The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
810 Federal Reserve Board OFFICE X-U212 CORRESPONDENCE TO Governor Crissinger FROM Mr. Goldenweiser December 8, 1924. SUBJECT: A r t i c l e in the Commercial and Financial Chronicle f o r November 22, 1924. Eight pages of the Chronicle for Novenfcer 22 were devoted to an a r t i c l e e n t i t l e d "Imperfect working of Federal Reserve System - over-satu r a t i n g c r e d i t and currency". In view of the wide c i r c u l a t i o n of the Chronicle among persons i n t e r e s t e d in f i n a n c i a l problems, i t i s worth while to consider some of the p o i n t s in t h i s e d i t o r i a l . Resolution of Bankers' Association. The a r t i c l e begins with a quotation from the r e s o l u t i o n of the American Bankers' Association l a s t October in Ciicago to the e f f e c t t h a t the Operations of the Federal reserve banks "may tend to accentuate the swings of the f i n a n c i a l pendulum r a t h e r than to keep the swings from going too f a r in ei t h e r d i r e c t i o n , " and that i t should be c a r e f u l l y considered whether i t would not be"wise to l i m i t the Federal reserve banks to t h e i r primary function as banks of issue and r e d i s c o u n t . " The w r i t e r believes t h a t the Bankers 1 Asso- c i a t i o n r e s o l u t i o n "has come not a moment too soon." He thinks t h a t "in view of the recent glutted condition of the money markets of the country no one can t r u t h f u l l y a s s e r t that the Federal reserve banks have functioned properly"and that "the volume of the c i r c u l a t i n g medium of the country i s being kept at a level enormously above what i t should be. " Page 2. a-4212 Causes of excessive ease in the money market. The w r i t e r discusses the reasons usually assigned f o r the over abundance of funds, namely, the trade recession and the gold inflow, but i s convinced t h a t in addition to these causes the a c t i v i t i e s of the Federal r e serve banks have contributed to the excessive supply of c r e d i t . He i s of the opinion t h a t , while the irember banks have gone back to normal conditions a f t e r the war, "the reserve banks have been unable or unwilling to get back and have stopped a t the half way p o i n t . " On t h i s point the writer i s c l e a r l y mistaken, since the t o t a l volume of member bank c r e d i t a t the present time i s about $2,300,000,000 larger than a t the post-war peak in the autumn of 1920, while t o t a l earning a s s e t s of the reserve banks are about $2,300,000,000 l e s s than they were a t t h a t time. As proof of the statement that the reserve banks have increased the amount of c r e d i t in the market the writer p o i n t s out that while what he c a l l s "mercantile paper" (discounts) a t the reserve banks i s now only about $23^,000,000, the reserve banks have bought during the year over $500,000,000 of Government s e c u r i t i e s and l a t e l y have purchased large volumes of acceptances. In t h i s statement the w r i t e r overlooks, f i r s t , that while the reserve banks have purchased Government s e c u r i t i e s to t h e extent of $500,000,000 there has been an equivalent decline of discounts, and, secondly, that purchases of acceptances have been l a r g e l y on the i n i t i a t i v e of acceptance dealers who have o f f e r e d t h e i r b i l l holdings to the reserve banks because the firmer cond i t i o n s in the money market have caused the member banks to c a l l some of their loans to these d e a l e r s . A comparison of conditions now and a year ago 8123 PAGE 3 - X-4212 and an examination of the gold inports during the period i n d i c a t e that f o r the year as a wiiole the increase of member tank c r e d i t approximately c o r r e s ponds to the amount for which the gold imported from abroad furnished a b a s i s . Total loans and investments of a l l member banks increased by about $2,000,000,000 between September 13, 19^3 an( ^ October 10, 1924, and n e t gold inports for the period were about $375,000,000, indicating t h a t the gold inflow ?,lone, when aaded to the reserves of member banks, has been much more than suff i c i e n t to serve as a b a s i s f o r the increased lending power of member banks. Ea-rning a s s e t s of the reserve banks, on the other hand, are ne higher now than they were a year ago. Functions of the reserve banks. The w r i t e r ' s views on the scope and functions of the Federal reserve system are that "the reserve banks exist only to provide surplus or excess c r e d i t " and t h a t "in a period of pronounced ease in the money market . . . not a dollar of t h e i r deposits ought to be put out in the shape of reserve n o t e s . ยป The question whether the reserve banks are to be merely emergency i n s t i t u t i o n s operating a t times of seasonal or c y c l i c a l demand for excess c r e d i t or whether they shall be continuously in the market, i s a question on which there has been much d i f f e r e n c e of opinion. The Federal Reserve Board however, has from the beginning taken the p o s i t i o n that i t i s important f o r the reserve banks a t a l l times to remain in touch with the market and that f o r t h i s reason i t i s necessar for these banks always to have in t h e i r possession discounts, acceptances, or s e c u r i t i e s in order not to be cut off e n t i r e l y from contact with the c r e d i t situation. Pa-ge 4. X-4212 The w r i t e r ' s views on currency. On the subject of Federal reserve notes the writer has strong convictions baseo l a r g e l y on a misunderstanding of the nature of the Federal reserve note. He says that when money rates are down to 3 and 3 l / 2 per cent and there i s no mercantile demand f o r reserve bank c r e d i t , t h i s i s conclusive evidence that there should be no Federal reserve n o t e s outstanding, and that gold rather than notes should be in c i r c u l a t i o n . This view overlooks the f a c t that Federal reserve notes are not issued by the reserve banks, except in response to a currency demand, and that i t makes no d i f f e r e n c e in the e x i s t i n g c r e d i t and money market s i t u a t i o n whether the reserve banks issue Federal reserve notes or gold in response to t h i s demand. I t i s true that by paying out gold the reserve banks decrease their p o t e n t i a l lending power more than by issuing Federal r e serve notes, but in view of the f a c t that t h i s p o t e n t i a l lending power i s now f a r in excess of any probable demand f o r reserve bank c r e d i t , t h i s e f f e c t of paying out gold i s of only academic i n t e r e s t . The saturation p o i n t . The w r i t e r says that the only way the reserve banks can acquire gold i s either by i s s u i n g Federal reserve notes br by accepting gold on deposit. From t h i s he argues that i f the note issues and the deposit l i a b i l i t i e s of the r e serve banks exceed t h e i r gold reserves, t h i s i s evidence t h a t the reserve banks have put into use more c r e d i t than they have received from the p u b l i c . This statement i s fundamentally correct. I t i s true t h a t to the extent that the deposits and notes exceed the reserves of the reserve banks there i s more bank c r e d i t in use, as a r e s u l t of the operation of the reserve banks, than there Page 5 X-4212 would have been i f the deposits had been held by tha member banks and the geld had been in c i r c u l a t i o n . The conclusion, however, that t h i s excess, which amounts to about $1,000,000,000 represents "saturation" ?f c r e d i t by the reserve banks does not follow. While the excess measures the extent to which the existence of the reserve b&nks has added to the volume of c r e d i t in existence, i t i s not clear what i s meant by s a t u r a t i o n . The f a c t i s that the larger volume of currency in c i r c u l a t i o n a t the present time compared with l $ l 4 , p r i o r to the establishment of the Federal Reserve System, i s due t# the higher level of p r i c e s . The l e v e l of wholesale p r i c e s i s about $0 per cent above what i t was in 1913 and. the volume of money in c i r c u l a t i o n i s about 40 per cent above i t s level at that time. I t may be argued that i t i s because of the increase in I currency that p r i c e s have increased, but whatever t r u t h there may be in t h i s argument i t s proper application i s to %e war period and not to recent activ*> i t i e s of the reserve banks. P r i c e s increased during the war in the United S t a t e s and throughout the world, and in order to meet the requirements of b u s i ness at the e x i s t i n g p r i c e level more currency i s required than was needed in 1914. The complete adjustment between the demand f o r currency and the volume of i t outstanding "under the p r e s e n t plan i s one of the d e f i n i t e gains r e s u l t i n g from the establishment of the Federal Reserve System, and t h i s adjustment i s in no way a f f e c t e d by the policy of thd reserve banks to pay out one or another kind of currency, a point which the writer f a i l s to understand. He i s e n t i r e l y mistaken when he says that i f the gold coming from abroad had merely displaced Page 6 X-U212 Federal reserve notes in c i r c u l a t i o n there v/ould lse-,no. such redundancy of currency and no such plethora, of funds as now p r e v a i l s . " The f a c t i s that the Federal reserve banks have paid out $700,00C,GGC of gold i n t o c i r c u l a t i o n in the l a s t two y e a r s , an amount somewhat in excess of gold imports f o r the p e r i o d , and Federal r e s e r v e rote c i r c u l a t i o n has declined by approximately the same amount. The Federal reserve banks have paid out more gold i n t o c i r c u l a t i o n since the middle of 1922 than they have received from abroad, so that the tot&l cash reserves are now smaller than they were two years ago, but t h i s policy has had no e f f e c t on c r e d i t and currency conditions, beyond merely changing the form of money in c i r c u l a t i o n . Expenses of the reserve banks. The author also discusses the n e c e s s i t y f o r the reserve banks to earn t h e i r expenses, and expresses h i s conviction t h a t t h i s was the one reason why the managers of the system permitted the issuance of a large excess of reserve bank c r e d i t w h a t e v e r ingenious arguments they may have put f o r t h to explain t h e i r actions. In t h i s connection he quotes B. M. Anderson tc the e f f e c t t h a t g r a t u i t o u s s e r v i c e s by the r e s e r v e banks should be discontinued, and W i l l i s t o the e f f e c t t h a t earning a s s e t s of about $1,000,000,000 a year w i l l be required to meet the expenses of the reserve banks and t h a t , t h e r e f o r e , t h e banks should enter the market more a c t i v e l y . He does not argue with W i l l i s , who b e l i e v e s t h a t the reserve banks should a t a l l times be a large f a c t o r in thenarket, but draws from W i l l i s 1 view the opinion that the f r e e services are a great menace because they make i t necessary f o r the reserve banks to keep $1,000,000,000 of c r e d i t constantly in u s e . Page 7. X-4212 > The discount r a t e . The w r i t e r quotes Anderson to the e f f e c t that the discount r a t e should be regularly kept higher than the markst r a t e , "but goes f a r t h e r than' Anderson by saying that the rediscount r a t e should never be l e s s than $ or 6 per cent. This i s in keeping with h i s general theory t h a t the Federal reserve banks should function only in emergencies. Reserve bank c r e d i t , according to h i s view, should be used only when i t i s badly needed and when a d i f f e r e n c e of a few per cent would hardly be noticed. To the w r i t e r "there i s something preposterous about the attempt to t h r u s t excess c r e d i t , the only c r e d i t at the command of the Federal reserve banks, upon the member banks when they have no need f o r I t * " He thinks t h a t the e f f e c t of t h i s i s to force banks into speculation. He says t h a t in view of the f a c t that the banks can borrow from the reserve banks a.t 3 a nd 3 1/2 per cent and can buy good investments a t 4 and 5 per cent, their r e f r a i n i n g from doing t h i s i s a sign that they have b e t t e r vision than the reserve banks. The f a c t that member banks have at a l l times lent or invested funds up to the l i m i t of t h e i r available reserves and t h a t they have now a volume of c r e d i t f a r in excess of the 1920 peak i s not taken .into consideration in t h i s statement. He also sees a danger in the f a c t t h a t , the lower the discount r a t e the more the reserve banks w i l l have to have invested in order to earn t h e i r expenses, and that t h i s v i cious c i r c l e would lead to progressive i n f l a t i o n . The w r i t e r ' s remedies. As a f i n a l conclusion from t h i s discussion the w r i t e r proposes the r e p e a l of the 1917 amendments which required that a l l the reserves of the member Page 8 X-U212 banks bo kept with the reserve banks snd permittod the reserve banks to iusua notes d i r e c t l y against gold. If the w r i t e r ' s views on the s i t u a t i o n were c o r r e c t h i s remedies would not be adequate. With the present volume of reserves the r e serve banks could t r a n s f e r to the member banks that proportion of the reserves held by these banks p r i o r to 1917 and s t i l l have enough funds l e f t for any amount of c r e d i t expansion that may reasonably be anticipated; P r o h i b i t i n g the reserve banks from issuing notes against gold would under the present circumstances have no e f f e c t whatever, as i s indicated by the f a c t , already mentioned, t h a t the reserve banks have a c t u a l l y paid out gold r a t h e r than notes to the .extent of $700,000,000 without any e f f e c t on the c r e d i t s i t u a t i o n . To sum up, the author, displeased with the f a c t that the i n t e r e s t r a t e i s what he considers abnormally low and believing that the reserve banks are a t l e a s t in p a r t responsible, has based h i s arguments on a misunderstanding of our system of currency issues and of the scope and l i m i t s of the power possessed by the Federal r e s e r v e banks. There may be too much bank c r e d i t in use, but the w r i t e r o f f e r s no f r e s h evidence on t h i s point and proposes no remedies t h a t would accomplish h i s purpose.
@FedFRASER