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X -9126 September 28, 1928. The Effect of Government Security Operations on Member Bank Reserves During the Period of the 3ff/o Rate, Namely, from August 4, 1927, to February 3, 1928s The claim is often made that the reduction in the discount rate from 4 to 3-kfo, and the accompanying purchases of Government securi ties during the period in which this rate was in force, - August 4, 1927 to February 3, 1928, - caused "easy" or "Cheap" credit which was responsible for the speculative craze on the New York Stock Exchange. For example, the New York Commercial Chronicle of August 4, 1928, stated: "Who is responsible for the speculative folly, the ill effects of which are now visible on every side? Not the banks, no matter how their course is to be deprecated, but the Federal Reserve, every move of which during the last twelve months has been fraught with latent mischief. Did not the Federal Reserve banks last summer reduce their rates of rediscount to 3-gfo, even compelling one obstreperous Reserve bank in the west to make the reduction against its emphatic objection and protest? At that time, the member banks were not borrowing, as they are to day, over yl5000,000,000 at the reserve banks, but barely half that amount, and could not be induced to increase their borrow ings even at the low rate of 3g-/c, since they had no use for the money. Did not the Reserve banks then undertake to thrust out Reserve credit on unwilling banks by purchasing several hundred million dollars of Government bonds, thereby flooding the market with Reserve funds to a corresponding amount?" The 3 ^ discount rate was in force, at least at New York, from August 4, 1927, to February 3, 1928, and it will be interesting to consider just what was the course of Federal Reserve credit in the whole System during this period, and examine as to how far the above -2 - .,-912 6 criticism of "cheap" money through lower discount rates and Govern ment security operations, is justified. The essential figures are as follows: August 4, 1927 - February 5, 1928: Member bank reserve balances increased Gold stock decreased Discounts increased Acceptances increased United States securities decreased All other Federal Reserve credit decreased Total Federal Reserve credit increased Treasury credit increased Money in circulation decreased Foreign bank deposits, etc. decreased 107,000,000 203.000. 000 61,000,000 2 0 5 ,000;000 2,000,000 60,000,000 204.000. 000 8,000,000 105.000. 000 6,000,000 Taking this period as a whole, it is clear that, comparing the beginning and end of this period, neither discounts nor Government securities were having any inflationary effect, for discounts had increased only 61 millions, a normal seasonal increase, at the end of the period, while Government securities had actually declined 2 millions. Furthermore, the total increase of Federal Reserve credit during the period, - 204 millions, - just offset the gold exports which were 203 millions, while the decline in money in circulation, 105 millions, - practically accounts for the increase in member bank reserves, - 107 millions - during the period. The above figures show that the hundreds of millions of Govern ment bonds, the purchase of which by the Federal Reserve System "flooded the market" - as claimed in the above quoted editorial, - X-9126 -3- had been neutralized by the sale of even larger amounts of these bonds, there being at the end of the period 2 million dollars less of such holdings than at the beginning, - and all this under the 3£f/o rate l It may be claimed, however, that these figures do not give a clear picture of what took place, because during the month of January, 1528, the tide turned, Federal Reserve credit declining 373 millions and member bank reserve balances declining 113 millions. Let us then consider the period from August 4, 1927, to December 31, 1927, ex cluding the month of January 1928 when credit conditions were re versed. The following table shows the situation: August 4, 1927 to December 31, 1927: Member bank reserve balances increased Gold stock decreased Discounts increased Acceptances increased United States securities increased All other Federal Reserve credit decreased Total Federal Reserve credit increased Treasury credit increased Money in circulation increased Foreign bank deposits decreased Other items increased 220,000,000 200,000,000 173.000. 222.000. 205.000. 23.000. 577.000. 20.000. 175.000. 3.000. 000 5.000. 000 000 000 000 000 000 000 The above figures show that during that period there were gold exports to the amount of ^200,000,000, while the purchase of Govern ment securities increased 205,000,000. set off the one against the other. circulation m s It would seem to me fair to So also the increase in money in ^175,000,000, and this was practically offset by the 000 X-S126 -4 increase in discounts of ^173,000,000. It would seem clear that the gold exports of 0200,000,000 during this period, if not offset in some manner, would have forced a defla tion of member bank deposits amounting to at least ten times the amount, or about 2 billions of dollars, and the worst that can be said as to Government security operations during this period is that they prevented a radical deflection caused by gold exports. They cer tainly, taking the period as a whole, brought about no inflation of deposits. It may be claimed, however, that while these figures are correct, taking the w h o l e period, yet that there were particular times during this period when the purchase of Government securities placed money in the market which went directly into member bank reserves, thus making additional deposits growing out of loans, possible. Let us then consider the two quarterly periods of the latter part of 1927, during which the 3^/o rate was in force. Let us take the quarter beginning in July and ending in Septem ber, during all of which period, except July, the 3&yo rate was in effect. The figures for this period are as follows: Member bank reserve balances increased Gold stock decreased Discounts decreased Acceptances increased Government securities increased All other Federal Reserve credit decreased Total Federal Reserve credit increased Treasury credit increased Money in circulation increased Foreign bank deposits decreased 44.000. 000 16.000. 000 6,000,000 39.000. 000 136,000,000 20.000. 000 149,000,000 9,000,000 97,000,000 5,000,000 175 -5 - A-9126 The increase in member bank reserves during this period was very moderate, - only 44 millions, - v and taking the quarter as a whole could be covered by acceptances, - 39 millions, - and foreign bank deposits, - 5 millions, while the Government security opera tions, - showing an increase of 136 millions, - would, as to all but 17 millions, have offset the gold exports 16 millions, the de cline in discounts, 6 millions, and money in circulation, which latter increased 97 millions* Let us now consider the quarter, October through December, 1927. The figures for this quarter are as follows: Member bank reserve deposits increased Gold stock decreased Discounts increased Acceptances increased United States securities increased All other Federal Reserve credit increased Total Federal Reserve credit increased Treasury credit increased Money in circulation increased Foreign bank deposits decreased Other items decreased 194.000. 192.000. 145.000. 142.000. 111.000. 26,000,000 424,000,000 13.000. 55.000. 3.000. 000 1.000. From the above figures, it appears that gold exports had in creased 192 millions, and money in circulation had increased 55 mil lions, which was offset by Government security purchases, - 111 millions, and discounts, - 145 millions# On the other hand, the member hank: reserves at the end of this period had increased 194 millions, which increase was practically furnished from the increase in acceptances, - 142 millions, other Federal Reserve credit + 26 4 000 000 000 000 000 000 000 000 -6- X-9126 millions, and Treasury credit,-*13 millions. nn examination of the above table seems to show that neither the discounts under the 3^o rate, nor the Government security opera tions were, on the whole, primarily or necessarily responsible for the increase in member banks reserves upon which the pending specula tion on the New York Stock Exchange rests. I'Giile it is often claimed, as shown above, that the lowering of the discount rate to produced "easy11 or nchea.p,! credit, it should not be forgotten that credit was easy or cheap, if you so wish to call it, before the rate reduction of August 4, 1927, from 4 to • For example, on March 31, 1927, as compared with the previous December 31, 1926, gold imports had increased 105 millions, money in circulation had decreased 233 millions, discounts had decreased 186 millions, and acceptances had decreased 142 millions, the total Federal Deserve credit decrease being 308 millions. Similarly, comparing June 30, 1927, with March 31, 1927, we find that discounts had decreased 8 millions, acceptances decreased 28 millions, money in circulation decreased 11 millions, and that while Government securities increased 22 millions, the total Federal Reserve credit increase was only 9 millions. The above gives a fair picture of the easy money conditions existing before the rate v/as reduced from 4 to 3yL;%. -7 1 The purpose of the reduction of the rate from 4 to X -9126 was primarily to prevent a continuance of gold imports into the United States, which, in the absence of any large volume of discounts which could have been paid off, would certainly have tended to in flate the credit structure. Another reason -was to give, if possible, some relief to business, commerce, and agriculture, which had been in a state of recession but vrz is just beginning to improve. It is fair to state that this lowering of the rate did accomplish both of the above purposes in more or less degree. The conclusion I reach from these figures is that while psycho logically an easier feeling was created, the increase in member bank reserves can be explained without reference to lower discount rates or Government security operations. Turning now to the so-called brokers1 loans, a study of the charts will fail to reveal any material difference in the increase of such loans, either prior to, during, or subsequent to the 3 discount rate, except that the New York banks have shown a tendency to reduce these loans, more or less overcome by an increase on the part of out-of-town banks, while the loans made "for others" have steadily increased from the middle of 1926 to date, this increase being practically the same, whether during low rate or high rate periods. As regards Government security operations, I am inclined to 78 -8 - X -9126 believe that Federal Reserve credit conditions would have been sub stantially the same had there been no such operations during the 3vf/o period, as discounts would have taken their place* In conclusion, it seems to me that the claim tha.t the 5 ^ dis count rate and Government security operations during the period running from August 4, 1927,- to February 3, 1928, created cheap money, and flooded the member bank reserve account, thus exciting speculation on the Hew York Stock Exchange, is a myth which has no foundation in reality* faking the whole period during which the rate was in ef fect, - August 4, 1927 to February 3, 1928, - while Government se curity purchases moved up and down, being 2 millions less at the end than at the beginning, the growth of acceptance holdings was steady and was 205 millions more at the end than at the beginning* The acceptance growth seems more responsible for the increase in member bank reserves than Government securities*
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