The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
. ~- 70 . W. P. 8, HARDIN$, GOVIINOR ALaiRT STRAUSS, Yl~l IIOYIINOR ADOLPH C. MILLER CHARLES S. HAMLIN HENRY A. MOEHLENPAH CUTER ILASS BICIITARY or THI TIIAIUIY CH!-IRIIAM FEDERAL RESERVE BOARD JOHN SKILTON WILLIAMS COIIPTROLLII OF THI CUIIINCY ADDRESS REPLY TO W. T. CHAPMAN, SICRITARY R. G. EIIERSOH, ASSISTANT SICIITARY W, II, IMLAY, FISCAL AGIJIT WASHINGTON FEDERAL RESERVE BOARD Jmuary 10,1920 X-1786 Remazoks of Mr. James B. Forgan before the .American Econoxxdc Association on· tbe subject of n Prices ald -13anldng Polict'. Subject:· •. Dear Sir:- There 1s enclosed berewi th for your information ex~racts fran reilr.arks by Mr. Janes :B. Forgan, President of the Federal Advisory Council on the subject of "Prices and :Banking Policy" at a recel'lt meeting of the American Economic Association. Very truly yours • Enc .. II Governor. . letter to Chairnen and Governors of all F .R. · »a:nks. 71 X-1766 a Extracts from remarks by Mr. James B. Forgan, PreHident of the Federal Council, on t~e subJect of " Prices and Banking Policy 11 at a recent meeting of the Pmerican Economic Association. ~dvisory "Tbe most urgent :p-ractical question raised by Professor Moulton is, as to whether the Federal Reserve system is J;Oing to prove the unfailing tower of strength:,we have accustomed ourselves to consider it and whether) as has been generally proclaimed, it will forever prevent tbe recurrence of tbe ,periodical fina1:..cia.l r;anics, which prior to its organization were so frequept in this country. 1 "Professor Moulton s!'lys that it has recently been computed that the Federal Reserve banks as a whole could still expand the total volume of credit by over a billion dollars before the reserves of the system as a whole would be down to the limits prescribed by law. 1 This may be so, provided they can continue to get an ever expandin5 outlet for their circulation, which now stands at over ~~~~00,000,000 and u they can maintain continue to increase their reserve d.eposits now '>t.a:nding at over $l,SOO,OOO,OOQ. These two amounts combined - $4,6oo,oou,OOO, form the credit ext~ndcd tr; the Fed~ral Reserve banks by thair member banks ani the :public against which tht:y are required to keep a mimimum gold reserve of 4o% on the former (their circulation) and of 35% on the latter (their reserve deposits). On the basis of the credits thus ex. tended to them and of their ;:;old r<.?serve they have loaned to member banks over ~2,J.OC.>~·Qu0,000, about 73% of which is a6ainst Government securities, besides which they carry Government obligations amounting to $300 ,OvG 1000 and :Banker 1s acceptances, amounting to $5b5,000 ,000. or J.lthoush composed of twelve individual entities, the Federal Reserve system must be regarded as one individual whole. The financial pressure is not felt with equal force all over the country at the same time, but varies with the seas~nal requirements of different sections, The strength of the syst~m lies very largely in coo,perative action ty the tNelve banks, which finds its most vital expr~ssion in the maintenance of the Gold Settlement Fund in vvashingtor•• The policy of the Federal Reserve board is to treat the twelv"> banK.s as integral partG:''Jf one system. This is 1' I -2- ,. X-1786 a necessarily so. Under this policy ~t is interesting to note that some of the largest Federal Reserve :Bar.!.Ks have recently re~uired assistance in order to keep their reserves up to the mirtitnum lee;ai req_uirements, while some of the smaller banks, which a few mont:11s a5o had to be similarly assisted, now stand well to the top of the list in their p~r centage of reserves to deposits. The ratio of total reserves to net deposits and Federal Reserve notes of the system is at present 45% - tho lowest ::QOint yet reached - a year ago it was 50% - two years age 62.% - three years ago 77% snd four years ~o 157%. These figures clearly indicate that there are limits to the Federal Reserve system as there are to all institutions of human origin and warrant the words of caution used by Professor Moulton "If we allow the situation to go forward until the reserves of the Federal Reserve system have been reduced to the legal minimum we will be in precisely the same situation that we have always been in, in ti.me of crisis, namely Ni th a fundt.rnental need for a te:n:lForary expansion of loans with . which to tide the business world over a threatening financial abyss, but with utter inability to make any such expansion." Of course, the Federal Reserve Boar~ has authority in an emer~ency to reduce the legal reserve req_uirements of the Federal Reserve Banks or to suspend them for a. stated period, but panic of considerable ca;,nitude would doubtless J?reva.il before such eetion would be taken or it miGht follow should such action be taken. It certainly behooves us to call a. halt L~w and to 6ive due heed as to whither we are driftin6· I therefore a5ain agre0 with Professor Moulton that in the li;ht cf the present situation the reserves of the Federal Reserve system should be conserved and that the only effective measure available to the Federal Reserve BankS should be applied viz. to raise tb.e discount rates on all lines of paper d5.scounted by them. This policy has recently been adopted s• far as removin,.; the preferential rates ~n loans secured by Government ob1i 6 ations is concerned and has already had the effect of reducin~ somewhat the volume ef such loans, which is ~ood n3 far as it &oes, but this has been practically offset by an increase in co~mercial paper rediscounted and bankers acceptances purchased showin~ the correctness of Professor Moulton •s statement. ''If member banks are compelled to reduce their btrrowtngs from the Federal Reserve Banks on 1war paper', the result will merely be 1 so lonb as a demand for their funds continues, to shift the borrowins process to c1ro1cercial paper· There would then be no chan~e in the total amount of credit ~xtension by the Reserve Lanks.w He then draws attention to the fact that "Funds may be drawn from Federal Reserve :Banks by an. indirect process , 11 ref err :in;:. to theil· j_:)Urchases of acceptances in the open market.· This is exactly what has taken place since the rates on twar paper' loans were raised. He then reaches the inevitable conclusion that 1' if the total volame of bank loans is to be reduced it wi 11 the ref ore be : necessary 11 .. 72 X-17S6 a -3f ., 73 ·:for discount rates to be raised on all classes of paper and for the Federal Reserve banks to refuse to expand their own market purchases·" In explanation of the policy of the Federal Reserve banks in r~gard to discount rates as heretofore approved by the Federal Reserve Board with advice of the Federal ~dvisory Council, I would say that conditions confronting them have prevented the application of reco~ized economic principles. The controlling factor b.as been the necessity of the Government for credit to enable it t•. prosecute and win the war.· Not only had the Federal Reserve banks to make such rates as would enable the Government to float its low rate securities in tbe sbape Of bonds and certificates o£ indebtedness, but they had to take charse of these issues and do everythinb they could to induce thair member banks, at their own expense, to help distribute thorn, arA to extend to their customers who bought them such credit as was necessary at correspondin~ly preferential rates. It was patriotism that for the time bein:;!, disp1e,,;ed or disre6a:rded eccnomic ~~ laws ani principles. The hope for the future is in the claim of the Treasury Department that after its financing, necessary to :provide for its certificates maturing within the next sixty days has be~n accomplished, its urgent necessities will be out of the way and its requireroe~>s will thereafter be -m.~t b"y floating short term certificates, issued mn anticipation of the quarterly collection of Federal taxes. Such c~rtificates having only a short time to run and the certainly of th3ir payment at maturity will afford them .a ready market with the large taxpayers as We 11 as with the banks~ It will be no lon:ser necessar_y to arbitrarily distribute them ~ong the banks by allot~ent in proportion to their resources. The desire to have the Gover~nt successfully achieve its last refunding operations in connection with its $2,}00,000,000 o:f certificates maturing between December 15 and February 2B was the principal reason why the discount rates at the Federal Reserve banks were not raised on all lines of paper at tb.e time the preferential rates on paper secured by Gover~ · ment bonds were wi thd.rawn. Wh\m this Government financing is out of the way, as it is expected to be very shortly, there is little doubt in my opinion that the Federal Reserve bunks under the advice of the Foderal Reserve Doard will ruise their rates for the purpose of cb.eckinb undue expunsion of credit vihenever such action se~ros necessary_ Thus they will secure sorue contrul of the discount market whicb. abnormal conditions have so far prevented. There is JUSt a possibility that after we @;et throuoh with this Government financin~ and with the usual first-of-the-year operations the borrowini:, dernands of the member banks on the reserve banks may :perceptibly fall ~ff and a shrin.kae;e in the volume of Federal Reserve notes may take pla.coe. Tl.tis would occur in th.:o: natural course of 11 • • .... 74 X-1736 a ' e"tents, If 1 however, in the interest of our f creign trade, and for humanitarian and ethical reasons, we are going to extend to E\J:r:'OIJean co~-~1!,t?5.es tbe ::-recUts th:-,y :require, t::J enable them to obtain from us the foodst\~fs and raw materials they so urgently need, which I firmly telieve w~ should) there is small :prospect of the demand for bank credit weakening during the year 1920. If the Governrrent should assist in this necessary European financint?;, as I also think it should, it.may have to be still further financed and again theories may have to be suspended in view ~f the conditions we will have te face. The necessities of the railroads· for large amounts of credit after they are returned to their owners is another important factcr which will operate in maintaining a strong demand for bank credit for seffie time to come. " Under the abnormal c ondi ti ens new prevailing ani with eu.ch Wlcerteinty as to futu.re <ievelopments, the1·e can \le rHt doubt that the resources of the Federal Rese:r·ve Banks should be conserved as much as possible, and that the policY of the rrember banks sholild. be to discriminate against all loans f cr s:pecalative purposes and to make careful investigation as to the use to be made of all monies borrowed from the~ by their customers. I am not without hope that if such policies are pursued, financial panics may be avoided and that, notwithstanding the strain, which seems inevitable, the Federal Reserve system will prove equal to itv - :But we must be on our J;Ua.rd; we must look ahead and not strain the elasticity of the system to the breaking point. If its reserves continue to shrink, the t:rakes must be applied by mater:i.ally raising the discount rates • ..
@FedFRASER