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UHITXD fifiTXS SMAT1 Committee on Banking and Currm&cy November 3, 1947 Honorable Marriner 8* Xccles, Chainnan Board of Govsroors Federal Reserve System Washington, C. Dear Governor Icclee* I received i n today 1 • mall a l e t t e r from an o f f i c i a l of a large and successful American oompsny, o f f e r i n g several suggsstions f o r controll i n g the pressnt price s p i r a l through the Federal Reserve. Two of the recommendations are quite unique, end while I think the Administration would hesitate some time before adopting theft, X would l i k e to have your views ae t o how e f f e c t i v e and p r a c t i c a l you think they would be. Front h i e l e t t e r t o me I quotes • I have alwaye understood that one of the p r i n c i p a l reasons f o r the existence of ths Federal Reserve was to control such situations} i . e . , put the brakes on i n a boo*, and encourage expansion I n a depression* I suggsst that the following action by the Federal Reserve would be e f f e c t i v e i n the present situation* (a) Require a l l megfcer banks to carry l a r g e r deposit reserves with the Federal Reserve, thus topping up ernceee reserves* (This w i l l require l e g i s l a t i o n by the Congrees*) (b) Announce t h a t the Federal Reserve w i l l make no further purchases of Government bonds from any member bank f o r the purpoee of enabling the member bank t o Increase the frota^ of i t s loans and investments beyond the pre*eat l e v e l . (This would s t i l l permit the member bank to emercise discretion I n varying from time t o time the proportions of various type loans and investments* For example, a member bank could Increase the proportion of eoneumer type loans by making a corresponding reduction i n commercial, I n d u s t r i a l , a g r i c u l t u r a l , and r e a l estate types of loene«) (c) I f the action taken i n ( a ) and (b) did not bring the credit expansion t o a h a l t (although X think that i t would), then the Federal Reserve should s t a r t to s s l l Government bonds, of *aich i t now holds I 2 2 b i l l i o n * You w i l l , no doubt encounter objections to the above proposal Honorable Marriner 8« Icclee Faga Two I t w i l l be said that the inevitable result of such Action w i l l be to harden Interest rate* «ad thus incrsass the coat to the Government of carrying l t a huge debt* My answer to t h i s l a t h a t auoh a result l a undoubtsdly l i k e l y , but that wo have t o measure t h l a increased coat against tha alternate ooat t o tha people of t h i a oountry I f tha Federal Reserve doaa not take action. For azample, an lncra&aa of i S I n tha carrying charge on t h a Government dabt would raault i n an Increasad gross lntaraat payment by tha Government of $2*5 b i l l i o n par yearj however, tha Government would promptly recover perhaps AO* of t h l a I n taxes, leaving a not additional lntaraat ooat to tha jpeople of t h l a oountry of $1*5 b i l l i o n . Aa against t h l a additional ooat however, I t might wall bo that tha c o s t ^ f ~ l l v i n g savings would aggregate $10 b i l l i o n aa a raault of bringing tha prica s p i r a l t o a halt* A saying of $1 a bnahel on wheat alone would amount to $1.4 million* Furthermore I t w i l l ba aald that tha proposed action w i l l dapraas Govern omnt bond prices. Thla undoubtedly would be t r u e , but hare again I n assessing t h a damage wa have to d i f f e r e n t i a t e between a bookkeeping loss baaed on markat quotations of tha *o*ent and ultimate actual losses t o ths bond owners• Large numbers of holders would suffer no actual ultimate loss* For example, Government agencies, inaursnoe oompaniee and bsnka * i o have inveated I n the bonds can hold then to maturity and suffer no loss of prin~ cipsl. Corporations i*»o hold tax c e r t i f i c a t e s would suffer no loss of principal* Individual holders of the I , F and 0 type bonds would suffer no loos of principal* I n f a c t , no one who l a prepared to hold his bonds to maturity would suffsr any loss of principal* I t haa also been suggested that i f the Individual holdera of large numbere of I , F end 0 bonds should see market quotations for Government bonds f a l l i n g , they might deluge the Treasury with requeeta for payment of t h e i r bonds, to ifeloh they are e n t i t l e d under the contraota* My reaction t o thla l a that they would be lees l i k e l y to pressnt these bonds for payment I f the price l e v e l I s stabilised or receding than they would be I f the prlca l e v e l keeps arising* I n t h i s l a t t e r event, as they sse the purohaalng power of t h e i r dollar bonda being reduced, they may be more Interested I n cashing the bonds and converting the proceeds to something more tangible* To conclude, everyone aeeos to agree that we are I n a dangeroua Inflationary eltuatlon* I n t r y i n g to bring t h l a altuation under control we are not making f u l l uae of the most effective t o o l at our diaposal, namely, Federal Eeaerve action to halt further credit expansion. We are avoiding f u l l use of t h i s t o o l because of what I would c a l l "compartmentallsed* thinking, which sses merely one slds of the result of such action, i * e * , higher cost to ths people of carrying the Government debt) but f a l l e t o con~ alder the much larger offeettlng aaving to the people which w i l l raault from halting the price a p l r a l . * Kith kind regards, Sincerely, (Signed) C< B* Buck November 13* 1947 Honorable C« Douglass Buck, United States Senate, Washington, D* C, Dear Senator Buck! This i s I n response t o your l e t t e r o f November 3 , 1947* qttfliing p o r t i o n s o f a l e t t e r from a correspondent who suggested certain courses of a c t i o n by the Federal Reserve nhich he b e l i e v s s would be e f f e c t i v e i n the present situation* I t i s evident t h a t he has given unusual thought t o the monetary aspect a o f t h e problem but t h a t he may not have eeen t h e Board1 a Annual Reports for 1945 1946 i n which we reviewed t h e i n f l a t i o n a r y aspect* of t h * s i t u a t i o n itoich have developed since t h e war and the w i t t i n g l i m i t a t i o n s on Federal Reserve a u t h o r i t y * these reports outlined f o r l e g i s l a t i v e consideration some measures ihich might have corrective value* I i s enclosing copies so that i f you wish you may send them t o your c o r r e s pondent f o r h i f i f u r t h e r study w i t h s p e c i a l Reference t o h i s f i r s t proposal, rs&ating t o reserve requirements* are hopeful t h a t t h e forthcoming session of Congress w i l l give thoroughgoing c o n s i d e r a t i o n t o t h e question as t o what a d d i t i o n a l powers i n t h i s f i e l d might p r o p e r l y be vested i n t h * Federal Reserve System* I n t h i s connection, I might say t h a t i t r e q u i r e s *cos^>artJ&entali*ed t h i n k i n g " , as your correspondent put i t , i n order t o come t o t h e conclusion t h a t Federal Reserve powers could be s u c c e s s f u l l y used t o combat the i n f l a t i o n * t h e Federal Reserve System can worfc toward economic s t a b i l i t y through i t s i n f l u e n c e on the flow o f money but m a n i f e s t l y t h e r e mjre l i m i t a t i o n s on toe e f f e c t i v e n e s s of such i n f l u e n c e , because o f the non--monetary f a c t o r s a f f e c t i n g p r i c e s and business a c t i v i t y which cannot be c o n t r o l l e d by monetary a c t i o n * The goal can only be obtained through the c o o r d i n a t i o n o f t h e major p o l i c i e s of Government i n t h e domestic and f o r e i g n f i e l d which i n f l u e n c e business a c t i v i t y , i n c l u d i n g p a r t i c u l a r l y those w i t h respect t o t a x a t i o n , expenditures, f o r e i g n t r a d e , a g r i c u l t u r e and l a b o r * Then* subjects w i l l o f course receive a c t i v e c o n s i d e r a t i o n at the forthcoming session* With respect t o your c o r r e s p o n d e n t ^ second proposal, t h a t t h e Federal Reserve make no f u r t h e r purchases o f Government bonds from any member bank f o r the purpose o f enabling the member bank t o increase t h e t o t a l o f i t s loans and investments beyond t h e present l e v e l * t h i s sug~ g e s t i o n i s predicated upon an i n c o r r e c t assumption* The Federal Reserve do«s n o t make purchases f o r t h i s purpose, and i n p r a c t i c e they are n o t made d i r e c t l y from t h e i n d i v i d u a l member bank* They are mad* I n t h e market from recognised dealers f o r t h e purpose p r i m a r i l y o f m a i n t a i n i n g s t a b l e c o n d i t i o n s or o f i&oreasing t h e general supply o f funds i n t h e market when needed* The pmrpo&e he has i n mind could only be accomplished To* Honorable C* Douglass Buck through some such method as those outlined i n the Board1 a Annual Heporta. As to your c o r r e s p o n d e n t t h i r d suggestion t h a t , i f the operat i o n of h i e f i r s t two suggestions did not bring the credit expansion t o a h a l t , then the Federal Reserve should s t a r t to s e l l Government bonds, the adoption of such a course of action would not only create d i f f i c u l t m&rkwi problems f o r t h e Treasury i n refunding i t s maturing and called securities but the price declines night be so sharp t h a t they would be seriously harmful t o the holders of outstanding long«*term Government bonds and might have unfavorable repercussions on the functioning of many organisations such as insurance companies, educational i n s t i t u t i o n s * t r u s t funds, and others dependent upon t h e i r investments i n Government s e c u r i t i e s . It i s not an altogether s u f f i c i e n t answer i n such caaes t o say t h a t they might hold t h e i r investments through to maturity* Circumstances and situations frequently a r i s e i n which they must be able t o l i q u i d a t e or t o readjust t h e i r investments t o some extent* I n t h i s connection you w i l l be interested i n knowing that one of the r e s u l t s of the policy which i s being followed by the Treasury i n r e funding maturing obligations i s t h a t through the issuance of shorter-term obligations, even though at s l i g h t l y higher rates than have prevailed heretofore, there i s a substantial reduction i n the o v e r a l l cost to the Government of carrying i t s debt. This i s due to the f a c t that a, large volume of maturing obligations were securities o r i g i n a l l y issued forianger terms which have carried higher rates than the short«-tera securities i n t o which they are being refunded* I t has not been intended t h a t the refunding policy should have the e f f e c t of increasing the rates carried by thelongerterm issues of the Government* However l o g i c a l may be the reasoning advanced by your correspondent, i t i s not believed t h a t the Treasury or the Congress would w i l l i n g l y accept the budgetary consequences of a course of action which would result i n raising these rates* fee must f i n d some other way* I am glad t o have the opportunity to consider and t o reply to the proposals quoted i n your l e t t e r . I hope t h a t t h i s reply w i l l be of some assistance t o your correspondent i n his f u r t h e r study of the problem* With kindest personal regards, Sincerely yours, (Signed) M.S. Eccles M. S, Eccles, Chairman* Xnclosures
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