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450 J11X OJ'PICIO MEMBERB DAVID f. HOUSTON iiCIITAIY OP THI TIIAIUIY CHAIRMAN • FEDERAL RESERVE BOARD JOHN SKILTON WILLIAMS COMPTIOLLII OP THI CUIIIHCY ADDRESS REPLY TO FEDERAL RESERVE BOARD WASHINGTON W. P. G. HARDING, GOVIRNOR ALBERT STRAUSS, YICI GOVIINOR ADOLPH C. MILLER CHARLES S. HAMLIN HENRY A.MOEHLINPAH W. T. CHAPMAN, SICRITARY R. G. EIIERSON. ASSISTANT SICJIITART W.II.IIILAY, FIICAL AGINT May 24, 1920. X-1936-7 Su.bject: Dear Transmitting Copies of Board letter to Senator Owen, and Response to Senate Resolution #363. sir:- There is enclosed herewith for your information copy of Boardts reply to a letter from Senator Owen, in which he critisises the discount policy of the Federal Reserve Banks, and also copy of the Board's re~y to Senate Resolution #363. Very truly yours, Enc. Governor. To Chairmen of all F.R Banks. • . .. 451 May 25, 1920. X-1936. Sir: On May 17th, 1920, the Senate adopted the following resolution. "Resolved, That the Federal Reserve Board be directed to advise the Senate what steps it purposes to take or to recommend to the member banks ~f the Federal Reserve System to meet the existing inflation of currency and credits and consequent high prices. and what further steps it purposes to take or recommend to mobilize credits in order to move the 1920 crop 11 • In res:nonse the Board desires to say that it has recognized for many months past that the expansion of bank credits in.this country was proceeding at a rate not warranted by the production and oonsumption of goods. It has repeatedly admonished the Federal Reserve Banks that influence should be exerted upon the member banks to induce them to avoid undue expansion of loans and to keep their ~olume of out- standing credits within moderate bounds, Beginning six months ago the rates of discount on various classes of paper at the Federal Reserve Banks were advanced. During the latter part of January the present rates were put into effect. These advances, while undoubtedly checking credit transactions which otherwise would have been made, have not been entirely effective in bringing about the reduction in loans desired and which might normally have been eX})ected during the early months of the year. Liquidation during these months ... ' 452 .. X-1936 -2-. is entirely natural and healthy and is necessary in order that the hanks may be prepare~ to meet the demands made upon them during the cro"P making md harvesting seasons, but there has been no such liquida... tian and on the contrary coniT~rcial loans have steadily increased. Thus it a~ars that the public has anticipated demands for banking credit which are usually made later on in the year. The average reserves of the Federal Reserve Banks are new a little over 42~ per cent, as against t,~Vel ve 45 per cent at the beginning of the year and about 51 per cent months ago. The Federal Adtisory Council, which is composed of one member from each Federal Reserve District, elected annually by the Board of Director.s of the Federal Reserve Bam, is required by Section 12 of the Federal Reserve Act to meet in Washington at least fOur times each year. The Council is authorized "to confer directly with the Federal Reserve Board on general business conditions; to make oral or .··· written representations concerning matters 1dthin the jurisdiction of said board; to call for infonnation and to make ~ecomnendations in regard to discount rates, . rediscount business, note issues, reserve conditions in the various Districts, the ~chase and sale of gold or securities by reserve batiks, open-market Oll9rations by said banks, and the general affairs of the reserve bariking system.. "· Upon receint of a notice that. the Council would hold its regular meeting on May 17th, the Board extended an invitation to the three Class 11 A" Directors of each Federal Reserve Bank, who are .the re'Presenta- tives of the stOCkholding banks, to come to Washington at the. 453 X-1936 - 3 same time for conference with the Federal Reserve Board and the Federal Advisory Council. This conference was held on the 18th instant and it was developed at the meeting that the present credit expansion is due in great part to the abnormally high prices of goods and commodities nc•prevailing throughout the c'ountry and to the congestion of foodstuffs and essential raw materials at, or near, points of production because of lack of transpottati~ facilities. The Board is convinced that if the unsold portions of last year's crops can be brought to market before the ne•.JV crop matures, the liquidation of credits which are no''V tied up in carrying the old crops will be sufficient to offset to a considerable degree the credit demands which ·~ill be made upon the banks in moving the crop of 1920. At the conference above referred to the Board's views were outlined by its Governor substantially, as follow·s: The member banks should lean less heavily upon the Federal Reserve Banks and rely more upon their own resources. unnecessary and habitual borrowirlgs should be discouraged and the liquidation of long standing, loans should proceed. Bc~s no~essential were cautioned, however, that drastic ste-ps should be avoided and that the methods adopted s~.ould be orderly, for gradual liquidation will result in permanent improvement ·vhile too rapid deflation would be injurious and should be avoided. The Board pointed out the necessity for extending such credits as may be necessary to promote essential,production, especially of foodstuffs and that if for any reason it should prove impracticable to increase essential production, there should be . greater econoiizy" in consumption and more moderation in the use of credit. The problem of. the baclring 454 X-1936 - 4system of the country is to check further expansion and to bring about a normal and heal thy liquidation without curtailing essential production and without shock to industry, and, as far as possible, without disturbance of legitimate comrr.erce and business. In order to eftect this it seems necessary to distinguish betw·een essential and non-essential loans but the Federal Reserve Board feels it would be a most difficult task, which i t should not undertake, to attempt by general rule of country-wide a~lication to make this distinction. During the-war there '"as a broad underlying principle that essentials must be "necessary or contributory to the conduct of the ·war", but notwithstanding the sharp outline of this principle much difficulty was experienced by the various war boards in defining e.ssentials and non-essentials. All the more diffiC'Ul t would it be for the Federal Reserve Board to make such a general definition in the present circumstances. Section 13 of the Federal Reserve Act defines the eligibility of paper for discount by the Federal Reserve Banl~s and lays down a general rule that any paper maturing within the time prescribed and "issued or drawn for agricultural, industrial or commercial purposes, or the proceeds of 1111hich have been used, or are to be used, for such :9\li'POses" is eligible. Xo expressed condition is made regarding the essential or non-essential character of the transactions giving rise to notes which may be offered for discount and the Federal Reserve Board is not re·quired, and properly could not be ex:oected, generally to adopt such a criterion of eligibility. It is too much a matter of local conditions X-1936 455 - 5 - '. and local knowledge to justify at this time any general coUntry-wide ruling by the Board even if such a ruling were deemed helpful. On the other hand, there is nothing in the Federal Reserve Act which require .I a Federal Reserve Bank to make any inrestment or to rediscount any particular paper or class of paper. both Sections Reserve Act, 13 and h~~ever, 14 is permissive only~ The language of Section requires the directors of 4 of the Federal a Federal Reserve Bank to administer its affairs "fairly and impartially and without discrimination in favor of. or against any member bank". and subject to the provisions of law and the orders of the Federal Reserve Board to extend "to each member bank such discounts, advancements and accommodations as may be safely and reasonably made with due regard for the claims and demands of other member banks". Thus the Directors of a Federal Reserve Bank have the power to limit the vol~ and character of loans which in their judgment may be safely and reasonably made to any member bank The recent amendment to paragraph (d) of Section authorizes each Federal Reserve Bank on its reference to action t~en 01m 14 distinctly account, ,'Vi thout by any other Federal Reserve Bank, to establish a normal discount or credit line for each member bank, and permits the imPosition of graduated rates on discount lines in excess of the normal line. This amendment, however, does not repeal or modify Sections 4 and 13, and a Federal Reserve Bank is still free to decline to discount any paper which in its judgment does not constitute .a desirable investment for it or which in its opinion would not constitute a safe and reasonable investment within the meaning of Section 4. .. - 6- 456 X-1936 It is the view of the Board, however, that while Federal Reserve Banks may properly undertake in their trmsactions with r.:.ember banks to discriminate between essential and non-essential loans, nevertheless that discrimination tnigbt much better. be made at the source by the rr.ember banks themselves. The individual banker comes in direct contact with his customers; he is better qualified than anyone else to advise the customer, because of his familiarity, not only with the customer's business but with the general business conditions and needs in his irorr&diate locality- In making loans he is bound by no general rule of law as to the character of. the purpose for which a loan is being asked.. He is entirely free to - exercise discretion, and can make one loan and decline another as his judgment may dictate. He can estimate with a fair degree of accuracy the legitimate demands for credit which are liable to be made upon him, as well as the fluctuations in the volume of his deposits. what industries sustain his co~unity, Be knows and is thus qualified to pass upon • the essential or non-essential character of loans offered him. He mows, or should know, what rediscount line he may reasonably expect of his Federal Reserve Bank, and he ought not to ~anent addition to his capital, rega~ this line as a per- With knowledge of the limitatio.ns or penalties put upon his borrowings froru the Federal Reserve BankS the banker r.m.y be depended upon to use a more discriminating Judegr.ent in granting credit accOimlodations to his customers • and that JudgtiJent he u~st exercise if the present situation is to be remedied fundamentally. It is true that under existing conditions the volume of credit required in any transaction is much greater than was the case in pre-war times; but it is also true that the resources of the uember 2.nd non-~ember banks would • 457 ~-1936 -'7- countr.r be at19le to tel:o care of tho essential business of tho luge axtont ot non-essentiDls ~ uell o:.1e. creC.it. If "fr~zcn if there loe.ns" ,·;oro liquitied, \"Jere mt~. .e. treer l.'lld flO\; to o. 'ot zoods if conunoc!ities thich Dl>e held b2.c1: oitJtor for· s;>oculc.tive 1JU.r:..X>ses or bo.cc.use of look of trc.ns:.,10rtation fc.cilitios shoulC:. go '. to tho ma.rltets, Wld if ltU"ge stockS of merchandise should be reduced, tho rasul ta.nt role.::.so of credit •:ould have a most bonoticia.l oftoct u:)()n t;lO general situa-tion. In tho ;;tOntitime everything must bo dono to e:t'.Jedito tllti release of those cret!.its end to restrict non-ossunticl cr~its in futuro. Uhile tho problem of croct.it rosuletion · Dnd control is ne.tion£11 · ~ ovcm interna-tional 111 its· scope, ·Yet in the lAst «l.mlysis it is moroly en S(;Groge.tion of individual :JroblCDJ, c:'.lX,_ t~ ~o:ter \:orkillg out of tho s itua.tion must dopond u:;.on tho :;m.blic one. u:>on tho banks ,.-hich ~ tm public. TbcJ public mu.st bo mndo to roclize tm nt;')Cessity of in expenditures ond in consequent dem.'\llds for btm:'ing cret!.it. themselves· :-..ro best Able to i.Jtt')r.oss the i.J:l;.ortcmco of this :.ith OCODOJI\Y' The bcnlts ~licy 1QO:Il the VUblic. Fo.c tho. i"urthur infomc..tion oi t~ · !:).,.n;.to t.~ ·Zoc.rd quot\:s fron tho i-o;?ort of tho Foccrc:.l ;.dvisory Council ·mcdc to it on :Io.y 18th, sisnoc by · ·Janos D. Forscn, President. · ·•Tb.e.Councll n::.s i;;ive:n consiC..erc.tio:n to the mnttvrs· inClude?. in your coniJUllicction of .:'-:_.;rU l'7th onC!. bogs to rv.}ly thereto in the follo·:in;; n"'mlcr, follo· ~~ the ort.or sot Out "'a<J you. (c) "Co.usos of continued c::;.."'.;lsion of orc<'!.its m.. of Fee:"rt'.l noto issuos.u . . • ·There nrc lno.JW' co;.ltributi.DG .cc.usos of · hich thG fo1.lo•.:ing nw:y be regarded c.s "'..r~'OOunt •. • I • f X-1936 · .-8-- 1. ·ia recognize, of ~ourso, tba.t tho first cause is the GroD.t :Jar. . ~. GroD.t oxtrc.vogc.nco, nc.tional, municipal and individuol. 3. Inoffici<llcy OZld indifference of labor rosultilig in lossontng production. 4. ~ Shortage of tr~sportation f~cilittcs, thus 2reventtng tbo normal movement of comroodities. 5. The vicious circle of increasing uages ~?rices.· (b) 'Ko•i ccn the reserve }Osition of the Fodor~ Reserve .i3alits be mater i.a.lly strensthened beiorc t!le seD.SonL'.l e..emand sets in rlOXt toll 'li tbout undue distu:rbaaco of th.:. ::>rocesses of :;>roc'!uction e.Dl distribution?• · By lll"~ing u_1on mmbor bm:;:s through tlw· Federal Reserve 1>e.n1rs the '\11sdom of shQuing borrouers tn... necessity of tho curtailment of' g'-nora.l oroC'.its, and eSj?Oaia.lly for non-ossontia.l uses, as \:'Ull as continuing to disotull'agc loans for oe.:.>tta.l and speculative purposes: by chco:.;:ing O::OCSSiVO borrOYiing3 through tho a)pl i<?C-tiOU Of higher r~tos. · (o) 'If stc?s oo.nnot be tt.kcn at this ti.DJ loe.ding to a more normel ?roportion bot\10on tb.c wluoo of credits tWd tho volume of' goods, \:hotJ. can they be taken?• •' !n our O?inion steps should bo ~en now, as outlined in cnsr:or to the last question. . . (d) 'JhD.t is tho offoct tt:?On tho gonornl si tue.tion of the incrouscd Trcas-ll.cy borrO\<ings. o.nd '1ht.t shOuld bo tho policy of th..; Fode~~.l Rv• · servo Donl~s in ost.:::.bl ishing rat us of c!i scotu1t o~t l2:;?... r scoured by certificutus of indob~~dncss?• It is obvious that tho borrowings ot tac Trccsury b::.vo tho S.:tlo effect u,.:on tho gc~rol credit situation es those of other borro,:ors. Tho Oounc U \"<Ould ~st tho 'ttisdom of Congressional roliot from tho 'blDdon of govc~nt financing by a policy· of rigid .oconoll\f; tho provision of the w:t l.aus for the. saJto of a more cauitablo distribution of tho burden r:ithout reducing thv rov1..111110; the vnictmvnt of the oudg..:.t systom, th;;; budget to include provision for the grac!ua.l ~-:.ym,,;nt of the short time oblit:,~tions of the Tro<".SU.ry. These ~.oulc! of nocossity procludu unwise t:;;>;.nocr;r tat ions, such a.s the ?reposed. soldier •' bonus. In viotl of tho l::Jorgc volume of Troc.sury certificates of indobtoencss carried. by mmbor ba.nlcs ct the instance of tho Troc..sury Dopartuunt, ro believe th.-:.t rt.tos· established by the Fodc~>l Roso:rvc Danlts on ~p.;r · scoured by them shoulct not bo mtcri~ly grca.t;;r tll"fl tho rates bomc by tho corti:tic::.tos." · f . ~ 459 - 9- X-1936 The l3oard feels assured that the banks of the country now realize the necessity of more conservatism in extending credits and of a reasunable reduction in the volume of credits now outstanding. The Board will not hesitate • so far as it may be necessary, to bring to bear all its statutory powers in regulating the volume of credit 1 but wishes to .point out that the more vital problems relating to the movement of the 1920 crop are physical rather than financial. This was the unanimous view of those present at the conference on the 18th instant, at which the following resolution was adcpted: "The whole cmtrltcy is suffer'\n.g ftorn inflation of prices with the consequent inflation of etedit. From reports made by the members of this conference, representing every section of the country, it is obvious ·that great sums are tied up in prod.uc ts which if marketed. would. relieve necessity, tend to redace the price level and. relieve the strain on our credit system. "Th.is. congestion of freight is found. in practically all of the large railroad centers and shippil1g ports. It arises chiefly from inadequate transportat.ion facilities available at this time and is seriously crippling business .. We are informed that the per ton mile of freight increased in three years - 1916, 1917, and 1915 - 47%, while the freight cars in service during the same period increased 1.9%· "A striking necessity exists which can orlly be reJ.ieved through ·the upbuilding of the credit of the railroads. This must come through adequate and prompt increase in freight rates. .Any delay mee.ns the paying of greater cost directly and indirectly and places a burden on the credit system which in the approaching time for seasonal expansion may cause abnonnal strain.. Even under the load of war inflation, high· price level, and extravagances the bank reserves would probably be sufficient if quick transportation could be assured during the time of the greatest strain. "Therefore l3e It Resolved: That this conference urge as the most important remedi;;-tihat the Interstate Comrr.erce C~ mission and the Uhited States Shipping l3oard give increased .' 460 -10- rat os ::nC. cdcquo..tc fc.cilities such ii~Jl110c1i:: t c effect as mcy be unr:;:c.ntod under their authority o.nd th:::.t c.. committee of five, ru?ros •.mting tho vc.rious sections of tho country, be c. pointed by t~1c Ch<::.irmcm to present this resolution to tho Intcrstcto Commerce Cormaission anc"'.. 'cl1c United St2.tos Shi:?lJing Jo ard ui th st~ch vcrb2-l :_?rcsontation as may soum a}proprio.tc to t:1c colrJl;1i t t oc. n :L:uch uill clo:;_Jond U~_)On tho rcsto1·ction of the normal efficiency of railro2.d and steamship lines. If ccloquatc trc..ns:;>ortation facilities cz,n be :;;rovidoc:. the Bo<:rd sc-..:s no occcsion for '1 C~)j_Jrchc:nsion ith tho mov LZn..:nt o f cro·)s nm1 being gro1m .. Governor,. Thc 'resident of tl1C Sono.tc. in connection . .,.. 461 - ,. "' X-1937 M~y My 24, 1920. dear Senator: Your lstttr of the 14th instent was duly received, but unusual pr~ssure of routi~e busin~ss hes prevented an earlier reply. let~er I notice that you renew the suggestion made in your oi April 27th that the Federal Reserve Board lower the discount rates of Federal R~serve Banks as a means of helping to r~store Liberty Bonds to par, and that you take the· view that as the Federal R0serve Banks pay no interest on deposits and that as they made very large earnings last year on a four per cent rate; that "3 per cent is a rate high enough to enable them to make all the money they ar~: entitled to make out of the public", and you say that "the Federal Reserve Banks shuuld not be put in the attitude of profite,:ring or of settin6 the example of profiteering to member banks". Your suggestion that the discount rates of the Federal Reserve Banks be fiXed with reference to their divideQd requirements is cer~· ainly a novel one, but before entering into a discussion of the propriety of fixing rates from this point of view I wish to say soEething regarding your intimation that the Federal Reserve Banks are putting th8mselves in the attitude of profiteering. Section 7 of the Federal R<.oserve Act provides that 11 after all ! . X-1937 l 462 • .. 2 neeessr,ry expenses of D FeC..eral reserve :-··f!i.nk have be:;n :pa.id or provided for, the stockholders shall be entitled to receive an son~~l dividend of six per centum. on the pflid-in cari tal stock, which dividend shtl.ll be cumulative". As originally enacted this section ~rovided further that d'ter dividend claims had been fully met "all the net earnings siJ.;;.ll be p&iel. to the Uni tad Stntes ns a franchise tt.IX, except thr.t o.oe-nalf of such net e11.rnings shall be paid into ::.. suzo:plus fund until it shall .:-..motlllt to forty rer centum of the raid-in cn;i tal stock of such b~l.Jlk". The Act of MP.rch 3, 1919, which ~assed the Senate only as a result of your watchful care throughout an all-night session net~r the eDd of the Si.Xty..fifth .. Congress, amended Section 7 by providing that "after the aforesaid divi- <iend claims have been fully met, the net ecrnings shull be raid to the United States as n fr~chise tax.excert that the whole of such net earn- ings. including those for the yenr ending Decerober-thirt~first, nineteen hl.U'ldred snd eighteen, shall be 1aid into a sur}'lus fw:ld until it shall ataQUl';lt to one hutldred rer centum of the subscribed ca.:t~ita.l· stock of such batlk, and that thereafter ten 1er centum of such net eW'lline,s bho.ll be ::,··a.ici into the surplus" .. Section 7 also rrovides t~t in case a Federal Res.;,rve Batlk shoulC.. ue "dissolved or go into liquidation, any surplus remaining after tbe payment of all debts, dividend requirements ~s hereinbefore }TOVi~ea. onci the J.ar value of the stock, shall be paid to and. become the pTO}erty of the United States•. On May 21, 1920. the paid.-in cai-'i:t.al stock of all the twelve Federal Reserve Banks aggregated. $93,786,000. an this •'· X-1937 463 - 3basis of capitalization for the year the member banks can receive dividends at the rate of &f,, aroounting to $5.627, lCo; the rerr.ainder of the net earnings, however great, will be Gove~ent ~-a.ia. in larger 1art d.irectly to tb.0 as a franchise tax, the balance being carriea to the surplus fUDds of the Federal Reserve Banks \dth ultiwate reversion to tbe ment. Gov~r~ On May 21, 1920, the cunsolidated statenent of tb.e twelve: Federal R';serve :Banks shc.wsbills disc cUll ted secured by Goven:m:ent war oblit;atiuns, $1,446,723,000; all other rediscounts for met:~ber banks, .. $l,053.6o3,0CO; bills bought in the open market, $417,368,000; ~ng a total of notes and -bills rediscounted of $2,917, 754,uoo. .At the sou:e tir:.e the reserve deposits·of member banks were $1,633,665,000; total r~serves held were $2,u79,533,v00, and Federal Reserve m•t0s in actuAl circulation arr.ounted to $},085,202.000. The ability of the Federal Reserve Baaks to extend so lar~e a voluPe of discount accomroOd.ati.:.ns is due to the use of F~u.ertl Resez:ve.:o.otcs, and this ~act ought not to be overloo]l:ed. ·xt follows therefore that the earnings of the Federal Reserve Banks are derived. in lorg~r :;;:art from. the circulation Qf. Federal R,c;serte notes. which P.re obligations of the Govc,rn· .. went~ The Federal Reserve Board is· authorized in Section 16 of th~ Fe~eral R3serve Act ~o requ_ire the Federal Res_erve Bmlk~ to pa.y such rate of interest as the ·Board may ~s.tablisb o:o. the· amount of Federal Reserve notes outstanO.ing less the awotmt of .;old .or gold certificates held by the Federal Age~ts .as· ·coll:ate.ral se,curity.. :Res~rve Cb. Mal 21st, after setting aside the reser:ve . of 35% ·agains.t net deposit iia)ilities.· the combined statement of the Federal. Reserve B~ shows a reserva against Federal Reserve notes outstandint:S of 464 • - 4- 47.1%. Even though all excess gold were deposited with the Federal Reserve Jgents there would be 52.9% of the outstand~ng note issue, or $1,6)2,071.356~ subject to an interest charge, the.imposition of which would very~ateriall~ reduce tbe apparent earnings of the Federal Reserve :Barlks. The .Act gives tbe :Boord discretion in the matter, however, and no charge .has been iLlposed for the reason that the excess earnings of t:Ue Federal Reserve Banks go to the Government in any event .. It seems to me, Senator. that you are disposed in all your discussions of the money and credit situation to ignore the fundaruental law of supply and demand. Let me point out a few statements in your last letter which appear to be incon~!.stent. You state that you are "certainly- opposed to inflatiod, but you are "strongl7 in favor of the e.xten!lion of business, increasing production and improving distribution b7 extending credits or. a stable low interest rate", and you s;q "The expans."n of credit for s~h purposes is JUstified, but, of course, the eXpansion of credit beyond the av~.ilable fied•. resources, even for the most 'important of purposes, is not Justi- You say further that "credits ought to be extended at a low rate to the extent of the ce.pacit7 of the Reserve Banks f~r productive purposes", and 701.1 intimate that as the Federal Reserve :Banks pay no interest on de• posits, a three per cent rate is high enou~. While you do not.sa.• in direct terms that Federal Reserve Banks should stand ·ready to make loano on Liberty Bonds an4 Victory Notes at a three per cent rate your letter admits of this constNCtion. although you do say that y:ou do not advocate the Reserve 'B&nks ."lending be~ their resources at any rate, or on any seeuri ties". You say ".Assuredly raising the rates of interest will deflate c.redi ts, even the X-1937 465 - ? cr~dits of the United States, of which I co~plain, but I am anxivus the Federal Reserve Bunrd sbD.ll unly deflate thuse credl.ts that require deflati n and not defl<::te credits uf the Gvverm.::ent and vf legitimate productiv:; business which uugnt not to be deflated". You say th~,t "The <..nly deflatiln of credit JUStified is the deflativn of credits ·3:wrluye<i in SJ:eculati ve loans <.in com:ocii ties fur inv~::stt ent hoar.1in~ L:f securities, vn real estate, and on r.rofi tec•rs" .. From all tuis I understend your view to be that the Federal Reserve Banks should letld at a low stable rc::,t~.-' on Go~rc;.;rmuent securities ro:lri. on other eligU;le paper, barring only "s1·eculative. loons on inv<.:-stoent securities. on real estate, end on corurrioclities for hoarding by ~rofitaers" <~ t4~t in your Judgcent this stable low rote ought to be three }er cent. You adwit the correctaess of the otservation made in w:r letter of tr.e 3rd instant that •there is a c1orld-wide der::;and for capital, c..nd tbe der:ald for -bank credit in this country for agricultural. cotuJ:.-ercial aDd ever been _known before; investr"'ent industrial rur-.f.Oses is heavier than has dewands for new construction, for the maintenanc~ and equifwent of railroads, end for the finaocin 6 of our foreign trade are v0ry great". You these ask •Are JUst dewands to be met 1y denying the credits, or ~re they to La re:;:;ressed by raising the re.tes". 1 cannot escape the conclusion, Senator, that were the Federal Reserve B£~ks to establish the stable low rate 1jroposed by you they would soon reach the limit of their available r.::sources, beyond which r-oint, you state, the eXJ;·ansion of credit, •even for th6 most im:portant of I.lurposes, is not JUstified". It se .:os to rue that the ado} tion of the·I·Olicy l)roposed by yol;. would result in a wild scramble 466 .. - 6for discount a.ccorr.n,od.ations at the FeO.er"-1 Reserve Banks with e<n enforced denial of cell c re:di t after the first few days. The Bo::-.rd is insisting that all br.nks use a discrirainc=tting Jud.gr..;ent in r~aking ~iving loans, preference to those which are necessary for the production and distribution of the basic necessities of life 1 such as clothing, food and fuel. but in the exercise of this discretion it is ~ecessary to have the restraining influence of a rate. It is idle to 1,-rea.ch against excessive borrowings and then to invite bo:rrowin6s by an artificially low rate less than half the•cur:rent open market :rate. You hav.e had Et good deal to say about the low r.o,tes which prevailed in bygone years, in Ene;landy France and Belgium., and I r'"ight co.ll your at-: tention also to the low rrtes which prevodled at the Federal ReservG Banks during the year 1915 when there was no demAnd for loans. But we are dealing ·vi th the pressing problems of t.ht: present; ·changing cond.i tivJlS must be recognized and dealt with as occasion demands. You no doubt know, although you have never called attention to the fact, that official discount rates are high everywhere, even in countries wnere inflation has been carried to extren::es and which are no longer on a gold basis. The official rate in Italy is ~%. that of the B~ of France is that of the Bank of England is The Federal Reserve ~oa:rd 7%, 6%, 'md having recently been raised from A%~ does not take the view that discount rates should be arbitrarily fixed by it; it recognizes the fact that there are certain basic conditions which credit throughout affec~ th(> demand for and the supply of tb.t,o.~!!'~'mtrJ' a.n·~":.throughout the world, and that the formal 467 - 7establishment of a discount rate is r-;erely an interpretativn of these con· di tions. You cdl attention to tne fact th..'lt the open market rate in Londrm during the war was 3~ficial bank rate of 7%. It is now 6-3/4 to 6-7/S per cent, against an of. You do not q_uestion the wisdom of the canager~~nt of the bank of Englmd, wh~ch you sa;r is conducted bt tL£ wi~JU t oerchwt;"' in the world, although I have ~lw~s h~ an idea that ~any of these merchants are credit merchants, or private bankers, :'Ol.~, they would be called in tb.is country~ The advances in rates ·in London are evidently· cu~ to natural causes and there has been no attempt to maintain artificially the low to w.b.ich you r,~fer. r~tes Wl:lr·then is it not Just as reasonable to concede to the directors of the Federal Reserve Banks and to the Federal Reserve Board some degree of honestJ of purpose and intelligence in making the advances in rat~s of which you complain so vigorously? From yuur own figures, Senator, it is clearly impossible for the Fed- eral Reserve Banks to carry at any rate which may be fixed the entire volume of the Government war obligations, and if a stable low rate of 3% were to be established no very great volume of additional loans could be wade, and instead of there being a stabilization of the bond market there would be chaoti~ c ondi ti ons .. The obligations of the Gov,,rnxr.ent of the United States offer the best o~portunity ~ for invsstment in the world today. They are being sold now on oost attractive ~vestment basis, ?.nd us speculative t~ndencies are curbed, as tb.e g?,ins of the profiteers are r~uced, as commodity rrices decline, and as the business and industr.y of this country settle down to ~ more nort:ta.l peace basis, .the market value of these securities will rise ver7 f 468 • X-1937 -8- r·apidly. This conclusion is justifieQ. by the experience of the past. The six per cent 20-year bonds of the Government during the Civil War sold at a heavy discount (I thinlc they were do1.m at one time to about 80), but two years from the time of th~ir greatest depression they -ryrernium reached par and were selling at a .. of about 25% in twelve :ve.ars before their maturity. a si~ilar experience with Lib~rty 1669. only · I a:n satisfied that •ve 'vill have Bonds, ~rovided there are rigid -economies in Governmental ·expenditures from this time forth and inflationary tendencies gene~ally are held in cheek~ I do not know of anything further that I can say regarding the . call money rates in New York. You continue to insist that the powers of the aovernment·should be exercised through the off~ces of the Federal. Reserve Board, the Federal Reserve Ban!cs and the Comptroller of the Currency to rerr.ove .the causes which lead to fluctuating rates there, and I have already "';))inted out to you that the interest rates in New York City are regul_ated ,,Y the laws of the St#;\te of New York and that there is nothing that. can 1;e done by. -the Federal Reserve Board,· or by the Federal Reserve Barfr." of Ne111 .York, exce-pt, perhaps, to decline to make loans on Governrnant bonds to collateral. ~'anks which in turn lend on Stock Exchange This would result in even higher rates. It is_ interesting to note, ho,Never, that the high rates of which vou c~lain reached their peak in November, 1919, be~ore the discount :rates of the Federal Reserve Banks had :been advanced and that since the rates ·~ere advanced to their present level. on January 2Jrd last, call 469 X-1937 ~- • money rates have ruled, with the exception of one or two temporary flurries, ~ite steadily around their present level of from six to seven per cent. Very truly yours, w:-P. G. HARDING, Governor. Ron. Robert L. Owen, United States Senate, Washington, D. C.
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