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November 18, 19U0

IASY
Decline in ^onoy Sates

Money rates are at an extraordinarily low level. As is'shown
by tot attached table, rates on various classes of loans and open-r.-arket
investments declined substantially between 1929 and 1936 and declined
soiaewhat further since then*
term open-market rates*

'£he rost drastic declines have been in short-

Hates on Treasury bills and Treasury notes have

approached tero and in certain periods these obligations have been selling
at negative rates*

Yields on bonds of all kinds have also declined*

Hates

on ooEEierci&l loans by banks in le&din, cities, whioh were exceptionally
nigh in 1929* dropped abruptly between that y*r

and 1936»

Further de-

clines have not been reported since that time, but £tany loans to wellestablished customers are being made at rates lower thsc those rerorted*
All kinds of real estate leans have also declined in yield, but are still
at levels that are relatively not low*

Problems Raised by Low Hates
For
For some time past the lower returns on first-elsjss investments
have constituted an acute problem for all kinds of endowed and fiduciary
institutions*

Insurance companies have difficulty in finding what they

oonaider satisfactory investments} beneficiaries of trust funds have had
their incomes seriously curtailed, and universities and other institutions
of learning, as well as charitable foundations and all kinds of other endowed organ isationa, have had difficulties in meatin^ their budgets.




Some

- 2 -

of the adjustments that have been ?aade to the lower l#vel of return*
on investments are a necessary recognition of the fact th^t th© economic
position of the country has radically ©hanged*
it has beeosae a ereditor country*

From & debtor country

Instead of having & limited supply of

reserve r.oney it has a great abundance of reserve funds*

F^ates whieh

were normal a decade or two ago would be clearly out of line with presentday conditions*

Bet ;reat increase in available capital has radically

ehanged the rel*.tloa«hip betweea th« sup ly and the demand for long-term
funds, and capital may well find it necessary to be satisfied with a lower
return than was to be expected at a time when the country was still ex*
perieneinr, a scarcity of investment funds#

The fundasent&l adjustment hat

now been made, however, Ami further de«lime» endanger th« fuaotionit^; of
the capitalistio system, a funclatsental principle tf w ich is thtt invested
capital is entitled to a reasoaablo re-turn.
For Banks.
There haa been a good deal of oritieism of easy money by banks
which have viewed with apprehension the disturbance of the rate structure
to which they hare been accustomed*

nevertheless, it snould be recognised

that the readjustment downward of certain ratos which have been too high was
necessary, particularly in reducing the cost of money to local borrowers in
smaller cities and in rural districts*

It is also true th*t, as a result of

availability of CHnrernmeat securities, of the decline In losses and the increase in recov«ries of items previously written off, together with reduced




. 3-

payments of interest on deposits, banks hare had reasonably good earnings
in recent years. Further declines of the higher long-term rates, however,
and continuance of excessively low rates on large loans and epen-aarket
investments makes the problem a serious one for the banks.
Inflationary Danger
Aside from the point of viewof the lenders as to returns on
their money, the very lew level of interest rates now prevailing may
contribute to unhealthy inflationary developments if they should get
started. The situation is a very different one from the period of deflation when abundance of funds at as reasonable rates as possible was
a means of combating the downward spiral, YJith business and employment
Increasing, with the prospect of a broad and rapid recovery, the possibility must be faeed that the availability of funds at excessively low
rates would tend to encourage unsound expansion.
Reasons for Low Rates
In the light of these circumstances, a careful review of the
reasons for the excessively low rates and of System policy in relation
to it is appropriate, with a view to formulation of a poliey for the
immediate future and for the longer range.
The System*s «o-called "easy money" poliey in the last ten or
eleven years way be reviewed from several angles. The term "easy money"
has four different meanings whieh are not always clearly distinguished.

It is sometimes


used in describing efforts to combat deflation, sometimes

• k*
in referring to the reduction of money rates, at other tines It refers
to a policy of providing abundant funds for lenders, and still another
Meaning is one that has reference to the possibilities of inflation.
The System1 s policy in general has been directed primarily towards the
furnishing of abundant funds, without special reference to money rates.
In the four years from 1929 to 1935 the System was combating
deflation. During that period a rapid decline in money rates was en*
oouraged by System policy. With the exoeption of a brief period in the
autumn of 1951* after England went off gold, the System pursued a policy
of easing credit conditions and adding to the volume of available funds.
This was for the purpose of helping to arrest the violent deflation which
was under way. The System reduced its discount rates and made large purchases of Government securities. Most of the funds released by the System,
however, did not increase member bank reserves, but merely helped the
banks to meet the foreign demand for gold, and the domestic demand for
currency for hoarding, and at the same time to reduce the member banks*
indebtedness to the Federal Reserve Banks. It was a period of tight
not easy money in whieh the Federal Reserve System was attempting to
moderate existing bad conditions.
By the autumn of 193? the banks had reduced their indebtedness
to the Federal Reserve Barks to a small amount, gold and currency had begun to pour back into the banking system, and funds began to accumulate in
the form of excess reserves. In November 1933 member banks had
$800,000,000 of reserves in exoess of




requirements.

Since that time the System has not added in the net to

i t s portfolio, but on the contrary hi s substantially reduced i t .

The con-

tinuous growth of men- er bank reserves from 1933 to 1940 has been Sue
chiefly to the inflow of p l l ^rom abroad and to a l©sser degree to
s i l v e r purchases by the Government,

^he banks have beea out of dobt

ana d l the f 'unis added to reserves have helpen to support the growing
volume of deposits

nd to build up an extraordinary volume of excess

reserves.
The excess reserves, therefore, are attributable chiefly to
the gold inflow,

As i s well <cno^nt much of the gold has come as th*

r e s u l t of an export balance of
have purchased.

rade.

*e have sold more goods than are

As e creditor nation to which payments are constantly

being made from abroad on interest «nd principal of indebtedness, we
M)uld have to h a e an import balance of commodity trade i f we do not
wish to be recipients of gold.

Our t a r i f f policy, which was conceived

at a time when t h i s wss a debtor nation, i s not adapted to our new condition aad i t s continuance has contributed in so small measure to the Inflow of gold.

Much the greater part of erold, however, has come not in

settlement of couaaodity trade balances, but in the

om of capital seek-

ing asylum from disturbed conditions sbroed.
Large-scale Government expenditures financed to a eonside able
extent by borrowing from sanies has also been e factor in the decline in
r a t e s , because i t has created a large volume of deposits in the hands of




* i •
the public available for investment.

Goveisiraont deficit ^inenclng ioes

I t increase menbe* bank reserves, as i s sometimes stated.

On the con-

trary, i t creates ^epOAite and, therefore, increea 8 MM voliae of reui7"»<5 r^'srvj^
takea the 'JIB •

a<i reduces excess reserve?,

*t does, however, when i t

b.rre«t&#i from banks, create & large relume of funds in

the h^c's of tt;e public that presses on theinvestKent

markat end tends to

reduce yields on fixed interest obligations.
All these factors have
of e nip >iy of ftMldtb

r ; tly contributed to tn© building up

On the otaer h»nd, the leaand has not been adequate

to absorb this gro*ing supply*

Bsnfe loans here been in small volume o*i.ng

to t i e low level of business aetivlty #
ly because of scarcity of opportunity.

investment h&» lagged behind, pert|

«rtly because o^ eautloc

duced by lack of assurance of succen ful business operations.

in»

The situa-

tion tee been one in <vhieh persons vith alecuate credit standing were not
borrowing, ^cile persons and institutions *?Mcb. wirini to borrow lacked
the necessary basis of credit*
A great de 1 aee been '.one by the Government to relieve distressed conditions of borrowers on "«r»s ^nd urban ho«e» and this has
greatly improved not only the ntatas of the borrower, but slao the
fiaancial condition i f the lenders.

Meverthalees, the policy of Qov-

erm^nt agencies to borrow at the low rates available to the Government
fmdreland to the public at v&«t looks like very low rates to business
leaders has been one of the factors dep easing money rates*

While the

rgency refinancing has done a gre-at deal of good from the public pcint

view, «ven


in the

*leld of Governmsat credit agencies the ti".e has come

-

7

-

when the lending policy of these organiza:io«s should be carefully
reconsidered in the light of changed conditions.

Recent s
The System hss orov*n continuously an awareness o* the
of inflation sud has not been interested in low rates &.

, particu-

l a r l y on short xaonsyt
An indication o f the System's - t t i t u ; e toward short-term openmerket rates i s £lTea by the "act that in 1939 i t allowed i t s sntire
portfolio of |500t000,000 of Treasury b i l l s to mature in order to increase
the supply of these b i l l s available end relieve the pressure that wes
forcing these rates below a no-yield level.
The Systesa has been interested in maintaining funds ^butt'-aat for
all legitimate enterprises at 8 time t&en business recovery has been
iscoiaplete.

At the e^m© time i t has beea aware o^ the possibilities of

inflation arising from an orer supply of ^un s«

In 1935 the pov r to

raise rest?Te requirements was obtained in order to absorb some of the
res ires on whi h a

urtber erpensioa could occur,

^he i&x i | ich

Congress granti-ct to the Bo&rc. in tiiis matter wes limited to doubling
the reserrefi, ^nd in 1936 and 1937 the System used this power
to the full.




In the spring of 1938 i t reduced re^uiraaeats by one-eighth

•8-

as a part of a general government program for dealing with deflationary
developments at that time.

But this reduction was of no particular con-

sequence because the S./rtem retained the power to reabsorb the reserves
thus released and because dirstribtrelon and further large gold imports
soon increased bank reserves to a point where the System's power was not
adequate to control them.

The Chairman of the Board of Governors opposed

the silver purchase policy, and tried to obtain authority for discouraging the inflow of foreign capital which was the ssost important tingle
cause of the growth of excess reserves.

The Board has constantly pointed

out to Congress and to the public the need for adequate powers for controlling reserves.

Particularly in i t s annual report for 1936 the Board

stated emphatically that i t would not be in a position to discharge i t s
responsibilities unless it were given adequate authority to deal with
reserves.
Prograa
The important question, however, i s what can and should be done
now in order to prevent further declines in money rates and to increase
somewhat those rates that are excessively low.

It would seen that the

first necessary action would be to stake strong representations to Congress for obtaj ning additional powers over reserves.

In the seoond place

the System should recommend the discontinuance of the policy of silver
purchasest thirdly, i t should give careful study to the question of gold
policy, particularly after active warfare stops*

I t would seen that for

the present purchases of gold are principally from England and there would


http://fraser.stlouisfed.org/
be ofnoSt. support
Federal Reserve Bank
Louis

for depriving England of this means of obtaining necessary

armament.

After the war stops, however, the question of the gold pur-

ehase polloy will have to be reconsidered in t he light of world condition* as they emerge from the conflict.
The System's policy in regard to open-aer ket operations has
for some time past been one of attempting to aaintain orderly conditions
in the Government security market end indirectly in the entire capital
market.

Purchases of ^overnment bonds during the drop in the market after

the outbreak of the

or Id Me? hare been offset to a very large degree by

•ales made at times when the sarket has been strong end the demand for
securities has exceeded the supply.

Some further reduction in securities

may be desirable and feasible, but i t should be pointed out that i f the
System*s earning assets f e l l to the point where i t did not earn enough t o
meet i t s expenses, this would either diminish the System's finanoial independence or else stake i t necessary fbr i t to discontinue or charge for
many services to business which i t now performs free of cost to them.

So

long as membership in the Federal Reserve System i s optional i t i s doubtful whether much ean be accomplished in fte way of service charges without
encouraging some banks to leave the System,
In the field of public finance It i s clear that in present
conditions everything should be done to encourage such financing as i s done
by borrowing to come out of savings and not through the creation of additional bank credit.

This means that the System should use i t s influence

with the Treasury in the direction of Issuing long-term obligations which
mor* generally are purchased by investors rather than short-term obligations




- 10 •which are irore likely to be absorbed by banks.

It should encourage

ths) issuance of savings bonds with current income coupons in order to
induce small oarers who wish to have current income on their savings
to purchase Government bonds*
Finally, the System should consider the point wt which further
governmental expenditures should be met out of taxation rather than frost
boffowing.

This should be done as soon as i t becomes clear thi-t further

additions to theincOme stream through Government financing; no longer
increases the nation*s real income and ie beginning to result in a rise
in prices*

It would appear that when the national incase reaches the

level of 95 or 100 billion dollars i t will become safe to balanoe the
budget out of existing or newly imposed taxation.

Prevision far this

situation should be made promptly since the formulation Q?.' tax measures
i s a lengthy process, and oertain new taxes beooae fully effective only
after a lapse of more than a year fron the time the laws are passed*
The System should be prepared to make i t s views on this subject known
to the Congress*