Full text of Marriner S. Eccles Papers : Memo to Mr. Goldenweiser, Box 100, Folder 9, Item 1

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^ U J J

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October 3, 1940.
To

Mr. Goldenweiser

From

Mr. A l v i n H. Hansen

Subject:

I n t r o d u c t o r y Statement
on Research P r o j e c t .

F o l l o w i n g are f o u r r e p o r t s r e l a t i n g t o t h e study w h i c h we have
undertaken i n t h e Defense Program and i t s impact upon t h e American economy
w i t h s p e c i a l r e f e r e n c e t o problems o f concern t o t h e Board o f Governors o f
t h e Federal Reserve System.
The f i r s t i s a Progress Report d e t a i l i n g t h e t o p i c s under i n v e s t i g a t i o n , t h e memoranda which have been prepared, and t h e i n t e r d e p a r t m e n t a l
conferences which have been h e l d on v a r i o u s problems.
The second i s a P r e l i m i n a r y Report s t a t i n g i n summary f a s h i o n
some g e n e r a l conclusions r e l a t i n g t o t h e Defense Program and i t s a f t e r m a t h .
I n t h i s statement I have discussed t h e g e n e r a l s i t u a t i o n c o n f r o n t i n g our
economy a t t h e p o i n t when t h e Defense Program begins; t h e magnitude and
t i m i n g o f t h e Defense O u t l a y s , t o g e t h e r w i t h t h e probable e f f e c t o f t h e s e
o u t l a y s on t h e n a t i o n a l income, output and employment; t h e probable t a x
r e c e i p t s and d e f i c i t s d u r i n g t h e next two f i s c a l y e a r s ; t h e probable f l o w
o f c o r p o r a t e , i n s t i t u t i o n a l and i n d i v i d u a l savings which may be a v a i l a b l e
f o r p r i v a t e o u t l a y s on p l a n t , equipment and housing, and f o r investment i n
new (tovernment i s s u e s ; t h e a p p r o p r i a t e methods o f f i n a n c i n g defense expendit u r e s , whether borrowing from banks, from t h e p u b l i c , o r f r o m t a x e s ; t h e
danger as we get on w i t h t h e defense program o f running headlong i n t o gene r a l i n f l a t i o n , and t h e v a r i o u s means o f meeting t h i s s i t u a t i o n ; post-war
slump and how t o deal w i t h i t ; and f i n a l l y , long-range f i s c a l p o l i c y , w i t h
s p e c i a l r e f e r e n c e t o a thorough r e o r g a n i z a t i o n o f t h e F e d e r a l - S t a t e f i s c a l
setup and machinery f o r developing a f l e x i b l e t a x program.
The t h i r d i s an o u t l i n e o f problems—some immediately p r e s s i n g
and o t h e r s o f a long-range character—about w h i c h t h e Board ought, i n t h e
near f u t u r e , t o reach d e f i n i t i v e conclusions w i t h respect t o p o l i c y and
lines of action.
The f o u r t h i s a s p e c i a l memorandum on proposed changes i n our
gold p o l i c y , i n two p a r t s , t h e f i r s t (A) d e a l i n g w i t h general aspects and
t h e second (B) d e a l i n g w i t h a l t e r n a t i v e f o r m u l a t i o n s o f f u t u r e g o l d p o l i c y .
These r e p o r t s should be considered as t e n t a t i v e as t h e y have n o t
a l l been read by a l l t h e s e n i o r members o f t h e Board's research s t a f f .




-2September 2S5, 1940.
PROGRESS REPORT ON RESEARCH RELATING TO TrfB
DEFENSE PROGRAM AND ITS IMPACT UPON THE
NATIONAL ECONOMY
Enclosed herewith, i n a separate memorandum, i s a b r i e f s t a t e ment i n d i c a t i n g t e n t a t i v e conclusions w i t h respect t o the Defense Program
and i t s e f f e c t on the economy.
The present memorandum i s intended t o give a summary statement
of areas under consideration and t h e l i n e s of i n v e s t i g a t i o n t h a t have been
started.

I t l i s t s t h e various memoranda which have been prepared bearing

on the economic problems r e l a t i n g t o defense, and makes a short resume o f
inter-departmental conferences which have been held dealing w i t h various
aspects of the s u b j e c t .




A.

Topics I n v e s t i g a t e d

The s p e c i f i c t o p i c s i n v e s t i g a t e d may be o u t l i n e d as f o l l o w s :
1.

The magnitude and t i m i n g of the Defense Program.

2.

The probable e f f e c t of the Defense Program upon
the n a t i o n a l income, employment and output.

3.

The probable magnitude of p r i v a t e investment i n
p l a n t , equipment and housing, and the probable
expenditures on automobiles and household equipment at various income l e v e l s .

4*

The probable volume of business p r o f i t s ; of c o r porate, i n s t i t u t i o n a l and i n d i v i d u a l savings at
various income l e v e l s .

5.

The probable magnitude of t a x r e c e i p t s (assuming
d i f f e r e n t t a x s t r u c t u r e s ) at various income l e v e l s .

6.

The probable Federal expenditures and d e f i c i t s under the Defense Program.

7.

The probable volume of Federal borrowing from comm e r c i a l banks, savings i n s t i t u t i o n s , corporations
and i n d i v i d u a l s .

-3-

(2-)
8.

The prospect w i t h respect t o commodity p r i c e i n f l a t i o n ( i n d u s t r i a l , a g r i c u l t u r a l and food p r i c e s )
under varying conditions*

9.

The danger of bottlenecks w i t h special reference
t o s t e e l , r a i l w a y equipment and s k i l l e d l a b o r .

10.

The prospect w i t h respect t o wage increases and
labor unrest.

11.

Control of I n f l a t i o n : r a t i o n i n g , p r i o r i t i e s and
other d i r e c t measures of c o n t r o l ; consumption
taxes; Keynes plan f o r compulsory saving and def e r r e d paymentj excess reserves and d i r e c t monetary controls.

12.

The impact of the t a r on f o r e i g n trade and postwar trade p o l i c y .

13•

Gold and exchange p o l i c y of the U. S . , e s p e c i a l l y
i n view of Germany's access t o the gold and f o r eign balances of v i r t u a l l y the e n t i r e European
continent.

14*

Problems r e l a t i n g t o the post-defense slump, p a r t i c u l a r l y post-defense Federal budget, the f i s c a l
capacity of the States, the Federal-State f i s c a l
relations, variable grants-in-aid, social security
programs ( i n c l u d i n g o l d age, unemployment, food
stamp p l a n , h e a l t h , education), Federal works p r o grams, housing.

15.

Long-range proposals w i t h respect t o expansion,
f u l l u t i l i z a t i o n o f resources, anti-depression
p o l i c y , f l e x i b l e t a x s t r u c t u r e , f l e x i b l e program
of p u b l i c works, a F i s c a l A u t h o r i t y Planning Agency.
B.

Memoranda Available

Under the various t o p i c s the f o l l o w i n g memoranda have been p r e pared (some q u i t e independently of the present research program) and are
a v a i l a b l e (except where noted).




I.

Magnitude and Timing of the Defense Program.
1.

Present and Prospective Plans f o r N a t i o n a l Defense (Sherrard).

-4(6)
2.
II.

Revised Estimates of Present Defense Program
(Sherrard).

Outlook f o r National Income, Employment and Output*
1.

P r i v a t e Durable Goods Expenditures a t Higher
Income Levels (Terborgh).

2.

The Business Outlook f o r F i s c a l Years 1941 and
1942 ( D i v i s i o n s of Business Review and Indust r i a l Economics, Department of Commerce).

3.

Immediate Prospects f o r Trade i n War or Peace
(Gardner).

4.

N a t i o n a l Income under Conditions of F u l l Employment (Barton).

5.
III.

The Magnitude of the Recovery Problem ( S a l a n t ) .

Business P r o f i t s and Savings.
1.

Data on Corporate P r o f i t s a t Various Income
Levels (Edmiston).

2.

Estimates of Savings at Various Income Levels
(Hersey).

IV.

(Not yet completed)

Federal Tax Receipts.
1.
2.

3.

Probable Yields of an Excess P r o f i t s Tax (Colm).

4.
V.

Tax Receipts a t Various Income Levels (Edmiston).
Economic E f f e c t s and Estimated Yields of a set
o f Tax Proposals designed t o r a i s e revenue
vdthout r e s t r i c t i n g consumption ( K r o s t ) .

Data on Consumption versus Other Taxes, 1932-39
(Krost).

Federal Expenditures and D e f i c i t s , and Federal Financing Un-

der the Defense Program.




1.

Financing N a t i o n a l Defense ( K r o s t ) .

2.

Budget Outlook and Treasury Financing (Edmiston).

3.

Estimated D i s t r i b u t i o n of Government Bonds upder
the Defense Program ( P i s e r ) *




-5(6)
4.

VI.

Present S i t u a t i o n i n the C a p i t a l Markets w i t h
s p e c i a l Reference t o the Defense Program
(Burr).

European War Finance.
1.
2.

VII.

Notes on B r i t i s h Government Finances, 1934-1941
(Jaszi).
German Armament and War Financing (Kindelberger).

Commodity Price I n f l a t i o n .
1.

Psy Roll Taxes as a Device f o r R e s t r i c t i n g Consumption ( K r o s t ) .

2.
3.
4.

Present Banking and Credit S i t u a t i o n (Thomas).
Prospective Banking Developments (Commercial
Loans, Deposits, V e l o c i t y , e t c . ) at Various
Income Levels (Thomas), (not completed)

5*

Banking L e g i s l a t i o n f o r a Defense Program (Hersey).

6.

Program f o r Price S t a b i l i t y ( G a r f i e l d and Gehman).

7•

Progress of Price Program (Gehman).

8.

A Federal P o l i c y of Stock P i l e s of S t r a t e g i c
Commodities (Gehman).

9»

VIII.

D i r e c t Methods of Price Control (Despres).

Outlook f o r Farm Prices (Report of Conference
w i t h S t i n e ' s section, Bureau of A g r i c u l t u r a l
Economics).

Bottlenecks.
1.

Steel Requirements under the Defense Program
(Bassie).

2.

The Janeway Report on Railway Car Equipment
(Terborgh).

3.

The Defense Program and Housing ( F o s t e r ) .

4»

Estimates of Available Manpower (Barton).

5.

Labor Supply and the Defense Program (Barton).

-6-

(6)
6.
7*

Report on Labor Conference, August 28 (Barton).

8.
IX.

Recent Developments i n the Labor Aspects of
the Defense Program (Barton).

Labor P o l i c y end N a t i o n a l Defense (Reynolds);
(not completed).

Gold and Foreign Trade P o l i c y .
1.

Gold, Blocked Balances and Exchange (Gardner).

2.

A Pan-American Trade Bloc (Upgren).

3.

The Future P o s i t i o n of Germany and the United
States i n World Trade (Upgren).

4.

The Resources of Germany and the United States
(Upgren).

5.
6.

Gold P o l i c y (Hansen).

7.

Our Future Gold and Trade P o l i c y (Hansen).

8.
X.

Western Hemisphere Bloc (Hansen).

Gold, BlockedWar (Despres). Export Controls
during the Balances and

Federal-State F i s c a l Relations ( K r o s t ) ; ( n e a r l y completed).
C.

Conferences w i t h other Government Agencies

Inter-departmental meetings of research workers from various agencies have been h e l d dealing w i t h various aspects of t h e Defense Program and
i t s impact on the economy.

These may be d i v i d e d i n t o the f o l l o w i n g areas:

(1) Taxation and F i s c a l P o l i c y ,

(2) The Impact o f the Defense Program on

the N a t i o n a l Income and Employment,
Supply,
Prices.




(3) The Defense Program and the Labor

(4) Gold and Foreign Trade P o l i c y ,

(5) The Defense Program and

-7(6)

I.

Conferences on Taxation and F i s c a l P o l i c y .
1.

N a t i o n a l Income and Taxation ( J u l y 24) •

Present a t t h i s conference were Colm and Means (Budget Bureau), Blough, Sheere and Shoup (Treasury), Heer (Federal S e c u r i t y Agency),
Coe (Defense), G i l b e r t (Commerce)* Despres and Hansen (Federal Reserve
Board).
Discussion was devoted t o appropriate methods of f i n a n c i n g
the Defense expenditures:

t a x a t i o n of various types versus borrowing from

the p u b l i c and from banks.
2.

Federal State F i s c a l Relations (September 4)-

Present were Frank Bane, Ostrander, Vichery and N i e b y l (Def e n s e ) , Colm, Means (Budget), Eleanor Dulles, Coy ( S e c u r i t y Agency),
Blough, Coe (Treasury), Bean ( A g r i c u l t u r e ) , B l a i s d e l l , Altjaan (National
Resources), Deway Anderson (T.N.E.C*)> Despres, K r o s t , Hansen (Federal
Reserve).
The conference considered the current Federal-State f i s c a l
r e l a t i o n s , the f i s c a l i n c a p a c i t y of the States, the problem of v a r i a b l e
g r a n t s - i n - a i d , and the means o f implementing a study of the whole problem.

I t was the consensus of t h e meeting t h a t i t would be desirable t o

have a study made t h i s autumn by the F i s c a l D i v i s i o n i n t h e Budget Bureau.
(Subsequently I had a conference w i t h Mr. Smith, D i r e c t o r o f the Budget,
who expressed himself as favorable t o the proposal).

I t was also agreed

t h a t i t would be desirable i n the near f u t u r e t o have a N a t i o n a l Commission set up t o study the whole problem along the l i n e s of the recent Royal
Commission i n Canada.




-8-

(7)
II.

Conference on Defense, N a t i o n a l Income and Baployment (Aug-

ust 1 ) .
Present were Means and Colm (Budget), Paradiso (National Resources), Meehan, G i l b e r t (Commerce), Levin (Defense), L o r i n g Wood (Labor),
Howard Myers, John Webb and Alan Sweezy (W.P.A.), G a r f i e l d , Thomas, Goldenweiser, Hansen (Federal Reserve).

(Bean of A g r i c u l t u r e , unable t o be pres-

ent, made a v a i l a b l e a p r e l i m i n a r y r e p o r t ) .
The meeting considered the problem of estimating the probable
impact of t h e Defense Program on income and employment.

Following the

meeting, personal exchanges of i n f o r m a t i o n have been made growing out of
discussion at the conference.
III.

Conference:

Defense and Labor Supply (August 28).

Present were Lubin, Nathan, T o l l e s , M a r t i n (Defense), Howard
Myers, John Webb (W.P.A.), Loring Wood, Boris Stern (Labor), Stocking,
Hollander (U. S. Employment Service), Weiss (Wages and Hours), Somers
( N a t i o n a l Resources), Hetzel ( C . I . O . ) , Boon (Machinists), Shishkin (A.F.
of L . ) , Barton, Goldenweiser, Hansen (Federal Reserve).
The conference considered t r a i n i n g programs, prospective
labor s c a r c i t i e s by i n d u s t r i e s and occupations, competitive bidding f o r
s k i l l e d l a b o r , p r i o r i t i e s as a method of dealing w i t h labor shortages,
prospective wage demands ancl labor r e l a t i o n s i n connection w i t h the Defense Program.
IV.

Conferences on Gold and Trade P o l i c y .
lf

Conference on Foreign Trade ( J u l y 18).

Present were Pa3volsky, Hawkins ( S t a t e ) , Wheeler ( A g r i c u l t u r e ) , Fox ( T a r i f f ) , Gardner and Hansen (Federal Reserve).




~9~
(8)

Conference considered the problems r e l a t i n g t o a Western Hemisphere b l o c , the degree of self-containment of t h i s b l o c , and o f a German
dominated European Continent, i n c l u d i n g Northern A f r i c a and the Near East.
Projected researches i n the various d i v i s i o n s were o u t l i n e d .
2.

Conference on Gold Policy (August 30)•

Present were Eddy (Treasury), G i l b e r t (Commerce), E s e k i e l
( A g r i c u l t u r e ) , Gardner, Goldenweiser and Hansen (Federal Reserve).
The new problem, created by the a b i l i t y of Germany t o l a y
hands on large amount of gold h e l d i n the conquered or dominated c o u n t r i e s ,
was considered and a l t e r n a t i v e proposals f o r dealing w i t h t h i s s i t u a t i o n ,
V.

Conferences on the Defense Program and Prices.
1.

Conference on the Defense Program and A g r i c u l t u r a l Prices

(August 6 ) .
This conference was h e l d a t Stine 1 s o f f i c e and included about
10 research workers i n t h i s f i e l d .

The current s i t u a t i o n v&th respect t o

the loan p r i c e , the Government loan stocks, current crops, exports, domest i c consumption and carry-over were considered w i t h respect t o c o t t o n , wheat
and corn.

Other commodities considered were meats, p o u l t r y products, a n i -

mal and vegetable f a t s , d a i r y products, f r u i t s and vegetables.

I n general

the conclusion was reached t h a t , b a r r i n g general p r i c e i n f l a t i o n , the a g r i c u l t u r a l p r i c e index could not be expected t o r i s e by more than 10 t o 15
*

per cent w i t h a n a t i o n a l income of #90 t o $100 b i l l i o n s .

I n the case of

c o t t o n , i t was b e l i e v e d t h a t an income of t h i s magnitude might r a i s e domest i c consumption t o 9-5 m l l i o n bales.
not exceed 2 m i l l i o n bales.




Cotton exports a f t e r t h e war might

With respect t o vAieat, i t was believed t h a t

-10(12)
domestic consumption might be l i f t e d s l i g h t l y t o 700,000,000 bushels a t
high income l e v e l s , 100,000,000 short o f the annual production.

With r e -

spect t o corn and meats, i t was thought t h a t , a t $90 t o $100 b i l l i o n i n come l e v e l , the current large carry over of p o r k - l a r d products might be
l i f t e d w i t h some improvement i n p r i c e s .

Farm income from other meats could

be expected t o r i s e considerably w i t h a r i s i n g n a t i o n a l income.
come from both increased production and higher p r i c e s .

Prices are c u r r e n t -

l y very low f o r p o u l t r y products, animal and vegetable f a t s .
ate p r i c e increases can be expected.

This would

Only moder-

A considerable increase i n the p r i c e s

of d a i r y products, f r u i t and vegetables can be expected.
2.

Conference on S t e e l (and other metals) Prices (August 12).

Present were Durand, Winslow ( T a r i f f ) , Wallace^ Humphrey (Def e n s e ) , Gehman, Conklin, Thomas, Hansen (Federal Reserve).
Discussion r e l a t e d t o possible bottleneck i n s t e e l capacity,
and t o copper, manganese and other metal p r i c e s ; the extent t o which t a r i f f
reductions might be used as an instrument o f p r i c e c o n t r o l ; r a t i o n i n g ; p r i c e
controls.
D.

Future Study

As the Defense Program unfolds, c o n t i n u a l r e v i s i o n of the estimates
r e l a t i n g t o i t s impact on various aspects of the economy w i l l have t o be
made.

Gradually the p i c t u r e w i l l become c l e a r e r and more accurate judgments

can be a r r i v e d a t .

With respect t o p o l i c i e s , i t w i l l be necessary t o d i g

v e r y much deeper than has been possible i n the exploratory studies thus f a r
made.




-11-

September 25, 1940
PRELIMINARY REPORT ON
THE DEFENSE PROGRAM AND THE NATIONAL ECONOMY
1.

Recovery from the deep depression of 1932-33 proceeded

w i t h f i t s and s t a r t s b u t , on the whole, a t a f a i r l y s a t i s f a c t o r y r a t e
u n t i l 1937.

The speed o f the recovery, up t o t h i s p o i n t , was c l e a r l y

one of the most r a p i d i n our h i s t o r y , and probably about as r a p i d as the
economic organism could d i g e s t .

The recovery was, moreover, one of the

longest i n American experience.
I n 1937, however, the recovery was checked a t what was l i t t l e
b e t t e r than a half-way p o i n t .

Indeed, a major depression was allowed

t o develop u n t i l w e l l i n t o 1938.

l a t e 19399 however, stimulated t y

the v/ar, the 1937 l e v e l was recovered, but no new ground conquered.

In

broad o u t l i n e s , the recovery made s a t i s f a c t o r y progress u n t i l August,
1937, and since then has been operating a t about 70 per cent of reasonably f u l l c a p a c i t y .
A combination of circumstances produced the depression of
1937.

A p a r t of these could have been avoided, but i n considerable

measure i t was a normal r e a c t i o n from a prolonged upswing.

With r e -

spect t o the mistakes made, account should c e r t a i n l y be taken of them
f o r f u t u r e reference, and every e f f o r t made t o avoid them.

Some ( f o r

example the labor d i f f i c u l t i e s ) were r e l a t e d t o fundamental changes
which the American econony was undergoing.

But whatever the causes,

once the down t u r n was s t a r t e d , i t was a mistake t o permit the a c c e l e r a t i o n by introducing a c o n t r a c t i o n i s t p o l i c y a t j u s t the p o i n t when
vigorous expansion should have been undertaken.




I f a bold program o f

-12(12)
Federal expenditures had been undertaken i n September, 1937, when danger signals were s u f f i c i e n t l y i n evidence, the p r e c i p i t o u s stock market
crash o f October could have been averted, and the recovery pushed f o r ward a f t e r only a moderate and wholesome ( i n terms of the c o s t - p r i c e
s i t u a t i o n ) set-back.

Federal expenditures should have been shot up,

i n f i s c a l 1938, #2 t o $3 b i l l i o n d o l l a r s i n excess of 1937 l e v e l — o r ,
i n other words, t o $10 or $11 b i l l i o n s .

We may remind ourselves t h a t

$12 b i l l i o n s i s the f i g u r e contemplated i n the current f i s c a l y e a r .
Had the defense program, or something equivalent, been s t a r t e d i n the
autumn of 1937, the n a t i o n a l income could have been r a p i d l y l i f t e d t o
$90 or $100 b i l l i o n s by 194-0.
Despite the f a i r l y good showing made i n the recovery up t o
1937, the f a c t i s t h a t n e i t h e r before nor since d i d the a d m i n i s t r a t i o n
pursue a r e a l l y p o s i t i v e expansionist program.

U n t i l 1936, p u b l i c

works outlays f e l l f a r short of the l e v e l of the Twenties, and since
then have only s l i g h t l y exceeded t h a t l e v e l .

For the most p a r t , the

Federal Government engaged i n a salvaging program and not i n a program
of p o s i t i v e expansion.

The salvaging program took the form of r e -

f i n a n c i n g of urban and r u r a l debt, r e b u i l d i n g the weakened c a p i t a l
s t r u c t u r e o f the banks, and supporting r a i l r o a d s a t or near bankruptcy.
The R. F. C. poured $10 b i l l i o n d o l l a r s i n t o these salvaging operations.
The Federal Government stepped i n t o the breach and supported the hard
pressed State and l o c a l governments—again a salvaging operation.

One

has only t o consider the items accounting f o r the increase i n recent




-13-

(31)
year s i n t h e Federal budget t o see how t r u e t h i s i s .

Unable t o c a r i y

the r e l i e f burden and t o continue a normal program o f p u b l i c works,
the l o c a l u n i t s turned t o the Federal Government.

#13billions

of

the Federal d e f i c i t o f $18.7 b i l l i o n s , from 1934-39 i n c l u s i v e , i s accounted f o r by the single item o f unemployment r e l i e f .

Other items

which g r e a t l y r e l i e v e d the f i s c a l p o s i t i o n of l o c a l governments were
the a g r i c u l t u r a l program, i n v o l v i n g expenditures of $3*2 b i l l i o n s , and
p u b l i c works ( l a r g e l y as grants i n a i d or as s u b s t i t u t e s f o r d i m i n i s h ing l o c a l outlays) amounting t o $5•A b i l l i o n s i n the same period.
That a salvaging program of t h i s magnitude was necessary was
of course due t o the unprecedented depth o f the depression reached t y
early 1933•

An important lesson t h a t we can l e a r n from t h i s e x p e r i -

ence i s the waste of funds f o r salvaging purposes which must be i n curred i f a depression i s allowed t o cumulate u n t i l the n a t i o n a l income
i s cut i n two.
sponge.

Under such circumstances, the econoray d r i e s up l i k e a

Vast governmental expenditures, designed t o f l o a t the "sponge"

t o a high l e v e l of p r o s p e r i t y , are instead absorbed t y the sponge i t self.

The expenditures seemingly run t o waste.

process.

This i s the salvaging

Only when t h e economy has become thoroughly l i q u i d can f u r -

ther funds f l o a t i t t o higher l e v e l s .

A deep depression requires vast

salvaging expenditures before a vigorous expansionist process can
develop.
2.

The current defense program o f f e r s , however, an opportu-

n i t y t o complete the recovery movement h a l t e d t y the 1937 depression.




-14-

(31)
We are c u r r e n t l y a long way from f u l l employment.

The n a t i o n a l income

f o r 1940 w i l l probably be about $73-5 b i l l i o n , s l i g h t l y above the 1937
level.

The Federal Reserve index of production w i l l average about 120

compared w i t h 113 i n 1937 and 110 i n 1929.

Employment w i l l average

about 46 m i l l i o n , compared w i t h 46.6 m i l l i o n i n 1937 and 47.9 m i l l i o n
i n 1929•

We have c u r r e n t l y a labor force estimated a t from 55 t o 57

million.

There are thus 9 t o 11 m i l l i o n unemployed.

While some p a r t

of t h i s number are more or less unemployables, on the other side i t
should be remembered t h a t there are probably 2 t o 3 m i l l i o n surplus
workers now counted as employed i n a g r i c u l t u r e , who would eagerly seek
jobs i n urban i n d u s t r i e s whenever opportunity a f f o r d e d .

Moreover, the

World War experience i n d i c a t e d t h a t there i s a vast p o t e n t i a l labor
supply which can r e a d i l y be drawn i n t o the labor market—when labor
s c a r c i t y becomes intense.

Thus, i n 1918, 44 m i l l i o n were employed,

i n c l u d i n g those drawn i n t o the armed f o r c e s , while the normal labor
force was only 41 m i l l i o n s .

Three m i l l i o n p o t e n t i a l workers, not n o r -

mally i n the labor market, had been drawn i n t o employment.

This i n d i -

cates t h a t the p o t e n t i a l increase i n labor resources i s greater than
i n d i c a t e d by the formal and somewhat a r t i f i c i a l f i g u r e s w i t h respect
t o the s o - c a l l e d normal labor supply.
3.

With respect t o p l a n t and equipment, the p o s s i b i l i t i e s

f o r expansion, as Terborgh showed i n the J u l y issue of the Federal
Reserve B u l l e t i n , i s enormous i n the non-continuous process i n d u s t r i e s .
Two or even three s h i f t s could, i f necessary, be introduced.




This

would provide g r e a t l y expanded output without any large c a p i t a l o u t lays.

The s i t u a t i o n i s most c r i t i c a l i n s t e e l , a continuous process

industry.

Here we are already operating a t over 90 per cent capacity.

Exports t o B r i t a i n , the defense requirements, r a i l r o a d equipment p u r chases, together w i t h the increased demand f o r consumers1 durables,
notably automobiles, as the n a t i o n a l income r i s e s — a l l these converge
upon the s t e e l i n d u s t r y .
S t e e l thus threatens t o become our most serious bottleneck.
Our s t e e l ingot capacity i s about 12 per cent above 1929*

A projected

t r e n d based on i r o n and s t u e l production from 1899 t o 1929 i n d i c a t e s
a peace-time consumption of these products, a t f u l l employment, of
about 30 per cent i n excess of tho 1929 output.

Taking account o f

fundamental changes i n t h e uses o f s t e e l and other f a c t o r s , t h i s f i g ure i s probably too h i g h .

War-time consumption of s t e e l i s , however,

quite a d i f f e r e n t matter.

S t e e l ingot capacity on January 1, 1940 was

around 72.8 m i l l i o n gross t o n s .

Considering the m i l i t a r y requirements,

nearly 80 m i l l i o n tons w i l l be needed a t a $90 b i l l i o n d o l l a r l e v e l .
Thus already i n 1942 we s h a l l encounter a shortage unless s t e e l capaci t y i s enlarged.

At f u l l defense e f f o r t i t i s estimated t h a t the r e -

quirements would be 105 m i l l i o n tons, about 50$ i n excess of current
capacity.
tons.

Coke consumption i s moreover c u r r e n t l y running a t 63,000,000

At peak l e v e l s l a s t w i n t e r the output of coke was about

60,000,.000 t o n s .

Last autumn, when the s t e e l industry was running a t

over 90 per cent capacity, coke output was inadequate t o meet the




-16(12)
s t e e l requirements, and the e x t r a coke needed was supplied from stocks.
4.

How r a p i d l y we s h a l l encounter bottlenecks i n c e r t a i n

types of s k i l l e d l a b o r , and e s p e c i a l l y i n s t e e l capacity, w i l l depend
upon the magnitude and speed of the defense program and the stimulus
i t gives t o income and employment.

The Secretary of the Treasury e s t i -

mates t o t a l m i l i t a r y eaqpenditures, during f i s c a l 194-1* &t $5 b i l l i o n .
I n view of the g r e a t l y enlarged arsoy program (which o f f e r s easier opp o r t u n i t y f o r quick expenditures) i t i s not impossible t h a t $4*5 or
possibly $5 b i l l i o n might be reached.

I t must be recognized, however,

t h a t defense expenditures are c u r r e n t l y running a t the r a t e of only
$2-1/2 b i l l i o n s .

Henco the expenditures would have t o r i s e s t e a d i l y

t o a t l e a s t a $7 b i l l i o n r a t e t y the end o f f i s c a l 194-1 i n order t o
reach a t o t a l o f $4*5 b i l l i o n s f o r the y e a r .

Should spending a t the

r a t e of $7 b i l l i o n s be reached t y July 1941, i t would appear possible
t o achieve a t o t a l defense expenditure o f #10 b i l l i o n s i n f i s c a l 194-2.
But i f t h i s r a t e were averaged f o r the y e a r , the r a t e of expenditures
would have t o r i s e t o about |13 b i l l i o n by July 194-2*

I f this level

were reached i t would appear possible t o spend #18 b i l l i o n f o r defense
i n f i s c a l 1943•
The i n t e r n a t i o n a l s i t u a t i o n might, of course, e a s i l y become
so menacing t h a t we should be compelled t o push on as r a p i d l y as p o s s i ble t o a f u l l defense e f f o r t w i t h expenditures of $18 b i l l i o n or more
i n 1943.

This, however, would involve a d r a s t i c increase i n the de-

fense program as now contemplated.




The present program involves:

-17-

(31)

(1) A navy of 3,000,000 tons (approximately 3 times the
size of our present e f f e c t i v e navy).
(2) F u l l equipment f o r an arny of 1,200,000 men, and,
i n a d d i t i o n , equipment of c r i t i c a l items faot r e a d i l y o b t a i n able on short n o t i c e through commercial channels) f o r an add i t i o n a l 800,000 men. Housing f a c i l i t i e s f o r 800,000 d r a f t e e s ,
and f o r 200,000 n a t i o n a l guardsmen.
(3) An a i r f l e e t of 35,000 planes i n c l u d i n g f i g h t i n g ,
bombing and t r a i n i n g planes, w i t h production f a c i l i t i e s f o r
an output of 50,000 planes per y e a r .
To r a i s e the navy, army and a i r force t o t h i s l e v e l would ent a i l an "expansion" cost of $18.5 b i l l i o n s .

Pay and subsistence of

draftees during t r a i n i n g are not included i n "expansion", but are accounted f o r under "personnel and operation" i n the t a b l e given below.
I n t h i s l a t t e r item are also included the expenses of t r a i n i n g 40,000
a i r force personnel annually.

I n a c e r t a i n sense a l l these items, a t

l e a s t i n the e a r l i e r years, r e a l l y c o n s t i t u t e * p a r t of expansion, and
i f they were so included the t o t a l cost of l i f t i n g the armed force t o
the contemplated strength would approach $25 b i l l i o n s .
The array expansion program i s expected t o reach a peak i n
f i s c a l 1942 and t o be p r a c t i c a l l y completed i n 1943.

The navy expan-

sion program i t i s thought would reach a peak i n 1943 and would be
completed by 1945.

I n the meantime, however, the operating expenses,

i n c l u d i n g personnel and replacement, w i l l r a p i d l y r i s e .

The program

now l a i d o u t , as nearly as i t can be pieced together w i t h respect t o
magnitude and t i m i n g , i s given i n the t a b l e below:




-18-

(12)
DEFENSE PROGRAM
( I n B i l l i o n s of Dollars)
F i s c a l Year
(Ending
June 30)

Grand T o t a l
4.5

1941
19-42
1943
1944
1945
1946
1947

Expansion
2.4
6.5
5.0
3.2

10.0

9.0
7.5
5.5
5.5
5.5

1.0

0.5

2.1
3.5
4.0
4.3
4.5
5.0
5.5

6.0

6.0

1950

Operating Expenses,
I n c l u d i n g Personnel
and Replacement

I f the present program were c a r r i e d out w i t h o u t r e v i s i o n upward, a t a p e r i n g o f f i n defense expenditures would thus begin i n f i s c a l
1943.

I t i s r a t h e r d i f f i c u l t t o b e l i e v e t h a t an upward r e v i s i o n w i l l

not occur.

I n the event, however, o f a negotiated peace—say next

s p r i n g — i n which England emerged as the undisputed sea power, we should
probably f e e l r e l a t i v e l y safe even though Germany were l e f t i n command
o f t h e European c o n t i n e n t .

The present defense program m i g h t , t h e r e -

f o r e , appear adequate w h i l e , on the other s i d e , the s i t u a t i o n would n o t
be s u f f i c i e n t l y safe t o warrant i t s abandonment or c u r t a i l m e n t .

Under

these circumstances, the model given i n tho t a b l e above might be substantially realized.
Two other e v e n t u a l i t i e s are however e q u a l l y , or perhaps even
more, probable.

On the one side Germany may conquer England.

In this

event i t would appear c e r t a i n t h a t we s h a l l step up our defense expendit u r e s w i t h utmost speed, perhaps reaching $12 t o §15 b i l l i o n s i n 1942,
and $20 t o $25 b i l l i o n s i n 1943.




This would put us d e f i n i t e l y on a war

basis so f a r as expenditures are concerned.

On the other side, England

may withstand the a t t a c k and continue the war i n d e f i n i t e l y .
come presents two a l t e r n a t i v e s f o r us.

This o u t -

E i t h e r we s h a l l speedily enter

the war, or we s h a l l continue t o give maximum support t o England short
of war, meanwhile r a p i d l y increasing our own m i l i t a r y strength.

I n the

former case our expenditures might r a p i d l y r i s e t o $30 or $40 b i l l i o n s .
I n the l a t t e r case we might spend $10 t o $12 b i l l i o n s i n f i s c a l 1942 and
$18 t o $20 b i l l i o n s i n f i s c a l 1943.
Whatever the various a l t e r n a t i v e outcomes (excluding entrance
i n t o the war) the expenditures i n f i s c a l 1941 are not l i k e l y t o f a l l
below $4 or t o exceed $6 b i l l i o n s .
wider f o r f i s c a l 1942.

The probable range i s of course

We may perhaps set the minimum f o r t h a t year

a t $8 b i l l i o n s , and the maximum a t $15 b i l l i o n s .

The range of p o s s i -

b i l i t i e s f o r 1943 i s , of course, enormous, perhaps from $5 t o $25 b i l lions.

I f we a c t u a l l y enter the war these upper l i m i t s w i l l of course

be exceeded t y a wide margin.
5.

I t i s scarcely worth while t o attempt any estimates of the

e f f e c t o f the defense program on n a t i o n a l income f o r 1943.

But some

t e n t a t i v e f i g u r e s may be suggested f o r f i s c a l 1941 and 1942.
The defense expenditures w i l l enlarge d i r e c t l y the t o t a l i n come stream by a c e r t a i n amount.

Moreover, there w i l l be c e r t a i n r e p e r -

cussions upon p r i v a t e investment i n p l a n t and equipment induced t y the
general expansion.

A considerable p a r t of the increase i n p l a n t and

equipment r e q u i r e d f o r the production of m i l i t a r y equipment w i l l be f i nanced d i r e c t l y t y the Government.




Moreover, i n view of the short

amortisation period allowed, the c a p i t a l outlays f o r new p l a n t and equipment, even though p r i v a t e l y financed i n t h e f i r s t instance, w i l l w i t h i n
a few years be recovered i n the prices charged, and so, i n e f f e c t , would
be financed t y the Government.

Nevertheless, the general expansion of

income w i l l doubtless induce a considerable amount of investment i n p l a n t
and equipment which w i l l be financed q u i t e independently of the defense
outlays.
I n 1940, w i t h a n a t i o n a l income of |73 or $74 b i l l i o n s ,
t a l outlays on p l a n t and equipment amounted t o about $7.5*

capi-

At a n a t i o n a l

income of $90 b i l l i o n s , i t i s expected t h a t expenditures on p l a n t and
equipment might r i s e t o $11.0 b i l l i o n s ; and a t $100 b i l l i o n income l e v e l
t o $13.5.

As i n d i c a t e d above, however, a considerable amount of these

o u t l a y s , r e l a t i n g t o the defense e f f o r t , w i l l be financed d i r e c t l y or
i n d i r e c t l y t y the Government.

I n so f a r as t h i s i s the case, one would

be g u i l t y of double counting i f one added t o the s t i m u l a t i n g e f f e c t of
the defense outlays the p l a n t and equipment expenditures d i r e c t l y or i n d i r e c t l y financed out o f defense o u t l a y s .
I n the current year housing and n o n p r o f i t c o n s t r u c t i o n i s r u n ning a t about $2.4 b i l l i o n s .

At a n a t i o n a l income of $90 t o $100 b i l -

l i o n s , t h i s might r i s e t o $3.5-$4*5 b i l l i o n s .

This assumes t h a t the

defense e f f o r t w i l l not a r b i t r a r i l y c u r t a i l c o n s t r u c t i o n .

Automobile

purchases are running a t $2.7 b i l l i o n s t h i s y e a r , and might r i s e t o
$3*5 - $ 4 * 0 b i l l i o n s .

Household durables are running c u r r e n t l y a t $5

b i l l i o n s and would r i s e t o $6 - $7 b i l l i o n s a t a $90 t o $100 b i l l i o n i n come l e v e l .




-21-

(11)
Past experience i n d i c a t e s

approximately

a 1 to 1 r a t i o

between

increases i n expenditures on durable goods, p u b l i c and p r i v a t e , and i n creases i n nondurable consumption expenditures.

At a $90 b i l l i o n income

l e v e l possible increases i n p r i v a t e consumers1 durables, as i n d i c a t e d
P r i v a t e producers 1 durables

above, are estimated a t about $3 b i l l i o n s .

we may perhaps estimate a t $2.5 b i l l i o n s , exclusive of the p a r t financed
d i r e c t l y or i n d i r e c t l y by the Government.

We assume outlays on m i l i t a r y

equipment (operating expenditures excluded) i n 1942 of $6.5 b i l l i o n s .

Non-

m i l i t a r y p u b l i c construction (Federal, State and l o c a l ) may be expected t o
f a l l by say a l ^ L l i o n below the $3.6 b i l l i o n l e v e l of 1940.

Public and

p r i v a t e durables ( i n c l u d i n g defense equipment) on these assumptions would
thus run about $11 b i l l i o n s i n excess o f 1940.

This would leave, a t a $90

b i l l i o n n a t i o n a l income, $6 b i l l i o n s as the increment of nondurable consumption above the 1940 l e v e l .

This appears excessively modest, but on the

other hand the estimates suggested f o r p r i v a t e durables may be too high.
Assuming tho curront defense program, i t would therefore appear
t h a t a n a t i o n a l income o f $90 b i l l i o n s by calendar 1942 i s a conservative
figure.

No important p r i c e r i s e i s assumed.

Wholesale prices might move

t o an index of say 85, an increase of about 10 per cent above the current
price l e v e l .
Various studies (Bean, Paradiso, Salant) i n d i c a t e approximately
an increased employment of 1 m i l l i o n f o r every $3 b i l l i o n increase i n nat i o n a l income a t approximately stable p r i c e s .

On t h i s basis, 5*5 m i l l i o n

a d d i t i o n a l workers might be absorbed i n t o employment by 1942, i n c l u d i n g
those drawn i n t o the armed f o r c e s .

These and other estimates are summar-

ized i n the t a b l e below:
Defense
Federal
Outlays
Expenditures
Year
(Billions)
(Billions)
1940
$1.6
$ 9.0
1941
4.5
11.5
1942
10.0
16.0




National
Income
(Billions)
$73
80
90

Employment
^Millions)
46.0
48.2
51-5

Federal
Reserve
Index
120
130
145

-22(12)
6.

We have had estimates prepared g i v i n g probable t a x r e -

c e i p t s at various income l e v e l s .

These estimates, based on (a) the

current r a t e s t r u c t u r e , (b) current rates plus proposed excess p r o f i t s ,
and (c) suggested increase i n various taxes, are given i n the t a b l e below:
TAX YIELDS
Income Level

Current Rates

Current Rates and
Excess P r o f i t s Tax

Heavier Tax
Strqcture 1 /

6.6

7-0

7.5

80
90

8.5
10.0

9.0
11.0

10.0
12.5

100

12.4

13.5

15.5

70

1/

$

E x i s t i n g t a x s t r u c t u r e amended by ( l ) an excess p r o f i t s t a x ;
(2) an increase i n the corporation income t a x t o 25 per cent;
(3) lowering of exemption i n estate t a x t o #10,000, and changes
i n g i f t t a x ; (4) a b o l i t i o n of p r i v i l e g e of f i l i n g separate r e t u r n s ; (5) s u b s t i t u t i o n of f l a t t a x c r e d i t f o r personal exempt i o n ; (6) a b o l i t i o n of o p t i o n a l c a p i t a l gains t a x r a t e .
The t a x r e c e i p t s of f i s c a l 1941, f o r example, are based p a r t l y

on calendar 1939 and p a r t l y on calendar 1940.

On account of t h i s l a g i n

revenue c o l l e c t i o n s , not u n t i l a full-employm§nt income has been reached
and maintained f o r two f u l l years w i l l the t a x revenues reach a l e v e l
commensurate w i t h the p r e v a i l i n g n a t i o n a l income.

Thus, during the pe-

r i o d of r a p i d expansion, the t a x revenues w i l l l a g behind t h e r i s i n g i n come, and t h e d e f i c i t s i n c u r r e d w i l l correspondingly be r e l a t i v e l y l a r g e .
I f the f u l l employment income can be maintained f o r some years, the d e f i c i t would sharply d e c l i n e , r e l a t i v e t o those incurred during the period
of r a p i d expansion.




-23(13)
The f o l l o w i n g t a b l e presents estimates of expenditures, t a x
r e c e i p t s , d e f i c i t s and open market borrowings based on the assumption
stated above w i t h respect t o the defense program and i t s secondary r e percussions on the economy.

Federal
Expenditures
(toil-

Tax
Deficit
(billions)

Total
Gov 1 t
Life
Federal
Trust
InsurBorrowing, Funds &
ance,
Including
Recap- Savings
Guarant u r e of Banks,
teed
Capital
Baby
I ssues
Funds
Bonds

Other:
Banks,
CorT)ora_
>rpora«
;ions,
.
idivic 1
uals

Year

Defense

1940

1.6

* 9.0

• 5.4

3.6

3.6

1.0

1.3

1.3

1941

4.5

11.5

6.8

4.7

5.7

2.0

1.8

1.9

1942

10.0

16.0

8.5

7.5

8.5

1.5

2.0

5.0

1942

10.0

9 . /

6.5

7.5

1.5

2.0

4.0

^ f

3

1/

Present t a x s t r u c t u r e plus moderate excess p r o f i t s tax*

2/

Tax s t r u c t u r e revised according t o suggestions made abovef
I t i s reasonable t o assume t h a t a new revenue b i l l would be

passed i n 1941 > p r o v i d i n g enlarged revenues f o r f i s c a l 1942, as indicated
i n the second set of f i g u r e s f o r t h a t year i n the t a b l e above.

Taking

these l a t t e r f i g u r e s , we get a d e f i c i t of $4*7 b i l l i o n s f o r 1941, and
| 6 . 5 b i l l i o n s f o r 1942.

How t h i s d e f i c i t , i n c l u d i n g the guaranteed debt,

might be financed i s i n d i c a t e d i n the l a s t three columns.
I n the event t h a t defense expenditures were shot up sharply i n
1943 t o around #18 b i l l i o n s , we could expect a d e f i c i t of around $14 b i l l i o n s , unless t a x r a t e s were sharply increased.
cations o f such a s i t u a t i o n are discussed below.




The i n f l a t i o n a r y i m p l i -

-24(U)
7.

This leads us t o a consideration of the probable f l o w of

savings, together w i t h t h e demand f o r savings funds i n terms of (a) r e quirements of p r i v a t e investment i n p l a n t equipment and housing, and
(b) f i n a n c i n g the Federal d e f i c i t .

The d i f f e r e n c e between the gross

savings and the demand f o r savings, p r i v a t e and p u b l i c , w i l l i n d i c a t e
the necessary increase i n the money stream—partly i n t h e form of new
money (demand deposits) and p a r t l y i n the form of a c t i v a t i o n of funds
formerly held i d l e .

Increases i n the money stream are expressed i n an

increase i n M and an increase i n V.
F i r s t , i t i s necessary t o consider the probable course of corporate p r o f i t s , dividends, net corporate savings and i n d i v i d u a l savings
from dividends.

The f o l l o w i n g t a b l e presents rough estimates ( i n b i l -

l i o n s ) a t various income l e v e l s .

National
Income

P r o f i t s of
Corporations
Reporting
Net
Income

Net "
Profits
of a l l
Corporations

Net Corporate P r o f i t s after
Dividends
Taxes
1/

Net Corporate
Savings

Individual
Savings
from
Dividends

7.8

$ 5.3

1 4.3

$3.8

$ 0.5

$ 1.0

80

9.2

6.7

4.8

4.0

0.8

1.2

90

11.5

9.0

6.7

5.1

1.6

1.7

100

14.8

12.3

9.3

5.9

3.4

2.0

$74

1/

$

These are based on the e x i s t i n g t a x s t r u c t u r e and are t h e r e f o r e
too l a r g e i f the t a x s t r u c t u r e i s revised upward.
We must next seek t o piece together t h e t o t a l probable f l o w of

gross savings from a l l sources—corporate, i n d i v i d u a l and i n s t i t u t i o n a l .




-25-

(31)
Very rough

estimates (which are being revised) are given i n the t a b l e

below:
(In billions)

Depreciation
and
Depletion
Funds

Net
Corporate
Savings

$ 74

$ 4.7

# 0.5

$ 1.0

80

4.8

0.8

90

4.9

100

5.0

Individual I n vestments
i n Real
Estate,
New Issues,
etc.

National
Income

Individual
Savings
from
Dividends

I

Institutional
Savings; L i f e
Insuranc e, Sav- T o t a l
ings,Deposits, Gross
Savings
Bldg. & Loan
Trust Funds,
Baby Bonds f &c.

2.0

$ 4.5

$ 12.7

1.2

2.2

5>0

14.0

1.6

1.7

2.4

6.0

16.6

3.4

2.0

2.6

6.5

19.5

We may now set the estimated volume of gross savings over
against the t o t a l demand f o r savings, p r i v a t e and p u b l i c , together w i t h
the deficiency which must be made up by an increase i n demand deposits
or by use of i d l e funds.

This i s done i n the t a b l e below:
(In billions)

Year

Private
Fixed
Capital
N a t i o n a l Investment
Income
Plant,
Equipment,
Housing

Federal
Deficit
Plus
Guaranteed
Issues

Total
Demand
for
Savings

Total
Gross
Savings

Gap
Filled
by I d l e
Funds and
Additional
Bank Credit

1940

$ 74

$ 10.0

1 3.6

$ 13.6

$ 12.7

$ 0.9

1941

80

12.0

5.7

17.7

14.0

3.7

1942

90

14.0

7.7

21.7

16.6

5.1

•1943

100

16.0

14.0

30.0

19.5

10.5




-26-

(16)

The f i g u r e s f o r 1943, w h i l e set down here f o r i l l u s t r a t i o n purposes, r e a l l y present a c o n t r a d i c t i o n .

I t i s probable t h a t a d e f i c i t of

$14 b i l l i o n s would create a considerable i n f l a t i o n and so d r i v e the nat i o n a l money income up beyond the $100 b i l l i o n l e v e l .

I f t h e income i s

t o be held t o t h i s l e v e l , heavy consumption taxes would have t o be app l i e d , thereby reducing the d e f i c i t .
I f these estimates are at a l l probable, they would i n d i c a t e
t h a t the defense program and the required plant and equipment i n c i d e n t a l
t o t h i s program and t o the expansion of the n a t i o n a l income could be f i nanced without any considerable increase i n bank c r e d i t u n t i l a n a t i o n a l
income of $90 b i l l i o n s i s reached.

I t w i l l be noted t h a t the estimated

gap t o be f i l l e d by increase i n demand deposits and by use of i d l e funds
f o r the two years 1941-42 amounts only t o $8.8 b i l l i o n s .

Considering the

vast volume of i d l e funds now a v a i l a b l e (estimated a t about $10 b i l l i o n s )
i t appears t h a t no l a r g e amount of bank c r e d i t expansion ( c e r t a i n l y not
of i n f l a t i o n a r y proportions) i s necessary during the years 1941-42.
From the standpoint of the M V type of a n a l y s i s , no s u b s t a n t i a l
increase i n demand deposits i s necessary t o c i r c u l a t e a n a t i o n a l income
even of $100 b i l l i o n s .

At the current volume of demand deposits, the i n -

come v e l o c i t y would be 3*1 compared w i t h 3.5 i n 1923-29.

Using both de-

mand deposits and currency combined ( t o represent M) the income v e l o c i t y
would be 2.6 compared w i t h 3.0 i n 1923-29.
8.

These considerations r a i s e the question of the appropriate

method of f i n a n c i n g t h e d e f i c i t i n c u r r e d by the defense expenditures.




-27(31)
What p a r t , i f any, should be financed from borrowing from the commercial
banks?

What p a r t s h a l l be financed from borrowing from the public and

what p a r t from taxes?

Should the proportion financed from each of these

three sources vary at d i f f e r e n t l e v e l s of business a c t i v i t y ?
I n general, i t may be argued t h a t i n the e a r l i e r stages of r e covery from depression considerable r e l i a n c e should be placed on borrowi n g from banks.

I n t h e d e f l a t i o n a r y phase the volume of demand deposits,

as w e l l as t h e i r turnover r a t e , t y p i c a l l y declines sharply.

An increase

i n the l e v e l of income can, i n the circumstances, be f a c i l i t a t e d by monet a r y expansion (both M and V) t o a l e v e l corresponding t o the requirements
of a l a r g e r volume of t r a n s a c t i o n s .

Thus some expansion ( v a r y i n g w i t h the

magnitude of the p r i o r contraction) can be j u s t i f i e d .

And p a r t i c u l a r l y

if

considerable r e l i a n c e i s placed upon governmental expenditures as a means
of securing recovery, i t i s appi-opriate t o borrow from the banks, since
t h i s procedure increases or maintains a high degree of l i q u i d i t y f o r p r i vate enterprise and f a c i l i t a t e s recovery by keeping i n t e r e s t rates low.
B u t , as the n a t i o n a l income r i s e s , i t i s appropriate t o t u r n i n creasingly (a) t o borrowing from the n a t i o n ' s savings stream, and (b) t o
taxation.

As the n a t i o n a l income r i s e s , savings w i l l tend t o increase,

thereby making a v a i l a b l e funds from which the Government can borrow
and t a x .

As the recovery approaches f u l l employment, i n c r e a s i n g r e l i a n c e

on taxes r a t h e r than on borrowing i s i n d i c a t e d since t a x a t i o n i s , on b a l ance, more r e s t r i c t i v e than borrowing.

Borrowing from the commercial

banks i s most expansionist i n e f f e c t , borrowing from other sources and




t a x a t i o n of the savings stream (progressive taxes) occupy an intermediate p o s i t i o n , w h i l e consumption taxes are d e f i n i t e l y r e s t r i c t i v e .

Thus

the normal sequence i n f i n a n c i n g governmental outlays i n d i f f e r e n t
phases of recovery are; f i r s t , borrowing from banks; second, borrowing
from savings stream; t h i r d , progressive taxes and, f o u r t h , consumption
taxes.
This sequence more or less automatically takes place without
conscious planning or design.

At higher l e v e l s of business a c t i v i t y ,

commercial banks are able t o f i n d , i n some measure, other o u t l e t s f o r
t h e i r funds.

Moreover, a t higher income l e v e l s , the volume of savings

increases and i t i s possible t o s e l l more bonds t o savings i n s t i t u t i o n s ,
Government t r u s t funds and the pub3.dc.

F i n a l l y , the progressive sector

of the t a x s t r u c t u r e y i e l d s much l a r g e r revenues when t h e n a t i o n a l i n come has r i s e n .
These tendencies p a r t l y explain the changing proportion of the
Federal expenditures financed from ( l ) borrowing from commercial banks,
(2) borrowing from other sources, and (3) from taxes i n the period 1933^
36 compared w i t h the period 1937-39.

The f i r s t period was one of r a p i d

increase i n the n a t i o n a l income from $40 b i l l i o n s t o $65 b i l l i o n s .

The

second was a period of r e l a t i v e s t a b i l i t y a t around a $70 b i l l i o n s i n cone l e v e l .

I n the f i r s t p e r i o d , 50 per cent of the Federal expenditures

were r a i s e d from borrowing, of which one h a l f was from commercial banks
and the Federal Reserve Banks, w h i l e less than h a l f came from savings i n s t i t u t i o n s , t r u s t funds and the p u b l i c .




I n the second period only 30

-29(31)
per cent was r a i s e d from borrowing, a l l of which came from savings and
none of i t from t h e commercial banks.

The decline of commercial bank

holdings of Governments i n the recession of 1937 l a r g e l y accounts f o r
t h i s f a c t , w h i l e the growth of Government t r u s t funds p a r t l y accounts
f o r the increasing r o l e of savings i n Government f i n a n c i n g operations.
Moreover, l a r g e r r e c e i p t s from the progressive taxes a t higher n a t i o n a l
incomes enabled the Government t o r a i s e nearly 70 per cent of i t s r e quirements from t a x a t i o n i n 1937-9.

I t i s not suggested t h a t the r e l a -

t i v e proportions r a i s e d (a) from taxes, (b) from banks, and (c) from
borrowing from the savings stream, were the c o r r e c t ones.

I t i s only

suggested t h a t the changes t a k i n g place from the f i r s t period of r a p i d
recovery t o the l a t e r period of r e l a t i v e s t a b i l i t y a t moderately high
income l e v e l s was i n the r i g h t d i r e c t i o n .
S t a r t i n g from the income l e v e l of $73-74 b i l l i o n s i n 1940, how
f a r should t h e defense expenditures be financed by borrowings from the
commercial banks?

We have already noted above t h a t there may be s u f f i -

c i e n t savings ( i n c l u d i n g funds now held i d l e ) t o finance both the Fede r a l d e f i c i t and the p r i v a t e demand f o r c a p i t a l through f i s c a l 1942.

It

does n o t , t h e r e f o r e , appear necessary, so f a r as the g l o b a l f i g u r e s are
concerned, t o r e s o r t t o any considerable expansion of bank c r e d i t f
t h i s may not necessarily mean very much.

But

The mere f a c t t h a t corporations

and f i n a n c i a l i n s t i t u t i o n s have funds a v a i l a b l e does not insure t h a t they
w i l l purchase Government bonds i n so f a r as p r i v a t e investment o u t l e t s
are not adequate t o absorb t h e i r i d l e balances.




Thus the mere availability

-30(31)
of funds does not insure t h a t banks w i l l not have t o be r e l i e d on t o f i nance a p a r t of t h e d e f i c i t •
According t o the estimates suggested above, the open market
would have t o absorb about $3.7 of new d i r e c t and guaranteed issues i n
1941, and about $6.0 b i l l i o n s i n 1943•

I t may be assumed t h a t the baby

bond market, l i f e insurance companies and the mutual savings banks would
absorb about $2.0 b i l l i o n s per y e a r .

From 1932 t o 1939, l i f e insurance

companies, mutual savings banks and a l l " o t h e r " investors increased t h e i r
holdings of Governments by $1.7 per year on the average.

In addition, i n -

d i v i d u a l s and corporations w i t h r i s i n g incomes and a p a t r i o t i c appeal
ought t o take a considerable volume of defense bonds.

I f the open market

operations do not exceed the magnitudes i n d i c a t e d , i t ought not t o be necessary f o r banks t o p a r t i c i p a t e i n 1941 and 1942 i n excess of from $1 t o
$2 b i l l i o n s per y e a r .

Such p a r t i c i p a t i o n would hold bank c r e d i t expan-

sion t o r e l a t i v e l y small p r o p o r t i o n s .
Moreover, i t must be noted t h a t the t a x r e c e i p t s suggested i n
the above c a l c u l a t i o n s of the d e f i c i t may be regarded as minimum.

I n the

event t h a t the t a x s t r u c t u r e were amended so as t o increase sharply the
excess p r o f i t s t a x rates and t h e rates on the upper middle income bracke t s , the t a x r e c e i p t s could probably be increased by $1 t o $1.5 b i l l i o n s ,
thereby reducing the volume of open market issues during t h e two-year period.
Unfortunately, the 1940 Revenue Act r e q u i r i n g t h a t any d e f i c i t
i n c u r r e d by reason of defense expenditures must be financed by the sale




-31-

(31)

of short-term o b l i g a t i o n s m i l i t a t e s against t h e i r absorption by i n s t i t u t i o n a l and p r i v a t e savings funds.

For the moment t h i s may not be too

serious, since maturing short term o b l i g a t i o n s may be replaced by longer
term issues acceptable t o f i n a n c i a l i n s t i t u t i o n s and the p u b l i c .
the matter could l a t e r become serious.

But

This l e g i s l a t i o n should be r e -

pealed, thereby g i v i n g t h e Treasury f u l l freedom t o finance the d e f i c i t
by the issue of o b l i g a t i o n s o f such character as appear most appropriate
i n terms of monetary and f i s c a l p o l i c y .

Congress and the public should

be impressed w i t h the importance of f i n a n c i n g the defense d e f i c i t e i t h e r
by borrowing the p u b l i c ' s savings or out of taxes.

Bank c r e d i t expan-

sion on a l a r g e scale, when the n a t i o n a l income has already reached $74
b i l l i o n s , and huge Federal outlays have been appropriated or authorized
t o be expended as r a p i d l y as f e a s i b l e , might i n v i t e dangerous p r i c e i n f l a t i o n as the economy approached f u l l employment.
Taxation and borrowing from the n a t i o n a l savings stream does
not i n v i t e i n f l a t i o n .

But t h e r e i s , nevertheless, no assurance t h a t

p r i c e i n f l a t i o n may not i n f a c t cone, even though the Federal d e f i c i t i s
not financed by borrowing from the commercial banks.

I n the f i r s t place,

i n d i v i d u a l s may be induced t o subscribe t o defense bonds i n excess of
t h e i r savings, covering the d i f f e r e n c e by borrowing from t h e banks.
i n g the l a s t World War about $3 b i l l i o n s were so financed.

Dur-

I f large re-

l i a n c e must be placed on bank c r e d i t expansion t o finance a war d e f i c i t ,
t h i s method has advantages over d i r e c t borrowing from banks.

I n the sec-

ond place, a s u b s t a n t i a l r i s e i n business a c t i v i t y might r e s u l t i n a




-32-

(31)
considerable demand f o r bank

loans and might induce banks t o enlarge

t h e i r holdings of p r i v a t e bonds and mortgages.

Indeed i t was t h i s de-

velopment which accounts mainly f o r the enormous c r e d i t and p r i c e i n f l a t i o n of the l a s t World War.
Conditions are now i n many respects d i f f e r e n t .

There are c u r -

r e n t l y no good reasons f o r urging t h e p u b l i c t o buy bonds beyond t h e i r
capacity t o save out of income.

P r i v a t e business concerns have l a r g e

i n t e r n a l sources of funds a v a i l a b l e f o r expansion, and are r e l a t i v e l y
l i t t l e i n need of bank

funds•

Moreover, since much of the plant and

equipment required f o r the defense program w i l l be financed by the Government d i r e c t l y or i n d i r e c t l y , i t i s evident t h a t t h i s minimizes the
requirements of p r i v a t e e n t e r p r i s e .
9-

Even t o manage defense outlays of $10 b i l l i o n s i n f i s c a l

1942 without running i n t o p a r t i a l i n f l a t i o n w i l l demand the utmost v i g ilance.

Paradoxical as i t may seem, u n t i l an approach t o f u l l employment

i s reached, expansion w i l l help t o prevent i n f l a t i o n .

This i s t r u e be-

cause, u n t i l f u l l employment i s reached, the main danger of i n f l a t i o n
l i e s i n the development of bottlenecks.

Unless these bottlenecks are

broken we s h a l l be compelled t o choke o f f f u r t h e r expansion i n order t o
prevent the s c a r c i t i e s caused by the bottleneck from r e s u l t i n g i n i n f l a t i o n a r y p r i c e and wage increases i n t h e areas a f f e c t e d .

From these areas

there i s danger t h a t the i n f l a t i o n a r y development may spread t o the whole
econoiny.

The only sound way t o prevent bottleneck i n f l a t i o n i s t o break

the bottlenecks.




I n so f a r as the bottlenecks cannot be f o r e s t a l l e d by

-33-

(31)

the p r o v i s i o n of adequate p l a n t and equipment capacity and by an adequate supply of s k i l l e d mechanics, p r i o r i t i e s and r a t i o n i n g w i l l be necessary.

I n f l a t i o n i s f a r more serious and i n s i d i o u s than unemployment.

I t w i l l not do t o l e t i t get s t a r t e d i n any area.
A danger p o i n t t h a t i s l i k e l y t o f l a r e up w i t h i n the next few
months i s a stock market boom.

The market i s " b i t i n g a t the b i t " , ready

t o leap forward the moment B r i t a i n ' s s t a y i n g

power seems assured.

Stock

market booms tend t o engender commodity and inventory speculation.

Be*-

f o r e t h i s movement gets under way, the margin requirements ought t o be
raised.
I f we succeed i n avoiding, or a t ar$r r a t e holding t o a m i n i mum, bottleneck i n f l a t i o n and speculative p r i c e developments i n the sec u r i t y and commodity markets, we s h a l l f i n a l l y encounter, as we approach
f u l l employment, the problem of general i n f l a t i o n .

For the c o n t r o l of

general i n f l a t i o n , t a x a t i o n bearing on consumption i s t e c h n i c a l l y a pot e n t weapon, but p r a c t i c a l l y and p o l i t i c a l l y the matter i s veiy d i f f i cult.

T h e o r e t i c a l l y , the most desirable method i s probably a t a x on

pay r o l l s deducted from wages.

According t o the Keynes p l a n , such de-

ductions should, however, be c r e d i t e d t o the wage-earners i n the form of
a blocked p o s t a l savings account.

These accounts would be unblocked by

proclamation of a designated monetary a u t h o r i t y a f t e r the war emergency
i s over, and s p e c i f i c a l l y when a slump was beginning t o develop.

Vari-

ous s t a t i s t i c a l series might be invoked t o guide the monetary a u t h o r i t y ,
f o r example, the Federal Reserve production index, income paid o u t ,




-34-

(31)
wholesale p r i c e s , employment, e t c .

The d i f f i c u l t y w i t h the Keynes plan i s t h a t there i s probably
l i t t l e hope t h a t i t would be acceptable t o wage-earners.

Wage-earners

can be appealed t o on a voluntary basis t o purchase Government bonds,
and even t o pay onerous taxes, but they are not l i k e l y t o accept a compulsory deferment of wage payments.

I t w i l l not be easy t o convince

them t h a t such compulsory deferment i s r e a l l y i n l i e u of taxes.
w i l l want t h e i r wages as earned.

They

Possibly, i f the taxes were imposed

as a necessary defense measure, w i t h l i t t l e being said about the f u t u r e
refund, the plan might a c t u a l l y prove more acceptable.
There i s moreover the d i f f i c u l t y w i t h pay r o l l taxes (whether
a c t u a l or i n the form of deferred payment) t h a t such taxes i n a period
of buoyant expansion and labor s c a r c i t y may lead t o demands f o r wage i n creases s u f f i c i e n t t o cover the t a x .

Should t h i s occur, no curtailment

of consumption would r e s u l t from the i m p o s i t i o n of the t a x .
I t i s possible, however, t o apply the fundamental p r i n c i p l e s
of the Keynes plan on a voluntary

basis.

A modified Baby Bond, w i t h 3

per cent i n t e r e s t payable annually, and w i t h s u b s c r i p t i o n p r i v i l e g e 3.imi t e d t o $500 per year so as t o l i m i t the sale t o low-income groups, might
be made very a t t r a c t i v e and, i f properly advertised and pushed w i t h a
p a t r i o t i c appeal, could reach wide masses of the population.
The defect i n a voluntary plan, of course, i s t h a t i t s magnitude w i l l necessarily be small compared w i t h what might be achieved by
a compulsory plan.




I t w i l l , t h e r e f o r e , be d e s i r a b l e , once an approach

t o f u l l employment i s reached, t o r e s o r t t o other forms of consumption
taxation.

A t a x l e v i e d on "value added" has been suggested.

Such a

t a x i s said t o be preferable t o a sales t a x by reason of greater simp l i c i t y of a d m i n i s t r a t i o n .

I t has, however, the disadvantage t h a t , i n

p r a c t i c e , i t w i l l probably tend t o encourage p r i c e increases a t every
stage i n the productive process.

To some e x t e n t , sales taxes also give

the r e t a i l e r an opportunity t o r a i s e the p r i c e by more than the amount
of the t a x .

But i t i s probable t h a t the impact of a sales t a x on p r i c e

increases i s r e l a t i v e l y less than i n the case of a "value added" t a x .
The best plan i s probably a contingent sales t a x .

Congress would f i x

the r a t e s , but would give a monetary a u t h o r i t y (such as the Federal Reserve Board) power t o determine when the t a x s h a l l be imposed and when
i t s h a l l be withdrawn.

The monetary a u t h o r i t y might also be empowered

t o apply v a r y i n g r a t e s , w i t h i n l i m i t s imposed by Congress, according t o
the requirements of the economic s i t u a t i o n .
With respect t o the broader monetary power4 of the Board, i t
would be a mistake t o leave them out of account, or t o regard them as
obsolete.

While d i r e c t methods of c o n t r o l , supplemented by f i s c a l de-

v i c e s , should be used i n the f i r s t i n s t a n c e ,

the time may nevertheless

came when i t w i l l be necessary t o apply monetary checks t o expansion.
I t i s , t h e r e f o r e , desirable t h a t the Board be granted now the power necessary t o reduce the excess reserves t o manageable proportions so as t o
make open market operations e f f e c t i v e as a check upon bank c r e d i t expansion.




-36(31)
I f defense expenditures are shot up t o $18 b i l l i o n s i n 1943*
as appears by no means improbable, the danger of i n f l a t i o n w i l l be very
serious.

With Federal expenditures running a t $24 b i l l i o n s , and the

t a x s t r u c t u r e revised t o include s t i f f excess p r o f i t s taxes and other
changes making the rates more progressive, there would s t i l l be a d e f i c i t of $12 or $13 b i l l i o n s .

Add t o t h i s the guaranteed debt would r e -

quire a f l o t a t i o n of $14 b i l l i o n s .

I t i s d i f f i c u l t t o believe that t h i s

would not produce a p r i c e i n f l a t i o n of dangerous proportions.

To p r e -

vent t h i s i t would be necessary t o r a i s e perhaps $10 b i l l i o n s i n sales
or some other form of consumption taxes.
10.

We consider next t h e problem of the post-defense slump.

Every great war e f f o r t i n the past has ended i n a slump.

Must not the

defense e f f o r t i n e v i t a b l y do so also?
I t may be argued t h a t the two cases are not exactly p a r a l l e l .
Wars, whether they ended i n a settlement which a f f o r d e d prospects f o r a
stable peace or only i n a t r u c e , i n which both sides were g i r d i n g themselves f o r a renewal of t h e encounter, at a l l events brought about a
cessation of a c t i v e h o s t i l i t i e s .

The cessation of h o s t i l i t i e s means the

release of v a s t f i g h t i n g forces f o r c i v i l i a n p u r s u i t s , even though the
productive resources engaged i n producing war equipment continued t o b u i l d
armaments as r a p i d l y as tinder war c o n d i t i o n s .

The disbanding of the

armies of i t s e l f b r i n g s about a sharp curtailment of m i l i t a r y expenditures.

Moreover, the cessation of the wastage of m a t e r i a l s i n a c t u a l

combat permits a very l a r g e curtailment o f t h e armament i n d u s t r y even




-37(31)

though the p o l i c y were adopted t o maintain the f u l l m i l i t a r y
strength of the n a t i o n .

Thus the cessation of war i n e v i t a b l y r e -

s u l t s i n the sharp curtailment of m i l i t a r y expenditures, regardless of the p o l i c y adopted w i t h respect t o the maintenance of
m i l i t a r y p l a n t b u i l t up by the war.
But the expansion of a m i l i t a r y machine does n o t , as i n
the case of war, necessarily e n t a i l any subsequent decline i n expenditures. And t h i s i s t r u e even though i t i s decided t o b u i l d the
m i l i t a r y force up t o a d e f i n i t e size beyond which i t i s not allowed
t o grow.

There are two aspects t o a m i l i t a r y production program.

One has t o do w i t h expansion of t h e m i l i t a r y p l a n t and the other
has t o do w i t h replacement, maintenance and upkeep a t the l e v e l
reached.

The l a r g e r the p l a n t , the l a r g e r becomes the maintenance,

upkeep and replacement.

I t i s p e r f e c t l y possible t o a r t i c u l a t e the

expansion expenditures w i t h the growing replacement, maintenance
and upkeep expenditures i n such a manner t h a t the t o t a l outlays on
both together w i l l r i s e t o an asymptote without t u r n i n g i n t o a decline.

As replacement, maintenance and upkeep increases, the ex-

pansion expenditures are tapered o f f u n t i l eventually the whole
consists of replacement, maintenance and upkeep.

The f o l l o w i n g

t a b l e ( i n b i l l i o n s ) i l l u s t r a t e s " s u c h a development i n a manner t h a t
i s a t any r a t e not i n h e r e n t l y unreasonable.




-38-

(31)

Year

Total
Military
Expenditures

Expenditures f o r
Expansion of
M i l i t a r y Plant

(

Operating Expenditures:
Replacement, Maintenance
and Personnel

1941

$ 4.5

2.5

2.0

1942

10.0

6.5

3.5

1943

12,0

7.5

4.5

1944

12.0

6.0

6.0

1945

12.0

5.0

7.0

1946

12.0

4.0

8.0

1947

12.0

3.0

9.0

1948

12.0

2.0

10.0

1949

12.0

1.0

11.0

1950

12,0

0.0

12,0

Contrary t o the assumption made a t the beginning of t h i s pap e r , when we were contemplating the construction (as c u r r e n t l y envisaged) of a m i l i t a r y p l a n t i n v o l v i n g the expenditure f o r expansion of
nearly $20 b i l l i o n s , the plan suggested i n the t a b l e above involves a
doubling of t h a t program.

The operating expenditures, i n c l u d i n g replace-

ment and personnel, t o maintain a m i l i t a r y establishment of t h i s magnitude would r e q u i r e , i t i s estimated, an annual expenditure of approximately
$12 b i l l i o n s .
The precise f i g u r e s chosen are of no s p e c i a l s i g n i f i c a n c e .
What i s s i g n i f i c a n t i s t h a t some such p a t t e r n , i n v o l v i n g expansion over
a prolonged p e r i o d , w i l l i n e v i t a b l y have the e f f e c t of r a i s i n g t o higher




(31)

-39-

and higher l e v e l s the cost of replacement, maintenance and upkeep.

A

p o i n t i s t h e r e f o r e necessarily reached sooner or l a t e r a t which the mere
l i m i t a t i o n s of productive resources w i l l compel a t a p e r i n g o f f of t h e expansion expenditures, so t h a t whatever l e v e l of maximum defense e f f o r t
i s reached—whether $10 b i l l i o n s , $20 or $30 b i l l i o n s , — e v e n t u a l l y t h i s
l e v e l of expenditures w i l l t u r n out t o consist exclusively of replacement, maintenance and upkeep.
Now i t i s c e r t a i n l y not impossible t h a t some such p a t t e r n may
be followed i n our defense e f f o r t .

I t does not appear probable now, a t

any r a t e , t h a t anything can happen i n the near f u t u r e which w i l l t u r n
Europe and Asia i n t o s t a b l e , peaceful continents during the next two or
three decades.

Even though we suppose t h a t somehow H i t l e r i s m completely

collapses i n Germany, the problems of Europe would not thereby suddenly
be solved.

A new Europe w i l l have t o be created.

I t w i l l have t o be

p o l i c e d by somebody u n t i l stable p o l i t i c a l conditions can be restored.
Moreover, the i n c r e a s i n g l y menacing p o s i t i o n of Japan i n the P a c i f i c , i n
a d d i t i o n t o the European t u r m o i l , points toward the p r o b a b i l i t y t h a t we
may w e l l sharply r e v i s e our defense program, perhaps doubling the c u r r e n t l y planned expansion.
The greatest l i k e l i h o o d of any sudden sharp curtailment i n m i l i t a r y expenditures i s t h a t the whole program may collapse i n consequence
of a negotiated peace between Germany and England.

I f t h i s does not oc-

cur i t i s not probable t h a t we s h a l l suddenly sharply c u r t a i l our defense expenditures.




Some considerable c u r t a i l m e n t , say from $10 t o $8

-4.0-

(30)

b i l l i o n d o l l a r s , or from $15 t o $12 b i l l i o n s , i s however not improbable.
The defense program i s l i k e l y t o r e v o l u t i o n i z e the Federal budget even a f t e r the major e f f o r t has been completed.

Even the present p r o -

gram c a l l i n g f o r expansion outlays of $20 b i l l i o n s w i l l e n t a i l maintenance,
upkeep and replacement expenditures of about $6.5 b i l l i o n s per year.

Thus

the m i l i t a r y item i n the budget would be $5.5 b i l l i o n s higher than i n the
pre-defense period 1937-9.

I f the n o n - m i l i t a r y items i n the budget con-

t i n u e t o t o t a l about $7.0 b i l l i o n s , as i n recent years, t h i s would r a i s e
the t o t a l Federal budget t o $13.5 per annum.
Assuming t h a t changes w i t h respect t o the development of new
i n d u s t r i e s , f o r e i g n investments and the f o r e i g n balance

w i l l more or less

o f f s e t each o t h e r , we might expect the stimulus o f $5.5 b i l l i o n a d d i t i o n a l
m i l i t a r y expenditures per year t o y i e l d a n a t i o n a l income of about $85
billions.

I t i s probable t h a t the defense program w i l l accelerate the

development of a number of new i n d u s t r i e s , i n c l u d i n g commercial a v i a t i o n ,
e l e c t r i f i c a t i o n , a i r c o n d i t i o n i n g and the l i k e .

On the other hand, the

f o r e i g n trade s i t u a t i o n i s l i k e l y t o prove l e s s favorable than i n the l a t e
Thirties.

Investment i n plant and equipment, and i n r e s i d e n t i a l and com-

m e r c i a l c o n s t r u c t i o n , together w i t h the purchases of automobile and household equipment, may be expected t o be on a considerably higher l e v e l than
i n the l a t e T h i r t i e s .

But these f a c t o r s ( i n p a r t as secondary repercus-

sions of t h e enlarged m i l i t a r y expenditures) have already been taken account of i n the $85 b i l l i o n f i g u r e suggested above.




-41(31)
Should we succeed, during t h e major defense e f f o r t , i n l i f t i n g
the n a t i o n a l income l e v e l t o $95 or $100 b i l l i o n s , a subsequent decline
t o about $85 b i l l i o n s ( t h e cumulative impact of the i n i t i a l decline would
f o r a time d r i v e the income much lower) would, r e l a t i v e t o the high l e v e l s previously reached, make a serious depression.
I t i s possible t h a t shortages, accumulated i n various l i n e s
during the major defense e f f o r t , might cushion the d e c l i n e .

Priorities

and r a t i o n i n g may have c u r t a i l e d automobile purchases, r e s i d e n t i a l b u i l d i n g , c o n s t r u c t i o n of p l a n t and equipment i n n o n - m i l i t a r y l i n e s .
A number of changes r e l a t i n g t o the s o c i a l s e c u r i t y program
could help cushion the post-defense d e c l i n e .

The unemployment insurance

pay r o l l t a x could be reduced t o 2 per cent.

T h i s , together w i t h s h o r t -

ening the w a i t i n g period and l i b e r a l i z i n g the b e n e f i t s , could remove a l together the drag of around h a l f a b i l l i o n d o l l a r s o f annual net
accumulation experienced i n recent years.

On the other hand, the unem-

ployment pay r o l l t a x might be kept a t 3 per cent, and the fund p a r t l y
converted i n t o a modified Keynesian deferred payment plan.

A p a r t of

the fund, under t h i s p l a n , would be earmarked t o the c r e d i t of each worker f o r deferred payment i n the post-defense slump, without the worker
having t o w a i t f o r unemployment t o enable him t o receive b e n e f i t s .

A

part would be accumulated i n the Unemployment Fund t o be paid out i n r e g u l a r unemployment b e n e f i t s .
Social services are c e r t a i n t o be extended i n the near f u t u r e
i n various d i r e c t i o n s .




These could be implemented and timed so as t o

help cushion the post-defense slump.
should be g r e a t l y expanded.

The old-age assistance program

This could be done i n various ways.

Under

the 50-50 Federal matching system, t h e b e n e f i t s now range from $6.00 per
month i n the poorer States t o $38 per month.

I n order t o remedy t h i s

s i t u a t i o n , i t w i l l be necessary f o r the Federal Government t o make l a r g e r
grants t o the f i s c a l l y incompetent States.

The Federal Government might

make an o u t r i g h t minimum grant of $15 per o l d person assisted i n a l l
States, w i t h the requirement t h a t each State c o n t r i b u t e a t l e a s t $3*00
i n addition.

This would e s t a b l i s h a minimum b e n e f i t of $18 per month i n

the poorer States.-

I n a d d i t i o n , the Federal Government should match each

a d d i t i o n a l d o l l a r contributed by the States u n t i l a maximum b e n e f i t of
$40 per month was reached.

I n a d d i t i o n , the means t e s t should be l i b e r -

a l i z e d so as t o admit any aged person t o b e n e f i t s whose income was judged
inadequate.
A good case could be made t o support the t h e s i s t h a t old-age
assistance ought t o be taken over e n t i r e l y , both w i t h respect t o administ r a t i o n and c o s t , by the Federal Government.

This could help t o r e l i e v e

the States 1 f i s c a l s i t u a t i o n and tend t o check f u r t h e r increases i n State
consumption taxes.
Other methods designed t o l i b e r a l i z e b e n e f i t payments t o aged
persons are as f o l l o w s :

(l)

A l l persons over the age of 70 might be

given o u t r i g h t a Federal pension of $30 (man and w i f e together $45) > w i t h out having t o meet a means t e s t .

This proposal would reserve the old-age

insurance plan and old-age assistance now i n operation t o those aged 65




t o 70 i n c l u s i v e .

About 3,250,000 persons are included i n each group.

This proposal f o l l o w s i n general the B r i t i s h system.

(2)

Every person

over the age of 65 might be paid a pension of |15 without a means t e s t ,
t h i s pension t o be supplemented by the current p r o v i s i o n f o r old-age i n surance b e n e f i t s , and, f o r those not covered by insurance, by old-age assistance on the s i m p l i f i e d income means t e s t .

The l a t t e r proposal i s

complicated by the f a c t t h a t under i t most persons would receive b e n e f i t s
from two sources.
There i s much t o be said f o r the dual system—insurance benef i t s f o r those aged 65 t o 70 i n c l u s i v e , and non-contributoiy pensions beyond 70.

I n the f i r s t place, t h i s plan would preserve i n t a c t the old-age

insurance system already f i r m l y established and w e l l received by the gene r a l p u b l i c , but would l i m i t i t s a p p l i c a t i o n t o those aged 65 t o 70.

It

would cover i n the pension scheme a l l aged persons over the age of 70,
thereby r e s t r i c t i n g the means t e s t ( a t best d i f f i c u l t t o administer and
undesirable s o c i a l l y ) t o those aged 65 t o 70 not covered by the old-age
insurance.

Together m t h a Federally administered old-age assistance

plan f o r uncovered persons under 70, a Federal pension plan f o r those
over 70

would g r e a t l y r e l i e v e the burden of the States, and f a c i l i t a t e

reduction i n State consumption taxes, o r , a t any rate, enable the States
t o p a r t i c i p a t e on a Federal g r a n t - i n - a i d basis i n other expanded s o c i a l
welfare programs without r a i s i n g consumption taxes beyond the present
high l e v e l .




Public h e a l t h and Federal a i d t o education are the most pressing.

-44-

(34)

The recent inter-department committee on medical care recommended a p r o gram c o n s i s t i n g of three p a r t s :

( l ) expansion of general p u b l i c health

services, i n c l u d i n g the strengthening of public health f a c i l i t i e s ,

in-

creased e f f o r t s t o eradicate t u b e r c u l o s i s , venereal diseases and m a l a r i a ,
and t o decrease the m o r t a l i t y r a t e from pneumonia and cancer, t o provide
mental hygiene and i n d u s t r i a l hygiene services, t o provide more adequate
maternal and i n f a n t care, medical care f o r c h i l d r e n and treatment f o r
c r i p p l e d c h i l d r e n ; (2) t o provide g r e a t l y enlarged public h o s p i t a l f a c i l i t i e s , i n c l u d i n g general and special h o s p i t a l s , and sanitariums f o r t u bercular and mental cases; (3) t o provide medical care i n the home f o r
the medically needy—those on r e l i e f or w i t h incomes below $1000 (about
o n e - t h i r d of the population).

Such a program would involve expenditures

ranging from about $250,000,000 i n the f i r s t year t o about $900,000,000
i n the t e n t h year.
A g r e a t l y enlarged public health program should be pushed now
as an important and necessary part of defense.

Hanson Balwin has stated

t h a t , i n New York C i t y , 60 per cent of prospective army r e c r u i t s are
turned down l a r g e l y by reason of physical defects.
Related t o an enlarged public h e a l t h program i s the Food Stamp
Plan.

More than 20 m i l l i o n i n the lower income groups are l i m i t e d i n

t h e i r food consumption t o 5 cents per meal per person.

The

Food Stamp

Plan has revealed t h a t the consumption of f o o d s t u f f can be very g r e a t l y
increased i n the lower income l e v e l s , thereby r e l i e v i n g i n some measure
the a g r i c u l t u r a l surpluses.




I n a d d i t i o n t o food, c o t t o n has been

(41)
experimented w i t h on a small scale.

-45-

I t i s estimated t h a t a subsidy of

1600,000,000 through a Cotton Stamp Plan would increase the domestic consumption of cotton by 2,000,000 bales.
A l a r g e number of b i l l s are c u r r e n t l y before Congress, c a l l i n g
f o r Federal a i d t o education i n order t o relieve the pressure on the State
budgets, and t o provide more adequate services ( f o r example, a d u l t education).

The b i l l s c a l l f o r Federal c o n t r i b u t i o n s ranging from $100,000,000

t o $300,000,000 per y e a r .
Assuming an expansion of s o c i a l s e c u r i t y and welfare programs
along the l i n e s i n d i c a t e d , with the Federal Government carrying a larger part
of the c o s t , we may envisage a post-defense Federal budget roughly of the
proportions i n d i c a t e d i n the t a b l e below.

I t i s assumed t h a t the Federal

Works program ( i n c l u d i n g public works, the W.P.A., C.C.C. and N.Y.A.)
w i l l continue a t about the pre-defense l e v e l of $3*5 b i l l i o n s per y e a r .
At higher n a t i o n a l income l e v e l s , w i t h less unemployment, i t may of course
be expected t h a t outlays f o r W.P.A., N.Y.A. and C.C.C. would be considerably lower.

On t h e other hand, i t i s expected t h a t Federal p u b l i c works

and Federal grants t o public bodies f o r public works would increase along
l i n e s discussed below.

I t i s assumed t h a t the a g r i c u l t u r a l program, while

continued at about the former l e v e l , would be heavily s h i f t e d away from
d i r e c t subsidies t o farmers and i n c r e a s i n g l y toward the Food Stamp and
Cotton Stamp Plan type of o u t l a y s .

I n t h i s manner, the a g r i c u l t u r a l p r o -

gram would consist mainly of a plan t o expand t h e domestic market f o r agr i c u l t u r a l products through Federal subsidy t o the low income urban groups.




(36)
Post-defense Federal Budget
(in billions)
L e g i s l a t i v e , j u d i c i a l and c i v i l establishments
I n t e r e s t on the public debt
Defense (maintenance and operation of enlarged p l a n t )
Social s e c u r i t y and welfare ( i n c l u d i n g veterans)
Federal Works ( i n c l u d i n g W.P.A., C.C.C. and N . I . A . )
A g r i c u l t u r a l Program ( i n c l u d i n g stamp plans)

$ 1.2
1*5
6.5
2.0
3.3
1*0
$15.5

Total

Even at r e l a t i v e l y f u l l employment there would s t i l l be room
f o r a r e s t r i c t e d W.P.A. program, and perhaps also f o r the C.C.C. and the
N.I.A.

The country i s going t o be very much surprised how l a r g e a l i s t

of persons e l i g i b l e f o r W.P.A. w i l l remain on the r o l l s even a f t e r employment has r i s e n by f i v e , s i x or seven m i l l i o n s .

As i n d u s t r i a l em-

ployment increases, 2 or 3 m i l l i o n farm boys w i l l be taken on and, t o
the extent t h i s i s done, urban unemployment i s not r e l i e v e d .
ment i s alrea<3y going on.

This move-

I t i s said t h a t a i r p l a n e manufacturers f i n d

young men from the farm excellent workers and quick t o l e a r n .

Moreover,

there are s t i l l about 1 m i l l i o n persons e l i g i b l e f o r W.P.A., but not on
the pay r o l l owing t o lack of funds.

F i n a l l y , probably a considerable

p a r t of the unemployment f o r c e i s quasi-unemployable, y e t these could
u s e f u l l y be put t o work on w o r k - r e l i e f p r o j e c t s , r a t h e r than put them on
the dole.

Even a t peak employment l e v e l s , t h e r e f o r e , there i s l i k e l y t o

remain an important f u n c t i o n f o r the W.P.A.
A public works program, Federal, State and l o c a l , should be
c a r e f u l l y planned and held i n reserve f o r the e v e n t u a l i t y of a p o s t defense slump.




I n a d d i t i o n , low^cost housing should be undertaken on

-47(41)
a scale comparable w i t h the B r i t i s h program during the l a s t two decades.
I n England something over 50,000 u n i t s were constructed on the average
annually during the Twenties and T h i r t i e s .

I n terms of our population,

t h i s would amount t o 150,000 u n i t s per annum.

According t o a p u b l i c a -

t i o n of the United States Housing A u t h o r i t y , a public housing program
which would reasonably assure the decent housing of the e n t i r e n a t i o n
would c a l l f o r the c o n s t r u c t i o n of about 300,000 u n i t s per annum over
the next 15 years.

Such a program would c a l l f o r a Federal annual sub-

sidy of between $100,000,000 and $200,000,000 extending over a period
of 60 years.

The c a p i t a l outlays would not be made by the Federal Gov-

ernment since the U.S.H.A. i s authorized t o issue guaranteed bonds.

The

Federal subsidy, plus the l o c a l Government c o n t r i b u t i o n and the r e n t s
c o l l e c t e d from tenants, cover operating costs together w i t h amortization
of the U.S.H.A. guaranteed bonds.
11.

From the standpoint o f long-range planning r e l a t i n g t o

f u l l u t i l i s a t i o n of resources and anti-depression p o l i c y , two defects i n
our i n s t i t u t i o n a l arrangements present serious obstacles t o a f u l l r e a l i z a t i o n of the desired o b j e c t i v e .
State f i s c a l setup,

One has t o do w i t h the current Federal-

and the other w i t h lack of a f i s c a l a u t h o r i t y w i t h

power t o administer a f l e x i b l e f i s c a l program w i t h respect t o expenditures and t a x a t i o n .
Any proposal t o introduce an e f f e c t i v e n a t i o n a l f i s c a l program
adequate t o cope w i t h modern problems encounters at once the anomalies
and c o n f l i c t s inherent i n the overlapping f u n c t i o n s and t a x i n g powers of




-48(41)
the Federal, State and l o c a l Governments.

Moreover, the expanding func-

t i o n s of Government, p a r t i c u l a r l y i n the f i e l d of s o c i a l welfare, place
upon the States f i n a n c i a l burdens beyond t h e i r capacity without r e s o r t
t o heavy consumption taxes.

This form of t a x a t i o n runs p r e c i s e l y counter

t o the main o b j e c t i v e of f i s c a l p o l i c y — t h a t of securing reasonably f u l l
employment.

Thus, i n recent years many States have been compelled t o

l e v y sales taxes i n order t o provide o l d age assistance and other expanding s o c i a l services.

Indeed, the leadership of the Federal Govern-

ment, through the t r a d i t i o n a l 50-50 matching system, has compelled the
States, by reason of t h e i r f i s c a l incapacity t o l e v y adequate progressive taxes, t o r e s o r t i n c r e a s i n g l y t o consumption t a x a t i o n .

Thus by

1938 the State and l o c a l bodies were c o l l e c t i n g $3,250,000,000 i n sales,
l i q u o r and tobacco, gasoline and p a y r o l l taxes.
This s i t u a t i o n w i l l sooner or l a t e r necessitate a thorough
reorganization and r e - a l l o c a t i o n of functions and t a x i n g powers.

Such

a reorganization has been recommended i n Canada i n a recent report by
the Royal Commission on Dominion-Provincial F i s c a l Relations.

I t may

be t h a t the time i s not r i p e f o r a complete overhauling of the FederalState f i s c a l r e l a t i o n s i n the United States.
anything l i k e so

We are not confronted w i t h

acute a c r i s i s as t h a t c o n f r o n t i n g Canada.

The Federal

Government has been able t o step i n t o the breach through the assumption
of a major p a r t o f the burden of urban and a g r i c u l t u r e r e l i e f and grantsi n - a i d t o l o c a l p u b l i c works p r o j e c t s .

The p u b l i c debt of States and

m u n i c i p a l i t i e s has accordingly, f o r the country as a whole, ceased t o r i s e .




-49(41)
The c r e d i t p o s i t i o n of the l o c a l governments has thereby been strengthened
materially.

But while we are not confronted w i t h an immediate c r i s i s ,

the cumulative e f f e c t of growing s o c i a l services, financed l a r g e l y by
consumption taxes, i s t o place an increasing drag upon economic expansion and f u l l employment of our resources.
Short of a d r a s t i c reorganisation, the problem can be eased
by a m o d i f i c a t i o n of the Federal g r a n t - i n - a i d program and by the assumpt i o n t y the Federal Government of c e r t a i n r e s p o n s i b i l i t i e s now c a r r i e d
wholly or i n part by the States.

Thus the o l d age assistance program

(perhaps converted i n t o an o u t r i g h t pension f o r those over 70) ought
probably t o be taken over e n t i r e l y by the Federal Government.

Other

s o c i a l welfare programs which, by reason of a d m i n i s t r a t i v e problems or
otherwise (education, f o r example) should be l e f t under State c o n t r o l
w i t h Federal supervision, should be financed by a v a r i a b l e Federal grant
adjusted according t o the f i s c a l capacity of the various States.

Without

f a r - r e a c h i n g modifications i n t h i s general area, we s h a l l not be able t o
undertake an e f f e c t i v e f i s c a l program w i t h respect t o f u l l employment of
our productive resources.
Nor can f i s c a l p o l i c y ever become a r e a l l y potent device f o r
economic s t a b i l i t y and expansion without p l a c i n g i t s operation on an
a d m i n i s t r a t i v e basis.

We have long been accustomed t o the a d m i n i s t r a t i v e

c o n t r o l o f monetary and banking p o l i c y .

Ad hoc l e g i s l a t i o n by Congress

w i t h respect t o open market operations and re-discount rates would p a t e n t l y be impossible.




P r e c i s e l y the same i s t r u e of f i s c a l p o l i c y i f

it

-50(41)

i s t o be used e f f e c t i v e l y as an instrument t o c o n t r o l employment.

The

only reason why l e g i s l a t i v e enactment from time t o time i s regarded as
adequate i n t h i s f i e l d i s t h a t Governmental expenditures and t a x rates
are s t i l l expected t o f u l f i l only t h e i r t r a d i t i o n a l f u n c t i o n s .

Fiscal

p o l i c y has not yet won a place as an instrument o f economic c o n t r o l cont i n u o u s l y t o be applied as means t o secure employment s t a b i l i z a t i o n and
expansion.

T

Alien such a place s h a l l have been won, comparable w i t h t h a t

achieved by monetary p o l i c y , i t w i l l be recognized t h a t the i n t e r m i t t e n t
use, by s p e c i f i c and ad hoc l e g i s l a t i v e enactment, of p u b l i c expenditures
and t a x a t i o n a f t e r each special emergency has a r i s e n i s q u i t e inadequate
f o r the purpose i n hand.

I t w i l l become necessary t o subject these

powerful instruments t o continuous a d m i n i s t r a t i v e management i n order t o
render the c o n t r o l s u f f i c i e n t l y f l e x i b l e t o cope w i t h the ever-changing
economic

s i t u a t i o n and t o prevent disastrous cumulative movements from

g e t t i n g under way.
These considerations are p e c u l i a r l y p e r t i n e n t t o the problems
r a i s e d by the defense program.

Gearing f i s c a l p o l i c y t o the r a p i d changes

i n economic conditions which the defense program w i l l c a l l f o r t h requires
the development of new procedures.
p o l i c y i s appropriate.

For the time being, one type of t a x

But we may very soon encounter a s i t u a t i o n i n

which a q u i t e d i f f e r e n t t a x p o l i c y i s c a l l e d f o r .

Such conditions can

not be managed by piece-meal l e g i s l a t i v e enactment.
At the appropriate t i m e , the President should send a special
message t o Congress r e l a t i v e t o a long-run f i s c a l program adequate t o




-51(41)
cope w i t h the impact of the defense program upon the f u n c t i o n i n g of the
economy.

Such a message should c a l l f o r a comprehensive t a x program.

I n connection w i t h such a long-range program, Congress should be asked
t o authorize a Monetary and F i s c a l A u t h o r i t y .

Such an A u t h o r i t y should

be assigned the r e s p o n s i b i l i t y of advising and recommending t o the
Executive w i t h respect t o the implement at i o n of the comprehensive t a x
program.

The Executive, a c t i n g under the advice of the F i s c a l Author-

i t y , should be empowered t o increase or c u r t a i l , at the appropriate
t i m e , a s p e c i a l l y designated category o f public works expenditures
designed t o promote employment s t a b i l i t y and expansion.

He should

moreover be empowered, w i t h the advice o f the F i s c a l A u t h o r i t y , t o determine the t i m i n g of the i m p o s i t i o n of taxes designed t o check i n f l a t i o n or d e f l a t i o n , and t o change e x i s t i n g rates w i t h i n l i m i t s imposed
by the comprehensive t a x program.

Congress might s p e c i f y c e r t a i n

c r i t e r i a which the F i s c a l A u t h o r i t y would be required t o take cognizance of i n t h e determination of the appropriate t i m i n g o f such a d j u s t ments.

The determination ought c e r t a i n l y t o be d i s c r e t i o n a r y , but i t

i s possible t h a t the o b j e c t i v e c r i t e r i a could be s u f f i c i e n t l y d e f i n i t i v e
so t h a t l i m i t s could be imposed upon the range w i t h i n iflhich d i s c r e t i o n
could be exercised.

Upon such determination and proclamation by the

Executive the respective provisions of the comprehensive t a x measure
previously passed by Congress would become e f f e c t i v e
Admittedly Congress w i l l be r e l u c t a n t t o delegate power t o the
Executive on so v i t a l a matter as the t l i n i n g of the a p p l i c a t i o n of t a x




rates and expenditures.

But i f we are t o make the economy workable under

modern c o n d i t i o n s , i t w i l l be necessary t o engage i n bold s o c i a l e n g i neering.

And e s p e c i a l l y i s t h i s t r u e w i t h respect t o the defense program

and i t s aftermath.

I f the magnitude of the defense e f f o r t i s sharply

revised upward, the time i s coming when high consumption taxes should be
imposed, i n order t o prevent i n f l a t i o n .

I f we leave i t t o Congress t o

determine when t h i s time has a r r i v e d there i s the gravest danger t h a t
a c t i o n w i l l be taken too l a t e .

And s i m i l a r l y w i t h respect t o the t i m i n g

o f appropriate f i s c a l measures when the post-defense slump begins t o set




-53October 2, 1940
PROBLEMS RELATING TO THE DEFENSE PROGRAM OH VJHICH THE
BOARD OF GOVERNORS SHOULD EARLY COME TO SOME FAIRLY
DEFINITIVE CONCLUSIONS
I.

Bottlenecks.
Within the next 12 months there i s danger of serious mal-

adjustments unless steps are taken early t o prevent bottlenecks i n cert a i n areas.
2.

The areas t h a t appear most dangerous are:

Railway car equipment;

3*

1.

Steel;

S k i l l e d mechanics.

Various d i v i s i o n s of the Government are i n t e r e s t e d i n the
problem, but there i s danger t h a t no s p e c i f i c plan w i l l be undertaken t o
cope w i t h the problem unless a d e f i n i t e leadership i s o f f e r e d .

As a

f i r s t step, i t would probably be desirable t o c a l l a meeting of the spec i a l i s t s i n d i f f e r e n t Government departments best informed w i t h respect
t o s t e e l and r a i l w a y car equipment, and t o a r r i v e a t some agreement as t o
the minimum requirements.

( I s h a l l undertake t o arrange such a meeting.)

Following t h i s , a second step might be f o r Chairman Eccles
t o c a l l together leading o f f i c i a l s i n the Defense Commission, and elsewhere, who would be i n a p o s i t i o n t o act upon a p l a n .
II.

Comprehensive Tax Plan.
By January i t i s l i k e l y that Congress x v i l l be t a c k l i n g the

problem of a new revenue b i l l .

I t i s , t h e r e f o r e , urgent t h a t a compre-

hensive tax program be considered which would look beyond the immediate
s i t u a t i o n and envisage the whole defense program; a plan which would take
account of the d i f f e r e n t types of t a x p o l i c i e s required at d i f f e r e n t i n come and employment l e v e l s , and the means of implementing such a p o l i c y




-54-2-

i n a f l e x i b l e manner.

There i s danger t h a t a wrong type of taxes w i l ^ .

be l e v i e d e a r l y i n the next calendar year and t h a t there w i l l be a ser i o u s l a g i n the appropriate t a x p o l i c y l a t e r when i n f l a t i o n may be t h r e a t ening.
III.

Federal Borrowing*
Immediately urgent i s the question o f the repeal of the pro-

v i s i o n r e l a t i n g t o the short-term defense issues.

Some conclusion should

also be reached w i t h respect t o what measures ( i f any, beyond the m o d i f i c a t i o n of the p r o v i s i o n r e f e r r e d to) should be taken t o d i v e r t Federal borrowi n g from banks t o main r e l i a n c e on borrowing from the j j u b l i c .
Consideration should be given t o proposals about how borrowi n g from the p u b l i c could be encouraged on v o l u n t a r y l i n e s , and t o the
question whether or not some form of compulsory loan p o l i c y could be i n troduced a t the appropriate time, such as the Keynes plan.
IV.

Monetary c o n t r o l of i n f l a t i o n .
I t i s urgent t h a t we plan now means of preventing p r i c e i n -

flation.

While general i n f l a t i o n i s not now imminent, the defense pro-

gram may e a s i l y u n f o l d w i t h s u f f i c i e n t speed so t h a t the whole p r i c e s i t u a t i o n could very r a p i d l y change.

We have perhaps been l u l l e d t o sleep

over the l a s t 7 or 8 years, t h i n k i n g t h a t i n f l a t i o n i s q u i t e impossible.
As the defense program grows, the i n f l a t i o n problem w i l l become increasi n g l y serious and i t may be upon us much e a r l i e r than we now t h i n k .
An immediate danger i s the p o s s i b i l i t y of a stock market
boom.




I t might now be desirable, while the market i s r e l a t i v e l y dead,

-2-55-

(3)

t o r a i s e the margin requirements and thereby prevent the use of bank funds
t o set o f f a speculative stock market.
Consideration should also be given now t o the broader monetary control.

Ought l e g i s l a t i o n now t o be asked of Congress t o enable the

Board of Governors t o get under manageable c o n t r o l the excess reserves?
Consideration should also be given t o whether manipulation
of the gold prices and f o r e i g n exchange rates might be appropriate i n s t r u ments t o prevent commodity p r i c e i n f l a t i o n .
be paid f o r by gold.
V.

I n some cases, imports might

This p o s s i b i l i t y should be explored i n d e t a i l .

Other Price Control.
Consideration should be given t o appropriate Government p u r -

chase plans, designed t o prevent competitive bidding and consequently undue p r i c e increases.

Ought Government p r i c e s t o be f i x e d on a c o s t - p l u s ,

bulk l i n e o r on a p u b l i c u t i l i t y f a i r p r i c e basis?
When and i n respect t o what commodities should r a t i o n i n g be
i n s t i t u t e d and how should such a program be administered?
What new l e g i s l a t i o n , i f any, i s necessary t o implement t a r i f f rates as an instrument t o prevent abnormal p r i c e increases?

The powers

of the President i n the t r a d e agreement program do not appear t o f i t the
case.
VI.

Post-war p o l i c i e s w i t h respect t o gold and f o r e i g n assets i n

the (friited States.
I t i s impossible t o know whether a negotiated peace might
not be an e a r l y p o s s i b i l i t y , or a conquest of England.




I n e i t h e r event,

-56-

(34)

i t would be necessary t o be prepared w i t h respect t o a new gold p o l i c y .
Germany now can l a y her hands upon about #3*0 b i l l i o n s of gold, and moreover can command c o n t r o l over about #6.0 b i l l i o n s of f o r e i g n assets, i n cluding gold ear-marked i n the United States, balances held i n the United
States and investments i n the United States.

This s i t u a t i o n c a l l s f o r

some d e f i n i t e program and f o r m o d i f i c a t i o n s of the current p o l i c y .
VII.

Long range program w i t h respect t o a post-defense slump.
F i r s t i s the p o s s i b i l i t y of b u i l d i n g up cushions against the

slump, such as the d e l i b e r a t e s t a r v i n g of c e r t a i n areas such as housing
and automobiles during tho defense boom, vdiich would tend t o release
purchasing at the time of the impending slump.
The deferred payment plan of Keynes i s another possible
means of cushioning the slump.
Consideration should be given t o the post-defense Federal
budget.

I n l i e u of tho curtailment of defense expenditures, what plans

should be made w i t h respect t o s o c i a l welfare expenditures, i n c l u d i n g
old-ago pensions, p u b l i c h e a l t h , education, food and cotton stamp plans
and low-cost housing.
As a means of minimizing the post-defense slump, what could
be accomplished by a d r a s t i c reorganization of the Federal-State f i s c a l
setup?

Kow f a r could l e v e l l i n g o f consumption taxes be achieved by r e -

a l l o c a t i o n of the f u n c t i o n s as between tho Federal and l o c a l governments,
and by a m o d i f i c a t i o n of the g r a n t s - i n - a i d system, and by r e - a l l o c a t i o n
of t a x sources?




-57September 4> 1940
A.
1.

OUR FUTURE GOLD AND TRADE POLICY

The p o l i c y of buying gold at a f i x e d r a t e ($35. per oz.)

was adopted and continued f o r a number of reasons, not always very
c l e a r l y defined b u t , nevertheless, consciously or unconsciously p l a y ing a role.

I n 1934 i t was f i r s t undertaken p a r t l y i n response t o

powerful pressure, p a r t i c u l a r l y from conservative f i n a n c i a l groups,
against a continuation of the u n c e r t a i n and somewhat e r r a t i c course
followed i n the l a s t quarter of 1933, when gold was being purchased
at p r i c e s varying day t o day and week t o week.

The country d i d not

wish t o entrust any a d m i n i s t r a t i o n a u t h o r i t y — i n t h i s case the Treasu r y — w i t h the r e s p o n s i b i l i t y of buying gold on a v a r i a b l e p r i c e basis.
Public opinion had not been schooled and ripened t o accept a f l e x i b l e
exchange p o l i c y — a t l e a s t not one of our own making.

There were s t i l l

important gold standard countries v i s - a - v i s whom a f i x e d d o l l a r p r i c e
of gold would a u t o m a t i c a l l y e s t a b l i s h f i x e d exchange r a t e s .

And, w i t h

respect t o England, the exchange rates would be f i x e d by B r i t i s h action
and p o l i c y and not by the decision of a d m i n i s t r a t i v e a u t h o r i t i e s i n
the United States.

The f i x e d gold p r i c e avoided the d i f f i c u l t i e s o f

d i r e c t and continuous management.

Thus the program t o buy gold a t a

f i x e d p r i c e was adopted l a r g e l y i n response t o a demand f o r an automatic system and f o r f i x e d exchange rates i n so f a r as t h i s could be
achieved under conditions then p r e v a i l i n g .
Once t h i s p o l i c y was adopted, various f a c t o r s c o n t r i b u t e d
to i t s retention.

The new high p r i c e of gold pushed the d o l l a r down

i n r e l a t i o n t o other currencies, and served completely t o wipe out the




-ss-

Cs)
appreciation of the d o l l a r w i t h respect t o s t e r l i n g .
p r e c i a t i o n had c o n t r i b u t e d t o the d e f l a t i o n .

This e a r l i e r ap-

Accordingly, d e l i b e r a t e

depreciation of the d o l l a r had been demanded by l a r g e and i n f l u e n t i a l
i n d u s t r i a l and a g r i c u l t u r a l groups, and any tendency, subsequently, t o ward a reversion t o d o l l a r appreciation was s t r o n g l y r e s i s t e d .

The

heavy i n f l o w of c a p i t a l which q u i c k l y set i n e a r l y i n 1934 would doubtless have brought about aid appreciation of the d o l l a r had the Treasury
not met t h i s i n f l o w w i t h u n l i m i t e d purchases of gold a t the new f i x e d
price.
More r e c e n t l y , e s p e c i a l l y i n 1938 and 1939> a p a r t of the
gold i n f l o w balanced an excess of goods and services over imports of
goods and services.

While the p u b l i c was u n w i l l i n g t o permit the

Treasury t o issue currency f o r the purpose of f i n a n c i n g public works,
i t was i n l i n e w i t h established orthodox theory and p r a c t i c e t o permit
the issue of currency i n exchange f o r gold, thereby subsidizing an
excess of exports and s t i m u l a t i n g employment.

Both employers and em-

ployees welcomed t h i s p o l i c y .
Thus, the fear of a d m i n i s t r a t i v e c o n t r o l of exchange rates
by the f i n a n c i a l conservatives, the concern of a g r i c u l t u r a l and other
i n t e r e s t s w i t h the danger of d e f l a t i o n should t h e d o l l a r be allowed t o
appreciate, and the t r a d i t i o n a l desire of American business and labor
t o stimulate the recovery by means o f an excess of exports combined t o
b r i n g widespread support f o r the inauguration and maintenance of the
gold-buying p o l i c y .




F i n a l l y , once the war had s t a r t e d , i t was at once recognized
t h a t the gold-buying program represented a convenient way o f overcoming
the l i m i t a t i o n s imposed by the Johnson A c t .

A i d could be given the

A l l i e s without i n c u r r i n g a r e p e t i t i o n of the unfortunate experience
w i t h respect t o the war loans.
2.
buying program.

Events now force us, however, t o reconsider our gold
Germany, i n command of the Continent, has at her d i s -

posal some $3*0 b i l l i o n s of gold, not i n c l u d i n g the $1.5 earmarked i n
the United States.

This could be used t o buy American exports and t o

strengthen the German d i c t a t o r s h i p and hegemony over Europe.
are confronted w i t h a new problem.

Thus we

I t would be i l l o g i c a l t o spend b i l -

l i o n s of d o l l a r s f o r defense against Germany and, on the other side,
permit our gold-buying program t o a i d and strengthen the German economic
and m i l i t a r y system.

This statement does not imply, however, t h a t we

should refuse t o trade under any terns w i t h Germany.

An exchange of

goods against goods would, at l e a s t , be as b e n e f i c i a l t o us as t o her.
But an exchange of goods against gold would amount t o p l a c i n g our productive resources at the f r e e disposal of Germany.
3.

What our f u t u r e gold p o l i c y should be w i l l be determined,

i n f a c t , by the k i n d of world we s h a l l face when peace i s declared.
s h a l l l i m i t our consideration of a l t e r n a t i v e s t o two:

(a)

We

German con-

t r o l o f the European continent, r e s u l t i n g i n a m i l i t a r y a l l i a n c e between
the B r i t i s h Empire and the United States;

(b)

a conquest by Germany of

the B r i t i s h I s l e s , r e s u l t i n g i n a m i l i t a r y a l l i a n c e between Canada and
the United States.




-60(31)
U.

I n the former case, m u l t i l a t e r a l trade could be carried

on between the countries of the Western Hemisphere, the B r i t i s h Empire
countries, the B r i t i s h possessions i n the Far East, China and Japan.
Trade between the United States and these countries could be fostered
by trade agreements of the type promoted by Secretary H u l l , based on
e q u a l i t y of treatment of a l l the countries concerned.

Trade with

Germanized Europe would be conducted, i f a t a l l , on a barter basis
whenever such barter trades seemed advantageous t o us.

Already we

have the precedent for the d i f f e r e n t i a l treatment of Germany i n the
f a c t t h a t the concessions made under the H u l l trade agreements were
never generalized to Germany.

Moreover, trade with Germany, even be-

fore the outbreak of war, had shrunk t o a small f r a c t i o n of i t s former
magnitude, and had become equalized on a b i l a t e r a l basis.

Such trade

as there was had not y e t , on our side, become canalized into a Government t r a d i n g corporation, but the German t r a d i n g methods indicate t h a t
machinery of t h i s character i s the l o g i c a l method of conducting trade
vrith t h a t country.

I t i s assumed t h a t even though a peace i s made be-

tween England and Germany, i n e f f e c t such a peace would be an armed
truce.

Both Great B r i t a i n and the United States would continue t o r e -

gard Germany, q u i t e f r a n k l y and openly, as a p o t e n t i a l enemy, even
though h o s t i l i t i e s had ceased.

This condition already describes the

r e l a t i o n s of the United States with Germany at the present moment.
While formally at peace, we are not giving Germany equal treatment, i n
terms of t r a d e , with other countries, and we do not disguise the f a c t




-61-

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t h a t we are arming t o defend ourselves against her aggression.

Such a

s t a t u s , p l a c i n g Germany i n a special category, could e a s i l y become f i x e d ,
p a r t i c u l a r l y under peace terms which would, i n f a c t , be an armed t r u c e .
Under these circumstances, i t would not be d i f f i c u l t t o r e fuse t o buy gold from Germany while continuing t o buy gold from other
countries.

I n order t o prevent the b e n e f i t s accruing t o other coun-

t r i e s from f i l t e r i n g over t o Germany, we would have t o i n s i s t t h a t our
purchases would be conditioned on t h e i r cooperation.

The b e n e f i c i a r i e s

of our gold purchases would not be permitted t o buy gold from Germany,
f o r t h i s would only amount t o an evasion of our p o l i c y .

Nor could they

be permitted t o u t i l i z e t h e i r improved monetary and c r e d i t s i t u a t i o n
(by reason of our gold purchases) so as t o give Germany a favored p o s i t i o n w i t h respect t o trade c r e d i t s .

Our own gold buying program could

be continued only so long as these countries cooperated w i t h the United
States i n a program designed t o prevent any of the b e n e f i t s from gold
purchases f l o w i n g t o Germany.
A simpler device would be t o stop gold purchases a l t o g e t h e r .
This would compel t h i s and other gold producing countries t o face the
problem of l i q u i d a t i n g the gold i n d u s t r y .

One s o l u t i o n would be t o buy

up the mines at a moderate s t i p u l a t e d p r i c e and close them down.

Such a

p o l i c y would also require the payment of a dismissal wage t o the wageearners.

But while we could probably, by t h i s method, manage the

l i q u i d a t i o n of our own gold production, such a program would create
serious d i f f i c u l t i e s f o r Canada and L a t i n American c o u n t r i e s .




Cessation

-62(31)
of gold purchases from them would c e r t a i n l y not c o n t r i b u t e t o closer
economic and p o l i t i c a l r e l a t i o n s between the countries of the Western
Hemisphere.
5.

I n the event of a defeat of England and a break-up of

the B r i t i s h Empire, our i n t e r n a t i o n a l r e l a t i o n s would be more than ever
centered on the Western Hemisphere.

Indeed, t h i s Hemisphere would

probably be compelled t o become l a r g e l y s e l f - s u f f i c i e n t .

These circum-

stances would i n d i c a t e a continuation of gold purchases from Canada
and L a t i n America, but complete cessation of purchases from other gold
producing c o u n t r i e s .

The f o r e i g n trade of the United States would be

r e s t r i c t e d mainly t o the Western Hemisphere countries.

Since there i s

very l i t t l e trade between these c o u n t r i e s , almost a l l of i t being w i t h
the United States, i t f o l l o w s t h a t there i s l i t t l e scope f o r a m u l t i l a t e r a l trade p o l i c y .

B i l a t e r a l balancing of trade between the United

States and each of t h e Western Hemisphere countries would be the l o g i c a l
policy.

This could be supplemented by b a r t e r trade arrangements, where

they could p r o f i t a b l y be made.




-63September 27, 1940
B.

GOLD POLICY:

ALTERNATIVE FORMULATIONS

The general p r i n c i p l e s upon which our gold p o l i c y must be
founded are r e l a t i v e l y simple and e a s i l y s t a t e d .

The a p p l i c a t i o n of

the p o l i c y depends, however, upon a v a r i e t y of circumstances, o f t e n
conflicting.
The continued use of gold i n i n t e r n a t i o n a l settlements helps
t o give support and encouragement t o greater freedom of trade and capit a l movements i n the i n t e r n a t i o n a l markets.

The complete abandonment

of gold purchases w i l l tend t o i n t e n s i f y the movement toward the comp l e t e governmental c o n t r o l of a l l i n t e r n a t i o n a l t r a n s a c t i o n s .
Apart from t h i s consideration, gold purchases by the United
States c o n s t i t u t e an a i d t o any n a t i o n possessed of gold and i n need
of commodities which we can supply.

I f such nations are already u t i -

l i z i n g t h e i r resources t o capacity, the sole of gold enables them t o
increase t h e i r m i l i t a r y and c i v i l i a n supplies beyond t h e i r own capacity
t o produce.

Under current world c o n d i t i o n s , i t may be argued t h a t such

nations are extremely lucky t o f i n d any country which i s w i l l i n g t o
take and store away u n l i m i t e d supplies of gold i n exchange f o r u s e f u l
commodities.
For our own p a r t , the purchase of gold may however be usef u l , p a r t l y as a means of preventing an unfavorable appreciation o f
the d o l l a r and p a r t l y as a means of s t i m u l a t i n g our exports, thereby
achieving a f u l l e r u t i l i s a t i o n than might otherwise be possible of our
productive resources.




-64-

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I n b r i e f , then, we w i l l want t o continue t o buy gold t o the
extent t h a t we wish t o give a i d and support t o c e r t a i n c o u n t r i e s , and
t o the extent t h a t our gold purchase p o l i c y w i l l support a g r i c u l t u r a l
p r i c e s and stimulate employment.
During the war we s h a l l want t o give a l l possible a i d t o
Britain.

So long as she has any gold resources, t h e r e f o r e , we s h a l l

want t o continue t o purchase gold.

We s h a l l want t o pursue t h i s p o l -

i c y even though no d i r e c t b e n e f i t s accrued t o our own economy.

More-

over, during the war and the continuation of the blockade o f Germany,
i t may be safe t o buy gold from a l l sources without encountering the
danger t h a t our gold purchase p o l i c y w i l l render a i d and assistance t o
Germany.

This i s , however, a matter which needs watching.

Germany

might s e l l the gold of the countries r e c e n t l y coming under her dominat i o n t o South America, thereby achieving f o r e i g n exchange assets which
would be immensely valuable a f t e r the war.
The possible outcomes of the war are manifold.

But i t

will

help our t h i n k i n g on the subject t o envisage three e v e n t u a l i t i e s .
These, of course, shade o f f more or less i n t o each o t h e r .

Moreover,

s o c i a l and p o l i t i c a l upheavals i n the b e l l i g e r e n t countries may profoundly a l t e r the s i g n i f i c a n c e of each a l t e r n a t i v e outcome f o r the
United States.
The war may end i n a B r i t i s h v i c t o r y .

I n t h i s event, we

should not need t o f e a r t h a t a gold purchase program would strengthen
a dangerous p o t e n t i a l enemy—Germany.

We should accordingly be f r e e

t o determine our gold p o l i c y on tho basis of i t s e f f e c t on us and on




-65-

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England.

England would doubtless be i n need of American exports of

foodstuffs (though preference might not u n l i k e l y be granted to the
Dominions and to South America), machinery and other equipment to
help r e b u i l d her battered i n d u s t r i a l p l a n t .

We should want to f u r -

nish t h i s a i d , and would probably prefer to take gold rather than
grant c r e d i t s .

Moreover, a f t e r the defense emergency, we s h a l l prob-

ably be b a t t l i n g w i t h recession and

unemployment

and would welcome any

l i f t from increased exports.
I n the event of a crushing German v i c t o r y , including the
conquest of England, our sphere of influence would probably s h r i v e l
to North America and the Caribbean area.

We should, under these c i r -

cumstances, bo ax^ming ourselves to the utmost.

We should want to pre-

vent Germany from using her gold resources to strengthen her m i l i t a r y
power.

We would therefore, c e r t a i n l y be compelled to implement a pol-

icy under which no gold would be purchased by us d i r e c t l y or i n d i r e c t l y
from Germany.

We could continue to buy gold from Canada and from the

L a t i n American countries w i t h i n our o r b i t .
these countries i s almost non-existant.

M u l t i l a t e r a l trade between

B i l a t e r a l trade between each

of these countries and the United States would constitute v i r t u a l l y
the whole of Western Hemisphere trade.

Gold purchases from these

countries could easily be incorporated as a part of that b i l a t e r a l
trade.

The volume of our gold purchases, under these circumstances,

would be r e l a t i v e l y small.

And controls could e a s i l y be implemented

( f o r example—quotas based on annual production) to insure that no
benefits would flow i n d i r e c t l y to Germany.




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(16)

I n between i s tiie p o s s i b i l i t y of a negotiated peace i n which
England emerged as the recognized sea power and Germany as the recognized land power dominating the European Continent.
presents the most serious dilemma.

This s i t u a t i o n

We should want to pursue a gold

policy which would a i d and strengthen England.and, at the same time,
prevent any benefits from t h i s policy flowing to Germany.
Three d i f f e r e n t typos of p o l i c i e s might be invoked.

First,

we could pursue openly a dual policy — one applicable to Germany and
countries i n her o r b i t , and another to the r e s t of the world.
would admittedly not be a policy of equal treatment.
inate against Germany.

This

I t would discrim-

But we should doubtless be discriminating

against her i n other respects also.

We have never generalized the

t a r i f f concessions made under the H u l l trade agreements to Germany.
There i s nothing i n i n t e r n a t i o n a l law which compels us to t r e a t

all

countries a l i k e w i t h respect t o trade, exchange regulations or gold
purchases.
Such a dual p o l i c y , openly pursued, would involve no subterfuges.

Subterfuges f o o l nobody anyway.

forthright policy.

I t would be a straightforward,

I t would enable us to continue to give aid to Eng-

land and other countries which we regarded as actual or p o t e n t i a l
allies.
lems.

And i t would ease our own unemployment and a g r i c u l t u r a l probI t would, moreover, f a c i l i t a t e the development of m u l t i l a t e r a l

trade i n the Anglo-American bloc, including the B r i t i s h Empire, the
Western Hemisphere and the Far East.
exchange i n t h i s area.




I t would help to restore f r e e

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Second, an opportunist policy might be adopted.
announce a cessation of unlimited gold purchases.

We would

As a general pol-

icy we would not stand ready to buy gold from anybody.

We would,

however, consider i n d i v i d u a l cases, not on a country-by-country basis,
but i n terms of separate deals.

We would engage now and then i n spe-

c i a l b a r t e r arrangements i n which we agreed to take gold at such prices
as might be determined by negotiation.
A t h i r d policy could be implemented along the l i n e s of the
B r i t i s h Exchange Equalization Account and the T r i - p a r t i t e Agreement.
We might agree to buy gold on a discretionary basis (both w i t h respect
to volume and price) from c e r t a i n countries included i n the gold s t a b i l i z a t i o n arrangement.

These countries would agree to buy gold ex-

clusively from each other, but e n t i r e l y on a discretionary basis.

In

t h i s manner Germany and a l l the countries i n her o r b i t would be excluded.
Since the discretionary purchase of gold by any one country
might, i n a f r e e exchange market, a f f e c t unfavorably the exchange
rates of other countries, such purchases would always have to be made
on a consultative basis with the various countries concerned.

Ex-

change rates would not be allowed to vary beyond c e r t a i n l i m i t s except
by consultation and agreement.
Arrangements might be made with each country to place c e r t a i n
commodities on a proscribed l i s t .

Export licenses would have to be ob-

tained i n order to trade i n these goods.

Outside of the proscribed l i s t

( i f any) a c i t i z e n of any f o r e i g n country involved i n the scheme could




-68(6)
buy anything from us provided he could f i n d the necessary exchange.
The exchange would be created by sales of goods to us or by borrowing.
I f , however, a c e r t a i n country desired more exchange and wished to
s e l l us gold, that would become a matter f o r special negotiation between the Exchange Equalization accounts of the two countries.

In

making such arrangements, we would take into account the goods wanted,
the country concerned, e t c .
This scheme might o f f e r a device by which the countries i n
the gold s t a b i l i z a t i o n bloc could l i m i t the purchase of newly mined
gold f o r t h e i r own producers.