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7'
CREDIT POLICIES
HEARINGS
BEFORE THE
JOINT COMMITTEE ON THE ECONOMIC REPORT
CONGRESS OF THE UNITED STATES
EIGHTIETH CONGRESS
SECOND SESSION
PURSUANT TO
SEC. 5 (A) OF PUBLIC LAW 304,
79TH CONGRESS
APRIL 13, 16, MAY 12, 13, 27, 1948
Printed for the use of the Joint Committee on the Economic Report
77099
UNITED STATES
GOVERNMENT PRINTING OFFICE
WASHINGTON: 1948
JOINT
COMMITTEE ON THE ECONOMIC
REPORT
UNITED STATES SENATE
HousE OF REPRESENTATIVES
ROBERT A TAFT, Ohio, Chairman
JESSE P. WOLCOTT, Michigan, Vice Chairman
JOSEPH H. BALL, Minnesota _
GEORGE H. BENDER, Ohio
RALPH E. FLANDERS, Vermont
ROBERT F. RICH, Pennsylvania
ARTHUR V. WATKINS; Utah
CHRISTIAN A. HERTER, Massachusetts
JOSEPH C. O'MAHONEY, Wyoming
EDWARD 3. HART, New Jersey
FRANCIS J. MYERS, Pennsylvania
WRIGHT PATMAN, Texas
JOHN S. SPARKMAN, Alabama
WALTER B. HUBER, Ohio
CHARLES 0. HARDY, Staff Director
FRED E. BERQUIST, Assistant Staff Director
JOHN W. LEHMAN, Clerk
WrLTmAm H. MOORE, Economist
II
CONTENTS
Statement of:
Bopp, Karl E., Federal Reserve Bank of Philadelphia -138
Eccles, Marriner S., Federal Reserve System -1,
Riefler, Winfield W., Federal Reserve System -131
Rowe, John J., Fifth Third Union Trust Co., Cincinnati, Ohio -55
Schram, Emil, president, New York Stock Exchange -111
Sproul, Allan, Federal Reserve Bank of New York -87
Thomas, Woodlief, Federal Reserve System -131
Page
29
CREDIT POLICIES
TUESDAY, APRIL 13, 1948
CONGRESS OF THE UNITED STATES,
JOINT COMMITTEE ON THE ECONOMIC REPORT,
Washington, D. C.
in the main caucus
call,
to
pursuant
in.,
a.
10
at
met
The committee
room, Senate Office Building, Senator Robert A. Taft (chairman),
presiding.
Present: Senators Taft (chairman), Flanders, and Watkins; Representatives Rich, Herter, Patman, and Huber.
The CHAIRMAN. The committee will come to order.
This is the opening of hearings which the committee wishes to conduct to study the whole question of credit control, particularly the
control of bank credit, the maintenance of the interest rate,'and the
maintenance of the price of Government bonds. We also intend to
ask the witnesses something regarding the question of the availability
of money for investment, and whether there is a sufficient supply of
equity capital as opposed to bank credit.
Mr. Eccles, you are the first witness, and we will be glad to have you
proceed.
STATEMENT OF MARRINER S. ECCLES ON BEHALF OF THE BOARD
OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, WASHINGTON, D. C.
Mr. ECCLES. Mr. Chairman and members of the committee, when
I testified before this committee last November 25, I emphasized that
I was speaking only for the Board of Governors of the Federal Reserve
System. In presenting a further statement today covering the
monetary and credit situation as it has developed in the intervening
4 months, I am again speaking only on behalf of the Board.
We, of course, do not participate in the Government's military or
rearmament planning or in the formulation of programs for foreign
relief. Accordingly, what the Board has authorized me to say with
regard to the impact on our economy of military and relief expenditures
is said solely from the standpoint of the implications so far as monetary
and credit policies are concerned. We feel that in any effort to deal
with monetary and credit problems under the situation now existing,
we should clearly recognize the alternatives before us and the economic consequences of expanding military outlays superimposed
upon the present large budgets for military purposes and for our
program of world aid.
Never in our memories has the world been pervaded by greater
fears, confusion, and discouragement, arising chiefly because of the
disappointments of the past and the uncertainties of the future.
The great hopes we had during the war for achieving a lasting peace
in a prosperous world have'been steadily diminished because a few
1
2
CREDIT POLICIES
ruthless and despotic men hold a sword of Damocles over the heads
of free peoples throughout the world. It is difficult, if not impossible,
to plan for a rational economic future either at home or abroad while
that sword hangs over us.
We think that the prospect of removing the threat by peaceful
means will be immeasurably enhanced the sooner we assert our moral
and physical power to establish the foundations for peace before we
are engulfed by the economic and social problems which grow more
menacing the longer the establishment of a firm basis for permanent
peace is delayed.
Monetary situation in November: When I last appeared before this
committee, the country was faced with rapidly mounting inflationary
pressures. The issue then was how to curb inflationary forces by
striking directly at the basic cause, namely, an effective demandcomposed of spending out of past savings, current income and new
credit-in excess of the over-all supply of goods and services. As
pointed out in the Board's statement to this committee, correction
of inflation at its advanced stand had to be on a broad front; fiscal
policy had to be our main reliance; and monetary and credit policy
was supplementary to other fundamental actions. The Board felt
then, as it feels now, that effective monetary and credit policy would
require legislation to provide the Federal Reserve System with new
powers that would serve as a partial substitute for those traditional
powers which had become largely unusable in view of the huge public
debt.
I would like to emphasize there that we say "new powers," and not
"increased or greater powers." We speak of new powers, which are
only a partial substitution for powers that have formerly been used,
those which we call the traditional powers.
The essential monetary fact in the inflationary situation at that
time was the amount of liquid purchasing power in the hands of the
public, that is, currency, bank deposits and Government securities,
aggregating In all about $254,000,000,000, or more than three
times the amount held in 1940. This amount of cash or cash equivalent was in large part inherited from the financing of the enormous
Federal deficits incurred in preparation for and prosecution of global
war. Not only did we have this huge volume of cash or cash equivalent already available last November, but at that time, despite the
anti-inflationary influence of the Government's large budgetary surplus, the amount of liquid funds was being rapidly increased as a result
of bank credit expansion to finance businesses and individuals as well
as state and local governments.
Because of the necessity for protecting the Government's fiscal and
debt management position by maintaining an orderly and stable
market for Goivernment'securities, the Federal Reserve System was
then and still is unable to restrain effectively further monetary expansion. The commercial banking system held nearly $70,000,000,000
of Government securities, which were being converted into
additional bank reserves through sales to Federal Reserve. In
addition, the System was providing reserves to banks by purchasing
Government securities sold by nonbank investors. That, of course,
was in support of the Government bond market.
The CHAIRMAN. Will you spell out how that works, Mr. Eccles?
That is, how banks are provided with reserves by the purchase of
CREDIT POLICIES
3
Government securities held by nonbank investors? Will you spell
it out so that it is clearer?
Mr. ECCLES. Yes.
If a corporation, or an individual, anyone other than banks, sells
securities in the market, and the residual. market is the Reserve
System, they of course are paid for those securities in Federal Reserve
funds. The recipient of the funds puts the money into the bank, and
the bank therefore has excess reserves on one side and deposits on the
other.
In other words, the Federal Reserve creates the money, that is,
reserve money, whenever we purchase securities. When you purchase
the securities from other than banks, the seller gets deposits, and the
bank of course bhs excess reserves on the assets side of its ledger to
offset the deposits it receives on the liabilities side.
The CHAIRMAN. That assumes that they do not reinvest in other
securities.
Mr. ECCLES. Who?
The CHAIRMAN. The people who sell the bonds.
Mr. ECCLES. Well, if they do, then somebody else gets the money
and that goes back into the banks in the same way. The only way
that you can extinguish additional bank reserves, once created by the
Reserve System, is for the Reserve System to sell an amount of
Government securities to offset the amount which they purchased or
to have the Government, through a budgetary surplus, retire
Government securities which the Reserve System holds.
Senator FLANDERS. Is the result the same if the Treasury pays off
securities?
Mr. ECCLES. Well, if the Treasury pays off securities out of its
surplus funds, that is generally deflationary. Where the Federal
Reserve buys securities, that is generally inflationary. It is exactly
the opposite.
Senator FLANDERS. Is it deflationary or neutral if the Treasury
receives funds from taxation and then pays off its securities? I do
not see how that is deflationary. Is that not neutral?
Mr. ECCLES. No, it isn't neutral at all; because as the money goes
out of the bank into the Treasury
Senator FLANDERS. I am not talking about what is bank held,
although we will come to that later. I was thinking of what is
privately held.
Mr. ECCLES. But the Government doesn't pay off the privately
held securities. What the Government does with its surplus funds is
-to retire the securities that the Federal Reserve owns, so that the
money does not return to the banking system. If the Government
took tax money that it receives and paid-off securities held by taxpayers, then the same amount of money would be returned to the
spending stream that was taken away in taxation.
Senator FLANDERS. That is neutral.
)Iir. ECCLES. That is neutral.
Senator FLANDERS. What happens, however, if it takes tax money,
reducing deposits thereby, and pays off bank held securities?
Mr. ECCLES. Well, that would be neutral. Because the money
that the bank held on deposit for the taxpayer goes to the Government, and the Government, of course, would return that money to
the bank. What would happen is that the bank's deposit would be
4
CREDIT POLICIES
diminished when the tax was paid. An asset equal to that amount,
of course, would be reacquired when the money. is returned.
But what really happens as a practical matter when the tax money
is drawn out of the banks? The banks are put under pressure to meet
that withdrawal, and therefore they have to sell Government securities
at the time the tax money is drawn out. If money is not returned to
them by the Government as fast as it is being drawn out, then the
banking system has to sell securities to meet the withdrawal of tax
money. The Federal Reserve, of course, buys those securities from
the banking system. Then the Government pays off securities held
by the Federal Reserve.
The CHAIRMAN. Is not the net result, though, of the whole business
more or less neutral? That is to say, you take a certain amount of
taxes out of the banks. You thereby reduce their deposits. After
the process is finished, they have replaced their bonds with cash.
They have paid off their deposits.
Mr. ECCLES. That is not quite correct. The process is a reversal
of war financing.
During the war period the banks bought Governments and created
deposits. That is what is called deficit financing, done through the
banking system. When there is a budgetary surplus and the funds
are used to pay off the banks, then you have reversed the process.
You extinguish the money created, and you likewise extinguish a like
amount of the assets that the bank s hold in the form of Government
bonds. So that it is a reversal of deficit financing, which is inflationary. Therefore, it is equally as deflationary on the money system as
it is inflationary duringThe CHAIRMAN. I.do not see why it is deflationary at all. I could
see why the drawing of deposits out is deflationary. But when you
get all through, the bank has 100,000 less assets, we will say, and
100 less deposits.
Mr. ECCLES. That is deflationary. There is that much less money
in the money system, just the same as budgetary financing is inflationary, because you create new money through the banking system
when you finance the deficit, and you extinguish that money when
you have a budgetary surplus.
The CHAIRMAN. Do they not actually have more money that you
lend by reason of the fact that, although the assets are not turned
into cash, you can turn them into cash?
Mr. ECCLES. But the point is that the banks are less willing to
expand credit when they are deficient in their required reserve and
find it necessary to sell or liquidate some of their earning assets.
-When the banks have a deficiency in their reserves, which they do
as their deposits are drawn out in taxes, they must either collect
loans or sell Governments or borrow from the Federal Reserve.
Therefore, they are under pressure.
The CHAIRMAN. Now, they can sell Governments. In fact, the
very hypothesis is that the Federal Government is paying the Governments off, so they replace their Governments with cash.
Mr. ECCLES. No; they do not replace them, because the Governxment uses its surplus cash to retire securities held by the Reserve
*System.
Representative HERTER. In one case the bank had both the bond
and the cash; in the second case, it had only the cash. When it had
CREDIT POLICIES
5
both the bond and the cash, the bond becomes then an asset that they
can discount at the bank, and again re-create credit. If you retire
the bond, it becomes a deflationary operation.
Mr. ECCLES. But you see what happens: As the money is drawn
out of the banks, in order to meet the withdrawal, the banks must
sell something or collect a loan'or borrow in order to meet the tax
withdrawal.
The CHAIRMAN. Having done that, are they not. just where they
were when they began?
ivir. ECCLES. That is right. But when you do that, it is strongly
deflationary. If you kept the process up long enough, instead of
having, as you have today, 170 billions of cash and deposits, you
would go back to the 66 billions we had before the war.
The CHAIRMAN. But as long as they have 70 billions of bonds, I
do not see why it is deflationary. They turn it into cash, and they
are exactly where they were before.
Mr. ECCLES. That is exactly why we proposed the special reserve
before, and why we talk about reserve requirements; because of the
ease with which the banks can meet current credit demands.
There is no problem at all of the banks meeting the withdrawal
demands or the credit demands, because of the fact that they have
this large amount of Government bonds that is readily convertible
into reserves, upon which a multiple credit expansion can take place.
Senator FLANDERS. Mr. Eccles, as a project of adult education
for the junior Senator from Vermont, I wish it were possible to put in
balance-sheet form at the end of each transaction what happens in a
bank statement when, in the process of deficit financing, banks
acquire bonds, what happens when they let them go, how it affects
reserves, how it affects loan capacity, and so on.
Now, my reason for wanting to see this in a single sheet that I can
hold in my hand and look at the figures, instead of listening to dissertations, is this:
Out at the meeting of the American Economic Association in
Chicago last December, I listened to dissertations. And I -came out
very much confused.
Just as an onlooker, not knowing all of the rules of the game, I
judged at the time that the decision, perhaps on points, lay with those
who felt that there was no automatic deflationary effect to the retirement of bank-held bonds; which completely reversed the automatic
inflationary effect of acquirement by the banks of bonds in the process
of deficit financing.
In other words, it was not completely the reverse.
And I wonder if it would not be possible for you to prepare and insert
in the record at a later date these. processes of acquiring and disacquiring Government bonds by the banks and its effect on the bank
statement, on its ability to loan; its effect on reserves, and its ability
to loan. I would rather see it in figures than in a mass of words.
Mr. ECCLES. I think that it possibly can be done.
Or course. to understand the process of creating money through the
banking system, one first must understand the principles of accounting
and likewise the principles of central banking. That becomes basic.
And it really isn't simple. One can be very easily misled. It is a
subject that requires study and concentration, and especially when
you think in terms of 15,000 banks.
6
CREDIT POLICIES
If you would think in terms of 1 bank with 15,000 branches, then
the process becomes more easily understood. But it becomes extremely confused when you consider it from the standpoint of the
State nonmember banks which carry reserves with Reserve city banks.
And when you consider, in addition, in connection with the three types
of member banks, it becomes quite confusing because of the different
reserve requirements and the effects of different reserve requirements
of member and nonmember banks.
If I may proceed with my statement, perhaps some clarification will
come out of later discussion.
The CHAIRMAN. I would like to have the same thing Mr. Flanders
does. But I think I understand the inflationary process, although it
seems to me there is quite a difference of opinion in the reports I have
read on this deflationary effect, the paying off of bonds in the hands
of the banks.
I would like to see just what does happen when the taxes are drawn
out and then when the bonds are sold or paid off. I think such a thing
might be helpful.
Mr. ECCLES. Of course, how do you reverse the inflationary process?
Certainly we know that financing of budgetary deficits through the
banking system creates new deposits, just like any other form of credit
creates deposits. If loans are being paid by one group of our citizens
as fast as loans are being made by another group, there is no change in
the total deposits.
But to the extent that all credit, including Government credit, is
expanded by the banking system, you create new deposits. And
just to the extent that credit is contracted, public as well as private
credit, by the banking system, you are reversing the process and you
are extinguishing deposits.
The CHAIRMAN. On the other hand, the bank has loaned a lot of
money to the Government. The Government comes in and pays it
off, and they take the money and loan it to somebody else. I don't
see anything deflationary about that.
Mr. ECCLES. But they don't pay it to somebody else when the
Government retires debt held by the Reserve banks. The money
disappears. It never gets back.
The CHAIRMAN. But I am suggesting that, as to the mere fact that
they have the additional money, and the Government pays off and
turns around and lends to somebody else, there is not anything
particularly deflationary about that.
Mr. EcCLES. What happens when the Government collects more
money in taxes than it spends; that is, when it has a budgetary
surplus? That money, that surplus money, actually, to the extent
that it is used to pay off the Government bonds that the Federal
Reserve System has acquired, is not returned to the spending stream,
and it actually extinguishes an amount of deposits equal to the
liquidation of that credit. The exact opposite would be the case if
there was a budgetary deficit and the banks financed the deficit.
A budget surplus with retirement of Federal Reserve-held debt is
a direct and complete reversal of deficit financing through the banks,
and it extinguishes the same amount of money.
Representative HERTER. Following that same line of reasoning you
mentioned a moment ago, the support of the bonds by the Federal
Reserve; if the Federal Reserve has to support the bond market and
CREDIT POLICIES
7
has to go in and buy in order to hold the levels up, that becomes in
itself an inflationary process, does it not?
Mr. ECCLES. That is correct. It makes it very easy for the banks,
as long as they have the large volume of Government bonds which
they acquired during their war financing operation, to get Federal
funds or Reserve funds. They can get them with great ease. Therefore, it is difficult to put pressures upon the banks to hold down
expansion of private bank credit.
Representative HERTER. Well, recently, when the bond market was
dropping, did not the Federal Reserve have to put in a good deal to
hold the bond market up?
Mr. ECCLES. The Federal Reserve dropped the bond market
substantially in December, because we felt that there was no justification for supporting the market at the premium prices which had
prevailed. In other words, we felt that there was too much of an
inducement, both to the banks and to the nonbank investors who had
market bonds to sell those bonds while they could not only get the
return of their money, but could get a premium upon them, than
would be the case if the premium disappeared.
And in many cases banks had bought Government bonds at a substantial premium. Then, when the Government bond market was
permitted to drop, book value actually exceeded market value,
because these banks had purchased Governments at considerably
higher prices than the support level that we dropped to.
Now, that action deterred to some extent, and I think a very
considerable. extent, bank selling of Government bonds.
The CHAIRMAN. Will you proceed, then, Mr. Eccles?
Mr. ECCLES. If I may, to get this in the record-I believe I stopped
at this point. In addition, the System was providing reserves to
banks by purchasing Government securities sold by nonbank investors.
Finally, bank reserves were being substantially augmented by a heavy
inflow of gold.
In brief, the banks at that time were in a position to supply unlimited amounts of additional credit, and, in the face of strong demands for additional credit from all sources, further rapid monetary
expansion was occurring, intensifying existing inflationary pressures.
This situation was potentially explosive because production and employment were close to the maximum then possible.
In other words, to merely add to the supply of money when you
were using your production and employment to practical capacity
only forced up prices. And, of course, that is the difficulty in the
various foreign countries today, where the amount of their bank
deposits in currency so far exceeds the supply of goods, and where
many of them are still operating on unbalanced budgets and creating
more money, because the Government defiqits that they are running
are being financed by the banking system. And that is why you see
the terrific inflationary situations that exist in other countries. It is
the same process that proceeded here to a very limited extenV. But
it is exactly the same principle.
Changes since November: Last November we expected some abatement of inflationary pressures in the first quarter of this year. Such
a situation developed. It was recognized that there would be a large
volume of funds drawn from the banks by business and individuals
in order to pay taxes, which would result in a large cash surplus
available to reduce the public debt.
8
CREDIT POLICIES
It was also recognized that the existing and contemplated program
of monetary and credit policy would have some restrictive effect.'
The program-that is, this contemplated program, which was carried
out-included the statement by the bank supervisory agencies urging
the banks to be more restrictive, the lowering of Federal Reserve
support levels for Government securities late in December, a slight
rise in rediscount rates early in January, and some increase in reserve
requirements for banks in New York and Chicago in February.
The banking fraternity, recognizing the dangers in rapidly expanding bank credit and the need for restraint, undertook a Nation-wide
educational program to bring about restriction by voluntary means.
Finally, there was a widespread belief that the supply of goods in
many fields was gradually catching up with deferred demands and
that favorable crop developments would combine to lessen inflationary
pressures by the spring of this year. That is what you would call a
psychological effect.
Monetary developments since November have accorded generally
with expectations held at that time. Fiscal and monetary operations
together effectively offset factors increasing bank reserves during the
period; that is, during this 4 months' period that we had some inflationary factors. And here is what they were: the inflow of gold, the
return of currency from circulation-which has amounted to about
$1,200,000,000 from its peak in December, and which, of course,
adds to deposits of banks and to excess reserves-and purchases by
the Federal Reserve of Government securities from nonbank investors.
Representative RICH. May I ask a question right there? Was that
paper?
Mr. ECCLES. Yes; that was paper currency.
That is the currency
in circulation, which decreased about $1,200,000,000 from its peak, in
December.
Of course, it always goes up prior to the Christmas holiday season.
There is always a seasonal drop in the volume of currency in the first
quarter of the year, but the seasonal drop this year has been considerably more than normal.
Representative RICH. Was there any part of that, any great part
of that, in coin?
Mr. ECCLES. No; that wouldn't amount to much. The coin in
circulation is a very small factor. It is bills.
To continue with my statement, these inflationary factors include
the inflow of gold, return of currency from circulation, and purchase by
the Federal Reserve of Government securities from nonbank investors.
These factors all added to the reserves of the bank. However, they
were more than offset by the fiscal and monetary operations during
that same quarter. Here is what they were.
During the 4-month period December through March the Federal
Reserve purchased 8.6 billion dollars of Government securitieswhich will give you some idea of the size of our operations-largely
bonds,,and sold in the market 6.3 billion dollars of securities, chiefly
bills and certificates. That was because we dropped the Government
bond market, and there was for a time fear that the price of longer
term securities would go lower, therefore, they were being sold and
replaced to some extent with short securities.
The Government retired $3,900,000,000 of its securities held by the
Federal Reserve. That was the budgetary surplus. The net result
CREDIT POLICIES
.9
of these operations was to reduce the Federal Reserve holdings by
$1,600,000,000, and thus to keep the bank reserve positions under
pressure during this period.
Now, $1,600,000,000 forf that period as a reduction in total Federal
Reserve holdings during that period was a very large amount. In
other words, if we bought $1,600,000,000 more securities from the
banks than we sold, that would give the banks $1,600,000,000 of reserves, upon which you could expand $10,000,000,000 of credit. We
contracted enough Federal Reserve funds in that 4-month period
to support the $10,000,000,000 of bank credit. That is what $1,600,000,000 amounts to.
The combined effect on the money supply of Treasury and Federal
Reserve operations, which were only made possible by the large
budgetary surplus, was strongly anti-inflationary. The money supply
was contracted by nearly $4,000,000,000. Commercial bank loan
expansion was sharply curtailed, partly reflecting fiscal and monetary
developments, and partly reflecting the effectiveness of warnings by
banking supervisors and the success of the bankers' own program of
voluntary restraint, and partly reflecting the usual seasonal slack in
business loan demand- during the first quarter. There was an expansion totaling only about $700,000,000 of bank credit during the
entire quarter; which, of course, was a very great slackening compared
with what was happening last fall when bank credit was expanding at
the rate of about a billion and a half a month.
Concurrently with these developments, the world crop outlook has
become more promising, and prices of-farm products and foods have
declined. In addition, productive activity generally has held close to
maximum levels. These developments have exerted an anti-inflationary influence.I
Prospective monetary and credit situation: Notwithstanding these
salutary developments, it cannot be said that inflationary dangers
have been removed. Farm prices, 'though lower than they were, still
continue firm, even though at present levels they are much higher
relatively than prices of most other commodities.
Current and backlog demands for many goods continue to be very
strong. Prices of industrial products, wages, rents, transportation,
and some other services, are still advancing. The' money supply,
though contracted by an estimated $4,000,000,000, remains excessive
in relation to the total product. Public holdings of cash or cash
equivalent available for spending are nearly as large as last fall$250,000,000,000, compared with $254,000,000,000-and continue to
be broadly distributed among holders.
The cash equivalent, of course, is the Government securities held
outside of the banks. Commercial banks, though obliged to sell some
securities to offset shrinking deposits during this last quarter period,
still.hold $66,000,000,000 of Government securities, which are readily
convertible at the bank's discretion into reserves. Upon these reserves, a 6 to 1 expansion of bank credit and deposits can be built.
To the extent that the monetary gold stock is increased and Government securities are sold to the Federal Reserve by nonbank investors,
still more reserves would be created. These additional reserves could
also support an inflationaty-6 to 1 expansion of bank credit.
On the basis of the monetary situation alone, there would still be a
dangerous inflationary potential, even if no further impetus were given
10
CREDIT POLICIES
to inflationary pressures by other forces. However, upward pressures
are now in prospect as a result of several important new factors. One
of tbese is the tax reduction bill. This bill will add about $5,000,000,000
to the purchasing power of the public and take away a like amount
from Federal revenues in the next fiscal year.
The international financial obligations which we have now accepted
are another factor likely to add many billions to Govrernment expenditures in the future. The expanding program of military preparedness
will further increase the budget burden for next year and future years
by still more billions. Stemming from these developments, on top of
existing inflationary conditions, is a rapidly changing public psychology
with respect to the inflationary outlook.
Businesses and consumers will be more disposed to use existing liquid
resources, and to expand their borrowings to finance current expenditures. The prospect is that the demand for new financing, aside from
Government requirements, will exceed the supply of available savings.
'ihis would mean that many in need of financing will turn to the banks
for credit. A growth in the total volume of bank credit and money
under such a situation can only add to inflationary pressures. Moreover, these pressures would be aggravated if the demands of the
defense and foreign-aid programs for goods which are already in short
supply further reduce the quantities available to the public.
The Government's fiscal operations for the balance of the 3alendar
year 1948-that is, the last three quarters-are likely to show a
budgetary deficit, which would eliminate the only remaining important
anti-inflationary influence. During the last three quarters of the year,
it is estimated that the budgetary deficit may exceed $3,000,000,000.
You will note, in parentheses, in the statement, this observation:
In view of large tax receipts in the first quarter of 1949, however, there may be
a small budgetary surplus for the 12-month period beginning with April 1 of this
year.
'Ihe CHAIRMAN. This, of course, is highly conjectural on a lot of
things.
'Mr. ECCLES. Of course, you can't do other than make your estimates based on the known factors. It is, we admit, difficult to see
very far into the future under these conditions. But we feel that the
'conditions are not likely to be more favorable than we anticipate.
They could be less favorable. I think that the statement here is a
conservative one, and does not undertake to exaggerate the possibilities.
Representative RICH. Is not the great question just what Congress
is going to do between now and the end of the fiscal year in making
commitments?
jMr. ECCLES. That, of course, is the basic question insofar as the
budget picture is concerned.
Representative RICH. And you have already figured now that with
the commitments that have already been made and passed into law,
you are going to be three billions in the red.
Mr. ECCLES.- Well, that is with some military expansion.
Representative RICH. You have given credit for some?
Mr. ECCLES. That is right.
Representative RICH. But you do not know what the ultimate
amount is going to be. I guess nobody does.
Mr. ECCLES. That is right. We have the estimate for the next
fiscal year, the 1949 fiscal year, of revenues, based on full production
CREDIT POLICIES
11
at approximately these price levels, and the tax revenues on that
basis, together with the estimated expenditures.
The CHAIRMAN. Mr. Eccles, the first 9 months of this fiscal year
there was a budget surplus'of up to $8,000,000,000.
Mr. ECCLES. Or thereabouts.
The CHAIRMAN. Somewhere near eight. Now, of that eight
billion dollars. or so, practically all but $1,000,000,000 came in the first
quarter of the year. Is that not correct?
Mr. ECCLES. I think most of it certainly did. There may have been
more than a billion in the other quarters.
The CHAIRMAN. And in your estimate here, about a deficit of $3,000000,000, you are taking the 9 months beginning the first of April, to
the end of the year, and leaving out the first quarter, which was the
lucrative quarter?
Mr. ECCLES. But, you see, the inflationary impact comes during
the next 9 months. And that is a period in which the banks will be
under no pressure whatever, but it will be a period when the Government may actually have to give reserves to the banking system. So
the point that I will make here is to show what we have ahead of us
for the next 9 months.
Now, it is true that the following 3 months, in the first of the year,
will be likely mildly deflationary, if you get the budget surplus during
that period that is contemplated.
But in the interim period, the next 9 months, during the period
when we need some restraint, we will not have any. That is the
point that I am making, because I am going to argue why we should
get some more credit controls here in the picture, and that is the
immediate problem.
The- CHAIRMAN. I just wanted to make it clear that when you are
talking about a deficit, you are talking about the 9 months which
may produce a deficit even this year, and which consisted this year of
a surplus of eight billion.
Mr. ECCLES. Yes; but I also pointed out what would happen for
the year.
The CHAIRMAN. I did not question the accuracy, Mr. Eccles. I
merely wanted to be sure that the newspapers understood what the
basis of it was.
Mr. ECCLES.'That is why we we put in parentheses here that for
the year as a whole there would likely be a small budgetary surplus.
It was to emphasize the 9 months that we were speaking about, where.
there would be the deficit. During that period, you will not have the
anti-inflationary effect of a budgetary surplus.
The CHAIRMAN. Can you give us for the whole year your estimate
of receipts? You said you had those estimated. I would just be
interested to know what they were. Is that from April 1 to April 1,
or the fiscal year?
Mr. ECCLES. The fiscal year.
The CHAIRMAN. The next fiscal year?
Mr. ECCLES. Yes. These are cash budget receipts; 42X.
The CHAIRMAN. Forty-two and a half after'the tax reduction?
Mr. ECCLES. Yes.
The CHAIRMAN. Now, in all of these estimates, you, of course,
have not taken account of $3,000,000,000 of cash surplus, of money
which is taken into the trust funds of the Government and not paid
out; so that from an inflationary-deflationary standpoint, you have
12
12"CREDIT
POLICIES
got to add $3,000,000,000 to any surplus§4 you have, or deduct that
from any deficit that you are talking about.
Mr. ECCLES. Well, we estimate, however, -as I will show in this
statement, that we recognize what that is. The effect of that
is
covered.
The CHAIRMAN. In other words, the Government's cash position
is about $3,000,000,000 better than the budget position.
Mr. ECCLES. No, we estimate that it will take those receipts, plus
the receipts from the sale of savings bonds, to pay off the redemption
of savings bonds and to likewise pay for the redemption of other
securities held by holders that will not accept refunding. I refer
to
maturing marketable Government securities. On these, as they
mature and refunding issues are offered, there is always a substantial
amount that has to be paid in cash.
The CHAIRMAN. I understand. That is what you do with it. But
that does not change the Government cash position. If you wish
to take the Government's cash budget as against its book budget,
you still have to add about $3,000,000,000 for the cash budget;
do
you not?
Mr. ECCLES. But you see, we take into account the receipts from
social-security taxes, and that is largely where the cash surplus comes
from. It will take that cash, plus the estimated cash they get
from
the sale of savings bonds, to pay off the savings bonds that are being
redeemed and other securities that fall due that will not be refunded.
Therefore, those funds are not available for other expenditures,
as
I will bring out here.
Now, here it is: It is also estimated that combined sales of savings
bonds and other public debt receipts will approximately cover voluntary redemptions of public debt by holders of maturing issues.
that is just what I said. That is what our statement means. Well,
The current deficit will need to be financed by drawing on Treasury
deposits which have been built up by tax receipts during recent
weeks, or by borrowing in the market. Under these circumstances
there can be no net retirement of Government securities held by
Federal Reserve System; that is, during this 9-month period. the
the extent that the Treasury may need to borrow new money, To
probably will have to be obtained largely from the banking system. it
Representative HERTER. Is there not a drive being started very
shortly in that connection?
- Mr. ECCLES. It is already under way. But we do not estimate
that that drive is going to bring in more than enough revenue
to
offset the redemptions.
Representative PATMAN: I notice an effort is being made to reduce
the interest on postal savings from 2 to 1 percent. That will not
be
helpful in your savings drive; will it, Mr. Eccles?
Mr. ECCLES. Well, I do not think that the savings drive is for
savings. The savings drive, of course, is largely for the sale postal
of E
bonds, which yield 2.9; and the postal savings mechanism, I think,
is
not a comparable or a competitive savings operation with the sale
of
Government bonds.
The bankers, of course, feel that the Government pays 2 percent,
which is what they paid when savings money was worth 4;
that is,
when the banks used to pay 4 on savings money. The Government
still pays 2. Now, the banking system pays anywhere from 1 to 1X2.
CREDIT POLICIES
13
Very few banks can pay 2 for savings funds. The banks feel, therefore,
that the Government is in competition, and paying for savings funds
more than the banks can afford tb pay; and that the Government
should reduce the rate that it pays on savings payable on demand.
Postal savings are really demand money.
Representative PATMAN. I understand the arguments for it. But
the fact remains that if you put your money into postal savings, it has
the same effect as putting it in bonds; does it not?
Mr. ECCLES. Oh, sure. The Government puts the postal savings
in bonds.
Representative PATMAN. Well, why discourage the people about
that? A lot of people will put their money in postal savings that will
not put it in banks, as evidenced by the fact that postal savings have
increased up to about $3,000,000,000; have they not?
Mr. ECCLES. I don't know what the postal savings amount to.
Representative PATMAN. I think it is proabbly near three. That
being true, if you reduced the interest rate to 1 percent, you will
probably encourage a lot of people to take that money out and put it
in a spending stream, which would be inflationary.
Mr. ECCLES. It is just a question of the competition of Government
with private interests. That is what the issue is.
Representative PATMAN. But that has nothing to do with the savings, the way I view it. Of course, that is a good argument for the
banks.
Mr. ECCLES. Of course, if the Government wants more savings,
they could pay 3 percent on postal savings.
Representative PATMAN. I am not talking about increasing them,
of course.
Mr. ECCLES. I think it would have very little effect. I think that
you would find that people put money in postal savings, not because
of the 2 percent interest. I think, for example, that there are a great
many foreigners who have put their money with the Government,
because they just feel that is the safe place to put it. And I think
it is the principal they are interested in more than the return.
I don't believe that the rate would really be as effective in changing
the amount of savings as a lot of people think. I don't believe the
banks would get much of that money, even if the rate were less. I
think they might get a little, but I do not believe it would affect it.
Because certainly 2 percent for savings that can be drawn out on
demand is a very high rate under present conditions, and you would
think that postal savings would have grown far beyond anything
that they have.
Representative PATMAN. But the Federal Reserve Board made the
conditions, did it not?* Did not the Federal Reserve Board fix the
rate of interest that the banks can pay on time deposits?
Mr. ECCLES. All we do is to fix the maximum.
Representative PATMAN. And you fixed it low, did you not?
Mr. ECCLES. No.
Representative PATMAN. HOW low is it?
Mr. ECCLES. Two and a half.
Representative PATMAN. Two and a half percent.
Mr. ECCLES. But nobody is paying it. The rate that the Federal
Reserve has fixed is possibly higher than any bank in this country
pays.
77099-48-2
14
CREDIT POLICIES
Now, one of the reasons that we did not put it lower-I think we
would have put it down to 2 percent some time ago-was because the
Federal Deposit Insurance, which hadtjh fixing of the rate on the
nonmember banks, would not go below 2%2 percent, and therefore,
because of that situation, the Federal Reserve felt they were in no
position to reduce the rate below two and a half.
I think it is an academic rate. It is entirely meaningless in relationship to the rate that could safely be paid.
Representative RICH. You stated that the banks, for savings,
were unable to pay more than one or one and a half percent?
Mr. ECCLES. That is right; the commercial banks.
Representative RICH. The commercial banks?
Mr. ECCLES. That is right.
Representative RICH. If the Government pays 2 percent, how can
they afford to pay 2 percent, if the banks are unable to pay more than
1% percent?
Mr. ECCLES. The banks pay taxes and have a lot of expense to
absorb, and the Government does not.
Representative RICH. The Government has no expense?
Mr. ECCLES. Not in postal savings. The postal savings money is
immediately invested in Governments.
Representative RICH. The Government pays the clerk for looking
after that.
Mr. ECCLES. Well, it is paid by the Post Office.
Representative RICH. And the Post Office is $400,000,000 in debt.
So the Government is paying for that, and they are going in the red.
Mr. ECCLES. Well, but the Government is paying a lot of money too
for war bond drives, in order to sell money to the public.
Representative RICH. I still contend that the Government has expense in handling the postal savings.
Mr. ECCLES. I suppose they do. I suppose they have some expense,.of course. But the fact that it is done through the Post Office
is important. They don't have the rent to pay. They don't have the
same expenses that the banks have to pay.
Representative RICH. I think they do. I think they have the same
expense. In fact, I think the Federal Government has a whole lot
more expense than the banks when it comes right down to it.
Mr. ECCLES. Yes, but not for operating the postal savings system,
Representative RICH. Well, that is the Government's way of keeping books, and they have been used to that, and the public pays the
bill.
Mr. ECCLES. All I am saying is the no bank can pay 2 percent,
certainly the way the money market has been over a long period of
years, for savings funds. Because when they get 1 percent on Treasury
bills, and they get one and an eighth, on Treasury certificates, the
highest rate they get is the 2 percent on the Treasury eligible bonds.
There are a few prewar bonds that were issued at 2% percent, but they
are selling at such premium that the return is possibly around 2
percent for very long-term bonds. And for commercial paper,-.the
rate is 1%.
True, there are some loans and investments that banks can get
that are above two, but I would say that the average rate, certainly
of the commercial banks in the reserve cities would not average 2
percent on their entire portfolio.
15
CREDIT POLICIES
Representative PATMAN.: 'But that is on a basis of 6 to 1 expansion
too, is it not, Mr. Eccles?
Mr. ECCLES. Yes, but why would they want to pay 2 percent for
money in order to be loaned it at 2 percent? They have to carry a
reserve against those deposits.Representative PATMAN. They would loan it six times.
Mr. ECCLES. No, they don't.
Not that bank.
It is the banking
system.
Representative PATMAN. I mean the banking system.
Mr. ECCLES. But the banking system isn't one bank.
Representative RICH. I quite agree with you that the banks cannot
pay more than 1Y2 percent on their savings under present-day conditions, and, for the same reason, the Federal Government cannot
afford to do it. Because it shows from the handling of it under the
Post Office Department, that all branches of the Post Office De.partment except the first-class mail have gone into the red.
Mr. ECCLES. I think it is contended that the Government should
pay less on postal savings. That is the point that Congressman
Patman is making here.
Representative RICH. What do you think?
Mr. ECCLES. I think there is some merit in reducing that rate.
I think that the 2 percent has been paid over a long period of years,
and there has been a very great change in the interest rate on money
over that period. But I think that is a little aside from our subject
today.
The CHAIRMAN. All right, then. Will you proceed with your
statement?
Mr. ECCLES. I said here that to the extent that the Treasury may
need to borrow new money, it probably will have to be obtained
largely from the banking system.
During the next few months, Treasury use of accumulated balances
with the Federal Reserve banks will add to bank reserves.
Now, let me explain that.
Some of the tax money beyond what the Government has spent
has been deposited with the Reserve banks and the balances of the
Government with the Federal Reserve banks have been built up.
Therefore it is unavailable as reserves to the private banks. If the
Treasury was not going to need those balances, it would use that
money to pay off its Government securities held by the Reserve banks.
But the Treasury is going to need all of those balances, and they will
be drawn down. They are not very large; I think at this time they
are a little over a billion dollars. They were large earlier, but the
Treasury has been using the balances.as they came into the Federal
Reserve to pay off the securities held by the Reserve banks. That is
why there was the reduction of securities held by the Reserve banks
that I spoke of earlier. From this point on, the balances will no
longer be used to retire Government debt held by the Reserve banks,
but-will be disbursed into the spending stream, and will become excess
reserves to the banking system. That is the point I want to make
here: that these balances will add to bank reserves as they are spent.
The bank reserves will also continue to be augmented by the inflow of
gold, and possibly by further Federal Reserve purchases of Government securities from holders wanting funds for other uses. These
last two factors may operate for a long time in the future. As long as
I
16-
CREDIT POLICIES
we have to support the Government market and noribank investors
find other markets for their funds, which, under inflationary conditions
they don
Representative HERTER. When you say you have to, is that not a
matter of decision with you?
Mr. ECCLES. It is a matter of decision by the Government, too.
It is a matter of decision by the Federal Reserve and also the Treasury.
We feel, if we are going to have to manage the public debt, you have to
manage the market, and the failure to support the Government market
would make it, we feel, practically impossible to do the necessary refunding that the Treasury has to do currently.
Representative HERTER. May I ask you there: You speak of its
being inflationary when you buy all of these long-term Government
bonds in order to support the market.
Mr. ECCLES. That is right. That is the dilemma.
Representative HERTER. And you bought 4 or 5 billions of them.
On the other hand, the market is falling off.
Mr. ECCLES. If Vou raise the interest rate, then you drop the market,
and it raises all kinds of serious questions. Of course, that is quite a
debate all in itself.
Representative HERTER. But that is a discretionary matter with
you. There is nothing statutory as far as that is concerned.
Mr. ECCLES. That is right. It isn't statutory at all. I raised the
question before that I wished Congress would indicate that, if they
felt we should no longer support the Government market. I felt that
Congress should take some responsibility for that.
Representative PATMAN. Suppose you should not support the
market, what would happen to these banks, if the bonds were to go
below par?
Mr. ECCLES. The difficulty is that you do not know the support
price. That is one of the problems you are confronted with. And that
raises the critical problems of refunding operations in connection with
public debt. It has implications that .are very far reaching. We
have given lots of thought to the problem, and we have studied it
from various angles.
The people in the Reserve System, not only the Board, but the
Reserve bank people, as well as the Board people, are unanimous,
I think, in feeling that, taking the matter on balance-with the public
debt the size that it is, so much larger than the entire private debt,
in fact equal to about 60 percent of all the debt-we must maintain
stability of Government securities market and confidence in it. The
public have taken quite a drubbing already on the decrease in the
purchasing power of the dollar that they put in bonds, and now, to
make them take a further decrease, by letting the bonds drop below
par would be a very serious step.
I want to make another matter clear: We have never made the
statement that we should support all Government securities at par.
What we have said is that we should maintain the 2% percent rate
on the long-term bonds. That should be the basic long-term rate.
The short rate should be permitted to fluctuate to the extent that
it can be useful. And if the short rate should go up, certainly the
very short securities may drop below par. And they have. The
Federal Reserve System has never taken the position that every issue
of Government bonds should always be redeemable at par; we have
CREDIT POLICIES
17
taken the position that the 2% percent rate should be maintained, and
shorter term issues could fluctuate as the shorter term rate might
fluctuate.
Representative RICH. Let me ask you this: The stability of bonds
created by the purchase of them by the Federal Reserve is not any
more likely to make for 'a stable and economic Government than it is
if the Congress does not stop the spending because we will be just as
bad off in the future, because there will come a time when you cannot
stabilize the bonds if they increase the size of our. national debt.
Mr. ECCLES. You can stabilize the bonds, but you do not stabilize
the purchasing power of the dollar. A dollar could be worth far
less than it now is, and the bond could still be supported at par.
Representative RICH. The point is that we are not making for a
stable government as long as we keep on with the spending.
Mr. ECCLES. That is right; especially deficit spending.
The CHAIRMAN. Can we get along now?
Mr. ECCLES. I would like to finish this, if I can, without any interruption.
The CHAIRMAN. Fine.
Mr. ECCLES. As I said, these last two factor may operate for a long
time in the future; that is, the gold imports adding to the reserves, and
the purchase of Government securities from nonbank investors. If
the international outlook does not improve, Government deficits may
continue, and even increase substantially, and banks may be called
upon to purchase additional Government securities. Under these
conditions, the Federal Reserve would find it difficult, and perhaps
impossible to sell Government securities in order to absorb the bank
reserves without seriously unsettling the market for such securities.
Where you have a deficit, and if the banks are required to buy, then,
of course, the Federal Reserve is more likely to have to support the
market, in other words, to have to buy. Under those circumstances
you certainly cannot sell in the market and thus absorb the reserves
that gold imports create, or the reserves that are created when the
Federal Reserve buys bonds from nonbank investors. That is the
point that we make here, namely, that it is very difficult to absorb
excess bank reserves in these conditions by reversing our action by
selling in the market.
Prospects are, therefore, that in the future gold inflow and Federal
Reserve purchases of securities in maintaining an orderly market for
long-term Treasury bonds, will further increase bank reserves. Banks
would thus be in a position to expand loans and investments for private
purposes, and this would mean still more inflationary expansion of the
money supply. To restrain such potential expansion, the Federal
Reserve would have to take action to absorb an excessive volume of
reserves. Two type of measures should be considered:
First, interest rates on short-term Treasury securities and discount rates-that is, the discount rates of the Reserve banks-should
be permitted to rise to the extent possible without raising rates on
long-term bonds; that is, without raising the long-term 2'S rate; and,
second, to the extent that this action is not adequately restrictive, the
Federal Reserve should have the power to increase Federal Reserve
requirements substantially to cover at least any growth in the total
supply of reserves.
18
CREDIT POLICIES
The first of these measures which could be adopted by the Federal
Reserve and the Treasury without new legislation would be designed
to induce banks to purchase short-term Government securities, and
to discourage the extension of credit to' private borrowers. Policies
during the past year have moved in that direction about as fast as is
feasible without unduly upsetting the market. There are limits,
however, to such a course. Short-term rates probably cannot be
raised much more without unsettling the 2% percent rate for long-term
Treasury bonds.
When I say "cannot be raised much more," I am thinking in terms
of an eighth of 1 percent, to a maximum, say, of one-quarter. If you
made the certificate rate 1% that would be raising it an eighth. If
you raised it a full quarter, ultimately that would be 1%. There may
be, under certain conditions, a possibility of going as far as 1% in a
short-term rate, but I certainly can't foresee that now..
Such an action, of course, would tend to induce the banks, when
they got reserves, to buy securities from the Federal Reserve; whereas
at 1 percent for bills, and 1% for certificates, there is a good deal of
pressure on the banks to go out into the market and make loans
at higher rates. That creates new money, whereas, if they bought
the short-term Governments from us, it wouldn't do so.
Clearly, you can't let the short rate go up to a point where pressure
on the long-term rates result, so you have to support the long-term
market. The problem is one of maintaining a balance, depending
upon the conditions. However, it is doubtful how much any rate
that is feasible will deter banks from making loans to private borrowers
or purchasing higher-rate securities. In other words, there is a.
question, even if you went up an eighth or a quarter, as to just what
extent that might deter the credit extension. We think it would
have some effect, but we can't say that it would be very anti-inflationary, or very restrictive.
Representative HUBER. At that point, Mr. Eccles-during consideration of the tax bill, it was often said that the legislation would
provide an incentive for risk capital. Are not the banks bulging
now with money? Would you feel that that statement was true?
Mr. ECCLES. You mean the money of their depositors?
Representative HUBER. Well, it would provide an incentive for
risk capital.
Mr. ECCLES. What would?
Representative HUBER. The tax reduction bill.
Now, is there not a surplus of money throughout the banks of the
nation?
Mr. ECCLES. Yes. I think Senator Taft said he wanted to discuss
that a little later. If I can finish this, I would like to say something
on that subject in relation to budgetary deficits.
Representative HUBER. I would like to hear you.
The CHAIRMAN. The lack of risk capital is more the unwillingness
of people to put their money into that kind of thing. It has nothing
to do with the amount of money. They have the money, apparently.
Mr. ECCLES. As to the need for additional powers, I have tried'to
build up the case here, to show what has happened in the last quarter.
And now I point out what may well be the need for additional powers.
CREDIT POLICIES
19
NEED FOR ADDITIONAL POWERS
Accordingly, the Board believes that the System should be given
authority to increase the- reserve requirements of all commercial
banks. For the present, this authority should make it possible
for the System to require all commercial banks to maintain primary
reserves with the Federal Reserve System, amounting to 10 percent
of the aggregate demand deposits, and 4 percent of the time deposits,
in addition to present requirements. This would give to the Reserve
System power to increase bank reserves in the aggregate by a maximum of about $12,000,000,000.
An authority of this amount would enable the System to absorb
the reserves that are likely to arise from gold acquisitions, or fromnecessary System purchases of Government securities sold by nonbank investors over the next few years. In other words, it would
enable.the System to sterilize the gold imports and reserves created
by our support of the Government bond market.
In case banks should persistently follow the practice of selling
Government securities to the Federal Reserve in order to expand
private credits, notwithstanding higher short-term interest rates and
increased primary reserves, as indicated, then the system should be
granted supplementary authority to impose a special reserve requirement along the lines proposed by the Board last. November. This
type of authority may be described as an optional reserve requirement,
because it could be held at the option of the individual bank, in specified cash assets, or in short-term Government securities.
The maximum requirement under this plan could properly be
limited to 25 percent of the aggregate demand deposits, and 10 percent of the time deposits. To be effective and equitable, it should
apply to all commercial banks; that is, the nonmembers, as well as
the members. A detailed description and analysis of the Board's
special or optional reserve proposal-I say optional because that is
a more accurate description of it than special-was submitted to the
House Committee on Banking and Currency, and has been published
in the Federal Reserve Bulletin.
The CHAIRMAN. I do not quite understand.
Does this 25 percent include the 10'percent?
Mr. ECCLES. No; that is entirely another item. It would have
different use, different application.
The CHAIRMAN. You are proposing 10 percent plus 25 percent?
Mr. ECCLES. We are saying that the 10 percent would be the cash
reserve requirement, in case the bank should persistently follow the
practice of selling Government securities, and so forth, in order to
do this, notwithstanding the raising of the short rate, and-notwithstanding the increase in the primary reserve requirements.
The CHAIRMAN. Is not your total 10 percent higher than last fall?
Last fall I thought you had the 25 percent.
Mr. ECCLES. Now we are suggesting deferring the 25 percent special
reserve until we see if the 10 percent primary reserve is adequate.
The CHAIRMAN. So that when you came along with the 25 later,
you could absorb, and would not necessarily have to put the whole
25 on top of the 10.
20
CREDIT POLICIES
Mr. ECCLES. No; the 10 is strictly a cash reserve, largely for the
purpose of sterilizing gold imports and reserves that we would create
by the purchase of securities from nonbank investors. But if banks,
in spite of that, continued to sell Governments to get reserves for the
purpose of making credit expansion, we would need the optional
reserve. You see, it depends upon inflationary developments, especially upon the budget picture. As I will bring out later, the possibility of needing the special reserve as an additional authority depends upon conditions, and all we are doing now is pointing out
what would seem to be a maximum possibility in the field of monetary
and credit policy, to deal with an emergency.
The CHAIRMAN. I was only trying to get clear as to what your
proposal was. It is now 14, 20, and 26; and if you add 20 percent, it
will be 24, 30, and 36. And then your suggestion is that in some
events, you would add 25 percent on top of that?
Mr. ECCLES. Yes, but we would give the banks the option of holding the special reserve in cash or in Government securities.
The CHAIRMAN. That would hardly be in bonds, I take it.
Mr. ECCLES. It could all be in securities, that is, short-term securities, if they wanted to hold it. The whole thing would be in bills
and certificates. As a matter of fact, of course, the 25 could include
the 10. That is a question of action by the Congress. In other
words, if you wanted to give authority to increase the reserve from
the 10 to the 25, making it optionial to put those reserves in short-term
governments, that could be done. That would be a modification.
The CHAIRMAN. All right. Proceed.
Mr. ECCLES. To the extnt that it may become necessary to rely
upon the banks for any new Government financing operations, the
optional reserve requirements would be an especially valuable instrument. And in the case of large-scale deficit financing, it would be
essential. In such financing, it would be advisable to make available
to banks only short-term securities. Application of the optional reserve requirement would have the effect of immobilizing these securities, so that they could not be used to obtain reserves to pyramid
new bank assets upon them on a 6 to 1 ratio. In other words, securities issued in new Treasury financing through banks would be tied
to the deposits created by their purchase.
If we had done that in the financing of the last war, we would have
avoided a lot of the trouble with which we are now confronted. In
other words, if the banks had been limited in their purchase of securities, to short-term securities, and then those securities, at least a
portion of them had been required to be held against the deposts they
had, you wouldn't have bad this freedom which' the banks now have
to create a multiple credit expansion, leaving the central banking
system unable to deal with the situation, so long as it is obliged to
support the market. What we are trying to do now, when we propose that requirement, is to go back and to correct some of the mistakes
that were made in the form of Government war financing.
Representative RICH. Under those conditions, would you not expect
the banks to stabilize the market, then, instead of the Federal
Reserve?
Mr. ECCLES. We can only stabilize it through the banks, we have
no way of doing it except through the banking system. We have to
operate through them.
CREDIT POLICIES
.21
Representative RICH. You would not expect them, as individuals,
to go out and do what you are supposed to do, as the Federal Reserve,
would you?
Mr. ECCLES. No. But we stablized the market by buying securities in the market. And we have no way of stopping the banks from
selling the securities that they have, and thus creating reserves upon
which they can expand $6 worth of credit. That is the point.
. Representative RICH. If you had that power, you could do what
*thebanks could.
Mr. ECCLES. We have always had more power than the banks. We
have no power now to control the bank credit expansion, and that is
the point I want to make.
The special reserve plan would assure a ready market for short-term
Governments, and the Treasury would be helped in successfully carrying out both its refunding operations and its deficit financing. These
are the important aspects of the proposal, if we get into substantial
deficit financing. At the same time, the Federal Reserve would be
enabled to exercise some restraint on the money market for private
credit. This is the basic merit of the optional reserve plan.
The dominance of public debt in the present credit situation has
rendered the system's traditional powers generally unusable for
purposes of restraining further inflationary credit expansion. The
Reserve Board is not seeking additional power beyond what it formerly
possessed; it is merely pointing out that the system has little or no
authority to deal with the credit situation as it currently exists, and
seems likely to develop.
. If the Congress wants the Federal Reserve System to perform the
functions for which it was established, the System must have a substitute, or at least a partial substitute for those powers that have become
unusable. The Board feels that it would be remiss if it failed to
bring this matter to the attention of the Congress.
There is no simple way of holding in check bank credit expansion in
excess of essential public and private needs. The problem should be
met in a combination of ways-by general credit controls, and in
particular areas by selective controls, such, for example, as the reimposition of consumer installment credit regulation, and the continuation of existing margin requirements on stock market credit.
OTHER ANTI-INFLATIONARY ACTIONS
The Congress is currently considering the continuance of easy
mortgage credit for housing. Easy mortgage credit is one of the most
inflationary factors in the domestic credit picture. At the very most,
Government mortgage credit programs at this time should be limited
to relatively low-cost housing, particularlyfor rental housing, and
should be accompanied by some restriction on other less essential
types of housing. The housing shortage cannot be overcome by
increasing the competitive pressures on scarce supplies of materials
and manpower. They are the limiting factors on the volume of construction. It is one thing to provide easy credit facilities to encourage
special types of residential construction activity iunder a system of
allocations and permits. It is quite another thing to provide such
encouragement in a free market already characterized by heavy
22
CREDIT POLICIES
accumulated demands and by strategic shortages in supply that are
likely to be intensified by the defense and world-aid programs.
In restraining inflationary pressures under present and prospective
conditions, monetary and credit policies must be combined with fiscal
and other governmental policies. The public should be given every
possible assurance that the Government will protect the purchasing
power of the dollar so that the public would be more willing to defer
the satisfaction of wants, particularly for houses and durable goods.
Wherever possible, Government expenditures that will add to pressures on the labor and capital goods markets should be deferred, and
State and local governments should be requested likewise to defer
nonessential expenditures of this type. There should be early action
to close loopholes in our tax laws, and to strengthen the tax collection
machinery. If the stage is reached at which Government expenditures
again threaten to create large budgetary deficits, then a reimxosition
of wartime levels of taxation and direct economic controls along the
lines proposed by Mr. Baruch, for example, should be undertaken.
Now, you notice, I have said, "If the stage is reached at which
Government expenditures again threaten to create large budgetary
deficits, then a reimposition of wartime levels of taxation and direct
economic controls along the lines proposed by Mr. Baruch, for example,
should be undertaken.
If young men are to be drafted into the military forces, then a way
should be found to keep men at work in essential industries, and thus
prevent the serious inflationary effects brought about by strikes.
The situation now and in 1940: I want to bring out that this
reversal of our program, which indicates a substantial expansion,
looking to the future of our military, as well as a foreign aid program
that we can't see the end of, is a much more difficult program to carry
out than would be the case if the situation now was comparable with
that of 1940.
The Board believes that any realistic appraisal of the economic outlook from the standpoint of monetary and credit policy must take
account of the underlying facts of the international situation.
During the war, there was no doubt about the ultimate victory.
the country looked forward confidently to an era of stability and peace
following the hostilities. Nearly 3 years after the end of the figbting,
however, we seem to be further away from these goals than ever. Our
national debt still exceeds $250,000,000,000, or more than five times
the prewar levels.
Federal budgets have never fell under
$37,000,000,000 a year, and we are confronted now with the prospects
of an expanding debt and budgets. During the war, we expected the
peace to bring an end to these enormous drains on our resources.
Today there is no end point in sight. Threatening as the inflationary potential was at the end of the war, it is worse today. When we
embarked upon the defense program in 1940, we had a tremendous
slack in the labor force with nearly 12 millions fewer employed than
now. We had surpluses of most raw materials, of unused industrial
capacity, of housing, of foodstuffs and of countless other things. The
impact of our heavy armament expenditures was not inflationary so
long as the total demand on our resources did not exceed our capacity.
It rapidly became inflationary as civilian purchasing power created by
the war expenditures, through deficit financing, began to exceed the
available supplies of goods and services.
CREDIT POLICIES
23
We held the excess purchasing power fairly well in check while the
was was on. We have now seen the consequences of premature.
removal of the harness of wartime controls. Even the one remaining
anti-inflationary force, that is, a large budgetary surplus used to reduce
our money supply, is no longer in prospect.
Over-all policy alternatives: On the basis of present trends, we
believe that the country, sooner or later, has to choose between three
broad alternatives.
First, we can continue on the present course of providing essential
foreign aid, and of carrying out a military program on a scale of as yet
undetermined size and cost, while at the same time we have no effective
checks on the free play of economic forces. That is the certain road,
if followed long enough, to a ruinous inflation. Surely no one would
seriously contend that we can go on adding more and more pressure in
the boiler of inflation without an ultimate explosion. Those who view
us with a hostile eye no doubt hope that we will wreck our economy
on the shoals of inflation. It would be a cheap way to defeat us.
Secondly, the country could be subjected to a full harness of direct
economic controls-for example, allocations, construction permits, rationing, price and wage controls, as well as taxation at higher levels.
Without such a harness, amounting to a regimentation of the economy in peacetime, there is no sure protection against inflationary
dangers that may lie ahead. They cannot be successfully combatted
by any single means, or on any single front. There is no power that
the Board now possesses, or that Congress can give us in the monetary
and credit field that would be adequately effective by itself-and I
should add there, "under the conditions of large budgetary deficits."
Beyond that, we must ask ourselves whether the public would be
willing in peacetime to submit to the sacrifices and rigid restraints of a
wartime economy. If our preparedness program calls for a military
draft upon our young men, should it not call also for control of the
profits arising from that program?
We mav well ask for how many years must we maintain enormous
and probably expanding military expenditures-and 1 could add "and
world aid." The question is: how long? to what end? and at what
consequences to our economy? We do not have the inexhaustible
supplies of'manpower and resources to support indefinitely, with no
end point in sight, programs of the magnitude which we now are
shouldering or contemplating.
The CHAIRMAN. "Contemplating" might do. But why the"shouldering"? Your own figures show that you get 42S billion from present
taxes, and you are not going to spend that much.
What is the burden of shouldering, that you cannot go on shouldering if you have to? I would like to cut it down, but what threat is
there contained in it?
Mr. ECCLES. I do not think you can do it indefinitely, sir.. You
have inflationary pressures, as we have pointed out, with what you
are ,already doing, and you have plenty of inflationary dangers even
with some budgetary surpluses. With practically no budgetary surpluses, inflationary dangers are very much greater than would otherwise be the case.
The CHAIRMAN. We are no- better and no worse off. Maybe it is
.the exceptional condition, but we are no worse off from an inflationary
standpoint than we were in November, when you were here before.
24
CREDIT POLICIES
Mr. ECCLES. We do not think that youtcan go on indefinitely.
The CHAIRMAN. You cannot go on increasing, but when you say
"those that you now have," I do not see why you cannot go on indefinitely.
Mr. ECCLES. I don't see how you can, without getting an inflationary development. I think you have got to have some budgetary
surpluses in this situation.
Representative RICH. Mr. Eccles, you made this statement in your
previous paragraph:
"If our preparedness program calls for a military draft upon our
young men, should it not call also for control of the profits arising
from that program?"
Then should we not have controls on everything? And then we
would have just exactly what Russia has.
Mr. ECCLES. Well, what I am saving is that if you get into a
budgetary deficit, if you get into an expanding Military Establishment, due to a world situation, then you certainly do not want an
uncontrolled inflation here, which could well result. Therefore, the
next thing to do is, as I indicated, have Baruch plan of such controls.
Certainly that would be most difficult in peacetime, and certainly,
if we should develop what we call a preparedness program on a scale
that would create such deficits--and some people talk of such a program-such controls would become necessary. A preparedness program of that sort means an armament race, and an indefinite expansion, if you are going to be prepared. Preparedness is a relative thing.
To be prepared, you have got to be better prepared than the people
you are preparing to deal with. That, I think, is one of the discouraging things in the picture today, so far as the American public
is concerned.
Representative RICH. When a bill was set up for universal military
training, and selective service, and those things were put into effect,
then, according to your statement, we have to put regulation on
everything.
Mr. ECCLES. I did not mean that by my statement. If that is the
way it is interpreted, that is not the way it is meant.
Representative PATMAN. It refers to profits, does it not, Mr. Eccles?
Mr. ECCLES. Yes. Certainly if we are going to carry out a program
here, of armament expenditure, and you are going to draft men-I
don't know whether you are going to get universal military training
or not, but I mean if you do that-certainly there will be substantial
profits created or maintained, or that are likely, as a result of large
Government expenditures. The question arises as to whether you
wouldn't be justified in recapturing some of those profits, as a result
of armaments expenditures, and thus improve the budget picture and
lessen the inflationary pressures.
Now, that is something for the future. I am not talking about that
for the present. I am merely saying that in this statement we are
trying to review briefly the past. We are trying to consider the
immediate present over the next 9 months. And then we are trying
to look beyond the uncertain future as to what some of the problems
indicated may well be.
The CHAIRMAN. MNr. Eccles, do you want to finish.this morning?
MTr. ECCLES. If I could finish this statement, I would like to do that.
The CHAIRMAN. Then, after that, does the committee want Mr.
Eccles to conie back for questioning? And if so, when?
CREDIT POLICIES
25
Mr. ECCLES. I am available at the pleasure of the committee,
either this afternoon or tomorrow, or wbenever the committee wants
to interrogate me.
Representative PATMAN. He only lacks a page and a half, to finish.
The CHAIRMAN: Yes. But for me, tomorrow morning would be
more favorable. However, the House is not in'session today so I
guess this afternoon would be better.
Mr. ECCLES. That would suit me fine.
The CHAIRMAN. Then when we recess, we will recess until 2:30.
Mr. ECCLES. Thank you.
The CHAIRMAN. One thing, Mr. Eccles, on the question of inflation:
These things seem to be so difficult to predict. People are so likely
to be wrong. I never have any great confidence about future things,
until at least there is an indication of what is happening?
*One thing that everybody seemed to agree on was that the price
of meat was going up. I admitted it. But it does not seem to have
gone up.
Senator FLANDERS. Mr. Chairman, may I make some remarks
about that?
The CHAIRMAN. Certainly.
Senator FLANDERS. In the first place, I think that the proposed
legislation and the discussion had a great deal to do with consumer
resistence, which helped to keep the price down.
It did another thing. It filled up every freeze locker, both private
and public in the hands of the packers and in the hands of the chain
stores, full of meat. That is now coming out, and again helping to
keep the price down. And maybe we will have it in the fall, but I
think our little crusade worked out very nicely.
The CHAIRMAN. Oh, very well. But I was just talking about these
predictions.
I I was out West, and I find that today nearly half of the packing
houses have been shut down by strike, and still the price has not
gone up. And a great deal of meat. is being held back on the farms,
because they do not want to send it in when there is a strike, so when
the strike is settled, you are likely to get a large amount of meat in
addition.
I see ho immediate prospect for the'carrying out of these predictions on meat, which was the key food practically.
So I do not know whether these inflationary threats are quite
justified or not.
Mr. ECCLES. You have to anticipate. If you don't, it is too late
after you get it. And it seems to me that you have got to take into
account the matter of what are the potentials. You have to be
prepared to deal with those potentials if inflation really begins to
develop. Because if you are not prepared, it develops, and it is too
late to deal with them.
Of course, we have had, without any question, a very serious
inflation already. We talk about inflation as something in the future.
We already have got it. And the purchasing power of the money
that our people have saved and put into bonds and put into fixed
income-bearing securities, has already been almost cut in half in its
purchasing power.
Therefore, we cannot afford, it seems to me, to jeopardize the possibility of a further devaluation in the purchasing power of our money.
26
CREDIT POLICIES
We must be prepared to deal with it vigorously; and to do so, we
must anticipate it.
The CHAIRMAN. I agree with you. I think there are likely to be
some further increase. I am -not claimihg'that there will not be. J
just wonder if it is quite as direful as you seem to predict.
Mfr. ECCLES. Well, I am not trying to throw any fear into this. I
am merely pointing out what the real possibilities are today. And
certainly if the world situation should improve, if we got a basis of
peace, if our Government expenditures can be curtailed, if the world
recovery is rapid, and we are relieved from a lot of the foreign aid,
such as we are now undertaking, if our military expenditures, instead
of expanding into the further billions can be held within the range
where they are, then, of course, that could change the situation.
On the other hand, the world situation, we must admit, is ominous.
And we have got to anticipate what may be the responsibilities of the
Government, the burden of the budget, and the inflationary effects
if conditions do not improve. We cannot go on year after year bearing these crushing costs without jeopardizing what we seek to save.
If we were confident of the early establishment of peace, we could
tolerate a tightly controlled economy. We believe that the time
element is the very essence of this grave problem.
Our Nation sought neither territory nor reparations in either
World War. We seek neither now. We ask only for the earliest possible establishment of the foundations for enduring peace. To that
end, our third and best course may be to choose a combination of
alternatives; that is to say, acceptance of such controls as may become
necessary to prevent inflation at home, while abroad we lay at the
earliest possible moment the foundations for peace. And by that I
mean: by doing whatever is called for to assure an establishment of
peace, rather than an indefinite program of increasing military expenditures for a preparedness program that may end in an armament race.
We simply cannot afford an indefinite armament race that calls
for an expanding of Government expenditures, without, of course,
either having inflation, or an imposition of all of the restraints that
our people do not want and should not have. Rather, we must relieve
our budget load, and in that way We get away from risking these
Government controls, high levels of taxation, or inflation. 'Only in
that way can we do it.
Representative RICH. Mr.. Eccles, from what we were doing now,
you would think we had lost the war. We are paying to everybody.
But you made a statement here a moment ago. You said "our
foreign expenditures which we cannot see the end of." Now, what do you mean by that? Have you something in your
mind that these Members of Congress have not been told yet?
Mr. ECCLES'. That is all I have to say on that, Mr. -Congressman.
Representative RICH. Do you not think it is about time that we
stopped this foreign spending?
Mr. ECCLES. I have nothing to say on 'that. I merely say that I
do not see the end of them, and I do not know that you do, or anyone
else. .
Representative RICH. I thought from that statement that you
probably knew something that has not been conveyed to us yet, as
Members of Congress.
Mr. ECCLES. I said in the beginning of the statement that we had
nothing to do whatever with either the preparations for war, or the
CREDIT POLICIES
27
foreign expenditures. I made that very clear in the beginning. And
in what I am saying here, a lot of these remarks are aside.
This statement is the Board's statement.
Representative RICH. Do you not think we have already spent too
much on foreign countries?
Mr. ECCLES. A discussion of that subject is not appropriate at this
time.
Representative RICH. I am trying to keep a sound financial structure here in this country. That is what I thought we were going to
discuss.
Mr. ECCLES. An answer to that question would not help you in
establishing a sound financial structure.
Representative RICH. Surely it does. The more we spend, the
more trouble you get into.
Mr. ECCLES. An answer to your question will hot help, in my
opinion, to clarify the matters under discussion.
Surely an informed public would be ready to accept even burdensome controls and taxation if convinced they are essential to safeguard
our economy against a ruinous inflation, and that there is an early
endpoint in sight which will enable us to maintain our system and our
institutions in a peaceful world.
To sum up the situation as the Board sees it, we are faced with the
possibility that still further upward pressures will be added to the
tremendous inflationary potential generated by war.financing and
intensified by subsequent developments. We should do everything
possible within the existing authority of the Government to moderate
and counteract these forces. Federal, State, and local governments
should practice the strictest economy and defer all public works and
similar expenditures that can be postponed until there is a surplus of
manpower and materials instead of the shortages that now exist.
Every effort should be made not onoy to preach, but to practice economy and savings at this time. The need still is urgent to spend less
and save more, and to invest in Government savings bonds. Every
assurance should be given that the purchasing power of these savings
will be protected.
Representative RICH. I will say that that is a fine statement.
Mr. ECCLES. So far as the monetarv and the credit field is concerned,
we have tried to make clear that action on these fronts alone cannot
guarantee stability. Nevertheless, we believe that the Reserve
System should be armed with requisite powers, first, to increase basic
reserve requirements of all commercial banks and, later on, if the
situation requires it, to provide that all such banks hold an additional
special or optional reserve. Both of these would be protective
measures.
The first could be used to offset gold acquisitions and purchases of
Government securities by the Federal Reserve, and thereby restrict
the continued expansion of our already excessive money. supply.
The secondwould be essential in case banks embark upon an.inflationary credit expansion. through the sale of Government securities
to the Federal Reserve, or to assist the Government in case of largescale deficit financing.
We believe it is the-part of prudence to recognize clearly that the
underlying cause of continuing inflationary dangers arises from the
disappointment of our great hopes for the early establishment of
world peace. Surely we must summon all of our human and material
28
CREDIT POLICIES
resources needed to assure that peace. If necessary to protect our
economy at home, so that we shall not lose by inflation what we seek
most of all to save, we should be willing and prepared to reimpose
in the future to whatever extent the situation demands a harness of
controls, including higher levels of taxation. Nobody wants such
regimentation, but in the hard choices before us, it is infinitely
preferable to economic chaos and possible collapse of our system, to
which all freemen look to deliverance from the evils of war and misery
that feed on economic distress.
We are aware that the questions of policy designed to achieve the'
cardinal purpose of assuring an enduring world peace are outside the
domain of those charged with responsibilities in the monetary and
credit field, but we feel that such-responsibilities have to be exercised
in the light of the burdens which the economy must bear. The earliest
attainable settlement of the issues that now stand in the way of
lasting peace offers the best hope for the preservation of our institutions, and our freedoms. Meanwhile, they must not be jeopardized
either by uncontrolled inflation or long-continued regimentation at
home.
The CHAIRMAN. The specific recommendation for legislation, I
take it, boils down at the moment to a 10-percent increase in reserves;
maintaining the ratio, from 14-20-26 up to 24-30-36. Is that the
same relationship between the different types of banks?
Mr. ECCLES. I would simplify the statement. We said 10 percent.
I think if legislation was to be considered, we would make some slight
modification, and make it a little simpler by saying: As to the nonreserve-city banks, which are 14, make that 25; as to the reserve city
banks, which are 20, make that 30; and as to the central reserve city
banks, which are 26, make that 35.
The
CHAIRMAN.
25-30-35.
Mr. ECCLES. That is right. I think that would be a little fairer.
The credit expansion is just as great, if not greater with the nonreserve-city banks, and they are, I think, even more liquid from the
standpoint of short-term Governments and reserves than are the city
or the larger banks.
The CHAIRMAN. Of course, the increase in reserves, the straight
increase in reserves, is not a difficult legislative task. But I take it it
involves an increase of 10 percent, or a new reserve of 10 percent on all
banks, whether they are part of the Federal Reserve System or not.
Mr. ECCLES. Yes; that-is correct.
The CHAIRMAN. And that does present, I concede, legislative problems.
Mr. ECCLES. It does.
We would not advocate any increase what-
ever, unless it covered all banks. I think that to try to cover only
member banks would be certainly a terrific discrimination. Even
when we doubled reserve requirements on member banks, it was quite
an imposition, and it makes it practically impossible to increase the
membership of the System.
I think that if you increased reserve requirements of member banks
only, membership would 'be too much of a penalty, and certainly
further increases in reserves would likely drive a good many banks out
of the System. And to the extent that banks are out of the System,
your whole monetary control is weakened.
CREDIT POLICIES
29
The CHAIRMAN. Is there any doubt about our power, our constitutional power, to do that, do you think?
Mr. ECCLES. You mean increasing the 10?
The CHAIRMAN. The reserve on non-member banks and State
banks who are not members.
Mr. ECCLES. There is no question about it. The question of whether
banks are engaged in interstate commerce has already been decided in
the Wage-Hour Act. And the Board has administered regulations
on consumer credit that covered all non-member banks.
The CHAIRMAN. But the question is that that might have been a
war power.
Representative PATMAN. Maximum interest rates, too.
Mr. ECCLES. Well, no interest can be paid on odemand deposits.
We administer that only for all member banks.
The CHAIRMAN. The committee will recess until 2:30.
(Whereupon, at 12:30 p. in., a recess was taken to reconvene at
2:30 p. m., of the same day.)
AFTER RECESS
(The hearing resumed at 2:30 p. in.)
The CHAIRMAN. The committee will come to order.
STATEMENT OF MARRINER S. ECCLES, CHAIRMAN OF THE BOARD
OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, ACCOMPANIED BY WOODLIEF THOMAS, DIRECTOR OF THE DIVISION
OF RESEARCH AND STATISTICS; AND RALPH A. YOUNG, ASSOCIATE DIRECTOR OF THE DIVISION OF RESEARCH AND STATISTICS, FEDERAL RESERVE SYSTEM-Resumed
The CHAIRMAN. Mr. Eccles, I think I remember going over with
you some tables showing the effect on bank reserves of different
inflationary elements. Have you anything of that sort on the next 3
months or the next 9 months, or whatever period you choose? It
seemed to me that I remember estimates of gold imports and things
of that kind that might throw a little light on the subject.
M/r. ECCLES. I have not seen any tables, and I do not know whether
the economists in our research department have anything on that.
You do not mean charts, you mean tables?
The CHAIRMAN. I meant tables; yes, of what the effect on the
bank reserves is going to be in terms of actual figures; what they are
now and what they are likely to be. To interpret your statement with
actual figures, I mean.
You are asking for a 10-percent increase in reserves which I say
will take up the estimated increase in reserves during some period.
I wanted to see why you estimate those and what the figures will
show.
Mr. ECCLES. What we say here, Senator, is the potential which
would be available from gold imports and would be available from the
purchase of nonbank securities. We suggested that there were two
things that might be done in order to deal with that situation. The
first one was that the interest rates on short-term securities and the
discount rates should be permitted to rise to the extent possible.
77099-48-3
30
CREDIT POLICIES
The CHAIRMAN. As far as you could and maintain 22 pp- 6.at longterm rate?
Mr. ECCLES. That is right; and that was the one thing. The other,
of course, was that to the extent that this action is not adequately
restrictive, that is, that it would not divert the reserves that the banks
got into those short securities held by the Federal Reserve, then the
Federal Reserve should have the power to increase reserve requirements substantially to cover at least any growth in the supply of such
reserves.
Then we went on to say later that if we got this power up to the 10
percent, it would equal in the aggregate $12,000,000,000, and that
should be sufficient under the present situation for several years.
Now, we go on to say that if the budgetary situation should be such
as to create substantial deficits, and we go on to say further that if,
in spite of the rise in short rates or the increase in reserve requirements, that the banks continued an expansion of private credit on a
dangerous basis, or an inflationary basis, then the other power should
be added.
The CHAIRMAN. : understand that, but what I want to know is
why 10 percent; why the $12,000,000.000; what is it that supports
that figure that is necessary for the increase in reserves?
Mr. ECCLES. I suppose we could get along with a less amount and
then request additional authority if it was needed. Congress could do
that. The only thing is the very fact that the Board had that much
power I think psychologically would be effective and desirable. I
think the fact that the Board could increase the reserve requirements
would tend to keep the banks in a much more liquid position than if
they felt they had no further power; that they would be inclined to
keep their governments and particularly their shbrt-term governments to be able to meet an increase in the reserve requirements.
If, on the other hand, the authority was of a lesser amount than
that, I think it would be much less effective as an anti-inflationary
influence.
The CHAIRMAN. Breaking down these deposits, how do you get the
$12,000,000,000 as between demand and time?
Mr. ECCLES. I think that we can supply the figures.
Mr. YOUNG. That would be about $10,000,000,000 against demand
deposits and nearly $2,000,000,000 against time deposits, breaking
that $12,000,000,000 down.
The CHAIRMAN. That is about $10,000,000,000 more than now or
more than you can do if you increase requirements at central reserve
city banks to the limit allowed.
Mr. YOUNG. Yes.
The CHAIRMAN. You could increase it some without any additional
authority.
Mr. THOMAS. Reserves could be increased about $1,000,000,000
now.
The CHAIRMAN. I am wondering where the 12 comes from. It
seems to be $8,000,000,000 on demand and 1.4 billion dollars on time,
and that is 9.4 billion dollars, and what is the rest of it? Does that
include only the Federal Reserve System or what?
Mr. THOMAS. It would be around $10,000,000,000 on demand,
because you have to include the interbank deposits. The $82,000,000,000 of demand excludes interbank deposits. We will insert a
31
CREDIT POLICIES
table which shows the break-down by class of bank, using deposit
figures for a recent date.
Existing and requested potential increases in commercial bank required reserves
(estimates as of Feb. 29, 1948)
[In billions of dollars]
Class of bank
Member
Potential increase in required primary
reserves under-
Present authority of the system --DemaAd deposits
-Time deposits
All banks
-
----
Additional requested authority
---Demand deposits i
Tim e deposits 2---------------------
-
Central
reserve
city
.
Resrve
city
onty
Nonmember
banks
1.0
1.0
None
None
None
1.0
None
1.0
None
None
None
None
None
None
None
11.9
2.6
3.8
3.8
1.7
10.4
1.5
2. 5
.1
3.3
3.2
9.6
1.4
.5
.3
XFigured on the basis of 9 percent for central Peserve city banks, 10 percent for Reserve city and nonmember banks, and 11 percent for country member banks.
2 4 percent of time deposits for each class of bank.
The CHAIRMAN. How do you figure that? Do you have any
estimates on the import of gold? What are they running since the
first of the year?
Mr. THOMAS. It is $400,000,000 since the.first of the year.
Mr. ECCLES. We figured from 1.5 to 2 billion dollars, and we figured
not less than 1.5 billion dollars and not more than 2 billion dollars.
That is about as near as the amount can be estimated.
The CHAIRMAN. For the year, per annum?
Mr. ECCLES. That is right, for the year. There may be further
contractions of currency.
The CHAIRMAN. HOW far does that affect the reserves, is that
dollar for dollar?
Mr. ECCLES. Dollar for dollar, and it also affects deposits dollar
for dollar.
The CHAIRMAN. And the other element is what?
Mr. ECCLES. That is the purchase of nonbank holdings of Government securities by the Reserve banks. Supporting the market,
buying securities from corporations and individuals selling on the
market increases bank reserves and deposits dollar for dollar.
* The CHAIRMAN. If you have just a break-even budget, what is the
situation then?
Mr. ECCLES. That, of course, would mean that the Treasury would
not have to offer any new securities to the banks. But depending
upon the amount of demand for municipal financing and long-term
corporate financing, what we find has happened is that insurance
companies, savings banks, and various institutional investors have
sold their GovernmDnts, substantial amounts of them, to make other
investments that are more remunerative.
You see, during the war they had no outlet for the funds they
accumulated. The insurance companies and savings banks, as well
as many institutional investors, purchased billions of dollars of the
32
CREDIT POLICIES
marketable Government securities, which meant, of course, that th-e
savings of the people in those institutions were already speht. They
were spent for war. Those institutions are now selling off those bonds
that were bought out of savings. They are being sold faster than other
savers in the market will buy them. To hold the market the Federal
Reserve has to buy them, and that creates reserves.
The factors that cause that sale and that determine the extent to
which they will sell depend somewhat on inflationary developments.
If there should be no inflationary developments, there would be much
less likelihood, and possibly, I think, little likelihood of those market
bonds held by nonbank investors being sold on balance.
The CHAIRMAN. Do you not have the same situation with nonbank
investors exactly like banks? As long as you have large amounts of
Government bonds out, and the Federal Reserve bank will buy them
at par, whenever another good investment comes along they sell them
to you and put the money into the new investment.
Mr. ECCLES. That is much less true of the banks, very much less
true of the banks than it is of the other institutions.
The CHAIRMAN. They make loans, but I am talking about the
insurance companies. Somebody comes along with 3 or 4 percent
mortgage to build a new building, and since you are willing to buy the
bond at par and they can get 3/1 instead of 2Y2, they sell them. to you.
That raises the whole question that we are raising, the question that
some people, that whether or not the policy of always maintaining
Government bonds at par is not necessarily inflationary and whether
as long as you maintain it you can in any way prevent the lending of
money by banks and insurance companies or anybody else who has
invested in Government bonds to any degree they want to invest.
Mr. ECCLES. Of course, we recognize the difficulty that that problem raises, and we have recognized it all along, that to hold a rate for
an indefinite period on a Government security does raise the very
question that you have mentioned here. But it is a question of
alternatives. It is a dilemma that we are confronted with. We
have recognized that and pointed it out to the committee last fall.
Now, we are not proposing to hold all Government securities necessarily at par. What we have said is that we maintain the long-term
22 rate, letting the short-term rate fluctuate. Of course that depends
upon the Treasury's willingness, I think, because we have tried to
cooperate fully with the Treasury, and at no time have we tried to
force a rate on to the Treasury that they are unwilling to accept. I
do not think that it would be practical to do so. I think the central
bank has certainly got to recognize the responsibility of the Treasury
and to advise and work with Treasury officials in that regard; and I
will say this, that in that connection the Treasury and the Federal
Reserve have cooperated pretty fully in connection with the management of the public debt. But the short-term rate is the rate that
should be permitted to fluctuate, depending upon the market demand
or the market situation so far as it would fluctuate while you are
maintaining a 22 rate.
Now, it is not going to fluctuate so much as long as you have a
peg on a 22 long-term rate, as I indicated this morning.
The CHAIRMAN. My question goes to the 232 long-term rate.
CREDIT POLICIES
33
Mr. ECCLES. It has got to go to that point. That is the basic
question.
The CHAIRMAN. How many of these 232's do the insurance com-
panies hold altogether?
Mr. ECCLES. They hold a very large amount of them.
The CHAIRMAN. And necessarily to get more return as fast as 3x
or 4 percent mortgages come along, they are going to sell the Governments, because here is a bond you are bound to get par for, and you
turn around and you can increase your interest.
Mr. ECCLES. The point is the Government itself has helped that
more than the insurance companies. For instance, the title 6 mortgages for housing and what we call the GI guaranteed housing program has been a tremendous stimulation. In other words, the Government has competed somewhat against itself for this rate by its
policy in connection with the ease with which it has made very longterm mortgage money available.
However, I will say that only comparatively recently was the 23
rate reached. You see, the long-term yield last year was down to
2%, with the 23' bonds selling at a substantial premium. The shortterm yield was permitted to rise last year from 3/8's to 1X%. We also
raised the rediscount rate a little. The effect was to tend to bring
down, or at least one of the effects was to bring down, the price of
long-term Governments. In other words, to raise the rate to 232.
Rates on other bonds which were selling almost at a 23 percent rate,
gilt-edged industrial and municipal securities, went up to 3 percent.
Many of the municipals which are entirely tax-exempt and do attract the funds of wealthy people were selling at 132 percent. Now,
they are the same ones that are selling at around 232. Now, the 4
percent mortgage, 20 or 25 year mortgages, which involve monthly
payments and a lot of work and a lot of trouble, are no longer attractive. So the Government is now proposing that the Congress
appropriate another $500,000,000 to provide a secondary market so
that the Government itself can buy a guaranteed mortgage, that the
Government, in effect, guarantees.
Now, that is competing with itself for the 232 rate, and that certainly
is a policy that is diametrically opposed to an anti-inflationary policy.
I think that should be recognized.
The CHAIRMAN. On the other hand, it is quite possible that banks
might get more money for mortgages for lending on housing if there
were no FHA and that they might be more willing to sell their Governments.
Mr. ECCLES. I am not arguing against the FHA, but I am arguing
against the Govermnent appropriating money which cuts into the
budget picture for the purpose of providing a secondary market. Now,
the reason that it needs a secondary market, if it needs one, is because
the insurance companies and others are not willing to sell 232 percent
Governments today as they were. There is very little sold on balance
any more. That is the way this situation at the mement is at least.
Although there was a lot sold last December and in January, of the
long-term 232's, the effect of our dropping them to par and the fact
that they have confidence that the market is going to be maintained,
tended to make them hold on to long-terms. The whole long-term
34
CREDIT POLICIES
market is stabilized around that 22 rate. Today, there is not as
much housing mortgage money available at 4 percent as there Nias
because the holders of Government bonds are no longer as willing to
sell them to make mortgage loans.
The CHAIRMAN. If it is supposed to be a Government guarantee,
they are a little shy of having too much of one type of security like
that, 1 think. Many of the smaller banks are filled up to their limit,
what they think is their limit, for that kind of paper.
Mr. ECCLES. They are not as readily marketable. A guaranteed
FHA mortgage, title 6 mortgage, does not have the ready market
today that it did have.
The CHAIRMAN. Do you think the Government can maintain Government bonds at par?
Mr. ECCLES. Yes; I think so. I do not think that that is going to
be any problem. But it is inflationary certainly to the extent that
you create reserves in the banking system unless we have an opportunity to sterilize the effect. There would be no problem at all if you
could do that. You could maintain the long-term 232 rate indefinitely.
TIe CHAIRMAN. Would you get concerned if the Federal Reserve
banks got completely filled up with these Government bonds?
Mr. ECCLES. The question is what is being filled up? When?
The CHAIRMAN. You have got $20,000,000,000 now.
Mr. ECCLES. We have got over $20,000,000,000 now, that is everything, short and long, and the whole portfolio.
The CHAIRMAN. If it runs up to $60,000,000,000, suppose that
happens?
Mr. ECCLES. The total volume of marketable long-term bonds held
by nonbank investors is, I think, about $50,000,000,000. That is
the marketable ones. You see, we have over $50,000,000,000 of the
E, F, and G bonds. These savings bonds are not marketable but of
course are cashable at par. The long-term marketable are not eligible
to the banks, and they amount to something around $50,000,000,000.
The CHAIRMAN. And the banks hold how much?
Mr. ECCLES. The banks own $67,000,000,000 of the total Governments, but they are not the restricted type; they are another type.
The CHAIRMAN. Who has the rest? There are $50,000,000,000
E, F, and G and $50,000,000,000 2%2's outside and $67,000,000,000 to
banks, and that leaves about $83,000,000,000.
Mr. ECCLES. You have got $13,000,000,000 of weekly bills that
fall due every week, a billion a week.
The CHAIRMAN. Those are the banks?
Mr. ECCLAS. They are held by corporations, some of them, just
in anticipation of taxes, and the Federal Reserve is a very large holder
of bills, most of our portfolio of $20,000,000,000 is bills and certificates.
You see there is something like twenty-odd-billion dollars of certificates, 1% percent certificates. Then, of course, there are these securities that are held by the trust funds, too; the Government itself has
a substantial amount of that debt held in the social security and other
funds.
I have a table here which shows estimated holdings by investor
classes as of March 24, 1948.
35
CREDIT POLICIES
Estimated ownership of interest-bearingFederal securities,' Mar. 24, 1948 2
[Par values in billions of dollars]
Investor classes,
Type of security
Marketable securities:
1. Bills, certificates, and
Treasury notes
2. Treasury bonds, due or
callable:
(a) Within I year
(b) 1-5 years
(c) After 5 years
45.7
15.0
16.5
4.1
46.4
65.0
.1
2. 0
3.5
2.7
34.0
11.4
.2
3. Miscellaneous 3 _________
Total marketable
161. 5
Nonmarketable securities:
1. Savings bonds
52.9
4.
2. Savings notes
3. Depositary bonds 4. Special issues5. Armed forces leave bonds
6. CCC demand obligations
7. Treasury bonds, investment series
8.
Total nonmarketable
Total all securities --
U. S. Goy- Insurance Mutual
erment
o
Federal
savngs
Reserve Comnier- agnis compabanks
nies
banks eilbnsand trust
f unds
Total
all
investors
-
|-
20. 6
5.1
----
1.0 --.
89. 2
250. 7
- ----
20. 6
(4)
.1
(4)
--
0.6
12.4
.1
3.0
18.8
.1
1.9
9.1
1.1
5.2
17.2
.1
(4)
(4)
5.6
1.2
3-
-
.3
5.0
(4)
64.6
-
.3 -.
29.3
.7
(4)
(4)
1.1
0.1
(4)
All other
nvstr
inetr
23.0
11.7
36. 0
.4
.3
51.0
5. 0
(4)
29.3------
.7
(4)
.2
3
.1
.3
.1
1.8
29.4
.8
.4
56.8
66. 4
35.0
23. 8
12.1
92.8
I Consists of all interest-bearing securities, issued or guaranteed by the U. S. Government.
2 Preliminary.
3 Federal Housing Administration debentures, postal savings and Panama Canal bonds.
4
Less than $50,000,000.
The CHAIRMAN. How many bonds would the 25-percent special
reserve immobilize?
Mr. THOMAS. About $16,000,000,000.
The CHAIRMAN. That is only 16 out of the 67.
Mr. THOMAS. That is short-term.
Mr. ECCLES. I think it is more than that. I think that we can
insert a table on the figures. Last November we had all of those
figured out as of the figures available at that time. It would need to
be brought up to date, making use of the latest call-report figures;
namely, those for December 31, 1947. I will also insert into the record a table showing the estimated distribution of bank holdings of
Government securities, by call date and class of bank.
36
CREDIT POLICIES
Potential requirement for holdings in short-term Government securities under the
special or optional reserve plan
[Estimates as of Dec. 31, 1947. in billions of dollars]
Class of bank
Member banks
All
banks
Maximum special reserve requirement
Less holdings of excess cash assets -9.7
Maximum requirement for holdings in short-term
Government securities -20
Central Reserve
Reerve' Reseve
city
ct
Country
Nonmember
banks
30. 2
7.5
2.7
9.9
3. 2
S. 9
2. 9
3.9
9
5
4. 8
6.7
6.0
3.0
I Based on aggregate figures by classes of banks.
Estimated distribution of United States Government securities held by all commercial
banks Mar. 24, 1948, by call date and by class of bank
[Book value, in billions of dollars]
U. S. Government securities call class
Total
Within
I year
1 to 5
years
5 to 10
years
10 to 15 S5 to 20
years
years
All commercial banks
67.0
20.7
34.5
6.7
2.2
2.9
Member banks, total;
55.9
16.9
29.0
5.9
1.9
2.2
Central Reserve city:
New York City
Chicago
.----Reserve city
Country
111
2.8
19. 5
22.5
3.4
.8
6. 2
6. 5
6.1
1. 2
9.1
11.8
1. 2
.5
2.1
2.1
.3
.2
.7
.7
Insured nonmember banks ---
9. 9
3 4
4_.9
Noninsured banks -1.2
.4
661
1
(')
Over
20 years
.1
.1
.6 ----1.4 ----6_
I Less than $50,000,000.
Mr. THOMAS. That would be about $30,000,000,000, and you would
have about $10,000,000,000 of other assets.
Mr. ECCLES. That is more like it. That is $30,000,000,000 of
short-term Government securities.
The CHAIRMAN. That $30,000,000,000 would be immobilized.
Mr. ECCLES. Yes; except that you permit them to use other assets
in lieu of that. That is any assets that they have above 20 percent
of the demand deposits, and the reason for that is, for instance, that
a bank that is a member of the Federal Reserve System has its reserve
requirements with the -Reserve bank, and they have cash on hand,
and they have items in process of collection that they call transit
items, and they have balances with city banks.
Now, they may have as much as 30 percent reserve in all of those
factors, and it would be unfair to impose the 25 percent on any bank,
no matter what reserve they had. Therefore, you start with 20
percent as the basis, and any bank which is carrying reserves and
cash of more than a 20 percent figure, it would apply that against
the 25 percent special reserve. In other words, the special reserve is
composed of short-term securities or other cash items, balances in
other banks, which is above 20 percent.
CREDIT POLICIES
37
Now, if you did not do that, then you would practically destroy
the correspondent bank relationships. There are a lot of nonmember
banks as well as niember banks that would maintain substantial
balances with the correspondent bank; and if those balances, plus cash
on hand, plus excess reserves with the Federal Reserve, in the case
of a member, are above 20 percent of demand deposits, they would be
permitted to count that as part of the special reserve.
In other words, you have got to start on a base point of 20 percent.
Now, some banks carry as high as 40 and 50 percent of demand
deposits in interbank balances and cash and currency, in which case
they would practically have no requirement under the 20 percent
because they already are in that position. So now to explain the
application of the 25 percent, if banks had nothing above the 25 percent, then to apply the 25 percent would immobilize $30,000,000,000
of short-term Governments; but taking the picture as it now is, there is
about $10,000,000,000 of the cash items and balances such as I have
mentioned above the 20 percent of demand deposits. So that that
would mean if this were applied, it would only immobilize about
$20,000,000,000 of short-term Governments.
The CHAIRMAN. In effect, if you exercise full power, they could not
put in loans and investments of more than half of their deposits?
Mr. ECCLES. That is about right.
And what is more, that frac-
tional reserve of 6 to 1 is cut down to about 2k% or 3 to 1, and not more
than 3, I would say closer to 2M. Therefore, you get away from that
large multiple deposit expansion. So that even if banks then did
sell Governments to the Reserve banks, the ability of the banking
system to expand on the basis of the reserves thus obtained would
be reduced.
In suggesting the use of the optional reserve power, as you well
know, we have indicated here that it would be applied only in case the
credit expansion and inflation is continuing, in spite of the use of the
powers we might get under the increasing of reserve requirements also,
if a substantial budgetary deficit is incurred, we would be unable to
increase reserve requirements because either a substantial part of it
or all of it would have to be financed bv the banks. Deficit financing
would mean that you actually wanted the banks to buy Government
securities. Therefore you would not increase the cash reserve because
that would force them to sell Government securities. Consequently,
if you run into large budgetary deficit financing,- this special reserve
requirement seems to us essential, if you are going to do that financing
on the basis of selling short-term Governments to the banks.
We feel that that is the way to do unavoidable bank financing of a
Government deficit. We should not want again to see long-term
Government securities sold to the banks and have the trouble that we
have had in the past. By this special reserve requirement, you would
immobilize the securities sold to the banks as you put them out. If
you made the special requirement higher, that would be an inducement
for the banks to buy more Governmnet securities. The special
reserve would also be of great assistance in refunding maturing
issues, because the banks then would not be inclined to sell the securities to make loans, in fact, they would probably be obliged to hold
some securities as a part of the optional reserve.
The CHAIRMAN. I have one thing, Mr. ECCLES. I might have to go
over to make a quorum, and Mr. Patman has some questions to ask.
38
CREDIT POLICIES
Will you put in the record the figures that we referred to, that is, the
figures showing the effect of this thing on the reserves, and also I
think any other figures dealing with the total outstanding bonds and
whether held by banks or private individuals, and so forth. There is
a table here in the Treasury Bulletin of March 1948, but I think it
would be desirable to have those figures in the record, whatever you
think is material to the committee.
Mr. ECCLES. We will put them in at the appropriate places.
* I would like to say one thing, Senator, on this question of interest
rates, because I think that I may have made a wrong impression in
my remarks this morning. I come to that conclusion by reason of a
report over the Dow-Jones ticker that I saw when I went back to the
office. The report is that Eccles told the committee that the Reserve
Board is considering raising interest rates en short-term securities
and discount rates. That is, I think, a misinterpretation of my statement. What I certainly meant to say, and what I think my statement
implied is that restrain such potential expansion-and that is the
expansion that would be created or possibly could be created by the
reserves that would come into the banks from the sources that have
been enumerated-I said the Federal Reserve would have to take
action to absorb any excessive volume of reserves. To restrain credit
expansion, we would have to take some action. I said that there are
two types of measures which should be adopted. It might have been
better to have said two types of measures should be considered, but
certainly to deal with a potentially inflationary situation, I am sure
that it is the view of the Board that they should be adopted.
One of these measures is some further rise in short-term interest
rates and in discount rates. The question of raising the interest rates
is not a matter for the Board. The question of raising the interest
rates on short-term Government securities is a matter for the Treasury,
in consultation with the Open Market Committee, and in the light
of the advice of the Open Market Committee.
Now, the question of raising the discount rates is a matter for Board
approval. The Board does exercise control over the discount rates.
We can approve of the rates submitted by the banks, or if we disapprove of them then they have to submit a rate that we will approve,
so the practical effect is that we can control the discount rates.
I went on further to say that the first of these measures, namely,
that of increasing the interest rate on short-term Government securities, was the matter that could be adopted or considered by the
Federal Reserve and the Treasury without any new legislation. I
also said that the action would be designed to induce banks to purchase short-term Government securities.
It would look from the reporting of this morning's testimony that
the Reserve Board, if they decided you should raise short-term rates,
would just proceed to raise them. As I stated, that is not.a power
which the Reserve Board has. The Treasury fixes the rates on the
short-term securities that they are going to offer, and it is done in
consultation with, and on the advice of, the Open Market Committee,
of which all of the Board are members. In addition to the Board
members, there are five Reserve bank presidents; so that the Board,
of course, exercises a very considerable influence in advising on the
question of interest rates.
CREDIT POLICIES
39
But this reporting gives the impression that interest rates might be
raised tomorrow because we favor doing it, and therefore we can do it.
I just wanted to have the press get the correct picture here, namely,
that although we favored, under the conditions which are indicated,
dealing with them by raising the rates to the extent that we can do
it without raising the rates on long-term bonds-and that may be a
very limited amount-the raising of interest rates is not a power which
is within the Board's prerogative.
Representative PATMAN. I understood you to say this morning
that the 22 percent interest rate on government securities shoild be
maintained.
Mr. ECCLES. That is right.
Representative PATMAN. You mea:n to say the 2% percent rate on
Treasury bonds; in other words, the bonds will be taken at par, so
that the rate will not go down or will not go up; is that right?
Mr. ECCLES. Well, if the 2/% percent rate on the longest term
Government securities is maintained, that means that longest term
bond would be supported at par.
Representative PATMAN. Do you expect to-do that?
Mr. ECCLES. As a matter of fact, the support price is 100%2.
The reason for this support price is to enable the ultimate seller to get
par, because when he sells his bond he cannot bring it right in to the
Federal Reserve bank. He sells his bond to a security dealer, and
by the time it gets to the Reserve System there is some cost in handling
it. We wanted to be sure that the seller would get par. And to do
that, we had to allow %2 above par to allow for the commissions and
costs in between.
Representative PATMAN. That is about what they are selling for
now; is that not right?
Mr. ECCLES. I think they are slightly above that. They have
fluctuated. They have been up eight-thirty-seconds above that.
Representative PATMAN. It is the intention of the Board to maintain at least that rate?
Mr. ECCLES. It is the announced purpose of the Open Market Committee, and also the announced purpose of the Treasury, to maintain
that rate on the longest term Government bonds. There is no commitment, so far at least as the Open Market Committee is concerned,
to maintain securities, all securities, at par.
Representative PATMAN. I did not mean to say all securities. I
meant the 232 percent securities.
Mr. ECCLES. That is the basis.
Representative PATMAN. You expect to keep them at par?
Mr. ECCLES. Yes, and that means, of course, as long as you do that,
the shorter, medium-term securities will sell at a premium. Therefore, there is not much likelihood of any of the securities going below
par except if the short-term rate is raised. If the short-term rate is
permitted to rise as much as a quarter, then the securities falling
dlue within a year or maybe 2 years might fall slightly below par.
Representative PATMAN. What is the average going interest rate
now for the Government bonds, or the Government securities?
Mr. ECCLES. I think around 2 percent.
Representative PATMAN. Is it not a little higher than that?
Mr. ECCLES. It fluctuates, depending upon the amount of savings
bonds out, because that is a fairly high rate. Of course, you have to
40
CREDIT POLICIES
take the average rate into account, in raising the short-term rate
I should point out that a good portion of the increase
the shortterm rate would go to the Federal Reserve, which in turn in
would return
the lion's share to the Treasury as a tax.
Representative PATMAN. Because the Federal Reserve owns most of
the securities?
Mr. ECCLES. It owns a large amount of bills and certificates.
Representative PATMAN. I notice they were increased from about
three-eights in January of 1947 to about ninety-seven one-hundredths.
Mr. ECCLES. That was done practically all at once, because that
three-eights was an unreal and unnatural rate. That three-eights
then prevailing represented the rate on securities owned by rate
the
Federal Reserve. There was no market for bills outside the Federal.
What we felt should be done was to make the bills a market instrument;
in other words, to put them on a real bid basis instead of the existing
artificial basis. That is to say, we felt that we should let the market
determine what a 1-year bill should pay or yield.
Representative PATMAN. I notice, though, Mr. Eccles, that. the
bankers' acceptances, 90-day bankers' acceptances, went up from
about eighty-one one-hundredths in January of 1947 to about 1.08 in
1948. They went up considerably, too, along with those securities.
. Mr. ECCLES. That is right, because the yield on bills and certificates
went up.
Representative PATMAN. Which one pulled the other up?
Mr. ECCLES. The Governments pulled up the others, I think.
Representative PATMAN. Pulled up the private ones?
Mr. ECCLES. The Governments dominate the whole market.
Representative PATMAN. Now you take the corporations, the
interest rate increased from 3.13 in January of 1947 to 3.53 in January of 1948.
Mr.
ECCLES.
That is right.
Representative PATMAN. You say the Governments pulled them up?
Mr. ECCLES. Entirely.
Representative PATMAN. Why should the Governments do that?
Mr. ECCLES. Because, with a marketable public debt
billion dollars, Government securities dominate the market. of 165
Representative PATMAN. It occurs to me that that is interfering
with the market.
Mr. ECCLES. It was not interfering at all, because we were
an artifically low level. We were the ones that were pegging supporting
shortterm rate at seven-eighths for certificates and three-eighths the
for
and therefore there was no market for bills and practically all bills,
bills
went to the Federal Reserve, and a great many of the certificates
at seven-eighths went to the Federal Reserve.
Because we were paying such a low rate on the short-term
the 232 percent Governments wvent up to a premium of nearlypaper,
and the municipals dropped down to a 1%2 percent rate. It was107,
all
due to the fact that we're permitting the banking system to create
money at a very, very rapid rate.
What the banks were doing was this: Because the rate was so low
on the short-term paper, they were selling the short-term paper
to the
Federal Reserve and buying the longer-term. paper in the market.
And a 2-percent bond-that was eligible for the banks to purchase
went down as low as 1%percent yield, and to a very high premium.
CREDIT POLICIES
41
In other words, we forced the rate down and prices up through pegging
the market at seven-eighths on the short' term.
Now, we have shifted the emphasis of our support program to the
2% long-term rate. What we were doing-the fact that we were
pegging seven-eighths short-term rate-drove the long-term rate down.
Under these conditions, the refunding which was being done by private
corporations and others was at lower and lower rates. We were
getting into a position where it was increasingly difficult to ever let
the short-term rate go up without also raising the long-term. rate
and causing insurance companies and many others to incur very large
losses on the securities that they had purchased at the' low rates.
We felt that there is some obligation, certainly, to investors as well
as there is to borrowers; that there was no justification in maintaining
that short rate and forcing the long rate up. You can make a pretty
good case for holding the long-term rate at 2%, while the public debt
is as large as it it. If it were not for the fact that the public debt is
so large that there is a very big job of r'efunding to be done constantly,
and that these securities are held so widely by banks and many other
institutions, then certainly in a situation today where the total volume
of savings in the country possibly does not equal the demand, you
should let the savings rate really go up. We are tending to keep the
savings rate down as long as we hold the 2%-percent rate, and we are
criticized for it.
But as I said to Senator Taft, you have a problem. of alternatives
here. 'It is the judgment of the Board that even though the demand
for savings might temporarily justify a higher rate because the savings
today are possibly less than the demand for money, we should continue to hold the 2%-percent long-term rate. However, we also agree
that the long-term rate should reflect the actual volume of savings
that is taking place in the country in relation to the sustainable
demand.
Representative PATMAN. But there is plenty of money or credit
available.
Mr. ECCLES. The trouble is, it is bank credit. Borrowers go into
the banks and obtain bank credit. That expands the total volume of
money, and because you cannot expand the supply of goods and labor,
it reflects itself in higher prices.
Representative PATMAN. Really, there is about three times as much
money and credit available now as ever before in history.
'Mr. ECCLES. But you have also the fact that the national product
has pretty largely absorbed that inflation of money:. The national
product has gone up since 1940 from $100,000,000,000 to $240,000,000,000. Now, that is an increase of one and two-fifths; whereas,
the supply of money has increased nearly one and two-thirds. The
supply of money is still more than adequate; there is an excess of it. '
Representative PATMAN. That is what worries me. I cannot
understand, M'Ir. Eccles, this fact: It occurs to me that the law of
supply and demand would cause interest rates to go down instead of
going up, since you say there is adequate credit, more than we have
ever had before.
MN'r. ECCLES. But there is a question of who wants to borrow the
money and who wants to lend it. You cannot assume that a person
who owns money is necessarily going to, be willing loan it at these rates.
That is, one of the reasons that the money may not' be flowing, to
42
CREDIT POLICIES
even though you have got a lot of it, as freely and readily as otherwise it would flow, is because there are some who feel that the rates
do not justify the risk. What you have today is an abnormally low
velocity of money.
Representative PATMAN. Here is the danger that I see in this
increase in the interest rates. You take the cities and counties and
States-they will have to pay more.
Mr. ECCLES. They ought to pay more. Why shouldn't the investor
get more interest when the purchasing power of the dollar is diminishing?
Representative PATMAN. And that, of course, causes an increase
in taxes, too.
Mr. ECCLES. Possibly so, that is right. But why shouldn't people
pay more taxes, or why shouldn't the farmer pay more taxes when he
gets three times as much for his wheat? Why shouldn't the laborer
who gets two or three times as much for his wages pay more taxes,
and why should the entire cost of the inflation be borne by the saver,
the person who has got money to rent?
Representative PATMAN. Utilities will have to pay more interest,
and they will want an increase in rates, and it increases everything.
That is inflationary.
Mr. ECCLES. The rates are still excessively low. Money rates are
the one part of the economic situation that is still deflated. The
person who has been hurt the worst is the pensioner, the saver, and
the person who depends upon a return from a fixed investment.
There are two reasons for this.
Representative PATMAN. Or fixed salaries and wages.
Mr. ECCLES. That is right, too. The saver not only gets a much
smaller return on his dollars, on his loans or investments, than he ever
got in the 1920's or in previous years, but the dollar will likewise
purchase a lot less, so that if it were not for the problem that the
management of the public debt would create, and the huge size of
the public debt, and what it would do to the value of the securities
held by banks, insurance companies, and institutions generally, there
is a very good case on the grounds of equity today to make for raising
of the rate.
Representative PATMAN. You are raising the rate.
Mr. ECCLES. I am speaking of the long-term investment rate. The
short-term rate is not the investment rate; the short-term rate is the
bank rate.
Representative PATMAN. But something has caused the corporate
rate to go up considerably.
Mr. ECCLES. It is because the short-term rate went up, and that
reflected itself in the long-term rate until the support price of the
22 bonds was reached.
Representative PATMAN. It occurs to me that, although I am sure
the Board did not intend it that way, it is going to practically stop
the housing program based on 4 percent equity. It will not be long
before the people will not take these 4 percent mortgage loans.
Mr. ECCLES. I think that they will take the 4 percent mortgage
loans; that is not so much the problem. If the loans were better loans
than they are, they could be sold. One of the troubles with these
loans is that there is no down payment. And certainly it would be
a good thing if there was a smaller market for mortgage loans. In
CREDIT POLICIES
43
that case there would possibly be fewer people trying to build houses,
and if there were, then the cost of building labor and materials would
not go higher. The trouble in the housing field has been that 'you
have an inflation here since the war ended of practically 100 percent
in the cost of houses, and you are getting people in debt at excessively
high-priced housing today. If we should at some time get a change
in these values, and get any recession, it is going to put a real burden
on these people that we want to help. You do not help a person by
getting them in debt to buy property on a long-term basis at an inflated price, and it seems to me that one of the reasons that construction costs are so greatly inflated is because the amount of money
made available for construction, and particularly in the housing field,
has exceeded the supply of building labor and material. Because
there has been practically no down payment required, it has taken
practically no capital to get into the industry, and we have found
literally thousands of speculative builders go into the business with
practically nothing on their own. The net result is that there is a
highly speculative situation in the housing field. If that has slowed
up and if there is not the mortgage money available, I think that
that is one of the most wholesome situations that can happen as an
anti-inflationary development at this time. One of the best things
that could happen at this particular stage-as an anti-inflationary
measure-would be to have the cost of housing come down, particularly the cost of the materials and the labor that goes into the housing.
Representative PATMAN. Construction costs you only pay one
time, and interest you pay every year until it is paid off.
Mr. ECCLES. That is right.
Representative PATMAN. Do you not think it is easier now to pay
$10,000 for a home with a low interest rate over a period of 30 or 40
years, than before the war to pay $5,000 with a high rate-of interest,
may be with three mortgages?
Mr. ECCLES. What I am advocating-and I- am not saying that
even the 4 percent rate should necessarily change-is that there
should be some down payment required; that people should not go
into the business without any money or capital of their own, and that
people should not buy houses without any equity of their own. That
is what I am largely contending here.
Now, it may well be that an increase in the rate on housing mortgages of one-half of 1 percent would be all that would ever be required,
so long as the 2% percent rate is maintained on long-term Governments.
It is that close a margin. The margin between the desirability of a
4 percent housing mortgage and a 3 or a 3Y2 percent bond is just about
one percentage point.
Representative PATMAN. I know, but one-half of 1 percent every
year for 40 years runs into money, you know; that is paid every year.
Mr. ECCLES. If they paid it in 20, it would be half as much. '
Representative PATMAN. We have a bill over in the House, and of
course I am in favor of Senator Taft's bill, the Taft-Ellender-Wagner
bill, because it has some public housing in it, too, and I am for that.
..Mr. ECCLES. We ought to wait for a period when it is favorable
to do that.
Representative PATMAN. Are you not going to consider the people
who are out of homes?
44
CREDIT POLICIES
Mr. ECCLES. But you are not going to get more homes.
All
you
are doing is inflating the price of homes. If by reducing the rate
from 4 to 3 that was actually going to build more homes, at less money,
then I would be for it. If you had idle men and idle material and the
thing that was short was money, then we ought to do everything for
the Government to help to stimulate the construction industry in order
to use up the idle labor and the idle facilities.
Representative PATMAN. Do you not think that there are certain
things that we have to do, although possibly inflationary, in order to
give homes to people?
Mr. ECCLES. I think if you were getting more homes, that is one
thing. But merely by making more favorable terms you do not get
more homes. It is like I said in the installment credit field: Merely
by making installment credit terms more favorable to buy an automobile is not going to produce more automobiles.
The CHAIRMAN. I think it does produce more homes, though.
Mr. ECCLES. I doubt it.
Representative PATMAN. I think so, definitely.
The CHAIRMAN. I think we have gotten beyond the bottleneck stage
in homes, pretty nearly.
Mr. ECCLES. I hope so, but so long as you have the shortages that
you have in the basic materials and building labor, I cannot see how
more credit will produce more housing. Lumber is a terrifically inflated item; it is still up. I know something about it. Lumber is up
from the OPA ceiling price by more than 100 percent.
The CHAIRMAN. Why should we send $300,000,000 worth abroad,
then?
Mr. ECCLES. That is another question, but certainly lumber is
fantastically high. It is higher than any farm product, I think.
And on top of that, you have building labor that is extremely high and
very inefficient, generally speaking.
Representative PATMAN. And on top of that, you know what the
steel situation is. I know people in the building business, and they
do not verify the fact that it is easy to get deliveries on materials at
all. They are still very tight, and there are still gray markets in
many items.
Representative PATMAN. I want to ask you a few questions bearing
directly on your testimony, Mr. Eceles, please.
Now, you want these reserve requirements raised. At least you
want the Board to have the power and the authority to raise them if
necessary. You believe that will make credit harder to get; and credit
being harder to get will stabilize the economy just a little bit better
and keep prices down.
Mr. ECCLES. Let me put it this way: We feel it would sterilize the
inflationary effects of the excess reserves that gold imports create,
and it would tend to sterilize the effect of the reserves that would be
created in our support of the 2,%market if insurance companies and
others sell 2% bonds.
Representative PATMAN. YOU made that very plain in your
testimony.
Mr. ECCLES. Otherwise, the banks would have these reserves
and they would be out under pressure to be making loans, under an
inflationary condition. If 'we had that condition in deflation, it
would be fine. But in a condition now where the supply of money is
CREDIT POLICIES
45
already excessive in relation to the total product, to be inducing the
banks to seek loans and to be putting in a condition where it is in
their interest so to do, because they have idle funds, idle reserves,
that we have created for thin, or our gold policy'has, is something
that we do not want to do.
Now, last year they were doing just that.
Representative PATMAN. If you had this power, Mr. Eccles, and
you exercised it, which, of course, you would do under the circumstances
Mr. ECCLES. Well, we would if bank credit expanded, and if it
didn't we wouldn't be justified in doing it.
Representative PATMAN. If you did, do you think that would have
a tendency to keep prices down?
Mr. ECCLES. Yes. It would have a tendency to keep credit expansion down. And to the extent that credit expansion was kept down
the money supply would be kept down. Certainly you can't get
inflation without money. Inflation is a reflection of the expansion of
the money supply; not dire-ctly, because velocity must be taken into
account, too; but certainly, without an expansion of the volume of
money on a given supply of goods and services, you are not going to
get a dangerous inflationary situation.
Representative PATMAN. Suppose the Board'had the power today.
Would you want the Board to exercise that power to lower the present
prices?
Mr. ECCLES. Well, we couldn't. There is no power today under
which we could do that.
Representative PATMAN. I say if you had the power you are asking
to be given to you, had that power now, would you use it to lower
prices and wages?
Mr. ECCLES. You couldn't lower prices and wages by doing it.
If we undertook to lower prices and wages, it would have to be done
by withdrawing support from the Government market and raising
the discount rate.
Now, we could actually make credit so tight if we refused to buy
Govermuents and raised the discount rates accordingly that it would
be just like it was after World War I. You certainly could create
that kind of a situation with that kind of a policy. But so long as
you support the 2% percent Government rate you really can't make
bank credit tight. And that is something to which we are committed
for the foreseeable future.
Nobody wants to say forever, but certainly so far as the Federal
Reserve people can see things at the present time, we have an unavoidable responsibility to the support of the 22 percent rate.
. As I stated, while you are doing that, you really can't make bank
credit tight. If you increased the reserve requirements to the full
extent that is indicated here, that is a total amount of $12,000,000,000,
and the banks have $67,000,000,000 of Governments, they could
easily meet that requirement. They could meet it.simply by selling
$12,000,000,000 of Governments, and they would still have $57,000,000,000 left.
Representative PATMAN. Now, I want you to apply that from a
practical standpoint by using a Reserve city bank as 'an illustration.
How could a Reserve city bank increase its reserves to make
additional loans? And how much could they increase them?
77099-48
46
CREDIT POLICIES
A/Ir. ECCLES. How do you mean?
Representative PATMAN. How could a Reserve city bank, in selling
bonds to the Federal Reserve bank of that district, increase its ability
to expand its loans?
JVlr. ECCLES. Well, if a bank hasn't got any excess reserves, or,
that is, has no money to lend-then, let us say they wanted a million
dollars of reserves. They would sell a million dollars' worth of their
Governments. Those Governments would be purchased by the
Federal Open Market Committee from the dealers to whom they
were sold, and funds would be credited to that bank that sold the
bonds.
Now, assume that bank makes a loan, and this is the way it makes
a loan. It gives credit to the borrower in the form of a deposit account. Then, in place of the bond that is held, the bank has a note
of the borrower.
Representative PATMAN. They could have an aggregate of how
much in notes?
Mr. ECCLES. Well, just one for one; that bank.
Representative PATMAN. I know; that particular bank. But in the
entire Reserve System, it would be about 10 to 1.
Mr. ECCLES. Whenthe customer draws down that deposit, it is
transferred to another bank. That other bank must lay 20 percent
against its new deposit and then has 80 percent of that money to loan.
It doesn't know where the deposit came from. It doesn't know anything about it. It is the reserve funds that were created in the first
instance which are important. And when these reserve funds once
get into the spending stream, then the effect of their use is to create at
least six times that amount of money, which in turn becomes part of
the spending stream.
Representative PATMAN. That is the average.
Mr. ECCLES. Yes; that is minimum. You have to take savings into
account and also nonmember banks. Nonmember banks are not now
subject to Federal Reserve requirements. Under State banking laws,
nonmember reserve requirements can be met by holding deposits
with member banks.
Representative PATMAN. How large a national income do you think
we should try to maintain in order to pay our national debt, Mr.
Eccles, with the least discomfort and inconvenience?
Mr. ECCLES. I think if we are going to have reasonably lull employment at current price levels we have to maintain a national income,
certainly, with the present population, of around $200,000,000,000.
Representative PATMAN. $200,000,000,000?
Mr. ECCLES. I think so.
Representative PATMAN. I would just like to know that the Federal
Reserve Board certainly has nothing in mind like what happened in
1920.
Mr. ECCLES. Well, you can be perfectly sure of that. As far as the
present Board is constituted, I am perfectly certain of it.
Representative PATMAN. That is the reason I wanted you to say
"about $200,000,000,000," because if you keep it about $200,000,000,000, you cannot go to far on that.
Mr. ECCLES. The idea that the Federal Reserve canRepresentative PATMAN. Yes; but to encourage it, Mr. Eccles; not
to do anything to stop it. That is what I have reference to.
CREDIT POLICIES
47
Mr. ECCLES. Of course, it is a very difficult thing to stop inflationary pressures at this stage without, maybe, getting some deflation.
In this connection, I would like to make another observation. With
reference to the matter of some rise in the short-term rate, we have
already had some. Ion other words, the rate has gone up from Y8to
13/8. Now, if you were to get some little further rise in the short-term
rate, when the situation is reversed, you can drop it. But you cannot
drop it if it, is already on the floor.
And the same thing is true in the financing of housing. In this sort
of a situation, if you get a little higher rate, and if then you get a deflation, you can lower the rate. It is a good thing to have some backlog of housing at lower prices rather than filling up the entire backlog
at these inflated prices, so that if you do get a slump you have
absolutely no backlog available.
Representative PATMAN. I think those of us who are looking at
this housing problem are not looking at this from that standpoint
solely. We are looking at it from the standpoint that although it
might cause some inflation, it is justified by reason of the necessity of
getting decent housing for people.
Mr. ECCLES. It is justified up to the point that there are labor and
materials available without inflating further the price of labor and
materials. I would like to qualify that. I would say that it would
even be desirable if there was a little surplus labor and material in
the housing field, so that you might get the cost down a little. Housing
construction is so badly inflated that it would not hurt any if they
had a little deflation.
Representative PATMAN. You would not try to adopt any policy
that would cause that, would you, Mr. Eccles?
Mr. ECCLES. I would, if the question of supplying a secondary
market was all that was involved. I would say if there was likely
to be some easing in the price of housing, some increased efficiency
in the building of housing, some slightly reduced cost in housing, if
there was no secondary market provided, and hence if there was a
little less housing taken for the time being, I would be all for it. I
would be for it especially in view of the other inflationary pressures,
due to the foreign aid, and our military, and our tax-reduction program.
Representative PATMAN. Mr. Eccles, suppose that, after you get
those powers, lumber should go up 25 percent, for a known reason,'
and other basic materials like steel and cotton and wheat and things
like that should also go up. Would the Board take any action calculated to reverse that trend?
Mr. ECCLES. If-that was based on a further bank credit expansion;
yes. I do not think that could happen without further bank credit
expansion.
I think these prices that you indicate are going up will immediately
reflect in increased bank credit.
Representative PATMAN. Then, if you deny them credit, that will
have a tendency to keep the prices back.
Mr. EccLEs. That will keep them in line.
Representative PATMAN. That is a lot of power, Mr. Eccles.
Mr. ECCLES. That is right.
Representative PATMAN. Of course, in an exaggerated case such as
I mentioned, it certainly would be justified.
48
CREDIT POLICIES
Mr. ECCLES. But as I told the committee before, we certainly are
not seeking any additional power, and what is proposed here is less
power than the System has always had, but which it now is unable
to use if it supports indefinitely the 2%percent rate.
Representative PATMAN. All I want you to do is to make it plain
and continue to make it plain that you are not contemplating any-
thing that happened in 1920.
Mfr. ECCLES. Well, I am perfectly sure that everybody in the Board
is conscious that if the Board were to use any power that would tend
to stop the boom, or interfere with the boom, it would be an unpopular
thing to do. Booms are always popular, and it isn't possible for the
Reserve System to ever win. They just don't have a chance to win.
Because any action that they take is sure to be unpopular with a lot
of people.
Whenever you try to curb any use of credit or expansion of credit,
you can be perfectly sure it is a very unpopular thing to do. But
after all, that is one of the jobs of the Board that the Congress meant
to give them, and I think that the Board should have the courage to
do something about it, or the power should be given to somebody else.
Because certainly if you are going to have any stability in the economy,
you have got to deal with it either by direct means, which is contrary
to the American way of doing it-and I mean direct controls, allocations, and everything-or you have got to try to get it in an inlirect
way, in a functional way, through fiscal and monetary and credit
policy.
Now, that, it seems to me, is the only alternative.
And I, for one, prefer to have some freedom, and fluctuation and
try to get at it through fiscal, monetary, and credit policy, rather than
a completely regimented and controlled economy, which we have to
adopt in emergencies, in war. And if, for military or other causes,
due to developments, we have to run a large budgetary deficit, then
certainly we will have to put those controls in again, or we will have to
have an inflationary development.
That is the point I tried to make.
The CHAIRMAN. Mr. Eccles, earlier today you suggested you
might have some ideas on the question of whether under present
conditions there is enough inducement for people to invest in equities
,as against loans.
- One of the reasons that has been suggested for the excessive pressure for loans, is the inability to get equity money. If that is so,
what has caused it, and what is the remedy?
Mr. ECCLES. There is certainly no shortage .of equity or other
money today. That isn't the problem. The problem today is the
shortage of material. And if there was more equity money, there
would be more demand for goods that are in short supply. The
problem is not a shortage of money.
*The CHAIRMAN. Now, we have had some cases brought to my
attention. Ong was the company that wanted to sell stock and could
not, and wanted to withdraw stock issues; and there. were several
stock issues withdrawn here some months ago.
They could not sell
more bonds, because the Public Utilities Cominission said that would
be an improper balance; that what they needed was more equity
money.
Mr. ECCLES. That is right.
CREDIT POLICIES
49
The CHAIRMAN. Would you think that that was a special case?
Or do you think that situation has changed?
Mr. ECCLES. I think that there are a lot of such situations; and I
think if the equity market was open, you would have more inflation
than you have got. Because, if it was easier for corporations to get
money than it is today, you certainly would have more of it spent.
You would have more of them trying to expand the capital-goods
market. There seem to be enough corporations with enough money
already on hand or with Government bonds.
The CHAIRMAN. It is suggested, however, that most of that money
comes from profits. Profits are very ephemeral and likely to disappear
from the exchange; and they cannot get outside money, outside new
money.
Mr. ECCLES. It is because they are trying to expand faster than
savings are accumulating. And that is undesirable, because when
you are expanding new investments, either by corporations or individuals, faster than the community as a whole saves the money,
you have inflation again.
The CHAIRMAN. Well, of course, this is more of a long-term problem than it is an immediate problem; because, as you say, you do not
need at the moment more money. But there is a study by Professor
Kuznets, I think, simply to show that there was no net saving in
the thirties; practically no new investment, We were not moving
ahead as we had before.
Mr. ECCLES. Because you had a lot of unused capital facilities,
and consumer purchasing was not in the then deflated conditions
adequate to use what new investments had already been created in
the twenties. You had idle capacity, and that is why in the thirties
you didn't have a lot of new investment going forward; because
there was too much idle capacity in almost every field.
The CHAIRMAN. Well, I mean, that is the cart before the horse.
If you had had more investment, if you had had more willingness to
put money into capital goods, you might have started up an industry
that would have really pulled us out of the depression. In fact, that
is the way we have gotten out of depressions before. In the thirties
there was no such money. Except for a brief period in 1937, it collapsed overnight.
Mr. ECCLES. If we had had more consumption that might not have
been true. As you survey the situation, we had an excess of office
buildings and hotels and apartments and factory production of all
kinds. We had idle railroads. We had an excess of utilities. We had
an excess of automobiles. In.almost any field you looked at in the
thirties there was excess capacity. What was lacking at that time
was consumer purchasing power.
Today you have a complete reversal of that situation. You have
a situation where the general public's demand for saving has exceeded
the total volume of savings. In order to carry forward the housing
and other new investment, there has been a heavy reliance on the
use of bank credit. When the bank credit starts to tighten up slightly,
then the Government wants to step in and to supply it in one way or
another.
The CHAIRMAN. Apparently nobody is willing to put any equity
money into housing. That may be because nobody wants to put it
50
CREDIT POLICIES
into equities, or maybe they do not want to put it into housing. I
do not know which. But very little is going in.
Mr. ECCLES. It is because of the inflated price, and people have no
confidence in buying. When you put equity money in housing, it
means that you have made an investment in housing at these prices.
Few enterprisers want to do that. They are perfectly willing to have
the little fellow come along and put his equity in and go in debt for
the housing at these prices. The builder is unwilling to put his
equity money in housing because he just does not have confidence
that it is a good investment at these prices.
I think that is one of your major troubles in the housing field.
That certainly would be my feeling. And I would feel the same way
about putting money into an office building, or into a hotel.
The CHAIRMAN. It is suggested that with the present tax rates
nobody with very much income can long afford to put money into
equities.
Mr. ECCLES. Into what?
The CHAIRMAN. Put money into equities, and take a chance; when
he can get 22 percent on a Government bond.
Mr. ECCLES. W'hat present tax rates do is to induce the people to
put money into municipals. The wealthy people today put their
money into municipals. The municipal rate will give them 4 or 5
percent, when you take into account the fully tax-free feature. There
is no Government bond or comparable security that will pay them
anything like that.
The CHAIRMAN. Do you not have the dilemma that the very wealthy
man will not put money into equities and the poor man should not?
The poor man puts it necessarily into insurance or savings banks,
which have to put their money into loans. So the more you shift
savings to the lower-income groups, the less equity money you have.
Mr. ECCLES. Of course, I know the argument of the brokers. They
say if we would reduce margins, then, of course, the equity market
would go forward. Well, that is merely a case of expanding credit
largely for speculation, because that is how the margin trading would
be financed. And that means bank loans to brokers or to others for
the purpose of buying securities.
They would be better off to have the bank loan to the corporation
.in the first instance than to have the money loaned to individuals
through the brokers, or directly for the purpose of buying the securities. You do not accomplish anything by that route. And the only
way you can help the equity market is where you have more savings
available, and then there is a chance for those funds to go into
equities.
The CHAIRMAN. I would say, off-hand, just from having contact
with a few securities, that there is very little interest in buying stocks
today. I am not talking about margins. I mean investing in stocks.
I do not know just why.
Mr. ECCLES. Well, it is because people have no confidence in the
future. It is the whole uncertainty. People are feeling today that
they do not know whether you are going to have a deflation or an
inflation. The whole question of what is going to happen in the
world picture is causing people to be very, very hesitant. If there
was some assurance that you were going to have more of an inflation,
it would improve your equity market tremendously. On the other
CREDIT POLICIES
51
hand, if there was a feeling that you were not going to have any
further inflation, then, of course
The CHAIRMAN. As of November, everybody was rushing in here
saying there was going to be an inflation surely, inevitably. It did
not produce anybody rushing out to buy stocks that I ever discovered.
Mr. ECCLES. We didn't come in and say there was going to be an
inflation. We have pointed out definitely that so far as the monetary front was concerned, there would be no inflation on that front
until after the first quarter. During the first quarter, we said that
there would be a deflationary situation, due to taxation. You will
recall that we said, as to the proposal that we discussed at that time
before the committee, the special reserve plan, that there was no
pressure for it at the time; that it could be considered after the first
quarter.
The CHAIRMAN. That was not the general tone during the special
session in the fall. Yours was the most conservative view we had on it.
Mr. ECCLES. I was dealing with it, of course, only on the credit and
the monetary front. And with reference to the question of equities,
this argument has been raised: that a reduction of taxes in the higher
brackets would induce the well-to-do people to use the savings that
they would get as a result of the tax reductions to buy equities; and
thus, it would not be necessary for the corporations to use bank credit
to the same extent. It may be that some of the tax savings of the wellto-do would go into equities, and corporations would carry out their
expansion as a result of getting that money, instead of using bank
credit. Or they might carry out an expansion which they would not
carry out if they could not sell their equity; and that expansion might
might be inflationary and undesirable.
Again, they may already have the bank credit, and if they could
sell equities, they would pay off the bank loan. That would be
deflationary. But to the extent that the Government would lose
revenue in taxes, and just to that extent, the Government would be
less able to pay off its debt at the banks.
You have got to remember that the Government has debts as well
as corporations, and the question of taxation is a question of whether
or not the taxpayer pays it to the Government and the Government
applies that on its debt, or whether the individual keeps the money
and provides the equity money to the corporation, so that the corporation can pay it on its debt.
Now, in an inflationary situation such as you have now, I think it
is more constructive for the Government to collect it and apply it on
its debt. I certainly think if you had a reversal of business conditions,
that is, a deflationary situation, then you would want to reverse that.
If we try to do everything in an inflationary situation that we ought
to do in a deflationary situation, we will have nothing to do, if we ever
get a deflationary situation to counter it. The principal hope of a
capitalistic democracy, it seems to me, is to be able to use its fiscal
and monetary policy both against deflation and against inflation.
Flexible fiscal and monetary policy is essential to stability.
I recognize that that is not an easy thing to do. And the opposite
to that is to let nature take its course on the boom-bust theory that
private capital, and individuals left to their own devices without
Government doing anything, will work their own way out better.
That is the other side of it.
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CREDIT POLICIES
The CHAIRMAN. Your theory sound like a theory of mine. I always
refused to have my tonsils taken out, on the ground that if I ever got
sick I wanted to have something left to do to cure it.
Mr. ECCLES. I would not say that, if we didn't already have a
continuing inflation.
The CHAIRMAN. I agree.
This question that we are raising is a long-term question. I mean
I am not trying to apply it to the immediate problem. I don't think
there is any concern about it at this moment. But I do think there is
a good deal of doubt whether, as we have the high tax rate, which I
think we are bound to keep on high incomes, and more of savings in
the lower income groups, we are going to get equity money.
It does seem to me that that presents a long-term problem that
somebody is going to have to consider.
Mr. ECCLES. Of course, the community-property tax has gone a
long way to help very substantially the people in the higher brackets.
Certainly from $25,000 to $100,000 they have had real relief as a result
of that community-property tax; that is, those who were not already
in community-property States, and I happen to be one of them.
The CHAIRMAN. And those who had not already divided -their
property with their wives.
Mr. ECCLES. I was all in favor of the community-property provision.
The CHAIRMAN. In any event, you do not think that there is any
concern immediately regarding the question of getting more equity
money?
Mr. ECCLES. No, I don't think there is any concern at all. I
think that concern would come and would possibly be met, if you
had a deflationary situation.
Certainly at that time, I think the Board, Senator, would be justified
in reducing margins very substantially on security. . If you had a
deflationary situation, where bank credit was rapidly contracting and
unemployment developing, we certainly would not hesitate to encourage bank credit.
Representative PATMAN. On the question of equity capital, Mr.
Eccles, is it not a fact that most investors can get the benefit of the
capital-gains tax and not be eut over 25 percent in taxes anyway?
Mr. ECCLES. Yes; they can get it on real estate. They can get it
on any asset.
Representative PATMAN. Is not most equity capital in that category?
Mr. ECCLES. It is all in that category. If you buy it and it goes
up, and you sell it while it is up, after a 6-months' period.
Representative PATMAN. That is what I mean; for a profit.
Of course, if it goes down, you are at a disadvantage taxwise.
Mr. ECCLES. That is true.
Representative PATMAN. YOU can only deduct how much, as a
maximum amount, on a long-term capital loss?
Mr. ECCLES. Over a 6 months' period you get the benefit of a capital
gain.
Representative PATMAN. That is where it increases.
Mr. ECCLES. If you have a capital gain, it means 25 percent.
That is really where the tax is.
CREDIT POLICIES
53
Representative PATMAN. That is when it increases. But suppose it
goes down? There is a limit to what you can charge off, is there not?
Mr. ECCLES. That is right.
I think you can charge off not more
than a thousand in any one year, unless you charge if off against the
capital gain. You can charge off the capital loss on one security
against a capital gain on another, but if you do not have a capital
gain, and take the capital loss, then you can only charge off a thousand,
I think it is, a year.
Representative PATMAN. It is not cumulative.
Mr. ECCLES. Up to 5 years; $1,000 a year up to 5 years.
The CHAIRMAN. Of course, in that kind of equity investment, you
only bring that result about by selling out. You put the money into a
business, and then you have to figure on selling it out and putting it in
another business.
Mr. ECCLES. I will tell you one of the principal reasons that cor-
porations have a disadvantage in selling equities against bonds:
that in the case of financing by bonds or mortgages, they can deduct
the interest against their income tax. If they finance on an equity
basis they of course cannot deduct their dividends against the earnings.
Corporations prefer debt up to a point of safety. Naturally they
do not want to get to a dangerous point, but they actually prefer
debt, because there is such a tax advantage. The stockholder of the
corporation pays his share, in effect, of the corporation tax, which is
about 40 percent, out of earnings. Then, on the earnings that are
left, to the extent that they are paid in dividends, he pays surtax on
the dividends.
So, you see, there is quite a premium on the use of equity capital as
against debt. And that is one of the principal deterrents to the use of
financing by equity capital. That is a much more important factor
in the picture than any other: the tax disadvantage of equity capital
as against using the debt form.
Representative PATMAN. I have no other questions.
The CHAIRMAN. We thank you very much, Mr. Eccles.
The committee will recess until Friday at 10 o'clock, and will meet
in room 138 at that time.
(Whereupon, at 4:20 p. m., an adjournment was taken, to reconvene
at 10 a. in., Friday, April 16, 1948.)
CREDIT POLICIES
FRIDAY, APRIL 16, 1948
CONGRESS OF THE UNITED STATES,
JOINT COMMITTEE ON THE ECONOMIC REPORT,
Washington, D. C.
The committee met at 10 a. in., pursuant to adjournment, in room
138, Senate Office Building, Senator Robert A. Taft (chairman),
presiding.
Present: Senators Taft (chairman), Watkins, and O'Mahoney;
Representatives Rich, Patman, and Huber.
The CHAIRMAN. The committee will come to order.
Do you want to read your statement through, Mr. Rowe, or do you
want questions as you go along?
STATEMENT OF JOHN J. ROWE, PRESIDENT, THE FIFTH .THIRD
UNION TRUST COMPANY, CINCINNATI, OHIO
Mr. ROWE. I will be very happy to have questions as I go along.
However, whatever you want will be satisfactory.
I want first to state that I have been a amateur student of the
Federal Reserve System for a great many years. It just happened
that in 1929 I was president of the Cincinnati Clearing House Association; and, as president of that association, I had the opportunity
of looking over very, very carefully, the assets of several banks that
were more or less in trouble.
The CHAIRMAN. You had, then, been in banking all your life?
Mr. ROWE. Since just before. the panic of 1907.
I arrived in banking just before the panic of 1907 and have been in
banking ever since; not theoretical banking, but practical banking.
The CHAIRMAN. And you were with the First National Bank of
Cincinnati up until when?
Mr. ROWE. I was with the First National Bank from 1907, was
president of it from 1929 to 1934, and then accepted the presidency
of the Fifth Third Union Trust Company in 1934, where I have been
since.
The CHAIRMAN. And those are the two largest banks in Cincinnati?
3Mr. ROWE. Yes.
I should like to speak of the adequacy of present powers of the
Federal Reserve Svstem and other Federal agencies to prevent undue
expansion and contraction of bank credit, and current proposals for
increasing those powers, as has been recommended in the economic
report of the President.
The preamble to the Federal Reserve Act is as follows:
An act to provide for the establishment of Federal Reserve banks, to furnish
an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other
purposes.
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CREDIT POLICIES
The origin of the Federal Reserve System stemmed, in my opinion,
from the panic of 1907 when the actual supply of available currency
ran out. The public, in great numbers, insisted upon asking for cashin many ways as unexplainable as when cattle stampede.
Panic, in its worst sense implies blind, black, unreasoning fear;
often is psychological, and sometimes causes are not unreasonable.
Inelasticity of currency was the first hurdle to jump; hence, that portion of the Federal Reserve Act.
The second aim, namely, to afford means of rediscounting commercial paper, has worked fairly well. The intent is thoroughly
covered by the wording, but in the panic of 1929-33 there were banks
who had to pay heavy penalties for what was deemed to be excess rediscounting at the very time when they needed a low interest rateat the very time when they needed to reduce expenses to regain
solvency. Instead, they had to pay a higher rate.
It is somewhat like medieval (lays, when a desperately sick man was
bled, when the reverse was needed for recovery.
Today, borrowing by member banks at the Federal is practically
wholly against Government bonds which the banks, very rightly, in
my opinion, consider their most liquid asset.
The third preamble proposed-a more effective supervision of banking in the United States-was believed to mean an improvement in
bank examinations, but a steady and persistent growth in the idea of
Government management witb the conviction that thousands and
thousands of member banks should not think for themselves but need
more and more all-wise and omniscient regulations by the few, produced a steady broadening of the definition of this word "supervision." More and more power was given to the Federal Reserve
Board to issue regulation after regulation, so that today men active in
the bank have to constantly refer to long series of operating letters by
number and regulations by letters, which now run through all of the
letters of the alphabet, from A to Z.
If this is what the word "supervision" means, it seems to me that
the adequacy of the present powers of the Federal Reserve System are
fully adequate and, in fact, more than adequate.
The thinking back of requests for greater powers seems to revolve
about so-called inflation, the necessity to prevent further rise in price
levels, and a desire to put a flood under the price of Government bonds.
Economists seem to differ amazingly as to the causes of increasing
prices, and unless there be an agreement among competent-thinking
people as to causes, it is impossible to gage the adequacy of remedies.
The general thought seems to be that if one adds up total deposits
in banks, and the total of E bonds in the hands of the public, which
are payable on demand, plus paper money in circulation, the magnitude of the total is a self-evident cause of inflation, due to the size
of this potential spending power. To my mind, it is almost completely incorrect thinking. As Charles Lamb put it, "The world
is divided into two classes of people-the spender and the lender."
In other words, the spender and the saver, and I think it is obvious
that this is true.
Moneys awaiting investment, saved to provide for the long range
future, in an amount which obviously is unascertainable, should be
deducted from the total "inflationary" money as being noninflationary. This includes most E bonds and practically all savings deposits
CREDIT POLICIES
57
and currency in safe deposit boxes and the matresses. It is not
circulating.
Next, there is a direct relationship between a person's bank account
and his current normal expenses, and as living expenses have mounted
and quarterly tax payments to be made have mounted, it is my
experience that the average individual's personal checking account
averages much more than it used to. Accounts of this nature should
be deducted.
We then come to corporation accounts, and there, there is a direct
relationship of needed cash in bank, pretty much based upon the
annual volume of business of each company or partnership. The
rule of thumb figure is that business enterprises keep 10 percent of
their annual volume of sales in cash, largely in the bank. With
sales volume at present levels, it is obvious that business bank
balances are larger, perforce.
In my opinion, bank deposits have gone up as business volume
and living costs went up, and it is very much like the old question
of which came first-the chicken or the egg. It is therefore unfair
to say that the increase in bank deposits increased prices, as it seems
almost obvious that increased prices and volume of business demanded
increased deposits.
This happening is exactly in accord with the preamble to the
Federal Reserve Act, namely, elasticity of the money supply. How
otherwise would it have been possible to increase industrial production as we did as is shown on this chart. (Chart inserted at the end
of Mr. Rowe's statement, p. 85.)
The increases in wages cannot be overlooked as the prime factor
in so-called inflation.
Consider the changes in industrial production with the growth of
national personal income, and it seems to me obvious that bank
deposits had to go up to make the facts possible. The fact that
national personal income continued to go up after the war, while
industrial production dropped sharply, demonstrates clearly that
this is a major reason for the rise in prices; namely, that income has
continued to go up while industrial production went down-the
old-old law of supply and demand:
Demand-ability to purchase-namely, personal income, continued
to rise while the supply of goods went down.
During the war the people were glad to postpone their buying.
After the war they very naturally and very humanly wanted that they
could get and were willing to pay for it.
In my opinion, cures rest with a variety of necessary factors:
increased production calls for bank credit or new capital for new tools.
In other words don't stifle bank credit if you want to get production
up and prices down.
And the man-hours involved require lengthening of working hours
rather than limitation of hours per week.
Wages are the overwhelming cost in production and the services,
and round after round of increased wages can only mean increased
costs; hence, increased prices. To think that prices can be held down
by restricting credit seems to me utterly absurd.
It is my firm conviction that effective supervision of banking means
progressively better and better bank examinations.
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CREDIT POLICIES
The job has been done far better, in my opinion, since the bank
holiday than.before, but no matter how good it has been, it still can
be better.
The divergence in the performance of the banks of the country in
keeping themselves strong and sound with carefully valued assets,
measured risks in proportion to each bank's net worth, demonstrate
clearly that the private management of banks differs greatly in this
regard, and that such remedy as is needed lies in the present powers
of supervision and examination, not in regulation..
I offer the following chart of changes in net worth of a selected group
of banks, which tells the story. (Chart inserted at the end of Mr.
Rowe's statement, p. 85.)
Here you have merely a selection of banks that performed very well
after the bank holiday and before, and others that didn't show as well.
Names are not given. They are simply chosen more or less at random.
We start with 1929 net worth. Whether it be big net worth or
little, that is the par of their net worth, par for that golf course. And,
of course, since 1929, their deposits have gained tremendously, so that
the net worth of the banks today should be far more than it was in
1929 in relation to their debts.
The CHAIRMAN. You knew that Mr. Rich was a very fine golf
player, did you not? He is one of the best.
Mr. ROWE. That is fine. I will continue with the "par" idea.
Now, the net worth of these fellows at the bottom is almost a 70percent decline, and these others are comparable. Two of them never
dipped below their 1929 total.
And here [indicating] you see the result of their gain in net worth:
careful about their dividends, plowing it in, building up to keep this
country on a firm foundation. And it comes from business to keep on
a firm foundation; not through ukase.
It is perfectly clear that bank examinations could be better. I have
never yet seen a bank examiner come in and, with his letter to the
Board of Directors, say, "Your bank is grade A when it comes to
carefully valuing your assets," or "Your bank is grade Z," or just
make it, broadly, "good," "medium," and "poor." And that goes
for all of the mechanisms, not the individual loans, but the mechanisms, as to whether your assets are soundly and carefully valued, and
whether you will rate good, bad, or indifferent.
That is what the bank directors should be told. Particularly the.
country bankers think their banks are fine.
Representative RICH. Well, the country banker who wants to do
a good job is just the same as the city banker.
Mr. ROWE. Just the same. And your country banker is probably
smarter than the.city banker on the average, but there are probably
many more of them.
Representative RICH. I have been a president of a country bank
for 35 years, and I know what it is, and I wish I was not in the banking business today. It is a tough responsible job.
The CHAIRMAN. What the chart really shows is that a large number
of those banks were valued as to their assets; with the consent of the
examiners, way above what they were in 1929.
Mr. ROWE. Of course, the examiners had a strong alibi: that nobody could dream that the quotations could go down as far as they
did.
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CREDIT POLICIES
59
But there was one group of loans, one class -of security, that could
have been shown to be vulnerable. And the reasons, I don't think
have ever been studied the way they should be.
Representative RICH. Lots of these bank examiners go around and
examine the portfolio, and when it comes to local individuals and business they do not know anything about them, and they tell you that
you have to write them off; when the hanker himself oftentimes
knows very well that they are worth 100 cents on the dollar. They
ask you to put your money in something else that is listed; and the
country bankers have been told many times to do the thing that has
not in my judgment been the right thing to do.
Mr. ROWE. I agree with that.
Representative RICH. The examiners are just as human as the
bankers, and they go by a rule of thumb, or a rule laid down for them
by somebody higher up. They are told to place their value of assets
as to whether is is listed on the big board. You know what happens
to things on the big board. That goes up and down as much or
more than many local securities that are not listed on the big board.
Mr. ROWE. But there are certain securities that have very heavy
debts, heavy preferreds, ahead of them; others that have none.
Representative RICH. The majority of people in the banking business today, or a great many of them, I will say, put the great amount
of their assets in Government bonds.
Mr. ROWE. It is overwhelming.
Representative RICH. And then here in Washington we say Government bonds have to be stabilized. And where are you? The first
thing you know, if anything should happen to them, what is going to
happen to banks?
Mr. ROWE. Now J would like to show the totals of selected assets
of banks, if I may. (See chart at end of Mr. Rowe's testimony, p. 85.)
Here are all of the commercial banks [indicating]. And from 1935
to 1947, of course, their deposits have gone up tremendously, as we
all know. That is their total. This is their demand [indicating].
And as to their loans, there is a great deal said about how fast the
loans are climbing. Mind you, the deposits bear a direct relationship
to the volume of business. You see, this line is almost at the same
angle as the volume of business, and when business is at that volume,
you have to have money, and the bank is merely a tool of industry.
These loans are going to have to go a great deal higher. And they
ought to be encouraged rather than discouraged, in my humble
opinion. And as to the total capital accounts, if you are going to
have a strong nation, those accounts have to be bigger. The relationship there, as to debts-and that is what deposits are; that is
what the banks owe-is all out of line. And they need earnings.
Things should be done to help them rather than to hold them back.
Don't take blood from a dying man when he needs a blood transfusion.
Now, the same thing applies as to your Federal Reserve banks, which
I will come to in just a minute.
Representative RICH.. That same thing not only happens to banks,
but applies to business as well.
Mr. ROWE. Everything.
Representative RICH. And business today is getting in bad shape
because of the fact that you have the high prices of commodities.
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CREDIT POLICIES
o
You think you are increasing your capital and your earnings, and the
fact of the matter is that you have inflated prices and you have not
nearly as much assets as you had a year ago. You have inflated
assets.
Mr. ROWE. I may add to that. Business is simply production,
distribution, transportation, power; and the banks are the fiscal
department of business. We are all partners. When any one of
them is in bad, the others are hurt.
This chart on the right emphasizes the need for better bank earnings, largely retained in order to safeguard properly the public. It
is an interesting point, looking over some of the larger banks, to note
that the 3.3 percent at one end of the spectrum goes up to 20.7 percent
for net worth at the top.
Think of the divergence; and the opportunity for bank examiners
to press the ones who have a poor ratio of net worth to deposits to
pay low dividends and build up their net worth. Instead of that, I
find one here that has a 3.9 ratio of net worth to deposits, paying out
57 percent of its earnings in dividends; while one with 17.7 peicent of
capital funds to gross deposits only paid out 49.2 percent.
I think bank examiners could comment; on that.
The proposal to increase reserves of member banks with the Federal,
simply adds up to the fact that member banks will have to sell Governments, and the Federal Reserve banks will have to buy them, in
order to provide the funds to deposit with the Federal, should reserve
requirements be increased.
If those commercial banks have to put more deposit idle money
with the Federal, the only thing that they have got to deposit with the
Federal-they haven't got currency; in the aggregate, they can't
give a check on each other. We haven't the gold to put in which we
had originally, which was the concept. The concept was that we
would deposit gold, and we had the reserve. But the increase means
that the Federal owns more Governments, and we own less. Therdfore, our earnings will be down, because we have that additional
completely idle sterilized money in our balance sheet.
The Federal Reserve bank is a completely separate solar systemif one may use the word-than the solar system of the member banks
considered as a consolidated balance sheet. We member banks have
no gold to deposit. To borrow the needed increased Federal Reserve
balances, and to continue to owe that money would be obviously
disastrous. We have no gold to deposit nor have we currency. The
currency demand has been made by the public. It is something
over which we, nor the Federal Reserve banks, have no control
whatsoever; hence, we have no idea when there will be a flow-back
of currency which would increase our reserves and which, if and when
it occurs, will give the bank funds with which to buy Government bonds
from the Federal.
None of us know when that will occur, and the probabilities are
that it will be a long and slow process; hence, not part of this discussion.
To my mind, this process, that of the three ways to increase member
bank balances at the Federal due to increased reserves, the only
practical one is to have the Federal own more United States bonds
and the banks less.
Representative RICH. Now, let me ask this:
CREDIT POLICIES
61
Supposing the banks all want to sell their Governments, and the
Federal Reserve is not able to take them over.
Representative PATMAN. You do not mean to say the Federal
Reserve would not be able to take them over?
Representative RICH. Supposing they were not able to.
Representative PATMAN. But the fact is that they are, is it not,
Mr. Rich?
Mr. ROWE. Take this net worth picture.
In the first place, their net worth is just negligible. And I left off
anything here that was less than 2 percent of the balance sheet as
being unimportant. That means that in these year-end figures, at no
time did the Federal borrowings even show on the chart. They were
just negligible from 1935 to date. Their assets are gold and their
Governments.
One this chart, one line reperesents the Governments, and the gold
line represents the gold. And their total assets have to equal their
total liabilities. Their total liabilities are their deposits.
It is just like a thermometer. When one of them goes up, another
has to go down; and when the other goes up, the first has to come
down. If both assets lines go up, then both liabilities lines have to
move accordingly.
Their charge, by the preamble of the Federal Reserve Act-which
is just exactly what has happened-is to. provide elasticity to money
the public demands. At no time was it paid out because the Government wanted to pay pay rolls with Federal money, and so they took it.
It wasn't put out the way it was in the Revolution, where they put
paper money out because they didn't have any credit. It was put out
because the public wanted it and needed it, for higher pay rolls and
every other reason. The gold just happened to flow into this country,
naturally. It was the one safe haven in the world. Let us hope we
keep it that way. And the deposits are the net result. They bought
that many Governments.
If we need more deposits, if they require us to keep more deposits,
they are going to have to own more Governments. It is just as simple
as that, and there is no possible way out of it. And I am coming to
that a little later.
It is so obvious that the public may feel that the Government bond
market needs and must have that support. And there is a limit
beyond which you can't go. And then where are you?
It is like committing a murder. If you commit one, it leads to
other ones. It is dangerous ground.
To my mind, as I said, this proves that of the three ways to increase
member bank balances at the Federal, due to increased reserves, the
only practical one is to have the Federal own more United States
bonds and the banks less.
The effect of this is lower earnings for the member banks, when they
need the exact opposite, namely, higher earnings to protect their
deposits and to get back to a better than 10 percent ratio of net worth
to debt-and mind you-deposits are bank debt, and a 10 percent
margin against bank debt, namely, net worth, seems to me on the
low side, not on the high side.
When, as and if the public realizes that the result of increasing reserves is to reduce the Government bonds owned by banks and increase the Government .bonds owned by the Federal, there could
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CREDIT POLICIES
easily be a growing apprehension lest the Government bonds have to
be artificially supported in price, and that the case is so desperate that
this action had to be taken.
Now, up to date all the Federal has been doing is to buy longs, and
sell shorts. They haven't gone up any. They have merely shifted
their portfolio.
There is another point. As we banks, as. these reseives are increased, own less Governments earning money, what are we going to
do? We are going to have to start raising rates on commercial loans,
to get it back. And that will put further pressure on the Government bond market, because the interest comparison will be more out
of line again.
Representative RICH. That is right. As the rates for commercial
paper go up, naturally the bankers are going to get rid of their Governments, because they have the low rate.
Mr. ROWE. If we can get higher rates on paper, short of 1, 2, or 3
years, we will take it, as against something else.
Representative RICH. As the demand increases all over the country
by business for bank loans, naturally, the pressure is going to be to
dispose of the Governments.
Mr. ROWE. And I say that our loan total in relation to the curve of
industrial production is very low. It will be much higher. It will
have to be and should be.
Now, mind you, up to date, they have not increased their holdings
of Governments, so the public does not see Ut. The general public
does not care much about shifting maturities.
Credit is as delicate as a gossamer thread, and the slightest breath of
suspicion could cause a panic on the part of holders of Government
bonds to get out of them. The result of this form of panic could
accomplish the exact opposite of what we all desire, namely, to steadily
and persistently increase private ownership of Government bonds.
In the parlance of the investment banking profession, the digestion
of a new issue of securities takes time to accomplish.
It is not easy to offer a large corporate bond issue, and get them in
the hands of permanent investors at once, and the digestion process
goes on until-again in the parlance of the investment banker-a
specific bond issue has been well digested; well placed, and necessitous
selling can be easily matched by new investor demand.
The size of the Federal debt naturally takes longer for this digestive
process. In my opinion, they are moving from the hands of the weak
holder to the hands of the strong holder better than any of us could
dream when we contemplated, early in the period of increased Federal
debt, how it would be possible to achieve this imperative digestion.
Efforts to interfere with the natural process of this digestion can
easily work in the opposite direction. People are prone to mass
psychology, and no changes should be taken whatsoever.
As to the suggestion that banks either may or must own a percentage of Governments against deposits as an additional reserve, the
arguments mentioned immediately before this hold to an even greater
degree. The moment there is a requirement to own Governments,
there is the risk of engendering fear as to the credit of the Government.
Government bonds in the hands of the banks are constantly referred to as-monetization of the debt. Isn't the same thing true of
every single loan that banks make unless money is borrowed at one
bank in order to pay debts at another?
CREDIT POLICIES
63
The double-entry system of bookkeeping means that for every debit
there is a credit, and on consolidated balance sheets of all the banks,
when one bank makes a loan, the proceeds are promptly deposited in
other banks as the borrower pays the bills, to pay which he borrowed
the money.
When people and companies have their bills paid, they are apt to
pay bills promptly that they owe, so that obviously in due course, the
immediate monetization of debt results in larger payments of preexisting debts-so the double entry growth on both sides of the ledger
of the consolidated banks becomes a slow process.
In periods of great expansion in business activity, obviously bank
loans go up and bank deposits go up.
During the war the banks loaned money to the Government, and
created the deposits imperatively needed to take care of mounting
volume of production.
As long as production and prices call for high totals in dollars of
industrial production, batnk deposits will remain up, and bank loans
and bank holding of governments will remain up.
The judgment as to what is too much credit has to be made by each
bank.
The Federal Reserve examining authorities have plenty to do in
challenging the ability to pay of every borrower as they examine
banks, and take what they deem to be appropriate action in citicism
or in ordering charge-offs.
Now, as to the question of the necessity or responsibility of continuing support of the Government bond market and ways in which this
might be done with a minimum stimulus to undue expansion of credit:
It strikes me that the fundamental question is, whether the 12
Federal Reserve banks should be operated for and on behalf of the
member banks, who are, after all, the shareholders, or whether they
should be band in glove with the Treasury Department to assist in
the mechanical handling of renewals as Government securities mature,
or as new and additional borrowing takes place, and by supporting
the market on long maturities.
To my mind, this is an extremely serious question. We believe in
across-the-table bargaining for private business, and it strikes me that
the same rule should apply to the Government.
In other words, when the Federal is buying bonds from the Government, they ought to be on one side of the table, and the Treasury
Department on the other.
As a people, we Americans revolted from the age-old tradition of
divine right of kings; we built up this great country after the Revolution, having achieved independence, and steadily and persistently
have endeavored to eliminate special privilege, et cetera, and most of
us, I believe, have felt that we had accomplished a democratic government made up of elected representatives of the people, and that they
were not imbued with divine powers or divine rights, but were accountable to the people.
Based upon this, should it not be obvious that the prime obligation
of the Federal Reserve banks is to carry out the Federal Reserve law
as written and amended, and not take unto themselves the additional
task of serving the United States Treasury except insofar as the actual
law provides?
Section 14, paragraph 3 of the law gives the following powers to the
Federal Reserve banks:
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CREDIT POLICIES
P'URCHASE AND SALE OF OBLIGATIONS OF UNITED STATES, STATES,
ET CETERA
COUNTIES,
(b) To buy and sell, at home or abroad, bonds and securities of the United
States, bonds of the Federal Farm Mortgage Corporation having maturities from
date of purchase of not exceeding six months, bonds issued under the provisions of
subsection (c) of section 4 of the Home Owners' Loan Act of 1933, as amended,
and having maturities from date of purchase of not exceeding six months, and
bills, notes, revenue bonds, and warrants with a maturity from date of purchase
of not exceeding six months, issued in anticipiation of the collection of taxes or in
anticipation of the receipt of assured revenues by any State, county, district,
political subdivision, or municipalities in the continental United States, including
irrigation, drainage and reclamation districts, such purchases to be made in accordance with rules and regulations prescribed by the Board of Governors of the
Federal Reserve System: Provided, That any bonds, notes, or other obligations
which arc direct obligations of the United States or which are fully guaranteed by
the United States as to principal and interest may be bought and sold without
regard to maturities either in the open market or directly from or to the United
States; but all such purchases and sales shall be made in accordance with the
provisions of sect on 12A of this Act and the aggregate amount of such obligations
acquired directly from the United States which is held at any one time by the
twelve Federal Reserve banks shall not exceed $5,000,000,000.
You will note from this that great stress is placed upon not extending
maturities beyond 6 months, except in the case of United States
securities. This makes abundantly clear the recognition on the part
of the lawmakers that there are great market hazards in securities
with maturities longer than 6 months should going interest rates
change.
Well-run banks, particularly since the panic of 1929, have as deep a
fear of market risk, and the necessity of carrying securities in their
portfolio at the market, as they have of credit risks, and as one reads
published statements of banks and studies composite balance sheets
of banks, it is made abundantly clear that banks having more than
their net work in securities other than Governments are few, and
further, that they are, almost universally, afraid of having more than
a fraction of those other bonds in maturities of over 5 years.
It would seem to me obvious that what is sound policy for member
banks is sound policy for the Federal Reserve banks. In fact, inasmuch as they are the final place of recourse, should any member
bank's deposits shrink faster than they can liquidate assets, it behooves
the Federal Reserve banks to be even more careful in owning any substantial totals of bonds maturing in more than five years.
If the 12 banks which have the supervising and examining powers
over the member banks violate this principle of being careful about
market risk, will not their powers as an examining authority and the
looked-up-to adviser of member banks be seriously impaired?
For the Federal Reserve banks to own approximately five times
their net worth in Government bonds maturing over 5 years strikes
me as being packed full of inherent danger.
And that has gone up to almost six times since I wrote this paper.
The fear that United States bonds of longer maturities could sell
with any permanence at heavy discounts is based upon the thinking
that should general interest rates go up a great deal the market price
of United States Governments could go down severely. On the other
side of this picture is the fact that if the United States finances are
handled wisely, the fundamental credit of the Government will be
unimpaired.
CREDIT POLICIES
635
United States Government bonds are unquestionably the most
riskless security in the world today. They have unquestioned value
as collateral. If a customer comes into the bank to borrow money
on United States Government bonds, there can and should be no question about his being able to get the money against a reasonable margin, depending upon the maturity of the bonds.
There is an implicit belief that Government, bonds are completely
acceptable collateral at the Federal Reserve banks without question.
when member banks wish to borrow on them. This unquestioned
factor of. complete eligibility as collateral bears a close resemblance to
Government bonds which had a circulation privilege when the national banks were permitted to issue national bank notes secured by
Government bonds plus a 5 percent redemption fund or, in other
words, a 5 percent margin.
The market record of the old circulation bonds shows clearly the
premium value which this circulation privilege gave them. Government 2 percent bonds, with no maturity at all, merely a call price on
and after 1930, sold constantly through the panic of 1907 above par.
In fact, their quotation in 1907, was 106% high, low 104'8, for a 2 percent Government bond with no maturity at all, and with panic raging
and securities selling on a 6 percent basis. In 1914, they sold at a
high of 99 and a low of 97, when corporate bonds were at a substantial
discount.
The general belief that interest rates during the war were inordinately low and due entirely to the "management of the public debt"
can be severely questioned. Historically, money rates reach a peak
as a depression starts, and work lower following a panic.
A study of the open market money rates in England from 1683 to
1939 proves this point without question. Following the unsettled
conditions in the very early 1800's, open market money rates there
declined from 4.9 percent to a low of 2.3 percent by 1824. My own
belief is that the panic of 1819 in this country was worse than the
panic of 1929.
Shortly after the upset of 1837, they dropped from 6.5 percent to
2.2 percent; advanced to 7.7 percent in 1847, and declined to 2 percent
by 1852; back to 7X percent by 1857, and down to 2% percent by 1859;
up to 7 percent in 1865, and down to a low of 1.75 percent in 1867, a
fractional interest rate. And people say we have never seen a fractional interest rate, until just latterly, accomplished by money management. But it dropped sharply in England following the panic of
1907.
After the 1929 panic and the bank holiday in this country, there
was a clear indication that few people or companies wished to borrow
and the lending officers in banks, in my opinion, were in many cases
afraid to lend. There is an old adage that when money is cheap,
credit is hard to obtain-another way of saying that a burnt child
dreads the fire, and when there is little -demand for money, rates go
down.
Many people think that money rates are a state of mind. Sometimes the fish bite, and sometimes they don't.
This fear of private debt has to a great degree remained with us
through the depression and through the war. With the end of the
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CREDIT POLICIES
war, people felt that they wanted to go places. They could not buy
automobiles, refrigerators, et cetera, during the war, so that when they
could get them, they wanted them.
For many reasons it was a logical thing for interest rates to continue to get easier and easier duriog that long period dating from the
bank holiday and through the war.
Government bonds should have a substantial premium value; in
other words, sell at a lower interest rate due to their availability as
collateral, and the fact that they are practically the only riskless
investment in the world; and I feel that much too great weight is
being given on what is called the imperative necessity to sustain a
market price of par for long Government bonds.
It seems quite possible to me that an average price of par or better
for these bonds can be a natural market. In the long run, due to the
size of the total amount of the Governrnent, debt, outstanding bonds
have to take their market risk depending upon comparable prices for
other securities, and when allowance is made for the outstanding
advantages to the holder of Government bonds, when seeking credit,
they should and will sell at a much lower yield than any other security
in the world.
Representative RICH. The rates of money are based upon the same
thing as commodities, the law of supply and demand.
Mr. ROWE. It is very similar.
Representative RICH. And the rates for money are dependent
upon the law of supply and demand for loans and volume of cash
in the banks.
Mr. ROWE. Well, money isn't quite the law of supply and demand,
because by double entry bookkeeping you can supply all the money
in the world under our present system. You don't get to the bottom
of the barrel.
But the demand side is psychological, and when they want it they
pay a higher rate, and when they don't want it, is goes down.
Representative RICH. That is right.
Now, here is one thing. In that last paragraph, you say:
It seems quite possible to me that an average price of par or better for these
bonds can be a natural market.
You are figuring, then, from that standpoint, that we should not
guarantee the price of Government bonds?
Mr. RowE. Certainly. I say we should not. Unquestionably.
Representative RICH. That is right. Then, if we do not, Government bonds can, and may possibly, go below par.
Mr. ROWE. Certainly. What of it? But they may not.
Representative RICH. It might make an awful furor, but in the end
it eventually has to come to that, and it will create a little fear in
the Members of Congress.
Mr. KOWE. It will hold them down on their spending.
Representative RICH. Yes; the people are going to tell Congress
that "the first thing you people have to do is to stop your spending,
'or Government bonds may go down still further."
Mr. ROWE. Here we have the greatest borrower in history, the
United States Government. And when they attempt to restore the
price of par, all they are doing is saying, "We are going to endorse
that note."
.
CREDIT POLICIES
67
The maker offering to endorse the note! It is ridiculous.
Representative PATMAN. That argument about the law of supply
and demand applying in the case of money and credit and interest
rates is disturbing to me, in view of the fact that we have more credit
now available than ever before in history. And yet interest rates
are going up. Why would not interest rates be going down?
Mr. ROWE. Why wouldn't they?
Representative PATMAN. Yes.
Mr. ROWE. Well, the reason is that the borrower has to pay the
interest, and the borrower has to be willing to come in.
Representative PATMAN. Yes, I know. But if the law of supply
and demand operates in the case of banks and interest rates, why
should interest rates be going down now instead of the reverse? We
have three times as much volume as we ever had before, including
credit.
Mr. ROWE. Total loans at the banks, all the commercial banks of
the country, have only gone up that much [indicating], while their
total deposits have gone up that much. Percentage of borrowing to
requirements is very, very low. Loans are roughly one-third of our
earning assets, and the other two-thirds are Governments.
Representative PATMAN. What is the potential borrowing power of
the country now, unused?
Mr. ROWE. Under the Federal Reserve Act, it is practically limitless. The present ratio of gold is so liberal that we don't have to
think anything about the ceiling of the amount of available money,
should the credit require it.
Representative PATMAN. And the point that the gentleman from
Pennsylvania raised a while ago can be answered by the statement
that the Federal Reserve banks can purchase all Government bonds
now, if it were necessary.
Mr. ROWE. Yes, but there is.the other point which is very valid,
made by the gentleman from Pennsylvania, the other side to that;
that while we have this elasticity of both money and credit in our
Federal system, there is no doubt about it-and you have that elasticity, terrific elasticity-but as loans start to turn up, the lender
charges a little more interest.
Representative PATMAN. I know, but if the law of supply and
demand operates and you have more money than you ever had before,
why should they not charge more? The law of supply and demand
would necessarily cause interest rates to go down.
Mr. ROWE. Because there is a ceiling to the amount that these
banks will lend, self-imposed. They know that they can go ahead
and hit the ceiling.
Representative PATMAN. But you have not approached it.
Mr.. ROWE. I want to show that we are approaching it. I would
like to show that.
Here is your net worth of all the banks [indicating]. Now, very
few banks want to go over five times their net worth on loans. They
do not care about how much they go on short Governments because
there is no market risk, and they think they know there is no credit
risk. But a careful banker doesn't like to get his loans over five
times his net worth, or maybe six.
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CREDIT POLICIES
0
Representative PATMAN. Just one minute, in order to educate me.
What do you construe to be his net worth? His capital undivided
profits? Surplus?
Mr.
ROWE.
Yes.
Representative PATMAN. What is the total net worth of banks
now in the Nation? About 3% billion dollars? I haven't looked it
up in some time. Last time it was a little over $3,000,000,000.
Mr. ROWE. The total net worth of the commercial banks of the
country is about $10,000,000,000.
Representative PATMAN. You say capital and surplus and undivided
profits, amount to $10,000,000,000?
Mr. ROWE. Yes.
Representative PATMAN. They certainly have gone up enormously
in the past 3 years then.
Mr. ROWE. They have gone up that much [indicating on chart].
But look at what has happened to that.
Representative PATMAN. How much is the capital by itself?
Mr. ROWE. I haven't got that separated. I don't see any reason
to separate it.
Representative RICH. Capital is the surplus and undivided profits,
plus reserve for depreciation, plus capital stock paid in.
Mr. ROWE. Net worth is their margin, the margin for their depositors. And come a black panic, most of them feel that they would
like to have a 20 percent margin of their own net worth against those
loans. A 20 percent margin is five times your loans, five times your
net worth.
, Representative PATMAN. You have about 10 percent margin now,
do you not?
Mr. ROWE. No; in the aggregate I imagine we have better than
10 percent; toward 15.
RepresentativePATMAN. Of course) I do not dispute your figures.
I am sure you know exactly what you are talking about, and I do not.
But that seems awfully large to me for capital and surplus and undivided profits, just those three items, of the commercial banks.
Mr. ROWE. Weh, they have total deposits of $144,000,000,000.
Representative PATMAN. I am not talking about deposits.
Mr. ROWE. But they owe $144,000,000,000, and they haVen't got
a 10 per cent margin on it, of their own net worth. And I say that
they should have at least 10 percent of their debts.
Representative PATMAN. I will thoroughly agree with you on that.
War. ROWE. They should have at least 10 percent of their debts on
their net worth. And they only have 10. It ought to be another
4 at least.
Representative PATMAN. Do you have the amount of capital of all
of the commercial banks available?
Mr. C. 0. HARDY (staff director). I do not have it here. I can
check it.
Representative PATMAN. Excuse me for interrupting.! But I still
cannot understand why we have three times as much money, and yet
the interest rates are going up.
Mr. ROWE. Well, they have gone up so very little.
Representative PATMAN. Why should they go up at all? It looks
to me like they should go down a little bit.
CREDIT POLICIES
69.
Mr. ROWE. Money is to a great extent a psychological thing.
There used to be an old adage that when the borrower came in to
borrow money with his hat on his head and a cigar in his mouth, rates
were very low. When he came in with his hat off and threw his
cigar away before he came in, rates were very high.
That merely emphasizes that there is a psychology in it, a state of
mind.
Representative PATMAN. In other words, psychology enters into it
more than the law of supply and demand.
Mr. ROWE. They are both factors. The law of supply and demand
affects the psychology, so you can't say which is paramount, because
one affects the other. But to my mind, in the first place, all the
banks have had to raise their wages to keep in line with everybody.
else. Costs are up. And we have so far accomplished the magnificent achievement, many banks have, of raising from 1% percent on
6 months paper to I /4. That is the extent of it on the short paper.
But the very minute these loans creep up, so that they approach, or
are more than five times your capital account, the banks are not going
to be quite so ready to lend, and will charge more money.
REPRESENTATIVE RICH. The demand in business today is for more
money from the banks.
Mr. ROWE. No question of it.
Mr. RICH. And the banks are asking higher interest rates for the
use of that money. And as they are doing that, they are getting rid
of their Government securities, because they have invested heavily
in them. And it is up to the Federal Reserve now to take them. If
the Federal Reserve does not take them, I do not know who will.
Representative PATMAN. I think we should say, then, that the law
of supply and demand does not operate in the banking system.
Representative RICH. Were you ever in a bank?
Representative PATMAN. I have been a borrower. I have been on
the other end.
Representative RICH. Then you do not know anything about it.
Representative PATMAN. The law of supply and demand cannot
operate, then, if you have three times as much money with interest
rates going up.
What would you think about having three times as much wheat,
and wheat going up?
Representative RICH. Well, I never took wheat for collateral.
Representative PATMAN. I will ask the gentleman if he was ever in
a wheat field.
Mr. ROWE. Income is up three times, or a little more,. and so is
industrial production, though not quite so much. And the requirements for loans, we know, will be very much higher. We have been
held down so, with wages and low interest, that the capital accounts
have not increased the way they should have.
. In other words, your net worth, your base of your business, ought
to grow with your-deposits. And we have these huge deposits. We
still remember 1929. And we are going to keep our assets liquid, we
banks. That is the firm conviction of every banker. And his feeling
is that the most liquid asset he has got are his Government bonds.
Now, the statistics on the Government bonds are clouded by the
fact that the Government borrowed a great deal more than they
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CREDIT POLICIES
needed in the final war loan drive, left the money on deposit with
banks, and later retired other debt. So that statistically, the great
height of the Federal debt, and this magnificient lowering of it is a
fact, and is statistically accurate.
But actually, the last 20 billions, or whatever it was, should not
have been counted. Because they did not use it, and they repaid it
promptly.
Representative PATMAN. That is when we had a balance in the
Treasury of about $20,000,000,000-odd, was it not?
Mr. ROWE. Yes; in the final bond drive the public bought the long
bonds, to a much greater degree than everybody expected. They
felt the war was over and this was the last drive, and they could buy
those bonds, and a 23-percent market was assured. They were
pleased with the market level. They had been careful of the long
bonds before that.
The bankers and the Treasury Department, in my opinion, were
just as much amazed when those bonds jumped up to a 104-point
premium a few weeks after the end of the final bond drive as they
could be. The public took hold of that bait, and ran for it, and ran
them up to 104.
Representative RICH. And the reason today that the short-term
bonds are selling at a premium, and the long-term bonds can be
bought at par, is that the bankers now are waiting for commercial
loans to come in, so that they can pick up a higher interest rate to
increase their capital and surplus. They will sell governments.
Mr. ROWE. I do not know that the banks are delaying on their
holdings of Governments.
Representative RICH. Well, they are trying to have short-term
Governments rather than long-term Governments.
Mr. ROWE. Yes; because they appreciate, again, that the market
risk on their Governments has been demonstrated by the rapid decline
in quotation, and the terrific decline in municipal bonds.
Representative RICH. The reason the bankers want short-term
Governments is so that he can turn them into cash and get rid of his
obligation, and get increased interest rates from commercial borrowers. I know that is what we are trying to do in our bank, and I am
sure that we are only taught by some of you bigger bankers that that
is the way to do business.
Mr. ROWE. You want liquidity.
Representative HUBER. Are you a banker, Mr. Rich?
Representative RICH. Oh, in a small way.
Representative PATMAN. If you had complete liquidity, you would
not have much of a banking system, would you?
Mr. ROWE. Our deposits are payable on demand. Our reserve in
the Federal Reserve Bank cannot be withdrawn. We must keep a
certain fixed amount. We can dip below for a day or so, but it is
necessary to pay a penalty if it lasts for any length of time. So it is
absolutely frozen. Our real reserves for all of us are our accounts we
keep with larger banks. That is what we check on, and that is what
has a flexibility. And we have to hold, in addition to our reserve
balance with the Federal Reserve, I think it is fair to say, at least
half again as much on deposit with larger banks.
So that we have a large amount of nonearning assets. That is our
first line of defense for liquidity, for fluctuation in deposits.
CREDIT POLICIES
71
Representative PATMAN. But you do not hope to obtain complete
liquidity, do you?
Mr. ROWE. Certainly not.
Representative PATMAN. That was the question that was raised
here a while ago.
Mr. ROWE. Certainly not.
Representative PATMAN. That would destroy you.
Mr.
ROWE.
It is my judgment that the Federal Rleserve banks
should let the market take care of itself slowly and persistently over
the years, reduce the total of long bonds they own and replace them
with shorter maturities, in order to keep the reserve balances of their
member banks on an even keel.
The underlying purpose of the Federal Reserve Act was to provide
both elasticity to currency and elasticity to credit, and the mechanism
of the Federal Reserve bank, simple as it is, under existing laws can
easily accomplish that result. They merely have to have in their
assets a total of gold, Governments and bank borrowings against the
required total of currency in circulation and required reserves for their
members, with their net worth total included in these liabilities.
Now as to the net worth total, recently the earnings above dividends
have been withdrawn from the banks and paid to the United States
Government.
Representative PATMAN. Let me ask you a question there, Mr.
Rowe. You state that the Federal Reserve banks have, as a part of
their assets, gold. You mean gold certificates, do you not?
Mr. ROWE. Oh, yes. But after all the public think they own that
gold, so I call it gold just for the sake of brevity.
Representative PATMAN. Excuse me.
Mr. ROWE. Section 7, paragraph 3 of the Federal Reserve Act is as
follows:
EXEMPTION FROM TAXATION
Federal Reserve banks, including the capital stock and surplus therein, and the
income derived therefrom shall be exempt from Federal, State, and local taxation,
except taxes upon real estate.
Section 7, paragraph 1, of the Federal Reserve Act is as follows:
DIVIDENDS AND SURPLUS FUND OF RESERVE BANKS
After all necessary expenses of a Federal Reserve bank shall have been paid or
provided for, the stockholders shall be entitled to receive an annual dividend of
6 per centum on the paid-in capital stock, which dividend shall be cumulative.
After the aforesaid dividend claims have been fully met, the net earnings shall be
paid into the surplus fund of the Federal Reserve bank.
These two paragraph seem to me to say that the Federal Reserve
banks were expected to build up their capital and surplus over and
above the limited dividends authorized to member bank stockholders,
and that they should do just what the member banks should do,
namely, keep their net worth in proper and suitable proportion to
their total balance sheet.
Representative PATMAN. What is the net worth of the 12 Federal
M
Reserve banks?
Mr. ROWE. About a billion dollars, $750,000,000 to a billion dollars.
Representative RIcH. Has the Federal Reserve paid into the
Federal Treasury any part of its earnings?
Mr. ROWE. The Federal Treasury took its earnings for last year.
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CREDIT POLICIES
Representative PATMAN. There is no law requiring it now. That
law was repealed.
Mr. ROWE. Then, what right did the directors of the Federal
Reserve bank have to pay that money over?
Representative PATMAN. Because in the original act, the purpose
as there set forth is to render certain services and accommodations; and
the rest of it is intended for compensation for the Government.
Originally the law specifically provided a certain amount, and it
was provided that when the capital reached a certain amount, it
would overflow back into the Treasury. Later that law was repealed.
I think that was in 1935. And although it has been repealed, the
earnings of the banks have been so large that they have voluntarily
relinquished their earnings, or have paid them over into the Treasury
of the United States; I mean, in excess of a certain amount.
Mr. ROWE. May I ask you a question? How do you reconcile that
with this statement in the law that after the aforesaid dividend claims
have been fully met, the net earnings should be paid into the surplus
fund of the Federal Reserve bank?
Representative PATMAN. The law provides that above a certain
point it would go over into the Treasury. At one time the law was
that 40 percent should be. paid over, and then it was increased to
100 percent.
Mr. ROWE. This clause, section 7, paragraph 1, of the Federal
Reserve Act, says:
After all necessary expenses of a Federal Reserve bank shall haye been paid or
provided for, the stockholders shall be entitled to receive an annual dividend
of 6 percent on the paid-in capital stock, which dividend shall be cumulative.
After the aforesaid dividend claims have been fully met, the net earnings shall
be paid into the surplus fund of the Federal Reserve bank.
Representative PATMAN. That is right.
Mr. ROWE. It does not say anything about taking it out.
Representative PATMAN. I think you will find a limitation there.
Mr. ROWE. Let me go on for just a minute. There is a double
liability on the shares of the Federal Reserve bank.
Representative PATAIAN. They have not paid but half of it so far,
though.
Mr. ROWE. They have paid half of it; so that they could be called
upon for the other half. They could be called upon for the full
amount, the old half plus the new half.
Representative PATMAN. You do not expect that to be done, do
you, in view of the fact that the Government credit is behind those
banks?
Mr. ROWE. I most certainly do anticipate it if we continue to
go along with as reckless spending on the part of the Government as
we have been having over the next decade or so.
Representative PATMAN. The credit of the Nation is behind those
banks.
Mr. ROWE. All I am saying is that the credit of the Nation is
something that has to be guarded. And we have taken plenty of
risks with that credit.
Representative PATMAN. I will agree with you. That is the reason
I voted against that tax bill.
Mr. ROWE. Personally, I can find nothing in that law that leads
me to believe thay have the moral right to pay those earnings out
CREDIT POLICIES
73
instead of leaving them in the surplus fund of the Federal Reserve
banks, particularly due to the double liability clause on us stockholders.
Representative RICH. You might ask some of these Members of
Congress about their voting for all of this spending.
Representative HUBER. Is there any reckless spending today?
Representative RICH. Certainly. Lots of it in Government.
Representative HUBER. I am asking Mr. Rowe.
Mr. ROWE. I cannot help but feel that the growth in the total
number of people in the Federal pay roll today, versus 1940, or any
year you want to take, is to me simply unexplainable, and unbelievable.
Representative HUBER. We will call that to the attention of Mr.
Taber and IVlr. Bridges, who have been going over these things with
a fine-tooth comb.
Representative RICH. I might tell you that Mr. Taber is doing a
great and yeoman job. The only trouble with Mr. Taber is that he
is unable to do the thing that the executive department of the Government is supposed to do. And he has no control over that. And you
are not going to get any relief until you change the executive branch
of the Government and those who are supporting it.
Representative HUBER. Of course, the executive branch is spending
the money appropriated by Congress.
Senator WATKINS (presiding). Shall we let the witness finish his
statement?
Senator O'MAHONEY. May I ask the witness if he has made any
study of spending by State governments?
Mr. ROWE. Only broadly.
Senator O'MAHONEY. I think that is one of our great oversights.
Now, the fact of the matter is that the budgets of the States have
been growing more rapidly, even, proportionately, I think, than the
budgets of the Federal Government.
For example, the State of New York this year presented the largest
budget in history, and it happens that that budget was presented by
a gentleman who is one of the leading and outstanding members of
the party which denounces spending in the Federal Government.
I find that the budget of the State of California for this year is the
largest budget in history. And again, the gentleman who presented
that budget is an outstanding and a very efficient member of the same
political party that denounces Federal spending. And if I am not
mistaken, an examination of the budget of the State of Minnesota
also indicates that it is the biggest in history.
Representative HUBER. Will the Senator yield there; and include
Pennsylvania?
Senator O'MAHONEY. I have no doubt. And Ohio.
Representative RICH. Will the gentleman yield?
Senator O'MAHONEY. Certainly.
Representative RICH. Do you not know that every State in the
Union is in better financial condition than the Federal Government?
And do you not realize that all of the spending that is to be done
ought to go back to the States and be dropped here in Washington?
You ought to study that a little.
Senator O'MAHONEY. That is one of the reasons, Congressman
Rich, why I also, like Congressman Patman, was against throwing
away the surplus which the Federal Government had, and which it
might have applied on the reduction of the national debt.
74
'CREDIT POLICIES
Representative RICH. You have never voted as you talk now.
Representative PATMAN. Of course, the Federal Government bailed
out the States a few years ago, too.
Senator WATKINS. Let us let the witness finish his statement.
You may proceed.
Mr. ROWE. I again call your attention to the charts which show
the growth of member banks net worth from 1935 to 1947, and ask
you to contrast it with the totals for the Federal Reserve System as
to net worth in proportion to its balance sheet: The withdrawal of
earnings from the Federal Reserve bank to the United States Treasury
seems to me of more than doubtful propriety. Federal Reserve banks
are the keystone of the credit position of the banks of this Nation.
In my opinion, great stress should be placed upon building up the
net worth of the member banks and of the Federal Reserve banks,
and that is an essential and the objective we all have, namely, to
keep our whcle financial structure in this country on a completely
sound basis so that the risk of the impairment of credit is reduced,
so far as possible, to a minimum.
Representative PATMAN. I would like to ask a question or two, on
that last paragraph.
Senator
WATKINS. YOU may.
Representative PATMAN. The money that is issued, about seveneighths of it now, is Federal Reserve notes, is it not, Mr. Rowe?
Mr. Rowe. Yes, sir.
Representative PATMAN. That is the circulating medium of exchange. Now, these Federal Reserve notes are issued by the 12
Federal Reserve banks, are they not?
Mr. ROWE. I think they gave that up.
Representative PATMAN. Well, look at one of them and read it.
That Federal Reserve note does not say it is an obligation of the
Federal Reserve bank. It says the "United States of America"
promises to pay to the bearer. And since that is, you might say, a
blanket mortgage against all the property of all the people, including
their incomes, do you not think that the Government is entitled to
just a little compensation for the use of that privilege?
Mr. ROWE. This says "Federal Reserve note."
Representative PATMAN. Now, read the rest of it.
Mr. ROWE. They are all alike, except that they have ar imprint
of Cleveland or Jackson, or what have you, on them. This says:
This note is legal tender for all debts, public and private, and is redeemable in
lawful money at the United States Treasury, or at any Federal Reserve bank.
Representative PATMAN. Read all of it. Read where it says, "The
United States of America will pay to the bearer."
Mr. ROWE. It says, "Federal Reserve note, United States of
America."
Representative PATMAN. Read it just like it is, unbroken, if you
please.
Mr. ROWE. Well, it is broken on the note: "The United States of
America," is the fancy part at the top.
Representative PATMAN. That is right. That is the first of it.
Mr. ROWE. And down here, it says, "Will pay to the bearer on
demand twenty dollars."
Representative PATMAN. Now, you see, that is an obligation not
of the Federal Reserve bank that issued that, but an obligation of the
people, of the United States Government.
CREDIT POLICIES
75
Now, since the United States Government is permitting that great
privilege to be used by the banks, do you not think the United States
Government should at least collect just a small bit of compensation
for its use?
Mr. ROWE. I most certainly do not, for this reason: The Federal
Reserve banks have gold in their vaults.
Representative PATMAN. How did they get that gold? They
passed laws to make people turn it in.
Senator WATKINS. Let him finish,' please.
Mr. ROWE. The people turned in their gold and were given paper
money.
Representative PATMAN. But they were compelled to by law.
Do you think the law should compel people to help the private banks?
Mr. ROWE. How is the Federal.Reserve bank making any money
whatsoever on converting the gold, which.used to be in the hands of
the public into paper money?
Representative PATMAN. That is the basis of credit, and the
Federal Reserve banks are privileged to use that basis of credit.
Now, criminal laws were passed compelling people to turn that
gold in. And certainly you could not insist that was turned in for the
exclusive benefit of the private banks, Mr. Rowe. That is going
too far.
Mr. ROWE. You are speaking as though the Federal was given a
specific privilege, when all they did was to supply the public with
paper money and be a warehouse for the gold. Later, the warehousing was taken away from them, and the gold was put in a safer.
place, or so it was deemed.
-But there is nothing in the law that contemplated the withdrawal
of earnings from the banks to the Federal Government.
Representative PATMAN. Nothing in the law that does what?
Mr. ROWE. That contemplated the withdrawal of earnings from
the Federal Reserve banks.
Representative PATMAN. In the original act, Mr. Rowe, it was
very plain.
Mr. ROWE. But it is not, as amended now. I am talking of the act
as amended. .
Representative PATMAN. But the very act itself contemplates it.
Otherwise it would be wrong for Members of Congress to vote for laws
putting people in the penitentiary if necessary, to compel them to turn
in their gold to private banking institutions, or for their use. You
know, that would be a terrible position to put Members of Congress in.
They voted for that law on the theory that it was helping the United
States Government.
And when the Federal Reserve banks make this issue on the credit
of the Nation, the Nation is entitled to some compensation.
Representative RICn. Mr. Rowe, if I remember correctly, this gold
that was taken, was taken by Executive order, and the power was
turned over to the Chief Executive, and you know who that was.
And he took all the gold from everybody.
Representative PATMAN. I know, but laws were passed later which
doubtless the gentleman voted for.
Representative -RICH.. That . was when you gave that power. I
voted against the President having such power.
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CREDIT POLICIES
Representative PATMAN. But that was recognizing the Executive
order, showing it was right. And that required people to turn their
gold in.
Mr. ROWE. It doesn't seem to me very logical for the Federal Reserve banks to think that they are making any money on having replaced the gold that was the circulating medium of the country, with
paper money. They did not make a dime on the transaction. They
make no money on that. They are making their money on their
deposits, with which they can have earning assets.
Representative PATMAN. You mean the Federal Reserve banks?
Mr. ROWE. Federal Reserve banks.
Representative PATMAN. They do double duty, do they not? You
use them, and the Federal Reserve banks use them
Mr. ROWE. We don't use them.
Representative PATMAN. YOU can use them. They are double-duty
reserves. The deposits you put into the Federal Reserve System, you
get credit for. You can use them.
Mr. ROWE. How do we use them?
Representative PATMAN. Well, by expanding your loans; by having
the reserves in your local Federal Reserve bank. You know more
about that than I do.
But this is what I cannot understand. I believe in the private banks.
I believe in the commercial banks of this country. I -am proud that
we have a wonderful banking system. We want to encourage it. We
do not want to do anything against it. What I cannot understand is
why you insist that the Government cannot have anything out of the
Federal Reserve System when the banks themselves only have an investment of about $150,000,000, about 3 percent.
'
They paid 3 percent out of six. Well, let us say you have $200,000,000. How can you say you own the Federal Reserve Banking System,
.that issues money upon the credit of the Nation, and has already
outstanding liabilities of $47,000,000,000; which shows that the amount
the banks have in certainly is insignificant by comparison.
It is certainly not enough to support $47,000,000,000. It is insignificant. It is practically nothing. And I cannot understand why
you would say that the banks should run the Federal Reserve System
-and should own it, with that very small ownership.
Mr. ROWE. Here is the balance sheet, the way the member banks
make up theirs. You see here this $197,000,000 of capital.
Representative PATMAN. That is all the commercial banks have
invested?
Mr. ROWE. That is all we have invested. And if we were called
upon to put in the other-Representative PATMAN. But you will never be called upon. The
Federal Reserve banks have to pay 6 percent on.that. Why should
they be asking for more to pay 6 percent on? You will never be called
upon for it.
* Mr. ROWE. That may be. I do not know whether we will be or not.
But it is an obligation of ours to pay that in.
Representative PATMAN. But you are not shuddering under that
obligation, because there is no danger. The Government is behind
you.
Mr. ROWE. I am concerned about the attitude that the Government can do no wrong, and the Government's credit will remain
unimpaired forever.
CREDIT POLICIES
77
Representative PATMAN. I am concerned with anyone having that
attitude, too.
Mr. ROWE. I am terribly bothered by it. Now, the total net worth
of this balance sheet would have as low as $700,000,000 of net worth.
As compared with the $48,000,000,000, that, to my mind, is too small
a margin for any operation.
Representative RICH. Mvlay I ask you this question: Suppose the
Federal Reserve bank carries all of the bonds that the banks present
for them to carry, and they take them over. And then, supposing
the Government bonds go below par. Of course, naturally, everybody says that you carry them at par whether they are below par or
not. That way, they could keep solvent.
But if anything happened, and they were supposed to carry them
at market value, the Federal Reserve would be wiped out almost
overnight.
Mr. ROWE. Careful banks certainly expect to carry their Governments at cost, or market, whichever is lower, and continue to be able
to do that.
Representative PATMAN. That is where it is above par. But, of
course, at one time during the depression they were allowed to carry
them at par, although they were below par, were they not, Mr. Rowe.
Mr. ROWE. They were allowed to.
Representative PATMAN. That is what I mean; yes.
Mr. ROWE. But the depositor, who chooses which bank he is going
to keep a very large sum of money in, is going to a bank that is able
to carry his securities at the market. In other words, we do not care
what the Government lets us do in the way of appraising assets above
market value. Competition is going to drive the deposits to the
banks that were strong enough to mark down the market.
Representative PATMAN. Especially when you go above $5,000?
Representative RICH. Anybody in the banking or mercantile or
any other kind of business carries them at cost or lower, whichever is
the lower.
Mr. ROWE. Certainly.
Representative RICH. Always. That is only sound business.
Mr. ROWE. But the point I am trying to make is that in my judgment, rather than use this capital surplus, it should grow and grow
and get into tVis column [indicating].
Representati e PATMAN. But you wanted to grow, Mr. Rowe, on
the earnings of the Government. The banks are not proposing to
increase that amount. You are not proposing to put any more
money in it.
Mr. ROWE. We are perfectly willing, if we are asked to.
I am perfectly certain they do not want to ask us, because they
don't want to pay the 6 percent.
Representative PATMAN. But the point I make is that your investment there is so small that it is insignificant. It is practically nothing.
And you are not operating on that capital. You are operating on
the credit of the Nation. That is what you are operating on. You
are operating on the ability of the people to pay taxes.
Mr. ROWE. Why, it seems to me that you are saying that after the
Federal Reserve buys Government bonds, and has earnings, then,
over and above its normal operating expenses, that money, derived
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78
CREDIT POLICIES
practically solely from Government coupons, has to be paid back to
the Government.
Representative PATMAN. Why certainly, and for this reason: a
government obligation for a government obligation. In other words,
the Government bond is put over into the Federal Reserve bank.
The money that is paid out on it is also an obligation of the Government, and not the Federal Reserve bank.
Mr. ROWE. Do you want me to carry on for a minute?
Representative PATMAN. Certainly. It is all right with me.
Mr. ROWE. It seems to me that you are putting your finger on the
fundamental difference of opinion. This country feared a central
bank. The row over the renewal of the charter of the First Bank
of the United States, and then the terrific row under President Jackson on the renewal of the charter of the Second National Bank is
sufficient to indicate that the people were afraid of a crushing monopoly
in the banking business, and they would not renew those charters.
When the Federal Reserve Act came along, the whole talk was as to
12 Federal Reserve banks; not one single word about a central bank.
The growth of the thought of turning it into a central bank has all
come since the New Deal era.
The conception in this country was one of 12 separate banks, with
a Central Federal Reserve Board; but always 12 separate banks. It
was not until long afterward that the power and authority of each
separate bank to invest.its own money as it saw fit was taken away,
.and the open market committee created.
If anybody feels that the central banks of the world have done a
great job, look at the Bank of England and look at the Bank of
Germany. And look at the Bank of France. The moment the
banking and the emission of currency become the complete creature
of the Government and the Government takes to wasteful spending,
your whole credit structure will go down, and go down like a plummet.
Representative PATMAN. But Mr. Rowe, you seem to think it is all
right for the Government to issue money on the credit of the Nation,
but let the banks have the benefit of it.
Take this district here, which is in the Richmond Federal Reserve
area. All ri ht. . Suppose the Government sells the Richmond bank
a million dollars in Government bonds. The Richmond bank pays
the Treasury, up here, a million dollars. In what? In other Government obligations.
Mr. ROWE. No. I beg your pardon. They give them a check.
Representative PATMAN. I know. But they could get the money
if they wanted it. The check is as good as money. And if you carried it to its logical conclusion, the money they use is Federal Reserve
notes. And that Federal Reserve note is a Government obligation.
If that was an obligation of the bank, your argument would be
logical and reasonable, but since the Government's own money, and,
the Government's own obligation are being used, why should not that
money flow back into the Treasury, as to any excess?
Mr. 'ROWE. I don't see how you can say this is an obligation of the
Federal Reserve banks.
Representative PATMAN. No, it is an obligation of the United
States Government. Just read that at the.top of the bill. It says
"The United States of America," and not "The Federal Reserve
Banks."
CREDIT POLICIES
79
Mr. ROWE. Then why is it on their balance sheets as a liability?
Senator WATKINS. It is a joint obligation. is it not?
Mr. RowE. I don't think it is a joint obligation at all. I think
"The United States of America," on there ispure scenery.
Representative RICH. I have listened to them for 10 years, and I
have not been able to understand them yet.
Representative HUBER. I am surprised that a banker would complain of the New Deal banking program, because as I remember the
bankers were not getting along so well up until the New Deal.
Representative PATMAN. And they have not had a failure in the
last 10 years.
Representative HUBER. And I believe you were one of the proposers
of that.
Representative PATMAN. I was one of the proposers of the Federal
Deposit Insurance Law.
Mr. ROWE. I was one of those who felt that that was a great mistake and we should not have it.
Representative HUBER. Again, we have two philosophies.
Representative RICH. Just a difference of opinion.
Senator NNATKINS. If this debate has been going on for 10 years, I
am sure we are not going to finish it today.
Are there any other questions?
Representative HUBER. I have one brief question.
As I see it, the commodity in which a bank deals is dollars. In
effect, you rent out dollars to those who return-them in good shape,
plus some interest: Why, if you reduce the price of borrowing these
dollars, would not that line change a little bit? There would be some
more incentive for people to borrow money at a lower interest rate,
and would not those lines come closer together on your chart?
Mr. ROWE. I doubt very much whether the interest rate affects the
amount, or the desire to borrow at all. Companies borrow because
they need the money.
Representative PATMAN. And they cannot sell bonds or stocks.
Mr. ROWE. And the markets for equity money are not favorable.
Representative PATMAN. Yes. That is right.
Mr. ROWE. The individual fears debt, but when he has to borrow,
he borrows to have a home, and what have you. The corporation
treasurer wants to get the lowest going rate. He wants to do as good
a job for his company as the corporation of the same size and same
quality does. So that when the borrowers borrow, they pay what
they have to pay. And the costs of banks have gone up very sharply.
We all realize that our net worth in proportion to our total deposits
isn't as big as it should be.
Also, competition holds the rates down too. We can't raise them.
If a man can borrow at another bank cheaper than be can borrow at
the first bank, he will go where he can get it cheaper.
It isn't as though there were any super group fixing the rates. The
rates are fixed by every bank separately. There are some country
banks that lend nothing under 5 percent.
That is a fair statement, is it not?
Representative RICH. That is right, many of them 6 percent.
Mr. ROWE. Many of them 6 percent.
In the early days, money could be 3 percent, or 23/ in New York,
and 7 or 8 in San Francisco, before the Federal Reserve System came
along, and helped to unify and make a better clearance for money.
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CREDIT POLICIES
Representative PATMAN. You favor the Federal Reserve System,
do you not?
Mr. ROWE. Oh, definitely. I want it lived up to; not given more
powers. I want the powers they have exercised better. I am not
criticizing them. I say they have done a much better bank examining
job, but that I hope it will continue to get better.
The strength of this Nation is inevitably bound up with this. The
bank panic of 1929 shows that we are terriblv intertwined. I am
speaking for a stronger Federal Reserve bank, with a building up of
capital. There should be no extension of powers. There is no necessity for member banks to keep a larger idle balance with the Federal
Reserve bank. There is no need for it. It will simply mean we will
then own less Governments, and they will own more, and we will then
have to fight for higher rates of interest, because we have to make up
for that loss of earning power that will have happened by losing some
earning-assets, Governments, which is the only thing we can move
into the Federal stream to create the additional reserves that they
are talking about.
I am pleading for a strong Federal Reserve System with adequate
net worth shown on its books in proportion to its liabilities, and for
a strong banking system, with the member banks of this great Federal
Reserve System given an opportunity to build up their own net worth
and value their own assets more and more conservatively in the next
depression.
Representative RICH. So that in the time when the banks of the
country need the bonds, the Federal Reserve will not tighten up on
member banks, but open up and pour the money back into the banks
for the assets which they hold, if they want to deposit them with the
Federal Reserve for additional capital. That only makes for strong
banks as well as a strong Federal Reserve.
Mr. ROWE. If I may add just one thing. The Federal Reserve
System has republished the booklet, The Federal Reserve System,
Its Purposes and Functions, and they start out with a foreword:
"Central banking is essential to the economic stability and progress
of any modern country."
That is a flat statement. I doesn't seem to me that the Central
Bank of France, or the Central Bank of Germany, or the Bank of
England has done any outstanding job. To say that that is essential
to the economic stability and progress of any modern country, I
think, IS laughable.
Representative RICH. It does not look that way, when they are all
coming over here and asking us to pour the money back into these
countries. And we have been nuts enough to pour it into those
countries and tax our people as we do.
Mr. ROWE. And I don't think that we are a central bank, actually,
as the British would call it.
Representative PATMAN. I think you are just playing on words.
I say that with. all due respect, Mr. Rowe, but I do not think it
means exactly what they had in England, or in France, or in Germany.
We do have a central banking system, not one bank, but a coordinated
banking system. We have 12 Federal banks serving different areas
of the country, and there is coordination through a Federal Reserve
Board. And to that extent you could call it a central banking system,
because the money comes from one central place, that money that
CREDIT POLICIES
81
you read was owing a while ago. That comes from one place, the
Bureau of Engraving and Printing; and to that extent it is a Federal
banking system.
Mr. ROWE. Give me one further minute here.
Chapter 1 is entitled "Purpose of the Federal Reserve System."
This follows, in italics:
The principal purpose of the Federal Reserve is to regulate the supply, availability and cost of money with a view to contributing to the maintenance of a
high level of employment, stable values, and a rising standard of living.
Contrast that with the preamble to the Federal Reserve Act.
Representative PATMAN. You are in a dispute with the Federal
Reserve Board now, and not with this committee. Because the
language that they used, the phrases they used-Mr. ROWE. I am simply urging that there be a better knowledge on
the part of the public of what our Federal Reserve System really is,
rather than what somebody thinks it is.
Representative HuBER. The public generally think that the Federal
Reserve System is a Government agency.
Mr. ROWE. They generally do.
Now, I just want to read the preamble of the act:
An act to provide for the establishment of Federal Reserve banks, to furnish an
elastic currency, to afford means of rediscounting commercial paper, to establish
a more effective supervision of banking in the United States, and for other purposes.
Representative PATMAN. Pretty well expressed, is it not?
Mr. ROWE. Very well expressed; and quite different from this
opening preamble of this pamphlet.
Representative PATMAN. You could enlarge upon it by saying that
these 12 Federal Reserve banks will have a coordinating agency here
in Washington; which they have. And they get their money from
one source.
Senator O'MAHONEY. I read with very much interest the paper
which you have presented here; and I have listened too, to your
answers to various questions.
I gather that your position is that the Government should allow
the banks to run the banking business; that the separate Federal
Reserve banks should have the largest possible amount of autonomy,
without direction by the Reserve Board; that the System should not
be used to support Government bonds; and that the operations of the
Federal Government should be reduced to a minimum. Is that right?
Mr. ROWE. The operations of the Federal Government?
Senator O'MAHoNEY. The operations of the Federal Government.
When you speak of reckless spending, and of sound financing, do you
not mean the abandonment by the Federal Government of various
enterprises of various kinds into which it has entered in recent years?
Mr. ROWE. I certainly do; a trend downward, instead of constantly
broadening the sphere.
Senator O'M\AHONEY. So that it boils down to this: You would like
to see the Government get out of banking as far as is possible and
get out of all forms of business as far as possible, and allow this
matter to be handled by the people.
Mr. ROWE. That is right.
Senator O'MAHONEY. Now, I ask if that does not involve an
assumption that the people themselves, in their individual capacities,
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CREDIT POLICIES
could do this? When you speak of the several Federal Reserve banks
handling the banking business without too much direction from the
Reserve Board, you are thinking of decentralization, are you not?
Mr. ROWE. Yes.
Senator O'MAHONEY. And you feel that the largest amount of
decentralization would be good for the country, do you not?
Mr. ROWE. Yes.
Senator O'MAHONEY. I agree with you in that. But I ask you
how it is possible for us to decentralize the Government when we are
confronted with a stupendous concentration of economic control over
the business of the country, and of the people.
Mr. ROWE. Through existing Government agencies?
Senator O'MAHONEY. No; concentration through private management. That, I think, Mr. Rowe, is the cause of all this concentration
that you speak of.
Now, let me give you an example, or let me ask one or two questions.
When you speak as you do here on page 12, I want to tell you my
understanding of your language. And let me read for you the paragraph at the top of page 12:
The fear that United States bonds of longer maturities could sell with any
permanence at heavy discounts, is based upon the thinking that should general
interest rates go up a great deal, the market price of United States Governments
could go down severly. On the other side of this picture is the fact that if the
United States finances are handled wisely, the fundamental credit of the Government will be unimpaired.
Now, I take that to mean that you acknowledge that if bonds of
long maturities were selling at heavy discounts for any length of time,
the market price of those bonds would go down severely. And therefore, you say the way to prevent that is to have Government finances
handled wisely.
And that I take to mean that you would like to have the Government abandon the activities which were undertaken, from your point
of view, when the New Deal began. Is that right?
Mr. ROWE. Well, I don't mean for a minute to say that there
haven't been some very real advances in Government thinking. I
do feel that the total amount of Government bureaus, and the right
to rule, to make laws by proclamation, the giving or powers to make
rules and regulations which become law, have gone very much too far.
Senator O'MAHONEY. I agree with that. I have said that on
numerous occasions.
But when we talk about Government spending, let me ask you, for
example:
Do you believe that the Federal Government should undertake
Federal aid to education in the States?
Mr. ROWE. I think, of course, States' rights should be preserved
much more than the-y have been, and that there are certain fields
where the States could take care of themselves, given ability to get
their fair share of taxes.
Senator O'MAHONEY. Yes. But I am talking now about the terms
of your statement here, about wise Government financing.
Now, this is the picture which we have. Up here in the Senate
today, sir, the Senate has passed a bill for Federal aid to education,
which will provide for an outlay of at least $300,000,000 a year, to
aid the States to maintain education. And that aid is based upon a
payment of not less than $5 per head, even to the States which have
CREDIT POLICIES
83
such good credit that they can maintain their educational systems
without aid:
Now, that bill was passed by this Senate.
Up on the floor now, we have the Taft-Wagner-Ellender bill, which
provides for public housing, and the investment of Federal funds in
housing.
Now, that bill is supported, as the names of the sponsors indicate, by
members of both parties. It is Government spending.
MV~r. ROWE. All I can say to that is that I do not feel I am at all
confident that the study I have made would permit me to say how I
would vote on half a dozen bills that are pending.
v
Senator O'MlAHONEY. Then you would say to Senator Watkins and
myself that you would not undertake to pledge yourself now to vote
against Federal legislation for, say, the irrigation of arid lands in the
West.
Mr. ROWE. My inclination would be to vote against any extension
of Federal powers. In any matter of that kind, I would have to fight
with myself to keep an open mind on the merits of the case.
Senator O'MAHONEY. And what would you say with respect to the
recommendations for Federal spending to control floods? And what
particularly would you say to the residents and the businessmen and
the bankers of West Virginia and Ohio and Kentucky who are suffering now because of the fact that the floodwaters of the Ohio River are
destroying commercial values?
Should the Federal Government have no obligation in that respect?
Mr. ROWE. They most certainly should. Now, that, of course,
stems back over the years.
Senator O'MAHONEY. Very good.
Mr. ROWE. The problem of your waterways and, to my mind,
your ports of entry into these United States, are clearly in the province
of the Federal Government, because that is over State lines.
Senator O'MAHONEY. Then we are in agreement, Mr. Rowe, that
Federal spending for flood control in your opinion is not reckless spending.
Mr. ROWE. Certainly. There must be several that are not reckless
spending. I am simply saying that for a Government to carry the
size of budget it is now carrying, against an absolute peak gross income
of individuals, is to set up a situation in which they cannot sustain
that total taxation, come a terrific decline in total income.
Senator O'MAHONEY. I think you are quite right about it. But I
want to call your attention to tha fact, Mr. Rowe, that four-fifths of
the present Federal budget is due to war and preparation for war. I
want to call your attention to the fact that the interest upon the
national debt alone, $5,000,000,000 a year, is more than half of what
the national budget was, the total national budget, at the height of
New Deal spending in 1939, when the total budget for military spending and for civilian spending was only $9,000,000,000.
Now, it has become a very easy thing to denounce so-called New
Deal spending, and to overlook the fact, which is the' fact, that in
1940, before we became involved in the events leading to World War
II, the national debt was only $49,000,000,000, of which only
$22,000,000,000 had been inherited from the Hoover administration.
Mr. ROWE. World War I?
Senator O'MAHONEY. From World War II, and from deficit spending during the last 2 years of the Hoover administration.
84
CREDIT POLICIES
Mr. ROWE. A small sum.
Senator O'MAIIONEY. A small sum? It
amounted to about
$6,000,000,000.
Mr. ROWE. They had reduced the debt $9,000,000,000.
Senator O'MAHONEY. Yes, but then they put it up again. They
reduced it about $8,000,000,000.
But may I say, since you suggest it, that five times during that
period they reduced the taxes. If they had not reduced the taxes,
we probably could have paid off the whole debt. But that is neither
here nor there. The fact is that deficit spending, which began in
1930, added $6,000,000,000 to the debt.
And then, because the country was in a terrific dilemma, and there
was no possibility of independent Federal Reserve banks or any
banking houses coming to the aid of national credit, the Government
had to step in.
Senator V\ ATKINs. Do you have any further questions, Senator?
Senator O'MAHONEY. I am trying to determine just to what degree
the witness would advise this Congress to curtail Federal spending
and where he would do it.
Mr. ROWE. Oh, I would just like to answer that in this way: That
the only conception I can have of it is that the Government has a
right to spend what it can properly take in in taxes without jeopardizing the economy of this country-just like a business-and that the
Federal Reserve System ought to build up a larger net worth and not
have its earnings taken out by the Treasury, so that it has a strong
balance sheet; that the member banks should be encouraged to sound
banking, and to build up their net worth over the period; and that an
increase in reserves hampers their ability to build up and remain
strong.
Senator O'MAHONEY. Well, now, if we could apply the surplus
which we shall have on the 30th of June upon the national debt, that
would have tended, would it not, to have built up the net worth, or
contributed to the net worth of the Government of the United States?
Mr. ROWE. The Government of the United States has naturally
every right to pay down on its debt wherever it can.
Senator
O'MAHONEY.
Not only the right; but would you not say
it has the duty?
Mr. ROWE. The duty. It is better for everybody.
Senator O'MAHONEY. And would you not call it sound financial
policy for the Congress, in order to reduce taxes, to shift $3,000,000,000
of its surplus in the present fiscal year over to the next fiscal year, in
order to cover up a deficit which would be occasioned by the reduction
of Federal receipts following the reduction of taxes?
Mr. ROWE. I am no authority on that.
Senator O'MAHONEY. All right, Mr. Chairman.
Representative HUBER. Mr. Rowe, Senator O'Mahoney says that
the interest on the national debt is $5,000,000,000. Then, in effect,
are we not borrowing money and paying interest on money by voting
the tax reduction, and is that sound Government practice?
I would like to ask you that, because I realize you are an authority
on interest and banking matters.
Mr. ROWE. It seems to me that the imperative need for venture
capital in this country, the imperative need for equity capital in this
X
CC,MI 1DO-511 TE
COtoE/ PCO51TE
FEDEQAL IE5SE2VE
£1ANWK5
BANKS
ALL COMME12CIAL
N (J. 5. A
-T
rN 3I LLION
aSCALE
165,
MONVEY .- .
.
150,
GOLDC.
4
135,
120
I
(f-I
z
105,
. _
,-J
90Q
z
i
_
.
.
I-
+
.
TOTAL
.__
i1
LiJ
73
I
I
-
ij
I
i
i
Il
I
l
!
'
i!
I'
i
a
oI
,
Ii
_ILO
I
.
T
AN A
Acc'T
!.-, D.rAL CAPITAL
1l
'
I
1
I
--
1935 '36 57 '38 *39 40 41
42 45 44
M5 46 47
193556 '37 'M8
39 *40 :41 *42 *43 44
:4:6 '47
77099 0 - 48 (Face p. 84) No. 1
INDus-TI2iAL
NATIONAL
!SOuQCE -
YEAQLY
5
PI20DCJGTiON
INCOME
PE-1ONAL
250
DErr OF COANIFRCe-
5TATi5TIC5 iN biLLiON5 OF DOLLA25
YEA2LY
_
_
___
'225i,225 ___
INDEX
;93.5.39 - loo - AD-.rJTE-- F0R 5rAS0NALVJAI~AT'0N
SocjicD
Bo^Ro OF GOVEroRj FF~rrAL RESE.RVE-s.FM
AVEPAGE5T
I
ALL
200'
OTHE2
INCOME-
__
At
1751
_
DiviDEND5 AND INTE'50T
125
-4
PJQoP2IEToPQ
100'
AND QENTAL
1935 36737338
'_
______
INCOMF-. --
39 40
41
100i.F
VVAGE5
12.5
AND
j;;
i
1'4
.?
42
43 44
45 46 47
WIN~~~~~~~~~~~~~~~~~~~~~~~~
25
'
1,
I
5ALA IES
1935 36 '37 '38 '39 40 :41 :42 :43 44 '45 46 47
i4 57 38
1955 36
10011
25
'*
4.
2X7
42 43
.5j-6 41
39 40
h
~
1
A 42 43 44 45 :46 47
1935 '36 '7 '38 '39 401
77099 0 - 48 (Face p. 84) No. 2
PE2CENTAGE
CHANGE iN CAPITAL
AD, COMPAE:D
WiTH THE
fKUND5
UNCL'JDNirG
1929 PO5iTION
_
OF
TWELVE
MAJOQ
E5ANKiNG
QE5E2VE5
_
IN5T1TUi)N/5
7
- ------- --- - - 00"
-I--
A. s-o2 M92
1933
1I4
i934
1 5i
1935
t
-i-
3
1936
1
1937
1 3
1938
-
+
1
1939
1
-t
1
41
1941
F-~~
M912
1943
~~~~~
1944
I
1945
I-C..,
1946
- -- - -i -^
t*V4QvR^-
1947
AtA-L As'
1948
77099 0 - 48 (Face p. 84) No. 3
85
CREDIT POLICIES
country, by strong, good, going companies, who need more, common
stock to sustain their base of debt and preferred, is clear. And as
long as taxes remained at the high level they were before this tax
reduction came along, you were stifling your source of income and the
future.
I say it is good business to lower the taxes, thereby reducing the
amount which you can pay off on your debt. Because in the long
run you will get more taxes by having done so, sir.
Representative HUBER. As to this risk capital today, with maximum production and almost a severe allocation of materials, is there
any possibility of new enterprises right now?
Mr. ROWE. I have them offered to me, two or three a week; people
with an idea, who want to go places, with no money, no proven earning
power, and just a beautiful idea.
Representative HUBER. Do you have to turn them down?
Mr. ROWE. We can't find the risk capital. I go to people, and they
say, "Why, don't be silly. After March 15 I haven't got a dime. In
fact, I had to sell principal in order to pay my final adjusted tax."
Representative HUBER. That is all I have.
Senator WATKINS. Thank you, Mr. Rowe.
The committee will now be in recess, subject to the call of the Chair.
(Whereupon, at 12:20 p. in., the hearing was adjourned, subject to
the call of the Chair.)
STATEMENT OF CONDITION,
THE FEDERAL RESERVE BANKS,
WEEK ENDING FEB. 25, 1948
[Figures in thousands]
Resources:
Gold certificates -$21,
Other cash -367,
U. S. Government securities -21,
Discounts and advances -279,
Industrial loans ---------Federal Reserve notes of other banks -126,
Bank premises --------------------------Uncollected items -2,796,358
Other assets -150,
Due foreign banks ---------------
776, 219
880
033, 836
149
4, 353
905
32, 891
232
95
567, 918
Total resources -46,
Liabilities:
Capital stockSurplus:
Sec.7 -$448,
See. 136h --------Other capital accounts --------------------------------Federal Reserve notes Deposits:
Member banks -$16,
U. S. Treasury -1,
Foreign -448,
Other -452,
Liability for accrued dividend -------------------Deferred liabilities
Total liabilities -46,
197, 384
189
27, 543
799, 290
655, 975
761
355
475, 732
50, 905
24, 065, 495
19, 356, 381
15, 647
2,406,374
567, 918
CREDIT POLICIES
WEDNESDAY,
MAY 12, 1948
CONGRESS OF THE UNITED STATES,
JOINT COMMITTEE ON THE ECONOmic REPORT,
Washington, D. C.
The committee met at 10 a. m., pursuant to call, in room 312,
Senate Office Building, Senator Robert A. Taft (chairman), presiding.
Present: Senators Taft and Flanders.
The CHAIRMAN. The committee will come to order.
You may proceed, AMr. Sproul.
STATEMENT OF ALLAN SPROUL, PRESIDENT, FEDERAL RESERVE
BANK OF NEW YORK
Mr. SPROUL. In your invitation to me to appear before this committee you posed four questions which, among others, you hoped
might be discussed. They were:
1. Adequacy of present powers of the Federal Reserve System and
other Federal agencies to prevent undue expansion and contraction
of bank credit, and current proposals for increasing those powers,
as has been recommended in the Economic Report of the President.
2. Extent to which existing powers should be utilized in dealing
with current credit situation.
3. The necessity or desirability of continuing support of the Government bond market and ways in which this might be done with a
minimum stimulus to undue expansion of credit.
4. Justification of current complaints about difficulty in securing
adequate funds for modernizing and expanding business facilities,
especially for small business; effectiveness of current methods of
channeling savings into investment.
My statement will concern itself with these questions, or at least
with the first three, although not necessarily in the order given nor as
direct answers, since they all relate to the general problem of inflation and bank credit. I shall also want to lay some stress on the longer
range problem involved, although not neglecting our immediate
situation. Perhaps I can best present my views in a series of propositions or paragraphs, with a minimum of argument, leaving to subsequent discussion the elaboration of those points in which you are
particularly interested. Or, if you prefer, I could submit more detailed
memoranda on any points which you wish to have covered more
fully in the record.
1. First it is essential that we try to put the problem in proper perspective. It has become a commonplace to say that our difficulty lies
in the existence of an enormous volume of purchasing power, which
has meant an effective demand in excess of the existing supply of goods
and services-and that this is inflation. Stated thus baldly, attention
is focused on the monetary aspect of our problem and many are led
87
88
CREDIT POLICIES
to the conclusion that only by monetary action can we really cope
with it. The figures most usually quoted are the increase in the money
supply-adjusted demand deposits plus currency outside banksfrom 33.8 billion dollars in 1939 to 113.7 billion dollars in December
1947, and the inflation potential in such a tremendous increase is
emphasized. These figures, however, are not very illuminating taken
by themselves; they must be related to changes in the gross national
product-or to some other measure of over-all production-before
we can see where we are and where we may be going. Money does not
exist in a vacuum; it has work to do. The facts are that the gross
national product is estimated to have increased from 90 billion in
1939 to an annual rate of 241 billion in December 1947, and that the
ratio of our money supply to the gross national product has, therefore, only increased from 37.4 to 47.2 percent during that period.
That puts a very different light on the inflationary potential still
resident in the existing volume of money. We have already gone a
considerable way in growing up to our increased money supply, and
adjusting our general price level to it. And if there has been a substantial and more than passing reduction in the velocity of moneythe velocity of money is believed to have dropped substantially in
the 100 years before the Second World War-it might be argued that
we have gone most of the way in closing the gap-that the price level
has come near adjustment to the money supply. I would not want
to press this argument too far, but it does help, I think, to put our
problem in proper perspective.
2. This is not a surprising development. It is really a continuance
of the record of progress of our industrial civilization, distorted by the
incidence of war. The progress of the United States in terms of
increase in the national income during the present century has been
phenomenal. From 1899 to 1947 there was a fivefold expansion,
and even when account is taken of the increase in population, and
the decline in purchasing power of the dollar, the average real income
per capita appears to have increased about 2% times in less than 50
years. If it were not for the waste of wars and of periods of unemployment, and if it were not for the inequitable distribution of the gains
of productivity, as one group or another-farmers, management,
owners, organized labor-found itself in a position to receive or to
grab a bigger hunk of the pie, we should have had declining prices
commensurate with declining real costs, and a lesser need for growth
in the money supply. In that sense we have had a more or less continually inflationary economy, interrupted by depressions, but accentuated periodically by wartime wastes of resources and expansion of
money supply. The record, however, is one of growing up to the
increased money supply-plus declining velocity of money-with
intervening shake-outs as in 1920-21 and 1930-32. We have never
substantially reduced the money supply without concurrent serious
declines in production and employment, which, I believe, no one
would wish to contemplate now in the light of the domestic and international situation. In other words, our main hope is not in a get
tough monetary policy on the theory that a bust now is better than
more boom and more bust later. Our hope lies in gradual adjustments
in various parts of the economy, staggered in incidence, while the
money supply and the general price level achieve an approximate
balance somewhere near the present relationship.
CREDIT POLICIES
89
3. This does not relieve us of the responsibility of trying to prevent
a further increase in the money supply while inflationary pressures
are still strong in our economy, and that is what we have been doing.
It is not true that we have had no effective policy and could have none
because our existing powers were inhibited by considerations involved
in the management of the national debt. By means of a coordinated
program of debt management and credit policy, both relying on
fiscal policy and on the maintenance of some uncertainty as to the
next move, for their main strength, we have held back the further
expansion of bank credit. The voluntary program of the commercial
banks has worked toward the same end. There is reason to believe
that this program has been cumulative in effect, even though it is
obvious that credit has not been made either very tight or very
costly. As you know, there was an expansion of bank credit in 1947,
which we would have liked to prevent, at least in part, since it is
difficult to see how the whole of the expansion could have contributed
to increased production, but during the first 3 months of 1948 we
regained much of the ground we lost during the preceding 12.
Adjusted demand deposits plus money in circulation totaled about
$109,400,000,000 at the end of 'March 1948, compared with $113,700,000,000 in December 1947 and $110,000,000,000 in December 1946.
That is taking advantage of the very favorable situation which existed
during the first quarter of 1948, in which most of the Treasury's
surplus for the fiscal year-1948 was concentrated, in which a sharp
break in agricultural prices shook the easy optimism of business and
and consumers, and in which business borrowing is not ordinarily
large in any case. Nevertheless, I should say that we could take
considerable satisfaction in our performance with our existing powers,
if it were not for recent events which have aggravated the problem
ahead.
The CHAIRMAN. Mr. Sproul, my recollection is that Mr. Eccles
presented figures showing the increase in bank loans. You are dealing
here only with deposits. It is my recollection that the increase in
bank loans during the year 1947 was somewhere between five and
seven billions.
Mr. SPROUL. I think seven billion perhaps was the figure used,
offset perhaps to some extent by a decline in investment; so that the
total of bank deposits did not increase by the amount of the increase
in bank loans.
The CHAIRMAN. Now, for the last 3 months, the first quarter of this
year, have you any figures showing whether bank loans have increased
again, or whether they have stood still, or whether they have gone
backwards?
Mr. SPROUL. In the first 3 months, the bank loans in the country
are estimated to have increased perhaps $500,000,000.
The CHAIRMAN. ID the first quarter?
Mr. SPROUL. Yes.
The CHAIRMAN. I think the National City Bank Review made the
general statement that the increase in bank loans had been stopped,
or checked; or there was some such statement. But they did not give
the figures either.
Mr. SPROUL. The reporting member bank figures, which are the.
ones which are generally made public, do show that the increase has
90
CREDIT POLICIES
been checked. But I think the figures for all banks of the country,
those outside the larger cities as well as those in the largest cities,
when they are available, will show that there was some increase during
*the first quarter.
The CHAIRMAN. Do you think this American bankers campaign has
had an influence in holding down bank loans?
Mr. SPROUL. I think it has had an influence. I think you will have
to give it some credit for the results.
The CHAIRMAN. With prices still rising slightly, you would have to
increase bank loans somewhat, would you not?
Mr. SPROUL. Yes. That is the chicken-and-egg situation; a rise in
prices requires some increase in bank loans, and some increase in bank
loans results in some rise in prices. They chase one another.
I was dealing here with the supply of money, which is simply deposits
plus currency, which represents the amount of purchasing power in
the hands of the public.
The CHAIRMAN. The volume of money never has had any impression
on me at all. I do not think the volume of money makes any difference.
It seems to me it is a result; not a cause. That is as contrasted to
additional purchasing power, the creation of current purchasing
power, where there seems to be an inflationary element.
Mr. SPROUL. That, I think, is what we have been restraining: the
further increase of current purchasing power.
4. It is clear, I think, that proposed increases in our military
expenditures and tax reduction (plus continued foreign aid) taken
together have created a new situation with respect to the coordinated
program of credit policy and debt management which we have been
pursuing to restrain the expansion of bank credit. A main reliance
of that program, a whacking surplus in the cash budget, has been
taken away from us. There are various extimates of what the fiscal
results of the year 1948-49 will now be but, with the possible exception
of some congressional committee estimates, they do not leave us much
fiscal ammunition. A great deal depends, of course, on how rapidly
increased appropriations for preparedness are translated into actual
expenditures. Our figures indicate that, barring a possible business
recession which would cut down Treasury receipts, there will be a cash
surplus of between 1 and 3 billion dollars. This amount is probably
no more than enough to take care of voluntary public redemptions
of maturing Treasury securities, leaving nothing for redemption of
securities held by Federal Reserve Banks; which has been the way in
which we have cut down the supply of credit available during the
past quarter.
Senator FLANDERS. Excuse me a moment. "This amount" you
say, "is probably no more than enough to take care of voluntary
public redemptions of maturing Treasury securities." By that do you
mean a net redemption-the difference between new purchases and
redemptions?
Mr. SPROUL. Yes.
Senator FLANDERS. You are expecting a considerable net redemption in the publicly held securities?
Mr. SPROUL. With each new issue which is exchanged for a maturing
issue, there is a substantial amount of cash redemption. It is a natural
part of the whole exchange operation.
The CHAIRMAN. You are not talking about E bonds, particularly?
CREDIT POLICIES
91
Mr. SPROUL. I am talking about current market obligations.
Because on E bonds, and F and G bonds, there have been net sales
rather than net redemptions.
Senator FLANDERS. Does this sentence, however, mean that
publicly held bonds of all sorts will not be sold as fast as they mature;
that new issues will not be sold as fast as the bonds mature?
Mr. SPROUL. The sale of E, F, and G bonds, to the public for
instance, or the sale of special issues to Government accounts, would
provide the funds with which these market issues would be redeemed,
market issues which are not exchanged for new offerings.
Senator FLANDERS. I was just trying to see why a cash surplus of 1
to 3 billions could not be used for redemption of reserve bank securities.
It would seem to me if it cannot be used for that redemption it would
be because there is a net loss in refinancing.
Mr. SPTROUL. A net loss in connection with market obligations;
although that loss is made up in other ways in the Treasury's cash
position. Now to proceed with my argument.
Because of the uneven distribution of Treasury receipts and expenditures, the Government might conceivably be a temporary borrower
of small amounts for short periods during the latter part of the
calendar year 1948-that is, during the first half of fiscal 1949. Our
existing program of credit control will not be in working order much
longer without some adjustment.
5. It is uncertain, of course, whether there will be a revival of strong
inflationary pressures during the second half of this calendar year, or
later, and it is still debatable what and how much should be done to
try to curb such pressures by over-all monetary action if they still
persist. It has seemed likely, as a consequence of approaching completion of postwar plans for plant construction, expansion, and improvement in a number of industries, that there would be a falling off
in business capital expenditures during the latter half of 1948 or the
first half of 1949. If Government expenditures (and deficits) do not
pick up rapidly, it is conceivable that the inflationary effects of renewed spending may be offset by this decline in private capital expenditures. There are other elements in our economy-that is, supply of .some goods overtaking demand and the prospect of better
world crops this year than last year-which would also mean a relaxation of inflationary pressures or even the introduction of deflationary forces. W i-se can be set off against tax reduction, a sustaining
influence on t'Le demand side, increased military expenditures which
will give a fillip to domestic production, European and other foreign
aid expenditures which will help maintain a high level of foreign demand, and a third round of wage increases, all of which singly or taken
together have inflationary implications. It cannot be too easily assumed, however, that we are definitely headed into another inflationary upsurge, nor, if we are, that it will be of the kind to demand
drastic over-all monetary measures. Let me quote from the official
press:
Release concerning the memorandum to the President by the Council
of Economic Advisers, dated April 9, 1948:
Appraisal of the combined impact of these two plans [foreign and preparedness
programs] may be undertaken by an examination, first, of their general impact
upon the economy, and, second, of their impact upon specific situations of shortage. Viewing first the general impact, we concluded in our October foreign aid
92
CREDIT POLICIES
report that the export surplus in 1948 under an aid program of the size then contemplated would not inject a new inflationary influence because it would not
exceed the export surplus already felt in 1947. As finally adopted, the European
recovery plan will involve an export surplus in 1948 at least S2,000,000,000 below
the level that the October report contemplated and found to be safe. This
leaves room for the safe absorption of a defense program of considerable magnitude. The defense program, as now formulated, implies at 3 to 4 billion dollar
commitment for the fiscal year 1949. In the President's letter of April 1, transmitting an additional budget request, there was outlined a program involving
additional expenditures for the armed services of only 1.7 billion dollars in fiscal
1949. Of this amount, not more than half will represent actual payments to the
public in 1948, and only a part of this will represent a demand for additional
goods. Thus, in terms of its general impact upon the economy, the defense plan
would seem to be something the country could readily take in its stride.
With increasing appreciation of these facts, the tendency for business to react
to the defense program in terms of an incipient new boom has abated, and there
has been an increasing disposition to assess the plan as an offset to softening
tendencies which might be developing during 1948 rather than as a further stimulus to an already strongly inflationary situation.
But while a 3 to 4 billion dollar program may not seem disturbing to a $240,000,090,000 economy when viewed generally, the conclusion is different when we turn
to its specific impact upon particular production and market situations. Just as
in the case of the European recovery program, to which it is now added, the real
issue as to whether additional economic controls are needed grows out of the
concentration of both programs on certain classes of goods and areas of production
where shortages have been most severe and persistent. These areas include products of farm origin, particularly livestock products and textiles, steel and other
metals, and the sources of power and heat, including coal, petroleum, gas and
electricity.
This may be an argument, say, for allocation of certain materials
where specific bottlenecks develop or shortages appear, or for some
other kind of direct controls, but I certainly do not think it is an
argument for drastic over-all monetary controls.
6. Nevertheless, if we take account of the possibility that we may
be faced with the necessity of resisting strong inflationary pressures
during the second half of this year, or the first half of next year or
later, we must also take account of the possibility that these pressures
will give rise to increased and inflationary demands for bank credit,
even though they are primarily due to nonmonetary causes. Fiscal
policy, debt management and credit control should then be ready to
make their contribution to the renewed struggle against inflation.
The choices before us have been classified (assuming for the present
that we shall not quickly revefse ourselves and increase taxes) as
trying to cut down (a) military expenditures, (b) other Government
expenditures, (c) private or public investment, (d) personal consumption.
Here I express rough opinions. Although there should be room for
some paring of previously planned military expenditures now having
a lower order of priority, and every effort should be made to this end,
it is unlikely that much will be accomplished. Similarly, in the field
of other Federal Government expenditures, every effort should be
made to hold them to a minimum, but the prospect for substantial
economies is doubtful. Federal investment expenditures may be
curtailed, but State and municipal expenditures are expanding rapidly.
As I have suggested a gradual decline in private capital expenditures
seems likely, unless the contemplated effects of increased military
spending are exaggerated or actual expenditures prove to be greater
than presently estimated, and pressure for private capital expenditures
again increases.
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93
The CHAIRMAN. I do not see much evidence of any increased military
spending that would require a capital expenditure outside of the
airplane industry; and even there, as I understand it, the industry
is oversupplied with capital already, and it will only be a question
of tools.
Mr. SPROUL. That seems to be the place where the largest immediate
influence will be felt, and where working capital rather than investment capital is a primary need. I think you are right.
An invigorated campaign to sell savings bonds can help sop up
loose dollars. And, finally, by means of action in the monetary and
credit field we can attempt to prevent or restrain a further expansion
of consumer and business purchasing power based on bank credit,
but we can not do much, if anything, about purchasing power already
in existence, unless we want to take measures so drastic as to risk a
serious over-all decline in production and employment.
7. Does this leave us entirely helpless with our present powers?
I think not. With fiscal policy inhibited and debt management
reduced in scope, monetary policy may be able to play a relatively
more important role than in the recent past when it has been leaning
heavily on Treasury surpluses. If there is a decrease in the demand
for private capital funds the pressure on long-term rates which asserted
itself last fall will be relieved. Maintenance of the 2'S percent longterm rate on Government securities should not then require us to
put large sunis into the market if, in fact, support by us is necessary.
Meanwhile, we could proceed further with increases in short-term
rates, so as to maintain a healthy degree of uncertainty as to future
action, so as to keep the banks liquidity conscious, and so as to encourage them to use whatever reserve funds come into their possession
(through gold imports, return flow of currency, Treasury expenditures, or otherwise) to purchase short Governments from us. While
I do not believe that a public hearing of this sort is the place to try
to give details of the immediate moves which the Treasury and the
appropriate groups in the Federal Reserve System may be considering,
I can say that I do not agree that we have necessarily approached
the limit of increase in rates on short-term Government securities
which might be permitted without endangering the long-term market.
The pattern of interest rates, in which rates follow a smooth downward curve toward the short-term end of the rate structure, has now
prevailed for so long that we tend to regard it as normal. In fact,
however, the present rate pattern was an outgrowth of quite abnormal
circumstances-namely, the accumulation, before the war, of a huge
volume of excess reserves in our banking system. Prior to 1930 shortterm interest rates were more commonly above long-term rates than
the reverse. And even if we admit that other things are no longer
equal, we need not be too concerned about the long-term market.
In theory at least, so long as we are firm in our support of the 2Y2
percent rate for long Government bonds, we have made that a demand rate and there is no reason why rates on shorter term obligations could not approach this figure. The facts, as distinguished
from the theory, of course, might suggest or require that we stop at
a lower figure.
One fact that must be taken into account, but must not be allowed
to outweigh more important considerations, is the cost of servicing
the public debt. It is easy, if one does not stop to make an actual
77099-48--7
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CREDIT POLICIES
calculation, to exaggerate the effects of a rise in short-term rates on
the positive and immediate cost to the taxpayer of interest payments
on the public debt. The fact of the matter is that a rather considerable rise in short-term rates could occur without too much positive
effect on the budget during the next few years. The major factor
in the rise in the budgetary item of interest payable on the public
debt that has already occurred is not the small advance in shortterm interest rates to date, but rather the increasing rate of
interest accruals on savings bonds, due to the practice of accruing
interest on the basis of the the increments in redemption values,
rather than at the rate of interest payable from issue date to maturity
date. This practice has had the effect of reducing the budgetary
provision for interest payments on the debt in the earlier years of the
life of the bonds, at the expense of substantial increases in the later
years. But, of course, no increase in actual cash outlays is involved
until the bonds are redeemed. Once the facts of this situation are
understood, the argument that we cannot follow an appropriate monetary policy, because of its effects on the burden of servicing the public
debt, loses some of its force.
8. This latter discussion may suggest a subsidiary question which I
knowis in some of your minds. W'hy should we support the Government security market, and to that extent circumscribe our powers and
our actions to control the volume of credit? Obviously, there is a
conflict between our desire to restrain credit expansion and our acceptance of the obligation to maintain stability in the Government security
market, although this conflict has been exaggerated in some current
discussion. The facts are that the System's purchases of Government
securities have been exceeded by the System's sales and redemptions,
by more than 12 billion dollars since market support purchases were
begun last November. The total amount of Federal Reserve credit
outstanding has been reduced by approximately 3 billion dollars since
the end of 1946 and by about 4 billion dollars since the end of 1945.
We have moved to offset the effect of gold inflows and other factors
tending to expand commercial bank credit, despite our concern about
the Government security market. Our policy has been actively antiinflationary, if it has not been deflationary. If this had not been so,
there would have been no need for us to support the Government
security market. Banks would have been swimming in reserve funds,
and Government securities (and probably other securities) would have
had a more or less continuous bull market. I suggest, therefore, that
it has been possible to support the Government security market, as
we have been supporting it, without stimulating an undue expansion
of bank credit.
I justify the policy we have followed, not on the basis of cheap
money or low interest rates so far as the Government debt is concerned, although that has its important aspects, but because I question
what good could have been accomplished by a vigorous aggressive
policy of over-all credit contraction-such sales of Government
securities from our portfolio as might have broken the market. As I
said, in my testimony before the Banking and Currency Committee of
the Senate last December, in view of the large involvement of our whole
economy with a Federal Government debt of over $250,000,000,000,
in view of the continuing need for refinancing parts of that debt, and in
the face of an imperative demand for maximum production, if we are
CREDIT POLICIES
95
to solve our domestic problems and meet our commitments abroad, it
seems to me that those who suggest raising the discount rate sharply
and selling Government securities out of System account, without
regard to the effect on the price and yield of such securities, are talking
in terms of a situation which does not presently exist. Such action
would probably be effective in checking the further expansion of bank
credit, but at a cost in fiscal and financial disorder, and in terms of
reduced production and employment which no one would want to
contemplate now.
The CHAIRMAN. It would seem to me that that could be approached
from a different standpoint, not selling Government securities, but of
buying Government securities. I do not know that anybody has
suggested that the Government would go out and flood the market
with Federal securities, but the question is whether they are going to
support the market by buying securities.
Mr. SPROUL. In a real sense we have not been buying them,
because, as I said, net vie have sold and redeemed substantially more
than we have bought.
The CHAIRMAN. That may have happened in the last few months,
but that is not what is going to happen from now on.
Mr. SPROUL. That has happened since 1945.
The CHAIRMAN. 1945? You mean you have fewer bonds in the
Federal Reserve System now than you had in 1945?
Mr. SPROUL. Yes. We have taken 3 to 4 billion dollars out of the
market, 4 billion I believe, since the end of 1945.
The CHAIRMAN. That resulted from that big sale of bonds, from the
big redemption of bonds after the last bond drive, from the accumulation of cash and the paying off of those bonds, did it not? I mean, you
claim that you have not been supporting that.
Mr. SPROUL. No; but we have been supporting in a way that has
resulted in a net reduction in the amount of Federal Reserve credit in
use. We have not put Federal Reserve funds into the market net over
this whole period.
The CHAIRMAN. That certainly is contrary to what I have been
thinking; if you take out the effect of that last bond drive.
Mr. SPROUL. It all comes down to whether we have put funds into
the market or taken them out, which is the basis for expanding or
contracting bank credit. And we have taken them out, net.
The CHAIRMAN. Well, I just do not think the figures will support that
statement, if you take out the figures on this last bond drive.
Mr. SPROUL. The Victory loan drive?
The CHAIRMAN. Yes, the Victory loan drive; if you take out the
effect of that. Well, those figures can be obtained anyway.
Mr. SPROUL. A general monetary control, if used drastically enough
works through a restriction of production. The steps in the process
are restriction of money supply, rise of interest rates, contraction of
employment and production, contraction of income. I know of no
monetary device which would enable us to avoid these consequences,
and I think it is an illusion to think that some painless way of avoiding
the consequences of making credit really tight, can be found. To use
our existing powers without regard to interest rates and the Government security market, in order to get the effect our critics suggest,
would mean that our action would have to be drastic enough to lower
the money income of a large segment of the consuming public. To
/
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CREDIT POLICIES
accomplish this by over-all monetary or credit action would mean a
serious decline in production arly employment. Such action could
only be justified if we were faced with a runaway inflation due solely
or primarily to monetary causes. That is not our present situation
and that cannot be the right policy now.
9. To sum up this section of my testimony, we are in difficult but
not impossible circumstances. We may be faced with another upsurge of inflationary pressures, but that is not certain, and insofar as
the remedy is to be found in rhonetary action-and in most circumstances it will be supplementary at best-we still have a few shots
in our locker. In other words, we should neither magnify the dangers
we face nor minimize the effectiveness of the weapons we have to
combat those dangers.
10. It has been suggested, however, that our situation may become
much more critical, that we may be faced at some future time with an
accelerating price rise, that our present powers may run out or prove
ineffective, and that we should arm ourselves with additional powers
as a necessary precaution. It has been proposed, first, that the
Federal Reserve System be given authority to increase the primary
reserve requirements of all commercial banks, and, second, that if
still further powers are needed the System be granted supplementary
authority to impose a special reserve requirement permitting banks
to hold, at their option, an additional reserve in specified cash assets
or in short-term Government securities. I do not think that either
of these proposals would be particularly effective in checking the kind
of inflation we are supposed to be worrying about-that is, a real runaway inflation with a monetary background-while constantly seeking
their imposition does run a considerable risk of seriously interfering
with our present program, and their actual application could not help
but be upsetting to the securities market as deficient banks adjusted
their positions to meet the new requirements.
It is true, of course, that an increase in reserve requirements, either
primary or special or both, would put pressure on the banks and would
reduce the ratio of possible expansion of bank loans and investments
based on a given volume of reserves. But so long as we maintain our
present policy of support of the Government securities market, banks
would still be able to obtain additional reserves (and some multiple
expansion of credit would still be possible), if the alternative were to
deny funds to a borrower they wished to accommodate, or to pass up
an attractive investment. Commercial bank policy, individual
customer relationships, the incidence of possible capital losses, and
relative interest rates, woutd still be the sanctions in such cases, and
our influence could be brought to bear just about as effectively by
increasing short term interest rates, as by the more clumsy method
of increasing reserve requirements. As an instrument of short-run
credit policy, increases in existing reserve requirements, which must
be applied in jerks and in chunks to large groups of banks regardless
of their individual policies and positions, are not very useful. And
if we should, in the future, get into a situation in which it is imperative
that additional emergency powers be available and used, in which
aggressive monetary action must be taken to check a runaway inflation, regardless of the risks of such action, the powers would have
to be stronger than any yet proposed. It would not be enough merely
to reduce the possible ratio of expansion of bank credit; we should
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97
probably need powers that would enable us to stop the further expansion of bank credit in its tracks. I would rather try to meet that
situation when and if we come closer to it, than try to anticipate its
requirements now.
The CHAIRMAN. Mr. Sproul, you have emphasized that the fear
is of a runaway inflation. Most of the fears presented to us have
not been as to a runaway inflation but as to a creeping inflation, one,
which steadily increases prices and wages and is accelerated by more
bank loans, which are produced in turn by the wages and prices, and'
do forth. I do not think anyone really fears a runaway inflation
particularly.
Mr. SPROUL. Then I say the powers we have are adequate to cope
with the creeping inflation. We do not need new powers; in fact, we
should not use the new powers, if we had them, to cope with the
creeping inflation.
The CHAIRMAN. You have not coped with it in the last 15 months.
Mr. SPROUL. I think we have had considerable influence in coping
with the increase in bank credit during that period; and I bring to
my support the figures that you do not believe, which indicate that
the volume of purchasing power has been held steady.
The CHAIRMAN. You yourself say you have had an increase in bank
loans of $7,000,000,000 in a year, which has added that much to the
purchasing power of the people.
Mr. SPROUL. It was offset by decreases in other items of the bank's
accounts, so that the total volume of purchasing power-that is,
deposits and currency-is no larger at the end of the first quarter of
this year than it was at the end of 1946.
The CHAIRMAN. I do not see any balance against that $7,000,000,000
except the Government surplus. I do not see any control on the part
of the banks or the Federal Reserve Board that had an effect on it.
Mr. SPROUL. There was a decline in bank investments; growing,
to be sure, out of the Government's reduction in its outstanding debt.
But the means and methods of using that surplus to retire Government debt held by the Federal Reserve banks in large part, has meant
that to a considerable extent the funds taken out by taxes did not go
back into the market in the redemption of securities held by the public,
or by the banks.
The CHAIRMAN. You are saying that the Government fiscal policy
as to the surplus has balanced that increase in purchasing power.
But I do not see just what effect the policy of the Federal bank has had
on it, or how it in any way has restrained it particularly. You have
raised your rates of interest a little, perhaps, and you have raised the
short-term stuff, and you have increased the reserves a little bit; or
the Board has.
Mr. SPROU-L. The major influence was the Treasury cash surplus
and the method used in disposing of that cash surplus. There is no
question about that. That is what we have been leaning on. But
we have geared our debt management policy, or the Treasury has,
to the Treasury cash surplus in such a way as to make it all work
together. The Treasury cash surplus could have been used to retire
the credit held by others than the Federal Reserve banks, without
having this restraining effect.
The CHAIRMAN. That is right. There would have been more
inflation.
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CREDIT POLICIES
Mr. SPROUL. 11. Going beyond such temporary emergency action
which might be considered, in the future, as a way of meeting an
urgent and critical (but still hypothetical) situation, a more fruitful
long-term approach to the whole problem of reserves would seem to
be to attack the problem at its base. First, there is the method of
fixing reserve requirements. I think the present method is based too
much on geography and too little on existing banking facts. It is
time to give serious consideration to a system of reserves related to
the character of deposits rather than to their location. I think we
shall find that, in the words of a recent study, we are now at a point
where we could device a uniform system of reserve requirements,
uniform as to banks wherever located, and distinguishing only interbank deposits, demand deposits, and time (savings) deposits which
would be economically defensible, admninistratively feasible, equitable
as between banks, and adapted to our banking system as it has
evolved through the years.
Second, there is the question of the leverage factor in our present
system of proportionate reserves. There may well be reasons, taking
the long view, for an increase in the reserve requirements of the commercial banks of the country, and of the limits within which those
requirements can be varied by the Federal Reserve System. I am
inclined to believe that this could be a progressive step in our monetary-banking organization, especially if there should continue to be
a persistent and substantial inflow of gold. With a modern centralbanking system operating in a highly developed deposit-banking system, and with a decreasing reliance upon gold, much of the need for
low reserve requirements and consequent economizing in the provision
of money by commercial banks has disappeared. In these circumstances there may well be a balance of advantage in higher reserve
requirements, as a means of reducing the dangerous expansibility and,
at times, destructive contractability of a money supply based on a
low reserve ratios of commercial banks. There may be too great an
element of leverage in our present system to be left at the disposal of
14,000 banks. We should try to discover whether there is some
practical way, as a long-term improvement and not as an emergency
device, to increase reserve requirements so that the ratio of expansion
on a given base would be less than it is now. Perhaps the answer
could be found in a modified ceiling reserve plan, which would authorize an increase in reserve requirements-whether primary or
special-on any increase in deposits after the effective date. Not an
increase to 100 percent or anywhere near it but to some figure which,
on the average, would bring total reserve requirements nearer to the
desired ration, whatever it might be determined to be, than the ratios
which now exist. These are the directions in which I believe Federal
Reserve study and the consideration of congressional committees
should be taking us.
12. There are other things to be considered if we are going to take
the long view rather than the short view. There is the integration of
monetary and credit policy and powers which have been given to the
Federal Reserve System, with related powers exercised by the Treasury and other agencies of the Government. These diverse authorities
wield overlapping powers which have been granted over a period of
years-frequently with a view to strengthening some weak spot in
our economy-without much regard for their accommodation to an
CREDIT POLICIES
99
over-all economic policy. Action taken in one place may accentuate
inflationary or deflationary tendencies while we are fighting them in
another. Then there is the organization and functioning of the Federal Reserve System itself. I have always believed and still believe
that we have in the Federal Reserve System a wise blend of national
authority and regional responsibility, of Government control and
private participation. But it is some time since the Congress gave
us its mandate and various interpretations of its intent have gained
currency. More and more it seems to have become the habit to
think of the System as a head office in Washington with 12 branches
or subsidiaries in the 12 Federal Reserve districts, and even to forget
that the Board of Governors is a Board and not a chairman with
deputies, great though the powers of the Chairman may be. More
and more it has become the habit to minimize the value or deny the
propriety of any private participation in the affairs of the System.
I oppose these tendencies.
I think we shall do well to retain the regional characteristics of the
System, both in the matter of decentralized operation and, more
important, in the matter of System national policy. No one would
deny the need for coordination of general credit policy, but we now
have, in the Federal Open Market Committee, the statutory means of
achieving this while retaining some regional participation and responsibility. This committee is composed, as you know, of the seven members
of the Board of Governors and five of the presidents of the Federal
Reserve banks. Here are brought together, under statutory auspices
and with statutory responsibilities, men who are devoting their full
time to the problems of the Federal Reserve System and who are in
touch with governmental policies and private views and opinions, in
Washington and throughout the country. The Federal Open Market
Committee now controls the principal weapon of credit policy-open
market operations in Government securities. It is time, I think, for
the Congress to consider whether it would not be a foward and constructive step to charge the Federal Open Market Committee with
the related credit powers now exercised solely by the Board of Governors, and to consider this committee as the body to which any additional powers should be granted.
I also think we shall do well to retain the modest measure of private
participation in the affairs of the System which we now have, and to
make effective use of those public spirited men who are willing to
serve as directors of the Federal Reserve banks. It has been argued
that the only way to insure the place of the Federal Reserve System
in our financial affairs is to deprive it of all taint of private participation. The Government, so the argument runs, would be willing
to place full reliance on the System's existing powers, or to give it
additional powers, only if the remaining vestiges of private participation are removed. This seems to me to be a misreading of the
longer term future and a miscalculation of the policy which will serve
us best now. Rather than seek powers by trying to make ourselves
just another Government agency, we can claim powers because we
are a successful working example of Government functioning in the
economic field, with the aid and support of private business. Our
experience in Government-business cooperation-Government having
the dominant voice, as it should have in the field of monetary and
credit policy-might be a sign-post along the way to solution of one
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CREDIT POLICIES
of the major economic problems of the postwar years: The relation
between Government and business in our whole economy.
It may be that these are not matters within the immediate purview
of your committee. They are matters, however, which affect any
long range consideration of credit powers and credit policy. There
has been no general review of our whole monetary and credit organization and its workings since the studies of the National Monetary
Commission which preceded the establishment of the Federal Reserve
System in 1913. It is time, I submit, to review all of our legislative
authorities in the light of our experience and our existing economic
environment.
The CHAIRMAN. Mr. Sproul, it seems to me there is still a dilemma.
I still do not see how you can restrain bank credit if the rates of interest
tend to rise. You say the 22 percent will not rise. But suppose it
does. Is there any restraint o-l ban-k credit, as long as you have the
obligation to maintain the 22's at par?
Mr. SPROUL. Yes, I think there is.
The CHAIRMAN. And let us take the normal condition of a Government fiscal policy, where you have a small surplus, a couple of billion,
$2,500,000,000, or so, a year, which, as you point out, is likely to be
used up in different ways. Do you think that you can exercise any
real restraint on bank credit while those bonds are maintained at par?
Mr. SPROUL. Yes, I think we can prevent an indiscriminate and
loose extension of bank credit. I do not think we can stop all expansion of bank credit. But a certain amount of bank credit expansion
may be necessary, in a full employment, or high employment, high
production economy.
The CHAIRMAN. I think so, too. I do not mean to say that you
want to stop the expansion of bank credit; but to restrain it from being
an undue influence. You say yourself that in effect the increase in
reserves is more or less useless, because as long as you maintain Government bonds at par the banks can sell their bonds to the Government and replenish their reserves and loan the money. So that method
is not very useful, I suppose, unless you tied it up to the whole extent,
as Mr. Eccles thinks of, in taking 25 percent or so in Government bonds.
It might deprive them of the Government bonds they need to sell to
the Government. I do not know.
Mr. SPROUL. You would have to freeze the whole of the Government bond portfolio of the banks in order to plug that leak.
The CHAIRMAN. Yes.
Mr. SPROUL. But I do not think that is necessary to put restraint
upon the expansion of bank credit. I think uncertainty as to what
is going to be the future course of interest rates, uncertaintly as to
what the banking authorities are going to do, plus the desire on the
part of the banks themselves, not to go wild on this situation, can be
a sufficient restraining influence insofar as bank credit is a factor.
And, as I have said, I think it is only a minor factor. It is not the
major factor. And we cannot deal with the situation solely by means
of bank credit. In other words, we cannot do all the wrong things
every place else and then expect to correct the situation with bank
controls.
The CHAIRMAN. Well, you have your housing credit and the spending of Government money in different programs. You have a great
many things that join in this situation.
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101
Mr. SPROUL. And you cannot do everything else wrong and then
come to bank credit and say, "Correct this for us."
The CHAIRMAN. It would be one of the elements of a possible
inflation. It has been in the past at times.
Mr. SPROUL. Yes.
The CHAIRMAN. You have not expressed direction your opinion as
to the necessity for maintaining the Government bonds at par. You
think that probably should be continued?
Mr. SPROUL. I think that probably should be continued.
The CHAIRMAN. You do not think it is necessary, but you think it
should be continued?
Mr. SPROUL. I think it should be continued for the foreseeable
future, and under existing circumstances and conditions, yes.
The CHAIRMAN. As to only the 2y2's?
Mr. SPROUL. The 2M is the anchor rate. I do not think we can,
should, or want to commit ourselves to maintaining all Government
securities of all maturities at any rate. But I think for the present
we have pretty well committed ourselves and should commit ourselves
to the 2% percent rate.
The CHAIRMAN. What would happen if you did not maintain it,
and the bonds fell below par? What do you think would happen?
Mr. SPROUL. Well, I have a list of things I think might happen:
1. A decline in prices of long-term Treasury bonds more than
fractionally below par, under existing conditions, would throw the
whole market for long-term securities-corporate and municipal, as
well as Federal-into confusion, as it would raise questions, which
no one could answer with confidence, as to how far long-term rates
might rise, and how great might be the loss in market value of Government securities bought at or below a 2% percent basis and of other
securities bought at proportionate yields.
2. Potential buyers would tend to stand aside until they became
convinced that bond prices were down to levels at which the chances
of a recovery definitely outweighed the chances of a further declinethat yields were above what they regarded as the "natural" levels.
3. Conversely, present holders who are in a position to act quickly
on either side of the market would probably offer their securities for
sale until prices fell approximately to levels corresponding with their
ideas of the "natural" interest rate, in the expectation that they would
be able to repurchase the securities at lower prices. Many present
holders who anticipated other needs for their funds would probably
try to sell their securities, regardless of whether or not they had any
definite idea as to the level at which equilibrium might be restored in
the market, in the effort to assure the availability of the funds in
liquid form when they were needed.
4. An attempt to reestablish stability in the market, for example at
a level only moderately below par, would encounter serious difficulties, as it would be hard to restore the confidence that was destroyed
by failure to make good on all the assurances that have been given in
recent months that the 2% percent rate would be maintained.
5. Under these conditions, flotations of long-term securities would.
be made very difficult if not impossible, until the market became
stabilized at a new level, and even then could proceed only on a limited
scale until confidence developed in the new level. There is no telling
how long that would take.
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CREDIT POLICIES
6. The resulting interference with business and other financing
would tend to have a depressing effect on business and employment.
The effects would extend beyond industries dependent upon business
capital expenditures, State and local government public works,
and so forth. For example, the mortgage market would be affected
and therefore residential building. Curtailment in these industries
would quickly affect the markets for consumers' goods and extend the
area of contraction.
7. There is no reason to expect that savings would be stimulated
materially unless the rise in rates was substantial, and even then there
would be little incentive to invest so long as the security markets
remained in an unsettled condition.
8. If the decline in prices of marketable Government bonds went
very far, holders of savings bonds might become frightened and redeem
their bonds, even though yields to maturity remained above yields on
marketable securities. And well before redemptions increased
materially, sales (especially of F and G bonds, but also of E bonds)
would be likely to diminish sharply. Consequently a considerable
shift in the relative volume of redemptions and sales might be expected,
which might go to the point of involving sizable net redemptions, with
effects on the Treasury's cash position that would be likely to have
further adverse repercussions on the bond market.
9. Finally, maintenance of the 2%2 percent long-term rate will
facilitate a moderate credit policy designed to discourage bank loan
expansion, since it will permit execution of a program involving some
rise in short-term rates without throwing the whole bond market into
confusion and risking the whole train of consequences outlined above.
In other words, I see no great gain to be achieved by letting that
2% percent rate go now, and I see serious difficulties in the securities
market, and, beyond that, in the whole field of financing business and
industry.
The CHAIRMAN. It would undoubtedly start a tremendous confusion
for a while. There is no doubt about that.
But the difficulty that I see is the fact that the elements which have
restrained bank credit, that is, in the Government surplus, are going to
continue. Reduction of the Government debt is not going to go on
at the rate in which it has gone on for the last few years. Your position
really is that the 2% percent rate is a pretty natural rate?
Mr. SPROUL. I think it probably is.
The
CHAIRMAN.
And probably in the long run it might maintain
itself?
Mr. SPROUL. I think it will.
The
CHAIRMAN.
But we probably ought not to take a chance on it.
Mr. SPROUL. I think we have a very sensitive market, a very
sensitive banking situation. Everybody is an economist and sees
depressions and inflations and recessions under the bed. And very
minor moves by the monetary authorities can have major effects.
Because everybody reads the services and the reports and gets alarmed
if a mouse appears.
The CHAIRMAN. Senator Flanders?
Senator
FLANDERS.
I have one or two questions here, Mr. Sproul,
that have been accumulating.
I would like to ask you about the limitations of fiscal and monetary
policy. Senator Taft expressed his fears of a creeping inflation rather
CREDIT POLICIES
103
than a runaway inflation. Is there anything that can be done in the
fiscal monetary field with relation to an expanding wage and price
structure? Is there anything that can be done that is not catastrophic?
Mr. SPROQJL. Yes, I think there is. I think clearly capital expenditures by the Government should be kept at the absolute minimum,
and whatever pressure can be brought on the States and the municipalities to do the same thing under the existing circumstances-I do
not think that pressure is much, but some can be exerted-would be
desirable. I think, as I indicated, any place along the line where
ordinary governmental expenditures can be reduced, cut down, that
would be effective. I think military expenditures should have an
order of priority, and those of lower priority perhaps sacrificed. In
those areas of expenditure, both capital and current, fiscal policy in
the broad sense can be used, certainly without catastrophic effects;
in fact, with beneficial effects. Also you may come to the time, if our
rearmament expenditures increase substantially, that you will want
to reconsider your action on taxes.
Senator FLANDERS. Just avoid for a moment that unpleasant subject, and thinking of the present danger of this third turn of the wageprice spiral, when you were asked whether there is anything that can
be done about that in the monetary and fiscal field, you instanced
various cases in which it would be possible to defer actions. But
those deferments are going to pile up on you and become unmanageable. You cannot indefinitely defer needed expenditures; cities,
municipalities, the Government cannot do that. They keep piling up
on you until you have to do something about them.
Then this creeping inflation requires decisions as to bank credits
and industrial credits. They require increased sums for carrying inventory. They require increased working capital. They result in
increased accounts receivable. All of that requires more credit.
They all appear on the books as profit and so stimulate the wage
demands. And if they eat up liquid resources and lead directly into
further credit expansion.
Now, can you do anything really, in the long run, in fiscal monetary
policy, about that situation? You can, of course, end prosperity.
Mr. SPROUL. Yes. We can take very drastic action and send the
whole thing tumbling down, which I do not think we want to do. Or
we can restrain it, so that while you need more credit to carry inventories you do not get into the business of speculating in inventories,
or, as to expansion of capital equipment, you do not anticipate the
continuance of a bull market in your products indefinitely over the
years. In terms of Federal Government expenditures, those that cannot be deferred or avoided, you nevertheless try to gear in with a
decline in capital expenditures by the private economy, which I think
is a likely development within the next year or so, unless rearmament
expenditures increase very greatly, and more rapidly than is now
estimated.
Senator FLANDERS. What you are saying leads to a further question,
as to the advisability of applying qualitative controls to credit. You
just described some qualitative credit controls; or they are more in
the nature of credit qualities, maybe, than credit controls. Would
you feel, distinguishing one example you have just given, our credit
104
CREDIT POLICIES
needed for carrying a given volume of inventory that is higher priced
from buying ahead and speculating in your inventory, that there is
any field there for definite controls on the credit qualities of the banking system?
Mr. SPROUL. I think that particular form of selective credit control
is one that would have to be left to the commercial banks themselves.
I think there are areas of selective credit control where the terms of the
control can be so clearly delineated, and where the restraints can be so
general rather than pin point, that the monetary authorities might well
have selective credit control powers. One of those areas is consumer
credit. Another is margin requirements. And that might be extended into the field of commodity trading, or, conceivably into the
field of mortgage credit. But as to general business credit, that is a
selective control that has to be left to the.commercial banks. Otherwise you get into the area of saying A can have a loan and B cannot.
And I do not think that is any business of the central banking system.
Senator FLANDERS. Suppose that distinction has to be made every
day in the ordinary run of the banking business, but it is difficult to
legislate. I am glad to get that list of possible qualitative credit
controls.
Of course, Congress is committed, or the Senate is, to one of them
at least.
Now, another question that I wanted to ask was this: We are to]
by committees of Congress which have been studying the thing tha
we may want to increase our military expenses for the armed services,
and I forget whether it is 3 or 4 years, up to $17,000,000,000, in place
of the $11,000,000,000 which we have expended this year; and with,
so far as I can observe, no results. We are assured by the armed services that we have got nothing from the $11,000,000,000 we spent this
year.
That, however, is neither here nor there as far as this committee is
concerned.
But with an increased expenditure of $6,000,000,000 more, with a
concurrent withdrawal of men from production as the number of men
in the armed services is increased, are we or are we not going to face,
coming upon a period of relatively full employment, an inflationary
situation which cannot be handled by the means we have been discussing this morning.
Mr. SPROUL. Yes. I think we may. And I think you then will
have to reconsider your tax policy. You will have to reconsider the
question of allocation of materials and other direct controls. We will
have to have a much stepped-up and invigorated savings bond program. We will have a return of many of the circumstances of a wartime situation if the expenditures for military preparedness get into
the area of and the magnitude of wartime expenditures.
Senator FLANDERS. I do not know that I have any other questions.
The CHAIRMAN. Mr. Sproul, you have, as number four on your
opening page:
Justification of current complaints about difficulty in securing adequate funds
for modernizing and expanding business facilities, especially for small business;
effectiveness of current methods of channeling savings into investment.
Would you care to say a word about that? We were going to have
Mr. Schram here this morning, and I rather assume that is one of the
lines that he will follow. And we have a good deal of complaint, and
CREDIT POLICIES
105
some evidence, I think, that it is very difficult to get new money into
equity investment particularly.
Mr. SPROUL. I know less about that question than about bank
credit. Perhaps it is more difficult than what I have been discussing
and to that extent I may have avoided it.
I think first, however, we want to get our facts clear. In 1947 the
figures of the Department of Commerce show that there were
$26,500,000,000 raised by corporations, of which $14,500,000,000 were
for plant and equipment, $7,000,000,000 for inventory replacement
and expansion and $5,000,000,000 to meet an increase in receivables.
They got the $26,500,000,000 through retained profits, $10,000,000,000; depreciation reserves, $4,500,000,000; net new capital issues
$4,000,000,000 of which 26 percent only were stock issues, bank loans
of $3,500,000,000, increased tax liabilities $3,000,000,000, and increased
trade accounts payable $1,000,000,000.
The CHAIRMAN. YOU say 26 percent of the $4,000,000,000 was
stocks?
Mr. SPROUL. That is right. The important point is that $10,000,000,000 came from retained profits plus 26 percent of $4,000,000,000
all of which was equity capital. They were getting it out of the
present stockholders, you might say, rather than going to the market.
The CHAIRMAN. But those profits may not last forever and also
those are the large corporations and it raises the question whether
when you get small corporations who cannot raise the money whether
they can get any equity money at all.
Mr. SPROUL. In 1946 when we had a rising stock market, a very
much larger amount of equity money was obtained through the sale
of new stocks and it was obtained by small as well as large corporations..
I think the record of 1947, on which much of the current complaint is
based is partly due to the fact that the situation has not been conducive
to the free offering of stock in the market.
One thing I would like to say about that is that I do not think the
way to meet that situation is by pumping more credit into the stock
market, by giving us a boom in the stock market, based on credit, in
addition to the other booms which we may have.
The Chairman. You mean keep the present 75 percent margin?
Mr. SPROUL. I would have to be convinced that the 75 percent
margin requirement was interfering with getting capital for productive
purposes, which I do not think it is, before I would want to see that
margin requirement lowered.
The CHAIRMAN. Apart from the stock market, what do you think
is the difficulty in getting investment capital?
Mr. SPROUL. That is in getting it for small business which is not
able to meet its needs by the method of retained profits, a method
which has been available to the large and established corporations.
I think the difficulty resides more largely in tax policy than it does in
credit policy or is the situation in securities market. I think the
possibility of gain in the one case where you win is so largely offset by
the losses in the many cases when you lose that our tax program ought
to be adjusted to give greater rewards for winning.
Senator FLANDERS. And besides that you do not get what you win.
Mr. SPROUL. No; that is the difficulty.
The CHAIRMAN. You cannot get any return on it after you get it.
Mr. SPROUL. No.
106
CREDIT POLICIES
In addition to this difficulty of getting adequate funds, either capital
or credit, we have found in our experience with loans to business, and
particularly to small business, having difficulty in financing itself, that
its problems cannot all be solved with credit or with capital. There
are difficulties in terms of lack of ability to keep up with improvement
in methods and procedures, and lack of ability with respect to accounting and management, which greatly increases the hazards of those
businesses. It would be atpretty dangerous game to try to plug it all
up with credit or even easier access to capital.
The CHAIRMAN. There was a plan, I have seen some plans of trying
to get the investment of smaller savers on the theory that the large
people are always going to have high rates. The6 savings now come
in the lower echelon where they ought not to take the same risk and
do not ordinarily do so, putting their savings into insurance and so
forth. Some plan of setting up companies that would diversify
investments in common stocks and perhaps some investment in
insurance from the Federal Government for certain percentage of
over-all losses.
Have you gone into that?
Mr. SPROUL. There have been a number of such plans studied.
I have never yet seen one that looked like a commercially profitable
venture and, therefore, they do not develop into working programs.
The CHAIRMAN. I mean the trouble, as I see it, you probably have
as much savings as perhaps you ever had but being in lower income
groups where they cannot afford to take the risks is your problem.
Mr. SPROUL. That is right.
The savings are being channelled more and more into insurance
companies or savings banks or pension plans which by reason of law
or policy do not go into equities. Even if these institutional sources
relax their requirements they w ill probably go into established companies and would not go into the risky small business ventures.
The CHAIRMAN. In this small housing, we have a plan for insurance
company investment. It is an experiment and it may not work at all.
I think it guarantees tow and three-quarters percent and limits them
to four and a half or something like that.
Senator FLANDERS. Insurance companies are not particularly
excited about that.
The CHAIRMAN. No, but it was an approach toward insuring an
equity investment that might be followed in some kind of investment
company investing in equities.
Mr. Sproul, going back to this other figure, you refer to a reduction of Federal Reserve bank holdings, taking this from the Federal
Reserve bulletin of April 1948, December 1945 Federal Reserve
bank holdings were listed at $24,000,000,000 Government bonds,
$24,262,000,000, and that has been reduced in January 1948 to
$21,925,000,000. Your statement that that reduction has been made
is entirely correct.
On the other hand, the point I am trying to make is that the
Government bonds, outstanding Government bonds in that period
have been reduced from $198,000,000,000 to $164,000,000,000 a
reduction of $34,000,000,000 of which only about $2,300,000,000 was
a reduction of holdings of Federal Reserve banks, and that we cannot
hope to continue that reduction in government bonds. That was
partly due to that last sale?
CREDIT POLICIES
107
Mr. SPROUL. Yes.
The CHAIRMAN. I still feel that the Federal Reserve is going to be
up against a problem of buying more Government bonds unless the
interest rates tend to get stronger and that if they do, if they are in
that position, they cannot very well restrain bank credit.
Mr. SPROUL. My hope and expectation is that if and as we have to
buy long Government bonds we will be able to sell short Government
bonds and sell more of them than we buy long or at least sell an equal
amount.
The CHAIRMAN. I would suggest that the table on page 432 be
placed into the record at this point.
(The table appearing on p. 432 of the Federal Reserve Bulletin is
on p. 108.)
0
Ownership of United States Government securities, direct and fully guaranteed
[Estimates of the Treasury Department.
Par value, in millions of dollars]
Held by banks
Total
Interest
bearing
securities
End of month
1940-June
1941-June
December
1942-June
December
1943-June
December
-- ---
----
1944-June
December,
1945-June
December
1946-June
December
1947-June
s-.-c---------1947-August
September
October
November
December
1948-January
.
.
.
Total
Commercial I
banks
Held by nonbank investors
Federal
Reserve
Banks
.
Total
Individuals
Insurance
companies
Mutual
Other
corpora-
savings
tios and
banks
associations
State and
local governments
Special
issues
Public
issues
47,874
54, 747
63, 768
76, 517
111, 591
139,472
168, 732
201,059
230,361
256, 766
276, 246
268, 578
257, 980
255, 197
18, 566
21, 884
23, 654
28, 645
47, 289
59, 402
71, 443
83, 301
96, 546
105, 992
115,062
108,183
97,850
91,872
16, 100
19, 700
21,400
26, 000
41, 100
52, 200
99, 900
68, 400
77, 700
84, 200
90,800
84, 400
74, 500
70,000
2, 466
2,184
2,254
2, 649
6, 189
7, 202
11, 543
14, 901
18,846
21, 792
24, 262
23, 783
23, 350
21,872
29,308
32,863
40, 114
47, 872
64, 302
80, 070
97, 289
117, 758
133, 815
150, 774
161, 184
160, 395
160, 130
163, 325
9, 700
10, 900
13, 600
17, 900
23, 700
30,300
37, 100
45, 100
92, 200
58, 500
63, 500
62, 900
63, 600
66, 100
6, 500
7, 100
8, 200
9, 200
11,300
13, 100
15, 100
17, 300
19, 600
22, 700
24, 400
25, 300
25, 300
25, 000
3, 100
3, 400
3, 700
3, 900
4, 500
5,300
6,100
7, 300
8, 300
*9,600
10, 700
11. 500
11, 800
12, 100
2, 500
2,400
4, 400
5,400
11, 600
15, 500
20, 000
25, 800
27, 600
29,800
29, 100
25, 200
22, 100
20, 100
400
600
700
900
1,000
1, 500
2, 100
3,200
4,300
5,300
6, 500
6, 500
6, 300
7, 100
4, 775
6, 120
6, 982
7,885
9,032
10,871
12, 703
14, 287
16, 326
18, 812
20,000
22,332
24, 585
27, 366
2,305
2, 375
2,558
2, 737
3, 218
3,451
4, 242
4,810
5,348
6,128
7'048
6, 798
6, 338
6, 445
257, 183
256,177
256,348
255 674
254, 281
91,892
92, 129
91,968
91, 509
91, 159
69, 700
69,800
69,800
69, 300
68, 600
22,192
22, 329
22, 168
22, 209
22, 559
165,
164,
164,
164,
163,
66, 600
65, 700
65, 700
65, 600
65,300
24, 900
24, 700
24, 900
24, 700
24, 300
12, 200
12, 100
12, 200
12, 100
12,000
20, 700
20, 400
20, 400
20, 300
19, 900
7,200
7,100
7, 200
7, 300
7, 300
29, 220
29, 520
29,447
29, 517
28, 955
4, 496
4,424
4,488
4, 675
5, 397
254, 030
90,825
68, 900
21, 925
163, 205
65, 400
24, 100
12, 000
19, 900
7,200
29, 148
5,452
291
048
380
165
122
_
I Including
U. S. Government
agencies and trust
funds
holdings by banks in territories and insular possessions, amounting to 100 million dollars on June 30, 1942, and 500 million on Dec. 31, 1947.
^
w
U
"
H
~d G
t.
-
0
"
M*
109
CREDIT POLICIES
Summary datafrom Treasury survey of ownership of securities issued or guaranteed
by the United States I
[Marketable public securities. In millions of dollars]
U. S.
Govern-Isr
End of month
Federal
Reserve
7,009
24, 262
23 783
232,350
21,872
22,559
21,925
76,578
66, 962
62,961
61,370
61,588
2,476
and
trust
funds
ing
Banks
Insu rcom-
Commer- Mutual
savings
cial
ment
Total
outstand- agencies
banks'
Other
corn-s
panics
banks
TYPE OF SECURITY
Total: a
1945-Dec ----
-------
1945--Dec ----
-------
1946-June Dec -----------------1947-Jufie----------
Certificates:
1945-Dec ----------
1946-June-34,
Dec1947 June-25,296 f
Deec---------1948-Jan ---------Treasury notes:
1945-Dec ----------1946--June ------Dec ---------1947-June---------Dec ---------1948-Jan---------Treasury bonds:
1945--Dec ---------1946--June---------Dec ---------1947-June---------Dec---------1948-Jan ---------BONDS
6,768
6, 302
5,409
5,261
6 315
82,830
10,491
11,220
11, 521
11, 45
11,552
11,593
23, 183
24, 285
24, 346
23,969
22, 895
22,657
1-----
51,046
47, 015
44,177
42,684
42,54
41,867
1, 723
5
12,831
17.039
17. 033
3
2
14,466
14,745
15, 775
11
14,496
38, 155
38
8,364
804
29,987
58
64
48
6,813
7, 496
6,f280
21, 220
20, 677
30
34
6,797
682
6,8538
6, 712
200
275
269
351
7, 386
7,423
22, 967
18, 261
10, 096
8, 142
11,375
11,375
8
9
6
7
4
4
2,120
1, 748
355
369
1, 477
1, 543
15,701
11, 396
6,120
4, 805
5, 327
5,168
179
227
211
183
98
128
576
623
603
285
245
271
4,383
4, 258
2,796
2, 443
4, 224
4, 260
6,915
6,658
6,186
5,306
5,173
5,168
947
755
753
727
2,853
4,791
40,8535
47, 335
48, 408
48, 756
47,424
40,591
10,217
10, 743
11,049
11, 407
11, 226
2 1,149
22, 230
23, 073
23, 226
23, 305
22, 213
21,655S
33, 579
30, 764
29, 700
28,822
28, 974
28,499
15,222
10,119
7,8S02
11,255
14,203
17,798
185
4
29
83
69
69
2,017
1,411
72
251
1, 693
1, 759
9,956
5,655
4,341
6,936
8,244
9,465
63
116
181
374
266
343
235
495
591
420
316
423
2, 761
2,418
2,591
3,191
3,675
5, 739
35,376
35,055
39, 570
42,522
49,948
46,413
408
443
576
469
344
344
693
831
698
1, 377
1,825
25,165
25,285
28,470
29,917
33,415
31,494
701
709
1,947
1,574
1,876
1,908
1, 742
1, 506
2, 101
2,671
3,946
2,941
6, 673
6, 319
6.1550
7,193
9,896
7,941
31,025
32,847
27,283
18. 932
10, 270
10,270
787
716
529,
'423
370
370
210
135
72
40
426
494
21,007
21,933
16,687
11,577
6,090
6,0583
2,058
1,609o
2,042
1,245
576
570
2,902
2,822
2,826
2,002
580
842
6,083
5,832
5, 156
3.9645
1,928
1,841
2, 779
3,400
2,975
3, 374
4,393
4,38
90
83
78
78
834
2,255
3,691
3,308
2, 433
2,587
5,003
4, 788
5,823
6,026
5,303
6,751
8,0606
8,457
10,996
12,547
11, 768
11,137
18,211
17, 730
17,037
15,5136
14,838
ec- --D-5Y
1948-Jan -
TREASURY
198, 820
- 189,649
176, 658
-------168,740
- 165,791
164,948
--
1946-June Dee -----1947-June Dec 1948-Jan Treasury bills:
120, 423
119, 32,3
119,323
119,323
117,863
117,863
18
73
11,433
9, 709
1,142
1,187
787
3
----------2
1
1
11
1
1,424
1,088
479
1,494
1,941
25
39
194
357
18,091
91
3603
11, 211
16,676
11,2 21
8,36
243
257
249
576
490
362
10,439
10,459
821
2, 052
3, 092
AND NOTES,
DUE OR CALLABLE
Within 1 year:
1941-Dec ---------1956-June---------Dec---------1947-June.--------Dee---------1945-Jan ---------1-5 years:
1945-Dec ---------1946--June---------Dee---------1947-June---------Dee--------1948--Jan ---------6-10 years:
1945-])eec---------1946~-June---------1)ec ---------1947-June---------Dec ---------1948- Jan ---------16-20 years:
19456-Dec ---------1946--June---------Dee---------1947-June---------Dec -9-------1948-Jan ----------
34,985
37,189
32,384
40,352
4,757
94,757
See footnotes at end of table, p. 1 10.
77099--48--8
-797
11,905
11,829
9,88S6
12,425
17,710
17,138
110
CREDIT POLICIES
Summary data from Treasury survey of ownership of securities issued or guaranteed
by the United States '-Continued
[Marketable public securities. In millions of dollars]
U. S.
Govern-Inu
Total
ment
Federal
outstand- agencies Reserve
ing
and
Banks
trust
funds
End of month
Comnmercial
banks2
Mutual
savings
nsur
pank
iesm
pne
Other
Oaa
TREASURY BONDS AND NOTES,
DUE OR CALLABLE-con.
After 20 years:
1945--Dec ---------1946-June----------------Dec ---------1947-June 1948-Jan .....
......
24, 781
22, 372
22,372
14,405
2, 764
2,103
2,084
964
57
57
85
29
2,418
2,550
2,632
2,593
2,051
2,510
2,687
1,649
6,933
6,325
6, 602
3,358
10,5119
8,826
8,313
5,812
-
I Figures include only holdings by institutions or agencies from which reports are received. Data for
commercial banks, mutual savings banks, and the residual "ot her" are not entirely comparable from month
to month. Figures in column headed "other" include holdings by nonreporting banks and insurance
companies as well as by other investors. Estimates of total holdings (including relatively small amounts
of ronmarketa ble issues) by all banks and all insurance companies for certain dates are shown in the table
above.
2 Including stock savings banks.
aIncluding Postal Savings and prewar bonds, and a small amount of guaranteed securities, not shown
separately below.
Source: Federal Reserve Bulletin.
The CHAIRMAN. Are there any further questions, Senator Flanders?
Senator FLANDERS. NO.
The CHAIRMAN. Thank you, Mr. Sproul.
Certainly no questions which I have asked are to indicate any
opinion on my part. I am like the radio; I want the press to know
I am trying to bring out voice, not expressing an opinion myself.
The committee will stand in recess at this time.
(Thereupon, at 11:30 a. in., the committee recessed to reconvene
at 10 a. in., May 13, 1948.)
CREDIT POLICIES
THURSDAY,
MAY 13, 1948
CONGRESS OF THE UNITED STATES,
JOINT COMMITTEE ON THE ECONOMIC REPORT,
Washington, D. C.
The committee met at 10 a. in., pursuant to adjournment, in the
Labor and Public Welfare Committee room, United States Capitol,
Senator Ralph E. Flanders, presiding.
Present: Senator Flanders (presiding), Representatives Rich, Hart,
and Huber.
Senator FLANDERS. The hearing will be in session.
This morning we have Mr. Emil Schram, president of the New
York Stock Exchange.
You have, I see, Mr. Schram, a typewritten presentation, which
you may proceed with as you wish.
STATEMENT OF EMIL SCHRAM, PRESIDENT, NEW YORK STOCK
EXCHANGE, NEW YORK, N. Y.
Mr. SCHRAM. Thank you. I would like to read it, Mr. Chairman,
if you will bear with me. It should take about half an hour.
Senator FLANDERS. Go right ahead, sir.
Mr. SCHRAM. Mr. Chairman and gentlemen of the committee,
my name is Emil Schram. I am a resident of New York City. My
home address Is 784 Park Avenue. I am president of the New York
Stock Exchange.
I wish to express my sincere thanks for your courtesy in permitting
me to set forth my views on inflation, credit controls, the capital
markets, and the Government bond market.
It is my understanding that the committee is examining the question
of high prices in general as well as various anti-inflationary proposals.
These are subjects of encyclopedic proportions on which there is a
vast literature with plenty of disagreement among the doctors, and
I shall speak from my experience rather than attempt to present an
economic dissertation.
Inflation, to put it bluntly, is a state of mind. It cannot be understood solely in monetary or fiscal terms or if attention is paid only to
interest rates or commodity prices. I like to think in terms of the
future and base my opinions largely on an analysis of present conditions, which are never exactly like those of the past. Reference to
experience has value mainly in conditioning our minds to follow the
facts no matter where they may lead us.
In the early and midthirties, you will recall, herculean efforts were
made by the monetary authorities to generate the forces of recovery
by pushing funds out and creating excess reserves so that the commer111
112
CREDIT POLICIES
cial banks would add to their loans and investments. Excess reserves
piled up but business nevertheless languished and unemployment was
large.
Finally the central bank authorities were compelled to admit that
while a horse can be led to water, it cannot be forced to drink. We
are accustomed to think that periods of a balanced budget necessarily
coincide with so-l:id credit conditions and an absence of inflation, yet
in the period ending in the 1929 crash, the budget was balanced aMd,
more than that, a large surplus-that is, for those days-made it
possible to reduce the Federal Government's debt roughly by $8,000,000,000 between 1921 and 1939.
Again, the deficits in the fiscal years 1934, 1935, and 1936 did not
make for anything approaching full employment, let alone inflation.
Interest rates in 1936 and 1937 which now seem high, were being
condemned as representing the consequences of easy money policies
of an unsound nature. We know, from previous periods of business
expansion, that businessmen will borrow in one period at relatively
high rates and look with a cold eye on financing plans at other times,
although the cost of borrowed money is relatively low. As a matter
of fact, our building booms always seem to harmonize with a period of
increasing and high costs.
If commodity prices were a perfect mirror of inflation, a slightly
downward slump in the midtwenties to 1929 could not have occurred.
The history of commodity prices in those years would give one a most
distorted view of the larger business picture. This is simply by way
of comment and I think illustrates why I have stated bodly that inflation is psychological, or a state of mind, hoping that you gentlemen
will credit me with some acquaintance withthe economic facts of life.
I would not like to try to define inflation in a way that would stand
up against the criticism of monetary experts, but I think that we can
best recognize its existence or absence by a homely truth: We have
inflation when money is running after goods and deflation when goods
are running after money. The great problem, I might add, is to
find a way of avoiding both of these conditions and pave the way for
more stability so that we do not always appear to be in a period where
a large number of people realize that prices are low, but cannot pay
even these low prices for goods and services because of lack of income
or, having income, find it hard to make both ends meet because prices
are high.
By my own definition, in the 2 years after VJ-day and until recently,
we were in an inflationary period because certainly money was running
after goods and services. A public which had done without many
things and had ample funds was determined to do without no longer.
More recently, despite developments such as the coal strike which
has tended to accentuate shortages in certain fields, the areas of
shortages has shrunk. It is my conviction that it will shrink further
in coming months as the remaining pipe lines are filled and production
and consumption come into greater balance.
According to the latest figures, the monthly production of washing
machines has reached 400,000 against approximately 290,000 a year
ago and the adequacy of the supply of such consumer durable goods
as radios and refrigerators is common knowledge to everyone who reads
the newspapers or walks into an electrical appliance store.
For a number of consumer durable goods which were so difficult
to get a year ago prices have been reduced-this despite higher wage
CREDIT POLICIES
113
costs. Shortages that vexed us a few months ago have disappeared.
There is no longer any shortage of men's white shirts and the best
authority, your wives, will confirm the fact that many food items
such as citrus fruits, which a year ago were hard to get, are in ample
supply and in several cases, prices have tumbled severely.
I realize, of course, that some shortages in the heavy goods industries
still exist and it does not seem possible for the automobile industry
to catch up on the demand for some time. Only a few months ago,
this committee heard testimony on the alleged shortage of meat. If
there was one subject on which everyone agreed, it was that in April
and May meat prices would soar. The fact is that recently hogs in
Chicago, as a result of heavy receipts, slumped to $21.75 against
$23.50 only a month ago and were at the lowest prices since OPA days.
It
i3
COmmOD knowledge, however, that luxury businesses have suffered
sharp curtailment.
One field that is so important as to deserve special comment is the
housing shortage and real estate. In a very thoughtful survey
published by the Federal Reserve Bank of Cleveland as a supplement
to the April Monthly Business Review, it is pointed out that since
early 1947 the rate of family formation appears to have declined
substantially.
For the first time in recent years the increase in dwelling units
appears to have exceeded the increa 3e in family formation. The
survey concludes that while demand for the present is still in excess
of the ability of the construction industry to produce, there is some
evidence that the intensity of the demand for housing will gradually
taper off. To quote:
The gradual prospective reduction in the housing deficit, coupled with increasing
pressure of those costs on income, and coupled with evidences of tightening of the
mortgage market, should all contribute to progressive lessening of the intensity of
demand.
In the field of small housing, we find an area in the economy where
it seems the Government must continue to lend a helping hand. The
Congress has been mindful of its responsibilities to the country in
this regard in its constant and careful study of the problem. There
.is pending a long-term housing measure known as the Taft-EllenderWagner Act which is concrete evidence of further consciousness of the
housing problem on the part of Congress. The FHA mortgage
guaranty authority (title 6) lapsed as of April 30, and I understand
that Congress is presently reviewing the advisability of extending this
authority for 1 year. In other words, small and mass housing continues to require a form of subsidy from the Federal Government.
In the broad objective of such legislation, I concur; as to the methods
of assistance, I prefer to leave that decision to those in the Congress
who have given real study to the question, as in the case of your
distinguished chairman, Senator Taft.
I do point to the fact that the former Chairman of the Federal
Reserve System, Marriner Eccles, disputed the soundness of provisions of the Housing Act which made credit available on excessively
easy terms in that buyers were encouraged to go deeply into debt,
adding to inflationary pressure.
I understand the approximate carrying charge on a small home
under the GI bill of rights to be about I percent of the purchase
price per month. A builder informed me the other day that in the
114
CREDIT POLICIES
outlying areas of New York a $19,500 home may be mortgaged for
$14,500 through private channels; that the GI can obtain an additional
loan of $3,000 for a total of $17,500 and the additional $3,000 is
guaranteed as to payment by the Federal Government. The carrying charge in this particular case is about $150 a month, or $1,800 a
year.
In the bracket of a $10,000 home, the carrying charge is approximately $80 per month. It seems to me that at this rate of monthly
outlay we must expect that some purchasers will find it difficult to
maintain their payments. This will be especially true should we
find employment and prices at lower levels in the coming years.
I am a firm believer in the rights and advantages of ownership on
the part of all of our citizens, whether they be well off or of moderate
means. There is a certain something, by way of better citizenship,
that accrues to the Nation from the privilege of ownership. That is
why it is the duty and responsibility of every public official and of the
Congress to safeguard and protect property rights and the rights of
ownership if enterprise as we know it is to endure. The reward is in
the pleasure of living in freedom and liberty. I heartily endorse
Government planning and assistance in the field of small and mass
housing throughout the Nation.
It is a healthy sign for a nation to be critical of itself, but I sometimes think that we have overdone criticism of our performance since
the end of the war. On the one hand, 60 million employees were
regarded by Government economists as a goal to be reached in the
fifties and by many business economists as an example of wishful
thinking, to the discredit of neither view.
The fact remains that practically 60 million have been employed
and production has been rolling for months. According to the most
widely used index of production, that published by the Federal
Reserve Board, industrial production in January and February of
this year was at the rate of 192 and 194 percent of the 1935-39 average
and in March was back to 192 only because of the coal strike. As a
matter of fact, in no month since last September has this index been
under 190. This is a record of which both labor and business management should be proud. The consuming public, too, has exercised
discrimination. I am told that merchandise which moves today has
to have appeal both with reference to quality and price. The large
volume of liquid savings accumulated mainly during the war period
seems to be either dedicated to specific purposes such as the purchase
of a home or automobile or to some other special need.
I do not believe there is any evidence to support the idea that a large
percentage of the accumulations will suddenly appear as a broad-scale
demand for commodities. If this has not already happened in the
face of all sorts of inflationary scares, I am inclined to dismiss it as a
future source of concern. Two important bits of economic evidence
are:
One, the continued decline in money in circulation which now
amounts to approximately 27.7 billion dollars, a reduction of 400
million dollars since the comparable date a year ago. The total is
now about the smal'est since August 1945.
Two, the annual rate of turn-over of demand deposits outside of
New York City is almost exactly the same as in 1941 prior to our
entry into the war. In my judgment, this is strong proof of intelligence on the part of the public in refusing to become panicky or to
CREDIT POLICIES
115
be stampeded into a rash, indiscriminate preference for goods over
money.
The timely price reductions recently announced by United States
Steel Corp., General Electric Co., and Westinghouse Electric Corp.
signal wise business statesmanship. Undoubtedly the 21 billion
dollars which will have been spent in the years 1946 through 1948 by
manufacturing companies on new plant and equipment are also
beginning to show up in cost sheets, and if a third round of wage
increases is of minor proportions, additional price cuts will herald
the return of a competitive era.
Credit controls, I admit, have charm. I can well recall when all
of us, including the Federal Reserve System, were much younger
and thought the Federal Reserve authorities could regulate the
business cycle in the same way that an engineer regulates the speed
of a train. No one would be happier than I if the matter were as
simple.
In a study by Dr. Charles 0. Hardy, economic adviser to your
committee, entitled "Credit Policies of the Federal Reserve System,"
the author set forth the theory of central bank control of the business
cycle. Abbreviating this lucid description somewhat, the basic idea
is that commercial banks cannot afford to hold surplus or excess
reserves, and the public cannot afford to hold surplus cash and bank
balances.
Dr. Hardy then wrote this commentary on the various methods of
pursuing a liberal central bank policy which, according to theory
willy-nilly translates itself into increased willingness and ability to
buy on the part of the public, and so stimulates business revival. He
stated:
The difficulty with this program is in the assumption that the response of the
banks and that of the public to easy money in times of depression will be the same
as it would be in times of prosperity. Depression psychology is ignored. But
this is to ignore the central element in the problem. A depression exists precisely
because there is a general preference for cash, and for safe short-time investments
expressed in cash terms, over commodities and securities. To increase the supply
does no good unless the preference decreases.
More recently, the experience of 1936-37 is illuminating. Federal
Reserve authorities disclaim responsibility for the precipitate decline
in business-the decline in industrial production between September
1937 and June 1937 was one third and employment in manufacturing
industries fell almost 25 percent-and are inclined to point to the
drop In net Government contribution to income following upon the
collection of new social-security taxes.
It cannot be questioned that the Federal Reserve was aware of this
fact and would not have taken its series of steps to cut excess reserves
by raising reserve requirements had the subsequent decline in business
been envisaged.
Even after the three increases between August 1936 and May
1937 had doubled reserve requirements to 26 percent for central
Reserve city banks, 20 percent for Reserve city banks and 14 percent
for country banks, excess reserves amounted to some $770,000,000.
As I see it, this case illustrates the danger of a restrictive policy and
the rapidity with which psychology can change, for business expenditures dwindled and in retrospect psychology probably had more to
do with the change than actual stringency in the money market.
116
CREDIT POLICIES
Frankly, I do not want to pose as a monetary expert and feel much
closer to the capital market. From this vantage point, I am astonished at the continued attempt to draw an iron curtain around the
separate parts of the capital and money markets, all of which are
inseparably interwoven. The current issue of the Cleveland Trust
Co.'s economic bulletin contains a chart of common stock yields and
the return on bonds which is so striking that I have attached a copy
to my remarks. The explanation as set forth is also worthy of your
attention.
Senator FLANDERS. That will be received for the record.
(The chart referred to, with accompanying explanation, follows in
the record at this point.)
THE CLEVELAND TRUST COMPANY BUSINESS BULLETIN
STOCK AND BOND YIELDS
Yields on common stocks are now relatively high, while those on bonds are not
much above their all-time low of 1946. Over the past 48 years, the average yield
on common stocks was 5.85 percent. In March of 1948 it was 6.81 percent.
Corporate bond yields averaged 4.97 percent during the same period, and were
3.10 percent in March.
The diagram shows the changes in stock and bond yields beginning with 1900.
For stocks, the curve represents the average yield of all common stocks regularly
traded in on the New York Stock Exchange. The yield for any given month is
obtained by dividing the sum of all the dividends paid per share during the
previous 12 months, by the sum of all the prices. The curve for bonds shows
the average yields to maturity of high- and medium-grade corporate bonds. It
is based on the index of Standard & Poor's Corp. from 1900 through 1918, and
on the Moody index from 1919 to date.
On the diagram the yields are plotted for the last month in each quarter during
the 48 years from 1900 to 1947, inclusive, making 192 quarters represented in all.
In addition, the yields for March 1948, are shown. A comparison of the March
stock yield of 6.81 percent with all those which preceded it discloses two points
of particular interest. First, the March figure has been exceeded in only 45, or
less than one-fourth, of all the 192 earlier dates. Second, that figure was nearly
2.2 times the March yield of 3.10 percent on bonds a ratio exceeded in only 14 of
the 192 prior quarters.
If a curve of general business activity were also drawn on the diagram, it would
show that an average stock yield as high as that in March is very unusual when
business is above normal.
The foregoing facts illustrate the lack of response by investors to the large
increase in corporate profits, and a relatively more moderate incresae in dividends,
over the past 18 months. During this period the spread between stock and bond
yields has become steadily greater despite the very low return available on bonds.
Corporate bond yields will probably not attain much higher levels as long as
the Federal authorities continue to influence long-term interest rates by supporting
the Government bond market, through purchases at fixed prices when the occasion
arises. A reduction in the spread between stock and bond yields would thus
depend mainly on lower stock yields, either by way of rising stock prices or
smaller dividends.
There have been several reasons for the relative lack of enthusiasm toward
common stocks. Among them are the double taxation of dividends; the doubt
that current dividends could be maintained if business should slacken, because
of the high break-even point in corporate operations; and the effect of high taxes
in reducing venture capital. Influenced by these and other factors, many indiviaual investors have preferred the greater security of bonds, or even idle cash,
in these times of perplexing uncertainties.
STOCK AND BOND YIELDS
AVd
April 15, 1948
kI
a
tZI
Fo
qb
l
The Cleveland Trust Co.
0
I-4
w
118
CREDIT POLICIES
Mr. SCHRAM. The present margin requirements are clearly discriminatory in the one market that is noninflated. As I stated in my
testimony before the Senate Finance Committee a few months ago,
this is a matter that transcends Wall Street and La Salle Street. It
reaches into every town, mining district, and rural area-wherever
America is engaged in wealth-creating activities.
I am convinced that a healthy, dynamic stock market would also
help the bond market, especially Government bonds. This may
seem contradictory. Yet, it follows that a considerable part of the
financing consummated last year through bank loans, term loans,
and long-term debt issues went to the insurance companies and banks
because the companies issuing securities could not finance through
the sale of equity securities.
The economic bulletins have noted the fact that weakness in
Government bonds and the sales by financial institutions which
brought pegging operations to the forefront coincided with the
expansion of the corporate investments of these institutions. An
improved stock market as a result of a reduction in margin requirements and capital gains taxes would have a twofold result: One,
financial institutions could replace with Government bonds the loans
paid off through stock financing; two, and stocks which are not sold
because of the onerous tax burden would in many cases be liquidated
and the proceeds put into Government obligations, assisting in the
private placement of the Government debt.
Since the end of the war, the Revenue Acts of 1945 and 1948 have
been steps in the right direction, renewing the flow of risk savings,
made impossible under the burden of wartime taxation. The return
flow of risk savings must be accompanied by incentives putting
capital to work, as an integral part of our production and employment
mechanism.
The relief I have called for will enable the capital accumulating
groups whose function it is to take the risks of ownership to perform
their proper office. The larger body of small savers whose savings
are channeled into institutions, principally life insurance companies,
savings banks, building and loan associations, who invest solely or
largely in debt securities, would continue to contribute to the national
savings, undisturbed by the ups and downs in risk investment. I
might add that I would prefer to have it this way, and would not
advocate a policy encouraging our life insurance companies to provide
risk capital through the purchase of common stocks, except as a
last resort.
Senator FLANDERS. In that sentence, you are departing from the
manuscript as we have it. You say here:
and would advocate a policy encouraging our life insurance companies to provide
risk capital through the purchase of common stocks, only after careful study.
Mr. SCHRAM. The meaning is the same. For emphasis, I changed
the wording just a little, Senator.
When the economic historian sets forth the financial development
since VJ-day, he will have to explain how it was that the interest rates
were kept at unprecedentedly low levels while the national debt and
deficit were soaring and how it came about that almost simultaneously
with the end of deficit financing and the beginning of debt retirement,
substantial changes took place in the bond market. It would seem
CREDIT POLICIES
119
that as the supply of Government securities declined their value also
declined.
The explanation is that the Government bond market which now
dominates the interest rate pattern of the country has become a
not
managed market, and probably must continue so, but we should
place
to
mistaken
be
to
out
turned
has
that
policy
monetary
permit
us in an economic strait-jacket determined by the past.
Even a 2.5 percent long-term rate may be subject to change without
the catastrophic effects feared by some. The country's economic and
financial system has adapted itself in the last 20 years to more fundamental changes. To insist on a 2.5 percent rate and at the same time
the
express deep concern over alleged inflationary tendencies, to say
least, is inconsistent.
Leaving the narrower field of the Government bond market for the
rebroader concepts of central bank policy, what is the object of the
newed efforts of credit control? If it is in effect to hold down prices,
I point out that the Federal Reserve Board itself in the past has turned
for its
down any mandate that it use commodity prices as the guide period.
prewar
the
in
again
and
1920's
the
in
policies. It did this
With a $40,000,000,000 budget and $250,000,000,000 debt, it is folly
Reto expect a return to the prewar price level. As yet no Federalprice
serve or Treasury official has expressed his opinion on where the
level should be-we may ask what is the happy price level?
Until that question is answered, I would hesitate about giving the
Federal Reserve Board additional powers. The means of bringing
about the natural answer is to permit the forces of supply and demanda
to work themselves out through budgetary controls so as to avoid
renewal of deficit financing, and by making saving more attractive.
An economy operating at almost 200 percent the prewar level cannot
exist on a prewar credit diet. Practically every severe period of business depression and unemployment has been preceded by a contraction
of the monetary supply.
be
Consequently, it seems reasonable to ask that other methods
used first and the need for such drastic action be established beyond a
the
reasonable doubt. I must say that we seem to be obsessed withthat
monetary side of the price equation and seem to have forgotten
there is another side-the supply of goods and commodities.
For this reason, I find the observations of the Federal Reserve
Bank of New York in its current annual report of special interest.
In the section of Federal Reserve credit and credit policy, it is stated:
and currency
The growth in the money supply in the form of demand deposits
was, no doubt, a contributing
amounted during 1947 to about 3 percent. Thisthat
rise was induced primarily
influence in the rise of commodity prices, but
of industrial proby other factors, such as crop failures in Europe, rising costs
supply, a heritage of
duction in this country, and the existing excessive money
circumstances of the
the war and its financing. It is doubtful whether, in the
entirely (it is even more
year 1947, credit expansion could have been prevented
of the public during the
doubtful that purchasing power placed in the hands
measures as
war could have been substantially reduced), except by such drastic
would have interfered seriously with production-production urgently needed to
meet domestic and foreign demands.
I am glad that we are again thinking about production, supply,
and costs rather than in exclusively monetary and fiscal terms.
In conclusion, I believe that if we have our eye on the big fundashall
mentals, like the football player who always follows the ball, we
120
CREDIT POLICIES
be doing our best job. I keep my eye on employment and underlying
all my views is the goal of continued high employment, the great
challenge to our society.
The times call for acute thinking and appraisal of the basic forces
in the economic process rather than snap judgment. My thinking
is along lines of stability. Provided we keep our heads, I do not
fear runaway inflation nor do I look for the great depression whose
failure to appear has so chagrined the Marxian economists and statesmen. We cannot hope to attain absolute stability-it is not part of
a dynamic economy. However, if we do not depress business psychology unnecessarily, and adopt voluntary restraints such as the
American Bankers Association has advocated, I see no reason why
a large volume of goods and services cannot continue to be produced
and taken off the market. Over the longer term, a return of the
upward trend of greater productivity per man-hour will enable us to
resume the improvement in living standards that is the most noteworthy feature of the romance of American economic history.
We have emerged from the period of shortages and unless the
Congress permits the budget to become unbalanced again, I firmly
believe we have already entered the postwar period of stabilization.
Senator FLANDERS. Thank you, Mr. Schram.
I would like to ask you a few questions which I have noted down in
the course of your reading.
On page 4, you mentioned the tightening of the mortgage market.
Why should that insured mortgage market tighten?
Mr. SCHRAM. Why should an insured-mortgage market tighten?
Senator
FLANDERS. Yes.
Mr. SCHRAM. Well, I don't think that it should, really. I think
that those mortgages have proved to be very good investments
for banks.
Senator FLANDERS. I ask the question because we get complaint
from those endeavoring to purchase homes at this time that it is
being made more difficult for them to get FHA accommodations at
banks than was the case a year ago. That, perhaps, is a little outside
of your field of experience.
1 was wondering what the reasons for that would be.
Mr. SCHRAM. I would assume that the cost factor would enter into
that a great deal. But with the mortgages insured, it seems to me
that the banks would be willing to continue to make those loans.
Senator FLANDERS. I have not gone further than that point in my
questioning of those more directly concerned.
I have before me the transcript of yesterday's hearing. And yesterday, the chairman, Mr. Taft, questioned Mr. Sproul with respect to
justification of current complaints about difficulty in securing adequate
funds for modernizing and expanding business facilities, especially
for small business. That is another question, though. I will come
to that a little bit later.
On page 9 of your manuscript, you read points one and two there a
little more rapidly than my mind moved. You are explaining, apparently, why the weakness in Government bonds coincided with the
expansion of the corporate investments of these institutions and an
improved stock mackyet, as a result of the reduction in margin requirements, would have a twofold result. First, you say, "financial institutions could replace with Government bonds the loans paid off
through stock financing."
121
CREDIT POLICIES
What'financial institutions are you referring to? The banks?
Mr. SCHRAM. I am talking about both banks and insurance companies, particularly insurance companies, life insurance companies,
Senator. I think life insurance companies are making loans today
that banks ought to be making, and I think banks are making loans
from funds where the money should be secured in the equity market.
Senator FLANDERS. But if the present 75 percent margin were
reduced to 50 percent, do you think that equities would have a far
better market? Is that what you are saying?
Mr. SCHRAM. It would have a much broader market, Senator. I
feel quite strongly about that. I disagree with the Federal Reserve
most heartily in that particular point.
Senator FLANDERS. Mr. Sproul apparently followed Federal Reserve thinking in his testimony yesterday on that point.
Mr. SCHRAM. I understand that he did.
Senator FLANDERS. He saw no difficulty with the present 75 percent
margin requirement.
Mr. SCHRAM. When you analyze the loans that are being made,
you find that there is a decided trend toward debt financing, which
I think is a very dangerous trend.
Now, the Federal Reserve on several occasions has said the stock
market is one of the healthiest spots in our economy today. But
still they say that you have to put up $100 worth of collateral to
borrow $25. I think they are very inconsistent. I think that the
securities market has been inspiring all of the business activity and
operating at a very high level. The stock market has been the one
depressed industry in the country.
Senator FLANDERS. Now, this diagram which accompanies your
testimony, this diagram of the Cleveland Trust Co.'s bulletin, shows
the stock yield as being much above the bond yield.
Mr. SCHRAM. That is correct.
Senator FLANDERS. Do you lay that largely to the sluggishness of
the market, due to the high reserve requirements? Is that the only
thing which brings those yields so much higher?
Mr. SCHRAM. I think there are two factors there.
One is the
margins, and the other is the lack of incentive, due to the tax structure,
and with particular reference to capital gains.
Now, there is not much incentive to purchase risk securities today.
Senator FLANDERS. You might review the present capital gains
situation. I remember it is 25 percent. And after how many months?
Mr. SCHRAM. Six months.
Senator FLANDERS. That would seem, on the face of it, to be fairly
liberal purchasing except for quick turn-over.
Mr. SCHRAM. The quick turn-over ,of course, is taxed at the income
rate.
Senator FLANDERS. Yes.
Mr. SCHRAM. But the capital gains tax for the long period, 25
percent, is a very high rate.
Senator FLANDERS. It is now in comparison with the straight
income tax as to most of those who are in the market.
Mr. SCHRAM. Senator, I think that is one of the great mistakes that
we make. We confuse a capital levy with income. I think it is
unfair to think of a capital gains tax as an income tax.
Senator FLANDERS. I was not thinking of it from the standpoint
of theory. Because the point you are just making can be maintained.
122
Mr.
CREDIT POLICIES
SCHRAM.
Oh, yes.
Senator FLANDERS. But I was thinking of it more from the standpoint of the individual investor, who, it would seem to me, forgetting
theory and just facing the facts, would say: "Here is the stock which
gives a good yield and it seems as though its present price, considering
everything, is lower than it should be. It gives a good income at the
present price, End it seems as though its price ought to be higher
later on."
Forgetting theory, as to whether it is a capital levy or whether it is
an income-tax proposition, why should I not take a chance on this,
after reviewing all the information I have at hand in connection with
this stock?
Mr. SCHRAM. Senator, you know, the capital-gains tax is one tax
where you have a choice of whether you pay it or whether you do not
pay it.
Now, capital has aged tremendously in this country. It is now
owned by people who really should dispose of those securities-or
their capital assets; they are not all securities. We usually think of
capital-gains tax in terms of securities.
Senator FLANDERS. It is physical properties of all sorts.
Mr. SCHRAM. That is right.
Now, an elderly person has a low acquisition cost. He takes his
profit, pays the 25 percent, and he dies a week or a month later. His
estate is really cut down tremendously.
Now, in that he cannot afford to take that chance. We need to
broaden our markets. If we could lower that tax, it would encourage
people to divest themselves of those holdings.
Senator FLANDERS. You are speaking of lowering the estate tax?
MC. SCHRAM. No, I am speaking of lowering the capital gains tax.
If we could encourage those securities, those assets, to be sold, and
get them into newer channels, a great deal of money would normally
go into Government bonds. It would make revenue for the Government. It would actually be a revenue producer; and of course, the
capital gains tax has never been considered a revenue producer. It
would be of tremendous help if we could get those securities out of
those old ownerships and into younger hands, and diffused.
Senator FLANDERS. I get the point you are trying to make there.
Again referring to this Cleveland Trust Co. chart, I presume charts
have been made which indicate earnings as well as dividends on stocks.
These relate to yields. That is the personally available yield. I
imagine that that stock line would go out of sight off the chart if it
were plotted on company earnings against stock market prices.
Mr. SCHRAM. Yes; it would be much higher.
I think perhaps right at the moment some of them might be coming
down quite rapidly.
Senator FLANDERS. I can understand the disparity between company earnings and market price, because so much of the company
profit is not available profit at all. It is the cost of carrying highpriced inventories, the cost of carrying the increased working capital
requirements, which shows on the books a profit but really is not
available.
Mr. SCHRAM. And they have to be retained, too, for expansion
purposes, because the money is not available in the equity market.
Senator FLANDERS. They have to be retained; yes.
CREDIT POLICIES
123
Mr. SCHRAM. Of course, these high profits, given time, adjust
themselves. They do not remain out of line very long.
Senator FLANDERS. It was Mr. Sproul's contention yesterday that
the money supply and the supply of goods and services, and consequently -the price level, were tending toward stability. They were
coming together.
Mr. SCHRAM. I think that is definitely true.
Senator FLANDERS. That is a hopeful sign if that is true.
Now, again referring to Mr. Sproul's testimony of yesterday on
page 10 you say:
Even a 2.5-percent long-term rate may be subject to change without the catas-
trophic effects feared by some.
He made the statement that he felt it should be kept at 2.5 percent,
and he used some such words as these: "For any foreseeable future."
He left the small knothole to creep out through in some distance.
But do you share his feeling that under any conditions foreseen at
present it would be a serious thing if the Government securities, the
long-term securities, were not pegged?
Mr. SCHRAM. I am afraid that for a while they will have to be
pegged, especially because of the condition of the equity market.
With your flow of savings-and the flow of savings, of course, has been
from the low income brackets-going into insurance companies, and
the insurance companies persisting in selling governments and going
into the making of these industrial loans, then of course you have to
have some support from the Government bond market. My contention is: do something for the equity market. Broaden that out.
Permit these companies to do what historically they have always
done: finance through equity financing rather than debt financing.
Then I think you will have funds that will give you support in the
Government bond market. But at the present time I think the
Government bond market is going to have to be supported, and should
be.
They seem to insist on drawing an iron curtain, as I have said,
between our equities and the bond market, and the Government bond
market. You just can't do it. They are all wrapped up in the same
ball of wax, and they have to be considered as one unit.
That is where the great mistake is being made today by the Federal
Reserve Board in my opinion.
Senator FLANDERS. On page 11, at the top of the page, you express
your feeling that the prewar price level will remain and should remain,
will naturally remain, at a considerably higher level than the prewar
level.
Now, I have no figures before me, but I think it is the personal
experience of everyone who is as old as you and I are that the price
level after the First World War was higher than the price level before
the First World War. We went up onto a new plateau then. And
we eventually adjusted ourselves to it, I think far too painfully, particularly so far as the agricultural factor of our economy was concerned. But it seems reasonable. to expect, on the basis of any previous experience with previous wars, that that result does take place.
And that coincides with Mr. Sproul's testimony, as to our gradually
coming into a balance at a higher level than the prewar level. And
with that you agree.
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CREDIT POLICIES
Mr. SCHRAM. Yes; I do. Of course, I think that in time, if industry is given sufficient funds for expansion and technological improvements, which you must have, you will get some adjustment of
price level. I think we have already seen some of that taking place.
Senator FLANDERS. Do you agree that the mechanism by Which
.we have increased the productivity of the manpower has been largely
through capital investment in more productive facilities?
Mr. SCHRAM. Yes, sir; I do. And that figure is mounting almost
every day, Senator. The dollars invested per man now for a job is
going up constantly. And it has to go up.
Senator FLANDERS. I presume you would then feel-while I do not
know that you express it directly here, I think I have heard you express it before-that tax policies which encourage investment in
more efficient productive facilities are essential to a continued increase in productivity per man-hour, and that is the basis for the
continued rise in our standard of living.
Mr. SCHRAM. Unquestionably. And our economy of this country
has been financed with private funds, not public funds. That is why
our economy is such a dynamic economy.
We seem to think that that is no longer necessary.
For 15 years, Senator, as you will realize, there has been little need
for private capital. We have followed another procedure.
Most of the funds, beginning back in 1933, were furnished by the
Government. And, as you know, I was part of the agency in Washington, the RFC, that played a great part in furnishing funds to all
types of business, insurance companies, railroads, and so on.
We got into the war period, and again the Government financed
business. It had to. There has been little need for private capital.
Now we come to a time when there is a tremendous need for capital.
And we find the atmosphere such that it is not available.
I just hope that this committee will give very serious thought to that
particular question because I think that is the only way we are going
to continue to have a dynamic economy in this country.
We must encourage savings and investment in American industry.
Senator FLANDERS. Now I come to two other questions that give
me, personally, a great deal of trouble.
One is the question as to whether the inflationary spiral is not one
exceedingly difficult to control under the conditions which we wish to
maintain, and which we have maintainod for a long period, the conditions of practically full employment.
Does that not present new problems in the way of controlling the
inflationary spiral?
Does not the fact of full employment present great difficulties in
keeping that spiral under control?
Mr. SCHRAM. I think the one thing you have to keep your eye on,
as I have tried to point out, is that question of full employment.
That, I think, is very important.
Senator FLANDERS. Stability of a sort might be more easily obtained with a pool of unemployed than with full employment, perhaps?
Mr. SCHRAM. Well, I don't know. I have always been afraid of
these schemes that seem to call for a "healthy unemployment."
I do not think there is such a thing.
Senator FLANDERS. I agree with you that healthy unemployment
is socially exceedingly unhealthy. And we do not want to succumb
CREDIT POLICIES
125
to such an idea. But I am disturbed at the difficulty of controlling
the spiral under long continued full employment, which is our
objective.
2Mr. SCHRAM. That is right.
Now, of course, you do have a very tight labor market. And you
have had. There is some loosening up now.
Senator FLANDERS. There is some loosening here and there.
Mr. SCHRAM. But on the whole, I think we have a tremendous area
for expansion. And if industry is able to finance itself in a proper
manner-and I say that advisedly-I do not think we have much to
fear.
I do not like to see industry being financed with this procedure of
increasing the debt structure. Because that money becomes "scared
money" awfully fast. And there you get into a psychological situation which I think is exceedingly dangerous.
You get a little bit of a set-back, and they are forced to dump
inventories, and you get a psychology there that I think is very
dangerous.
Now, if industry is financed as it should be, with equity financing,
it is not "scared money." That is, you have better control over it.
Management has a greater opportunity. But you have a high concentration of debt in one or two companies, and the first thing you
know, the business is going to be run by the fellows they owe the
money to, and I think it is a very dangerous procedure.
Senator FLANDERS. Coming to the last sentence now, you say:
We have emerged from the period of shortages, and unless the Congress permits
the budget to become unbalanced again, I firmly believe we have already entered
the post-war period of stabilization.
But we are faced with requirements by the armed services which
will raise our expenditures in 3 or 4 years' time on the $11,000,000,000
for this fiscal year just ending now, in a gradual rise to $17,000,000,000.
Can we absorb that without getting unbalanced again?
Can we have that period of not nearly an increased percentages of
production going into something else than consumption, but also a
decreased manpower available, due to the manpower being diverted
into production into the Army and Navy?
Can we face that without again getting into deficit spending, without
getting into money supply that is again chasing a lessened product
and without again requiring our entry into a period of controls?
IV/r. SCHRAM. Senator, I do not see anything in this present program-that is, the European relief program and the increase in the
demand of the armed services-that is dangerous. Because the
expenditures are going to be made over a long enough period of time
that I think we will be able to keep pace with it.
Senator FLANDERS. Do you think that in 4 years we can absorb
that extra $6,000,000,000 which is suggested?
Mr. SCHRAM. Yes. Yes; I think we can.
Now, if we get over on the side of war, then, of course, I don't
know. I wouldn't attempt to predict that. Because when you have
to go all out, you get along the best you can.
But I don't see anything in the present situation that would allow
me to believe we are getting the thing out of balance. You know, I
have great faith in the judgment of the American people. You can
get prices too high, and they just refuse to buy.
77099-48-9
126
CREDIT POLICIES
We saw quite a bit of evidence at the peak of this price trend. They
developed a buying resistance. And I just have an awful lot of faith
in the judgment of the American people.
Senator FLANDERS. Well, I have been worried by this $6,000,000,000
additional, but I am glad to find someone who is not seriously perturbed by it.
Mr. SCHRAM. My observation is that the planning of expenditures
for the next fiscal year is not going to be such as to throw us out of
balance. I believe we will be able to absorb those expenditures.
Representative HUBER. I feel as you do, Senator. I remember
when we thought that $2,000,000,000 were going to upset the applecart.
Now, you mentioned the healthy dynamic stock market. I wonder
what steps could be taken to prevent it from becoming too dynamic,
with a resultant recurrence of the conditions of 1929.
Mr. SCHRAM. 1929 saw a situation which I do not think can possibly
return.
I am very frank to say to you that in 1929, I think we had more or
less of a rigged or manipulated market. 'W e had absolutely no control
at that time. We got a psychology that was rampant in this country
at that time that was very difficult to stop.
Everybody thought that all they had to do was to buy something
today and it would be worth a lot tomorrow. They did not use
very good judgment.
We have controls today that I think would make another 1929
almost impossible. That was pretty much of a rigged market.
There was permitted at that time these options, these pools, and
these manipulated practices that are just unthinkable today, that
could not possibly happen.
For example, you had no margin requirements at all in 1929. Banks
could lend anything they wanted to, and brokers could lend anything
they wanted to.
Now we have a lot of control. We have the SEC Act, which I
think has been an excellent piece of legislation. And the stock
exchange itself has gone just as far, if not further than the SEC in
many respects, in control.
We certainly do not want another 1929, and I would be the first
one to come down here if anything like that was in prospect. Because
that is the last thing we want.
Representative HuBER. I am glad to have you point that out for
the record.
.Mr. SCHRAM. But with a 50-percent margin, you could not possibly
get enough borrowing.
There is practically no borrowing now on securities. I think it is
about $400,000,000 which is practically nothing.
In 1929, I am told that that figure got up to ten or 12 billion dollars,
*or something like that. It is just unbelievable.
Today there are being loaned on securities, I think, a little less than
$500,000,000 or perhaps $500,000,000. I think margins should
immediately be put on a 50-percent basis.
It does not make sense to say that the stock market is one of the
steps in our economy, but in the same breath say that you could only
borrow 25 cents on the dollar on securities of the best industries of this
country.
CREDIT POLICIES
127
Representative HUBER. You mention the adoption of voluntary
restraints. That, is a thing we are all interested in, and everybody
talks about it. But we have not achieved it so far.
I wonder what there is in store for us in the future all the way along
the line.
Mr. SCHRAM. In what respect?
Mr.
HUBER.
You mentioned in your statement here, that-
if we do not depress business psychology unnecessarily, and adopt voluntary
restraints such as the American Bankers Association has advocated-
you see no reason why a large volume of business and services cannot
continue to be produced and taken off the market.
Mr. SCHRAM. Yes, there I am speaking of the association. And I
think they have done an excellent job. Bank loans, I think, have
been reduced approximately $500,000,000 since the 1st of January.
They are a little more selective.
Then I think with those voluntary controls that we will get over into
the area of the individual.
I think I can say when it comes to the price structure, I have great
faith in the American people. When prices get too high, people now
just will not buy. Then the prices will go down.
Senator FLANDERS. Are there any questions?
Mr. Hart?
Representative HART. No questions, Senator.
Senator FLANDERS. Mr. Rich?
Representative RICH. You spoke about the Federal Reserve stabil-
izing things in 1929.
Well, did it?
In 1929 the Federal Reserve tightened up on its loans to the banks,
and the banks were unable to secure funds, which closed a lot of the
banks.
And I do not believe that the Federal Reserve at that time functioned properly, or we would not have had so many banks close.
Mr. SCHRAM. The Federal Reserve, of course, did not have the
authority at that time that they have today.
Representative RXCH. Well, they were just acting as good bankers
would, to save their own institutions. Instead of loaning to the banks
and letting the Federal Reserve take' the shot, the Federal Reserve
put themselves in a good position and let the banks take the shot.
It seems to me that it was not wise to handle it at that time, because
I had some experience in it.
Now, you said that you had faith in the American people not overextending themselves, or faith in the Congress, relative to our
spending.
'We are now spending about 11Y billion dollars for war. And they
tell me it is going to cost $25,000,000,000 for 1951 if we put into effect
the plan that they are nowv contemplating for building up the Army.
Well, if we put that into effect, and it costs us $25,000,000,000,
that is going to be 11 X billion over what we are spending now. That
is going to make our budget over $50,000,000,000.
Do you think we can handle a budget of $50,000,000,000 under our
present economy?
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CREDIT POLICIES
Mr. SCHRAM. I think your budget at present levels is about as
much as the present economy can stand. I do not think you can get
very much above your $40,000,000,000.
Representative RICH. I think you are right on that. And I question whether the Congress, then, should assume these greater responsibilities for spending until we know just definitely how far we can go.
If we get into war, naturally, as you said before, we do not know
what the answer is.
But under present-day conditions, we ought to try to maintaincut it down if possible, but certainly not go over-the $40,000,000,000.
I agree with you.
Mr. SCHRAM. I think the $40,000,000,000 is just about the limit
that our economy can stand.
Senator FLANDERS. Mr. Schram, to improve the stock market, you
made two suggestions:
One was the lowering of the margin requirements, and the other
I judge was the elimination of the capital gains tax.
You would eliminate it, would you?
Mr. SCHRAM. I believe it should be eliminated, yes; but I think
that is a pretty big step to make at this time.
I think I would advocate at the moment that it. be reduced from
25 to 12}% percent. I say that because I think something should be
done quickly.
To completely eliminate it, I think, would require considerable study.
Now, I -am heartily in favor of the present plan to close these loopholes that exist in the capital gains tax, such as we had in commodity
trading.
I do think that this capital gains tax subject should be studied very
carefully by a committee of Congress, planning toward the complete
elimination of it. Because it is a capital levy, and it is nothing else.
It is an un-American procedure, and it puts a handicap upon the
accumulations of savings that is very dangerous to the type of economy
that we have always enjoyed in this country.
Senator FLANDERS. Have you any other suggestions then, than
these two, to improve the equity market?
Mr. SCHRAM. Well, I am only speaking of those that are immediately
available.
Yes; I have another suggestion that I would like the Congress to
look into, and that is in the field of double taxation of dividends. I
think that is another situation. In fact, I tried, as you know, to
encourage the Finance Committee to give a credit in this last tax
bill, just 3 percent of the normal tax, which would have cost about
$165,000,000, I believe.
But I think the encouragement that corporations would have had
at that time would have increased their payments to stockholders,
and I think on balances it would again have made money for the
Treasury.
Senator FLANDERS. That is one of those things like the weather,
that everybody talks about and nobody ever does anything about.
Mr. SCHRAM. I always live in hopes, Senator, I am never pessimistic.
I am always going to keep trying.
Senator FLANDERS. Are there any other questions?
Representative RICH. May I ask this question of Mr. Schram:
Under section 102 of the Revenue Code, a corporation is supposed to
CREDIT POLICIES
129
pay out 70 percent of its earnings to its stockholders, or the Government comes along and takes 27% percent of the amount that they do
not pay out.
Now, as the situation is today, with the high prices which are bound
up with the inventories of the corporations, it is clear that they have
increased their assets not so much in goods as in high prices.
Therefore, many corporations, in order to save that 2732 percent, are
going out and constricting things and buying things that they really
could get along without, or would get along without. Yes, I had better
put it that way. They would get along without these things.
They build new buildings, in order to save the 27% percent; thus
creating a scarcity in the commodity market of the building materials
that they use.
They go and buy machinery, and they put that into their plant.
Probably they increase the efficiency of their plant; but they are doing
it for the purpose of trying to save that 27% percent.
So with the scarcity of steel and the scarcity of materials like that, it
seems to me that that tax is working a hardship on corporations, and
it also is working a hardship on the commodity market. I think that
should be eliminated.
I, myself, personally, think so.
What is your opinion of it?
Mr. SCHRAM. I was not aware that corporations were deliberately
expanding for the sole purpose of trying to avoid the penalties of section 102. I think that it is my general impression that the Treasury
has been very lenient in its administration of that particular section.
And in talking to a lot of people that I come into contact with, I
have found that they rather indicate that that has not been too troublesome.
I understand, though, that there are some suggestions for a change.
I think that corporations have had to retain earnings for the purpose
of expansion. And I was not aware, Congressman, that the many
corporations were deliberately expanding in order to avoid 102.
Representative RICH. I know to the contrary that there are a lot of
them who would like to keep themselves in a good position financially,
but because of that section they are going out now and doing a lot of
things that they would not do normally.
Mr. SCHRAM. Is that so?
Representative RICH. Because their income and their profits have
been reflected in high prices. And they have less merchandise, less
goods, than they had a year ago. But they have more value, because
of the high prices.
Mr. SCHRAM. I would think that that would be rather an unwise
procedure.
Representative RICH. You suggest, then, that the corporations
spend the 27% percent; let it remain in, without doing those things?
Mr. SCHRAM. If they do not need the money, they ought to pay it
out to stockholders. Thev can avoid 102 in that way.
Representative RICH. Yes, they can do it in that way. Then the
stockholders will do exactly what you say they should not do.
Mr. SCHRAM. What is that?
Representative RICH. Pay the double tax.
Mr. SCHRAM. Yes, they would have to pay the double tax.
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CREDIT POLICIES
Representive RICH. But you say they ought to have relief from
that.
Mr. SCHRAM. That is right.
Representative RICH. So that the corporation would be subjecting
the stockholder to double taxation.
Mr. SCHRAM. Yes.
Representative RICH. Is that right?
Mr. SCHRAM. They have to pay the dividends yes.
Representative RICH. But you say you want that changed. You
say it is not right.
Mr. SCHRAM. That is right.
But if they distributed the earnings, they would have to pay the tax.
Representative RICH. But you want them to be relieved from that
taxation.
Mr. SCHRAM. I do not say that the tax should be eliminated completely. But certainly they should be relieved to a certain point,
because I believe in the graduated tax.
Representative RICH. So do I.
Mr. SCHRAM. And I think those in the higher income brackets
should pay a higher rate of tax. But they certainly should be relieved
up to the point of double taxation.
Representative RICH. I was trying to find out what your opinion
was, from the corporate standpoint, of weakening their financial
structure by creating more buildings or more machinery, or something,
on which they will be taxed more in local taxes, then they felt they
could not do it; because 2732 percent is an awful bite out of the taxes
of a corporation.
Mr. SCHRAM. I would not consider that very sound management.
Representative RICH. I consider that it is not a very sound law.
Mr. SCHRAM. I can agree with that too.
Representative RICH. That is the point. 1 wanted to know whether
you agreed with that.
Mr. SCHRAM. Yes, I think that should be corrected.
Senator FLANDERS. If there are no other questions, we will excuse
Mr. Schram, and thank you for your testimony, and for your willingness to come down here.
Mr. SCHRAM. I was very glad to come here and testify, Senator.
(Whereupon, the committee adjourned at 11:30 a. in., upon the
call of the Chair.)
CREDIT POLICIES
THURSDAY, MAY 27, 1948
CONGRESS OF THE UNITED STATES,
JOINT COMMITTEE ON THE ECONOMIC REPORT,
Washington, D. C.
to
call, in room 138,
10
a.
m.,
pursuant
The committee met at
Senate Office Building, Senator Robert A. Taft (chairman) presiding.
Present: Senator Taft (chairman) and Representative Rich.
The CHAIRMAN. The committee will come to order.
You are going to make an opening statement, Mr. Riefler?
STATEMENT OF WINFIELD W. RIEFLER, ASSISTANT TO THE
CHAIRMAN, BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM
Mr. RIEFLER. Mr. Chairman, my function here is mostly to introduce the two other gentlemen, who have worked on this plan, and who
have presented it to the Federal Reserve Board and the presidents of
the Federal Reserve banks.
It was quite interesting to me on the day of my arrival at the Federal
Reserve Board a few weeks ago to hear this plan presented. It just
happens that when I left the Federal Reserve System in 1933, I was
secretary of the previous Federal Reserve System committee, dealing
with this same subject.
It is a subject we have been studying in the System for a very
long time. This program is still under study. The committee has
just presented its report. It is now being considered by the Federal
Reserve banks and by the Federal Reserve Board.
The CHAIRMAN. I think perhaps the gentlemen in the room could
hear this if you spoke up a little louder.
Mr. RIEFLER. This plan is now being studied by the Federal
Reserve banks and the Federal Reserve Board. What we are presenting here this morning is the report of the committee has it as been
presented to both of those bodies.
This should not be confused with the special-reserve plan which the
Federal Reserve Board has presented to Congress during the last year.
Now, first, I think that Mr. Thomas, Director of the Division of
Research of the Federal Reserve Board, will present the general background that makes the subject of reserves important and tell us why
it is that the System is studying this subject.
The CHAIRMAN. Mr. Thomas?
STATEMENT OF WOODLIEF THOMAS, DIRECTOR OF RESEARCH,
BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM
Mr. THOMAS. Mr. Chairman, just by way of background, I think
it is useful to have an understanding of why there are bank reserves.
131
132
CREDIT POLICIES
It is important to recognize that the name of this central banking
system that we have in this country is the Federal Reserve System;
and it is well named, because reserves are the basis of the System's
operations.
Now, "reserves," as used in this sense, are assets that banks hold in
certain forms or in certain amounts these may be designated by law,
or may be a matter of tradition.
Now, the common conception and the earlier conception of the primary function of bank reserves has really gone through a stage of
evolution. Originally it was considered that the principal purpose of
requiring banks to hold a certain amount of reserves against their
deposits was to assure the convertibility of thsoe deposits into cash.
Or else, there were reserves against batik notes; and the purpose of
that was to assure .the convertibility of those bank notes, that is,
to assure the ability of the individual banks to meet their liabilities on
demand during any period of strain.
But in the course of time, even before the establishment of the
Federal Reserve System, it became evident that reserves alone were
not an adequate protection to banks and their depositors. No reasonable amount of reserves could be sufficient to meet a large-scale
withdrawal of deposits.
Furthermore, with the organization and establishment of the
Federal Reserve System, the convertibility of deposits into cash became
assured by the ability of the banks to borrow on their assets from the
Federal Reserve. And that was a more important aspect of the
safety and convertibility than just the amount of reserves that banks
held.
Under the Federal Reserve System, reserves have served primarily
not so much as a means of preserving the liquidity of banks or assuring
their safety or their ability to convert their deposits on demand, but
they have been a medium through which an influence can be exercised
on the expansion and contraction of credit.
The CHAIRMAN. Is there not still a function there, in keeping a certain amount of cash or convertibility? If.you have everything in
loans, your losses would be a much larger percentage of total assets
and would endanger the deposits.
Still there is a question of safety of deposits in reserves, is there not?
M4r. THOMAS. Well, if the reserves are 20 percent, of course, that
amount is held as an asset which is definitely 100 percent good, as it
were; and to that extent the deposits are safer. If you had a 40 percent
requirement, deposits would be that much safer. But if you require
banks to hold reserves of 20 percent, and the bank loses a million dollars
*ofdeposits, it can only use 200,000 of those reserves to meet that drain
,on deposits. It has to get the 800,000 somewhere else.
The CHAIRMAN. No; I meant the ultimate safety of the deposits.
I did not mean the convertibility.
-\r. THOMAS. The ultimate safety is better, the higher the reserve
requirement. That is unquestionably true. The more reserves they
have, the more assurance there is of safety. But the other assets
make up the larger part of the assets of the bank; so that it is more
important that they be safe than it is that they have to depend
entirelv on their reserves.
I do not want to say that that is not an important part of the
function of reserves, but it is not the most important part.
CREDIT POLICIES
133
By requiring banks to immobilize, you might say, a certain part
of their assets-banks have to hold a certain part in an immobile
form-you bring about the result of reducing the part that the banks
can re-lend. So therefore, the higher the reserve requirements are,
the less tanks can make loans on the basis of new funds that come to
them. And that reduces what we call the ratio of multiple credit
expansion.
If a certain amount of gold comes in. one bank can sell that gold
Ato the Treasury, and it gets an additional reserve, and it can make a
loan of 80 percent of that. When the funds go to another bank, that
bank can lend an amount equal to 80 percent, and so, until you get
into an expansion of credit of five times the original deposit. Well,
the higher the reserve requirement, the less multiple credit expansion
there can be.
So that one of the most important functions of reserves, is to limit
the ability of banks to expand credit.
Now reserves, in order to perform these functions, have to be of two
sorts. I mean, they have to have two characteristics. One is that
they have to be assets that are assured, that have assured safety and
liquidity; like a deposit with a Federal Reserve bank, a currency
obligation of the Government. And the reserve assets have to be
limited in amount. If they are readily available, a bank could go out
and obtain additional reserves, and it can continue to expand credit
on the basis of those additional reserves.
For instance, if you had all Government bonds as satisfying the
reserve requirements, a bank could go out and buy Government
bonds, and satisfy its requirements, and then the money that is used
to buy Government bonds would go to some other bank, and it could
expand credit on the basis of it.
So you have to have assets that are limited in amount, in order to
be reallv effective as a limitation on credit expansion.
Now, the purpose of the Federal Reserve System,was, first, to hold
the reserves of the commercial banks. The commercial banks are
required to hold their reserve balances with the Federal Reserve.
And second, the System must regulate the supply of those reserves.
Really, in a sense, the System was organized for the purpose of
providing facilities which could create additional money.
Before the Federal Reserve Act went into operation we had a banking system in which the amount of money the banks could lend was
limited. They couldn't obtain additional funds. We had periodic
panics where there was a big demand for money, and money couldn't
be obtained. The banks all tried to get it out of New York, and you
had a panic resulting.
The Reserve System was organized for the purpose of making it
possible to supply additional reserves under such circumstances.
At the same time, the System had to operate under certain limitations. They couldn't be in a position of supplying unlimited amounts
of reserves.
So the System has to regulate the supply of reserves which the banking systems can obtain, in accordance with the needs of the economy,
in order to prevent undue inflation or to prevent undue deflation.
The regulation of the supply of reserves by the Federal Reserve
System is operated in part through its lending facilities to the com.mercial banks, by rediscounting their paper. And that is influenced
by raising or lowering the discount rate.
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CREDIT POLICIES
In part, the system can supply reserves through open market
operations; that is, by buying and selling securities or bills in the open
market on its own account.
And a third means of regulating the supply of reserves is by changing
the requirements, the amount of reserves that banks are required to
hold. That instrument can be used to regulate the available supply
of reserves. If banks have a lot of reserves that they are not using,
the System could absorb them, or make them unavailable for use by
making banks hold more. The System under other circumstances.
could raise reserve requirements and make it necessary for banks to
sell some of their assets to the Federal Reserve in order to meet those
requirements. Although that would increase the supply of reserves,
it would at the same time reduce the other assets available to banks
for meeting the credit demands of the public.
The System can also increase the supply of reserves by lowering the
reserve requirements.
Now, that particular power, which was granted first in 1933 and
then, under slightly different process, in 1935, has now all been used
up. The Federal Reserve authorities can lower reserve requirements. They cannot raise them, with one minor exception.
Banks obtain reserves also through gold inflow. They also could
obtain reserves if currency returned from circulation into the banks,
and that currency was turned over to the Federal Reserve System.
It would give the banks additional reserves.
On the other hand, if banks have to meet a currency drain, they
have to draw on their reserve balances, and that reduces reserves.
Another element which affects temporarily the supplies of reserves,
is the fluctuations of the Treasury deposits with the Federal Reserve.
They may go up and down, but generally that is only a temporary
influence and not a long-term one.
I would like not to leave the impression that this regulation of the
supply of reserves is entirely automatic, that you can completely
control the money and the supply of credit just through regulation of
reserve supply; because a lot of it depends upon the willingness of
borrowers and lenders.
We have had periods where banks held large amounts of excess reserves, and did not use them, because either the borrowers were not
willing to borrow, or the banks were not willing to lend on the basis
of the sorts of loans that they could get, or they were not willing to
buy the securities that were available.
We have had other periods where the banks have freely made loans
and have borrowed from the Federal Reserve for the purpose; or one
bank would borrow, and one would go to another bank, and it would
make the loan.
So this is not a fixed and automatic relationship. The banks have
a great deal to say about how much reserve bank credit is brought
into use, how much they make use of their reserves to expand credit.
And the borrowing public also has a great deal to say about it.
Now, there are two aspects to this problem of bank reserves that
the Federal Reserve System is concerned with, and one is the changes
in the total volume of reserves. That is the one that I have been
talking about mostly. At the present time, the possibility of expanding bank reserves is really very large, because for one thing we have
the likelihood of continued inflow of gold to this country of maybe a
CREDIT POLICIES
135
billion or 2 billions a year, that will supply the basis of expansion of 6
to 10 or 15 billions of additional credit. And for another thing, the
banks hold very large amounts of Government securities, much
larger than they have ever had before, or been accustomed to holding
in the past. And they can sell those. With the Federal Reserve
policy of supporting the Government bond market, the Federal
Reserve would buy them, and that would create additional reserves.
Now that is one aspect of the problem which has been presented to
your committee pretty thoroughly by Governor Eccles.
The other aspect, which is the question which we want to discuss
somewhat more carefully, is the question of the structure of reserve
requirements. And that is how much each bank shall hold and the
basis of the requirement that determines how much each bank shall
hold.
We have a certain amount of reserves which is related to the total
credit structure, but there is a lot of question as to the details of the
operation, whether one bank shall hold more reserves than another,
and on what basis that shall be worked out.
The present system of reserve requirements is one that is based on
the location of banks and the tyDe of deposits. It is a system that
was inherited from the National Banking System. It developed at a
time when some banks held reserves with other banks. So that was
carried over into the Federal Reserve System, and we have operated
largely on that basis.
The city banks that used to hold the reserves of the country banks
have to carry higher reserves with the Federal Reserve than the
country banks have to carry.
I For instance, the banks in the central reserve cities of New York and
Chicago, under the law, had to carry between 13 and 26 percent of
their deposits, their demand deposits, with the Federal Reserve.
The banks in what used to be 60 and is now a slightly smaller number
of cities, called reserve cities, have to carry in reserves between 10 and
20 percent of their demand deposits, the exact amount being fixed by
the Board under the power to change the requirements. The other
banks, which for convenience we will call country banks, have to
carry reserves of from 7 to 14 percent of their demand deposits. And
then, all banks have to carry reserves of between 3 and 6 percent of
their time deposits.
All of those requirements are now at the maximum level, except
the requirement for central reserve city banks in New York and
Chicago.
There has been a lot of discussion throughout the history of the
Sytem as to whether this is a particularly equitable method of distributing the reserves among banks, whether it is logical, what is the
basis of it, and why should banks in these cities have higher reserve
requirements than banks in the country.
It used to be that these city banks carried iii bank deposits the
reserves of other banks, but they don't any more. They still have a
lot of interbank deposits. But should a distinction be made between
interbank deposits and any other kind of deposits?
There was a question as to whether the distinction between time
deposits and demand deposits was a justifiable one.
Representative RICH. You speak in reference to the country banks
making their deposits in the citv banks, and with reference to the
requirement that they carry a Federal Reserve. Well, are not the
136
CREDIT POLICIES
reserves that are carried by the city banks the same money that is
deposited by the country banks? And if you permit the city banks
to load up fully on the reserves that they carry of the country banks,
supposing the country banks would recall those loans. The city
banks would be in difficultyf, would they not?
Mr. THOMAS. Yes. That is one reason why originally those were
higher. But at the present time, the city banks can meet the drain
if necessary by.calling on the Federal Reserve for accommodations.
And the present system requires the city bank to hold the reserve
against these interbank deposits; so that if the funds are shifted from
the country bank to the city bank, if the city banks hold the reserve,
why should the country bank hold some?
Representative RICH. In my judgment, the city bank should have
a greater reserve than the country bank.
Mr. THOMAS. Well, there is a logical basis for that. But there are
other people who think that that is not a necessary distinction now.
And it is one of the controversial questions which we shall discuss
a little more fully later.
But there has always beea this question of the classification of cities.
The banks now are classified on the basis of their location and not
on the basis of the type of business they do. You have in a city a
bank that may have no interbank deposits, but it has to carry just
as high reserves against its other deposits as the city bank that has
interbank deposits. And the law permits banks in outlying sections
of cities, to be classified on a lower basis than the banks in the center
of the city. And we have had many studies in the past with respect
to that.
Representative RICH. Is that not because of the fact that the ones
in the central cities have greater capitalization and greater deposits?
And they are always after the deposits of these outlying banks, the
country banks. Therefore, you have to be careful that you do not
permit them to have the same opportunity to make greater loans,
because they are the ones that can get stuck. Because the smaller
banks are going to call on them in case of necessity.
Mr. THOMAS. That is the basis of it. But you have the same
requirement, though, whether a bank holds interbank deposits or does
not. The small bank in the central city has to carry just as much
as the big bank, even though it is doing an entirely different kind of
business.
The CHAIRMAN. Your suggestion there would be based on the
distinction between straight deposits and interbank deposits, rather
than where the bank is.
MXr. THOMAS. I am anticipating now Mr. Bopp's discussion. I am
trying to indicate some of the problems that have arisen.
Now, the System has studied this whole question of reserve requirements and the structure of reserves, and the classifications of cities
for many years. We did some studying back in 1928. A committee
made up of representatives of the Federal Reserve banks and the
Board, with '\r. Riefler as its secretary, made a report in 1931, which
recommended uniform requirements for all deposits wherever located,
and of whatever type, except that there would be an additional
requirement based on the turnover of those deposits, the amount of
checks drawn against them.
CREDIT POLICIES
137
Now, that is a logical and sound system. Because if the purpose
of reserves is to influence the economic situation of the country, and
to influence the banks in their lending activities, the use of this money
is just as important as the amount.
So we subsequently made a very careful analysis of how this would
apply to different banks, and different cities, and found that the
administrative problems involved were very tremendous.
The CHAIRMAN. Was the suggestion that you would have more
reserves if.you had a more rapid turn-over?
Mr. THOMAS. Yes, that was the suggestion.
The CHAIRMAN. That relates the whole thing rather more to your
original idea of liquidity than it does to the expansion of bank loans.
Mr. THOMAS. Something of volatility. But it also relates it to the
use that is made of the money as well as to the amount that is there,
and the extent to which it is used as well as the amount.
Well, we found that there was a lot of variation in the use of
deposits, according to the ways of doing business. In a livestock
center, for example, a lot of the banks had money going in and out
during the day in tremendous amounts. The same thing is true in
a city like Memphis, where there is a lot of cotton money, where there
is a lot of cotton business going on.
So it was difficult to apply administratively.
Then, furthermore, it did not meet the problem that has subsequently
developed, of the total expansion and the total supply of reserves.
Because we had a very low velocity, but a very large volume of reserves.
There have been other system studies. There was at one time a
study that suggested that a higher reserve requirement be placed on
all further increases in deposits. I think Allan Sproul suggested that
in one of his speeches recently as worthy of consideration.
Again, that is a logically defensible method. There may be some
way of working it out. It has also administrative difficulties.
Then you have had the proposal that the Board has made, of a
reserve to be held in the form of certain types of Government securities,
the supply of which is limited.
Recently the System has been faced particularly with this problem
of classification of cities. Last year or early this year certain cities
were reclassified. And it was faced with the question of: What is
the basis of clasification? So a System committee has studied that
question. It was a committee made up of the research people from
various reserve banks and the Board. It tried to work out a scheme
which would meet some of the difficulties in the question of the structure of reserves.
Now, Mr. Bopp, who is the vice president and director of research
of the Federal Reserve Board of Philadelphia, served as chairman of
that committee. That committee made a report which should be
taken as a study and not as a recommendation.
I know members of the committee itself did not recommend it for
adoption. They simply presented it as one of the schemes which
might solve some of the problems. It has not been adopted by any
of the System authorities for recommendation, but it has simply been
thrown on the table here for as wide a discussion as it can get by interested people.
If you will, Mr. Chairman, I would like to have Mr. Bopp present
that.
The CHAIRMAN. Proceed, Mr. Bopp.
138
STATEMENT
CREDIT POLICIES
OF KARL R. BOPP, VICE PRESIDENT,
RESERVE BANK OF PHILADELPHIA
FEDERAL
Mr. Bopp. Mr. Chairman, I am quite willing to assume responsibility for this report. I would like to say, however, that I deserve
very little credit for such merits as it may have. It is important to
note that it is a study and not a recommendation.
A central bank that is alive to its responsibilities is studying reserves of commercial banks continuously, because, as Mr. Thomas
has said, reserves are the principal means by which a central bank influences the supply of money in a country. The inequities and administrative difficulties inherent in our present structure of reserve
requirements, have been recognized for a long time.
I was very much intrigued by the proposals of the System Committee in 1931, that Mr. Riefler mentioned. Those proposals were
based on, and they contributed to, modern development in monetary
principles, in which emphasis has been shifted from the quantity of
money as such to the flow of expenditures in the economy. I
abandoned this particular application reluctantly only as I saw the
administrative and practical difficulties revealed in tests of those
proposals as applied to individual banks.
Frankly, I was initially skeptical of the plan that is analyzed in the
study before you.
I remember discussing some of the basic features as they were
advanced several years ago by some of the people in the System.
My concern at that time, however, was that of an interested observer
or spectator rather than a participant.
In due course I became a participant by being asked to serve as
chairman of a System staff committee to study the general problem
of member bank reserve requirements. And I soon learned what
President Wilson meant when he said:
We shall deal with our economic system as it is and as it may be modified, not
as it might be if we had a clean sheet of paper to write upon.
There are always the practical difficulties that one runs into.
As the committee worked on its assignment, it developed the general
principles on which this report is based; namely, that a structure of
reserve requirements could be economically defensible, administratively feasible, equitable, and adapted to the American system of
banking as it has developed.
Vith respect to the specific results of this work, as embodied in this
study, I should like to emphasize two things. First, significant contributions have been made by the staff at the Board of Governors and
at the Reserve banks. And second, this study is not completed and
hence is not presented in the form of specific recommendations by the
staff, nor has it been adopted by the responsible authorities in the
System.
With that introduction, Mr. Chairman, it may be well to read the
study as it is. Please feel free to interrupt at any time with any questions, if you like.
Representative RICH. First let me ask you this question:
Why do you not give us your recommendations? If you are giving
us a study, it seems to me if you came here with a concrete proposal
we would be better able to judge the merits of it than we would if it
is left to us to determine that. You ought to have conclusions, cer-
CREDIT POLICIES
139
tainly, after you read your report; and we would like to know what
your conclusions are.
Mr. Bopp. With respect to that, Representative Rich, I would
say only this: that the study is in preliminary form, and there may be
bugs in it. We would like to have it for discussion by all interested
parties, so that they can find out what the bugs are.
Representative RICH. That is the reason I would like to have
your definite conclusions; and then we can pick the bugs out. But
if we are left open to find the bugs, it might be pretty difficult, because
we may not have the same line of thought that you have.
Mr. Bopp. The particular problems that arise, so far as our present
system of requirements is concerned are, I think, analyzed in the study.
And I have specific methods of attack-I don't like to call them
proposals-on these problems included in it. So I think some of
your questions may be answered in the study.
The CHAIRMAN. Is this the first time this study has been made
public? You say you discussed it with the Board.
Mr. Bopp. This is the first publication of it.
The ability of a commercial banking system to create deposits
depends on the volume of reserves available to its members and on the
relationship between reserves and deposits. In order for the monetary
authorities to exert an effective influence over the volume of deposits,
it is necessary that they have adequate influence over the volume of
reserves and adequate administrative authority over reserve requirements. This is the first and more important aspect of the current
problem of bank reserve requirements. It is this aspect of the problem
that proposals for increasing existing primary reserve requirements or
requiring a temporary additional reserve in the form of short-term
Government securities, or excess cash reserves, are designed to meet.
In this memorandum a provision is included which allows for raising
or lowering the level of reserve requirements; and whatever reasons
justify an increase in existing reserve requirements are equally applicable to the corresponding provision here described.
The second aspect of the current problem of bank reserves-the
one to which this memorandum is directed primarily-is the plan or
system of distributing reserve requirements among member banks.
Such a plan should be economically defensible, administratively
feasible, equitable, and adapted to the American system of banking.
The desirability of establishing a more logical and effective method of
determining the distribution of reserve requirements among member
banks has long been recognized. Periodic recommendations have
resulted from continuous study of the problem in the light of experience.
This earlier work has been taken into account in the preparation
of this report.
II. A plan: This plan contemplates that the Federal Reserve Act
be amended to(1) Eliminate designations of central reserve cities and reserve cities.
(2) Prescribe basic initial reserve requirements against classes of
deposits as follows: (a) 30 percent against interbank deposits whether
demand or time; (b) 20 percent against other demand deposits less
cash items in process of collection; (c) 6 percent against time deposits,
or perhaps 6 percent against savings deposits and 20 percent against
other time deposits.
140
CREDIT POLICIES
(3) Empower the Federal Open Market Committee to increase or
decrease these basic requirements by some suitable proportionperhaps a maximum of 50 percent-in either direction as to any or
all classes of deposits. This would deal with the first aspect of the
current reserve problem, namely, raising the level of total reserve
requirements; this provision of the plan is.merely an alternative to
the proposals for increasing existing primary reserve requirements or
requiring a special reserve of short-term securities. It would also
permit a lowering of total reserve requirements if circumstances should
arise in the future which made that desirable.
The CHAIRMAN. Where is the power now to increase or decrease
reserves?
Mr. Bopp. The Board of Governors, sir.
The CHAIRMAN. You suggest here the Federal Open M i rkct Committee.
Mr. Bopp. I should think that the report of the committee should
have been concerned with system authorities rather than specifying
which authority. And this was put in because Governor Eccles
proposed that that power be lodged in the Federal Open Market
Committee.
Am I correct?
Mr. THOMAS. That is correct. That is again one of the moot
questions, as to where it should be lodged.
Representative RICH. They set the rates of reserve. Now, we
have the State reserves, who set the reserve of the State hanks. And
we may have 48 different sets of reserves in those 48 States. Then
we have the Federal Reserve banks, which are federally controlled,
and they set the reserves there. So you have in the banking system
a great number of reserves, dependent upon the location of banks.
Mr. Bopp. That is one of the reasons, Representative Rich, why
we have not come forward with this as a recommendation: because
of the problem which is mentioned on page 3, which I might read at
this point:
Along with the changing of member bank reserve requirements, consideration
should be given to the desirability of prescribing uniform reserve requirements
to be observed by all nonmember commercial banks in lieu of or in addition to
those prescribed by State law.
That is certainly one of the knotty and difficult problems in this
whole area.
Representative RICH. The only thing, as I view it, is that the State
banks are always jealous of the National banks and trying to have
the Federal Government interfere with the operation of the State
banks.
Mr. Bopp. Nonetheless, bow many State member banks do we
have?
Mr. THOMAS. We have about 1,900 State member banks. But
they hold a large part of the deposits of all State banks.
Representative RICH. You have never found any difficulty in
reasoning with the State banking system as to the reserves that they
should set? I think they are always cooperative, are they not, in
trying to set the reserves?
Mr. Bopp. Frequently those State bank reserve requirements are
established by law, without any power as to change lodged in any
State authority.
CREDIT POLICIES
141
Representative RICH. Certainly, however, if you can show the
law they now have in those various States is wrong, I think that
could be corrected. You know, the State banks are very jealous and
very concerned as to the effort to have all the power centered in
Washington. And so am I. I do not want it. I think we have too
much power here, and the less power we have here the better it will
be for this country.
We have to get the power back to the States, rather than bring it to
Washington.
So I think we have to be awfully careful in lodging the power with
the Federal Reserve or with the Federal Government.
Mr. Bopp. As I say, that is one of the thorny, knotty problems.
Representative RICH. It is a good thing that we have a knotty
problem there. Because if we had it in the hands of a few here in
Washington, the devil only knows what would happen.
Mr. Bopp. It explains one of the reasons why this is still a study
and not a recommendation. Because that is a problem which is
involved in specific recommendations.
Representative RICH. Well, I am glad you have no recommendation
there.
Mr. BoPP. (4) Permit vault cash to be counted as part of required
reserves.
(5) Permit a member bank to deduct from its required reserves
a percentage of its balances due from other mnimber banks equal to the
percentage of reserves required to be held against interbank deposits.
This would replace the present method of allowing a member bank to
deduct from its demand deposits the amount of its balances due from
other banks before computing its required reserves. It might be
better as well as simpler to treat "cash items in process of collection"
as the equivalent of "due from banks," instead of as a deduction from
demand deposits.
(6) Empower the Board of Governors to waive, by regulation, during a transition period, penalties for deficiencies in reserves resulting
from increased requirements on the proposed new basis.
M\1r. THOMAS. I may say there, on that point, that the powers in
the present act may be adequate.
Mr. Bopp. So that no change would be required.
Mir. THOMAS. That is, again, one of the things that will have to be
studied by lawyers and administrators.
Mr. BoPP. Analyzing these specific provisions, then, item by item,
and first with respect to the elimination of central reserve city and
reserve city designations:
Under existing statutes, the Board of Governors, for purposes of
establishing reserve requirements, classifies banks into three categories-central reserve banks, reserve city banks, and banks not in
reserve cities. It also determines actual requirements for the three
classes of member banks within the limits prescribed by law.
The names attached to the categories of banks reflect their origin.
The National Bank Act authorized banks to keep a portion of their
reserves in the form of deposits at other banks. Classification of
cities was a method of identifying reserve depositary banks or at least
banks that were eligible to receive reserve deposits. The obvious
intent was to require higher reserves to be carried by banks wvhich
held reserves of other banks. However, all eligible banks were sub77099-48
10
142
CREDIT POLICIES
jected to higher reserve requirements, whether or not they actually
held deposits of other banks.
Representative RICH. Could they not have a reserve, of the amount
of money that was deposited by member banks through the country
banks, and then have a reserve on their own deposits in the same
depositary bank?
Mr. BoPP. I think that we will come to the problem you have in
mind, Representative Rich. You will see that this fifth point attempts to cover exactly that.
Representative RiCH. You will cOme to that later.
Mr. Bopp. Yes.
This method of basing reserve requirements on the location of a
bank rather than on the character of its business has resulted in
inequities. Inequities are bound to arise when some banks in a city
held substantial amounts of interbank deposits and others do not.
The only choice before the Board of Governors is to classify the city
as a reserve city or as a nonreserve city. If it does the former, it
penalizes-relative to banks doing similar business elsewhere-the
banks with little or no interbank deposits; if it does the latter, it
favors-relative to banks doing similar business elsewhere-the banks
with such deposits.
Representative RICH. Now, when you take the State banks, the
Banking Commissioner willl grant permission to a small bank ourin the country to have as a depositary a bank in a larger town. Or
you can have it in Philadelphia or New York; or, we will say, where
I live, up in Pennsylvania. Or we will take a small country bank,
for instance, like Williamsport. I am speaking of a smaller bank
outside of Williamsport. We can use the Williamsport, or we can
use the Philadelphia or New York bank. That is permitted in the
State of Pennsylvania.
Now, why is it not good business to do that? The bank that they
have in Williamsport in turn would use the larger city bank. So
that you do not put everything in Philadelphia and New York and
Chicago, and a few cities like that.
Mr. Bopp. Again, one of the difficulties that arose in connection
with that, which was part of the old national banking system, was
that it permitted what technically came to be known as "pyramiding
reserves." That, again, is a problem that is dealt with subsequently
in the memorandum: the problem of how much cash reserve you
actually have if part of your reserve is in the form of deposits.
Representative RICH. XWhat would be the difference if, for instance,
a little country bank made its deposit in NVilliamsport and then in
turn theVWilliamsport bank deposited it in New York? They have
to carry the same reserves. And if you put it all in New York, they
would have the same amount; would they not?
Mr. Bopp. They would, according to this plan which we have here.
But that would not be the case under either the present State system
or under the old national banking system, when we had it. Because
you would have, let us say, the individual customer depositing his
funds in the Williamsport bank; and. just to take a figure arbitrarily,
let us say they have a 20 percent reserve against that, which, let us
say, they deposit in New York.
The New York bank then keeps a reserve of, we will say, 20 percent
against that 20 percent. So that the cash reserve against the $100
deposit is only $4.
CREDIT POLICIES
143
To complete that; On the contrary, if the individual had his money
in the Nell York bark, he would have a 20 percent reserve. That
is what is technically called pyramiding reserves. And the attempt
in this particular plan which we have is to make sure that irrespective
of what the particular bank does, the amount of reserve, really, in
the banking system-Representative RICH. All right. Let us make two sets of reserves,
one for deposits on deposists. That could be easily arranged, and
you would not have it in the large cities, then. You could keep it
back in the country where it belongs, and keep it out of the Federal
Government, where it does not belong.
Mr. Bopp. That is the purpose of the second provision which we
have here.
Such inequities have been mitigated slightly by the qualification
that the Board may designate outlying banks in central reserve and
reserve cities as country banks; but not all inequities can be eliminated,
becaus3 the adjective "outlying" also relates to location, not to
character of business.
The administrative problems that have arisen from the requirement to designate cities, though not significant with respect to credit
control, have been among the most difficult confronting the Board of
Governors. Mere reference to the questions, extensive correspondence, and heŽarings incident to the Board's recent adoption of standards for designating and terminating reserve cities is sufficient to
demonstrate the impossibility under present law of dealing with
reserve classifications of cities on a basis that is equitable and satisfactory to the System and to member banks.
Representative RICH. Why is it necessary for you to have the
power to designate what cities shall be used as depositaries, and what
banks? Why do you not give that to the banks in accordance with
their financial structure, whether it be in the larger cities or whether
it be in some of the smaller cities?
Mr. Bopp. This study asks that question, and can't find an adequate
justification for it. And then says that perhaps a more appropriate
method can be devised. But the present law requires the Board
to do it.
Representative RIcH. I think the law is wrong. 1 think it ought to
be changed.
If you think that, why do you not make that recommendation?
Mr. Bopp. The first recommncndation-and by "recommendation,"
I mean the first part of this plan-is to eliminate designations of central
reserve cities, and central reserve cities.
Representative RICH. You are not afraid of making a recommendation because you are working for some Federal organization, and afraid
you might hit somebody higher up, are you?
Mr. Bopp. No, sir.
Representative RICH. I would make a recommendation, then, if I
were you.
Mr. Bopp. (2) Classification of deposits for reserve purposes: A
system. of reserve requirements should be effective on an over-all basis,
administratively feasible, and equitable among commercial banks.
In revising a system, consideration should be given also to the impact
of the change, so as to create a minimum of hardship cases. Views
differ, of course, as to the precise system that best meets these criteria.
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CREDIT POLICIES
One of the, bases of the plan discussed in this memorandum is the
assumption that as a practical matter it is desirable, at least for a
fairly extended transition period, to continue some differentials in
reserve requirements in addition to those between demand and time
deposits and that experience and studies have demonstrated that
interbank deposits, which underlie existing statutory differentials, are
the simplest, most practicable, and on-the whole the most acceptable
basis for such additional differentials in reserve requirements.
At one extreme, it has been argued that deposits should not be
classified at all or that requirements should be uniform against all
classes. This was the situation under the National Bank Act and is
still the situation under the banking laws of some States. At the
other extreme, it has been argued that a detailed classification should
be made based on such characteristics as turn-over, volatility, size,
and economic activitity of depositor-whether an individual or a
business, whether local or national.
Both views have been challenged in principle, in practice, or both.
The practical objection, of compelling importance, to treating all
deposits alike is that the impact of launching such a system would be
to cause serious dislocations in the banking system because, depending
on the level set, it would create enormous excess reserves in reserve
and central reserve cities, enormous deficiencies elsewhere, or both.
The principal objection to an elaborate classification is that it is not
an appropriate means of achieving the presumed objective. That
objective would be to give the monetary authorities selective as well as
general influence over the quantity and flow of credit in various
sezments of the economy.
To accomplish this objective, however, it would be necessary to
identify either deposits or debits to deposit accounts, or both, in
terms of the economic activities to which selective controls are to be
applied. If deposits were chosen, it would be necessary to classify
them, not on the basis of present ownership, but on the basis of
intended expenditures-a hopeless prospect. If, on the other hand,
debits were chosen, discriminatory requirements could be avoided by
shifting to cash transactions, by means of "clearing arrangements,"
and by other devices. It is virtually impossible to devise a comprehensive system of classification which would be administratively
feasible.
The suggested threefold classification and the proposed basic
initial requirements would minimize disturbances created by initiating
a new system while yet retaining effective over-all control. It is
recognized, however, that any classification is somewhat arbitrary.
In terms of function, for example, some depositors hold savings in the
form of demand deposits, others in the form of savings deposits, and
still others in the form of other time deposits. By and large, however,
the three classes of deposits are used for different purposes. In
addition, they are readily identifiable, and difference in treatment is
an established part of American banking traditions.
There is substantial agreement that time-or at least savingsdeposits should be treated separately. Such deposits are not, strictly
speaking, a means of payment, but they perform other functions of
money, such as being a store of value. For practical reasons the
existing reserve requirements on time deposits ought to be retained
as the basic requirements under the proposed plan.
CREDIT POLICIES
145
There are also strong reasons for treating interbank deposits
differently than other demand deposits. In the first place, interbank
deposits are legal reserves for nonmember banks; they underlie the
deposits and credit extended by such banks. In determining appropriate reserve requirements for such "deposits," it needs to be emphasized that they are reserves on the basis of which other deposits are
built. If nonmember banks were required to carry reserves with the
Federal Reserve banks, the fact that their present balances due from
banks are their reserves would become very obvious when the nonmember transferred a substantial portion of such balances from their
member bank correspondents to the Federal Reserve banks.
Similarly, member banks, taken individually rather than as a group,
treat their "due from bank" as something more than secondary
reserves. In practice, such balances are often used in preference to
reserve balances with Reserve banks to make loans or meet deposit
withdrawals. Moreover, they are readily convertible by the owner
bank into Reserve bank reserves-and in the event of a substantial
increase in requirements undoubtedly would be converted to a considerable extent; they are, in other words, much like additional reserves of the owner bank. The depoistary bank, in turn, performs
some quasi-central banking functions, including not only holding of
reserves of other banks but also clearing and other services.
Furthermore, to require higher reserves against interbeank deposits
would be in harmony with current and old Federal and State laws,
which contain provisions requiring banks holding reserves of other
banks to hold higher reserves. Such treatment would, in fact, accomplish the original intent of those who established present and historical
differentials in reserve requirments. It would also be in harmony
with the formula or standard only recently adopted by the Board of
Governors, after extensive consideration, for the designation of reserve
cities, and with the basis on which the Board has in the past granted
or refused to grant permission for reduced reserves to be maintained
by outlying banks in reserve cities.
Finally, there is a compelling practical reason. Elimination of
designation of cities without separate treatment of interbank deposits
would result in creation of large excess reserves at central reserve and
reserve city banks and of large deficiencies at other banks if over-all
requirements were set so as to maintain approximately the current
volume of total required reserves.
Even though one held the view that in principle all demand deposits
should be subjected to identical requirements, it would be desirable
during a transition period to establish different requirements so as to
permit a gradual change and thus minimize sudden dislocation; in
fact one feature of the plan here outlined is that it would permit this
very thing to be brought about at an appropriate time: Uniform
requirements on all demand deposits-interbank, individual, partnership, and corporate.
The particular requirements that are suggested have been selected
only after considerable discussion and analysis. Many different combinations of requirements were tested for feasibility and effectiveness
on an over-all basis. Combinations which satisfied this criterion were
then applied to individual banks. On the basis of preliminary tests
made thus far, it appears that on the whole the proposed basic combinations meet the criteria satisfactorily. It should be noted, how-
146
CREDIT POLICIES
ever, that there would be plenty of room for adjustments-in requirements on any one or two or all three classes of deposits.
In general, these new requirements would hit hardest those banks
outside reserve and central reserve cities subject to "country" bank
reserve requirements, which nevertheless do a type of business similar
to that done by most large banks in such cities, including many that
hold substantial amounts of interbank deposits. Included also are
banks that hold large proportions of demand deposits, are "loaded
up," and have relatively sn-11 armount3 of ssult Cosh and b+l^nces
due from correspondents. Conversely, banks with relatively large
amounts of vault cash and balances due from correspondents and
relatively large proportions of time.deposits would experience reductions in their required reserves. From the standpoint of more effec
tive control of banli credit, that would appear to be the result desired.
The CHAIRMAN. You increase all country banks from 14 to 20
percent? Is that right?
Mr.Bopp. On demand deposits, yes.
Mr. THOMAS. We give them the privilege of counting as reserves 30
percent of their balances due from member banks and all their
vault cash. That pretty much washes out for the country banks as
a whole.
Mr. Bopp. Yes, in general; so far as we can see, it would be only
the large country banks which have large interbank deposits and
relatively small amcunts due from other banks, that would be hit,
but not the ordinary run of country banks.
The CHAIRMAN. The last proposal was 30, reserve, and 35, central
reserve, maximum. And here you give them 20, with a power to
raise to 30.
Mr. Bopp. You see, the initial requirements were set, so that the
total reserve requirements for the country as a whole-the initial
problem that Mr. Thomas discussed-would be the same under this
proposal as those presently existing.
(3) System authority to vary requirements: The basic initial
reserve requirements mentioned in item 2 were selected so that total
reserve requirements for all member banks would equal, approximately, the present maximum level. These initial requirements
would not, of course, prevent multiple deposit expansion based on
new reserves that member banks may acquire from gold imports,
purchases of Government securities by the Federal Reserve System,
and a return flow of currency from circulation.
Methods of preparing to neutralize such reserves have been discussed extensively in public hearings and in the press. One method,
recommended to Congress by the Board of Governors, would be to
authorize the System to require banks for an interval to maintain a
special reserve of short-term Government securities. Another,
suggested in lieu of a special reserve, would be to authorize a substantial increase in primary reserve requirements.
The desirability of enabling System authorities to change reserve
requirements from time to time within prescribed statutory limits,
in order to prevent injurious credit expansion and contraction, is
an accepted principle. The statutory limits should be set with reference to initial requirements, although it is not essential that the same
degree of variability be granted in both directions.
Although the chief purpose of authorizing changes in reserve requirements is to influence total requirements, experience has demonstrated
CREDIT POLICIES
147
that discretion should be granted as to each requirement as well as
the requirements as a whole. In this connection, it should be pointed
out that various groups of member banks could be variously affected
by selective use of changes in the requirements against different classes
of deposits. Thus, combinations of changes in requirements on the
three classes of deposits could be utilized to exert differential influence
on banks doing different types of business. For example, an increase
in the requirement against interbank deposits would result in increases
in required reserves of banks with an excess of "due to other banks"
over "due from other banks," while at the same time causing increases
in excess reserves of banks with an excess of "due from other banks"
over "due to other banks." An increase or decrease in the requirement for either nonbank demand deposits or time deposits would, of
course, affect all banks alike in proportion to their holdings of such
deposits.
(4) Vault cash, reserves, and credit control: The transition to the
new system of reserve requirements would be facilitated by permitting
banks to count vault cash as legal reserves. Establishment of the
suggested uniform requirement against other demand deposits would
increase required reserves of country banks. Since, however, such
banks hold somewhat larger amounts of vault cash, relatively, the
increase in their total requirements would be offset in part by permit-
ting them to count vault cash as legal reserves, as well as by larger
credits for their balances with other banks.
The role of vault cash in the banking system has changed funidamentally in the past half century. Before the Federal Reserve System was established. vault cash was the ultimate reserve of the banking
system, since it alone was available to "cash" deposits. Inability to
create additional reserves or cash when needed or to mobilize and
utilize existing vault cash was among the principal weakenesses of
the banking structure before the Federal Reserve System was established. The implications of the new System were not understood
completely. With the purpose of encouraging the movement of cash,
particularly gold, into the Federal Reserve banks, the Federal
Reserve Act, as amended in 1917, excluded vault cash from legal reserves of member banks. This purpose no longer has any significance
since gold or gold certificates may no longer be held by commercial
banks.
The use of vault cash as reserves would not impair the System's
influence over the volume of bank credit, provided initial requirements
are established at appropriate levels to offset the change. From the
point of view of credit control, System authorities need not be concerned as to the form of Federal Reserve bank liability-whether
against Federal Reserve notes or reserve deposits-that a member
bank prefers to hold as reserves.
To permit vault cash to be counted as legal reserve might also make
membership in the Federal Reserve System somewhat more attractive
to banks now outside the System, since they are accustomed under
State laws and long established traditions to look upon vault cash as
their primary reserves.
(5) New treatment of balances due from banks: Correspondent
balances ought to be related to reserves in such a way that (a) a shift
of funds by member banks into or out of "due from banks" would not
affect the total volume of excess reserves in the System as a whole;.
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CREDIT POLICIES
(b) "reserve credit" would be allowed for precisely the portion of
"due from banks" that is on deposit in Federal Reserve banks-by
way of the reserve requirement imposed on deposits due to banksand; (c) correspondent bank relationships and interbank balances
would be recognized as an established part of our banking system
but would be neither encouraged nor discouraged.
Item 5 is designed to accomplish these results. So long as the rate
at which the "country" bank or the Reserve city bank is allowed
reserve credit for its "due from" balances is equal to the rate at which
depositary banks are required to maintain reserves on interbank
deposits, a given reserve will support the same volume of nonbank
deposits irrespective of whether the ownership bank keeps all of its
reserve with its Federal Reserve bank, or keeps a portion of it on
deposit with a correspondent-and, therefore, indirectly with a
Federal Reserve bank. In either case, only vault cash and balances
which are directly or indirectly on deposit with Federal Reserve banks
would constitute legal reserves.
The relation between correspondent balances and reserves has
created some of the knottiest problems of monetary policy. Under
the National Bank Act, as has been mentioned, such deposits within
limits were legal reserves. Reserves were "pyramided" through redeposit and the basic cash reserves of the entire banking system were
far less than the legal reserves. Furthermore, the decisions of banks
to change the form-that is, as between cash and correspondent balances-in which they kept their reserves affected the total volume of
deposits that a given case reserve would support.
With the intention of solving the first difficulty, the Federal Reserve
Act specified that after a transition period all legal reserves of member
banks except prescribed amounts of vault cash would have to be held
as deposits in the Federal Reserve banks. Since balances due from
banks could no longer be used by member banks as legal reserves, it
was no longer possible for member banks to pyramid reserves. The
situation which formerly prevailed as to all banks still prevails with
respect to nonmember banks, though fortunately the great bulk of
nonmember bank balances is deposited in member banks, where the
process of pyramiding stops. In some respects banks balances still
affect member bank reserves because(a) Balances due from both member and nonmember banks are
deducted from gross demand deposits in computing reserve requirements. The result is that a percentage of such balances is in effect
counted as reserves.
(b) The percentage of "reserve credit" now depends on the reserve
requirements of the owner-bank, rather than on the reserve carried
against the interbank deposits by the depositary bank. This results
in anomalous situations such as the following: A country bank gets a
"reserve credit" of only 14 percent of its "due from" account although
its central Reserve city depositary is carrying a 22 percent reserve
against the deposit; a Reserve city bank has a 20 percent "reserve
credit" for any balance it has on deposit in a country bank, even
though the latter carried only a 14 percent reserve against the deposit.
The present unsatisfactory situation would be aggravated if reserve
requirements on interbank deposits were raised substantially but
owner-banks were given no additional credit for the higher reserves
carried on such deposits; the only equitable credit for balances due
CREDIT POLICIES
149
from banks is one that directly reflects the ultimate reserve held against
such balances at the Federal Reserve bank.
(c) Member banks-individually, not as a group-can, as a practical matter, readily convert balances due from other banks into
reserve balances.
IV. Summary: This analysis may be summarized as follows:
The present system of reserve requirements is frequently inequitable;
required-reserves of many banks are higher or lower than those of
other banks doing a similar business simply because of the classification of the communities in which they are located.
The uniform system of reserve requirements under discussion would
eliminate inequities by requiring all member banks, regardless of
location, to maintain the same percentages of reserves against the
three major classes of deposits. It would eliminate also the longstanding administrative problem incident to reserve city designations
and terminations. It would permit, if desired, the bringing about
gradually of uniform reserve requirements on all demand deposits,
including interbank deposits, if such action should at some future time
be considered appropriate and desirable.
Banks whose business requires the holding of disproportionately
large amounts of vault cash would no longer be penalized by being
required to maintain the same reserves in Federal Reserve banks as
other banks doing a similar type and volume of business, but whose
cash requirements were less.
Changes in the volume of interbank deposits would no longer affect
the volume of other deposits of member banks that could be supported
by a given aggregate volume of reserves; city banks would have to
maintain larger reserves against balances due to country correspondents, but the latter would be given corresponding credits against
their required reserves for such balances. This would be particularly
important if interbank deposits were subject to considerably higher
requirements than other demand deposits.
This is in contrast to the present system under which the volume
of bank credit that can be supported by a given aggregate amount of
reserves can increase or decrease as a result of reductions or increases
in interbank balances.
The required reserves of some individual banks would be increased,
while those of other banks would be reduced, but the changes would
be reasonable and in the direction of greater equity.
The CHAIRMAN. That is a very clear report. I suppose there will
be people who will object.
Mr. Bopp. I would anticipate that, Senator.
The CHAIRMAN. Some banks, I suppose, will object.
Mr. Bopp. And there may, of course, be difficulties or bugs, as we
call them in it. And it is well to have public discussion, so that they
can be. ironed out. It is an attempt to get at a problem that is a
knotty one, and a difficult one.
Representative RICH. I think it is, too, and I think if you had come
right out openly and made your recommendations on that, we could
then have other people criticize them, and we could come to a conclusion probably as to what was the right thing to do.
But even if you were to do that, I have seen the time when the
Federal Reserve System did not function. When we had the last
great depression, instead of the Federal Reserve trying to help out the
150
CREDIT POLICIES
local country banks that had demands thrown upon them, they
restricted loans to these country banks. In other words, they saved
the Federal Reserve bank, when the time came for really sound
action on the part of the Federal Reserve. They were bankers, just
the same as in the local country banks, and they saw what was
happening, and they were trying to protect the Federal Reserve from
being broken down. Thus, the country banks had to stand the shock,
and they could not, and many of them had to close. Whereas, if the
Federal Reserve, which was set up for the primary purpose of trying
to save the banking system, would have functioned as it should have,
when Gene Meyers was head of it, we would not have seen the great
number of banks close up that were closed up during the depression
years.
Mr. Bopp. This report, of course, would not solve what may be
termed the policy problems of the System. As I see it, there is no
automatic mechanism which would do that.
The CHAIRMAN. How much do the banks rely on the prestige of
being Reserve cities? Is the battle to be a Reserve city, or is it not
to be a Reserve city?
Mr. THOMAS. That was the problem. The problem was that in
setting up standards to reclassify cities, some which are now ]Reserve
cities, or were Reserve cities, would be classified on a lower reserve
requirement basis. And the banks objected. They did not want the
privilege of carrying lower requirements, because they liked the
distinction.
The CHAIRMAN. It made it easier to get the country banks to
deposit, perhaps.
Mr. THOMAS. Well, that was their reasoning. Of course, there are
some banks in cities that are not Reserve cities, that still get a lot of
country bank deposits.
The CHAIRMAN. But this would just abolish it all. There would
be no distinction at all between cities.
Mr. THOMAS. No, the distinctions would be between bank deposits
on the basis of the type that the particular bank held.
The CHAIRMAN. What is your idea of procedure on this thing? Mr.
Rich has asked your recommendation. I suppose you may have some
hesitation to recommend until the Federal Reserve Board or some
authorities have approved it, and made a recommendation. What
if the status of your study? Is this now before the Board?
Mr. THOMAS. It has been presented to the Board, and to the
Reserve bank presidents for consideration and study. Whether they
will want to make a recommendation on this subject remains to be
seen. They certainly will want to look into it and get the benefit
of as much discussion and opinion as possible.
The CHAIRMAN. Of course, when it comes to recommendations
from the Federal Reserve Board to Congress, it immediately becomes
involved with these other plans that have been presented.
Mr. THOMAS. That is right.
The CHAIRMAN. On increasing reserves, or reserves in short-term
Government, and so on.
Mr. THOMAS. Yes. I would like to add to what Mr. Bopp has
said to Mr. Rich: that our unwillingness to make a definite proposal
now, you might call intellectual modesty. We like to get the benefit
of other people's views before we make up our minds definitely.
CREDIT POLICIES
151
Representative RICH. Are you presenting that to this committe2
and Expecting us to make the recommendations?
Mr. THOMAS. No, sir.
Representative RICH. Of course, we would do it if we thought it
would amount to anything.
The CHAIRMAN. We have no intellectual modesty. [Laught-r.]
Representative RICH. That was the reason I made the statement
I did about the Federal Reserves. I was associated with countrv
banks, and I know a lot of banks that wanted to get loans from the
Federal Reserves. But they were bankers, just the same as in the
country banks, and they tightened up, and would not give the country banks any assistance. Therefore, thev were just like the fellow in
the small country bank. They wanted to save the Federal Reserve,
which was set up for the purpose of standing the shock on banks.
And it was 10 percent of the deposits of the various banks.
Supposing the Federal Reserve had gone broke? It would not have
hurt anybody or anvthing. Whereas, on the other hand, they let a
lot of the country banks go broke. I was associated with some of
them, but thank God we did not go broke at that time, because we had
ability enough or we had cash enough to withstand the shock. And it.
might have just been the good fortune of some of the bankers.
But the point I am trying to make here now is that the Federal
Reserve just acted the same as the local banks, trying to save the
Federal Reserve, and they did not do the thing that the Federal
Reserve was supposed to do: to take the shock from the other banks
and save the local situation.
And that is the reason I criticized them at that time.
Mr. THOMAS. I may say, on that point, although it is not the question we are here to discuss, that at that time the Federal Reserve was
operating under an act which limited its ability to extend credit.
Representative RICH. They could have extended credit.
Mr. THOMAS. And since then, we have had the Banking Act of
1935, which makes it possible to extend credit more freely.
Now, I am not saying that in all cases as completely free extension
of credit was given as might have been possible, but that is a matter of
policy.
Representative RICH. If at any time in the future we get into a
bank panic, and the Federal Reserve officers refuse to make loans to
country banks, we will get into the same position. It will not do the
work that it is set up and intended for. And I hope when the time
comes that the Federal Reserve officers, whoever they may be, will
realize that it is their duty to try to aid and assist the banks of the
country, rather than to try to save the Federal Reserve.
Mr. THOMAS. I think that was the purpose behind the Banking
Act of 1935.
The CHAIRMAN. I thank you very much, gentlemen, for this.
Our
committee will study the question of reserves.
Representative RICH. Will you make the recommendations, then?
The CHAIRMAN. I think, in view of the fact that the Federal Reserve
Board is studying the question, and in view of the variety of different
proposals that have been made, by Mr. Eccles and others, and Mr.
McCabe's unwillingness to appear at all at the present time, we had
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CREDIT POLICIES
better study the question of reserves over the summer and wait
until
Representative RICH. After election?
The CHAIRMAN. Until there is at least some more consolidated
opinion from the experts as to what they think they would recommend
to the Congress.
I understand that you are really just presenting this so that we may
undertake study of it.
Mr. THOMAS. It is for your information, and we did not ask to come
up and present this as a proposal.
The CHAIRMAN. We asked you to do it, yes.
Representative RICH. I would say further, Mr. Chairman, that if
these gentlemen have some recommendations they would like to make,
and they would like to have them kept confidential, I would like toe
receive them. They will be kept confidential; I promise you that.
The CHAIRMAN. I think we could bear that in mind.
We will continue studies during the summer. And I think, on the
whole, it is fair to say to the press that as far as any question of change
in the present policy as to the maintenance of Government bonds is.
concerned, I do not think this committee is going to make any recommendation for such change. Certainly it would take a great deal more
study, before we would undertake any such proposal, and certainly
there will be none such at this session.
Mr. THOMAS. We are at your disposal any time you want assistance
in studying these problems.
The CHAIRMAN. These hearing-, then, are closed for the present.
session.
(Whereupon, at 11:40 a. m., hearing in the above-entitled matter
was closed.)
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