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X
CREDIT POLICIES
HEARINGS
BEFORE
THE
JOINT COMMITTEE ON THE ECONOMIC KEPOET
CONGRESS OF THE UNITED STATES
E I G H T I E T H CONGKESS
SECOND SESSION
PURSUANT
TO
SEC. 5 (A) OF PUBLIC LAW 304,
79TH CONGRESS
A P R I L 13, J6, M A Y 12, 13, 27, 1948
P r i n t e d for the use of the Joint Committee on the Economic Report
U N I T E D STATES
77099
GOVERNMENT PRINTING OFFICE
W A S H I N G T O N : 1948
JOINT
UNITED
C O M M I T T E E
STATES
SENATE
ON
T H E
ECONOMIC
H O U S E OF
REPORT
REPRESENTATIVES
JESSE P . W O L C O T T , Michigan, Vice Chairman
R O B E R T A T A F T , Ohio, Chairman
G E O R G E H . B E N D E R , Ohio
J O S E P H H . B A L L , Minnesota
R O B E R T F . R I C H , Pennsylvania
R A L P H E . F L A N D E R S , Vermont
C H R I S T I A N A . H E R T E R , Massachusetts
A R T H U R V. W A T K I N S , Utah
E D W A R D J . H A R T , N e w Jersey
J O S E P H C. O ' M A H O N E Y , W y o m i n g
W R I G H T P A T M A N , Texas
F R A N C I S J. M Y E R S , Pennsylvania
W A L T E R B . H U B E R , Ohio
J O H N J. S P A R K M A N , Alabama
CHARLES O. HAKDY, Staff Director
FRED E . BERQUIST, Assistant Staff Director
JOHN TV. LEHMAN, Clerk
WILLIAM H . MOORE, Economist
CONTENTS
Statement of:
Bopp, K a r l R., Federal Reserve Bank of Philadelphia.
Eccles, Marriner S., Federal Reserve System,,
Riefler, Winfield W. f Federal Reserve System...
Rowe, John J., F i f t h T h i r d Union Trust Co., Cincinnati, Ohio
Schram, Emil, president, New Y o r k Stock Exchange
Sproul, Allan, Federal Reserve Bank of New Y o r k
Thomas, \Yoodlief, Federal Reserve System._
. ._
in
138
1, 29
131
55
111
87
131
CREDIT POLICIES
TUESDAY, APRIL 13, 1948
C O N G R E S S OF T H E U N I T E D S T A T E S ,
J O I N T C O M M I T T E E ON T H E E C O N O M I C R E P O R T ,
Washington, D. C.
The committee met at 10 a. m., pursuant to call, in the main caucus
room, Senate Office Building, Senator Robert A. Taft (chairman),
presiding.
Present: Senators Taft (chairman), Glanders, and Watkins; Representatives Rich, Herter, Patman, and Huber.
The C H A I R M A N . The committee will come to order.
This is the opening of hearings which the committee wishes to conduct to study the whole question of credit control, particularly the
control of bank credit, the maintenance of the interest rate, and the
maintenance of the price of Government bonds. We also intend to
ask the witnesses something regarding the question of the availability
of money for investment, and whether there is a sufficient supply of
equity capital as opposed to bank credit.
M r . Eccles, you are the first witness, and we will be glad to have you
proceed.
STATEMENT OF MARRINER S. ECCLES ON BEHALF OF THE BOARD
OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, WASHINGTON, D. C.
M r . E C C L E S . M r . Chairman and members of the committee, when
I testified before this committee last November 2 5 , 1 emphasized that
I was speaking only for the Board of Governors of the Federal Reserve
System. I n presenting a further statement today covering the
monetary and credit situation as i t has developed in the intervening
4 months, I am again speaking only on behalf of the Board.
We, of course, do not participate in the Government's military or
rearmament planning or in the formulation of programs for foreign
relief. Accordingly, what the Board has authorized me to say with
regard to the impact on our economy of military and relief expenditures
is said solely from the standpoint of the implications so far as monetary
and credit policies are concerned. We feel that in any effort to deal
w i t h monetary and credit problems under the situation now existing,
we should clearly recognize the alternatives before us and the economic consequences of expanding military outlays superimposed
upon the present large budgets for military purposes and for our
program of world aid.
Never in our memories has the world been pervaded by greater
fears, confusion, and discouragement, arising chiefly because of the
disappointments of the past and the uncertainties of the future.
The great hopes we had during the war for achieving a lasting peace
i n a prosperous world have been steadily diminished because a few
1
CREDIT POLICIES2'
ruthless and despotic men hold a sword of Damocles over the heads
of free peoples throughout the world. I t is difficult, if not impossible,
to plan for a rational economic future either at home or abroad while
that sword hangs over us.
We think that the prospect of removing the threat by peaceful
means will be immeasurably enhanced the sooner we assert our moral
and physical power to establish the foundations for peace before we
are engulfed by the economic and social problems which grow more
menacing the longer the establishment of a firm basis for permanent
peace is delayed.
Monetary situation in November: When I last appeared before this
committee, the country was faced with rapidly mounting inflationary
pressures. The issue then was how to curb inflationary forces by
striking directly at the basic cause, namely, an effective demand—
composed of spending out of*past savings, current income and new
credit—in excess of the over-all supply of goods and services. As
pointed out in the Board's statement to this committee, correction
of inflation at its advanced stand had to be on a broad front; fiscal
policy had to be our main reliance; and monetary and credit policy
was supplementary to other fundamental actions. The Board felt
then, as it feels now, that effective monetary and credit policy would
require legislation to provide the Federal Reserve System with new
powers that would serve as a partial substitute for those traditional
powers which had become largely unusable in view of the huge public
debt.
I would like to emphasize there that we say "new powers," and not
"increased or greater powers." We speak of new powers, which are
only a partial substitution for powers that have formerly been used,
those which we call the traditional powers.
The essential monetary fact in the inflationary situation at that
time was the amount of liquid purchasing power in the hands of the
public, that is, currency* bank deposits and Government securities,
aggregating in all about $254,000,000,000, or more than three
times the amount held in 1940. This amount of cash or cash equivalent was in large part inherited from the financing of the enormous
Federal deficits incurred in preparation for and prosecution of global
war. Not only did we have this huge volume of cash or cash equivalent already available last November, but at that time, despite' the
anti-inflationary influence of the Government's large budgetary surplus, the amount of liquid funds was being rapidly increased as a result
of bank credit expansion to finance businesses and individuals as well
as state and local governments.
Because of the necessity for protecting the Government's fiscal and
debt management position by maintaining an orderly and stable
market for Government securities, the Federal Reserve System was
then and still is unable to restrain effectively further monetary expansion. The commercial banking system held nearly $70,000,000,000
of Government securities, which were being converted into
additional bank reserves through sales to Federal Reserve. I n
addition, the System was providing reserves to banks by purchasing
Government securities sold by nonbank investors. That, of course,
was in support of the Government bond market.
The C H A I R M A N . Will you spell out how that works, M r . Eccles?
That is, how banks are provided with reserves by the purchase of
CREDIT P O L I C I E S
Government securities held by nonbank investors?
i t out so that it is clearer?
M r . ECCLES.
3 '
Will you spell
Yes.
I f a corporation, or an individual, anyone other than banks, sells
securities in the market, and the residual market is the Reserve
System, they of course are paid for those securities in Federal Reserve
funds. The recipient of the funds puts the money into the bank, and
the bank therefore has excess reserves on one side and deposits on the
other.
I n other words, the Federal Reserve creates the money, that is,
reserve money, whenever we purchase securities. When you purchase
the securities from other than banks, the seller gets deposits, and the
bank of course has excess reserves on the assets side of its ledger to
offset the deposits i t receives on the liabilities side.
The C H A I R M A N . That assumes that they do not reinvest in other
securities.
M r . E C C L E S . Who?
The C H A I R M A N . The people who sell the bonds.
Mr. E C C L E S . Well, if they do, then somebody else gets the money
and that goes back into the banks in the same way. The only way
that you can extinguish additional bank reserves, once created by the
Reserve System, is for the Reserve System to sell an amount of
Government securities to offset the amount which they purchased or
to have the Government, through a budgetary surplus, retire
Government securities which the Reserve System holds.
Senator F L A N D E K S . Is the result the same if the Treasury pays off
securities?
Mr. E C C L E S . Well, if the Treasury pays off securities out of its
surplus funds, that is generally deflationary. Where the Federal
Reserve buys securities, that is generally inflationary. I t is exactly
the opposite.
Senator F L A N D E R S . Is i t deflationary or neutral if the Treasury
receives funds from taxation and then pays off its securities? I do
not see how that is deflationary. Is that not neutral?
M r . E C C L E S . No, i t isn't neutral at all; because as the mone^ goes
out of the bank into the Treasury
Senator F L A N D E R S . I am not talking about what is bank held,
although we will come to that later. I was thinking of what is
privately held.
M r . E C C L E S . But the Government doesn't pay off the privately
held securities. What the Government does with its surplus funds is
to retire the securities that the Federal Reserve owns, so that the
money does not return to the banking system. I f the Government
took tax money that i t receives and paid off securities held by taxpayers, then the same amount of money would be returned to the
spending stream that was taken away in taxation.
Senator F L A N D E R S . That is neutral.
M r . E C C L E S . That is neutral.
Senator F L A N D E R S . What happens, however, if i t takes tax money,
reducing deposits thereby, and pays off bank-held securities?
M r . E C C L E S . Well, that would be neutral. Because the money
that the bank held on deposit for the taxpayer goes to the Government, and the Government, of course, would return that money to
the bank. What would happen is that the bank's deposit would be
CREDIT POLICIES4'
diminished when the tax was paid. An asset equal to that amount,
of course, would be reacquired when the money is returned.
But what really happens as a practical matter when the tax money
is drawn out of the banks? The banks are put under pressure to meet
that withdrawal, and therefore they have to sell Government securities
at the time the tax money is drawn out. I f money is not returned to
them by the Government as fast as i t is being drawn out, then the
banking system has to sell securities to meet the withdrawal of tax
money. The Federal Reserve, of course, buys those securities from
the banking system. Then the Government pays off securities held
by the Federal Reserve.
The C H A I R M A N . I S not the net result, though, of the whole business
more or less neutral? That is to say, you take a certain amount of
taxes out of the banks. You thereby reduce their deposits. After
the process is finished, they have replaced their bonds with cash.
They have paid off their deposits.
M r . E C C L E S . That is not quite correct. The process is a reversal
of war financing.
During the war period the banks bought Governments and created
deposits. That is what is called deficit financing, done through the
banting system. When there is a budgetary surplus and the funds
are used to pay off the banks, then you have reversed the process.
You extinguish the money created, and you likewise extinguish a like
amount of the assets that the bants hold in the form of Government
bonds. So that i t is a reversal of deficit financing, which is inflationary. Therefore, i t is equally as deflationary on the money system as
i t is inflationary during
The C H A I R M A N . I do not see why i t is deflationary at all. I could
see why- the drawing of deposits out is deflationary. But when you
get all through, the bank has 100,000 less assets, we will say, and
100 less deposits.
M r . E C C L E S . That is deflationary. There is that much less money
in the money system, just the same as budgetary financing is inflationary, because you create new money through the banking system
when you finance the deficit, and you extinguish that money when
you have a budgetary surplus.
The C H A I R M A N . Do they not actually have more money that you
lend by reason of the fact that, although the assets are not turned
into cash, you can turn them into cash?
M r . E C C L E S . But the point is that the banks are less willing to
expand credit when they are deficient in their required reserve and
find i t necessary to sell or liquidate some of their earning assets.
When the banks have a deficiency in their reserves, which they do
as their deposits are drawn out in taxes, they must either collect
loans or sell Governments or borrow from the Federal Reserve.
Therefore, they are under pressure.
The C H A I R M A N . N O W , they can sell Governments. I n fact, the
very hypothesis is that the Federal Government is paying the Governments off, so they replace their Governments with cash.
M r . E C C L E S . No; they do not replace them, because the Government uses its surplus cash to retire securities held by the Reserve
System.
Representative H E R T E R . I n one case the bank had both the bond
and the cash; in the second case, i t had only the cash. When it had
CREDIT P O L I C I E S
5 '
both the bond and the cash, the bond becomes then an asset that they
can discount at the bank, and again re-create credit. I f you retire
the bond, i t becomes a deflationary operation.
M r . E C C L E S . But you see what happens: As the money is drawn
out of the banks, in order to meet the withdrawal, the banks must
sell something or collect a loan or borrow in order to meet the tax
withdrawal.
The C H A I R M A N . Having done that, are they not just where they
were when they began?
Mr. E C C L E S . That is right. But when you do that, i t is strongly
deflationary. If you kept the process up long enough, instead of
having, as you have today, 170 billions of cash and deposits, you
would go back to the 66 billions we had before the war.
The C H A I R M A N . But as long as they have 70 billions of bonds, I
do not see why i t is deflationary. They turn i t into cash, and they
are exactly where they were before.
M r . E C C L E S . That is exactly why we proposed the special reserve
before, and why we talk about reserve requirements; because of the
ease with which the banks can meet current credit demands.
There is no problem at all of the banks meeting the withdrawal
demands or the credit demands, because of the fact that they have
this large amount of Government bonds that is readily convertible
into reserves, upon which a multiple credit expansion can take place.
Senator F L A N D E R S . Mr. Eccles, as a project of adult education
for the junior Senator from Vermont, I wish it were possible to put in
balance-sheet form at the end of each transaction what happens in a
bank statement when, in the process of deficit financing, banks
acquire bonds, what happens when they let them go, how i t affects
reserves, how i t affects loan capacity, and so on.
Now, my reason for wanting to see this in a single sheet that I can
hold in my hand and look at the figures, instead of listening to dissertations, is this:
Out at the meeting of the American Economic Association in
Chicago last December, I listened to dissertations. And I came out
very much confused.
Just as an onlooker, not knowing all of the rules of the game, I
judged at the time that the decision, perhaps on points, lay with those
who felt that there wTas no automatic deflationary effect to the retirement of bank-held bonds; which completely reversed the automatic
inflationary effect of acquirement by the banks of bonds in the process
of deficit financing.
I n other words, i t was not completely the reverse.
And I wonder if i t would not be possible for you to prepare and insert
in the record at a later date these processes of acquiring and disacquiring Government bonds by the banks and its effect on the bank
statement, on its ability to loan; its effect on reserves, and its ability
to loan. I would rather see it in figures than in a mass of words.
M r . E C C L E S . I think that it possibly can be done.
Or course, to understand the process of creating money through the
banking system, one first must understand the principles of accounting
and likewise the principles of central banking. That becomes basic.
And it really isn't simple. One can be very easily misled. I t is a
subject that requires study and concentration, and especially when
you think in terms of 15,000 banks.
C R E D I T P O L I C I E S6'
I f you would think in terms of 1 bank with 15,000 branches, then
the process becomes more easily understood. But i t becomes extremely confused when you consider it from the standpoint of the
State nonmember banks which carry reserves with Reserve city banks.
And when you consider, in addition, in connection with the three types
of member banks, it becomes quite confusing because of the different
reserve requirements and the effects of different reserve requirements
of member and nonmember banks.
I f I may proceed with my statement, perhaps some clarification will
come out of later discussion.
The C H A I R M A N . I would like to have the same thing Mr. Flanders
does. But I think I understand the inflationary process, although i t
seems to me there is quite a difference of opinion in the reports I have
read on this deflationary effect, the paying off of bonds in the hands
of the banks.
I would like to see just what does happen when the taxes are drawn
out and then when the bonds are sold or paid off. I think such a thing
might be helpful.
M r . E C C L E S . Of course, how do you reverse the inflationary process?
Certainly we know that financing of budgetary deficits through the
banking system creates new deposits, just like any other form of credit
creates deposits. I f loans are being paid by one group of our citizens
as fast as loans are being made by another group, there is no change in
the total deposits.
But to the extent that all credit, including Government credit, is
expanded by the banking system, you create new deposits. And
just to the extent that credit is contracted, public as well as private
credit, by the banking system, you are reversing the process and you
are extinguishing deposits.
The C H A I R M A N . On the other hand, the bank has loaned a lot of
money to the Government. The Government comes in and pays i t
off, and they take the money and loan it to somebody else. I don't
see anything deflationary about that.
M r . E C C L E S . But they don't pay i t to somebody else when the
Government retires debt held by the Reserve banks. The money
disappears. I t never gets back.
The C H A I R M A N . But I am suggesting that, as to the mere fact that
they have the additional money, and the Government pays off and
turns around and lends to somebody else, there is not anything
particularly deflationary about that.
M r . E C C L E S . What happens when the Government collects more
money in taxes than i t spends; that is, when it has a budgetary
surplus? That money, that surplus money, actually, to the extent
that i t is used to pay off the Government bonds that the Federal
Reserve System has acquired, is not returned to the spending stream,
and i t actually extinguishes an amount of deposits equal to the
liquidation of that credit. The exact opposite would be the case if
there was a budgetary deficit and the banks financed the deficit.
A budget surplus with retirement of Federal Reserve-held debt is
a direct and complete reversal of deficit financing through the banks,
and i t extinguishes the same amount of money.
Representative H E R T E R . Following that same line of reasoning you
mentioned a moment ago, the support of the bonds by the Federal
Reserve; if the Federal Reserve has to support the bond market and
CREDIT P O L I C I E S
7 '
has to go in and buy in order to hold the levels up, that becomes in
itself an inflationary process, does it not?
M r . E C C L E S . That is correct. I t makes i t very easy for the banks,
as long as they have the large volume of Government bonds which
they acquired during their war financing operation, to get Federal
funds or Reserve funds. They can get them with great ease. Therefore, i t is difficult to put pressures upon the banks to hold down
expansion of private bank credit.
Representative H E R T E R . Well, recently, when the bond market was
dropping, did not the Federal Reserve have to put in a good deal to
hold the bond market up?
M r . E C C L E S . The Federal Reserve dropped the bond market
substantially in December, because we felt that there was no justification for supporting the market at the premium prices which had
prevailed. I n other words, we felt that there was too much of an
inducement, both to the banks and to the nonbank investors who had
market bonds to sell those bonds while they could not only get the
return of their money, but could get a premium upon them, than
would be the case if the premium disappeared.
And in many cases banks had bought Government bonds at a substantial premium. Then, when the Government bond market was
permitted to drop, book value actually exceeded market value,
because these banks had purchased Governments at considerably
higher prices than the support level that we dropped to.
Now, that action deterred to some extent, and I think a very
considerable extent, bank selling of Government bonds*
The C H A I R M A N . Will you proceed, then, Mr. Eccles?
M r . E C C L E S . I f I may, to get this in the record—I believe I stopped
at this point. I n addition, the System was providing reserves to
banks by purchasing Government securities sold by nonbank investors.
Finally, bank reserves were being substantially augmented by a heavy
inflow of gold.
I n brief, the banks at that time were in a position to supply unlimited amounts of additional credit, and, in the face of strong demands for additional credit from all sources, further rapid monetary
expansion was occurring, intensifying existing inflationary pressures.
This situation was potentially explosive because production and employment were close to the maximum then possible.
I n other words, to merely add to the supply of money when you
were using your production and employment to practical capacity
only forced up prices. And, of course, that is the difficulty in the
various foreign countries today, where the amount of their bank
deposits in currency so far exceeds the supply of goods, and wiiere
many of them are still operating on unbalanced budgets and creating
more money, because the Government deficits that they are running
are being financed by the banking system. And that is why you see
the terrific inflationary situations that exist in other countries. I t is
the same process that proceeded here to a very limited extent. But
i t is exactly the same principle.
Changes since November: Last November we expected some abatement of inflationary pressures in the first quarter of this year. Such
a situation developed. I t was recognized that there would be a large
volume of funds drawn from the banks by business and individuals
in order to pay taxes, which would result in a large cash surplus
available to reduce the public debt.
CREDIT P O L I C I E S8'
I t was also recognized that the existing and contemplated "program
of monetary and credit policy would have some restrictive effect.
The program—that is, this contemplated program, which was carried
out—included the statement by the bank supervisory agencies urging
the banks to be more restrictive, the lowering of Federal Reserve
support levels for Government securities late in December, a slight
rise in rediscount rates early in January, and some increase in reserve
requirements for banks in New York and Chicago in February.
The banking fraternity, recognizing the dangers in rapidly expanding bank credit and the need for restraint, undertook a Nation-wide
educational program to bring about restriction by voluntary means.
Finally, there was a widespread belief that the supply of goods in
many fields was gradually catching up with deferred demands and
that favorable crop developments would combine to lessen inflationary
pressures by the spring of this year. That is what you would call a
psychological effect.
Monetary developments since November have accorded generally
with expectations held at that time. Fiscal and monetary operations
together effectively offset factors increasing bank reserves during the
period; that is, during this 4 months' period that we had some inflationary factors. And here is what they were: the inflow of gold, the
return of currency from circulation—which has amounted to about
$1,200,000,000 from its peak in December, and which, of course,
adds to deposits of banks and to excess reserves-—and purchases by
the Federal Reserve of Government securities from nonbank investors.
Representative R I C H . May I ask a question right there? Was that
paper?
M r . E C C L E S . Yes; that was paper currency. That is the currency
in circulation, which decreased about $1,200,000,000 from its peak, in
December.
Of course, it always goes up prior to the Christmas holiday season.
There is always a seasonal drop in the volume of currency in the first
quarter of the year, but the seasonal drop this year has been considerably more than normal.
Representative R I C H . Was there any part of that, any great part
of that, in coin?
M r . E C C L E S . N O ; that wouldn't amount to much. The coin in
circulation is a very small factor. I t is bills.
To continue with my statement, these inflationary factors include
the inflow of gold, return of currency from circulation, and purchase by
the Federal Reserve of Government securities from nonbank investors.
These factors all added to the reserves of the bank. However, they
were more than offset by the fiscal and monetary operations during
that same quarter. Here is what they were.
During the 4-montli period December through March the Federal
Reserve purchased 8.6 billion dollars of Government securities—
which will give you some idea of the size of our operations—largely
bonds, and sold in the market 6.3 billion dollars of securities, chiefly
bills and certificates. That was because we dropped the Government
bond market, and there was for a time fear that the price of longer
term securities would go lower, therefore, they were being sold and
replaced to some extent with short securities.
The Government retired $3,900,000,000 of its securities held by the
Federal Reserve. That was the budgetary surplus. The net result
CREDIT POLICIES
9'
of these operations was to reduce the Federal Reserve holdings by
$1,600,000,000, and thus to keep the bank reserve positions under
pressure during this period.
Now, $1,600,000,000 for that period as a reduction in total Federal
Reserve holdings during that period was a very large amount. I n
other words, if we bought $1,600,000,000 more securities from the
banks than we sold, that would give the banks $1,600,000,000 of reserves, upon which you could expand $10,000,000,000 of credit. We
contracted enough Federal Reserve funds in that 4-month period
to support the $10,000,000,000 of bank credit. That is what $1,600,000,000 amounts to.
The combined effect on the money supply of Treasury and Federal
Reserve operations, which were only made possible by the large
budgetary surplus, was strongly anti-inflationary. The money supply
was contracted by nearly $4,000,000,000. Commercial bank loan
expansion was sharply curtailed, partly reflecting fiscal and monetary
developments, and partly reflecting the effectiveness of warnings by
banking supervisors and the success of the bankers' own program of
voluntary restraint, and partly reflecting the usual seasonal slack in
business loan demand during the first quarter. There was an expansion totaling only about $700,000,000 of bank credit during the
entire quarter; which, of course, was a very great slackening compared
with what was happening last fall when bank credit was expanding at
the rate of about a billion and a half a month.
Concurrently with these developments, the world crop outlook has
become more promising, and prices of farm products and foods have
declined. I n addition, productive activity generally has held close to
maximum levels. These developments have exerted an anti-inflationary influence.
Prospective monetary and credit situation: Notwithstanding these
salutary developments, i t cannot be said that inflationary dangers
have been removed. Farm prices, though lower than they\vere, still
continue firm, even though at present levels they are much higher
relatively than prices of most other commodities.
Current and backlog demands for many goods continue to be very
strong. Prices of industrial products, wages, rents, transportation,
and some other services, are still advancing. The money supply,
though contracted by an estimated $4,000,000,000, remains excessive
in relation to the total product. Public holdings of cash or cash
equivalent available for spending are nearly as large as last fall—
$250,000,000,000, compared with $254,000,000,000—and continue to
be broadly distributed among holders.
The cash equivalent, of course, is the Government securities held
outside of the banks. Commercial banks, though obliged to sell some
securities to offset shrinking deposits during this last quarter period,
still hold $66,000,000,000 of Government securities, which are readily
convertible at the bank's discretion into reserves. Upon these reserves, a 6 to 1 expansion of bank credit and deposits can be built.
To the extent that the monetary gold stock is increased and Government securities are sold to the Federal Reserve by nonbank investors,
still more reserves would be created. These additional reserves could
also support an inflationary 6 to 1 expansion of bank credit.
On trie basis of the monetary situation alone, there would still be a
dangerous inflationary potential, even if no further impetus were given
CREDIT POLICIES10'
to inflationary pressures by other forces. However, upward pressures
are now in prospect as a result of several important new factors. One
of these is the tax reduction bill. This bill will add about $5,000,000,000
to the purchasing power of the public and take away a like amount
from Federal revenues in the next fiscal year.
The international financial obligations which we have now accepted
are another factor likely to add many billions to Government expenditures in the future. The expanding program of military preparedness
will further increase the budget burden for next year and future years
by still more billions. Stemming from these developments, on top of
existing inflationary conditions, is a rapidly changing public psychology
with respect to the inflationary outlook.
Businesses and consumers will be more disposed to use existing liquid
resources, and to expand their borrowings to finance current expenditures. The prospect is that the demand for new financing, aside from
Government requirements, will exceed the supply of available savings.
This would mean that many in need of financing will turn to the banks
for credit. A giowth in the total volume of bank credit and money
under such a situation can only add to inflationary pressures. Moreover, these pressures would be aggravated if the demands of the
defense and foreign-aid programs for goods which are already in short
supply further reduce the quantities available to the public.
The Government's fiscal operations for the balance of the oalendar
year 1948—that is, the last three quarters—are likely to show a
budgetary deficit, which would eliminate the only remaining important
anti-inflationary influence. During the last three quarters of the year,
it is estimated that the budgetary deficit may exceed $3,000,000,000.
You will note, in parentheses, in the statement, this observation:
I n v i e w of large t a x receipts i n the first quarter of 1949, however, there m a y be
a small budgetary surplus for the 12-month period beginning w i t h A p r i l 1 of this
year.
The C H A I R M A N . This, of course, is highly conjectural on a lot of
things.
M r . ECCLES. Of course, you can't do other than make your estimates based on the known factors. I t is, we admit, difficult to see
very far into the future under these conditions. But we feel that the
conditions are not likely to be more favorable than we anticipate.
They could be less favorable. I think that the statement here is a
conservative one, and does not undertake to exaggerate the possibilities.
Representative R I C H . Is not the great question just what Congress
is going to do between now and the end of the fiscal year in making
commitments?
M r . ECCLES. That, of course, is the basic question insofar as the
budget picture is concerned.
Representative R I C H . And you have already figured now that with
the commitments that have already been made and passed into law,
you are going to be three billions in the red.
M r . ECCLES. Well, that is with some military expansion.
Representative R I C H . You have given credit for sopcie?
M r . ECCLES. That is right.
Representative R I C H . But you do not know what the ultimate
amount is going to be. I guess nobody does.
M r . ECCLES. That is right. We have the estimate for the next
fiscal yea-r, the 1949 fiscal year, of revenues, based on full production
CREDIT POLICIES
11 '
at approximately these price levels, and the tax revenues on that
basis, together with the estimated expenditures.
The. C H A I R M A N . M r . Eccles, the first 9 months of this fiscal year
there was a budget surplus of up to $8,000,000,000.
M r . E C C L E S . Or thereabouts.
The C H A I R M A N . Somewhere near eight. Now, of that eight
billion dollars or so, practically all but $1,000,000,000 came in the first
quarter of the year. Is that not correct?
Mr. E C C L E S . I think most of i t certainly did. There may have been
more than a billion in the other quarters.
The C H A I R M A N . And in your estimate here, about a deficit of $ 3 , 0 0 0 0 0 0 , 0 0 0 , you are taking the 9 months beginning the first of April, to
the end of the year, and leaving out the first quarter, which was the
lucrative quarter?
M r . E C C L E S . But, you see, the inflationary impact comes during
the next 9 months. And that is a period in which the banks will be
under no pressure whatever, but i t will be a period when the Government may actually have to give reserves to the banking system. So
the point that I will make here is to show what we have ahead of us
for the next 9 months.
Now, it is true that the following 3 months, in the first of the year,
will be likely mildly deflationary, if you get the budget surplus during
that period that is contemplated.
But in the interim period, the next 9 months, during the period
when we need some restraint, we will not have any. That is the
point that I am making, because I am going to argue why we should
get some more credit controls here in the picture, and that is the
immediate problem.
The C H A I R M A N . I just wanted to make i t clear that when you are
talking about a deficit, you are talking about the 9 months which
may produce a deficit even this year, and which consisted this year of
a surplus of eight billion.
M r . E C C L E S . Yes; but I also pointed out what would happen for
the year.
The C H A I R M A N . I did not question the accuracy, M r . Eccles. I
merely wanted to be sure that the newspapers understood what the
basis of it was.
M r . E C C L E S . That is why we we put in parentheses here that for
the year as a whole there would likely be a small budgetary surplus.
I t was to emphasize the 9 months that we were speaking about, where
there would be the deficit. During that period, you will not have the
anti-inflationary effect of a budgetary surplus.
The C H A I R M A N . Can you give us for the whole year your estimate
of receipts? You said you had those estimated. I would just be
interested to know what they were. Is that from April 1 to April 1,
or the fiscal year?
M r . E C C L E S . The fiscal year.
The C H A I R M A N . The next fiscal year?
M r . E C C L E S . Yes. These are cash budget receipts; 4 2 } £ .
The C H A I R M A N . Forty-two and a half after the tax reduction?
M r . ECCLES. Y e s .
The C H A I R M A N . Now,
in all of these estimates, you, of course,
have not taken account of $ 3 , 0 0 0 , 0 0 0 , 0 0 0 of cash surplus, of money
which is taken into the trust funds of the Government and not paid
out; so that from an inflationary-deflationary standpoint, you have
C R E D I T P O L I C I E S12'
got to add $3,000,000,000 to any surplus you have, or deduct that
from any deficit that you are talking about.
M r . E C C L E S . Well, we estimate, however, as I will show in this
statement, that we recognize what that is. The effect of that is
covered.
The C H A I R M A N . I n other words, the Government's cash position
is about $3,000,000,000 better than the budget position.
M r . E C C L E S . N O , we estimate that it will take those receipts, plus
the receipts from the sale of savings bonds, to pay off the redemption
of savings bonds and to likewise pay for the redemption of other
securities held by holders that will not accept refunding. I refer to
maturing marketable Government securities. On these, as they
mature and refunding issues are offered, there is always a substantial
amount that has to be paid in cash.
The C H A I R M A N . I understand. That is what you do with it. But
that does not change the Government cash position. I f you wish
to take the Government's cash budget as against its book budget,
you still have to add about $3,000,000,000 for the cash budget; do
you not?
M r . E C C L E S . But you see, wTe take into account the receipts from
social-security taxes, and that is largely where the cash surplus comes
from. I t will take that cash, plus the estimated cash they get from
the sale of savings bonds, to pay off the savings bonds that are being
redeemed and other securities that fall due that will not be refunded.
Therefore, those funds are not available for other expenditures, as
I will bring out here.
Now, here i t is: I t is also estimated that combined sales of savings
bonds and other public debt receipts will approximately cover voluntary redemptions of public debt by holders of maturing issues. Well,
that is just what I said. That is wThat our statement means.
The current deficit will need to be financed by drawing on Treasury
deposits which have been built up by tax receipts during recent
weeks, or by borrowing in the market. Under these circumstances
there can be no net retirement of Government securities held by the
Federal Reserve System; that is, during this 9-month period. To
the extent that the Treasury may need to borrow new money, i t
probably will have to be obtained largely from the banking system.
Representative H E R T E R . Is there not a drive being started very
shortly in that connection?
M r . E C C L E S . I t is already under way. But we do not estimate
that that drive is going to bring in more than enough revenue to
offset the redemptions.
Representative P A T M A N . I notice an effort is being made to reduce
the interest on postal savings from 2 to 1 percent. That will not be
helpful in your savings drive; will it, M r . Eccles?
M r . E C C L E S . Well, I do not think that the savings drive is for postal
savings. The savings drive, of course, is largely for the sale of E
bonds, which yield 2.9; and the postal savings mechanism, I think, is
not a comparable or a competitive savings operation with the sale of
Government bonds.
The bankers, of course, feel that the Government pays 2 percent,
which is what they paid when savings money was worth 4; that is,
when the banks used to pay 4 on savings money. The Government
still pays 2. Now, the banking system pays anywhere from 1 to 1%
CREDIT POLICIES
13 '
Very few banks can pay 2 for savings funds. The banks feel, therefore,
that the Government is in competition, and paying for savings funds
more than the banks can afford to pay; and that the Government
should reduce the rate that i t pays on savings payable on demand.
Postal savings are really demand money.
Representative P A T M A N . I understand the arguments for it. But
the fact remains that if you put your money into postal savings, i t has
the same effect as putting i t in bonds; does it not?
M r . E C C L E S . Oh, sure. The Government puts the postal savings
in bonds.
Representative P A T M A N . Well, why discourage the people about
that? A lot of people will put their money in postal savings that will
not put i t in banks, as evidenced by the fact that postal savings have
increased up to about $3,000,000,000; have they not?
M r . E C C L E S . I don't know what the postal savings amount to.
Representative P A T M A N . I think it is proabbly near three. That
being true, if you reduced the interest rate to 1 percent, you will
probably encourage a lot of people to take that money out and put it
in a spending stream, which would be inflationary.
M r . E C C L E S . I t is just a question of the competition of Government
with private interests. That is what the issue is.
Representative P A T M A N . But that has nothing to do with the savings, the way I view it. Of course, that is a good argument for the
banks.
M r . E C C L E S . Of course, if the Government wants more savings,
they could pay 3 percent on postal savings.
Representative P A T M A N . I am not talking about increasing them,
of course.
M r . E C C L E S . I think it would have very little effect. I think that
you would find that people put money in postal savings, not because
of the 2 percent interest. I think, for example, that there are a great
many foreigners who have put their money with the Government,
because they just feel that is the safe place to put it. And I think
i t is the principal they are interested in more than the return.
I don't believe that the rate would really be as effective in changing
the amount of savings as a lot of people think. I don't believe the
banks would get much of that money, even if the rate were less. I
think they might get a little, but I do not believe it would affect it.
Because certainly 2 percent for savings that can be drawn out on
demand is a very high rate under present conditions, and you would
think that postal savings would have grown far beyond anything
that they have.
Representative P A T M A N . But the Federal Reserve Board made the
conditions, did i t not? Did not the Federal Reserve Board fix the
rate of interest that the banks can pay on time deposits?
M r . E C C L E S . A l l we do is to fix the maximum.
Representative P A T M A N . And you fixed i t low, did you not?
M r . ECCLES.
No.
Representative P A T M A N . H O W low is it?
M r . E C C L E S . T W O and a half.
Representative P A T M A N . T W O and a half percent.
M r . E C C L E S . But nobody is paying it. The rate that the Federal
Reserve has fixed is possibly higher than any bank in this country
pays.
77099—48
2
CREDIT P O L I C I E S14'
Now, one of the reasons that we did not put i t lower—I think we
would have put it down to 2 percent some time ago—was because the
Federal Deposit Insurance, which had the fixing of the rate on the
nonmember banks, would not go below 2K percent, and therefore,
because of that situation, the Federal Reserve felt they were in no
position to reduce the rate below two and a half.
I think it is an academic rate. I t is entirely meaningless i n relationship to the rate that could safely be paid.
Representative R I C H . Y O U stated that the banks, for savings,
were unable to pay more than one or one and a half percent?
M r . E C C L E S . That is right; the commercial banks.
Representative R I C H . The commercial banks?
M r . E C C L E S . That is right.
Representative R I C H . If the Government pays 2 percent, how can
they afford to pay 2 percent, if the banks are unable to pay more than
1 y2 percent?
M r . E C C L E S . The banks pay taxes and have a lot of expense to
absorb, and the Government does not.
Representative R I C H . The Government has no expense?
Mr. E C C L E S . Not in postal savings. The postal savings money is
immediately invested in Governments.
Representative R I C H . The Government pays the clerk for looking
after that.
M r . E C C L E S . Well, it is paid by the Post Office.
Representative R I C H . And the Post Office is $400,000,000 in debt.
So the Government is paying for that, and they are going in the red.
M r . E C C L E S . Well, but the Government is paying a lot of money too
for war bond drives, in order to sell money to the public.
Representative R I C H . I still contend that the Government has expense in handling the postal savings.
M r . E C C L E S . I suppose they do. I suppose they have some expense, of course. But the fact that it is done through the Post Office
is important. They don't have the rent to pay. They don't have the
same expenses that the banks have to pay.
Representative R I C H . I think they do. I think they have the same
expense. I n fact, I think the Federal Government has a whole lot
more expense than the banks when i t comes right down to it.
M r . E C C L E S . Yes, but not for operating the postal savings system,
Representative R I C H . Well, that is the Government's way of keeping books, and they have been used to that, and the public pays the
bill.
M r . E C C L E S . All I am saying is the no bank can, pay 2 percent,
certainly the way the money market has been over a long period of
years, for savings funds. Because when they get 1 percent on Treasury
bills, and they get one and an eighth, on Treasury certificates, the
highest rate they get is the 2 percent on the Treasury eligible bonds.
There are a few prewar bonds that were issued at 2% percent, but they
are selling at such premium that the return is possibly around 2
percent for very long-term bonds. And for commercial paper, the
rate is 1%.
True, there are some loans and investments that banks can get
that are above two, but I would say that the average rate, certainly
of the commercial banks in the reserve cities would not average 2
percent on their entire portfolio.
CREDIT POLICIES
15 '
Representative P A T M A N . B u t that is on a basis of 6 to 1 expansion
too, is i t not, M r . Eccles?
M r . E C C L E S . Yes, but why would they want to pay 2 percent for
money in order to be loaned i t at 2 percent? They have to carry a
reserve against those deposits.
Representative P A T M A N . They would loan i t six times.
M r . E C C L E S . No, they don't. N o t that bank. I t is the banking
system.
Representative P A T M A N . I mean the banking system.
M r . E C C L E S . B u t the banking system isn't one bank.
Representative R I C H . I quite agree w i t h you that the banks cannot
percent on their savings under present-day conpay more than
ditions, and, for the same reason, the Federal Government cannot
afford to do it. Because i t shows from the handling of i t under the
Post Office Department, that all branches of the Post Office Department except the first-class mail have gone into the red.
M r . E C C L E S . I think i t is contended that the Government should
pay less on postal savings. T h a t is the point that Congressman
Patman is making here.
Representative R I C H . What do you think?
M r . E C C L E S . I think there is some merit i n reducing that rate.
I think that the 2 percent has been paid over a long period of years,
and there has been a very great change i n the interest rate on money
over that period. B u t I think that is a little aside from our subject
today.
The C H A I R M A N . A l l right, then. W i l l you proceed w i t h your
statement?
M r . E C C L E S . I said here that to the extent that the Treasury may
need to borrow new money, i t probably will have to be obtained
largely from the banking system.
During the next few months, Treasury use of accumulated balances
w i t h the Federal Reserve banks will add to bank reserves.
Now, let me explain that.
Some of the tax money beyond what the Government has spent
has been deposited w i t h the Reserve banks and the balances of the
Government w i t h the Federal Reserve banks have been built up.
Therefore i t is unavailable as reserves to the private banks. I f the
Treasury was not going to need those balances, i t would use that
money to pay off its Government securities held by the Reserve banks.
B u t the Treasury is going to need all of those balances, and they w i l l
be drawn down. They are not very large; I think at this time they
are a little over a billion dollars. They were large earlier, b u t the
Treasury has been using the balances as they came into the Federal
Reserve to pay off the securities held by the Reserve banks. T h a t is
w h y there was the reduction of securities held by the Reserve banks
that I spoke of earlier. From this point on, the balances w i l l no
longer be used to retire Government debt held by the Reserve banks,
b u t w i l l be disbursed into the spending stream, and w i l l become excess
reserves to the banking system. That is the point I want to make
here: that these balances w i l l add to bank reserves as they are spent.
The bank reserves will also continue to be augmented b y the inflow of
gold, and possibly b y further Federal Reserve purchases of Government securities from holders wanting funds for other uses. These
last two factors may operate for a long time i n the future. As long as
CREDIT P O L I C I E S16'
we have to support the Government market and nonbank investors
find other markets for their funds, which, under inflationary conditions
they do—•—•
Representative H E R T E R . When you say you have to, is that not a
matter of decision w i t h you?
M r . E C C L E S . I t is a matter of decision by the Government, too.
I t is a matter of decision b y the Federal Reserve and also the Treasury.
We feel, if we are going to have to manage the public debt, you have to
manage the market, and the failure to support the Government market
would make it, we feel, practically impossible to do the necessary refunding that the Treasury has to do currently.
Representative H E R T E R . M a y I ask you there: You speak of its
being-inflationary when you buy all of these long-term Government
bonds i n order to support the market.
M r . E C C L E S . That is right. That is the dilemma.
Representative H E R T E R . And you bought 4 or 5 billions of them.
On the other hand, the market is falling off.
M r . E C C L E S . I f you raise the interest rate, then you drop the market,
and i t raises all kinds of serious questions. Of course, that is quite a
debate all i n itself.
Representative H E R T E R . B u t that is a discretionary matter w i t h
you. There is nothing statutory as far as that is concerned.
M r . E C C L E S . That is right. I t isn't statutory at all. I raised the
question before that I wished Congress would indicate that, if they
felt we should no longer support the Government market. I felt that
Congress should take some responsibility for that.
Representative P A T M A N . Suppose you should not support the
market, what would happen to these banks, if the bonds were to go
below par?
M r . E C C L E S . The difficulty is t h a t you do not know the support
price. T h a t is one of the problems you are confronted with. A n d that
raises the critical problems of refunding operations in connection w i t h
public debt. I t has implications that are very far reaching. We
have given lots of thought to the problem, and we have studied i t
from various angles.
The people i n the Reserve System, not only the Board, but the
Reserve bank people, as well as the Board people, are unanimous,
I think, i n feeling that, taking the matter on balance—with the public
debt the size that i t is, so much larger than the entire private debt,
in fact equal to about 60 percent of all the debt—we must maintain
stability of Government securities market and confidence in i t . The
public have taken quite a drubbing already on the decrease in the
purchasing power of the dollar that they put i n bonds, and now, to
make them take a further decrease, by letting the bonds drop below
par would be a very serious step.
I want to make another matter clear: We have never made the
statement t h a t we should support all Government securities at par.
W h a t we have said is that we should maintain the 2% percent rate
on the long-term bonds. T h a t should be the basic long-term rate.
The short rate should be permitted to fluctuate to the extent that
i t can be useful. A n d if the short rate should go up, certainly the
very short securities may drop below par. A n d they have. The
Federal Reserve System has never taken the position that every issue
of Government bonds should always be redeemable at par; we have
CREDIT POLICIES
17 '
taken the position that the
percent rate should be maintained, and
shorter term issues could fluctuate as the shorter term rate might
fluctuate.
Representative R I C H . Let me ask you this: The stability of bonds
created b y the purchase of them by the Federal Reserve is not any
more likely to make for a stable and economic Government than i t is
if the Congress does not stop the spending because we w i l l be just as
bad off i n the future, because there will come a time when you cannot
stabilize the bonds if they increase the size of our national debt.
M r . E C C L E S . Y O U can stabilize the bonds, but you do not stabilize
the purchasing power of the dollar. A dollar could be worth far
less than i t now is, and the bond could still be supported at par.
Representative R I C H . The point is that we are not making for a
stable government as long as we keep on w i t h the spending.
M r . E C C L E S . That is right; especially deficit spending.
The C H A I R M A N . Can we get along now?
M r . E C C L E S . I would like to finish this, if I can, without any interruption.
The C H A I R M A N . Fine.
M r . E C C L E S . A S I said, these last two factor may operate for a long
time in the future; that is, the gold imports adding to the reserves, and
the purchase of Government securities from nonbank investors. I f
the international outlook does not improve, Government deficits may
continue, and even increase substantially, and banks may be called
upon to purchase additional Government securities. Under these
conditions, the Federal Reserve would find i t difficult, and perhaps
impossible to sell Government securities i n order to absorb the bank
reserves w i t h o u t seriously unsettling the market for such .securities.
Where you have a deficit, and if the banks are required to buy, then,
of course, the Federal Reserve is more likely to have to support the
market, i n other words, to have to buy. Under those circumstances
you certainly cannot sell in the market and thus absorb the reserves
that gold imports create, or the reserves that are created when the
Federal Reserve buys bonds from nonbank investors. That is the
point that we make here, namely, that i t is very difficult to absorb
excess bank reserves in these conditions by reversing our action by
selling in the market.
Prospects are, therefore, that i n the future gold inflow and Federal
Reserve purchases of securities i n maintaining an orderly market for
long-term Treasury bonds, will further increase bank reserves. Banks
would thus be in a position to expand loans and investments for private
purposes, and this would mean still more inflationary expansion of the
money supply. To restrain such potential expansion, the Federal
Reserve would have to take action to absorb an excessive volume of
reserves. Two type of measures should be considered:
First, interest rates on short-term Treasury securities and discount rates—that is, the discount rates of the Reserve banks—should
be permitted to rise to the extent possible without raising rates on
long-term bonds; that is, without raising the long-term 2l/2 rate; and,
second, to the extent that this action is not adequately restrictive, the
Federal Reserve should have the power to increase Federal Reserve
requirements substantially to cover at least any growth in the total
supply of reserves.
18
CREDIT
POLICIES
The first of these measures which could be adopted by the Federal
Reserve and the Treasury without new legislation would be designed
to induce banks to purchase short-term Government securities, and
• to discourage the extension of credit to private borrowers. Policies
during the past year have moved in that direction about as fast as is
feasible without unduly upsetting the market. There are limits,
however, to such a course. Short-term rates probably cannot be
raised much more without unsettling the 2% percent rate for long-term
Treasury bonds.
When I say "cannot be raised much more/' I am thinking i n terms
of an eighth of 1 percent, to a maximum, say, of one-quarter. I f you
made the certificate rate 1% that would be raising i t an eighth. I f
you raised i t a full quarter, ultimately that would be 1%. There may
be, under certain conditions, a possibility of going as far as 1% i n a
short-term rate, but I certainly can't foresee that now.
Such an action, of course, would tend to induce the banks, when
they got reserves, to buy securities from the Federal Reserve; whereas
at 1 percent for bills, and 1% for certificates, there is a good deal of
pressure on the banks to go out into the market and make loans
at higher rates. That creates new money, whereas, if they bought
the short-term Governments from us, i t wouldn't do so.
Clearly, you can't let the short rate go up to a point where pressure
on the long-term rates result, so you have to support the long-term
market. The problem is one of maintaining a balance, depending
upon the conditions. However, i t is doubtful how much any rate
that is feasible w i l l deter banks from making loans to private borrowers
or purchasing higher-rate securities. I n other words, there is a
question, even if you went up an eighth or a quarter, as to just what
extent that might deter the credit extension. We think i t would
have some effect, but we can't say that i t would be very anti-inflationary, or very restrictive.
Representative HUB EH. A t that point, M r . Eccles—during consideration of the tax bill, i t was often said that the legislation would
provide an incentive for risk capital. Are not the banks bulging
now w i t h money? Would you feel that that statement was true?
M r . E C C L E S . You mean the money of their depositors?
Representative H U B E R . Well, i t would provide an incentive for
risk capital.
M r . E C C L E S . What would?
Representative H U B E R . The tax reduction bill.
Now, is there not a surplus of money throughout the banks of the
nation?
M r . E C C L E S . Yes. I think Senator T a f t said he wanted to discuss
that a little later. I f I can finish this, I would like to say something
on that subject i n relation to budgetary deficits.
Representative H U B E R . I would like to hear you.
The C H A I R M A N . The lack of risk capital is more the unwillingness
of people to put their money into that kind of thing. I t has nothing
to do w i t h the amount of money. They have the money, apparently.
M r . E C C L E S . A S to the need for additional powers, I have tried to
build up the case here, to show what has happened in the last quarter.
A n d now I point out what may well be the need for additional powers.
CREDIT POLICIES
19 '
N E E D FOR A D D I T I O N A L P O W E R S
Accordingly, the Board believes that the System should be given
authority to increase the reserve requirements of all commercial
banks. For the present, this authority should make i t possible
for the System to require all commercial banks to maintain primaiy
reserves w i t h the Federal Reserve System, amounting to 10 percent
of the aggregate demand deposits, and 4 percent of the time deposits,
i n addition to present requirements. This would give to the Reserve
System power to increase bank reserves i n the aggregate by a maxim u m of about $12,000,000,000.
A n authority of this amount would enable the System to absorb
the reserves that are likely to arise f r o m gold acquisitions, or from
necessary System purchases of Government securities sold by nonbank investors over the next few years. I n other words, i t would
enable the System to sterilize the gold imports and reserves created
by our support of the Government bond market.
I n case banks should persistently follow the practice of selling
Government securities to the Federal Reserve i n order to expand
private credits, notwithstanding higher short-term interest rates and
increased primary reserves, as indicated, then the system should be
granted supplementary authority to impose a special reserve requirement along the lines proposed by the Board last November. This
type of authority may be described as an optional reserve requirement,
because i t could be held at the option of the individual bank, i n specified cash assets, or i n short-term Government securities.
The maximum requirement under this plan could properly be
limited to 25 percent of the aggregate demand deposits, and 10 percent of the time deposits. To be effective and equitable, i t should
apply to all commercial banks; that is, the nonmembers, as well as
the members. A detailed description and analysis of the Board's
special or optional reserve proposal—I say optional because that is
a more accurate description of i t than special—was submitted to the
House Committee on Banking and Currency, and has been published
in the Federal Reserve Bulletin.
The C H A I R M A N . I do not quite understand.
Does this 25 percent include the 10 percent?
M r . E C C L E S . N O ; that is entirely another item. I t would have
different use, different application.
The C H A I R M A N . Y O U are proposing 10 percent plus 25 percent?
M r . E C C L E S . We are saying that the 10 percent would be the cash
reserve requirement, i n case the bank should persistently follow the
practice of selling Government securities, and so forth, i n order to
do this, notwithstanding the raising of the short rate, and notwithstanding the increase i n the primary reserve requirements.
The C H A I R M A N . I S not your total 10 percent higher than last fall?
Last fall I thought you had the 25 percent.
M r . E C C L E S . N O W we are suggesting deferring the 25Jpercent special
reserve u n t i l we see if the 10 percent primary reserve is adequate.
The C H A I R M A N . SO that when you came along w i t h the 2 5 later,
you could absorb, and would not necessarily have to put the whole
2 5 on top of the 10.
20
CREDIT
POLICIES
M r . E C C L E S . N O ; the 10 is strictly a cash reserve, largely for the
purpose of sterilizing gold imports and reserves that we would create
by the purchase of securities from nonbank investors. B u t if banks,
i n spite of that, continued to sell Governments to get reserves for the
purpose of making credit expansion, we would need the optional
reserve. Y o u see, i t depends upon inflationary developments, especially upon the budget picture. .As I will bring out later, the possib i l i t y of needing the special reserve as an additional authority depends upon conditions, and all we are doing now is pointing out
what would seem to be a maximum possibility i n the field of monetary
and credit policy, to deal w i t h an emergency.
The C H A I R M A N . I was only t r y i n g to get clear as to what your
proposal was. I t is now 14, 20, and 26; and if you add 20 percent, i t
will be 24, 30, and 36. A n d then your suggestion is that in some
events, you would add 25 percent on top of that?
M r . E C C L E S . Yes, but we would give the banks the option of holding the special reserve i n cash or in Government securities.
The C H A I R M A N . T h a t would hardly be in bonds, I take it.
M r . E C C L E S . I t could all be in securities, that is, short-term securities, if they wanted to hold it. The whole thing would be in bills
and certificates. As a matter of fact, of course, the 25 could include
the 10. T h a t is a question of action by the Congress. I n other
words, if you wanted to give authority to increase the reserve from
the 10 to the 25, making i t optional to put those reserves in short-term
governments, that could be done. T h a t would be a modification.
The C H A I R M A N . A l l right. Proceed.
M r . E C C L E S . T O the extent that i t may become necessary to rely
upon the banks for any new Government financing operations, the
optional reserve requirements would be an especially valuable instrument. A n d i n the case of large-scale deficit financing, i t would be
essential. I n such financing, i t would be advisable to make available
to banks only short-term securities. Application of the optional reserve requirement would have the effect of immobilizing these securities, so that they could not be used to obtain reserves to pyramid
new bank assets upon them on a 6 to 1 ratio. I n other words, securities issued in new Treasury financing through banks would be tied
to the deposits created by their purchase.
I f we had done that i n the financing of the last war, we would liave
avoided a lot of the trouble w i t h which we are now confronted. I n
other words, if the banks had been limited in their purchase of securities, to short-term securities, and then those securities, at least a
portion of them had been required to be held against the deposts they
had, you wouldn't have had this freedom which the banks now have
to create a multiple credit expansion, leaving the central banking
system unable to deal w i t h the situation, so long as i t is obliged to
support the market. W h a t we are trying to do now, when we propose that requirement, is to go back and to correct some of the mistakes
that were made in the form of Government war financing.
Representative R I C H . Under those conditions, would you not expect
the banks to stabilize the market, then, instead of the Federal
Reserve?
M r . E C C L E S . We can only stabilize i t through the banks, we have
no way of doing i t except through the banking system. We have to
operate through them.
CREDIT POLICIES
21'
Reprssentative R I C H . Y O U would not expect them, as individuals,
to go out and do what you are supposed to do, as the Federal Reserve,
would you?
M r . E C C L E S . N O . B u t we stablized the market by buying securities in the market. And we have no way of stopping the banks from
selling the securities that they have, and thus creating reserves upon
which they can-expand $6 worth of credit. T h a t is the point.
Representative R I C H . I f you had that power, you could do what
the banks could.
M r . E C C L E S . We have always had more power than the banks. We
have no power now to control the bank credit expansion, and that is
the point I want to make.
The special reserve plan would assure a ready market for short-term
Governments, and the Treasury would be helped in successfully carrying out both its refunding operations and its deficit financing. These
are the important aspects of the proposal, if we get into substantial
deficit financing. A t the same time, the Federal Reserve would be
enabled to exercise some restraint on the money market for private
credit. This is the basic merit of the optional reserve plan.
The dominance of public debt in the present credit situation has
rendered the system's traditional powers generally unusable for
purposes of restraining further inflationary credit expansion. The
Reserve Board is not seeking additional power beyond what i t formerly
possessed; i t is merely pointing out that the system has little or no
authority to deal w i t h the credit situation as i t currently exists, and
seems likely to develop.
I f the Congress wants the Federal Reserve System to perform the
functions for which i t was established, the System must have a substitute, or at least a partial substitute for those powers that have become
unusable. The Board feels that i t would be remiss if i t failed to
bring this matter to the attention of the Congress.
There is no simple way of holding in check bank credit expansion in
excess of essential public and private needs. The problem should be
met in a combination of ways—by general credit controls, and in
particular areas by selective controls, such, for example, as the reimposition of consumer installment credit regulation, and the continuation of existing margin requirements on stock market credit.
OTHER A N T I - I N F L A T I O N A R Y
ACTIONS
The Congress is currently considering the continuance of easy
mortgage credit for housing. Easy mortgage credit is one of the most
inflationary factors in the domestic credit picture. A t the very most,
Government mortgage credit programs at this time should be limited
to relatively low-cost housing, particularly for rental housing, and
should be accompanied by some restriction on other less essential
types of housing. The housing shortage cannot be overcome by
increasing the competitive pressures on scarce supplies of materials
and manpower. They are the limiting factors on the volume of construction. I t is one thing to provide easy credit facilities to encourage
special types of residential construction activity under a system of
allocations and permits. I t is quite another thing to provide such
encouragement in a free market already characterized by heavy
22
CREDIT P O L I C I E S
accumulated demands and by strategic shortages in supply that are
likely to be intensified by the defense and world-aid programs.
I n restraining inflationary pressures under present and prospective
conditions, monetary and credit policies must be combined w i t h fiscal
and other governmental policies. The public should be given every
possible assurance that the Government will protect the purchasing
power of the dollar so that the public would be mors-willing to defer
the satisfaction of wants, particularly for houses and durable goods.
Wherever possible, Government expenditures that will add to pressures on the labor and capital goods markets should be deferred, and
State and local governments should be requested likewise to defer
nonessential expenditures of this type. There should be early action
to close loopholes in our tax laws, and to strengthen the tax collection
machinery. I f the stage is reached at which Government expenditures
again threaten to create large budgetary deficits, then a reimoogition
of wartime levels of taxation and direct economic controls along the
lines proposed by M r . Baruch, for example, should be undertaken.
Now, you notice, I have said, " I f the stage is reached at wilich
Government expenditures again threaten to create large budgetary
deficits, then a reimposition of wartime levels of taxation and direct
economic controls along the lines proposed by M r . Baruch, for example,
should be undertaken.
I f young men are to be drafted into the military forces, then a way
should be found to keep men at work i n essential industries, and thus
prevent the serious inflationary effects brought about by strikes.
The situation now and i n 1940: I want to bring out that this
reversal of our program, which indicates a substantial expansion,
looking to the future of our military, as well as a foreign aid program
that we can't see the end of, is a much more difficult program to carry
out than would be the case if the situation now was comparable w i t h
that of 1940.
The Board believes that any realistic appraisal of the economic outlook from the standpoint of monetary and credit policy must take
account of the underlying facts of the international situation.
During the war, there wTas no doubt about the ultimate victory,
the country looked forward confidently to an era of stability and peace
following the hostilities. Nearly 3 years after the end of the fighting,
however, we seem to be further away from these goals than ever. Our
national debt still exceeds $250,000,000,000, or more than five times
the prewar levels.
Federal budgets have never fell under
$37,000,000,000 a year, and we are confronted now w i t h the prospects
of an expanding debt and budgets. During the wTar, wTe expected the
peace to bring an end to these enormous drains on our resources.
Today there is no end point i n sight. Threatening as tlie inflationary potential was at the end of the war, i t is worse today. When we
embarked upon the defense program i n 1940, we had a tremendous
slack i n the labor force w i t h nearly 12 millions fewer employed than
now. We had surpluses of most raw materials, of unused industrial
capacity, of housing, of foodstuffs and of countless other things. The
impact of our heavy armament expenditures was not inflationary* so
long as the total demand on our resources did not exceed our capacity.
I t rapidly became inflationary as civilian purchasing power created b y
the war expenditures, through deficit financing, began to exceed the
available supplies of goods and services.
CREDIT POLICIES
23 '
We held the excess purchasing power fairly well i n check while the
was was on. We have now seen the consequences of premature
removal of the harness of wartime controls. Even the one remaining
anti-inflationary force, that is, a large budgetary surplus used to reduce
our money supply, is no longer i n prospect.
Over-all policy alternatives: On the basis of present trends, we
believe that the country, sooner or later, has to choose between three
broad alternatives.
First, we can continue on the present course of providing essential
foreign aid, and of carrying out a military program on a scale of as yet
undetermined size and cost, while at the same time we have no effective
checks on the free play of economic forces. T h a t is the certain road,
if followed long enough, to a ruinous inflation. Surely no one would
seriously contend that we can go on adding more and more pressure i n
the boiler of inflation without an ultimate explosion. Those who view
us w i t h a hostile eye no doubt hope that we will w e e k our economy
on the shoals of inflation. I t would be a cheap way to defeat us.
Secondly, the country could be subjected to a full harness of direct
economic controls—for example, allocations, construction permits, rationing, price and wage controls, as well as taxation at higher levels.
Without such a harness, amounting to a regimentation of the economy i n peacetime, there is no sure protection against inflationary
dangers that may lie ahead. They cannot be successfully combatted
by any single means, or on any single front. There is 110 power that
the Board now possesses, or that Congress can give us i n the monetary
and credit field that would be adequately effective by itself—and I
should add there, "under the conditions of large budgetary deficits."
Beyond that, we must ask ourselves whether the public would be
willing in peacetime to submit to the sacrifices and rigid restraints of a
wartime economy. I f our preparedness program calls for a military
draft upon our young men, should i t not call also for control of the
profits arising from that program?
We may well ask for how many years must we maintain enormous
and probably expanding military expenditures—and 1 could add " a n d
world aid." The question is: how long? to what end? and at what
consequences to our economy? We do not have the inexhaustible
supplies of manpower and resources to support indefinitely, w i t h no
end point in sight, programs of the magnitude which we now are
shouldering or contemplating.
The C H A I R M A N . "Contemplating" might do. B u t why the "shouldering"? Your own figures show that you get 42% billion from present
taxes, and you are not going to spend that much.
What is the burden of shouldering, that you cannot go 011 shouldering if you have to? I would like to cut i t down, but what threat is
there contained in it?
M r . E C C L E S . I do not think you can do i t indefinitely, sir. Y o u
have inflationary pressures, as we have pointed out, w i t h what you
are already doing, and you have plenty of inflationary dangers even
w i t h some budgetary surpluses. W i t h practically no budgetary surpluses, inflationary dangers are very much greater than would otherwise be the case.
The C H A I R M A N . We are no better and no worse off. Maybe i t is
the exceptional condition, but we are no worse off from an inflationary
standpoint than we were in November, when you were here before.
24
CREDIT
POLICIES
M r . E C C L E S . We do not think that you can go on indefinitely.
The C H A I R M A N . Y O U cannot go on increasing, but when you say
"those that you now have," I do not see why you cannot go on indefinitely.
M r . E C C L E S . I don't see how you can, without getting an inflationary development. I think you have got to have some budgetary
surpluses in this situation.
Representative R I C H . Air. Eccles, you made this statement in your
previous paragraph:
" I f our preparedness program calls for a military draft upon our
young men, should i t not call also for control of the profits arising
from that program?"
Then should we not have controls on everything? And then we
would have just exactly what Russia has.
M r . E C C L E S . Well, what I am saying is that if you get into a
budgetary deficit, if you get into an expanding M i l i t a r y Establishment, due to a world situation, then you certainly do not want an
uncontrolled inflation here, which could well result. Therefore, the
next thing to do is, as I indicated, have Baruch plan of such controls.
Certainly that would be most difficult in peacetime, and certainly,
if we should develop what we call a preparedness program on a scale
that would create such deficits—and some people talk of such a program—such controls would become necessary. A preparedness program of that sort means an armament race, and an indefinite expansion, if you are going to be prepared. Preparedness is a relative thing.
To be prepared, you have got to be better prepared than the people
you are preparing to deal with. That, I think, is one of the discouraging things in the picture today, so far as the American public
is concerned.
Representative R I C H . When a bill was set up for universal military
training, and selective service, and those things were put into effect,
then, according to your statement, we have to put regulation on
everything.
M r . E C C L E S . I did not mean that by m y statement. I f that is the
way i t is interpreted, that is not the way i t is meant.
Representative P A T M A N . I t refers to profits, does i t not, M r . Eccles?
M r . E C C L E S . Yes. Certainly if we are going to carry out a program
here, of armament expenditure, and you are going to draft men—I
don't know whether you arc going to get universal military training
or not, but I mean if you do that—certainly there will be substantial
profits created or maintained, or t h a t are likely, as a result of large
Government expenditures. The question arises as to whether you
wouldn't be justified i n recapturing some of those profits, as a result
of armaments expenditures, and thus improve the budget picture and
lessen the inflationary pressures.
Now, that is something for the future. I am not talking about that
for the present. I am merely saying that in this statement we are
t r y i n g to review briefly the past. We are trying to consider the
immediate present over the next 9 months. A n d then we are trying
to look beyond the uncertain future as to what some of the problems
indicated may well be.
The C H A I R M A N . M r . Eccles, do you want to finish this morning?
M r . E C C L E S . I f I could finish this statement, I would like to do that.
The C H A I R M A N . Then, after that, does the committee want M r .
Eccles to come back for questioning? A n d if so, when?
CREDIT POLICIES
25 '
M r . E C C L E S . I am available at the pleasure of the committee,
either this afternoon or tomorrow, or whenever the committee wants
to interrogate me.
Representative P A T M A N . He only lacks a page and a half, to finish.
The C H A I R M A N . Yes. B u t for me, tomorrow morning would be
more favorable. However, the House is not i n session today so I
guess this afternoon would be better.
M r . E C C L E S . That would suit me fine.
The C H A I R M A N . Then when we recess, we will recess u n t i l 2:30.
M r . E C C L E S . Thank you.
The C H A I R M A N . One thing, M r . Eccles, on the question of inflation:
These things seem to be so difficult to predict. People are so likely
to be wrong. I never have any great confidence about future things,
until at least there is an indication of what is happening?
One thing that everybody seemed to agree on was that the price
of meat was going up. I admitted it. B u t i t does not seem to have
gone up.
Senator F L A N D E R S . M r . Chairman, may I make some remarks
about that?
The C H A I R M A N . Certainly.
Senator F L A N D E R S . I n the first place, I think that the proposed
legislation and the discussion had a great deal to do w i t h consumer
resistence, which helped to keep the-price down.
I t did another tiling. I t filled up every freeze locker, both private
and public i n the hands of the packers and i n the hands of the chain
stores, full of meat. That is now coming out, and again helping to
keep the price down. And maybe we w i l l have i t i n the fall, but I
think our little crusade worked out very nicely.
The C H A I R M A N . Oh. very well. B u t I was just talking about these
predictions.
I was out West, and I find that today nearly half of the packing
houses have been shut down by strike, and still the price has not
gone up. A n d a great deal of meat is being held back on the farms,
because they do not want to send i t in when there is a strike, so when
the strike is settled, you are likely to get a large amount of meat in
addition.
I see no immediate prospect for the carrying out of these predictions on meat, which was the key food practically.
So I do not know whether these inflationary threats are quite
justified or not.
M r . E C C L E S . Y o u have to anticipate. I f you don't, i t is too late
after you get it. A n d i t seems to me that you have got to take into
account the matter of what are the potentials. You have to be
prepared to deal w i t h those potentials if inflation really begins to
develop. Because if you are not prepared, i t develops, and i t is too
late to deal w i t h them.
Of course, we have had, without any question, a very serious
inflation already. We talk about inflation as something in the future.
We already have got it. A n d the purchasing power of the money
that our people have saved and put into bonds and put into fixed
income-bearing securities, has already been almost cut i n half i n its
purchasing power.
Therefore, we cannot afford, i t seems to me, to jeopardize the possibility of a further devaluation in the purchasing power of our money.
26
CREDIT
POLICIES
"We must be prepared to deal w i t h i t vigorously; and to do so, we
must anticipate i t .
The C H A I R M A N . I agree w i t h you. I think there are likely to be
some further increase. I am not claiming that there will not be. I
just wonder if i t is quite as direful as you seem to predict.
M r . E C C L E S . Well, I am not trying to throw any fear into this. I
am merely pointing out what the real possibilities are today. A n d
certainly if the world situation should improve, if we got a basis of
peace, if our Government expenditures can be curtailed, if the world
recovery is rapid, and we are relieved from a lot of the foreign aid,
such as we are now undertaking, if our military expenditures, instead
of expanding into the further billions can be held within the range
where they are, then, of course, that could change the situation.
On the other hand, the world situation, we must admit, is ominous.
A n d we have got to anticipate what may be the responsibilities of the
Government, the burden of the budget, and the inflationary effects
if conditions do not improve. We cannot go on year after year bearing these crushing costs without jeopardizing what we seek to save.
I f we were confident of the early establishment of peace, we could
tolerate a tightly controlled economy. We believe that the time
element is the very essence of this grave problem.
Our N a t i o n sought neither territory nor reparations in either
World War. We seek neither now. We ask only for the earliest possible establishment of the foundations for enduring peace. To that
end, our third and best course may be to choose a combination of
alternatives; that is to say, acceptance of such controls as may become
necessary to prevent inflation at home, while abroad we lay at the
earliest possible moment the foundations for peace. And by that I
mean: b y doing whatever is called for to assure an establishment of
peace, rather than an indefinite program of increasing military expenditures for a preparedness program that may end i n an armament race.
We simply cannot afford an indefinite armament race that calls
for an expanding of Government expenditures, without, of course,
either having inflation, or an imposition of all of the restraints that
our people do not wyant and should not have. Rather, we must relieve
our budget load, and i n that way we get away from risking these
Government controls, high levels of taxation, or inflation. Only i n
that way can we do i t .
Representative R I C H . M r . Eccles, from what we were doing now,
you would think we had lost the war. We are paying to everybody.
B u t you made a statement here a moment ago. You said "our
foreign expenditures which we cannot see the end of."
Now, what do you mean by that? Have you something in your
mind that these Members of Congress have not been told yet?
M r . E C C L E S . T h a t is all I have to say on that, M r . Congressman.
Representative R I C H . D O you not think i t is about time that we
stopped this foreign spending?
M r . E C C L E S . I have nothing to say on that. I merely say that I
do not see the end of them, and I do not know t h a t you do, or anyone
else.
Representative R I C H . I thought from that statement that you
probably knew something that has not been conveyed to us yet, as
Members of Congress.
M r . E C C L E S . I said i n the beginning of the statement that we had
nothing to do whatever w i t h either the preparations for war, or the
CREDIT POLICIES
27 '
foreign expenditures. I made that very clear i n the beginning. And
i n what I am saying here, a lot of these remarks are aside.
This statement is the Board's statement.
Representative R I C H . D O you not think we have already spent too
much on foreign countries?
M r . E C C L E S . A discussion of that subject is not appropriate at this
time.
Representative R I C H . I am trying to keep a sound financial structure here i n this country. T h a t is what I thought we were going to
discuss.
M r . E C C L E S . A n answer to tliat question would not help you i n
establishing a sound financial structure.
Representative R I C H . Surely i t does. The more we spend, the
more trouble you get into.
M r . E C C L E S . A n answer to your question w i l l hot help, i n my
opinion, to clarify the matters under discussion.
Surely an informed public would be ready to accept even burdensome controls and taxation if convinced they are essential to safeguard
our economy against a ruinous inflation, and that there is an early
endpoint i n sight which will enable us to maintain our system and our
institutions i n a peaceful world.
To sum up the situation as the Board sees it, we are faced w i t h the
possibility that still further upward pressures w i l l be added to the
tremendous inflationary potential generated by war financing and
intensified by subsequent developments. We should do everything
possible within the existing authority of the Government to moderate
and counteract these forces. Federal, State, and local governments
should practice the strictest economy and defer all public works and
similar expenditures that can be postponed u n t i l there is a surplus of
manpower and materials instead of the shortages that now exist.
Every effort should be made not onoy to preach, but to practice economy and savings at this time. The need still is urgent to spend less
and save more, and to invest i n Government savings bonds. Every
assurance should be given that the purchasing power of these savings
w i l l be protected.
Representative R I C H . I will say that that is a fine statement.
M r . E C C L E S . SO far as the monetary and the credit field is concerned,
we have tried to make clear that action on these fronts alone cannot
guarantee stability. Nevertheless, we believe that the Reserve
System should be armed w i t h requisite powers, first, to increase basic
reserve requirements of all commercial banks and, later on, if the
situation requires it, to provide that all such banks hold an additional
special or optional reserve. B o t h of these would be protective
measures.
The first could be used to offset gold acquisitions and purchases of
Government securities by the Federal Reserve, and thereby restrict
the continued expansion of our already excessive money supply.
The second would be essential i n case banks embark upon an inflationary credit expansion through the sale of Government securities
to the Federal Reserve, or to assist the Government in case of largescale deficit financing.
We believe i t is the part of prudence to recognize clearly that the
underlying cause of continuing inflationary dangers arises from the
disappointment of our great hopes for the early establishment of
world peace. Surely we must summon all of our human and material
28
CREDIT
POLICIES
resources needed to assure that peace. I f necessary to protect our
economy at home, so that we shall not lose by inflation what we seek
most of all to save, we should be willing and prepared to reimpose
i n the future to whatever extent the situation demands a harness of
controls, including higher levels of taxation. Nobody wants such
regimentation, but i n the hard choices before us, i t is infinitely
preferable to economic chaos and possible collapse of our system, to
which all freemen look to deliverance from the evils of war and misery
that feed on economic distress.
We are aware that the questions of policy designed to achieve the
cardinal purpose of assuring an enduring world peace are outside the
domain of those charged w i t h responsibilities i n the monetary and
credit field, but we feel that such responsibilities have to be exercised
i n the light of the burdens which the economy must.bear. The earliest
attainable settlement of the issues that now stand i n the way of
lasting peace offers the best hope for the preservation of our institutions, and our freedoms. Meanwhile, they must not be jeopardized
either by uncontrolled inflation or long-continued regimentation at
home.
The C H A I R M A N . The specific recommendation for legislation, I
take it, boils down at the moment to a 10-percent increase i n reserves;
maintaining the ratio, from 14-20-26 up to 24-30-36. Is that the
same relationship between the different types of banks?
M r . E C C L E S . I would simplify the statement. We said 1 0 percent.
I think if legislation was to be considered, we would make some slight
modification, and make i t a little simpler by saying: As to the nonreserve-city banks, which are 14, make that 25; as to the reserve city
banks, which are 20, make that 30; and as to the central reserve city
banks, which are 26, make that 35.
The C H A I R M A N . 25-30-35.
M r . E C C L E S . T h a t is right. I think that would be a little fairer.
The credit expansion is just as great, if not greater w i t h the nonreserve-city banks, and they are, I think, even more liquid from the
standpoint of short-term Governments and reserves than are the city
or the larger banks.
The C H A I R M A N . Of course, the increase i n reserves, the straight
increase in reserves, is not a difficult legislative task. B u t I take i t i t
involves an increase of 10 percent, or a new reserve of 10 percent on all
banks, whether they are part of the Federal Reserve System or not.
M r . E C C L E S . Yes; that is correct.
The C H A I R M A N . A n d that does present, I concede, legislative problems.
M r . E C C L E S . I t does. We would not advocate any increase whatever, unless i t covered all banks. I think that to t r y to cover only
member banks would be certainly a terrific discrimination. Even
when we doubled reserve requirements on member banks, i t was quite
an imposition, and i t makes i t practically impossible to increase the
membership of the System.
I think t h a t if you increased reserve requirements of member banks
only, membership would be too much of a penalty, and certainly
further increases i n reserves would likely drive a good many banks out
of the System. A n d to the extent that banks are out of the System,
your whole monetary control is weakened.
CREDIT
POLICIES
29'
The C H A I R M A N . I S there any doubt about our power, our constitutional power, to do that, do you think?
M r . E C C L E S . Y O U mean increasing the 10?
The C H A I R M A N . The reserve on non-member banks and State
banks who are not members.
M r . E C C L E S . There is no question about it. The question of whether
banks are engaged in interstate commerce has already been decided i n
the Wage-Hour Act. And the Board has administered regulations
on consumer credit that covered all non-member banks.
The C H A I R M A N . B u t the question is that that might have been a
war power.
Representative P A T M A N . M a x i m u m interest rates, too.
M r . E C C L E S . Well, no interest can be paid on demand deposits.
We administer that only for all member banks.
The C H A I R M A N . The committee w i l l recess u n t i l 2 : 3 0 .
(Whereupon, at 12:30 p. m., a recess was taken to reconvene at
2:30 p. m., of the same day.)
AFTER
RECESS
(The hearing resumed at 2:30 p. m.)
The C H A I R M A N . The committee will come to order.
STATEMENT OF MARRINER S. ECCLES, CHAIRMAN OF THE BOARD
OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, ACCOMPANIED BY WOODLIEF THOMAS, DIRECTOR OF THE DIVISION
OF RESEARCH AND STATISTICS; AND RALPH A. YOUNG, ASSOCIATE DIRECTOR OF THE DIVISION OF RESEARCH AND STATISTICS, FEDERAL RESERVE SYSTEM—Resumed
The C H A I R M A N . M r . Eccles, I think I remember going over w i t h
you some tables showing the effect on bank reserves of different
inflationary elements. Have you anything of that sort on the next 3
months or the next 9 months, or whatever period you choose? I t
seemed to me that I remember estimates of gold imports and things
of that kind that might throw a little light on the subject.
M r . E C C L E S . I have not seen any tables, and I do not know whether
the economists i n our research department have anything on that.
Y o u do not mean charts, you mean tables?
The C H A I R M A N . I meant tables; yes, of what the effect on the
bank reserves is going to be in terms of actual figures; wiiat they are
now and what they are likely to be. To interpret your statement w i t h
actual figures, I mean.
You are asking for a 10-percent increase i n reserves which I say
will take up the estimated increase in reserves during some period.
I wanted to see why you estimate those and what the figures will
show.
M r . E C C L E S . What we say here, Senator, is the potential which
would be available from gold imports and would be available from the
purchase of nonbank securities. We suggested that there were two
things that might be done in order to deal w i t h that situation. The
first one was that the interest rates on short-term securities and the
discount rates should be permitted to rise to the extent possible.
77099—18
3
CREDIT
30
POLICIES
Tlie C H A I R M A N . A S far as you could and maintain 2){ P P ^ E N T longterm rate?
M r . E C C L E S . That is right; and that was the one thing. The other,
of course, was that to the extent that this action is not adequately
restrictive, that is, that i t would not divert the reserves that the banks
got into those short securities held by the Federal Reserve, then the
Federal Reserve should have the power to increase reserve requirements substantially to cover at least any growth in the supply of such
reserves.
Then we went on to say later that if we got this power up to the 10
percent, i t would equal in the aggregate $12,000,000,000, and that
should be sufficient under the present situation for several years.
Now, we go on to say that if the budgetary situation should be such
as to create substantial deficits, and we go on to say further that if,
i n spite of the rise in short rates or the increase in reserve requirements, that the banks continued an expansion of private credit on a
dangerous basis, or an inflationary basis, then the other power should
be added.
The C H A I R M A N . I understand that, but what I want to know is
w h y 10 percent; why the $12,000,000,000; what is i t that supports
that figure that is necessary for the increase in reserves?
M r . E C C L E S . I suppose we could get along w i t h a less amount and
then request additional authority if i t was needed. Congress could do
that. The only thing is the very fact that the Board had that much
power I think psychologically would be effective and desirable. I
think the fact that the Board could increase tlie reserve requirements
would tend to keep the banks in a much more liquid position than if
they felt they had no further power; that they would be inclined to
keep their governments and particularly their short-term governments to be able to meet an increase in the reserve requirements.
I f , on the other hand, the authority was of a lesser amount than
that, I think i t would be much less effective as an anti-inflationary
influence.
The C H A I R M A N . Breaking clown these deposits, how do you get the
$12,000,000,000 as between demand and time?
M r . E C C L E S . I think that we can supply the figures.
M r . Y O U N G . T h a t would be about $ 1 0 , 0 0 0 , 0 0 0 , 0 0 0 against demand
deposits and nearly $2,000,000,000 against time deposits, breaking
that $12,000,000,000 down.
The C H A I R M A N . T h a t is about $ 1 0 , 0 0 0 , 0 0 0 , 0 0 0 more than now or
more than you can do if you increase requirements at central reserve
city banks to the l i m i t allowed.
M r . YOUNG.
Yes.
The C H A I R M A N . Y O U could increase i t some without any additional
authority.
M r . T H O M A S . Reserves could be increased about $ 1 , 0 0 0 , 0 0 0 , 0 0 0
now.
The C H A I R M A N . I am wondering wher<? the 1 2 comes from. I t
seems to be $ 8 , 0 0 0 , 0 0 0 , 0 0 0 on demand and 1 . 4 billion dollars on time,
and that is 9.4 billion dollars, and what is the rest of it? Does that
include only the Federal Reserve System or what?
M r . T H O M A S . I t would be around $ 1 0 , 0 0 0 , 0 0 0 , 0 0 0 on demand,
because you have to include the interbank deposits, The $82,000,000,000 of demand excludes interbank deposits. We w i l l insert a
CREDIT
POLICIES
31'
table which shows the break-down by class of bank, using deposit
figures for a recent date.
Existing
and requested potential increases in commercial bank required reserves
(estimates as of Feb. 29, 1948)
[In billions of dollars]
Class of bank
Potential increase i n required primary
reserves under—
Present authority of the system.
Demand deposits..
Time deposits..
Additional requested authority..
Demand deposits
L.
Time deposits 2 _
Member
A l l banks
Central
reserve
city
Reserve
city
Country
Nonmember
banks
1.0
1.0
None
None
None
1.0
None
1.0
None
None
None
None
None
None
None
11.9
2.6
3.8
3.8
1.7
10.4
1.5
2.5
.1
3.3
.5
3.2
9.6
1.4
.3
1
Figured cn the basis of 9 percent for central Feserve city banks, 10 percent for Reserve city and nonmember
banks, and 11 percent for country member banks.
2
4 percent of time deposits for each class of bank.
The C H A I R M A N . H O W do you figure that? Do you have any
estimates on the import of gold? What are they running since the
first of the year?
M r . T H O M A S . I t is $ 4 0 0 , 0 0 0 , 0 0 0 since the first of the year.
M r . E C C L E S . We figured from 1 . 5 to 2 billion dollars, and we figured
not less than 1.5 billion dollars and not more than 2 billion dollars.
T h a t is about as near as the amount can be estimated.
The C H A I R M A N . For the year, per annum?
M r . E C C L E S . That is right, for the year. There may be further
contractions of currency.
The C H A I R M A N . How far does that affect the reserves, is that
dollar for dollar?
M r . E C C L E S . Dollar for dollar, and i t also affects deposits dollar
for dollar.
The C H A I R M A N . A n d the other element is what?
M r . E C C L E S . T h a t is the purchase of nonbank holdings of Government securities by the Reserve banks. Supporting the market,
buying securities from corporations and individuals selling on the
market increases bank reserves and deposits dollar for dollar.
The C H A I R M A N . I f you have just a break-even budget, what is the
situation then?
M r . E C C L E S . That, of course, would mean that the Treasury would
not have to offer any new securities to the banks. B u t depending
upon the amount of demand for municipal financing and long-term
corporate financing, what we find has happened is that insurance
companies, savings banks, and various institutional investors have
sold their Governments, substantial amounts of them, to make other
investments that are more remunerative.
Y o u see, during the war they had no outlet for the funds they
accumulated. The insurance companies and savings banks, as well
as many institutional investors, purchased billions of dollars of the
32
CREDIT
POLICIES
marketable Government securities, which meant, of course, that the
savings of the people in those institutions were already spent. They
were spent for war. Those institutions are now selling off those bonds
that were bought out of savings. They are being sold faster than other
savers in the market will buy them. To hold the market the Federal
Reserve has to buy them, and that creates reserves.
The factors that cause that sale and that determine the extent to
which they w i l l sell depend somewhat on inflationary developments.
I f there should be no inflationary developments, there would be much
less likelihood, and possibly, I think, little likelihood of those market
bonds held by nonbank investors being sold on balance.
The C H A I R M A N . D O you not have the same situation w i t h nonbank
investors exactly like banks? As long as you have large amounts of
Government bonds out, and the Federal Reserve bank will buy them
at par, whenever another good investment comes along they sell them
to you and p u t the money into the new investment.
M r . E C C L E S . That is much less true of the banks, very much less
true of the banks than it is of the other institutions.
The C H A I R M A N . They make loans, but I am talking about the
insurance companies. Somebody comes along w i t h 3 or 4 percent
mortgage to build a new building, and since you are willing to buy the
bond at par and they can get 3% instead of 2% they sell them fcTyou.
T h a t raises the whole question that we are raising, the question that
some people, that whether or not the policy of always maintaining
Government bonds at par is not necessarily inflationary and whether
as long as you maintain i t you can in any way prevent the lending of
money b y banks and insurance companies or anybody else who has
invested i n Government bonds to any degree they want to invest.
M r . E C C L E S . Of course, we recognize the difficulty that that problem raises, and we have recognized i t all along, that to hold a rate for
an indefinite period on a Government security does raise the very
question that you have mentioned here. B u t i t is a question of
alternatives. I t is a dilemma that we are confronted with. We
have recognized that and pointed i t out to the committee last fall.
Now, we are not proposing to hold all Government securities necessarily at par. What we have said is that we maintain the long-term
2% rate, letting the short-term rate fluctuate. Of course that depends
upon the Treasury's willingness, I think, because we have tried to
cooperate fully w i t h the Treasury, and at no time have we tried to
force a rate on to the Treasury that they are unwilling to accept. I
do not think that i t would be practical to do so. I think the central
bank has certainly got to recognize the responsibility of the Treasury
and to advise and work w i t h Treasury officials in that regard; and I
w i l l say this, that i n that connection the Treasury and the Federal
Reserve have cooperated pretty fully i n connection w i t h the management of the public debt. B u t the short-term rate is the rate that
should be permitted to fluctuate, depending upon the market demand
or the market situation so far as i t would fluctuate while you are
maintaining a 2% rate.
Now, i t is not going to fluctuate so much as long as you have a
peg on a 2% long-term rate, as I indicated this morning.
The C H A I R M A N . M y question goes to the 2j4 long-term rate.
CREDIT P O L I C I E S
33 '
M r . E C C L E S . I t has got to go to that point. That is the basic
question.
The C H A I R M A N . H O W many of these 2%'s do the insurance companies hold altogether?
M r . E C C L E S . They hold a very large amount of them.
The C H A I R M A N . A n d necessarily to get more return as fast as 3 K
or 4 percent mortgages come along, they are going to sell the Governments, because here is a bond you are bound to get par for, and you
turn around and you can increase your interest.
M r . E C C L E S . The point is the Government itself has helped that
more than the insurance companies. For instance, the title 6 mortgages for housing and what we call the G I guaranteed housing program has been a tremendous stimulation. I n other words, the Government has competed somewhat against itself for this rate by its
policy in connection with the ease w i t h which i t has made very longterm mortgage money available.
However, I w i l l say that only comparatively recently was the 2}£
rate reached. You see, the long-term yield last year was down to
2%, w i t h the 2% bonds selling at a substantial premium. The shortterm yield was permitted to rise last year from %'s to 1%. We also
raised the rediscount rate a little. The effect was to tend to bring
down, or at least one of the effects was to bring down, the price of
long-term Governments. I n other words, to raise the rate to 2%
Kates on other bonds which were selling almost at a 2% percent rate,
gilt-edged industrial and municipal securities, went up to 3 percent.
M a n y of the municipals which are entirely tax-exempt and do attract the funds of wealthy people were selling at 1% percent. Now,
they are the same ones that are selling at around
Now, the 4
percent mortgage, 20 or 25 year mortgages, which involve monthly
payments and a lot of work and a lot of trouble, are no longer attractive. So the Government is now proposing that the Congress
appropriate another $500,000,000 to provide a secondary market so
that the Government itself can buy a guaranteed mortgage, that the
Government, in effect, guarantees.
Now, that is competing w i t h itself for the 2% rate, and that certainly
is a policy that is diametrically opposed to an anti-inflationary policy.
I think that should be recognized.
The C H A I R M A N . On the other hand, i t is quite possible that banks
might get more money for mortgages for lending on housing if there
were no F H A and that they might be more willing to sell their Governments.
M r . E C C L E S . I am not arguing against the F H A , but I am arguing
against the Government appropriating money which cuts into the
budget picture for the purpose of providing a secondary market. Now,
the reason that i t needs a secondary market, if i t needs one, is because
the insurance companies and others are not willing to sell 2){ percent
Governments today as they were. There is very little sold on balance
any more. T h a t is the way this situation at the mement is at least.
Although there was a lot sold last December and i n January, of the
long-term 2}£'s, the effect of our dropping them to par and the fact
that they have confidence that the market is going to be maintained,
tended to make them hold on to long-terms. The whole long-term
34
CREDIT
POLICIES
market is stabilized around that 2% rate. Today, there is not as
much housing mortgage money available at 4 percent as there was
because the holders of Government bonds are no longer as willing to
sell them to make mortgage loans.
The C H A I R M A N . I f it is supposed to be a Government guarantee,
they are a little shy of having too much of one type of security like
that, 1 think. M a n y of the smaller banks are filled up to their limit,
what they think is their limit, for that kind of paper.
M r . E C C L E S . They are not as readily marketable. A guaranteed
F H A mortgage, title 6 mortgage, does not have the ready market
today that i t did have.
The C H A I R M A N . D O you think the Government can maintain Government bonds at par?
M r . E C C L E S . Yes; I think so. I do not think that that is going to
be any problem. B u t i t is inflationary certainly to the extent that
you create reserves in the banking system unless we have an opportunity to sterilize the effect. There would be no problem at all if you
could do that. Y o u could maintain the long-term 2% rate indefinitely.
The C H A I R M A N . Would you get concerned if the Federal Reserve
banks got completely filled up w i t h these Government bonds?
M r . E C C L E S . The question is what is being filled up? When?
The C H A I R M A N . You have got $ 2 0 , 0 0 0 , 0 0 0 , 0 0 0 now.
M r . E C C L E S . We have got over $ 2 0 , 0 0 0 , 0 0 0 , 0 0 0 now, that is everything, short and long, and the whole portfolio.
The C H A I R M A N . I f i t runs up to $60,000,000,000, suppose that
happens?
M r . E C C L E S . The total volume of marketable long-term bonds held
b y nonbank investors is, I think, about $50,000,000,000. That is
the marketable ones. Y o u see, we have over $50,000,000,000 of th8
E , F, and G bonds. These savings bonds are not marketable but of
course are cashable at par. The long-term marketable are not eligible
to the banks, and they amount to something around $50,000,000,000.
The C H A I R M A N . And the banks hold how much?
M r . E C C L E S . The banks own $ 6 7 , 0 0 0 , 0 0 0 , 0 0 0 of the total Governments, but they are not the restricted type; they are another type.
The C H A I R M A N . Who has the rest? There are $ 5 0 , 0 0 0 , 0 0 0 , 0 0 0
E , F, and G and $ 5 0 , 0 0 0 , 0 0 0 , 0 0 0 2%'a outside and $ 6 7 , 0 0 0 , 0 0 0 , 0 0 0 to
banks, and that leaves about $ 8 3 , 0 0 0 , 0 0 0 , 0 0 0 .
M r . E C C L E S . Y O U have got $ 1 3 , 0 0 0 , 0 0 0 , 0 0 0 of weekly bills that
fall due every week, a billion a week.
The C H A I R M A N . Those are the banks?
M r . E C C L A S . They are held by corporations, some of them, just
i n anticipation of taxes, and the Federal Reserve is a very large holder
of bills, most of our portfolio of $20,000,000,000 is bills and certificates.
Y o u see there is something like twenty-odd-billion dollars of certificates, 1}& percent certificates. Then, of course, there are these securities that are held by the trust funds, too; the Government itself has
a substantial amount of that debt held in the social security and other
funds.
I have a table here which shows estimated holdings by investor
classes as of M a r c h 24, 1948.
CREDIT POLICIES"
35
1
Estimated ownership of interest-bearing Federal securities,
Mar. 24, 1948
2
[Par values in billions of dollars]
Investor classes
Type of security
Total
all
investors
Marketable securities:
1. Bills, certificates, and
Treasury notes.
2. Treasury bonds, due or
callable:
(a) Within 1 year
(b) 1-5 years
(c) After 5 years..
..
3. Miscellaneous 3 ..
4.
Total marketable..
....
Nonmarketable securities:
1. Savings bonds.
2. Savings notes
3. Depositary bonds
4. Special issues
5. Armed forces leave bonds.
6. CCC demand obligations.
7. Treasury bonds, invest-
U.S. GovFederal Commer- ernment Insurance Mutual
agencies compa- savings
Reserve cial
banks
and trust
banks
banks
nies
funds
16.5
0.1
1.1
12.4
2.7
34.0
11.4
.3
5.0
.1
3.0
18.8
(<)
5.2
17.2
.1
161.5
64.6
5.6
23.0
52.9
5.1
.3
29.3
1.2
45.7
4.1
46.4
65.0
.2
.1
2.0
3.5
.1
.3
(V 1
(4>
36.0
51.0
5.0
29.3
.7
.2
1.8
Total nonmarketable _.
Total all securities _.
1.1
(0
ment series
8.
A l l other
investors
20.6
35.0
56.8
92.8
1
a
3
Consists of all interest-bearing securities, issued or guaranteed by the U. S. Government.
Preliminary.
Federal Housing Administration debentures, postal savings and Panama Canal bonds.
* Less than $50,000,000.
The C H A I R M A N . H O W many bonds would the 25-percent special
reserve immobilize?
M r . T H O M A S . About $ 1 6 , 0 0 0 , 0 0 0 , 0 0 0 .
The C H A I R M A N . That is only 16 out of the 67.
M r . T H O M A S . T h a t is short-term.
M r . E C C L E S . I think i t is more than that. I think that we can
insert a table on the figures. Last November we had all of those
figured out as of the figures available at that time. I t would need to
be brought up to date, making use of the latest call-report figures;
namely, those for December 31, 1947. I w i l l also insert into the record a table showing the estimated distribution of bank holdings of
Government securities, by call date and class of bank.
CREDIT
36
Potential
requirement
for
POLICIES
holdings
in short-term
Government
special or optional
reserve
plan
securities
under
the
[Estimates as of Dec. 31,1947, in billions of dollars]
Class of bank
Member banks
AU
banks
Maximum special reserve requirement,..
Less holdings of excess cash assets
Maximum requirement for holdings i n short-term
Government securities
1
Central
Reserve, Reserve,
city
city
Nonmember
banks
Country
30.2
9.7
7.5
2.7
9.9
3.2
8.9
2.9
3.9
.9
20.5
4.8
6.7
6.0
3.0
Based on aggregate figures b y classes of banks.
Estimated
distribution
banks
of United States Government
securities
held by all
Mar. 24, 1948, by call date and by class of bank
commercial
[Book value, i n billions of dollars]
U. S. Government securities call class
Total
Within
1 year
1 to 5
years
5 to 10
years
10 to 15
years
15 to 20
years
A l l commercial banks.
67.0
20.7
34.5
6.7
2.2
2.9
Member banks, total
55.9
16.9
29.0
5.9
1.9
2.2
11.1
2.8
19.5
22.5
3.4
.8
6.2
6.5
6.1
1.2
9.1
11.8
1.2
.5
2.1
2.1
.3
.2
.7
.7
.1
.1
.6
1.4
9.9
1.2
3.4
.4
4.9
.6
.7
.1
.3
.6
Central Reserve city:
New York C i t y .
Chicago
Reserve city
Country
Insured nonmember banks
Noninsured banks
0)
Over
20 years
.1
* Less than $50,000,000.
Air. T H O M A S . T h a t would be about $ 3 0 , 0 0 0 , 0 0 0 , 0 0 0 , and you would
have about $10,000,000,000 of other assets.
M r . E C C L E S . T h a t is more like it. That is $ 3 0 , 0 0 0 , 0 0 0 , 0 0 0 of
short-term Government securities.
The C H A I R M A N . T h a t $ 3 0 , 0 0 0 , 0 0 0 , 0 0 0 would be immobilized.
Air. E C C L E S . Yes; except that you permit them to use other assets
in lieu of that. That is any assets that they have above 20 percent
of the demand deposits, and the reason for that is, for instance, that
a bank that is a member of the Federal Reserve System has its reserve
requirements w i t h the Reserve bank, and they have cash on hand,
and they have items in process of collection that they call transit
items, and they have balances w i t h city banks.
Now, they may have as much as 30 percent reserve in all of those
factors, and i t would be unfair to impose the 25 percent on any bank,
no matter what reserve they had. Therefore, you start w i t h 20
percent as the basis, and any bank which is carrying reserves and
cash of more than a 20 percent figure, i t would apply that against
the 25 percent special reserve. I n other words, the special reserve is
composed of short-term securities or other cash items, balances in
other banks, which is above 20 percent.
CREDIT POLICIES
37 '
Now, if you did not do that, then you would practically destroy
the correspondent bank relationships. There are a lot of nonmember
banks as well as member banks that would maintain substantial
balances w i t h the correspondent bank; and if those balances, plus cash
on hand, plus excess reserves w i t h the Federal Reserve, in the case
of a member, are above 20 percent of demand deposits, they would be
permitted to count that as part of the special reserve.
I n other words, you have got to start on a base point of 20 percent.
Now, some banks carry as high as 40 and 50 percent of demand
deposits in interbank balances and cash and currency, in which case
they would practically have no requirement under the 20 percent
because they already are in that position. So now to explain the
application of the 25 percent, if banks had nothing above the 25 percent, then to apply the 25 percent would immobilize $30,000,000,000
of short-term Governments; but taking the picture as i t now is, there is
about $10,000,000,000 of the cash items and balances such as I have
mentioned above the 20 percent of demand deposits. So that that
would mean if this were applied, i t would only immobilize about
$20,000,000,000 of short-term Governments.
The C H A I R M A N . In'effect, if you exercise full power, they could not
put in loans and investments of more than half of their deposits?
M r . E C C L E S . That is about right. A n d what is more, that fractional reserve of 6 to 1 is cut down to about 2}{ or 3 to 1, and not more
than 3, I would say closer to 2%. Therefore, you get away from that
large multiple deposit expansion. So that even if banks then did
sell Governments to the Reserve banks, the ability of the banking
system to expand on the basis of the reserves thus obtained would
be reduced.
I n suggesting the use of the optional reserve power, as you well
know, we have indicated here that i t would be applied only in case the
credit expansion and inflation is continuing, in spite of the use of the
powers we might get under the increasing of reserve requirements also,
if a substantial budgetary deficit is incurred, we would be unable to
increase reserve requirements because either a substantial part of i t
or all of i t would have to be financed by the banks. Deficit financing
would mean that you actually wanted the banks to buy Government
securities. Therefore you would not increase the cash reserve because
that would force them to sell Government securities. Consequently,
if you run into large budgetary deficit financing, this special reserve
requirement seems to us essential, if you are going to do that financing
on the basis of selling short-term Governments to the banks.
We feel that that is the way to do unavoidable bank financing of a
Government deficit. We should not want again to see long-term
Government securities sold to the banks and have the trouble that we
have had in the past. B y this special reserve requirement, you would
immobilize the securities sold to the banks as you put them out. I f
you made the special requirement higher, that would be an inducement
for the banks to buy more Governmnet securities. The special
reserve would also be of great assistance in refunding maturing
issues, because the banks then would not be inclined to sell the securities to make loans, in fact, they would probably be obliged to hold
some securities as a part of the optional reserve.
The C H A I R M A N . I have one thing, M r . E C C L E S . I might have to go
over to make a quorum, and M r . Patman has some questions to ask.
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CREDIT
POLICIES
W i l l you put i n the record the figures that we referred to, that is, the
figures showing the effect of this thing on the reserves, and also I
think any other figures dealing w i t h the total outstanding bonds and
whether held by banks or private individuals, and so forth. There is
a table here i n the Treasury Bulletin of March 1948, but I think i t
would be desirable to have those figures in the record, whatever you
think is material to the committee.
M r . E C C L E S . We will put them in at the appropriate places.
I would like to say one tiling, Senator, on this question of interest
rates, because I think that I may have made a wrong impression in
m y remarks this morning. I come to that conclusion by reason of a
report over the Dow-Jones ticker that I saw when I went back to the
office. The report is that Eccles told the committee that the Reserve
Board is considering raising interest rates on short-term securities
and discount rates. That is, I think, a misinterpretation of my statement. What I certainly meant to say, and what I think my statement
implied is that restrain such potential expansion—and that is the
expansion that would be created or possibly could be created by the
reserves that would come into the banks from the sources that have
been enumerated—I said the Federal Reserve would have to take
action to absorb any excessive volume of reserves. To restrain credit
expansion, we would have to take some action. I said that there are
two types of measures which should be adopted. I t might have been
better to have said two types of measures should be considered, but
certainly to deal w i t h a potentially inflationary situation, I am sure
that i t is the view of the Board that they should be adopted.
One of these measures is some further rise in short-term interest
rates and i n discount rates. The question of raising the interest rates
is not a matter for the Board. The question of raising the interest
rates on short-term Government securities is a matter for the Treasury,
i n consultation w i t h the Open Market Committee, and in the light
of the advice of the Opei^ Market Committee.
Now, the question of raising the discount rates is a matter for Board
approval. The Board does exercise control over the discount rates.
W e can approve of the rates submitted by the banks, or if we disapprove of them then they have to submit a rate that we will approve,
so the practical effect is that we can control the discount rates.
I went on further to say that the first of these measures, namely,
that of increasing the interest rate on short-term Government securities, was the matter that could be adopted or considered by the
Federal Reserve and the Treasury without any newT legislation. I
also said that the action would be designed to induce banks to purchase short-term Government securities.
I t would look from the reporting of this morning's testimony that
the Reserve Board, if they decided you should raise short-term rates,
would just proceed to raise them. As I stated, that is not a power
which the Reserve Board has. The Treasury fixes the rates on the
short-term securities that they are going to offer, and i t is done in
consultation with, and on the advice of, the Open M a r k e t Committee,
of which all of the Board are members. I n addition to the Board
members, there are five Reserve bank presidents; so that the Board,
of course, exercises a very considerable influence i n advising on the
question of interest rates-
CREDIT POLICIES
39 '
B u t this reporting gives the impression that interest rates might be
raised tomorrow because we favor doing it, and therefore we can do it.
I just wanted to have the press get the correct picture here, namely,
that although we favored, under the conditions which are indicated,
dealing w i t h them by raising the rates to the extent that we can do
i t without raising the rates on long-term bonds—and that may be a
very limited amount—the raising of interest rates is not a power which
is w i t h i n the Board's prerogative.
Representative P A T M A N . I understood you to say this morning
that the 2K percent interest rate on government securities should be
maintained.
M r . E C C L E S . That is right.
Representative P A T M A N . Y O U mean to say the 2% percent rate on
Treasury bonds; in other words, the bonds will be taken at par, so
that the rate will not go down or will not go up; is that right?
M r . E C C L E S . Well, if the 2% percent rate on the longest term
Government securities is maintained, that means that longest term
bond would be supported at par.
Representative P A T M A N . D O you expect to-do that?
M r . E C C L E S . As a matter of fact, the support price is 1 0 0 % 2 .
The reason for this support price is to enable the ultimate seller to get
par, because when he sells his bond he cannot bring i t right in to the
Federal Reserve bank. He sells his bond to a security dealer, and
by the time i t gets to the Reserve System there is some cost in handling
it. We wanted to be sure that the seller would get par. And to do
that, we had to allow %2 above par to allow for the commissions and
costs in between.
Representative P A T M A N . That is about what they are selling for
now; is that not right?
M r . E C C L E S . I think they are slightly above that. They have
fluctuated.
They have been up eight-thirty-seconds above that.
Representative P A T M A N . I t is the intention of the Board to maintain at least that rate?
M r . E C C L E S . I t is the announced purpose of the Open Market Committee, and also the announced purpose of the Treasury, to maintain
that rate on the longest term Government bonds. There is no commitment, so far at least as the Open Market Committee is concerned,
to maintain securities, all securities, at par.
Representative P A T M A N . I did not mean to say all securities.
I
meant the 2l/2 percent securities.
Air. E C C L E S . That is the basis.
Representative P A T M A N . You expect to keep them at par?
M r . E C C L E S . Yes, and that means, of course, as long as you do that,
the shorter, medium-term securities will sell at a premium. Therefore, there is not much likelihood of any of the securities going below
par except if the short-term rate is raised. I f the short-term rate is
permitted to rise as much as a quarter, then the securities falling
chw, w i t h i n a year or maybe 2 years might fall slightly beIowT par.
Representative P A T M A N . What is the average going interest rate
now for the Government bonds, or the Government securities?
M r . E C C L E S . I think around 2 percent.
Representative P A T M A N . I S i t not a little higher than that?
M r . E C C L E S . I t fluctuates, depending upon the amount of savings
bonds out, because that is a fairly high rate. Of course, you have to
40
CREDIT
POLICIES
take the average rate into account, in raising the short-term rate
I should point out that a good portion of the increase i n the shortterm rate would go to the Federal Reserve, which in turn would return
the lion's share to the Treasury as a tax.
Representative P A T M A N . Because the Federal Reserve owns most of
the securities?
M r . E C C L E S . I t owns a large amount of bills and certificates.
Representative P A T M A N . I notice they were increased from about
three-eights in January of 1947 to about ninety-seven one-hundredths.
M r . E C C L E S . That was done practically all at once, because that
three-eights was an unreal and unnatural rate. That three-eights rate
then prevailing represented the rate on securities owned by the
Federal Reserve. There was no market for bills outside the Federal.
What we felt should be done was to make the bills a market instrument;
in other words, to put them on a real bid basis instead of the existing
artificial basis. That is to say, we felt that we should let the market
determine what a 1-year bill should pay or yield.
Representative P A T M A N . I notice, though, M r . Eccles, that the
bankers' acceptances, 90-day bankers' acceptances, went up from
about eighty-one one-hundredths in January of 1947 to about 1.08 in
1948. They went up considerably, too, along w i t h those securities.
M r . E C C L E S . That is right, because the yield on bills and certificates
went up.
Representative P A T M A N . Which one pulled the other up?
M r . E C C L E S . The Governments pulled up the others, I think.
Representative P A T M A N . Pulled up the private ones?
M r . E C C L E S . The Governments dominate the whole market.
Representative P A T M A N . N O W you take the corporations, the
interest rate increased from 3.13 i n January of 1947 to 3.53 in January of 1948.
M r . E C C L E S . T h a t is right.
Representative P A T M A N . Y o u say the Governments pulled them up?
M r . E C C L E S . Entirely.
Representative P A T M A N . W h y should the Governments do that?
M r . E C C L E S . Because, w i t h a marketable public debt of 165
billion dollars, Government securities dominate the market.
Representative P A T M A N . I t occurs to me that that is interfering
w i t h the market.
Air. E C C L E S . I t was not interfering at all, because we were supporting
an artifically low level. We were the ones that were pegging the shortterm rate at seven-eighths for certificates and three-eighths for bills,
and therefore there was no market for bills and practically all bills
went to the Federal Reserve, and a great many of the certificates
at seven-eighths went to the Federal Reserve.
Because we were paying such a low rate on the short-term paper,
the 2% percent Governments went up to a premium of nearly 107,
and the municipals dropped down to a 1% percent rate. I t was all
due to the fact that we're permitting the banking system to create
money at a very, very rapid rate.
What the banks were doing was this: Because the rate was so low
on the short-term paper, they were selling the short-term paper to the
Federal Reserve and buying the longer-term paper in the market.
A n d a 2-percent bond that was eligible for the banks to purchase
went down as low as 1% percent yield, and to a very high premium.
CREDIT P O L I C I E S
41 '
I n other words, we forced the rate down and prices up through pegging
the market at seven-eighths on the short term.
Now, we have shifted the emphasis of our support program to the
2y2 long-term rate. What we were doing—-the fact that we were
pegging seven-eighths short-term rate—drove the long-term rate down.
Under these conditions, the refunding which was being done by private
corporations and others was at lower and lower rates. We were
getting into a position where i t wras increasingly difficult to ever let
the short-term rate go up without also raising the long-term rate
and causing insurance companies and many others to incur very large
losses on the securities that they had purchased at the low rates.
We felt that there is some obligation, certainly, to investors as well
as there is to borrowers; that there was no justification in maintaining
that short rate and forcing the long rate up. You can make a pretty
good case for holding the long-term rate at 2% wiiile the public debt
is as large as it it. I f it were not for the fact that the public debt is
so large that there is a very big job of refunding to be done constantly,
and that these securities are held so widely by banks and many other
institutions, then certainly in a situation today where the total volume
of savings in the country possibly does not equal the demand, you
should let the savings rate really go up. We are tending to keep the
savings rate down as long as we hold the 2%-percent rate, and we are
criticized for it.
B u t as I said to Senator T a f t , you have a problem of alternatives
here. I t is the judgment of the Board that even though the demand
for savings might temporarily justify a higher rate because the sayings
today are possibly less than the demand for money, we should continue to hold the 2 ^-percent long-term rate. However, we also agree
that the long-term rate should reflect the actual volume of savings
that is taking place in the country i n relation to the sustainable
demand.
Representative P A T M A N . B u t there is plenty of money or credit
available.
M r . E C C L E S . The trouble is, i t is bank credit. Borrowers go into
the banks and obtain bank credit. T h a t expands the total volume of
money, and because you cannot expand the supply of goods and labor,
i t reflects itself in higher prices.
Representative P A T M A N . Really, there is about three times as much
money and credit available nowr as ever before in history.
M r . E C C L E S . B u t you have also the fact that the national product
has pretty largely absorbed that inflation of money. The national
product has gone up since 1940 from $100,000,000,000 to $240,000,000,000. Now, that is an increase of one and tw^o-fiftlis; whereas,
the supply of money has increased nearly one and two-thirds. The
supply of money is still more than adequate; there is an excess of i t .
Representative P A T M A N . T h a t is wiiat worries me. I cannot
understand, M r . Eccles, this fact: I t occurs to me that the lawr of
supply and demand would cause interest rates to go down instead of
going up, since you say there is adequate credit, more than we have
ever had before.
M r . E C C L E S . B u t there is a question of who wants to borrow the
money and who wants to lend it. You cannot assume that a person
who owns money is necessarily going to be willing loan i t at these rates.
T h a t is, one of the reasons that tho money may not be flowing, to
42
CREDIT
POLICIES
even though you have got a lot of i t , as freely and readily as otherwise i t would flow, is because there are some who feel that the rates
do not justify the risk* W h a t you have today is an abnormally low
velocity of money.
Representative P A T M A N . Here is the danger that I see i n this
increase in the interest rates. You take the cities and counties and
States—they w i l l have to pay more.
M r . E C C L E S . They ought to pay more. W h y shouldn't the investor
get more interest when the purchasing power of the dollar is diminishing?
Representative P A T M A N . A n d that, of course, causes an increase
in taxes, too.
M r . E C C L E S . Possibly so, that is right. B u t why shouldn't people
pay more taxes, or why shouldn't the farmer pay more taxes when he
gets three times as much for his wheat? W h y shouldn't the laborer
who gets two or three times as much for his wages pay more taxes,
and why should the entire cost of the inflation be borne by the saver,
the person who has got money to rent?
Representative P A T M A N . Utilities will have to pay more interest,
and they w i l l want an increase i n rates, and i t increases everything.
T h a t is inflationary.
M r . E C C L E S . The rates are still excessively low. Money rates are
the one part of the economic situation that is still deflated. The
person who has been h u r t the worst is the pensioner, the saver, and
the person who depends upon a return from a fixed investment.
There are two reasons for this.
Representative P A T M A N . Or fixed salaries and wages.
M r . E C C L E S . T h a t is right, too. The saver not only gets a much
smaller return on his dollars, on his loans or investments, than he ever
got i n the 1920's or i n previous years, but the dollar will likewise
purchase a lot less, so that if i t were not for the problem that the
management of the public debt would create, and the huge size of
the public debt, and what i t would do to the value of the securities
held by banks, insurance companies, and institutions generally, there
is a very good case on the grounds of equity today to make for raising
of the rate.
Representative P A T M A N . Y o u are raising the rate.
M r . E C C L E S . I am speaking of the long-term investment rate. The
short-term rate is not the investment rate; the short-term rate is the
bank rate.
Representative P A T M A N . B u t something has caused the corporate
rate to go up considerably.
M r . E C C L E S . I t is because the short-term rate went up, and that
reflected itself i n the long-term rate u n t i l the support price of the
2K bonds was reached.
Representative P A T M A N . I t occurs to me that, although I am sure
the Board did not intend i t that way, i t is going to practically stop
the housing program based on 4 percent equity. I t will not be long
before the people m i l not take these 4 percent mortgage loans.
M r . E C C L E S . I think that they will take the 4 percent mortgage
loans; that is not so much the problem. I f the loans were better loans
than they are, they could be sold. One of the troubles w i t h these
loans is that there is no down payment. A n d certainly i t would be
a good thing if there was a smaller market for mortgage loans. I n
CREDIT POLICIES
43 '
that case there would possibly be fewer people trying to build houses,
and if there were, then the cost of building labor and materials would
not go higher. The trouble i n the housing field has been that you
have an inflation here since the war ended of practically 100 percent
in the cost of houses, and you are getting people in debt at excessively
high-priced housing today. I f we should at some time get a change
in these values, and get any recession, i t is going to put a real burden
on these people that we want to help. You do not help a person by
getting them in debt to buy property on a long-term basis at an inflated price, and i t seems to me that one of the reasons that construction costs are so greatly inflated is because the amount of money
made available for construction, and particularly in the housing field,
has exceeded the supply of building labor and material. Because
there has been practically no down payment required, i t has taken
practically no capital to get into the industry, and we have found
literally thousands of speculative builders go into the business w i t h
practically nothing on their own. The net result is that there is a
highly speculative situation in the housing field. I f that has slowed
up and if there is not the mortgage money available, I think that
that is one of the most wholesome situations that can happen as an
anti-inflationary development at this time. One of the best things
that could happen at this particular stage—as an anti-inflationary
measure—would be to have the cost of housing come down, particularly the cost of the materials and the labor that goes into the housing.
Representative P A T M A N . Construction costs you only pay one
time, and interest you pay every year u n t i l i t is paid off.
M r . E C C L E S . T h a t is right.
Representative P A T M A N . D O you not think i t is easier now to pay
$10,000 for a home w i t h a low interest rate over a period of 30 or 40
years, than before the war to pay $5,000 w i t h a high rate of interest,
may be w i t h three mortgages?
M r . E C C L E S . W h a t I am advocating—and I am not saying that
even the 4 percent rate should necessarily change—is that there
should be some down payment required; that people should not go
into the business without any money or capital of their own, and that
people should not buy houses without any equity of their own. T h a t
is what I am largely contending here.
Now, i t may well be that an increase i n the rate on housing mortgages of one-half of 1 percent would be all that would ever be required,
so long as the 2% percent rate is maintained on long-term Governments.
I t is m a t close a margin. The margin between the desirability of a
4 percent housing mortgage and a 3 or a 3% percent bond is just about
one percentage point.
Representative P A T M A N . I know, but one-half of 1 percent every
year for 40 years runs into money, you know; that is paid every year.
M r . E C C L E S . I f they paid i t i n 20, i t would be half as much.
Representative P A T M A N . We have a bill over i n the House, and of
course I am i n favor of Senator Taft's bill, the Taft-Ellender-Wagner
bill, because i t has some public housing i n i t , too, and I am lor that.
M r . E C C L E S . We ought to wait for a period when i t is favorable
to do that.
Representative P A T M A N . Are you not going to consider the people
who are out of homes?
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CREDIT
POLICIES
M r . E C C L E S . B u t you are not going to get more homes. A l l you
are doing is inflating the price of homes. I f by reducing the rate
from 4 to 3 that was actually going to build more homes, at less money,
then I would be for i t . I f you had idle men and idle material, and the
thing that was short was money, then we .ought to do everything for
the Government to help to stimulate the construction industry in order
to use up the idle labor and the idle facilities.
Representative P A T M A N . D O you not think that there are certain
things that we have to do, although possibly inflationary, i n order to
give homes to people?
M r . E C C L E S . I think if you were getting more homes, that is one
thing. B u t merely by making more favorable terms you do not get
more homes. I t is like I said i n the installment credit field: Merely
b y making installment credit terms more favorable to buy an automobile is not going to produce more automobiles,
The C H A I R M A N . I think i t does produce more homes, though.
M r . E C C L E S . I doubt it.
Representative P A T M A N . I think so, definitely.
The C H A I R M A N . I think we have gotten beyond the bottleneck stage
i n homes, pretty nearly.
M r . E C C L E S . I hope so, b u t so long as you have the shortages that
y o u have i n the basic materials and building labor, I cannot see how
more credit will produce more housing. Lumber is a terrifically inflated item; i t is still up. I know something about i t . Lumber is up
from the OPA ceiling price by more than 100 percent.
The C H A I R M A N . W h y should we send $ 3 0 0 , 0 0 0 , 0 0 0 worth abroad,
then?
M r . E C C L E S . That is another question, b u t certainly lumber is
fantastically high. I t is higher than any farm product, I think.
A n d on top of that, you have building labor that is extremely high and
very inefficient, generally speaking.
Representative P A T M A N . A n d on top of that, you know what the
steel situation is. I know people in the building business, and they
do not verify the fact that i t is easy to get deliveries on materials at
all. They are still very tight, and there are still gray markets i n
many items.
Representative P A T M A N . I want to ask you a few questions bearing
directly on your testimony, M r . Eccles, please.
Now, you want these reserve requirements raised. A t least you
want the Board to have the power and the authority to raise them if
necessary. Y o u believe that w i l l make credit harder to get; and credit
being harder to get w i l l stabilize the economy just a little bit better
and keep prices down.
M r . E C C L E S . Let me put i t this way: We feel i t would sterilize the
inflationary effects of the excess reserves that gold imports create,
and i t would tend to sterilize the effect of the reserves that would be
created in our support of the 2% market if insurance companies and
others sell 2% bonds.
Representative P A T M A N . Y O U made that very plain in your
testimony.
M r . E C C L E S . Otherwise, the banks would have these reserves
and they would be out under pressure to be making loans, under an
inflationary condition. I f we had that condition i n deflation, i t
wTould be fine. B u t i n a condition now where the supply of money is
CREDIT POLICIES
45'
already excessive i n relation to the total product, to be inducing the
banks to seek loans and to be putting i n a condition where i t is i n
their interest so to do, because they have idle funds, idle reserves,
that we have created for thm, or our gold policy has, is something
that we do not want to do.
Now, last year they were doing just that.
Representative P A T M A N . I f you had this power, M r . Eccles, and
you exercised it, which, of course, you would do under the circumstances
M r . E C C L E S . Well, we would if bank credit expanded, and if i t
didn't we wouldn't be justified in doing it.
Representative P A T M A N . I f you did, do you think that would have
a tendency to keep prices down?
M r . E C C L E S . Yes. I t would have a tendency to keep credit expansion down. And to the extent that credit expansion was kept down
the money supply would be kept down. Certainly you can't get
inflation without money. Inflation is a reflection of the expansion of
the money supply; not directly, because velocity must be taken into
account, too; but certainly, without an expansion of the volume of
money on a given supply of goods and services, you are not going to
get a dangerous inflationary situation.
Representative P A T M A N . Suppose the Board had the power today.
Would you want the Board to exercise that power to lower the present
prices?
M r . E C C L E S . Well, we couldn't. There is no power today under
which we could do that.
Representative P A T M A N . I say if you had the power you are asking
to be given to you, had that power now, would you use i t to lower
prices and wages?
M r . E C C L E S . Y O U couldn't lower prices and wages by doing i t .
I f we undertook to lower prices and wages, i t would have to be done
by withdrawing support from the Government market and raising
the discount rate.
Now, we could actually make credit so tight if we refused to buy
Governments and raised the discount rates accordingly that i t would
be just like i t was after World War I . Y o u certainly could create
that land of a situation w i t h that kind of a policy. B u t so long as
you support the 2% percent Government rate you really can't make
bank credit tight. And that is something to which we are committed
for the foreseeable future.
Nobody wants to say forever, but certainly so far as the Federal
Reserve people can see things at the present time, we have an unavoidable responsibility to the support of the 2% percent rate.
As I stated, while you are doing that, you really can't make bank
credit tight. I f you increased the reserve requirements to the full
extent that is indicated here, that is a total amount of $12,000,000,000,
and the banks have $67,000,000,000 of Governments, they could
easily meet that requirement. Tliey could meet it simply by selling
$12,000,000,000 of Governments, and they would still have $57,000,000,000 left.
Representative P A T M A N . Now, I want you to apply that from a
practical standpoint by using a Reserve city bank as an illustration.
H o w could a Reserve city bank increase its reserves to make
additional loans? A n d how much could they increase them?
77099—48
i
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CREDIT
POLICIES
M r . E C C L E S . H O W do you mean?
Representative P A T M A N . H O W could a Reserve city bank, i n selling
bonds to the Federal Reserve bank of that district, increase its ability
to expand its loans?
M r . E C C L E S . Well, if a bank hasn't got any excess reserves, or,
that is, has no money to lend—then, let us say they wranted a million
dollars of reserves. They would sell a million dollars' worth of their
Governments. Those Governments would be purchased by the
Federal Open M a r k e t Committee from the dealers to whom they
were sold, and funds would be credited to that bank that sold the
bonds.
Nowr, assume that bank makes a loan, and this is the way i t makes
a loan. I t gives credit to the borrower in the form of a deposit account. Then, in place of the bond that is held, the bank has a note
of the borrower.
Representative P A T M A N . They could have an aggregate of how
much in notes?
M r . E C C L E S . Well, just one for one; that bank.
Representative P A T M A N . I know; that particular bank. B u t in the
entire Reserve System, i t would be about 10 to 1.
M r . E C C L E S . When the customer draws down that deposit, i t is
transferred to another bank. That other bank must lay 20 percent
against its new deposit and then has 80 percent of that money to loan.
I t doesn't know where the deposit came from. I t doesn't know anything about it. I t is the reserve funds that were created in the first
instance which are important. And when these reserve funds once
get into the spending stream, then the effect of their use is to create at
least six times that amount of money, which in turn becomes part of
the spending stream.
Representative P A T M A N . That is the average.
M r . E C C L E S . Yes; that is minimum. You have to take savings into
account and also nonmember banks. Nonmember banks are not now
subject to Federal Reserve requirements. Under State banking laws,
nonmember reserve requirements can be met by holding deposits
with member banks.
Representative P A T M A N . H O W large a national income do you think
ws should try to maintain i n order to pay our national debt, M r .
Eccles, w i t h the least discomfort and inconvenience?
M r . E C C L E S . I think if we are going to have reasonably l u l l employment at current price levels we have to maintain a national income,
certainly, w i t h the present population, of around $200,000,000,000.
Representative P A T M A N . $200,000,000,000?
M r . E C C L E S . I t h i n k so.
Representative P A T M A N . I would just like to know that the Federal
Reserve Board certainly has nothing i n mind like what happened i n
1920.
M r . E C C L E S . Well, you can be perfectly sure of that. As far as the
present Board is constituted, I am perfectly .certain of i t .
Representative P A T M A N . That is the reason I wanted you to say
"about $200,000,000,000," because if you keep i t about $200,000,000,000, you cannot go to far on that.
M r . E C C L E S . The idea that the Federal Reserve can
Representative P A T M A N . Yes; but to encourage i t , M r . Eccles; not
to do anything to stop i t . That is what I have reference to.
CREDIT POLICIES
47 '
M r . E C C L E S . Of course, i t is a very difficult thing to stop inflationary pressures at this stage without, maybe, getting some deflation.
I n this connection, I would like to make another observation. W i t h
reference to the matter of some rise i n the short-term rate, we have
already had some. I n other words, the rate has gone up from % to
1 %. Now, if you were to get some little further rise i n the short-term
rate, when the situation is reversed, you can drop it. B u t you cannot
drop i t if it is already on the floor.
And the same thing is true i n the financing of housing. I n this sort
of a situation, if you get a little higher rate, and if then you get a deflation, you can lower the rate. I t is a good thing to have some backlog of housing at lower prices rather than filling up the entire backlog
at these inflated prices, so that if you do get a slump you have
absolutely no backlog available.
Representative P A T M A N . I think those of us who are looking at
this housing problem are not looking at this from that standpoint
solely. We are looking at i t from the standpoint that although i t
might cause some inflation, i t is justified by reason of the necessity of
getting decent housing for people.
M r . E C C L E S . I t is justified up to the point that there are labor and
materials available without inflating further the price of labor and
materials. I would like to qualify that. I would say that i t would
even be desirable if there was a little surplus labor and material i n
the housing field, so that you might get the cost down a little. Housing
construction is so badly inflated that i t would not hurt any if they
had a little deflation.
Representative P A T M A N . Y O U would not t r y to adopt any policy
that would cause that, would you, M r . Eccles?
M r . E C C L E S . I would, if the question of supplying a secondary
market was all that was involved. I would say if there was likely
to be some easing in the price of housing, some increased efficiency
in the building of housing, some slightly reduced cost in housing, if
there was no secondary market provided, and hence if there was a
little less housing taken for the time being, I wTould be all for it. I
would be for i t especially in view of the other inflationary pressures,
due to the foreign aid, and our military, and our tax-reduction program.
Representative P A T M A N . M r . Eccles, suppose that, after you get
those powers, lumber should go up 25 percent, for a known reason,
and other basic materials like steel and cotton and wheat and things
like that should also go up. Would the Board take any action calculated to reverse that trend?
M r . E C C L E S . I f that was based on a further bank-credit expansion;
yes. I do not think that could happen without further bank credit
expansion.
I think these prices that you indicate are going up w i l l immediately
reflect in increased bank credit.
Representative P A T M A N . Then, if you deny them credit, that w i l l
have a tendency to keep the prices back.
M r . E C C L E S . That will keep them in line.
Representative P A T M A N . That is a lot of power, M r . Eccles.
M r . E C C L E S . That is right.
Representative P A T M A N . Of course, in an exaggerated case such as
I mentioned, i t certainly would be justified.
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CREDIT
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M r . E C C L E S . B u t as I told the committee before, we certainly are
not seeking any additional power, and what is proposed here is less
power than the System has always had, but which i t now is unable
to use if i t supports indefinitely the 2% percent rate.
Representative P A T M A N . A l l I want you to do is to make i t plain
and continue to make i t plain that you are not contemplating anything that happened i n 1920.
M r . E C C L E S . Well, I am perfectly sure that everybody in the Board
is conscious that if the Board were to use any power that would tend
to stop the boom, or interfere with the boom, i t would be an unpopular
thing to do. Booms are always popular, and i t isn't possible for the
Reserve System to ever win, They just don't have a chance to win.
Because any action that they take is sure to be unpopular w i t h a lot
of people.
Whenever you try to curb any use of credit or expansion of credit,
you can be perfectly sure i t is a very unpopular thing to do. B u t
after all, that is one of the jobs of the Board that the Congress meant
to give them, and I think that the Board should have the courage to
do something about it, or the power should be given to somebody else.
Because certainly if you are going to have any stability in the economy,
you have got to deal w i t h i t either by direct means, which is contrary
to the American way of doing it—and I mean direct controls, allocations, and everything—or you have got to t r y to get i t in an indirect
way, in a functional way, through fiscal and monetary and credit
policy.
Now, that, i t seems to me, is the only alternative.
A n d I , for one, prefer to have some freedom, and fluctuation and
t r y to get at i t through fiscal, monetary, and credit policy, rather than
a completely regimented and controlled economy, which we have to
adopt i n emergencies, in war. A n d if, for military or other causes,
due to developments, we have to r u n a large budgetary deficit, then
certainly we will have to put those controls in again, or we will have to
have an inflationary development.
T h a t is the point I tried to make.
The C H A I R M A N . M r . Eccles, earlier today you suggested you
might have some ideas on the question of whether under present
conditions there is enough inducement for people to invest in equities
as against loans.
One of the reasons that has been suggested for the excessive pressure for loans, is the inability to get equity money. I f that is so,
what has caused it, and what is the remedy?
M r . E C C L E S . There is certainly no shortage of equity or other
money today. T h a t isn't the problem. The problem today is the
shortage of material. A n d if there was more equity monsy, there
would be more demand for goods that are i n short supply. The
problem is not a shortage of money.
The C H A I R M A N . Now, we have had some cases brought to my
attention. On^ was the company that wanted to sell stock and could
not, and wanted to withdraw stock issues; and there were several
stock issues withdrawn here some months ago. They could not sell
more bonds, because the Public Utilities Commission said that would
be an improper balance; that what they needed was more equity
money.
M r . E C C L E S . T h a t is right.
CREDIT P O L I C I E S
49 '
The C H A I R M A N . Would you think that that was a special case?
Or do you think that situation has changed?
M r . E C C L E S . I think that there are a lot of such situations; and I
think if the equity market was open, you would have more inflation
than you have got. Because, if i t was easier for corporations to get
money than i t is today, you certainly would have more of i t spent.
You would have more of them trying to expand the capital-goods
market. There seem to be enough corporations w i t h enough money
already on hand or w i t h Government bonds.
The C H A I R M A N . I t is suggested, however, that most of that money
comes from profits. Profits are very ephemeral and likely to disappear
from the exchange; and they cannot get outside money, outside new
money.
M r . E C C L E S . I t is because they are trying to expand faster than
savings are accumulating. A n d that is undesirable, because when
you are expanding new investments, either by corporations or individuals, faster than the community as a whole saves the money,
you have inflation again.
The C H A I R M A N . Well, of course, this is more of a long-term problem than i t is an immediate problem; because, as you say, you do not
need at the moment more money. B u t there is a study by Professor
Kuznets, I think, simply to show that there was no net saving i n
the thirties; practically no new investment, We were not moving
ahead as we had before.
M r . E C C L E S . Because you had a lot of unused capital facilities,
and consumer purchasing was not in the then deflated conditions
adequate to use what new investments had already been created i n
the twenties. You had idle capacity, and that is why in the thirties
you didn't have a lot of new investment going forward; because
there was too much idle capacity in almost every field.
The C H A I R M A N . Well, I mean, that is the cart before the horse.
I f you had had more investment, if you had had more willingness to
put money into capital goods, you might have started up an industry
that would have really pulled us out of the depression. I n fact, that
is the way we have gotten out of depressions before. I n the thirties
there was no such money. Except for a brief period i n 1937, i t collapsed overnight.
M r . E C C L E S . I f we had had more consumption that might not have
been true. As you survey the situation, we had an excess of office
buildings and hotels and apartments and factory production of all
kinds. We had idle railroads. We had an excess of utilities. We had
an excess of automobiles. I n almost any field you looked at i n the
thirties there was excess capacity. What was lacking at that time
was consumer purchasing power.
Today you have a complete reversal of that situation. You have
a situation where the general public's demand for saving has exceeded
the total volume of savings. I n order to carry forward the housing
and other new investment, there has been a heavy reliance on the
use of bank credit. When the bank credit starts to tighten up slightly,
then the Government wants to step in and to supply i t i n one way or
another.
The C H A I R M A N . Apparently nobody is willing to put any equity
money into housing. That may be because nobody wants to put i t
50
CREDIT
POLICIES
into equities, or ma3Tbe they do not want to put i t into housing. I
do not know which. B u t very little is going in.
M r . E C C L E S . I t is because of the inflated price, and people have no
confidence i n buying. When you put equity money in housing, i t
means that you have made an investment in housing at these prices.
Few enterprisers want to do that. They are perfectly willing to have
the little fellow come along and put his equity in and go in debt for
the housing at these prices. The builder is unwilling to put his
equity money in housing because he just does not have confidence
that it is a good investment at these prices.
I think that is one of your major troubles in the housing field.
T h a t certainly would be my feeling. And I would feel the same way
about putting money into an office building, or into a hotel.
The C H A I R M A N . I t is suggested that w i t h the present tax rates
nobody w i t h very much income can long afford to put money into
equities.
M r . E C C L E S . I n t o what?
The C H A I R M A N . Put money into equities, and take a chance; when
he can get 2% percent on a Government bond.
M r . E C C L E S . W h a t present tax rates do is to induce the people to
put money into municipals. The wealthy people today put their
money into municipals. The municipal rate will give them 4 or 5
percent, when you take into account the fully tax-free feature. There
is no Government bond or comparable security that will pay them
anything like that.
The C H A I R M A N . D O you not have the dilemma that the very wealthy
man w i l l not put money into equities and the poor man should not?
The poor man puts i t necessarily into insurance or savings banks,
which have to put their money into loans. So the more you shift
savings to the lower-income groups, the less equity money you have.
M r . E C C L E S . Of course, I know the argument of the brokers. They
say if we would reduce margins, then, of course, the equity market
would go forward. Well, that is merely a case of expanding credit
largely for speculation, because that is how the margin trading would
be financed. And that means bank loans to brokers or to others for
the purpose of buying securities.
They wTould be better off to have the bank loan to the corporation
in the first instance than to have the money loaned to individuals
through the brokers, or directly for the purpose of buying the securities. Y o u do not accomplish anything by that route. And the only
wray you can help the equity market is where you have more savings
available, and then there is a chance for those funds to go into
equities.
The C H A I R M A N . I w^ould say, off-hand, just from having contact
w i t h a few securities, that there is very little interest in buying stocks
today. I am not talking about margins. I mean investing i n stocks.
I do not know just why.
M r . E C C L E S . Well, i t is because people have no confidence in the
future. I t is the whole uncertainty. People are feeling today that
they do not know whether you are going to have a deflation or an
inflation. The whole question of what is going to happen in the
world picture is causing people to be very, very hesitant. I f there
was some assurance that you were going to have more of an inflation,
i t would improve your equity market tremendously. On the other
CREDIT P O L I C I E S
#
51
•
hand, if there was a feeling that you were not going to have any
further inflation, then, of c o u r s e —
The C H A I R M A N . A S of November, everybody - was rushing i n here
saying there was going to be an inflation surely, inevitably. I t did
not produce anybody rushing out to buy stocks that I ever discovered.
M r . E C C L E S . We didn't come i n and say there was going to be an
inflation. We have pointed out definitely that so far as the monetary front was concerned, there would be no inflation on that front
until after the first quarter. During the first quarter, we said that
there would be a deflationary situation, due to taxation. Y o u will
recall that we said, as to the proposal that we discussed at that time
before the committee, the special reserve plan, that there was no
pressure for i t at the time; that i t could be considered after the first
quarter.
The C H A I R M A N . That was not the general tone during the special
session in the fall. Yours was the most conservative view we had on it.
M r . E C C L E S . I was dealing w i t h it, of course, only on the credit and
the monetary front. And w i t h reference to the question of equities,
this argument has been raised: that a reduction of taxes in the higher
brackets would induce the well-to-do people to use the savings that
they would get as a result of the tax reductions to buy equities; and
thus, i t would not be necessary for the corporations to use bank credit
to the same extent. I t may be that some of the tax savings of the wellto-do would go into equities, and corporations would carry out their
expansion as a result of getting that money, instead of using bank
credit. Or they might carry out an expansion which they would not
carry out if they could not sell their equity; and that expansion might
might be inflationary and undesirable.
Again, they may already have the bank credit, and if they could
sell equities, they would pay off the bank loan. T h a t would be
deflationary. B u t to the extent that the Government would lose
revenue in taxes, and just to that extent, the Government would be
less able to pay off its debt at the banks.
You have got to remember that the Government has debts as well
as corporations, and the question of taxation is a question of whether
or not the taxpayer pays i t to the Government and the Government
applies that on its debt, or whether the individuaf keeps the money
and provides the equity money to the corporation, so that the corporation can pay i t on its debt.
Now, i n an inflationary situation such as you have now, I think i t
is more constructive for the Government to collect i t and apply i t on
its debt. I certainly think if you had a reversal of business conditions,
that is, a deflationary situation, then you would want to reverse that.
I f we t r y to do everything in an inflationary situation that we ought
to do in a deflationary situation, we will have nothing to do, if wa ever
get a daflationary situation to counter it. The principal hope of a
capitalistic democracy, i t seems to me, is to be able to use its fiscal
and monetary policy both against deflation and against inflation.
Flexible fiscal and monetary policy is essential to stability.
I recognize that that is not an easy thing to do. A n d the opposite
to that is to let nature take its course on the boom-bust theory that
private capital, and individuals left to their own devices without
Government doing anything, will work their own wTay out better.
T h a t is the other side of it.
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CREDIT
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The C H A I R M A N . Your theory sound like a theory of mine. I always
refused to have m y tonsils taken out, on the ground that if I ever got
sick I wanted to have something left to do to cure it.
M r . E C C L E S . I would not say that, if we didn't already have a
continuing inflation.
The C H A I R M A N . I agree.
This question that we are raising is a long-term question. I mean
I am not trying to apply i t to the immediate problem. I don't think
there is any concern about i t at this moment. B u t I do think there is
a good deal of doubt whether, as we have the high tax rate, which I
think we are bound to keep on high incomes, and more of savings i n
the lower income groups, we are going to get equity money.
I t does seem to me that that presents a long-term problem that
somebody is going to have to consider.
M r . E C C L E S . Of course, the community-property tax has gone a
long way to help very substantially the people i n the higher brackets.
Certainly from $25,000 to $100,000 they have had real relief as a result
of that community-property tax; that is, those who were not already
i n community-property States, and I happen to be one of them.
The C H A I R M A N . And those who had not already divided their
property w i t h their wives.
M r . E C C L E S . I was all i n favor of the community-property provision.
The C H A I R M A N . I n any event, you do not think that there is any
concern immediately regarding the question of getting more equity
money?
M r . E C C L E S . No, I don't think there is any concern at all. I
think that concern would come and would possibly be met, if you
had a deflationary situation.
Certainly at that time, I think the Board, Senator, would be justified
in reducing margins very substantially on security. I f you had a
deflationary situation, where bank credit was rapidly contracting and
unemployment developing, we certainly would not hesitate to encourage bank credit.
Representative P A T M A N . On the question of equity capital, M r .
Eccles, is it not a fact that most investors can get the benefit of the
capital-gains tax (ind not be out over 25 percent i n taxes anyway?
M r . E C C L E S . Yes; they can get i t on real estate. They can get i t
on any asset.
Representative P A T M A N . Is not most equity capital i n that category?
M r . E C C L E S . I t is all i n that category. I f you buy i t and i t goes
up, and you sell i t while i t is up, after a 6-months' period.
Representative P A T M A N . That is what I mean; for a profit.
Of course, if i t goes down, you are at a disadvantage taxwise.
M r . E C C L E S . T h a t is true.
Representative P A T M A N . Y O U can only deduct how much, as a
maximum amount, on a long-term capital loss?
M r . E C C L E S . Over a 6 months' period you get the benefit of a capital
gain.
Representative P A T M A N . T h a t is where i t increases.
M r . E C C L E S . I f you have a capital gain, i t means 25 percent.
T h a t is really where the tax is.
CREDIT P O L I C I E S
53 '
Representative P A T M A N . That is when i t increases. R u t suppose i t
goes down? There is a limit to what you can charge off, is there not?
M r . E C C L E S . T h a t is right. I think you can charge off not more
than a thousand in any one year, unless you charge if off against the
capital gain. Y o u can charge off the capital loss on one security
against a capital gain on another, but if you do not have a capital
gain, and take the capital loss, then you can only charge off a thousand,
I think i t is, a year.
Representative P A T M A N . I t is not cumulative.
M r . E C C L E S . Up to 5 years; $1,000 a year up to 5 years.
The C H A I R M A N . Of course, in that k i n d of equity investment, you
only bring that result about by selling out. Y o u put the money into a
business, and then you have to figure on selling i t out and putting it i n
another business.
M r . E C C L E S . I will tell you one of the principal reasons that corporations have a disadvantage in selling equities against bonds:
that in the case of financing by bonds or mortgages, they can deduct
the interest against their income tax. I f they finance on an equity
basis they of course cannot deduct their dividends against the earnings.
Corporations prefer debt up to a point of safety. Naturally they
do not want to get to a dangerous point, but they actually prefer
debt, because there is such a tax advantage. The stockholder of the
corporation pays his share, in effect, of the corporation tax, which is
about 40 percent, out of earnings. Then, on the earnings that are
left, to the extent that they are paid in dividends, he pays surtax on
the dividends.
So, you see, there is quite a premium on the use of equity capital as
against debt. A n d that is one of the principal deterrents to the use of
financing by equity capital. That is a much more important factor
in the picture than any other: the tax disadvantage of equity capital
as against using the debt form.
Representative P A T M A N . I have no other questions.
The C H A I R M A N . We thank you very much, M r . Eccles.
The committee will recess until Friday at 10 o'clock, and will meet
in room 138 at that time.
(Whereupon, at 4:20 p. m., an adjournment was taken, to reconvene
at 10 a. m., Friday, April* 16, 1948.)
@FedFRASER