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MANILA OFFICE OF TH E GOVERNOR F eb ru ary 22, 1951 VIA AIRM AIL Honorable M ariner E c c le s c /o Board of Governors F e d e ra l R eserve System Washington, D. C. Dear friend: I am glad to read in your note that you are back in Washington after a short vacation in the W est. I have been following with much in terest your continued fight for sound m onetary policy. I have just read in the issue of TIME of F eb ru ary 19th that while you stood strongly for damming up the flow of money, the F e d e ra l R eserve Board itself “did nothing deci siv e .*' It might have been different if you w ere still Chairman. It seem s that cen tral banks will always find it a difficult job to get fisca l policy in tune with cen tral bank policy. Ju st to show you what I m yself am up against h ere, I am enclosing herewith copy of my speech before the Chamber of C om m erce of the P h i lippines. In the opinion of the B ell Mission which was sent out here by P r e s i dent Truman last y e a r, the C entral Bank has been doing rath er well. I am glad we w ere able to implement properly our exchange control since we put it into effect in D ecem ber, 1949. L a s t y e a r, we had for the f ir s t time a fa vorable balance of payments of a little m ore than $100 million. I am telling you all these because you did so much in 1947 to heilp dispel the m isappre hension of certain people in the United States about the wisdom of our estab lishing a cen tral bank. Our problem is not how to run an institution of this kind, but how to make the Government adopt a sound fiscal policy. This, of co u rse, is a problem which exists in many countries. With kindest re g a rd s, Sincerely yours, M. CUADERNO, Sr. E n cl.: As stated C e n t r a l B a n k of t h e P h i l i p p i n e s COMPLIMENTS of G o v e r n o r M. CUADERNO, Sr. Speech delivered by GOVERNOR Mo CUADERNO, S r. of the C entral Bank of the Philippines before the Chamber of Com m erce of the Philippines January 26, 1951 I consider this a propitious moment and an appropriate forum for summ arizing as com prehensively as possible and clarifying further the position that the Central Bank has taken at various tim es with regard to the different branches of the national economic policy. This e co nomic policy is like a tree with com m ercial, m onetary, fiscal,, cred it, investment and employment b ran ch es» All these branches sprout from the sam e trunk and a re supposed to yield the common fruit of a higher dom estic production and a m ore equitable distribution of the benefits of productive effort. The growth of these branches should be even and synchronized in o rd er that the whole tree m ay be beautifully propor tioned. It is regrettab le that their unity of purpose and motivation and need for synchronization is often lost sight of whenever each one is appraised and debated upon individually. As a consequence, our ef forts as gardeners are often rewarded with a distorted growth and a sour fru it. The crop of financial problems that we are reaping today is wholly traceab le to ouctr-failure in the past to appreciate this need of balance. We have failed, for instance, to give full and concrete implementation to the urgent and farsighted plea of the late P resid en t Roxas in his inaugural add ress of May 28, 1946. At that tim e, he said, and I quote; -2 - "The coincidence of easy money and high p rice s gives to some of our people the false illusion of national p rosperity and the mad notion that we have time to. dally fend debate. The prosperity of money and p rice s is a hallucination, a night m arish dream resulting from the 'scarcity of com modities and the influx of a half billion dollars of troop m oney. We will find that m ere money, bloated with inflation and circulating in narrow channels, does not bring about prosp erity and na tional w ell-being. E v ery day, that money is being siphoned from our land by m ore and m ore im ports - not productive im ports, but im ports of consumption. The well-being of the tradesm en alone is not the well-being of our people. D isaster awaits us tomorrow if we do not rouse ourselves and get back to work, to productive w o rk .’1 In another m essage on June 3, 1946, he followed up this plea with the suggestion that "taxes m ust be re a listica lly readjusted to the in flation which holds us in its g r ip ." The m easu res subsequently re co m mended by the Tax Commission which he formed were inadequate and so a l so are the m easu res that have been taken in pursuance of the recom m end ations of the Joint Philippine-Am erican Finance Commission in 1947 in the field of fisca l policy and economic development. You will all r e m em ber that the months and early y ears following liberation w ere y ears of commodity sh ortages, high p rice s and high money incom es. The money income stream was fed by the swollen tribu taries of U. S. government expenditures, government spending and an extraord in arily prosperous copra trad e. It is true that p rices w ere subsequently brought down by the tremendous influx into the economy of imported m erch and ise. But had vigorous taxation and tax collection been instituted then, a goodly portion of the large money incom es and high profits being made during those y e a rs could have been siphoned off from the hands of the public, thus reducing the volume and p ressu re of effective demand and p recip i tating a further fall in p rice s at least down to the point where the in te r nal p rice level would be in a m ore appropriate relation with the p rice - 3 level prevailing in the United states market. This also would have discouraged to a substantial degree tbe inordinate investment made by both private and government enterprises in commercial pursuits and real estate and would have prevented the expenditure of large amounts of foreign exchange in non-essential and luxury imports. The large revenue that might have accrued from tbe higher taxes could have saved the government from the necessity of continuing to pursue a policy of deficit spending and of relying primarily on bank credit for its fi nancial requirements. But the opportunity had been lost and it is easy to see now that our present difficulties with regard to the international reserves, to the inflationary rise of prices, to the critical condition of the gov ernment finances and th'fe increase of the unemployed in some sectors of the economy are all directly traceable to our failure to act in the past on the fiscal front.' It is also easy to see that all these problems are inter-related and spring from some common roots and that the real basic remedy must be apolied to those roots in order that a permanent solution may be achieved. The control devices that are now being employed may hold the tide of inflation momentarily but they would eventually be ineffective unless the forces that generate the pressures they are trying to repress are neutralized. When the expenditures of United states government agencies in the Philippines started to decline after 1948, money incomes conti nued at a high level nevertheless partly because of improved export receipts but primarily because of government deficit spending on a larger scale.! The excess of expenditures over income since liberation - 4 - was financed with pre-war credit balances, foreign borrowings, bor rowings from special funds, the sale of treasury notes and bills to financial institutions and by the dangerous practice of expanding bank credit through the Philippine National Bank and the central Bank. These sources of funds can hardly be relied upon now to pro vide additional amounts for the urgent budgetary requirements of the government. Pre-war credits and the special funds have been exhausted. Further loans for budgetary purposes from the United states are now out of the question. Government securities will not receive a favor able reception in the money market for as long as government finan ces have not been placed on a sound basis. On the other hand, the international situation imposes upon the government the urgent neces sity of providing for vital services to insure our continued political survival. The government must have an adequate source of revenue and if we should fail to provide it with the necessary amount of funds via the normal instrumentality of taxation, it will be forced to rely upon continued borrowing from the Central Bank and the Philippine National Bank, in the present economic state of the nation such bor rowings and additions to the total money supply could only serve to reinforce the inflationary pressures already existing and precipitate a further spiralling of prices which no price control measure no matter how comprehensive and efficient could possibly stem. It can also create a tremendous pressure of demand for imports, considering our heavy dependence on foreign sources of supply even for some of the most elementary items of consumption, a pressure so strong that our import control and exchange control machinery may not be able to hold it for long.: Should this happen the ultimate consequence should -5- be obvious to you. We m ay have to re s o rt to the age-old method of effecting an adjustment between the internal and international p rice levels with all the painfulconsequence^|nd uncertainties that usually follow in its wake. I have tried and I hope 1 have succeeded in outlining to you the vital connection of the tax m easu res that a re now being considered by the Congress to the maintenance of m onetary stability and the p r e s e r vation of the value of our cu rren cy . Our long-run objective, however, does not consist in the m ere maintenance of m onetary stability but in stability at the highest level of production and employment consistent with the re so u rce s available to this economy. We are all agreed that for this purpose what is needed is to produce m ore not only of those products that earn foreign exchange for the economy but also of those com modities and se rv ice s that are consumed p rim arily in the d o m e stic m ark et. Much public discussion has already taken place on the subject of econom ic development, and in ord er to clarify whatever m isunderstand ing m ay have grown about the position of the Central Bank in this m at te r, I should like to state once m ore than the Bank is one of the m ost vigorous supporters of an economic development program for this coun try . The fact that the Bank counsels against deficit spending and against indiscrim inate bank cred it expansion for financing government development schem es should not be interpreted to mean that it is in favor of achieving m on etary stability even a t . the cost of economic stagnation. But because m onetary stability is its p rim ary resp o n si bility, the Bank is interested in ensuring the clo sest coordination between the investment policy of the government, its fiscal policy and m onetary policy in gen eral. It is an xiou s to prevent any form of - 6 - development financing that would only intensify inflationary p ressu res in the present situation. It m ust be realized that for as long as government budgetary deficit spending continues supported prim arily by bank cred it for so long will the present p re ssu re s raising the level of p rice s grow unabated. If on top of these, additional money income is created via development financing supported prim arily by bank credit, then a degree of inflation might develop which m ay jeopardize the effec tive implementation of the economic development program itselfo It is commonly held that government investment even if supported by bank cred it is a commendable thing provided expenditures are not for budgetary purposes but for development p ro jects; that the effect of controls has been to increctse unemployment in com m ercial establish m ents, in the construction trades and in other se cto rs of the economy and that this development would surely precipitate a decline in the level of money income and, therefore, a depression in the level of econom ic activity* It is said that because private capital in this country is timid in entering new investment outlets, the government should step in and deliberately in crease the level of investment to stave off the dire consequences of a recessio n in the national incom e. Consequently, it is argued that the government should move rapidly to implement as many government development p rojects might have to be as is sufficiently planned and studied even if the financing of such p ro jects be supported p rim arily by newly created bank credit„ Much has been written in the course of the last twenty y ears about the benefits that deficit spending and a cheap money policy could bring to a country in a condition of underemployment. The experience, however, of countries that have tried this instrum ent _ 7 - has shown that it :.s not of proven efficacy in all environm ents. The peculiar conditions obtaining in a p articu lar country determ ines in a large m easure the degree of efficacy t|iat. could be achieved. In a. country like the United States, for exam ple, with a tremendous indus tria l potential and a rich dom estic m ark et, such a policy may be e x pected to result imm ediately in increasing effective demand, increasing employment and expanding production. During a depressed period when labor is unemployed, there also exists in the economy a substantial amount of unused plant facilities., A rise in effective demand stimulated by government deficit spending re a cts imm ediately on these re se rv o ir of unemployed re so u rce s which are harnessed back to production with out too much delay. There is, thus, an immediate expansion of produc tion and an inflationary in crease in the dom estic p rice level due to the injection of additional purchasing power via government deficit spend ing is avoided. In such an economy as the United States' government deficit spending becom es a dangerous expedient only after reaching a condition of full employment. In an underdeveloped country like the Philippines, however, the environment is totally different. It is true that we have v ast potential re so u rce s but these a re reso u rces that can not be harnessed overnight to effective production without p a s s ing through a protracted period of conversion, construction, training and development. The present degree of immobility of these re so u rce s is such that they can not be expected to add effectively to the total volume of commodities available for consumption during the period of conversion. During that period, however, they will be already arm ed - 8 - with purchasing power which would exert further pressure on the m ar ket for consumable goods and tend to raise domestic prices all the m ore. Because of our continued dependence on imports this would increase our balance of payments difficulties. The Central Bank has always taken the position that sound eco nomic development can only be successfully achieved if monetary stability is not impaired. The impairment of monetary stability can only discourage and inhibit any confidence that the public may have to invest. The Central Bank is in favor of the vigorous implementa tion of economic development provided that side by side with such a policy a vigorous fiscal policy is adopted whereby adequate govern ment revenues could be raised to meet all the essential expenditures of government and the financial requirements of the government sector of the development program. It recognizes that the financing of this program may not be able to wait upon the full mobilization of private savings and their effective canalization into desirable in vestment outlets. Consequently, it urges that pending the develop ment of desirable savings habits on the part of the people and the full development of financial institutions that could effectively harness these savings the government must move aggressively to effect a system of public savings via taxation and to use the proceeds there from in promoting its own development schemes as well as providing a framework of incentives for those that might be undertaken by p ri vate enterprises. The Central Bank's position in this respect finds -9- support in the report of the Bell Mission. Allow me to quote a little bit from that report: "The present attitude of the Central Bank is not con ducive to the excessive creation of bank credit for the busi ness community. The practical danger of an excessive ex pansion of credit arises from the exigencies of Government.. If the Government operates on a large current deficit which cannot be financed in other ways, it will in practice have to be financed by the Central Bank. The law may limit the amount of d irect loans to the Government; and the Central Bank may re sist making even these loans. In the end, however, the Cen tra l Bank will have to find the means to enable the Government to meet its obligations. The only practical and dependable safeguard is to avoid such an emergency by a strong fiscal policy. "Perhaps even more dangerous, because it is likely to be defended with specious reasoning, is the creation of large amounts of Central Bank credit for the Government for in vestment purposes. The government has already invested excessively through the various government corporations. So long as they do business they will press for more funds to extend their activities. The emphasis on development will provide an atmosphere in which it will be easy to assume that somehow an expansion of credit for investment is not infla tionary. And as this credit will not be available from the pri vate banking system, there will be great pressure to secure it from the Central Bank either directly or through the Philip pine National Bank." The Philippine Economic Survey Mission in its report on August 11, 1950, on the Revised Agricultural and Industrial Development Program called attention to the ,run-away inflation that could develop under present conditions if "substantial deficit spending and indiscri minate bank lending should continue concurrently with the implementa tion of the investment program ." The Commission suggested that the inflationary risk "could be minimized and kept within manageable bounds by appropriate fiscal policies, administration and management that seeks to eliminate deficit spending and implements aggressively an adequate - 10 - program of raising tax revenues." In its annual Report for 1949, the Central Bank called attention to the dangerous inflationary im plica tions of bank credit expansion to support government budgetary de ficits and government investments and suggested that aggressive steps be taken immediately to raise tax revenues to meet these require ments. If a further deterioration of the internal and external value of the currency is to be avoided, if the government is to be placed in a position to meet current and future budgetary requirements adequate ly* and if the vigorous implementation of the economic development program is not to be delayed on account of inflationary pressures generated by government deficit financing itself, fiscal m easures capa ble of achieving a balance in the budget at a high level and of meeting a portion of the internal currency requirements of the development program should be adopted and implemented now. Decisive action in this respect is necessary whether or not the country receives economic aid from the United States. No amount of economic assistance from that country within the realm of present possibilities can prevent the deterioration of the domestic situation unless that aid is complemented by essential fiscal and investment reform s. That the United States has indicated its willingness to help is, of course, our good fortune but the institution of and the responsibility for domestic financial stabilization and social improvement is wholly our own. I am not lacking in the con fidence that we shall prove equal to the demands of the critical present and that provided we act promptly enough, we may yet ensure for the next generation a regime that is less troubled, more stable, and more bountifully provided than our own. ?!a ro h 9# 1 951 Governor M. Cuaderno. Sr., Central Bank of the Philippines, Manila, Philippine Islands. Dear Governor* I hare read your speech to the Chamber of Coamerce of the Philippines with great interest. Your analysis of the economic forces operating in the Philippines during the past several years is most penetrating and illuminating. I am glad that you have emphasized the vital connection of the tax measures now under consideration by your Congress to the maintenance of monetary stability and the preservation of the value of your currency. At the same time, however, you have not overlooked the fact that the long-run objective of the Philippines is not the maintenance of monetary stability by itself. As you point out, what you are seeking is monetary stability of a sort which will prozaote the highest level of production and employment consistent with the resources available to the Philippine economy. ■tore than anything else, I was delighted to see how effectively you exploded the fallacious argument that deficit spending and cheap money policies can accelerate the rate of economic development of the Philippines. Yours is the most forceful statement of the differences be tween the environment of an underdeveloped country and th%t of a highlydeveloped country like the United States, and the significance of this difference for monetary and fiscal policy, that I have had the pleasure of reading anywhere. The point which is usually overlooked by advocates of deficit financing as an instrument of economic development in under* developed countries is that the vast potential resources oi such coun tries cannot be harnessed over-ni^ht to effective production without passing through a protracted period of conversion, construction, train ing and development. As the experience of many Latin American countries demonstrates, attempts to force the rate of economic development by excessive expansion of credit produces inflation. Inflation, in turn, causes balance-of-payments difficulties, an inequitable distribution of the national income, and the making of investment decisions on the basis of criteria which are not in the long-run interest of the country* X comment on these matters at suoh length because i understand that there are influential voices in the Philippines that advocate ir responsible financial policies and 1 wish to give you ny strong moral RLE COPY - 2 - support in combating and enlightening such advocates* May your pro gram have the full measure of' suocess which it deserves* It was a great pleasure to hear from you and I hope that you shall continue to keep in touch with me. Beoausc of t h e vital role which the federal Reserve had in the establishment and organi zation of the Central Bank of the Philippines, I am particularly interested in following your progress. You may be interested in the enclosed statement, which was prepared in connection with an address which I delivered recently before the Executives* Club in Chicago With best wishes for the success of your program and kindest regards, I remain Sincerely yours. e its CiiSimf M* S. Eccles,
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