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January 15, I9I48. Dear Allan: Your letter of January 1J to Senator Taft is timely and excellent and I am very glad that you sent me a copy of it. It is of such interest to the other members of the Board that I am circulating it for their confidential information. Since you wrote the letter the President's Economic Report has gone to Congress and may possibly project the question of market support into the arena of political debate. In any case, I would be interested to know what you think of it when you have had an opportunity to look it over, particularly pages Ifi and 85 dealing with credit regulation and debt management. Sincerely yours, Mr. Allan Sproul, President, Federal Reserve Bank of New York, Hew York k5, Hew York. ET:b i FEDERAL RESERVE BANK OF NEWYORK45 January 13, Hon. Marriner S. Eccles, Chairman, Board of Governors of the Federal Reserve System, Washington 25, D.C. Dear Marriner: Enclosed is a copy of a letter which I have written to Senator Taft and which I thought might be of interest to you. Yours sincerely, Allan Sproul, End. VICTORY BUY AVINGS 8ONDS AND \ STAMPS illSC. 1AO*—BOM- 1-47 FEDERAL RESERVE BANK OF NEW YORK January 13, Honorable Rob*rt A. faft United States Senate •tshlngtoa, £• C. Dee? Senator Tafti t* your talk on the radio last Thursday «v*iing and was, of course, "professionally" interested in your brief cosascect on credit policy. I t awakened In aj sdnd sehe&s of vh*t X had s*«n reported in the Nev York Tiaes about a press conference you held In Kansas City late la Deeeaber, vbicb disturbed *e &« did your stataaent over the radio. particularly disturbed »e. *ir».. voujp atattm«at tfcst *the Administration l e t bank loans increase in. a y^ar by $5,000,000,000, creating that aaa? «or© paper dollars, cod failed t \*s« thai eovtn i t always bad to restrict fcaafc credit 11 . And at Kansas City you verejreported to I»YO said tJ»t •S»«ry banker tMuks tfeat tk«y b(Mr«v%f^Ll powtr «:ad fe&ve had full pover tr regulate business credit trader the t*»(0ttonal aethods of selling GorerB*eat b<»ide aud ittlsisg ife* x«iiseoont rate »s5 that authority ba« «xlet«d right along, they feare had It ©ad they b£fm not used it 11 . I recognize very v e i l that there are usually two sides t arery question atd tk«t t-hlf one ht.« ^aay facets. I voulr? likt to pleee before you a point of riev, howrrer, vhich I hare already expressed before the Banking &nd 0arr»acy Cos»itt** of ifc# S«aftt# (eopy of sj- t*istiaoRy i s ecelo««d) 9 and which I believe lifts validity in the present situation. I was brought up em tbe tstee of the distomat r^t« end open market op#r»iticass t- ccatrol the use of benk credit, and through control of bank credit t try tc help control the swings sf business actd of prices. That tralniag would prediftpvse a« now to the use of the discount rate and of sales of Gorernaent securities as a check m iafl*tion, but I don't think these weapons can now be used in the way you iaply -~ that i s , a l l out and t the extent necessary to "stop inflation in i t t tracks* *® &n« vriter has phx«sed it* Since July 1947 «• have been folloving a aodest progrea designed t o Bring about sc^ae increase in interest rates and sooie decline in back reserves and we hfcve bad a sodest .««&sur« of success* Although la both f your stateaents you bave said that "the adadniatratioa (I do not accept your identifying the ad&lnifttration dnd the Federal $***rw System as cse *nd the aes®) l e t bank loans increase in a year by $5 billion", the sore important figure frost the standpoint of inflationary pressures Is hov ouch the aooey (currency and deaand deposits other than Government and interbank deposits and cash in bank MISC.140-B—3OM-0-4S Senator Taft 1A3AB raults) belonging to the public ha* inc»eas*d. During 1947 thie sum rot* from |110 billion to $113 or 114 billion (estiaated), not a vary large factor, I should »ay, in the inflationary develo..aents of the year. With respect to interest rates, three months Treasury b i l l s vhich were at 3/8the of one «r cent nov earn nearly 1 per cent, one year Treasury Certificates of Indebtedness are issued at 1 1/8 per cent instead of 7/8 per cent, long tern restricted (not eligible for bank investment) Treasury bonds yield 2.48 instead of 2.33 (and a lov of 2*12 per cent in 1946), present rates on other Government securities hare risen at least proportionately, rates on state and municipal securities and on corporate securities here risen substantially, and bank lending rates are up somewhat. Tho -mount of Federal Reserve credit in use, vhich determines whether we have added to or subtracted froa bank reserves, declined froa !&4i375,OOO,OOO at the beginning of 1947 (January 8th) to $22,320,000,000 at the beginning of 1948 (January 7th). Since we began giving support to the long tarsi Scv<;rns»ent security saarxct In Hoveaber 1947, an operation which coincided vith the v:at recent period of heightened interest in inflation, and which h&e drawn critical comment froa soae bankers (not VWBXJ backer by any means) *«*d uthors, v# fe*v# actually shown it net reduction of 1366,000,000 in our t o t s l hol^ir^e of Government securities (wa sold or redeemed acre short tera securities th*s we bought loag tens) $nd tae total amount of all Federal Reserve credit cutst&cglng has chaage^-tiW^S^i^JiOOOjOOO to £22,320,000,000• In other worde, we have been taking<xun4» ^ t oxNfehe market and exerting a restraining pretfeure on the banVIng arstea. This lokbtaa possible because of a coordinated credit and debt Wnageajikt policy designed for this purpose* In ay opinion, i*« are doi&g art such as\a ^iellcat* situation will ai.ov toward iaposing reserve pressure*;tarsusing Treasury surpluses t . retire reserve bank holdings cf Cbvezaaent securirlee and by\asfe»ing the support price levels (increasing the yields) lof Qovemaent securities* I t see&s to me that we should havt the grsjfttftetSehafieu of SHcces^ i f we are able to continue this program, and that i t i s such more important, therefore, that thsre continue to be a substantial aaount\f Treairy fundfi Kvsll&ble t retire Federal Beserve held debt than that we «a£ex4ll-out acmetary action (aggressively raising discount rates and selling Government securities). I would agree that by exerting aggressive pressure on bank reserves we eoulI set in aotloa forces which would bring about deflation. Experience suggests that i f we chop into this situation with a aeat axe we could also start a depression, and t h i s despite the existence of what appears to be an almost insatiable domestic and foreign demand for our products* To use our existing powers as your statement seems to imply we might have used them, would mean that our action would have to be drastic enough to lower the money income cf & large segment of the consuming public* To accomplish this by overa l l monetary or credit action would mean a serious decline in production and employment. Otherwise the policy, br hypothesis, f a l l s or else our present modest program stands approved. I t seems t me, therefore, that you may be chiding us for not having used powers, which we would be foolish to use — which are not really available to us in the present state of domestic and international affairs, and in the face of a Federal debt exceeding $250 billion and interwoven into our whole economy* MISC 14O-B 5OM-2-4B ->- Senator Teft 1/13AS This latter point suggests a subsidiary ousstion which say be in j ur mind and which I know is in the minds of sooe bankers, insurance executives and others. Why should we sup ort the long tern Government security market at the 2 1/2 per cent level and to that extent circumscribe our powers and our actiona to control the volume of credits To me it la not primarily a question of cheap money or low intereat rate* ao far aa the Government debt ie concerned, although it is cohering to calculate how big an increaae in the coat of servicing the debt would be involved If short tern Intereat rates rose, aay, t 2 or 3 per cent (a not Impossible- level if an aggressive credit contraction policy were pursued) * It is primarily a question of what good can be accomplished In the present situation b a Tigorous aggressive policy of over-all credit contraction and what are the risks. Our critics say t m t if a drastic fall in market values of Government securities is the price we must pay to bring about deflation now, and prevent a worse "bust" Later, we should pay it. I say we can't bring about deflation by general credit action unless we bring about such an indiscriminate reduction in consumers* disposable income as to threaten the disaster ve are trying t avoid. To illustrate, the food situation is near the root of auch of our present troubles and continued high or rising prices for food makes much mere likely another round of wage increases and sc on. But how can we expect A reduction %n the aggregate dcoand for food (or other scarce materials) to follow a policy' of allowing Government security prices to seek their own level — or^V>reing, them down by System salsa %Q contract credit — unless the policy wereiae Rigorous as to reduce substantially production and employment &ad, tberefpre, vqnsuaers* disposable ineoiae. Ve are all a little enchanted,/6f course, vith th# idea of a modest downturn which would relieve some existing pressures and forestall worse disturbance later* But no one has yet f und out a suire way of bringing Just a little depression, and X think ou$ present program of sodest restraints involving a combination of debt management and credit policy is the best course t follow in trying to achieve that\objeetlv* in so/far as credit policy can be the cure mm which isn't too far In my opinion. / It mig£fc fitill be argued, X suppose, that abandoning our support of the Government security aarkct could be encompassed within our modest program and that only moderate declines In prices would occur, that Government securities would reef eh a "natural* l^el, and that everything would tfean be much better. VIth meikete as delicately balanced aa our contacts and experience indicates the present markets to b#, X cannot agree with this opinion or judgment. Without our support, under present conditions, almost any sale of Government bonds undertaken for whatever purpose (laudable or otherwise) would be likely to find an almost "bottomless market* on the first day support was withdrawn. A rapid descent in prices going far beyond any question of the Government's credit (which is still high) or relative Intereat rates would be aoet likely. Uncertainty would almost surely persist for a considerable tisae after such a development, the Governmentfs necessary refunding operations would be made very difficult, and private security markets would be seriously affected. In such circumstances, there c uld easily be a flight of "s*sh" out of both markets, and price changes so erratic as to make new financing almost impossible for some time, with what ramifications X do sot like to contemplate. In the face of a Federal debt of over |25O billion dollars, in all sorts of forms MISC. 14O-B 5OM-2-48 3ea»tor Taft 1/13/48 held by all aorta of holders, and with a high eaaauaption high employment ay, in which there art already Btvtrt stresses and strains, va can»t treat tha Ckureraaent security aarkat as va might a $50 million issue of tha XIZ corpora* tioxw I asa not a balisrar 1st Sara and aora Oovaramant controls, certainlyf but this is oaa eantrol *^bich I would mot waat to try to lat go, voluntarily, undsr prasaaat dreuaatances. I have vrittan yoa at this iangth beeauaa at ay conoarn that thera b« understanding of our prasant policy of credit adaiaistr&tion and debt vaaagam«at, aad baeausa of ay raspact for your ability to plow through and la form yourself about the raftny problems with which you oa*t be eoaeeraad. lours faithfully. Saelosure ilia© Sproul Pr© aidant
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