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THE CAUSES of THE
PRESENT DEPRESSION
and POSSIBLE REMEDIES




WINTHROP W. ALDRICH
Chairman Governing Board and President
The Chase National Bank
of the City of New York

T H E CAUSES of T H E
PRESENT DEPRESSION
and POSSIBLE REMEDIES




The Finance Committee of the United
States Senate has been directed to study
and analyze the causes of the present
depression and possible legislative remedies.
At its invitation Mr. Aldrich appeared
before the Committee at Washington, D. C.
on Wednesday, February 22, 1933, and
made the statement which is published
herein.




THE CAUSES of THE PRESENT DEPRESSION
and POSSIBLE REMEDIES

M R . CHAIRMAN:

I am glad to appear before you in response to your
invitation, not because I have any panacea to present, but
because I think it eminently desirable that there should be
frank interchange of opinion between those who are charged
with responsibility for government and those who are
charged with responsibility for finance and for other phases
of the economic life of the country. It is in some ways
unfortunate that the political capital and the financial
capital of the country should be separated. Misunderstandings between the financial community and the Congress
have created many needless difficulties. I feel sure that
many of these misunderstandings would pass away and
better cooperation would exist if we knew one another better
personally, and had the opportunity of talking more frequently and frankly with one another.
I understand that you wish me to present my views as to
proper remedies for the present economic trouble. In order
to do this it is necessary that I should first undertake to
diagnose the situation, and I will ask you to bear with me
therefore while I present something of the history of the
events which led up to the existing situation. This will
introduce the presentation of the remedies which I shall
venture to propose.




3

CAUSES
The present depression has, of course, many features of
preceding depressions. Any period of intense financial and
business activity develops stresses and strains and maladjustments which compel liquidation and reaction. But the
unprecedented severity—absolutely unprecedented as far
back as good statistical records go—of the present depression, and the slowness with which the automatic restorative
forces have worked, must be found in certain unprecedented
circumstances which have preceded it. These are, I believe,
as follows:
(1)

Shift from Debtor to Creditor Position of U. S.

The immense shift produced by the war in
international debtor and creditor relations,
and, very especially, the great shift of the
United States from a debtor to a creditor nation.
Before the war we owed Europe a great deal of money,
represented largely by American stocks and bonds held
abroad. During the war we re-purchased most of these
and we bought a great many European securities. Finally,
following our entrance into the war in 1917, our own government advanced roughly ten billion dollars to our European
allies.
Before the war we paid interest and amortization on our
debt to Europe by sending out an excess of exports over
imports. In general the normal thing for debtor countries
is to have an excess of exports over imports, and for creditor
countries to have an excess of imports over exports, or a socalled "unfavorable'' balance of trade. England before the
war regularly received about a billion dollars more imports
than she sent out in exports, the difference being covered by
her interest on foreign investments, her shipping services,
banking services, and other items. France regularly
received about half a billion dollars more a year than she




4

sent out in goods. Germany, the Netherlands and Switzerland all had import surpluses or unfavorable balances of
trade, because the rest of the world, debtor to them, paid
them in goods. The logical expectation following the war
was that countries formerly creditor and now debtor would
send out an excess of exports, and that countries formerly
debtor and now creditor would receive an excess of imports.
(2) Inter-governmental Debts

One of the worst legacies of the war was the existence of
the inter-governmental debts, and especially the reparations.
These debts involve both a budgetary problem and a
transfer problem.
The budgetary problem is the problem of raising the
money that has to be paid to the foreign government through
taxation or other means in the debtor country, and in the
currency of the debtor country. As all the principal debtor
countries, very especially Germany, had exceedingly high
taxes anyhow, taxes running far beyond anything we have
experienced in the United States, the additional pressure
on their budgets of raising the money for inter-governmental
payments was very severe. This was softened for England,
and eliminated for France, so long as Germany paid reparations. In the case of Germany herself, however, the pressure
was so great as really to be endurable only in times of very
active business, and it was a major contributing factor to
the fiscal deficit which was so embarrassing to Germany in
late 1928, in 1929 and in subsequent years. The existence
of the huge reparation debt, moreover, greatly lessened the
credit of the German government, so that it was unable to
make much use of the resource which a great government
usually can use in times of depression, of borrowing to fill
in the gap between its revenues and its expenditures.
The other problem involved in inter-governmental debt
payments, as in all international payments, is the transfer




5

problem—the problem of exchanging the domestic currency
for the foreign currency in which the debt payments have
to be made. A debtor country can make payments in the
currency of the creditor country to the extent that it can
send out a surplus of exports over imports, or can entertain
foreign tourists or can perform shipping services, etc., or to
the extent that it can borrow foreign currencies, the latter
being of course not a real solution but merely a deferment
of the problem.
If there had been adequate freedom of movement of goods
from country to country, the debtor countries could have
solved this transfer problem by sending out goods. But
the existence of the reparations and other inter-governmental
debts was a great factor contributing to international fears
regarding the movement of goods, and intensified the widespread policy of tariffs and other trade restrictions which
the world has been engaging in on an increasing scale since
the war. During the period when bank credit was expanding rapidly and foreign loans were placed easily, transfers
were made without difficulty. But when there came a
sudden cessation of foreign loans and debtor countries were
suddenly called upon to pay, the problem of transition was
a grave one. Germany herself did make the transition in
1929, and began to send out more goods than she took in,
and some other countries made heroic efforts along these
lines. But almost immediately a movement began to stop
this by further trade restrictions and when we ourselves
raised our tariffs still higher in 1930 there came a very
general and widespread intensification of trade restrictions
throughout the world. Tariffs are not the only, or even the
worst, trade barriers. Quotas, vexatious inspections, exchange controls, and many other trade barriers can be even
more restrictive. The payment of inter-governmental debts
became increasingly difficult, although they were continued
down into the summer of 1931.




6

(3) High Protective Tariffs

Our own high protective tariff policy inaugurated in 1922,
preceded by some increases in 1921, prevented our foreign
debtors from sending us goods in adequate amount to pay
interest and amortization on their debts and at the same
time buy our exports in accustomed amount. This tariff
policy would promptly have checked our export trade but
for the extraordinary financial development next listed.
(4)

Cheap Money and Bank Expansion

The gigantic and unprecedented expansion
of commercial bank credit in the United States
from the middle of 1922 to early 1928, amounting to 1 4 ^ billion dollars in loans and investments and 13}4 billion dollars in deposits,
accompanied by great expansion of bank
credit in many parts of the world.
This expansion was due (a) to gold coming to us from
other countries which were off the gold standard, and
(b) to cheap money policies of the Federal Reserve Banks,
both of which operated to create excess reserves in the
member banks, with the resultant multiple expansion of
member bank credit.
Perspective on the figures for expansion given above is
gained by recalling that the expansion of bank credit
required to win the war, from early 1917 to the end of 1918,
was only five billions, eight hundred millions in deposits
and seven billions in loans and investments.
The vastly greater expansion in the period from 1922 to
1928 was not needed by commerce and was not used by commerce, and went into (1) real estate mortgage loans in
banks, (2) instalment finance paper in banks, (3) stock and
bond collateral loans in banks, including loans against
foreign stocks and bonds, and (4) bond purchases by banks,




7

including foreign bonds. The consequences of this great
expansion of credit, used in these ways, were, of course,
excess construction, including road building, real estate
speculation on a great scale, over-expansion of instalment
buying, and an immense over-issue of securities including
many ill-considered securities, but including also many
others which would have been good if the total over-issue
had not been so great, the rapid multiplication of bond
houses, investment trusts and other financial machinery and
a progressive deterioration in the quality of bank credit.
The 25,000 banks of the country were not in a position to
prevent this expansion and their managements were led
inevitably into many mistakes in policy because of it. The
control of the expansion was in the hands of the Federal
Reserve System.
Bank Expansion, Foreign Loans and Export Trade

One very important incident of this expansion was the
masking of the difficulties of international debt payments,
including interallied debts and reparations, and the maintenance of our export trade despite trade barriers. This was
particularly true following the Dawes Plan in 1924. The
Dawes Plan was accompanied by an immense government
security buying programme on the part of the Federal
Reserve Banks. Following this came a tremendous volume
of foreign loans which offset the influence of the high protective tariffs upon our export trade. We were able to get
out, especially following the summer of 1924, a great volume
of farm products and raw materials at good prices which
restored, in a precarious fashion, the balance between agricultural and raw material production on the one hand, and
manufacturing on the other hand, giving us active business
while the foreign loans went on.
The following table exhibits the relationship between
American exports and foreign loans, and agricultural prices.




8

AMERICAN EXPORTS, IMPORTS, FOREIGN LOANS AND
AGRICULTURAL PRICES
Index of Agri(In millions of dollars)
liars)
cultural Prices
New Foreign at the Farm.
Excess of
Security
Yearly Average
Exports
Exports
Imports
Issues
1910-14 = 100*
719
630
124
1922
3,832
3,113
376
267
135
1923
4,168
3,792
981
1,047
134
1924
4,591
3,610
683
1,078
147
1925
4,910
4,227
1926
4,808
4,431
377
1,145
136
1927
4,865
4,185
680
1,562
131
1928
5,128
4,091
1,037
1,319
139
1929
5,241
4,399
842
759
138
782
1,010
117
1930
3,843
3,061
333
255
80
1931
2,424
2,091
295
26
57
1932
1,618
1,323
*Year Book of Agriculture, 1932, p. 902. Crops and Markets, January, 1933, p. 31.

(5)

The Three Main Causes of the Depression

In these three factors, then, (a) inter-governmental debts,
(b) high protective tariffs and other trade barriers, increasing
in severity throughout the commercial world, including high
protective tariffs on the part of our own great country,
which had suddenly become creditor on a great scale, and
(c) six years of cheap money and rapid bank expansion, we
have the main explanation of the unprecedented financial
boom, the unprecedented financial break and the unprecedented severity of the depression.
(6) Artificial Price Maintenance

An important secondary factor was growing interference
with natural competitive markets in the period preceding
1929, partly governmental and partly by private organizations. The efforts to valorize wheat by holding movements
proceeded on a great scale from 1926 to 1929. Through the
activities of the Canadian grain pool and holding movements
under government auspices in Hungary and elsewhere, the
world's visible supply of wheat was nearly doubled between
the summer of 1926 and the summer of 1929. In the autumn
of 1929 our own Farm Board stepped in. The net effect
of these efforts to maintain the price of wheat was merely




9

to defer the facing of facts. Production held up more than
it would otherwise have held up, consumption was checked,
and surplus was accumulated. A similar policy, with a
similar result, appeared in the case of copper, though the
business interests responsible for the policy were quicker to
recognize their mistake and quicker to change their policy
than was our government in the case of wheat.
(7)

Cheap Money in U. S. and in England

The cheap money policy of the United States was part of
a policy of cooperation between the Bank of England and
the Federal Reserve Bank of New York. The British
believed that cheap money and expansion of bank credit
were all that were necessary to get good business going again,
and that it could be used as a substitute for industrial readjustments, including the scaling down of prices and costs.
Without the strength in gold which we had in the United
States, they tried to force the policy through anyhow. They
failed to get good business by this policy, but they did
succeed in getting credit so over-expanded that when the
acute pressure came in the summer of 1931 they found
themselves in a frozen position and without adequate gold
reserves, and abandoned the gold standard.
The last chance the world had to call a halt on the
over-expansion of credit and on speculation based on the
over-expansion of credit without an unmanageable reaction
was in 1927. I am informed that the Bank of France and
the Reichsbank in Germany did try to tighten up then,
Paris warning London that it was having to buy too much
sterling, that easy money in London was financing speculation in the French franc and that the Bank of France,
though reluctant to pull gold out of the London money
market, would have to convert sterling into gold unless
the process stopped.
The conference of the governors of the central banks held
in New York in the summer of 1927 had a very momentous




10

decision to make. Represented there were the Bank of
England, the Bank of France, the German Reichsbank and
the Federal Reserve Bank of New York. The representatives
of the Reichsbank and of the Bank of France are understood
not to have made any commitment regarding policy at this
conference except a promise to communicate their intentions
with respect to taking gold from London and New York in
the future. They left the country before the governor of the
Bank of England did. Following this conference there came
in the early autumn of 1927, a renewal and an intensification
of the cheap money policy of the Federal Reserve System.
The rediscount rate was first reduced by the Kansas
City Federal Reserve Bank, followed shortly by most of the
others. Several hundred millions of government securities
were purchased by the Federal Reserve System. Bank
expansion moved rapidly, and almost all of it went into the
securities market, either in the form of bank investments in
bonds or in the form of collateral loans against securities.
Shortly following this began a very intense speculation in
securities, with rising security prices which ran through
1928 and into the late autumn of 1929.
(8) Gold Exchange Standard

Beginning in the middle of 1926, there came an extraordinary development in the substitution of balances in
foreign banks, for actual gold in the central banks, as
reserve money—the so-called "gold exchange standard/' as
distinguished from the strict gold standard. In the two
years that followed this went very far. In particular,
dollars borrowed in the United States through the flotation
of bonds were used by foreign central banks as a substitute
for gold, and funds borrowed in London in the form of
sterling balances in British banks were similarly used as the
reserves of Continental banks. This permitted the credit
expansion at home and abroad to go much further than if




11

each bank had carried its own gold. It created a very
dangerous situation, the extent of which we realized in the
Winter of 1931 and the Spring of 1932.
The Liquidation of the Gold Exchange Standard

Events began to move very rapidly in 1931. First,
Austria was pulled down. Then Germany, though repaying
gigantic sums to her creditors, was finally obliged to ask for
moratorium and Standstill, and then the run on England's
gold reserve began. The gold exchange standard on a great
scale is only a fair weather proposition. When doubt
arises regarding the goodness of balances in foreign markets,
and different countries seek to convert their balances into
gold and bring them home, a very difficult situation is
created. England and Germany were unable to meet this
situation. We ourselves were so strong in gold that we did
meet it. But the liquidation in 1931 and 1932 of the gold
exchange standard, which had been built up by the overexpansion in 1926-28, was one of the big factors in intensifying the present depression and making it as severe as it is.
We must never let international short term credit relations
get over-extended to this extent in the future.
International Cooperation of Central Banks

This leads me to an observation regarding proposals that
there be international central bank cooperation designed to
regulate commodity prices or designed to keep cheap money
throughout the world in ordinary times, with a view to making world prosperity. The experience of recent years surely
justifies grave reservations on this point. Our effort to
cooperate with England from 1924 on, and especially in
1927, was very largely responsible for the excess of cheap
money which has made us so much trouble. Incidentally,
it created a world situation which meant a breakdown of
central bank cooperation in 1931 and 1932, when the central
banks of the Continent tried, unsuccessfully, to withdraw




12

their balances from the Bank of England, and did successfully withdraw their balances from us. I firmly believe that
the best policy is for each central bank, including the
Federal Reserve Banks, to look after its own money
market in ordinary times and to reserve international
cooperation for special limited purposes, and for times of
emergency.
This was the rule in pre-war days, and it was a good rule.
Any country, in pre-war days, which was expanding credit
too rapidly, was very likely to find its expansion checked as
other money markets pursuing a more prudent policy began
to take some gold away from it. Booms did not go so far,
and set-backs were not so violent.
(9)

Fear Regarding Standard of Value

The international scare in the Autumn of 1931 and the
Spring of 1932 regarding the standard of value itself, the
fear lest we and other countries should abandon the gold
standard, precipitated the severest of all the troubles. No
other fear is so terrible as this. The countries of Europe
which during and following the war had such cruel experiences with depreciating and fluctuating currency, reacted
to it in an extreme way. Our own people very generally
trusted the American dollar, in view of our unbroken record
since the end of 1878 in keeping the dollar good as gold, but
even they could not escape the pall of fear which pulled
down the volume of business in this country by almost one
third from the middle of 1931 to the middle of 1932, which
brought the greatest percentage decline of all in security
values, and which pulled railroad traffic down from the levels
at which the railroads' credit was good to levels at which the
railroads' credit was gravely shaken, and which intensified
the problem of unemployment to an appalling degree. I
shall refer again to this point in discussing "inflation" as a
possible remedy for the present trouble.




13

(10)

Broken

Equilibrium

Business life goes on well when different kinds of production are in good balance, different types of goods being
produced in right proportions so that the sale of one kind
of commodity produces income which can be used to purchase other commodities, so that goods can clear the markets
of one another. The gravest effect of the breakdown of
international trade, in the United States as in many other
countries, is to throw out of balance the different kinds of
production. At the present time nearly every country is
geared up to do more export business than it can do under
existing conditions, and has an undue percentage of its
labor resources directed toward foreign markets. Every
country is faced with the necessity of a radical shift in its
activities, reducing its activities for export and increasing
its activities for internal consumption, unless the trade
barriers can be reduced and the foreign markets restored.
In the United States, this means especially that agriculture and other raw material production is greatly overexpanded in relation to manufacturing, which has meant so
great a break in the prices of agricultural and raw material
commodities that the producers of these things cannot buy
even the relatively scant present output of the factories at
prevailing prices. The balance among industries must be
restored, and the only quick and sure way to do this is to
restore the export market.
Equilibrium and Foreign Trade

The importance of foreign trade in our economic life has
been questioned on the basis of certain estimates by the
Department of Commerce, which made foreign trade 9.9
per cent, of the production of movable goods in 1927, and
9.8 per cent, in 1929.
I must say first, that these figures of the Department of
Commerce do not seem to me quite correct. In figuring the




14

total of movable goods they have taken account of agricultural products, mining products, and value added by
manufacture, which is right. Then they have added to
the totals, railway freight receipts, which I think is wrong
when we are seeking a total to compare with exports. If
we are going to consider freight receipts at all they should
be divided between export business and domestic business
and allowance should be made for the longer haul in the
export trade. Further, the Department should consider
shipping and other items. But I think the simplest and
best way is to consider merely goods produced and goods
exported. When this is done the percentages rise somewhat,
standing at 11.2 per cent, in 1925, 11 per cent, in 1927, and
10.8 per cent, in 1929. Herewith are the Department of
Commerce figures with the freight receipts eliminated:

PRODUCTION OF MOVABLE GOODS AND PROPORTION EXPORTED
(Freight Receipts Eliminated)
(Millions of dollars)
Year
1899
1904
1909
1914
1919
1921
1923
1925
1927
1929

Agricultural
Products
3,355
4,262
6,472
8,165
17,677
10,268
12,382
11,968
11,616
11,911

Manufactures
4,831
6,179
8,385
9,710
24,809
18,332
25,850
26,778
27,585
31,885

Mining
600
850
1,238
1,450
3,158
2,900
4,300
4,100
4,000
4,100

Total
8,786
11,291
16,095
19,325
45,644
31,505
42,332
42,851
43,201
47,896

Exports
United
States
Merchan- Per cent,
dise
of Total
1,253
14.3
1,426
12.6
1,701
10.6
2,071
10.7
7,750
16.9
4,379
13.9
4,091
9.6
4,816
11.2
4,759
11.0
5,157
10.8

Source: Foreign Trade of the United States, Department of Commerce, 1931, page 11.

But I do not rest the argument on this tabulation. Eleven
per cent, of our total business is a big percentage, but the
percentage of many highly important individual products




15

is enormously greater. The following table shows the
percentage of various important exports exported in 1929:
Cotton
55 per cent.
Tobacco
41
»
Lard
33
»
Wheat
18
Copper
,
36
»
Kerosene
35
"
Lubricating Oils
31
»
Gasoline
14
»
Typewriters
40
»
Printing machinery
29
»
Sewing machines
28
"
Agricultural machinery
23
"
Locomotives
21
»
Passenger automobiles
14
"
(Source, Moulton & Pasvolsky's "War Debts and World Prosperity," page 409.)

Not even these percentages, however, tell the whole
story. For important great areas, the dependence on foreign markets is even greater. Bright tobacco in Virginia,
and cotton in Texas, are cases in point. You can prostrate
a whole State when the foreign market for its principal
crop is cut off. No percentages can take adequate account
of the organic interdependence of foreign and domestic
business.




16

REMEDIES
I think that the foregoing analysis of the major causes of
the present situation will justify my proposals as to remedies. Some of them I shall list briefly.
1. Prompt settlement of the inter-allied debts.
2. Prompt reciprocal reduction of tariffs and the moderation of other trade barriers.
These two things are basic to the restoration of our export
trade, which, in turn, is basic to the restoration of balance
in our own economic life, so that our farmers and other
producers of raw materials, receiving good prices for their
products, may be able to buy the products of our factories
in adequate volume, restoring activity and employment in
the cities and restoring an adequate volume of traffic for
the railroads.
Interim Measures

3. While these basic measures for restoration of normal
activity are being put through, I would continue a policy
of emergency credit relief, making use of the Reconstruction
Finance Corporation. We must face the fact, however,
that not all of the existing fabric of capital debt can be
maintained in full.
There are important cases where the capital structure is
top-heavy, and where it is desirable to scale it down to
conform to the existing facts. The Reconstruction Finance
Corporation should not be called upon to validate capital
structures which cannot be maintained even when we get
a moderate business revival. Instead, we should scale down
fixed charges in a good many important cases. It is good
credit policy to tide over in emergencies solvent institutions
whose total assets exceed their total liabilities, but it is
not good policy to undertake to validate the really inadequate assets of insolvent institutions. To facilitate reorganizations, the new bankruptcy legislation—that relating




17

to corporations as well as that relating to individuals—
should be enacted as soon as possible.
4. I would extend emergency credit relief to the farm
mortgage situation, and also to certain city mortgage situations when, in the judgment of the Reconstruction Finance
Corporation, a general financial interest is involved. In
connection with farm mortgage relief, I would make every
effort to deal with intelligent discrimination in individual
cases, seeking to bring debtors and creditors into agreement
with one another, seeking to limit the government's financial
commitments to what is necessary to persuade creditors to
make the necessary adjustments, but still doing the thing
in a big enough way to make sure that an honest and competent farmer does not lose his farm. It is to the interest
of the country and to the interest of the creditors, by and
large, that that farmer who with his family knows the farm,
knows its potentialities, knows local markets and has the
home lover's interest in the farm, should be able to stay
upon it and control it.
Differential Treatment of Debtors

I think we ought to avoid sweeping legislation making a
general rule for every farmer. There are some farm mortgages which are perfectly good, where the farm debtor is
able to pay interest and amortization, and where he needs
no relief. There is no reason why the contract here should
be altered. There are other cases where the farmer needs
a great deal of relief. The same thing is true in connection
with city mortgages and other debts. Such relief as is
given should be given to embarrassed debtors and not to
debtors as a class. We must protect the commercial
morality of the country in the interest of the future giving
and taking of credit. We must seek to be fair to creditors
as well as to debtors. If we establish a precedent of allowing
men who are perfectly able to pay their debts to escape from




18

them in part, merely because other men are unable to pay
their debts in full, we shall strike a severe blow at the fabric
of confidence in the future.
My view is that we shall get out of this depression by
removing its causes. The chief of these is a broken equilibrium, growing out of strangled international trade. This
has made raw materials and farm products pile up unsold
in the United States, even though offered at very low prices,
and has led to an immense contraction in the volume of
manufactured goods, and in manufacturing activity, though
the prices of these things have not fallen nearly as much as
have farm prices and raw material prices.
I would ease off the situation by giving emergency credit
to prevent further forced liquidation of good assets at
depression levels. And I would emphasize the necessity of
undeviating adherence to sound money and sound public
finance as vitally important to alleviate the fears which have
arisen with respect to our currency and our government
credit.
I am aware that there is another view, or set of views,
advanced by men who think that the trouble with the world
is simply a shortage of money and credit, and who propose
to bring about a revival of business by what they call
"inflation."
"Inflation" Has Many Meanings

The word "inflation" is a very unsatisfactory word. It
covers a wide variety of meanings, and I believe it best to
distinguish among some of these and to talk about concrete
proposals. Among the possible meanings are the following:
(1) The
(2) The
(a)
(b)




issue of irredeemable paper money.
debasement of the standard of the currency—
by reducing the gold content.
by introducing bimetallism with silver.
19

(3) Going off the gold standard by suspending gold
payments, which gives you practically the same situation
as (one)—namely, the issue of irredeemable paper money.
(4) Some men would call a great increase in gold
production in the world leading to an increase in gold
throughout the world "inflation."
(5) Some have called the concentration of gold in a
single country "inflation." Thus Professor Fisher referred
to the gold which we obtained during the war as causing
"gold inflation."
(6) Some would call any expansion of bank credit
"inflation."
Cassel and Keynes

(7) Some would limit the word "inflation" to those
changes in the currency and credit situation which raise
commodity prices. This, for example, was Professor Cassel's
view, and he denied pointedly that there was any "inflation"
from 1922 to 1928 because commodity prices did not rise.
The fact that credit expanded enormously and that we were
having great speculative excesses and great price rises in
real estate and in the stock market meant nothing at all
to him, and he demanded even more credit when commodity
prices softened a little. Mr. J. M. Keynes, in his recent
treatise on money (Volume II, page 190) says with respect
to the years 1926-29:
"Anyone who looked only at the index of prices would
see no reason to suspect any material degree of inflation;
whilst anyone who looked only at the total volume of bank
credit and the prices of common stocks would have been
convinced of the presence of an inflation actual or impending.
For my own part, I took the view at the time that there was no
inflation in the sense in which I use this term. Looking back
in the light of fuller statistical information than was then
available, I believe that whilst there was probably no material inflation up to the end of 1927, a genuine profit inflation




20

developed some time between that date and the Summer of
1929."
This confession of error on Mr. Keynes' part comes too
late to do anybody any good. He was one of the men who
were urging cheap money through the whole of the period
from 1922 on, and he continued to do it after the stock
market broke in 1929.
Quality and Quantity

One very important distinction must be drawn in connection with these various ideas: (1) that of an impairment
of the quality of the currency itself, and the other that of
mere quantitative increase either of money or of credit.
But then a further point comes up at once, that an increase
in quantity, if it goes far enough, will impair quality. If
paper money, redeemable in gold, is issued in such quantity
as to raise doubt about the adequacy of the gold reserves on
the part of the issuing authority, runs can be started which
will either force a great contraction of the quantity, or force
suspension of gold payments and damage the quality.
Similarly, an over-expansion of bank credit impairs the
quality of credit. We saw this on a great scale, running
progressively from 1922 into 1929, bank credit expanding
in excess of commercial needs went into capital uses, speculative uses, and consumption loans, taking the form of real
estate mortgages, instalment finance paper, stock and bond
collateral loans and bank investments in bonds.
Moderate amounts of any of these would have been all
right, but the total was so great that there came impairment
of quality, and the capital values of securities and real
estate which underlay the credit became top-heavy and
broke violently. Then there came loss of confidence in the
assets of many banks, followed by a loss of confidence in
their liabilities—namely, their deposits, which led to runs on
banks, which took reserve money out of them and which




21

forced even strong, solvent banks to contract credit. We
thus ran through the scale whereby "expansion" or "inflation" of bank credit forced liquidation or "deflation" of
bank credit.
When there is sufficient loss of confidence in the quality
of credit, this can generate doubt also as to the goodness of
the currency itself, and we saw this on a great scale in
1931-32. Foreign fears regarding the goodness of the
American dollar led to withdrawals of hundreds of millions
of dollars in gold from us and further quantitative contraction in bank credit in the United States, even though the
dollar itself stood sound and strong.
Paper Money

Whatever else we may have in the matter of currency
and credit policy, we must at all hazards protect the quality
both of our currency and of our credit.
Paper money is, after all, a credit instrument—a promissory note. I know of no case where a government has
actually issued such paper with an announced intention of
never redeeming it. The value of irredeemable paper money
rises and falls with the prospect of redemption. There is
no mathematical rule relating quantity of issue to the extent
of depreciation. Unpredictable events may cause the value
to slump or recover violently—as the Battle of Gettysburg,
which caused a great rise in the value of the Greenbacks in
three days. These fluctuations are disturbing to all business,
and only a few reckless speculators gain.
The issue of new paper money currency is futile. If it is
redeemable and confidence in the gold standard remains
unshaken, the paper will not stay in circulation but will
merely pile up in banks. If confidence, however, is shaken,
the effect is either forced liquidation, or else the abandonment of the gold standard. In the latter case, you cannot
multiply quantity fast enough to keep up with depreciation.




22

The gold value of the trillions in circulation in Central
Europe in 1921 was a fraction of the value of the billions in
circulation in 1913.
Debtors and Depreciation

Debtors are supposed to gain by currency depreciation.
But Germany, 85% of whose mortgage debt was wiped out
by the disappearance of the mark, showed no gains as a
result. Following stabilization, it was compelled to pay
such fantastic rates of interest for all new credit that its
debt burden was soon very heavy again.
Debasing the Gold Content of the Dollar

With respect to the quality of credit and the efficiency
of credit in accomplishing economic purposes, it is clear,
of course, that there must be confidence. But confidence is
not a vague general thing. It is a specific thing. Confidence
in bank deposits means confidence that the bank will be
able to pay cash on demand. Confidence in the currency
means confidence that the government or bank of issue will
pay gold on demand, and the full amount of gold specified.
Two factors are involved in both these things: (1) belief
in the ability to pay and (2) belief in the intention and good
will of the bank or government. The latter is of absolutely
vital importance.
Good Faith the Foundation of Credit

The preservation of good faith, the keeping of contracts,
even though they hurt, are absolutely vital. An honest man
can go bankrupt and retain his reputation, if he has clearly
done the best that he can and protected his creditors to the
extent of his ability. Such a bankrupt can come back again
and receive credit again in the future. But the man who
has turned sharp corners, who has evaded obligations, whose
word is not accepted because he has broken his word, must
for the future either pay cash or offer excellent collateral
with a big margin.




23

The proposal that our government should deliberately
debase the dollar by reducing its gold content, if carried out,
would shock credit throughout the world for a prolonged
period.
The Good Faith of the American Government

The shock to confidence, at home and abroad, of a
deliberate breach of faith of the United States Government
with respect to the gold standard of the present standard
of value (meaning the present standard of weight and
fineness) would be something we could not get over in years.
Our government has given its solemn promise on every
Liberty bond to pay gold coin of the United States of the
present standard of value. The same promise is on the
Federal Reserve notes and the laws relating to them. The
law defines the standard of value as 23.22 grains of fine gold,
or 25.8 grains of standard gold nine-tenths fine. The same
promise is printed on virtually all our privately issued
bonds and State and municipal bonds, and in a multitude
of mortgages. We are bound by every promise.
These gold clauses in the government bonds were put
there because of the fears which had risen in investors'
minds growing out of our Greenback period and growing
out of the silver agitation of the '90s. They were put there
to assure our investors that, even if the government should
ever get into such a position that it could not redeem its
paper money, it would still pay interest and principal on its
public debt in gold, which the country did even in the years
1861-79. It could not redeem its Greenbacks in gold, but
it could pay interest and principal on the public debt in
gold and it did so. For the greatest government in the
world, without compulsion, deliberately to break these
solemn promises would be an incredible shock to good faith
everywhere. Excuse can be made for embarrassed countries
like England for going off the gold standard that they




24

couldn't help it, but no excuse could be made if we did it
deliberately.
Destroying Confidence Wrecks Buying Power

The result of an action of this kind on our part, from the
standpoint of the volume of credit and revival of gold prices
throughout the world in the future, would be demoralizing
in the extreme. The actual quantity of circulating money
in the world constitutes a very small part of the world's
buying power. The great bulk of it is credit. If we should
do this thing, creditors, investors and lenders everywhere
would for years to come be timid and apprehensive. The
experience of the French people with the depreciation of
their own currency has already put them in this frame of
mind. France with all her gold has done very little in the
way of investing since the de facto stabilization in the winter
of 1926-27, and when she has put out her cash she has done
it for the most part on short term, constantly watching,
frequently calling it back. The French people are continually apprehensive regarding currency. In the winter of
1931-32 they were hoarding gold. They could not get gold
in small amounts from the Bank of France. The Bank
pays out only large gold bars, and the French people were
consequently paying a premium over the French franc for
American gold coin, and were paying a premium on small
slices cut from gold bars. If we should deliberately debase
our currency, as an act of choice, we should make general
this kind of fear. Instead of getting easy and automatic
expansion of credit in the near future, we should have a
world much more reduced to a cash basis than it is even
today.
Effect on Prices of Debasing Dollar

This consideration should make it clear why those who
would expect a doubling of commodity prices to follow a
cutting in half of the gold dollar would be radically disap-




25

pointed. The weight of purchasing now carried by gold and
credit together would, in that case, be thrown back to a
disproportionate extent on gold alone, and the value of
gold would consequently undergo a real rise. Prices in
terms of gold would fall. Prices in terms of the new 50
per cent, dollar might rise a little, but not at all in proportion to the cut in its gold weight, and not certainly at all.
The prestige and the reputation for financial integrity of
the American government, of the United States Treasury,
and of the Federal Reserve Banks, are two of the biggest
capital values in the world and two of the most essential
features of world financial organization. Wantonly to
destroy them, quite apart from the question of morality, would
be an act of economic destruction of fearful magnitude.
The worst of our whole trouble came from the end of
September, 1931, into the middle of June, 1932. England's
abandonment of the gold standard caused a great scare
regarding the standard of value itself. Creditors and investors everywhere called loans, refused new credits and sold
investments. In two immense waves, foreigners pulled
hundreds of millions of dollars out of the United States.
Fear and hysteria drove the New York Times index of
production down from 75 to 52 within twelve months.
With a demonstration in the middle of June, 1932 that we
could meet the foreign drain of gold, and with the magnificent vote of the United States Senate on June 17 against
the soldiers' bonus bill, an immense sigh of relief went up.
Securities rallied, and then business had its first real upward
move in three years. Whatever else we do, we must not
invite a repetition of this panic regarding the standard of
value itself.
Debasement Could Not Solve Farm Problem

I want to say one further thing with respect to those who
would advocate cutting the gold content of the dollar as a




26

means of raising the farmer's prices. Quite apart from the
moral and financial objections which seem to me so vital, I
would observe that the plan would not do the farmer anything
like enough good, even if it worked out perfectly. Suppose
that the dollar were cut in two and suppose that all commodity prices should double. The farmer could then see his
fat hogs rise from 3}i cents a pound to 6)4 cents a pound;
but at the same time the prices of everything he buys are
doubled. This does not help the farmer much. I would like
to see the farmer get nine cents or ten cents for his hogs,
and I want the price of his cotton doubled or more than
doubled, without a rise in the prices of the manufactured goods
which he buys. The manufacturer does not need higher prices
—what he needs is volume—but the farmer must have
radically higher prices. We must get the balance restored
between the manufacturer and the farmer. This means
that the farmer must get his export market again. I would
strike at the export trade—not at the currency.
Silver Inflation

Testimony before your committee, and the cross examinations, have raised questions regarding the possibility of
using silver, either under a bimetallic system or in some other
way, and I want to make some observations regarding that.
First, let me say that, in my opinion, the suggestion that
our foreign trade has been primarily damaged by a decline
in the price of silver seems to me to have no merit. Our
trade with the one great silver country, China, has kept up a
great deal better than our trade with the world as a whole,
as shown by the following figures:
U. S. EXPORTS, 11 MONTHS ENDING NOVEMBER
1929
1930
1931
1932




Total
$4,814,444,000
3,568,494,000
2,240,219,000
1,481,750,000

Index
100
74.1
46.5
30.8

27

To China
$114,437,000
82,157,000
84,193,000
52,165,000

Index
100
71.8
73.6
45.6

Silver bimetallism at 16 to 1, or any other ratio than the
commercial ratio, would mean the debasement of the
currency and the abandonment of the gold standard, but
the adoption of bimetallism at the current ratio would still
involve breach of contract under the gold standard and
undermine confidence and good faith, and, moreover, would
accomplish none of the purposes that the silver people have
in mind, because what they want to do is to raise the price
of silver.
I see no reason to go any further with silver than is proposed by the economic experts who prepared the agenda for
the coming World Economic Conference. They rule out
the use of silver, even in moderate amounts, as part of the
reserves in central banks, saying that silver is unsuitable for
such use because there is no fixed price at which it would be
received by other central banks in the settlement of balances
on international account. They make a few minor concessions
to the notion that certain countries might withdraw very
small denominations of bank notes and substitute silver
subsidiary coins for them, and that some other countries
might enlarge the use of subsidiary silver coinage. But
they accept none of the main proposals made by the silver
advocates, and I think they are right. I recommend their
view to your committee, and I submit for your records
what appears to be a verbatim account of their recommendations, as prepared at Geneva, taken from the New
York Herald Tribune of February 9, 1933:
"After keeping relatively stable from 1921 to 1929, the price of
silver in gold currencies fell abruptly by more than one-half in less
than three years. There is no doubt that this sudden decline must,
in the main, be attributed to the same causes as have acted on the
general level of prices, and may thus be said to illustrate in a particular case the incidence of the world depression. Some special
factors can, however, be found which have accentuated the downward
trend, and these were to some extent already operating before the
depression set in. Such factors are the demonitization of silver, the




28

reduction of the silver content of token coins, and also the disposal of
surplus stocks.
We have considered a series of proposals which have been discussed
in recent years with a view to raising the price of silver, and we wish,
in this connection, to make the following observations:
(I) It has been suggested that some form of bimetallism should
be introduced.
We would point out that a bimetallic standard, which presupposes
a fixed relation between the value of gold and that of silver, could be
safely introduced only if the most important countries of the world
agreed to such a measure. As the only international monetary standard
which is at present likely to command universal acceptance is the
gold standard, the idea of introducing bimetallism must be regarded
as impracticable.
(II) It has been proposed that banks of issue should be allowed to
hold increased quantities of silver in their legal reserves.
On the assumption that no form of bimetallism will prove acceptable,
silver is unsuitable for extensive inclusion in the metallic reserves of
a central bank, there being no fixed price at which it would be received
by other central banks in the settlement of balances on the international
account.
(III) It has also been suggested that governmental action should
be taken for the purpose of improving the price of silver.
WTe would, in this connection, refer to the suggestion made in a
previous part of this report, to the effect that, in countries where
banknotes of small denominations are in circulation, these small notes
might be withdrawn and replaced within proper limits by subsidiary
coins, and we think that the conference should, in this connection,
examine to what extent the use of silver in subsidiary coinage could
be enlarged. Whatever sales of government stocks of silver may be
deemed desirable it is important to conduct these in such a manner
as to avoid any unnecessary disturbance of the market.
The conference should also consider whether, and if so by what
methods, the marketing of the metal by producers and currency
authorities is susceptible of improvement. The question of developing
new and enlarged industrial uses for silver is, in our judgment, also
worthy of careful consideration.
From the point of view of commercial relations with silver-using
countries, particularly China, trade interests would best be served,
not by a rise in the price of silver, as such, but by a rise in the general
level of commodity prices. Any action which would tend to raise




29

that level and in due course achieve its stabilization may be expected
to have a favorable effect on the price of silver, and would, on general
grounds, be welcome. ,,
"Inflation"

by Government Borrowing

Among the many meanings of "inflation" is one that
relates to public finance, and here there are rnany proposals,
ranging from moderate notions of necessary government
borrowing, which I should favor, to extravagant notions
regarding government borrowing which would be dangerous
in the extreme. Excessive borrowing by the government
can, of course, impair first the credit of the government,
and then, ultimately, as the government leans on the
Federal Reserve Banks too heavily, threaten the currency.
Sound Public Finance

We must have sound public finance. This means: (a)
reduced expenditures and increased Federal taxation. I
personally do not like a sales tax applied at a uniform rate
to all manufactures. A very moderate tax would bear very
heavily on some lines where demand is highly elastic, and a
heavy tax would not make much difference in certain lines
where demand is very inelastic. Necessities could stand
much heavier percentage taxes than can articles which
people can easily do without. Taxes could be put on tea
and coffee and on such things as spices, of which small
amounts are used in the individual's daily consumption, at
much higher rates than on articles which make up a substantial part of the day's consumption. I do not pretend to
have worked this out with any detail, but I do believe that
a series of special sales taxes at different rates, classifying
commodities with reference to elasticity of demand, would
be less burdensome by far than one uniform flat rate. Of
course, taxes should not be pyramided; they should strike
production only in one stage and not in successive sales.




30

I am very hopeful, too, quite apart from reasons of taxation, that you will soon be getting a good revenue from beer
and from wines.
Let me add that more moderate tariffs, which will let
goods in instead of keeping them out, will be of real help
to this problem of raising the government's revenues. In
pre-war days the tariff was in fact our main source of
Federal revenue, down to the time when the income tax
came in.
But, in addition, expenses must be cut drastically. The
discussion which has already taken place at these hearings
has indicated possibilities in connection with the government's outlay to veterans who have no disabilities connected
with service in the war, and the possibility of cutting that
item very drastically is one which we cannot afford, for
political reasons, to ignore. It is my understanding that
very great reductions of expenditure can result from reorganization and consolidation of government bureaus, and
from the elimination of overlapping functions. The political difficulties of this are, of course, recognized, but, in a
great fiscal difficulty, political difficulties must be overcome.
I think, too, that the reduction in prices which has taken
place ought to make it possible for us to cut almost every
item of government expense except the fixed interest on
public debt, and even there something can be done by
refunding.
What "Balancing the Budget11 Means

The budget ought to be balanced, in the sense that all
ordinary expenses are covered by current taxes, and that
the borrowings for special and non-recurrent purposes
should be covered by additional taxes to the extent of
current interest.
The orthodox canons of sound public finance would
require, under anything like ordinary conditions, further




31

taxes to cover current sinking fund on all new borrowings
and also on existing debt. I have not consulted other
bankers with respect to this point, but my personal view
would be that, in a time of great depression such as the present, it is legitimate to borrow for contractual sinking fund
requirements and to eliminate this item from the budget
proper. Taxes which under existing conditions are adequate
to balance the budget in the sense above described would,
with any considerable improvement in business, be very
much more than adequate for sinking fund requirements.
My personal view is that we need not count in the deficit
any expenditure which does not actually increase public
debt.
If the Congress and the Treasury give definite and convincing evidence of their intention of dealing with this
problem with full responsibility, they will strengthen the
credit of the government and, in my opinion, the government bond market will take what bonds are really necessary
for the meeting of this emergency. If, on the other hand,
there is an evasion or failure to grapple with the problem
earnestly and courageously, or light-hearted adoption of a
borrowing programme without consideration of this point,
the government will speedily find its securities sinking in the
market and the market wholly unreceptive to new issues
except at very high rates. The credit of the government is
basic to every other credit, and we must protect it unflinchingly.
Government borrowing is necessary for emergency credit
relief and for loans to the States to give direct unemployment relief. I recognize and would emphasize the responsibility of the whole country to the suffering millions who,
through no fault of their own, are victims of this great
depression.
But we must not overstrain the finances of the government and we must not jeopardize the credit of the govern-




32

ment by proposals of a great government-borrowing programme for new public works on the theory that this will
start a business revival. The government's credit cannot
stand a great deal of that in addition to its necessary
borrowing.
Further, we do not need government borrowing for new
public works to start a business revival. If we move
promptly to restore our export market for farm products
and raw materials, we shall get a business revival quickly,
and such government borrowing will be unnecessary. If,
on the other hand, we use government borrowing as a
substitute for the restoration of the export market, in the
hope that we can force a revival of business merely by
spending borrowed money in a country whose industries are
badly unbalanced, the borrowing and the spending will be
ineffective.
"Inflation" by Forced Expansion of Bank Credit

I should avoid further artificial efforts to force an expansion of bank credit. It was forced expansion of bank credit
from 1922 into 1928 that was responsible for a great part
of the present trouble. The renewal of government security
purchases by the Federal Reserve Banks following the break
in 1929, and especially in early 1930, was responsible for the
false stock market boom in early 1930, and the renewal of
excessive security issues which complicated very much the
difficulties in the period that followed.
I strongly sympathized with the Glass-Steagall Bill, and
with the government security purchases of the Federal
Reserve Banks in the panic of the Spring of 1932, especially
when the foreign run on our gold was on, as a means of
preventing further forced liquidation. But heavy excess
reserves, in the absence of confidence, will not force bank
expansion. On the other hand, in times when confidence is
normal and when borrowers (especially speculators) are
ready to borrow at low rates, and when banks trust the




33

security offered, excess reserves of 50 to 100 million dollars
mean cheap money and rapid bank expansion. Excess
reserves of 500 or 600 million dollars, in a period of reviving confidence, would be exceedingly dangerous.
The volume of bank credit in the country does not depend
alone on the volume of bank reserves. It depends also on
the temper of the business community, which is governed
by the prospects of business, and on the movements of
goods and on the prices at which goods move. Given the
restoration of the export trade and revival of agricultural
and raw material prices, credit will expand rapidly. There
is no use trying further to force it from the other end by an
artificial increase in bank reserves.
Nor is there any use in trying to increase the volume of
currency in circulation by paying out more paper money.
If the paper money is redeemable and confidence in the gold
standard is not shaken by this, it will not stay in circulation
but will merely pile up in banks. If the paper money is
issued in such amount as to shake confidence in the gold
standard, the effect would be forced liquidation and tightened credit.
State and Municipal Taxes and Expenditure

The Federal Government, even though reducing expenses
sharply, will still need to have increased taxes in view of
the present low returns from taxes and in view of the
necessity of providing for interest for additional borrowing.
The States and local governments, on the other hand, in
many cases can reduce taxes, and this is particularly true
of rural local governments, where the tax burden has
grown so enormously in recent years, and where the farmer
pays the bulk of his taxes. I am told of one farm in an upstate New York county where taxes in the last year have
been reduced from $380 to $200, due to vigorous action by
the county commissioners, who have cut salaries and sharply
reduced the county expenses.




34

Our local government has been a haphazard growth
rather than a businesslike adaptation of government to
needs. Areas in many cases are altogether too small. They
were set in horse and buggy days. There are many places
where groups of small counties could be combined into one
county, with the elimination of several sets of officers.
There are many unnecessary road districts and school
districts, each with independent sets of officers. There are
immense possibilities for curtailing expenses in the cities.
Even with the additional burden of direct unemployment
relief which is thrown so heavily upon local government by
this great depression, I am satisfied that the possibilities
of saving are so enormous in the general field of local government that the total of the taxes can be radically cut. Much
is being done in many States looking toward this development, and the Federal Government might very well use
some of its existing instrumentalities for the study of what
is going on, giving publicity to it, and acting as a clearing
house for information regarding it.
International Goodwill

We should move as rapidly as possible and contribute as
much as we can toward bringing about peaceful relations
throughout the world, so that nations will be willing to go
in for a thorough-going lightening of the burden of armament. I do not think that we shall contribute to this by
peremptory demands that other nations disarm, because
such demands may even intensify the fears that have led
to the excessive armament. In general, it is far more fear
than lust for dominion that accounts for excessive armament.
Tying Together Various Remedies

In connection with the programme which I have outlined,
the desirable thing seems to me to be to accomplish all of
the parts as rapidly as possible. When it comes to doing one
thing conditioned upon some country doing another, I would




35

be thoroughly opportunistic, bringing them together if it
facilitates the transaction, and separating them if the effort
to tie them together creates difficulties. In connection with
tariff revision, I think that there is a great advantage in
tying our reductions and the reductions of other countries
together by reciprocal tariff agreements. I believe that
public opinion on both sides of the water will be much
readier to move in this way.
I think it might be difficult to tie together the settlement of inter-allied debts with a disarmament programme.
Disarmament will be much easier to achieve when business recovery is already under way and when nations
with a new economic hope are forgetting their fears and
hatreds. It is noteworthy, for example, that, as between
France and Germany, the era of good feeling was also the
era of business prosperity, from 1924-25 down toward the
end of 1928.
When it comes to international negotiations, it must be
remembered that public opinion in every country is sensitive, that there are many points of national pride involved,
that no country will accept dictation from any other country,
and that public opinion in every country needs to be
educated to make the necessary concessions to national
pride in other countries.





Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102