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ADDRESS OF CHARLES G. DAWES BEFORE THE UNION LEAGUE CLUB CHICAGO The Dangers of the FEDERAL RESERVE LAW in its Present Form and how it should be Amended to Avoid Them https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Saturday, January 9, 1915 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Address of CHARLES G. DAWES Before the Union League Club Saturday, January 9, 1915 The Dangers of the FEDERAL RESERVE LAW in its Present Form and how it should be Amended to Avoid Them Gentlemen: My subject was announced as the chairman has said, “The Federal Reserve Bank: Its Benefits, Its Dangers, and Its Relation to the Future Business of the Country,” but my address will be for the most part upon “The Dangers of the Federal Reserve Law, In Its Present Form, and How It Should Be Amended to Avoid'Them,” for what has happened in our community within the last two weeks in connection with criticism of the management of the local Federal Reserve Bank, is but the beginning of a controversy which in time to come, will sweep over this country and which, if not fore seen by change in legislation, may (as twice before in our history) bring us into commercial chaos and financial ruin. The ever live question in a republic is the relation of the centralization of power to the diffusion of power. Under neath every question of politics in a republic, underneath every question of economics in its public aspect, is that dif ference among our people between the policy of the concen tration of power, and the policy of the distribution of power among a large number of competing units. And if in the Federal Reserve Bank Act we find certain principles which have been overlooked in their public relation, which are certain to bring upon sensitive institutions (for a bank is a sensitive institution) this old, old controversy, it is time to point out these principles, it is time to point out the dangers, before the credits of the banks- have gone into general busi- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ness, before the whole commercial edifice depends upon them as a foundation, and before the time when political attacks upon the Federal Reserve Law and the banks organized under it may result in a contraction of credits from which we suf fered twice before, in the case of the First and Second Banks of the United States, and in the latter instance brought us into the chaos and the panic and the ruin of 1837. I wish to show why in my opinion the Federal Reserve Law as it is at the present time upon our statute books will inevitably in the course of a few years, bring our people face to face with the controversy through which this country went in 183z, when Andrew Jackson at the head of the radi cals, supported by the independent state banks, attacked the United States Bank—a controversy which resulted in the destruction of the bank and of the commercial prosperity of the United States at that time. The Federal Reserve Banks are great credit creating, devices designed to use as a foundation of credits money of the United States Government, and money belonging to other banks already in use by these other banks as a foundation of existing credits. They were designed to relieve us from an inelasticity, not a dearth, of currency. Whatever may be their present impression, the people eventually will never consider the Federal Reserve Banks as “banks for bankers,” but as banks to be operated primarily, as well as secondarily, in the public interest and not solely in the interests of the national banks of the United States. This will result, not only from the fact that the co-operation of the United States Government is essential to make the Federal Reserve Bank fully effective in times of emergency, but because to exist and still preserve a reasonable capacity for public usefulness in times of emergency, the Federal Reserve Banks must loan chiefly in the open market in competition with other banks. This results from the fact that we have ample currency in the United States except at times of special demand when the crops are to be moved, or in times of financial panic. Under the Aldrich bill, the immediate .retirement of our $700,000,000 national bank note circulation, secured by gov ernment bonds, was provided for, which would have made a https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 4 vacuum in existing circulation which the Central Reserve Association could fill by loans to member banks. The Federal Reserve Law, however, makes no material reduction in the outstanding bond secured national bank note circulation, since it provides for the retirement of not to ex ceed $20,000,000 per year. The Federal Reserve Banks, there fore, will be forced into the open market for loans not only by the general demand of the people, but as a matter of business necessity. Over a year ago, I pointed out that in normal business times banks will not pay a higher rate, as a rule, to borrow money from Federal Reserve Banks than they now pay in open competition for the money of the de positing public; in other words, about 3 to 4 per cent for time money and 2 to 3 per cent for demand money. This is the reason why so few Federal Reserve notes have been thus far issued. If the Federal Reserve Banks should loan their money to the member banks at these low rates in normal times they would employ so much of their resources to pay their expenses and dividends as to impair their usefulness in times of emergency. The higher the rate which they re ceive upon their loans, the less will their credits have to be expanded in normal times and the greater will be their note issuing capacity in times of emergency. They can make these open market loans under one of the least discussed and yet one of the most important provisions of the Federal Reserve Law which authorizes the purchase of domestic bills of exchange without the endorsement and guaranty of member banks. Nothing is easier than to change the form of ordinary commercial paper into domestic bills of ex change. But the law should be amended to clearly define powers which, while now existing under the law, require to be exercised a change in the usual form in which credit is now granted. This brings me, then, to my first point against the law in its present form, that it provides for a dual trusteeship and for the control of Federal Reserve Banks by bankers whose institutions will be in competition with the Federal Reserve Banks in the open loan market. And let me say here, in con nection with this local controversy which has arisen, that it is not necessary for me, in this presence or in any other, to https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 5 defend the competency or ability or the honesty of the two leading bankers of this city, now members of the Board of Directors of the Federal Reserve Bank of the city of Chicago. (Applause.) As a member of the board of directors and executive committee of the Peoples Trust & Saving's Bank of Chicago, and knowing his ability and competency, I happen to be the man who first suggested Mr. Earle M. Reynolds for its president, upon Mr. Bosworth’s resignation, and I seem to have involved George M. Reynolds in some criticism by it. It is hardly worth while, before such an audience, to discuss such things as that, except as they are related to the great coming controversy in which the impossible principle of dual trusteeship provided for by the Federal Reserve Law will eventually involve all of the Federal Reserve Banks. This first controversy has arisen upon apparently unessential things, but wait until all over this country these banks com mence their operations and listen to the clamor of the dema gogue, that the business of the Federal Reserve Banks is being repressed in order to protect the banks of those men which are in competition with them—that they are not being used as agents of the public or in the public interest, but in the interests of the national banks of the United States which seek to use them and the money of the United States Gov ernment deposited in them. I only mention this local con troversy, which is not worthy to be dignified by detailed discussion, as indicating what, in a few years, when the credits of the Federal Reserve Banks are expanded, will, unless the law be amended, be an issue upon every political stump of the country in a great campaign, when the Federal Reserve Banks, as did the Second Bank of the United States, will fight for their continued existence and for the mainten ance of the foundations of general credit. And now I come to a very important part of this argu ment—the future relation of the United States Government through the United States Treasury, to the Federal Reserve Banks and the political and business consequences which will arise because of it. I want to make important in your minds the relation of the Secretary of the Treasury—the Govern ment—to the Federal Reserve Banks, because it is through that relationship chiefly that the banking system of the https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 6 United States from now on will become a subject of political controversy unless the law is amended. The note issuing capacity of the twelve Federal Reserve Banks of the United States, based upon that provision of law which allows them to issue notes with a 40 per cent gold reserve, after maintaining a 3'5 per cent lawful money reserve on their deposits, is $427,225,000. Bear in mind that these figures assume that the full 40 per cent gold reserve is maintained. Through the power of the Federal Reserve Board to suspend reserve requirements, the note issuing capacity of these banks can be much increased, but I am now considering the banks as operating in normal times. Their expenses—roughly estimated, but near enough, I think, for the purpose of argument—dividend requirements and sur plus requirements, will be about $4,500,000 per year. To provide this sum, they can loan in the open market $100, 000,000 at 4% per cent or to the member banks $180,000,000 at, say, 2y^ per cent. In the first case they would have left a note issuing capacity of $327,000,000 and in the second case of $247,000,000. As the deposits of the Federal Reserve Banks increase under its provisions requiring reserve deposits from national banks, these amounts will be somewhat increased. The net deposits of the national banks of the United States—to protect against the fluctuations in which is the chief function of these banks—is $7,291,342,479. In my judgment, this approximate amount of notes would be inadequate to care for the situation in times of emergency, and the banks, to perform their func tions, must encroach upon the 40 per cent gold reserve or rely upon the assistance of the government deposits, made by the Secretary of the Treasury. We must remember that the net deposits of the state banks of the United States ag gregate a sum greater than those of the national banks of the United States—that, in times of emergency, the inability of the state banks to meet the currency situation will, greatly stimulate the demands upon the national banks. Even if the Secretary of the Treasury has not deposited government money with the Federal Reserve Banks before, he certainly would do it at any time that the Federal Reserve Banks would otherwise have to encroach upon their 40 per cent gold reserve in issuing federal reserve notes. 7 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Do you realize that when the Secretary of the Treasury deposits the general fund holdings of the United States Treasury, as he is authorized in his unlimited discretion to do, in Federal Reserve Banks, that he will have more money on deposit than all the national banks of the United States put together have on deposit with them at the present time? The deposits of the Federal Reserve Banks now aggregate $249,786,000. The general fund holdings of the United States Treasury which can be deposited and withdrawn by the Secretary of the Treasury at his sole and unlimited discretion, amount to $255,722, 000. If he deposits that money, $99,700,000 of which is in gold, and these banks expand their business and there should be put out by these banks, on the basis of these gov ernment deposits, several hundred millions of notes, tell me, after this credit has gone into circulation, who will be the great power in connection with the Federal Reserve Banks —the Federal Reserve Board or the Secretary of the Treas ury? Supposing that in any State bank, with $40,000,000 of deposits one depositor controlled $20,000,000 of them, what would be his influence upon any business engagements which the bank might consider? The Secretary of the Treasury is a political office holder, the representative of a political administration. If, for the third time, the money of the United States Government goes into the business of the country through the Federal Reserve Banks and the independent sub-treasury system which grew out of the last disastrous experience of this kind, is abolished, the position of power of the Secretary of the Treasury will be that exercised by R. B. Taney, the Secretary of the Treasury under Andrew Jackson. Before we consider what he might or might not do, let us consider for a moment the situation which, whenever the United States deposits have gone into business, he is not only likely but certain to confront. A great clamor will have arisen in the country against the control of the Federal Re serve Banks by competing- bankers. A claim will be made, if the money of the Federal Reserve Banks has been loaned to member banks, that if it had been loaned to the public https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 8 general interest rates would be lower. If, on the other hand, these deposits had been loaned to the public by the Federal Reserve Banks, a great clamor will be heard about the tremendous power exercised by those dominating the banks and opposition will arise from the independent banks, both state and national, suffering- from competition in the loan market from funds taken from national banks without in terest and from government deposits. A clamor will come from those unable to secure credit from the Federal Reserve Banks, which would accommodate in normal times large institutions as distinguished from small institutions because the credit emissions of large institutions are better than those of small institutions, as a rule. A clamor will arise that these Federal Reserve Banks possessing great power over credits and business conditions are dictating terms under which general business can be transacted. Imagine the position of an administration under such a situation. If it did not yield to it, it would go out of power and another would be put into power which would yield to it. Let. us see what R. B. Taney said and let us see what he did. And if anybody sees anything inappropriate in this attitude taken by Taney, who afterwards became Chief Justice of the United States, as applied to the situation in which this country will be after the expansion of the credits of the Federal Re serve Banks, let him say so: I am reading from the Financial Report of the Secretary of the Treasury of the United States for 1833. “It is a fixed principle of our political institutions to guard against the unnecessary accumulations of power over persons or property in any hands, and no hands are less worthy to be trusted with it than those of a money corporation. In the selection, therefore, of the state banks as the fiscal agents of the' government—” This is when he commenced to withdraw the government deposits, because of the political pressure against the system, because of the political prejudice in this country against the power which must necessarily attach to semi-public banks if they are to perform the function for which they were created—- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 9 “In the selection, therefore, of the state banks, (that is, as distinguished from the Second Bank of the United States) as the fiscal agents of the government, no disad vantages appear to have been incurred on the score of safety or convenience, or the general interests of the coun try, while much that is valuable will be gained by the change. I am, however, well aware of the vast power of the Bank of the United States and of its ability to bring distress and suffering on the country. * * * But I have not supposed that the course of the government ought to be regulated by the fear of the power of the bank. If such a motive could be allowed to influence the legislation of Congress, or the action of the Executive Department of the Government, there is an end to the sovereignty of the people and the liberties of the country are at once surrendered at the feet of a moneyed corpora tion. They may now demand the possession of the public money, or the renewal of the charter; and if these objects are yielded to them from apprehensions of their power, or from the suffering which rapid curtailments on their part are inflicting on the community, what may they not next require? Will submission render such a corporation more forebearing in its course? What law may it not hereafter demand, that it will not, if it pleases, be able to enforce by the same means?” In that year, 1833, the Government of the United States had on deposit with the Second Bank of the United States less in proportion to the other deposits of the bank than the Secre tary of the Treasury is now authorized to deposit in the Fed eral Reserve Banks as compared with its present deposits. The government then had on deposit with the Second Bank of the United States $6,512,000 while the private deposits of the bank were $9,868,000—about 50% more than the United States deposits. Three years later, the Secretary of the Treas ury had completed his part of the war against the Second Bank of the United States. In March 1836, the United States de posits were but $324,000 and the private deposits had shrunk from $9,868,000 to $3,390,000. The country was on its way to financial ruin. The great panic of 1837 which followed, was brought about not alone by the war of Andrew Jackson and https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 10 the radicals of the country, but by the war of the independent state banks which resented the competition of government money used by the Second Bank of the United States. I am not here to criticise Andrew Jackson. As a result of his war while panic and disaster ensued for a time, there was laid the foundation of our great independent competing banking sys tem composed of 27,000 units which have aided in building up and developing the richest and most powerful business nation of the world. As a result of that war, were laid the foundations of the independent sub-treasury system, through which, Uncle Sam having had trouble in getting his money out of the banks, where he had deposited it, from that time on, kept the bulk of it in his own pocket. He had so much in his pocket in 1907 that in that panic he could spare enough to the banks of the country to tide them over. It is far from my intention to criticise Andrew Jackson or the result of his war, but I do say that it is nothing short of folly for us to re-establish by law the conditions which brought about the Jacksonian war and the prostration of business. It is not a popular thing to criticise a law from which everybody hopes good, but I say that the time to correct this law is before the credits of the Federal Reserve Bank have been expanded. Two great amendments in addition to the one regarding open market operations must be made to this law to remove its menace to our future prosperity. The law must be amended to take the control of the Federal Reserve Banks from their competitors. I realize that the law has compelled the National Banks to buy the stock of the Federal Reserve Banks—that they are the owners of them—that ordinarily control should not be divorced from ownership—that it seems unjust from a banking standpoint that the bankers should not control them, but this is a case where the interests and attitude of the pub lic are involved, and the banks in time will suffer more from the retention of control than from its elimination. I say this without any hesitation; I give warning that the people of this country will demand that these banks be operated in dependently, and not by trustees, already charged with the duties of trusteeship over competing corporations. I am here to say that this principle of dual trusteeship established by this law is wrong, not only as a principle, but as a policy. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11 Amend this law so as to keep the banks under the control of business men and not politicians, but take that control away from competitors. If you do not, you have laid the foundations of a political controversy in which the Andrew Jackson of the future, voicing the demand of the people, will again lay our commercial edifice in ruins. This can be avoided; and the stand of true patriotism is to make an effort to avoid it rather than to wait in an unreal and fancied security until danger has become disaster. There was a day one spring when Johnstown, Pennsylvania, was at peace and quiet in the feeling of security and the enjoyment of prosperity. But was it out of danger, because the danger was not realized? There ought to be some man in the Senate of the United States, some man, some where, who, in connection with this great danger which threatens the United States, could do as the man did who rode down before the flood from that crumbling Johnstown reservoir, and cried to that peaceful people, the warning of the disaster which was coming. If the Federal Reserve Banks are built upon the crumbling foundation of false principles, make no mistake, their reser voir of credits'will break in time, and our prosperity will be submerged. The second great amendment which must be made to the Federal Reserve Law is the curtailment of the immense power over government deposits in the banks which is now left to the sole and unlimited discretion of the Secretary of the Treasury. In the first place, he should not be permitted to place any of the general fund holdings of the treasury in the Federal Reserve Banks, to become a foundation of banking credits in normal times. Fie should not be allowed to deposit the general fund holdings of the treasury in the Federal Re serve Banks until the Federal Reserve Banks had reached the limit of their possible expansion without government de posits, and then only under such restrictions as would com pel the banks to return the money after the crisis was past. The right to deposit and draw United States money in the Federal Reserve Banks should not be left to one man’s dis cretion, but should be subjected to proper checks against the possible wrongful use of such vast power. But some one may say, that our protection is the Federal Reserve Board. Is https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12 that permanent? Let the Federal Board be conservative as it is now, how long, against the pressure which will come from the people of the United States, can the Federal Re serve Board stand? We must make up our minds that these great credit creating devices are going to be used, and the power of any one administration or any one Secretary of the Treasury to deposit and draw at his unlimited will and discre tion what would amount at this time to one-half of the total assets of the Federal Reserve Banks must be prevented by amendment of the law. I care not who the man is—I have confidence in Secretary McAdoo, but that power should not be his, or that of any other one man. This law must for the first time be.discussed with relation to the politics of the country. For the most part, the law is conformable to sound economics. It is capable of being made of great usefulness to our people, but in order to be so, it must be amended before your business and my business becomes adjusted to and dependent upon the existence of a large volume of credits, which, when these wrong principles involved in the law are justly attacked, and contraction sets in, will overwhelm us in the ruin which our forefathers went through seventy-eight years ago. The ques tion of whether political appointees are put in charge of the bank, injurious as that would be, is subsidiary: the most im portant question is whether we - can correct this law and prevent an attack upon these institutions upon whose proper handling of credits and currency our prosperity of the future depends. I thank you. (Applause.) https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis