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1085 F E D E R A L R E S E R V E B O A R D WASHINGTON December 2,1920. X-2074 Subject Board's reply to l e t t e r cf c r i t i c i s m free: Senator R.L. Owen. Dear S i r : There i s enclosed f o r your information a copy cf t h e Board's reply t o a l e t t e r from Hon. R.L. Owen, United S t a t e s Senator, i n which the Senator c r i t i s e s c e r t a i n p o l i c i e s of t h e Federal Reserve System, Senator Owen's l e t t e r t o the Board has been published i n t h e l o c a l a f t e r n o o n papers today, and the Board has given a copy of i t s l a t t e r t o the Associated P r e s s . You a r e a t l i b e r t y t o f u r n i s h copies of the Board's l e t t e r t o anyone interested. Very t r u l y ycurs, Enclosure. Assistant Secretary. To Governors and Chairmen of F.R. Banks. 1086 COPY November 29,1920. X-2074 My dear Senator: Your l e t t e r of the 18th I n s t a n t Was received several days ago and has been given c o n s i d e r a t i o n by the Federal Reserve Board. You urge ( l ) t h a t the r a t e s of discount e s t a b l i s h e d by t h e Federal reserve banks upon the approval and determination of the Federal Reserve Board be lowered, and (2) t h a t the l o a n s of the Federal reserve banks be expanded "to the extent which may be required f o r purposes of l e g i t i m a t e production and d i s t r i b u t i o n " . The Federal Reserve Board i s r e l u c t a n t to discuss proposed changes i n discount r a t e s , and hae c o n s i s t e n t l y cautioned a l l Federal, r e s e r v e banks t o r e f r a i n from any announcement of recommendations made by t h e i r d i r e c t o r s u n t i l the r a t e s ha \e been approved and made e f f e c t i v e by the Federal Reserve Board. Premature d i s c u s s i o n of discount r a t e s would have.an u n s e t t l i n g e f f e c t and would give those b e s t i n p o s i t i o n t o form an opinion a s t o t h e probable a c t i o n of t h e Board an advantage over those not thus s i t u a t e d . While the r e s e r v e s of the Federal reserve oamcs a s a system a r e stronger than they were several weeks ago, t h e r e i s s t i l l a l a r g e amount of inter-bank r e d i s c o u n t i n g being done, and several of the Federal r e s e r v e banks would today have r e s e r v e s much below the normal minimum required by law - some l e s s than one-half - but f o r the f a c t t h a t under the a u t h o r i t y of paragraph (b) of Section 11 of the Federal Reserve Act they a r e p e r m i t t e d by the Federal Reserve Board t o r e d i s c o u n t some of t h e i r discounted paper with other Federal reserve banks. and p l S c i ^ r t J T E k of°EnglandJ*and S the B ^ d t e g r e t s t h a t % % t h i ^ j o i n t stock banks t o r e l y t o a g r e a t e r degree upon t h e i r own resources i n extending accommodations while s t i l l a f f o r d i n g them an o u t l e t f o r any undue accuomulation of l o a n s . The exigencies of war f i n a n c i n g i n t h i s country were such a s t o make necessary t h e adoption of a policy j u s t the r e v e r s e of t h e time-honored p o l i c y of the Bank of England, and while t h e margin between -2- X-20?U a 1087 Federal r e s e r v e bank r a t e s and current market r a t e s i s not now a s wide a s was the case a year ago, the average l e g a l and current r a t e throughout the country i s s t i l l higher than t h e Federal reserve bank r a t e . I t i s the e x p e c t a t i o n of the Board, however, t h a t conditions w i l l u l t i m a t e l y a d j u s t themselves so t h a t Federal reserve bank r a t e s may be maintained a t a l e v e l s l i g h t l y higher than current r a t e s without any disturbance t o commerce and b u s i n e s s . In f a c t t h i s adjustment has a l r e a d y begun in some d i s t r i c t s where member banks have reduced t h e i r r a t e s on commercial l o a n s . V-hile members of the Board always keep i n mind the matter of discount r a t e s and discuss the s u b j e c t f r e e l y among themselves, they r e a l i z e t h a t i n the determination of Federal reserve bank discount r a t e s r e c o g n i t i o n must be given to going r a t e s and i n t h e r a t e r e v i s i o n s which the Board has approved from time t o time the view has always been taken t h a t discount r a t e s cannot be pegged or fixed a r b i t r a r i l y f o r there a r e always c e r t a i n basic conditions a f f e c t i n g t h e demand f o r and t h e supply of c r e d i t throughout t h i s country and.throughout the world which must be taken i n t o account, and the : formal establishment of a Federal reserve bank discount r a t e i s merely an i n t e r p r e t a t i o n of these c o n d i t i o n s . The whole question of discount r a t e s was discussed a t l e n g t h i n my two l e t t e r s t o you of May 3rd and 24th, 1920. As t o the expansion of loans of the Federal reserve banks " t o t h e extent which may be required f o r purposes of l e g i t i m a t e production and d i s t r i b u t i o n " , your a t t e n t i o n i s called to the f a c t t h a t a t the close of business Friday, November 26, 1920, the invested a s s e t s of the twelve Federal reserve baiks, including bankers' acceptances discounted and bought, member banks' f i f t e e n - d a y c o l l a t e r a l notes secured by Government o b l i g a t i o n s , and e l i g i b l e commercial paper discounted f o r member banks, amounted t o $3,303,7^7,000 a s compared with $3,024,741,000 on Friday, November 28, 1919* Federal reserve notes outstanding on November 26, 1920 amounted t o $3,325,629,000 a s a g a i n s t $2, 852,27 7>000 on November 28,1919* These f i g u r e s prove t h a t during the p a s t twelve months there has been no curtailment or r e d u c t i o n i n t h e aggregate of the c r e d i t s extended by or through t h e Federal reserve banks, but on t h e contrary t h e r e has been a very s u b s t a n t i a l i n c r e a s e which has been steady and continuous a l l through the year, a s i s shown g r a p h i c a l l y by the chart t o which I c a l l e d your a t t e n t i o n when you were i n my o f f i c e a few days ago. As you know, the Federal reserve banks a r e not permitted by law t o have d i r e c t dealings with t h e p u b l i c ; they a r e allowed merely t o rediscount f o r member banks, upon t h e i r endorsement, e l i g i b l e paper a s defined by t h e Act, r e p r e s e n t i n g l o a n s or advancements made by the member banks to t h e i r cilstomsrs, The discount powers of r a t i o n a l banks a r e broadly defined in those s e c t i o n s of the Revised S t a t u t e s of the United S t a t e s commonly known a s "The National Bank Act", and those of t h e s t a t e banks and t r u s t companies which a r e members of the Federal reserve system a r e governed by the laws of the r e s p e c t i v e s t a t e s i n which these i n s t i t u t i o n s a r e l e g a t e d . Thus t h e Federal Reserve Board has no control over the discount p o l i c i e s of i n d i v i d u a l member banks and- cannot f o r c e them t o make l o a n s which they do not d e s i r e toumake, nor can i t r e s t r a i n them from making loans which i n t h e l a w f u l e x e r c i s e of t h e i r d i s c r e t i o n they may make. The e x t e n t t o which the discount f a c i l i t i e s a f f o r d e d by the Federal reserve banks a r e now being used shows t h a t through t h e medium of member banks t h e Federal r e s e r v e banks a r e p a r t i c i p a t i n g a c t i v e l y i n extending c r e d i t s . On August 22, 1907, j u s t b e f o r e the panic of t h a t year, b i l l s payable and r e d i s c o u n t s of a l l n a t i o n a l banks amounted t o $59,177,000 against 1088 i ; -3- X-2074 a t o t a l l o a n s and discounts of $4,709,027, 000, the percentage of b i l l s payable and r e d i s c o u n t s t o t o t a l loans being 1.26%. On September 23, 1908, the p e r centage was 1 . 1 1 $ : on September 1 2 / 1 9 1 4 , t o t a l b i l l s payable and r e d i s counts ha# increased t o the then unprecedented amount of $150,071, 000, or 2,34% of the t o t a l loans, which amounted to $6,417,9^0,000. This increase was due t o t h e disturbance i n c i d e n t to the outbreak of the European war. On September 12, 1916, b i l l s payable and rediscounts had f a l l e n t o $9l-l.i$93,000, or 1.1&$ of the t o t a l of loans of a l l r a t i o n a l banks. On September 11, 1917, the f i r s t year of our p a r t i c i p a t i o n in the war, b i l l s payable and r e d i s counts amounted t o $285,104,000, or 3.09$ of the t o t a l loans, $9#234,289,000. These f i g u r e s , of course, r e f l e c t war f i n a n c i n g . The same observation w i l l apply t o f i g u r e s compiled from r e p o r t s of condition of national banks on August 31, 1918, and September 12, 1919, :.5«vhen the percentages of r e d i s counts to t o t a l loans were 12.8$ and 13.04^ r e s p e c t i v e l y . There has, however, been no new f i n a n c i n g by the Government since the f l o t a t i o n of t h e Victory Loan; the t o t a l volume of Government obligations outstanding has decreased since September 12, 1919) when rediscounts and b i l l s payable of a l l n a t i o n a l banks amounted t o $1,50$,516,000, while on September £, 19-0, the n a t i o n a l banks' l i a b i l i t y f o r money borrowed i n t h i s way amounted to $2,299,o40,000, . or 16.8% of t h e i r t o t a l loans of $13,723,611,COO. The f i g u r e s for s t a t e banks and t r u s t companies a r e not a v a i l a b l e , but t h e r e i s no reason to believe t h a t the proportion of money borrowed by these i n s t i t u t i o n s t o t h e i r loans and discounts i s any l e s s than t h a t shown by the rational banks. The foregoing f i g u r e s demonstrate c l e a r l y t h a t the present discount r a t e s a t the Federal reserve banks a r e by no">'means p r o h i b i t i v e and the Board does not believe t h a t if Federal r e s e r v e bank discount r a t e s should be lowered i n advance of a decline i n the general l e v e l of i n t e r e s t r a t e s there would be any apprec i a b l e reduction i n the r a t e s member banks would charge t h e i r customers. You r e f e r i n your l e t t e r t o the f a c t t h a t "the Federal Reserve Board i s approving a &%• r a t e on loans secured by Treasury C e r t i f i c a t e s of i n d e b t edness" . As you know, the r a t e of i n t e r e s t borne by these o b l i g a t i o n s i s determined by the Secretary of the Treasury, Recent i s s u e s of Treasury c e r t i f i c a t e s have borne i n t e r e s t a t from 5*% t o 6 p e r annum according to t h e length of time they have t o run. I t i s the Board's understanding t h a t i t i s the policy of the present Secretary of the Treasury t o o f f e r c e r t i f i c a t e s at r a t e s s u f f i c i e n t l y high a s t o make them a t t r a c t i v e t o i n v e s t o r s , l a r g e and small, thus e f f e c t i n g t h e i r d i s t r i b u t i o n t o the public instead of having them congested i n the p o r t f o l i o s of the banks or passed along by them t o the Federal reserve banks. The Federal Reserve Board has approved f o r notes secured by Treasury c e r t i f i c a t e s of indebtedness r a t e s corresponding with the r a t e s of i n t e r e s t borne by the c e r t i f i c a t e s , thus giving member banks an opportunity of carrying them without l o s s pending t h e i r d i s t r i b u t i o n but o f f e r i n g the banks no inducement i n the way of a spread i n t h e r a t e t o r e t a i n them a s an investment i n s t e a d of p a s s i n g them on t o t h e p u b l i c . In t h i s way the banks of t h e country and the Federal r e s e r v e banks a r e b e t t e r able t o respond to the requirements of a g r i c u l t u r e , commerce and i n d u s t r y than would be the case if a l a r g e r p o r t i o n of t h e i r a s s e t s were invested i n Government o b l i g a t i o n s , X-207U a You s t a t e t h a t " i t seems t o be the policy of the Board to r a i s e the r a t e s of i n t e r e s t f o r the purpose of broadly d e f l a t i n g c r e d i t s " . The r a t e s were r a i s e d not f o r the purpose of a broad curtailment or d e f l a t i o n oi c r e d i t s , but with the object of bringing about more moderation i n the use of c r e d i t s , which a year ago were being d i v e r t e d i n t o a l l kinds of s p e c u l a t i v e and n o n - e s s e n t i a l channels, and f o r the a d d i t i o n a l purpose of conserving the resources and c r e d i t power of t h e member banks and of the Federal reserve banks i n order t h a t they might b e t t e r respond t o the seasonal needs which a r i s e every autumn. The chart t o which r e f e r e n c e has been made shows t h a t on September 1% 1919; the t o t a l earning a s s e t s of a l l Federal Preserve banks were i n round a,nountg $2,350,000,000, while on January 27, 1920, the t o t a l was n e a r l y $3,300,000,000, an increase of almost $1,000,000,000, or nearly 5 $ w i t h i n a period of four months. The chart shows g r a p h i c a l l y t h a t the angle of ascending c r e d i t during t h i s t i n e was 45 degrees. Certainly no banking system which permitted so rapid an expansion of c r e d i t could long s u s t a i n i t s e l f , and while no d e f l a t i o n was attempted, measures were taken t o r e g u l a t e the c r e d i t expansion. Consequently the Board approved a sharp advance i n discount r a t e s f o r a l l of the Federal reserve banks between January 23 and January 30th. This advance brought about a moderate amount of l i q u i d a t i o n , and the chart shows t h a t by March 26th, the earning a s s e t s of the Federal reserve banks had declined to $3,200,000*000. About the middle of May, however, the tendency towards f u r t h e r expansion ag&in became marked and the earning a s s e t s of the Federal reserve banks approached the previous l e v e l of $3,300,000,000. On the 18th of May the Board held a conference with members of the Federal Advisory Council and the Class "A" d i r e c t o r s of the ^Federal reserve banks, a t which i t pointed out t h a t i n view of the e s s e n t i a l c r e d i t requirements which the banks had ahead of them l a t e r on i n the year, i t was necessary t o check the r a t e of expansion, Following the conference the banks of the country were urged t o use more d i s c r i m i n a t i n g judgment i n the matter of extending c r e d i t and to give p r e f e r e n c e i n t h e i r loaning operations to e s s e n t i a l c r e d i t s , being advised a t the same time t h a t they themselves must be t h s judges of the e s s e n t i a l c h a r a c t e r of the purposes f o r which loans were asked of them. I t i s i n t e r e s t i n g t o note t h a t a somewhat s i m i l a r policy of c r e d i t r a t i o n i n g has been urged by t h e French Government upon French banks, and t h a t the B r i t i s h banks under the l e a d e r s h i p of t h e Bank of England have f o r many months p a s t been e x e r c i s i n g a d i s c r i m i n a t i n g judgment i n granting c r e d i t accommodations. At the beginning of the p r e s e n t year, upon the previous recommendation of t h e Royal Commission on Currency and Exchanges, and a t the i n s t a n c e of the Chancellor of the Exchequer, a l i m i t was fixed on the maximum amount of currency n o t e s which might be i s s u e d - d u r i n g the year 1920, not t o exceed the -raximum amount o u t s t a n d i n g during the year 1919 -5- X-2074 a Following t h e conference on May 18th t h s darning a s s e t s of the Federal r e s e r v e banks gradually declined u n t i l July 23rd, when they were around $3,150# 000, 000, Since t h a t date they have advanced s t e a d i l y with occasional s l i g h t r e c e s s i o n s u n t i l November 26th when t h e t o t a l amount reached $3 , 303 , 74-7., 000, The chart shows t h a t while the angle of c r e d i t from September 19, 1$19, to January 27, lg20, was about 45 degrees upward, the angle from January 27, 1920, to November 26, 1920, shows an upward s l a n t of only about 2 degrees. In your l e t t e r you s t a t e t h a t the Federal Reserve Board has been p u r s u i n g f o r a year a p o l i c y of high i n t e r e s t charges which has "brought on a c o n d i t i o n of i n d u s t r i a l depression r e s u l t i n g i n checking, and i n some cases a b s o l u t e l y stopping, l e g i t i m a t e production and l e g i t i m a t e d i s t r i b u t i o n " . You seem t o l o s e s i g h t of the f a c t t h a t t h e p r o d u c t i o n of g r e a t a g r i c u l t u r a l s t a p l e s t h i s year has been unusually l a r g e and t h a t the p r i c e r e c e s s i o n s of which you complain are due i n p a r t t o worldwide c o n d i t i o n s : and you a l s o ignore the economic f o r c e s governing the movement i n p r i c e s which f o r months p a s t have been i n evidence a l l over t h e w o r l d . I t was g e n e r a l l y recognized many months ago, f o l l o w i n g t h e c o l l a p s e of the s i l k market i n Japan e a r l y l a s t spring, t h a t c e r t a i n p r i c e r e a d j u s t m e n t s were i n e v i t a b l e . In f a c t , a s e a r l y a s August 1$19 t h e continuous expansion of c r e d i t and the c o n s t a n t l y advancing c o s t s of l i v i n g became o b j e c t s of grave p u b l i c concern, and the Senate addressed a communication on the s u b j e c t t o the Federal Reserve Board on August 5# 1919* Shortly a f t e r w a r d the P r e s i d e n t i n an a d d r e s s t o Congress c a l l e d a t t e n t i o n to t h e dangers of the s i t u a t i o n . From t h a t time u n t i l t h e adjournment of Congress l a s t June these m a t t e r s were the s u b j e c t of f r e q u e n t d i s c u s s i o n s i n both Houses. In the United S t a t e s an important f a c t o r has been t h e r e v u l s i o n of sentiment a g a i n s t the unnatural l e v e l s 6 t £ a i n e d by p r i c e s i n the year 1919, when circumstances over which the Federal Reserve Board haA no c o n t r o l , prevented t h e Federal r e s e r v e system from e x e r c i s i n g ifti important f u n c t i o n of r e g u l a t i n g t h e flow and volume of c r e d i t . On the 17th of May l a s t the -Senate adopted a r e s o l u t i o n (No, 3^3) d i r e c t i n g t h e Federal Reserve Board "to advise the Senate what s t o p s i t purposes t o t a k e or t o recommend t o t h e member banks of the Federal Reserve System to meet t h e e x i s t i n g i n f l a t i o n of currency and c r e d i t s and consequent high p r i c e s , and what f u r t h e r s t e p s i t purposes t o t a k e or recommend t o mobilize c r e d i t s i n order t o move the 1920 c r o p " . There were l a r g e i m p o r t a t i o n s of wool brought i n t o t h e United S t a t e s j u s t a t t h e time when our domestic wool c l i p was coming i n t o t h e market, which r e s u l t e d i n a slump i n the p r i c e of wool, and i n t h e u t t e r demorali z a t i o n of the wool market. Sugar was advanced by s p e c u l a t i v e manipulation u n t i l i t reached a p r i c e which checked domestic consumption and v i r t u a l l y stopped e x p o r t s t o Europe while s t i m u l a t i n g imports i n t o t h e United . S t a t e s from p r a c t i c a l l y a l l eug^r producing c o u n t r i e s i n the w o r l d . Then followed a d r a s t i c d e c l i n e i n t h e p r i c e of sug^r. Imports of rubber and c o f f e e i n c r e a s e d i n l i k e manner u n t i l t h e accumulated s t o c k s became so g r e a t t h a t t h e markets c o l l a p s e d . The domestic p r o d u c t i o n of o t h e r g r e a t s t a p l e s - c o t t o n , corn, wheat, r i c e and tobacco - proved t o be g r e a t e r and t h e demand f o r them l e s s t h a n had been expected, and the p r i c e s c i 1091 -6- X-2074 a of t h e s e commodities have declined s h a r p l y . Meanwhile t h e r e has been, ever since the Board undertook to hold the t i d e of expansion i n check a year ago, a p e r s i s t e n t campaign of m i s r e p r e s e n t a t i o n of the Board's p o l i c i e s with f r e q u e n t misstatements of studied avoidance of b a s i c f a c t s and f i g u r e s . Not only have exaggerated ideas of the powers of the Board been disseminated, but some of t h e Board's c r i t i c s have published statements repeatedly t o the e f f e c t t h a t i t s p o l i c i e s were ruinous, t h a t i t was determined t o bring about d r a s t i c d e f l a t i o n , and t h a t the i n e v i t a b l e r e s u l t would be widespread d i s a s t e r . I t speake well f o r the common sense of the country t h a t the p u b l i c has r e f u s e d t o be stampeded, although perhaps the c r i t i c s may have succeeded i n some cases i n making conditions appear worse t h a n they r e a l l y a r e . The Board b e l i e v e s t h a t the unfavorable conditions which are now the s u b j e c t of so much complaint were i n e v i t a b l e and could not i n any event nave been long d e f e r r e d . I t confidently a s s e r t s t h a t but f o r the precautionary measures taken several months ago conditions today would be f a r worse than they are with the prospects of s t a b i l i z a t i o n and r e v i v a l much more remote. The Bbard agrees with you, however, t h a t i n some sections t h e r e has been a very s u b s t a n t i a l curtailment of c r e d i t s during the p a s t twelve months, p a r t i c u l a r l y in those c r e d i t s which a r e r e l a t e d t o nonproductive a c t i v i t i e s . This curtailment i s p a r t i c u l a r l y in evidence i n the City of New York, as pointed out by you i n your l e t t e r when you say " i n c i d e n t a l l y , the individual deposits of New York City batiks which were November 12, 1313, $6,313/998,000 were reduced on November 10, 1920 to $4,916,375> 000, a net l o s s of deposits i n New York City of about $1,400^000,000' and a net r e d u c t i o n of loans amounting to a s i m i l a r amount". There has not however been a s i m i l a r curtailment i n the country a t l a r g e , f o r a s you say i n your l e t t e r "but while the i n d i v i d u a l d e p o s i t s and loans of New York City banks were coming down, the t o t a l d e p o s i t s of a l l the banks of the country, including bank d e p o s i t s , increased according to the Comptroller v e l e t t e r of October 13, 1920, $4, 04$, l64, 000, and loans increased $5, £05,73W 000 ( i n cluding o v e r d r a f t s and discounts) f o r the f i s c a l year ending June 30th, 1920, so t h a t t h i s d i s p a r i t y of reduced deposits and loans in New York City i s a l l the more conspicuous". You say f u r t h e r t h a t "the New York City banks have above a l l o t h e r s pursued the policy of i n d i s c r i m i n a t e d e f l a t i o n , and have d e f l a t e d t h e i r own d e p o s i t s a c c o r d i n g l y . The balance of the country's banks, t h e r e f o r e , increased t h e i r d e p o s i t s , exclusive of New York, about $5, 000, COO, 000", The Board has no information showing t h a t t h e banks of New York City have pursued a "policy of i n d i s c r i m i n a t e d e f l a t i o n " , f o r although t h e r e has been a s u b s t a n t i a l r e d u c t i o n i n the volume of S t r e e t loans, secured by stock exchange c o l l a t e r a l , the f a c t s a r e t h a t the f a l l i n g off i n t h e d e p o s i t s of New York City banks has been caused p r i n c i p a l l y by withdrawals by i n t e r i o r correspondents, and not only have banks i n o t h e r s e c t i o n s of the country checked h e a v i l y upon t h e i r e x i s t i n g balances i n New York City 1092 -7 X-2074 a but they have increased considerably t h e i r discount l i n e s with t h e i r correspondent banks in t h a t c i t y , Ac You s t a t e "the p r i c e of Government bonds has been s e r i o u s l y d pressed because the American market of stocks and bonds i s loca e m ^ New York City, where t h i s p o l i c y of d e f l a t i o n i s p e c u l i a r l y i n evidence In my previous correspondence with you I pointed out t h a t the d e c l i n e i n the market value of Government bonds was no r e f l e c t i o n upon t h e i r i n t r i n s i c worth, f o r i t r e f l e c t e d merely temporary conditions i n t h e money market. Government bonds are investment s e c u r i t i e s payable at a f i x e d time in the f u t u r e and bearing a r a t e of i n t e r e s t lower than t h a t borne by other high-grade s e c u r i t i e s a v a i l a b l e f o r purchase by the^ p u b l i c . With the exception of the F i r s t Liberty Loan which bears i n t e r e s t at the r a t e of only ) i $ , the Government war o b l i g a t i o n s have very limited t a x exemptions. The i n v e s t o r can choose between Government bonds b e a r i n g 4 0 , i n t e r e s t with n e g l i g i b l e tax exemptions, s e c u r i t i e s issued by p r i v a t e corporations tearing much h i g h e r r a t e s of i n t e r e s t , and municipal bonds bearing i n t e r e s t at the r a t e of 5$ o r m o r e 7 'hich have f u l l tax exemptions. Your a t t e n t i o n was a l s o c a l l e d to the f a c t t h a t the average p r i c e of Liberty Bonds i n the market declined to acout 9#a t a time when Federal reserve banks were discounting a t a •+% r a t e notes secured by Liberty Bonds carrying a r a t e of In your l e t t e r of April 27th you a t t r i b u t e d the d e c l i n e i n the market value of Liberty Bonds e n t i r e l y to the advance i n discount r a t e s at the Federal reserve banks, giving no c o n s i d e r a t i o n to the p o s s i b l e e f f e c t b£ the withdrawal from the market of the w a r Finance Corporation as a d a i l y purchaser. In my l e t t e r to you of May 3r&» I ventured the p r e d i c t i o n t h a t "the policy of the Federal Reserve Board to curb i n f l a t i o n w i l l , in the long run, r e s u l t in improving the market value of Liberty Bonds and a c o n t r a r y policy of f u r n i s h i n g c r e d i t at cheap r a t e s a t a time l i k e t h i s would impair the market. The value of a promise to pay a sum c e r t a i n a t a f u t u r e date i s impaired by the i n f l a t i o n which the Board i s t r y i n g to c o n t r o l . " In my l e t t e r to you of May 24th, I s t a t e d "the o b l i g a t i o n s of the Government of the United S t a t e s o f f e r the b e s t opportunity f o r investment in the world today• They are being sold now on a most a t t r a c t i v e investment b a s i s , and as speculative tendencies are curbed, as the gains of the p r o f i t e e r s are reduced, as commodity p r i c e s d e c l i n e , and as the b u s i n e s s and industry of t h i s country s e t t l e down to a more normal peace b a s i s , the market value of these s e c u r i t i e s w i l l r i s e very r a p i d l y . " A comparison of market quotations l a s t May with those of the p a s t week w i l l show t h a t Liberty Bonds have advanced s e v e r a l p o i n t s . You s t i l l appear to be i n c l i n e d to the opinion which you expressed in your l e t t e r s to the Board l a s t spring t h a t Federal reserve bank d i s count r a t e s should be r e l a t e d t o the earnings of the Federal reserve banks. You say i n your l e t t e r of November 18th that "the Federal r e serve banks earned l a s t year over one hundred p e r c e n t , and are earning now at a r a t e in excess of one hundred and f i f t y p e r c e n t . p e r annum on 109,3 M —8— X—d07 4 s i t s c a p i t a l , c o n t r a r y to a sound p u b l i c p o l i c y - This excess p r o f i t i s a l l the more r e p r e h e n s i b l e because i t goes to the Treasury, i s made "by a Governmental i n s t r u m e n t a l i t y and puts the Government in the p o s i t i o n of p r o f i t e e r i n g , and s e t t i n g a n a t i o n a l bad example." I endeavored t o p o i n t out i n my l e t t e r of May 24th t h a t the earnings of the Federal reserve banks were the r e s u l t of t h e i r l a r g e volume of invested a s s e t s , as much as the r a t e of i n t e r e s t obtained from these investments, which include r e d i s c o u n t s f o r member banks. The earnings of the Federal reserve banks depend as much upon the volume of loans and investments as upon the r a t e of d i s c o u n t . The p r e s e n t large volume of invested a s s e t s of a l l Federal Reserve banks r e s u l t s in p a r t from the demand f o r currency which i n the fortn of Federal reserve n o t e s has been f u r n i s h e d by the Government through the Federal reserve banks. The volume of these n o t e s now i n c i r c u l a t i o n i s about * 3 I 3 C 0 , 0 G 0 , 0 0 0 . A d i r e c t i n t e r e s t charge of 2% on these n o t e s a g a i n s t the Federal reserve banks, which the Board i s authorized by law to impose, would b r i n g a r e t u r n to the Government of *66,000,000, an amount approximately as g r e a t as t h a t which a l l the Federal reserve banks are expected in January t o pay t o the Government as a f r a n c h i s e tax out of t h e i r excess e a r n i n g s . Had such an i n t e r e s t charge been imposed t h i s year the e a r n i n g s of the Federal reserve banks on t h e i r c a p i t a l would not have been regarded as abnormal. The c a s e , however, may be s t a t e d in another way.aud i t i s well t h a t i t should b e , in view of your repeated charge of " p r o f i t e e r i n g " . In an ordinary banking corporation the sole c o n t r i b u t i o n by the stockh o l d e r s i s the p a i d - i n c a p i t a l stock plus accumulated and u n d i s t r i b u t e d earnings; the d e p o s i t s , which are the p r i n c i p a l b a s i s of t h e b a n k ' s earning power, come from the p u b l i c . In such cases the earnings a r e measured i n terms of percentages of the b a n k ' s c a p i t a l , or i t s c a p i t a l and s u r p l u s . The Federal reserve banks on January '1, 1$21 w i l l have an earned and accumulated surplus equal to about 200% of t h e i r p a i d - i n c a p i t a l . They a l s o hold the reserves of t h e i r stockholding banks, which are d e p o s i t s without i n t e r e s t c o n t r i b u t e d not by the public but by the stockholding banks, and these reserve d e p o s i t s during the p a s t year have averaged about $1,800,000,000. I f , t h e r e f o r e , the percentage of earnings of the Federal reserve banks should be expressed in terms r e l a t e d not t o the c a p i t a l s t o c k alone but to the t o t a l c o n t r i b u t i o n s of t h e i r stockholders, t h a t i s , c a p i t a l plus reserve "balances, without taking i n t o account the s u r p l u s which in the l a s t a n a l y s i s i s the property of the Government, the n e t earnings of the Federal reserve banks f o r the p r e s e n t year w i l l be, not 150$ or more, b u t b a r e l y 7$ 0 I i t h e i r l i a b i l i t y to s t o c k h o l d e r s . The Board does not deem i t necessary t o e n t e r i n t o a d i s c u s s i o n of your a n a l y s i s of the p o s i t i o n of the Bank of England. Our f i n a n c i a l s i t u a t i o n i s d i s t i n c t l y d i f f e r e n t from t h a t of England, our laws and banking p r a c t i c e s are n o t the same, and i t i s d i f f i c u l t t o make a comparison of the statement of the twelve Federal r e s e r v e banks combined hi _9_ x 207u a with the statement of the Bank of Englnad. You say "England i s not on a gold b a s i s " , It i s c e r t a i n , however, t h a t America i s . • R e s t r i c t i o n s upon the export of gold from t h i s country were removed by the P r e s i d e n t in June, 1919* and since t h a t time we have maintained an a b s o l u t e l y f r e e gold market, thereby enhancing g r e a t l y American p r e s t i g e everywhere end e s t a b l i s h i n g a c r e d i t throughout the world never b e f o r e enjoyedOur f r e e gold market i s one of the chief i n f l u e n c e s which causes such a world-wide premium on d o l l a r s , which i n c i d e n t a l l y gives us a command of the world market f o r g o l d . You p o i n t out i n your l e t t e r t h a t on a recent date "gold was a t a premium of f o r t y - f i v e per cent- in London while s e l l i n g a t par in New York. This e x p l a i n s why the paper pound S t e r l i n g i n New York i s s e l l i n g on the Exchange around $3*35 p e r pound" . Would i t n o t , however, be more accurate t o s t a t e the case the other way around and t o say t h a t because the paper pound g t e r l i n g i s a t a discount and because the paper currency of other c o u n t r i e s i s a t a d i s c o u n t , gold i s s e l l i n g at a premium i n England and i n other c o u n t r i e s , while s e l l i n g a t p a r i n New York where American paper currency has a value equal to t h a t of gold? The Board r e g r e t s to l e a r n t h a t in your opinion public confidence i n the wisdom of the Federal Reserve- Board and the Federal reserve bank management i s being impaired, b u t hopes that even th'Ough your views and those of the Board as to the proper p o l i c y t o be pursued i n the p r e s e n t circumstances may not coincide in a l l r e s p e c t s you may l a t e r on reach the conclusion in the l i g h t of subsequent events t h a t the oa s p o l i c i e s are sound. I t i s impossible to f o r e c a s t the f u t u r e accura e y , but the recent past i s an open book and we should always s r i v e o p r o f i t by experience. You may remember t h a t about eighteen t>e ^^ e v e d. i t possible t o s t a b i l i z e the p r i n c i p a l f o r e i g n Arrerir a m a i n t a i n them at a p a r i t y with each o t h e r and with the a m a t t e r cf J i >&n^ * remember c o r r e c t l y you urged the Board as reference duty to undertake t h i s s t a b i l i z a t i o n . In view of the are e x p e r i e i ^ your l e t t e r to the embarrassment t h a t export houses the the riroblp-m« inference may be drawn t h a t you do not now regard 6 C t e d with once did and t w our f o r e i g n trade as being as Simple as you Board t o • ?° U r e a * i z e how impossible i t would have been f o r the n t r y h8d the B<mrd attempted to c a r r y out your s u g g e s t i o n . R e s p e c t f u l l y yours, W. P - G. HARDING Hon. Robert 1 . Owen, united S t a t e s S e n a t e . G o v e r n o r .
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