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A G E N D A (Document of Reference as a Guide to the Discussion) ROUND TABLE DISCUSSION EXPLORING THE GOVERNMENT SECURITIES OUTLOOK (Economic Aspects) Metropolitan Club Washington, D. C. Monday, February 26, 1940 - Five P t F. Dinner (Informal) at 6s30 P. I. . Moderator Earl B. Schwulst, First Vice President Bowery Savings Bank, New York (Sponsored by the Savings Bank Journal) !.lilton W. Harrison, Publisher EXPLORING TBE GOVERNMENT SECURITIES OÖTLOOK '(Economic Aspects) From the economic aspect, holders of Government bonds are inter ested primarily in three things: I. The future price of their holdings, which is the same as saying the future course of money rates» II. The marketability of their holdings* III. The preservation of the purchasing power of the principal invested in the bonds and in the interest income derived therefrom. I. The Price of Bonds or the Future Course of Interest Rates< A. Excess Reserves; 1« Over the near term prospect of, say, the next twelve months, is there any likelihood of a sub stantial reduction in excess reserves as a result of (a) Gold exports? (b) Increase in reserve requirements? (c) Free use of gold? (d) Expansion in the currency? (e) Substantial increase in bank loans? (f) Additional government borrowing? (g) The opening up of the capital market for "new money” borrowing? (h) Sales or maturities of Government securi ties held by Federal Reserve banks? 1^. Over the near term prospect of, say, the next twelve months, is there any likelihood of a sub stantial increase in excess reserves as a result of (a) The release of gold from earmark? (b) Further gold shipments from abroad? (c) Decline in bank loans? -2(d) Decline in circulation? (e) Decrease in commercial bank bond holdings through sales to the Federal Reserve Bank or to other purchasers 2. At the present time, the reserve requirements of member banks are between 12 and 22-3/4%• Are these requirements likely to be increased during the next twelve months? To what extent would it be possible for the Federal Reserve System to reduce excess reserves through increasing reserve requirements? 3. Through the sale of Government securities, the Federal Reserve Bank could reduce reserves by $2,477,000,000. If these bonds were all bought by member banks, exoess reserves would then be re duced by a similar amount; if bought by others than member banks and paid for with deposits in member banks, excess reserves would be reduced by the amount so purchased loss the reserves required on these deposits, which would be somewhere between 12 and 22-3/4 per cent. Do you think that over the next year the System will attempt to raise money rates through the sale of Government securi ties? 4. To what extent are excess reserves reaching a level whore they are losing their potency as a bond mar ket factor? Are the reserves growing in the case of individual banks to the point where the banks simply will not invest them? To what extent is this due to the fact that these banks may be carry ing large bank and foreign deposits against which they m y feel they should be reserved substantially 10C$? To what degree is it due to the deolining capita1-deposit ratio or other pertinent ratios? 5. In your judgment, is the price of bonds so high that even a slight tendency of excess reserves to fall would give rise to psychological or panicky selling of bonds by institutions and other holders desiring to "beat the other fellow to the trough"? ]<Vhat factors might set this sort of thing off? Would the result bo anything more than temporary that is to say, might we not expect a rebound upward in the market? 6. Will excess reserves have to be practically totally exhausted before we arrive at a position where we might say that we are definitely headed for higher money rates and lower bond pricos? -3 - B. The Gold and Silver Question: 1. To what extent may the Treasury use discretion in purchasing gold and silver under existing law? As a practical natter, does it contemplate indefinitely taking at £35 an ounco all gold tendered from whatever source? Vihat is its position in this regard with respect to silver? 2. At the present time, this oountry holds $18,035,000,000 out of a total estimated world gold monetary stock of $26,000,000,000, or 69%. Since the devaluation of the dollar and the fixa tion of the price of gold at §35 an ounco, the net imports of gold have amounted to $11,120,820,000. In 1939, such net imports amounted to £3,574,151,000 and so far in 1940 they have amounted to $383,370,000. In 1939, exclusive of Russia, the world production of gold amounted to over $1,200,000,000. It has increased since wo established the gold price of $35 an ounce approximately $750,000,000 per year. Are there any foreseeable limits as to the amount of gold which the United States Treasury will pur chase? 3. Is it likely that a substantial rise in the com modity price level in the United- States would tend to make gold flow from the United States rather than into it, or are there other factors, such as the need of warring nations for supplies and the general foreign unrest, which are likely to induce the con tinued flow of gold to this country, almost irre spective of the course of commodity prices? 4. In the light of past experience, is the Treasury likely to resort again to the sterilization of gold imports? Would such a course of action appear to be advisablo from the standpoint of our banking system? 5. Would it be advisable to circulate gold again within the country, and what would be the means of effect uating such a policy? vJhat would be the result upon excess reserves and interest rates? Are there any fears in your mind that the concentration of monetary gold in this country is likely to militate against the ultimate resumption of the gold stand ard internationally? Vihat would be the means at our disposal of bringing about a redistribution of gold? 6. Would it be inadvisable to take off the fixed price of £35 an ounco for gold or place an import duty -4 - upon gold? Would such action tend to curtail the importation of the metal into this country? What would bo the effect on world gold price? On the dollar? On Commodity prices? C• 7. What means are there at our disposal of preventing the further taking into our monetary system of further gold importations into the country? 8. What are the prospects for further devaluation of the dollar, and what would bo the effect of such devaluation upon excess reserves and the interest rate level? Fiscal Policy of the Government: 1« What means are available to the Government, in cluding the Treasury, the Federal Reserve System and governmental agencies to control or influence the money market? To what extent can that control or influence be exorcised? To what degree is there uniformity of action or coordination among those various bodios? 2. In what way does the financing of governmental deficits affect the money market? 3. On the basis of the recent budget submitted by the President, to what extent will the Treasury have to sell bonds in the general market during the next fiscal year? 4. What are the prospects for reduced governmental expenditures and increased taxation? Is the debt limit likely to be raised during the next fiscal year? 5. What consideration has been given to the effect upon money rates and bond prices in the eventuality of our being drawn into the war, and what have been the results of such consideration? 6. To what extent can the government finance its re quirements through the sale of Baby Bonds? Should the demand for these bonds continue to expand at the rate experienced during the past twelve months, how groat a deficit could be financed by the Governnent within the next year or two upon the assumption that governmental expenditures and governmental receipts (from sources other than the sale of Baby Bonds and other borrowings) remain the same? 5- 7. Is thorc danger in building up a large potential demand liability in the form ofEiby Bonds? Under what circumstances do you think a "run” might materialize? 8» Yihat, generally, are the prospects of a reduction in governmental expenditures or an increase in governmental receipts, or both; that is to say, what prospects arc there for an approach to the balancing of the national budget? 9. To what extent has Treasury policy in retiring the supply of short maturities by refunding into longer bonds affected rates? 10. Would you approve the use by the Treasury of long term, non-raarket securities, similar in type, for example, to savings bonds - which securities would be issued to savings banks, insurance companies, and similar holders? Would you approve of the issuance of perpetual obligations of the type of British Consols? D. Expansion of Commercial Loans and Improvement in General Business: 1. Commercial loans of member banks show a not increase of approximately $500,000,000 since early in the Spring of 1939 and have reached a total of $4,330,000,000. In the previous business expansion of 1936-1937, tho total expansion from the lowest point to the highest point was approximately $1,700,000,000. Can we expect or should we make plans for an expansion during tho yoar 1940 of as groat an amount from tho prcsont lovel to tho peak of total loans or equal to the total expansion seen in the previous period or greater? In short, is it likely that excess reserves may be materially drawn upon to meet the requirements of an expansion of business? 2. If we actively participate in the war, what are the prospects that substantial commercial and govern mental credits will be extended? 3. Will American manufacturers borrow to invest sub stantial amounts in additional plants or production of war materials for tho United States or bolligorants? To what extent do you foresee Anerican in dustry in general entering the capital market for new financing? -6- E. 4, Should we allow for an advance in commodity prices at least equal to the level that existed in 19361937? To what extent do you think we may expect an advance in commodity prices? 5. Is there stantial security in loans any probability that there will be a sub incroaso in the public's interest in markets which will create a large increase on securities? General Que sti ons: 1. If we should be drawn into the war, what would bo tho proximate and more or loss long term effect upon money rates and Government bond prices? 2. How low can bond yields go before Government bonds simply cease to bo attractive investments to com mercial banks, savings banks, and insurance companies with due regard to the maturities which are accept able to those types of investors? How many years interest income will have to be represented by bond profits before holdors will be induced to take those profits and hold cash idle in anticipation of get ting back into the market at a lower level at some future time? 3. Can trusteos justify the purchase of twenty-five year Government bonds to yield less than to maturity? 4. In the event of our participation in the war bring ing with it a soiling wave in Government bonds, would the long bonds or the short bonds feel the effects first or would they both go down together? In the event of business expansion, would the banks sell their short Government securities, and would this be a tip-off to holders of long bonds that the prices of such bonds might likewise shortly be depressed? 5. If substantial ar.jounts of bonds were offered in the open market, with the consequent lowering of bond prices generally, at what level would bonds having maturities of 5 years - 10 years - over 10 years appear to be attractive purchases to commercial banks, savings banks, and life insurance companies? (it would bo of considerable interest if each person present could be polled on his current guess as to the possible yield that would be available on the long term Governments (now 2*35%) at the end of 1940. These guesses would be treated as confidential.) 6. Let us assume that a conservative is nominated by -7 - both parties at the forthcoming conventions. Would institutional investors be thinking along the lines of further building up or of decreasing their total Government holdings? (a) Would chances of a decreased supply of Govern ments and better outlook for a balanced budget cause buying? (b) Would possible big business expansion, develop ment of loans, and consequent inflationary ef fects tend toward the taking of profits in Governments and reduction in total holdings? (c) Or would little material change occur, given interest rates like those now prevailing? Yiould actual buying or selling depend on whether bonds were available at rates which yielded a profit over the cost of the money, or vice versa? (d) Would the feeling be that Baby Bond sales and proceeds from trust funds would provide the needed cash from then on? (e) Would any conservative government be expected to apply the stabilization fund toward the re duction of the debt? (f) Is it possible that present expectations (for nothing better than tapering deficits through 1942) will disappear during 1940? (g) If institutions such as savings banks and in surance companies, by some means, have their confidence restored, what mediums of investment are open to them through which they can more actively employ their funds at rates that will make it a good business operation? (h) Suppose the ultimate in confidence could be generally agreed upon, i)vhat new action along investment lines could be taken by trustees of savings banks or trust committees that is not being undertaken today? 1. 2. 3. II. Life Insurance companies? Fiduciaries? Commercial banks? The Marketability of Government Bonds A. Certain Technical Questions: -8- B. 1» Should the prosont practice of giving exchange privileges to maturing obligations be continued? Would it be sounder practice and would better distribution be obtained by the use of partial 11right” privileges? 2. Is it desirable to stop the practice of padding subscriptions? -//hat stops could bo taken to stop the padding of such subscriptions? 3. Yfhy should notes be tax exempt? 4» Should tho Treasury discontinue the use of special issues in trust funds? 5. Is there sound policy behind the distribution of the Government debt in money bills, notes, medium and long term bonds? 6. '/Thy should the Treasury continue the use of split maturities? 7* Is it sound fiscal policy for the Government to do its financing through the issuance of securities by governmental agencies? Is not the effect of this to disguise the true situation with respect to the national budget and the total national government debt? General Questions: 1. How large can the Federal debt safely grow? It is said that we might go considerably farther than we have up to this time in discounting the future growth of the country and therefore the ability of the country to "grow up to” a Government debt structure expanded far beyond its present propor tions. Do you subscribe to the economic soundness of this statement? 2. Will comr.eroial banks soon find themselves in a position whore they will refuse to expand their de posits further, as '..111 be necessary through the continued purchase of new Government bond issues? That is to say, they will not buy new bonds and ex pand thoir deposits if by so doing they are likely to impair seriouslj' their capital-deposits ratio. Will the commercial banks be willing to accept new capital funds fron the Reconstruction Finance Corporation in order to be able to continue to buy Government bonds without distorting their capitaldeposits ratio, provided those capital funds are offered on such a low interest basis that the •9- investment of those funds by the banks in Govern ment bonds could be done profitably? 3. Are the banks' supervisory authorities, in the event of a decline in Government bonds, likely to perr.it banking institutions and insurance companies to carry Govornment bonds at so-called conventional values? Is this sound? 4. Should the Federal Reserve banks lend the equivalent of par on Government bonds if the market is lower than par? 5. At present levels is not the Government bond market exceptionally vulnerable and is there not a general feeling among holders that such a condition of vul nerability exists? 6. Is it a fact that the low yields on Government bonds and other prime credits have discouraged savers and lenders? 7f Is it true that the Federal Reserve banks are, prac tically speaking, ineffective as an agency for con trolling the supply of raoney and oredit tinder exist ing conditions? 8. What resources would be open to the Treasury if the commercial banks of the country should in general feel that they can absorb safely no more Government securities? Woul-d the Treasury have to resort then to the direct sale of its bonds to the Federal Re serve System? If so, what would be the effect upon Government bond prices and interest rates? 9. Yihat are the theoretical limits within which the Federal Reserve system could absorb the existing Government debt and/or additions thereto? 10. Is it true that the market for Government bonds is really a liquid market or is it true that with re spect to long Goveruneat bonds in particular the largo institutional holders really have a frozen asset - an assot of which no great number of them could divest themselves at any one time? In short, are not the institutional holders in the position of having to take, willy-nilly, whatever amount of new Government bonds m y be offered to them out of the fear that their refusal to do so would bring about such a break in the Govornment bond market as to cause very heavy losses through Government bond depreciation? In short, they must buy new issues to support the market for the ones they already hold. -10- Ill. 11. In the event we are brought into the war, to whom would the Treasury look for the absorption of the large amount of new bonds that would have to be issued? Gas consideration been given to institut ing a system of forced savings to be used for the purchase of such Government bonds? 12, Approximately §52,326,000,000 of deposits are in banks insured by the Federal Deposit Insurance Cor poration. Its not worth is $424,000,000 and it can borrow an additional $975,000,000, of which only $500,000,000 would come from the United States Treasury and the R. F. C., and the balance from open market borrowing, ?<ill the Corporation be a material protection in preventing public distrust in the face of a drastic decline in bond prices? Intrinsic Value of Government Bonds A. General Questions: 1. Are there fears in the minds of bond holders that the Governments fiscal policies are definitely out of hand and that only through forced inflation of commodity prices and wage levels can tax receipts be brought up to a point where the budget can be definitely balanced? Will not this bring with it a reduction in the purchasing power of the principal invested in the bonds and the interest collected thereon, with the consequent forcing of the prices of such bonds downward?
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