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February 20, 1951* Dear Mr. Webb: I am enclosing the material which I discussed with you on the telephone yesterday and again today. I hope it may serve your purpose and be of some assistance to the Senator in the preparation of his reply. Sincerely yours, M. S. Eccles. Mr. Charles Webb, Assistant to the Hon. John V. Bricker, United States Senate, Washington, D. C. This article is protected by copyright and has been removed. The citation for the original is: Elliott, John. “Truman Sway Over Reserve Is Questioned: Partiality to Treasury in Fight on Rates Noted.” New York Herald Tribune, February 18, 1951. Governor Vardanian* s letter makes it appear that because the Reserve System has given rigid support to the Government bond market ever since me entered World War II any decision to change that support now is arbitrary and unreasonable. His letter totally ignores the vast difference between the situation at the time me entered the war and there* after, as contrasted %&th the economic picture now* Prior to World War H we were still in a depression idth excessively low interest rates, mil lions of unemployed and unused productive capacity. Pearl Harbor froze us into that too easy credit structure because it was not possible to finance the huge Government deficits which immediately became inevitable without assuring the treasury of a fixed pattern of rates* Huge deficits cannot be financed en a falling bond market and a rising interest rate structure. That condition prevailed throughout the war. When the war ended many Government economists erroneously believed that we would have a sharp deflation* Moreover, treasury financing, instead of being infla tionary, began in postwar years to exert a strongly deflationary force, particularly to the extent that the surplus was used to pay off bank-held debt. For the calendar year 19k*>9 for instance, the cash deficit was $it3*7 billion. There was a small cash surplus in l?ii6, a s u r p l u s ' 7 billion in 192*7, and $8.1 billion in 19l£. Also, while A. I*. M. Wiggins served as (Mder Secretary of the Treasury the interest rate on Treasury certificates was permitted to rise from 7/8*s per cent in 19kl to 1-1/8 per cent at the beginning of 19^8 and to 1-1/1* per cent in the fourth quarter of that year* The treasury bill rate was similarly freed from pegging operations and was allowed to adjust to the certificate rate, rising from 3/6*8 per cent in mid 19k7 to one per cent by the year end, * A to see that the situation was vastly i i •0 i 5 I I I i if H i j ! ! h *JI f i 111 i I ! I I i u !i * 1 i 1 It is plain - 3~ th e n th e r e w i l l b e no c h a n c e o f a v o id in g m ore a n d m ore c r e d it i n f l a t i o n . The tim e i s s h o rt. U n le s s a c t io n com es p ro m p tly to a d o p t m ore r e a l i s t i c r a t e s t h a t w i l l a t t r a c t t r u e in v e s t o r s a n d c a u s e them to h o ld G overn m en t s e c u r it ie s * in f la t io n a r y s c a n s io n o f b a n k c r e d it w i l l m ount h ig h e r a n d h ig h e r and w i l l b re a k t h r o n g a n y dam o f p r ic e , w age, and l i k e c o n t r o ls w h ic h a re s e t u p . I t is r e a lis t ic th e r e i s th e u rg e n c y o f th e p ro b le m a n d th e n e c e s s it y f o r m ore d e b t m anagem ent p o lic ie s t h a t V ardam an o v e r lo o k s i n a rg u in g t h a t no re a s o n n o t to c a r r y on id t h p o l ic ie s w h ic h a r e d e s t r o y in g th e c o n fid e n c e o f th e d o l la r . I n th e p o s tw a r y e a r s , when Vardasaan im p lie s th e R e s e rv e System s h o u ld h a ve b ro k e n o u t o f th e s h a c k le s o f p e g g e d r a t e s f o r G overn m en t s e c u r it ie s , t h e r e w e re w id e s p re a d e x p e c ta t io n s t h a t th e p o s tw a r boom w o u ld p la y i t s e l f o u t , a s i n f a c t i t was b e g in n in g t o do b e fo r e th e K o re a n s it u a t io n to u c h e d o f f th e p r e s e n t in f la t io n a r y s p r e e . Vardam an s t a t e s t h a t th e "B o a rd h a s n e v e r a s k e d th e C o n g re s s f o r r e l i e f fro m i t s im p lie d o b lig a t io n ” t o s u p p o rt G overn m en t s e c u r it ie s * O f c o u rs e th e B o a rd n e v e r a s k e d f o r su ch a th in g * to abandon s u p p o r t. and i n A c t u a lly , b e g in n in g w it h i t s s u b s e q u e n t r e p o r t s and in I t n e v e r w as p ro p o s e d AmmaH R e p o rt f o r X9hS re p e a te d s ta te m e n ts b e fo r e C o m m itte e s o f C o n g re s s th e B o a rd h a s a s k e d th e C o n g re s s to r e v ie w th e s it u a t io n a n d t o g iv e th e R e s e rv e S yste m a d d it io n a l, o r s u p p le m e n ta l, p o w e rs to d e a l w it h b a n k c r e d it # The r e c o r d o f th e F e d e r a l R e s e rv e S y s te a i s c le a r * On Decem ber 3 1 , l^ h O , n e a r ly a y e a r b e fo r e th e o u tb re a k o f w a r, th e R e s e rv e B o a rd , th e P r e s id e n t s o f t h e tw e lv e R e s e rv e B a n k s , and th e tw e lv e m em bers o f th e -Ir F e d e r a l A d v is o r y C o u n c il j o in e d i n a s p e c ia l r e p o r t t o th e C o n g re s s , The r e p o r t p o in te d o u t t h a t th e la r g e d e fe n s e p ro g ra m upon w h ic h th e c o u n tr y w as th e n e m b a rk in g w o u ld h a ve s e v e re in f la t io n a r y co n se q u e n ce s# The r e p o r t c a lle d a t t e n t io n t o th e f a c t t h a t th e b a s k in g s y s te m h e ld a huge vo lu m e o f e x c e s s r e s e r v e s on w h ic h in c r e a s e s i n be b a s e d . The r e p o r t s a id * th e m oney s u p p ly c o u ld MThe F e d e r a l R e s e rv e S yste m f in d s i t s e l f in th e p o s it io n o f b e in g u n a b le e f f e c t iv e ly to d is c h a r g e a l l o f i t s b ilit ie s * r e s p o n s i W h ile th e C o n g re s s h a s n o t d e p r iv e d th e S yste m o f r e s p o n s ib ilit ie s o r o f p o w e rs, b u t i n f a c t h a s g ra n te d i t e x t r a o r d in a r y w o r ld c o n d it io n s , i t s new p o w e rs , n e v e r t h e le s s , due t o a u t h o r it y i s now in a d e q u a te t o c o p e w it h th e p r e s e n t a n d p o t e n t ia l e x c e s s r e s e r v e p ro b le m # * p ro g ra m w as recom m ended in th e r e p o r t . A f iv e - p o in t The f i r s t and m a jo r p r o p o s a l w as t h a t C o n g re s s g r a n t th e S y s te a a u t h o r it y t o d o u b le th e s t a t u t o r y r e s e r v e re q u ire m e n ts and to make them a p p lic a b le to a l l b a n k s r e c e iv in g dem and d e p o s it s r e g a r d le s s o f w h e th e r o r n o t th e y w e re m em bers o f t h e F e d e r a l R e s e rv e S y ste m . Had C o n g re s s se e n f i t t o g r a n t t h is a u t h o r it y th e r e s e r v e requirements a g a in s t destand d e p o s it s c o u ld h a v e b e e n in c r e a s e d fro m th e p r e v io u s s t a t u t o r y maximum o f 26 t o c e n t r a l r e s e r v e c i t i e s , fro m $2 p e r c e n t f o r b a n k s in 20 t o 1*0 p e r c e n t f o r b a n k s i n re s e rv e c i t i e s , and fro m l l ; t o 26 p e r c e n t f o r s o - c a lle d c o u n tr y b a n k s* U n fo r t u n a t e ly , n o th in g - w as done a t t h is e a r ly d a te t o d e a l w it h th e a n t ic ip a t e d p ro b le m o f in f la t io n a r y o v e re x p a n s io n o f b a n k c r e d it * In it s f i r s t p o s tw a r r e p o r t t o C o n g re s s i n 1 9h$* th e B o a rd r e v ie w e d th e m o n e ta ry s it u a t io n *ahich h a d r e s u lt e d fro m th e w a r an d a g a in c a lle d a t t e n t io n t o th e in a d e q u a c y o f t h e System * s p o w e rs t o d e a l w it h - t h is saise p ro b le m . 5- T h a t r e p o r t s ta te d s "T he c r e a t io n o f u n n e c e s s a ry b a n k c r e d it b y t h e c o in ra e rc ia l b a n k in g s y s te m i s o f th o s e c h a r g e , -w ith m o n e ta ry r e s p o n s ib ilit ie s # o f in d if f e r e n c e th e p a r t ic u la r c o n c e rn I t c a n n o t b e a m a tte r t h a t a t p r e s e n t th e c o u n try * s c e n t r a l b a n k in g m echanism la c k s a p p r o p r ia t e n e a n s , t h a t c r e a t io n o f b a n k c r e d it • •••'*» b e n e e d e d , t o r e s t r a in u n n e c e s s a ry The B o a rd a d v o c a te d in c r e a s e s i n s h o rt- ter® in t e r e s t r a t e s and s u g g e s te d a num ber o f s u p p le m e n ta l m e a su re s to d e a l w it h b a n k r e s e r v e s * Hone o f th e s e m e a su re s w as a u t h o r iz e d b y th e C o n g re s s* A g a in i n it s A n n u a l E x p o r t t o C o n g re s s c o v e r in g th e y e a r 1 J& 6 , th e B o a rd r e c u r r e d t o i t s d ile m a , p o in t in g o u t t h a t th e n e e d f o r th e S ystem to s u p p o rt G overnm ent s e c u r it ie s and m a in ta in an o r d e r ly m a rk e t le f t i t w ith o u t a d e q u a te m eans o f r e s t r a in in g b a n k c r e d it e x p a n s io n * The B o a rd s t a t e d t h a t -w h ile an in c r e a s e i n d e g re e o f f l e x i b i l i t y s h o rt-te n a r a t e s and a g re a te r w o u ld b e d e s ir a b le , i t w o u ld n o t s u f f ic e o f i t s e l f » to p re v e n t th e s h if t in g b y b a n ks fro m h o ld in g s o f G ovem raen t s e c u r it ie s t o p r iv a t e lo a n s o r c o r p o r a te s e c u r it ie s , i f m e n ts w e re a v a ila b le . w o u ld b e i n a t t r a c t iv e lo a n s o r in v e s t On th e b a s is o f s u c h s h if t s th e b a n k in g sy ste m a p o s it io n t o c r e a t e r e s e r v e s said to en gage i n u n c o n t r o lle d c r e d it e x p a n s io n . In it s A n n u a l R e p o rt f o r l* ? ltf, u n d e r th e h e a d in g * In a d e q u a c y o f E x is t in g M o n e ta ry I n s tr u m e n ts ” , it s d ilem m a* T h is r e p o r t s ta te d * th e B o a rd a g a in c a lle d a t t e n t io n t o * 6. ^ I n f la t io n a r y p o t e n t i a l it ie s la t e n t i s th e p o s tw a r mone t a r y s it u a t io n an d lim it a t io n s o f th e R e s e rv e S yste m * s s t a t u t o r y p o w e rs f o r e x e r t in c a n e f f e c t iv e a n t i- in f la t io n a r y in f lu e n c e u n d e r c o n d it io n s b ro u g h t a b o u t t y th e w a r w e re f i r s t p o in te d o u t in th e B oard * s A n n u a l R e p o rt f o r \9h$» D e v e lo p m e n ts s in c e t h a t tim e h a ve e m p h a sise d th e d ile im a o f th e S ystem i n u n d e rta k in g r e s t r i c t iv e a c t io n w it h in th e e x is t in g fra m e w o ric o f i t s a u t h o r it y w h ile m a in t a in in g a r e s p o n s ib ilit y f o r th e o r d e r lin e s s and s t a b i l i t y o f th e G overn m en t s e c u r it ie s m arket# The B o a rd b e lie v e s t h a t i t w o u ld b e u n w is e to s e t a s id e t h is r e s p o n s ib ilit y i n v ie w o f l i k e l y a d v e rs e e f f e c t s on f in a n c ia l in s t it u t i o n s , o n th e G o ve rn m ent* s f i s c a l an d debt-m an ag em en t o p e r a t io n s , and on th e f in a n c ia l p o s it io n o f b u s in e s s # " A f t e r e x t e n s iv e s tu d y o f the p ro b le m o f b a n k c r e d it r e s t r a in t s , th e B o a rd c o n c lu d e d t h a t , i n o r d e r to b e i n a p o s it io n t o m eet f u r t h e r c o n t in g e n c ie s of in f la t io n a r y b a n k c r e d it e x p a n s io n w ith o u t a b a n d o n in g s u p p o rt o f th e G o v e m ia e n t s e c u r it ie s m a rk e t, some w o rk a b le a d d it io n t o th e 3jwtm*s e x is t in g a u t h o r it y msgr b e n e e d e d , a t le a s t o n a t e a p o r a iy b a s is * R a p id ban k c r e d it e x p a n s io n d u r in g the se co n d half o f 1 $* ? c le a r l y in d ic a t e d t h a t e x is t in g r e s t r a in t s a r e n o t a d e q u a te f o r th e s e o b j e c t iv e s . I n re s p o n s e to a r e q u e s t fro m coses!ttees o f C o n g re s s , i n a s e s s io n c a lle d to c o n s id e r em e rg e n cy m e a su re s t o a id E u ro p e a n r e c o v e r y and t o c o p e w it h i n f la t io n a r y d e v e lo p m e n ts i n th e e con om y, th e C h a irm a n o f th e B o a rd o f G o v e rn o rs p re s e n te d an a n a ly s is o f th e c r e d it s it u a t io n and th e B oard* s p r o p o s a l f o r le g i s la t i o n t o p e r m it the im p o s it io n o f m ore e f f e c t iv e r e s t r a in t s * 8 C o n g re s s g ra n te d a lim it e d , te m p o ra ry a u t h o r it y a p p lic a b le o n ly t o som ber b a n k s and t h i s a u t h o r it y w as draw n upon to h e lp r e s t r a in f u r t h e r b a n k c r e d it e x p a n s io n d u r in g m o st o f 1 9l$» th e B o a rd s a id : In it s 19hB R e p o r t t o th e C o n g re s s , * W ith a la r g e G overnm ent d e b t w h ic h i s lik e ly to be a d o m in a n t p a r t o f th e d e b t s t r u c t u r e f o r m any y e a r s , th e F e d e r a l B e s e rv e h a s to co p e w it h th e d u a l p ro b le m o f m a in t a in in g an o r d e r ly G overnm en t s e c u r i t ie s m a rk e t and e x e r c is in g c o n t r o l o v e r th e vo lu m e o f b a n k r e s e r v e s * R The r e p o r t a d d e d : 8I n i t s A n n u a l R e p o r ts a n d other p u b lic s ta te m e n ts the end o f the war, the B o a rd o f G o v e rn o rs has s t r e s s e d lim it e d e f f e c t iv e n e s s o f the t r a d it io n a l in s t r u m e n ts o f p o lic y i n th e general Monetary situation c r e a t e d ’e y w a r s in c e the c r e d it fin a n c e * - 7 * I n A u g u s t 191*8, the C o n g re s s g ra n te d te m p o ra ry authority for i n c r e a s in g the r e s e r v e re q u ire m e n ts of m ember banks* this te m p o ra ry a u t h o r it y e x p ir e d on Ju n e 3 0 , 1 9k9* **In h is S c o n o n iic R e p o rt f o r 19h9» th e P r e s id e n t p o in t e d o u t t h a t th e n e n e ta r y a u t h o r it ie s s h o u ld a t a l l tim e s b e i n a p o s it io n to c a r r y o u t t h e ir t r a d it io n a l f u n c t io n s o f e x e r t in g e f f e c t iv e r e s t r a in t upon e x c e s s iv e c r e d it e x p a n s io n i n an in f la t io n a r y p e r io d a n d c o n v e r s e ly o f e a s in g c r e d it c o n d it io n s in a t i s s o f d e f la t io n a r y p re s s u r e s * The p o w e rs o f th e F e d e r a l R e s e rv e to e x e r t e f f e c t iv e r e s t r a in t on c r e d it e x p a n s io n a re lim it e d b y th e o b lig a t io n to s u p p o rt th e m a rk e t f o r G overrau en t s e c u r it ie s * I n o r d e r to b e i n a b e t t e r p o s it io n to d is c h a r g e i t s r e s p o n s ib ilit y f o r m a in t a in in g so u n d c r e d it c o n d it io n s , th e B o a rd re q u e s te d c o n t in u a t io n o f th e te m p o ra ry a u t h o r it y t o apply a s u p p le m e n ta l r e s e r v e re q u ire m e n t t o member b a n k s , and th e e x t e n s io n o f th e re q u ire m e n t to a l l in s u r e d b a n ks* "T h e Board r e c o g n iz e d that the p ro p o s e d supplemental r e s e r v e re q u ire m e n t w as n o t th e p e r f e c t o r final way o f p r o v id in g th e F e d e r a l R e s e rv e w it h a d e q u a te m eans t o p e rfo rm i t s p r im a r y fu n c t io n * I t w as p ro p o s e d a s an in t e r im a u t h o r it y t h a t c o u ld b e u s e d , i f n e c e s s a r y , w it h o u t m a k in g d r a s t ic ch a n g e s i n e x is t in g p r a c t ic e s , u n t i l a m ore fu n d a m e n ta l s o lu t io n c o u ld b e p ro v id e d * * T h is r e p o r t u rg e d th e C o n g re s s t o r e v ie w th e s it u a t io n , in c lu d in g a d o p tio n o f su ch m e a su re s a s s lig h t b e a p p r o p r ia t e t o d e a l p ro b le m * wlih th e c o n tin u in g N o th in g c a a e o f th e s e re c o is n e n d a tio n s * The y e a r 1 9h9 n a rk e d a n a b a te m e n t o f th e in t e n s e in f la t io n a r y p r e s s u re s w h ic h h a d d o m in a te d th e p o s tw a r econosay* H o w e ve r, th e B o a rd , i n A n n u a l R e p o rt t o th e C o n g re s s , s a id s "T h ro u g h o u t th e y e a r 19h9» th e g e n e r a l and s e le c t iv e in s tr u m e n ts a v a ila b le t o t h e F e d e r a l R e s e rv e a u t h o r it ie s w e re c o o r d in a te d i n a f l e x ib l e p ro g ra m f o r a d ju s t in g t h e a v a i l a b i l i t y and c o s t o f c r e d it t o th e c h a n g in g n e e d s o f th e econozsy* As dow nw ard t r e n d s i n b u s in e s s a c t i v i t y , e a ap lo yia e n t, and p r ic e s a p p e a re d e a r ly i n th e y e a r , th e B o a rd o f G o v e rn o rs s h if t e d th e e m p h a sis o f c r e d it p o lic y fro ® r e s t r a in t to e a se * T ow ard th e end of th e y e a r , a f t e r in c r e a s in g e v id e n c e of e co n o m ic r e c o v e r y , th e open m a rk e t o p e r a t io n s o f th e F e d e r a l R e s e rv e p e r m it t e d s h o r t t e r s i m oney r a t e s to r i s e i n re s p o n s e to g ro w in g dem and f o r c r e d it * it s credit, discount rates, reserve creases in short-ter® isoney rates* conditions nith relatively low rates of acute inflationary pressures these fears the of supplements problem* Mhm the Korean situation the Board naa again left without biH ties in. the credit of consumer instalment and moderate in*tiiraughout this failed to support, or actively to deal with the reserve off another sieans of carrying out its lietter & Memo. 2/20/51 — Material for Senator John W. briefer — To use in connection with his reply to Gov. Vardatnan (Controversy)
@FedFRASER