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THE ROLE OF THE FEDERAL RESERVE IN WARTIME

An address by Thomas B* McCabe, Chairman,
Board of Governors, Federal Reserve System,
before the American Academy of Political
and Social Science, Philadelphia, Pennsylvania,
January

26 , 1951*

THE ROLE OP THE FEDERAL RESERVE IN WARTIME
An address by Thomas Bi MCCabe, Chairman,
Board of Governors, Federal Reserve System,
before the American Academy of Political
and Social Science, Philadelphia, Pennsylvania,
January 26, 195>1*
On my way here tonight, I felt very guilty about leaving Washington
at this critical time —

much like a small boy who is playing truant in order

to join his old friends at the favorite swimming hole0

Had I followed my

head instead of my heart, I would have promptly and decisively refused the last
of Dr. Patterson's cordial invitiations which I received last autumn®
wavered which, as you know, is fatal*

But I

That gave my good friend, A1 Williams,

a golden opportunity to put me on the spot, and finally in December I decided
to come#
I am one of the Philadelphians who can never repay Dr* Patterson for
keeping the flame of freedom burning in this historic Academy, this forum which
carries forward the tradition of Benjamin Franklin's junta, a society that repre­
sents the culture of Philadelphia in its truest sensec The members of this
society are true exponents of the maintenance of Philadelphia's rich heritage
in our democracy — men and women devoted to our country, quick to expend them­
selves in its service, concerned for its future, and possessed of the background
and capacity to evaluate its problans*
Surely, I thought, in these "times of troubles" I would lack neither
the topics nor words for an appropriate address*

Little did I reckon with the

march of events, with the demands of this, my homeplace, with the dictates of
my conscience, or with the brilliance of the preceding speaker#

I felt very

humble when I appeared before the Douglas Subcommittee of the Congress more than
a year ago, when Les Chandler was chief braintrust to the exceptionally able
Committee, and I had to withstand for hours a grueling cross-examination on the
intricate and complex problems of money and credit*

few
men in this


Les is one of the very

country who has mastered these subjects and attained a position

-2of renown throughout the financial community.

It is good to know that his pro­

ficiency and commanding talents are available in these critical times®

He is

one of U00 economists who recently joined in a public statement on antiinflationary measures®

The statement issued by this distinguished group

strongly supports’the program which the Federal Reserve has been pursuing and
will continue to advocate in its efforts to combat inflation and to maintain the
integrity of the dollar^
You will recall that five years ago this month the Academy devoted an
evening to a discussion of the Bretton Woods Agreements -- a subject which at
that time was of major importance to the country*

I had the privilege on that

memorable occasion of sharing the platform with the then Secretary of the
Treasury, now Chief Justice Vinscn®

Never was I more proud of Philadelphia than

then-? because this was the only major city in the United States in which ten of
the leading banks came out boldly in a joint public statement endorsing the
International Bank and the Fund.
There is no place where I could speak with more confidence and under­
standing than here among my old friends and favorite haunts#

Many of you have

gone to extraordinary lengths to counsel, advise and support me in periods of
stress when I really needed your help and the warmth of your friendship *

I

feel I stand on hallowed ground in a city where the spirits of Alexander Hamilton,
Robert Morris* Thomas Willing, Benjamin Rush, Jay Cooke, and many others still
live in our memories#

These men had the vision, the courage* and the pioneer

spirit to give Philadelphia its reputation as one of the great financial centers
of our country#
It was here that the first central bank of the United States was es­
tablished*. And here that the great debate between Alexander Hamilton and
Thomas Jefferson took placea

Hamilton, x^ho fathered the first Bank of the

United States, insisted that it should be under private, not public, direction,
under guidance of individual interest, not of public policy.

Jefferson, who

distrusted centralization of financial power under private direction, insisted


http://fraser.stlouisfed.org/
that central banking
Federal Reserve Bank of St. Louis

be a public function subject to public control*

The

-3-

differing philosophies of these two great men have been debated vigorously
through the years.

It was Nicholas Biddle and his second bank that were

subjected to the burning wrath of President Andrew Jackson when the question
of the renewal of the charter of that institution became the focal point of
political combat in that era.
It was also in this Third Federal Reserve District about forty years
ago that Woodrow Wilson and Carter Glass held their initial conference in
Princeton which gave birth to the Federal Reserve System.

Wilson, who had been

greatly concerned about the monetary situation of the country, had made revi­
sion of the currency and the banking laws a matter of first priority for his new
administration.

Despite his confinement to bed with a severe cold, he summoned

Mr. Glass to his Princeton bedside for a two-hour session at which the proposed
Federal Reserve Act was developed,

I was in Swarthmore College at that time,

and as a student of money and banking shared in the civic excitement that
launched this country on its third attempt to create a central banking
mechanism —

the Federal Reserve System.

It was here about thirteen years ago that I was called upon to be
Chairman of the Federal Reserve Bank of Philadelphia.

It v/as from here that I

five times departed to undertake tours of public service, most recently to become
Chairman of the Board of Governors of the Federal Reserve System.
Tonight we meet in a community which is recognized as the virtual
’
’
cradle of thrift” in these United States.

When we consider how war and the

makings of war erode the savings of our people, it is clear that Philadelphians
will be particularly concerned to see that the present defense program is
financed in such a way as to safeguard the value of these savings.




Today well over 100 billion dollars of the savings of our people
are set aside in government and private programs for retirement, pensions,
and insurance protection*

Additional billions reside in savings accounts in

our banks, in mutual savings banks, and in savings and loan associations*
Still other billions are invested in Government bonds#
Every one of us counts heavily on these thrift reservoirs to guarantee
our future security*

Tonight I want to tell you of the great concern of the

Federal Reserve over the steady decline in the purchasing power of these sav­
ings and its efforts to arrest any further decline*
I wish there were time for me to tell you the full story of the
Federal Reserve System*

If I could, I think all of you would have a better

'understanding of why I have devoted so much of my life to it*

Perhaps then you

could realize the depth of my conviction that it represents the last bulwark of
the private enterprise system*
I would like to analyze the Federal Reserve Act so that you could see
why it is such a monumental piece of legislation; how it adheres so closely
to the historical concept of the proper role of a central bank; how it has
profited by previous experiences, and has blended the best of the philosophies
of Hamilton and Jefferson into a unique democratic institution devoted to the
public interest in the broadest sense*
The Federal Reserve System was created by Congress*

There is not

the slightest doubt that it could likewise be destroyed by Congress, or that
it would be destroyed or radically altered if it pursued policies against the
public interest, as interpreted by the people's elected representatives.

But

the point I wish particularly to emphasize is that the Congress deliberately
sought to insulate the Federal Reserve from predatory and political pressures*




I would like to tell you from ray own experiences that I have never
seen men take their responsibilities more conscientiously or display greater
loyalty than those on the staffs of the Federal Reserve Banks and of the
Board*
Their proficiency and farsightedness are recognized the world over
if we may judge from the innumerable requests from the central banks of other
countries who seek the advice and counsel of our staff on problems of organiza­
tion and operation.

I think you would be interested, too, in the instances

where men, coming to Washington in many different capacities, have asked the
Board for help and consultation.

They appreciate the competence and objectivity

of our staff.
I wish I could tell you about the directors of the Federal Reserve
Banks and branches.

You would be impressed by the extremely high caliber

of the men from industry, agriculture, education and finance who give so
generously of their time to serve their country in this fashion.
Tonight there is not time even to touch the highlights of this
thrilling story.

Events are taking place with breath-taking rapidity.

Tomorrows problems are arriving ahead of schedule.
On

the one hand, we have the problem of mobilizing our manpower

and our resources for defense.

At the same time, we have the problem of

maintaining a sound economy and a sound dollar to back up our military efforts,
I am convinced that these are not two separate problems and that we will be
making a terrible mistake if we consider them so,

I am convinced that you

can*t solve the one without an attempt to solve the other.
a defense program without a sound dollar.




You can’
t maintain

-6-

In the past six months we have given top priority —
so —

and rightly

to a reassessment of our international position, and to the development

of a comprehensive military program.

We have given urgent consideration to

procurement problems and production problems.

Now that these programs are

launched, the next order of business must be to work out a comprehensive
program for maintaining the integrity of the dollar —

a comprehensive

program for mobilizing our financial resources.
That directly involves the Federal Reserve.

As the nation’
s monetary

authority, it is our statutory responsibility to be a special guardian of the
integrity of the dollar.

Our function is to press for a comprehensive credit

and monetary program to prevent a nbuilt-inlf inflation that would plague us
in the years to come.

It is the duty of a central banking organization, be­

cause of its unique position in the government, to bring these questions to
the foreground of public attention.
The overriding problem which any government faces in a period of war
or of large-scale defense preparations is how to raise the staggering amounts
of money that are required without permanent injury to the economy.

I cannot

overstate the importance of the methods by which these funds are raised,
whether it be by taxation or by borrowing.

If the job is done properly, the

whole effort to stabilize the economy and preserve the soundness of the dollar
is made immeasurably easier, both now and in the future.

If done badly, it

is no exaggeration to say that it is possible to destroy the very society we
are struggling to preserve.
, History is replete with examples of the disastrous consequences of
reckless reliance on central banks to finance war expenditures.




Even in our

*-?-•
own country, the present complications in debt management and monetary policies
are in no small measure related to recognized deficiencies in the financing
of Yforld V/ar II.

As the President so clearly and correctly pointed out last

Fall, uVJe borrowed too much and did not tax ourselves enough.

Tie

must not

run our present defense effort on that kind of financial basis."
Now, what does this mean for our present problem?
I am just old-fashioned enough to believe that if we are going into
a garrison state, and we may be in that garrison state for years, it is ab­
solutely imperative and essential that we start right.

And starting right means

that we start with a balanced budget and a sound fiscal program.

Otherwise,

deficits will accumulate and the inflation cannot be controlled.
I think the primary problem before the American people is just how
much security do we need and how much security are we willing to pay for.
It is as simple as that.

Unquestionably, our military needs are enormous

and rightfully so.
Obviously, if all-out war were to come, we would be faced with an
entirely different set of circumstances and military requirements.

At this

stage, however, we must provide for a security program that can be indefinitely
sustained.

Too often in the past our people have changed radically in their

thoughts about security and the size of the military forces.
like a pendulum.

Vie

have been

At times like Pearl Harbor we have gone to great lengths,

spent money to any degree to get security.

And then when the immediate threat

was over, the pendulum swung to the other extreme where we were willing to
pay for very little in the way of military forces.
We must come of age in this matter of military force and have a
well thought-out program.




Now that we have started, it must be one that can

be sustained.

Ify

greatest fear is that if we go too far during this period,

the people will not continue to support the program.

If we do not go far

enough, then the threat of attack becomes greater because we will not be
prepared.

Therefore, we must bring sound judgment and reason to meet this

problem today.
I, for one, am willing to spend every dollar for defense that the
people of the country are willing to pay for.
limit of our ability to pay.

And I am willing to pay to the

The limit on our ability to pay is not measured

so much by the personal sacrifice as it is by the possible impairment of our
economy.

It seems to me that is the only consideration —

impairment of our economy.

the possible

If we tax too heavily we could impair it, but I

have not heard any amount of taxes recommended yet that, to my mind, would
seriously impair the economy if the taxes are apportioned in the proper way.
People are willing to sacrifice if they know the story —

know that

the dollars taxed out of their pockets are buying security and are not being
squandered for non-essentials.

Certainly, if we have the right to draft

eighteen-year old boys against their will and ask them to pay the greatest
price of all, it seems to me that we are not unreasonable in asking those
who stay at home to give up something.
So, the first fundamental principle in fighting inflation is a balanced
budget and, preferably, receipts substantially in excess of expenditures so we
will have a little more ammunition to fight inflation.
Right now —
chance.

before the rate of defense spending builds up —

Never has our economy been more prosperous.

is. our

Never have we been in

a better position to absorb higher taxes without impairing that economy.

When

I read that it may be the end of summer before a tax program can be enacted,




- 9 -

I think strongly we are wasting six or seven months we can ill afford to lose
in the battle against inflation.
You may have noticed that my distinguished friend, Senator Robertson
of Virginia, has recently advocated a "quickie" tax measure to plug this gap.
I have no doubt that the Governments tax experts would welcome an opportunity
to provide the Congress with specific recommendations for attaining this
objective,
I am realistic enough to know that there is a real danger that the
Government will eventually be running in the red despite the efforts to put
the defense program on a pay-as-you-go basis.

If we do start borrowing again,

we must not forget that some kinds of borrowing are much more inflationary than
others, and that the most inflationary source of money is that raised through
the banking system.
VJhen funds are raised directly from the banks, the money supply is
immediately increased.

This adds to civilian buying power and in a period when

scarcities prevail, builds up inflationary pressures*
To the extent that we borrow from individuals through, the sale of
savings bonds and from insurance companies, mutual savings banks and other
reservoirs of savings, money is being absorbed that would otherwise be available
for spending and investment.

So long as these funds remain invested in Govern­

ment securities, their inflationary effect is deferred —

that means that the

purchasers as a whole must hold on to them, not redeem them or sell them in the
market.

I wish to emphasize that so long as these funds remain invested in

Government securities, their inflationary effect is deferred.

This is the

crucial test of effectiveness and must be a keystone of debt-management
policies.




- 10 -

The trouble arises, as it has in the postwar period, when these
securities are subsequently sold either by banks or nonbank investors, particu­
larly when they are bought by the Federal Reserve.
furnished with "reserve dollars”.

Then the banking system is

These have accurately been called "high-

powered”dollars because they can become the basis for a multiple expansion of
credit.
About one-fourth of our total expenditures in World War II was raised
through borrowing from the banking system*
more than doubled during the war.

As a result, our total money supply

Since then it has risen further, and today

amounts to over 1?5 billion dollars.
I would like to summarize the main lessons from our experience in
financing World War II —

first, we did not tax enough; second, too large a

portion of the borrowing thereby required was raised through the banking system;
and third, too large a portion of the funds we raised from nonbanking sources
which, though they were saved at the time, did not remain immobilized after the
war.

The inflationary problems of the postwar period with which we are all so

painfully familiar resulted in large part from the expanded money supply and
also from the sales of Government securities by insurance companies, banks, and
other lenders to the Federal Reserve System.

Too many individuals and insti­

tutions liquidated all or a portion of their bonds and spent the cash or re­
invested it as opportunity presented itself.
We must do our utmost to avoid repeating these mistakes.
In addition to financing the Government as much as possible through
taxation and borrowing from nonbank investors, the next requisite for fighting
inflation is to restrict credit.




Credit of various kinds has been vital to the

-11-

development of this country*

Credit is absolutely essential for the defense

effort as well as for the sound functioning of the economy*
far too much credit for the postwar inflationary period#

But we have had

If we are to

have

steady economic progress, we should severely restrict credit in periods of
inflation and be liberal with credit in periods of recession#

This task is

the statutory responsibility of the Federal Reserve#
It is not necessary here to do more than enumerate the various in­
struments of credit regulation that may be used#
types —

They are of two broad

(1) general instruments and (2) selective instruments#

The first

group includes measures* such as the rediscount rate, Federal Reserve open
market operations, and the fixing of reserve requirements, through the use
of which the Federal Reserve can influence the supply of funds that banks
can lend*

The selective instruments place limitations on particular types

of credit*

These include margin requirements on stock market loans, regu­

lation of consumer instalment credit and similar regulation of mortgage loans#
Both types of measures have already been used by the Federal Reserve to re­
strain credit expansion#

It appears likely that further restrictive action

may be required*
I have indicated that, in my judgment, the overall program adopted
to finance World War II was inadequate#

I feel also that the Federal Reserve

went too far in the direction of inflexibility#
perience as the subsequent record shows#
It speaks for itself*

We profited by that ex­

I ask you to look at that record#

It exemplifies more eloquently than any words I could

utter, our determination to continue to work unceasingly for a program ade­
quate to meet the needs of the times#




- 12 -

The final essential in fighting inflation is the promotion of
savings*
I have no use for those who scoff at the E Bond campaigns today.
They simply do not realize the implications of their statements when they
discourage people from saving.

The average working man who buys E Bonds

is investing money that he would ordinarily put into gadgets or little
richer cuts of meat.

The real significance of the E Bond campaigns is

not only to get people to save and thus help to combat inflation, but at
the same time to give them a financial stake in the Government.

This is

the same principle that has led enlightened businessmen to encourage em­
ployee stock ownership.
I am convinced that, even though the purchasing power of the
dollar has diminished, the people whose E Bonds are maturing this year
will have more to show for their dollars than would otherwise be the
case.

Those dollars would have gone into many things and they would

have little or nothing to show for them today.

From the broader point

of view of support for our Government, some, like the boys in Korea, are
risking their lives, others devote their talents to public service,
still others take

leadership in civic affairs.

But practically all of

us can save something to invest in Government securities.
The lessons of what inflation does to a man’
s savings are
something we cannot overlook if we are to escape serious social reper­
cussions in the years ahead.

The difficulty is that the inflation process

is not unlike a habit-forming drug that lulls our sensibilities to these




- 13 -

realities.

Actually, inflation as we have thus far experienced it in

this country has not been hard to take,
prices.

Wages have increased faster than

Business profits have risen to unprecedented levels.

has enjoyed substantial gains in real income.

The farmer

Consequently, it is ex­

tremely difficult to get the public as a whole to fight an enemy who
masquerades as Lady Bountiful.
If we are to conquer the inflationary forces inherent in our
present situation, we must deal with the fundamental causes I have
discussed*
Only because so many of my friends in Philadelphia have asked
me, ’
’
What can I do as an individual about such a vital problem?'1, will I
attempt to suggest an answer to this question,
Many of you are officers and directors of various kinds of busi­
ness enterprise throughout this community.

In your various capacities you

can make valuable contributions to the fight on inflation by making sure
that the business is not accumulating excessive inventories, or following
other policies that contribute to inflation.
group of bankers these questions:

A short time ago I asked a

flow many loans have you made during the

past six months that were not really essential?

In how many cases have

your customers1 needs required the full amount they have borrowed?

In how

many cases have you renewed or extended loans when a part, or a larger part,
might have been paid off?
and all lenders.

These same questions apply to insurance companies

The sum total of these marginal amounts has swelled the

money supply and added an increment of buying power to the market that is
reflected in the rise of prices, wages, and costs in general, and in the
scarcities that pervade the market today.




- Ik Furthermore* there are great opportunities for action in this
emergency by civic groups.

Collectively, your influence may be multi­

plied not only locally, but on the national level as well*
immeasurably to focus

You can help

attention on what I consider to be the Number

One unresolved problem of today —

Inflation —

and on the comprehensive

approach that is needed to deal with it#
Undoubtedly, the greatest result of all will come if each of us
will take leadership in the practice of voluntary self-restraint.
no time to splurge, to be extravagant, to spend unnecessarily.

This is

It is no

time to finance such spending on the part of others, to countenance such
spending, or to give it social sanction.
of voluntary self-restraint.

Let us not underestimate the force

We live in a social environment and we respond

in our actions to forms of behavior that are approved.
ing and extravagance can be contagious.

We know that hoard­

So can restraint.

Inflation is not inevitable*
It is true that sacrifices will be necessary to preserve the
dollar but we have demonstrated willingness to undergo sacrifice, supreme
sacrifice, once we understand the end in view and the need.
I can have little patience with those who say the American public
lacks the courage, the will and the vision to comprehend and to conquer evil
forces, whether abroad or at home, that would destroy the institutions which
are the source of our incomparable strength and of the hopes of free peoples
throughout the world.
Woodrow Wilson, in commenting upon the issues of his day in the
monetary and credit field, summarized the role of the individual in this
way:




-

15

-

"There is a sense in which a democratic country forces states­
manship upon every man of initiative, every man capable of leading anybody;
and this I believe to be the particular period when statesmanship is forced
upon bankers and upon all those who have to do with the application and use
of the vast accumulated wealth of this country . . . We should seek to give
the discussions of such matters such publicity and such general currency
and such simplicity as will enable men of every kind and calling to under­
stand what we are talking about and take an intelligent part in the dis­
cussion.

We must open our thoughts to the country at large, and serve the

general intelligence as well as the general welfare*"