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Marrimer S Eccles

I 8 S U E D BY T H E



Marrincr S. Eccles
President Leggett, members, and guests of the
National Association of Supervisors of State Banks:
Because of our common problems and responsibilities, I appreciate this opportunity to participate
in your proceedings. In the chaotic world of today,
groping for answers to the overriding problems of
economic security and enduring peace, we can find
comfort in the strong and healthy position of our
banking system. At the same time we must be
fully aware of the dangers which the present
vigorous inflationary forces may threaten for the
banking system.
I N F L A T I O N , T H E C O N S E Q U E N C E OF W A R


Postwar inflation, with its severe distortions in
the structure of prices, wages, and profits, is primarily due to the enormous wartime increase in
our money supply. The banks of the country,
including the Federal Reserve Banks, in helping
to meet the needs of war finance, brought about
this increase. In the six years from the middle of
1940 to the middle of 1946 the Federal Government spent nearly 400 billion dollars, most of which
was for national defense and war purposes. Much
less than half of this amount was met by tax receipts
and the balance of about 225 billion dollars was
borrowed. During this six-year period commercial
and Federal Reserve Banks together increased their
holdings of Government securities by 90 billion
dollars, and savings institutions, businesses, and
individual investors purchased the remainder of
the securities sold.
Commercial bank holdings of Government securities have been reduced somewhat since the
postwar peak by the Treasury's debt retirement
program, but they are still more than four times
as large as in 1940. In expanding their portfolios
of Governments, banks did not decrease their holdings of other assets. As a matter of fact, the total
of their loans, other securities, reserves, and other
cagh has increased since 1940 by about 21 billion
dollars. As a result of this credit expansion, commercial bank deposits increased by 70 billion dollars.
* Address by the Chairman of the Board of Governors of the
Federal Reserve System to the National Association of Supervisors of State Banks, Washington, D. C., Sept. 25, 1947.

In addition, currency in circulation showed a growth
of 20 billion dollars.
This expansion in bank credit and consequently
in the money supply was made possible by the large
excess reserves which were held by the banks at
the beginning of the war, and by the additional
reserves that were provided by the Federal Reserve
through an increase of,over 20 billion dollars in
its holdings of Government securities.
It is inevitable that in financing a war, business
and individual holdings of money and Government
securities increase. The reason for this is that
people are paid for furnishing the goods and services which arc needed to carry on the war and are
not available for purchase by business and consumers. Consequently, incomes expand more
rapidly than consumption can be increased. Unless
taxes are raised sufficiently to absorb all of the
surplus income, savings must increase, and they
must be held largely in the form of bank deposits,
currency, or Government securities. To the extent
that the Government expenditures are not met by
taxes or the sale of securities to nonbank investors,
the balance must be absorbed by die banking system, which results in expansion of the money
If the public had attempted to spend their entire
excess income, prices would have risen very rapidly.
However, due to the willingness of the public to
save during the war period and due to the effective
harness of wartime controls that were put into
effect, prices rose but litde during the war. By
the end of the war vast holdings of money and
other liquid assets had been accumulated and large
deferred demands had been built up. At the prevailing level of prices, demand was far in excess
of any supplies that could be made available within
any short period of time.
It should have been apparent that if these forces
were permitted free play, a sharp rise in prices
would result. The people o£ the nation, however,
not fully realizing the dangers in the situation,
made clear their wishes that controls be removed.
Business wanted freedom from allocations, price
controls, building permits, rationing, and business
particularly wanted repeal of the excess profits tax.



though much smaller amounts, to keep the peace.
Large parts of the world have been devastated and,
even in those parts left intact, the customary processes and channels of trade and commerce have been
destroyed or upset. People in nearly all nations
have vast holdings of money and large deferred
demands for the necessities of life* and supplies of
nearly everything to meet these demands are inadequate. The money they have, however, cannot be used to make purchases from countries
which have goods for sale, and they have little else
to offer in exchange. When people are thus upset,
they are susceptible to the lure of political panaceas
and arc likely to generate feelings of hatred toward
others more fortunate than they. This state of
mind is a threat to stability and peace in the world.
In the twofiscalyears from July 1946 to June
1948 we have budgeted expenditures of more than
25 billion dollars for the maintenance of our national defense. We have provided altogether since
the end of the war foreign grants and credits of
approximately 16.5 billion dollars* which is only
two-thirds of our military budget for thefirsttwo
postwar fiscal years. Surely this is a small amount
to'make available for helping to win the peace,
when compared with our vast expenditure of 350
billions used to win the war.
It cannot be denied or ignored that continued
large loans and grants to foreign countries are
either a heavy current burden upon our taxpayers
or a strong inflationary force on our economy, but
so are our even larger military expenditures, which
are considered by many as necessary for maintaining peace.
We should be fully aware of the costs and risks
of providing foreign aid and make adjustments in
our policies accordingly. We cannot be lavish in
aid to other countries without suffering the consequences of inflation, heavier taxation, or the reimposition of controls. Countries receiving assistance should recognize the burden that is being
imposed on our economy, and it is imperative that
they take measures to assure the most effective
use of their own resources as well as of those received from us. If these requirements are met, it
would be shortsighted, as well as highly selfish,
for us to deny aid needed to prevent starvation
and to reconstruct productive capacity jn other
countries. Our reason for denying the aid would
We spent nearly 350 billion dollars to win the be that we wanted to increase our already large
war, and we shall need to spend substantial, al- consumption in order to counteract inflation. Yet

Farmers wanted release of all controls affecting
agricultural products. Labor wanted removal of
restraints on higher wages. Bankers generally sympathized with the desires of all these groups to
remove controls. In response to these public pressures, wartime controls, such as allocation of raw
materials, building permits, price and wage restrictions, as well as the excess profits tax, were prematurely abandoned.
We are currently witnessing the results of this
national policy. With demand for goods already
large because of high levels of current income and
with a huge backlog of domestic and international
demand reinforced by huge accumulations of liquid
assets after five years of war, price inflation was
inevitable. The country is now suffering the consequences of having placed our reliance upon the
restoration of a Competitive price situation to bring
about necessary postwar readjustments in an abnormal period when effective demand far exceeds
available supplies.
As a result, the economy is caught fast in a serious
wage-cost-price spiral. Short farm crops at home
and abroad have intensified this spiral. International crisis, in part the result of our rising prices,
is imposing on us obligation* that can only be discharged by actions that will increase our inflation
difficulties. Yet we should not allow what is left
of European democracy to perish through starvation and communism. Nor can we ultimately solve
our problem of inflation without the restoration of
Europe's vast productivity to help take care of the
world's needs. H i e danger that faces us is that
inflation will go on unchecked and end, as inflations always have ended, in economic collapse.
The higher the spiral of inflation is wound by
further general price and wage increases, by further
rapid expansion of private debt, and by failure to
reduce public expenditures for ail purposes that
can be eliminated or postoned until the emergency
has ended, the more serious the inevitable readjustment is certain to be. The longer the ultimate
reaction is postponed, the longer it will take to
reach a stable condition of employment and production. Readjustment in our domestic situation
is'overdue, and the sooner it can be brought about,
the better it will be for the nation and the world.



the best remedy for inflation is marc production,
and the greatest unused productive resources' now
lie outside of this country, but they cannot be effectively operated by starving people devoid of equipment and supplies.

banks, shifts of deposits from bank to bank necessitate corresponding shifts of assets or other adjustments. For this reason our banking system requires
a high degree of liquidity and these requirements
have been enlarged by the great wartime growth
and broad distribution of bank deposits.
Another problem confronting bank supervisory
What bearing, you may wonder, does all this agencies is the great existing potential for further
have upon our common problems and respon- expansion of credit. Generally in the past banks
sibilities of bank supervision? The Federal Re- could not expand their loans and investments,
serve has a close interest in these matters, because except when new funds came to them or unless
we are responsible for providing the reserves that they were willing to borrow. When one bank lost
support our entire money apd credit system. We funds, it had to borrow or liquidate assets. While
must constantly consider whether the existing for individual banks that situation still exists, the
supply of bank credit is redundant or inadequate. very large holdings of Government securities now
This judgment must be based upon the needs and held by banks makes it easy for them to shift to
behavior of the economy. There is not time here other assets that seem more attractive.
to discuss the specific objectives, standards, and
When banks sell their Government securities, in
various other considerations that provide the basis the absence of any other buyer, the Federal Reserve
for these policy decisions. The Board of Governors, is obliged to purchase them. Otherwise, the Govthe Federal Open Market Committee, composed ernment securities market would decline and might
of the Board and representatives of the Federal Re- collapse. This would not only greatly increase the
serve Banks, the operating officials of the Reserve cost of carrying the public debt, but would seriously
Banks, and the Federal Advisory Council in giving endanger our entire financial structure, in which
advice, must constantly keep in mind the impact Governments now occupy such an important place.
of Federal Reserve policies on the economy.
When the Federal Reserve System acquires addiInternational affairs are of importance to us be- tional Government securities, new reserves are
cause of their general impact on our domestic created; these reserves pass to other banks and
economy and more directly because the net resultant ultimately may provide the basis for an expansion
of all international financial transactions is re- in credit amounting to six to ten times the reserves
flected in gold movements. Gold, together with made available. This ability of the banking system
Federal Reserve Bank credit, supplies the basic to bring about the creation of new reserves without
reserves of our banking system. The interest and borrowing is a new element in the credit situation.
responsibilities of the Reserve System in this field With an active demand for loans, it can be a powerare recognized by the Congress in including the ful inflationary force. The Board has long recogChairman of the Board of Governors as one of five nized this problem, discussed it fully in its Annual
members of the National Advisory Council. This Reports to Congress for 1945 and 1946, and preCouncil has responsibility for supervising and co- sented proposals for its solution. Most of you may
ordinating the international financial policies of the be familiar with the substance of these reports;
Federal Government.
time does not permit a full discussion of them here.
Up to date little support has been received for the
Board's suggestions, and nothing whatever has been
Because of their interests and respohsibilities, the done to put the Board in a position where it could
Federal Reserve authorities are greatly impressed restrain inflationary expansion by the banking syswith the changed position of banks that has resulted tem.
from war. These changes will affect the duties
Another potential' for credit expansion is the
and responsibilities of all bank supervisory agencies. large flow of gold that is now coming into this
The vast volume of deposits and currency not only country. This inflow has already amounted to
offers a threat of inflation for the economy as a nearly 2 billion dollars this year. Since the middle
whole, but it may create serious problems for in- of the year total loans and investments of comdividual banks. With our system of 14,000 separate mercial banks have been expanding at a rate equiva^



lent to 10 billion dollars a year. If this should
continue it would* provide an inflationary force
more than double the anti-inflationary effect of
the prospective surplus in the Federal budget for
this fiscal year. It would equal the inflationary
impact of the unprecedented surplus of exports over
imports in this country's foreign trade during recent
months. Under present circumstances, it does not
appear possible for the Federal Reserve System to
check this credit expansion by selling Government
securities and thus absorbing bank reserves.
Banks have been the beneficiaries of wartime
developments. Their assets have increased tremendously and these assets are perhaps more liquid
and less subject to depreciation than at any previous
time of active business. Bank earnings have grown
more rapidly than expenses, so that profits are
relatively large, and capital structures have been
enlarged. Finally, their large holdings of Government securities make it possible for banks to shift
readily to any other more attractive assets that
may be available.
Banks can also suffer the consequences of unpleasant economic developments, as they have at
times in the past. Some of the most disastrous of
these developments have occurred during my career
as a banker and businessman and during the
careers of, most of you. Banks are most seriously
affected when they have helped to bring about the
conditions by undue expansion of credit followed
by rapid liquidation.
Although present inflationary developments are
largely the result of warfinance,in the past two
years expansion of private credit has become a
factor of increasing importance. Conditions are
favorable for a further substantial expansion of
private credit that may contribute further to excessive inflation and lead to disastrous consequences
for the economy. Such a development would endanger the healthy position of our banking system.


As I have indicated, the existing general monetary and credit powers of the Federal Reserve are
inadequate for preventing such a development.
Nor can bank supervision, in view of its limited
scope and of the inflationary forces already generated, be expected to prevent further inflation. We
can, however, understand the nature of the problem
and use our influence to discourage banks from
.contributing to it. This would help to diminish

resulting undesirable effects upon banks.
specifically can be done?


(1) Maintenance of a high degree of liquidity
should be encouraged; banks should be discouraged
from reducing their large holdings of Government
securities and cash assets in order to acquire less
liquid and more risky assets.
(2) Supervisors should take a critical attitude
toward any expansion of loans, unless they contribute direcdy to increased production and movement of goods. This attitude should apply particularly to consumer credit, real estate loans based
on inflated values, loans to carry excessive inventories, and any loans for speculative purposes.
(3) As long as banks maintain their present
large holdings of cash and Government securities,
most of them are adequately capitalized. Banks
with low ratios of capital to risk assets, however,
should build up their capital. If banks persist in
increasing their risk assets, they should be required
to enlarge their capital accordingly by retention of
earnings. If retained earnings are not sufficient,
then additional stock should be sold.
It is important for us to keep in mind that future
losses of banks are determined by current policies.
While each individual loan of a bank may appear
sound taken by itself, the practices of banks in the
aggregate may contribute to generally unhealthy
conditions. In an unsound economy, banks in
general cannot remain sound. Our banks now
appear to be in a position to withstand the severe
economic storm that is threatening. This is not
the time for them to remove their storm shutters
or venture out into the gale.
In summary, I would reassert that the wartime
increase in money and incomes relative to the
supply of goods and services has created an inflationary development with severe distortions in
prices, wages, and profits. Readjustment in our
domestic situation is overdue. T l y sooner it can
be brought about, the better it* will be for the
nation and the world; the longer it is postponed,
the more severe will be the inevitable readjustment.
We are faced with a choice between unattractive
alternatives. We must decide how much we are
going to spend preparing for the next war and for
other purposes that might be eliminated or deferred.
At the same time we need to determine how much
we are going to make available to maintain peace
through provision of vital food and needed pro-


ductivc facilities to the starving and destitute
Western European democracies. It should be recognized that we cannot continue to spend as much
as we have been for all of these purposes, in the
presence of other strong inflationary pressures in
the economy, without severe costs and risks.
We are on the horns oLa dilemma. We simply
cannot reduce taxes
the same time
assist Europe. We cannot expand domestic credit,
both public and private, for the purpose of having
all we want and assist Europe and avoid inflation.
We must give up something or we are going to pay
much more dearly in the long run. If we desire to
preserve democracy and peace in the world, we must
assist in feeding the starving people in the democracies of Europe and help them to get into produc-

tion because it is only by their production that we
will be relieved and more will be available in this
country. If controls are needed to do that, we
should have controls. If the public understands
the problem and voluntary rationing can do it, of
course that is the desirable way to do it. We have
got to deal with the economic facts of life as they
are. As bank supervisors you can try to see to it
that the banks of this country put some pressure on
credit expansion and stop this inflationary growth
that they are responsible for collectively, though
individually they may not be aware of it. If you
want public authorities to have control over credit
expansion, consider the recommendations of the
Board in its annual reports of 1945 and 1946 before
it is too late.