer to security
owner. On the other hand, if a surplus is used to reduce debt held by the
cocmercial banks, a portion of the money supply will be extinguished, vrtiile
the immediately available supply of bank reserves for new money creation

will be increased. If a surplus is used to retire Federal Reserve held debt,

16?
bank reserves as well as the money supply will thereby be reduced.
Clearly, this last disposition of a budget surplus is the one'that will
make a maximum contribution to a policy of monetary restraint.
A similar type of analysis applies to the financing of a deficitleading to a similar conclusion, namely, that if the deficit is to make
a maximum contribution to monetary expansion it should be financed to the
extent that it is feasible to do so through borrov/nig from the central
banks—in our own country the Federal Reserve Banks.
Other Aspects of Government Finance
In addition to the management of budget surpluses and deficits, Government finance affects monetary policy through its management of outstanding public debt. Aspects of debt management, such as methods of refinancing, maturity, distribution, and of course the pattern and level of
rates, must all be comprehended in, or related to, modern monetary policy.
The principal objective of debt management from the point of view of
monetary stability is easy enough to state: during inflationary periods
when the monetary flow is excessive, it is desirable to attract investors1
funds into public debt holdings and av.ray from private investment expenditures, thereby reducing the active money supply. Curing deflationary
periods, it is desirable to induce an exchange of public debt holdings
for cash, thereby increasing the active money supply.
In this area of debt management more than anywhere else in the monetary and fiscal field, it seems to ne, we are limited in the development
of stabilizing policies by the incompleteness of our knowledge. V/ith a
debt of the magnitude of 250 billion dollars, with a stable level of .
long-term interest rates held long enough to permeate the entire asset
and liability structure, and v/ith a tense international situation, we do
know that monetary policy must maintain orderly conditions at all times
in the Government securities market,
But ivithin this limitation, how much can be done? Are there changes
to be made, through refinancing operations, in the maturity and ownership distribution of the debt that would improve it from the point of
view of monetary stabilization? During inflationary periods, is some
flexibility in the prices of Government securities compatible vdth maintenance of orderly market conditions? V.'hat rauld be the sure effects of
such flexibility? Y/ould these effects compensate for the known advantages of certain confidence in the orderliness and stability of the Government securities market?
Firm answers to questions such as these are prerequisite to development of debt management policies. Yet, even vdth much more intensive
thought than this matter has thus far been given, the answer will be slow
in coming. We have, after all, only acquired our present huge public
debt within the past decade. We will need to proceed cautiously in building up our experience in improving methods for its management.
Concluding Comment
In the present lecture, I have endeavored to sketch the evolving
or central banking policy in relation to economic

role
of monetary

170
stability. You vrill see that over the years it has undergone a profound
change. If I have read the trend of history correctly, the change has
been consistently in the direction of a broader and more flexible role,
but vdth more definite responsibilities toward facilitating the maintenance
of high levels of employment, stable values, and a rising standard of living—in short, towards facilitating greater over-all economic stability.
If vie agree that this reading of history is a proper one, then we
must conclude, I think, that the contemporary role of monetary policy is
indeed a matter of crucial importance to all of us. V/e must also ask ourselves a very basic question: do we know enough about economic behavior
and organization to stabilize a progressive private enterprise economy by
the application of monetary and other public economic policies?
You are all familiar with the wide range of answers given to this basic
question. They extend from a doctrinaire affirmative to an agnostic negative. L!y own position, as you might deduce, is towards the middle of these
extremes. I do not believe that any one possesses the ultimate truth on
the question. Nor do I think that we know too little aid can never know
enough to have a rational basis for action that will advance us along the
road of stability. I do believe our knowledge and understanding is great
enough so that v/e can proceed with some confidence of ultimate success.
In going forward, we must recognize that monetary policy can carry only
its share of the responsibility, that many other public policies—particularly fiscal policy—will have to do their part. V:e must recognize,
too, that if the responsibilities are to be carried effectively, the public agencies charged with carrying them out will need to be adequately
equipped with g>propriate authority to perform their proper functions.

171
Lecture delivered under the
Charles R. TJalgreen Foundation for the Study of American Institutions
University of Chicago, Chicago', Illinois
March 11, 19h9
THE PROBLEM OF POST-WAR MONETARY POLICY
In ny previous lecture I dealt in very broad terms with the subject
of contemporary monetary policy in relation to economic stability. Today,
I have planned a more specific approach. I propose to discuss the problems of monetaiy policy as they have developed in the context of our
post-war experience to date*
Since the end of the war, monetary policy has had to cope with wore
or less continuous inflation. Effective demand, until recently, has con-?
sistently exceeded the available supply of goods largely because spending
from current income has been substantially supplemented by drafts on accumulated liquid savings and by rapid expansion of private credit. This
condition of excessive demand has inevitably placed an upward pressure on
prices. Advancing prices accompanied by expanding money income, leading
to further price increases, is the spiraling process of inflation v.ith
which v/e are now all too familiar. As a result, between mid-19li6 when
price controls were initially terminated, and August 19ii8, wholesale
prices rose SO per cent, consumer prices 31 per cent and total personal
incomes expanded by 2U per cent.
Basically, our post-war inflation is the product of our wartime financial policies. The war cost around 320 billion dollars. This huge
volume of expenditures w as financed in part out of our current income,
tapped through taxation and sales of securities to the public; and in
part through expansion of the money supply brought about by borrowing
from the banking system*
Purely from the point of view of monetary stabilization, taxation
is, of course, the ideal method by vhich to finance a war. Vtfien taxes
are imposed, the spending power of the public is reduced by the au:ount
the Government's is increased, and current expansionary pressures are
thereby held to a minimum. Also, and perhaps more significantly for our
problems, taxation does not add to the "liquidity" of the economy, since
the taxpayer receives in exchange only a tax receipt vhich he cannot convert into spending power either in the present or the fUtrre.
Borrowing from the noriboik public shares with taxation the ad vintage
of absorbing current spending power, but has quite opposite liquidity imr
plications. The loss of spending power involved in lending to the Government is not permanent as with taxation, but may be reclaimed by the
lenders at a future date. In other words, unlike taxation, issuance of
Government securities to the public results in an expansion of the econostock of liquid assets.
Borrowing from the banking system is an outright inflationary method
of financing war expenditures. It absorbs no current income, but instead
produces an immediate expansion of the money supply. Furthermore, as
matters have turned-out, it leaves the banking system in possession of as
sets that can, when the opportunity arises, be readily converted info
Digitized forreserve
FRASER funds to back a multiple expansion of private credit.

172
It was not reasonable to expect our expenditures for war to be financed entirely through taxation* There are serious obstacles, essentially
non-monetary in nature, that place a definite upper limit to the tax burden
that can be imposed even in wartime. As the tax burden grows, particularly
i/vhen it grows rapidly, the interrelated problems of administrative feasibility, equity, and incentives become increasingly difficult to handle.
More safeguards against widespread evasion and its generally demoralizing
effects have to be devised. Numerous special adjustments are required to
maintain a general consistency with the community!s standards of fairness,
without vhich no tax system can long survive as an effective instrument of
policy. And, finally, a rapid stepping up of the tax bill may, at least
in the short run, have adverse effects on effort incentives and thereby
interfere with achieving a maximum wartime output.
Just where that upper limit of taxation is, cannot be determined exactly, but it is safe to say that we fell short of it by much too wide a
margin. Less than one-half of the funds raised by the Treasury between the
middle of 19U0 and the end of 1915 came from tax sources.
Further, not only did we rely much too heavily on borrovdng, but on
borrowing of the most inflationary kind. Of the total amount borrowed by
the Treasury from mid-19UO to the end of 1915 more than two-fifths came
from the banking system including commercial banks, Federal Reserve Banks
and mutual savings banks. Thus, in our war finance we made the twofold
mistake of taxing too little and borrovdng from the banking system too much.
As a consequence, then, of our wartime financial policies we entered
the postwar period with an economy characterized by an excessive degree
of liquidity. Government securities held by commercial banks—their highly
liquid secondary reserves—grew from 17 billion in June 19l|0 to 91 billion
by December 19145* They constituted the bulk of total bank loans and investments. It is estimated that over the v/ar period the stock of liquid
assets—currency, bank deposits, and Government securities—held by individuals and businesses including insurance companies, increased approximately threefold while over the same period the gross national product
only about doubled.
This greatly increased ratio of liquid assets to the value of the
national product reflected in part a considerable restraint on the part
of consumers and business concerns who, for economic as well as patriotic
reasons, were willing to accumulate liquid reserves rather than bid for the
scarce supply of goods that were available during the waro And, of course,
the high "liquidity ratio" that developed ever the v/ar reflected the fact
that we had gnerally effective direct controls on prices and materials.
Combined with a heavy backlog of unsatisfied real demands, this high
degree of liquidity meant that strong inflationary pressures would inevitably develop, particularly if the wartime controls were prematurely removed.
But our wartime policy of heavy reliance on borrovdng held yet another
implication for the problem of stabilization in the post-war world. Our
national debt grew during the war to a peak of 2?5 billion dollars, a
figure of astronomical proportions by prewar standards. Its ownership vras

173
widely distributed and its interest pattern had become integrated into
the whole asset and liability structure of our economy. Confidence in
the market value of the public debt was almost synorymous with a stable
financial organization.
Clearly, no realistic conception of the problem of postwar stabilization could afford to ignore these facts about the public debt. Yet to
take them into account, enormously complicated the role that monetary
policy was" called upon to play in our postwar econony. For it meant that
no measures could be undertaken to control an expansion of credit and the
money supply that were inconsistent vdth the objective of maintaining an
orderly and stable market for government securities at all times•
Now, I do not want at this time to cover again the pros and cons of
the support policy that the System has follovai since the end of the war.Suffice it to say that as I have understood the arguments set forth by
serious critics, they have always seemed to be veiy uncertain as to just
v/hat the consequences of suspending supports would be. And in view of
the uncertain effects of such an action and the compensating advangages
vtfiich confidence in the stability of Government security prices has had,
it seems to me that the decision to adhere, to the support program has
been necessary and wise*
Nevertheless, it is true that for the Reserve System to fulfill the
role of residual buyer in the Government securities market placed severe
limitations on the usefulness of traditionally powerful techniques for
controlling the volume of credit and deposit expansion. As a residual
buyer the Federal Reserve System became a soiree of reserve funds which
commercial banks could tap at their own volition by offering Government
securities for sale. Banks also received additional reserve funds involuntarily whenever nonbank investors sold securities to the Reserve
Banks. And with a fractional reserve banking system, each dollar of reserve funds provides the basis for a manifold expansion of private credit
and the money supply.
Moreover, because of the abundant security holdings that the banking
system acquired through the processes of war finance, coianercial banks no
longer had extensive need for borrowing funds from the Federal Reserve
Banks. Adjustments of reserve positions could be achieved instead through
security sales in the supported market. As a result, except for viiatever
psychological impact it might have, the rediscount rate lost its effec-.
tiveness as an instrument of credit control.
Finally, sales from their holdings of Government securities offered
an easy means by which banks could offset in some measure pressure that
might be brought to bear on their reserve position through a rise in reserve requirements. In consequence, relatively small changes in reserve
requirements could not be relied on to have severely restrictive effect.
And while larger variations in requirements could be an effective weapon,
they have not been available to the Federal Reserve during most of the
post-war period because of practical exhaustion of statutory discretion
on the upward side.
Thus, under the circumstances that have existed during most of the
close of the war, the traditional instruments available

since the
period

17U
to the Federal Reserve for influencing money and credit developments in this
country were either ineffective, inoperative, or near exhaustion. meanwhile,
the volume of credit extended to private borrowers during this period underwent a considerable expansion. From the end of 19h5 to the end of 1918,
commercial and industrial loans of all insured commercial banks almost doubled, v;hich represented an absolute increase of approximately 9 billion
dollars, Agricultrual loans of these banks rose by 1-1/2 billion over the
same period, while real estate loans increased by approximately 6 billion.
Finally, the increase for the period in the consumer loan category of insured banks amounted to almost li-l/2 billion dollars.
I do not mean to suggest that our post-war monetary policy has
b^
a failure. There have been significant elements of restraint, without which
the situation would have been decidely worse.
The most important factor of restraint in the post-war period has been
the Treasury cash surplus. For the calendar years I9I46, 191*7 > and 19h8,
Treasury receipts from taxes and other sources exceeded cash outlays by a
total of about" Ih billion dollars. This surplus has exerted a powerfully
contractive effect directly on the expenditure-income stream and on the
supply of credit and money. Without it the upward pressure on prices would
unquestionably have been more severe.
Further, a substantial portion of the surplus has been used to retire
debt held by the Reserve Eanks. As I pointed out in my first lecture, this
disposition of the surplus is the one most consistent with a policy of monetary restraintj for it results in a withdrawal of funds not only from the
general income stream, but from the commercial banking system as well, thereby
bringing pressure to bear on the reserve position of commercial "banks. The
Treasury also exerted a similar pressure on bank reserves by drawing down
the deposits that had been permitted to accumulate previously in the war
loan accounts of commercial banks.
Moreover, the System has vigorously used its relatively modern accessories—control over stock market credit and control over consumer instalment credit. Since the end of hostilities in mid-19U5, margin requirements
for extensions of credit on listed securities by banks and by brokers and
dealers have not been below 75 per cent, and for the year ending January
19ii7 were at the level of 100 per cent. Bank loans for purchasing and
carrying securities other than U. S. Government securities amount to only
about a billion dollars today. These loans have not increased since the
war—in fact, they have declined slightly while debit balances of customers
at their brokers and dealers have also decreased since the end of the war
and are today actually less than their credit balances# Credit and monetary expansion in the post-war period has not been due to speculative credit in the stock market#
Regulation of consumer instalment credit, in the periods it has been
in force since the war, has also been an influence in restraining the increase in this type of credit. As you know, Congress, in mid-19U7, "terminated this authority effective November 1, 19hi. Subsequently expansion
in this credit went forward at a sharply increasing rate. Since September
of 19U8, when the regulation was reinstated on the basis of authority
granted in the special session of Congress, consumer instalment credit
has increased only moderately, although prior to that action it had been

175
expanding at a rate of nearly 200 million dollars a month. Only a few
days ago, as you know, the Board modified somewhat the September terms
of consumer instalment credit.
The System has also used carefully its influence over interest rates,
. To raise the cost of reserve funds, to the banks, and also to encourage
banks and non-bank investors to hold on to the short-term Government securities they ovm and to buy more rather than to unload them on the System, short-term market rates and Federal Reserve discount rates have
been permitted to rise. Rates on Treasury bills have risen from 3/3 of
1 per cent in mid-191^ to more than 1 per cent today. Yields on one-year
certificates have increased from 7/8 to 1-l/lj per cent, while the Federal
Reserve Banks have raised their discount rates from 1 to 1-1/2 per cent.
The System has applied more vigorously than the banking comnunity
has desired available statutory authority to regulate member bank reserve
requirements. Prior to the legislation enacted in August, increasing
member bank reserves was a-possible course of action only for the New
York and Chicago banks, since for all other classes of banks requirements
v.ere at their legal limit. In January, and again in June of last year,
the Federal Reserve Board raised by 2 percentage points the reserve requirements on net demand deposits at New York and Chicago baiks. Oxi the
basis of the temporary authority granted by the Congress in August, the
Reserve Board raised reserve requirements by 2 percentage points on demand deposits and 1-1/2 percentage points, for time deposits early last
fall.

•

Finally, the System has used its informational resources to iirge
upon Congress and the public the importance of restraint in credit expansion and of the need for a strong fiscal policy.
The American Bankers Association has cooperated in this program by
urging bankers to practice self-restraint in their own as well as in the
national interest, and some other lenders have taken a similarly enlightened view of the need for self restraint in lending.
The fact that despite a vigorous application of those powers which
could be used under existing circumstances, we nevertheless experienced^
considerable post-war inflation has, it seems to me, one very clear implication. There is a basic need for strengthening our monetary powers.
Monetary authorities should have at their disposal at all times
adequate means for checking growth of the money supply vdthout endangering the Government's credit. To this purpose the System needs to be
given authority to prevent or restrain credit expansion by an increase
in reserve requirements of banks. By this authority the System could absorb or immobilize additional reserves acquired from a return flow of
currency, from gold inflow, or from sales to the Reserve Banks of Government securities, either by banks or by their depositors. Furthermore, on
grounds of fairness as well as on grounds of making the requirements more
effective, the authority ought to be extended to all insured banks.
As a supplement to quantitative controls over bank reserve positions,
selective-type controls need to be developed further to strengthen the
influence over monetary and credit developments. Experience with
Digitized forSystem's
FRASER

176
controls over stock market and consumer instalment loans has demonstrated
the helpfulness of operating directly on the demand side of the credit market. The Board strongly believes in the continued usefulness of both of
these controls for achieving greater economic stability, and has recommended
to the Congress enactment of legislation vhich would replace the present
temporary authority to regulate consumer instalment credit vdth a permanent
authority.
The case for continuing regulation of consumer instalment credit merits
special comment* Consumer instalment credit is directly associated with
the distribution and financing of durable goods. In an advanced and rich
econorry such as ours, increases in our standard of living come about more
and more in terms of ownership and enjoyment of a greater volume of durable goods. These goods, however, usually have a long and variable life
of service. They are generally items of high unit vaLue and not many of
each are purchased in the average consumer's lifetime. Original purchases
and replacements can be postponed for indefinite periods. Even if their
purchase were on a strictly cash basis, demand would be unstable with changing conditions of unemployment, income and buying psychology. With unrestrained use of instalment credit financing, instability in the demand for
durable goods tends to be accentuated. In periods of business expansion
consumers draw heavily on their future income to swell their purchases of
these goods. VJhen a downturn sets in, instalment loans are being paid off
and the payments reduce further an already inadequate volume of consumer
purchasing power. By limiting or relaxing the terms of instalment credit,
not to s tifle its growth but to spread its growth, much can be done to
space our purchases of durable goods more evenly over time. This will add
to the stability of the entire econony.
Recently we have had an interruption of the inflationary course. In
an increasing number of areas supplies have caught up with, and in numerous
lines, exceeded demand at current prices. Indicative of the changed situation are the recent declining prices, the moderate slackening of investment
in producers1 goods and business inventories, and the increased supplies
of goods, many of vhich were in tight supply a year ago. Average wholesale and consumer prices have been declining from their August peaks*
In fact, by mid-February average wholesale prices were slightly lower than
a year ago, while consumer prices were probably very close to their levels
of February 191*8. Prices of farm products in mid-February were 8 per cent
and foods 6 per cent below a year ago. Average prices of° commodities other
than farm products, and foods were only 3 per cent above a year ago, and
have been virtually unchanged on the average since August, vdth prices of
most commodities in their group other than metals generally either remaining stable or drifting dowu Retail sales have recently shown substantial
evidence of increasing consumer resistance. VJhen figures become finally
available on department store sales for February they will probably show
a decline from a year ago despite intensified merchandising efforts.
Though employment has continued at generally very high levels there
have been recent declines. Claims for unemployment compensation increased
more than seasonally and by mid-February they totaled about 750,000 or
US per cent higher than a year ago.
Notwithstanding these developments I strongly emphasize the need for
authority adequate to cope vdth inflation. I certainly

Digitized for making
FRASER the System's

177
hope that there will not be further inflation. My emphasis rather reflects my concern that our System at all times be equipped to cope v/ith
whatever monetary problems we may be facing.
The Reserve System today is far better equipped than ever before
to help offset deflationary forces should they actually develop. A major
deficiency of the banking system that has aggravated business contrac- :
tions in the past—the inability of the central bank to provide adequate
funds when needed by the market—no longer exists. The System has virtually unlimited means of supplying the market with additional reserves
through purchase of Government securities. The Reserve Banks at present
hold 23 billion dollars of gold certificate reserves, and, on the basis
of existing legal gold reserve requirements, the System could more than
double its outstanding note arid deposit liabilities. Moreover, as a
result of the liberalised lending authority provided by the Banking Act
of 1935 advances can now be made on any assets of member banks that are
acceptable to the Reserve Banks as security. Thus the supply of funds
will not be undesirably restricted by the need to adhere to "eligibility?1
rules. Further, when other lenders arc not available, the System empowered to make direct loans to business firms for working capital purposes. Finally, the System can always contribute to monetary ease generally by a reduction in reserve requirements and in special areas through
relaxing instalment credit and margin requirements.
ILy point, then, is that monetary policy must be as adequately forearmed to cope with expansive forces in the econoiry whenever they occur as
it now is to counteract the forces of contraction (always bearing in r.ind
that on the downside our major contribution is to create a monetary climate favorable to business expansion; the forces that generate expansion
lie outside the realm of monetary policy alone). Only if the System is
forearmed can we have the full advantage of the stabilizing potentials
ties of action in the monetary sphere—about which I have already indicated irQr optimism. It is ny conviction that monetary policy, aLong with
coordinative action in the fiscal area, can contribute a great deal to
curbing the effects of unstabilizing elements in our economic life. However, I want to emphasize again the essential role that timing Yd. 11 always
play in determining the success or failure of even the best of available
weapons. Not only must we have the power to act, but it is essential
that our action be undertaken in the right amount at the right time.
In conclusion, I would like to say that rny interest in this general
monetary approach to economic stabilization is based not only on rry optimism vith regard to its results. Ly interest is also based on the conviction that this is a good approach for a free competitive econony. It
calls for no great expansion of the allocative powers of Government over
the nationsfs resources. It calls for no proliferation of Government
directives the mechanism of a regimented econoiry. Rather, it promises
both economic stability—which we somehow have to achieve—and economic
freedom—which we dare not give up.

179
Outline of Remarks before
Convention of Wisconsin Bankers Association
Milwaukee, Wisconsin
June 21. 19A9
THE CURRENT ECONOMIC SITUATION
I•

Introduction:
A. For over seven years, we have been in a war end postwrr bociru
Thus, In the fourth quarter of 191& when the boon was clote to
its peak
1. Gross national product (reflecting changes in both production
and prices) was at en annual rate of 265 billiontioliur®as
compared with 90 billions in the year 1939 > tx. increrse of
almost 200 per cent.
2. Industrial production (1935-39 = 100) averaged 194, us compared with 109 in 1939*
3* Employment in nonngricultural establishments (secondly
adjusted) averaged 45•5 million persons, as conpared
with 30,3 million in 19394. Unemployment averaged 1,8 million persons com^rea vith
9.5 million in 1939.
5, Wholesale prices had increased ty 112 per cent and con^omer
prices by 73 por.cent from 1939.
B, This boom appears to hove cone to on end late last year. This
evaluation is nade on the basis of both 1. Analysis of the basic factors which c&.used the boom &nd
which have now largely run their course.
2. The fact that most measures of economic activity end prices
have been generally downward since last fall or '..-inter.
a. Thus, gross national product declined to an annual i-ato
of 256 billion dollars in the first quarter of 19/.9, a
decline of 9 billion dollars, or 3 per cent fron the
record rate of the preceding quarter. This we*: tho firsi
significant decline since the end of the e&rly reconversion period, A ftirther decline of 2 or 3 per cent is
estimated for the current quarter.
b. In May industrial production was 12 per cent below its
postwar peak of last Hovember.
c. Wholesale prices have declined 3 per cent (in the first
week of June) aid consumer prices 3 per cent (e&ti::iated
May) from their peaks of lt\tc august.

d. While employment is still at £ relatively high level,
unemployment has increased substantially, amounting

180
to 3-3 million persons in May,
C. Corporate profits before tax for the first quarter of 1949 ure
estimated to be at an annual rate more then one-seventh below
the postwar record level of the 4th quarter.
D. In the first five months of 1949, ban:: loans are estimated to
have declined about 1.5 billion dol3.ars in contrast to an increase of 1.5 in the same period last ye&r.
E. The basic questions th*vt now confront us are 1. How severe will the adjustment or recession be?
2. How long will it lest?
3. What actions should be taken by (a) private business and
(b) Government to improve the situation?
F. lie must not overlook the fact, however, that despite recent declines employment, production, prices, and profits are still all
high in relation to 1939.
II. The postwar boom was largely the outgrovrth of wartime developments
and policies.
A. The length of the war and the intensity of our effort created
vast postwar demands1.
2.
3.
4.
5.

For replenishment of inventories.
For plant and equipment by industry Lnd farms.
For consumer durables and housing.
For schools, roads, and other state aid local improvement*.
High incomes contributed to demand for all sorts of commodities and services.

B. The war and postwar developments also provided the financial resources to make these demands effective.
1. Holdings of liquid assets were at record levc-ls and fairly
widely distributed—largely as a result of our heavy reliance
on borrowing to finance war expenditures.
a. More than half of our wartime expenditures were financed
through borrowing. From December 1939 to December 1945
the national debt, ether than that held by Federal
agencies and trust funds, increased by over 200 billion
dollars.
b. From the end of 1939 to the end of 1945, personal holdings of liquid assets (i.e. currency, bank deposits,
and Government bonds) more than tripled, increasing
from about 50 to over 150 billion dolltrs*
2. Incomes were high end rising.

Profits were high and profit prospects good.

181
4. Credit vus easily available and cheap.
C. At the same time, the highly unsettled international situation,
resulted in heavy Federal expenditures both for foreign aid, relief and reconstruction, end defense.
D. Demand generally was in excess of supply currently kva
E. As a result of all of these factors prices rose rapidly,
III. Since late last year, most indicators point to a narked change in
the nature of postwar economic activity end prices.
A. Reflecting the changed situation is the feet that c yocr ago
our ir/yor immediate concern was with risinj prices c.\nd roefcsures
designed to curb inflation; vrhile currently our m-ijor concern
is with declines in employment end industrial output.
B. The magnitude of the declines which have already occurred should
not be overstated, although m&ny measures of activity and
prices—pcrticulerly the more sensitive ones—heve shown large
declines.
C. As pointed out earlier, gross national product declined by 3
per cent in the first quarter of this yeur &nd hat* probably declined further since then. The decline in the first quarter
was largely accounted for by a considerable drop in expenditures for personal consumption, a sharp reduction in the rate
of inventory accumulation, and declines1 in expenditures for
new private construction end producers durable equipment.
1. Following a smell increase in the fourth quarter of 1948,
expenditures for personal consumption declined by almost
4.5 billion dollars (seasonally adjusted annual rcte) or
2-1/2 per cent, the first reduction in the postwar period.
Expenditures for both durable end nondurable goods declined
substantially with expenditures for services shoving c snail
increase. Such expenditures appear to have levelled off
'since the first quarter.
a. V-hile total retail sales increased about 1 per cent from
March to April, they wfere 2 per cent below .i yecr ago.
Sales of automotive stores were 18-1/2 per cent ibove a
year ago, but sales of all other store types (except
drug stores) were lower.
b. Department store sales in Kay were about 5 per cent below a year ago.
2. Noiifarm inventories were accumulated at an annual rate of
over 4 billion dollars in the fourth quarter of 1948. In
the first quarter of 1949 this rate dropped to about 1.5
billion dollars. On the basis of data through April, it
appears that inventories are being liquidated in the current
quarter.

182
3. Expenditures for new private construction shoved a decline
(at an annual rate) of more than 1 billion dollars or 3
per cent in the first quarter. In April and ilcy, however,
such expenditures leveled off, end in terms of contracts
awarded'which would become expenditures later, increased
somewhat.
a. In the first four months of 1949, the number of new
residential units started was almost 13 per cent fewer
than a year ago. However, the increase from March to
May was greater than a yeer ago, and the number of new
starts in May this year was only 5 per cent below the
very high number of a year ago when they amounted to
100,000 units.
b. Public construction has continued to increase strongly
and has maintained the total volume of construction
activity above the comparable periods of lust year.
c. Costs of construction and prices of building materials
have declined somewhat from their peuks of lact year.
D. Noteworthy has been the steady decline in industrial production
for the past 7 inonths. The Board's seasonally adjusted index is
estimated at 172 in May. (1935-39 = 100) a decline of 12 per cent
from the postwar peril: of 195 of last November, k further substantial decline now appears highly probable for June.
1. The declines have been general throughout manufacturing and
mining, with output declining in nearly all major industry
groups and with output of durables cmd nondurables each declining 13 and 11 per cent respectively.
a. Especially large reductions have taken place in textiles,
machinery, chemicals, and fuels.
2. Steel production has declined steadily. For the week beginning the 13th of June the scheduled rate was 86.7 per cent
of capacity compared with the actual March rate of almost
103 per cent. .
3. Output of passenger automobiles, however, has been maintained at very high levels, except for the Ford strike.
E. The postwar expansion *of employment came to a halt in the fall of
1948. Since then, the deihand for labor has declined while unemployment and part-time employment have increased.
1. Unemployment was 3.3 million in May compared to 1.6 million
in October and 1.8 million a year ago. A further increase
is expected in June as new workers enter the l&bor force from
schools and e.s industrial employment declines further.
2. Seasonally adjusted employnent in nonagricultural establishments in May 1949 was 1.9 million less then in October and
about 1 million less than a year ago.

183

Although declines in einploynont since last October
liave been general, tho largest relative reductions
liave been concentrated in iuanufacturing, transportation, and ccacninication. Average hours of
work have also declined sharply in ziauufacturinc
from 40.0 in October to 38,3 in April.

Total seasonally adjusted man-hours worked in vuinufacturing in April 1949 were 11 per cent fever than
in October 1943 and declined further in Ijby.

Weakening in the labor market has boen reflected in wajes.
a.

Average hourly earnings in uonufacturing liuve declined, slightly below the December peak.

Ueekly wages in manufacturing liave been reduced owing to the reduction in average hours of work and in
April were 052.62 or 02.39 below the end of 1948.

Total wage and salary receipts declined 5 billion
dollars f roa their peak in ilovG&bor 1943 to April
1949, vhen they were r-t an annual rcto of lj>3 billion dollars, and were reduced further in liay,
probably by an additional 1 or 1-1/2 biLJion.

Personal income had declined by 7 billion dollars, or over 3
per ec-nt, from its peak in Lecei.iber 1943 to April this year
vhon i- reached 214 billion dollars.. It is estimated to decline further in licy, probably by about 2 billion dollars.

After reaching their postwar peaks in August of lust year
prices of all commodities
at wholesale have declined 8 per
cent, and consumers1 prices 3 per cent.
1.

Significantly, prices of all comodities other than f a m
products and foods have been declinir^ steadily in recent
months and for the week of June 7 wore 5.5 por cent belov
t:*eii- highs of mid-November last year and almost 3 per
cent below a year ago. These price declines have been
widespread.

Prices have weakened in the metals .'Markets this year.
Since December motal scran prices have dropped about 50
per cent. Prices for copper, lead, and sine have fallen
sharply, and some reductions have been made in prices of
some iron and steel products.

Prices of basic conrioditios have declined more tl\an 27
per cent fron August to the Middle of June.

IV. The economic developments described above seen to indicate that the
postwar expansive forces have finally lost such of their vigor.
Throe years of hitfh-level industrial production and wore than ample
harvests have converted shortages to surpluses at prevailing prices.

Inventories have been adequately built up at all stages of
production and distribution for practically all commodities.
In fact, inventories are currently being reduced as pointed
out above*

Backlog consumer demands for durables have been satisfied, except possibly for autos.

The expansion prograa of industry for plant and equipment are
ne^ring completion in many cases. Thus, the Coixaerce-SEC
Survey estimates th£it planned expenditures on new plant and
equipment this year will be about 5 per cent below those of
1948. I lore serious in its implications than this rather
moderate reduction in the total for the year is the expectation that expenditures in the second half of this year will be
14 per cent below the second half of 1948. For nanufacturing
industries the decline in the second half of 1949 is estimated
at 22 per cent. On the other hand planned expenditures for
electric and gas utilities show increases over a year ago.

Demands from abroad are also less urgent then earlier, as the
process of reconstruction makes headway.

Government—Federal and state and local—ic likely to increase
its expenditures on goods and services for the remainder of
this year but'such increase will bo less than last year when
private densand was more urgent than currently. Furthermore,
the personal incone tax reduction of last year resulted in a
sharp increase in consumer incone available for personal
spending. This will presumably not be repeated this year.

'.ihile it io clear frora the recent record of major business indicators that ve are in a period of downward readjustment of employment,
activity, and prices, it should be stressed that the deflationary
process lias thus far been an orderly one.
A.

I shall not attempt to predict the detailed course of activity
for the period ahead. Ue nust remember, however, that ours
is a cyclical econor.iy and that there has been much variation
in the intensity and duration of the downswings. In 1924 the
downward adjustment was r.ioderate and short. In 1920-21 and
1937-33 industrial production declined by one-third in a
short period. Fran 1929 to 1932, licuidation was prolonged
and drastic.

In appraising the prospects, however, we must take into account
oi*e many supporting factors v/hich are present and which should
moderate the speed and limit the depth of any cumulative adjustment. Attong these are the following:

Unemployment compensation benefits which partially maintain the income and expenditures of the unemployed. On
the average, those covered by such benefits receive about
$20 a week for a laaxiHum of about 6 months.

185
2. Payments under the farm support programs are maintaining
incomes aid reducing the dangers of unlimited price declines.
3. Continued large and widely-distributed holdings of liquid
assets—Government bonds, savings and checking accounts*
It should be pointed cut, however, that the Board's recently computed Survey of Consumer Finances indicator thr:t
the proportion of units with no liquid assets has ricen
from 24 per cent in 1946 to 29 per cent this year.
4« While a reduction iix personal incomes and housim; prices nay
muke a part of our large mortgage debt vulnerable from the
standpoint of the borrower, widespread use of mortgage
amortization and of Government guarantees provides the
lender with important protections*
5. The fact that the postwar period has generally been free
of speculative excesses in the securities .markets, tho
strong financial status of industry, and the gre?j.t strength
of tho banking system are factors th&t racke a prolonged and
drastic liquidation less likely than in other periods of
decline.
6. The current reduction of inventories hr.s resulted in production lower t h m consumption in some lines imd the basis
is being laid for renewed buying i.nd increased production.
In this connection, the Board's uinuel Survey of Conruiaer
Finances shows that demand for automobiles, appliances,
furniture uid houses continues to be large.
7. Government expenditures are high and likely to increase
further. It is likely that budget expendituree in fiscal
1950 will amount to about 44 billion dollars.
8. The expected payment of over 2 billion dollars of dividends
on National Service Life Insurance in the first half of
next year may prove an important expansive factor.
VI. lihile the cushions mentioned before will be of great help in limiting declines in activity, they do not assure high levels of output
and unemployment. Both the private sector of the economy and government must adopt appropriate policies to attain this.
A. jin excessive concern with security end liquidity may well prove
self-defeating, l.e must not forget th&t c. major factor in the
adequate workins of the free enterprise system is the willingness—even the eagerness—of businessmen to assume ricks.
B. A bold approach should be taken towards reducing costs and
prices. Pror/ipt :jid realistic price reductions—even if they
require reduced profit margins—would help maintain sales and
thereby both incomes and employment.
C. Banks and other financial institutions should continue to
available an ample supply of credit at rel&tively low cost and

106
without strong pressure on borrowers for repayment.
D. Government policy should fce directed towards encouraging business and consumer spending. In part, this may be accomplished
by expending Government expenditures and by appropriate tcx
policies, such es reductions in excise taxes. Decline•; in economic activity are likely to result in z. Federal each deficit
for fiscal 1950. Ue nust be realistic enough about such a
prospect to realize that drastically cutting expenditures or
raising taxes in an effort to prevent u deficit would be partly
self defeating since they would probebly result in still lower
levels of activity, employment, and income, further increases
in unemployment compensation and relief payments, .Mid further
reductions in tax receipts.

187
Lecture at
School of Banking. University nf fflai»nn«Hn
Madison, Wisconsin
August 31, 1949
THE FUNCTION OF BANK RESERVES
The term "bank reserves" is one that may have several meanings. It
may be used to refer to the total amount of reserves which qualify for
meeting legal requirements of commercial banks or it may be used to include quick assets that banks hold as secondary reserves. Both commercial banks and the Federal Reserve Banks hold reserves but those are cuite
different in form. In our discussion today, when I refer to bank reserves
I shall in general be referring to the reserves that member banks hold on
deposit with the Federal Reserve Banks, of which a part are legally required reserves and a part may be excess reserves. Nonmember bank reserves take several forms in accordance with various state lav?s, but the
bulk of them are held in vault cash and on deposit with correspondent
banks. Reserves of the Federal Reserve Banks consist of gold certificates
held in their vaults•
For more than a century, it has been an accepted feature of the nationf s banking system that commercial banks should be required to hold a
certain fraction of their deposit or note liabilities in reserves. As
our monetary and banking institutions have developed, however, our conception of the primary function of legal reserves of banks has undergone
significant change. Originally the principal purpose of legally required
reserves was to assure the ability of individual banks to meet liabilities
on denand during a period of strain. That is to say, it was to provide
for the convertibility of bank notes and bank deposits into cash. With
the establishment of the Federal Reserve System, the role of bank required
reserves was greatly modified, and today they serve mainly to set a limit
on the total volume of bank credit and the money supply.
Reserve requirements against circulating bank notes became a part of
American banking law a century ago, and requirements against bank deposits
were introduced by the National Bank Act in 1863 and by two States even
earlier. At first each bank's reserves comprised the specie in its own
vaults. Later these reserves came to include funds which a bank might
have on deposit with another bank in a financial center.
In the course of time it became evident that reserves alone were not
an adequate protection to banks and their depositors. The reserves which
a bank was legally required to maintain were not reserves which the bank
could pay out. In other words, required reserves did not assure the ability of a bank to honor its obligations on demand. Moreover, since part
of these reserves was held on deposit with correspondent banks, their recall for meeting the demands of local depositors only transferred to the
correspondent banks the problem of raising cash to liquidate banking system liabilities. In fact, in deposit withdrawal emergencies, outlying
banks tended to rely on borrowing from their correspondent banks with whan
they maintained deposits. But these banks could use only their excess
reserves for such lending, and the scattered excess reserves of the entire banking system were inadequate when a large number of banks were
facing unusually heavy depositor withdrawals.

188
Gradually it became more clnarly understood that the ultimate safety
of bank deposits depended much more upon the availability of a. reservoir
of reserve funds, to be drawn upon in case of n-3ed, than upon legal reserves. That is, what was needed was an institution to provide additional money and reserves in emergencies; and, more important, to provide additional means of payment, undor appropriate regulatory safeguards in accordance with the growth of agriculture, industry and
commerce.
The Federal Reserve System was established primarily to meet these
needs* The Reserve authorities were empowered to issue money. They^
vere also empowered to lend to member hanks or to buy United States Government securities or. certain kinds of commercial paper in the open market, a process that creates member tank reserves in the form of member
bank deposits at the Reserve Banks. It was provided that member banks
could not legally reduce their reserves below the statutory minimum and
since excess reserves do not produce income, it vas expected that member
banks would not ordinarily keep excess reserves. The Federal Reserve
System, through its discount and open market instruments, w?s given authority to exercise a regulatory influence over the volume of deposits
which member bank lending and investing activities could create.
These facts gave bank reserves and reserve reouirements a new significance. Instead of serving largely as an individual bank's main
guaranty of readiness to honor its obligations, they beenme the moans by
which the central banking authorities exert u restrictive or expansionary
influence, as public economic interest directs, on the ability of banks
to extend credit and expand deposits.
Relationship of reserve requirements to the volume of deposits:
The two factors I have just mentioned—the volume of bank reserves
and legal reserve requirements—serve as a team to set a limit to the
total volume of deposits at any time. I shall have more to say later
about the volume of bank reserves* First, I should like to examine with
you, as I have before, the present-day role and significance of brink reserve requirements—that is, the percentages of demand and time deposits
that banks are required to hold as reserves.
At existing levels of reoerve requirements, one dollsr of reserves
will support over 6 dollars of bank deposits. Stated in another way, a
given addition to1tank reserves makes possible about a six-fold increase
in bank deposits. A contraction in reserves of a given amount tends to
produce a six-fold contraction of deposits.
The basic principle underlying this possible expansion and contraction is that bank deposits have their principal source in bank lending
and investing. If there were only one bank, in the country and if we can
assume that people hold their money in the form of bank deposits, the
bank could expand its deposits indefinitely by making loans to its customers find crediting the proceeds of the loans to its customer checking
accounts. Being the only bank, it would not need to fear loss of deposits to other banks. Those who receive checks drawn on the bonk would
deposit them at the bank* the effect would be merely a transfer of deposit ownership on the books. The only limitation on the expansion in

185
deposits would arise out of the amount of reserves in proportion to its
deposits which the bank maintained, either because of its ovn rules or
because of legal reserve requirements. At the present time member bank
reserve requirements average about 3 5 per cent of total deposits. Fifteen per cent rsserves permit deposits to expand about six and two-third
times. Thus, if there were but one large commorcial bank serving the entire country r»nd holding all the deposits of the people, its deposits
could expand to $666 for each additional $100 of reserves.
But we have not one bank but approximately lit,000 commercial banks.
Therefore, in the actual competitive situation that exists no bank can
expand its deposits by making by itself new loans and investments of six
times the amount of any newly acquired reserves* It can not do so because bank customers do not borrow with the expectstion of leaving the
borrowed funds on deposit; they borrow in order to spend, and the funds
they borrow are more apt to be checked out to another bank than to remain with the bank which lent them. Consider en illustration of how
credit and deposit expansion tends to occur, using an average reserve
requirement for all banks of 15 per cent. When a bank receives a deposit
of §100, it must put aside $15 as a reserve against the deposit and it
can lend 585. When it has done this it lias both the £100 deposit and the
§85 deposit put to the account of the .borrower. But this ?S5 will probably be transferred by a payment to a depositor of a second b&nk. The
second bank receiving the 885 deposit must increase its reserves by 15
per cent of the deposit; that is $12.75* It then has §72.25 left which
it can lend and which will probably find its way through a payment to a
third bank.
This process may continue through a succession of banks, assuming a
demand for bank credit, until taking all tho banks together a result is
reached which is the same as would be reached if there were only one
bank. That is, all banks taken together constitute a system comparable
to a single bank performing all the banking business. Deposits may shift
from bank to bank but, as a general thing, they do not ."Leave the banking
system. So, the process of lending and moving funds from bank to bank
with resulting increases in deposits and in required resenres can continue
through a succession of banks until the total of the new deposits, counting the original deposit of $100 at the first bank and the deposits created through the successive loans and investments, will amount to £666.
The reserves set aside by the banks involved will total $100, which is
the 15 per cent required against the aggregate deposit of $666.
From this illustration we may draw two important generalizations.
First, the lower the percentage reserve requirements of banks are, the
greater the volume of credit and deposit expansion a given volume of additional reserves will support and the greater the volume of credit and
deposit contraction a given loss of reserves will tend to require. Second, with our system of H,000 independent banks, legal reserve requirements at some level are an essential element in the mechanism through
which the total volume of bank credit and deposits may be brought under
some over-all control.
Reserve requirements of the Federal Reserve Banks:
I believe it is helpful for a fuller understanding of the modern role
of commercial bank reserves to contrast the significance of commercial

190
bf:nk reserve requiroments and the requirements in gold certificate reservos applicable to the Federal Reserve Banks. It needs to be recognized th&t ^sfiir as reserve requirements are concerned, as in other respects, there are important differences between commercial bunks and
Federal Reserve Banks, As we have seen, the principal present-day function of commercial bank reserves is as a mechanism through which the
total amount of money in the country may be influenced. Vhat is the
purpose or role of the reserve requirements imposed by law on the Federal
Reserve Banks?
The reserve of 25 per cent against deposit and note liabilities that
the Federal Reserve Banks are required to hold in gold certificates has
importance in connection with two major kinds of functions performed by
the Federal Reserve System. Such reserve requirements could, in a p^iod
of vast credit expansion, restrain the System from expanding Reserve Bank
credit beyond a certain point• This would then tend, to put an automatic
limit, although sometimes a high one, on the total monetary end credit ^
expansion that could take place. The System, however, does not expand its
credit irresponsibly; substantial increases in Reserve Bank credit have
been made only to meet national emergencies of depression end war. Moreover, if the System were disposed to act in an irresponsible way to expand credit in a period of inflation, it has now more than enough leeway
of excess reserves to cause very ssrious damage before itn reserve limits
would even begin to be effective.
While the limit on the expansion of Federal Reserve credit which is
set by the gold reserve requirement is not an effective or necessary device for curbing monetary expansion, it aay at some stage hinder the Federal Reserve in meeting a financial emergency. The System is the agency
responsible for assuring the convertibility of bonk deposits (and today
perhaps I should also add Savings Bends) into currency, should anything
cause the people to want to hold currency rather than bank deposits or
these other liquid assets. The System also is responsible for providing
needed elasticity in the supply of available bank reserves. The reserve
requirements on the Reserve Banks serve to limit their capacity to perform these functions. It seems to me that under the kind of a monetary
and banking system we now have, there is no reason for any mechanical
limitation on the capacity of the Federal Reserve to insure the convertibility of bank deposits into currency or to extend needed credit to member banks.
Federal Reserve influence over the volume of bank reserves;
As I pointed out earlier, two factors limit the volume of deposits
that banks may create and hold: the volume of bonk reserves, find the reserve requirements of banks. When the volume o£ bank reserves increases,
banks as a group may expand their deposits by a multiple amount; conversely, a loos of reserves tends to induce a multiple contraction of
deposits. Thus if the Federal Reserve can influence the volume of bank
reserves it can restrain or promote the expansion of bank deposits and
help to bring about their proper adjustment to the needs of the economyThere are three principal instruments which the Federal. Reserve System may employ to alter the volume of bank reserves. One meens of control has been through changes in Reserve Bank rediscount rates. When a

191
member bank has lent or invested all of its available funds, it may obtain additional reserves by rediscounting or borroving at its Federal
Reserve Bank. Although when a member bank applies for such accommodation
the Reserve Bank is under no obligation to grant credit, a member bank
with satisfactory collateral can usually obtain it. Federal Reserve policy of encouraging or discouraging borroving by member banks is expressed
principally not in the granting or refusing of loans but in the rate
charged for rediscounts and advances. 1/hen the Federal Reserve believes
that it is in the public interest to encourage credit expansion, it traditionally sets its rediscount rate low in relation to prevailing market
rates, When it wishes to discourage credit expansion, it raises the rediscount rate.
Banks, and the entire money market as well, also have access to Reserve Bank credit through Federal Reserve buying of bills. These may be
either Treasury bills or bankers1 acceptances, but the latter while of
great importance in the 'twenties are not widely usod today. The influence of the System over the extent of such access to Reserve Bank credit
is traditionally made effective by raising or lowering interest yields or
rates at which the Federal Reserve will purchase these market instruments.
Relatively low Federal Reserve buying rates encourage the money market to
sell these to the System; high rates discourage such sales. The bill
avenue has been traditionally the cheapest way to Federal Reserve credit,
arid today the Treasury bill is playing an important role in the adjustments in reserve positions made by- banks, particularly the money market
banks. Recent actions taken by the System to increase the flexibility of
market interest rates to adjust to changing credit situations may tend to
give the bill instrument an even more pivotal role in the credit mechanism.
With both the rediscount instrument and the bill buying mechanism the
Federal Reserve operates essentially passively to influence the volume of
bank reserves. That is, having set for the time its rediscount and bill
buying rates, the System traditionally awaits the action of banks and the
money market in general to seek out Federal Reserve credit. The Federal
Reserve has an active instrument of control over the volume of bank reserves in its open market policy. That is, it can enter the market at its
own initiative to sell Government securities to contract Reserve Bank
credit and to buy Government securities to expand that credit. Bonk reserves may thus be contracted or expanded by the System as it seems in the
public interest to do so.
Federal Reserve authority to change member bank reserve
requirements:
As you know, the Board of Governors has the power to vary the reserve
requirements of member banks. The basic requirements established by law
against demand deposits are 13, 10, and 7 per cent for central reserve
city, reserve city, and country banks, respectively. These may be raised
by the Board to a maximum of 26, 20, and 14- per cent, respectively. Reserve requirements on time deposits at all member banks may range from 3
per cent to 6 per cent. In August, last year, Congress, as an anti- ^
inflation measure, gave the Board temporary authority to impose additional
reserve requirements on member banks up to U per cent on demand deposits
and 1-1/2 per cent on time deposits. Under this authority, which expired
at the end of June, the Board raised reserve requirements last September,

and lowered them in May and June.

192
The instrument of changes in reserve requirements is not one that is
well adapted to frequent use for influencing the total volume of bank
credit and bank deposits. It is instead a measure to be used from time
to time as needed for contracting or expanding the liquidity position of
the banking system and for bringing the other credit control instruments
of the Federal Reserve into broad contact with the credit situation. In
the period of financial reconversion from war through which we have now
largely passed, however, changes in bank reserve requirements assumed exceptional importance as an instrument for credit and inflation control.
This was the case because the System1s other instruments for influencing
the total volume of money and credit were severely limited in use by
special circumstances arising out o? the financing of the war and the
absence of real peace after the war. Recent developments, which I shall
discuss shortly, indicate that perhaps greater emphasis may now safely
be placed on other monetary instruments and that the instrument of changes
in reserve requirements may play a more balanced role in the future.
Recent Federal Reserve Credit Action;
A year ago, when I discussed the subject of tank reserves at a
seminar session of this School of Banking, circumstances were such that
these Federal Reserve instruments for affecting the volume of bonk reserves were very severely limited in their usefulness. At that time,
with financial transition to peace-time conditions only partially accomplished and with the international situation ss it was, stability in the
Government securities market was an overriding consideration. Open market operations, therefore, were not then usable for the purpose of affecting aggressively the volume of bank reserves. For exercising some
measure of restraint on monetary expansion over the period of postwar inflation, monetary authorities were obliged to rely on use of the then
substantial Treasury cash surplus, en a modest rise in short-term rates,
and on increases in reserve requirements.
By the end of last June circumstances were such that the Federal
Open Market Committee was able to announce a change in policy which should
help to restore the effectiveness of certain traditional instruments for
influencing the volume of bank reserves. Purchases, sales, and exchanges
of Government securities are now made with primary regard to the general
business and credit situation. The policy of maintenance of a relatively
fixed pattern of rates has been discontinued, although it will continue
to be the System's policy to maintain orderly conditions in the Government security market, end the confidence of investors in Government bonds*
About the time the change in open market policy vas announced, excess reserves of member banks were expanded approximately 800 million dollars by the expiration of the special reserve requirement authority that
Congress granted to the Board a year ago. These free funds, seeking investment, pressed down the market yields on all Government securities,
but particularly short-term interest rates. After the short-term yields
had declined about 1/4 of 1 per cent it became clear that these rates
were under such pressure that further precipitous declines were likely*
and the System made short-term Government securities, largely bills,
available from its portfolio in order to avoid a disorderly market
situation.

193
In early August the Board announced further reductions in reserve
requirements, and over August and early September these reductions are
making available to member banks an additional 1,800 million dollars of
excess reserves. Short-term Government securities, again primarily bills,
are being supplied in the market from the System portfolio" so that banks
may find at least temporary investment for these funds without pressing
down short-term yields to an undue extent.
Generally speaking, the Board's reserve requirement actions coupled
with the change in open market policy of the System have had two major
effects that should help to promote the availability of bank credit at
this time. Member bank liquidity positions—that is, their holdings of
cash, excess reserves, and short-term Government securities—have been
expanded by about 2,600 million dollars* At the same time the yields on
short-term Government securities are down considerably from what they
were in the early summer, and accordingly the attractiveness of these investments is much reduced as compared with say a loan to a business concern or to a farmer. I should also mention the fact that the Reserve
System is no longer freely selling Government bonds to keep their yields
from declining. With the adoption of this policy by the System, pressure
of market forces brought about a decline in yields on medium, and longterm Government securities, with an accompanying tendency for investors
to seek corporate and municipal securities as outlets for the funds they
have available for investment. I believe that these credit actions by
the Federal Reserve have had some influence in making the current economic
situation somewhat more favorable than in general it promised to be a
few months ago.
How should the burden of holding reserves be distributed
among banks?
In order to keep the volume of money in the country at a level which
is appropriate to economic conditions, we have seen that under our banking system it is essential that banks be required to hold reserves, and
that the Federal Reserve be able to influence the volume of reserves arailable to banks. At any given time, there is an appropriate volume oC total
reserves that banks as a group need to hold to promote monetary stability.
But bank reserves are immobilized assets that cannot be loaned or invested
to earn an income. The required reserves which an individual bank holds
represent, therefore, a contribution which the bank makes to effective
national monetary policy. The basis or principle for allocating the total
burden of holding required reserves as among different banks thus becomes
extremely important.
The Federal Reserve System has studied the problem of allocating the
reserve burden among banks for a long time. As you all doubtless know,
the existing statutory basis for member bank reserve requirements dates
back to the establishment of the National Banking System over 85 years
ago. The requirements are related to the geographic location of the bank.
That is, a bank's classification for reserve requirement purposes depends
on whether it is located in a central reserve city or in a reserve city,
or whether it is outside of these cities—a so-called country bank. A
member bank located for example in a reserve city must under this scheme
hold reserves at the higher percentages designated for such a center
whether or not it is doing a reserve banking type of business. Another

19k
member bank doing a reserve banking business but located outside the reserve city areas need hold on3.y country bank reserve requirements. Prom
time to time the Federal Reserve has boen able to relieve some bonks in
reserve cities of a discriminatory reserve burden through its limited
discretionary authority relating to outlying nreas of reserve cities. Hut
many cases of inequity cannot te solved in this way and a basic problem
of equity of reserve requirement treatment as among mer.iber banks still
remains.
There is also a fundamental problem of equity as between mer.iber end
nonmember banks, where the differences in treatment are frequently very,
very vide. Certainly fron the standpoint of the reserves it must hold,
the average nonmember tonk is now making a disproportionately small contribution to monetary stability. The nonir^mber bank not only is subject
generally to much lower reserve requirements, but it is also permitted to
hold its reserves at correspondent city banks where they serve a double
purpose—both as legal reserves and as a needed correspondent balance. A
member bank holds both a reserve balance in its Reserve Bank and balances
with its correspondents. Further, the actual contribution to monetary
control of a reserve balance held with a correspondent bank is only equal
to that fraction of the balance which the correspondent bank is in turn
obliged to hold with its Reserve Bank, since the correspondent bank is
free to, and usually does, invest or lend the remainder* In sone states,
moreover, nonmember b&r.ks are permitted to invest a portion of their reserves in interest bearing public securities. Discriminatory treatment^
in favor of nonmember banks as far as reserve requirements are concerned
tends to weaken the ability of the Federal Reserve to promote proper adjustment of the volume of money to the needs of the economy. The large
difference in the requirements tends to discourage banks from joining the
System, end could result in weakening the System by encouraging banks to
withdraw from membership. It is difficult to see the justification for
discrimination of this kind.
Uniform Reserve Plan;
As I said a year ago at this School of Banking, a staff committee
of the Federal Reserve System has developed a plan for rationalizing
existing practices for distributing the reserve requirement burden among
banks. They have called the plan the Uniform Reserve Requirement plan,
and at the request of the Joint Committee on Economic Report of Congress
they presented to that Committee the results of their study. The suggestions of the Federal Reserve staff group are in the discussion stage
and have no official status in the System. I find the ideas in the plan
very interesting, however, and I should like to tell you something about
them. The plan deals only with member bank reserve requirements, but if
it is adopted it could be, and I believe certainly should be, extended
with appropriate modifications to cover all commercial banks.
The Uniform Reserve Requirement plan consists of five basic points.
These have been described by the chairman of the staff committee that
developed the plan as follows:
First, the plan would abolish central reserve city and reserve city
designations of banks. In other words, the geographical basis for the
assessment of reserve requirements would be dropped as too inequitable as

among banks which are doing various kincis of coraiaercial banking business.

The second point of the plan is that, for purposes of reserve requirements, deposits would bo classified into interbank deposits, other
demand deposits, and time deposits. Many a theoretical hair has been
split in disputes over the classification of deposits. The compelling
practical objection to treating all deposits alike is that, depending on
the level set, starting such a system vould create enormous excess reserves in central reserve city banks, enormous deficiencies in non-reserve
city banks, or both. The compelling practical objection to a full system
of deposit classification is that it would be impossible to administer,
since any classification of deposits is somewhat arbitrary. Advantages
given for the proposed classification are that, by and l?^rge, the three
classes of deposits are used for different purposes, are readily identifiable, have traditionally been treated differently, and differential
treatment would minimize initial disturbances while yet retaining effective over-all control. The staff committee recommended that initial
requirements be established at 30 per cent against all interbank deposits,
20 per cent against other demand deposits, and 6 per cent against time
deposits, which would have left the total volume of reauired reserves at
about the level existing at the time. (Slightly lower requirements would
be appropriate of course should the plan be adopted now.)
The third point of the plan is that the Federal Reserve should be
given authority to chnnge the requirements within limits established in
the law, We have already discussed the use of chonges in reserve requirements from time to time in order to help prevent injurious credit expansion or contraction. This is a modern instrument of central banking
policy which is discussed with approval in virtually every textbook on
money and banking.
As a fourth point, banks vould be allowed to count vault cash as
part of their legal reserve. The role of vault cosh in the banking system has changed fundamentally in the past half century. Before the Federal Reserve System was established, vault cash was the ultimate reserve
of the banking system, since it alone was available to meet cash withdrawals. The Federal Reserve Eanks, however, are authorized to create
additional reserves or cash when needed. The use of vault cash as reserves would not impair the System's influence over the volume of bank
credit, provided initial requirements are established at appropriate
levels to offset the change. From the point of view of credit control,
there need be no concern as to the form of Federal Reserve Bank liability—
whether it be Federal Reserve notes or reserve deposits—that a member
bank prefers to hold as reserves. The transition to the new system of
reserve requirements would be facilitated by permitting banks to count
vault cash "as legal reserves. Establishment of the suggested uniform requirement against other demand deposits would increase required reserves
of country banks. Since, however, such banks hold relatively larger
amounts of vault cash the increase in their total requirements vould be
offset in part by permitting them to count vault cash as legal reserves.
The fifth and last point is to permit a bank to count as reserves
that portion of its balances held at other banks which those banks, in
turn, are required to hold as reserves against such balances. ^The relationship between correspondent balances and reserves is a problem with a
long history. After many ciscussions the staff concluded that correspondent balances ought to be related to reserves in such a way that (a) a

shift of funds by member banks into or out of "due from tanks" would not

196
affect the total volume of excess reserves in the system as a whole;
(b) "reserve credit" would be allowed for precisely the portion of "due
from banks" that is on deposit with Federal Reserve Eanks (by way of the
reserve requirement imposed on depcs.its due to br.nks); and (c) correspondent bank relationships and interbank Valances vould be recognized
as an established part of our banking system. Tae fifth point is designed to accomplish this result. So lor.;* as the rate at vhich the
"country" bank or the reserve city bank is allowed reserve ciedit for
its "due from" balances is equal to the rate at which depositary banks
are required to maintain reserves on interbank deposits, a given reserve
will support the same volume of nonb&ak deposits irrespective of whether
the ouner-tenk k-sups all of its reserve with its Federal" Reserve Bank,
or keeps a portion of it on deposit with a correspondent and therefore
indirectly with a Federal Reserve Bank. In eithei* case, only vault cash
and balances which are directly or indirectly on deposit with Federal
Reserve Banks would constitute legal reserves.
The analysis of the Uniform Reserve Plan may be summarised as
follows:
Reserve requirements are an essential feature of the mechanism by
which the volume of money and credit is adjusted to the needs of the
economy but the present system of reserve requirements is frequently inequitable; required reserves of many banks are higher or lower than those
of other banks doing a similar business simply because of the classification of the communities in which they are*located. The uniform system
of reserve requirements would require all member banks, or preferably all
commercial banks, regardless of location, to maintain the same percentages of reserves against each of the three major classes of depositsinterbank deposits, other demand deposits, and time deposits• Eanks
whose business requires the holding" of disproportionately large amounts
of vault cash would no longer be penalized by being required to maintain
the same reserves in Federal Reserve Banks as other banks doing a similar type and volume of•buoiness but whose cash requirements wore less.
Changes in the total volume of interbank deposits would no longer affect
the volume of other deposits of member banks that could be supported by
a given volume of reserves. City banks would have to maintain larger
reserves than now against balances due to country correspondents, but the
latter would be given corresponding credits for such balances against
their required reserves• The uniform system would increase the required
reserves for some banks and lower them for others, but the changes would
be reasonable and in the direction of greater equity.

197
Speech delivered before
National Association of Bank Auditors and Comptrollers
Bellevue-Stratford Hotel, Philadelphia, Pennsylvania.
October 24, 1949
MONETARY MANAGEMENT ABROAD AND AT HOME
There are many. clifferent attitudes toward the role and importance
of what is called monetaiy management. If we assume that money lo'-us the
way 5.n economic development, then the administration of Money is about
the iiost important task of government. On the other hand, if we assume
that money follows rether than leads in economic change, then the function of r.:onetaiy management is to keep money in its proper and subordinate place. If ve assume that the function of r4oiiey in the econorry
lies somewhere between these two extremes—probably the moro correct view
to take—then the monetary policy is one of several important factors
that influence the course of economic development and the degree oi*
stability which characterizes such development.
Monetary Postwar Problems
There is general agreement today, I believe, that monetary aanagament is essential to economic stability. And for good reason. Ve have
recently passed through an extended and disruptive period of world-wide
war. Like all major vars in history, the second world war was partly
financed by the creation of money—in short by inflation. Since the.war,
all the major participants have been seeking to adjust their economies
to swollen money supplies. They know from hard experience that at?-.bio
progress is impossible when economic activity is driven and distorted by
inflationary pressures«
Attainment of postwar financial stability lias been difficult enough
in the United States. But our wartime monetary expansion, although
dramatic, was moderate in comparison with that of tho war ravaged countries of Europe. Also, our productive capacity was not subject to wartime destruction and our output is now greater than it was before the
war. Consequently, ve in the United States were subjected to neither
unduly repressive postwar measures, like i.ricc controlc or ro.tloni.ng, nor
excessive open price and wage inflation. The problem of dealing with
raonetaiy expansion becomes extremely difficult only when accompanied by a
sharp drop in the available supply of commodities, such as occurred in
most countries of 3urope and the Far East.
After the first world war, in n-ost countries of Europe, Monetary
management had been confronted with a similar situation. It took :r.ore
than half a decade to restore some kind of nonetaiy stability in the most
important countries of Continental Europe. That stability was l-enched
only after a number of nations, and especially Germany, had experienced
uncontrolled hyper-inflation that reduced the value of money almost to
zero. By comparison with the events following the first world war, the
results of monetary management following the second world war have been
very good indeed. This tine, inflation was curbed in most countries
within three years after the end of hostilities, and there are reasons
for believing that postwar inflation has been curbed for good.

198
Monetary Stabilization in llestern Germany
The most noteworthy example of success in monetary stabilization is
that afforded by Western Germany. In that countxy wartime government expenditure had expanded the supply of money to about ten tines the amount
that would have been needed under normal economic conditions, and perhaps twenty times the amount consistent with the level of economic
activity actually existing immediately after the war. llestern Germany's
currency reform of June 1948 reduced tho existing supply of money by
more than 90 per centj most holders of currency and bank deposits received
only one new mark for 16 old ones. Economic activity picked up imacdiately. Previously, with money virtually worthless, incentives for harder
work and better nanagenent wore almost entirely lacking. Restoration or
a sound monetary systen provided fresh incentives for both, raising the
level of production by two-thirds within less than a year.
llhile Western Germany still has a long way to go to complete economic
recoveiy, the standard of living of its population at present is probably
not appreciably lower than that of other Western European countries.
Furthermore, the country is well on its way to becoming again a leading
industrial nation, aid should be able to contribute to the general rehabilitation of Continental Europe. Monetary stabilization, of course,
was not the only reason for that sudden change. Stabilisation was
accompanied Xrj a radical reduction of government restrictions of economic
activity and by subctantial grants under the European Recoveiy Program.
Without financial stabilisation, however, action to decontrol would have
been impossible and our economic aid would have been largely squandered.
Monetary Stabilization in France and Italy
In a less spectacular way, similar developments have taken piece in
France and Italy. In both countries, monetary over-expansion had been
about as bad as in Gernany, but the economic consequences were less disastrous, mainly because controls hampered econonic activity less seriously.
In Germany, inflation was "repressed"; that is to say, effective controls
prevented prices and wages from rising. In France and Italy, inflation
came more into the open; the authorities were unable to keep prices stable.
The continuous rise in prices hampered the revival of production less tii£-n
the "repressed" inflation of the kind that prevailed in Geinany. However,
the rise in prices impaired the competitive position of French and
Italian export industries in world trade and thereby intensified balanceof-paynents difficulties. These difficulties, arising from having to pay
more foreign exchange to other countries than was received from them,
have plagued all European countries since the war.
In France, postwar inflation was stopped after the aiddle of 1948.
This was accomplished in part by restrictive credit policies and by fiscal
measures; in part it reflected the effects of a good harvest. Between
that period and the middle of 1949 industrial production rose by about 25
per cent. In an even more decisive zaoveiient, the volume of exports rose
by 40 per cent while imports remained approximately constant/ As a result, the deficit in the balance of trade was cut to one-fourth, fron a
monthly average of §110 million in 1948 to $28 million in the summer of
1949.

199
In Italy, financial stabilisation was virtually achieved in 19'V7,
as the result of the strict monetary policies of the government. Uetween 194-7 and 1948 the volume of exports increased by 40 per cent, with
imports regaining constant. Thus the excess of imports over exports was
cut in half, from 0300 million to g/f00 million per year. In both countries ERP assistance was essential to bridge tho regaining G a P a n J v a s
helpful in blocking further inflation; but that aid would have been
largely dissipated if it had not been accompanied by financial stabilization •
Monetary Difficulties in the United Kingdom
An example of a different kind is provided by the United Kingdara.
The economic situation in that country, which is niore dependent than any
other upon foreign trade and international finance, is too complicated to
permit easy generalization. Few observers doubt, however, that the repressed inflation from which the country has been suffering sirice the
end of the war has played an important role in its econonic difficulties.
Between 1938 and 1946, the supply of money in the United Kingdom rose
about three times as much as prices and wages, while production remained
virtually unchanged. A large inflationary potential thus regained unabsorbed and made necessary the continuation of stringent wartime controls. Between 19/+6 and the present, production increased by one-third.
Even so, upward pressures on prices and wages remained a factor disturbing not only the possibilities of domestic progress but especially the
prospects of attaining a balance in Britain's international trade.
The inflationary situation in Britain, as usual, reflected an excess of consumer capacity to buy over the available supply of commodities
and services at prevailing levels of prices. As a result, there vas a
particularly strong demand for iraports and for the domestic use of exportable goods. Since a hard core of imports is essciiti&l Tor the very
existence of the British people, Britain has experienced great difficulties, despite stringent controls, in keeping imports from rising. At
the sane tLae, the country lias beon confronted by a growing inability to
meet the competition of other exporting nations on foreign Harl:ets3. As
long as the world-wide scarcity of goods was so pressing as to permit
the sale of virtually any exportable surplus, there was no serious problem cf finding markets for exports. When the world export boom beg^vn to
slacken, however, the rise in" exports which had been the just prirlo of
Britain's econonic management Glowed down arid exports to tho dollar area
fell substantially. Unfortunately, it was impossible to bring about a
drop in imports. The balance-of-trade difficulties and the so-called
dollar shortage in the countries that use sterling currency (the sterling
area) thus can be at least partly explained by the difficulties which
the United Kingdom encountered in its effort to stabilize its domestic
nonctary system.
Change in Dollar-Sterling Rate
Repressed inflation in the United Kingdom was a very important element in precipitating the recent wave of currency devaluation, v/hat
happened may be explained this way. It wes impossible, as a natter of
practical politics, to adjust the swollen domestic money incomes plus the
accumulated buying power in the form of liquid asset holdings to the

•200
available supply of real goods end services—either
by cutting down the
volume of r.;onoy through a currency reform ol1 the German type, or by
peraitting the price level, but not the wsge level, to rise as in France
and Italy. Therefore, the only c:lterne.tive for Britain was to reduce the
entire r.-onetciry level of the donestic econorny in relation to world i*iarket prices by curtailing the va3.ue of the domestic currency in terao of
the world's nost" stable currency, the U. S. dollar.
Re-establishment of Britain1s international balance may be achieved
through the effects of this action on imports and exports. On the import
side/the rise in the donestic price of dollar imports :.iay keep dollar
imports down by increased reliance upon the market mechanism rather than
by arbitrary and disturbing rationing. In other words, people will buy
fewer imported goods because imports have become too expensive, not because of Government.controls. On the export sie'e, the main result ic an
inducement to producers in Britain and throughout the sterling area to
divert a larger part of their total production to the export market at
existing dollar prices. In other words, since the equivalent of say 100
dollars now yield3 about 36 pounds to the British producer, instead of
25 pounds, exports to the dollar area have become more profitable. Moreover, by increasing the margin between costs.and prices, devaluation makes
possible more aggressive competitive efforts, including price competition.
British domestic costs have been cut, if not in comparison to British
prices, at least in relation to international dollar prices. It is true
that these results might be endangered if British labor were to insist on
increasing wage rates in proportion to the devaluation, or if increased
taxation counteracted the incentives for management to raise exvorts.
But if a substantial rise in British domestic costs is avoided, there is
indeed hope that devaluation may contribute towards the realisation of
British financial stability.
It is pertinent to observe that r.iany other countries decided to join
the British in devaluation, including such countries as France and Italy
which had already curbed the danger of inflation. If they had not so
joined, the improved competitive position of the British exporters would
have threatened the success which* French and Italian anti-inflationary
policies have hrd to elate. In both countries, monetary stabilization has
been too recent and is still too precarious to withstand great shocks.
This development indicates plainly how problems 01 financial stability
in one country affect not only that nation itself but the entire vorld
econory.
Problems of Sucessive Monetary Stability: Supply and Composition of Credit
Recent European monetary experience gives a-nple proof, I think, of
the crucial role that attainment of financial stability Liust pL?.y in economic rehabilitation. It further shows, in iny opinion, that curbing of expansion in the money supply does not complete the task of monetary :uanagoment. Two additional problems are particularly important.
The first problem grows out of the danger that too greet a stability
in the supply of money and credit may lead to recession, or at least to an
unwarranted slowing down of econoinic progress* An expanding econoiny needs
an expanding supply of money and credit, and the lack of necessary expansion may bring about a deflationary situation.

201
The second problem relates to the fact that not only the quau bity
but also the composition oi\credits affectc an economy's progress. It
often happens that short-tern credit is ample but long-term credit insufficient. In that case, the oversupply of short-terra credit may lead
to inflationary symptoms in some parts of ths economy while the scarcity
of long-ten1:] credit may lead to recession in other parts.
Deflationary Tendencies in Western Germany and Italy _
So::ie observers believe that in V/estern Germany and in Italy Monetary nsanajonisnt has recently ovor-enphr-sized tho objective of stability
of the money supply, and that the -gains of stabilization may thus have
been jeopardized to sone extent. Tliese two countries have received high
praise because of their management of money and credit. Eotli nations
have been cblo to end a period of inflation without catastrophic disorganization of their economic structures. In both countries, however,
some recent tendency toward a slowing down of recovery and a reenergence of unemployment has appeared.
In neither of these countries covud this tendency be ejzpiainud m&inly by ultra-prudence in monetary nana^c.iiont. Italy iiay suffered fron
overpopulation for many years,, and unless it finds new ways of utilising
its excess manpower, the problem probably will not be solved e-:cent by
large-scale emigration. Just for that reason a rax;id rate of industrialization is extremely important to Italy's further recovery. Weather
conditions, affecting the supply of hydro-electric power, i-iay also to
some extent be responsible for temporary stagnation. Sone critics contend, however, that the disinclination of the central banking rarthorities to refinance sufficient credits bears a siiare in tho responsibility,
and that as a result of this policy, Italy ho.s not been able to utilise
all the possibilities opened by the aid granted under EH?.
The situation is similar in Germany. After the tstcnishing success
of the currency refoivi of June 19/^i, production moved at a breath-taking
pace until March 19/.9, when it reached 90 per cent* of 1936. By that time
the fear of renewed inflationary developments had induced the central
banking authorities to concentrate upon the struggle against overexpansion of money. Monetary mana^eiriont, aided by other contributing
influences, indeed succeeded in preventing inflationary tendencies during
the fall of last year from developing further. But industrial production
soon stopped its rise and did not reach the Larch level again until
August 1949. Unemployment increased to more than 1.2 million, or 9 per
cent of the employed labor force.
As in Italy, tho rise in unemployment in western Germany is attributable in large yart to causes which could not be remedied cry monetary
management. The inflow of 3 nillion refugees from Eastern Gerriany has
disturbed the balance of the population, and unemployment is particularly
strong in thoee areas in which Ihe refugees have settled. So:.ie analysts
believe, however, that not more than one-third of the total unemployment
could be explained in this way and that it would help to eliminate at
least part of the remaining two-thirds if appropriate credits were being
available to German industries.
The managenent of the Geruan banking system has good reasonsto

202
beware of credit policies tlu-t might again bring about the aL
trace of now inflation. In view of the extrenely unstable domestic and
international political situation in Gottjany, however, the recent rise
in unemployment, with its accompanying social tensions, is particularly
dangerous, Ite-emergence of the specter of unemployment that haunted
Geruany in the thirties -.night sooner or later lead to an overthrow of
the present administration and to dangerous monetary experinmts. On
the other hand, the recent development may be nothing xore serious ti'ian
the inevitable consequence of the transition from an inflationary to a
reasonably balanced situation•
Long-term Credit Problems in Western Germany
The example of Western Germany also shows the importance of the
composition of the supply of new credit, Host economists agree that
lack of sufficient investment is frequently the cause of unemployment.
Often the insufficiency of investment is duo to lack of opportunities for
profitable expansion, or to a scarcity of manpower and natural resources:
but under present conditions it is often ascribable to the lack of longterm credit. In countries which suffered fron wartime destruction ani from
inflationary developments in the postwar period, private savings—which
normally form the basis of long-terra credit funds—are generally at a low
level. The gap therefore has to be closed either by the banks with the
help of the central banking system, or by public authorities. Large-scale
creation of long-tena credit by the banking system is generally considered
to be unsound and unsafe banking practice. It has inherent dangers of
inflationaiy over-expansion and is likely to be followed by a period of
contraction, ncde more difficult by frozen bank assets. Large-scale credit
creation by public authorities usually either has inflationary implications (if based on deficit finance) or requires that taxes be maintained
at, or increased to, very high levels. But high taxation tends further to
reduce private savings and investment. Both methods have to be used with
the greatest caution, and are at best poor substitutes for the formation of
capital out of private savings.
In Western Germany the" central banking authorities have been extreme!/
reluctant to extend rediscount and similar facilities to lon£-ters credit
institutions. Very recently, the central banking system, after long deliberation, has been permitted to refinance 300 million narks, or about i>12
million, of medium and lon^-term credits, but this sun is very small in relation to needs. The Reconstruction Loan Corporation, which has the function of financing investments, lies so far received loan applications for
7-4 billion marks, but has been able to grant loans of only 0.4 billion.
This situation has led to an increasingly largo role by public authorities
in financing new investment, largely out of current tax revenues. The
prominence of government financing contrasts heavily with the intention of
the German government to return as fully as possible to a free economy
based upon private initiative, lloreover, the government itself has
recognized that the existing level of taxation is a serious obstacle to
further economic progress, sapping incentives for both labor and investment. The only part of public investment that is not based on taxation
utilizes the so-called counterpart payments, namely the payments received
by the local government from purchasers of goods imported by means of U. Said. These funds, however, can be invested only according to a program
which has to be approved by our Economic Cooperation Administration.

203
Accordingly, the release of these funds is a complicated process. Counterpart funds, moreover, will not be tvailablo after the end of tbo
European Kecovery Program. Reostablishrient of a well-functioning
donestic capital market is thus one of the moot important goals of fiscal and credit policy in Geminy, as it nuat also be in many other
European countries which seek to recover frc:a the distortions caused by
the recent war.
Long-term Credit Problems in Low Countries
Another example nay help us to understand the importance of the
problem of long-term credit utilization. Bel/jium and the Ilotheriamis
are two neighboring European countries very similar in si&e, population,
and economic, social, and political conditions. Hot long after the war,
they reached an agreement to form an economic union. Since then, their
econonic fates have taken veiy different turns. It is true that a large
part of these differences may be explained by events beyond their control. Belgium was liberated in 1944 and suffered very little wcv dvsaage
while the Ilntherlands was liberated
nany months latex* raid only after
heavy destruction. Belgium1 s colonial possession, the Congo, re:::a.i.ned
under Allied administration throiighout the war and in postwar yoars has
become extremely prosperous. Indonesia, the main overseas territory of
the Netherlands, was for many years under Japanese domination and hes
been ravaged by civil war ever since the end of tha Japanese rule so
that it has become a burden rather tiicn an economic advantage to the
nother country, iiorecver, the Netherlands has been hit far inore severely
tlian Belgium by the impoverishment of Gemany, with which it had very
close econonic ties.
It is therefore not surprising that Belgium has recovered nore fully
and more rapidly than the Uetherlande. To some extent, however, the
difference in development also may be due to a different course of
economic and financial management. The Belgian £.u •horities promptly
adopted a successful currency reform in 1944, which set the pace for all
other Western European attempts of that kind and also permitted Belgian
industry to become geared to the satisfaction of consumer demands rather
than to a high degree of investment. The "otherlands1 authorities, on
the othor hand, enbarked on one of the most ambitious investment programs
of Continental Europe, destined to overcome as rapidly as possible th3
destruction caused by the war and also to provide for a rapidly increasing population.
As a result of all of these factors, Belgium soon was able tc regain
a higher degree of financial stability than ?.:ost of its neighbors and to
dispense with virtually all wartine controls of private econonic activity. As in so n-any other countries under conservative financi.il :nanr.gemont, however, there have been some recent signs of slackening progress
and rising unemployment. These developments rcay be interpreted either
as reflecting deflationaiy troubles or as indicating a transition to a
normally balanced economy. In any case, the Belgian currency is today,
next to the Swiss franc, the most coveted jjuropetn currency.
The Netherlands, on the other hand, has been confronted with great
difficulties in meeting the capital requirements of its investnent program and has felt compelled to retain a systeri of strict government

20U
controls over nost phases of its economic life. Furthermore, it lir.s boon
allocated a very large aiiount of aid under the European Recovery Program
while Belgium not only has not received any net assistance but has undertaken to provide credits for less fortunate European nations. Despite
that aid the Netherlands must still follow a policy of strict austerity
and has shown until recently familiar symptoms of repressed inflation.
Advantageous as its large investment program may prove to be in tho long
run, it certainly lias outrun the country's capital resources. Only as a
result of truly heroic efforts have the Netherlands people in recent
months come somewhat nearer to internal and external financial stability.
Conclusions: Monetary Problems of the United States
Lot us now recapitulate the results of our hurried review of monetary roanagraent in Europe* The example of Western Germany, France, Italy,
and Belgium has demonstrated the overwhelming importance of financial
stability for achieving and maintaining prosperity. The case of the
United Kingdom has shown us iiow fundamentally a financial disequilibrium
in a major country affects the international financial relations of the
entire world. However, the examples of Uestem Germany, Italy, and
Belgium have indicated the necessity for supplementing stability by the
guaranteeing of a steady flow of credit so as to avoid the danger of
interrupting economic growth. Finally, the development of Western
Gernany and the Netherlands has shoun the special importance of a sufficient supply of long-term credit as a source of expansion and progress.
Each one of these countries hes tried to solve its problems in a
different fashion* I am anxious to emphasize that EQT discussion of these
differences should not be interpreted as criticism. Every government
must deal with a complex social and political situation, and a policy
that seens best to the outsider may be impossible to pursue. The danger
of inflation, for instance, appears in a very different light in Gennaiy
after two hyper-inflations in one generation, and in Britain, where the
currency has never become worthless. France, which has also suffered
from inflation in the past, nevertheless seems to prefer inflation to
government controls, in contrast to the Netherlands, which has not had a
serious inflation. Ilhile the problems themselves are the saae the l/orld
over, the solution tliat would be right for one country night be wrong
for another.
It remains only to consider very briefly the application of these
results in our own country. The United States, like all other countries
involved in the second world war, had to finance the war to a large extent by inflationary methods. Postwar readjustment of our economic system, despite the vast monetary expansion during the war, has been greatly
facilitated not alone by our tremendous productive capacity but also by
the high degree of public confidence in money and Government bonds and
the willingness of the public to hold large amounts of these assets as
liquid reserves. This willingness to hold licoiid reserves psraitted a
rapid reconversion and a tremendous increase in civilian output during
the years following without completely upsetting our price system. Ue
are all aware that we did have a substantial rise in prices and wages,
but it might have been nuch greater if monetary management had not taken
measures to keep the inflationaiy tendencies under control*

International Aspects of U. S. Monetary Management
Domestic uonetary ;:ianage-.-ent in this period could not concentrate
exclusively upon our donestie problems. Ths United States could reestablish a lasting prosperity only in a world which in turn enjoy3 a
reasonable decree of stability and prosperity. It was therefore- vital
for the success of our own financial reconversion fro.~i war that we aid
in tho rehabilitation of tho chief trading countries of the world. To
this end, we made very substantial-loans and grants to European and Far
Eastern countries. Moreover, in order to ensure the adequate utilization of these loans and grants, we had to interest ourselves in the
problems of domestic financial stability of the countries to which we extended our aid.
Our influence upon financial developiaents in foreign countries rests
in considerable part upon our voice in the use of the counterpart funds.
These funds represent the payments in local currency nade by the purchasers of the goods Imported under our relief pro^rons and especially
under the grants of tho European Recovery Progr&n. The counterpart funds
are locally the property of tlie local governments. Eut the govenments
are pledged to dispose of there only with our expressed approval. In
many countries these funds are large enough so that decisions as to their
use or non-use have fundamental effects upon financial stability, expansion, or stagnation.
In these decisions we are confronted with the vory jjroblen which was
tho main subject of our discussion, nanuly the choice between insisting
upon strict stability in the supply of raoney or permitting a moderate
expansion. In the first case, we nay invitu stagnation. In the second,
expansion may go too fr.r an.-! end in an inflationary spiral. TJise decisions involving the use of counterpart funds can claim sor.e credit for
stopping inflation in Europe, but difficult questions rei-iain to be solved
in countries now threatened by a stoppage in progress and by rising unemployment.
Domestic Aspects of U. S. Monetary Management
To a lesser degree, these saiae problems confront -uonetery r.ana(jeneijt
at hone. The threat of inflation, which darkened our economic pvospocts
in the prosperous years fro* 194-6 through 1943, was followed by a slight
downtrend in our economic activities, which bogan in tho wintor of 194U4-9. This downtrend, however, nay be hailed as a necessary and inevitable
readjustment. The pent-up denancl for goods and services that had noi
been available for many years was bound to disappear. Labor and management have been noting adjustment to a more normal level of de.a?.nfif ontailing a reduction in output said prices that :*ad risen out of proportion
to the development of the econorqr as s. whole. The supply o.C uoney has
been more stable between the middle of 1943 uid tlio middle of 1949 tir:.n
at any other time since the beginning 01 the second world war.
It is true that uuring the pact twelve months our industrial production declined by 1?. per cent and the number of our unemployed, although still at a low level, was almost doubled. In recent nonthc,
however, an upturn in sales and in production has been evident, although
output is n w * being curtailed by strikes. Tho devaluation of many

206
foreign currencies nay pose sone short-run problens in our international
trade before its lone-run benefits beccxio apparent. These facto indicate
the difficulties of the task with which we are confronted.
Froia our domestic as veil as our foreign e::perience it lias long boon
recognized that the objective of monetary inanagenent nsuct be to regulate
the supply, availability, and cost of aoney with a view to contributing
to the isaintenance of a high level of employment, stable values, and a
rising standard of living. Economic progress involves the absorption of
an ever-increasing number of vorkers together with an ever-increasing
productivity per worker in a way that will not le::d to unsustainable expansion. Monetary management alone cannot achieve these results, but
without monetary iiiana^er.ient they are not likely to be reached at all.
The United States is at present the leading country of the free
world, both because of its material resources and because of dogged adherence to the principles and practices of free enterprise. Our economic
fate vill deteiTvine the economic and political future of nany other
nations. Me muct achieve steady economic progress, without inflation or
serious depressions, not only for our o^/n sake but also to roiniorce the
faith of the rest of the world in the economic and social principles for
which we stand.

207
Speech delivered before
Midwest Conference of the Robert Morris Associates
Sherman Hotel, Chicago, Illinois
December 9, 19h9
WHAT DOES A CREDIT MAN THINK ABOUT ODAY?
One thing I fm not going to do is try to tell you how" to run your
business. Capable credit men need no such advice—and the others
wouldn't take it anyway. A good credit man knows the many elements to
be considered in granting a loan and he knows that he cannot afford to
overlook any one of them in reaching his decision. Something of little
importance today may, because of rapid economic and other changes, be
of first importance tomorrow.
You members of the Robert Morris Associates are well aware of the
need for evidence of the borrowers integrity, for assurance that the
money he borrows will be employed for provident and productive purposes,
and for reasonable certainty that the loan can and will be repaid upon
the terms and conditions granted. You know that your advice and counsel
must accompany many loans if the credit is to be used to best advantage.
You are aware of the dangers of relying too heavily on the continued
success of any one industry or enterprise, and of the need for diversification in your lending activities. In short,
you know the many angles
to this business of lending other peoples1 money to other people, and
you are endeavoring to consider all of them in an effort to protect
your depositors, to provide a fair return on the investment of your
stockholders, and to assure the maximum sound productive use of credit
in your community.
It is not my purpose this evening to review the many detailed considerations that enter into the granting of a loan. Rather, as a
native of this city and former associate of yours, I should like to discuss some of the broader problems of national and international credit
policy with which I have been conversant for the past 16 years. In
today's world, the conduct of economic affairs at home and abroad is
greatly influenced by considerations of social responsibility. In the
interest of the greatest good for the greatest number we as a nation
have set ourselves the task of maintaining high employment, stable
values, and a rising standard of living.
The att;dnment of these national economic objectives, in view of
the growing complexity of our economy, gives rise to many perplexing
problems. Considering the essential role of credit in our highly
specialized system of producing and distributing goods and services, it
is not surprising that these problems are a matter of concern to each
and every credit man in our country.
The Robert Morris Associates deserve high praise for publicizing
the essentials of constructive credit policies and for encouraging and
facilitating the exchange of information and ideas among credit men.
The Associates1 financial statement studies, which are continually being
enlarged and refined, have provided members with standards of comparison
that are extremely useful in analyzing and evaluating particular loan
applications, and in detecting changes in business financial structure.

208
Through its ..lorrcnly )3ulJ etin and meetings such as this, the Robert Morris
Associates are encouraging" that sort of thoughtful analysis essential to a
sound solution of our many problems and to the realization of our economic
goals.
The Role of Credit and Credit Institutions
V.'e all know that an adequate supply of credit at the right place, the
right time, the right cost, and the right repayment terms is essential to
the smooth functioning of our economy. Thers is hardly an individual, a
business man, a municipal or state government, or a national government that
doesn't need credit fro-n time to time. In order to meet these varied needs
for credit, different t;/pes of lending and investment institutions have
been developed. Some, liko the coiranercial bank, evolved in response to a
need for short-term business credit; others, such as the savings and loan
association, were created for the purpose of supplying special types of
longer ter:a credit. Still others," such as mutual savings banks and insurance companies, have, in recent years, turned to lending and investing
funds normally supplied by commercial banks. The commercial bank, however,
is still pre-eminent in the field of shorter-tena credit. It must, because
of the high proportion of its demand to its total liabilities, concentrate
on shorter-term credit. In contrast, life insurance companies, the
majority of whose obligations represent lifetime contracts
with policyholders, and mutual savings banks, which hold, peoples! savings, are able
to extend credit for longer periods through the purchase of long-term bonds,
obligations secured by real estate, and other investments of a long-term
nature.
V/hile the demand character of much of their deposit liability largely
restricts commercial banks to short-term lending, member banks can, if confronted vdth unforeseen deposit withdrawals, obtain funds from their lieserve Banks. In its capacity of lender of last resort, the Federal Reserve
System has introduced a much greater degree of flexibility into coranercial
bank lending than previously existed. In this respect, the powers of the
System were broadly expanded in 1935* Banks can now grant loans without
fear that tomorrow or the day after they may1 be forced to liquidate them
on short notice in order to meet depositors demands. On the other hand,
we recognize that certain types of credit extension are not for commercial
banks—among them, purchase and lease of business properties and investment in equity shares. In other words, the role of the commercial bank
should continue to be largely that of provider of short- and medium-tern
credit to business corporations, unincorporated enterprises, farmers,
consumers, home owners, and all levels of government."
In this connection, I should like to say a word about public lending institutions that provide emergency financial assistance to banks
and business. I think most crecJit men would agree that Government
competition in the field of direct lending is undesirable if private
lending institutions can provide the amounts and types of credit needed^
On the other hand, I think we should have some public credit agency or
agencies available on a standby basis to render assistance in periods
of financial stress—at least until such time as the commercial lending institutions are able to cope vdth any conceivable situation. In
addition, there may be some remaining gaps In our present structure of

20?
financing agencies—for example, agencies that would provide long-term
debt capital to snail enterprises. Such caps may have to be filled by
new types of private or public financial institutions.
Whether the potential expansion of Government lending agencies
poses any serious competitive threat for private credit institutions
will depend, in uy opinion, on our success in minimizing or eliminating
cyclical expansion and contraction of business activity and credit and
in filling any gaps with appropriate private lending institutions
wherever possible,
Tho dual responsibility of the conmercial banker on the one hand
to protect the interests of his depositors and stockholders, and on the
other hand to expedite the production of essential goods and services
by granting credit, is a difficult one. The desire to protect depositors may cause individual bankers to change their credit policies at
the first signs of financial stress. The over-all effect of such
action, by sharply curtailing or even liquidating credit lines, might
seriously impede economic activity and hurt all bank depositors. Individual bankers might find it difficult to continue granting credit
freely v/hen competitors are calling in their weaker loans and tightening up their credit terms.
The only real solution to this problem lies in the prevention, by
means of over-all credit and monetary action, and other public and
private means too numerous to mention on this occasion, of any economic
development that might lead to sharp retrenchment and liquidation of
credit.
Role of the Federal Reserve System
The Federal Reserve System, as the central monetary and credit
authority, is charged with responsibility for regulating the over-all
supply, availability, and cost of money with a view to contributing to
the maintenance of high levels of employment, stable values, and a
rising standard of living.
In an effort to meet its responsibilities, the System takes positive action to curb or to encourage credit expansion, as circumstances
require. It operates by using either quantitative or selective instruments, or both. Cuantitative instruments, such as changing the
required reserves of member banks or open market purchases or sales of
Government securities, increase or decrease the reserve base for credit
extension but leave to the individual bank the decision as to the type
or types of credit that should be expanded or contracted. Selective
credit instruments, such as margin requirements for the purchase or
carrying of listed stocks or emergency regulation of consumer instalment
credit, apply to a particular type of credit, but impose no direct limit
on the total amount of credit outstanding.
Generally speaking, action taken by the Federal Reserve System to
influence the expansion or contraction of credit has the primary effect
of suggesting, rather than requiring, certain responses on the part of
individual lenders. This is particularly true in time of economic

210
recession when"the Federal heserve can enlarge the basis for credit expansion but is pov/erless to force additional credit into business and trade
channels. The latter can be done only by aggressive response on the part
of individual banks in extending credit and by willingness on the part of
business men and others to utilize credit in expanding their operations.
To make this possible, both public and private policies should inspire
confidence on the part of business men, bankers, and the general public.
In influencing credit policies in an effort to contribute to monetary and economic stability, the Federal Reserve System must act in the
public interest. Oftentimes S U C H actions are unpopular, especially among
the banking fraternity. Sometimes central banking officials resign,
voluntarily or othervdse, because of the unpopularity of their actions.
This is particularly true in periods of inflation, when moat people do
not want to see business activity curtailed. However, as recently
demonstrated in a number of Viestern European countries, the need for
drastic action to ensure monetary stability does arise and the results
of such action are beneficial. In the end, most groups recognize the
wisdom of action which they £t first opposed.
In the final analysis, the major contribution of the System to the
smooth functioaing of our economy lies in its early detection of undesirable economic trends and prompt action to guide commercial credit
policy a;vay from paths that may lead to serious inflation or deflation.
Viithout the understanding and cooperation of the entire banking system
and the public much of the effectiveness of Federal Reserve action is
lost.
The organisation of the Federal Reserve System, with its 12
regional banks and their 2li branches, provides grass-roots information
on what our leaders in the fields of agriculture, industry, commerce,
and banking are doing and planning. In similar manner, the System
obtains first-hand information about economic developments in foreign
countries and in the field of international trade and finance through
its membership in the National Advisory Council and from various Federal Reserve and other Government missions and representatives abroad.
Much of this information is relayed to credit men through the publications of the System so-that individual lending policies may .be reviewed
in relation to national and world-wide economic* developments.
The Current Business Situation and Outlook
In tho first place, as you know, determination of appropriate
credit policies depends in part on our longer-range economic objectives.
But it depends also on the present and probable future course of business activity. Between November I9I48 and July 191$ industrial produc-er
tion, as measured by the Federal Reserve index, declined roughly 17 V
cent| during the sane period, wholesale prices, as measured by the allcommodity index, dropped 6 per cent and business inventory holdings
declined 5 per cent. These declines in industrial activity and prices,
together with smaller business credit demands on banks and other lending institutions, prompted several monetary and credit actions by the
Federal Reserve System during the spring and summer of 19U9. Downpayment and repayment requirements on consumer instalment loans were

211
gradually moderated prior to the termination of Regulation Y.r. Margin requirements on stock exchange loans were decreased substantially, successive reductions in reserve requirements of member banks v/ere instituted,
and a policy of flexibility in open market operations to permit freer
play of general credit forces in the determination of market rates and
yields was adopted.
The moderate recession in business activity that we experienced
during the first half of this year probably reflected inventory and price
readjustments, rather than any basic difficulties, '..liether the recovery
that began this summer may lead to further inflationary pressure or vail
be replaced by a resumption of the earlier downward readjustment is now
a subject of considerable discussion.
Among the various aspects of the present situation that suggest
continued high levels of business activity, one of the most significant
is the record level of construction activity. In a recont joint report,
the Department of Commerce and Department of Labor estimated that the
tobal value of new construction put in place during 19li9 would exceed 19
billion dollars, or slightly more than the 19U8 total of 18.8 billion.
I.'ioreovcr, these same sources predicted that the total of new construction
expenditures in 1950 v/ill equal that of 19h9.
Consumer expenditures on goods and services of all types v/ere still
running at an annunl rate of 179 billion dollars a year in the third
quarter of 19h9—less than 2 per cent under the peak annual rate reached
in the fourth quarter of 19U8. i.Ioreover, recent Federal Reserve Board
surveys have revealed the existence of continued large-scale demands on
the part of individuals for automobiles, houses, and other durable goods.
Not only is the demand great, but individuals have cash or other liquid
assets, or are able to borrow, to finance purchases of these goods*
National service life insurance premium refunds during the winter and
spring of 1950 are counted upon to bolster consumer demand, while .
continued large-scale Government expenditures will sustain a demand for
many types of goods and services. The over-all financial position of
business is sound, despite a substantial increase in business indebtedness during the past few years. In general, the supply of credit is
large and elastic and the cost, both of short- and long-term credit,
relatively low. Furthermore there is a marked absence of speculative
excess, such as we had in the late twenties, while the great strength of
the banking system enables it to deal effectively with any sort of
economic development one might reasonably expect at this time.
At the same time, we should not overlook the fact that we have gone
a long way toward satisfying the immediate postwar demands for industrial
plant and equipment, business inventories, and consumers1 goods. Business expenditures on new plant and equipment, which reached a peak of
5.1| billion dollars in the fourth quarter of 191*8, are estimated at U.3
billion dollars for the fourth quarter of 19U9--a decline of about 20 per
cent. Business inventories, which expanded by 28 billion dollars between
December 191*5 and December 19143, have since declined by roughly k billion
dollars, wholesale prices have continued to fall and at the end of
October were about 8 per cent below their level of a year ago. Uhile
industrial production has picked up since July, and i3 admittedly being

212
held back by recent v/ork stoppages in the coal and steel industries, the
current level is still some 1*2 per cent below the level reached in the
same month last year.
Moreover, there is some possibility that business expenditures on
nev/ plant and equipment vdll continue to decline, and that further increases in business inventory holdings vdll be relatively small. Bumper
crops in many lines of agricultural production foreshadow continued dovmward pressure on farm prices and incomes. It is evident to you, I am sure,
that we are still confronted with narked price disparities, such as aluminum versus copper, synthetic fabric versus cotton and wool cloth, and
lumber versus other building materials* For example, the price of lumber
is still over 3 times its 1939 .average, as compared vdth a current average
price of building materials (excluding lumber) that is somewhat less than
twice the 1939 level. More liberal pension fund provisions, of the type
recently negotiated in the steel industry, together with postwar wage increases in most lines of industry and trade, and the high cost of postwar
additions to plant and equipment, have saddled many business concerns vdth
relatively large and inflexible cost structures which may seriously impede
price reductions that might be needed if demand should start to fall off.
All things considered, the credit man is faced with the rather forrnidable fact that the present balance between further inflation and deflation
is a delicate one, which could easily be upset by expansion in Government
expenditures and deficit financing on the one hand, or by any pronounced
curtailment of consumer or business demand on the other. Such a situation
calls'for lending policies that vdll permit utilization of credit for continued production of goods and services, and at the same time vdll not
encourage premature exhaustion of consumer demand. Later in my talk I
shall mention several types of lending activity which credit men are
v/atching closely in view of recent economic developments.
Recent Economic Developments Abroad
If I learned anything in my several assignments abroad, it is the
fact that the time has long since passed when we could isolate our
domestic economy from that of the rest of the world, particularly from
the effects of economic developments in the western European countries.
Immediate postwar European demand for food and manufactured products of
various types provided a large export market for whatever could be
spared in meeting our domestic requirements. At the same time, and
especially as ECA aid became available, European countries began to rebuild their factories, re-establish their raw material supply lines,
and resume production of manufactured goods. In order to attract
private capital to their industries and place their own economies on
a sound footing, most of the western European countries introduced
drastic currency reforms for the purpose of stabilizing prices and
money values.
Once the European countries succeeded in establishing some
measure of internal stability, their next step on the road to economic
recovery was to rebuild their export trade, particularly to this
hemisphere. Devaluation of their currencies in relation to the dollar
has had the effect of lowering the price of European goods in the

213
American market and enabling European countries to sell more in this
country. At the same time, it has raised the prices of our goods in
foreign markets and curtailed their consumption to some extent. All
these changes are no doubt reflected in your thinking and planning.
It is most important to us that the progress toward general economic stability, in which most countries of the world have participated,
should continue. vVhile United States aid has been essential to the
progress that many foreign countries have made since the end of the war,
1 am confident that the contemplated gradual reduction in the amount of
such aid vail not interrupt nor delay such progress. However, this
does mean that if foreign countries are to continue buying goods which
they need from the United States, they must be able to expand sales of
such of their goods as have a market in this country. To spend dollars
here they must first earn dollars, directly or indirectly, and with much
of their international transport, financial, and other dollar producing
services destroyed or disrupted by the war, more emphasis must be placed
on the sale of ^oods in the v/orld market.
In this connection, the credit man today asks questions about the
value of the dollar, not only from our own domestic viewpoint, but in
relation to ths currencies of other countries. Recently you have been
hearing many rumors about devaluing the dollar in terms of the price of
gold. Devaluation of foreign currencies was a necessary step toward
trade expansion and recovery; undoing its effects by devaluing the dollar
would have just the opposite consequences. Nor would dollar devaluation
aid our domestic situation one iota. On tho contrary, it would add to
any inflationary tendencies that exist. There is no shortage of credit
or gold reserves in this country, and an increase in the dollar price of
gold, even if the legal obstacles to such action could be overcome,
would n-erely mean an indiscriminate subsidy to domestic and foreign gold
producers.
Financial Developments of Current Significance
Thus far, we have been talking about some of the broader aspects of
the domestic and international economic scene that have a bearing on
credit policies. Kovr let's take a look at a few of the more specific
problems in the field of credit and commercial banking that are of
interest to the credit man tod::-y.
Instalment credit. Since June of this year, the amount of consumer
instalment credit outstanding has increased by nearly one billion
dollars. Some thought is being given by the lending officer to the
implication of too rapid an expansion of such credit at this time. Many
people buy certain large items of furniture and major household appliances only once in their lifetime. To a certain extent, the sanie is
true in the case of. automobiles. Once immediate demands are fulfilled,
they may recur only after the lapse of considerable time. Moreover, the
use of instalment credit enables people to buy now and pay for purchases
out of future income. If we encourage too widespread a use of instalment
credit at a time when cash demands of consumers are high, we may exhaust
not only the present market but a good part of the potential market of
the future. The results of doing so should be perfectly obvious—sales

21U
of automobiles and other consumer goods nay suddenly fall off and unemployment may ensue, v;hile a larger proportion of the reduced income available
would go to pay for goods purchased last year or the year before.
No credit man is in a position to say who shall or shall not buy xvith
instalment credit, provided the borrower can establish his creditworthiness. On the other hand, he can influence the use of instalment
credit by maintaining prudent downpayment and amortization requirements.
Real estate credit. ;jy comments v.ith respect to instalment credit
are equally true of real estate credit. Daring the four years 19h6-l#
home mortgage debt alone has increased by an estimated net amount of some
17 billion dollars. In part, your concern is that the volume of debt
incurred may be so large as to threaten a serious credit liquidation. In
part, it is that the ability of individuals to purchase housing with the
aid of mortgage credit is being exhausted so rapidly that the remaining
demand Trill not be adequate to ensure continued high levels of employment
in the building and building materials industries. Again, the banker cannot deny credit to credit-worthy borrowers. He can, however, require
conservative owner equities and repayment provisions in times of abnormally
high demand, andr relax his requirements somewhat when the demand begins to
slacken. These are powerful measures of influence, and I am certain that
bankers want, in their own as well as in the general interest, to make the:a
as effective as possible.
Term loans. Term loans are often employed by the borrower in the purchase of machinery, equipment, and other more or less fixed capital items,
and are repaid out of future earnings. In recent years the well-informed
credit man is making term loans with caution, for three reasons. First,
construction and machinery and equipment costs are well above prewar levels,
and there is a good chance that such fixed assets may prove to be overvalued in the long run. 6econd, there is always some uncertainty about the
profitability of future business operations. Third, the situation with
respect to business expenditures on machinery and equipment is somewhat
analogous to purchasing of automobiles and housing by individuals—some
restraint in the use of credit during boom times should be encouraged.
From tine to time questions arise as to the feasibility of developing a formula, or of devising definitions and limits for the guidance of
banks in determining what proportion of their assets nay properly be
invested in term loans. Such an undertaking would have little chance of
success. In the first place, the diversity of type, purpose and conditions of such loans makes satisfactory deiinition practically impossible.
In the second place, the appropriate position for an individual lending
institution can only be determined after careful analysis and consideration of the character and volatility of its liabilities, its relative
capital position, and the probable credit demands to which it may be
subject. The determination of an optimum amount of term loans involves
problems similar to those in selecting an investment portfolio, and no
rule of thumb applicable to all banks would appear to*be practicable.
Conclusion
It is evident, therefore, that the time-honored distinction between

215
the trees and the forest is equally true of credit. The individual
credit man is primarily and rightfully concerned vdth the vrelfare of
the individual trees; the central credit authority is charged with
responsibility for promoting the welfare of the forest. While the interests of the two may appear to conflict in specific situations, the
thoughtful credit man realizes that there are no fundamental differences
in their ultimate objectives.
It is further evident that certain types of credit, notably consumer instalment and home mortgage, have increased substantially in
recent years. In the interest of minimizing their inflationary pressure,
spreading demand for automobiles, housing and other consumer goods over
a longer period of time and protecting loan portfolios against subsequent deterioration in value, credit men are examining downpayment and
repayment provisions vdth particular care.
As we know, change has always been characteristic of hunan behavior, whether it be social, political, or economic. The principal
difference in the economic changes that occur now and those of a hundred
years ago is that present changes occur more rapidly, and affect a much
greater number of economic activities. Ho able credit .nan can isolate
himself from change, nor prevent it by ignoring it. On the contrary, he
deems it his responsibility to maintain that prudent flexibility of
thought and action that welcomes the opportunities for constructive
service afforded by change. His is not a dull and routine duty. It is
full of constant interest—not only in loans and lending policies, but
also in broader econonic developments.

217
Speech delivered over
Radio Station W-I-N-D, Chicago, Illinois
December 9, 191*9
WHERE NOW?
Before facing up to that question, let me mention some of the important things that have to be taken into account in trying to answer
it.
To begin with, let iae speak about what has happened recently and
what is going on now. Back in November 191*6 there* were 57*000,000
people employed in our factories, in our stores and offices, and on our
farms. Approximately two years later—October 19l|3—the number so
employed reached a postwar peak of over 60,000,000 while the nimber
looking for work, the unemployed, had dropped to a little over l,50O,O0Cl
Between the end of last year and the middle of this year the number of
unemployed increased rather sharply to a little over ii,000,000. Since
then, business has recovered somewhat from its midyear lull and today
59,500,000 people are working while almost 3,500,000 are looking for
work. YJhile total employment is now only 600,000 below last year's
peak, the extent of the revival in business activity isn't quite so
great as these figures might suggest. Every year we find more young men
and women joining the labor force than we do older people leaving it—at
the present time the net addition is about 600,000 people a year. If
all the people who want to work are going to have jobs next year and the
year after, the total number employed will have to be larger than it is
now and larger than it was last year. That's a pretty big order, finding jobs to keep more than 60,000,000 people employed. It's going to
require a great deal of effort on the part of everyone to keep our
economic machine running smoothly and efficiently enough to provide all
these jobs.
During the first part of last year—19U8—everyone was aware of
rising prices and expanding business. In some ways it looked cood9 but
I think most people were uneasy about it. They felt that high prices
meant that it would be harder and harder for them to make both ends
meet. Then after the middle of 19I48 the picture changed. Between
November 191*8 and July 19li9, production in American factories declined
about 17 per cent. In the same period, wholesale prices fell about 6
per cent; and inventories of goods on hand fell 5 per cent. At the same
time a large part of bank loans to business was paid off, with the result that total borrovangs from banks by businessmen declined.
This general downward movement of prices, production, and business
in general gave everybody something new to worry about. .Ve had been
afraid that prices would go too high; now we began to fear they would
drop too low. Before, we had been afraid of a boom; now we began to be
afraid of a bust.
The decline which set in about the middle of 19U8 has proved to be
very moderate. This past summer there was marked recovery. The question now is whether that recovery will continue. In other words,
granted we are where we are, vvhat is going to happen next? The signs
are mixed*

218
On the other hand, it seems clear that the country has gone a long
way tov/ard satisfying the immediate poctv/ar needs for plant and equipment,
which is our production machinery, and this means less demand than there
has been for new factories, heavy machinery, and such things. On the
farms bumper crops have been harvested and their effect vail be to depress
the prices of farm products. This is in accord with the principle of
supply and demand. While prices on the average are down about 8 per cent
from last year, there are still disparities, such as the price of aluminum
versus copper, cotton and v/ool cloth versus synthetic fabrics, and lumber
versus other building materials. The price of lumber, for example, is
three times what it was ten years ago, while the average price of other
building materials is somewhat less than twice what it was just before
the v/ar. These disparities necessitate adjustments to establish a sound
balance which gives us stability. It takes time to work out these adjustments and meanwhile business is slowed dov/n by the process•
Against these conditions, which at least for tho time being tend to
restrain business expansion, there are other conditions which point to sustained activity. The general public's purchases of goods ai:d services
remain steady and strong, and there is evidence of a great backlog of demand for automobiles, houses, and other durable goods. Luring the winter
and spring of 1950, veterans will be receiving millions of dollars in refunds on their life insurance premiums, and most of this money vail be
spent for cars, homes, merchandise, and services. All of which means that
business ought to be brisk. At the same time, the credit situation seems
sound; individuals here and there may be heavily in debt, but taking the
country as a whole, private indebtedness is not excessive, and there is
no speculative mania such as we had in the late tv/enties.
The Federal iieserve System, as the central monetary and credit
authority, is charged with responsibility for regulating the over-all
supply, availability, and cost of money with a view to contributing to
the maintenance of high levels of employment, stable values, and a rising
standard of living.
From the standpoint of money and credit, which is the purchasing
power in our economy, there are two factors that 1 think.need to be'
watched in particular. The first is instalment credit. Since June cf
this year, the amount of instalment credit for the purchase of automobiles, home appliances, and so forth has increased by nearly one billion
dollars. These are not things that people buy and consume as they do
food and fuel and then come back for more. The purchaser of an automobile or of a washing machine is apt not to be buying again for a long
time, once a purchase is made. Obviously, if everybody bought cars and
appliances at the same time, there v/ould be a long period in which nothing
more could be sold. Exactly that situation will probaoly never occur, but
it is clear that when buying has been excessively heavy it tends afterwards to grow slack, hov/, instalment credit in the right amount helps to
•make buying steady and consequently helps to make production and employment steady. But too much instalment credit is as bad as not enough—or
worse, because it concentrates buying in boom periods instead of spreading it out evenly.
The other factor is real estate credit. Here the same thing is

219
true. The total of home mortgages outstanding increased by 17 billion
dollars during the four year period of 19k6, 19h7, 19h&, and 191*9. How
long can such a rate of increase continue? Is the ability to buy being
used up so fast that the construction business vail soon have nothing
left to live on? I don't know, but neither can I see how home buying
can go on indefinitely at the present rate.
So far, I have spoken only of conditions within the United States,
but it is "obvious that conditions outside the United States must also be
considered, ;Ve have been exporting large quantities of goods abroad
ever since the war, and those exports have been an important element in
American production. If, in the near future, any great change occurs in
the amount of exports we send abroad or in the amount of imports we purchase, it is inevitable, of course, that American business will be affected by the change. But the change, in the long run, should be to the
good. It provides a proper balance in international payments and eliminates need for our government gifts and loans.
Up to now, the aim of European countries has been to rebuild their
factories and regain their markets. Our aim has been to help them, so
that they can again stand on their own feet. But an essential feature of
the program of European recovery is that the United States bay a larger
amount of foreign products than it has in the past. This is simply
another of the possible changes to which American business may have to
become adjusted. Like most adjustments, it m i l involve practical difficulties, particularly with respect to those American products vath
v/hich imports from abroad vail directly compete; but actually the needed
increase in imports is only a very small fraction of our total trade.
According to a statement recently made by l-'r. Hoffman, Economic Cooperation Administrator, Europe needs to sell us an additional .J2-1/2
billion worth of goods to balance her payments—and this ,;-2-l/2 billion,
he points out, amounts to only one per cent of the total value of goods
and services produced (the gross national product) in this country during
19li8. The adjustment needed for us to absorb these additional imports
may not be painless, but it is essential* Foreign countries can not
spend dollars unless they can earn dollars. If we rash to have them
spend dollars by buying our products, we must be prepared to help them
earn dollars by buying their products.
This need for soiling goods in our markets was the reason for the
recent devaluation of currencies by Great Britain and other countries.
Devaluation is another name for reduced prices, for devaluation of a
country's currency reduces the prices of its goods in foreign markets.
The purpose of the recent devaluation, therefore, was to make foreign
goods more attractive to Americans by reducing their price. The United
States welcomed this reduction. Yet I should say in passing that, notwithstanding this fact, rumors have persisted that the United States was
going to devalue American currency too. There are not the slightest
grounds for this notion. It would be directly contrary to American
policy to devalue our currency, and it would directly spoil the efforts
we have been making to help other countries get on their feet and do
without the costly assistance we are now giving them.

220
To conclude—our economy, generally speaking, appears to be in pretty
good shape. However, it will bear careful watching, Y/e face the important
fact that the present balance between further inflation and deflation is a
delicate one which could easily -be upset. On the one hand, we may have
expansion In Government expenditures and borrowing of money by the Government above taxes to meet these expenditures. On the other hand, there is
always the possibility of a sizeable reduction of purchases of goods and
services by businessmen and by the public at large. To steer a safe course
between these two extremes will require constant vigilance, sound judgment,
steady nerves, and confidence in the future.

SPEECHES OF

M. S . SZYMCZAK
MEMBER

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
WASHINGTON, D. C.

RELATING TO

INDUSTRIAL LOANS
1935 - 1936

-1950WASHINGTON, D. C.

CONTENTS
Page
"Recent Relations of the Federal Reserve
Systems with Business and Industry - May 20 r 1935

"Leans to Irdustry and Business by the Federal
Reserve Banks" - September 5* 1S/35

"Federal Reserve System Loans to Industry" February 27* 1936

Business Recovery and Industrial Loans" Hay 8, 1936

"Industrial Loans" - June 18, 1936

Speech delivered before
Illinois Bankers Association
Decatur, Illinois
May -20, 1935
RECENT RELATIONS OF THE FEDERAL RESERVE SYSTEM
WITH BUSINESS AND INDUSTRY
The name is difficult. Once I almost lost a place on a college
football team because the coach thought that I was playing a practical
joke on him when I handed in my name vith others who vere applicants for
places on the team. He called ne later and said flYou are through.11 I
asked him why. He said "Because you can't play jokes on me. What was
it you handed in when I asked for names? It looked like the alphabet
thrown together without any vowels." I had to explain to him very seriously that thet was really my name. He finally believed me and I stayed
on the team.
Illinois is the State of my birth, in which I lived and worked for
many years. So you am understand that I was more than pleased to accept
the invitation of Mr. H. A. Brinknian, your President, to appear on this
program. I was especially glad to have the opportunity to meet you and
listen to what you have to sey, so that I might return to my office in
Washington better informed and better able to aid, even if in o small
way, in the solution of the problems presented daily to the Federal Reserve Board.
Let me begin by discussing something known to all of us - and lead
slowly to something that may be news to some of us.
As you know, the Federal Reserve Act emphasizes the principle that
the System shall be administered for "The accomodation of commerce, industry and agriculture." This is the basic thought of the Act.
The Federal Reserve banks - bankers' banks - are public institutions
serving the entire country. In addition to the banks which are members
of the System and stockholders of the Federal Reserve Banks, the System
consists, first, of 12 Federal Reserve banks, 25 Branches, and two Agencies. There are 9 Directors of each Federal Reserve bank; 6 are elected
by the member banks and 3 are appointed by the Federal Reserve Board.
Each Branch has 5 or 7 Directors, the majority of whom are appointed by
the Directors of the Federal Reserve bank of the district in which the
Branch is located.
Second, the System includes the Federal Advisory Council of 12
active bankers - one from each of the 12 districts - elected by the
Directors of the respective Federal Reserve banks.
Third, the System includes the Federal Reserve Board. Many powers
are vested in the Board, among them being the duty.to exercise general
supervision over the Federal Reserve Banks.
At the present time the Federal Reserve banks hold larger member
bank reserve deposits than at any other time in the history of the System,
and the member banks are less indebted to then than at any other time in

this history of the System. In 1920, fifteen years ago, the Federal

Reserve banks held the discounted paper of member banks in the.amount of
nearly three billion dollars; in contrast to this, on February 20th of
this year the amount of discounted paper was less than six million dollars. Fifteen years ago, in April 1920, member bank reserve deposits
were les* than two billion dollars; in April, of. this year they amounted
to nearly five billion dollars. At the. present time the excess reserves
of member bonks amount to more than two billion dollars.
. . • This aeans that the banks of the country have an enormous amount of
funds which are not in use. At the same time in the countiy as a vhole
there is an enormous number of men unemployed. We have, therefore, -this
situation: on.: the- one hand men are out of work, and on the other hand
money is out of: work. To the average layman, this is difficult to understand.
The Government is finding work for these idle men by embarking en
various public activities and projects. A large part of the money required for these work-relief projects is and will be provided by. the
local tanks1 purchases of Goverrcnent obligations. In other words, the
Government is using its credit to bridge the gap. Would you prefer to
have the Government continue doing this, or would you prefer to lend
money directly to local Enterprises yourself? I think I know your an^
swer, and that brings ae to the one: thing I want to emphasize here this
afternoon.
•
The Federal Reserve System has been authorized, and stands ready,
to assist you .in making loans to local enterprises under Section.- 1.3b
of the Federal Reserve Act .for the purpose of furnishing vorking capital
to established industrial and commercial businesses. When lending activities are resumed through the usual and accepted channels,'the Government will, as I understand it, withdraw gradually from its.Public Works
Program, and fron the use oi1 its credit for such purposes. Sincerely,
therefore, I should like very nuch to know ju::t what is the attitude of
the"individual banker toward the loans to industry and business authorized, by Section 13b of the Federal Reserve Act,. I should like to loicv
any1, and all reasons why these loans can or can -not.be made. This information will be helpful, not only to me.and to the Board, but to the
executive arid legislative departments of your Government in Washington.
It will Q I C O be helpful to you.
.
...
Accordingly,"I wish to sketch briefly the background of the industrial loans program of the Federal Reserve System, and place before you
as clearly as I can the adventages to you find to your co.inunities of
loans made under the provisions of Section 13b.. These provisions had
thoir origin in the feeling that as a result of long continued adverse
economic conditions a large number of small business and industrial enterprises vsre suffering from depleted working capital.
On tfareh 19,'1934, the President of the United States, the.Honorable Franklin D. Roosevelt, sc-nt a letter to Senator Fletcher, Chairaan
of the Senate Banking and Currency Committee, and to Representative
Steagali, Chairman oi^the House Coicnittee on1 Banking and Currency. In
this letter he suggested the creation of twelve Credit Banks for Industry, to help provide working capital for small industries, and to follow

up the aid given to agriculture, the banks end large business corporations, by doing something for the medium size man in .industry and
commerce.
On the sane day the President wrote the letter, Senator Fletcher
introduced in the Senate, and Congressman Cteagail introduced in the
House a bill "to provide for the creation of credit banks for industry".
But Congress decided, instead of creating a new agency, to give the
Federal Reserve Banks and the Reconstruction Finance Corporation authority to extend the credit vhich" was required. That is the way the law
now stands and the Federal Reserve System is firmly committed to carrying out the added responsibilities which Congress has given it.
The new legislation was adopted June 19, 1934. It amends the
Federal Reserve Act by the addition of Section 13b, vhich provides
that the Federal Reserve Banks may cooperate with member banks, nonmember banks, and other financing institutions in making loans to
furnish working capital to established industrial and conriercial
businesses, and in exceptional circumstances, may make such lorns
direct when credit is not available- on a reasonable basis fro:! the
usual sources.
An Industrial Advisory Committee composed of active business nien
in the district is created under the lav. The law limits funds available for advances and commitments by the Federal Reserve Banks to.the
total surplus of the banks as of July 1, 193A, or about $140,000,000,
plus certain payments to be made by the United States Treasury, which
would bring the total available up to about £280,000,000.
The Federal Reserve System went to work promptly. A conference of
Chairmen and Governors of the Federal Reserve Banks was held in Washington, June 25 and 26, &t which the new industrial loans provisions of the
Federal Reserve Act were the principal subject of discussion. Regulations had been drafted for the administration of Sectior 13b, and after
they had been considered by the Conference and approved by the Federal
Reserve Board, they were issued on June 26. In order to make as easy as
possible the performance of the- new functions granted to the Federal Reserve Banks, these simple regulations left the broad powers granted by
Congress to the Federal Reserve banks wholly unimpaired and prescribed
no restrictions beyond those prescribed in the lav itself. Any attempt
to supply technical definitions was avoided, lest it have.the effect of
restricting and hampering the operations of the Federal Reserve Banks.
The late Governor E. H. Black, who was very much interested in this
amendment to the Federal Reserve Act, wrote a letter on June 30 to the
Federal Reserve banks, in vhich he said in part:
11

1 an certain that you have carried home to your directors
our earnest feeling, first, that these new loans will materially aid the Recovery Program, second, that it gives your
bank an opportunity to render p. real service in your district,
and third," that this opportunity entails a responsibility that
for the good of the Federal Reserve System must be fully met."
Since then several conferences of Governors have been held in Washington, at which the administration of. Section l^b was .discussed in
detail. '.

I have visited every Federal Reserve bank, rnd about 90 per cent of
the Branches since July 1, 1934- In fact, I visited some of the districts
several times during the course of the last year for the purpose of discussing this subject with all concerned.
On September-27 a conference of the Chairmen of the Industrial advisory Committees was held in VJashington for consideration of the provisions
of Section 13b. By this time the administration of Section 13b had been
under way for some weeks and it was possible to consider the program in
the light of actual experience. Among other things consideration was given
at this conference to the report that n&ny member and non-member banks
were reluctant to make industrial loans because they were uncertain of the
attitude that might be taken by bank exeminers toward such loans when
found in the bank portfolios. It was recommended that a definite announcement be made as to the policy to be followed by examiners.
In compliance with this suggestion, the I'ederal Reserve Board on October 6 issued instructions as to the manner in which industrial loans
should be included in condition reports and examination reports. ' About
the seme time the Comptroller of the Currency issued corresponding instructions. The purpose of these statements by the Board and by the
Comptroller wae to clear up such doubt as might exist as to the classification of such loans end the net effect was to assure member banks that
industrial loans with long maturities which vere covered by commitments
.from the Federal Reserve 3anks or the Recorstruction Finance Corporation
would not be classified as "slow".
Pursuing the administration of Section 13b, Mr* Albert /w Creighton,
who is. Chairman of the Industrial Advisory Committee of the Boston Federal
Reserve District, and who is likewise Chairman of the-Committee consisting of the Chairmen of the 12 Industrial Advisory. Committees of the System,
is now in Europe studying industrial loans in the various countries, at
his own expense. He.is expected back some time in June with a .report of
what is being done in this respect by other Banks of Issue by other Governments, and by other banks and financing- institutions.
On December 11 and 12 a Conference of representatives of the Federal
Reserve banks, the Industrial Advisory Committees and the Federal Reserve
Board was.held at Cleveland to consider the procedure being followed by
the banks and the committees in passing on applications.. It was realised
that much of the success of the program depended upon a smooth and. expeditious handling of applications.
The fact vas emphusized that both the Industrial Advisory Committees
and the Federal Keserve BanKs have given and will continue to give careful
and sympathetic consideration to each application, regardless of the anount
of money being applied for.
On December 19 another Conference of the Chairmen of the Industrial
Advisory Committees was held in.Washington to review the work done by the
Committees and to consider ne^ns of furthering the program.
• Also the Federal Advisory Council, which was created in 1913, as you
know, met in Washington on September 17-18, 1934 ^nd discussed the subject
offorindustrial
loans under Section 13b in detail. At several of the meetDigitized
FRASER
ings since that date the Advisory Council has, upon the request of the

Board, discussed the cooperation in this matter of member banks with the
Federal Reserve Banks.
In addition to all these conferences and to continuous study of the
situation the Federal Reserve banks have actively convassed their districts in order to inform financing institutions and prospective
borrowers of the new provisions of the law. ILvery effort has been T.ade
through pamphlets, letters, addresses, personal calls and even by radio
to make the new functions of the Federal Reserve Banks widely known.
I have gone into all this rather ninute detail, even at the risk
of boring you, to give you some idea of the earnestness with which the
Federal Reserve System has prosecuted the industrial loans pro^ran.
The question naturally arises, what are the results? As of May
8, 1935, the Industrial Advisory Committees had approved 1,676 applications, amounting to $88,066,000 and the Federal Reserve banks had approved 1,509 applications, amounting to £84,003,000. Adding the advances
actually made ($29,626,000) and the commitments outstanding ($18,040,000)
for a co-nraitinent is equal to an advance, since the money must be kept
available for the purpose of taking up the paper - ve have a total of
$47,666,000 of credit actually in use. There have also been some repayments, some applications hevo been withdrawn, and sone are awaiting
completion by the applicant before disbursement of funds can bo made.
The fact thct the Federal Reserve banks hove about ?!280,000,000
available for industrial loans, under the provisions of the Act, and
after nearly a year have a little more than $88,000,000 of advances
approved by the committees might suggest either indifference on the part
of the Syster. to the program or thst there was little dexand for the kind
of credit made available by the Act. I believe that neither of these
conclusions is warranted by the facts. The Bonrd and the Federal Reserve
Banks have stressed the program repeatedly and at tho bane tine evidence
still exists of a need for such credit for snail industry and business.
As you know, there has been a certain amount of skepticism as to the
existence of this demand for credit. The skeptics may possibly be right.
But I do not know how we can prove what the need is, except by earnestly
pursuing the possibilities of extending credit to small industry under
Section 13b with all frankness and sincerity. Ve must at least exhaust
every means of informing bankers and borrowers vhat the opportunities
are.
Banks were very sick. They called the doctor. Tney recuperated.
Now they are, as it were, .learning to walk again, but they are very
cautious. That is human.•
Laws, too, are human. They are made by man in accordance with what
is considered tlie need of man. T.Te know of man's needs by the law of
averages.
Let me tell you of a human incident by which a clerk in o haberdashery tried to apply the law of averages:
A wife called at the haberdashery and said - "I wish a collar for

my husband." Ther'fclerk asked her for the size collar desired. . She said 11
1 don't know, I will go back and ask my husband. The. clerk, who thought
he knew something of human nature, said, "I think I know the size of th'e
collar your husband wears.11 She said "Really". The clerk .said "Yes I
think he wears a size 11 1/2 collar." She said "That is right - I remember now - but how did you know?" The clerk said - "A man who sends his
wife out for a collar wears about that size."
' I repeat that it is perfectly natural that after their experiences
of recent years bonkers should feel extremely conservative. It is perfectly, natural that 'applicants should have.difficulty in proving their
present prospects.are good. And it is to be expected that a new provision of law bringing the Federal Reserve System into the field of long
tern loens should be hard to nake generally known and understood. We
are vorking.as effectively as we can to overcome these obstacles.
How, after thus explaining the plans and intentions of the Reserve
System, I wish, to point' dut how this law directly concerns you as bankers.
Although it.is-prpvided in the law that credit for industry nay be
furnished to the borrower either by the Federal Reserve bank directly or
by the commercial banks with the cooperation of the Federal Reserve banks,
the law itself favors the latter procedure. To nake this point clear, let
me read the first two paragraphs of Section 13b:
The provision of the law- authorizing the Federal Reserve Banks to
discount or purchase loans made by member banks and other financing institutions is as follows:
"(b) Each Federal Reserve bank chall also have pov:ers
to discount for, or purchase from, any bank, trust
company, mortgage company, credit corporation for
industry, or other financing institution operating"in
its district, obligations having maturities not exceeding five years, entered into for the purpose of obtaining working capital for any such established industrial
or commercial business; to make loans or advances direct
to any such financing institution on the-, security of
such obligations; and" to'make commitments-with rogard to
such discount or purchase of obligations or with respect
to such loans or advances on the security thereof, including commitments made in advance of the actual undertaking of such obligations. Each such financing institution shall" obligate itself to the satisfaction of the
Federal Reserve bank for at least 20 per centum of any.
loss which may be sustained by such bank upon any of the.
obligations acquired from such financing institution, the
existence and amount of any such loss to bo determined in
accordance with regulations of the Federal Reserve Board."
In non-technical language, that provision enables the bankers to make
loans to furnish working capital to industrial and commercial borrowers
on long maturities and at the same time get the promise of the Federal Reserve bank to take over the loan at any time without recourse for 80 per
cent of the loan.

In order that the credit may be made available even though the
bankers fail to take advantage of this opportunity to put their funds
to work with a minimum of risk, the law also authorizes direct loans by
the Federal Reserve banks to industry by the following language:
"(a) In exceptional circumstances, when it appears
to the satisfaction of a Federal Reserve bank that an
established industrial or commercial business located
in its district is unable to obtain requisite financial
assistance on a reasonable basis from the usual sources,
the Federal Reserve bank, pursuant to authority granted
by the Federal Reserve Board, may make loans to, or purchase obligations of, such business, or may make commitments with respect thereto, on a reasonable and sound
basis, for the purpose of providing it with working
capital, but no obligation shall be acquired or conmitment made horeunder with a maturity exceeding fiv* years."
As thce lav.- was originally drafted those two paragrcphs appeared in
the order in which I have read them, but for some reason that order was
reversed in the legislative mill end to a casual reader of the law it
might appear that the emphasis was on direct loans by the Federal Reserve,
banks rather than on advances or commitments to banks. This is not the
fact. On the contrary, the law says definitely that direct loans are to
be made only in exceptional circumstances and when credit is not available from the usual sources; there is no such limitation on rediscounts or
on coinmitinerits covering loans made in the first instance by local banks
or other financing Institutions.
As a matter
of the money has
banks. And that
not organized to
certainly do not

of fact, strange as it may seem, up to the present nost
had to be placed on direct loans by the Federal Reserve
needs to be explained. The Federal Reserve banks are
take business away from the local bankers, and they most
wish to do so.

It is stipulated in the law that direct loans shall be made by the
Federal Reserve banks only in exceptional cases and when the required
credit is not available from the usual sources. The Federal Reserve
Board and the Federal Reserve banks-have felt that this stipulation was
extremely vise. The objection that -tho banker makes to these loans is,
of course, that they hav-? too long maturities and sometimes imiy be* considered poor risks; but these objections were largely "removed so far as
local" banks are concerned by the commitment which the Federal Reserve
Bank will ^akc to take over"the loan from the lending bank without recourse except that the lending bank must obligate itself for at leost
20 per cent*of any loss. This means, of course, that the member bank or
other financing institution which makes a loan is able to insure liquidity
for the loan, and also to have as much as 80 per cent of it underwritten
by the Federal Reserve bank. A long tern loan that may be discounted at
the Federal Reserve bank at any time without recourse as to 80 per cent
of any loss, is, from the- point of view of the coraraerical .bank, as liquid
as any-earning asset it may hold.
You, of course, are. trustees of your depositors* funds, and it certainly is not, and cannot be our aim to urge you to risk those funds by

loaning on a basis that is-not reasonable-,and-.not .pound. That is plain.
But in times like these-.when the-b^njes-have,raor^funds than they can
put to profitable use, and on tuat.account-"have difficulty in" making adequate earnings, it seems to me important that you should understand the
possibilities open to you under Sectipn 13b and should make the nost of
then.
In concrete terms, vhat. the provisions of the- law mean to you bankers
may be stated as follows:
First: You may mal:e e loan on a reasonable and sound basis" with a
maturity not exceeding five years to an established industrial, ot commercial business in your comunity for the purpose .of supplying it_vith
working capital.
Second; If the loan is acceptable to the Federal Reserve bank (which
may be determined before the loan is made) you nay obtain from the Federal
Reserve Bank a corrjnit-ner.t to take over the loan on stated tarms at any
tine within the period of the commitment.
Third: You pay the Federal Reserve Bank a email charge for this
commitment, the-amount paid depending principally upon .the length'of
time covered by the comnitrr.ent. For the Federal Reserve Districts"", in
'which this State is located, the Federal Reserve Bank rates or. commitments
are from 1 to 2 per cent per annum, which may be called either an insurance chargo or a chcirgo for standing by. Having paid it and. received its
commitment, the bank id assured that the loan which the commitment covers
is perfectly liquid.
Fourth: If you subsequently need to dispose of the loan on which
you hold the coznniifcnent,. you inform the Federal Reserve Bank of your
desire, and the loan is taken off your hands. The Federal Reserve Dank
discount rates on industrial loans in the Districts in which this State
is located are from 4.-1/2 to 6 per cent.
Fifth; Under the terras of the commitment, .the Federal Reserve Bank
will relieve you of obligation for as much as 30 per cent of any loss
sustained oh the loan., In other words, you can sell or rediscount the
loan without recourse up to 80 pc-r cent of its amount, but you continueunder obligation for the remainder, which may. b? only 20 per cent.
One'banker vho has been very active in making industrial loans
described in the following words his plan for setting up a special reserve to cover possible losses in such loans.
"The u^ual participation is, of course, "on an 80-20 basis. Generally the- entire loan boars the maximua rate of 6 per cent.1 lie look upon
the 80 per cent guaranteed part of the loan as s. prime investment - to the
point that if such an investment were available in the open market we would
be willing to buy sene on a 1 por cont per annum income basis, lTe take
all thfi income above 1 per cent obtainable from thtt part of the loan
guaranteed by the Federal Reserve bank and set it up in a special reserve
account to provide against any loss sustained in our participations."

I have been talking, so .far, necessarily, in general terns. Now let
me describe a typical actual loan under Section 13b.
A varnish manufacturer with a plant in a medium-sized industrial
city needed £25,000 working .capital. He needed it for a longer time
than his local bank cared to lend without provision for liquidity. Ac.cordlngly, an application was made by the local bank, which was a non. member, to the Federal Reserve bank for a commitment. After investigation of the business and the security offered the application for the
commitment was approved. A loan of $25,000 was .made by the local bank
repayable in equal semi-annual instalments, the last instalment becoming
due in four years. The security comprised a lien on plant and equipment,
assignment of stock in another corporation and assignment of two life
insurance policies. The loan bears interest at 6 per cent. Covering
this loan the Federal Reserve bank gave the local bank a commitment to
take over the loan at the local bank's request any time within twelve
months. The local bank pays 1 per cent per annum for this commitment.
Before- the end of the twelve months, it can either procure a commitment
for a further period, or ask the Federal Reserve Bank to take the loan
off its hands. The local bank is thus enabled to hold a loan of vhich
the liquidity is assured, on which its part of any loss nay not exceed
20 per cent, and on which it receives 5 per cent net.
You will also be interested in types of loans which have been rejected. Ve have had relatively few complaints from disappointed applicants. Those who have complained, however, have had their applications
reviewed by the Federal Reserve Banks and every effort has been made to
render assistance in accordance with the intent and purpose of the law.
There was recently received by one of the Federal Reserve Banks an application from a manufacturing company which had been organized in the
last year or so to reopen a plant that had been closed for some time.
The plant at one time had apparently been successful, but its former
owners had subsequently become bankrupt. The new company was organized
by people who had no previous experience in the business and who had insufficient funds. Their business records gave no assurance of ability
to succeed and their bankers were unwilling to make the loan nor participate in it. The Federal Reserve Bank was asked to lend them practically all of their capital. There was doubt whether the applicant
was eligible as an.established business, but even leaving that question
aside, the application had to be rejected because there was little prospect that the loan could be repaid from the profits of the business, and
the underlying security was inadequate, i notice that in the case of the
Chicago and St. Louis banks, the chief reasons for rejections have been
insufficient security, unsatisfactory financial condition, for the law
requires the loan to be made on a "reasonable and sound" basis, and ineligibility, in that funds were not really required for working capital.
Question has arisen as to whether the law permits loans to be made
in cases where the proceeds are to be used for the refunding of existing
indebtedness held by member, non-member banks or other financing institutions. . The purpose of the loans, in the language of the Act,, is to
furnish working capital to industrial or commercial businessj that is
one of the few specific conditions which the law imposes. Obviously,
a loan transferred from one creditor to another does not provide the
industrial or commercial borrower with additional working capital; nor,

10
considering the fect-thr.t the tanks are already supplied with more funds
than they are finding vise for, can it be said thet the? transfer of such
indebtedness fron local banks to Federal Reserve banks gives the local
banks funds required by other borrowers. .Consequently, applications have
had to be rejected where it appeared that the. principal effect of the loan
would be to transfer certain slow .assets from the portfolio of a menber
bank to the portfolio of a Federal Reserve bank. When,hovrever, the transfer of existing"indebtedness is clearly an essential part of a plan of
rehabilitation involving new working capital, it seems in accord with the
spirit of the law to' all,ow a portion of the proceeds of a given loan to
be used for refunding. .. .
Question has also arisen as to the moaning of the term "established11,
in view of the fact, that the law authorizes loans to be made to established industrial and commercial businesses. A ne-.; corporation niay perhaps be organized to take over an old business, and while the question
whether in any particular case ..the applicant can be regarded as an established business iacy have to bo- determined by counsel, it is felt that
in general the term should be interpreted as liberally as possible.
I vish to remind you that the Federal Reserve banks are not recuired
to submit each application to Washington for the approval or disapproval
of the Federal Reserve Board. The action taken by the Federal Reserve
bank in each case is final, although the Board does keep constantly in
touch with the Federal Reserve banks on the administration of Section
13b.
.
In this connection, if I had time, I should like to read you recent letters which the Board has sent to the Reserve banks. They have
suggested the expediting of work on applications so.as to .get funds
actually into use more quickly. They have emphasized the need of calling
the attention of all banks to the advantages of Sec.tion 13b." They have
stated the Board's judgment that loans should be. made by local banks
under commitment from the Federal Reserve tanks rather than by the Federal Reserve banks, directly..
.
"
In fixing their.rates on industrial loans direct to the borrower,
the Federal Reserve banks have tiled to avoid making rates, so low as
to attract this business away froia member, arid non-raeihber banks and other
financing institutions. In general, here in the middle vest,, cornriercial
banks raid other financing institutions appear to be getting from 5 to 6
per cent on such loans. The rates charged by Federal Reserve banks1 on
consnit-aents vary with different, conditions,, but in general run £rom .1
tp 2 per cent per annum v . So, for example, as in the case already described, on a loan which bears 6 per cent interest, a member or riorimember bank may pay 1 per cent to the Federal Reserve bank for a commitment, which will leave 5 per cent net to the member or non-member
bank*
The loans made either by £h.e Federal Reserve Banks direct pr by
financing institutions under "commitments from the Federal Reserve'Banks
vary in size from #250 up to amounts'of. several pillion dollars'. "The
maturities range from a few weeks to five years. A wide variety of enterprises is covered.
"

11
I night add that the automobile .industry is at the hcr-d of the list
in total amount advanced under Section 13b - nearly £12,000,000. It may
also be vorth noticing in the copy of my. speech, which will be, or has
been, handed you, how many of these concerns vhieh have been borrowing
under Section 13b are directly or indirectly connected with the building
industry. Most or then ire makers of or dealers in essential products
and necessities of life - 175 loans were nwide to manufacturers of and
dealers in food products, and 162 to dealers.in end manufacturers of
lumber and builders1 supplies.
I trust I h«.ve given you a definite idea of what industrial loens
should nean to you. I hope that if you find enterprises in your cormunities which could use addition-'i1 working capital to an advantage, you
will not hesitate to communicate with the Federal Reserve Bank about
such prospects.
In this connection, I should like to read you at least one letter,
copy of.which was received by a Federal Reserve Bank, which shows that
real assistance has. been rendered under Section 13b:
"We wish to thank you for having permitted the Federal
Reserve Bank to make lo^ns to individuals, as the banks thet
we do business with have refused to help UEJ had it not been
for the Federal Reserve we probably would have been at a
great handicap, that is, our farners would have had to go
on the relief. The folks here in the Reserve Bank are the
way real bankers should be: pror.pt, courteous, business
all the way through, and very competent.
"Thanking you and trusting that you will leave this
avenue of finance open to us, I cm
Faithfully yours

This loan ha3 already been paid back in full.
I could illustrate cases one after another, but even these would not
show all the assistance that has been rendered, for in many esses the
Federal Reserve banks and member and nonmeinber banks have helped the
small industry and business without even the necessity of granting a .
loan, by giving advice •- business and financial, by assisting in reorganizations, and in innumerable other ways that cannot be, and ere not, recorded in a statement of figures. Through Section 13b the Federal Reserve
System has come closer to the public in a tangible and concrete way,
though the figures, at first glance, night make the service actually rendered appear r&thor email.
If certain banks lending under Section 13b find that soae of these
loans are better risks than they had supposed, and thus decide to lend
a little more freely to comparable enterprises, it will be a distinct
advance toward putting bank funds profitably to work.
I

While, of course, there is much more to say about industrial loans,
realize tht.t the occasion does not permit an exhaustive discussion.
I am afraid I have already taken too much of your time, and I don't

12
wish to have you tell me so. You have been kind and courteous - quite
unlike the fellow who was listening to a long speech by a professor on^
the origin of nan.• Let me say to the press that -this is off the recora.
The professor, after three hours of continuous speaking, askod --"If man
originates from trie monkey, where is our tail?" Someone in the audience
replied quickly - "We have worn it off by this tine sitting here listening to you,"
I hope, however, that I have stated enough to arouse your interest
in the amendment, at lsast to the extent of reading Section 13b, which is
very short, and the regulations of the Federal Reserve Board and the Federal Reserve Banks of Chicago or St. Louis, in whose districts the State
of Illinois lies. These have been supplied to the Secretary of the Association, and he promised to distribute then among the delegates to this
Convention.
Senior officers of the' Chicago and the St. Louis Federal Reserve
Banks are present. They will be glad to meet you to discuss any matters
respecting the Federal Reserve System, and particularly participations
or commitments under Section 13b of the Federal Reserve Act, The Chairman
:
or Secretary of the Convention can direct.you.
Let me conclude by saying that of course we learn' by experience. As
the years roll by, we look back end find that the big things that we have
done - the really big things, in the final account - which helped our
comnunities and our country nost - were things that appeared very small at
the moment.
Hunan beings are apt to spend their efforts pushing large boulders
when the removal of several snail pebbles fror;* under the large bouiders
would enable the boulders to move of themselves - so with" our economic
problems.
Of course, we all look for a day when the sun will shine once again
on our highway. But the dawn doesn't usually corfto up like thunder. It
often .steals upon us almost unawares.
Just when our most strenuous endeavors "seem to be ending in flat
failure, and our most elaborate and test laid plans seem to bo goingwrong, ve are in no mood to notice the more certaiti, if less conspicuous
results of all our efforts. But why search for words of my own? There's
a brief poem that says it oil so much better, and it cones irresistibly
to my mind these1 days - perhaps-it is familiar to you:

"Say not, the struggle nought availeth,
The labor and the wounds are vain,
The enemy faints not, nor faileth,
•And as things have been, things remain.
If hopes were dupes, fesrs may be liars;
It nay be, in yon smoke concealedYour comrades chase e ] cn now the flyers,
And, but for you, possess the field-.

13
"For while the tired vavcs, vainly breaking,
Seen here no painful inch to gain,
Far back, through creeks and inlets making,
Cones, silent, flooding in, the main.
And not by Eastern windows only
llhen daylight comes, co;aes in the light.
In front, the sun climbs slow, how slowly,
But Westward, look, the land is bright!11

Speech delivered over
National Broadcasting Company System
September 5; 1935.
LOANS TO INDUSTRY AND BUSINESS BY THE FEDERAL RESERVE BANKS
Let me thank the National Broadcasting Company and officiated stations for extending me the privilege of addressing the country upon the
subject of "Loans to Industry and Business by the Federal Reserve Banks",
The occasion reminds me. of a time more than, twelve years ago when
• radio speeches were in-their infancy, and when regularly each week I
traveled to a North Side radio station in Chicago to deliver talks on
educational topics. This evening the topic I shall speak on.over this
national hookup is a quite different one, and yet in a sense what I said
then on economic-philosophic subjects involves the same fundamentals as
what I have to say tonight on the subject of credit.
By way of preamble, let me say that it is difficult, to say the
least, for anyone to state the principles upon which solution pf our economic problems is possible. No economist and no expert has been able to
state the remedy clearly and persuasively. That is because each economist and expert sees the "situation from his own point of view, and his
point of view is frequently based on opinions he has already expressed,
especially if he has written a book or two. I am not speaking disparagingly of economists and experts. I have two daughters who, I hope will
soon major in economics. I think very highly of economists and experts
and know they have contributed much. But I too have studied and taught
economics, and therefore know its limitations as well as its possibilities
Personally, however, I believe that the beginning of a solution of
our problems lies in a full realization that selfishness Is at thoir bottom.
If we could, without appearing to preach, or lecture, speak so as to move
the heart as well as the mind of man for and in behalf of his fellow man,
we would be making a real step in the direction of a permanent solution
of our economic perplexities* .. . .
It is humanly so difficult, however, for us to see anybody else's
needs and sufferings but our own. What is worse, perhaps, it is hard for
us to realize that our own welfare rests on what we are willing to do for
others. In human relations, repayment in kind is inevitable. We get
back eventually with interest, exactly what we give out to others - good
or bad. No matter how long it might appear to take - Human accounts are
settled one day*
You have heard this often and much more ably said than I can say it.
You have seen actual cases - by the House and Senate - yet you may be inclined to feel that it is too ea^y and can not be true. You may feel
that problems so intricate as ours can not be solved by so simple a(
method - that there must be some formula much more complex than just this
simple formula of charity - real charity of the heart.
We are inclined in our own human way to be much impressed by things
we do not understand1 - like the boy who came home from school one afternoon, and all out of breath said to his mother: "We had a very brilliant
professor teaching UG physics this afternoon. H2 took the place cf the

16
regular professor who is sick, and he talked to us all afternoon and nobody in class could understand a thing he said. It was just wonderful
Mother." How many of us are just like that boy. We look for complex and
mysterious remedies for our ills, and we place on a pedestal the individual whose words are big and whose theories are beyond our mental grasp.
Yet in fact truth is very simple. It i3 here - there - everywhere.
We could see it if it were not for the fog of prejudice and ignorance in
which we live. Occasionally the fog lifts and then we see the truth that
was there all the time. It may be astounding, - it may even be shocking,
but seeing it we accept it, for the light of truth is its own evidence,
and the mind can not resist it, nor remain dark when penetrated by its
beams. So it is with our economic difficulties. The solution of these
problems rests in simple truths that are all around us - truths in whose
midst we have our dwelling - truths which are near at hand and everlasting - truths which distinguish right from wrong in the relation of man
to man.
These are the principles upon which to base the solution of our
economic problems; and yet, because the statement of them is so simple,
I dare say you are smiling at this very moment and saying, "Doctor heal yourself". But no one can do it alone. The problem is collective
as well as individual, and the solution therefore must be collective as
well as individual.
The correction of evils, economic or social, must begin with a sincere and frank admission of our own limitations - our failures to see
the truth - our mistakes. From that point on we can begin to live a new
life for the good of society. Once we have begun our new economic and
social life based upon these fundamental principles, we can proceed
courageously without even the smallest fraction of a fraction of fear,
and going forward we become leaders - others follow. The world however
never follows one who is afraid or uncertain.
I have mentioned these general and fundamental considerations because they are the. essential background to my subject. What I am to
speak of is only one of the simple measures that we have adopted in order to meet the economic difficulties that.ve are endeavoring to solve.
It is a measure for the lending of money to established industrial and
commercial enterprises whose working capital has become depleted. It
is not a measure intended to dispel all our. economic difficulties. But
it is helpful, and for that reason I want to explain it so that every
business man to whom it may be of benefit may know of its provisions
and how he may avail himself of them.
Ah outstanding fact about the present business situation is that
the banks of the country have an. abundance of money to lend. There are
two main reasons why this money is not being used by borrowers. The
first and most important probably is that responsible business men do
not wish to borrow unless they are confident that they can make a profitable use of the funds. The second is that bankers do not wish to
lend unless they too are confident that the borrowers can make a profitable use of the funds. But credit is necessary for business, and no
effort is to be spared in removing obstacles to the availability of
credit whenever and wherever credit can profitably be used. Accordingly,

17
the Federal reserve banks^ have been authorized to make a distinct departure from their established; practice. • They"have been authorized under
certain circumstances to. guarantee loans which local banks may not be
willing otherwise to ma&e,1 and in"exceptional circumstances, to make, such
loans themselves.
."
'
•

•

Briefly, the conditions are as follows: A Federal reserve.bank wil]
either cooperate with a Ipcal bank in making a loan to a commercial or
industrial borrower, or it will make the loan direct. This provision
applies,.however, first, only to loans to established industrial and commerical businesses; second, only to loans which are for working capitalpurposes; third, only to loans which' have maturities of not more than
five years; fourth, only,to loans which can be made on a reasonable and
sound basis.
"
In administering the law the effort has been to avoid narrow interpretations. The question whether or not a business is an established
one is interpreted as liberally as possible, though the law can not by
any stretch of interpretation be held to authorise the making.of loans
to people who wish to start a new, business. Similarly, the term "working capital11, can not be stretched to cover loans made for the purpose of
the erection of buildings, the purchase and.installation of permanent
equipment* or the refinancing of existing indebtedness. Such uses of •.
credit are desirable and may be taken into consideration incidentally.in
passing upon applications for loans to provide working capital, but they
do not come within the primaiy purpose of this law, which applies instead to funds required for current operations.
The requirement that loans have maturities • of hot1- to exceed five .
years is a .veiy generous one. It gives the ordinary business man ample
time in which to restore his working capital! He can meet his successive
payrolls, purchase his materials, renew his inventories, and turn over
his stock again and again before his loan-has finally to be paid back.
Generally the loan is made payable in easy installments.
In imposing the requirement that the loans be made on a reasonable
and sound basis, Congress has left it to the judgment of the Federal
reserve..banks as to what security should be required in individual cases.
The types of business covered by these loans are of the utmost variety,
arid for that reason standard requirements as to security can not be made
in detail. It can only be required that the security offered, whatever
its nature, be adequate. The Federal reserve banks have on occasion accepted real estate mortgages, chattel mortgages, stock and bond collateral, pledge of accounts.receivable, endorsement, assignment of• life insurance policies, etc. No business man who has assets of value to.offer
as security need hesitate merely because they do not conform to the t.
types of collateral which banks usually require.
The Federal reserve bank's are not in cpmpetition with local banks
in making loans. On the contrary, the idea is that the Reserve banks
should cooperate with local banks, which are the proper agencies .to
supply credit to their communities. Accordingly, the first step for any
prospective borrower is to go to his local bank and state his needs. He
should say to his banker that he is not seeking an ordinary short-term
extension of credit, but a loan under the terms of Section 13b of the

18
of the Federal Reserve Act, His banker should know at once what he is
talking about. If he does not, the borrower should tell him" what he has
heard me say; he should tell the banker that under the provisions of. Section 13b of the Federal Reserve Act the-Federal reserve banks are authorized to cooperate with local banks in making loans for working capital
purposes. • In case the banker is not familiar with this fact he should
ask him to communicate with the Federal reserve bank of his district and
find out the particulars. And the local banker should be glad to do it.
Ordinarily, of course, he does not wish to make long-term loansj he
thinks of the depositors who may at any time demand their money, and he
wants his funds where he can call them in quickly if.he1 is subjected to
such a demand. But the banker need not worry about the. long maturity,
for under Section 13b the Federal reserve bank will grant him,a commitment to take the loan off his hands during the period of the commitment.
That commitment makes the loan as liquid as anything the banker can have
in his bank. Furthermore, in taking over the loan, the Reserve bank
will assume as much as four-fifths of any loss. It makes no. difference
whether the local bank is a member of the Federal Reserve System or not.
The borrower will probably find, however, that his banker already
knows all this; and if the applicants credit is good and the loan is
one that the banker is justified in making he will be very glad to place
his funds in use under an arrangement which assures him perfect liquidity
and guarantees him that his loss will not exceed 20 percent of the loan.
If, however, the banker does not respond, the borrower should communicate directly with the Federal reserve bank of his district* The
Federal reserve banks are authorized to make the loans direct only in exceptional circumstances and when credit is not available from- the usual
sources. The loan should be adequately secured and there should be a
reasonable prospect that it can be repaid from the operations of the business. The loan is not a gift. Applications are acted on as promptly as
possible. They are not referred to Washington. They are passed on in
the distrcits where they originate, and each Federal reserve bank has
final authority to reject or approve the loans for which it receives applications.
The provisions of Section 13b of the Federal Reserve Act have been
in actual operation for more than a year. In that time the Federal Reserve banks have approved nearly 1800 applications, aggregating about
$107,000,000.
As of June 30, the automobile industry was using over $7,000,000 of
this credit. Manufacturers of metals were using over $5,000,000. The
machineiy and machine tool industry was using over $3,000,000. Textiles
were using $2,500,000.
Loans have been made in all amounts• The smallest so far is a loan
of §250.00, the largest a loan of &6,000,000. It should be clear, therefore, that the program is one which is open to all business men, large or
small, whose businesses are established and whose prospects are such that
loans can be justified.
There now, that is simple, isnft it? - like those truths I mentioned
Digitized
FRASER
in for
the
beginning. Its purpose is to aid business and industry and to
http://fraser.stlouisfed.org/
maintain
and increase employment.
Federal Reserve Bank of St. Louis

19
For further information and for application forms, ask your banker,
or write to the Federal reserve bank of your district.
Thank you, and good night.

21
Speech delivered before
Cosmos Club
Washington, D. C.
February 27. 1936
FEDERAL RESERVE SYSTEM LOANS TO INDUSTRY
WHAT IS FEDERAL RESERVE SYSTEM
The Federal Reserve System was established in 1913 by the Federal
Reserve Act, one of the most important pieces of financial legislation
ever passed in this country. The System was created after many years o;
dissatisfaction with our banking and currency facilities, brought to a
head by the panic of 1907, and after a thorough study of banking here
and abroad by a National Monetary Commission established by Congress in
1908. Since 1913, on the basis of actual experience and in response to
new developments, numerous amendments have been made to the original
Federal Reserve Act, During the depression changes were made by the
Glass-Steagall Act of 1932, the Emergency Banking Act, the Banking Act
of 1933, the Gold Reserve Act of 1934 and other acts. The recent legislation, approved August 23, 1935, makes important permanent changes so
that the System can be more effective in the future in meeting the credii
needs of the country.
FUNCTIONS OF FEDERAL RESERVE BANKS
There are twelve Federal Reserve banks, one in each of the twelve
Federal Reserve districts into which the whole countiy is divided. Several of the Federal Reserve banks have branches which operate in different parts of their district. There are now in all twenty-five branches
and two agencies.
Banks of the country become eligible to use the facilities offered
by the Reserve banks by becoming members of the Federal Reserve System.
All national banks were required by law to join and State banks are permitted to become members if they fulfill certain requirements as to
capital structure and as to the general nature of their business.
Federal Reserve banks differ from ordinary commercial banks in both
their organization and their functions. Generally speaking, they do not
deal directly with the public. Their customers are the member banks who
come to secure credit or currency just as the public goes to the local
banks. The capital stock of the Federal Reserve banks is oyned by the
member banks, which are required by law to subscribe to capital stock
equal to six per cent of their capital and surplus. One half of such
subscription is paid in cash and the other half is subject to call. The
management of the bank is in the hands of a board of directors which
represents not only the member banks but other business interests of the
community.
One of the purposes of the Federal Reserve Act was to provide institutions which would hold reserves of the nation1s banking system.
All member banks are required by law to keep their reserves on deposit in the Federal Reserve bank of their district and it is the business of the Reserve banks to supply member banks with credit or cash in
such emergencies.

22
Reserve banks are sometimes known as the central reservoirs x>f.
credit of our banking system because of this function of holding in
trust the reserves of the member banks. Under the Federal BeServe System our banks no longer have any fear that they will be unable to get
their reserves when needed. One important risk .has been eliminated from
commercial banking.
Loans to Member banks: Equally important with their function of
holding member bank reserves is the power of the Reserve banks to make
loans to member banks. Through these loans the member banks are able
to increase their deposit balances, and thus provide the rese'rves necessary for the expansion of credit. Reserve banks, may supply funds to
member banks by rediscounting paper or by making advances to member
banks, as provided by law and Board regulations, or. by purchasing bills
and securities, and entering corresponding credit^ to the account of
the member banks, thus increasing their reserve balances. Meinber banks
in turn can increase their .loans to the public in the aggregate by an
amount several times the amount of the additional reserves.
Currency issued by Reserve Banks; Another phase of the activity
of the Reserve banks is the .issuance of Federal Reserve notes, which
are the paper money put out by the Reserve banks under the provisions
of the act for supplying the country an elastic currency; that is, currency whose volume can be readily increased or decreased according to
the public demand for it. Federal Reserve notes are obligations of the
United States and are secured by specific collateral pledged by the issuing bank. The bank-is required to keep reserves in gold certificates
at least equal to forty per cent-of the notes in actual circulation.
Other functions: Reserve banks have greatly simplified the procedure wheretjy banks collect checks they receive which are drawn against
other banks. This has been very use:ful to business men because, it has
permitted more prompt and cheaper settlement of many business transactions. The Reserve banks in effect.act as a nation-wide clearing
house. Banks merely send the checks against other banks to the Reserve
bank of their district. Checks on banks in the district are cleared on
the books of the Reserve bank and those on banks in other districts are
bleared through the other Reserve banks.. . The Reserve banks perform
similar services in connection with other credit, items, such as collec-.
tion Of notes, drafts, bonds and coupons, and the acceptance of exchange drafts. Machinery has. also been set up for prompt payment of '
funds from one part of the country to another without actual movement
of currency. The System maintains a fund in Washington called the ;'
Gold Settlement Fund established by deposits of the twelve Federal
Reserve banks. Transfers.from one district to another are made daily
by adjusting the accounts.of the various Reserve banks.
Reserve banks act as fiscal agents in connection with the issue and
retirement of Government debt and in administering deposit accounts of
the Government in the Reserve banks.
FUNCTIONS OF BOARD OF GOVERNORS
The most important duties of the Board of Governors in Washington
relate t6 the broad credit policy for the country as a whole and .are

sometimes spoken of as its power to influence the volume and cost of;

23
credit. Experience has indicatfed tH£t powers of the Board which affect
the expansion and contraction of'ihe general supply of credit are of
vital importance to the country, since the volume of credit is a factor
in determining the course of business, and proper changes in the cost
and volume of credit raay exert an influence toward moderating excessive
expansion or contraction of business, or in other words, may reduce the
danger of inflation and deflation.
. The Board's instruments for influencing the volume of. credit are it:
power to chsnge discount rated arid'reserve requirements, and through itc
majority members on the Federal Open Market Committee, to determine .opasmarket policies.
..•..Discount rates are the rates charged by the Federal Reserve banks
on loans to member banks. These rates determine the cost of borrowing
by member banks and consequently affect the cost at which the public can
borrow from these banks. Under the Federal Reserve Act changes in discount rates made by the various Federal Reserve banks are subject to review and determination by the Board of Governors. This gives the Board
final responsibility on the discount rates so that the most of the borrowing in the different sections of the country raay be kept consistent
with general credit conditions for the country as a whole.
The new banking act strengthens the Board1s power to control these
rates by making the further provision that discount rates must be submitted to the Board of Governors every fourteen days. This establishes
as a matter of law the requirement that the discount rate policy shall
be reviewed at least every two weeks.
The Board of Governors also has the power to change the reserve requirements of member banks. The volume of credit which any member bank
may extend is limited by the amount of reserves which are required by
law to be maintained against its deposit liabilities. Consequently the
power to change reserve requirements gives the Board an important means
of controlling the general volume of credit.
Another important means of control over the supply of credit are
the so-called open-market operations, responsibility for which under the
new banking act will be vested in a new Federal Open Market Committee.
This committee will consist of the seven members of the Board of Governors and five representatives of the Reserve banks selected by the Reserve banks in different regions.
Open-market operations consist of the purchase and sale by Reserve
banks of certain classes of securities, chiefly Government obligations.
These operations have the effect of increasing or decreasing the supply
of credit available in the market. By selling securities the Reserve
banks withdraw funds from the market and there is a decrease in the supply of credit. Through a purchase, of securities a Reserve bank putsfUnds
into the market, thus tending to ease credit conditions.
The Board of Governors has a variety of other duties which tie in
with its general responsibility for supervision of the System. These include the examination of Reserve banks, passing on applications of State
banks and trust companies for membership in the System, obtaining condi
tion reports from State member banks, administration of those provisions

of the Ciayton Anti-trust Act which relate.to, intfe^-lockijijg^.ciirectorate
regulation of!'the maxinum rate of: interest, to be paid by meiiiber banks p
time, and savings deposits^ regulations Tmdertfce.Security ^ E x c h a n g e
Act governing, the margin requirements for loans on securities listed oh
the. stock exchanges, and maintenance and operation .of the Gold Settlement Fund.
It is also a part of the System1 s problem to vatch indicators of'
credit trends and to develop a better general understanding of the facts
bearing upon credit" policy. The System has pursued a policy of Collecting information bearing on banking.conditions throughout the country
and on production, employment, trade and prices. In a monthly publication, the Federal Reserve Bulletin, and in its Annual Report, the Board
has undertaken to give to the public a comprehensive view of current
banking and financial developments at home and abroad and also to furnish detailed information on conditions. of. banks. throughout the country
and,on.the business situation.
LOANS TO INDUSTRY - SECTION 13-B
I want to take a few minutes now to tell you about recent special
work of the Federal Reserve banks." I.refer to.operations under an
amendment to the Federal Reserve Act approved June 19, 1934, which '
authorizes the Federal Reserve banks to make direct. loa.ns to industry
and to guarantee for banks certain types of loans to business men
which the banks might not otherwise be willing to make. The purpose of
these provisions is to give both bankers and business men some .added
assurance in making commitments during a difficult period when they tend
to feel unduly conservative.
Anyone in an established industrial, or commercial bu^in4s.p.'who
wants, a. loan for working capital purposes which is reasonable and sound
and has. a maturity of not more' than five, years "should now be able to
get such a loan" from his local bank.. This applies to bothjnember and
nonmember banks. Furthermore, if the local bank cannot accommodate the
borrower, he may be able to borrow from the Reserve bank itself. No
business man who'has assets of value to offer as security .need hesitate
because they' do hot' conform to the types of collateral' usually required
by banks.
•
1

The local banks are given special assurance in making thes£ loans
through the privileged status which they enjoy at the Reserve banld.;
The loans are eligible as a basis for borrowing at the Reserve banks.More than that, if the bank wants to dispose of a loan it can procure a
commitment from this Reserve bank to take it off its hands., and the bank
is.guaranteed against loss up to 80 per cent of the loan..
"
The Federal Reserve banks do not seek, however, to supersede" the
local banks. They do not make an advance if there is a local bank willing to make it. They seek to have the local bank at least participate
in,.the.loan, and the law goes so far as to permit the Reserve bank*to
relieve the local bank of all but 20 per cent of any loss on the loan.
Since the middle of 1934 when this program began the Federal Reserve
banks have, approved aDDlications for about $126,000,000 of such credit.

2$
The credit has been used by & Wide variety of businesses. Only established commercial and industrial enterprises are eligible, the loan must
be on a reasonable and sound basis, and the maturity must not exceed
five years.

27
Speech delivered before
Real Estate Board of Kansas City
Kansas City, Missouri
M a y 8, 1936 '
BUSINESS RECOVERY AND INDUSTRIAL LOANS
There are..three principal aspects, to.be noted in the credit situation during the last three years*' Thfcse are:
1. The growth of bank reserves.
2. The increase in the volume of bank deposits,
3. The limited use by business: and by
individuals of the funds which banks
have available.
•Growth of bank reserves
Since June 1933 the reserves of member banks have shovm exceptional
growth• They nov* stand at the highest levels, on record, #5*800,000,000.
Between .June 1933 and March of this year total member bank reserve balances had increased -^3,500,000,000. Required reserves increased in that
.period by about £.,000,000,COO, which left an increase, therefore, of
about s>2,500,000,000 in excess reserves. Excess reserves are now about
#3,000,000,000.
The growth of reserves ha3 resulted principally from the movement of
about &3,300,000,000 of gold to this country from abroad.
Since June 1933 the public debt has increased about ,#,000,000,000.
Banks (including Federal Reserve banks, member banks, mutual savings
banks, and other non-member banks) increased their holdings of Government
Obligations by nearly ^6,000,000,000,or 2/3 of the total increase of the
public debt. These funds borrowed by the Government from the banks have
been expended to provide relief and employment. They increased bank
deposits.
The increase in the volume of bank' deposits
The deposits of the general public, excluding inter-bank and United
States Government deposits, but ihcluding deposits'at non-i;iember as well
as at member banks, now: total about §15,000,000,000. There has been an
increase of about §11,000,000,000 since June, 1933. Deposits at present
are still below the 1929 peak by about y5,000,000,000. However, since
that time Postal Savings deposits not redeposited in banks have increased
by nearly #900,000,000, and money in circulation outside of banks has increased by. ^1,500,000,000. Accordingly, the available cash resources of
the public are altogether only about £3,000,000,000 - or 5 percent - less
than they were in 1929.
The increase of #11,000,000,000 in deposits since June 1933 is due
largely to an increase of about t?h,000.000*000 in monetary gold and silver stock and of about Mo,500,000,000 of Government expenditures from the
proceeds of direct obligations purchased by banks, including the Federal
Reserve banks, and by the Postal Savings System.

28
The limited use by business of the funds which banks have available
Although the volume of bank deposits is now almost as large as at
the peak in 1929, the rate of turn-over is still relatively small; deposits turned over about fifteen times,per annum in 1935 as compared
v/ith twenty-seven times in 1929, and as compared with twenty times in
other years more normal than 1929. Accordingly, although it is to be
expected that deposits will increase still further this year, as the^
result of government borrowing and expenditure, it does not necessarily
follov; that the rate of turnover will increase•
It is unusual for banks to have any large amount of excess reserves
such as they now have. Prior to 1931 they never had excess reserves of
more than #75,000,000 or <}100,000,000 altogether for any great length of
time. With excess reserves in such an amount as i?3,000,000,000 it is
natural that the banks should be seeking ways of putting these funds to
use.
It is obvious that the possible expansion that may take place on the
basis of present reserves is far greater than may be needed for sound
business conditions. On the present basis, credit could be extended and
bank deposits thereby increased to $90,000,000,000 or $100,000,000,000.
This would be about twice \\hat deposits are now, and about twice the
amount that they were in 1929 at the peak. These deposits would represent funds immediately available for use.
The possibility of increasing the use of funds and also the amount
of funds to be used depends upon two things: First, it depends upon the
desire of owners of existing deposits to use what they have either for
spending on a freer scale or for permanent investment. In the second
place, it depends upon the desire of business to use the funds already
available and to borrow still more for the purpose of expanding operations.
In the past year developments in capital markets were marked by a
sharp increase of activity. Stock market trading increased and securities prices rose by over 50 percent. New security issues in 1935 were
the largest since 1930. The principal issues however v/ere for refunding j these totaled #3,300,000,000. Issues to raise new capital totaled
only £L, 1*00,000,000, of vhich ^1,000,000,000 represented issues of
States, municipalities, and Federal land banks. Corporate issues for
new capital totaled only #1*00,000,000. This compares strikingly vdth
the figures in the late twenties when corporate'issues for new capital
amounted to #1*, 000^ 000,000 or more a year.
Although the greater portion of the financing indicated has been
for refunding of existing indebtedness, this refunding has been at
lower interest rates and consequently has tended' to decrease costs
and to increase the profitableness of enterprise. The small volume
of issues for new capital is not in any event an accurate measure of
business expenditures for plant and equipment, since not all the proceeds of such issues are used for this purpose, and since, on the
other hand, corporations have a large volume of idle funds available.
Moreover, developments in the business situation indicate that these
funds.are being more freely used.

29
Industrial loans
In this connection I think it v/ill be interesting to mention the
experience of the Federal Reserve banks in making idustrial loans. In
June 193U the Federal Reserve Act was amended by the addition of a new
section, namely 13b, authorizing the Federal Reserve banks to make credr
available for working capital purposes to established industrial and com*
mercial enterprises on maturities not exceeding five years. This au. thorization was made because it was felt that as a result of the depression a good many business enterprises had suffered such .depletion of
working capital that they were unable to take advantage of new business
opportunities. It was also felt that the local banks in many instances
were still reluctant to make credit advances. Under these circumstances
the Reserve banks were authorized to discount such paper for local banks,
and also to grant commitments to local banks insuring such paper up to as
much as 80 percent of its face value. The Reserve banks were also authorized, in exceptional cases where credit was notavailable from the
usual sources, to make loans for working capital purposes direct to the
borrower. This was a marked departure for the Federal Reserve banks,
viiich hitherto had held only short term obligations or marketable securities, and had not made loans direct to the borrowing public. The new
functions seemed required by the emergency however, and the Reserve banks
set out energetically to make the fact known to the business public that
credit for working capital purposes was amply available. Local banks
were also informed of the exceptionally favorable conditions upon which
they could make loans for such purposes. At the time banks were especially anxious to maintain a hi6hly liquid condition, and would not have
been interested in long term loans unless there were provision for their
liquidity. This was provided however by the coirjnitments granted by the
Reserve banks. Under their terirs, the Reserve banks would agree to purchase such loans from local banks practically on demand, provided of
course the loan hadfc>eenapproved in advance by the Reserve bank. When
it is considered that beside this provision for liquidity, there was also
a provision that the local bank might be relieved of 80 percent of the
risk, it is apparent that the terms were calculated to give substantial
encouragement to the local banks to make the loans which the depleted
condition of many businesses made necessary. By the same token it is
clear that the Reserve banks were in no sense entering into competition
with local banks.
As of April 2? the Federal Reserve banks had approved 2,139 applications for working capital credit in the amount of $131,000,000. In recent months there has been very little increase in the amount of such
applications approved. At the same time, however, there has been a distinct falling off in the number and the amount of applications received.
In the first three months of last year 8I4I applications were received
and the total amount was #29,000,000. In the first three months of this
year the number of applications received was only 3U7 and the amount was
only $13,000,000. Both in number and amount, applications were less than
half what they were in the corresponding period last year. Moreover,
there has been an almost uninterrupted decline every quarter since the
beginning of last year.
Repayments, on the other hand, show marked increases. In the first
quarter of last year they amounted to about 1^1,700,000; in the second

30
quarter, $2,100,000; in the third quarter, $1,600,000; in the fourth, quarter,
#3,600,000; and in the first quarter of this year, ^3>500,000.
The Federal Reserve banks sibill stand ready to make this1 credit available wherever it carr be done on. a reasonable-and sound basi3 and'local institutions are unvalling to advance it., la this connection, however^ it is
important to emphasize that the lav; permits ;the Reserve banks to make this
credit available only for working capital purposes and only to established
industrial and commercial businesses.• The credit is not available for permanent capital, nor to refund existing indebtedness.(except in minor amounts
incidental to provision of working capital), nor to new enterprises.
Increased production and trade
In 1935 there was a large increase in production and trade following
an. irregular upward movement since. 1932. The index of industrial production
for 1935 as a whole averaged 90 percent of. the 1923-1925 average and rose
to 10lt in December, partly because of an unusually large output in the automobile and related industries. There has since been some decline, February and L-arch. showing an index of 9h« There appears to have been an advance in the index since that time. It appears, therefore, that the recovery in industry reached in 1935 is being maintained in 1936.
This recovery appears in many lines of industry. It is apparent to
some extent in.non-durable goods, comprising mostly articles of everyday
consumption, v.tiich declined but.moderately in the depression. It is apparent principally in durable goods, comprising building material, industrial equipment, automobiles, and more lasting household equipment.
The greatest decline in the depression occurred in the field of construction. Residential building, which in 1933 declined to 11 percent of
the 1923-1925 average, did not increase until 1935. . Then, hov/ever, contracts
almost doubled those of the previous year. In the first quarter of 1936
there was an important increase in private construction other than residential. The greatest hope for expansion lies in the field of private construction. Shortages of residences have developed; new and improved types
of housing are available; financing costs are lov;er; the burden of financing
as a vfrole has been lightened; and the facilities for financing have improved*
Construction costs are also somewhat lower.
. ... In the field of trade, consumer purchasing has increased. Department
store sales' in 1935 were at 79 percent of the 1923-1925 average, compared
with 67 percent in 1933* Sales in March of this year were up to 88 percent.
In rural areas sales have shovrci a marked increase .in recent years, viiich
indicates that the status of farmers has improved. In recent weeks automobile sales have been at high levels, and gasoline consumption has been
the largest on record. YJholesale smiles have increased considerably, particularly in the durable goods lines - agricultural implements, hardware,
and household equipment.
These, then are the facts and figures on business recovery as of today.
Let me suggest in connection with industrial loans under section 13b
that you avail yourself of the willingness of the Kansas City Federal Reserve Bank to £ive you further., and .more detailed, information on the subject
for the general good of your community.

31
Speech delivered before
Washington Bankers Association Convention
:
Spokane, Washington
"""
June 18, 1936
INDUSTRIAL LOANS
"•hen the Federal Reserve Banks were established they were authorized
to discount for member banks only certain eligible types of paper. These
represented advances of credit for short terms only on the basis of commercial and agricultural activities. The idea in limiting the discount
powers of the Federal Reserve Banks to these classes of paper was to
facilitate the use of bank credit for legitimate commercial and productive purposes, and to discourage its use for speculative and nonpro- *
ductive purposes,
Without departing from this objective, it has been found necessary
from time to time in recent years to modify the limitations in the original Act, .,".ost of these departures were made as the result of emergency
needs arising during the depression. It was for this reason that in 1932
the Federal Reserve Banks'were authorized under certain conditions to
make advances to member banks on the basis of any collateral satisfactory
to the iteserve Banks, In the Banking Act of 1935 this provision, which
had previously lapsed, v/as restored to the Federal Reserve Act in Section
10b and made, more general in its application. The result is that at the
present time, as1 you knoir, Reserve Banks may make advances to member
banks on any type of collateral satisfactory to them, provided the paper
has not more than four months to run. This power is no longer restricted
as it formerly was, to periods of emergency. 'Advances of Federal Reserve
Bank credit on such bases as well as on the basis of the class of paper
originally defined as eligible arc now within the scope of the regular
powers of the Federal Reserve Banks. At the present time, of course,
v/hen banks in general have an abundance of funds, the authorization for
the Federal iteserve Hanks to make such advances has little occasion to
be exercised. If the banks have occasion to borrov/ in the future as they
have in the past, ho:vever, these powers may come to be of great importance.
There is one special type of loan which the ordinary bank would
probably hesitate to make if the law did not permit" the loans to be discounted at the Reserve Bank on especially favorable terms. These are
working capital loans with five year maturities, authorized by Section
13b of the Federal Reserve Act.
The difference between Section 10b and 13b is mainly that 10b
authorizes advances on any satisfactory collateral for not more than four
months; whereas 13b authorizes advances and discounts for v;orking capital
purposes for not more than five years.
The powers to discount industrial loans were given to the Federal
Reserve Banks under the terms of an Act of June 19, 193h9 v/hich' added
Section 13b to the Federal Reserve Act. The adoption of this measure was
preceded by considerable discussion as to the proper means of making
credit available to business enterprises whose working capital had been
depleted. One suggestion that has often been made is that there should
be intermediate credit banks established for the purpose. The basis for
the suggestion usually is that small business enterprise has great

32
difficulty in procuring capital, Whatever1 "the"merits of- this-question, Congress decided to use an exijting agency rather than establish
new ones, and to provide the facilities aimed at through extension of
the powers of the Federal Reserve Banks.
The amendment which was adopted authorized the Federal Reserve
Banks to discount loans made by member banks and others for working
capital purposes, or in cases where credit was not procurable from the
usual sources to make such loans,direct. The law stipulated that the
loans were to be made to established industrial or cojiLiiercial enterprises; they were to be for the purpose of furnishing working capital;
and they were to have maturities not exceeding five years* ;Vith
respect to such loans to be discounted by the Federal Reserve Banks,
the law reads as follows:
"Each Federal Reserve Bank shall also have power to
discount for, or purchase from, any bank, trust company,
mortgage company, credit corporation for industry, or other
financing institution operating in its district, obligations
having maturities not exceeding five years, entered into for
the purpose of obtaining working capital for any such established industrial or coolerci-al business; to make loans or
advances direct to ar\y such financing, institution on the
security of such obligations; and to make commitments with
regard to such discount or purchase of obligations or with
respect to such loans or advances on.the security thereof,
including commitments made in advance of the actual undertalcing of such obligations. Each such financing institution
shall obligate itself to the satisfaction of the Federal .
Reserve bank for at least 20 per centum of any loss which
may be sustained by such bank upon any of the obligations
acquired from such financing institution, the existence and
amount of any such loss to be determined in accordance with
regulations of the Board of Governors of the Federal Reserve
System."
You will notice that the Federal Reserve Banks may make these discounts
not only for member banks, but for non-member banks or any other type of
financing institution.
The arrangements that nay be made under this authorization are extremely favorable to the bank which desires to make the loans in cooperation with the Federal Reserve Bank; for the commitment which the
Federal Reserve Bank is authorized to grant, is an agreement under which
a local bank nay carry such a loan in its own portfolio at a good rate
of interest and with the privilege of disposing of it at any time at
the Federal Reserve Bank, Lloreover, when it is sold or transferred to
the Federal Reserve Panic, the latter vail assume vathout recourse as
much as 80 percent of ary eventual loss on the loan. .The commitment,
therefore, gives the local bank assurance that the loan is perfectly
liquid even though it may run for a period of five years, and also
that its own loss on the loan may be limited to 20 percent.
The Federal Reserve Bank of San Francisco makes a charge of from
1/2 to 2 percent per annum on the commitments it grants. The exact
rate depends upon various factors of credit risk, maturity, etc. It

33
charges a discount rate of from 3 to h percent on that portion of any
loan for v/hich the bank which made the loan retains obligation, and from
k to 5 percent on that portion from which the bank v/hich made the loan
is released from obligation.
In granting a comiaitment, of course, the Federal Reserve Bank has to
consider the credit risk exactly as if it were making the loan itself.
It may be said indeed that the Federal Reserve Bank assumes somev/hat
more risk in granting a commitment than in making a direct loan, since a
loan which it makes itself is under its own immediate care, whereas a
loan held by another institution is not. Obviously the circumstances
are such that the Federal Reserve Bank must be assured that the loan is
a good one and that it will be properly serviced. In practice, therefore, applications for such loans are usually considered simultaneously
by the Federal Reserve Bank and by the bank which contemplates making
the loan.
In cases where a loan is refused by the local banker but is considered by the Federal Reserve Bank a good- loan, the Reserve Baric may
make it direct. Under such circumstances it cannot be said that the Reserve Bank is competing with member banks. The Reserve Banks in general
prefer that local business be handled by local banking agencies. They
do not desire to develop direct banking relations with the public as a
matter of policy in ary cases where local banking facilities are
adequate.
As you know, the central banks of some other countries, for example,
the Bank of England and the Bank of France, have a certain amount of
private business which they conduct in competition with other banking
institutions. Before their central banking functions developed, these
institutions had much more of such business. The private business v/hich
they still have, however, is not essential to their functioning as
central banking organizations. The same thing is true in the United
States. The basic functions of the Federal Reserve Banks are central
bank functions. The Reserve Banks are in the main intended to supplement regular banking facilities and to stand in reserve behind the local
banks. They are not competitors of their members.
It is now nearly two years since the Federal Reserve Banks were
given the authority I have been discussing. In that period they have
received, as of June 39 8,127 applications of which 2,165 have been approved. The total amount that has been applied for is ^330,026,000.
The amount approved is ,,,132,626,000. Of this amount, ,27,lUi,OOO has
been conditionally approved, and ,;>105,1*82,000 finally approved. These
final approvals include direct advances outstanding of ,>3O,7O1,OOO and
commitments outstanding of o2li, 878,000. Repayments have amounted to
:?llj,938,OOO. Withdrawals of-approved applications, etc. have amounted
to .J21,6.76,OOO. Financing institutions participations with the Federal
Reserve Banks have amounted to -ill,970,000, and there is in process of
completion advances and commitnierits of about one and one-quarter million.
During the same period, that is since June, 193U, the Federal Reserve Bank of San Francisco has received l,06£ applications, of which
25U have been approved. The total amount applied for was ,p31,32U,OOO,
and the amount approved was .^ll,9U2,000. Outstanding advances now
amount
to pi, 668,000, and commitments outstanding amount to ^U, 363,000.

Repayments have amounted to $150,000.• The.Baric now has in process-ofcompletion approved advances and commitments of about vU&3*000«
The statute limits the amount available for these loans and commitments to 0280,000,000 for all the Federal Reserve Banks, of which
the-Federal Reserve Bank of San Francisco has 0l9>500,000. This constitutes a revolving fund, so that as payments are received and new
loans made, tho total credit that may be extended far exceeds the
amount mentioned.
In order to assist the Federal Reserve Banks in dealing in a field
of credit which Congress felt might be new to them, it provided that
each Reserve Bank should have an Industrial Advisory Committee, The
members of the Industrial Advisory Committee of the Federal Reserve
Bank of San Francisco are as follows:
Stuart L. Rawlings

V.P., Calaveras Cement Co.

Ralph Burnside

V.P., Eatonville Lumber.Co.

Shannon Crandall

Pres#,Calif. Hardware Co.

Henry D. Nichols

V.P., Tubbs Cordage Co. .

William G. Volkmann

S e c , A. Schilling & Co.

San Francisco,
Calif,
Eatonville,
wash.
Los Angeles,
Calif.
San Francisco,
Calif.
San Francisco,
Calif,

All applications received by the Reserve Bank are considered by the
Industrial Advisory Comrdttee and recommended for approval or disapproval*
The Baiak's action, however, is final. It is lending its ov/n funds" and it
has the say as to whether or not a loan should be made. Consequently it
may reject a loan recommended by the Industrial Advisory Committee or it
may decide to make one even though the Industrial Advisory Committee's
recommendation is adverse.
Furthermore, applications are not referred to Washington. They are
considered and passed upon finally by the Reserve Bank of the district
in which they originate. The Board in V,ashing,ton, D. C. merely issues
general regulations for the administration of Section 13b and supervises
the activity for the entire system.
. while you nay have full knov/ledge of this section and while .you may
have already availed yourself of its provisions, it seems entirely
proper that we should remind business men from time to time of the service that is boing rendered by an institution that v«as originally intended to be only a banker's bank. .It is with this purpose in mind
that I speak to you on this subject today.
There has been a falling off during recent months in the number of
applications submitted for industrial loans, as the follov.lng figures
for all districts show.

Period since enactment of Section 13b
June, 193k
1st
2nd
3rd
lith

6
6
6
5

months
months
months
months

Applications Received
Lumber
Amount

5053
1565
997
512

0135,000,000
75>OOO,OOO
Ui, 000,000
23,000,000

Applications Approved
Number
Amount

98U
662

3U7

172

05o,ooo,ooo
3?,ooo,ooo
35,ooo,ooo
9,000,000

Vihile the above figures show a marked falling off in the number and
amount of applications received and approved, it is important to observe
that the proportion of approvals has greatly increased. In the first
six months, that is, from June to December 193ii, only 1 9 P of applications were approved and only 27% of the amount represented was approved.
In the first five months of this year, 337> of applications were approved
and 3 7 P of the amount involved was approved. These figures indicate
that the average quality of the applications is now much better than it
was in 193lt.
The smallest amount of any loan made to date in the 12th district is
0500, and several loans of this amount have been granted. The largest
single loan approved in this district was for Ql,000,000.
..iany banks have found it desirable to make these industrial loans
even without Federal Reserve Bank participation. Kot all such cases
are reported, but the Federal Reserve Bank of San Francisco has been
informed that 72 applicants, applying altogether for $1,715,000, have
received loans vdthout participation by the Heserve Bank. Some borrowers who originally obtained credit from the Federal Reserve Bank
have subsequently borrowed from local banks and paid off the obligation
to tho Federal reserve Bank before maturity.
The principal lines of business which have received 13b credit in
this Federal ueserve district are the following:
.lind of Business
: lanufacturing
Lumber
wholesale and Retail
Packing

Number of Applications Approved

36
90
21

Amount Approved
5 3,912,000
3,78u,OOO
1,95U,OOO
665,000

In addition to the Federal iteserve Banks, the Reconstruction
Finance Corporation has also authority to make loans of similar nature
and for similar purposes.
It has been my opinion that the more often we discuss the Federal
Heserve System, the inore firmly will its functions become directed
toward the accommodation of cornmerce, industry, and agriculture, as was
intended in the original Act. That is why I appreciate the opportunity
you have given me to say these words about this particular, new function
of the Federal heserve Banks in the field of working capital loans.

SPEECHES OF

M. S . SZYMCZAK
MEMBER

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
WASHINGTON, D. C.

RELATING TO
POSTWAR RECONSTRUCTION
1945 - 1948

-1950WASHINGTON, D. C.

CQBTEKIS
"Economic Problems of Liberated Belgium" January
1945
•

"Belgian Post-War Reconstruction" November 2, 1945

"Our Foreign Lending Program" May 16,

1946

"Our Stake in German Economic Recovery" Uay 19, 1947

"Our Job in Germany Today" Uay 23, I947

"Our Interest in German Foreign
Trade" - June 12,

1947

"Our Interest in German Foreign
Trade" - June 13, 1947

"The Importance of Germany for the Economic
Reconstruction of Europe" - June 13, 1947

"American Economic Policy in Germany" June 23, 1947

5?1

"Ruhr Coal, Germany, and Europe" August 20, 1947

"Germany's Role in European Reconstruction" October 9, 1947

"U. S. Financial Assistance to Foreign
Countries" - April 11, 1948

"The European Recovery program" Hay 2, 19U8

"America's Role in the International Economic
Situation" - July 29, 1948

"Financial Problems of the European Recovery
Program" - September 1,
1948

Article published in •
The Federal Reserve'-Bulletin
January 19Z.5
ECONOMIC PROBLEMS OF LIBERATED BELGIUM

One glance at the map of western Europe will impress one vith :
Belgium's importance to postwar Europe* .
•
'
The present German counterattack emphasizes the strategic role of
Belgium-as the hub of international conmiunication lines between central
and.western Europe and the Channel ports, . Fortunately, the fighting has
not reached any important industrial, or agricultural area* But it may
have'1 completed the destruction- of the Ardennes forest", and certainly has
retarded the rehabilitation of the country by forcing the Allies- to devote more supplies and transportation facilities to purely military purposes. In view of the • additional losses uid sacrifices, the task of
reconstructing the Belgian econony now- becomes even more urgent. In spite of its small size, Belgium is one of the. most' important
industrial nations of the world and before the tfur its steel productionn
was surpassed only by that of the United States, Germany, the Soviet
Union, the United Kingdom, France, and Japan. Belgium,has suffered:
from German aggression longer than, any other western Country,, and its"
difficulties under German rule were symbolic of the fate of all the small
nations of Europe. Belgian developments will now be watched for any. clues
as to the future of these small nations after liberation',
; It may be expected that Belgium will play an importunt role in the
reconstruction of*other European countries. .Its. industries'will no doubt
be operating long, before., those of central and eastern. Europe,, and: part of
this output will.be available for export. The.use of these facilities
by the Allies during the years of reconversion and-rehabilitation, will
save valuable, shipping space .nd lessen the burden upon the resources:of
the other- United. Nations.
.With an appreciation of Belgium's .economic role in postwar ?Europei
the Belgian Delegation took -«JI. active part in and made L. . substantial?
contribution to the International Financial and Monetary Conference at.
Bretton Woods, last-July.
Belgium is a very densely populated country; in 1937 it had a population of 8.4 million, living in an. area of ll,8Q0. square .miles* Sixtynine per cent of• the working population in. 1930 was. engaged-in. industry
and commerce, as compared to 51 per cent. in. the.United States* -It.depends
heavily -upon foreign trade; in 1937 it had imports of 27*9 billion-.. •
francs reexports of. 25.5 billion, and a transit trade of 31*5 billion.
Imports *nd exports together were equal to about 70 per cent of its na.tional. income, as compared to less than 10 per cent in the United States.
The county's national wealth, estimated at 443 billion francs for
1939,.. has been reduced severely fcy the German occupation. The .Germans
not only conscripts workers for labor in Germany and-confiscated or
1/ The .Belgian, franc was quoted at 3.37 U. S. cents before the present
war/ and has.been equal to 2.28 cents since, liberation. Foreign trade
figures.are i'or-the area of the Belgian-Luxembourg customs:.union. ,;..•

looted the property of anti-Nazis and Jeta, but they also imposed tribute
pnyments upon the countiy in the form of occupation costs i..nd so-called advances. In 194-3 and 1944, these levies constituted about 45 per cent of
the total national output; for the :ntire period of occupation, they amounted to about 1^3 billion francs. These payments, financed partly by the
administration and partly by the central bank, increased the public debt
from 66 billion to 156 billion francs, and the note circulation from 31-5
billion to 99.5 billion francs during the period of occupation. Thus
Belgium vas at the same time swamped with juper money and denuded of goods.
The scarcity of necessary commodities, caused by the German efforts to
gear the economy to the German demands for armaments rather thai to the
needs of the Belgian population, was aggravated by the stoppage of imports.
As a result, Belgian national income, as measured in terms of actual purchasing power, declined from 6/+ billion to 27.5 billion prewar francs between 1939 and 19-43.
In spite of these losses, the situation of Belgium is in sone respects
better than that of, say, the United Kingdom or the Netherlands. The
country has retained most of its foreign assets (estimated at 50 bi3.1ion
francs as of 1939) and has not accumulated cny foreign debts. Before the
war, its exports were sufficient to pny for more than 90 per cent of its
imports. Its extensive colonial empire has remained free from Axis occupation. Most important of all, it suffered little destruction during the
campaign, its vital coal mines :nd the h&rbor of Antwerp remaining almost
intact.
Taska
The most urgent problems confronting the Government after liberation
were the country's needs for foodstuffs cJid coal. Its unsettled financial
condition also needed immediate attention. In order to combat inflation,
the Government blocked a voiy large pert of all cash holdings and buok
deposits and decreed an exchange of most of the old currency for new notes.
It is still too early to judge the effect of these measures?, but according
to preliminary reports the Government has succeeded at least in stopping
the increase in the cost of living and curbing black market activities. The
official price index stands at about 200 per cent of the 1939 average. Since
the franc has been devalued by about 32 per cent, the price level is now
equal to only 135 per cent of the 1939 figure in terms of gold or dollars.
If the index could be stabilized, and actual prices made to conform to the
official ones, this rise would be about the same <..s that of the wholesale
commodity prices in the United States.
The Government has supplemented its program of domestic financial stabilization by a series of treaties with neighboring countries. It has
negotiated a monetaxy and customs union with the Netherlands, and concluded
an agreement with the United Kingdom, providing for mutual credits up to the
equivalent of 5 million pounds for the purpose of ensuring the stability of
the exchange rate of pound sterling and franc. The full effect of these agreements, however, will not be felt until greater freedom of trade has been
restored.
Less progress has been made in solving the problems of food and fuel
supply. Belgium's coal production (30 million, metric tons in 1937). normally
is ample for all its needs. Under German occupation, howeveri production
fell to a fraction of normal, partly because of the lack of new machinery, but
mainly because of the lower efficiency of the miners, due to underfeeding and

even, more to their unwillingness to work for the 'Germans/ • in order to
restore the productivity of the mines, the Government, must make- tvailable more fcxod,: j-jicL t.lso convince the miners, that sabotage, strikes,
and slow-downs are no longer patriotic duties*
The food situation is particularly serious because in peacetime
Belgium imported" almost two-thirds of its foodstuffs requirements (4
million.metric. £ohs, valued at'5*4 billion francs, in 1937).. The
country is practically, self -sufficient in vegetables ;>nd potatoes,
and produces the larger part of its. requirements of milk, beet yugrir,
and fruit. This was.formerly true &lso of meat und cnircal fats* But
livestock production was based on' imported fodder <..nd concentrated
feeds, and under the German occupation the number of cattle v.^s reduced by about one-sixth in .order to reach a level more nearly corresponding to the domestic fodder supplies. The Belgian Congo used to
supply quantities of vegetable fats (palm oil), cane sugar, and coffee.
Grains (wheat, barley, and corn), which represent by far the most important single item, both as to bulk and value, will have to be "shipped
from non-Belgian overseas sources.
Ability to bring in required imports is limited ty" the 'scarcity of
shipping and the'necessity for using the harbor of Antwerp to supply
Allied troops on the western front. The even flow of^domestic.supplies
is hampered by the psychology of many farmers. For 4-2" years it was considered patriotic as well as profitable to hide farm products frpm the
adninistraticn(which acted as collecting tigent for the.Gorm^s) .^nd then
channel them into the black markets where Belgians could secure them.
Now the Government's problem is to convince the- farmer that such activities are not only unpatriotic but ,1s? improi'itt-ble. The deflationary
measures of the Government were intended in part to make it clear that
producers could not expect cay further rico in prices. The farm situation is somewhat complice ted by the linguistic problem; the "majority of
the farmers are Flemish while the majority of miners \.nd vprkers. in the
heavy industries are Walloons. Th^ Germans tried to exploit any differences between the two groups both in the First and the Second World VJcrs.
The farmers fared better than most other groups under the"German occupation, feeling leas political oppression and r.akiiig prof its. by black market operations. On the other hand, because cf their wartime profits .they
were harcf hit after liberation by the monetary progfoa of the ".Government.
KehrahilitfitAop-of Cfttmiiimication and Industry

•

• Once the people's minimum -requirements of food and fuel are satisfied, the rehabilitation of industry and conferee vill connend • chief attention. Paradoxically, resumption of trade will have to.precede the
•increase in domestic output to some extent, since Belgian industry is
based mainly .upon imported materials. However, Belgium has. large resources of gold and foreign exchange as well as an excellent credit rating, and imports therefore can be finunced before Belgian goods become
available fqr export. Difficulties in the supply of materials during the
.period of transition will arise from the lack of shipping raid other
reasons of military strategy rather than from financial factors.
. V" The Belgian cpal mine installations are.greatly in need of renova—
tionV" The equipment has not been renewed since 1939, and is largely..worn
out" of obsolete. A new source of supply for pit props must be found
because, some of the former sources can no longer be drawn on. - The Ger mans have devastated a large part of the forests of Belgium and adjoining

h
territories, which provided significant quantities of these props before the
war. Baltic timber may- be needed by the .states of the Soviet Union for the
rehabilitation of their own mines, and Baltic exports therefore may be diverted from the Belgian market even after complete defeat of Germany reopens
trade routes to the Baltic Sea.
The needs of the Belgian inland transportation system5 ere even greater
than those of the coal mines, • Belgium has had for years u very dense railroad network (3,215 miles with 3,358 locomotives end 117,000 freight cars in
1937). German requisition of rolling stock, the absence of replacement,
and inadequate upkeep have left the" system with a depleted >.nd dilapidated
stock of equipment. Highway traffic has suffered just as severely. Belgium
also has excellent roads (5,625 miles of national highways r.nd 23,125 miles
of provincial and municipal roads in 1938) and the number of motor cara was
large by European standards (154,000 passenger cars, 76,600 busses arid trucks,
and 67,000 motorcycles in 1938). Looting, requisitions, and lack of replacements, however, havo reduced these figures to a small fraction of their fcrmer
size. The important system of inland watervrays (1,080 miles with 9,000
barges and tugboats in 1937) needs new locks and new vessels.
Manufacturing industries will be compelled to import the machineiy and tools
necessary to get their own production under way until the domestic machineiy
industry is rehabilitated. Even in normal times, however, most raw materials processed by Belgian manufacturers must be imported. The speed vith
which particular branches of the industry will be able to reestablish their
plants and secure materials will not be uniform. In the field of metallurgy,
the steel industiy will be easiest to satisfy because about one-third of the
iron ore comes from Luxembourg ~nd most of the balance from Lorraine. Moreover, the steel mills were kept in good condition by the Germans in order
to produce armaments. The copper industiy depends largely upon imports
from the Belgisn Congo. The sine industry, next to that of the United
States the largestin the world (representing 13.5 per cent of world production in 1937) may have to overcome greater difficulties because the TQM
materials have to be imported mainly from non-Belgian overseas sources.
In the field of textiles and clothing, the wool and cotton industries
are the most important. Flemish woolen goods have been famous ever since the
middle of the tenth century, and before the W E T imported raw wool was the most
valuable single import (2 billion francs in 1937). From the point of quantity, wool and cotton imports were almost exactly equalj wool imports were
mainly of Australian origin while one-third of the botton caiae from the Congo
and a large part of the rest from the United States. Linen production, the
third largest branch of the Belgian textile industry, is based mainly upon
domestic raw materials. The rayon industiy was one of the oldest in Europe,
but its importance relative to other countries had decreased in the interwer
period. Under the German occupation, however, .it expanded at the expense of
the wool and cotton mills since raw materials for these industries were no
longer available.
Mining, ti'ansportation, metallurgy, and the textile industries,
together employ, about 60 per cent-of .11 industrial workers in the country.
Among the smaller fields of enterprise, the Belgian chemical industiy
in the past has acquired world fame. The country was one of the leading
producers of industri&l chemicals, artificial fertilisers, and photographic
chemicals. If the Allies strip the German dye trust of its monopolistic
power, the Belgian dyostuff industiy probably will forge to the front in
Continental Europe. Most of the industry's raw materials, with the

exception of coal tur, must to .imported, largely froa other Continental
European countries, Precicus stones, many of then obtained from the
Contfo, form the -bdsi's -of the Antwerp atone cutting and truiing industry,
the moot important' center of that kind in the world.
Prospects of Foreign Trade* and Shipping

.•

•

Belgian foreign tr&de may be expected to increase sharply as soon
as the wartime difficulties of transportation are overcome. Imports •
must rise if Belgian industry is to receive not only its usual raw
materials but also the machinery needed for- its reconstruction. Exports
must rise if the- pent-up demand of other European nations for industrial
products is to be satisfied.
• •
Belgium always has been a protagonist of free trade, and before
the First foorld War tariffs were for revenue only. In the interwar
period a more protectionist attitude was adopted, tut its free-trade
area was enlarged by a customs union with Luxembourg in 1922/and trade
agreements with the Scandinavian countries and the Netherlands (Oslo,
1930, and Ouchy, 1932). Treaties concluded immediately after liberation
with the Netherlands rnd the United Kingdom, indicate that" the country
intends to continue on this course. A credit agreement has been concluded vith France. Ihese Measures are the more important- since the three
countries just mentioned accounted for 4-5 per cent of Belgium's total
foreign trade in 1937.
. . . "
Closer economic relations with these areas are expected to compensate for the Iocs of part of the Gennan trade, which accounted for. 11.6
per cent of total Belgian commerce in 1937. During-the war, the Belgian
econoiry has be^n geared completely to Aeet Gerr&an needs, and Germany
became the country's best "customer.11 Therefore the-conseruences of a
disruption" of this trade will not be negligible. The prospects- for
Belgian trade vith Lue rest of Europe* are nore promising, however;.
European countries other than those mentioned ;.bove accounted in 1937
for Lt.5 per cent of tottd Belgian commerce. Belgium had .n excess of
imports in relation to nil central uric! eastern European countries (with
the exception of the Baltic states)• Therefore Belgian commercial relations vith these countries may profitably be resumed even before their
currency conditions return to normal. Moreover, Eelgicax industry is
able to replace Germany as :. source of supply for central Europe,
especially in the fields of metallurgy, textiles, and cheiuiccils.
Belgian" shipping ulso may be expected to' orofit from" the: German
defeat. The harbor of Antwerp handled in 1937 about-13,500 ships vith
25.5 million net register tons. This tonnage is bound to increase since
Antwerp's-main competitors, the-ports of the'Netherlands ^nd Germany,
will probably be out of coirxiission for sone time'to coiae; In1 spite of
the iiapoS'tdnce of the Belgian harbors, the Belgian merchant marine before
the war was negligible, consisting of only 96 vessels of 252,000 tons
•in 1939. Belgir.n ships handled only 9 per cent of the traffic in Belgian
ports while German ships handled 22 per cent — twice as **;iuch as the
trade with Germany itself. If Eelgian vessels replace the Gorman, at
least SL3 far as commerce in Belgian waters is concerned, the tonnage of
the Belgian merchant marine might well expand to muny times its prewar
size.

Belgian-United States Trade Relations
American investments in Belgium and Belgian investments in the
United States were small before the war; only Belgian balances with American banks were significant (182 million dollars at the time of the
German invasion, Jfey 1940). Mutual trade relations, however, were very
close. In 1937, the last year of'nonaal intern*tional relations in
Continental Europe, the United States took fifth place in Belgium's
foreign trade, with exports to Belgium of 95 million dollars, and imports
from Belgium of 75 million -. This volume does not, however, indicate the
limits of trtde possibilities between the two countries. After the first
World War, the United States exported goods valued at 373 million dollars
in 1919 t:lone, and the annual :-.verage for 1920-1929 was 123 million.
Total trade figures as well L& the value of important exports and imports
for characteristic years between 1919 and 1937 1 re shown in the accompanying table.
In addition to the commodities shown in the table, U. S. exports
to Belgium included feeds, fruits, tobacco, chemicals, semimanufactured
steel products, and industrial machinery while imports included other
precious stories, wool manufactures, nonferrous metals, glassware, fertilizers, and wood products. In the period of rehabilitation iirariediateiy
following the First World War, the United States exported large quantities
of breadstuffs, meat products, cotton cloth, cfettlo, anci wood products.
The sharp drop in U. S. exports to Belgium in the thirties was due in part
to the fall of the price level, but mninly to the shrinkage in the Belgian
national income. In 1939 > the income per head was equal to about 257
dollars, only about four-fifths that of the Netherlands, and one half that
of the United States. Under conditions of international p^aco and economic
cooperation « such as did not exist in the 'thirties ~ economic conditions
in Belgium should improve rapidly and bring about a proportionate rise in
imports, especially of consumers1 goods. Some of the goods.that are yoiy
sensitive to variations in the degree of prosperity form a large part-of
American exports to Belgium, such as automobiles, gasoline, ccinned fruit,
and tobacco.
The amount of U. S. imports from Belgium apparently is less elastic;
the 1937 figure was not surpassed materially in the intervar period. But
Belgium will be able to pay for its imports not only with the proceeds of
its own imports and with other revenues (foreign investments, tourist
traffic), but ..lso by utilizing the exports of the Belgian Congo. The
United States imported goods froi.1 the Congo valued at only 2.6 million
dollars in 1937, but since the outbreak of the Second World War imports
have sharply risen. They reached 25 million dollars in 194.0 and 34. million
in 194.1* and economic relations with the Congo have become? even closer
since the entiy of the United States into the War. Part of these imports
has been used for war purposes, another portion represents substitutes for
materials temporarily unavailable elsewhere, and come went to the United
States only as long as the Eelgian market was closed to them. But
at least part of the increase may veil :;rove permanent, caid together with
Belgian gold -And dollar balances already r.ccui.iulated, help to prevent a.
"dollar scarcity" in Belgium.

Belgian-United States Trade, 1919-1937
(Millions of dollars)
Commodity
U. S. imports:
Diamonds (cut, not set)
Flax and flax manufactures
Cotton manufactures
Iron and steel products
Furs (undressed)
All others
Total
U. S. exports:
Automobiles and accessories
Petroleum end products
Cotton (raw)
Wheat
Chemicals
Linseed cake
Copper
All others.
Total

1919

1929

1932

1937

1.8
(1)
0.2
0.2
0.2
5.3

17.2
6.5

5.8
2.5

21.8

7.7

1.4

1.0

u.u
6.8

1.7
0.3

9.1
5.8
4.9
2.9

T/.7

10.1

30.6

74*0

21.4

75.1

2.2
3.6
25.4
69.3
1.0
2.3
1.6
.267.0

26.5
12.7
20.3

7.2

6.3

21.5
33.3
11.6
10.6

?/ .8

1^1

25./.

377.9

114.9

40.3

95.3

6.6
0.7

4.5
8.8

6.0
3.0
0.2
1.2
1.1

4.7
4.2
4.0

1. Less than J',50,COO.
Based on data compiled from F0RE3GK COKTJLRGK ;J!D NAVIGATION OF
TriE UNITEI; STATES.
In this vsy, the reconstruction of the Belgian economy may be
expected directly to contribute to the economy of the United States,
and to strengthen the tics of international economic relations as
envisaged at Bretton Woods.
Belgium's economic stability is essential to winning thu

Speech delivered before.
Belgian Chamber of Commerce •
St,,Kegis Hotel, Hew York, N
November 2. 19Z5
"
BELGIAN POST-WAR RECONSTRUCTION
•. Belgium was the first of the liberated countries to tackle with
courage and decision the monetary and financial chaos bequeathed it by
the var. In October 1944 > immediately after liberation, the Government
eliminated excess purchasing power through a drastic reduction of the
amount of currency in circulation- This was accomplished by exchanging
pre-liberation money for new bank notes and blocking ail cash holdings
and .bank deposits of more than approximately 114 dollars. In October1945,.the legislature supplemented this action by imposing a confiscator;
tax upon war profits and a 5 per cent capital levy, and by converting
into a long-tern Government lofcn that portion of the blocked accounts
that was not absorbed by these taxes. These measures though thought
drastic by some, nevertheless, set an example for all other liberated nations, and they have been imitated in large degree all over Europe and
the Far East. Although the legislation brought temporary hardship to a
large part of the population, particularly businessmen, it was supported
by all political parties, conservative and socialist alike.
. As a result of these measures, Belgium's struggle against an overexpansion of the currency has been all but won. At the end of September
1945 >. bank note circulation amounted to 64 billion francs, as against
100 billion in September 1944, and 30 billion at the time of the German
invasion in *lay 1940. In compering the figures of 1945 and 1940, it mus
be remembered that the Belgian franc was devalued by about one-third to
2.28 .cents in terms of dollars in the. fall of 1944* It should also be
remembered that world market prices in terms of dollars have risen by at
least one-third since 1940.. Therefore, 64 billion francs in September
1945 .would be equivalent to about 32 billion in May 1940. Currency in
circulation at the present time would not appear excessive if the production of commodities could be increased to the pre-war level.
. . . Although-suffering from the consequences of war'and invasion, the
country's fiscal situation also appears to be well in hand- Government
expenditures for 1945 have been budgeted at 46 billion francs or almost
four times as much as before the war. The increase is due to the rise it
prices and wages and also to the special needs of tfie post-war period,
such as the expense of distributing foodstuffs, the reconstruction of
transportation facilities and public buildings, and the provisions made
f<ir war victims. During the first six months of 1945 tax collections
have amounted to only 9 billion, but the enactment of the Governments
liew tai program will undoubtedly increase revenues. The deficit, though
.lar&e, h<-s been inet hy borrowing from the public. Only expenditures for
advances'and "inutual. aid" to the Allies" were covered by central bank
credits, presumably because the Government .expects eventually to be reimbursed for these amounts in foreign exchange. The public debt has been
.estimated officially at.204 billion francs, as against 62 billion in
April 1940. ' The interest-bearing part of the debt however, is expected

10
to be reduced
as the result of the Governments fiscal program* If the
country1s national income again reaches the pre-war level, or about 130
billion francs at the current purchasing power, the service of the.debt
may be expected to require less than 5 per cent of the national income.
The most unsatisfactory part of the financial situation is the level
of prices and wages; Official prices have been maintained at about twice
the pre-war level, thus corresponding to the new dollar value of the franc
and the general increase in world market prices. The black market, however, has not been eliminated, and the actual cost of living therefore is
still about four times the pre-war amount. On the other hand* vage rates
have increased only about as much as the official prices, and the actual
purchasing.power of wages therefore has been virtually.cut in half. This
situation is unsound, not only because of it3 effect upon labor but also
because of the resulting disparity between the domestic and the international price levels. Pessimistic observers have suggested that the Government will be unable to prevent a further rise in official prices and wages,
and may be'compelled again to devalue the currency* The Government, however,
is convinced that as the rehabilitation of the economy progresses, the actual price level will eventually be brought down to the official figure and
thus permit the maintenance of the present wage scale and exchange rate.
It is not surprising that the financial situation of the country has
not fully returned to normal notwithstanding the success of the Governments
currency program. During the war, • the country suffered losses, including
about. 14-0 billion francs in payments to Germany, and a veiy large amount of
physical destruction and looting. Moreover, a large part of the country's
investments in Central and Eastern Europe is now practically worthless.
These losses represent a veiy substantial portion of the countiy's estimated pre-war wealth. Even after liberation, the destruction'of the countiy continued because of the unexpectedly long period of border fighting
and the reinvasion, which tool; place during the Ardennes offensive. For
many months, the Belgian transportation system had to be used predominantly for the military requirements of the Allies and could be of little
assistance in the rehabilitation of the country's economic system. The
Port of Antwerp, Belgium's main harbor, and the industrial center of Liege
were subject to V-l and V-2 bomb attacks which caused even more actual damage than the fighting. These events delayed the repatriation of deported
Belgian workers and retarded the reconversion of manpower and equipment to
civilian uses. Consequently the supply of consumer goods remained at the
low level which prevailed during the German occupation. This more than any
other fact hampered the Government's effort to raise the efficiency, of labor
to the pre-war level.
• :
Considering these difficulties, the progress made in the restoration
of the country's industries is indeed astonishing. As late as February
1945* the country had more than 300,000 unemployed. In spite of the repatriation since that date of an equal number of woncers deported during
the occupation, the number of unemployed had dropped by September to
100,000./ Power plants are working at 80 per cent or normal. The output
.of the coal mines, the backbone of the country's economic system, is approaching 60 per cent per normal and would be considerably higher if a
great number of the foreign workers who formed the bulk of the mining personnel before the war had.not left the countiy during the German occupation.

Inland-waterways and textile mills are1-also operating at almost 60 percent".. Railroads and heavy, industries are working at only 30 to 40 per
cent-of normal but even"these low figures are six' to eight times as high
a&;those-.reached.et the beginning of this year. These results h&ve been
achieved without aid fromUNnftA, and it appears certain that the country
will not need relief in the future.
..
::. ; The. most important obstacle to a more rapid pace of industrial recovery is the lack of imports* Railroads and coal mines, the two worst
domestic bottlenecks, require imports of new equipment for more, efficient
operation. The manufacturing industries all need*basic raw materials
from, abroad. Since the country is one of the aosb densely populated and
most highly industrialized nations of the world and is utterly dependent
upon foreign sources of grain and meat, the population needs large quantities bf imported foodstuffs. In 1937, Belgium imported 39 million tons
of^merchandise, valued at 27.5 billion francs. During the first six
•months of 1945, total imports were less than 1 million tons, valued at
about-2.7 billion francs. This drop was caused mainly by the scarcity of
shipping facilities. In recent months, more ship space has been made •
available for civilian gooda, and the monthly figures aro now approaching
an average of 1 million tons, or about one-third of the pre-war figure.
During-the next few years, however, Belgium will need even l&rger importe
than befote the war. Inventories, completely 3::hausted by the Germans,
must" be replenished, machinery and materials are needed to repair the
war damage, and consumer goods and other finished products, usually supplied by domestic sources, must be imported since domestic industries are
not yet operating at pre-var levels. It may be expected, therefore,
that in 1 % 6 imports will re*;ch a record total.
": Until- recently, the technical obstacles to increasing imports have
been so great that the financial problems of international trade wero of
• minor importance. In the future, however, the question of financing imports will become much more important. During the war, the Government
made plans for a complete customs union with the Netherlands and close
economic collaboration with France, AS yet these proposals have not been
put into effect, but the Government has concluded important trade and
credit agreements with the United Kingdom, France, the Motherlands, "
Switzerland, and the Scandinavian countries, and is how negotiating others. While these agreements retain distinct traces of bilateralism and
thus do not measure up to the standard of free trade, they assure a regu• lar'flow of merchandise within specified limits at stable rates of exchange and permit the country to -resume gradually its position as one of
:
" t h e centers-" for international commerce.
•' "•
.

•

1 :<

•

It is to" be expected that Belgium and the United States will soon
reach an understanding with' respect to commercial policy. For some time
'to-come this countiy may have-to be theioain source of supply for most •
1
liberated countries> especially for reconstruction machinery and Materials. It raav be expected that during the next year & much • greater part
of- Belgian imports will' come from the United States than in pre-war
times,
and that its deficit in respect to the United States alone may
:
-reach a vexy-. substantial sum. Under normal- conditions, this would- require no special attention since the >-Belgian balance of current interna-tlbnal payments as a whole was generally in equilibrium. In the past,
^•"the countiy was able to finance imports from the United States out of the

12
proceeds from its exports to other countries and out of its foreign investment revenues. In the more distant future, the Bretton Woods organizations are expected to reestablish the smooth working of the international transfer of payments- At present^ however, exports to most countries will not provide the Belgian economy with dollars because of exchange restrictions. The country, however,' can face the problem of its
dollar deficit with more confidence than most other European nations.
Its gbld and dollar assets are very considerable. Moreover, Belgiun is
the only Allied country that has granted more lend-lease aid to the
United States than it has received. Bjjr the end »of September 1945, total
lend-lease aid and advances to the Allies
ty Belgium totalled 24 billion
francs, or more than half the countryfs annual budget. In October 1945,
the United States and Belgium concluded an interim agreement settling
the mutual obligations. The United States paid a sum of 61 million dollars for troop pay advances made in francs t>y the Belgian Government
prior to VJ-Day". The United States also acknowledged that the goods and
services furnished to the American armed forces as "reciprocal aid" prior
to VJ-Day exceeded by at least 90 million dollars the lend-lease- aid
given to Belgium. In view of that excess, the United States permitted
the Belgian Government to select up to 45 million dollars of arny surplus
material stored in Belgium and having civilian utility, and cancelled a
Belgian debt of about 42 million dollars for lend-lease goods that had remained undelivered ty VJ-Day. Finally, the United States agreed to pay
in cash for all goods and services furnished to the American firmed forces
after that date.
" The Export-Import Bank of Washington has announced that it is about
to grant to Belgium a loan of §100 million, $45 million of which would
be for the purchase of lend-lease goods not delivered before the end of
lend-lease on VJ-Day. It has also announced that Belgium would be eligible to benefit from a credit line of vlOO million to be" opened to exporters of American cotton. . These credits and the settlement of Belgium's
troop pay advances and reverse lend-lease claims will probably cover the
greater part of the expected dollar deficit for 1946. The remainder of
the deficit could be taken out of the country's reserves. In 1947, the
deficit probably will have shrunk to manageable proportions, and in later
years the country's reconstruction may have advanced sufficiently to permit its balance of international payments to reach the pre-war equilibrium.
A solution of these financial problems will go far to enable Belgium
to readjust its foreign trade to the changes caused by the war. Belgium
has always been more dependent upon foreign commerce than most other countries; its total foreign trade in 1937 including imports, exports, and
transits, was larger than the total national income. The country is therefore greatly influenced by—and in turn exercises a great influence upon—
other parts of the world, especially Western and Central Europe. In 1937*
Germany was Belgium's second most important source of supply and its third
most important customer. The loss of much of the trade with Germany and
other Central European countries will be felt very deeply, and must be
counterbalanced by strong efforts to secure new markets for Belgian products, especially in fields formerly dominated by certain types of German
goods. Fortunately, the demands for most Belgian goods will be pressing
for many years to come. In 1937, about two-thirds of all Belgian exports
consisted of iron and steel,- non-ferrous metals, textiles, coal, machinery,

13
chemicals,-and precious stones. Iron, steel, and machinery; will be .
needed urgently for the reconstruction of the devastated areas. Belgium,
has a dominant position aiaong Continental European countries for the- re-,
fining of copper and zinc, and to a lesser extent of tin and lead. Having been cut off for six years from its main sources of supply of these
metals, Europe will be ready to accept almost any quantity of them in
the iranediate future. Textiles and coal at present are probably the
scarcest commodities in all Europe. Chemicals, and especially the famous Belgian fertilizers, will be vitally needed for the rehabilitation
of European agriculture. In this field, Belgium will profit from the
proposed dissolution of the German chemical trusts, which hitherto virtually iaonopolized the world market. Precious stones will not be needed
in impoverished Europe but the United States will probably provide a
remunerative market for them. Curing the years of general reconstruction, the export of all these items, and many less important ones, may
well be limited by the countryfs productive capacity rather than by the
demands of its customers.
For the United States, the revival of the Belgian export trade will
mean relieving the strain upon our own industries. During the immediate
future, our foreign trade policy may have to be directed toward preventing foreign demand from depriving domestic consumers of scarce commodities rather than toward a further expansion of exports, which will probably reach record dimensions in any case. Belgium will be able to produce such goods as machinexy, textiles, and chemicals, and provide such
raw materials as steel and non-ferrous metals, which the United States
will not be able to export in unlimited quantities because of urgent
needs for domestic use. Moreover, Belgium will be able to obtain from
its customers many goods for which there would not be a market in the
United States, such as grains, dairy products, ores, hard coal, hides,
and fibres. Belgian foreign trade will therefore supplement, rather
than compete with, our own. A typical example of this relation is indicated in the recent trade agreement between Belgium and Denmark, undei
which Denmark promises to supply Belgium with butter, cattle, potatoes,
fish, and seeds, while Belgium undertakes to furnish Denmark iron and
steel, chemical products, zinc plates, glass, and machinery. The exportation of Belgian fertilizers to Continental European countries will
be of particular importance. The rehabilitation of European agriculture
is necessary to end the semi-starvation of most European nations, and
incidentally to limit the shipment of UNHRA supplies from the United
States.
In recognizing the importance of free international trade, the
Belgian Government has shown great interest in the Bretton Woods agreements and the proposed international trade conference. The whole structure of the Belgian econony is based upon multilateral trade since- a
large part of its exports goes to countries other than those from which
it derives its imports. In 1937, the country had a sizable excess of
imports from the United States, Canada, and Argentina, and this excess
will probably be even larger in the post-war period. On the other hand,
it had a substantial surplus of exports to the United Kingdom, France,
and the Netherlands. Belgium therefore is vitally interested in having
the currencies of its customers freely convertible into dollars. Its
interest in this respect is identical with that of the United States.

Belgium will probably oppose any attempt to divide the world into currency blocs. We may expect-this similarity of economic goals to con- .
tribute toward making the traditionally friendly economic and financial
relations between the two countries even closer in the post-war period.

Speech delivered before
Annual Convention of Ohio Bankers Association
Columbus, Ohio

OUR FOREIGN LENDING PROGRAM
Most of Europe and important sections of Asia find themselves entering the period of peace with only a fraction of their normal export
trade. They have not adequate means of their dun ".to pay for the great
vpluniQ of imports that they must have if their populations are to be kept
aiivei the damage of the var repaired, and their industries restocked
with raw Materials and set functioning again. Once this job is done,.
the war stricken countries will be able to look after themselves. They,
will bhee again have the exports necessary to pay for the goods they need
and to service the debts they have incurred in process of rebuilding. .
Until this has been achieved, however, the United States, which has built
up its productive power during the war, must be prepared to supply the
goods and the needed financing on a great scale. Since this is a constructive job — one that strengthens the economies of the countries.and
expands their output — it is entirely appropriate that most of it should1
be done through loans rather than by a mechanism such as Lend-Lease.
The .countries that receive our aid will by reason, of that very fact be.
placed in position to repay us in the years ahead. We are already engaged upon this lending program and I hope to give you a brief picture of
it arid the philosophy behind it in my talk today. .
"
First, let me say, however, that we are going into it with our eyes
open. We have not forgotten what happened to the.investments that we
had abroad in the 1920's. Our experience then was.bad in many respects
though not as bad as is commonly supposed. As a matter of fact on our
total, foreign "investment in the 1920fs we havoreceived an aggregate service in dollars, which together vith the undefaulted loans and equity
holdings, is well in excess of the money we invested. Speaking very
broadly, we have received something like the equivalent of- 3 or U per
cent return on the whole investment. This is. primarily due to our good
experience on direct business investments abroad and, in any case, it is
far short of the 8 or 9 per cent which was charged on many individual
loans in the. 1920'sj but rates of that magnitude give, fair-warning that
the loan, that is being made is a pretty poor risk. And such rates constitute a burden on the balance of payments of the debtor country that is
almost impossible to carry when' a major world depression strikes.
This tiae the rate of interest we are charging on reconstruction
loans, is in the neighborhood of 3 per cent -- a rate which, as I have
just .remarked,
appears to have been actually realized on the investments
of the'l920!s as a whole. Also, this time foreign loans are being carefully screened to meet only the most urgent and productive needs. They
are" not. being blindly pressed upon countries to finance undertakings
that are beyond their means. They are. being judged in terms of the effects thqr will have upon the whole economy of a;countiy and its international position. And- notwithstanding the" enoiroous uncertainties, of the

years ahead, there are new factors in the situation that afford some hope

16
that the problem of transferring service on these loans across the international balance of payments will not prove to be the stumbling block it
was in the 1930's.
The chief ground for this hope is that we have probably learned
enough in the last ten or fifteen years to prevent the full recurrence of
such a depression, as then occurred, t/hile we are far from having mastered
the problem of how to keep a free economy running smoothly at naxiinum
production ~. while there are many years of trial and error ahead — we
have, I believe, learned enough to prevent the most extreme fluctuations.
Steadier economies in the major countries will lessen the disturbances to
international trade. In addition,! the most, upsetting element in the international situation in the 1930 s -- great capital flights — will be
severely under control in most countries in the years ahead. All this
will tend to U n i t the size of the international deficits ve must face.
And as these deficits occur the International
Monetary Fund, an institution which wts not available in the 1930!s, will swing into action. It.
will use its position to help assure that adequate corrective measures
are taken and taken in time. While they arc being taken and until they
can bear fruit, the Fund will be prepared to assist a country financially
by making foreign exchange resources temporarily available to it. Not only
will countries have access to the billions of dollars available in the International Monetaiy Fund, but they already have gold and dollar reserves
of their own, which are wore than double
the reserves that were available
to them to meet the crisis of the 1930 ! s. These reserves.are not, of
course, evenly distributed according to need, and in any case they must
largely be used for currency stabilization purposes rather than for the
reconstruction job. That job is too big for them. But the loans made for
reconstruction will be safer if a larger measure of currency stability and
freedom of exchange markets is achieved..
Here then are four major reasons — diminished business fluctuations,
control of capital flights, action of the International Monetary Fund, and
larger basic reserves abroad of gold and dollar exchange — f four najor reasons why the international financial breakdown of the 1930 s is not likely
to be repeated on the same scale again. I night add to. this list of economic factors the progress that we hope to riake in the forthcoming conferences
on coiimercial policy. If these conferences achieve substantial reductions
in the barriers to international trcde and open the field more widely to private enterprise and competition, the effectiveness of measures designed to
correct balance of payments deficits will be correspondingly enhanced. Even
on the political front, although the immediate problems are great, we are
better organized than in the anarchic period of the 1930'sj for now we have
the United iJations embracing all the great powers and with the United States
playing a full and purposeful role. The possibility that war will cut across
the whole pattern of international investment is materially lessened though,
of course, far froa eliminated by the United Rations Organisation.
All of this may sound a bit optimistic to you bankers. I can sympathise with that feeling. If one looks only at the problems that face us
today in the international sphere, there can be few grounds for optimism.
The problems themselves are unprecedented, and it would be a bold man who
would predict in just what way this war-stricken world will finally settle
down. What I have been trying to emphasize, however, is that we are far
better
organized, and equipped to deal vith these problems than we were with

those which were left behind by the first World War. We should not just
sit back and assume that history will repeat itself. The basis of international investment has been strengthened in many important respects and
tte are taking what the generals would call "calculated risks" when we
come to the assistance of the war-damaged countries of Europe and Asia.
If we can aid these countries to get back on their feet; if we can tide
them over these first years when their shortages are temporarily acute
and their means of paying for them through exports are not yet restored;
if we can help them to obtain the means to help themselves; then we may
find not only that they can repay us what we have lent, but that they
are strong enough to participate with us in building a world of free enterprise and expanding employment and production. It is in that sort of
world that democracy can best thrive.
We have kept these purposes clearly before us in the lending program we have undertaken. The key loan is, of course, that to the British,
The United Kingdom is the greatest trading nation in the world and the
pound sterling is the currency in which much of the world's business is
carried on. The many countries that export to England more than they
buy from her were at one time able to employ the sterling proceeds of
their sales to buy outside the sterling area — particularly in the
United States. Under war conditions this freedom was lost. England
could not possible restore it again in the difficult transition years
without the aid of the American loan. She doesn't have the dollars.
Without the loan she would be driven to desperate measures — to a whole
series of bilateral deals, every one of which would discriminate against
the United States and would draw world trade away from its most productive channels. Although in the end this system would seriously shrink
world trade as a whole and work against Britain's own interests, the
United Kingdom would be forced to get what she could out of it in the
critical transition years, anything gained in that period when exports
were still insufficient to pay for the most urgent import needs would be
worth considerable sacrifice of future potentialities. Once set on this
path it would be hard for her ever to disentangle herself. So many
vested interests would grow up around the discriminatory bilateral arrangements that even the Bretton Woods Fund could hardly blast them loose.
And with England playing this sort of economic game the chances for cooperation in the political field would be jeopardized.
The loan agreement with the British, therefore provides specificallj
that, within one year from the date when the agreement becomes effective,
sterling due on current transactions with any part of the world shall be
made convertible unless the United States consents to an extension of
time. This is written into an agreement in which 03,750,000,000 is provided to help England purchase the supplies she will urgently need before her exports and other sources of international income build up
. sufficiently to enable her to pay her own way. Because the loan aeals
with a key situation and has larger objectives than a mere financial
transaction, it is on a larger scale and on more liberal terms than any
other contemplated by the United States- It has ^ e n l a i d before Congress for approval; and the funds, if supplied, will be voted ty Congress
for this specific purpose.
The remainder of the United States lending program is largely being
carried
out ty the Export-Import Bank. Substantial credits, to be sure,

18
are being extended'by. other agencies ifl connection'with^the stLtf of'LendLease inventories arid' surplus'property abroad, and the Maritime -Commission
has been authorized' to.B'eii' ships on credit. All this is helping to meet
. the needs of Europe.and Asia on the basis of deferred payments. But.the
loans of. actual: money are being made almost entirely by the .Export-Import
Bank.

.' .'

• . . " ' . . •

Our policy on Export-Import Bank loans has been to meet only the most
pressing needs that must be financed before the International:Bank for Reconstruction and Development is ready for business. The resources, of the
Export-Import Bank were increased last summer from £700 million to §3>5OO
million and the President has stated that he will ask Congress for another
vl,Z50 million to enable the Bank to complete its part of the reconstruction
job. Substantial loans.have already been authorized to France, Belgium,
Netherlands, Denmark;, Norway, Finland, Poland, and Greece and still larger
loans to these and other countries are now under discussion. The programs
have been pared down repeatedly; but the rock-bottom needs that must be met
before the International Bank is reacjy to take over remain on a va,st scale.
Reconstruction loans by the Export-Import Bank have been made on a 3
per cent 20-year basis except for a few special loans for 30 years, at 2-3/8
per. cent. These special loans have teen made only to France; Belgium and
the Iletherlands and have.been for the purpose of financing goods authorized
under the Lend-Lease program but ordered after the end of the war. They
amount to about. ^.650 million. The remainder of the great Export-Import Bank
reconstruction loans, which are on a 3 per. cent basis with serial maturities,
may in the course of time prove salable in some measure to the private market. This is particularly likely in the case of the shorter maturities.
The Bank is anxious to sell as much as it can to the market because
it is under a legal directive to. supplement private investment rather than
compete with it and because the more it can sell, the more resources it
will have to do those parts of the job which private investors are not yet
ready to do. As you know, the ^200 million loan recently made to the
Netherlands Government was opened to the bank3. of the countiy on a participation basis. Since it was an extremely short maturity of from l t o 2 years
and bore an interest rate of 2-1/4 per cont it is not surprising that >A00
million of it was in fact taken by the banks. It is riot, to be sure, the
usual type of loan provided for reconstruction purposes. That would require
a much longer term. The $-,200 million credit is merely in anticipation of
other measures that the Dutch will take to borrow here or liquidate their
assets. Nevertheless it is" cause for considerable satisfaction'that a i:iarket .which is extremely, cautious about resuming international lending after
the experiences of the 1930*3 has made on this occasion so- substantial an
investment.
'
;
The. chief channel through which private funds will flow abroad in the
immediate future, however, is likely to be obligations of the International
Bank. The major. part: of the Bank's lending will be financed with- funds
raised in the market,' since the Bank can use only 20 per cent-of its own
capital for making loans. The remaining 80 per cent* can be called up only
to the extent it may be needed to meet the obligations of the.bank. The
Bank may raise funds.either by issuing its own securities or by guaranteeing the issues of foreign borrowers. In either case private.investors will
be
supplying funds to foreigners while the Bank assumes the credit..risk.

li
. . I should be interested to have your comments on the market prospects
for bonds of the International Bank. It is possible that there will be
an offering of such bonds before the year is out. As you know, the international Bank came into, existence last December, and in iiarch the
first meeting of its Board of Governors was held'in';Savannah*. The
smaller working group of Executive Directors to whom the Board has dele-"
gated sost of its powers is even now in session in Washington* The President of the Bank will have to build up a staff, and this day take
Gone months. Gradually the Bank will acquire working funds through calling up r. portion of its capital. Under its statutes, however, it can
hardly call up much more than §400 millions of dollar subscriptions before the fall; and if, as seems likely, the desiand of foreign countries
is predominantly for dollar resources, it may be necessary for the Bank
a at an early date to offer its bonds for sale in this country. .
At the outset insurance companies and savings banks in many States
may find that the existing legislation does not provide for purchase of
this new type of bond. Until a few months ago this was the case in New
York;" but through prompt action a law was passed permitting the savings
banlcs of that State to invest in the obligations of the new International
Banic when they becone available. Commercial banks in general will be
. free to invest lip to 10 per cent of their capital and surplus. It vill
be for them to determine to what extent they wish to purchase securities
of the International Bank, taking into account maturity, risk, marketability, etc. The Bank, will undoubtedly exercise great care to adapt the
fora of its securities to the potential market which it finds available.
As regards the basic risk involved I might make one comment. The
Bank cannot lend more than its unimpaired subscribed capital, surplus,
and reserves, which today amount to about V7,600 million. Hence if it
borrows and lends to the maximum possible," both its loans and its obligations will amount to about £7,600 million. The obligations will be
covered to the extent of about v3,2C0 million by the United States subscription. The remaining !*4,400 million will be covered ty claims
against foreign governments and central banks amounting to about ^12 bil
lion ~ i.e., v 4,400 million of foreign government subscriptions to the
capital of the Bank plus the ^7,600 million of loans, all of which must
have behind them the credit of a government, central bank, or similar in
stitution acceptable to the International tank. This s>12 billion of
claims against foreign governments or central banks would have to shrink
through defaults to #4,4.00 million before the bonds of the International
Bank would cease to be covered in full. Ho such shrinkage as this occurred in the servicing of our foreign investment during the ill-fated
1930 f s and there is little reason to believe that it will occur in the
decades ahead — particularly in view of the factors to which I have
called your attention earlier in this talk.
If the securities of the International Bank find a ready market in
the United States it should be able in 1947 to relieve the Export-Import
Bank of most of the burden of making reconstruction or development loans
While the shift fron the Export-Import Bank to the International Bank wi"
be fron un agency of the United States to an institution representing
some 40 nations, the predominant role of the United States in international lending will not be greatly altered ty the change. As I have already remarked, the United States investment market will be expected to

20
supply most of the International Batik's, ftinds* Furthermore the American
director of the bank wields about. 37 por cent of .the total voting power.
Even more important than this, however, are the provisions under which the
consent of the United States is required before the Bank can/lend.the dollars subscribedfay- the'. United States or can float or guarantee en issue,
in the .American market. .
.
....••...-..
The power to give or withhold1 consent in these cases, has been assigned by Congress to a new body which already has assumed primary importance in our international lending picture. I refer .to the national
Advisory Council on International Monetary and Financial Problems, commonly known as the K.A.C. This Council is conposed of- three Cabinet members — the Secretaries of State, Treasury, and Commerce -- and the Chairmen of the Federal Reserve Board and the Export-Import Bank. These five
men have been given the task of coordinating the foreign lending policies
and financial operations of this Government and of the United States representatives on the International Bank and the International Monetary Fund.
It is for them to keep the whole program that I have been discussing in
this talk in proper proportion and order. Hot only must it be adapted to
the needs and caps cities of one foreign countiy as against another, but it
must be fitted into the position of our domestic economy in such a way as
to help preserve its stability. The N.A.C. is taking its task with the utmost seriousness. The Secretary of the Treasury is.chaircan and there are
regular meetings in his office. The group is constantly shaping and reviewing the lending program of this countiy, both in detail and as a whole.
As the International Fund and Bank come into full operation the task of the
N.A.C. will be increased. But it is already clear that an adequate system
has now been devised for bringing together the Government agencies primarily concerned with our foreign financial policy. I believe that you have
in this Council the best assurance you could ask that the lending program
of the United States will continue to be broadly conceived and veil-integrated, and that it will make the most effective use of our admittedly
limited resources. It will be powerfully directed toward rebuilding the
kind of international world in which American free enterprise can thrive
side by side with foreign enterprise, and the foundations of the peace can
be made secure.
"
'

Speech delivered before
The Economic Club of Detroit
Book-Cadillac Hotel, Detroit, Michigan
May 19, 19U7 ,
OUR STAKE IN GERMAN ECONOMIC RECOVERY •
Two world wars and their aftermath have made it clear that the problem of Germany is one of the keys to world peace and prosperity. For tiro
years, your representatives in military government have sought a basis
for the solution of this problem. They can only succeed if the American
people are aware of both their achievements and their difficulties, and
if in turn the military government officials in Germany understand the
attitude of the public at home. To contribute to a mutual exchange of
such information is the main purpose of this paper.
Principles of American Economic Policy in Germary
We all know that the German econony operated in the past as one integrated unit. Each part made its contribution to, and received its support from, the rest of the country. This integration alone made possible
the industrial development of Germany* None of the areas that constitute
the nation was ever self-sufficient in the past or can be made self-sufficient in the future. None of the German industries draws its tools and
raw materials from one single area or one single zone of occupation.
Steel and coal of the British zone are vital to the metal-working industries of the American zone, but the coal mines in the British zone cannot
operate without pit props from the American and Russian zones. The light
industries of the American zone need optical glass from the Russian, and
glue from the French zone. On the other hand, they supply the French
and Russian zones with electrical equipment, anti-friction bearings, and
dyes tuffs.
For purposes of occupation Germany west of the Oder-Neisse line has
been divided into four zones: American, British, French, and Russian.
Koreover, the area of prewar Germany lying east of that line has been put
under Polish (or Russian) administration. The Potsdam Agreement provided
that the four zones should be treated as one economic unit. It has not
worked out that way, however. Therefore, I shall not speak so much of
global German problems such as economic unification, the levels to be
established for German industry, and the reparations program. Instead I
shall concentrate on discussing the economic problems of the American
zone and- as fkr as necessary of the combined American and British zones.
All of us are aware of the importance of early high-level decisions
on the basic economic questions which were recently discussed at Moscow.
The issues-, were pointed out some time ago by Secretary Marshall and we
all know their substance and the urgent need for their solution. . •
In .view of the history of German aggression and the part played
therein by German industry, it may be difficult to understand that one of
the major tasks of military government is the provision of assistance in
rebuilding at least part of the German industrial system. Such a reconstruction, however, is necessary for two reasons: to prevent Germany
from remaining a source of perpetual unrest in Europe, and to aid in the
recovery of our allies.

22
In. the crop year 19U6-U7, German farmers in "the- combined American
and British zones of occupation are producing foodstuffs sufficient to
provide an average diet of only about 1,000 calories daily for that part
of the population that does not live on self-sufficient farms. Such a
diet is less than half of the minimum standard endorsed by the United
Nations Food and Agricultural Organization. Unless we are prepared to
forego payment for the large supplies of food that must be sent to Germany, for an indefinite period just to prevent wholesale starvation, we
must permit Germany to redevelop its manufacturing industries which
alone can produce the exports necessary to pay for food imports9
Moreover, the products of German industry are indispensable for
the reconstruction of continental Europe. In 1936—the last year in
which the bulk of the German economy was operated on a peacetime levelGermany was the largest exporter to, and the largest importer from,
Austria, Bulgaria, Czechoslovakia, Greece, Hungary, Italy, Rumania,
Switzerland, Turkey, and Yugoslavia. It was first as a supplier and
second as a market for the Netherlands, Poland, and Sweden. 1/ Almost
the entire manufacturing industry of continental Europe was dependent
upon German machinery, precision instruments, electrical appliances,
optical goods, transportation equipment, and chemicals.

1/ The importance of Germany for. continental Europe is indicated by the
"" following table, showing G e r m a n s trade with some of the leading
European countries.

Country

Imports
from
Germany

Per cent
of total
imports

(Millions of
dollars)
Netherlands
Italy
France
Sweden
Switzerland
Denmark
Belgium
Soviet Union
Czechoslovakia
Norway
Austria
Turkey
Rumania
Hungary

151
116
106

99
92
83
82
62

55
til

U0
3U

33
33

Exports
to
Germany

Per cent
of total
exports

(Millions of
dollars)
23.3
26.lt
7.0
23.9
2U.8
25.3
11.5
22.8
17.5
17.6
16.9

15.1

39.0
25.8

7U
77

Uo
61
51
62

69
23
1*5
23
29
1*8
30
35

15.7
19.5

Iu3
15,8
19.h
20.3
10. h

8.5
1U#3
13*2
*•'•'*
16.1
51.0
21.1
23.1
^•*?

23
The fact that-Germany today cannot eyen supply spare parts is hampering economic reconstruction in such different countries as Austria,
the Netherlands, and Poland« The general shortage'pf'coai, which.is the
greatest single factor in retarding European recovery, i? .due largely to
low production in the Ruhr mines. Lack of German potash, is delaying the
rehabilitation of agriculture all over Europe. An increase in the out- *
put of coal and potash mines, however, depends upon the availability of
mining equipment and upon larger supplies of consumer goods for miners.
A German miner can earn in two days all he needs to buy his meager vaeekly
rations and thereafter has little incentive to work. A relatively small
increase in consumer goods offered to miners wag' an important element in
raising production in the Ruhr mines by about one-fifth between the fall
of 191*6 and the spring of 19l*7* A large-scale revival of German corisuma
goods industries would have proportionately greater results.
Our own economy would benefit from the resumption of German industrial exports because the availability of German goods would help meet
the foreign demand for many American goods which are still in scarce
supply relative to our own domestic demand. Furthermore, some European
countries can pay for imports from the United States only with the aid
of dollar credits because they lack dollar resources and lack exportable
commodities adapted to the American market. If they could import goods
from Germany, however, they could pay for them by exporting products
urgently needed in that country. In that way, they would lighten the
burden which the American economy has had to bear both in respect to the
reconstruction of their own econocy and to the rehabilitation of Germany,
For instance, before the war the Netherlands exported substantial quantities of vegetables to Germany vhile Germany paid for these imports in
steel and machinery. If that commerce could be restored tod^r, it would
make it unnecessary for the American economy to extend credits to the
Netherlands in order to enable that country to buy American machinery an
it TOuld make it also unnecessary to divert scarce American foodstuffs tc
Germary.
Obstacles
Y/hile the principle of assistance to German recovery has been generally accepted in this country, it has been very difficult to carry out
the program on an adequate scale. For obvious reasons of justice and
.policy, the countries invaded by Germany have been given a prior claim
to our aid. Our financial and material resources are limited and foodstuffs and raw materials continue to fall short of total demand. The
allocation of tfieat and non-ferrous-metals, for instance, is a task that
simply cannot be fulfilled to the satisfaction of all. Similarly, coal,
of Tflhich Germany is a major producer, is in generally short supply. In
order to promote reconstruction in the rest of Europe, we have had to undertake substantial exports of German coal even though the revival of
German manufacturing industry would have been considerably accelerated ii
it had been possible to retain German production for German domestic use.
It may be hoped that these scarcities vdll disappear within a few
years, but other obstacles may take their place. Concern has frequently
been expressed that the reconstruction of German industry may go too far
and restore Germaiy's v/ar potential. The occupying powers have tried to
differentiate between industries that could be used for aggressive pur
poses and therefore should be restricted, and others that might be

considered peaceful and therefore should be encouraged. The most innocuous
industries, however, could conceivably be used for War purposes, and dangerous ones frequently are indispensable for peacetime uses. For this
reason, some of the United Nations are critical of any move to improve the
level of Gennan industry even though they concede that such an improvement
would benefit them from the economic point of view.
Finally some countries see in Germany less a source of supplies or
a market for exports than a dreaded competitor. At present, such fears
seem premature since production the v/orld over has not caught up with demand, and German production remains a neglibible part of the total. As
soon, however, as v.-orld market conditions become less favorable to the
sellers, any increase in German industrial production and especially in
German industrial exports, may injure the interest of some industrial
group in other countries. Although such exports will in turn make possible imports into Germany and thus benefit the economies of Germany's trade
partners as well as its own, the groups benefiting from access to the
German market frequently will be different from those affected by German
competition.
Achievements of Military Government
Despite the conflict of objectives and the limited financial and
material means at the disposal of the occupation authorities, there has
been a degree of rehabilitation in Germany.
a) Food and Agriculture
The food situation continues to be the central German problem. It
is far from satisfactoiy, but we have been able to avoid not only outright starvation but also any serious deterioration of public health.
Since last fall the official ration has been maintained in the American
and British zones until recently at 1,550 calories daily for the so-called
normal consumer. This ration still is more than one-fourth below the
minimum necessary to insure health in the long run and more than twofifths below the German prewar standard of nutrition. Moreover, the
diet is far poorer in quality than would be advisable from the point of
view of nutrition, a larger proportion consisting of grain products and
a smaller proportion of so-called protective foodstuffs. Even so, the
ration has been maintained only by importing into the combined American
and British zones foodstuffs equal to about 60 per cent of their domestic
production. These imports, including monthly shipments of "200,000 tons
of bread grains and flour, and substantial quantities of potatoes, sugar,
fish, and milk, require an expenditure of $360 million in the current
crop year.
The food situation is constantly being threatened by the fact that
stocks of supplies are dangerously low. Food is needed in many parts of
the world. For the sake of food importing countries a further rise in
world market prices must be avoided as far as possible and priorities
must be established by the exporting nations. Eveiy ton of food allotted
to Germany causes hardship in other parts of the world. Difficulties in
oceart transportation frequently delay shipments urgently needed for maintaining stocks in Germany at the minimum level needed for the planning
of equitable distribution. Gennan farmers frequently 'fail to deliver

their quotas* Trains must be rerouted to alleviate a crisis in some
part of Germany> thus creating a shortage in another part* Losses from
pilferage increase in proportion to the deterioration of food conditions
An unfortunate accumulation of such factors was the cause of the difficulties currently experienced in the Ruhr district. Delays in deliverir.
the full rations invariably lead to unrest, diminish the efficiency of
labor and the output of industrial goods, and thus add to the difficulties of rehabilitation.
In future, v;e expect domestic production, collection, and distribution to yield substantially larger quantities than this year. Such an
improvement will depend upon the availability of fertilizer and upon a
supply of industrial consumer goods which will induce farmers to raise
more crops for sale. It also will depend upon the enforcement of a
strict program of collection and distribution which must be efficiently
performed by German officials. V/e can have the utmost confidence in the
ability of military government under General Clay to meetthis situation
if they are given fair means to carry out their program.
In the long run, however, the efficiency of industrial labor can
not be maintained on a diet representing less than 2,600 calories daily
for the so-called normal consumer. The American and British zones cannot expect to produce more food than sufficient for an average of 1,600
calories daily. Import requirements in the long run therefore will be
the equivalent of at least 1,000 calories daily, or about two-thirds moi
than actual imports in the current year.
b) Industrial Production
In 19h5, most manufacturing industries in the Western zones of Germany were at a standstill. % November 19U6, industrial production in
the American zone had reached lilt per cent of 1936—a year of virtually
full employment in Germany. l/l7ith the exception of lumber, the production of all commodities is below the 1936 figure, but by 191*8 prewar
output is expected to be reached in a. nurrber of important industries. 1
the British zone, industrial production had recovered last fall to only
38 per cent of 1936. The British zone includes mainly heavy industries,
most of which are under severe restrictions, as possible war industries,
while the American zone contains mainly li^ht industries, manufacturing
consumer goods.
l/' The rise in industrial production in the American zone is indicated
"" by the following table, comparing production of some important commodities in the first and the last quarter of 19h6.
Commodity
.Trucks (units)
Electric motors (thousands of horsepower)
Lumber (thousands of cubic meters)
Potash (metric tons)
Textile
yarns, including rayon (metric tons)

First quarter
• 19li6
iiOO

51*9
36,8U9
5,737

Last quartc
. 19U6
1,I|3I»

•

131

1,015
311,098

10,200

26
Unfortunately, the exceptional severity of the .last winter has undone
some of the progress experienced during the preceding year.; Industrial
production in the American zone fell in December to 39 per. cent, in January
to 31 per ceijCv, and in February to 29 per cent of 1936. In Karch it recovered to 3$ per cent, but this level still is about one-fifth below the
peak of November 19h6#
•:
In spite of the low level of production t h e ^ is little unemployments
Even in February 19 h7, unemployment in the American zone was less than
U50,000 out of a labor force of more than 7 million. Only in the whitecollar classes is the number of job openings constantly smaller than that
of job seekers. This is the result of three facts. The labor force has
been greatly reduced by v/ar losses and by the Allied retention of a large
number of prisioners of war in some countries. Secondly, much labor is
needed for work, such as removal of rubble and plant repair, which does
rpt show in production statistics but nevertheless is vital for resumption
of economic activity. Thirdly, for physical and psychological reasons,
the productivity of labor has fallen considerably, in some cases by as
much as two-thirds. The gradual revival of economic activity, more food,
housing facilities, and improved availability of industrial consumer goods
will do much to remove the causes of low efficiency.
c) Housing
Next to food, housing accommodations are the most pressing requirements of the German people. Despite all war losses, the population of
the American and British zones has risen by around 20 per cent in comparison to prewar, mainly because of the inflow of Germans expelled from
the area under Polish administration and from Chechoslovakia and other
Eastern European countries. At the same time, urban housing suffered
from terrific bomb damage during the war, especially in the industrial
and commercial centers. In Bremen, for instance, $5 per cent of all
homes were unusable in the summer of 1915Q Reconstruction has. been
hampered by the scarcity of building materials, which in turn is-due
largely to the lack of coal: approximately 12*5 tons of coal are needed
for producing the material necessary to build a small apartment. Allied
legislation provides for the equitable distribution of available housing
among the population, but this measure can bring only small relief since
the complete equalization of all housing v»uld only provide around 80
square feet per person in the American, and less than 70 square feet per
person in the British zone.
Improvement in housing conditions is particularly needed in the
Ruhr district since the inflow of additional miners from the Southern
area of our combined zones, required to. fulfill the program of output
expansion, depends upon the availability of homes. A short range program has been and a long range is being prepared to provide additional
housing, including temporary camps and billets and permanent reconstruction. In addition to building material, beds, bedding, and furniture must be produced. \Yhile military government plays an important
role in drafting the program, its execution is entrusted to the German
authorities. Military government has helped in that task by reducing
to a minimum the requirements for military installations.

d) Domestic Trade and Transportation
Despite the interdependence of the four zones of occupation, .interzonal trade has been slow to develop largely because of the lade of
economic unification,1/ Since January of this year, trade between the
American and British £ones has been free, as the result of the economic
merger of these zones, and trade between the merged zones and the rest
of Germany vail be increased under agreements concluded among the zonal
authorities. Until and unless the over-all economic unity of Germany is
achieved, however, German recovery will be hampered by obstacles to the
free flow of goods within the country. Transportation has suffered
particularly badly from war. damage* Military government can be proud*
however, of its record in repairing railroads, inland watervayo, port
facilities, and highways. Railroad tracks in operation represent 97 per
cent of the prewar total. Almost as many sunken vessels have been raise
in the American zone as in all other zones together and the proportion
of port channels cleared is higher than in aqy other zone. The American
zone also has a larger proportion of operating motor vehicles than any
other zone.2/ Despite this progress, transportation is even now in need
of repair and maintenance is a constant problem. Allocations of materials are being made for this purpose but must be revised as required to
meet new priority demands from other sides of the battered economic
structure.
e) International Trade
In 19U6, the foreign trade of the American zone was almost entirely
confined to the importation of foodstuffs and other essential goods by
the occupation forces in order to prevent disease and unrest ansong the
population. Such imports are financed by Y/ar Department appropriations.
The only other substantial import transaction was the shipment of some
surplus American cotton held by the Commodity Credit Corporation. This
cotton was delivered to German processors; the finished goods are being
exported in an amount sufficient to pay for the cost of the imports, and
the.rest is available for German consumption. In the fall of 192*6, sintf
lar arrangements were made by American Military Government for the impor
tation of raw materials required for the manufacture of. ceramics, optics
instruments, building materials, chemicals, and. toys. The interim financing for these imports is handled by the U. S. Commercial Corporation
1/ In the nine-month period April* through December 19h6, the American
zone shipped goods valued at 1*75 million marks (around #190 million
at the prewar exchange rate) into, and received goods valued at U71
million reichsmarks from, the other zones. Trade with the British
zone accounted for 63 per cent> with the French zone for 28 percent,
and with the Russian zone for only 9 per cent of the total.
y The work done in this respect may be illustrated by some figures:
Move than 200 miles of railroad tracks, 78 bridges, and 18,000 miles
of railroad telephone lines have been rebuilt; about 1,600 locomotives, 109,000 freight cars, and 8,600 passenger railroad cars have
been1 repaired; about 800 miles of inland waterways have been cleared
and 3;000 miles dredged; 978 river barges have been raised, and ab
1,350 repaired; more than 900 miles of highways and 261 highway
bridges have been rebuilt.

28
a subsidiary of the R.F.C. Exports from the American zone in 19h6 were
confined mainly to lumber and hops and a few industrial goods, taken from
existing inventories or produced from raw material stocks. The amounts
shipped were very small, in the neighborhood
of 3 per cent of the
estimated prewar exports of the zonefs area.
Imports into the British zone were similar to those of the American
zone, but exports from the British zone were considerably larger, due
almost entirely to Ruhr coal. Coal exports reached a weekly volume of
260,000 tons in the summer of 191*6, or about 1*0 per cent of prewar, but
this, involved heavy drafts on existing stocks and inadequate allocations
to the needs of the German economy. As a result, exports of coal had to
be reduced by about 30 per cent in the fall of 19U6. Even the peak figure
in the summer of 19U6 was far from sufficient to rceet demand in the rest
of Europe, and the reduction of coal exports was a heavy blow to the imper ting countries*
In the first months of 19U7, exports had to be curtailed still further
reaching a low of 103,000 tons per week in February• Meanwhile, however,
the output of the Ruhr mines had risen and coal exports could be increased
again* In April and May, the unsatisfactory food situation brought about
some labor disturbances which kept coal output somewhat below the March
peak.
As soon as these difficulties are overcome, a further rise in output
is expected, and in that case exports vail reach in summer a minimum of
265,000 tons per week, vliile at the same time allotments for the needs of
the merged zones will be a minimum of 860,000 tons per week, or about 30
per cent above the peak allotment in 19U6« The increase in domestic
allotment will mainly benefit industrial enterprises, which in this way
will be enabled to raise their output and thus to contribute more efficiently to the projected expansion of foreign trade.
Apart from coal exports, foreign trade of the merged zones in 191*7
will be determined by the working of the bizonal merger agreement. This
agreement provides for the cooperation of the American and British occupation authorities, and of the representatives of the German states, in
formulating an import-export program for the rehabilitation of the German
econony. A major objective of this rehabilitation program is to put the
merged zones of Germany back on a self-supporting basis, i.e., to develop
exports to a point Tihere they cover imports. Meanwhile, however, the
occupying powers must bear the cost not only of the basic program for the
prevention of "disease and unrest", but also of the raw material and
equipment imports required to "prime the pump" of German export industries.
Certain funds are already in hand for this second part of the program,
including the receipts from exports of 19U5-i|6, some former German external
assets transferred to the occupying powers under agreements with neutral
countries, and the credits negotiated with the U. S, Commercial Corporation.
The United Kingdom is participating in the program in two ways. It bears
half of the costs of sending basic necessities to the merged American and
British zones, and it finances half of the funds needed for "priming the
pump" of the area's industry. V/henever, in the future, additional advances
should be required, the United Kingdom also will bear an equal share with
the United States.

The expected increase in imports will necessitate, but also make
possible, larger German exports. In order to' facilitate exports, the
.occupation authorities have authorized foreign businessmen to correspond vith prospective' German trading partners. Only so-called nontransactional mail, i,e,, correspondence preparing rather than concluding actual contracts, has been allowed so far, but transactional mail
may be admitted in the near future, Military government also provides
facilities for foreign businessmen to travel in Germany and renew trade
contacts. Contracts have to be submitted for approval to the Joint
Export-Import Agency of the U.St-U.K. occupying powers, and all payments
have to be made to. the account of the Agency rather than individually to
German exporters. The Agency has issued rules of procedure, stating the
principles which ydll determine the approval or rejection of contracts,
and.has established branch offices in "the most important trading centers
of the merged zones, mainly the state capitals. Finally, the Agency is
prepared to act as seller of goods if a foreign buyer is prevented by
government restrictions from entering into legal contracts with German
nationals.
The necessity of setting Up the bizonal export-import organization
and the haxxiships of the winter months have delayed the beginning of the
new program* Despite these handicaps, foreign trade has started to rise
In the first quarter of 19U7, contracts for exports were negotiated to
the amount" of $22 million. Export deliveries, vhich, however, include
coal, reached. i?3U million. Imports, excluding basic necessities importe
by the, occupation authorities, v/ere approved to the sum of §10 million.
These amounts still are far below the levels that must be reached in
order to fulfill the bizonal program, but they represent a material improvement in, comparison with preceding periods.
f) Money and Exchange
VJhen the occupying pov/ers entered Germany, the collapse of the currency appeared imminent. Money in circulation had increased to approximately six times the prewar level. The German people's recollection of
the hyper-inflation that follorad the first World V/ar added to the
dangers bi the situation,
\
Despite the oversupply of money and the scarcity of goods, the
occupying powers took over the existing German system of price and wage
controls and have- been able to prevent any serious rise in legal prices
and v/ages. The official cost-of-living. index stood in December 19h6 at
approximately 120 per cent of 1938. It is true that only the meager official rations can be purchased at these prices; The supply of black
market goods, however, is probably smaller than the amount of goods distributed, through legal channels. Furthermore, mary black market transactions take the form of barter, especially for cigarettes, rather than
the form of sales at high money prices.'
...
The maintenance of the official price and wage level at virtually
prev/ar figures has had some unforeseen consequences^. At the beginning c
the. occupation, a military exchange rate of 10 marks
per dollar was
established, as cqnipared to a prewar exchange rate: of 2-1/2 marks per
dollar.. This rate was introduced nerely for the administrative use of

30
the occupying authorities, especially in calculating payments in marks to
the troops. Its application for general purposes, however, TOuld have
tended to upset-the entire price and wage system. German domestic prices
even before the war were managed in such a manner that they had lost all
relation to world market prices. No uniform exchange rate, and least of
all the military rate, would represent a generally applicable ratio between domestic prices as expressed in marks, and world market prices in
dollars.
Thus a difficult problem has arisen in connection with the pricing
of export and import goods. The German exporter receives for his sales
the legal domestic price in marks. Similarly, the German importer has to
pay for his purchases the legal domestic price in mar^s. On the other
hand, the foreign importer of German goods pays, and the foreign exporter
of goods receives, the world market price in dollars.
Therefore, the occupation authorities have decided for the time being
to refrain from fixing a uniform conversion factor for the translation of
mark into dollar prices, and vice versa. Instead we have issued a long
list of various conversion factors, reflecting for all major commodities
the actual relation between legal domestic prices in marks and world
market prices in dollars. For instance, the conversion factor for carbon
brushes is 30 cents, and for Pharmaceuticals 80 cents per mark. This
means that a certain quantity of carbon brushes that sells domestically
for 100 marks has to be priced for exports at #30, but Pharmaceuticals
that sell doirestically for 100 marks "have to be priced for exports at ^80.
As a practical matter, this is the best that can be done until major monetary reforms are undertaken in Germany and a more normal price system is
developed there. These problems have been under quadripartite (four
zones) discussion for some time and it is to be hoped that an early agreement will be reached.
g) Banking
In December 19U6, military government established a new central banking organization in the American zone. Following the principle of decentralization, each German state received its own central bank, which
took over the assets of the former Reichsbank as far as they were located
in its area. The organization of the central banks was largely influenced
by the model of the Federal Reserve System. As soon as the economic unification of Germany is implemented, the state central banks will be coordinated by a central board, which will issue currency through the medium of
the state central banks. Until such time, however, the central banks have
no power to issue bank notes or any other currency.
In consequence of our principle of decentralization, commercial banks
in the American zone have been ordered to sever their connection with
central offices in Berlin. Depositors are free, however, to dispose of
their accounts both within the American and in transactions with the
British and French zones, except for blocking measures applied in the
process of denazification. From the beginning of occupation to the end of
191i6, deposits in the American zone increased by 75 per cent. Most of the
rise in deposits had to be kept by the banks in cash or with other credit
institutions since no other investment opportunities are available. Total

3:
assets of the banks in the American zone were 75 billion marks, on June
30, 1916, of which one-third was kept in cash or bank balances, and tY/ofifths in Treasury, bills and other government securities, the service
of- which has been, suspended since the end of the war.
Problems and Prospects
... All these.achievements are merely the first step on the .road to rehabilitation. The obstacles that still have to be overcome are no.:doubt
as great as any which v/e have encountered so far.
First of all, the provision of the Potsdam declaration which calls
for the economic unification of Germany must be carried out. Unification in itself will not solve the economic problems of Germany., but it
will ensure the development of the inhole German economy pn a more
rational basis. Uncertainty as to economic unification ,is. a handicap in
many fields, notably in adjusting the so-called Level-of-Industry Plan
to changed conditions. Under that plan, vhich was approved by all four
occupying powers one year ago, maximum levels were established for most
German industries with a view particularly to preventing the resurgence
of German war potential. Liost experts agree that this plan needs substantial corrections, but the necessary amendments in each zone vail
largely depend upon developments in other zones and upon the question of
vhether the German economy is to be redeveloped as a unit or in separate
self-sufficient parts.
Another problem that urgently needs attention is currency reform.
The disproportion between the supply of money and of goods at prevailing
prices cannot be maintained indefinitely. All experts agree that a reduction in the volume of currency will be necessary. Obviously, the
execution of such a reform also depends upon the fate of unification.
If common action of all four occupying powers is not forthcoming, the
advantages and disadvantages of separate action in the merged American
and British zones must be weighed.
Other problems arise in connection with the political aims of
occupation. The decentralization of the German econony must be achieved
in order to nake it impossible for the country to reorganize for aggressive purposes. In this connection, military government in the
American zone has enacted a drastic decartelization statute, which is
aimed at destroying the concentration of economic power in Germany industry. Property of allied nations looted during the war has been and
is being restituted. War plants have been and are being destroyed, and
other plants have been and are being removed for reparations. The overall problem of reparations, however, still remains to be solved.
The lack of unified action of the four occupying powers, moreover, creates uncertainties that are detrimental to economic progress.
As long as the management of an enterprise does not know whether or not
a plant vdll be subject to restitution, or to destruction, or to removal
under the reparations program, it cannot make definite plans for reconstruction or start an investment program vhich might be interrupted at
any moment.
Finally, military government has to deal with the problem of reaching equilibrium in the balance of international payments of the merged

32
American and British zones. In this connection, the question of economic
unification again becomes decisive. As long as unification is not
achieved, interzonal trade must be treated as international rather than
domestic commerce, vrith the resulting need for controlling interzonal
payments.
The problem of equilibrium is particularly interesting to the American public. As long as the proceeds from exports do not exceed import
requirements, they must be devoted entirely to paying for current imports.
Only when an export-surplus is reached, will it be possible for our merged
zones to start repaying the advances made by the occupying powers for the
importation of basic necessities.
Our stake in the economic problems of Germany, however, is greater
than our interest in receiving repayment of our advances. V/e want peace,
and we know that in order to have peace, we must have economic stability
in Germany and in the rest of Europe.

33
Broadcast over
Station V-I-IT-X
Kay 23, 1947
OUR JOB IN GERMANY TODAY

Mr. Szymczalc gave c talk over the Veshington radio station SIITC on
May 23, 19^7, 8:30 p.m., on the subject "Our Job in Germany". The summary of the highlights of his radio address follows.
American policy in Germany aims at economic unification, according
to the provisions of the Potsdam Agreement/ In the short run, food continues to be the central question. The occupation authorities have been
able to avoid in the American sone not only starvation but also serious
deterioration in public health. " The present official ration of 1,550calories daily for the average consumer, however, is more than one-fourth
belov the minimum necessary to ensure the maintenance of public health
in the long run. Even so, the ration has been furnished only by importing into the zone from abroad foodstuffs equal to 60 per cent of domestic production.
Military government is also facilitating German efforts to rebuild
at least part of their industrial system. This may be difficult to
understand in view of the part played by German industry in the history
of German agfrrecsion. The reconstruction of German peaceful industries
is necessary, however, to prevent Germany from regaining a source of
perpetual unrest in Europe, to aid in the rocovery of our allies, and to
enable Germany to become self-supporting in international trstfe. At
present, production is somewhat smaller than in the foil of 19^6 because
of the exceptional severity of the last winter which disrupted transportation and production all over Europe. It is riuch larger, rovever, than
a year ego, end the outr>ut of several importcnt consumer foods industries
is expected to reach prewar levels by
Economic rehabilitation is hampered by the difficult currency situation. Money in circulation increased during the wor to six times tho
prewar level, and the extreme scarcity of joods acids to the danger of
inflation. The occupying powers have been able to prevent official
prices and wages from rising seriously, but only the meager rations are
availaUo at legal prices. In the lonr run, the disparity between the
supply of money and goods cannot be maintained. Currency reform is under
consideration by the four occupying powers, but if uniform action is not
forthcoming, the advantages and disadvantages of separate action by the
government of the combined American and British zones must be weighed.
Peaceful reconstruction of Germany also depends upon the integration of the German econony in the network of international trade. Imports into the American zone have consisted mainly of foodstuffs and
other essential goods necessary to avoid disease and unrest enong the
population. Military government also arranged for the importation of
cotton and other raw materials to be processed in Germany. A new cotton
program is now being discussed in Germany by American cotton shippers
and Export-Import Bank representatives with Military Government officials.

Part
of the finished goods are being exported to pay for imports, and the

rest becomes available to the domestic economy. Other raw materials imported are used for production for export only. The economic merger of
the American and British zones will irake possible a more ambitious program, and present plans call for putting ther merred zones on a selfsustaining basis by the end of 19^9« She American ta.x3>ayer is particularly interested in having the merged zones evolve an export-import balance because only thus can the merged zones pay for the importation of
the foodstuffs required to avoid starvation.
Our stake in the economic recovery of Germany, hoi/ever, is greater
than our interest in receiving payment for our supplies to Germany. \'e
want peace. In order to have peace we must have economic stability in
Europe. This means economic stability in Germany. At the same time we
are striking at the seeds of aggression in Germany by decentralization
of the country not only politically but also economically. Measures to
that end are now in effect. That is our long range objective.

35
Speech delivered before
New York Board of Trade
New York, 11. Y.
June 12, 19A7

•

OUR INTEREST IN GERMAN FOREIGN TRADE
Recoveiy in Europe is lagging. Since V-E Day, this country has provided billions of dollars of assistance to Europe,
Still we find the
continent struggling with shortages of food, ot1 fuel, of raw materials,
of most of the essential ingredients for economic recovery &nd stability.
Until Europe can export enough to pay its own way in the world, we 3hall
find ourselves continually confronted with a hard choice: Viercusteither
provide further billions of assistance or see economic, social, and political disintegration in that vital area. Ve face exactly this problem
in Germany; but, more importantly, our failure to handle it there on an
adequate scale will seriously reduce the chances of our success in the
rest of Europe. Other European countries are vitally dependent upon the
renewed flow of supplies from Germany, first and foremost of coal. The
reconstruction of the European economy is inseparable fron the rehabilitation of Germany.
Before the war Germany, next to the United States end the United
Kingdom, was the most important trading nation in the world. As late as
1937, despite efforts of the Kazi regime to make Genaany independent of
foreign supplies and markets, the country's foreign trade represented
about 9 per cent of the world's entire international cpLnnerce. Its exports reached #2.4. billion and its imports y2.2 billion, equivalent at '
present prices to {£ billion in each direction. More than half of these
exports and imports came from or went into those areas of prewar Germany
that today constitute the American and British zones of occupation.
About two-thirds of the imports were raw materials and seni-finished
goods needed for the operation of the Gorman industrial system. Almost
nine-tenths of the exports were finished industrial products. Germany
provided a highly important market for many foreign countries, and its
exports met essential needs in wide areas, especially in the rest of Continental Europe.
In 194.6, imports from other countries into the American and British
zones of Germany totaled about ^650 million, kore than four-fifths of
that amount represented foodstuffs needed to avert outright starvation
among the German population. Only about one-tenth of the total consisted
of raw materials for German industry, mainly American cotton and British
vool. The. importation of industrial materials thus was only a very small
fraction of the quantity which the zones used to import before the war.
Exports were equally small. They amounted to only some #150 million and
three-fourths of that sum was provided by coal exports from the Ruhr
mines in the British zone, itost of the remainder was raw materials like
lumber and hops. Exports of industrial goods were negligible.
As a result of this situation, the American and British occupation
authorities had to finance an import surplus into their zones of occupation amounting to about 6500 million in 194-6. Despite such a large outlay of money, the economic situation of the zones reiaained critical.
imports were just sufficient to keep the ration of the average
DigitizedFood
for FRASER

36
consumer around 1,550 culori.es per day, an amount one-fourth below the
minimum standard set up by the United Nations Food and Agricultural Organization, and two-fifths below the quentity needed for the maintenance of
an efficient labor force. The scarcity of imported raw materials vas an
important factor restricting the revival of industrial activity. Sta«jnation in German industry has prevented an adequate flow of German exports
to pay for imports and to contribute to the recoveiy of other European
countries.
In December 1946, the United States and the United Kingdom agreed
upon a new German foreign trade program based upon an economic ;.ierger of
the *ir.eric£n and British zones of occupation. The two occupying povern
set the goal of making the combined zones self-supporting within a period
of three years by stimulating both imports and exports, and in the meantime agreed to share equally in financing the necessary inport surplus.
They set up a «Joint Export-Import Agency ar*d implemented their aR-reeinc-nt
a few days ago by establishing .a German Economic Council• This Council
will be composed of representatives of the legislatures of the German
states located in the combined zones. It will be assisted by an Executive
Committee representing the governments of the German states, and by a number of executive directors, heading bizonal administrative departments.
Through these organizations the population of the occupied zones will be
mobilized for attaining the goals set by the Agency. It was hoped that
Franco and the Soviet Union would join in the agreement and thus reestablish the economic unity of Germany, which is indispensable for the eventual rehabilitation of the German economy and to which all four powers
had agreed at the Potsdam Conference of 1945* Unfortunately, the other
occupying powers refused to join in the merger, tnd the American and
British authorities had to proceed on their own, leaving the door open,
however, for future adherence by the other two powers.
In meeting our share of the cost of supporting Germany during this
interim period, we rely upon appropriations by the Congress to cover food
requirements. Raw materials and equipment for industrial rehabilitation,
on the other hand, are financed through credits from U. S. Government
agencies. The Comiodity Credit Corporation shipped §30 million worth of
surplus cotton into the American zone to be processed by German firus.
The finished materials are exported to en extent sufficient to pay for
the imported cotton and the remainder is either exported in order to pay
for the importation of additional raw materials or is made available to
the domestic German economy, The U. S. Commercial Company agreed to finance similar shipments of raw materials for the ceramics, glass, chemical,
toy and other industries. At present, a second cotton credit of V-20 million is being negotiated with the Export-Import Bank of Washington and
American cotton exporters.
The two occupying powers also have established a joint revolving fu
of foreign exchange that can be used for importing other goods needed by
German industries. The fund consists of the proceeds of exports from the
combined zones in 1945 and 1946, insofar as they have not been used already
for import payments, and of German external assets transferred to the tvo
occupying powers by neutral countries. This provides the Jo^nt Export-Import Agency with a necessary working balance for priming the pump of G n s n
export
industries.

37
The actual start of the foreign trade drive has been sonovhat delayed. For many months the unprecedented hardships of last winter disrupted transportation a:id production in Europe. The new export-import
organizations had to be set up and propor rules of pi-ocedure established.
The exr-ct specifier;tiens for the export-import programs, which had to be
submitted to the Agency by the Gei-cian authorities, often were found unworkable • Already, however, the Agency is approving export and import
contracts dt an accelerating rate. Moreover, the Agency has issued regulations facilitating the renewal of contacts between German and foreign
businessmen. American and other businessmen now may visit Germany in
substantial numbers, end after June 15 German exporters and foreign import srs will be-permitted to conclude contract negotiations by mail.
The Agency, however, has to approve all import and export contracts,
either at its headquarters or through one of its branches, and it is designated to receive all foreign exchange proceeds from export shipments.
These precautiors ere necessary in order to make sure that all export
proceeds are mobilized for the payment of essential imports.
Imports in 1947 viil have to include at least as much food as those
of 19^6. The deficiency of fertiliser and agricultural machiiieiy, and
the scarcity of able workers in Germany makes it unlikely th«t this ycarfs
crop vlll be much in excess of last year's. T>/en if some progress in
German production is made, however, it could not be siifficiont to bridge
the cap between present supplies and the ninii.»ura needed for the preservation of public health in the long run. In addition to food imports, the
combined zones will need imports of raw materials in substantially larger
volume than now contracted for. tihile for some tLae to C O M it will not
be feasible to restore tho proportion between imports of foodstuffs and of
industrial materials to tho prewar ratio of one to two, the value of material imports will have to approximate that of foodstuffs to enable
German industry to reach a satisfactory level of operations.
Exports in 194? arc expected to consist of coal, textiles, and other
rr.w materials tnd industrial products, each of these throe main categories to be of about equal value. In each case, however, reaching the goal
will mean a hard struggle. The authorities will h?ive to decide whether
the overall European eccnony is better served by exporting Ruhr coal or
by letting German industries uso that coal for the production of exportable finished goou3. If coal is to be used domestically, a given quantity
could yield far higher export proceeds than if it were exported as a raw
material. On the other hand, such a solution would be opposed bitterly
by the industrial groups in those countries that depend upon German coal
exports. This dependence is far greater than before the war: Only limited quantities of British and Sile&sian coal are available for export to
l/estera and Central Europe, and the shipment of American coal to Europe
is very expensive because of transport costs and cannot be easily expanded because of transportation difficulties. The present allotment of
Ruhr coal, agreed upon between the bizonal authorities and the French
Government, attempts to satisfy both domestic and foreign demand at least
to a somewhat higher extent thari in 19^6, but the fulfillment of tho prograr.i depends upon a substantial improvement in coal output. Coal production increased materially during the first three months of this yeer.
The advance, however, stopped in April and i-Iay, mainly because of labor
unrest caused by the tightening of the food situation. Satisfactory coal
Digitizedexports
for FRASERfro:a Germany thus will be possible only if increased domestic

38
production aided by increased imports makes available more food and other
consumer goods to .the Ruhr miners.
Increased exportation of textiles will depend upon additional imports
of cotton and wool. Here again iiuproveLient of labor efficiency through
greater availability of food and other consumer goods is an important factor. Exports of lumber and potash encounter difficulties similar to ohode
faced by coal exports. Both these materials are needed urgently in the
German oconoisy. Lumber is vitelly important for pit props in the mines
and for housing—next to food, the most severe shortage hindering improvement in labor productivity. Potash for fertilizers is indispensable for
raising the output of German agriculture. On the other hand, Germany's
neighbors need those materials for exactly the sezne reasons.
Sinilnr difficulties arise in tfcs importation of industrial materials.
Since German exports have to pay for necessary food imports, imported materials should be primarily such as to a:ake possible the production of oxports. On the other hand, tho considerations of labor policy vhich I indicated earlier make it necessary also to import materials needed for the
production of goods for German consumption, lie continually encounter this
problem of how much work individuc-ls can and will do. As long as the wago
of a German worker can be used virtually only for buying the meager official
food rations and similar goods, the German worker h&s no inducement to increase his efforts in order to secure a higher income. Labor productivity
cannot be restored unless higher earnings are accompanied by a greater supply of consumer goods. To achieve this end would require a sharp increase
in the production of goods for domestic consumption. The occupation authorities must approve a program dividing available rieens between the importation of materials for export and for the domestic market. If a liberal
allotment is made for consumer goods, however, the decision will bo severely
criticized by the uninformed public in the occupying countries, vhich have
to advance the funds for imports into the merged zones not directly covered
by German exports. If the allotment is not liberal, the Germans will be
inclined to feel that they s.re working for the occupying powers rether
than for themselves. Charges of exploitation of the combined zone3 by
American and British capital sound incredible to those vho know the burden
that the American and British taxpayers have to bear in order to keep the
zones alive. Such accusations are often node, however, in Soviet newspapers and propaganda broadcasts to Germany, and it would not be surprising if some German workers were led to believe them. This would impair
the beneficial effects of our import policy upon the efficiency of German
labor.
Another difficulty is presented by the state of the German currency.
The occupation authorities have been able to maintain official prices and
wages at only ZO to *5 per cent above the prewar level. Black market
prices, however, are either a multiple of the official quotations, or are
expressed in terms of cigarettes or foreign currency. Thus, the German
currency doos not fulfill its function as a generally accepted means of
payment. The German price eystem was isolated from world market developments by the Nazi regime even before the war. This circumstance, aggravated by the disparity between legal and black market price levels makes
it impossible to fix any given exchange rate as representing a reasonable
relation between the German and the world market price systems. Official

German
prices would be completely out of line with world market prices

if they were converted into dollars at the exchange rate of 10 marks
equal to 1 dollar, which was established at the time of occupation for
purposes of military accounting. For this reason, the Joint ExportImport Agency has issued a list of so-callsd conversion factors, giving
for each major type of commodities a specific relation between official
German prices in reichsmarks and world prices in dollar*: • ibr instance,
carbon brushes, which in Germany are selling for 100 marks, have a conversion factor of 30 cents per mark- This means that they are to be
offered in the world market for £30. On the other hand, certain pharmaceutical products have a conversion factor of 80 cents per mark, which
sieans that such goods selling in Germany for 100 marks are to be offered
in the world market for ^80. Vihile this solution is not ideal, it is the
best that could be found at present.
In the long run, however, currency reform will be indispensable for
the rehabilitation of foreign trade with Germany. Such a reforiD should
be carried out ty all four occupying powers in order not to create further barriers among the four zones or occupation. An Ar.ierican project
dealing with all aspects of the reforra has for some time been under discussion anong the occupying powers, and it is to be hoped that the relatively few unsolved, problems cr.n be settled in the near future.
Our efforts to reconstruct German foreign trade would be greatly
facilitated if Ger-aany's economic unity were restored in accordance with
the Potsdam Agreement. Since the four Bones are interdependent to a very
high degree, full rnerper would make possible a much more efficient economic oceration. If, however, the four powers cannot agree on the terms
of unification, the American and British authorities will have to press
forward in their efforts to put at least their area of occupation back
on its ov.il feet. This will require a reorientation of industrial production in the two zones, and &n increase in industrial activity above
the level set ty the four occupying powers about a year ago. Vithin this
framework the foreign trade program will make a decisive contribution to
the restoration of economic stability in Germany and thus in all of
Europe.

Ill
Broadcast over
N.3.C. Network
Juncl3,1947

•

"• '

•

OUR INTEREST IN GERMAN FOREIGN TRADE
Recovery in Europe is lagging. Since V-E Day, this countiy has
provided billions of dollars of assistance to Europe. Still wo find the
continent struggling with shortages of food, of fuel, of raw materials,
of most of the essential ingredients for economic recovery and stability.
Until Europe can export enough to pay its own way in the world, wo shall
find ourselves continually confronted with a hard choice: Me uuct either
provide further billions of assistance or see economic, social, and
political disintegration in that vital area. We face exactly this problem in Germany; but more importantly, our failure to liandlo it there on
an adequate scale will seriously reduce the chances of our success in the
rest of Europe. Other European countries are vitally dependent upon the
renewed flow of supplies from Gemany, firct and i'oreuost of coal. The
reconstruction of the European econcqy is inseparable from the roljabilitation of Germany.
Before the war Germany, next to the United States and the United
Kingdom, was the most important trading nation in the world. As late as
1937, despite efforts of the ilazi regime 1to make Germany independent of
foreign supplies and marlceta, the country s foreign trade represented
about 9 per cent of the world's entire international couimerce. Its exports reached $2.4. billion and its imports 02.2 billion, equivalent at
present prices to 0-4 billion in each direction. Horo tlian half of these
exports and imports cr.ne from or went in-o those ai'eas of prewar Germany
that today constitute the American and British zones of occupation.
About two-thirds of the imports were raw materials and semifinished goous
needed for the operation of the Geraan industrial system. Almost ninetenths of the exports were finished industrial products. Gerr^xny provided a highly important market for many foreign countries, anc its exports met essential needs in wide areas, especially in the rest of Continental Europe.
In 1946, imports from other countries into the American and British
zones of Germany"totaled about £650 million. More than four-fifths of
that amount represented foodstuffs needed to avert outrijjht starvation
among the German population. Only about one-tenth of the total consisted of raw materials for German industry, mainly American cotton and
British wool. The importation of industrial materials thus was only a
very small fraction of the quantity which the zones used to import before
the war. Exports were equally small." They amounted to only some 015O
million and three-fourths of that sum was provided by coal exports from
the Ruhr mines in the British zone. Most of the remainder was raw materials like lumbfer and hops. Experts of industrial goods were negligible.
As a result of this situation, the American and British occupation
authorities had to finance an iiaport surplus into thoir zones of occupation amounting to about 0500 million in 1 % 6 . Despite such a large outlay of money, the economic situation of the zones remained critical.
Food imports were just sufficient to keep the ration of the average consaner around 1,550 calories per day, an amount one-fourth below the

U2
minimum standard set up by the United Nations Food and Agricultural Organization, and two-fif tbo below the quantity needed for t:ie nainteiumce
of M I efficient labor force. The scarcity of imported raw raterj-alB was
an important factor restricting the revival of industrial acuivity.
Stagnation in Germany industry has prevented an adequate flow ox German
exports to pay for imports and to contribute to the recovery of other
European countries•
In December 19/+6, the United States and the United Kingdom agreed ^
upon a new Gorman foreign trade program based upon an economic merger 01
the American and British zones of occupation. The two occupying powers
set the goal of nicking the combined zones self-supporting vithin a period
of three years by stimulating both imports and exports, and in the
meantime agreed to share equally in financing the necessary iiaport surplus. They set up a Joint Export-Import Agency and implemented their
agreement a few days ago by establishing a Geznan Economic Council.
This Council will be composed of representatives of the legislatures of
the German states located in the conbined zones. It will be assisted by
an Executive Committee representing the governments of the Geroan states,
and by a number of executive directors, heading bizonal administrative
departments. Through these organizations the population of the occupied
zones will be mobilized for attaining the goals set by the Agency. It
was hoped that France and the Soviet Union would join in the agreement
and thus reestablish the economic unity of Gennany, which is indispensable
for the eventual rehabilitation of the Gerrtf-n economy and to which all
four powers had agreed at the Potsdam Conference of 19A5. Unfortunately,
the other occupying powers refused to join in the aorjjor, and the American
and British authorities had to proceed on their own, leaving the door
open, however, for future adherence by the other two pavers.
In meeting our share of the cost of supporting' Germany during this
interim period, we rely upon appropriations by the Congress to cover
food requirements. Haw materials and equipment for industrial rehabilitation, on the other hand, are financed through credits from U- S. Government agencies. The Commodity Credit Corporation shipped 030 million
worth of surplus cotton into the icierican zone to be processed by ttoman
firns. The finished raterials are exported to an extent sufficient to pay
for the imported cotton and the remainder is either exported in order to
pay for the importation of edcitional raw materials or* is made r-vailable
to the domestic Geraan economy. The U.S. Commercial Company agreed to
finance similar shipments of raw materials for the ceramics, glass,
chemical, toys and other industries. At present, a' second cotton credit
of 020 million is bein£ negotiated with the Export-Import Dank of Hashington and American cotton exporters."
Tho two occupying powers also have established a joint revolving fund
of foreign exchange that can bo used for importing other goods needed by
German industries. The fund consists of the proceeds of exports from the
combined zones in 1945 and 1946, insofar as they have not been used already
for import payments, and of German external assets transferred to the two
occupying powers by neutral countries. This provides the Joint ExportImport Agency with a necessaiy working balance for prtuin-"
the -pimp of
w
German export industries.

The actual start of the foreign trc.de drive )ius been souewhat delayed « For many months the unprecedented hardships of last viator disrupted transportation and production in Siirope. The new export-import
organizations had to be set up and proper rules of procedure established.
The exact specifications for the export-import program, which had to be
submitted to the Agency by the Gorman authorities, often wore found unworkable. Already, however, the Agenpy is approving export and ii-roort
contracts at an accelerating rate. Iioroovcr, tho Agency has isnuec1.
regulations facilitating the renewal of contacts between German and foreign businessmen. American and other businenunon now way visit Gernauy
in substantial numbers, anc! after June 15 Geraan exporters and foreign
importers vail bo permitted to conclude contract nogofciations by rjail.
The Agency, however, has to approve all import and export contracts,
either at its headquarters or through one of its branches, and it As
designated to receive all foreign exchange proceeds from export ship:aents. Thece precautions are necessary in ordsr to make sure that all
export proceeds are mobilized for the payment of essential "Imports.
Our efforts to reconstruct Ciexiiari foreign trade would be greevbly
facilitated if Gersuny's economic unity \iero restored in accordance with
the Potsdam Agreement. Since tiio four zones are interdependent to a
very high uegree, full nerger would i:iulr.e possible n much J.iore efficient •
economic operation. If, however, the four powers cannot agree on the
ternc of unification, the American on:l British autJiorities will te.ve to
press forward in their efforts to put ut least their area of occupation
back on its own feet. This will require a reorient&tion of industrial
production in the two aones, and an increr.se in industrial activity
above the levol sot by the four occupying povers about a year ago. In
this frnnework the foreign trade prosr^ \.'ill lanko a decisive contribution to the restoration of economic stability in Gcraany anJ thus in all
of Europe.

Speech delivered before
Directors of Savings Banks Trust Company
and Institutional Securities Corporation
New York,-N. Y.
June 13, 1947
THE IMPORTANCE OF GERMANY FOR THS ECONOMIC RECONSTRUCTION OF EUROPE
The American public is well aware of the general importance of reconstructing the German economy* Few people, however, understand how
much German rehabilitation moans for those areas that form the core of.
democratic capitalism in Europe.
For political reasons, the Nazi regime tried long before the war to
loosen the ties between the economies of Germany and the.western democracies. Germany became the most important trading partner of the other
Central and Eastern European countries, but this development did not appreciably diminish the overwhelming role that Western Europe and nonEuropean countries always have played in German foreign trade. In 1937—
the last year in which the German economy was run on a peacetime basis—
GermatBrhad imports of $2,2 billion and exports of 02.4 billion. Of its
imports, 35 per cent came from Western Europe, 23 per cent from the
Americas, 21 per cent from Asia, Africa, and Oceania, and 21 per cent
from Central und Eastern Europe. Of its exports, 47 per cent went to
Western Europe, 15 per cent to the Americas, 16 per cent to Asia, Africa,
end Oceania,"and 22 per cent to Central and Eastern Europe. Germany1 s
importance for the western nations becomes, even more apparent if countries
that supplied more than half of German imports and took more than half
of its exports, are listed in the order of their contribution to German
foreign trade. The nations from which Germany had the largest imports
were the United Kingdom, Argentina, the United States, Sweden, Italy, the
Netherlands, Belgium-Luxembourg, Brazil, Rumania, British India, China,
and Denmark. The countries that took the largest quantities of German
exports were the Netherlands, the United Kingdom, France, Italy, BelgiumLuxembourg, Sweden, Switzerland, Denmark, the United States, Brazil, China
and Czechoslovakia. Of these fifteen countries only Czechoslovakia is
located in Central Europe, and only Rumania in Eastern Europe. •
In the long run, those countries will have to reestablish the German
market as en outlet for their products. At present, however, Germany is
more important to then as a source of supply than as a customer.. Many of
the goods that Germany supplied before the war, are indispensable today
for the economic reconstruction of its former customers.
Among the raw materifils exported by Germany, coal always has played
the most important role. In 1937, Germany exported 40 million tons, the
value of which was then £180 million and would be today $400 million.
Most of it C U D G from the mines of the western zones, especially the Ruhr
and Saar districts, and went to Italy, France, Belgium-Luxembourg, the
Netherlands, and Switzerland. In 1946, exports from the western zones,
totalled 13.4 million tons, and these exports had to be divided among
many more claimants than the threefold amount in 1937, The decline in
the output of tne British mines, which made necessary a reduction, in ...
British coal and1coke exports (including bunker coal) from 52 million
tons in 1937 to 9 million in 1946, has deprived the Scandinavian countries
their customary source of.coal. The agreements concluded by Poland
Digitizedof
for FRASER

U6
with the Soviet Union have diverted to that country a large portion of
the Sileasian coal output from its usual Central European- markets- Domestic coal production almost everywhere in Europe was below prewar, on
account of war damage and disorganization. The only other source of ^
coal open to European countries was the United States, but the rise in
coal exports from the United States between 1937 and 1946 was only 29
million tons, or only two-fifths of the decline in exports from Germany,
Great Britain, and Poland. Moreover, American coal is too expensive
because of transportation costs for rational use in Europe. Thus coal
has remained the* most severe single factor retarding the recovery of the
industrial countries of Europe, and especially of France,, the Low Coun^
tries, Italy, and Austria.
The situation is the more serious since even the small German exports of 1946 were made possible only by drawing on existing stocks and
ty reducing at the same time allocations of coal to German industry to
a level which made the rehabilitation of the German economy impossible.
The collapse of the allied efforts to reconstruct the German economy on
a peaceful basis could be averted only by sharply curtailing export allocations in the fall of 1946. Under the system of allocations recently
established by the western occupying powers, the 1946 export volume will
be reached in 1947 only if present coal output is increased by about 10
per cent. A more nearly satisfactory export volume equal to about half
of the 1937 level will depend upon an increase in output by at least 40
per cent. •
Similar problems arise in connection with the exportation of German
potash, which in 1937 went mainly to the Netherlands, the United States,
Belgium-Luxembourg, and Denmark. Production of potash in the western
zones reached 75 per cent of prewar, but domestic demand was larger than
before the war because of the unavailability of potash from the eastern
zone of Germany. In order to satisfy the foreign needs and thus assist
in the rehabilitation of agriculture in western Europe, production in
the western zones of Germany would have to surpass the prewar level.
In the exportation of textiles, Germany played a relatively minor
role before the war, but at present the demand for such goods is so
great that the absence of Ger:aan supply is seriously felt in Europe. In
the fields of chemicals, however, the lack of German exports is far more
important. The industries of Sweden and the Netherlands as well as
plants in the United Kingdom and the United States, were heavily dependent upon semi-finished products of the German chemical industry. German
pharmaceutical products could be used to greatest advantage in* the public health programs forming part of the rehabilitation projects for
Greece, Italy, Austria, and even for the countries of the Middle and Far
East. While most of these products today can be made available from
American sources, many countries in need of them cannot afford them
since they cannot export to the United States but could export to Germany to pay for German products.
Next to coal, the greatest need of European industry todey is for
steel and steel products. In 1937, Germany exported semi-finished iron
and steel goods to the extent of 2.6 million metric tons, including intubes, plates, wires, and the like. The Netherlands alone imported
Digitizedgots,
for FRASER
from Germany 450,000 tons of such products, Denmark more than 250,000

1*7
tons, Greece almost 100,000 tons, and China about 150,000 tons. German
exports of finished iron and steel products, other than machinery,
amounted to almost 700,000 tons in 1937, of which almost one-tenth went
to the Netherlands. Exports of these two categories were larger than the
entire iron and steel production in the western zones of Germany in 1946,
and almost half of the total permitted to all of Germany under the socalled level-of-industry plan. • Unless that plan is revised* and actual
steel production increased up to the permitted limit, the exportation of
these materials badly needed for reconstruction will be impossible.
Exports of machinery and vehicles, although smaller in tonnage than
those of other iron and steel products, were even greater in value and
importance. In 1937, they reached about 1 million tons, valued at around
§600 million, and included among others $80 million of machine tools,
$125 million of electrical appliances, $80 million of motor vehicles,
$55 million of textile machinery, *md $4-5 million of precision instruments
and optical goods. Virtually all countries of the world were large customers, with the Low Countries, the Scandinavian nations, Italy, France,
and China among thrc most prominent. These countries today are in particular need of such machines for reconstructing their industrial system.
Nevertheless, there were no German exports of such commodities in 1946,
and under the levol-of-industry plan it is questionable whether-some important categories could ever again be exported.
The lack of these exports endangers daily the'work of the industrial
enterprises of Europe. It means that these industries, with their extensive use of German machinery, are unable to receive replacements or even
spare parts for the growing nunber. of machines that become unfit for
operations after the neglect of the war years and the strain of the postwar period. Recent setbacks in Kotheriand3 manufacturing industries, in
Polish coal mines, and in the Austrian transportation system were due to
the impossibility of making repairs without German spare parts. The
needed expansion of industry, and even the development of new plants to
replace those destroyed during the war, are hampered even more seriously
than mere repair work. The machinery industries of the few countries
that did not' suffer from the war, and especially those of the United
States, cannot make up for the deficit since they are fully occupied with
domestic orders and exports to their regular markets, and since in many
cases they do not specialize in the types of machinery needed by European
enterprises and traditionally produced" in Germany. Since it is to be expected that in the long run these countries will revert to their normal
German sources of supply, it would not be economical for the American
machinery industry to attempt to convert their manufacturing processes so
as to cater to vhat may prove to be a mere temporary demand.
Given the need for stimulating German exports in order to help in tho
recovery in the rest of Europe, the following steps are necessary. First
of all, the efficiency of German labor must be restored. This in. turn inn
plies an early currency reform so as to give the Geiroan worker wages expressed in a currency with real purchasing power. As long as the German
mark cannot be used for anything but the purchase of the meager official
rations, the German worker has no incentive for earning higher wages than
the modest amount that he can spend on his rations. This means that he
has no incentive to work efficiently; This tendency is reinforced by the
Digitizedfact
for FRASER
that es the result of the currency situation black market operations

1*8
ore far more remunerative than honest work* Plans for currency reform
have been formulated long ago, and only relatively minor points are in
dispute among the occupying powers. If it proves impossible to reach an
early agreement on these points among all four occupying powers, the
American and British authorities must weigh the advantages and disadvantages of unilateral action in the combined American and British zones.
Currency reform, however, can cure only, the monetary ca.uses of the
low level of German productivity* It is even more important to bolster
the purchasing power of the currency by an increase in the supply of consumer goods. The most needed of these goods are foodstuffs. At the
present rate of 1,550 calories per day for the so-called normal consumer,
labor efficiency cannot be maintained in the long run. The occupation
authorities hone to raise the ration in the not too distant future to
1,800 calories* per day, but even that would bo far from sufficient. We
must plan to reach about 2,600 calories per day; this would still be less
then the prewar level, and especially it would not mean a return to prewar standards of quality, but it would guarantee adequate nutrition. In
the long run, it can be hoped that the combined American and British
zones may produce domestic foodstuffs up to the equivalent of 1,600 calorics daily per normal consumer, as compared to the present level of
about 1,000 calories. In the next few years, however, no more than a
production of 1,300 calories can be expected. This means that we must
import at least 1,000 calories per day and person, and possibly as much
as 1,300 calories, or in other words, at least 60 per cent and perhaps
as much as 100 per cent more than during the current crop year. Importation of foodstuffs during the first six months of 194.7" into the combined American and British zones requires the expenditure of &270 million. On the basis of 2,600 calories, foodstuff" imports would cost at
least §850 million per year at present prices.
Food alone, however, would not sstisfy the needs of the German
worker. Next in importance is housing, much of which ccn be furnished
by the aid of domestic labor and materials, but for which some materials,
like non-ferrous metals, have to be imported. Third in line is clothing which in normal times can be supplied by German industry, but only
with the aid of imported raw materials like cotton and wool. At present,
German firms receive American cotton for processing purposes with the
provision that part of the finished products is exported in order to
pay for the Imported material; the remainder is either also exported in
order to pay for additional imports, or put at the disposition of the
German consumer. An extension of these arrangements is under negotiation with the Export-Import Bank and private cotton exporters. The
quantities in question, however, are far from sufficient. The population of the combined American and British zones need for their own consumption about 400,000 tons of textiles per year, of which about 200,000

^ n n n J° ttfln ™ d J??' 000 tons of ™ » 1 h ^ e to be imported. Another
100,000 tons of textiles have to be imported for processing and reexport. The total of 400,000 tons of imports which would still be less
than the prewar imports of raw and semi-finished textiles into the area
of thecombanea zones would cost around £300 million oer year at present prices.
*
Other raw materials for consumer goods industries, both for domestic
production
and reexports, include hides, lumber, gasoline, lubri
cants, and rubber. More Important than any of these goods, However,

h9
will be the importation of iron ore and non-ferrous metals needed to
enable the Germans to resume exports of steel and machinery. In 1937,
such imports required $340 million. In the postwar period the sum will
be somewhat smaller since the rise in prices will be overbalanced by the
reduction in German productive capacity, needed for reasons of international security. Altogether, the rehabilitation of the German capacity
to export will require the importation of industrial raw materials about
equal to the value of imported foodstuffs.
The American and British occupation authorities have given their
attention to this problem for many months* They have accumulated funds
to pay for some imports needed to prime the pump of the German industry,
and they have negotiated credits with public agencies to provide for additional raw materials. Again, however, the present program must be expanded if its purpose is to be fulfilled. New credits will not only have
every chance of being repaid out of the increased German exports, but
they will also enable the combined American and British zones to start
paying for the food imports which at present are financed by the occupying powers out of appropriated funds. It is to be expected that within a
few years the exports from the combined zones will be large enough to
make unnecessary the further use of appropriated funds of the occupying
powers, and perhaps even to begin the repayment of the funds advanced in
the interim period.
In addition to currency reform and increased imports of foodstuffs
and raw materials, the German export program needs the revision of the
level-of-industry plan adopted by the occupying powers in the spring of
1946. There can be no question of abandoning the main idea of that plan;
namely, the prevention of a revival of German war potential. The occupation authorities will continue to enforce the provisions of the plan in
regard to war industries. It will be necessary, however, to revise
periodically the list of industries classified as dangerous, and the quotas
of production established for restricted enterprises, which include most
of the heavy industries. In each case the possibility of an abuse of increased capacity will have.to be weighed against the advantages of using
that capacity for the benefit of the rest of Europe. It appears clear,
for instance, that the permitted steel production of 5»8 million tons for
the current year is utterly inadequate for the peacetime needs of Europe,
and the majority of the occupying powers seem to feel that about double
that amount would be more reasonable. Whenever possible, such revisions
should be undertaken by agreement of all four occupying powers. If, however, no such agreement can be reached, the American and British authorities again will have to veigh the arguments for and against unilateral
action in their zones of occupation.
Unilateral action, however, can provide only for a partial solution
of the German economic problem. Rehabilitation of the German economy
would be greatly facilitated if the occupying powers could reach an agreement on the implementation of the Potsdam Agreement which provided for
treating Germany as an economic unit. The division of Germany into zones
of occupation separated from each other ty excessive trade barriers and
other methods, already has hampered the reconstruction of Germany as much
as any other single cause. The nearer the German economy comes to reaching again a more°normal level of production, the more disastrous will be
the
separation. Every zone is dependent upon raw materials from other

zones, and can work rationally only if assured of markets for its products in the other zones. Moreover, only early economic unification can
prevent industries from being developed in one zone that will be forced
to close down once more efficient plants -in other zones will again be
able to compete with them,
*
The contribution that Germany can make to the rehabilitation of the
rest of Europe thus will be the greater, the closer the relations among
the occupying powers. Restoration of harmony among the Allies will make
possible agreements in the natters of currency reform, level-of-industry
plan, and economic unification. In this as in so many other respects,
the economic interests of Europe and the political interests of the
United States are in complete harmony.

SI
Speech delivered before
Institute on the United States in World Affairs
American University, Washington, D. C.
June 23, I?li7
AMERICAN ECONOMIC POLICY IN
American economic policy in Germany has tv:o main purposes: to contribute to the political security and to the economic rehabilitation of
Europe.
These tv;o purposes are not mutually contradictory* In general,
people are the more inclined to be peaceful the better their economic
situation. The Germans are no exception to this rule* During the prosperous years of the late 20's, German foreign policy was led by Minister
Streseroan who made important contributions to the restoration of friendly
relations among the European powers. The Nazi regime came into power
only vhen the depression of the early 30 f s had reduced the standard of
living of the German people far below the level reached before the first
world war. It is true, however, that economic rehabilitation alone might
not be sufficient to prevent aggressive tendencies from again influencing
German policy. Just before the outbreak of the second world war, Germany
was reasonably prosperous, but the improvement of its economic situation
did not lessen the aggressive tendencies of its government and of the
major part of the population. It would be a mistake, therefore, to concentrate all American efforts upon improving economic conditions in Germany. On the contraiy, it might become necessary in some instances to
adopt measures contraiy to the economic interests of Germany in order to
make impossible the revival of German war potential. The fundamental
problem confronting long-run American economic policy in Germany is to
find the correct proportion in which stimulation and limitation of reconstruction in Germany roust be blended*
In recent weeks there has been much talk about the need for coordinating American assistance to Europe, Vihile this need is extremely urgent, it would be a great mistake to assume that the American authorities
so far have been ignorant of that problem. Under the Bretton Woods
Agreements Act the National Advisory Council v/as established to coordi~
nate all international financial transactions of U. S, government agencies. The National Advisoiy Council not only instructs the American
representatives in the International hionetaiy Fund and International Bank
for Reconstruction and Development, but also advises the management of
the Export-Import Bank of Viashington and all other similar agencies. The
program for Germany is a part of the plans considered fcy the National Advisory Council and its member agencies. What has been lacking so far has
been less coordination of policies among the American government agencies
than full cooperation among the European countries. A basis for cooperation was laid some time ago when the Economic and Social Council of the
United Nations established the Economic Commission for Europe. It remained for the historic Harvard speech of Secretary Marshall, however,
to stimulate" concrete action to that end.
It is exactly the influence of the German econony upon the development of other European countries that makes the rehabilitation of Germany
necessary from the point of view of the economic stability of the v;orld.

52
Germany's neighbors, today more than ever before*, are dependent upon commodities produced by Germary. Before the war, all European industries
used large quantities of German machinery. Today such machinery is needed
not only for repairing the damage done to the industries of Germany's
neighbors during the war but also for developing those European countries
that need further industrialization. Cutting off the supply of German
machines has considerably delayed the rehabilitation of the victims of
German aggression and thus the restoration of economic stability in all
of Europe. Equally important for the other European nations are German
chemicals and textiles and especially German coal. On the other hand,
Germany's neighbors wish to export to Germany certain commodities vhich
are abundant in other parts of Europe and for which there is great need
in Germany. They cannot afford to let Germany have their products, however, without receiving German goods in return. If the Netherlands, for
instance, could export to Germany its vegetable surplus in return for industrial imports from Germany, both the Netherlands' and the German economies would profit. In addition, the American econony would be freed from
the obligation of advancing to the Netherlands the funds for importing
American rather than German machinery and advancing to Germany the funds
necessary for importing American rather than Netherlands foodstuffs. The
Low Countries alv/ays have benefited by a large volume of transit traffic
with the industrial districts of western Germany. The resumption of German industrial production vdll contribute substantially to the revival of
the Netherlands' and Belgian ports and thus to the economic rehabilitation
of those countries that form the core of democratic capitalism in continental Europe.
In the short run, the main purpose of American economic policy is to
prevent the German econony from suffering a complete breakdown. We must
admit that after two years of occupation the danger of such a breakdown
is not appreciably smaller than immediately after the end of the war.
Three reasons contribute to the unsatisfactory progress of German rehabilitation. First, twelve years of Nazi rule, six years of v/ar, and the
repercussions of defeat and occupation have had a great psychological
impact upon the German nation. The sense of responsibility and the desire for initiative have almost completely disappeared. The Germans
work a s well as ever if they are told exactly v.hk to do. But whenever .
they are asked to make decisions of their own, delays and uncertainties
arise. The American occupation authorities are neither able nor willing
to direct the German econony in every detail. They are not able to do
so because of the severe limitations in personnel and means imposed upon
the military administration in Germany, and they are not willing to do so
because this would run counter to the political principle of re-education
for democratic self-administration. The clumsiness of the German administrative machinery in evolving a system of economic policy is part of
the price v-hich must be paid if the occupation is to achieve political
as well as economic purposes0
The second reason for tho present state of the German econony is
the physical exhaustion of the population. For two years the average
German has had to live upon a ration which at best reached 1,550 calories per day or about 3/U of the minimum acceptable to the United Nations Food and Agriculture Organization. Furthermore, the Germans
lack housing as much as food. Floor space for the average German in

the
British zone of occupation, which includes the industrial heart of

Germany, is about 70 square feet. Other consumer goods are almost as
scarce as food and housing and especially clothing and footwear present
very difficult problems. A person viuo is gravely undernourished as well
as ill-housed and ill-dressed, cannot possibly perform the heavy v.*ork
needed for the reconstruction of the German economy,,
A third reason for the slowness of economic progress is the scarcity
of capital available for repairing the extensive war damage and for restocking inventories• The war has destroyed a large portion of Germany's
fixed capital and exhausted the supply of most raw materials needed by
German industryc Until Germany is able to accumulate nev/ capital either
by foreign credits or out of domestic savings, the German economy cannot
hope to reach the level of its prev/ar output.
The remedies for there ills are simple in principle but extremely
complicated in their practical application. The German psychology can be
changed only by a patient attempt at re-education which certainly cannot
be completed within a few months or even a few years. The best we can
hope for is to convince the Germans that cooperation with us is in their
own interest. This objective is not easy to reach since the Germans have
learned under the Nazi rule to distrust deeply all official declarations
of benevolent sentiments.
The lack of food and housing can be overcome only by an increase in
imports, accompanied by an increase in domestic production. This apparently simple measure is rendered difficult, however, by the general
scarcity of supplies* all over the world, and by the obligation imposed
upon the American authorities to contribute to the recovery not only of
Germany but at least as much to that of the other European nations. '.Vhatever supplies we send to Germany cannot be sent to one of our Allies.
Before allocating a shipload of food we have to decide where the shipment
would be best utilized and v.hat nation should be deprived of some assistance in order to make possible help to another0
The same dilemiaa confronts us in the case of capital assistance.
The industrial system not only of Germany but also of most other European
nations has been destroyed by the war, and the nations that have suffered
from German invasion expect us to help reconstruct their economies before
we help reconstruct German enterprises. Uachineiy and raw materials are
extremely scarce and we are unable to satisfy all foreign denands in addition to the needs of our domestic econony. Y."e have to wei£h our own
needs as well as the needs and the moral claims of many other nations before we can decide to give help to Germany.
The remedies for the ills of the German economy which we have discussed so far are not only clearly recognized by the American authorities,
but are also constantly applied in practice. Our program of re-education
is being implemented by a steadily increasing extent of self-administration granted to the German population in the American and British zones
of occupation. At the local and state level there is almost complete
autonomy subject only to the veto power of military government. At the
zone level we have established a state council (Landerrat) through which
the various state governments coordinate their policies. At the level of
the combined American and British zones we have established quite recentDigitized for
lyFRASER
a German Economic Council assisted by an executive committee and by a

staff under a number of executive directors. This council will act as the
supreme agency in economic affairs and will have power to give binding directives to the state governments. It will consist of representatives of
the German population and will be entrusted not only with executing the
economic policy of the occupation authorities but also with assisting in
the formulation of the policies themselves. • The occupation authorities
vdll confine themselves*largely to supervision and control. This program
will remain far from perfect as long as similar German institutions are
not established for all four zones of occupation so as to implement the^
Potsdam Agreement which provides for treating Germany as an economic unit.
The American and British authorities have urged the other occupying powers
to abide by the Potsdam Agreement and quite recently again expressed their
hope that the other occupying powers v;ould Join in the bi-zonal arrangements. So far, this has not been done and therefore the American and
British authorities have had no choice but to go ahead with establishing
German self-administration at least in their z ones of occupation*,
The problem of increasing the German supplies of basic necessities
has been pursued ever since the beginning of "the occupation. In 19'i5 arid
191*6, the American and British armies spent hu^e sums for importing into
their zones of occupation commodities needed for the prevention of disease
and unrest aiuong the population. In addition, they turned over large supplies of arny surplus for the use of the Gorman economy. In the calendar
year of 191:6 alone the total amounts made available to the Genrans were
360 million dollars in the American and 350 million dollars in the British
zone. The British zone has a larger population than the American* In
view of the grave economic difficulties from which the British people
themselves have been suffering for the past several years, it v;ould have
been impossible for them to spend as much per capita as the Americans. In
fact, the British, viiose economic plight is due to German aggression, have
again proved their sense of statesmanship as well as their economic foresight by diverting such a large amount of funds from their ov;n use to
that of their former enemies.
Since January 1, 191*7* the importation of basic necessities into the
combined American and British zones—so-called Category A goods—has been
financed equally by the United States and the United Kingdom. Urder the
bi-zonal agreement of December 2, I9I46, the two zones are treated as an
economic unit, and it is to be expected that the standard of living in
the British zone Till be raised to that of the American zone. In the
short run this means that the United States will spend somewhat larger
funds than would be necessary in order to supply only the American zone
with basic necessities. In the long run, however, the arrangement vdll
be to the benefit of the American public since the British zone not only
has larger needs at present, but also a larger potential for future industrial production. In a few years the British zone, therefore, may be
able to help to pay for the deficit of the American zone.
The basic necessities to be imported under the bi-zonal agreement
are not gifts presented to the German people. Germany will have to repay the sums advanced for such imports but only after it has reached a
level of production sufficient to pay for current imports. That is to
say, tnat the advances made by the American and British public for the
importation
of basic necessities will be re-paid after the balance of

payments of the American and British zones of occupation has reached

equilibrium on current account, but before any other payments to other
powers are made out of current production.
In the first six months of 19h7 the imports into the combined zones
of the so-called Category A goods, including 2.3 million tons of foodstuffs, will require 270 million dollars. This seems to be a very large
sum but it is far from sufficient. If we want to enable Germany to reach
its prev;ar level of production we must increase German food consumption
from the present average of 1,550 calories daily to about 2,600 calories.
Domestic food production in the American and British zones of occupation
last year averaged about 1,000 calories per day for the non-farm population. V:e can hope to increase this production in due time to the prewar
level of l,3C0 calories and perhaps to a maximum of 1,600 calories.
Even under the best conditions, however, production in the American and
British zones would leave a food deficit of 1,000 calories daily per
head of the non-farm population. Present imports provide for only about
600 calories daily per person. In the long run, therefore, food imports
far from being reduced will have to be increased substantially if our
economic goals are to be reached.
The need for continued food imports is another reason for reviving
German industry. Industrial goods must be produced in order to make
possible exports that can be used for the payment of food imports and the
production of industrial goods, in turn, is tied to the raising of the
consumption levels of the German worker.
In comparison with the importation of Category A commodities, imports of materials needed by German industry — the so-called Category B
goods — have remained almost insignificant. Kost of these imports are
made under credit arrangements whereby German manufacturers receive raw
materials for processing, and then export a quantity.of finished goods
sufficient to pay for the cost of the imported raw materials. The most
important transaction of that kind in the American zone was undertaken
by Military Government with the Commodity Credit Corporation and concerned 30 million dollars worth of American cotton. A second arrangement involving 20 million dollars worth of cotton at present is being
negotiated with the Export-Import Bank of Washington and American cotton
exporters• Smaller credits of a similar nature have been arranged with
the U. S. Commercial Company, a subsidiary of the Reconstruction Finance
Corporation; they concern raw materials for ceramics, glass, chemicals,
toys, and construction materials industries.
These arrangements are supplemented by the use of a fund accumulated
by the joint Export-Import Agency of the American and British tiilitary
Government. This fund includes the proceeds of exports from the American and British zones of occupation in 19ii5-ii6, plus a sum made available
to the United States and the United Kingdom by the Swedish Government out
of German external assets in Sweden, surrendered to the United Nations
under an agreement of July 191*6. The total fund is equal to around 100
million dollars and will provide means for importing such materials as
are required for priming the pump of German industry. It is to be hoped
that before this fund is used up^ current exports will provide the
amounts necessary to pay at least for the current imports of Category B
goods. For 19ltf> total imports of these goods may reach about $300 million. This would be less than half of the amount needed for insuring a

56
normal level of economic activity in Germany, but it would be about three
times the 19U6 volume of such imports fl
These Category B imports roust include both materials for the export
industries and for domestic German consumption. An increase in German
production depends heavily upon the improvement in the supply of food,
housing accofli!nod<vlions, and other consumer goods. Increased availability .
of such goods mede available to the"Ruhr miners was instrumental in bringing about a rise in coal production by 20 per cent between the fall of 19uo
and the spring of 19U7. The recent food shortages which were experienced
in the Ruhr as a result of la^s in transportation of imported supplies,
immediately resulted in a drop of coal output by almost 10 per cent* Imports of consumer goods actually may result in a larger production cf exportable goods tha;i the importation of the same amount of industrial raw
materials.
German exports so far have lagged even behind the small volume of
Category B imports. In 39U6, coal i'rora the Ruhr mines in the British
zone was the only commodity that was exported in substantial quantities
from either the American or British zones of Germany. These exports
reached 13 mil3.ion tons., value! at o!17 million, but they were not sufficient to satisfy even the most urgent nseds of other European nations*
Between 1937 and 19h6, British coal exports dropped from 52 million tons
to 9 million tons and Gorman coal exports from UO million tons to 13 million. The increase in American coal exports rrade up for less than half
of the deficit, and moreover, American coal, because of huge transportation costs, cannot be used economically in continental Europe* The coal
famine was irade worse by the decline in domestic coal production in most
other European countries and by the fact that as a result of Polish-Russian agreements large parts of the Silcsian coal production was deflected
from Central Europe to the Soviet Union,
German coal exports were kept even at their irodest level only by
drawing upon existing stocks and by curtailing allocations for German
consumption. The German industrial system thus v/as prevented from utilizing even that part of its capacity that otherwise would have been available. This system led to such difficulties in the German industrial districts that by the end of 19U6 coal exports had to be drastically reduced.
This reduction was in the interest of the economies of the rest of Europe
as well as of Germany. Coal allocated to German industry can be used for
producing exportable goods which have greater value and thus fetch higher
prices than the coal itself. In Moscow, the American and British authorities concluded an agreement with France providing for a flexible ratio
of coal exports to coal production. This agreement is based upon the
assumption that daily output in Ruhr mines will reach about 250,000 tons
daily by the beginning of July or 10 per cent more than the Kay average.
On this basis, the combined American and British zones would receive a
weekly coal allocation of 860,000 tons (including a small amount contributed by the Saar minos in the French zone) as compared to an average of
710,000 tons in 19li6. Deducting the quantities set aside for shipments
to the Russian zone and Berlin, this would leave an exportable quantity
of around 250,000 tons weekly as compared to an average of 230,000 in
191*6. Aqy increase in output of the coal mines vdll be divided in such
a way that the German econony receives 80 per cent and foreign countries

20 per cent of the additional tonnage. If, however, output increases

above 290, COO tons daily the allocation for exports vdll rise gradually
until any excess above 330,000 tons daily vdll be divided equally between domestic consumption and exports. The allocation of coal exports
among the various European nations in turn is determined by the European
Coal Organization which is to be integrated with the Economic Coianission
for Europe.
An increase in output to the point where exports v-puld take more
than 20 per cent of total production does not seem likely this year..
£ven if only the expected minimum of 250,000 tons daily is reached, Germany as well as the other coal consuming countries vail be far better
off than they were in 19U6. Unless this minimum can be achieved, however, the coining year will witness a repetition of the disasters of the
last winter when the lack of coal disrupted production and transportation in most European countries»
Exports of commodities other than coal amounted to about $37 million
in 1916. This compares with exports other than coal out of the area of
the present Anerican and British zones of • occupation totaling more than
#1.2 billion in 1937, Thus the exportation of goods other than coal
was about 3 per cent of prewar despite increases in the prices of most
export commodities. Moreover, in 1937 those exports included mainly
finished products vhile in 19it6 they consisted chiefly of lumber, hops,
and other raw materials while the volume of industrial exports was negligible. In the first four months of 19ltf, exports other than coal were
larger than in the corresponding period of 1916 but v;ere still below expectations. For the '.Thole of 19h7 it was planned to increase the exportation of commodities other than coal from the American and British
zones to about $250 million. The unprecedented hardships of the last
winter combined with the difficulties in setting up an entirely new export organization, however, have delayed the start of the foreign trade
program by several months*
German industrial production is somewhat higher than foreign trade
figures seem to suggest. In November 19li6 the production index in the
American zone of occupation stood at 1*1* per cent of 1936, a year in which
the German economy had about reached full employment on a peacetime basis.
In the following months, production lagged on account of the coal crisis
but in Llay this year the index had recovered to 16 per cent and it is expected that this figure will be substantially exceeded by the fall of
19h7« VTe may expect to reach in 19h8 the prewar level in some important
industries, provided that our import and export program progresses according to the present plans. In the British zone of occupation industrial production is somewhat lower since the British zone includes mainly
heavy industries which are severely restricted for reasons of military
security.
A large rise in production in heavy industries vdll imply chances
in the so-called level-of-industry plan, which was adopted by the four
occupying powers inthe spring of 19h6 and which sets specific limits to
the production of all industries that might be considered pert of the
German war potential. Under this plan Germany is forbidden to maintain
certain irdustries, especially in the field of synthetic oil, snythetic
rubber, synthetic ananonia, heavy machine tools, heavy textiles, radioacmaterials, war chemicals, radio transmitters, and a number of
Digitizedtive
for FRASER

58
non-ferrous metals. Steel production for the current year is limited
to 5.8 million tons, subject to review by the Allied Control Authority,
and the consumption of non-ferrous materials is limited to fixed quantitieso The capacity of the chemical industry and of the engineering industries are to be substantially reduced; that of the machine tool industxy, for instance, to 11. h per cent of the 1938 capacity. Production
limits in actual figures are set for automobiles, railroad cars, agriculture machinery and precision instruments. Only mining aid light
industries are to remain completely free from restrictions.
Because of the low level of economic activity in Germany not even the
limits set by the level-of-industry plan were reached in 19^6 or in the
first half of 19 h7. If the coal situation improves, however, the expected
increase in industrial production vdll render acute the problem of raising
the limit, especially in the field of steel production. In 1937 Germany
exported iron* and steel products equal to 70 per cont of the tonnage that
it is permitted to produce in the current year. Exports approaching the
prewar* level obviously would be possible only if that limit is substantially raised. Most occupying powers appear to feel that a level about
twice as high as that set for the current year would be reasonable. It
is to be hoped that this problem can be solved by agreement amonfc the
occupying powers, but if this proves impossible, the American and British
authorities will have to decide whether or not to permit a unilateral
increase in the level of industry in their zones of occupation.
The problem of reparations also affects the Geriran recovery. Under
the Potsdam Agreenent, Germany is supposed to pay reparations mainly by
transferring existing capital goods. In practice this method has not
been too successful. The removal of plants other than those that can be
used only for war purposes is likely to damage the German econony more
than it benefits the receiving countries. Moreover, the destruction of
productive facilities encounters the passive resistance of German labor
and has a detrimental effect upon Gerinan industrial efficiency. The
managers of German industries cannot make decisions about re-starting
or developing their enterprises unless they are satisfied that their
plants will not be dismantled and shipped abroad.
On the other hand, the payment of reparations out of current production vauld be economically feasible only if we could expect Gerrcany
to produce exportable goods in excess of those needed for the payment
for essential imports. As.long as such a surplus does not develop the
American and British treasuries have to finance the import surplus into
their zones of occupation. If this import surplus rer'e to be increased
by usine the proceeds of German exports for reparation payments rather
than for the payment of imports, tl-is would mean that the United States
and the United Kingdom would in fact bear the burden of the reparations*
Frcm the point of view of American economic policy, the plan of paying
reparations out of current production therefore has even more considerable
drawbacks than the plan devised at Potsdam. In any case, a speedy agreement among the four occupying powers vdll be necessary in order to put
an end to the present uncertainty vhich is an important factor in throtHingthe initiative of German entrepreneurs.
Another step needed for reviving the German econoiny is the solution
of the currency problem. At present the German currency can be used

virtually only for buying the official rations of food and consumers1
goods. The German worker, therefore, i s not induced to earn more money
than he needs for that purpose. This means th-tt he has no incentive for
working harder and better. Currency reform, by making the German currency again a generally accepted means of payment, would be a valuable
stimulus for increased labor efficiency. At the same time, i t would
contribute to eliminating black market transactions v;hich today absorb
a large part of the a c t i v i t i e s of the average German. Black market transactions are not only more profitable than honest work but also almost
indispensable for supplementing the meager rations. An elimination of
the black market, therefore, would also help to improve the labor situation.
Furthermore, the present currency situation makes the pricing of
imports and exports extremely difficult. German domestic prices have
lost a l l contacts vith world market prices since the Kazi regime deliberately attempted to i s o l a t e the German econony from the world market and
imposed a rigid system of price control. Today this isolation is enhanced}
by the differences between German legal and black market prices, the le-gal prices being far below and the black market prices far above the
world market level at the present military exchange rate. As long as
currency reform has not taken place i t is necessary to equate German and
world market prices by ireans of conversion factors which are s e t at different l e v e l s for different commodities. For instance, the conversion
factor i s 30 cents per mark for carbon brushes and 80 cents per mark for
Pharmaceuticals. This means that carbon brushes which are valued in
Germany at 100 marks on the basis of legal prices are quoted for export
at #30, while 100 marks worth of Pharmaceuticals are quoted for export
at 580. Such conversion factors can be set with relative ease for standard commodities, but i t i s very difficult to establish them for special
goods in which German exports constitute a large part of the world market,
for instance, optical goods and precision instruments. Currency reform
followed by an adequate readjustment of domestic German prices would
eliminate the need for such measures and make possible the restoration of
foreign trade on the basis of uniform prices and exchange rates.
Finally, the success of our economic policy in Germany would be
facilitated by the economic unification of Germany, as contemplated by
the Potsdam Agreement. The four z ones of occupation are highly interdependent. Tho American and British zones, for instance, need foodstuffs.,
potash, and brown coal from the Russian zone and chemical raw materials
from the French zone while much of their hard coal, steel products, and
industrial consumers1 goods have their markets in the areas of the other
zones. As long as the fate of unification i s undecided, a l l efforts t o ward economic rea>nstruction of the American and British zones vdll be
hampered by uncertainties as to the developments in other zones. There
w i l l always be the risk of developing industries which later will be unable to compete with enterprises in other zones, and of neglecting the
expansion of other industries that would find profitable markets in other
zones.
Unfortunately, the other occupying powers so far have not responded
to the repeated American and British appeals toward a restoration of German economic unity. I t i s our sincere hope, however, that v;e ehall find
a FRASER
way to an agreement with the other occupying powers, which will result
Digitized for
in a policy as beneficial for Germany as for the rest of the world.

61
Speech delivered before
Washington Rotary Club
Mayflower Hotel, Washington, D. C.
August 20, 19A7
RUHR COAL, GERMANY, AND EUROPE
Vihen I came back from Germany, about 3-i/2 months ago, I felt that
the American public needed to bo more fully informed of the crucial role
to be played by the German econooy in the .reconstruction of Europe. In
the meantiiaef the German question has become the center of attention.
At present, Anglo-Auerican discussions are taking place on the subject
of German coal mining, end another conference, with the participation of
French delegates, is going to tackle the over-all problem of the level of
Qenaon industry. Thus the need for emphasising the urgency of these subjects has lessened, but it still mcy be helpful to point out the essential questions involved in those discussions.
The main bottleneck of European rehabilitation is the scarcity of
coal, caused mainly by the decline in British and in Geruan coal production. In the Ruhr, where the most important German coal nines are located, daily output averaged some 4-30,000 metric tons before the war. I;.
1946, it stayed at Ies3 than 200,000 tons until late in the fall when an
increase in food rations for miners raised it gradually to 238,000 tons
in March 1947. Unfortunately, at that time growing unrest appeared in
the Ruhr. The food situation deteriorated because of the unprecedented
severity of the winter of 1946-47 that haiapered transportation and production in all of Europe, and the uncertainties of international political developments made the outlook even more glocny. Output dropped to
an average of 212,000 tons. Only in recent weeks did production again
approach the March figures, after the food situation had lnproved because of increased imports fro:a the U. S. and after added incentives in
the form of other consumer goods had been promised to the miners.
What did the drop in coal output mean to Germany? The four occupying powers, in the level-of-industry plan adopted in the spring of 1946,
agreed that German steel production, which is the basis of Germany's
heavy industiy, was to be'lir-ited to 5.8 million metric tons annually, a
figure corresponding to the depression level of 1932. Actually because
of the lack of coal the Ruhr district, to which the great bulk of total
German steel production was allocated, did not even produce half of the
permitted amount. As the result of the lack of steel, heavy industrial
production in the combined US-JX zones of Germany fclso has remained well
below the limits of the level-of-indastry plan. Moreover, the productior
of building materials (cenent), urgently needed for rebuilding the shattered German cities, and of textiles (artificial fibers) also was decisively affected by the lack of coal. Total industrial production in
the co:*inod OS-UK stones stood at 39 per c w t of 1936 in May and June
1947, the best mor.th3 of the period of occupation, as against a planned
level of 55-60 per cent.- In the field of agriculture, domestic production has declined to abcut 60 vrer cent of prewar. This decline is due
largely to the lack of artificial fertilizer, and this in turn, to the
lack of coal.
.
•
The scarcity of consumer goods leads to a vicious circle; the miners

62
won 1 * produce more coal if they donft receive more food, better housing
facilities, more clothing, and other consumer goods. In order to improve
food production, housing conditions and the supply of other consuner goods,
however, more coal roust be mined.
We might say that this dilemma is the consequence of German aggression, and that it is historic justice that the German people suffer.
But what are the consequences for the victims of German aggression? German coal always has been essential for the industries of most Central
and Western European nations. The Ruhr ulone used to export more than
30 million tons of coal per year. In 1946, for reasons of justice and
diplomacy we forced the export of coal at the expanse of German consumption. Liven so, we were unable to export more than 11 million tons—less
than one-third of prewar. And this smaller quantity had to be sufficient
for countries which suffered from a decline in their own coal production
and in British coal exports. Thus the lack of coal also prevented the
French, Belgian, Netherlands, Italian, and Austrian industries from utilizing their full productive capacities. In the winter of 1946-47, the
catastrophic situation of the German economy compelled us to curtail coal
exports far below the level reached in previous months so that in February 1947, exports dropped below half of the 1946 average, and in the
first five months of 1947 had reached an annual rate of only 8 million
tons, less than one-fourth of the prewar level. This decline in Ruhr
coal exports vas one of the most important reasons for the deterioration
in the European economic situation in the spring of 1947.
The drop in coal exportn is not the only adverse effect of the lag
in German coal production. Equally disastrous for Europe is the lack of
exports of Gorman industrial products. Before the war,*the German industry was the source of supply for the great bulk of European machinery
r.nd precision instruments. For instance, half of the Netherlands industry is equipped with German nachine tools. Some European countries had
hoped that the limitations imposed upon German industry would enable
them to capture German markets. But in many of these countries, the domestic industry cannot maize use of that opportunity because it cannot
work efficiently without German equipment and especially without German
spare parts. Thus some countries, like the Low Countries, the Scandinavian countries, and Austria that would have most reason to see German
heavy industry condemned to perpetual stagnation, today are among those
that ask most loudly for the revival of German heavy industry which has
to furnish them with urgently needed parts.
Finally, the lack of German coal production has made it necessary
for the US and UK governments to cone to the help of the German people in
order to avoid wholesale starvation, disease, and unrest. Since Germany,
largely because of the lack of coal, cannot produce the food and other
subsistence goods which the Geruian people need for survival, these commodities must be imported from the UK although other European countries,
raany of then our allies during the last war, also are in great need of
these goods, end although such exports are a tremendous burden upon the
UK and in a lesser degree a burden upon our own economy. To a certain extent, the presont exchange difficulties of the British people are due to
the exports to Germany. Moreover, these exports must be financed temporarily at least out of budgetary receipts, which f means out of the taxes
paia
by the British and American public. We don t consider thorn to be

63
gifts, to the German people, and we hope to be repaid in future years.
For the time being, however, the economic effect of these expenditures in
not much different from that of unilateral contributions.
Thus the problem of increasing the coal production of the Ruhr is of
the greatest interest not only to the Germans, but also to all European
countries end to the British and American taxpayer. In fact, it is one
of the few points on which all nations of the world are in complete agreement. The question is only, hov increased production should be attained.
The experiences in the fall of 194-6 and the summer of 1947 have shown
that an increase in goods ira-.de available to the miners, especially food,
housing and other consumer goods, will bring about an increase in output.
But such supplies have either to be taken away from the rest of the German people, whose meager rations do not leave room for such measures, or
again, have to be financed ty the occupation powers. The 3ritish obviously ere unable to take over additional burdens, and so the expense of
such an incentive program would have to be borne by the U. S. The cost
certainly would be worthwhile, even in terms of dollars, since eveiy increase in coal production lessens tho strain on our own economy by the
demands of other European nations for relief grants or credits with which
to purchase our own scarce coal. However, it is hardly possible for us
to pay for such a. program without having a controlling influence upon
its execution. The Ruhr ic in the British zone, and British ideas of
fcianagernent and ownership are sometimes somewhat different from our own.
It is incorrect to say that the British are bent on socializing the Ruhr
mines, or to say that we are absolutely opposed to socialization, but it
is true that there are so:ae differences of opinion. The first question
is whether or not we can expect the mines to bo better managed ty the occupation authorities or by the Germans themselves. Everybody acquainted
with military government procedures will agree that German management
would be uiore efficient. Then the question arises, who should do the
managing. The old masters of the Ruhr coal cartel were among the major
German v&r criminals, and we cannot think of restoring the crucial European industry to their control- Such a step would not only produce the
danger of outright sabotage of our efforts toward furopaan cooperation,
but also arouse our most faithful friends in western fJurope against us.
But where to find German managers not tainted by too close collaboration
with the old Hazi gang? The British argue that only socialization can
solve that dilemma, while we point out, first, that the Germans theaisebeare not too happy about that idea—the German bizonal economic council,
elected by the legislatures of the German states, just has appointed a
strictly anti-socialist directorate—and, secondly, that the inexperienced German democratic burocracy would be even less efficient thui the
experienced British administration. The present discussions certainly
will letd to some compromise, but only the future can tell whether it
will be practicable.
Another problsm is, what to do with the increased coal output once
it is mined. *We cannot expect production to increase so much that the
domestic as well as the export demand will be fully satisfied. A few
days ago, the German bizonal economic council submitted an economic plan
for 1947-48, based upon the production of 70 million tons of hard coal aa
against i>4 million in 1946-47. At the present rate of output, this figure appears reasonable. The council, however, wishes to cut exports substantially below the 1946 level, and to devote not only a larger part of

the present output but also the entire increase to German consumption.
This is understandable because the needs of the German economy are closer
to the heart of the German people and its representatives than the need of
the rest of Europe; moreover, it can be argued that German miners will be
spurred by the knowledge that all increases will accrue to the German
economy. But such a solution obviously would not be acceptable to Germany's neighbors that need German coal as urgently as Germany itself. In
contrast, the coal distribution plan agreed between the US-UK zonal authorities and the French in the spring of 1947 would allocate to exports
the present quota plus about one-fifth of the increase in output. Obviously, the French will nob agree to the execution of the coal program to
be turned over to German authorities, unless they are satisfied that their
import requirements will receive due consideration.
Once the question of allocating coal is solved, the problem remains
what to do with the coal reserved to the German economy. The German council proposes to allocate only 10 per cent of the German quota to household
consumption despite the hardship which such a small allocation is bound to
cause. The resumption of German industrial production is indeed more important than the comfort of the German population—although too much discomfort may force the population to spend a disproportionate amount of
time on the search for other fuel (woodcutting) and induce pilferage and
black market operations. Still, the problem remains whether to use the
remaining 90 per cent of the German quota mainly for the production of export goods, or for the production of goods destined to German consumption.
The diversion of too much coal to production for the German market will
leave the needs of the victims of Germany unsatisfied—and indirectly
force us to grant further aid to those victims—while a diversion of too
much coal to the production of export goods will hurt German labor morale
and efficiency, and in addition make necessary further relief imports into
Germany, thus again in the last resort burdening the U. S. economy.
So you see how closely related the coal problem is with that of the
level of the German industxy, end with our own contributions to the recovery of Europe. We can only hope that the participants in' the conferences will contribute to the solution of the over-all European problem
by keeping in mind the broad implications of their decisions. Their main
goal should be not just an increase of so much per cent in the production
index of such or such country, but the reintegration of the entire European
economy. That alone will bring about not only economic progress but also,
more importantly, the prospects of permanent peace.

Speech delivered before
Foreign Policy Association
Cincinnati, Ohio
October 9, 39A7
GERMANY'S ROLE IN EUROPEAN RECONSTRUCTION
Economic recoveiy of Europe is a prerequisite of economic stability
of the world. Economic stability is a prerequisite of peace. Economic
chaos leads to war.
All short-range measures in the field of international economics,
sometimes apparently contradicting each other, must be related to our
long-range policy: the maintenance of economic stability in this country
r.nd abroad, vith one single aim—peace in the world.
Our own economy is directly related to **hat happens in Europe. Wo
nust enable Europe to produce and exchange goods. We must help rebuild
a 3ound system of foreign trade, in the interest of both the Unitod
States and the rsst of the vorld, based upon the mutual exchange of
goods wid services and the unrestricted flow of means of payments*
Meanwhile, however, we must weather a transition period. At present,
our export surplus is abnormally large: it will have to be curtailedsome day. In the future, increased imports of goods and services will
supply o^her countries vith dollars* Until then, foreign purchases of
certain scarce goods affect our price structure. The world is in short
supply of our goods, and of the means of payments for our goods. In this
period of transition we raust be concerned primarily with forestalling
starvation and unrest in the world, in order to mtsko possible in the long
run normal economic conditions and stable economic"rel&tions between nations.
This general aim has been the reason for a second stage in our
policy in occupied Germany. During the war, we could not relax our efforts. Ve had to win the war—regardless of the economic consequences of
the destruction of Germany. The first directive sent to Gsnerci Eisenhower immediately before the end of hostilities in Germany expressly forbade the occupation authorities to be guided by the interests of German
rehabilitation, ^y its own terms, however, that directive—coianoniy
known as JCS-1067~w?;S only for "the initial post-defeat period11 and
never was intended to be a long range policy. The Potsdam Agreement,
concluded three months later, softenod that injunction, ii .aore penetrating study of the complex relations of European political and economic
problems has convinced most American experts and observers of the necessity of reintegrating the German econoay into the European framework.
Former Secretary Eyrnes at Stuttgart, Germany, in September 1946 gave a
clear public expression to this conviction. He concluded his historic
speech vith this statement: "The American people want to help the German
people to win their way back to en honorable place among the free and
peace-loving nations of the world*" This conviction resulted in the directive issued to the Military Governor of the U. S. zone of occupation
in July 1947. From f that time on, American policy has placed increasing
emphasis on Germany s importance for the rehabilitation of the rest of
Europe.

66
This shift in emphasis is not without some danger, riany European nations are apprehensive lest we go too far in aiding
Germany- Such a fear
is perfectly understandable in view of Germany! s aggressive war record •
It is exploited, however, by anti-Ancrican propaganda, which proclaims
daily that the American interest in Germany is a serious threat to the
safety of the rest of Europe. People are told that American imperialists
and capitalists went to rebuild Germany in. order to use a reconditioned
German war machine for dreams of vorld domination similar to those of
Nazism. We can dismiss these charges as senseless but we cannot dismiss
the genuine anxiety of many Frenchmen, Belgians, and Central Europeans
that we may further Geman rehabilitation at the expense of the recovery
of the rest of Europe and that unwittingly we may help to rebuild a dangerous German war potential. In recent weeks such concern has been expressed not only by responsible European statesmen but also by serious
American observers like former Under Secretary of State Sumner Uellos.
A continuous discussion of the German problem therefore is necessary in
order to refute the arguments against our participation in German rehabilitation, and, on the other hand, to define the limits which this participation should not exceed*
First of all we may concede that several reasons which sometimes
are advanced in support of this second stage in our policy cannot stand
up to serious exanination. It has been said that a harsh policy toward
Germany would be inconsistent with our ideas of international justice.
This argument overlooks the fact that whatever the Germans have suffered
for the last two and one—half years is nothing as compared to the suffering they brought to the rest of iiurope, and that morally the victims of
German aggression certainly have a better right to our assistance than
the Germans. Secondly, some people hope that the policy will lead immediately to a lowering of the cost of occupation. Me shall see presently that this will not be the case.
Thirdly, some business interests—in the words of Mr. Welles—expect fat profits from a highly industrialized Germany. These expectations
certainly will not be realized: even with all possible assistance, for
many years to come Genawiy will remain too poor to afford the importation
of American semi-luxuries. Moreover, the German economy is largely conpetitive with the toerican, and the reconstruction of the German industry
is just as likely to diminish as to increase tho profits of American industrialists. Apart from these considerations, the expenditure of huge
amounts of public funds in order to increase the chances for profits of a
few exporters or investors certainly would not be justified.
Finally, soae people cherish the hope that a rehabilitated Germany
could be used £.s a buffer state against the Soviet Union. These people
may well be mistaken. It is true that today most Germans are emphatically
anti-Russian, but this attitude need not endure. If the Soviet Government
wants to gain the good will of Germany, it need only offer to the Germans
sufficient political and economic concessions. For instance, as Walter
Lippnan recently pointed out, we could never match the territorial and
other advantages that Russia, as the supreme power in Eastern Europe,
could effectively promise to the Germans at the expense of its Eastern
European satellites. In such a case, any reliance upon Germany as an
against Russia would be ill-founded to say the least.
Digitizedally
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Thus we are willing to agree with many of the arguments that have
been brought forth against our occupation policy. These arguments, however, are not decisive because they overlook the essential point: unless
Germany is economically rehabilitated, liGstern Europe cannot attain economic stability. In order to refute the arguments against our efforts
toward the rehabilitation of Germany, we have to show that this rehabilitation is necessary for the recovery of Western Europe.
Let me eaph&sixe the fact that I speak to Gernan economic recovery
only as it plays an essential part in tho recovery of the econoray of
Ituropo.
The economic interrelation of Germany and Western Europe is based
upon Germany as a source of supply and Germany as a market. Under the
present conditions of scarcity* the first point is far iaore important
then the second. To a lar^a extent Germany has to supply tho rest of
Europe with two commodities of primary importance: cool and styel products. Most of the exportable coal comes from the Ruhr district, which
forms part of tho British zone of occupation. In peacetime this district
exported as much as three million tons par month, nuinly to Western
Europe. Huhr coal was essential for the heavy industries in France, Belgium, Luxembourg, the Netherlands, and Sweden.
Hard coal production in the areas that today form the British zone
of occupation dropped fro:a 117 million tons in 1936 to 54- million tons in
1946. After establishing a system of substantial incentives, including
a daily food ration to the Ruhr miners of 4>00U calories as compared with
a normal consumer's ration of 1,550 calories, whicli mtde them by far the
best supplied part of the German population, production increased in July
194-7 to an annual rate of 72 million tons. The deficit as compared to
1936 still amounts to about 45 nillion tons annually. These 45 million
tons are a principal reason for the present plight not only of Germany
but also of*the industrial countries of Western Europe. They are the bottleneck for the rehabilitation of transportation and for the production
of steel end machinery. Ths lack of transportation facilities and
E.achinory retards the reconstruction of all other industrial enterprises in Europe. It may even be said that these 45 million tons are also
one of the main reasons for the present world-wide scarcity of foodstuffs.
The European food deficit is largely due to the lack of fertilizer, and
the lack of artificial fertilizer in turn is due to the scarcity of coal.
Similarly, the lack of coal hampers the production of textiles and other
scarce consumer goods,
A less direct effect of the ltck of Ruhr coal is the deterioration in
the. international financial position of the United Kingdom. If industrial
production in continental Europe had reached a higher level, the United
Kingdom would have been able to purchase more of its necessary imports in
continental Europe, In that case; it would have experienced less of a
drain upon its dollar resources and perhaps would have beer, in a better
position to maintain the convertibility of sterling.
German steel and steel products are equally indispensable to the rest
of Europe. German machinery always has been extensively used in moat industries of Western and Central Europe- Half of all industrial enterprises in the Netherlands, for instance, are equipped with German machine

68
tools* During the war and postwar years, many machines wore destroyed,
and the rest has deteriorated* Their owners urgently need spare parts
for repairs and new units for reconstruction and expansion. It is not
surprising, therefore, that a recent statement by the Motherlands Government asserted that "the security and v/elfarc of the Kingdom are in a high
degree dependent on the prosperity of Germany • • . and the Netherlands
is vitally concerned in the decisions which are ultimately to be made by
the Allies with regard to the futuro of the German economy." The shutdown of the German machine industry has prevented the nines in Polish
Silesia from v;orking at capacity, hanpered transportation in countries as
far apart as Austria and the Low Countries, and made it impossible for
many other industrial nations to reach their prewar level of production.
It has thus delayed the recovery of all of Europe.
The Committee of European Economic Reconstruction, which was appointed
by the Vfestern European nations in response to the historic appeal by Secretary Marshall, clearly has recognized these facts. Although many of the
nations represented on the Conmittee had eveiy reason to feel extremely
hostile toward Germany, the Committee report emphasizes again and again
the need for an increase in the production of German coal and steel. It
bemoans the "continued inability of the German economy to supply the coal
and other products upon which so much of Europe's economic life depends•"
It proposes an increase in the coal production of the combined U.S.-U.K.
zones of Germany by 60 million tons and an increase in the steel production of these zones by 7«2 million tons annually over and above the present level. Finally, it states expressly that a large part of V/estern
Europe's import requirements for steel products should be met from these
zones. The proposal for the huge increase in steel output is particularly
remarkable in view of the fact that hitherto the French Government, whose
delegates played a leading role in drafting the report of the Committee,
had sharply objected to American and British proposals for large-scale expansion of German steel production. This change in attitude shows the interdependence of economic and political considerations in all European
problems. Deep-seated political animosities can be overcome once it is
understood hovr one country benefits from the improvement in the economic
status of another countiy.
The increase in German coal and steel production, however, cannot be
accomplished without an increase in total production. Ruhr coal output is
so much lower than before the war mainly for two reasons, namely the lowered productivity of labor caused primarily by lack of sufficient food and
the deterioration in mine equipment. The miners, despite the recent improvement of the economic situation, still cannot hope to receive for their
increased wages a substantially increased volume of food, other consumer
goods, and housing accommodations• they have little personal incentive,
therefore, to do their utmost in the mines• Moreover, after many years of
insufficient nutrition, defective housing, and lack of most amenities of
life, they are neither physically nor psychologically able to work as hard
as before the war. Thus any large-scale rise in Ruhr production will be
possible only if sufficient food is supplied and if the amount of consumer
goods available to the miners is substantially increased. Such an increase
in turn depends upon a rise in the German production of food and consumer
goods since continued importation of the bulk of such goods would place an
unbearable stress on the German foreign exchange position. Farmers and
workers who must produce the food and consumer goods needed by
Digitized industrial
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69
the niners<
3, also require more goods for themselves as an incentive for
*k* It vould be impossible, therefore, to atte.-cpt the regeneraharder work*
tion 6f one particular branch of the German economy, such as coal mining,
without being prepared to help ail other industries th<\t participate in
the production of consumer goods•
The second reason for the low output of the Ruhr mines is the obsolescence of the technical equipment. Since the beginning of the war and
especially since the end of hostilities, mine machinery has not been adequately renewed. More important still, transportation equipment has
been permitted to deteriorate so that the transportation of coal has become almost as much of a problem as its production in the aiiics. These
difficulties can be remedied only by making available iargo cuantities
of steel and steel products to those industries that produce the necessary equipment. For this reason an increase in the output of coal requires not only the revival of the German consumer goods industries but
also the reconstruction of the German heavy industries•
Steel production hitherto has been hampered by difficulties with
labor, equipiTient, end transportation similar to those encountered in coal
raining, and especially by the lack of coal. -Moreover, the so-called
level-of-industry plan, adopted in the spring of 1946 by the four occupying powers, limited steel production in all of Germany to 5.8 million
tons, or about half the amount that today is being contemplated for the
combined U.S.-U.K. zones alone. Although this limitation did not have
any direct effect since actual production regained far below the permitted level, it probably had an indirect influence by aaking managers
and workers despair of the future of the steel industry. An attitude of
"what's the use", fostered by the strict limitations of the level-ofindustiy plan, certainly contributed to the reduction in the efficiency
of German labor.
The recovery of the GeriTian industrial system also is necessary for
the solution of the second problem, namely, the restoration of Germany
as a market for the products of other nations. Germany njeds large
quantities of foodstuffs, raw inaterials, and other producers1 goods. At
present, it is unable to pay for any substantial amount of imports.
Shipments that the occupation authorities in the combined U.S.-U.K. zone?
consider absolutely necessary for the prevention of disease and unrest
have to be financed by advances from the occupying powers. In the first
six months of 1946, such shipments into the combined zone were valued at
t;299 million, including U 7 4 million of foodstuffs, £19 million of fertilizer, and $6 million of oil products. In contrast, comnerciul import;
totaled only &17 million. The value of food imports, ^nost of which casie
from the United States, certainly looks veiy large, but it was just sufficient to keep the German people on a semi-starvation diet of about
1,500 calories* a day for the normal urbs^n consumer—one-third less than
the amount considered a niininmin subsistence level by the United Nations
Food and Agricultural Organization. If we vant to restore a level of
nutrition that enables the German worker to reach his prewar efficiency,
food imports will have to be increased rather than reduced even if the
productivity of Gorman agriculture can be raised to its prewar level.
Obviously, these imports cannot be financed forever ty the occupying powers. Moreover, Germany needs raw materials and other producers' goods
in
such quantities that their value should at least equal that of food

70
imports* Exports of coal and crude steel, significant a3 they will be,
can cover only a fraction of that -value. Germany must be able to pay for
its imports by exporting finished industrial products, just as it did before the war.
The future need to export will be even greater than before the war,
because of the necessity for imports of foodstuffs end raw materials previously obtained from those parts of the Reich which now are under Polish
administration. Moreover, a larger proportion of imports will have to
come from the sterling and dollar areas, at least as long as the grain and
timber surpluses of Fastern Europe are withhold from western markets.
Fortunately, the highest valued types of exports from Western Germany, like
special machinery, precision instruments, and chemicals traditionally went
to the West. It is* true that as long as the general scarcity of dollars
continues Germany too will be affected. The dollar scarcity in Europe,
however, will be much smaller if Germany is reconstructed because Western
Europe vill obtain goods from Germany which otherwise would have to be purchased from the United States for dollars.
At present, ieiports of raw materials and other prodiAcerc1 goods are
negligible because they are not financed by the governments of the occupying powers, but handled on a commercial basis. They cannot, .therefore,
exceed the sum of exports end commercial credits. Luring the first six
months of 1947, exports froni the combined zones totaled only $66 inillion;
they consisted mostly of coal and some other raw materials .like timber and
potash, rather than of industrial product;; which before the war .formed the
bulk of German exports. So far, it has been possible to negotiate credits
only with the help of government institutions, such as the Export-Import
Bank, the U. S. Commercial Company, and the Commodity. Credit Corporation,
and their sum has not exceeded &60 million• Moreover, most of the credits
have taken the form of processing arrangements, German manufacturers, receiving raw laaterials such as cotton, and paying for them out of the proceeds of the exportation of the finished products. Such arrangements are
feasible mainly in some consumer goods industries, especially textiles,
and not readily applicable to the heavy industries which f o m the basis
of the German econony. Neither exports nor commercial credits, however,
can be expanded substantially as long as domestic industrial production is
hampered by the lack of imported raw materials and producer goods. Obviously, this vicious circle must be broken. At present, the bizonal Joint
Sxport-Iaport Agency has at its disposal a fund equal to more than $100
million, accumulated out of the proceeds of past exports-and of certain
former German assets made available to the Allies by the Swedish Government on the basis of an agreement concluded in 194.6. This relatively s:aall
fund is to be used for initial imports that will stimulate the production
of export goods, but tvo-thirds of it.consists of sterling and therefore
is available for international payments only within the sterling area,
which at present can supply only limited quantities of necessary commodities. Accordingly, the economy of the combined zones is confronted with
the problen of finding additional sums in dollars in order to finance adequate imports of goods other than minimum food requirements.
The extent of our contribution needed for the recovery of Germany
thus becomes- painfully clear: we must not only continue and if possible,
the- light of world conditions and the needs of liberated countries, inDigitized in
for FRASER
crease our exports of foodstuffs, but we must also make advances of one

71
kind or another for the importation of raw materials and equipment •
Moreover, as far as the materials have to be purchased in the dollar
area, ve are confronted with thtS fact that the United Kingdom has made it
known that it wishes to be relieved from the burden of having to use its
scarce dollar resources for German rehabilitation. The cost of the German occupation to be borne by the United States during the next few years
certainly will be higher rather than lower in comparison with 194.6-47 •
The report of the Paris Conference estimates the foreign trade deficit of the combined U.S.-U.K. zones in relation to the dollar area alone
at tfl.15 billion for 1948. This would be almost twice the total deficit
of the zones,, as estimated for the year 1947 at the time of the bizonal
agreement in December 1946. Only part of that increase, however, would
be caused by the proposed extension of the reconstruction program: a
largo part will be due to the rise in American prices, especially for
foodstuffs, and another part to the lag in the production of export goods
caused by the catastrophic weather of the last winter. The sum is very
large, but it is only one-seventh of the estimated total deficit of
Western Europe, exactly corresponding to the proportion of the population
of the zones to the total•population of Western Europe. Since Germany's
reconstruction is far less advanced than that of any other Western European nation, the estimate of German needs does not appear excessive.
The way for the implementation of our policy has been paved by the
joint U.S.-U.K. decisions that were taken.in the past veeks. We have
raised the permissible level of industry for the combined zones approximately to the 1936 figures so that there will be no artificial limitation
on the capacity of the German industries the rehabilitation of which we
shall deem essential. We also have secured an equal voice in the management of the Ruhr mines. In addition, discussions are about to commence
on the problem of sharing the occupation costs for the coning year between the United States and the United Kingdom. They will determine how
far the present agreement, under which each power defrays half of the
total, should be amended, at least as far as dollar payments are concerned.
All our efforts toward a solution of the German economic problem will
be in vain, however, if we do not allay the fears of our Allies that we
are putting the interests of Germany ahead of those of our friends.
Otherwise, we might lost, as a result of growing anxiety and animosity in
the rest of Europe, whatever we might gain from Gennan rehabilitation.
Fortunately, the*program adopted in Paris in response to the appeal of
Secretary Marshall promises the reconciliation of viewpoints. The plans
adopted in Paris show what commodities Western Europe needs. We also
icnow what commodities the German economy can produce if we are willing to
render initial assistance. For the reasons which we discussed previously,
it would not do to concentrate exclusively upon the reconstruction of
German export industries since all branches of the German economy are
needed for the efficient operation of the export industries. Within these
limitations, however, we certainly shall put emphasis upon the development of those German industries that produce the goods needed in Western
Europe. Obviously, it is easier to propose then© principles than to execute them. It will be necessary to reconcile the need for coal, steel,
and other goods for German domestic consumption with the equally pressing
needs for these commodities on the part of other nations. Last Spring, a

72
compromise was reached with the French, promising them <m increased percentage of Ruhr coal in case of an increase in output. The report of -the
Paris Conference shows that a similar solution is acceptable to the Western European nations in the matter of Ruhr steel- production. This indicates that working compromises also can be reached for other heavy industries.
In this connection, I am fully aware of the fact that our allies ars
interested not only in present allocations of increased Gorman production
but likewise* interested in future lohg-term allocations* which relate to
their long-range planning for the reconstruction of their ecovioioies and the
maintenance of economic stability at a high level. This is a proper concern of our allies and should not be overlooked. I feel certain it will
not be overlooked.
The reintegratlon of the German economy into the European framework
will pay, in the long run, for the financial burdens in the form of food
and other supplies which v*e have to assume during these coning years. In
this respect, the fact that the German econo.ay is competitive with the
American paradoxically will prove to be an advantage rather than a shortcoming. Ivhfitever Germany Ci.ui furnish to Western Europe need not be furnished fcy the United States. Since Western Europe suffers from a scarcity
of dollars, additional exports to Western Europe would have to be wade
largely on the basis of advances, the repayment of which would pose difficult questions. It will be cheaper for us to furnish foodstuffs and raw
materials to Germany rather than more expensive finished goods to Western
Europe. In this respect, the reconstruction of Germany will directly benefit the financial position of the United States.
German economic recovery and therefore European recovery,, however,
can not be attained by one step or gesture. It requires, first, an attitude. That attitude is that European economic recovery is necessary—to
Europe and to us. Second, it requires a realization that the alternative
is chaos. Third, it is evident to me that recovery in Europe is a gradual process in which we play an important part.
If we succeed in our rehabilitation program with proper safeguards
against German rearmament, Germany will plan again the economic role to
uhich it is predestined by its natural resources and the skill of its workers, and-the cause of intra-Europe^n econoraic cooperation will be materially advanced. Thus we are led back to our first premise. Our present
stage of economic policy in Germany is not dictated by soft hearts or short
memories, and it is not destined to give German recovery any priority over
and above the rehabilitation of the rest of Europe. On the contrary, it
is meant to make possible economic stability in all of Europe, and thus to
further the maintenance of our own economic stability at a high level,
end--:aost important of all—it is meant to promote world peace!

. 73
Speech delivered before
Polish Falcons of America
•William Penn Hotel, Pittsburgh, Pennsylvania,
April 11, 1948
.
U. S. FINANCIAL ASSISTANCE TO FOREIGN COUNTRIES
I wish to speak to you briefly this evening on the subject of the
international financial situation, and the financial assistance that the
United States has been giving and will be giving to other countries.
At the present time, the so-c&lled ERP—European Recovery Program—
occupies a central position in this countiy's foreign financial end economic program. However, the main problem that has to be met in Europe,
if that continent is to be self-supporting again, i3 not financial but i3
rather the problem of insufficient production.
To maintain the economic life of any modern country requires good3
and services of many different kinds, some of which can bo produced in
the country's own farms and mines, and factories, and some of which nust
be imported from outside. No country in Europe, or anywhere el3e in the
wox\Ld, con be entirely self-sufficient. In order to pay for the kinds of
goods that have to be imported, tho country rmi&t be able to produce other
kinds of goods in excess of its o\/n needs, and must be able to export anc
sell these goods abroad. Some countries have also helped out by selling
services, such as shipping services, to other countries - a sort of "invisible export" - which serves the same purpose as exporting goods.
If a country does not have enough exports to pay for the imports
that it needs, its first remedy is to increase its domestic production.
This, as I have said, is Europe's present problem. Another alternative
is for a country to reduce its domestic consumption. For Europe, however, this would be in general a most undesirable solution, since any
further reduction from present levels of consumption would reduce both
the willingness and the ability of their working populations to work, and
thus lead to a vicious circle of increasing inefficiency in production,
and ultimately to social unrest or economic breakdown or both. One might
say that a uain objective of American aid under the European Recovery
Program is to relieve European countries from the necessity of muking
further reductions in their domestic consumption in order to achieve a
balanced trade position.
Countries can also pay for foreign goods that they need by selling
gold or other assets that they have accumulated during past periods of
prosperity, but it must be obvious that countries, like individuals, can
only do this for limited periods. Many of the European countries have
been doing this, during, the last two years, and their holdings of such resources are being rapidly depleted. Finally, countries can obtain imported goods that they need by obtaining either loans or gifts from the
governments-of other countries or from private investors or ccntritutors
in other countries. It is the purpose of the ERP to provide such loans
or gifts during a temporary period while European countries are increasing their own production and developing .self-supporting economies.
The postwar difficulties of European countries have arisen from a

Ik
combination of different causes. At the and of the var, many countries
had widespread physical damage to be repaired. By now a" large part of
the direct damage to factories, railways, and the like has been repaired,
but to some extent the effects of this damage still continue. There was
also widesoread deterioration of equipment due to wartime wear ana inability to"make replacements. This will take years to maKe up ^n full,
and meanwhile, it is an important factor in preventing maximum efficiency
in production.
Mother quite different factor in the present difficulties of soae
European countries is the fact that they have lost or have had to liquidate large amounts of foreign investments, or they have lost large parts
of their merchant shipping fleets, which before the war had provided income that these countries needed to help pay for imports of foreign goods.
In addition most of the countries have faced the necessity of re-orienting their foreign trade because of changes in sources of supply and in
markets for their products.
Finally, almost all European countries have been faced with monetary
and fiscal problems which have caused serious dislocations throughout
their economic and social structures. It has been clear that European^
countries would not be able to get their production Roing again at maximum levels until they could restore adequate incentives to working men to
give their best efforts, incentives to business men to produce efficiently,
and a regular flow of supplies for industry and agriculture. This has involved political and social as well as economic problem, Uhere adequate
currency reforms and other anti-inflationaiy measures have been taken, they
have been very helpful, but in some cases, the underlying political and
social difficulties have proved to be more deep-seated than was at first
apparent, and the full solution of these problems is taking longer than
might have been hoped.
In addition to the dislocations within individual countries, all of
Europe has suffered from insufficient coordination between countries. **
is clear that greater efficiency c&n be obtained if each country arranges
its production programs and the development of its resources in cooperation with neighboring countries. However, international cooperation of
this kind is more difficult to achieve than appears on the surface, especially when the countries concerned are only in the first precarious stages
of recovery and are anxious to avoid disturbing their reviving domestic industries. When production of any sort is urgently needed, it may be too
early to start scrapping inefficient plant in some countries in the hope
that efficient plant can be developed elsewhere. Furthermore such schemes
may require a degree of government planning and intervention which ve
would be reluctant to see.
The production problem in Europe affects not only the European countries themselves but also the countries of Latin America and other parts
of the world. For example, the econoLiic development programs of Latin
American countries were interrupted during the war because both the Uni*ecl
States and the principal equipment-producing countries of Europe had converted their industries to the production of war materials. For the sfiie
reason, Latin American countries fell behind in the maintenance of their
existing industrial plants, railways, etc. The equipment needs of these

o
countries
http://fraser.stlouisfed.org/ cannot be fully net except as production becomes available &
Federal Reserve Bank of St. Louis

75
European v.s well as U. S, sources. At the same time, the countries of •
Europe constitute very important markets for Latin American agricultural
and mineral products. For'all these reasons, it is impossible to achieve
any real basic stability in other parts of the world as long as Europe IF
in its present state of uncertainty.
Because of these considerations, the United States Government laid
plans even before the end of the war, for the giving of necessary assistance to countries in Europe and other parts of the world. One step in
these plans included cooperation in organizing the United Nations Relief
and Rehabilitation Administration - UKRRA - for taking caro of the most
urgent needs of the populations in war-devastated countries. Congress
also increased the lending power of the Export-Import Bank by almost 3
billion dollars, and the Bank has now used most of this increase to extend rehabilitation loaris to European countries. In addition, large
amounts of credit were extended to European and other countries in connection with cur disposal of United States war surplus materials that
could be of use in their civilian economies. Finally, to meet the special problems of the United Kingdom in the period of transition after the
war, Congress approved a special loan of «>3>750,000,000 to that country.
As a result of these contributions by the U. S. Government, combinec
with very real efforts brought to bear by the European countries themselves, almost every country in Europe has made substantial economic pror
ress since the end of the w&r. The United Kingdom has succeeded in bring
ing its industrial output to levels above those of the prewar period, anc
has achieved considerable progress in readjusting its industrial structur
to meet longer-range postwar conditions. In France, industrial production has reached the 1938 level, and a bold policy of supplementing foreign assistance by large-scale liquidation of gold and foreign exchange
holdings made it possible to give a start to the ifonnet Plan of Reconstruction end Modernization. Italy has achieved considerable progress ir.
rebuilding its war-torn transportation system, in reviving industrial out
put, and in reestablishing its position in export markets. The Wetherlands has rebuilt its heavily damaged transportation system and drained
and put back into production practically all of the lands flooded during
the war, while Belgium has been able not only to place her economy on a
self-supporting basis, but also to extend assistance to neighbor countrie;
Norway has succeeded in replenishing its merchant fleet to about 85 per
cent of the prewar tonnage. Only Germany has shown very little evidence
of recovery,"largely as the result of the shattering effects of the war
upon its physical plant and the morale of its people. •
At the seme time, eastern European countries, notably Poland end
Czechoslovakia, have nude great progress in restoring the productivity of
their industries. In particular, the large increases in coal production
in Poland put that country in a position vhere it could make important
contributions to industrial recovery in other countries. On the other
hand, because of"political developments which interfered with coordination between eastern and western Europe, both groups of countries have
failed to achieve the; full degree of progress that might have been expected. ' " • ' ; ' " •
•

•

• • It became apparent, however, during 1947, that further economic assistance
on a large scale by the United States to European countries

76
would be necessary. Notwithstanding the substantial strides that had been
made, with American help; toward general economic recovery, it became
clear that the disruptions of the European economy were so widespread that
substantial further strengthening would be needed. It was necessaiy to
provide further financial aid if these countries were to continue to obtain needed goods from the U. S. end other foreign sources. At the same
time, if dollar aid vere given to European countries for this purpose, it
would help Latin American and other countries which try bo earn dollars
through sales to Europe in order to neet their own dollar needs.
In'June, therefore, the Secretary of State announced publicly the
concern of the United States regarding the European economic problem. He
explained also that he had in mind the entire contir.eit, including the
Soviet Union. The British and French foreign ministers then proposed a
general European conference to take up the subject, sad proposed that the
Soviet Government join in this project. Vlhen it appeared that agreement
could not be reached, the British and French foreign ministers nevertheless issued invitations to all other European countries (except Spain) to
send representatives to a meeting in Paris. In the end, however, not only
Russia but also the other countries which have fallen under its domination
refrained from sending representatives. The Committee of European Economic
Cooperation was then formed by the 16 remaining European nations, consisting mainly of the countries of western Europe.
This Coiumittee drew up and presented in September, a four-year program designed to restore Western Europe to a self-supporting basis. The
Committee's report called for closer cooperation among European countries
and it also gave estimates of the external assistance that would be required in order to carry out such a program.
The proposals made by this Coimidttee were given the most thorough
stucty in the United States Government. After critical review, they were
accepted as a reasonable starting point in formulating proposals for
United States aid. However, the Coomittee's estimates were scaled downward where they appeared to be higher than necessary. They were also
scaled downward where it appeared that the amounts of goods that were
called for would not actually be available in the world markets, or where
it appeared that the provision of these amounts would involve undue denands upon poods that are in short supply in the United States.
The estimates finally reached in the United States Government involve
U. 3. assistance to Europe in the amount of C?5-3 billion during the first
year of the program. There have been tentative estimates that the total
anount of aid needed to restore the European econoiny might be $17 billion
over a period of U-l/U years. It is clear, however, that estimates of
European requirements more than. a year or- so in advance must be of a rather uncertain nature.
This financial assistance from the United States is directed toward
genuine economic recovery in the participating countries of Europe (including western Germany). It is not in any sense intended to be merely relief
The program provides for food requirements and for supplies of fuel and raw
materials. But also, and more importantly, it provides for capital equipment to assist Europe in the task of building up its own productive capaThe program contemplates that the European countries will take
city.

77
vigorous steps to assure that all the assistance they receive from the
U. S. will be used efficiently"to further the objective of full recovery.
This includes the taking of financial and other measures to stablize
their currencies end generally to restore confidence in their monetary
systems* to stabilize their price systems, and to cooperate with each
other in increasing the.exchange of goods and services among European
countries, all with the objective of achieving the greatest possible efficiency in the use of their own resources to increase their production.
To the extent that European countries appear able to repay this
country for the assistance that they receive, it is contemplated that
the assistance will be extended in the form of a loan celling for repayment, tihere it does not appear that repayment will be possible without
jeopardizing the long-run objectives of the program, assistance will be
given on a grant basis instead,
1/hile attention has been concentrated on Europe in recent months,
the needs of other areas of the vor3.d have not been- ignored. Part of th
dollars supplied to European countries under the ERP will be spent by
them in Canada or Latin America. In this way, our aid to Europe will
also serve to provide Canada and Latin America with large amounts of cbllars that they in turn can use to pay for the goods that they need from
the United States. In addition the Export-Import Bank and the International Bank for Reconstruction and Development, in \iashington, are prepared to make loans to finance sound development projects in Latin
America as well as in other parts of the world. As for China, while
present political conditions make it impossible to plan any real economi
recovery in that country, it is contemplated that China will receive relief assistance that should enable it to hold its own in an economic
sense until its political difficulties are settled. In Japan the relief
assistance which*has been supplied since the end of the war may soon be
supplemented "by ;aoro far-reaching aid designed to put that countiy back
on its feet within a measurable period of time. Thus, the European Recovery Program is only one element, even though the largest, in this
countiy's plans for foreign economic cooperation.
It must be recognized that all of these programs iopose a very real
burden upon the United States—a financial burden upon our Federal budget and an economic burden upon our people who are called upon to export
to foreign countries far more goods and services than are received in ey
change. °Those programs have been decided upon, however, in the light ol
veiy"careful studies of our capacity to bear this burden. The conclusia
to b© drawn from these studies are that the foreign aid programs contemplated for the corning year will not impose any greater drain upon Unitoo
States resources than has occurred during the past year; that this drain
will not significantly affect the standard of living of the American
people; and that its initial inflationary ir.pact can bo held in check b>
appropriate domestic measures. The most important of these domestic
measures is fiscal policy; it is supremely important that Government expenditures on foreign aid be covered to the maximum extent possible with
a balanced budget. If this practice is followed, the purchasing power
created by foreign expenditures in this market will be withdrawn from th.
market through taxation. At the same time, in view of the inflatiom-iy
pressures arising from domestic as well as foreign sources, it is important to carry out a monetaiy policy designed to restrain undue expansion

78
of bank credit. If we pursue vigorous anti-inflationary policies in the
fiscal and monetary fields* we may be ."able to avoid reimposing direct controls upon the allocation and movement.of goods in the domestic economy.
There can not be any assurance in advance that the European Recovery
Program will be a success. The-European countries will have real problems to surmount in order to be fully self-supporting at the end of the
four-year period. The increasing political tension between eastern and
western Europe tends to worsen the economic prospects of both groups of
countries. Nevertheless, I feel most strongly that the 3RP represents a
wise policy on the part of the United States. The cost in money is large,
but is well within the capacity of this country. And by such a bold and
ambitious program, directed toward the economic health of key countries
of Europe, we can exert a powerful influence toward the maintenance of
peaceful conditions in the world, when and as the countries of western
Europe achieve the economic health that this program envisages, we can
confidently expect one result to be improvement in the economic condition
of other countries and progress toward the ultimate goal of a peaceful
and prosperous world.

Speech delivered
Occasion of the
1
the- 3rd of May
Patterson Park,
May 2," 19A8

on
Commemoration of
Polish Constitution
Baltimore, Maryland

THE EUROPEAN RECOVERY PROGRAM
One of the most important actions that Congress has taken in recent
years is the passage of the Foreign Assistance Act of 194-8, which became
law on April 3* The central feature of this Act is the authorizing of an
amount of #5*3CO,OOO,OOO to be used in a program of helping European
countries along the road-to full economic recovery, ifore importantly, as
a-matter of principle, Congress by this Act recognized the importance of
our taking bold economic and financial measures in order to maintain conditions abroad in which free institutions can survive.
An understanding of the background of this program is essential to
every American. Because the airplane and radio and other recent scientific developments have made the world so ruuch snaller than it used to be,
the situation in foreign countries is becoming more and more important in
our daily lives. Furthermore, the expenditure of large sums for foreign
assistance is bound to have effects on -our domestic financial situation,
and these two have to be taken into account.
The Reed for Production
The main problem that has to be mot in Europe, if. that continent is
to be self-supporting again, is the problem of reviving and increasing
the'production*of goods. Vfhile the European Recovery Program, as authorized by Congress, is expressed primarily in terns of giving financial and
material assistance to European countries, the great problem in the administration of this program will be.to see that the assistance i3 successfully used by the European countries in order to rebuild the productivity and efficiency of their own industries. ' .;
' The production problem in Europe assumes a very special importance
to all of us because it .affects not only, the European countries theiurselves-but also:the countries of Latin America and other parts of the
world. For example, the economic development programs of Latin, American
countries were interrupted. during the war because both tr:e United States
and the equipment-producing countries of. Europe had converted their industries to the production of war materials. For the same reason, Latin
American1 countries fell behind in the maintenance of their existing industrial plants, railways, etc. The equipment needs of these countries
cannot be fully met except as production becomes available from European
as well as U. S. sources*. At the same time, the countries of Europe are
normally very important markets for Latin American agricultural and mineral-products. For all these reasons, it is*impossible to achieve any
real basic stability in other parts of.the.world us long as Europe-is in
its present state of- uncertainty.
The Problem of Paying for Imports
To maintain the economic life of any country, in Europe or elsewhere
goods and services of many different kinds, some

Digitized forin
FRASER
the world, requires

80
of vhich can be produced in the countiyf s own farms and mines and factories, and some of vhich oust be imported' from outside* No country in the
present-day world can be entirely, self-sufficient. In order to pay for
the kinds of goods that Have to be imported, the countiy must.be able to
produce other kinds of goods in excess of its own needs, and oust be able
to export and sell these goods abroad. Some countries have also helped
out by selling services, such as shipping services, to other countries a sort of "invisible export11 - vhich serves the same purpose as exporting
goods.
If a country does not have enough exports to pay for the imports that
it needs, its first remedy is to increase its domestic production. This,
as I have said, is Europe's present problem. Another alternative is for
a countiy to reduce its domestic consumption. For Europe, however, this
would be in general a most undesirable solution, since any further reduction frGia present levels of consumption would reduce both the willingness
and the ability of their working populations to work, caid thus lead, to a
vicious circle of increasing inefficiency in production, and ultimately
to social unrest or economic breakdown or both. One might say that a main
objective of American aid under the European Recoveiy Program is to relieve
European countries from the necessity of making further reductions in their
domestic consumption in order to achieve a balanced trade position.
Countries can also pay for foreign goods that they need, by selling
gold or other assets that they have accumulated during past periods of
prosperity, but it mu3t be obvious that countries, like individuals, can
only do this for United periods. Many of the European .countries have
been doing this during the last two years, and their holdings of such resources are being rapidly depleted. Finally, countries can obtain imported goods that they need ty obtaining either loans or gifts from the
governments of other countries or from private investors or contributors
in other countries. It is the purpose of the.ERP to provide such loans or
gifts during a temporary period while European countries are increasing
their own production and developing self-supporting economies.
European Postwar Difficulties •
The postwar difficulties of European countries have arisen from a combination of different causes. At the end of the war,many countries had
widespread physical damage to be repaired. Etynow a large part of the direct damage to factories, railways, and the like- has been repaired, but to
some extent the effects of this damage still continue. There was also wide*
spread deterioration of equipment due to wartime wear and inability to nake
replacements. This will take years to make up in full, and meanwhile, i*
is an important factor in preventing maximum efficiency in production.
Another quite different factor in the present difficulties of some
European countries is the fact that they have lost or have had to liquidate
large amounts of foreign investments, or have lost large parts of their merchant shipping fleets. They have thus lost sources of income that had formerly helpted to pay for imports of foreign goods. .In addition most European countries have faced a great problem of re-orienting their foreign *rj "
This has arisen because some of the areas that had previously supplied %00^
to them have also suffered war dislocations. As a result European counts
must rely on Western Hemisphere suppliers to a greater extent than before

01
the war, and, in order to pay for larger imports from this henisphere,
they must endeavor to direct more of their exports here.
Finally, almost all European countries have been faced with monetary
and fiscal problems which have caused serious dislocations throughout
their economic and social structures. It has been clear that European
countries would not be able to get their production going again at maximum levels until they could restore adequate incentives to working men to
give their best efforts, incentives to business men to produce efficiently,
and a regular flow of supplies for industry and agriculture. This hac involved political and social a3 veil as economic problems• Where adequate
currency reforms and other anti-inflationary measuites have been taken,
they have been very helpful, but in some cases, the underlying political
and social difficulties have proved to be more deep-seated than was at
first apparent, and the full solution of these problems is taking longer
than might have been hoped.
In addition to the dislocations within individual countries, all of
Europe has suffered from, insufficient coordination between countries. It
is clear that greater efficiency can be obtained if each country arranges
its production programs and the development of its resources in cooperation v,;ith neighboring countries. However, international cooperation of
this kind is more difficult to achieve than appotrs on the surface, especially when the countries concerned arc only in the first precarious
stages of recovery and are anxious to avoid disturbing their reviving
domestic industries.
Postwar Progress
Even before the end of the war, the United States Government had begun to lay plans for the giving of necessary postwar assistance to countries in Europe and other parts of the world. One step in these plans
wa?3 cooperation in organizing the United Nations Relief and Rehabilitation Administration - UURRA - for taking care of the most urgent needs
of the populations in war-devastated coiintries. Congress also increased
the lending power of the Export-Import Bank by almost 3 billion dollars,
and the Bank lms now used most of ^his increase to extend rehabilitation
loans to European countries. In addition large amounts of credit were^
extended to European and other countries to buy United States VLT surplus
materials that could be of use in their civilian economies. Finally, to
meet the special problems of the United Kingdom in the period of transition after the war, Congress approved a special loan of ^3*750,000,000 to
that country.
As a result of these contributions by the U. S. Government, combined
with very real efforts brought to bear by the European countries themselves, almost every country in Europe h^s made substantial economic progress since the end of the war. The United Kingdom has succeeded in bringing its industrial output to levels above those of the prewar period,
France end Italy and the Netherlands have all restored their heavilyda;aaged transportation systems to a fair degree of efficiency £nd have
made important progress in industrial recovery. Belgium has been able not
only to place her econoiny on a self-supporting basis, but also to extend
assistance to neighbor countries. Norway has succeeded in replenishing
its merchant fleet to almost its prewar tonnage. Only Germany has shown

62
very little evidence of recovery, largely as the result of the shattering
effects of the war upon its physical plant"and the morale of its people.
At the same time, eastern European countries, notably Poland and
Czechoslovakia, have made great progress iri restoring the productivity of
their industries, in particular, the large increases in coal production
in Poland put that country in a position where it could make important
contributions to industrial recovery in other countries. On the other
hand, because of political developments which interfered with coordination
between eastern and western Europe, both groups of countries have failed
to achieve the full degree of progress that might have been expected.
It became apparent, however, during 19A7, that further economic assistance on a large scale by the United States to European countries
would be necessary. Notwithstanding the substantial strides that had
been made, with American help, toward general economic recovery, it became clear that the disruptions of the European economy were so widespread that substantial further strengthening would bo needed. Further
financial aid had to be provided if these countries were to keep on obtaining needed goods from the U. S. and other foreign sources. At the
same time, if dollar aid were given to European countries for this purpose, it would help Latin American end other countries which try to earn
dollars through sales to Europe in order to meet their own dollar needs.
Development of the ERP
In June, therefore, the Secretary of State announced the concern of
the United States regarding the economic problem of Europe — of the entire continent, including the Soviet Union. The British and French foreign ministers then proposed a general European conference to take up the
subject, and proposed that the Soviet Government join in this project,
lihen it appeared that agreement could not bo reached, the British and
French foreign ministers nevertheless issued invitations to all other
European countries (except Spain) to send representatives to a meeting
in Paris. In the end, however, not only Russia but also the other countries which have fallen under its domination refrained from sending representatives. The Co-iunittee of European Economic Cooperation was then
formed by the 16 remaining European nations, consisting mainly of the
countries of western Europe.
This Conauitteo drew up and presented in September, a four-year program designed to restore Western Europe to a self-supporting basis. The
Committee's report called for closer cooperation among European countries
and it also gave estimates of the external assistance that would be required in order to carry out such a program.
The proposals made by this Committee were given the most thorough
study in the United States Government. After critical review, they vere
accepted as a reasonable starting point in formulating our government's
estimates of the amount of United States aid that is needed. However,
the Comirdttee's estimates were scaled downward where they appeared to b 0
higher than necessary. They were also scaled downward where it appeared
that the amounts of goods that were called for would not actually be available in the world markets, or where it appeared that the provision of

these amounts would involve undue demands uoon goods that are in short
http://fraser.stlouisfed.org/
supply
inSt.the
Federal Reserve
Bank of
LouisUnited States.

Silt was after careful consideration of all these factors that Congress determined to authorize v5*3 billion of aid to Europe for the first
year of the recovery program. A program of four and a quarter years is
contemplated, although this is subject to annual review by Congress.
There have beon tentative estimates that the total amount of aid needed
over this period mi^ht be i,,17 billion, but it is clear that estimates of
European requirements more than a year or so in advance mist be of a
rather uncertain nature.
In approving the Program, Congress authorised the creation of the
j-CA — Sconouiic Cooperation Administration — as the agency to carry out
the responsibilities of the United States under the program. As Administrator of the program, the President immediately appointed ^r. Paul
Hoffman, one of the country's outstanding business executives, who has
been president of the Studebaker Corporation. Mr. Hoffman is recruiting
e, swiff of experts to assist hin in Washington, and he is also a member
of the National Advisoiy Council on International Honetaiy and Financial
Problems, vhich coordinates the policies of aLl government agencies engaged in foreign financial transactions• The Act also provides for a
roving ambassador to represent the Administrator in Europe and this post
is to be filled by Averell Harrixnan, who has been Secretary of Canmerce
and who had previously served in important government posts abroad.
There will be a special mission in each of the participating countries tc
supervise the operation of the program. Although the £CA is still in tht
process of being organized, an allocation of o21 million for the five
most needy countries was made within one week after the passage of the
/iCt. Further supply programs for all the participating countries are being established, and shipments of goods under the program have commenced.
Objectives of the Program
The program of assistance from the United States is directed toward
genuine economic recovery in the participating countries of Europe (including western Germany) • It is not in eny sense intended to be merely
relief. The program provides for food retirements and for supplies of
fuel and raw materials. But also, and more importantly, it provides for
capital equipment to assist liurope in the task of building up its ovn
productive capacity. The program contemplates that the :.'.uropean countries will take vigorous steps to assure that all the assistance they receive frora the U. S. will be used efficiently to further the objective
of full recovery. This includes the taking of financial and other measures to stabilize their currencies and prices and generally to restore
confidence in their monetary systems, and to cooperate with each other in
increasing the exchange of goods and services among European countries,
all with the objective of achieving the greatest possible efficiency in
the use 01 their own resources to increase their production.
To the extent that European countries appear able to repay this
country for the help that they receive, the assistance will be extended
in the form of a loan calling for repayment, l-ihere it does not appear
that repayment will be possible without jeopardizing the long-run objectives of the program, assistance will be given on a grant basis instead.
While attention has been concentrated on ^urope in recent months,
the
needs
of other areas of the world have not been ignored. Part of the

dollars supplied to European countries under the JSRP will be spent by them
in Canada or Latin America. In this way, our aid to Europe will also serve
to provide Canada and Latin America with large amounta of dollars that
they in turn can use to pny for the goods that they need from the United
States. In addition the Export-Import Bank and the International Bank for
Reconstruction and Development, in 1'ashington, are prepared to aeke loans
to finance sound development projects in Latin America us well as in other
parts of the world.
As for China, while present political conditions make it impossible
to plan any real economic recovery in that country, the Foreign Assistance Act of 19A8 includes t>338 Gillian for economic assistance to China,
in addition to <,I£5 uillion that can ba used for military aid. It is
contemplated that this relief assistance should enable China to hold its
ovn in"an economic sense until its political difficulties are settled.
In Japan the relief assistance which has been supplied since the end of
the war may soon be supplemented by more far-reaching aid designed to put
that country back on its feet within a neasurable period of true. Thus,
the European Recovery Program is only one element, even though the largest,
in this country's plans for foreign economic cooperation.
Meeting the Cost of ERP
It must bo recognized that all of these programs impose a very real
burden upon the United States — a financial burden upon our Federal budget and an economic burden upon our people who are called upon to export
to foreign countries far ;iore goods end services than ere received in exchange. These programs heve been decided upon, however, in the light of
very careful studies of our capacity to bear this burden. The conclusions
to be drawn from these studies are thai, the foreign aid programs conteniplated for the coming year will not impose any greater dx'ain upon United
States resources than has occurred during the pant ye^r; that this drain
will not significantly affect the standard of living of the American people; and that its initial inflationary impact can be held in check by appropriate domestic measures. Tho most important of these domestic measures is fiscal policy; it is supremely important that Government expenditures including those on foreign aid be covered to the maximum extent possible within a balanced budget. If this practice is followed, the purchasing
power created by these expenditures will be withdrawn fron the market
through taxation. At the same time, in view of the inflationary pressures
arising fron domestic as well as foreign sources, it is important to carxy
out a monetary policy designed to restrain undue expansion of banlc credit.
An expanded defense program is now being considered in Congress,
this program, if adopted, could add around ^4 billion to Government expenditures during the next fiscal year &nd perhaps greater amounts
^
future. This will cause additional upward pressure on prices. This development makes it even more imperative that anti-inflationary measures be
applied in a strong and thorough manner. If we pursue vigorous snti-inflationary policies in the fiscal and monetary fields, we may be able to
avoid reimposing direct controls upon the allocation and movement of g°°ds
in the domestic economy.
There can not be any assurance in advance that" the European Recoveiy
a success. The European countries will have.real
blem

Program will be

to sumount in order to be fully self-supporting at the end of the fouryear period. The increasing political tension between eastern end vestern Europe tends to worsen the economic prospects of both groups of countrios. Nevertheless, I foel most strongly that the ERF represents a vise
policy on the part of tho United States. The cost in money is large,
but is well within the capacity of this country. And by such a bold and
ambitious program, directed toward the economic health of key countries
of Europe, we can exert a powerful influence toward the maintenance of
peaceful conditions in the world, then and as the countries of western
Europe achieve the economic health that this program envisages, we can
confidently expect one result to be improvement in the economic condition of other countries and progress toward the ultimate goal of a peaceful and prosperous world.

Speech delivered before
Joint Convention of the National Advocates
Society, the Medical and Dental Arts Club,
and the Priends of Polish Art
Book-Cadillac Hotel, Detroit, Michigan
July 29, 1948
AMERICA'S ROLE IN THE INTERNATIONAL ECONOMIC SITUATION
I shall spaak on the problem of European recovery and on the role of
the United States in assisting Europe to return to a self-supporting basis. As you all know, this country is now engaged in a great European
Recoveiy Program, involving the expenditure of billions of dollors. This
program, which forms such an important part of our present foreign policy
is based not only on humanitarian.considerations but on tho conviction,
which I heartily share, that European recovery is essential to world stability and to the attainment of an enduring peace.
In speaking to you about Iiiuropean economic problems, I may refer to
my personal experience in Europe, both during the war and in 1946-47•
When I was sent to western Europe in 1944? it was clear that the recovery
of the war-ravaged countries would be a long and painful process^ but,
flushed with the recent Allied victories, most leaders were more optimistic than the economic conditions warranted. Two years later, this optimism in many places had given way to despair. It was realized that even
the progress already made could not be maintained without continued largescale assistance from the United States. Out of this despair was born
the conviction of the inter-dependence of the economic interests of
Europe and the United States, and thus the path was cleared for the
European Recovery Program.
The nature of Europe's present economic crisis is not difficult to
understand, but it requires a review of a few facts concerning the prewar situation. Before the war, the prosperity of European countries,
like that of most other advanced nations, was highly dependent upon foreign trade. By specializing on the kinds of production that ench country
could perform efficiently, and obtaining other goods through the channels
of international trade, European countries were able to achieve much
higher standards of living than would have been possible had each country
attempted to be self-sufficient. It should be emphasized, however, that
while the European countries were not self-sufficient, they vere selfsupporting. They paid for their purchases of goods and services from
abroad mainly in two ways: first, with the earnings fro.a their exports
of goods and services, and, second, with the income from investments
which they had made overseas. Thus their purchases from abroad were covered by their earnings from abroad.
The effect of the war was to alter this situation profoundly. In
the first place, the war brought about appalling destruction of factory
buildings and equipment and of transportation facilities, including merchant fleets. The effect of this was greatly to reduce the capacity to
export goods and services. In the second place, a largo part of the foreign investments of European countries was destroyed by enemy action or

88
had to be sold to fleet the coot of the war. Thus these countries lost an
important source of earnings that had gradually been built up during the
course of centuries.
Deprived of a lprge proportion of their normal external earning povor,
European countries at the" end of the war were confronted with a desperr.te
situation. In the absence of generous and prompt assistance from abroad,
widespread starvation would have been inevitable and on a scale vhich vould
have quickly led to revolutionary political changes. Fortunately, emergency relief assistance was immediately forthcoming on an extensive scale.
Through UIIIIRA (the United Kations Relief and Rehabilitation Administration)
and other agencies, the United States Government poured billions of dollars
of relief expenditures into Europe in order to alleviate the acute distress
occasioned by the war.
It was clear from the outset, however, that Europe's problems could
not be solved by mere relief neasures. The sharp disparity between import
requirements and earning capacity could be narrowed only by measures designed to increase the ability oC European countries to produce end to export. With foreign investments largely dissipated ay a result of the war,
it was clear that the volume of European exports would have to be raised
to a level much above that prevailing before th(s war if pre-war living
standards were to be restored on a self-sustaining basis. The necessary
increase in production srid exports could be attained only by measures of a
recover?/ rather than a relief nature — that is to say, by measures intended
not only to restore but to improve the European productive machine. To accomplish this, however, required outside help. Without outside assistance,
European labor and resources vouid have been required eiLaost entirely for
meeting the immediate urgent needs of consumption, and could hardly have
been used for investment purposes, no natter how productive, vhich would
not yield an immediate return.
At the end of the war, production in Europe was far below the pre-var
level. For Europe as i\ whole (excluding the U.S.S.R.), industrial production in the first quarter of 1946 was at only 68 per cent of the 1938 level,
and in the case of certain countries production was much lower than this
average. In Italy, for example, industrial production was at not much more
than a third of the 1938 level, while in Germany industrial production vas
running at only about a fifth of the pre-war rate.
In the three-year period since the end of the war, Europe has made a
dramatic recovery in production. In the first quarter of 1948, European
industrial production had almost recovered to the level of 1933, and if we
exclude Germany, where recovery has been conspicuously slow, European production was actually above the pre-war level*.
This does not mean that European consumption has returned to pre-war
standards. In the case of food consumption, for example, the average person in western Europe at the present time is eating 25 per cent less sugar*
30 per cent less meat, and 30 per cent less fats than before the war. The
reason that overall consumption has not leapt p£ce with overall production
is that a large fraction of current production is being devoted", as it
should be, to restoring and improving the productive capacity of Europe*
Moreover, for reasons which I have already pointed out, production will h&
toFRASER
rise to a level much above pre-war if Europe is again "to become selfDigitized for
supporting.

A problem very important in connection with European recovery has
been the notably slov recoveiy of Germany. At the present tine, industrial production in western Germany is at less than*half the pre-war
level. The drag on the rest of Europe resulting from this state of affairs is so important that I must give this matter special attention.
There may be some among you who deplore any help given to Germany
at a time when the victims of German aggression still need all the
assistance we can afford to grant. You have probably heard the propaganda that charges the United States with deliberately favoring the recovery of Germany, rather than the rehabilitation of the victims of
Gorman aggression, in order to prepare for a future alliance between the
United States and a revitalized German Empire.
I need hardly say that no responsible person in the United States
has ever had such intention—least of all the men who have initiated and
now administer the European Recoveiy Program. The main reason "V'hy the
European Recovery Program also embraces western Germany is the undeniable
fact that rehabilitation of the other European nations would be impossible without the recoveiy of production in Germany, l.'estern Europe must
exchange large quantities of exportable surpluses for German coal, steel,
inachinery, and chemicals which cannot be purchased from any other source.
This exchange, which before the var vas one of the strongest pillars of
Suropean foreign trade, must be resumed now end not in the distant future. Western 3uropo needs these German products for the reconstruction
of its own system of production, and it cannot wait for its own heavy industries to expand to such an extent as to make imports from Germany unnecessary. The United States simply cannot spare the additional quantities that western Europe would require if it were deprived of imports
fro.a Germany, .ioreover, the United States cannot increase its grants to
western Europe by the amount that would be reyuired if Germany did not
again become a market for western Europe's exportable surplus.
In 19/17, trade between Surope and overseas countries was approximately back to normal. Intra-European trade, excluding Germany, had also
made appreciable progress. The stagnation in the trade between western
-Europe and Germany, however, was a major cause of the unsatisfactory
state of overall recoveiy in western Europe. The redevelopment of that
trade is one of the most important contributions that can be nade to the
rehabilitation of the victims of German egression. In this connection,
we have implemented our assistance to Germany by the recent currency refora which will greatly assist in directing Gorman manpower £,nd natural
resources into useful production. Moreover, we insist upon developing
German production in such manner that Germany's contribution to European
recoveiy is maximized, while at the same tine making sure that no future
German government can use its reconstructed economy for purposes of aggression. We insist, therefore, upon continued German exports of coal
and timber to western ISurope, despite German domestic need of these vital
raw materials; and we insist upon the removal of the remainder'of the
German war industries and the limitation of German heavy industrial capacity. With these safeguards, the aaount spent for Gernan recovery will
be more useful to the rest of Europe than would a much larger amount de~
voted to additional direct assistance to the victims of Gernan aggression
Another factor retarding European recoveiy has been the marked debetween western and eastern Europe. Normally, eastern

cline in trade

90
Europe produces a surplus of foodstuffs and certain raw materials, such as
timber/which it exchanges for the; industrial products of the vest. The
importance of reviving this trade, which MBS highly beneficial to both
regions, was recognized from the outset by tiie franers of the ilnropean^
Recovery Program, and froa the very beginning eastern Europe has bsen invited to participate in the program. The Soviet Union not only declined
that offer, but also forced the other eastern European nations - some of
which were eager to participate ~ to remain outside. This failure to cooperate harms the eastern iuropebn countries more than the vest. Nevertheless, the western nations do not intend to follow the Soviet Union in its
avterupt to foreswear economic rationality for reasons of ideology. Vie^
have continued our endeavor to expand trade with the east, and the Administrator of the recovery program has made available funds for the purchase;
of scarce commodities in eastern Europe - such as Polish coal for Austria.
In this way, the eastern European nations derive some benefits from the
European Recovery Program, and there is reason to believe that they r.re
beglunin£ to rnalize the Iocs they were made to suffer when they vero prevented from becoming full-fledged partners in this ^re^t enterprise.
The present European Recovery Progran represents a unified approach
to the overall problems of Europe rcther than the vastly more expensive and
wasteful method of attempting to deal with the problems of individual countries on a piecemeal basis. Aftor careful and exhaustive study by the technical staffn of the United States Government, Congress has authorized approximately i^5 billion of aid to Europe for the first year of the recovery program. A program of four and a quarter years is contemplated, although this
is subject to annual review by Congress. There have been tentative estimates
that the tot&l amount of aid needed over this period night amount to .;17
billion, but it is clear thct estimates of European requirements more than a
year or so in advance must be of ar. uncertain nature.
These are very large sums of money, and we have a right to expect that
they will be used in the most effective possible manner. The United States
simply cannot afford to extend assistance to Europe without recoiving assurances th?.,t its contribution will be efficiently used for the purpose of
European reconstruction end that the recipient nations will cooperate to the
full e:ctcnt of their capacity in achieving the purposes of the program•
In this connection, the Administrator of the program has concluded
agreements under which all recipient nations- will undertake very substantial
obligations. These obligations include the stabilising of their national
budgets, their currencies, and their exchange rates. The European nations
agree to reverse the pre-war trend toward economic isolation, to reduce trade
barriers, and to cooperate in molting efficient use of their combined resources so as to minimize their dependence on the United States. They agree
to put at the disposal of the United States scarce strategic octerials in
reasonable quantities and at reasonable terms, and to p e m i t access to their
natural resources by American investors.
Finally, whenever the United States Government furnishes coimodities
or services on a grant basis, the participating countries agree to pay the
value of these ^oods and services in local currency into special accounts.
These sums will then be used for constructive purposes on the basis of agreements between the country involved and the Administrator of the program.
Such
purposes include expenditures for the development of new.resources, as

91
veil as retirement of currency or of government debt in order to put an
end to inflation. In a number of cases, the amount .in question will be
a very substantial fraction of the countiy.'s total money supply. Thus,
in these European countries, the Administrator will have the*power to
exercise a great constructive influence upon their financial situations.
While attention has- been concentrated on Europe in recent mo.v:th3,
the needs of other areas in the world have not been ignored. It has been
intended that a substantial part of the dollars supplied to European
countries under the European Recovery Program will be spent in Cam.da,
Latin America, and other areas outside.the United States. In this ray,
our aid to Europe will also serve to provide Canada and Latin /-aorica
with dollars which they in turn can use to pay for goods thoy need from
this country. In addition,.the Export-Import Rank and the International
Bank for Reconstruction and Development ere prepared to moke loons to
finance sound development projects in Latin America and other p^rts of
the world.
It must be recognized that our foreign economic program in the aggregate imposes a very real burden upon the United Stabou - a financial
burden upon our Federal budget and an econo-iic burden upon our people
who are called upon to export to foreign countries far i/iore gooJs end
services than they receive in exchange. The Administration's recommendations on foreign aid, .however, were decided upon in tho light of careful end comprehensive studies of our capacity to bear tiiis burden. The
conclusions to be drawn from these studies uro thrvt, the amount or? foreign
aid contemplated for the coming yecr will net impose any greater drain
upon United States resources then has occurred duving the past y e w ; that
this drain will not unduly affect the standard of jiving of the American
people; and that the inflationary impact can btf held in check by appropriate domestic measures. The most important of theso domestic measures
is in the realm of budgetary policy; it is supremely important that Government expenditures, including those on foreign aid, be covered within a
balanced budget. If this practice is followed, the purchasing power created by these expenditures will be withdrawn from the market through taxation. At the same time, in view of the inflationary pressures arising
from domestic as well as foreign sources, it is important to c^rry out a
.Monetary policy designed to restrain tha expansion of baiJc credit. To
achieve the proper combination of budgetary and monetary policies requires the close cooperation of the United States Troasiuiy und the
Federal ftcserve System.
Cooperation is also required anor^g all United States Government departments .-.rid agencies concerned with foreign economic policy, hi order
to coordinate the domestic and International financial policies of the
United States, Congress in 19^5 created the national Advisory Council on
International Monetary and Financial Problems. This Council consists of
the Secretary of State, the Secretary of the Treasury, the Secretary of
Commerce, tho Chairman of the Board of Governors of the Federal Reserve
System, tho Chairman of the Board of Trustees of the Export-Import Eank,
and now, also, the Administrator of the European Recovery Program. Since
its creation, the Council has played an active part in the determination
of international economic policy, and insures consistency of action on
the part of all government agencies dealing with foreign financial matters. It also directs the votes of our representatives in the Interna
tional
itonetaiy Fund, which is concerned with international exchange-rate

92
policies, and in the International Bank for Reconstruction and Development.
Finally since the inauguration of the European Recovery Program, the Council
has given advice to the Administrator of the Program. In all these ways,
the Council attempts to make certain that our domestic and international
policies are effectively geared together in a manner designed not only to insure the execution of our international obligations but to insure that our
international actions do not threaten the stability of our own economic system •
While the cost of our foreign economic program is not to be lightly
dismissed and represents a substantial meesure of genuine sacrifice, it is
small indeed compared to the cost of the alternative. If we should refuse
to extend assistance to foreign countries in critical need, we would have
to count on the likelihood of future developments of the most sinister charactor. We would hkve to expect revolutionary economic and political changes
throughout the world. All hope of a democratic international order would be
gone, V/ar-wracked countries in Europe, deprived of the hope of a return to
tolerable living standards, would become the easy prey of regimes which promise economic security in exchange for the surrender of political freedom.
Confronted with a world largely made up of dictatorships of the Left or Flight,
the United States would find itself isolated in a cold und hostile world. To
maintain even a pretense of security under these conditions would require a
level of expenditure for defense vastly greater than any now contemplated.
Against such expenditure, the present sums spent for foreign recovery pale
into virtual insignificance.
There are those who are aware that foreign aid is in the national interest but who nevertheless maintain that all that In needed is an emergency relief program entailing only a fraction of the cost of a genuino recovery program. But the only basis on which a relief program is less expensive than a
recovery program is if we confine our attention to the immediate future. In
the long run, a relief program is wasteful in the extreme, since it cietils
with symptoms rather than causes and does not contribute to the economic stability and eventual self-support of foreign countries.
Of course there is no certainty that our foreign recovery program
achieve all that we hope for it. Difficulties at present unforeseen nay arise
to disappoint and thwart us, but such possibilities should not blind us to the
certainty of disaster if we fail to carry out the attempt. In this connection,
there is grave danger that we shall set too much store on the results achieved
in the first year and, if these results are disappointing, take the shortsighted step of discontinuing or curtailing the program. In fact, the objectives sought try the program cannot possibly be achieved in one year, tnd to
expect more than a sound beginning of the desired recovery would be to misunderstand the nature both of the problem and of the remedy. It should be remembered that after the first l/orld War, which was vastly less destructive
and disruptive than the recent conflict, it was not until 1925, or seven years
after the defeat of Germany, that European economic activity was back to the
pre-war level.
To a veiy Itrge degree, the success of our foreign economic program
will depend upon our own future actions. This applies not only to our actions directly relating to the program itself but* to our decisions in the
broader field of economic policy as a whole. For example, we cannot expect either the recovery of world trade or the recovery of Europe if, after

a short breathing spell, we attempt to re-instate high tariffs and
thereby prevent Europo from selling the exports it uiuct sell if it is to
pay for the imports it needs and thus become self-supporting again. For
Europe to pay its way, it is not enough that European countries are able
to
£ESdyj£®. "the necessary volume of exports; they must also be able to
jgell the.a. This means that other countries, including our own country,
must be prepared to increase imports*
In the second place, we cannot expect Europe to achieve economic
and political stability if our own econony, -which is such sn important
segment of the world economy, is characterised by severe booms and depressions accompanied by equally drastic fluctuations in our purchases
from abroad, iiuca depends on our ability to keep our own house in order - particularly on our ability to avoid the evils of Inflation and Depression. Inflation is the immediate problem, and this ve itust fight at
the source, which means increased production of goods in short supply
and reduction of excess purchasing power. There must be control over
further expansion of credit, and certain direct controls m^y also be required to minimize the painful effects of inflation vhile we are cttoiaptirg, by nore fundamental ^.easuros, to deal with the causes, of the
problem.
To a degree which is almost impossible to exaggerate, the future depends on the type of leadership shown by this country. Of the nujor
countries which were engaged in the recent conflict, our country was almost alone in being able to keep its productive capacity intact, and it
has been estimated that the United States at present accounts for roughly
half the world's industrial production. Thus, without asking for the
role, we find ourselves catapulted into a position of grer^t power and influence v.hich carries with it a gre&t responsibility both abroed and at
home. In the sea of problems which now beset us and which lie ahead of
us, it will bo very difficult to steer a straight course, but we must reneiaber that the staices of our action are very great. Civilisation itself
may be in the balence. \!e must not fail.

9$
Speech delivered before
School of Banking, University-of Wisconsin
Madison, Wisconsin
September 1, 1948
FINANCIAL PROBLEMS OF THE. EUROPEAN RECOVERY PROGRAM
Introductory Remarks
The European Recovery Program can be distinguished from other types
of postwar assistance because of its main purpose - to bring about a
balanced economy in Europe and throughout the world. It represents n
unified approach to the over-all economic problems of Western fiurope.
American assistance under the program is intended to meet the costs of
imports of goods and services essential to maximize production within
the participating countries and to expand their trade e:aong themselves
and with the rest of the world. These long-range aims represent h great
progress over relief measures and wasteful methods of attempting to deal
with short-term problems of individual countries on a piecemeal basis. .
To these ends, self-help and mutual cooperation on the part of the
European countries are the necessary counterparts to American assistance,
and the United States has a right to expect that the very large sums of
money nade available by Congress will be used in the most effective possible manner.
The basic economic problem in Europe today is without doubt the
problem of producing more .goods. The physical damage end disorganisation caused by the war, as well as the deterioration of equipment caused
by wartime wear and neglect have not yet been entirely overcome. Furthermore, monetary and price dislocations arising out of the war have
proved to be serious obstacles to recovery. Production cannot be restored to maximum levels unless adequate incentives exist both for business and labor, so as to ensure £ regular flow of *-oods through the

heavily than beforo on the Western Hemisphere for needed supplies
This brings us to the problem of the balance of payments.
few countries