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F E D E R A L R E S E R V E BOARD STATEMEM" FOR TEE PRESS For r e l e a s e Thursday m o r n i n g , September 2 0 , a t 1 1 . 0 0 o ' c l o c k And. n o t b e f o r e . Address d e l i v e r e d by Governor Roy A. Young, b e f o r e the Indiana Bankers A s s o c i a t i o n , at its Annual C o n v e n t i o n a t Gary, I n d i a n a . September 2 0 , 1 9 2 8 . X-6139 The P r e s e n t C r e d i t S i t u a t i o n R e p r e s e n t a t i v e s of F e d e r a l r e s e r v e "banks h a v e a p p e a r e d "before a u d i e n c e s so many t i m e s t o d e s c r i b e c u r r e n c y , d i s c o u n t a n d o t h e r o p e r a t i o n s of t h e System t h a t t o d a y I am g o i n g t o d i g r e s s somewhat a n d t a l k a b o u t t h e p r e s e n t c r e d i t situation. This i s a l a r g e s u b j e c t , b u t inasmuch a s I am s p e a k i n g t o a n a u d i e n c e that i s q u i t e f a m i l i a r with banking p r a c t i c e , I f e e l I w i l l be a b l e t o g e t over t o you a c o n c i s e s t o r y i n t h e t i m e t h a t h a s b e e n a l l o t t e d t o me. I n o r d e r t o b r i n g t h e p i c t u r e up t o d a t e , i t i s n e c e s s a r y t o r e v i e w what h a s h a p p e n e d d u r i n g t h e p a s t e i g h t y e a r s . Gold i s t h e b a s i s of o u r c r e d i t s t r u c t u r e a n d w h i l e t h e g o l d s t a n d a r d , p e r h a p s , h a s some f a u l t s , i t i s the best b a s i s t h a t h a s y e t b e e n d e v i s e d a n d p u b l i c f a i t h i n i t s e f f i c i e n c y h a s b e e n demons t r a t e d c o n c l u s i v e l y d u r i n g t h e p a s t f i v e y e a r s by t h e w i l l i n g n e s s a n d e a g e r n e s s w i t h which many c o u n t r i e s h a v e r e t u r n e d t o soma f o r m of g o l d s t a n d a r d . All that h a s h a p p e n e d f o r t h e p a s t e i g h t y e a r s , t h e r e f o r e , c a n b e s t be r e v i e w e d by r e f e r r i n g t o g o l d movements. S i n c e September 1920 and up t o December 1924, g o l d f l o w e d i n t o t h e U n i t e d S t a t e s c o n t i n u o u s l y , t h e n e t i m p o r t movement f o r t h e p e r i o d a g g r e g a t i n g a p proximately $1,660,000,000, From September 1920 t o t h e s p r i n g of 1922, t h e g o l d r e c e i v e d f r o m a b r o a d was u s e d l a r g e l y by member b a n k s t o r e d u c e t h e i r b o r r o w i n g s f r o m t h e F e d e r a l r e s e r v e banks a n d t h u s improve t h e g e n e r a l c o n d i t i o n of t h e member ,banks and t h e r e s e r v e p o s i t i o n of t h e r e s e r v e b a n k s . Generally speaking, gold re- c e i v e <. d u r i n g t h i s p e r i o d d i d n o t , t h e r e f o r e , become a p a r t of t h e r e s e r v e s of mem3 b e r banks a n d d i d n o t f o r m t h e b a s i s of c r e d i t e x p a n s i o n . Between 1922 a n d 1924 g o l d i m p o r t s were s u f f i c i e n t t o meet t h e c o u n t r y ' s g r o w i n g demand f o r c u r r e n c y , and i n a d d i t i o n , t o i n c r e a s e t h e r e s e r v e s ,/+ \ - 1 S -2~ •: X-6139 of member b a n k s which were t h u s e n a b l e d t o expand t h e i r l o a n s and i n v e s t m e n t s w i t h out i n c r e a s i n g t h e i r b o r r o w i n g s a t t h e F e d e r a l r e s e r v e b a n k s . From 1924 t o t h e s p r i n g of 1927 t h e g o l d i m p o r t s j u s t a b o u t o f f s e t g o l d e x p o r t s , so t h a t t h e t o t a l i n c r e a s e i n g o l d h o l d i n g s of our c o u n t r y b e t w e e n September 1920 a n d t h e s p r i n g of 1927 a g g r e g a t e d , a s I h a v e s t a t e d b e f o r e , a p p r o x i m a t e l y $ 1 , 6 6 0 , 0 0 0 , 0 0 0 . With t h i s a d d i t i o n t o t h e g o l d b a s i s , through the i n v e r t e d pyramid p r i n c i p l e of c r e d i t , b a n k s were a b l e t o expand t r e m e n d o u s l y . A l l of t h i s growth, however, c o u l d n o t go i n t o t h e o l d - f a s h i o n e d f o r m s of c r e d i t b a s e d upon p r o d u c t i o n and d i s t r i b u t i o n o t h e r w i s e known a s e l i g i b l e p a p e r , a n d t h e r e f o r e t h e b a n k s h a d t o s e e k o t h e r f o r m s of c r e d i t . Naturally they turned to the investment c r e d i t market. With t h i s s t i m u l u s a n d s u p p o r t from t h e b a n k s t h r o u g h o u t t h e c o u n t r y , the i n v e s t - ment b a n k e r s a c c e p t e d t h e o p p o r t u n i t y and f i n a n c e d n o t o n l y now e n t e r p r i s e by l o n g t i m e c r e d i t s , b u t o l d e s t a b l i s h e d e n t e r p r i s e a s w e l l , w i t h t h e r e s u l t t h a t the p r o p o r t i o n of e l i g i b l e p a p e r d i m i n i s h e d i n t h e p o r t f o l i o s of t h e b a n k s w h i l e t h e p r o p o r t i o n of i n v e s t m e n t c r e d i t h e l d by t h e b a n k s i n c r e a s e d r a p i d l y . For a l l t h e banks of t h e U n i t e d S t a t e s a s of J u n e 30, 1928, t h e f i g u r e s a r e a p p r o x i m a t e l y a s f o l l o w s : U. S . Government bonds .$ 6,000,000,000 O t h e r s t o c k s a n d bonds 12,000,000,000 Loans on s e c u r i t i e s (Of which amount $3* 0 0 0 , 0 0 0 , 0 0 0 i s r e p r e s e n t e d by s o - c a l l e d brokers' loans) Loans on r e a l e s t a t e s e c u r i t y . .13,000,000,000 5,000,000,000 Loans t o c u s t o m e r s (Of which amount i t i s e s t i m a t e d that approximately $5,000,000,000 i s e l i g i b l e p a p e r h e l d by member b a n k s ) 20,000,000,000 Total l o a n s and investments $56,000,000,000 T h e r e h a s b e e n some c o m p l a i n t of l a t e t h a t i n v e s t m e n t and s p e c u l a t i v e c r e d i t h a v e n o t r e c e i v e d t h e i r p r o p o r t i o n of t h e bank c r e d i t a v a i l a b l e , b u t ~3~ X-6139 i t seems t o me f r o m t h e s e f i g u r e s - when you add t h e t o t a l amount of bonds t o the t o t a l amount l e n t on s e c u r i t i e s a n d a r r i v e a t t h e t o t a l of $ 3 1 , 0 0 0 , 0 0 0 , 0 0 0 - t h a t t h e s e f o r m s of c r e d i t h a v e "been t r e a t e d l i b e r a l l y "by t h e "banks. A l l of t h i s e x p a n s i o n of c r e d i t , up t o May 1927, was a c c o m p l i s h e d w i t h o u t i n c r e a s i n g t h e amount of F e d e r a l r e s e r v e c r e d i t , "because t h e f i g u r e s show t h a t e x c o p t f o r s e a s o n a l a n d h o l i d a y c u r r e n c y r e q u i r e m e n t s , t h e t o t a l a s s e t s of t h e R e s e r v e System h a v e c o n t i n u e d a r o u n d $ 1 , 0 0 0 , 0 0 0 , 0 0 0 s i n c e 1922, I n May of 1927, however, something h a p p e n e d t o which t h e American b u s i n e s s p u b l i c and f i n a n c i a l i n t e r e s t s did not a t t a c h s u f f i c i e n t importance. was a r e v e r s a l i n t h e d i r e c t i o n of g o l d movements. This From May u n t i l t h e e a r l y p a r t of November t h e R e s e r v e System o f f s e t t h e e x p o r t s of g o l d "by p u r c h a s e s of U. S . Government s e c u r i t i e s , f e e l i n g t h a t the time was. n o t o p p o r t u n e t o d i s t u r b our own d o m e s t i c s i t u a t i o n when t h e r e g u l a r s e a s o n a l a g r i c u l t u r a l r e q u i r e m e n t s were on and s t a b i l i z a t i o n p l a n s f o r some of our f o r e i g n f r i e n d s were not c o m p l e t e d - a n d s t a b i l i z a t i o n of f o r e i g n c u r r e n c i e s , i n d i r e c t l y , was of g r e a t i m p o r t a n c e to our domestic situation. D u r i n g November a n d December, when g o l d c o n t i n u e d t o f l o w f r o m t h i s c o u n t r y , t h e System d i d not o f f s e t t h e e x p o r t movements. This should have had the e f f e c t of r e t a r d i n g t h e r a p i d growth of c r e d i t , b u t i t d i d n o t , l a r g e l y b e c a u s e any i n c r e a s e i n F e d e r a l r e s e r v e bank c r e d i t a t t h a t t i m e was i n t e r p r e t e d by t h e banks a n d t h e p u b l i c a s b e i n g i n r e s p o n s e t o c u s t o m a r y s e a s o n a l r e q u i r e m e n t s , e v e n though i t h a d gone $ 2 0 0 , 0 0 0 , 0 0 0 h i g h e r t h a n t h e y e a r b e f o r e . The r e t u r n f l o w of h o l i d a y c u r r e n c y i n t h e l a t t e r p a r t of December a n d e a r l y p a r t of J a n u a r y was g r e a t e r t h a n i t h a d b e e n i n any y e a r f o r f i v e y e a r s a n d t h e r e f o r e t h e System s o l d a d d i t i o n a l Government s e c u r i t i e s t o p a r t l y o f f s e t t h i s r e t u r n f l o w . Gold h o l d i n g s changed b u t l i t t l e d u r i n g t h e months of J a n u a r y and F e b r u a r y b u t c r e d i t expanded a t more t h a n t h e normal r a t e , a n d c e r t a i n l y t h e r e was no e v i d e n c e t h a t t h i s a d d i t i o n a l c r e d i t was r e q u i r e d f o r business* -4- X-6139 T h e r e i s a n i m p r e s s i o n i n the, mind£ of many p e o p l e , i n c l u d i n g somo "bankers, t h a t a member bank d e l i b e r a t e l y borrows frotn i t s r e s e r v e bank a t a low r a t e to enable i t to l e n d a t a h i g h e r r a t e s o l e l y f o r the p r o f i t i n the t r a n s a c tion. I h a v e b e e n a s s o c i a t e d w i t h t h e System f o r t e n y e a r s a n d I c a n s a y w i t h o u t f e a r of c o n t r a d i c t i o n t h a t t h i s seldom h a p p e n s . What does h a p p e n g e n e r a l l y , however, is this: A member bank a c c u m u l a t e s d e p o s i t s i n t h e o r d i n a r y c o u r s e of i t s b u s i n e s s a n d , i f i t e x p e c t s t o c o n t i n u e i t s b u s i n e s s a t a p r o f i t , i t mast employ those funds almost i n s t a n t a n e o u s l y i n t h e c r e d i t f i e l d t h a t o f f e r s the b e s t r a t e s consistent with safety. i t s reserve L a t e r i t h a s a r e d u c t i o n i n d e p o s i t s a n d must r e p l e n i s h i n one of two w a y s . One i s by b o r r o w i n g f r o m t h e F e d e r a l r e s e r v e bank and t h e o t h e r i s by s e l l i n g some of i t s r e a d i l y m a r k e t a b l e a s s e t s . In the g r e a t m a j o r i t y of c a s e s t h e member bank which h a s wide f l u c t u a t i o n s i n i t s d e p o s i t s b o r rows f r o m t h e r e s e r v e b a n k . By d o i n g t h i s t h e bank a v o i d s d i s t u r b i n g i t s p o r t f o - l i o a n d u s e s t h e r e s e r v e bank f o r t h e l e g i t i m a t e p u r p o s e of b r i d g i n g o v e r a temporary shortage i n r e s e r v e s . N a t u r a l l y , when t h e r e d i s c o u n t r a t e i s low a n d t h e open m a r k e t r a t e h i g h , t h e r e i s a n i n c e n t i v e f o r t h e b a n k e r t o c o n t i n u e t o borrow r a t h e r than to c u r t a i l h i s investments. When t h i s p r a c t i c e becomes s i m u l t a n e o u s l y g e n e r a l i t f u r n i s h e s one r e a s o n , b u t o n l y one, f o r r a i s i n g t h e r e d i s c o u n t r a t e s . There was e v i d e n c e of t h i s i n F e b r u a r y , w i t h t h e r e s u l t t h a t a 4 f o r a t e was i n i t i a t e d by t h e d i r e c t o r s of t h e v a r i o u s F e d e r a l r e s e r v e b a n k s . However, c r e d i t c o n t i n u e d t o expand a n d t h e b a n k s c o n t i n u e d t o borrow f r o m t h e F e d e r a l r e s e r v e banks on r e d i s c o u n t s t o make up t h e l o s s i n g o l d a n d t h e s a l e of Government securities. No one p a r t i c u l a r bank was i n d e b t any g r e a t l e n g t h of t i m e ; i n f a c t , t h e i n f o r m a t i o n we h a v e i n W a s h i n g t o n i s t h a t t h e bank t h a t b o r r o w e d t o c o v e r a l o s s of d e p o s i t s g o t o u t of d e b t by l i q u i d a t i n g some of i t s i n e l i g i b l e a s s e t s . -5- X-6139 When i t did s o , h o w e v e r , d i r e c t l y or indirectly, it iaade it n e c e s s a r y f o r some o t h e r "bank t o borrow a n d so t h e b o r r o w i n g s of member banks were p a s s e d a r o u n d f r o m one bank t o a n o t h e r w i t h o u t r e d u c i n g t h e t o t a l i n d e b t e d n e s s of t h e member banks t o t h e F e d e r a l r e s e r v e b a n k s , b u t on t h e c o n t r a r y , i n c r e a s i n g i t . Again, i n A p r i l , t h e d i r e c t o r s of one of t h e F e d e r a l r e s e r v e banks i n i t i a t e d a r e d i s c o u n t r a t e of 4 - l / 2 $ . other reserve banks. T h i s was e v e n t u a l l y f o l l o w e d by a l l of t h e By J u n e t h e member b a n k s owed t h e System a p p r o x i m a t e l y $ 1 , 0 0 0 , 0 0 0 , 0 0 0 u p o n r e d i s c o u n t s a n d were i n a p o s i t i o n where t h e y c o u l d n o t g e t o u t of d e b t so r e a d i l y by s h i f t i n g t h e l o a d f r o m one bank t o a n o t h e r ; i n f a c t , t h e load centered mostly i n the l a r g e r c i t i e s . There was a r a p i d i n c r e a s e i n d i s c o u n t s i n t h e l a t t e r p a r t of J u n e a n d a l s o i n J u l y , some of w h i c h , of c o u r s e , r e p r e s e n t e d c u r r e n c y r e q u i r e m e n t s , b u t t h e i n c r e a s e h a d t h e earmarks of f u r t h e r p y r a m i d i n g of c r e d i t and n o t of b e i n g t h e o l d - f a s h i o n e d c r e d i t b a s e d upon p r o d u c t i o n a n d d i s t r i b u t i o n , f r i t h t h e r e s u l t t h a t some of t h e F e d e r a l r e s e r v e b a n k s , where many of t h e i r member banks wore h e a v y b o r r o w e r s , i n i t i a t e d a r e d i s c o u n t r a t e of 5 $ . This action, however, was n o t t a k e n i n t h e f o u r s t r i c t l y a g r i c u l t u r a l d i s t r i c t s w e s t of t h e M i s s i s s i p p i R i v e r where a 4-1/2fa r a t e i s s t i l l m a i n t a i n e d , l a r g e l y b e c a u s e t h e memb e r banks were n o t h e a v y b o r r o w e r s and b e c a u s e i t was a t t h e time of t h e y e a r when l e g i t i m a t e s e a s o n a l a g r i c u l t u r a l r e q u i r e m e n t s h a d t o be m e t . From J u n e up t o t h e p r e s e n t t i m e t h e r e h a s b e e n b u t l i t t l e change i n t h e g o l d h o l d i n g s of t h e U n i t e d S t a t e s . The System h a s n o t s o l d a d d i t i o n a l Gov- ernment s e c u r i t i e s s i n c e t h a t t i m e a n d h a s u n d e r t a k e n no open m a r k e t o p e r a t i o n s , e x c e p t / a temporary n a t u r e . To summarize, t h e b a n k i n g system of America b u i l t up a c r e d i t s t r u c t u r e by r e s o r t i n g t o t h e i n v e r t e d p y r a m i d p r i n c i p l e of c r e d i t on $ 4 , 6 0 0 , 0 0 0 , 0 0 0 of g o l d which we h e l d i n May 1927, a n d t o d a y , on $ 4 , 1 0 0 , 0 0 0 , 0 0 0 , i t i s n o t o n l y s u p p o r t i n g t h a t c r e d i t s t r u c t u r e b u t a much l a r g e r o n e . T h i s i s shown by t h e June -6- X-6139 30 r e p o r t s 6f member banks which i n d i c a t e a n i n c r e a s e above l a s t y e a r of $ 2 , 5 0 0 , 000,000 i n l o a n s and i n v e s t m e n t s . To s u p p o r t t h i s c r e d i t s t r u c t u r e , member banks have f o u n d i t n e c e s s a r y t o i n c r e a s e t h e i r b o r r o w i n g s a t t h e F e d e r a l r e s e r v e banks a p p r o x i m a t e l y $ 5 0 0 , 0 0 0 , 0 0 0 . From t h i s i t seems t o me t h a t t h e r e s e r v e banks a r e f u n c t i o n i n g j u s t a s t h e law i n t e n d e d t h a t t h e y s h o u l d f u n c t i o n . Miscal- c u l a t i o n s a s t o t h e f u t u r e a l w a y s h a v e a n d p e r h a p s a l w a y s w i l l o c c u r w i t h the banks and t h e b u s i n e s s p u b l i c and t h a t i s one of t h e r e a s o n s why we n e e d r e s e r v e b a n k s , i n o t h e r w o r d s , i n s t i t u t i o n s which e n a b l e t h e p u b l i c t o a d j u s t t h e i r m i s c a l c u l a t i o n s i n an o r d e r l y a n d s y s t e m a t i c way. So many f a c t o r s h a v e a n i n f l u e n c e on b a n k i n g t h a t i t i s a m i s t a k e t o a r r i v e a t the c o n c l u s i o n t h a t t h e F e d e r a l R e s e r v e System a l o n e , t h r o u g h i t s p o l i c i e s , makes c r e d i t s i t u a t i o n s . I t i s r e a s o n a b l e t o b e l i e v e from what I have c i t e d t h a t c o n d i t i o n s , over many of which t h e System h a s no c o n t r o l , form t h e b a s i s of r e s e r v e bank c r e d i t p o l i c i e s a n d r a t e s . Many p e o p l e i n America seem t o be more c o n c e r n e d a b o u t t h e p r e s e n t s i t u a t i o n t h a n t h e F e d e r a l R e s e r v e System i s . I f unsound c r e d i t p r a c t i c e s have de- v e l o p e d , t h e s e p r a c t i c e s w i l l i n time c o r r e c t t h e m s e l v e s , and i f some of t h e o v e r i n d u l g e n t g e t " b u r n t " d u r i n g t h e p e r i o d of c o r r e c t i o n , t h e y w i l l have t o s h o u l d e r t h e blame t h e m s e l v e s a n d n o t a t t e m p t t o s h i f t i t t o someone e l s e . Great c o n c e r n i s e x p r e s s e d o v e r t h e m y s t e r y of F e d e r a l r e s e r v e p o l i c i e s . D i s s a t i s f a c t i o n i s express- e d b e c a u s e t h e F e d e r a l R e s e r v e System r e f r a i n s f r o m p r e d i c t i o n a n d c a n n o t always anticipate. I h a v e s t a t e d t o you t h a t c o n d i t i o n s , t o a l a r g e e x t e n t , b r i n g a b o u t F e d e r a l r e s e r v e p o l i c i e s r a t h e r t h a n t h a t F e d e r a l r e s e r v e p o l i c i e s b r i n g a b o u t conditions. That i s j u s t t h e p o s i t i o n of t h e System a t t h e moment. If p a s t experience means a n y t h i n g , we know t h a t t h e a d d i t i o n a l r e s e r v e c r e d i t n e e d e d between now and December 31 w i l l a g g r e g a t e a p p r o x i m a t e l y $ 3 0 0 , 0 0 0 , 0 0 0 . T h i s w i l l come from t h e u s u a l s e a s o n a l r e q u i r e m e n t s of a g r i c u l t u r e . , a n d b u s i n e s s . Digitized t h e System t h a t for FRASER I t i s t h e e x p e c t a t i o n of t h i s a d d i t i o n a l c r e d i t w i l l be s e c u r e d by t h e member b a n k s r e d i s - -7- X-6139 c o u n t i n g w i t h o u t h e s i t a n c y to t a k e c a r e of t h e s e r e q u i r e m e n t s a n d t h a t t h e y w i l l lend to t h e i r customers a t reasonable r a t e s . I t f u r t h e r expects that t h i s addi- t i o n a l r e s e r v e c r e d i t w i l l n o t "be u s e d i n f u r t h e r e x p a n d i n g a bank c r e d i t s i t u a t i o n t h a t grew up when our g o l d r e s e r v e s were $500,000,OCX) l a r g e r t h a n t h e y a r e now and which h a s c o n t i n u e d t o grow w h i l e t h e r e s e r v e s h a v e b e e n s h r i n k i n g . If a f t e r J a n u a r y 1929 f o l l o w i n g t h e r e t u r n f l o w of h o l i d a y c u r r e n c y , t h e b a n k s s t i l l owe t h e System a p p r o x i m a t e l y $ 1 , 0 0 0 , 0 0 0 , 0 0 0 i n r e d i s c o u n t s , I , p e r s o n a l l y , w i l l f e e l t h a t t h e s i t u a t i o n h a s b e e n h a n d l e d a d m i r a b l y a n d I s h a l l h a v e no cause f o r c o n c e r n , b e c a u s e w i t h t h e t r a d i t i o n which t h e member banks h a v e a b o u t b o r r o w i n g c o n t i n u a l l y f r o m t h e F e d e r a l . R e s e r v e System, a d e b t t o t h e System of $ 1 , 0 0 0 , 0 0 0 , 0 0 0 w i l l h a v e a more m o d e r a t i n g e f f e c t u p o n t h e t o o r a p i d g r o w t h of bank c r e d i t t h a n any o t h e r s i n g l e c o n d i t i o n t h a t I know o f .
@FedFRASER