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A p r i l 27, 1938 Henry Edmistcm ANALYSIS OP THE MONETARY AND ECONOMIC ASPECTS OF CONGRESSMAN G0LDSB0R0UGHf8 RETAIL CREDIT BILL H, R. 7188 AND AMENDMENTS Congressman Goldsborougl^s new proposal i s quite different from the usual monetary authority plans f o r controlling booms and depressions which he and others have advocated i n the past. The p r i n c i p a l feature of his l a t e s t b i l l , introduced l a s t May and on which hearings were held l a s t summer and t h i s year, i s the scheme for increasing purchasing power i n a recession by offering d i s counts on consumer purchases at r e t a i l . The theory i s that the resulting i n - creased volume of r e t a i l sales would quickly work back through industry and restore capacity operations i n a l l l i n e s . Admittedly an increase i n business and consumer spending i s nooessary to promote business expansion, but Mr, Goldsborough's schcmo to achievc t h i s aim i s oversimplified, inequitable, and subject to many administrative and technical d i f f i c u l t i e s . Brief description of tho proposal A Federal Credit Commission i s established whose primary duty i s tho determination of a r e t a i l discount rato to apply on a l l purchases of consumers. This discount rato s h a l l bo fixed each month by tho Commission at the porcontago of i d l e productive capacity to t o t a l capacity which exists at the time, Tho rate shall be set by the b i l l at 15 percent u n t i l such time as the Commission otherwise determines, and i t shall not change more than 5 percent a month. No d i s - count i s to be granted i f the productive capacity of the country i s employed up t o 85 percent, so that i f any disoount rate i s proclaimed, i t can never be less than 15 percent* "When the plan has been placed i n operation, consumers w i l l go to tho stores and buy things i n tho usual manner at prevailing pricos, loss the discount at tho rate dotorminod by the Commission, I f tho rate wero 15 percent, for example, a $100 a r t i c l e would cost $85 and tho consumer would pay $85 i n oash and sign a voucher, supplied by tho Socrotary of tho Treasury, for $15, The r e t a i l merchant would therefore receive $85 i n cash and $15 i n warrants or vouchers. Those vouchers, however, could be deposited at his bank along with the cash and the r e t a i l e r would have the opportunity to check against the f u l l deposit of $100, The next step i s that the Secretary of the Treasury would issue a special kind of currency to be known as interbank currency notes equal to the amount of the voucher which the bank receives from the r e t a i l e r . These notes bear no i n - terest and would be available as backing for deposits created by the voucher. The notes would also bo availablo for interbank settlements and f o r payment of Federal taxes owed by the banks, but they would not be available to bo paid out to the p u b l i c . They would not, however, servo as reserves for a multiple expan- sion of bank c r e d i t . Tho idea i s that no i n f l a t i o n can occur so long as no moro notes are issued than are necessary to bring up the a c t i v i t y of the country to f u l l capacity and tho notes cannot bo used as rosorvos for credit expansion. Moreover, i f the Commission should f i n d that an i n f l a t i o n i s under way, i t could roquest tho Socrotary of the Treasury to r e c a l l a part of tho notes and tho banks would be required to contract t h e i r outstanding crodit accordingly. In order that the banks would not suffer an immediate loss through r e c a l l of tho notes, an amendment to tho b i l l provides that they shall be held i n trust f o r the banks by the Treasury and roturnod whon authorized by the Foderal Crodit Commission, In the meantime, however, they could not bo used to settle clearing balances, to count as reserves, or to pay o f f deposits i n case of l i q u i d a t i o n of a bank* Authority i s givon the Secretary of the Treasury to issue ten b i l l i o n s of notes to begin with* Ihe b i l l states that the proposal i s not to interfere with the Board of Governors i n any way or with the Federal Reserve System, which Shall continue t o have t h e i r present normal powers and duties. In fact, the Board i s given the added power t o r a i s e reserve requirements to 100 percent, as a further means of controlling a possible i n f l a t i o n i n the future. General orifeioisms of the proposal 1, Effectiveness as a recovery measure. - In the f i r s t place the economic v a l i d i t y of the underlying philosophy of the proposal i s open t o question. It is questionable, for example, that s u f f i c i e n t stimulation could be supplied by giv* ing discounts on r e t a i l sales i n a recession to guarantee that a l l forms of i n d u s t r i a l a c t i v i t y would r i s e to capacity• I t i s characteristic of a period of severe business recession that the production of perishable consumers1 goods declines much less rapidly and less substantially than doos the production of producers1 goods and durable consumers* goods* In these circumstances, there i s no assurance that the incomes of tho working classes through shortor hours and loss of jobs would not be f a l l i n g at such a rapid rate that even though r e t a i l d i s counts were given tho t o t a l volume of spending would continue t o docline. More- over, many persons who have incomes available f o r consumption expenditures might decide to c u r t a i l purchases i n a period of recession, even though pricos were f a l l i n g and a r e t a i l discount wore proclaimed, because they may expect that pricos w i l l f a l l further and a largor discount w i l l be given i n tho future. In tho meantime, however, they would spend only enough to cover tho chief necess i t i e s and would allow t h e i r surplus income plus the money saved on such purchases by the discount t o p i l e up i n the form of i d l e balances or perhaps use part of them to roduce indebtedness at banks and elsewhere, 2, Inequity of benefits provided by the plan. - A second imj^j^ant objec- t i o n i s that the method of giving benefits under t h i s plan disorltajp^tos against the low Income classes of the community. In order to obtain a subsidy from the r e t a i l discount, i t would be neoessary for the purchaser to have s u f f i c i e n t funds or be able to borrow the amount required to cover the difference between the l i s t price of the a r t i c l e s purchased and the r e t a i l discount,* This means that the beanefits would increase i n accordance with the volume of r e t a i l purchases and the p r i n c i p a l benefits would therefore accrue to the higher income groups* Those persons viho have l o s t t h e i r jobs through the decline i n production and, hence, have been deprived of t h e i r current sources of income would not be able to benef i t by the r e t a i l discount or would do so on a greatly reduced scale* This i s a form of discrimination that could not very well be j u s t i f i e d from the standpoint of public policy* The present system of direct r e l i e f and work r e l i e f i s predi- cated on giving assistance t o those persons who are unemployed and are therefore dependent upon public sources for t h o i r l i v e l i h o o d . I t should be noted that i t i s t h i s class which spends p r a c t i c a l l y i t s ontiro income f o r consumers1 goods* 3* Inflationary p o s s i b i l i t i e s * - In spite of the numerous safeguards which are incorporated i n the b i l l , Congressman Goldsborough's proposals contain a serious threat of ultimate inflation* In a period of sharp business recession, the amount of deposits created by the issuance of r e t a i l credit vouchers would be very large* On the basis of incomplete data, there i s reason to believe that i n 1932, for example, the amount would have totaled as much as $12,500,000,000* This increase i n deposits i n i t s e l f would not necessarily have led to inflationary conditions, provided the deposits were not subsequently used or that the banks contracted loans and investments and i n the process destroyed an equal amount of deposits* I t i s not necessarily true, however, that i n a period of recession loans and investments and deposits would automatically decrease and, hence, tho introduction of the r e t a i l discount might lead to a substantial increase i n t o t a l deposits* As time goes on, and the volume of spending increases and the a c t i v i t y of these depdsits picks up, there would be the p o s s i b i l i t y that an inflationary movement oould get under way i n a r e l a t i v e l y short time. In such circumstances i t would be very d i f f i c u l t to apply quickly measures which would force contract i o n and even i f such measures were adopted, i t would be at the r i s k of producing a drastic deflation, 4, D i f f i c u l t y of determining potential and unutilized capacity, - A num ber of the p r a c t i c a l d i f f i c u l t i e s would confront the Federal Credit Commission i n determining the potential oapacity and what percentage of t h i s capacity i s actually employed* On the baeis of our present s t a t i s t i c a l infonaation, t h i s would be an almost impossible task. Certainly i t would be necessary to set up elaborate and costly reporting systems, i f i t i s to be done on a current basis as contemplated under the b i l l . There are also a number of theoretical ques- tions i n connection with the d e f i n i t i o n of what constitutes potential capacity for a l l types of productive a c t i v i t y which would have to be settled before the discount rate oould be established with any degree of accuracy. Capacity i s re lated to price and i t would require high prices t o bring old obsolete equipment into production. Before capacity production i n a l l l i n e s i s reached, therefore many lines would be operating at f u l l oapacity and bottlenecks would appear. Further stimulation to r e t a i l sales i n such circumstances would be purely i n f l a t ionary* 5, Encouragement to price raising, - Another p r a c t i c a l problem i s that there seems t o bo no reason why r e t a i l stores could not raise prices to absorb the discount t o consumers. For example, stores could mark up a $10 a r t i c l e t o $12*50 and inform tho oustamer that i t w i l l only cost him $10 as usual, while the remaining $2,50 w i l l be met by the r e t a i l discount vouchor. I t might be possiblo to establish machinery for preventing such price increases, but this would appear t o be d i f f i c u l t because i t would bo hard t o determine d e f i n i t e l y tho roason f o r tho prico inoroase* Price increases might ho limited by offeotive compotition, but effoctivo competition i s not oomploto and there could bo cooperation among r e t a i l e r s or manufacturers to raise prices at least of certain types of a r t i c l e s . To the extent that the plan resulted i n price advances i t would f a i l t o produce additional purchasing power, 6, Administrative problems* - There would be many problems of policing the systom and a complex system of accounting and auditing would be necessary t o prevent widespread fraud* Licensing of a l l individuals and businesses which s e l l any goods or sorvices to ultimate consumers would also present many administrative diffioultios* Effoct upon the banking system The operation of the plan would seriously impair the e f f i c i e n c y of tho banking system and would rosult i n reduced bank earnings and possibly i n severe capit a l lossos* 1* Increased cost of bank operations* for which tho banks roceivo 11 - Tho expansion of bank deposits interbank curroncy" that carrios no interest would increase the expenses of banks without increasing t h e i r earning assets* Congress- man Goldsborough recognizes that the handling of the r e t a i l discount vouchers by the banks f o r customers would entail additional expenses and therefore provides that the Federal Crodit Commission s h a l l f i x tho service charge t o covor these expenses* I t would appear from tho language of tho b i l l that t h i s charge would bo i n tho form of an i n i t i a l deduction upon tho presentation of the vouchers by the r e t a i l o r s ! Such a charge would be e n t i r e l y inadequate and would be inequi- table as between individual banks* The p r i n c i p a l expenses to the banks would be the continuing ones of handling the larger volume of deposit transactions a r i s i n g from the creation of deposits against non-eaniing assets* TNhen the deposits o r i g i n a l l y created by deposit of a r e t a i l credit voucher are checked against and transferred to other "banks these hanks would not he able to make a special service charge* The most l i k e l y source of new income for the banks thus faced with decreased earnings would be to i n s t i t u t e additional ordinary service charges f o r handling deposit accounts* Competition and customer resistance would l i m i t the revenue that could be derived from t h i s source* In any event i t would bo a slow process and i n the t r a n s i t i o n period bank earnings would bo curtailed with impairments of banking c a p i t a l and probably failures i n the case of numerous individual banks* Tho introduction of higher service chargcs might also have other unde- sirable effects which arc d i f f i c u l t to prodict and could bo determined only by oxporionco with tho plan i n actual operation. For examplo, a higher l e v e l of scrvice charges might increase the volume of currency i n circulation* This would be a backward step i n view of the economy and e f f i c i e n c y with which business settlements are now effected through the use of checking accounts at commercial banks * 2. Effect of segregation of interbank currency from other bank reserves. - Many serious p r a c t i c a l d i f f i c u l t i e s would be encountered i n the segregation of the so-called interbank currency from other reserve funds of banks* The purpose of t h i s segregation i s , of course, to prevent the inflationary tendencies that would r e s u l t i f the new currency wore allowed to count as reserves upon which a multiple expansion of bank crodit could be based* The currency cannot be paid into c i r c u l a t i o n but i s legal tondor for making interbank settlements* In view of the fact that intorbank currency counts as reserves only dollar for d o l l a r , any adverso clearing balance would bo mot by uso of t h i s currency instead of regular reserves* Tho e f f e c t of thoso provisions would bo highly discriminatory among i n d i vidual banks* To i l l u s t r a t e l o t us assume that a bank has suffered a reserve - 8 deficiency through withdrawals of currency by the public or through adverse clearing balances after i t s interbank currency had been exhausted* "When the bank a t - tempts t o restore i t s reserves through s e l l i n g assets i t would receivo payment i n interbank currency* I t had l o s t reserves, however, which count as 1 to 5 against demand deposits whilo tho interbank currency i t rooeivos counts as reserves on a dollar for dollar basis* Consequently, i t would have t o s o l i four times as many assets as tho o r i g i n a l loss before i t s reserves wore brought back to tho legal requirements* . Congressman Goldsborough p a r t i a l l y recognized t h i s contingency by a provision to allow the conversion of interbank currency into legal tender currency when "there i s an emergency demand for currency that would lead to a dangerous forced l i q u i d a t i o n of assets*" This i s an emergency power, however, that appears to be designed t o protect the banking system as a whole i n ease of a wave of currency hoarding by tho public* I t apparently could not bo used by individual banks which sufforod curroncy withdrawals i n the normal course of operations* Moreover, i t would not help i n the case cited above where a bank suffered a reserve d e f i c i ency through adverse bank clearings* 3# gooall of intorbank curroncy notes* - Under the original b i l l tho re- c a l l of tho interbank curroncy notos would result i n immediate c a p i t a l losses to tho banks through tho Treasury acquiring a portion of t h o i r assets without reimbursing the banks* Tho amendment, para f ( i ) T i t l o I I I , i s designed t o correct this feature whioh would obviously bo disastrous to tho banking system* "While t h i s amendment would provent immodiato insolvency of a largo number of banks tho r e c a l l of interbank owrency would s t i l l presoirfc grave problems to many i n d i vidual banks* The amendment statos that tho recalled notes arc t o bo hold i n trust by tho Treasury f o r tho bonofit of the banks, but i t i s d i f f i c u l t to soe what theso "benefits" are* They would not bo available to tho banks to pay o f f 9 deposit or other l i a b i l i t i e s . The whole purpose of r e c a l l i n g them i s to reduce the reserves of the banks and force contraction of credit t o prevent inflationary tendencies that are developing. I t seems l i k e l y , however, that the cure would bo applied too late and might prove worso than the disease and a deflationary cycle would be precipitated,^ "When tho Commission docided to r e c a l l the notos the banks would bo f u l l y expanded on the basis of t h o i r available reserves i n cluding intorbank curroncy. Presumably, also, tho interbank currency would bo widely distributed among banks. Thus when the interbank curroncy notos are re- called i t would force a large number of banks t o liquidate assets at tho same time. This would probably load to dumping of securities, demoralization i n the markets, and the banks would probably suffer severe losses. Its effects would be similar i n t h i s respect to the effects of an increase i n reserve requirements when banks had no excess reserves. Congressman Goldsborough recognizes t h i s possible danger and provides (sec. 301, para, f ) that the banks s h a l l promote an orderly l i q u i d a t i o n and not use selective measures that would dopreciate particular classes of s e c u r i t i e s . How such a provision could be administered and enforced presents an i n s o l u b l e problem for the supervisory authorities. I f l i q u i d a t i o n under these circumstances loads to bank f a i l u r e s tho intorbank currency notes hold i n trust by the Treasury would not bo available t o meet the claims of depositors or other creditors unless released by tho Foderal Crodit Commission, I t might bo mentioned i n conclusion that Congressman Goldsborough does not appear to be greatly concerned with the possible detrimental effocts that the plan would have on the banking system. This i s perhaps because he has not thought through how the plan would operate i n practice. But also i t i s probably because ho believes that as banks moroly manufacture credit out of nothing they are not e n t i t l o d to rocoive a roturn on thoir loans and investments. flaw i n his roasoning on a l l banking matters. This i s a basic January 29, 1941 COORDINATION OF FISCAL, MONETARY, AND ECONOMIC POLICIES OF THE GOVERNMENT The Board of Governors has maintained consistently that the effective discharge of the Federal Reserve System1 s responsib i l i t i e s for monetary and credit policy are dependent upon coordination with the general economic policy being followed by the Government, the various phases of which are executed by a number of administrative agencies. Such coordination i s especially needed now that the national defense program i s moving into high gear and i n the near future w i l l exert an unprecedented stimulus to business a c t i v i t y and require a record volume of new Treasury financing. The magnitude of the program i s such that i n view of the underlying monetary conditions we could experience i n r e l a t i v e l y short time A the development of inflationary tendencies. These tendencies, if unchecked, would produce a r i s e i n prices which would retard the national e f f o r t for defense and greatly increase i t s cost, as w e l l as threaten the economic well-being of the general public. In order to f o r e s t a l l such developments, the Board feels that a l l agencies of the Government concerned with fiscal^ monetary, and economic p o l i c i e s should develop machinery for more continuous exchange of views and for closer cooperation i n the formulation of general policy. This i s especially true with respect to f i s c a l and monetary policies, which are immediate r e s p o n s i b i l i t i e s of the Federal Reserve and the Treasury. - 2 - Although most o f f i c i a l s would probably agree with the above position as a matter of p r i n c i p l e , there i s growing evidence that cooperation i n the formulation of policy has been neglected i n the recent past even more than formerly. A few specific examples of this are cited below. Treasury financing policy. Although representatives of the Federal Reserve System meet with the Secretary of the Treasury and his s t a f f prior to each Treasury financing, the discussions at these meetings are often confined to pricing and other technical aspects i n connection with a type of financing which has already been decided upon and perhaps tentatively announced i n the press. In view of the major financing operations required for the defense program, i t appears desirable that more consultation should be had i n formulating a general financing program, with a careful determination of the general objectives to be achieved and a detailed consideration of a l l possible types of issues that might be used to carry out these objectives. At any particular financing meeting appropriate issues can then be selected which w i l l conform with the general financing program i n so far as i s practicable i n the l i g h t of the market conditions existing at the time. The Board feels that i t i s peculiarly f i t t e d to advise the Treasury i n this respect. I t devotes i t s entire time to the consideration of monetary and credit conditions which involves the continuous study of business developments and Government f i s c a l - 3 - operations. Moreover, the Board i s i n constant touch with a l l developments &£. the Government security market. 2. Consultation with outside "experts". I t has long been the practice of the Treasury, when i t i s confronted with any new problem, to c a l l i n outside "experts11 for consultation. Accord- ing to the press, the Secretary of the Treasury recently conferred with Professors Jacob Viner of the University of Chicago and Roswell M a g i l l of Columbia University on "the types of new s e c u r i t i e s to be issued and the methods of marketing". I t i s d i f f i c u l t to see how people i n academic l i f e can give much p r a c t i c a l advice on these questions which involve continued and intimate knowledge of conditions i n the Government security market and i n investment markets generally. Considerations of an even more serious nature, however, ^mm^ htfikei' involved when outside "experts" with an intimate knowledge of d conditions are brought i n as was the case at the time of the outbreak of war when the Secretary employed Mr. Randolph Burgess of the National. C i t y Bank, Mr. Earle B a i l e y of the Tricontinental Corporation, and Mr. Tom K. Smith of the Boatmen1 s National Bank of St. Louis. Men of t h i s type often make recommendations which are prejudiced i n favor of the private i n t e r e s t which they represent. In addition, while connected with the Government on a temporary basis, they have access to c o n f i d e n t i a l information on prospective Treasury plans as w e l l as onkMrtMcJL Treasury and Federal Reserve current operations tff in the market,^whicn would provide t h e i r i n s t i t u t i o n s with invaluable tips on investment p o l i c y . The individual himself may be scrupulously - b - , honest i n seeking to avoid the divulging of any c o n f i d e n t i a l information, but may inadvertently l e t things s l i p which may be used by his business associates as guides to market operations* In t h i s connection, i t may be observed that a large New York City i n s t i t u t i o n , with which one of the Treasury 1 s outside "experts" was a high o f f i c i a l , purchased a substantial amount ($16,000,000) of Treasury bonds close to the lows of the market i n l a t e September and early October 1939* This action may have been a pure c o i n c i - dence, because i t has been the p o l i c y of t h i s i n s t i t u t i o n to buy Governments on the scale down when prices decline and to l i q u i d a t e part of i t s holdings on any substantial price advances* Regardless qf whether there has been any misuse of c o n f i dential information which must necessarily be made available to such advisors, the Treasury remains subject to c r i t i c i s m when i t ohvtoaS employes men t i k e t h i s on a temporary basis because of the possiA b i l i t i e s i n the s i t u a t i o n and also because of the c o n f l i c t s between private and public interests which i n e v i t a b l y e x i s t i n the formul a t i o n of financing policies* 3* Secretary Morgenthauys comments to the press on the Federal Reserve report* At his press conference on January 9 the Secretary asserted that a "substantial and unwarranted decline" i n the prices of Government bonds had been caused by the Federal Reserve System's special report to Congress on tfejgrmonetary conditions and indicated that he would oppose at least c e r t a i n aspects of the Board 1 * - 5 - proposals " i f Congress takes the matter seriously 11 . The Secretary was f u l l y advised about this report long i n advance of i t s publicat i o n and gave no prior indication that he would publicly express such an attitude toward i t . At the time of the Secretary's statement the long-term Government bond market had reacted s l i g h t l y over two points since the issuance of the Federal Reserve report, but i t was s t i l l higher than at any time prior to the election l a s t November. In fact, the y i e l d on the longest bonds outstanding was only about S M per cent as compared with the all-time low' y i e l d of 2.03 per cent reached early l a s t December. In connection with the Sepretary*s recent assertion that Government bonds had suffered a "substantial and unwarranted decline 11 , i t i s interesting to r e c a l l that t h i s longest bond issue was s e l l i n g at about 109 l / U par i n compared with less than September 1939 when the Secretary and, his outside banking advisors were urging the Federal Reserve to withdraw i t s support from the Government bond market. I t was our view at that time that ^Jdm speculative forces had driven prices of Government securities to unreasonably low levels i n view of underlying conditions, and we did not wish to see the development of panicky l i q u i d a t i o n that further speculative price declines might have engendered. Moreover, we did not wish to see the shrewd market speculators and the trading banks have the opportunity to acquire bonds at "bargain" prices. - 6 - Foreign loans of gold from the S t a b i l i z a t i o n Fund. Although a member of the Board*s s t a f f ms invited to s i t i n on certain Treasury conferences at which were discussed some of the technical details of recent foreign loans, the Board was not consulted on the broad question of the policy of using S t a b i l i z a t i o n Fund gold for this purpose. Use of this gold d i r e c t l y increases bank reserves and consequently affects the domestic monetary situation. Two such loans already announced, to China and Argentina, involve the use of 1100,000,000 gold from the S t a b i l i z a t i o n Fund, but no disbursements on either loan have yet been made. 5. Bank holding company b i l l * The new bank holding company b i l l under Treasury auspices was introduced without any consultation with or even advance notice to the Board of Governors. This action cannot be j u s t i f i e d i n view of the fact that this was exclusively a banking matter and the Federal Reserve i s the only Government banking agency which has had any experience i n the admini s t r a t i o n of bank holding company l e g i s l a t i o n .
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