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6'OARD OF GOVERNORS OF THE FEDERAL RBSERVE SYSTEM ^ Ti/i.t.ft December 12, 19U7 »jiq Chairman Eccles fSrom__Jfr^app w MESSAGE: ¥\ Attached are some notes on the proposal t o increase Federal Reserve Bank reserve requirements. I am c i r c u l a t i n g these comments t o Messrs• Thurston, Thomas, and Young as r e p r e s e n t i n g the r e a c t i o n s o f an independent "guinea p i g " . Attachment ^ f e s s a g e d e l i v e r e d by F . R . 468 Rev. 1/47 The f o l l o w i n g comments r e l a t e t o t h e p r o p o s a l t h a t t h e r e s e r v e s , i n t h e f o r m o f g o l d c e r t i f i c a t e s , r e q u i r e d t o be h e l d b y F e d e r a l Reserve Banks a g a i n s t t h e i r o u t s t a n d i n g n o t e s and d e mand l i a b i l i t i e s s h o u l d be i n c r e a s e d f r o m t h e p r e s e n t s t r a i g h t 25 p e r cent t o 40 p e r cent f o r n o t e s and 35 per cent f o r demand liabilities. T h i s p r o p o s a l has been p u t f o r w a r d as a c o n t r i b u t i o n t o t h e f i g h t a g a i n s t i n f l a t i o n , i t b e i n g now g e n e r a l l y r e c o g n i z e d t h a t i n f l a t i o n a r y p r e s s u r e s r e p r e s e n t a grave t h r e a t t o t h e h e a l t h and s t a b i l i t y o f our economy. I n t h e l i g h t o f t h i s avowed purpose, t h e proposed measure r e f l e c t s a b a n k r u p t c y o f i d e a s ; i n f a c t i t s i m p l y amounts t o a confession of f a i l u r e . I t would be t o o complimentary t o c a l l t h e p r o p o s a l w o e f u l l y inadequate j r a t h e r i t i s almost c o m p l e t e l y i r r e l e v a n t . I f i t i s p u t f o r w a r d as i n any sense a s u b s t i t u t e f o r e f f e c t i v e a c t i o n i n t h e c o n t r o l o f bank c r e d i t , i t amounts t o a f r a u d on t h e American p u b l i c and an i n s u l t t o t h e i n t e l l i g e n c e o f t h e e l e c t o r a t e . At t h e same t i m e , t h e a d o p t i o n o f t h e proposed measure, innocuous enough a t t h e moment, would c a r r y w i t h i t t h e danger t h a t a t some f u t u r e t i m e c o n t r o l i n t h i s manner over F e d e r a l Reserve System o p e r a t i o n s would l e a d t o d i s a s t r o u s consequences. These p o i n t s a r e f u r t h e r developed b e l o w : (1) The two p r i n c i p a l f u n c t i o n s w h i c h have t r a d i t i o n a l l y been d i s c h a r g e d b y g o l d r e s e r v e s a r e (a) a r e s e r v e a g a i n s t demands b y t h s p u b l i c f o r g o l d c o i n , and (b) a r e s e r v e a g a i n s t i n t e r n a t i o n a l payments. The f i r s t f u n c t i o n has disappeared i n t h e U n i t e d S t a t e s as w e l l as i n t h e r e s t o f t h e w o r l d as a r e s u l t o f t h e abandonment o f f r e e g o l d c o i n c i r c u l a t i o n . The second purpose r e m a i n s , b u t i n t h e case o f t h e U n i t e d S t a t e s , our p r e s e n t g o l d s t o c k i s more t h a n ample t o cover any c o n c e i v a b l e r e q u i r e m e n t s o f t h i s c o u n t r y f o r i n t e r n a t i o n a l payments. (2) I t remains t r u e t h a t t h e l e g a l reserve r e q u i r e m e n t s a p p l i c a b l e t o t h e F e d e r a l Reserve Banks m i g h t t h e o r e t i c a l l y be m a n i p u l a t e d by t h e Congress w i t h a v i e w t o c o n t r o l l i n g t h e p o t e n t i a l amount o f F e d e r a l Reserve c r e d i t . However, i n p r a c t i c e t h e r e s e r v e r e q u i r e m e n t s must e i t h e r remain f i c t i t i o u s and academic as a t t h e p r e s e n t t i m e , o r become a dangerous t h r e a t t o t h e i n t e g r i t y o f t h e F e d e r a l Reserve System. -2(3) From t h i s p o i n t o f v i e w , i t i s f o r t u n a t e t h a t under present circumstances t h e proposed increase i n t h e r e serve requirements o f t h e Federal Reserve Banks would be completely i n e f f e c t i v e . The new proposed r a t i o s , although s u b s t a n t i a l l y higher than the e x i s t i n g r a t i o , would nonetheless leave t h e Federal Reserve Banks w i t h h o l d i n g s o f g o l d c e r t i f i c a t e s s u b s t a n t i a l l y i n excess o f t h e r e q u i r e d amount. But since t h e i r operations and freedom o f a c t i o n would n o t t h e r e f o r e be s i g n i f i c a n t l y a f f e c t e d , i t i s apparent t h a t t h e proposed measure makes a b s o l u t e l y no genuine c o n t r i b u t i o n t o t h e c o n t r o l o f inflation. (4.) On t h e o t h e r hand, i f as a r e s u l t o f such f a c t o r s as t h e expansion o f currency i n c i r c u l a t i o n , the e s t a b l i s h e d reserve r a t i o d i d come t o be r e s t r i c t i v e upon the freedom o f a c t i o n o f t h e Federal Reserve Banks, i t would o b v i o u s l y have t o be changed. I t i s u n t h i n k a b l e t h a t Congress would a l l o w a s i t u a t i o n t o develop i n w h i c h t h e System would be powerless t o p r o v i d e c r e d i t and t o s t a b i l i z e t h e Government bond market merely f o r t h e sake o f m a i n t a i n i n g a completely a r t i f i c i a l l e g a l reserve r a t i o . I n t h i s r e s p e c t , t h i s measure i s f u l l y comparable t o t h e f u t i l e attempts t o l e g i s l a t e c e i l i n g s on t h e amount o f the p u b l i c d e b t . (5) I t may be claimed t h a t enactment o f t h e proposed measure w i l l have b e n e f i c i a l " p s y c h o l o g i c a l e f f e c t s " . I t i s e x t r e m e l y d i f f i c u l t t o conceive, however, why such e f f e c t s should be induced i n any p a r t o f t h e American people aside f r o m t h e l u n a t i c f r i n g e o f "hard-money" economic a n t i q u a r i a n s . Even i f such i n d i v i d u a l s are p s y c h o l o g i c a l l y s t i m u l a t e d , i t i s f a r from c l e a r how t h e y can take any a c t i o n which w i l l have t h e l e a s t c o u n t e r - i n f l a t i o n a r y i n f l u e n c e . T h i s i s c e r t a i n l y sweeping back t h e ocean w i t h a broom. (6) On t h e o t h e r hand, even f r o m the p s y c h o l o g i c a l p o i n t o f v i e w , t h e r e are dangers i n t h e course w h i c h has been advocated. I f conceivably t h e t i m e ever should be reached when t h e h i g h e r requirements became e f f e c t i v e , i t would be a t a moment o f s e r i o u s i n f l a t i o n a r y pressures. At such a t i m e o f c r i s i s , w i t h t h e c u r r e n t a l r e a d y r u n n i n g s t r o n g l y toward i n f l a t i o n , t h e i n e v i t a b l e r e d u c t i o n i n reserve requirements might w e l l serve t o strengthen such tendencies and t o undermine p u b l i c confidence i n t h e c u r r e n c y .
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