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BOARD OF GOVERNORS OF T H E FEDERAL RESERVE SYSTEM WASHINGTON O F F I C E OF THE CHAIRMAN M a r c h 20, 1956. D r , Alvin Johnson, The New School, 66 West 12th S t r e e t , New York 11, New York. Dear Doctor Johnson: Your much a p p r e c i a t e d l e t t e r of F e b r u a r y 27 d e s e r v e d a p r o m p t e r r e p l y . In the i n t e r v a l we have gone over the t r a n s c r i p t of the talk I gave at the New School and t r i e d to condense and clarify it a bit. The text thus r e v i s e d is enclosed and you a r e w e l c o m e , of c o u r s e , to make whatever use of it, if any, you may wish. Since it has a l r e a d y been r e p r i n t e d unr e v i s e d by the C o m m e r c i a l and Financial Chronicle it is not new, and my own leaning would be to do no m o r e with it. If I had the time and had not adhered to a selfimposed rule against p r e p a r i n g such a r t i c l e s , I would be glad to do one for Social R e s e a r c h . A s I a m s u r e you will u n d e r stand, one cannot say yes in one instance and no in another when asked to supply an a r t i c l e . Quite a few such r e q u e s t s come to this desk. If I w e r e to acquiesce even in one i n s t a n c e , then those to whom I have said no would be understandably miffed. N e e d l e s s to add, I a m flattered by your generous words and offer. With e v e r y good wish. Sincerely, Wm. McC. Martin, J r . Enclosure. I t ' s a v e r y r e a l privilege for me to be h e r e today, for I feel right at home at the New School. My introduction to the New School dates back to 1931, when I c a m e to New York from St. L o u i s , joined the New York Stock Exchange, and was looking around for something to do in the evenings. An official of the F e d e r a l R e s e r v e Bank of New York, who is now my a s s o c i a t e as Under S e c r e t a r y of the T r e a s u r y , D r . W. Randolph B u r g e s s , made some suggestions, r e m a r k i n g at one point that "at the New School an old friend of m i n e , D r . K e m m e r e r , is going to give a c o u r s e on the gold standard, and I think you might enjoy that. f! The r e s u l t was that I came up h e r e , signed up for D r . Edwin W. K e m m e r e r ' s c o u r s e , and from t h e r e on noted r e p e a t e d l y in a d i a r y I then kept, "Evening spent at the New School. Walked h o m e . " One e n t r y that i s p a r t i c u l a r l y a p p r o p r i a t e to mention today said, "Walked home with A. Wilfred May. about economics with h i m . Argued A m not s u r e whether I won or he did, but we both had a good t i m e . " I also a m v e r y pleased to be h e r e to pay tribute to D r . Johnson. H e ' s a m a n that w e a r s well, a s all of you know; h e ' s a m a n who has contributed a g r e a t deal to my intellectual s t i m u l u s ; h e ' s a m a n that I've found always to be p r o v o c a t i v e , stimulating, c o n s t r u c t i v e , a n d - - m o s t i m p o r t a n t of a l l - - n e v e r dull. Never have -2- I attended a meeting that D r . Johnson has p r e s i d e d over that, in any sense of the word, could be d e s c r i b e d as dull. to be in his p r e s e n c e again. So I'm v e r y honored I always think of him as one of my m e n t o r s and t e a c h e r s . Now that in itself is not enough for coming to a meeting of this s o r t . What, it s e e m s to m e , is m o r e i m p o r t a n t is to u n d e r - stand that it is through a s s e m b l i e s , convocations, m e e t i n g s , and d i s c u s s i o n s that we p r o p e l and m a i n t a i n our form of life and our d e m o c r a t i c m e a n s of e x p r e s s i o n , which is r e a l l y the i m p o r t a n t thing in a country such a s t h i s . I know s o m e t i m e s we get t i r e d of going to m e e t i n g s ; but it is only through d i s c u s s i o n and through constant evaluation and r e a s s e s s m e n t of the position that w e ' r e in that we can hope to safeguard the values which a r e useful to u s . Now when I look back and think of the l a s t 25 y e a r s in New York, I can't help but r e a l i z e , m o r e than IVe ever r e a l i z e d before, what is m e a n t when you h e a r that oft-repeated p h r a s e that the t r u l y educated m a n is one who has a g r a s p , an understanding, a knowledge, of what his intellectual inheritance i s . T h e r e ' s nothing new in that; t h e r e ' s nothing p a r t i c u l a r l y striking in it, but to a p p r e ciate it fully r e q u i r e s a lifetime of study, and steady and constant humility with r e s p e c t to the c u r r e n t state of o n e ' s own thinking or the c u r r e n t state of knowledge with which w e ' r e dealing. -3- I happen to be one who doesn ! t believe that h i s t o r y r e p e a t s itself. But I do think that t h e r e a r e guides in h i s t o r y to g e n e r a l p r i n c i p l e s , to g e n e r a l f o r c e s , which can be e x t r e m e l y valuable in meeting new situations. P e r h a p s we don f t gain as much as we should by e x p e r i e n c e ; I doubt if any two situations a r e ever s i m i l a r , but it does s e e m to me that you have to keep in mind the p e r s p e c t i v e of this h e r i t a g e that I ' m talking about if you want to build upon it. The y e a r 1856, a hundred y e a r s ago, gives me a s t a r t i n g point for these e x t e m p o r a n e o u s r e m a r k s today. P i e r c e was P r e s i d e n t of the United States in 1856. was out J a m e s Buchanan was to be P r e s i d e n t . decision was in the making. Franklin Before the y e a r The Dred Scott Kansas was bleeding. And a r i s i n g young political figure in the State of Illinois, A b r a h a m Lincoln, received in a political convention 110 votes for Vice P r e s i d e n t of the United S t a t e s . But none of these e v e n t s , although they m i r r o r e d what was to happen in the next hundred y e a r s , h a s the p a r t i c u l a r i m p o r t a n c e to my theme today of an event little noticed in 1856: the birthxrfxTSkeorfsrxH^^^iiexsK in late D e c e m b e r of that y e a r of Woodrow Wilson. F o r the A m e r i c a n c e n t r a l banking s y s t e m which we now have was developed and organized in 1913, only 42 y e a r s ago, under l e a d e r s h i p of Woodrow Wilson, whom the Nation is now honoring on the centennial of his b i r t h . -4- It i s from that starting point that I want to take off, because I think that too few of us r e a l i z e c l e a r l y how the r o o t s of our money and c r e d i t s y s t e m w e r e imbedded in the soil of our American democracy. Nothing I a m saying is intended to imply that I believe the F e d e r a l R e s e r v e System to be p e r f e c t , or to be the final fruition of the a c h i e v e m e n t s that this country can make in developing a sound s y s t e m of money and c r e d i t . But I think the evolution of the F e d e r a l R e s e r v e signalizes the p r o g r e s s and change that this country has made in adapting to a changing world. The e s s e n c e of what w e ' r e talking about today, new h o r i z o n s in money and banking, m u s t go back to this h e r i t a g e . If you will study the F e d e r a l i s t p a p e r s , or t r y to review the documents of the time in t e r m s of money and credit, I think you will see v e r y c l e a r l y that our forefathers w e r e p a r t i c u l a r l y apprehensive of abuse of money and c r e d i t . After a l l , they had experienced abuse of power; they understood what tyranny and d e s p o t i s m was; they knew what ff clipping the coin' 1 w a s - - t o put it in a loose p h r a s e - - a n d t h e r e f o r e they w e r e e x t r e m e l y apprehensive of p e r m i t t i n g government to get in any way into a position to n clip t h e i r coin 11 or to d e p r e c i a t e t h e i r c u r r e n c y . And t h e r e f o r e , in the e a r l y days of our country, you see e v e r y effort being m a d e , no m a t t e r what the c o n s e q u e n c e s , to p r e v e n t governmental i n t e r f e r e n c e in the affairs of money and c r e d i t . When -5- the first Bank of the United States was formed in 1791, after long debate it was decided that no government official could s e r v e even as a d i r e c t o r of the bank. By the t i m e we got to the second Bank of the United S t a t e s , in 1811, p r o g r e s s had been made to the point that it was stated that at l e a s t five government officials could s e r v e on the Board of D i r e c t o r s , but they could not p a r t i c i p a t e in giving the S e c r e t a r y of the T r e a s u r y r e p o r t s of what t r a n s p i r e d at the m e e t i n g s which they attended. debate. That was carefully stipulated in the Through 1840, in the debates that w e r e going on on the continuation of the second Bank, and coming into the 1856 period that I d e s c r i b e d , t h e r e was this constant d e t e r m i n a t i o n to p r e v e n t gsisttSS governmental i n t e r f e r e n c e , even if t h e r e were panics and disaster. And that feeling c a r r i e d all through the 70 f s and the 80 f s until, in 1907, we had an evolution in public thinking in the d i r e c t i o n of governmental intervention that laid the groundwork for the Federal Reserve System. I t ' s not news that, generally speaking, b u s i n e s s and banking opposed the e s t a b l i s h m e n t of the F e d e r a l R e s e r v e . But it would be superficial to say, "Well, that shows that b u s i n e s s and banking was blind. ,f What it shows is quite the r e v e r s e . It s e e m s to me it shows that b u s i n e s s and banking w e r e a w a r e of the fact that a g r e a t deal of power was now being given to a government b o d y - - -6- that we w e r e e m b a r k i n g upon a managed c u r r e n c y , something that s t r i k e s right at the r o o t s and h e a r t of our way of life and, if m i s managed, might produce all of the d a n g e r s and d i f f i c u l t i e s - - p e r h a p s w o r s e - - o f the money panics which we had been witnessing. But we had r e a c h e d a point, with the panic of 1907, where the decisions of the m a r k e t p l a c e w e r e considered to be too blind. The difficulties with m o n e y - - i t s d i s a p p e a r a n c e when m o s t needed, and its abundance when it was l e a s t n e e d e d - - h a d s t r u c k through to the c o n s c i o u s n e s s of the A m e r i c a n people to such an extent that they w e r e willing to r i s k the h a z a r d s of a managed c u r r e n c y and a full-blown governmental c e n t r a l banking s y s t e m . But they w e r e not willing to go all out. T h a t ' s where the s t r u c t u r e of the s y s t e m is i m p o r t a n t . After long debate, we came up with a regional s y s t e m of c e n t r a l banking. We c a m e up with 12 banks and 24 b r a n c h e s , coordinated in Washington by a governing body that was supposed to have only the m i n i m u m of power to make effective national policy. The Board in Washington was to be independent within the government but not independent of the government. It was to be a p a r t of the government, w h e r e a s the i n s t r u m e n t a l i t i e s , such a s the F e d e r a l R e s e r v e Bank of New York, w e r e to be qua s i - g o v e r n m e n t . The stockholders w e r e to be the banks of the country, but the p u r c h a s e of stock by the banks of the country was in no s e n s e - - a n d as the s y s t e m has evolved it has become c l e a r - - -7- was in no sense to be p r o p r i e t o r s h i p , but to be only a m e a n s of participation through the d e m o c r a t i c p r o c e s s in the o p e r a t i o n s and development of policy of the s y s t e m . A g r e a t many b a n k e r s , even at the p r e s e n t t i m e , think that it should be p r o p r i e t o r s h i p , and I think have m i s i n t e r p r e t e d , or m i s u n d e r s t o o d , what the r e a l f r a m e work and purpose of the F e d e r a l R e s e r v e Act w a s . Now I s t r e s s at all t i m e s the i m p o r t a n t word in our title. The i m p o r t a n t word is not " F e d e r a l " ; it is not " R e s e r v e " ; it is ^B±saaKxMSyxteflXDiyxxSx "System": two hundred and fifty d i r e c t o r s bringing to b e a r , through this p r o c e s s , the g r a s s - r o o t s thinking of the country upon the m a n a g e m e n t of our money and c r e d i t . And it s e e m s to me that when we make c h a n g e s , a s we made of a limited s o r t in the Banking Act of 1935, giving m o r e c e n t r a l i z a t i o n of power, in a c c o r d with the t r e n d s of the t i m e , to the governing body in Washington, we should f i r s t make s u r e we understand the d i r e c t i o n in which we a r e moving and the significance of the changes p r o p o s e d . Now this sytem that we have h a s worked r e a s o n a b l y effectively. It c e r t a i n l y h a s n ' t worked perfectly, but the F e d e r a l R e s e r v e System is the body, the only body in the government, that is charged full time with r e s p o n s i b i l i t y for the p u r c h a s i n g power of the d o l l a r , and m u s t always be thought of in that light if w e ' r e to think of it in its p r o p e r p e r s p e c t i v e . Benjamin D i s r a e l i , an -8- e x t r e m e l y i n t e r e s t i n g and stimulating m a n , said that individuals m a y form c o m m u n i t i e s , but it is institutions alone that make a nation. Such an institution is our F e d e r a l R e s e r v e S y s t e m , and it constitutes today one of the p r i m a r y bulwarks of our free e n t e r p r i s e s y s t e m . Because u n l e s s you have flexible money and c r e d i t policy you cannot have free e n t e r p r i s e in the sense that we so often use the word. So much for the institution which we have to manage or regulate the money supply. Now insofar as t h e r e is a m a j o r change in thinking out of this evolutionary p a t t e r n which I have sketched for you, it c o m e s to the fact that in the twentieth c e n t u r y , for the f i r s t t i m e , we see g e n e r a l acceptance of the r e s p o n s i b i l i t y of government to use all of its r e s o u r c e s to m i n i m i z e economic gyration and to accept r e s p o n s i b i l i t y for preventing, in so far as it can, major disturbances. century. I think that this is l a r g e l y a product of the twentieth I don't m e a n to be all e m b r a c i n g in that, or to rule out t r a c e s of the concept on e a r l i e r contexts, but it s e e m s to m e that a study of the F e d e r a l R e s e r v e Act alone d e m o n s t r a t e s how r e c e n t is widespread acceptance of this facet of government r e s p o n s i b i l i t y b e c a u s e t h e r e ' s no r e f e r e n c e to this b r o a d e r purpose in the p r e a m b l e of the original F e d e r a l R e s e r v e A c t . T h e r e ' s only a minor r e f e r - ence to it in the p r e a m b l e to the Banking Act of 1935. But you see its final fruition, in an inchoate way, I t h i n k , in the Employment Act of 1946. -9- Having given you the background of the institutional f r a m e w o r k within which w e ' r e working, I want to switch and say a little about the science or a r t - - I doubt if science i s the c o r r e c t w o r d - that has developed of e x e r c i s i n g effective and useful regulation of the money supply. In talking about these m a t t e r s , I fear that we get too technical at t i m e s . All of us r e a l l y understand the "cash m o n e y " we have in out p o c k e t s , and the "deposit money" in our checking accounts at the bank, jfee i t e m s that make up the money supply. The flow of that money and c r e d i t is m o r e difficult to visualize. I think of it as I do of a r i v e r or s t r e a m or a brook, gradually winding its way through the fields of b u s i n e s s and c o m merce. We should t r y to see that this brook, this s t r e a m , d o e s n ' t overflow its banks and flood the fields on either side, or dry up and leave those fields p a r c h e d . We m u s t recognize that i r r i g a t i o n and drainage a r e r e q u i r e d from time to t i m e . We want the volume of w a t e r in that s t r e a m to i n c r e a s e , but not u n l e s s the bed of the s t r e a m can a b s o r b it and hold it. We m u s t also recognize that people don't get r i c h by sitting on the bank and just dabbling their fingers in the s t r e a m , because this s t r e a m of money is just a m e a n s to an end of i n c r e a s i n g t r u e wealth and r a i s i n g living standards. Money should always be thought of as our s e r v a n t and not our m a s t e r . We should not get enamoured of the gold standard -10- or other automatic means of regulating it, because what we are essentially dealing with, and what we must recognize as the fundamental problem is human nature and human beings, and no one has yet devised any system of levers, or any formulas or devices by which you can regulate human nature or human beings. Now that is the really basic thing that we're dealing with in trying to regulate the money supply. Now let's take the general theory of restraint and inflation. I think all of us recognize that you can be more effective in restraining than you can be in galvanizing. It is comparatively easy to supply money when business is bad, but no one's going to borrow that money unless they think they can make a profit out of it. There- fore, it is certainly more difficult, from an economic standpoint, to fight deflation as such than it is to fight inflation as such with the tools at our disposal. But having said that, I might point out that the psychological or human nature aspect of this problem is such that it is more difficult to get people to accept restraint once things are going well, even though those restraints will be effective, than it is to work in the opposite direction. It requires a great deal more political courage, it requires a great deal more sensitiveness to the fear psychology, when people say, collapse. shoulders. n Ah, you may be inducing a You may be leading to ruination, and it will all fall on your You will be the one that will be blamed. ff W e l l , of -10- c o u r s e that is a complete misconception of the role of money and c r e d i t , b e c a u s e it i s n ' t that i m p o r t a n t or that powerful in the economy; n e v e r t h e l e s s , t h a t f s the e a s y political-catchword a p p r o a c h to this p r o b l e m . On the other hand, m o s t people who have studied this field recognize that the r e a s o n we a r e against inflation is b e c a u s e we know it leads to deflation. would c a r e about inflation. If it were not for the a f t e r m a t h no one I don't mind conceding to this audience, or any other audience, fayxfx that m y social philosophy is such that if I r e a l l y thought inflation would r e a l l y c r e a t e jobs and sustain t h e m I would be an inflationist. The only difference between me and some of my c r i t i c s in the C o n g r e s s is that we have different methods of pushing for the same end. My own view is that by and l a r g e , in t e r m s of employment, which is what w e ' r e working for, that t h e r e will be two people unemployed after inflation has run its c o u r s e , w h e r e a s t h e r e would only have been one unemployed in the r e s u l t i n g adjustment, if t h e r e had not been the p r e c e d i n g inflation. That is the r e a s o n we have to do everything we can to r e s t r a i n inflation. Now the psychology of this is that you can r e s t r a i n a m a n before he goes too far and he will forgive you. But if he goes headlong on his c o u r s e and then, after he has gotten in t r o u b l e , you come along and punish h i m , not only will he not forgive you but I doubt v e r y much whether you can r e s t o r e him to a working s t a t u s . -11- I just put that in a g e n e r a l , simple sense so that you can follow the general point of view that I have on this m a t t e r . To i l l u s t r a t e t h i s , I want to take the period when we knew that the inventory r e c e s s i o n of 1953-54 was o v e r , and that we w e r e e m b a r k e d upon expansion in this country and w e r e going to have relatively b e t t e r t i m e s . Now when I say that I a m fully aware that not e v e r y place in the United States has been equally p r o s p e r o u s . I am fully a w a r e of the fact that f a r m income h a s declined, that some of the p r i c e stability that we've had in the p a s t y e a r h a s been due to the fact that t h e r e ' s been a 3-1/2 to 5 p e r cent i n c r e a s e since the s u m m e r in i n d u s t r i a l p r i c e s , offset by a c o r r e s p o n d i n g decline in f a r m p r i c e s . T h e r e a r e people, probably some in this r o o m , who honestly believe that if it hadn't been for the m i s c a l c u l a t i o n s of the T r e a s u r y and the F e d e r a l R e s e r v e in 1953 with r e s p e c t to the i s s u ance of a l o n g - t e r m bond and a s o - c a l l e d n h a r d money policy," that t h e r e wouldn't have been any c o r r e c t i o n in 1953-54. T h e r e a r e some on people who honestly believe that we would just have gone/a steady upward s p i r a l . Now I ' m not going to comment on that in a technical s e n s e , I ' m m e r e l y going to t r y to emphasize that anyone who's going through any period and r e l a t e s this to human n a t u r e knows that when t i m e s a r e good or we go on a binge, such as we did in the p o s t - K o r e a n p e r i o d , that t h e r e a r e e l e m e n t s which human nature b r i n g s into any p i c t u r e that have to be c o r r e c t e d , and those e l e m e n t s include w a s t e , -12- e x t r a v a g a n c e , i n c o m p e t e n c e , inefficiency, and all the byproducts of exuberance. The inevitable a f t e r m a t h of all war is inflation. That!s p e r h a p s the w o r s t phase of w a r , but i t f s the one t h a t f s the l e a s t understood by people b e c a u s e i t ! s usually latent. During the war you have the self-discipline of p a t r i o t i s m to help control the latent inflation, but after the war the r e s t r a i n i n g influence of p a t r i o t i s m d i s a p p e a r s , the attitude of people c h a n g e s , and inflation e n s u e s . Now I f m not trying to wriggle out from under a c e r t a i n amount of r e s p o n s i b i l i t y for m i s i n t e r p r e t i n g or misgauging the psychology of the spring of 1953 in money and c r e d i t policy. I have admitted publicly that I don't think we handled the situation as well a s we might h a v e . But having said that, I emphasized that the place where the e r r o r was p r i m a r i l y m a d e , aside from d e t a i l s , was that in ! 52 we w e r e letting money get too e a s y and we w e r e not p e r m i t t i n g to be made in the m a r k e t the adjustment that eventually would have to be m a d e . Let me i l l u s t r a t e with one simple c a s e . When it was a p p a r e n t that b u s i n e s s was declining, and declining rapidly, in late 1953, I had a meeting h e r e in New York with a v e r y intelligent group of individuals whose b u s i n e s s was suffering. After the meeting they had some q u e s t i o n s , and one of the m e n t h e r e called on another individual and said, fl Joe, tell us why p u r b u s i n e s s is so bad. Em sure M r . Martin would like to know. n I'll never forget this m a n . -13- He got up and he looked at m e and he said, why my b u s i n e s s is so bad. n I c a n ' t tell M r . Martin I'd be a s h a m e d to tell him that. Until I've done the things that I know ought to be done in my b u s i n e s s , I don't know whether my b u s i n e s s is r e a l l y bad or not. " And then he explained to me what had happened in his b u s i n e s s . It was a v e r y revealing p o r t r a i t . He said, "My daughter m a r r i e d a fellow who, in my judgment is completely incompetent, but h e ' s in the family, so I gave h i m a job. " He said, n I've got twenty people working h e r e that I don't need, but b u s i n e s s has been so good that t h e r e was no p a r t i c u l a r incentive for me to c o r r e c t any of these situations in this shop. And honestly, t h e r e a r e so many things wrong with my b u s i - n e s s that I've postponed c o r r e c t i n g that I ' m going to say to M r . M a r t i n , 'I'd like to talk to you a y e a r from now about how my b u s i n e s s i s , and if i t ' s bad then I'll s t a r t crying, but not b e f o r e . m I thought that was an e x t r e m e l y revealing i l l u s t r a t i o n of the point that I ' m trying to m a k e . We m u s t r e m e m b e r that this economy of o u r s is not only a profit economy but i t ' s also a l o s s economy. A g r e a t many of these buildings that we see around us in New Y o r k - - a n d I love to walk around the s t r e e t s of New Y o r k - - h a v e been built out of l o s s e s , not out of p r o f i t s . I t ' s been a long time since any of us r e c a l l that, but I once held a few bonds on a building that a r e now selling at p a r , and I bought t h e m for five d o l l a r s in the open m a r k e t . Those l o s s e s -14a r e n o r m a l in a free society, t h e y f r e p a r t of the r e w a r d s and penalties of b u s i n e s s . B u s i n e s s is not always a one-way s t r e e t . it WQB, t h e r e ' d be no judgment in it. If And the only point I make of it is this: if it w e r e possible by inflation, or by conscious government policy toward inflation, to continuously have good t i m e s , we would have discovered that a long time ago, and t h e r e would never have been any setbacks at a l l . Now I want to go to a period where i t ! s perfectly obvious that we had to change our e m p h a s i s and ride herd on c r e d i t . This was a period in 1955 when it was obvious that c e r t a i n f o r m a tions w e r e developing in the economy that could o v e r s t r a i n our resources. By the spring of 1955 it was perfectly c l e a r that t h e r e was a w a g e - c o s t push, that we had high l e v e l s of employment on the whole, and we had a situation that had to be w a t c h e d the m o s t c a r e fully--inventories. Having been through one inventory r e c e s s i o n I don f t want to go through a n o t h e r . When the head of a company t e l l s m e that h e ' s trying to build up i n v e n t o r y - - a n d don't forget that inventory figures a r e the p o o r e s t figures we h a v e - - a n d he doesn't build inventory, then I know that his s a l e s a r e exceeding his expectat i o n s , and the f i r s t t i m e that his s a l e s don't exceed his e x p e c t a t i o n s , the inventory is going to shoot u p - - a n d t h a t ' s the thing you've got to w o r r y about. -15- Now we a l s o have had high and i n c r e a s i n g l e v e l s of c o n s u m e r c r e d i t and m o r t g a g e c r e d i t . t h e y ' r e too high. I ' m not going to say that I ' m not going to say what the t e r m s should b e . don't believe that I know. I But I do know that they should be watched as to the extent to which e a s y t e r m s , whether in r e a l estate or in c o n s u m e r p u r c h a s e s , a r e being used, when t h e y ' r e not needed, to b o r r o w from the future, in which event t h e y ' r e not contributing at that p a r t i c u l a r point to stability. I ' m not saying that whether that stage was r e a c h e d , I ' m simply citing that the t o t a l s of these f o r m s of c r e d i t w e r e at r e c o r d levels and growing, and that t h e r e was a tendency to loosen t e r m s whenever t h e r e was the slightest decline in s a l e s , and that we have been riding, in one s e n s e , a toboggan-that u n l e s s t h e r e is a r e c o r d at the c a s h r e g i s t e r the f i r s t of e v e r y month, s o m e t h i n g ' s wrong. That in itself is something that h a s to be watched, I think, p r e t t y carefully. Something e l s e worth careful attention was the m a t t e r of plans for plant and equipment e x p e n d i t u r e . This was a strong factor in 1955, and now it looks like 1956 is going to be a p r e t t y good y e a r for plant and equipment e x p e n d i t u r e s . Take all those things t o g e t h e r , and you f ve got a situation that has to be watched and analyzed. And it s e e m s to m e that if we have any balance at all that we should lean against the wind and let money and c r e d i t operate in t e r m s of supply and demand, which a r e these -16- b a s i c guiding p r i n c i p l e s that I've been talking about, and which cannot be completely eliminated no m a t t e r now much one might like to eliminate t h e m . Now h e r e I want to make a few c o m m e n t s about the free m a r k e t . It has become v e r y p o p u l a r - - i t was popular even in my e a r l y days at the New School--to h e a r it said that t h e r e was no such thing as a free m a r k e t . relative. To be s u r e , all these things a r e I don't believe that the concepts that we have, whether t h e y ' r e in p r i v a t e p r o p e r t y or free competitive e n t e r p r i s e or with the profit motive or with the free m a r k e t , a r e the s a m e today a s they w e r e when the P i l g r i m s landed on Plymouth Rock. have been modified through the y e a r s . been eliminated. All of t h e m But that doesn't m e a n they've And t h e r e is no m o r e effective m e a n s that t h e s e t i m e - h o n o r e d d e v i c e s - - s o m e people call t h e m , in a d e p r e c a t o r y way, c l a s s i c a l d e v i c e s - - f o r gauging and guessing what the equilibrating forces a r e . Now I went through a period in Washington when it was v e r y popular to say that exchange r a t e s would never make any difference any m o r e , i n t e r e s t r a t e s would n e v e r have any i m p o r t a n c e any m o r e b e c a u s e to be effective they'd have to be adjusted so violently that you'd have long l i n e s of unemployment around the country; that the international p r i c e m e c h a n i s m could never work again, that tariffs r e a l l y didn't make any difference, that t h e r e was no point in being a free t r a d e r b e c a u s e a p r o t e c t i o n i s t s y s t e m could be built -17u p - - a f t e r a l l , hadn't Hitler showed the way on it, and w e r e we e v e r going to get to a f r e e r m a r k e t ? It s e e m s to me that the m o s t striking thing, p e r h a p s , of the l a s t ten y e a r s has been a recognition that, with modifications, these things a r e still with us just a s is the law of gravity. That doesn ! t m e a n that you have to accept t h e m , any m o r e than the public had to go on accepting the money panics which p r e c e d e d the F e d e r a l R e s e r v e Act. It d o e s n ' t m e a n that, but it does m e a n that you have to understand t h e m , and if you want to eliminate t h e m or avoid t h e m or m i n i m i z e t h e m or change them t h e r e is a p r i c e to be paid. There a r e advantages and disadvantages which m u s t be weighed in the public mind. L e t me i l l u s t r a t e . This past s u m m e r I had a political officer in a s m a l l c o m m u n i t y - - i t ! s not a l a r g e one, so I don't think anyone will guess it h e r e , or I wouldn't cite t h i s - - c a l l and tell me that I should be removed from office because a sewer i s s u e that he was planning was being held up. I was quite i n t e r e s t e d in this p a r t i c u l a r c a s e . I happened to know this individual quite well, and I said, "This is a free society and you have a perfect right to t r y to r e m o v e m e from office. I don't have the slightest complaint about that, but what is the situation? Is t h e r e no money available at all for the sewer i s s u e in the c o m m u n i t y ? " -18- Well, investigation showed that the money was available in the community, only it was not available in quite the way that this individual wanted it, since the borrowed funds w e r e going to cost about one-eighth to o n e - q u a r t e r p e r cent m o r e than when l a s t they had floated a similar issue. And now the demands for money w e r e g r e a t in all the surrounding a r e a , and the b o r r o w e r s couldn't, in the money conditions p r e v a i l i n g , induce t h e i r b a n k e r s to come down. a frenzy. I told h i m , n o u t - - p e r h a p s they will. So this fellow was in I don't know whether they'll want to throw m e But I think you ought to a s k the v o t e r s of your community which they would c h o o s e - - t o pay 2 - 7 / 8 p e r cent for this sewer i s s u e - - a t which rate they can get the m o n e y - - o r w h e t h e r , r e g a r d l e s s of what happens to this p a r t i c u l a r sewer i s s u e , they would r a t h e r have the p u r c h a s i n g power of t h e i r c u r r e n c y depreciated a little bit in o r d e r to shave borrowing c o s t s . Stripped of t e c h n i c a l i - t i e s , that is e s s e n t i a l l y the p r o b l e m that you a r e dealing with. ff Now the F e d e r a l R e s e r v e - T r e a s u r y a g r e e m e n t in 1951 to unpeg the government s e c u r i t i e s m a r k e t was a decision to r e t u r n to the m a r k e t some of the f o r c e s that had been precluded from it by government policy for a period of n e a r l y ten y e a r s . Despite people saying that t h e r e w e r e other f a c t o r s at work, and I admit all those f a c t o r s , it s e e m s to m e that the r e c o r d d e m o n s t r a t e s that the c r e d i t m e c h a n i s m , once that unpegging o c c u r r e d , began to function again a s one of the g o v e r n o r s of the flywheel of the economy, and that people who had been buying m o r t g a g e s by the bushel b a s k e t - l o a d -19- without a second thought had to r e t u r n to a p r o c e s s of evaluation again and d e t e r m i n e whether they wanted to sell government s e c u r i t i e s at a l o s s in o r d e r to get funds to make m o r t g a g e loans at a higher r a t e . T h e r e ' s no r e a s o n why they shouldn f t make the choice, but they ought to know a choice is involved. They should not have government s e c u r i t i e s as i n t e r e s t - b e a r i n g money, so that t h e r e f s no b u s i n e s s choice involved. Now what, in e s s e n c e , is the f r a m e w o r k of our F e d e r a l R e s e r v e Act todays? It s e e m s to me that what C o n g r e s s was doing in enacting the F e d e r a l R e s e r v e A c t - - a n d it can amend and change the F e d e r a l R e s e r v e Act any t i m e it w a n t s - - w a s turning over the m a n a g e m e n t of the p e o p l e ' s money to a t r u s t e e s h i p . The F e d e r a l R e s e r v e System is that t r u s t e e and its t r u s t indenture is the F e d e r a l R e s e r v e Act. Now that is the background of our work today. But when I talk about this free m a r k e t concept and the i n t e r - r e l a t i o n s h i p of these f o r c e s , I a m a l s o talking about a free society. In this country, n e i t h e r the T r e a s u r y nor the F e d e r a l R e s e r v e is strong enough to dictate what the money m a r k e t should b e . If t h e r e had not been m a r k e t f o r c e s coming up from the g r a s s - r o o t s , t h e r e would have been no T r e a s u r y - F e d e r a l R e s e r v e accord in 1951. These m a r k e t f o r c e s still come up in tibi|pc this country from the g r a s s r o o t s , and they cannot be ignored. -20- P e r h a p s it would be helpful to mention some of the p r o b l e m s of the Open Market C o m m i t t e e . deal with each t i m e we have a m e e t i n g . We have four f a c t o r s to L e t m e explain briefly. F i r s t , we have to c o n s i d e r the r e q u i r e m e n t s of the United States T r e a s u r y . We m u s t work together with the T r e a s u r y ; when we talk about independence of the F e d e r a l R e s e r v e System w e ' r e not taMing about making it difficult for the T r e a s u r y to b o r r o w money. The C o n g r e s s a p p r o p r i a t e s the funds for government expendi- t u r e , and the T r e a s u r y m u s t finance the e x p e n d i t u r e s . Nobody h a s given the F e d e r a l R e s e r v e the authority to tell the C o n g r e s s what a p p r o p r i a t i o n s it should m a k e , and T r e a s u r y financing m u s t always be a major consideration<ff our policy. But that does not m e a n that e i t h e r the T r e a s u r y or the F e d e r a l R e s e r v e can ignore the m a r k e t and dictate what the r a t e s should b e . They have to go out into that m a r k e t and a s s e s s it and evaluate it and d e t e r m i n e r a t e s as b e s t they can in a c c o r d with these m a r k e t f o r c e s , limited or unlimited a s they m a y be by government policy and by other f a c t o r s . Next, we have to c o n s i d e r when we sit down a s an Open Market C o m m i t t e e the seasonal r e q u i r e m e n t s of b u s i n e s s ; t h a t ' s why w e ' r e in e x i s t e n c e . And we want to see that those r e q u i r e m e n t s a r e m e t , for in my thinking xflEx a c e n t r a l bank has failed in its task whenever money b e c o m e s completely unavailable. The forces of the m a r k e t m u s t be allowed to have some play, reflected in i n t e r e s t r a t e s , -21- but money should not become unavailable. F o r limited p e r i o d s , because this is a broad country, money m a y be l e s s available in one a r e a than a n o t h e r , but jit is our job to see that the seasonal r e q u i r e m e n t s of b u s i n e s s a r e m e t . T h i r d , we have to deal with the growth factor in the economy. The volume of money m u s t grow with the growing population and growing scale of economic activity. How much growth t h e r e should be is another m a t t e r ; some people think it ought to grow at the r a t e of 3 p e r cent; some speak of 5 p e r cent; I don f t know what the figure ought to b e , and I a m v e r y gun shy of p r e c i s e figures on anything of this s o r t . And it has to be r e m e m b e r e d , too, that, b e c a u s e of the velocity factor of money, when b u s i n e s s declines the same volume of money has l e s s effect than when b u s i n e s s is expanding. In other w o r d s , you can have an i n c r e a s e in the money supply when b u s i n e s s is declining and, with velocity also declining, it will count for l e s s than a s m a l l e r supply of money, moving at g r e a t e r velocity, at a t i m e when b u s i n e s s is booming. So in t h e s e m e a s u r e m e n t s you have to be e x t r e m e l y careful. A fourth factor that we have to deal with is the psychology--and that t h e r e is no way of m e a s u r i n g . In 1953 our technical m e a s u r e m e n t s of the money supply w e r e , I think, a l m o s t perfect; I don ! t believe t h e r e w e r e any e r r o r s of any i m p o r t a n c e made either by the T r e a s u r y or the F e d e r a l R e s e r v e during that p e r i o d . -22- Yet our e s t i m a t e of the psychological expectations of the community was off c o n s i d e r a b l y . The only c r e d i t at all that I take for the F e d e r a l R e s e r v e in that period is that we r e v e r s e d our c o u r s e a s quickly a s we could when we saw what those m i s c a l c u l a t i o n s of pxyxKh® psychology w e r e . And all I would say about the usefulness wk or adaptation of policy &t that p a r t i c u l a r point is that, since you deal with human n a t u r e and human beings and t h e r e f o r e c a n ' t develop a p r e c i s e operating f o r m u l a , you've got to be p r e p a r e d to respond quickly to developments as they o c c u r . You cannot expect to f o r e s e e future need p e r f e c t l y - - t o hit it right on the n o s e . Some people m a y think we should have eased c r e d i t two months e a r l i e r than we did in 1953, and some people m a y think two months l a t e r . But if you get within r e a s o n a b l e range y o u ' r e doing about a s well as is likely in an i m p e r f e c t world. With all that said, it still r e m a i n s that the p r o b l e m w e ' r e facing today is again the p r o b l e m of whether the community can develop sufficient s t a t e s m a n s h i p to keep its balance and recognize that we have not yet r e a c h e d a "new e r a " of p e r p e t u a l p r o s p e r i t y . It is disquieting to me to see signs of people believing that w e ' r e a lot s m a r t e r than we used to b e - - t o o s m a r t to make m i s t a k e s . I have studied the r e c o r d s of the F e d e r a l R e s e r v e covering the 1920's. I find a g r e a t deal of b r a i n s and a g r e a t deal of intelligence revealed in thos r e c o r d s , but not infallibility. I ' m by no m e a n s convinced that the p r e s e n t F e d e r a l R e s e r v e and the p r e s e n t !CX T r e a s u r y , or the -23- p r e s e n t b u s i n e s s l e a d e r s h i p , is going to be any m o r e immune to e r r o r than those who went b e f o r e . Holding a p r o p e r c o u r s e , in so far as p o s s i b l e , depends upon the community sharing in an u n d e r standing of the r e s p o n s i b i l i t y and conducting himself accordingly. It is in a period like this that the r e a l t e s t of free e n t e r p r i s e c o m e s . Having e x p r e s s e d disquietude about some i n s t a n c e s of u n r e a l i s t i c thinking, I ! d like to note a little p e r s o n a l e x p e r i e n c e that buoyed my feeling about the capacity of the m a n in the s t r e e t to cut through technical difficulties and get to e s s e n t i a l m e a n i n g s of e v e n t s . I happened to be in New York around November 18. We had just r a i s e d the discount r a t e , and the New York T i m e s had a little i t e m on the front page about it. I dropped in a little shop I have enjoyed visiting the l a s t twenty-five y e a r s just to sit a r r o u n d and talk with the people t h e r e . To my s u r p r i s e , on this morning they w e r e reading the New York T i m e s . One of these fellows turned to me and he said, " M r , M a r t i n , I see you r a i s e d the discount r a t e yesterday. rl And I said, " Y e s , J o e , what do you think of i t ? n "Oh, he said, "we've been having quite a d i s c u s s i o n h e r e , quite a d i s cussion. You know, we've had the b e s t b u s i n e s s in this litte shop that we've had in the l a s t twenty y e a r s . it. And you know what Ed over h e r e said about you? He said, KK 'You're doing the right thing. We never had anything like You're trying to p r e v e n t another -24- 1929, a r e n ' t y o u ? , M A little incident, but it left me a lot encouraged. It m a y be just a straw in the wind, but I said, "This fellow has some g l i m m e r of what the operation is and of what w e ' r e trying to do. I! Now that in a general way is all I want to leave with you today. Thank you v e r y much.
@FedFRASER