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July 5, 191*5
Honorable Bobert A. faft,
United States Senate,
Washington, D. C.
Dear Bobt
You have so many far more important things to deal with
that I an not suggesting you take the time to plow through the
enolosed memorandum at this point, but I thought you might like to
have it in hand for your own information in ease the subject should
oome up*
A month or so ago, I received a copy of a confidential
memorandum prepared by Benjamin H* Anderson on "The Control of Inflation, and the Treasury's Borrowing Policy*. In it he indicated
that he had sent the memorandum to a selected list and you are the
only one on it so far as I can tell, who is a member of the Banking
and Currency Committee of the Senate* While I donft imagine that
you or others who are informed would be mislead by Dr. Anders onTs
argument, it occurred to me that it might be well to have a state*
ment prepared by our research people to point out the flaws In his
reasoning and proposals* Accordingly, Dr. Goldenweiser, in consultation with our economic staff, wrote a memorandum which is also marked
"confidential* to give the other side of the picture, and I thought
you might wish to have it should the matter receive ary public attention or oome up in some way in the Senate or in the Committee*
With kindest personal regards, I am,
Sinoerely yours,
H« S» Socles,
Chairman*
Enclosure
ETjmla
June 15, 19U5
B.. M. AHJERSON'S FISCAL PROPOSALS
by
E. A. Goldenweiser, Economic Adviser,
Board of Governors of the Federal Reserve System
Mr. B* M. Anderson has written and circulated a paper on the
Control of Inflation and the Treasury's Borrowing Policy* In this paper
he compares our present position with that of France after the First World
War and suggests that they are very similar* Seoondly, he indicates that
the First World War was financed very much better in respect to avoiding
inflationary, pressures than the present war. Thirdly, he emphasizes the
danger in the present large volufrie of liquid assets and ascribes it to
wrong, financing and open-market policies by the Treasury and the System*
As a program to save the situation he proposes a funding of the Government
debt into long-term bonds at a rate of interest that would attract investors'
money. Just what rate this would be is not indicated, but Dr. Anderson
appears not to be too much disturbed by the idea of the rate rising to 1+
or 5 per cent* He wants this accompanied by a .sale of Government securities by the Federal Reserve Banks in order to tighten the money market, In
order to protect the banks from the large loss of principal that would result from the rise in bond rates, he proposes to give them an opportunity
to exchange their bond holdings for the higher interest securities with
some slight loss of principal — perhaps 2 per cent of the face value-*
Dr. Anderson's diagnosis and program deal with the immediate
situation and the immediate future, possibly the .next 1 l/2 or 2 years,
and the following discussion should be viewed with this time element in
mind.
Comparison with France and with First Vforld War
Dr. Anderson's comparison with France after the last war is quite
irrelevant. The differences between our situation and the situation of
France are far greater than the similarities. Our debt and debt service
are much smaller in relation to national income than was the case in France.
We have financed i+0 per cent of the cost of the war by taxation, while
France had so financed only about 12 per centf France had a very large
foreign debt, while we are still on balance a creditor in our international
accounts. Furthermore, the difficulties of France after the last war were
seriously aggravated by a flight of capital from the country, a development
that it is difficult to conceive for the United States in existing circumstances. For these reasons it- serves very little purpose to compare our
situation with that of France.
In the second place, Dr. Anderson thinks that the
financed very much better than the present war, because the
was higher and was rising* What he seems to have forgotten
time the entire monetary situation was different* Rates of
last war was
rate of interest
is that at that
interest were
- 2 much higher before the last war than they were before this war, because
we had a great demand for capital and limited reserves * Even so the war
was financed on a lower "basis- of rtttes than prevailed in the market and
this was criticized at that time by^persons of Dr. Anderson's general convictions as being unsound and inflationary. The Federal Reserve Banks had
a differential rate on war paper which was u3ed to a substantial degree.
The rate advanced as the war progressed and the Federal Reserve
was not used to stabilize the market through open-market operations. This
is generally considered now as having been poor policyj since* it increased
rather than decreased the difficulty of selling Government bonds outside
of the banking system, and since it is widely recognized that a great
national need should not be metr at a rising cost to the Government * The
fact that after the war rates advanced sharply, with the consequence that
the buyers of bonds £ook substantial losses, is not mentioned by Dr. Anderson,
but this surely should not be permitted to occur again. Also we had an inflation and a deflation after th£ last wan hot withstanding methods of financing that meet with Dr. Anderson's approval. Distant pastures are greener,
Dr, Anderson stresses the large amount of liquid funds that has
been created by financing the* present war and the danger that they constitute for the economy. There is no doubt- about the facts, but it might be
mentioned that the ratio, of deposits and currency to total national product
has changed very little. In fact, what Dr. Anderson forgets is that the
principal reason for th6 greater growth in liquid assets is that this war
was on an immensely larger scale than the First World War. As a matter of
fact, less than one-third of the First World War was financed by taxfcs as
against Uo per cent of the cost of this war, so that the record is better
this time than it v/as last time.
Dr. Anderson's apprehensions, about the size of our unfunded, or
short-term, debt does not appear to be justified. An unfunded, or shortterm debt presents difficulty to a Treasury only when there is difficulty
in obtaining funds to finance the Government's needs. This country faces
no such difficulty unless indeed it should adopt the sort of policy as that
recommended by Dr. Anderson.
Would higher rates prevent inflation?
T'he fundamental question is whether the remedy that Dr. Anderson
proposes would be in the public interest. He would like to see the rate
of interest on Government bonds go up to the point where they would be an
attractive investment and would find their way into firm hands where they
would be held. He offers some protection from the depreciation of outstanding bonds to the banks, but he says nothing about other institutions
and private individuals who have bought Government bonds in good faith. He
thinks that by his method inflation would be avoided.
Fir£t, the question should be asked whether higher ra.tes on Government bonds would result in larger purchases by investors, or whether, on
•the: contrary, the falling market on outstanding bfcnds might not result in a
- 3 loss of confidence in Government bonds as an investment and a flight from
Government bonds by many holders* It would seem that the latter is more
likely than the former* And if such a flight did occur, the Government
would have no choice but to create money in one w^y or another and thus to
fan the flames of inflation. Also, a drastic rise in interest rates on
long-term bonds would disriipt the financial .fabric of the countryf It would
also constitute a breach of faith to persons who have placed their resources
at the disposal of the Government to fight the war.
A narrowing of the spread between Shore-ana long-term rates
may develop when the pressure of war finance diminishes, but this
narrowing may be expected to be achieved by a gradual rise in short-term
rates, with long-term rates near the present level remaining as a firm
anchor of the rate structure.
Dr. Anderson thinks that rates will go up anyway, when the inflation, which he visualizes as the inevitable result of the present fiscal
policy, takes place. To him it is a choice between what he considers a
moderate advance in rates* now or a much greater rise later. This point
turns on one's views as to the inevitability of inflatibn and on methods of
preventing it* When one believes, as is stated in this comment, that Dr.
Anderson's proposals would aggravate rather than reduce the inflationary
danger — one cannot view the matter in terms of the alternative he presents.
Other social and economic consequences of high rates
It should be asked also whether a concentration of high-interest
bonds in firm hands would be the best economic and social policy. It would
seem that the opposite is the case. Firm hands, in plain English, means
wealthy investors. The-people of the United States, most of whom will have
veterans of the war in their families, are not likely to welcome high
taxation for many years for the purpose of paying interest to wealthy
holders of Government bonds.
It. seems apparent that the best condition of a large public debt
is the present wide distribution of low-rate securities among all groups of
people. The low rate will diminish the cost of the service of 'the debt and
the wide distribution will reduce the amount of diversion of income from taxpayers to bondholders. The tax rates will be lower and since taxes are
levied roughly in proportion to ability to pay recipients of interest on
the public debt will to a considerable extent pay the interest on the debt
to themselves. This is a sounder economic position and more in accordance
with equity. To have rich bondholders, because they were able to buy war
bonds in large amounts with profit to themselves, collect indefinitely a
heavy tribute from the rest of the population is not an objective to be
desired.
handicap
It would
would be
riskless
Furthermore, a high interest rate structure would be a severe
to business enterprise in the reconstruction period and thereafter.
discourage new undertakings, because the cost of acquiring capital
too high. The country has become adjusted to a rate of interest on
long-time investment of 2 l/2 per cent and the maintenance of that
-
k
-
i*ate would help greatly in facilitating productive enterprise, A policy of
maintaining the low rates established- during the war has been adopted in
England and in Canada on grounds that are similar to those presented here
for the United States. Governor Tdwetfs, of the Baftk of Canada, stated the
matter very pungently in his annual deport for I9b3* in which he said; "A
policy aimed at higher interest rates would only become intelligible if,
after war shortages are over, consumers' expenditures in capital developments were to proceed at a rate which would overstrain our productive
capacity, I see no prospect of such a situation arising in a form which
would call for a policy of raising interest rates."
In view of the enormous productive capacity of this country, which
has been built up and demonstrated by this war* it is incredible that' a
situation should develop in the foreseeable future in which consumer demands will exceed our productive capacity. This, of course, has reference
to a period after the country's industries have been reconverted to civilian
use. Acute shortages of goods exist now and are likely to exist for some
time to come, but the remedy for that is not in higher interest rates, which
would retard conversion* but in facilitating the conversion process in every
way,
Summary
To summarize, Dr. Anderson's comparisons with France and with
the First V/orld War are not enlightening, his belief in the magic of
higher rates in attracting investment funds and preventing inflation is
not realistic in existing circumstances, and his program of overcoming the
dangers of inflation by a radical advance in rates is a proposal that might
easily make inflation inevitable by undermining the public's faith in United
States securities and that would play havoc with our entire financial structure. It would also retard reconversion and hinder expansion of business
activity. Even if Dr. Anderson's expectations about attracting investors'
money were realized, the proposal would result in a highly inequitable and
politically dangerous situation, where a greatly increased burden of debt
service would be borne by the broad masses for the benefit of wealthy holders of war bonds.
Of all financial programs that have been proposed this is the
most irresponsible.
CONFIDENTIAL
Copy No. 4
For
J '
May 10, 1945
Memorandum on
THE CONTROL OF INFLATION, AND THE TREASURY'S BORROWING POLICY
by Benjamin M, Anderson, Ph. D.
Professor of Eoonomics, University of California,
Los Angeles, since 1939
Economist, Chase National Bank, 1920-39
Economist, National Bank of Commerce in New York,
1918-20
Assistant Professor of Economics, Harvard
University, 1913-18
Instructor in Economics, Columbia University,
1911-13
Head of Department of History and Economics,
State Teachers College, Springfield, Missouri,
1907-11
Author of
The Value of Money, New York, 1917 and 1936
The Effects of the War on Money, Credit and Banking
in France and the United States, Carnegie Endowment
for International Peace, 1919
The Chase Economic 3ulletin, 1920-37
The Economic Bulletin, issued by the Capital
Research Company, Los Angeles, since 1939
This document is confidential in the sense that I do not wish it
published. I am sending it only to highly responsible men, A great war
loan is impending, the success of which no one would wish to jeopardize.
The situation with respect to our public debt, our benking system and our
currency has grown extremely dangerous, as a result of the unsound policy
7/hich the Treasury has been pursuing. It is essential that there be the
frankest kind of discussion regarding the matter while there is still
time to reverse the policy and to avoid a ruinous inflation.
I am, therefore, sending this memorandum, each copy of which is numbered, to the President of the United States, to the Secretary of the
Treesury, to the members of the Board of Governors of the Federal Reserve
System* to the twelve Presidents of the Federal Reserve banks, to the
twelve members of the Federal Advisory Council, to the Chairmen of the Senate
Committee on Finance, to the Chairman of the House Committee on Ways and
Means, and to certain other highly responsible men, some members of Congress, some leaders in the banking profession, some economists, and others,
whose names will appear at the end of the document.
We can avoid a ruinous inflation if we act promptly, but not, I
believe, unless we do 8ct promptlyt
j
^
^^
CONFIDENTIAL
-2-
The p u b l i c ^ g j z L J ^ ^ a j j ^ d y ^ , ^ to a gigantic figure and promises
to be much biggeF before the wa.r is_j3vej^.
.The easg_with which the Treasury has been borrowing money at fan_tastically low rater~o?~"TnEerest from the banks ancfthe Federa 1 Reserve_
'banks "has generated a false sense of* financial onmjDgbgBL^ which is en^.
couraginp; the demand for great postwar extravagances, berth for govern^
'mental 'financing of exports to foreign countries and for unbearable gov^
ernmental expenditures at home*
France in World War I and the United States in World War II
How dangerous our position is may best be revealed by a comparison
of our war financing in World War II with that of France in World War I.
It—Brill be recalled that Frannfi grpntly weakened her- positinri.durilig-tha
war by hea^_rjedj^iKLe--U^Qii the Bank_of
increase—in.
TTftr bank nn-i-.ft i
She failed to pull up at the end of the war. In
1919 and 1920 the franc broke to low levels in the foreign exchanges. At
the end of 1926 France made a de facto stabilization of the franc with a
gold content of approximately 20% of the old par, and with commodity
prices at 641% of 1913 prices.
With respect to most points we are now a great deal further along
the road of inflation than France was at the end of the first world war.l
(1) The relation of government debt to national wealth is now worse
with us. 'France ended the" war with a~nati"onar"debt of 147,000,000,000
"francs as against a prewar national wealth estimated at 300,000,000,000
gold francs. The debt at par was 49^ of the national wealth. By 1926,
when France pulled up, she had a public debt of 287,000,000,000 paper
francs (internal),and 23,000,000,000 gold francs (external, including
debts to United States and British governments). (See Chase Economic
Bulletin, February, 1927). We had at the end of 1944, long before the
war is over, a national debt of £230,000,000,000, as against a prewar
national wealth not exceeding $387,000,000,000 . Our national debt
December 31, 1944, was thus 59,5% of the national wealth,
(2) _£i2fi_&rpwth of money in circnlatirm in
TTrH-h«r» g-t-a-t-oo cin^o
1939 is greater in percentag^JLhan the growth of money, in _cir-culati-on - in"T^i^anceH^
and August 29, 1918._ France had about
1 - This is the top figure suggested by the
National Resources Committee in "The Structure
of American Economy", June, 1939, Part I, Pages
374-376. Their top "probable" figure is
$360,000,000,000 and their lower ^probable"
figure is £350,000,000,000. I cannot find an
estimate sponsored by the Department of Commerce
lat er than 1922, when the figure was placed at
1321,000,000,000. Estimates both of national
wealth and of national income, of course, involve
assumptions, as well as facts, and the estimates
for France in 1913 are, of course, less dependable
than American estimates today.
j CONFIDENTIAL
-3-
9,000,000,000 francs in circulation, including about 3,000,000,000 francs
of gold, on June 4, 1914. 2,000,000,000 francs of this gold was turned
into the Bank of France in the three years that followed, and 1,000,000,000
francs of gold disappeared from circulation. By August 29, 1918, French^.
circulatl^i^^chi efly_Bnn kof. .Er.an.ce_notes,, hadjrisen roughly to 30,000,000,000
IranSsT^anincrease of_££3%. _ This grew to 53,>00,000 ,000 francs by June,
1926. In the United States money in circulation at the end of June, 1939, _
.stood at 17,000.JQQ.Q.000 , and it now stands at $26,000,000,000, an increase
of 271%^
(3) The percentage of national debt carried by the banks is far
greater wTEFTus than^with France! On December 31, 1917, the French pubiic
"debt stoo"5 at 123,000,000,000 francs, of which 12,200,000,000, or almost
exactly 10%, was held by the Bank of France. But the commercial banks in
France took very little of the public debt. The great banks, The Credit
Lyonnais, the Comptoir d'Escompte and the Societe Generale, were badly
shaken when the war broke out, and taken together, by the spring of 1918,
had made virtually no expansion in their balance sheets. To some extent
they had substituted government paper for commercial bills in their portfolios, but the amount was small. The only commercial bank that really
expanded greatly in France during the last war was a bank of second rank,
the Banque Nationale de Credit, which expanded a few hundred millions of
francs, lending both to the government and to business. At the beginning
of 1918 I should estimate that not more than 12% of the public debt was in
French banks, including both Bank of France and commercial banks.
In the United States, on the other hand, at the end of 1944, 42% of
the whole interest bearing public debt was in the commercial banks and the
Federal Reserve banks combined. Leaving out that part of the public debt
held by government agencies and trust funds, 46% of our interest bearing
public debt was in the Federal Reserve banks and the commercial banks.
Finally, looking only at the marketable public debt, and omitting that part
held by government agencies and trust funds, 58% was in the commercial
banks and the Federal Reserve banks.
France had very little increase in demand deposits during the war
and almost all was in the Bank of France itself, where there was an increase
of about 2,712,000,000 francs between June 4, 1914, and August 29, 1918.
Our commercial bank demand deposits ("adjusted") plus United States government deposits stood on June 30, 1939, at $28,147,000,000. On December 31,
1944, the figure stood at f-87,500,000,000, an increase of 2}0%. We have,
therefore, enormously outdone France m the increase of a circulating
medium, money plus demand deposits, during the war.
(4) The Bank of France steadily resisted inflationary developments,
urging upon the Treasury constantly that it should borrow as much as_
possible from the people^and its resistance had real results. Our own
"Federal Reserve System seems~ to have surrendered its money market policy
completely to the borrowing policy of the Treasury.
1 - I cannot, with the data at hand as I write,
give all my French figures as of the same dates.
Figures showing the classification and distribution
of our own public debt at the end of 1944 will be
found in the Federal Reserve Bulletin, March, 1945,
pages 257-58.
j CONFIDENTIAL
-4-
But we must now take account of favorable factors in our situation
as compared with the French situation in the last war.
(1) We are now doing very much better than France did in taxation.
/
/
(2) Although France had a strong gold position throughout, we have
what appears to be a world dominating gold position. But the outside world *
is gaining gold from us, and we are now apparently net debtor to the world
on current account. (See National City Bank letter of April, 1945).
(3) The relation of our national debt to our national inoome is more
favorable by a good deal than it was in France., The estimate for national
wealth in Francs in 1913 was 300,000,000,000 francs, and that for national
income was 50,000,000,000 francs, giving a ratio of 10 to 1. Real estate
is the biggest factor in national wealth and the French capitalized their
real estate on a very low yield basis in 1913. The ratio of national
wealth to national income in the United States was only 5-g- to 1 in 1912.
It was again 5j to 1 in 1939 if we take the figure of $387,000,000,000
given above for national wealth and compare it with the Department of Commerce estimate for national income for 1939, which was £71,800,000,000.
We do not know what our national income will be in the postwar period
and we are uncertain what our national debt will be.
Our Debt Largely Unfunded
^In the last war we place^the_-jiabt--j«4t h the-ppnplp primarily flriH ^n
long-term form." The government did spend for a few months funds borrowed
~dn snort-term from the banks, and then issued great funding loans, in which
bonds were placed with the people and out of which this short-term debt
to the banks was paid down. The curve for short-term debt rose to peaks
just before each funding loan, and then moved sharply down again. The banks
always held some of the government debt. At the peak of the public debt
they held about C4>000,000,000, but this included nearly $1,000,000,000
that they had held before the war to secure national bank notes and for
other purposes. Of the war debt they held little more than $3,000,000,000
at the peak in direct ownership, and much of this was short, and they had
also another $3,000,000,000 or
500,000,000 of loans secured by government
bonds which they had made to their customers to help them buy government
bonds*
The Federal Reserve banks owned almost no government securities during the last war, except for a few days at a time when each of the great
Liberty Loans was being floated.
When the war was over, the debt was largely funded.
knew where it stood. "
The Treasury
Our Treasury today cannot know where it will stand when the war is
over. The debt is very badly distributed. Of the part held outside the
banks ,_Uiejrg JLS--a_ great part in the hands of corporationg__yrhich are carrying
depreciation reserves, maintenance reserves and liquid funds for reconversion
purposes in government securities, but which must turn the government
CONFIDENTIAL
r
*
-5-
securities into cash to accomplish their purposes when the war is over.
A great deal is in the form of tax anticipation certificates which
will come back to the Treasury instead of cash.
Thj^rn-'cnl 1rd wnr nftvingfi hnnrin, .gigantic in volume^ajre_Jjii efferit.
demand deposits^ The holders can get their money at any time. These bonds
have been sold in a high percentage of cases with the argument that in
buying them the purchaser is buying a postwar automobile or a postwar home
or a postwar washing machine. The behavior of the sales and redemptions
of these bonds in the fiscal year 1945, as compared with the fiscal year
1944, is disquieting. The Treasury Daily Statement of April 20, 1945, shows
that in the fiscal year 1945 to date the Treasury has sold only $10,757,000,000
of these bonds., as against $12,612,000,000 in the corresponding period of
the fiscal year 1944. It shows also that in the current fiscal year the
Treasury has had to redeem $3,357,000,000 of these bonds, whereas in the
preceding fiscal year it redeemed only $1,774,000,000. The net intake of
the Treasury on these bonds in the fiscal year 1945 is thus only $7,400,000,000,
whereas in the corresponding period of the preceding fiscal year it was
nearly $11,000,000,000. (Since March 1, 1945, these redemptions have included redemptions of matured savings bonds, but the tendencies indicated
above were strongly in evidence before March 1). .The Treasury may have n
very grave problem with these__.degtand deposits when the war is over. It is
unfunded~~debt. The total of these savings bends was $40,361,000,000 at the
end of December, 1944, and the total of the Treasury tax and savings notes
was $9,843,000,000.
. Of the marketable issues, a very dangerously higlrjaroj^rti-on is in
unfunde d form._ The total of marketable issues was $162,843,000,000 as of
the end of December, 1944. We may break this up as follows: Treasury bills,
certificates and Treasury notes, total $69,868,000,000. To this we ought
to add the Treasury bonds maturing within five years, which stood at
$7,824,000,000, making a grand total of short marketable debt of $77,692,000,000
To this we should add the war savings bonds and the tax and savings notes
mentioned above, making $127,906,000,000 of unfunded debt, out of a total
of $230,000,000,000 of interest bearing public debt, or 56%.
Of funded debt in the form of bonds maturing after five years the
total is $83,761,000,000, but this funded debt of over five years maturity
is very badly held. $31,672,000,000 of this is in the commercial banks."
The part that is clearly well-placed consists of $7,567,000,000 in the
mutual savings banks, and $17,303,000,000 in the insurance companies, a
total of $24,870,000,000, in these two classes of institutions,
^The part that is held by individual investors is pathetically small.
The great buiJc"^T''triTe~nJtlbTic~debt ought to be in the hands of the individual
invest orS35d_j^_qught--txi-be
fprm. I cannot give the
"figure. ~Tt is part of $21,321,000,000 listed under the category "other",
which includes business corporations, states and municipalities, educational and charitable organizations, trust funds, investment banks, brokers,
and investment companies, as well as individual investors. The rates of
2% on ten-year bonds, and 2jf0 on twenty-year bonds are simply too low to
attract investors. The man who knows how to look at a bond table can see
to what prices they would go if the rate of interest should rise, and he
can look back over the history of government bond yields for the past
twenty-five years, and see yields exceeding
C0NFID3NTIAL
-6'
Diagnosis
The symptoms of pathology in the handling of the public debt ere
very clear in the figures given above• Whet is the explanation, what is
the cause of the pathology? The explanation is to be found in the fantastically low rates of interest at which the Treasury has been borrowing,
made possible by the artificial manipulation of interest rates by the
Federal Reserve System.
The lowest interest rates in ell history, at a time when the world
is destroying capital on a colossal scale, end when the government of the
United States is borrowing many tens of billions of dollars a year, are
obviously en anomaly. Normal interest rates reflect supply and demand of
capital, and rise as supply diminishes or as demand increases. There are
•four normal sources of capitals (1) consumer's thrift; (2) business
thrift, particularly the building up of corporete surpluses out of profits;
(3) direct capitalization, as where the farmer uses his spare time in
building fences end berns, or allows his flocks end herds to increase;
(4) governmental thrift, where taxes exceed public expenditure end the
government is paying down public debt*
New benk credit constitutes e fifth source of capital, safe
when cautiously used and kept in reasonable relation to the growth
four normal sources of cepitel end the growth of production in the
but dangerous in the extreme when used to excess, as we saw in the
1924-33.
enough
of the
country,
period
Bank credit es a substitute for savings is particularly dangerous
in war time. It has been the typical breeder of war and postwar inflation*
e
The classical case is. of-course-.-that- wiuere_fche_ governi^
upon credit from the state bank of issue, as Germany and France both did
"in world War I* The great expansion of bank notes is obvious* But an
expansion of bank deposits is in economic essence almost Identical with en
expansion of benk notes. Notes end deposits elike ere demand liabilities,
are both media of exchange. Psychologically, the note issue is the more
dangerous, lie ere, however, increasing both now on a colossel scale*
In World War I, between April, 1917, and December 30, 1918, we
expanded benk deposits by $5,800,000,000 and bank loans and investment by
$7,000,000,000. In the period from June of 1922 to April 11,1928, we
expended bank credit by #13,500,000,000 in deposits end by $14,500,000,000
in loans and investments* This generated our wild stock market and stock
market crash of 1929, and the resulting troubles of 1930-33. In the present
war, as we heve seen above, as^ a result of the Federal Reserve cheap money
policy and the policy of the Treasury of borrowing at low rates of interest
^from the banks,*we have generated an expansion"of"benk credit in the United"
Jjtetes of incredibly greater magnitude, end have increased our money in cir~
^culetion from $7,000,000,000 et the end of June, 1939, to $26,000,000,000.
We had elreedy very greatly overdone cheap money and benk expansion,
and government security parcheses by the banks, between March of 1933 pnd
June of 1939. The Federal Reserve authorities had been greatly concerned,
and had raised the reserve requirements of the member banks in late 1936
and early 1937 to double the minimum reserve requirementsw The Treasury
j CONFIDENTIAL
-7-
was concerned, end crested a "sterilization" fund. But Presidential action
compelled both the Treasury and the Federal Reserve authorities to retreat
with respect to these matters in early 1938.
The Warning of the Federal Reserve Authorities
But the Federal Reserve authorities remained concerned* In a report
to Congress on January 1, 1941, there was a unanimous recommendation by the
Board of Governors of the Federal Reserve System, the Presidents of the
twelve Federal Reserve banks end the twelve members of the Federal Advisory
Council urging the Congress to forestall inflationary tendencies (l) by
increasing the power of the Board of Governors to raise reserve requirements of the member banks; (2) by ending the President's power to devalue
the currency; (3) by repealing the power to issue three billion dollars
of greenbacks; and (4) by selling government securities directly to investors, rather than to the banks. The first end fourth of these recom" men^&£loris~ 1 ooked~airec£1 y. "toward Tirmer rates of~interest^
Belatedly, and by action originating in Congress, recommendations
(2) and (3) of this report have been adopted or appear to be in process
of adoption, but nothing has been done about recommendations (l) and (4)._
They seem to meet~~no' favor in the
The Federal Reserve System,
having made its protest, today lies supine. It imposes no. brakes. It
feeds the inflation of bank credit and currency.
Alleged Safety in New Techniques
We are told that new techniques have arisen which make the policy
safe. I see very little in the way of new techniques, and rather, e very
exaggerated use of old techniques.
"We have, first, the purchases of government securities by the
Federal Reserve benks, replenishing the reserves of the member banks. In
the first world war, the Federal Reserve benks did this in connection with
each of the four great Liberty Loens, reducing the strein in the money
market for a few days, while the loans were being floated, and then
promptly selling the government securities again. The magnitudes were
small—for the first three Liberty Loans a few tens of millions, and in
the Fourth Liberty Losn, something over two hundred millions—but only for
a few days.
In 1924 end 1927, the Federal Reserve banks bought several hundred
millions of government securities and held them for a good many months,
in each case generating a very dangerous expansion of bank credit, and in
the second case precipitating almost unmanageable difficulties.
JLj^the present wari
P^ri^ral R^s^rve benks have bought, govfirnmftnt-.
^securities in terms, not of tens of millions or of hundreds of millionsr
but of meny billions^. The figure stood at 32,184,000,000 on December 31,
1940, and at $20,153,000,000 on April 18, 1945. This is no new technique,
but the vast scale of its use makes one ponder.
j CONFIDENTIAL
-8Rediscount Rates Below the Market
In the lest war, Federal Reserve Bank rediscount rates were placed
below the market rates to facilitate wer financing. But they followed
the market up as the war went on. The New York Federal Reserve Bank rediscount rate was placed at 3% in 1917, moved up to
at the end of the
year, end to 4% early in 1918, remaining, however, below market rates. It
the present time, the Federal Reserve benk rediscount rate is
edvnces secured by government obligations maturing in one year or less.
Here agein there is no new technique, but merely an extreme application of
an old one.
Reducing Reserve Requirements
The Federal Reserve authorities now have power to reduce the reserve
requirements of the member banks, end they have already done this as far
as New York and Chicago benks are concerned. But in the last wer we.reduced
member bank reserve requirements by act of Congress in 1917—to levels that
made us greet trouble in the period of the 1920's.
Unlimited Access to Federal Reserve Banks et 3/8%
Finelly, the Federal Reserve banks buy government bills without limit
from the member benks et a fixed rete, 3/8 of 1% discount, with a repurchase
egreement. This is designed to make the member banks look upon government
bills as ready cash, end to meke them feel that it is not necessary to
carry excess reserves. It may be granted that we have here a new technique.
It is obviously a highly dengerous technique, and a highly inflationary one.
Using Up Ammunition Rapidly
In the process of this immense benk expension, we have used up
ammunition very fest. JThe^ reserve ratio of the Federal Reserve banks to
notes and deposits combined stood 8t 90% in April, 1942, 8nd at 47% on
April 18, 1945. Excess reserves, which stood at nearly $7,000,000,000
in early 1941, dropped below $1,000,000,000 in 1944.
Inflation Policy in Last l/Var
During our own participation in the last wer, we held down inflation
admirably. The greet rise in prices in the last war came between December
of 1915 and July of 1917, before our government war policy got into operation.
Commodity prices at wholesale in July of 1917 stood at 187% of 1913
prices. Under our war policy these prices receded to 182% in October of
1917, and then rose slowly, under the extreme pressure of the wer, to
207% in November of 1918, efter which they receded egein to 197% in Merch of 1919.
j CONFIDENTIAL
-9-
Our war policy in the first world wer with respect to prices contained four elements: (l) the sudden, very heavy application of war
taxation; (2) ,great__concern that bonds be sold to investors rather than M
Toi~berncs7 (3) a firm money^ne]^
down bank expansion. Commercial
paper rates in 1918 stood at 6%, though the government borrowed more
cheaply. Rates were mode, however, which would attract investors, and
which could look reasonable over a long period of time- I ho First Liberty
^
Loan was issued at
tax free, the Second hi c<?rty Loan at 4/6, _ l/fj^
the Fourth Liberty Loan at
the last three Liberty Loons being par- "
tL.lly tax exempt-* (4-) We had a 1 imitgjd_gjnourrt of price fixing,, applying
to scarce essentials, and accompanied alweysby^coirmlCuity "controls We
had retail price fixing only in the matter of scarce foods and fuels, and
here not until after wholesale price fixing had been well established. Tflt©
relied in the lest wer primarily on functional controls, rather then
direct controls, es far as commodity prices were concerned.
Primary Reliance on Price Fixing in Y»orld Wer II
In the present war, building up an immense inflationary flood by
the expansion of bank credit and money in circulation, we have used 8S
our primary device for controlling inflation, price fixing* covering
virtually all wholesale and retail prices and industrial weges.
Price Fixing Must End with the War
It is quite clear that these price controls cannot be tolerated if _
we are to have a free postwar economy. Prices have work to do. Prices
"are to guide end direct the ecdnomic Activities of the people. Prices
are to tell them what to do. Prices must be free to tell the truth.
Something may be said for the temporary continuation of price fixing, with rationing, in the case of very scarce essential commodities, but
each case should be scrutinized carefully. The general idea that price
fixing should be continued after the war for the purpose of preventing
inflation must be absolutely vetoed. Inflation must be controlled), if it
is controlled, by budget be1ancing_end control of money end credit*
Eliminate Inflationary Money and Credit Policies Now
The existing low interest rates are made possible only by the substitution of bank credit for investors1 savings.m If bank expansion were
"to s"to"p todayj interest rates would forthwith rise. If, on,.1khe~other.Jhand-y.
benk expansion"is not stopped, we shall have a tremendous inflation. An<L
then we shell see en immense rise of interest rates, the inevitable accompaniment of a great inflation. The choice is not between continuing low
interest rates and not continuing. The choice is rather between a moderete
end manageable reversal of policy in the near future, and an involuntery
submission to very high interest rates at a later date.
j CONFIDENTIAL
-10Prescription: Fund the Public Debt
Now end Reduce Money and Deposits Now
I believe we should act promptly while the war is still on, while
we still heve controlled commodity markets, and while we still have wartime motives to work with., ,_iji_fun(y.ng ^ e government debt into Loner-term
bonds et rates...of__interest wr'Ach will attract investors ' moriey. The vast
scale of the funding operations required means that we shcv"-d have to
supplement the attractive yield with effective bond-selling, including
neighborhood pressure. I believe that if we act promptly, these rates
can be intermediate between those we paid in the lest war, and those we
ere now paying.
We now have outstanding, as e result of the previous ebuse of benk
credit, an immense volume of idle money in circulation end an immense^
volume of idle deposits in the benks_*_ If these grew ective, we should
Tiave an "inflation that would blow us sky-high. The thing to do is to pull
them in and get them invested in government bonds before they begin to
work actively in other fields.
I cannot, of course, set exact figures at which investors will teke
long-term government bonds. Only the market cen do thet. But this idle
cesh is a market factor of first importance, tending to hold interest
rates down. I think the_thing to do is to increase the interest rates on.
new government securities forthwith to levels et wnicft investor!"* money
wilQkT.forthcoming7 This should be accompanied by a sale of government"
securities by the Federal Reserve banks to tighten up the money market correspondingly.
Existing Excess of Money and Credit Tend to
Hold Down Interest Rates for Refunding Purposes
Now a rise in interest rates would set in motion powerful counterforces which would tend to hold the interest rates down. With rising
interest rates, savings banks end other banks would find it worth-while to
offer attractive rates on savings accounts to the people, pulling in actual
cash from circulation. And commercial banks would be interested in reIducing or even dispensing with service charges on demand deposits, which
/would pull in a greet deal of money from circulation.
monfty
coming in from ciroulatA^jiKaild^fijijg.e -the hank reserve situation and tend
to hold interest rates down. Moreover, investors, attracted by higher
yields on government bonds, would make a market for very many of the
government securities now held by the banks. As the banks so Id .these—
securities to investors, investors, would .pay for them by checking against v
p*rr>iint,fi t canceling a great deal offr-hainflated deposits, and
Jl
once more easing the money market situation by reducing the reserve requirements of the banks.1
Protecting the Banks When Government Bond Yields Rise
There ere two mein objections to the policy which I propose:
1 - For en analogous situation, see my account of the
money market in 1928, in The Chese Economic Bulletin,
"Brokers* Loans and Bank Credit", October 31, 1928.
j CONFIDENTIAL
-11-
(l) thatJLt would involve dangers to the capital structures of those
benks now too heavily loaded with long-term government securities; (2)
that it_jEQuid_J.acxg.ese the tax money required to meet the debt service on
the Governments already enormous debt.
Let me say with respect to both these points that the problems grow
progressively worse the longer we refrain from facing them.
To protect the banks in this change of policy, I have proposed that
the benks holding long-tern government bonds be allowed to exchange them
"for liew Ti¥u^~at~th"e higher rates of interest, at e discount of, say,
2% as compered with cash subscribers, leaving them with some loss but not_
with losses that would ruin their depositors. The F.D.I.C., whose solvency
and liquidity are of highest importance, should have the same protection
as the banks.
F.n«TTflT ^h^mld >p expected_to take shorter
^maturities in making these exchanges. I have seen no other proposal for
dealing with this~~thit~ looks~~atf ell "adequate. It cannot be solved by
allowing the banks to carry these bonds at par on their books, regardless
of the market. Informed depositors would simply withdrew their funds
from banks whose cepitel structures were impaired, and put them into banks
whose holdings of government securities were predominantly short-term.
Nor do you solve any inflation problem by forcing the Federal Reserve
banks to take long-term bonds from the member banks at par.
The present artificielity in the interest structure runs far beyond
the regulation of member bank reserves and short-term money rates. JEhe
.Federal Reserve authorities are also undertaking to regulate the lon&term interest"retesTby' buying and selling government securities of,
different maturities. For an exposition of Federel Reserve policy with
respect to this matter, see the Federel Reserve Bulletin of July, 1943,
pages 590-91. A good many bankers have come to expect e sure market for
their long-term government bonds in the Federal Reserve banks themselves.
This is an ominous delusion. The holders of the ultimate reserves of the
country must not be investment institutions and must not be looked to, to
supply long-term capital or to manipulate the bond market. When the
Federal Reserve authorities ere finally driven to tighten the money market
in resisting a great inflation, they will not be able to protect the
prices of long-term government bonds without feeding the very inflation
they are trying to control.
The Interest Burden of the Public Debt
With respect to the interest burden on the government debt, let me
say thet this problem becomes progressively worse if we delay it. We
can now fund the government.debt--modernte rates of interest, as ~e£ove
indicgtedt I£JL_ howeve r , we weit^for inflgtion to come^ inte re-st rates—
wi 1 lrise..rapi dXx. and the Secretary of the Treasury will sweat blood as
"Treasury bills and certificates fall due, as people cash in their wsr
savings bonds, end as he hss to borrow money on the rapidly rising money
merket—or else print, which would not help the inflation.
CONFIDENTIAL
<~I2Drastic Federal Budget Economies Essential
The notion that we can permanently hold the debt service on the
public debt to a 2% rate is fantastic. The notion that we can permanently
service three hundred billions of public debt with six billions of interest
is fantastic. Yve had best face the facts now. The facts ere that our
postwar budget is goingto be very difficult to balance, end that we_face
the necessity for drastic economies in the postwar period,. The facts *
are that proposals for ""expending Federel expenditures after the war must
be fought aril along the line. We do not create social security when we
endanger the dollar in which social security payments are to be made.
irtificialities 3uilt on Artificialities
I cannot pretend to know with confidence what is going on in the
minds of men inside the government who, seeing the dangers, are still
afreid to face them. But I have heard some fantastic suggestions.
One of them looks to a compulsory holding by the member banks of
fixed quotas of non-negotiable government securities as a permanent
matter, et nominal rates of interest with, however, the understanding
thet in times of necessity they may turn these over to the Federal Reserve banks for cash. Now always in the past our government securities
in the commercial banks have been looked upon as secondary reserves.
Always in the pest we have had e free government bond market. The
liquidity of the banks, and their ability to make adequate loans to
commercial borrowers and their ability to meet depositors1 withdrawals
have alweys been greatly strengthened by their holdings of government
securities. To freeze government securities in the benks is to freeze
the banks. Moreover, the volume of bank deposits, which ought to be
related to the needs of commerce, would then tend to be frozen, governed
not by the needs of commerce, but by the Treasury's needs. Money market
control with respect to the needs of trade and with respect to the need
of checking inflationary tendencies would disappear under a system like
this. Again the Federal Reserve banks, trying to tighten up end prevent
the infletion from becoming a ruinous thing, would find themselves compelled to expand their credit as they took over government bonds from hardpressed banks. No such artificiality will help.
I had'lest Autumn from a man in the government's financial system,
whom I do not wish to identify as he wes talking with me privately, an
elerming suggestion which may or may not represent a considerable body
of inside thought. He told me thet we had learned meny things, which
economists had previously not known, which made it safe to proceed elong
lines that we hed formerly regerded as unorthodox. He seid thet two years
ego he had been afreid of the greet expension of benk deposits and money
in circulation which the Treasury's borrowing involved, and afraid of
the unfunded debt, but that today he hed no fear et all of inflation.
It will be perfectly possible with modern techniques to control the interest rates end to control inflationary tendencies. TShen I pressed him
regarding methods, he said that the Nazi had developed some very good
technical economic ideas^ I said, "Yes, if you heve enough regimentation,
j CONFIDENTIAL
-13-
if you have control of all commodities and all prices, if you have control
of every man's pocketbook and every man*s bank balance, if you have control of the farmer's consumption of his own production, if you can control
all exports and imports and foreign exchange transactions, and if you have
a sufficiently powerful and efficient Gestapo, you can take great liberties
with money and credit." He said that the trouble with the Nazi is that
they do not have consciences.
I may add* however, that without techniques of the Nazi type described in the preceding paragraph, it is not possible to continue our
present course and avoid a ruinous inflation.
I know at least one man in the Federal Reserve system who was reconciled to inflation nearly two years ago, who held that inflation
always follows a great war, and that it is necessary to cover up the great
war debt. To this man I would say, first, that I do not believe it. We
can, by sound measures taken promptly, protect our currency from further
debasement, and protect our price system from ruinous convulsive movements.
Moreover, the accomplishment of the measures which I propose would still
leave far more inflationary material lying around than I like to see*
For one thing, we have not yet felt the main impact of the 40% cut in the
gold content of our dollar in 1934, and we have not yet seen the consequences upon the world of the rise of annual world gold production from
#430,000,000 in old gold dollars in 1930 to roughty three times that
figure in new gold dollars in 1939. I would add that in any case the
most hopeless pessimist would wish to have some control of the situation.
Inflation is not something that you can turn off and on like water
at a faucet. Inflation and deflation are not simple terms, and they are
not simple opposites. There is no financial Westinghouse air brake by
means of which an inflationary movement can be smoothly tapered off and
brought gently to an end without a shock. Rather, inflationary forces
engendered in defiance of sound financial policy may seem harmless for a
long time, and then suddenly break forth into great violence.
It is far better for the Federal Reserve System to act now when
moderate restraining movements will accomplish a great deal, than to wait
until the great inflationary movement is under way and when even violent
methods of restraint may have limited efficacy. And it is far better for
the Treasury to face the financial facts regarding the public debt service now, while it is possible to fund the debt_,.cm.jBPderat.e t.ei'ms^ than
to wait to face the violently rising interest rates which a real inflation
always creates.
Benjamin M. Anderson
-14This memorandum is being sent to the officials listed in the second
paragraph on Page 1, and also to the following:
WASHINGTON OFFICIALS
Senator Josiah W. BaileySenator Harry F. Byrd
Honorable Clarence Cannon
Honorable Leo T. Crowley
Senator Forrest C. Donne11
Honorable Joseph W. Martin, Jr.
Honorable Frederick C. Smith
Honorable John W. Snyder
Honorable Hatton W. Sumners
Senator Robert A. Taft
Senator Millard E. Tydings
Senator Arthur H. Vandenberg
BANKERS
Baltimore
Mr. Morton M. Prentiss, First National Bank
Birmingham
Mr. Oscar Wells, First National Bank
Bost on
Mr. Walter S. Bucklin, National Shawmut Bank
Chicago
Mr. Walter J. Cummings, Continental Illinois Bank & Trust Company
Mr. Solomon A. Smith, Northern Trust Company
Cincinnati
Mr. John J. Rowe, Fifth Third Union Trust Company
Detroit
Mr. Walter S. McLucas, National Bank of Detroit
Kansas City
Mr. James E. Kemper, Commerce Trust Company
Mr. E. F. Swinney, First National Bank
Los Angeles
Mr. Arch W. Anderson, California Bank
Minneapolis
Mr. layman
K. Wakefield, First National Bank
New York
Mr.
Mr.
Mr.
Mr.
Winthrop W. Aldrich, Chese National Bank
J. Stewart Baker, Bank of the Manhattan Company
W. Randolph Burgess, National City Bank
S. Sloan Colt, Bankers Trust Company
Mr. Russell C. Leffingwell, J. P. Morgan end Company
Philadelphia
Mr. 0. Howard wolfe, Philadelphia National Bank
St* Louis
Mr. W.
Mercantile-Commerce
Mr.
TomL.
K.Hemingway,
Smith, Boatmen's
National Bank Trust Company
Mr. 7»alter W. Smith, First National Bank
Mr. Sidney Maestre, Mississippi Valley Trust Company
Sen Antonio
Mr. J. H. Frost, Frost National Bank
San Francisco
Dr. Otto Jeidels, Bank of America
Mr. F. L. Lipmen, Hells Fargo Bank & Union Trust Company
Mr. Charles K. Mcintosh, Bank of California
Seattle
Mr. G. H. Greenwood, Pacific Netional Bank
ECONOMISTS
Professor E. E. Agger, New Jersey Commissioner of Banking
General Leonard P. Ayres, Cleveland Trust Company
Professor B. H. Beckhart, Columbia University
Professor James W. Bell, Northwestern University
President Edmund E. Day, Cornell University
Frofessor Paul H. Douglas, University of Chicago
Professor Fred R. F&irchild, Yale University
Professor Robert Murray Haig, Columbi a University
Mr. Henry Hazlitt, New York Times
Dr. Virgil Jordan, Netional Industrial Conference Board
Professor Edwin W. Kemmerer, Princeton
Professor William K» Kiekhofer, University of Wisconsin
Professor Albert A. Kincaid, University of Virginia
frofessor Frank H. Knight, University of Chicago
Mr, D. W. Michener, Chase National Bank
Dr. Harold G. Moulton, Brookings Institution
Professor Harold L. Reed, Cornell University
Mr. George B. Roberts, The National city Bank
ECONOMISTS (con.)
Professor I. Leo Sharfmen, University of Michigan
Professor Welter E» Spahr, Secreteiy, Economists1 National Committee
on Monetary policy
Professor Mervel M. Stockwell, University of California, Los Angeles
Dean Gordon S. watkins, University of California, Los Angeles
Professor Ray B. Yuesterfield, Yale University
Professor John H. Mlliems, Harvard University
OTHERS
Mr. Henry deForest Baldwin, New York
Mr. nsa V. Call, Pacific Mutual Life Insurance Company, Los Angeles
Mr. Ea H. Collins, New York Hsreld-Tribune
Mr. James Ec Craig> New York Sun
Mr. John TN. Davis, New York
Honorable Lewis 1(V. Douglas, New York
Provost Clerence A. Pykstra, University of California, tos Angeles
Mr. Leroy Edwards, President, Los Angeles Chember of Commerce
Mr. Lamer Fleming, Jr., Anderson Cleyton & Company, Houston
Senator Thomas P. Gore, IfVeshington
Mr. Henry J. Haskell, Kansas City Star
Honoreble Alf M. Lendon, Topeka
Mr. William C. Mullendore, Pest President Los Angeles Chember of Commerce
Mr. John W. Owens, Baltimore Sun
Honorable Randolph Paul; New York
President Robert G. Sproul, University of California
Mr. Thomas F. Y.'oodlock, YJell Street Journel
@FedFRASER