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November 1?, 1919.
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My dear S e n a t o r :
Receipt i s acknowledged of your l e t t e r of t h e lUth i n s t a n t .
The Federal Reserve Act i s intended f o r the b e n e f i t of commerce
and i n d u s t r y and not f o r the s t i m u l a t i o n of the investment market or of
s p e c u l a t i v e movements. The s h o r t t i t l e of the Act r e a d s , as f o l l o w s :
"An Act To provide f o r the establishment of Federal Reserve Banks,
to f u r n i s h an e l a s t i c currency, t o a f f o r d means of r e d i s c o u n t i n g
commercial p a p e r , t o e s t a b l i s h a more e f f e c t i v e s u p e r v i s i o n of banking i n the United S t a t e s , and f o r other purposes." Section 1) of
the Act provides i n p a r t t h a t Federal Reserve Banks may discount
n o t e s , d r a f t s , and b i l l s of exchange a r i s i n g out of a c t u a l commercial
t r a n s a c t i o n s ; t h a t i s , n o t e s , d r a f t s , and b i l l s of exchange issued
or drawn f o r a g r i c u l t u r a l , i n d u s t r i a l , or commercial purposes, or the
proceeds of which have been used, or are t o be used, f o r such purposes.
I t provides f u r t h e r t h a t nothing contained i n the Act s h a l l be cons t r u e d t o p r o h i b i t such n o t e s , d r a f t s , and b i l l s of exchange, secured
by s t a p l e a g r i c u l t u r a l p r o d u c t s , or other goods, wares, or merchandise
from b e i n g e l i g i b l e f o r such d i s c o u n t ; " b u t such d e f i n i t i o n s h a l l not
include n o t e s , d r a f t s , or b i l l s covering merely investments of issued
or drawn f o r the purpose of c a r r y i n g or t r a d i n g ifa s t o c k s , bonds, or
other investment s e c u r i t i e s , except bonds aid notes of the Government
of the United S t a t e s " .
The Board has r e p e a t e d l y c a l l e d a t t e n t i o n t o the f a c t t h a t r e s o u r c e s
obtained from the F e d e r a l Reserve Bmks should n o t be Used f o r specular
t i v e p u r p o s e s , and a t v a r i o u s times when there has been unusual speculat i v e a c t i v i t y i t has i s s u e d p u b l i c warnings as t o t h e bad e f f e c t of
such a c t i v i t i e s upon t h e banking s i t u a t i o n . The f i r s t warning of t h i s
kind was i s s u e d a s long ago as October, 1915, and the warning has been
r e p e a t e d on s e v e r a l occasions since t h a t date when c o n d i t i o n s made i t
necessary.
On June 10, 1919, the Board made p u b l i c a l e t t e r , which i t had
addressed to a l l Federal Reserve Agents, reading as f o l l o w s :
"The Federal Reserve Boara i s concerned over t h e e x i s t i n g
tendency towards excessive s p e c u l a t i o n , and while o r d i n a r i l y
t h i s . c o u l d be c o r r e c t e d by an aavance i n discount r a t e s a t the
F e d e r a l Reserve Banks, i t i s n o t p r a c t i c a b l e t o apply t h i s check
a t t h i s time because of Government f i n a n c i n g . By f a r the l a r g e r
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889
p a r t of t h e i n v e s t e d a s s e t s of F e d e r a l Reserve Banks c o n s i s t s of
paper secured /by Government o b l i g a t i o n s , and t h e Board i s anxious
t o g e t some i n f o r m a t i o n on which i t can form an e s t i m a t e a s t o
the e x t e n t of member "bank borrowings on Government c o l l a t e r a l made
f o r p u r p o s e s o t h e r t h a n f o r c a r r y i n g customers who have purchased
L i b e r t y Bonds on a c c o u n t , or o t h e r than f o r p u r e l y commercial
purposes."
This l e t t e r was s e n t out f o r t h e purpose of a s c e r t a i n i n g t o what e x t e n t
Government o b l i g a t i o n s were b e i n g used t o secure loans from F e d e r a l Reserve
Banks f o r o t h e r t h a n commercial purposes or f o r c a r r y i n g s u b s c r i p t i o n s .
In i t s monthly p u b l i c a t i o n , t h e F e d e r a l Reserve B u l l e t i n , t h e Board
has c a l l e d a t t e n t i o n r e p e a t e d l y s i n c e t h a t d a t e t o t h e dangerous s p e c u l a t i v e t e n d e n c i e s which have "been p r e v a l e n t *
In a p r i n t e d s t a t e m e n t during t h e summer, the Board made the s p e c i f i c
announcement t h a t i t would n o t s a n c t i o n any p o l i c y which would r e q u i r e the
F e d e r a l Reserve Banks to withhold c r e d i t s demanded b y commerce and i n d u s t r y
f o r the . p r o c e s s e s of p r o d u c t i o n and d i s t r i b u t i o n i n order t o enable member
banks t o f u r n i s h cheap money f o r s p e c u l a t i v e p u r p o s e s .
In o r d i n a r y circumstances and normal times one check would have been
t o advance d i s c o u n t r a t e s , but owing t o t h e f a c t t h a t the Government has
s o l d over twenty-one b i l l i o n d o l l a r s of L i b e r t y Bonds and V i c t o r y Notes,
many of which s e c u r i t i e s have been s o l d t o persons who were unable t o pay
f o r them i n f u l l b u t were obliged t o pay f o r them i n i n s t a l m e n t s out of
s a v i n g s or accrued incomes, i t was f e l t t h a t an advance i n the d i s c o u n t r a t e
on n o t e s secured by Government o b l i g a t i o n s should, so f a r as p o s s i b l e , be
avoided.
The s p e c u l a t i v e movement continued; i t s demands on the banks f o r
c r e d i t coming on top of commercial r e q u i r e m e n t s , of t h e s e a s o n a l crop moving
demand, and of demands a r i s i n g out of the unusual c o n g e s t i o n of export
commodities a t p o r t a .uwiag t o t h e delays i n t r a n s p o r t a t i o n . As a c o n s e quence of. these c o n d i t i o n s , txie r e s e r v e s of the F e d e r a l Reserve Bam.s began
to d e c l i n e , and those of the Federal Reserve Bams, of Hew York, i n p a r t i c u l a r , dropped to such an e x t e n t t h a t the Board, about two weeks ago, approved
an i n c r e a s e i n d i s c o u n t r a t e s of t h a t i n s t i t u t i o n averaging about one-half
of one p e r c e n t . A l l o t h e r Federal Reserve Banks, s h o r t l y a f t e r w a r d s ,
e x p r e s s e d the desire* t o p u t i n t o e f f e c t a s i m i l a r advance i n t h e i r r a t e s ,
which t h e Board approved,
The F e d e r a l Reserve Bank of New York, on November 2nd, the d a t e on
which tne advance i n i t s r a t e s was made p u b l i c , i s s u e d the f o l l o w i n g s t a t e ment supplementing the r e p e a t e d warnings of the Board:
"The r e a s o n f o r the advance i n r a t e s announced, today by t h e
F e d e r a l Reserve Ban±c of Mew York i s the evidence t h a t some p a r t
of the g r e a t volume of c r e d i t , r e s u l t i n g from b o t h Government
and p r i v a t e borrowing, which war f i n a n c e r e q u i r e d , as i t i s r e l e a s e d
from t i n s t o time f r o o Government needs, i s b e i n g d i v e r t e d to
s p e c u l a t i v e employment r a t h e r than to r e d u c t i o n of baruc l o a n s .
As t h e t o t a l volume of t h e Government's loans i s now i n course
of r e d u c t i o n corresponding r e d u c t i o n s i n barn: loans and d e p o s i t s
should be made i n order to i n s u r e an o r d e r l y r e t u r n of normal
credit conditions."
Notwithstanding t h i s n o t i c e , a c t i v i t i e s on t h e exchanges continued
s t i l l d e c l i n e d . During the
Board s o l d to o t h e r F e d e r a l
and tne r e s e r v e s of the F e a e r a l Reserve Banic
http://fraser.stlouisfed.org/
week ending November och the F e d e r a l Reserve
Federal Reserve Bank of St. Louis
->
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Reserve Banks n i n e t y m i l l i o n d o l l a r s of acceptances f o r account of the
Federal Reserve Bank of New York, but i n s p i t e of t h i s a c t i o n the r e s e r v e s
of the New York hank f e l l to f o r t y per c e n t . In these circumstances, i n
order to prevent f u r t h e r expansion, i t "became necessary to c a l l the
a t t e n t i o n of the large r e d i s c o u n t i n g banns to the s i t u a t i o n .
The high r a t e s f o r c a l l money which have p r e v a i l e d continuously f o r
the p a s t two weeks and i n t e r m i t t e n t l y f o r several months p a s t , were in
themselves very c l e a r i n d i c a t i o n of the s t r a i n e d p o s i t i o n ' i n t o which the
unbridled s p e c u l a t i o n had thrown the stock market and rendered a r e a d j u s t ment i n e v i t a b l e unless the resources of the Federal Reserve Banks were to
be i n d i r e c t l y drawn upon f o r stock market purposes* The public has had ample
n o t i c e of the Board *s policy*
You are so f a m i l i a r with the Federal Reserve Act t h a t i t i s hardly
necessary to c a l l your a t t e n t i o n to that paragraph of Section 4, which t r e a t s
of the d u t i e s of the board of d i r e c t o r s of a Federal Reserve Bank and which
provides t h a t {r Said board s h a l l administer the a f f a i r s of said bank f a i r l y
and i m p a r t i a l l y and without d i s c r i m i n a t i o n i n favor of or against any
member bank or banks and s h a l l , subject to the provision of law and the
orders of the Federal Reserve Board, extend to each member bank such d i s counts , advancements and accommodations as may be s a f e l y and reasonably made
with due regard f o r the claims and demands of other member ban##** This
would, of course) a f f o r d means f o r a s t r i c t r a t i o n i n g of c r e d i t s should
such an extreme course ever become necessary.. I t i s i n t e r e s t i n g to note
that there no longer e x i s t s i n the mind of the public or in f a c t a connection
between c a l l money r a t e s and che commercial paper markejr, and i t must be
g r a t i f y i n g to a l l those i n t e r e s t e d i n sound banking methods that the events
of the p a s t week have had no e f f e c t upon the market f o r commercial paper*
Very t r u l y yours,
Governor,
Hon. R,L. Owen,
United S t a t e s Senate
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