The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
FRBSF
UU€€KLV l€TT€R
April 4, 1986
"Any Bonds Today?"
Any bonds today?
Bonds of Freedom, that's what I'm selling,
Any bonds today?
Scrape up the most you can, here comes
the freedom man,
Asking you to buy a share of freedom
today.
The words and music were by Irving Berlin, a
gift to Treasury Secretary Henry J. Morgenthau
who copyrighted the ballad on behalf of the
Treasury early in 1941 for use as the official
theme song of the National Defense Savings Pro
gram. As events already had begun to demon
strate, the defense buildup in response to
darkening war clouds abroad would shape the
nation's economy in the decade of the 1940s.
This Letter discusses the impact of war-related
activities leading up to and following Pearl Har
bor — a period that little more than one-quarter
of today's population is old enough to remember
— and how they influenced monetary policy
and the Federal Reserve System.
While the storm clouds gather . . .
In 1935, Army Chief of Staff MacArthur warned
that successive cutbacks had weakened the
nation's defense capabilities “below the danger
line." Between 1935 and 1939, defense spend
ing rose slowly to $1.4 billion, or 16 percent of
federal budget outlays. In January 1939, eight
months before the German and Soviet invasion
of Poland and the official start of World War II
in Europe, President Roosevelt gave a special
message to the Congress in which he asked for a
$500 million appropriation for national defense,
including $100 million to commence stockpiling
strategic materials. Over vocal opposition, his
request was granted at mid-year.
War broke out in Europe in September, and in
the ensuing two years prior to Pearl Harbor,
efforts to make America the “Arsenal of Democ
racy" rapidly gained momentum. During the
German breakthrough in France in May 1940,
FDR noted the “swift and shocking develop
ments" with a “ new element — air navigation
— which steps up the speed of possible attack to
250 to 300 miles a hour." He called the nation
Digitized E R A S E R p ro d u c e 50'000 planeS a year (d u r
ing the previous year production had doubled to
12,000 planes), and also requested and received
a $900 million appropriation to modernize the
armed forces.
While Life magazine (at 10 cents a copy)
queried “Will the U.S. mobilize its industrial
might in time?", FDR established an Advisory
Commission on National Defense under the
direction of Ford production manager William S.
Knudsen. The Commission would develop plans
to mobilize all areas of production in the
nation's economy — a task that eventually was
to be implemented by at least two dozen major
agencies charged with responsibilities ranging
from resource allocation to production and price
control. Through the twelve Federal Reserve
Banks, field programs were established to con
tact and advise small businesses of the pro
cedures for obtaining government defense
contracts.
“ Arms for the love of America"
In July, FDR requested and received a $5 billion
appropriation primarily for a “two ocean navy."
(One key Senator called the request “out
rageous.") At his urging, Congress also passed
legislation authorizing an embargo on the export
of “basic war materials." Early in 1941, Con
gress passed the “Lend Lease" bill, which
granted an initial $7 billion appropriation to
finance the sale, lease or transfer of “any
defense article" to “any country whose defense
was deemed vital to the United States."
The rapidity of the defense buildup was such
that defense spending accounted for one-half of
the $25 billion rise in GNP in 1941. It was by far
the major contributor to the 4.7 million rise in
employment between 1939 and 1941, and the
attendant drop in the unemployment rate from
17 to 10 percent. The latter was aided by adop
tion of the first peacetime Selective Service,
which tripled the armed forces to 1.6 million
just prior to Pearl Harbor. (Enacted in August
1940, the draft was renewed a year later by only
a one vote margin in the House of Representa
tives.) In 1941, virtually all of the nearly 3 mil
lion net increase in civilian jobs occurred in
defense industries and on the federal govern
ment's payroll.
FRI3SF
Our daily bread
The expansion in employment was accom
panied by an appreciable rise in hourly earnings
and the length of the workweek. Average hourly
pay in manufacturing rose to 73 cents in 1941
from 63 cents in 1939, the workweek to 41
hours from 38, and weekly earnings to $29.93
from $23.94. (The minimum wage in covered
industries was 30 cents an hour.) The con
struction industry led the pay scales at $1.01 an
hour ($35 a week), while retail trade logged 50
cents an hour — $24.42 a week or about $1,250
a year. Non-salaried doctors earned an average
of $5,100 in 1941, lawyers, $4,800, and
employees of the Federal Reserve System,
$1,740 — less than what they earned in 1929
and 1933.
The impact of the rapid defense buildup on eco
nomic activity was particularly evident in the
Twelfth District where employment and total
personal income increased by about 23 percent
and 40 percent respectively between 1939 and
1941, including a 34 percent rise in per capita
income to $974 — 22 percent above the
national average.
At the same time, prices in 1941 were very low
— about one-eighth today's level as measured
by the Consumer Price Index. A good apartment
in San Francisco could be rented for $30-$60 a
month and a new home purchased for $5,500,
including 10 percent down and monthly pay
ments of $36. A five cent fare on public trans
portation would convey a discriminating palate
to any one of a number of good Italian restau
rants for a 65-75 cent six-course dinner. To cap
the evening out, 25 cents would provide admis
sion to a downtown theater showing "The Mal
tese Falcon" or "International Squadron"
("Starring, in his most important role by far —
Ronald Reagan.")
The economics of Armageddon
But while prices generally were low by today's
standards, they also were increasing — con
sumer prices rose by 10 percent and commodity
prices by 18 percent during the two years
1940-41. Concerned over this development and
the inflationary potential of both the burgeoning
defense program and the large reservoir of liqui
dity that lay dormant in the excess reserves of
the banking system (over $6 billion, or almost
one-half of member banks' total reserves), the
Board of Governors and the Reserve Banks sub
mitted a special joint report to the Congress in
December 1940 embracing three principal rec
ommendations.
They urged that (1) government expenditures,
including the defense program, be financed with
existing deposits rather than new bank deposits
created through open-market purchases, (2) a
progressively larger portion of defense and other
expenditures be financed with taxes, and (3) the
budget be balanced as the economy approached
full utilization of its capacity.
In fact, at President Roosevelt's urging, the Con
gress raised personal and business taxes rather
stiffly in 1940 and 1941. The raise included
imposition of an excess profits tax "so the few
don't gain at the expense of the many . . . and
so no one will be enriched by the national re
armament effort." Nevertheless, while the
increase in taxes raised revenues to $9 billion in
1941 (and $15 billion in FY 1942), they still
failed to cover the rise in expenditures.
As a result, borrowing and the outstanding pub
lic debt rose substantially — the latter reaching
about $64 billion at the end of 1941 from $48
billion in 1939, of which $2.3 billion was held
by the Fed. (In their capacities as fiscal agents
for the Treasury, the Reserve Banks played a
major role in the bond sales campaigns, as they
did during World War I. But as an anti-inflation
ary move, they reduced their own holdings of
Governments by $200 million over this period.)
The nation's banks acquired about $5 billion
and businesses and the general public the
remaining $11 billion, including Defense sav
ings bonds and stamps. Defense bonds carried
an annual yield of V h percent when held to
maturity — substantially more than the prevail
ing 2 percent yield on long-term governments,
the Vioth of one percent yield on Treasury Bills,
and the 2Vi percent on savings deposits.
Supporting the Treasury
To help restrain mounting inflationary pressures
in the months before Pearl Harbor, the govern
ment imposed price ceilings on many key mate
rials, and the Fed raised reserve requirements to
the maximum limits permitted by law. The Fed
also implemented Congressional authorization
to impose controls on consumer credit, requiring
a minimum down payment of 30 percent and
maximum maturity of 18 months on big ticket
items. (At that time consumer installment debt
totaled $6 billion, compared with $545 billion
today.)
Following America's entry into the war on
December 7, the Board of Governors reaffirmed
its policy of "assuring that an ample supply of
funds was available at all banks for financing the
war effort." In short, much as it had during
World War I — except that this time the initia
tive for a support policy originated with the Fed,
not the Treasury — the Fed agreed to "peg"
(support) the prices of government securities by
purchasing them from banks and security
dealers whenever necessary to keep their prices
(and yields) from fluctuating beyond a very lim
ited range.
From 1941 through 1945 (the war ended in
August), an $80 billion net increase in govern
ment outlays (to $93 billion ) was by far the
major factor contributing to a $87 billion, fouryear rise in GNP (to $213 billion). Altogether,
the government raised about $350 billion during
the war years to pay the salaries of the nearly 12
million members of the Armed Forces and to
cover the cost of producing the materials and
tools they needed to do their job.
However, only about 38 percent of revenues, or
$135 billion, was raised through taxes (Form
1040 was introduced in 1941 and tax withhold
ing through payroll deductions, in 1943). The
remaining 61 percent ($215 billion) was raised
through borrowing and increasing the gross pub
lic debt by this amount to $279 billion. One
hundred and five billion dollars of the borrowing
— about one half— represented sales of bonds
to private investors other than commercial
banks, and $70 billion, sales to banks. The Fed
acquired $22 billion of government securities in
the market in connection with its support or
"pegging" policy, and the remaining $18 billion
was acquired by government agencies and trust
funds. Government securities accounted for all
but $4 billion of the $73 billion net increase in
total commercial bank loans and investments
during the war.
In 1942, the Chairman of the House Banking
Committee, Congressman Wright Patman, (D-
Texas), urged that the government finance its
expenditures simply by printing new money
rather than by borrowing, in order to save the
interest costs on a rising debt. Fed Chairman
Eccles replied that there "was no escape from
the truth that someone must pay for everything"
and that while, ideally, taxes rather than borrow
ings should finance more of the war cost, the
inflation that would result from printing money
rather than tapping savings to the greatest extent
possible would be a "disaster."
"The March of Time"
The policy of substantially monetizing the Treas
ury's huge borrowing requirements resulted in a
more than doubling of the money supply during
the war (and a near tripling from the time of the
defense buildup early in 1940), together with a
tripling in the volume of liquid assets accumu
lated by the public. (Individuals alone effected a
fivefold increase in their holdings of government
securities.)
The impact on prices of the huge increase in liq
uidity was muted during the war by the imposi
tion of rationing and comprehensive wage and
(except for securities and real estate) price con
trols, but prices still rose by 24 percent. A month
after the war ended, an article in the Federal
Reserve Bulletin noted that "the holding of these
liquid assets by business and individuals in such
large volume constitutes a new factor, one not
present in the previous period. The manner and
extent to which (they) will significantly affect the
functioning of the postwar economy is difficult
to determine in advance. They could lead to
inflationary developments if there is a rush to
purchase scarce goods before production
increases or if there is a wave of speculation . . .
(but) they can also have a stabilizing influence
on the economy through providing funds for
individuals and bankers to use during recession
periods."
As events shortly were to prove, both assess
ments were correct. And four more years were
to pass before the System was able to pursue a
monetary policy "independent" of the Treasury.
The problems that the System faced in attempt
ing to adjust its policy focus in the "Brave New
World" following the end of World War II will
be the subject of a future Letter.
Verle B. Johnston
Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San
Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Gregory Tong) or to the author____Free copies of Federal Reserve publications
can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.
uoq6u!qsom
oqopi
Momo(-|
qcqn
oiujojhd^
uo6 s jo
ouozpy
opoAay
ovjsoiy
ODSDUDJJ UDS
JO H uog
0 A J0 S 0 y |DJ©P©J
qu©oqjod©o ipjo©s©y
BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)___________________________________________________
Amount
Change
Outstanding
from
3/12/86
3/5/86
Change from 3/13/85
Dollar
Selected Assets and Liabilities
Large Commercial Banks
Loans, Leases and Investments' 1
2
Loans and Leases' 6
Commercial and Industrial
Real estate
Loans to Individuals
Leases
U.S. Treasury and Agency Securities2
Other Securities2
Total Deposits
Demand Deposits
Demand Deposits Adjusted3
Other Transaction Balances4
Total Non-Transaction Balances6
Money Market Deposit
Accounts—Total
Time Deposits in Amounts of
$100,000 or more
Other Liabilities for Borrowed Money5
201,779
182,880
52,805
66,271
38,506
5,570
10,840
8,059
200,714
47,695
32,539
15,382
137,637
518
504
272
80
60
79
58
72
-1,749
-1,932
- 120
- 258
441
45,959
132
37,823
25,599
187
146
-
-
-
12,581
11,347
312
3,854
5,562
241
135
1,098
7,114
3,586
3,525
2,101
1,427
6.6
6.6
- 0.5
6.1
16.8
4.5
1.2
15.7
3.6
8.1
12.1
15.8
1.0
2,007
4.5
1,160
6,632
Two Week Averages
Period ended
Period ended
of Daily Figures___________________________________ 3/10/86______________ 2/24/86
Reserve Position, All Reporting Banks
Excess Reserves (+ )/Deficiency (—)
Borrowings
Net free reserves (+ )/Net borrowed(-)
1
2
3
4
5
6
-
22
30
8
-
71
191
119
Includes loss reserves, unearned income, excludes interbank loans
Excludes trading account securities
Excludes U.S. government and depository institution deposits and cash items
ATS, NOW, Super NOW and savings accounts with telephone transfers
Includes borrowing via FRB, TT&L notes, Fed Funds, RPs and other sources
Includes items not shown separately
Digitized for FrASE R 1^
percen' change
-
2.9
34.9
@FedFRASER