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FEDERAL RESERVE^BANK OF RICHMOND MONTHLY REVIEW The Basis for Lasting Prosperity Farm Capital and Credit Trends in Virginia The Supply of Money in the United States The Basis For Lasting Prosperity Remarks by ARTHUR F. BURNS Chairman of the Board of Governors of the Federal Reserve System In the Pepperdine College Great Issues Series Los Angeles, California, December 7, 1970 Nearly three years ago, in a talk here in Los Angeles, I pointed out that once an economy be comes engulfed by inflation, economic policy makers no longer have any good choices. T o regain a last ing prosperity, a nation must have the good sense and fortitude to come to grips with inflation. There is, however, no painless way of getting rid of the injustices, inefficiency, and international complica tions that normally accompany an inflation. Events of the past several years have lent poi gnancy to these simple truths. Recent experience has demonstrated once again that the transition from an overheated economy to an economy of stable markets is a difficult process. Elimination of excess demand was an essential first step to the restoration of stability, but this step has brought with it a period of sluggish economic activity, slow income growth, and rising unemployment. And while we have made some progress in moderating the rate of inflation, our people are still seeing the real value of their wages and savings eroded by rising prices. The struggle to bring inflationary forces under control, and to return our labor and capital resources to reasonably full employment, is still going on. I am convinced, however, that corrective adjustments in the private sector over the past twelve to eighteen months are creating, in conjunction with govern mental stabilization policies, the foundation on which a prolonged and stable prosperity can be constructed. A cardinal fact about the current economic situa tion, and one that promises well for our nation’s future, is that the imprudent policies and practices pursued by the business and financial community during the latter half of the 1960’s are being replaced by more sober and realistic economic judgments. In my remarks to you today, I want first to review some of the key developments that lead me to this 2 conclusion. Then I shall turn to the tasks that must still be faced in order to enhance the prospects for an early resumption of growth in production and employment in an environment of reasonably stable prices. The current inflation got under way in 1964. Perhaps the best single barometer of the extent to which it served to distort economic decisions and undermine the stability of the economy is found in the behavior of financial markets during the late 1960’s. In 1968, well over 3 billion shares of stock exchanged hands on the New Y ork Stock Exchange — about two and one-half times the volume of five years earlier. The prices of many stocks shot up ward with little reference to actual or potential earn ings. During the two years 1967 and 1968, the average price of a share of stock listed on the New Y ork Exchange rose 40 per cent, while earnings of the listed companies rose only 12 per cent. On the American Exchange the average share price rose during the same two years more than 140 per cent on an earnings base that increased just 7 per cent. A major source of the speculative ardor came from some parts of the mutual fund industry. Long term investment in stocks of companies with proven earnings records became an outmoded concept for the new breed of “ go-go” funds. The “ smart money” was to go into issues of technologically oriented firms— no matter how they were meeting the test of profitability, or into the corporate conglomerates — no matter how eccentric their character. This mood of speculative exuberance strongly re inforced the upsurge of corporate mergers which oc curred during the middle years of the 1960’s. No doubt many of these mergers could be justified on grounds of efficiency. But the financial history of mergers— including some of the great conglomerates — suggests that many businessmen became so pre occupied with acquiring new companies and pro moting the conglomerate image that they lost sight of the primary business objective of seeking larger profits through improved technology, marketing, and management. W hen talented corporate executives devote their finest hours to arranging speculative maneuvers, the p roductivity of their businesses inevitably suffers and so too does the n ation’s productivity. These speculative excesses had to end, and it is fortunate that they ended before bringing disaster to our nation. Equity values are now being ap praised more realistically than a year or two ago. Investors are now more attentive to high quality stocks. Indeed, many of them have discovered or rediscovered that even bonds and time deposits are a fit use of their funds. Not a few of those re sponsible for the frantic search for “ performance stocks” have shifted to other activities or joined the ranks of the unemployed; so also have numbers of security analysts and stock brokers. W ith specula tion giving way to longer-term investment, the stock market is now channeling risk capital to business firms more efficiently. A searching reappraisal of the economic philosophy of mergers is also underway. Merger activity has slowed materially since m id-1969. T o some degree this is a response to the growing concern in govern mental circles over the dangers that may inhere in large concentrations of economic power. But it stems mainly from the fact that businessmen are recognizing that time and energy can usually be spent more productively in searching for ways to increase the economic efficiency of their firm than in a scramble for corporate acquisitions. 1964 and m id-1970, as an increasing number of firms— some of them with questionable credit stand ings— began to tap this market. The hazards in herent in the spreading reliance on commercial paper were taken much too lightly. After all, the relations between the buyer and seller of commercial paper are by their very nature distant and impersonal— un like the close working relationship that normally develops between a bank and its business customers. The buyer— typically an industrial enterprise— rarely has the facilities or the experience to carry out a full investigation of the risks attaching to com mercial paper. Moreover, the buyer regards his in vestment as temporary— to be withdrawn when cash is needed or when questions arise about the quality of the paper. The issuer, therefore, faces considerable uncertainty as to the amount of his maturing obliga tions that may be renewed on any given day. The risks facing the individual issuer and buyer in evitably pose a problem also for the nation’s financial system, since the difficulties experienced by any large issuer of commercial paper may quickly spread to others. These familiar truths were lost sight of in the in flationary aura of the late 1960’s. It took the de velopments of last summer, when the threat of fi nancial crisis hung for a time over the commercial paper market, to remind the business community that time-honored principles of sound finance are still relevant. A s a result of that experience and the testing of financial markets generally during the past two years, corporate financial policies are now more con structive than in the recent past. This year, new stock issues have continued at a high level— even in the face of unreceptive markets— as corporations have sought to stem the rise in debt-equity ratios. O f late, borrowing by corporations has been con centrated in long-term debt issues, and their rate of accumulation of liquid assets has risen. Liquidity positions of industrial and commercial firms are thus improving, though it will take some time yet to rectify fully the mistakes of the past. Businessmen are also reconsidering the wisdom of financial practices that distorted their balance sheets during the late 1960’s. In the manufacturing sector, the ratio of debt to equity— which had been approximately stable during the previous decade— began rising in 1964 and was half again as large by 1970. Liquid asset holdings of corporate busi nesses were trimmed to the bone. On the average, the ratio of prime liquid assets to current liabilities fell by nearly half during those six years. In per mitting such a drastic decline in liquidity, many of our corporations openly courted trouble. These efforts to restore sound business finances are not without costs to the nation. For example, long-term interest rates, while below their peaks at the end of last year or last spring, are still at un usually high levels because of this year’s extra Perhaps the most ominous source of instability produced by these financial practices was the huge expansion of the commercial paper market. The volume of commercial paper issued by nonfinancial businesses increased eightfold between the end of ordinary volume of new capital issues. But there can be no doubt that substantial adjustments in the financial practices of our nation’s businesses were essential if the basis for a lasting and stable pros perity was to be reestablished. 3 By and large, our major financial institutions con ducted themselves with prudence during the years when lax practices were spreading in financial markets. There were, however, some individual in stitutions that overextended loan commitments rela tive to their resources, others that reduced liquidity positions to unduly low levels, still others that per mitted a gradual deterioration in the quality of loan portfolios, and even a few that used funds of de positors to speculate in long-term municipal se curities. Fortunately, such institutions were dis tinctly in the minority. When the chips were down, our major financial institutions proved to be strong and resilient. And they are stronger today. As monetary policy has eased, the liquidity of com mercial banks has been increasing. Even so, loan applications are being screened with greater care. The emphasis on investment quality has also in creased at other financial institutions, as is evidenced by the recent wide spread between the yields of high and lower grade bonds. These corrective adjustments in private financial practices have materially improved the prospects for maintaining order and stability in financial markets. But no less important to the establishment of a solid base for a stable and lasting prosperity have been the developments this year in the management of the industrial and commercial aspects of business enterprise. During the latter half of the 1960’s, business profit margins came under severe pressure. The ratio of profits after taxes to income originating in corporations had experienced a prolonged rise during the period of price stability in the early 1960’s. But this vital ratio declined rather steadily from the last quarter of 1965 and this year reached its lowest point of the entire postwar period. Until the autumn of 1969 or thereabouts, the de cline in profit margins was widely ignored. This is one of the great perils of inflation. Underlying eco nomic developments tend to be masked by rising prices and the state of euphoria that comes to prevade the business community. Though profit margins were falling and the cost of external funds was rising to astonishing levels, the upward surge of investment in business fixed capital continued. True, much of this investment was undertaken in the interest of economizing on labor costs. Simultaneously, how inflationary developments would one way or another validate almost any business judgment. W hile the toll in economic efficiency taken by these loose managerial practices cannot be measured with pre cision, some notion of its significance can be gained by observing changes in the growth rate of pro ductivity. From 1947 through 1966, the average rate of ad vance in output per manhour in the private sector of the economy was about 3 per cent per year. In 1967, the rate of advance slowed to under 2 per cent, and gains in productivity ceased altogether from about the middle of 1968 through the first quarter of this year. The loss of output and the erosion of savings that resulted from this slowdown in productivity growth are frightfully high. The elimination of excess demand, which the gov ernment’s anti-inflationary policies brought about, is now forcing business firms to mend their ways. D e cisions with regard to production and investment are no longer being made on the assumption that price advances will rectify all but the most imprudent business judgments. In the present environment of intense competition in product markets, business firms are weighing carefully the expected rate of re turn on capital outlays and the costs of financing. The rate of investment in plant and equipment has therefore flattened out. and advance indicators sug gest that business fixed investment will remain moderate in 1971. Business attitudes toward cost controls have of late also changed dramatically. A cost-cutting process that is more widespread and more intense than at any time in the postwar period is now underway in the business world. Advertising expenditures are being curtailed, unprofitable lines of production dis continued, less efficient offices closed, and research and development expenditures critically reappraised. Layers of superfluous executive and supervisory per sonnel that were built up over a long period of lax managerial practices are being eliminated. Reduc tions in employment have occurred among all classes of workers— blue collar, white collar, and professional workers alike. Indeed, employment of so-called n on production workers in manufacturing has shown a decline since March that is unparalleled in the post war period. ever, serious efforts to bring operating costs under of stagnation. developed on a large scale, huge wage increases were output per manhour in the private nonfarm economy granted with little resistance, and some business in rose at a 4 per cent annual rate, and the rate ad vestments were undertaken in the expectation that vanced to 5 per cent in the third quarter. | Because of these vigorous efforts to cut costs, the growth of productivity has resumed, after two years control became more and more rare, labor hoarding * 4 In the second quarter of this year, These I productivity gains have served as a sharp brake on the rise in unit labor costs, despite continued rapid increases in wage rates. In my judgment, these widespread changes in busi ness and financial practices are evidence that genuine progress is being made in the long and arduous task of bringing inflationary forces under control. W e may now look forward with some confidence to a future when decisions in the business and financial community will be made more rationally, when managerial talents will be concentrated more in tensively on efficiency in processes of production, and when participants in financial markets will avoid the speculative excesses of the recent past. Let me invite your attention next to the role that government policies have played this year in foster ing these and related adjustments in private policies and practices. The fundamental objective of monetary and fiscal policies this year has been to maintain a climate in which inflationary pressures would continue to moderate, while providing sufficient stimulus to guard against cumulative weakness in economic ac tivity. Inflationary expectations of businessmen and consumers had to be dampened; the American people had to be convinced that the government had no in tention of letting inflation run rampant. But it was equally important to follow policies that would help to cushion declines in industrial production stemming from cutbacks in defense and reduced output of business equipment, and to set the economy on a course that would release the latent forces of ex pansion in our home-building industry and in state and local government construction. I believe we have found this middle course for both fiscal and monetary policy. A substantial reduction in the degree of fiscal restraint has been accomplished this year with the phasing out of the income tax surcharge and the in crease in social security benefits. These sources of stimulus provided support for consumer disposable incomes and spending at a time when manufacturing employment was declining and the length of the work-week was being cut back. I do not like, but I also am not deeply troubled, by the deficit in the Federal budget during the cur rent fiscal year. If the deficit had originated in a new explosion of governmental spending. I would fear its inflationary consequences. This, however, is not the present case. The deficit in fiscal 1971— though it will prove appreciably larger than originally an ness of economic activity. The Federal budget is thus cushioning the slowdown in the economy with out releasing a new inflationary wave. The Presi dent’s determination to keep spending under control is heartening, particularly his plea last July for a rigid legislative ceiling on expenditures that would apply to both the Executive and the Congress. H ow ever, pressures for much larger spending in fiscal 1972 are mounting and pose a threat to present fiscal policy. Monetary policy this year has also demonstrated, I believe, that it could find a middle course between the policy of extreme restraint followed in 1969 and the policies of aggressive ease pursued in some earlier years. Interest rates have come down, and liquidity positions of banks, other financial institutions, and nonfinancial businesses have been rebuilt— though not by amounts that threaten a reemergence of excess aggregate demand. A more tranquil atmosphere now prevails in financial markets. Market participants have come to realize that temporary stresses and strains in financial markets could be alleviated with out resort to excessive rates of monetary expansion. Growth of the money supply thus far this year— averaging about a 5 y2 per cent annual rate— has been rather high by historical standards. This is not, however, an excessive rate for a period in which precautionary demands for liquidity have at times been quite strong. The precautionary demands for liquidity that were in evidence earlier in 1970 reflected to a large degree the business and financial uncertainties on which I have already commented. It was the clear duty of the nation’s central bank to accommodate such demands. O f particular importance were the actions of the Federal Reserve in connection with the commercial paper market last June. This market, following the announcement on Sunday, June 21, of the Penn Central’s petition for relief under the Bankruptcy Act, posed a serious threat to financial stability. The firm in question had large amounts of maturing commercial paper that could not be re newed, and it could not obtain credit elsewhere. The danger existed that a w ave of fear w ould pass through the financial community, engulf other is suers of commercial paper, and cast doubt on a wide range of other securities. By Monday, June 22— the first business day fol lowing announcement of the bankruptcy petition— the Federal Reserve had already taken the virtually unprecedented step of advising the larger banks ticipated— reflects in very large part the shortfall of across the country that the discount window would revenues that has accompanied the recent sluggish be available to help the banks meet unusual borrow 5 ing requirements of firms that could not roll over their maturing commercial paper. In addition, the Board of Governors reviewed its regulations govern ing ceiling rates of interest on certificates of deposit, and on June 23 announced a suspension of ceilings in the maturity range in which most large certificates of deposit are sold. This action gave banks the freedom to bid for funds in the market and make loans available to necessitous borrowers. A s a result of these prompt actions, a sigh of re lief passed through the financial and business com munities. The actions, in themselves, did not pro vide automatic solutions to the many problems that arose in the ensuing days and weeks. But the fi nancial community was reassured that the Federal Reserve understood the seriousness of the situation, and that it would stand ready to use its intellectual and financial resources, as well as its instruments of monetary policy, to assist the financial markets through any period of stress. Confidence was thus bolstered, with the country’s large banks playing their part by mobilizing available funds to meet the needs of sound borrowers caught temporarily in a liquidity squeeze. The role that confidence plays as a cornerstone of the foundation for prosperity cannot, I think, be overstressed. Much has been done over recent months by private businesses and by the government to strengthen this foundation. If we ask what tasks still lie ahead, the answer I believe must b e : full restoration of confidence among consumers and businessmen that inflationary pressures will con tinue to moderate, while the awaited recovery in production and employment becomes a reality. The implications of this answer for the general course of monetary and fiscal policies over the near term seem to me clear. The thrust of monetary and fiscal policies must be sufficiently stimulative to as sure a satisfactory recovery in production and em ployment. But we must be careful to avoid ex cessive monetary expansion or unduly stimulative fiscal policies. Past experience indicates that efforts to regain our full output potential overnight would almost surely be self-defeating. The improvements in productivity that we have struggled so hard to achieve would be lost if we found ourselves engulfed once again in the inflationary excesses that inevitably occur in an overheated economy. I have recommended on earlier occasions that the Employment A ct of 1946 be amended to include explicit reference to the objective of general price stability. Such a change in that law will not, of course, assure better economic policies. But it would call the nation’s attention dramatically to the vital role of reasonable price stability in the maintenance of our national economic health. A t the present time, governmental efforts to achieve price stability continue to be thwarted by the continuance of wage increases substantially in excess of productivity gains. Unfortunately, the cor rective adjustments in wage settlements that are needed to bring inflationary forces under control have yet to occur. The inflation that we are still experiencing is no longer due to excess demand. It rests rather on the upward push of costs— mainly, sharply rising wage rates. W age increases have not moderated. The average rate of increase of labor compensation per hour has been about 7 per cent this year— roughly the same as last year. Moreover, wage costs under new col lective bargaining contracts have actually been ac celerating despite the rise in unemployment. In the third quarter of this year, major collective bargaining agreements called for annual increases in wage rates averaging 10 per cent over the life of the contract. Negotiated settlements in the construction industry during the same three months provided for wage in creases averaging 16 per cent over the life of the contract, and 22 per cent in the first year of the contract. N or is the end of this explosive round of wage increases yet in sight. Next year, contracts expire in such major industries as steel, aluminum, copper, and cans. If contracts in those industries are patterned on recent agreements in the construc tion industry— or, for that matter, in the trucking and automobile industries— heavy upward pressures on prices will continue. I fully understand the frustration of workers who have seen inflation erode the real value of past wage increases. But it is clearly in the interest of labor to recognize that economic recovery as well as the battle against inflation will be impeded by wage settlements that greatly exceed probable productivity gains. A s I look back on the latter years of the 1960’s, In a society such as ours, which rightly values full employment, monetary and fiscal tools are in adequate for dealing with sources of price inflation and consider the havoc wrought by the inflation of such as are plaguing us now— that is, pressures on that period, I am convinced that we as a people need costs arising from excessive wage increases. to assign greater prominence to the goal of price the experience of our neighbors to the north in stability in the hierarchy of stabilization objectives. dicates, inflationary wage settlements may continue 6 As for extended periods even in the face of rising un employment. In Canada, unemployment has been moving up since early 1966. New wage settlements in major industries, however, averaged in the 7 to 8 per cent range until the spring of 1969, then rose still further. This year, with unemployment moving above 6 y2 per cent, negotiated settlements have been in the 8 to 9 per cent range. Many of our citizens, including some respected labor leaders, are troubled by the failure of collective bargaining settlements in the United States to re spond to the anti-inflationary measures adopted to date. They have come to the conclusion, as I have, that it would be desirable to supplement our mone tary and fiscal policies with an incomes policy, in the hope of thus shortening the period between suppres sion of excess demand and the restoration of reason able relations of wages, productivity, and prices. T o make significant progress in slowing the rise in wages and prices, we should consider the scope of an incomes policy quite broadly. The essence of incomes policies is that they are market-oriented; in other words, their aim is to change the structure and functioning of commodity and labor markets in ways that reduce upward pressures on costs and prices. The additional anti-inflationary measures an nounced by the President last Friday will make a constructive contribution to that end. The actions to increase the supply of oil will dampen the mount ing cost of fuels, and the recommendations made by the President to improve the structure of collective bargaining in the construction industry strike at the heart of a serious source of our current inflationary problem. I would hope that every citizen will support the President’s stern warning to business and labor to exercise restraint in pricing and wage demands. A full measure of success in the effort to restore our nation’s economic health is, I believe, within our grasp, once we as a people demonstrate a greater concern for the public interest in our private de cisions. If further steps should prove necessary to reduce upward pressures on costs and prices, numerous with exceptional rapidity, or the creation on a na tion-wide scale of local productivity councils to seek ways of increasing efficiency, or a more aggressive pace in establishing computerized job banks, or the liberalization of depreciation allowances to stimulate plant modernization, or suspension of the DavisBacon A ct to help restore order in the construction trades, or modification of the minimum wage laws in the interest of improving job opportunities for teenagers, or the establishment of national building codes to break down barriers to the adoption of modern production techniques in the construction industry, or compulsory arbitration of labor dis putes in industries that vitally involve the public interest, and so on. W e might bring under an in comes policy, also, the establishment of a high-level Price and W age Review Board which, while lacking enforcement power, would have broad authority to investigate, advise, and recommend on price and wage changes. Such additional measures as may be required can, of course, be determined best by the President and the Congress. What I see clearly is the need for our nation to recognize that we are dealing, prac tically speaking, with a new problem— namely, per sistent inflation in the face of substantial unemploy ment— and that the classical remedies may not work well enough or fast enough in this case. Monetary and fiscal policies can readily cope with inflation alone or with recession a lon e; but, within the limits of our national patience, they cannot by themselves now be counted on to restore full employment, with out at the same time releasing a new wave of in flation. W e therefore need to explore with an open mind what steps beyond monetary and fiscal policies may need to be taken by government to strengthen confidence of consumers and businessmen in the nation’s future. In the past two years we have come a long way, I believe, towards the creation of a foundation for a lasting and stable prosperity. Confidence has been restored in financial markets. Businesses have turned away from the imprudent practices of the past. Productivity gains have resumed. Our balance of trade has improved. The stage has been set for a recovery in production and employment— a re other measures might be taken to improve the covery in which our needs for housing and public functioning of our markets. For example, liberaliza construction can be more fully met. tion of import quotas on oil and other commodities would serve this purpose. So also would a more T o make this foundation firm, however, we must find ways to bring an end to the pressures of costs vigorous enforcement of the anti-trust laws, or an on prices. expansion of Federal training programs to increase accomplish this objective. the supply of skilled workers where wages are rising at the outset, is the tough legacy of inflation. There are no easy choices open to us to But that, as I indicated 7 Farm Capital and Credit Trends in Virginia* The farming sector of our economy is unusually dynamic. Changes taking place in farming have im portant implications for farm operators and related businesses including financial institutions. This article describes the capital and credit trends on Virginia farms and discusses their implications for financial institutions. Many of the changes affecting farming increase capital requirements. Capital investment in farming is at an all-time high, and indications are that it will continue to increase. Several important factors ac count for the increase: 1. Consolidation has created fewer and larger farms. The number of farms in the United States decreased from 6.1 million in 1940 to approximately 2.9 million in 1968. Production assets per farm increased from $6,158 in 1940 to $79,223 in 1968.1 2. Capital is a substitute for labor and land in farming. Lower unit costs available through newer and larger machines and other forms of technology have forced farmers to move to larger scale operations. Most of this mechaniza tion and other technology is capital intensive. Production assets per farm worker increased from $3,326 in 1940 to $45,872 in 1968.2 3. The use of purchased inputs such as fertilizers and pesticides has increased. A s farms become more mechanized and specialized, they rely more on purchased inputs. The index of purchased farm inputs increased from 91 in 1950 to 124 in 1967.3 4. Operating costs per dollar of farm sales have increased because of expanding use of purchased inputs and rising prices for these in puts. The index of prices paid by farmers has risen more than one-third since 1950. Net farm income declined from 40% of cash receipts in 1950 to 33% in 1967/ These trends are likely to continue. Thus, farmers and others interested in agriculture are concerned * This article is an abridgement o f an earlier paper by the author, “ Farm Capital Formation and Financing in V irg in ia ,” Research Report A .E .4 , Departm ent o f Agricultural Economics, V irgin ia Poly technic Institute and State University (Blacksburg, V irg in ia : Oc tober 1970 ). 1 U S D A , E R S, Agriculture Inform ation Bulletin 334, Balance Sheet o f A griculture, 1968 (W ashington, January 196 9 ), p. 23. ■ Ibid., p. 24. ‘ n U S D A , Statistical Bulletin 223, Changes in Farm Production and E fficien cy, 1968 (W ashington, June 1968 ), p. 16. * Balance Sheet o f Agriculture, op. cit., p. 20. 8 about the availability of capital to support future ad justment and growth in the farm sector. There are basically two types of capital with which a business can be financed— equity capital and debt capital. Traditionally, farm growth has been financed largely with retained earnings. From 1900 to 1950, more than 85% of the new capital invested in United States agriculture came from farm savings.5 Recently, however, farmers have financed fewer of the increasing capital requirements from savings, and they have turned more to debt capital for financing. Farm debt has grown much more rapidly than in vestment in assets or production expenses since 1950." Total farm debt rose from $10.8 billion in 1950 to $49 billion in 1968— an increase of 350% . Changes in Virginia Farming V irginia farm ing has followed the national trend. The average farm size in Virginia increased from 103.1 acres to 149.4 acres between 1950 and 1964, while the number of farms decreased from 150,997 to 80,354. During the same period, average value of land and buildings per farm increased 226% — from $8,458 to $27,572. Between 1950 and 1964, realized net farm income in Virginia increased from $1,527 to $2,253 per farm, an increase of only 48% in contrast to a 226% increase in investment per farm in land and build ings. Thus, farmers have had to use more and more debt capital to finance farm growth. Average out standing debt per farm, excluding trade credit, rose from $728 in 1950 to $3,880 in 1964, an increase of 443% . W hile these data encompass farms of all sizes, the changes are even more striking when commercial farms— the larger, more dynamic units— are con sidered separately. Farms are classified by the Bureau of the Census into economic classes on the basis of the value of farm products sold as follow s: E co n o m ic C la s s 1 II III IV V VI V a lu e of Farm P ro d u c ts S o ld $40,000 20,000 10,000 5,000 2,500 50 and over to 39,999 to 19,999 to 9,999 to 4,999 to 2,499 5 Alvin S. Tostlebe, Capital in Agriculture-. Its Form ation and F i nancing Since 1870, A study by the National Bureau o f Economic Research (Princeton, N ew Jersey: Princeton U niversity Press, 1 957 ), p . 146. 6 Gene L . Swackhamer and Raymond J. Doll, Financing M o d em A griculture: Banking’s Problems and Challenges (K ansas City, M issouri: Federal Reserve Bank of K ansas City, 1 9 6 9 ), p. 10. i T a b le of the farms with gross sales of $5,000 or less had debts averaging $5,178.7 I SELECTED CHARACTERISTICS OF FARMS BY E C O N O M IC CLASS Virginia, 1964 E con om ic C la s s A ll O th e r F a r m s1 1 I II Percent Percent Percent 2.2 11.0 3.7 11.2 6.9 14.1 87.2 63.7 33.1 44.8 3.4 17.5 19.6 5.8 16.3 12.2 9.5 33.1 23.4 81.2 18.3 N u m b e r o f fa r m s A c r e a g e in f a r m s E x p e n d itu re s o n selected in puts: Feed fo r live sto ck a n d To ta l f a r m p ro d u c ts so ld p o u ltry Se e d s, p la n ts, a n d rtees Fertilizer m a te ria ls, g a s o lin e , oil, a n d p e tro le u m II Percent Item 15.9 18.2 47.6 1 In c lu d e s C la s s IV , V , a n d V I fa r m s , p a rt-tim e f a r m s , p a rt-re tire m en t f a r m s , a n d a b n o r m a l fa r m s . Sou rce: U. S. C e n s u s o f A g r ic u ltu r e : 1964, V o l. 1, P art 24 ( W a s h in g to n , 1967), S ta te T a b le 17. Table I shows data for the Virginia farm sector by economic class and permits the identification of com mercial farms as defined below. Class I and Class II farms— those generally con sidered the most economically viable in the present economic setting— contained only 5.9% of the farms but accounted for 50.6% of the value of all products sold and 22.2% of the land in farms. In 1964, Class I and Class II farms accounted for 64.4% of the feed, 59.3% of the livestock, 40.4% of the fertilizer Capital Requirements on Virginia Farms R e quirements for both investment capital and operating capital have been increasing for commercial farming in Virginia. Moreover, this trend is likely to con tinue. A study by the Virginia Commission of the Industry of Agriculture estimated that the number of farms in the state with gross sales of $20,000 or more will increase 58% between 1964 and 1980 and that the average value of production assets for these farms will increase 21% . The Commission estimated that average production assets for Class I and Class II farms will be $425,000 and $150,000, respectively, in 1980.* Loans to Virginia Farmers Increased capital requirements have had an impact on the size of loans and the use of credit by Virginia farmers. The ex perience of the Production Credit Associations re flects the increase in the size of loans (Table I I ) . Only 4.8% of the volume of outstanding P C A loans in 1960 was to borrowers with loan balances ex ceeding $50,000 compared to 16.3% in 1968. Bor rowers with loan balances under $25,000 decreased from 86.1% of the total in 1960 to 62.7% in 1968. Between 1950 and 1964 debt as a percent of cash farm income and non-real estate debt as a proportion of production expenses more than doubled. As agriculture in Virginia becomes more commercial, more debt capital will be used and loan size will continue to increase. materials, and 34.2% of the petroleum products pur T a b le chased by all farms. Conversely, Virginia farms with gross sales of less than $10,000 accounted for 87% of all farms and 64% of the land in farms. SIZE OF LOAN BALANCES FOR PCA BORROWERS They Virginia, June 30, 1960 and 1968 accounted for 33% of gross farm sales, 23% of feed, I9 6 0 27% of livestock, and 41% of fertilizer materials purchased. Average investment in production assets in 1964 The number of acres per farm averaged 739 and 147 for these classes, respectively. Clearly, the capital and credit needs of the larger commercial farms which control most of the assets in farming and account for a large proportion of the purchased inputs are different from those of the smaller farms. 1968 $2 5 ,0 0 0 a n d u n d e r 25,001 to 5 0 ,0 00 50,001 to 100,000 O v e r 100,000 T o ta l So u rc e : T o ta l C r e d it O u t s t a n d in g P er ce n tage of T o ta l T o tal C r e d it O u t s t a n d in g T o tal P e r c e n ta g e of 1,000 d o lla r s Siz e o f Loa n B a la n c e s was $330,160 for Class I farms compared to $36,270 for Class V farms. II Percent 1,000 d o lla r s Percent 15,421 1,621 762 86.1 9.1 105 4.3 0.5 17,909 100.0 28 ,2 34 62.7 9,475 5,58 7 1,738 21.0 12.4 3.9 45 ,0 3 4 100.0 F e d e ra l In te r m e d ia te C r e d it B a n k o f B a ltim o re . According to the 1964 Census of Agriculture, more than 75% of the farms in the United States with gross sales of $20,000 or more had debts averaging $40,425, while less than 60% 7 Bureau o f the Census, U. S. Census o f A gricu ltu re: 1964, Vol. I l l , Part 4, "F a r m Debt” (W ashington, 1968 ), Table 13. s A Report by the Commission o f the Industry of Agriculture, O p portunities for Virginia A griculture (Richmond, V irg in ia : Com monwealth o f V irgin ia, 1 9 6 9 ), p. 25. 9 T a b le III LEGAL LENDING LIMITS OF CO M M ERCIA L BANKS IN CLU DIN G BRANCHES IN LOCATIO NS OTHER THAN THAT OF THE HOME BANK Virginia, December 31, 1968 L e g a l L e n d in g Lim it to a n In d iv id u a l B o rro w e r B a n k s in T o w n s w ith P o p u la t io n of: 5,50 0 a nd u n d e r Num ber O v e r 5 ,50 0 Num ber Percent T o ta l 22 48 59 125 8.7 18.9 23.2 49.2 4 15 54 198 1.5 5.5 19.9 73.1 254 $ 2 5 ,0 0 0 a n d u n d e r 25,001 to 5 0 ,0 0 0 50,001 to 100,000 O v e r 100,000 S o u rc e : Percent 100.0 271 100.0 S o u th e rn B a n k e rs D ire cto ry , V ir g in ia , 1969. Availability of Credit General econ om ic con ditions affect the availability of credit to farmers in Virginia. W ith the exception of the Farm Credit System and the Farmers Home Administration (F m H A ), institutions that lend to farmers also lend to other borrowers. W hen these institutions can make loans more advantageously to nonfarm bor rowers, the flow of credit to farmers may be reduced. The Farm Credit System obtains loan funds from the sale of bonds on the national financial markets. Through this system, the farmer has access to the national financial markets. If conditions in the capital markets and the general economy make al ternative investments more attractive, funds available to the Farm Credit System will be reduced. Of course, the Farm Credit System can make its bonds more attractive by raising the interest rate, but this is reflected in higher rates to borrowers. The F m H A makes direct loans to farmers from Congressional appropriations. It also insures loans to farmers made by other lenders. The types of F m H A loans and the funds available can be changed at any time by Congress. Characteristics of Major Farm Lending Agencies Commercial Banks There were 233 state and na tional banks in Virginia in 1969 operating 998 of fices. A t the end of the year 189 of these banks held some farm loans. Most banks make both real estate and non-real estate loans to farmers. Generally, real estate loans are those loans secured by mortgages on farmland including improvements and used to pur chase farm units, additional land, or to finance capital improvements. Non-real estate loans are all those not secured by real estate. They may be either short or intermediate term. Short-term loans are repay able within 12 months and are used to meet current operating and living expenses. Intermediate-term Digitized10 FRASER for loans require more than 12 months to repay and are used for investments such as livestock and ma chinery. Many banks in rural America have encountered problems because farms have grown faster than the size of banks serving them. These banks often re ceive farm loan requests that exceed the amount they can lend under legal limits. The legal limit for na tional banks is 10% of the bank’s capital and surplus (except for livestock loans, which may go to an ad ditional 1 5 % ). State banks in Virginia can lend up to 15% of their capital and surplus to a single borrower. A request for a loan exceeding the legal lending limit is called an overline request. In 1966, a na tional survey of banks making agricultural loans revealed that 14% of all banks had over line requests from farm customers.9 This problem, however, does not appear to be serious in Virginia. Only 4 of 259 Virginia banks reported overline requests. M ore over, in 1968 only 22 offices of 254 banks and branches located in rural towns— towns with a population less than 5,500— had legal lending limits of less than $25,000, and 184 of these had legal lend ing limits of $50,000 or more (Table I I I ) . A ccording to the 1966 survey very few bank loans to farmers were for $25,000 or more. In 1968 all but 4 V ir ginia counties had at least one banking office with a legal lending limit of $25,000 or more, and all but 8 had at least one banking office with a legal lending limit of $50,000 or more. In 1962, Virginia banking law was amended to permit limited statewide branching.1 A s a result, 0 T a b le IV LEGAL LENDING LIMITS OF C O M M E R C IA L BA N KS EXCLUDING BRANCHES Virginia, December 31, 1968 L e g a l L e n d in g Lim it to a n In d iv id u a l B o rro w e r B a n k s in T o w n s w ith P o p u la t io n o f: 5,50 0 a n d u n d e r O v e r 5,50 0 Num ber To ta l S o u rc e : Num ber 19 37 34 22 17.0 33 0 30.4 19.6 3 13 31 78 2.4 10.4 24.8 62 .4 112 $ 2 5,00 0 a n d u n d e r 25,001 to 5 0 ,0 0 0 50,001 to 100,000 O v e r 100,000 Percent 100.0 125 100.0 S o u th e rn B a n k e r s D ire cto ry , V ir g in ia , Percent 1969. 9 Emanuel Melichar, “ Bank Financing o f Agriculture,” Federal R e serve Bulletin, Board of Governors of the Federal Reserve System (W ashington, June 1 9 6 7 ), p. 929. 10 For a detailed discussion o f Virgin ia banking laws, see Harmon H . Haymes, A Study o f Banking in Virginia, A report prepared for the Rural A ffa irs Study Commission (Richm ond, V irg in ia : Com monwealth o f V irgin ia, n .d .). the structure of Virginia banking changed sig nificantly, which is the primary reason that legal lending limits are not a serious limitation in Virginia. A branch office has the same legal lending limit as its home office. Thus, one of the major advantages of branch banking as far as rural areas are concerned is that the legal limit on the size of a loan a bank can make to a single borrower is increased. The impact of branch banking on legal lending limits in rural Virginia is suggested by a comparison of Tables III and IV . W hen banks and branches outside the parent bank’s area are considered, only 8.7% of the bank ing offices in rural towns have a legal lending limit of $25,000 or less and 27.6% have a legal lending limit of $50,000 or less. When the consideration of branches is excluded, 17% of the banks in com munities with a population of 5,500 or less have legal lending limits of $25,000 or less and 50% have legal lending limits of $50,000 or less (Table I V ) . E x cluding branches, only 22 banks in rural areas had a legal lending limit of $100,000 or more compared to 125 when branches were included. These data highlight the importance of branch banking to the growth of farm firms, especially in view of the large average investment projected for Class I farms in Virginia. Production Credit Associations There are 13 Production Credit Association (P C A ) offices in V ir ginia. P C A ’s are federally-sponsored credit co operatives owned entirely by the member borrowers. They make both short-term (less than one year) and intermediate-term loans (up to seven years) to farmers for any agricultural purpose. Most PC A loans are secured by real estate mortgages and first mortgages on chattel property. Any farmer is eligible to borrow from a PC A , but he must become a member of the association by purchasing stock equal to 5% of the value of the loan. When the loan is repaid, the stock may be sold back to the association. Federal Land Banks Like Production Credit A ssociations, Federal Land Bank A ssociation s Insurance Companies Insurance companies are a major institutional supplier of farm real estate loans in the United States. In Virginia both commercial banks and F L B A ’s extend more real estate credit than do insurance companies. Nine life insurance companies accounted for approximately 80% of all life insurance farm real estate loans in Virginia in 1968. Farmers H om e Administration The Farmers Home Administration is an agency of the U. S. De partment of Agriculture, which has 35 county of fices in Virginia, established to make a wide variety of low cost loans to farmers and rural residents. The Fm H A can make loans only to farmers who cannot obtain credit from other sources on reasonable terms, and F m H A borrowers agree to obtain credit from other lenders when their financial situation improves. Fm H A loans may be larger relative to security value than loans by commercial lenders. For ex ample, with direct farm ownership loans, F m H A may lend up to 100% of the normal value of the farm. The Farmers Home Administration has three ob jectives: (1 ) to strengthen the economic position of individual family farmers, (2 ) to improve rural communities, including towns with populations of less than 5,500, and (3 ) to alleviate rural poverty.1 1 A s a government agency, the FmPIA has three sources of funds to lend : (1 ) a direct loan account appropriated by Congress, (2 ) a revolving fund established by Congress for emergency loans, and (3 ) funds furnished by commercial banks and other lenders and insured by the F m H A . five types of loans: F m H A makes (1 ) operating loans for cur rent expenses, (2 ) long-term loans to buy and im prove farmland, including residence im prove ments, (3 ) em ergency loans in designated dis- T a b le V SELECTED CHARACTERISTICS OF PCA A N D BA NK BORROW ERS Virginia, 1966 (F L B A ’s) are federally-sponsored credit coopera tives. C o m m e r c ia l In Virginia, the 13 F L B A ’s and P C A ’s are housed together. F L B A ’s are limited by law to making real estate loans. Loans can be made for any constructive pur pose and may be for periods up to 35 years. F L B A borrower must derive the principal part of stock equal to 5% of the value of his loan and be Num ber A ve rage A ve rage A ve rage o f fa r m b o r r o w e r s a sse ts p er fa r m net w o r t h per fa r m to ta l d e b t p e r fa r m P C A 's Banks 5,9 5 0 $8 5,36 2 6 2 ,8 59 22,503 5 1 ,3 4 5 $5 0,83 5 38 ,4 13 12,326 An his income from farming. A farmer has to purchase come a member of the association. Item So u rc e : C o m p ile d fr o m d a t a m in istr a tio n a n d the p r o v id e d b y the Fa rm C r e d it A d F e d e ra l R e se rv e S y ste m . 1 Aaron G. Nelson and W illiam G. M urray, Agricultural Finance, 1 Fifth Edition (A m es, Iow a: Iowa State University Press, 1967 ), p. 320. 11 aster areas, (4 ) loans to finance recreational enterprises as a part of operating and farm ownership loans, and (5 ) rural housing loans. Trade Credit While the total amount of trade credit extended by suppliers of farm inputs in V ir ginia is unknown, evidence suggests that it is sub stantial. Merchant credit may be short term or intermediate term, and loans may be secured by the item purchased or they may be unsecured, openaccount loans. Trends in Credit Sources The proportion of total farm real estate credit held by different financial institutions in Virginia has changed considerably since 1950. The F L B A ’s increased their relative market share of such loans from 12% in 1950 to 29.5% in 1970; life insurance companies’ share de creased from 11.2% to 10% over this period. The relative market share of banks declined from 37.7% to 2 3% . Non-real estate farm debt provided by institutions in Virginia increased from $35.2 million in 1950 to $152.1 million in 1970. Contrary to the situation in real estate credit, banks have long been the major institutional source of non-real estate credit in V ir ginia. Their proportion of this type of credit de clined from 74.4% in 1950 to 62% in 1970. The P C A ’s held 33.5% of the non-real estate credit in 1970 compared to 15.1% in 1950. Reliable trend data on trade credit are not avail able on a state basis. The 1960 Sample Survey of Agriculture, however, indicated that merchant credit accounted for approximately 22% of non-real estate debt of farm operators in the United States.1 M ore 2 over, available evidence indicates that this is a grow ing source of credit.1 3 Characteristics of Bank and PCA Loans In 1966, the Federal Reserve System and the Farm Credit A dm inistration conducted an agricultural loan survey. T he Federal Reserve sample survey of 44 banks indicated that Virginia banks had 81,281 loans outstanding to 51,345 farm borrowers. The P C A ’s collected data from a 10% random sample of their borrowers which indicated that P C A ’s had made 7,810 loans to 5,950 borrowers. The survey showed that the P C A ’s serviced larger farm operations than did banks (Table V ) . Assets per farm averaged $85,362 for PC A bor rowers and $50,835 for bank borrowers, and average total debt per farm was 83% greater for P C A bor rowers than for bank borrowers. Average total debt varied widely by type of farm among both bank and P C A borrowers. General, tobacco, and meat animal farms were the three most important types. Important differences in the types of farms operated by PC A and bank borrowers help explain borrowing differences. One-fourth of P C A bor row ers operated meat animal farms, about tw ice the proportion found among bank borrowers. Dairy farmers accounted for 15.5% of PC A borrowers, also a much higher proportion than at banks. Gen eral farmers comprised a higher proportion of bank customers. Approximately one-third of P C A loans and more than two-fifths of bank loans were used for current operating expenses other than the purchase of live stock. Loans to purchase machinery and equip ment made up a fourth of bank loans but only 13% of P C A loans. The largest loans made by both institutions were for purchasing farm real estate. Approximately 10% of bank loans were for this purpose compared to only 2.6% of P C A loans. Loans with maturities of one year or less ac counted for approximately 60% of both bank loans and P C A loans. The percentage of loans with a ma turity of over three years was considerably higher for P C A ’s than it was for banks. There is a marked difference in the maturity of loans for machinery and equipment between the two institutions. Most bank loans for this purpose were for three years or less, compared to 61% of the P C A loans. This comparison suggests that banks are relatively conservative on such loans considering that the economic life of most farm machinery is greater than three years. Over one-half of the farm borrowers at both banks and P C A ’s were full ow ners o f the land they operated. Both institutions had about the same proportion of tenant farmers and landlords am ong their customers. However, part owners accounted for almost 24% of the PC A borrowers compared to only a tenth of the bank borrowers. Conclusion The capital needs of Virginia farmers have increased dramatically in recent years, and the evidence indicates that this trend will continue. Lending institutions can expect to face a rising de 12W illellyn Morelle, Leon Hesser, and Emanuel Melichar, Merchant and Dealer Credit in Agriculture, Board of Governors o f the Federal Reserve System (W ashington, 1966 ), p. 17. 1 John A . Hopkin and Thomas Frey, Problems Faced by Commercial :1 Banks o f Illinois in M eeting the Financial Requirem ents o f a D y namic A griculture, Agricultural Economics Report 99, Departm ent of Agricultural Economics, Agricultural Experim ent Station, U n i versity o f Illinois ( Urbana-Cham paign, April 1969 ), p. 9. 12 mand for credit. A s farms continue to increase in size, the demand for credit and the average size loan per farm will increase. Thomas E. Snider The Supply of Money in the United States Part I — The Institutional Development “ The primary purpose of the Federal Reserve ness venture. Like other business activities, pros Sprague in 1914, “ is to make certain that there will pecting and mining activities are equilibrated by forces of demand and supply working through always be an available supply of money and credit markets. in this country with which to meet unusual banking the quantity of standard money in existence at any requirements.” given time is determined by market forces. Act . . .,” wrote Harvard economist O. M. W . An article of encyclopedic length could be written in an attempt to answer the ques tions prompted by this statement. In metallic monetary systems, therefore, The use of metallic money, however, involves real For exam ple: costs to society, and these costs could be and were W hy money and economized— but not eliminated— by the substitu credit? What are “ unusual” banking requirements? tion of paper money for coin. Then, both paper and What is an “ available supply” ? Did a source of supply exist before the Federal R e metallic currency were economized by checkbook serve System? banking; and the prediction is now that checkbook If so, what happened to it that a new institution was called for ? banking probably will be replaced by electronic ma Sprague gave answers to some of these questions chinery and credit cards. in the long article he wrote (41 pages) for the The development of paper currency and check Quarterly Journal of Economics (February 1914) in book money provoked the first social concern over elaboration of the original topic sentence cited above. control of the quantity of money. Other economists, as well as bankers and central or created demand obligations were constrained to bankers, also have tried their hands at these ques redeem these notes or checks in metal—-gold or Banks that issued tions. The product has been an extensive literature. silver; so bank paper simply extended or economized Paradoxically enough, the Federal Reserve has not the existing quantity of precious metal. Governments emphasized strict control over the money supply also issued paper m on ey; but this kind of act re during most of its 50-odd-year history. quired political license, which was given neither It has put more emphasis on the cost and availability of credit. easily nor often. Only in recent years has the supply of money proper come into its own as a matter for critical discussion, political checks-and-balances between factions or branches of the government and constitutional pro E ffective constraints were the analysis, and investigation. scriptions. Central bank machinery took the separation of From Metallic Standards to Central Banking In attention to the money supply is more than a central bank oversight; it has roots and precedent in mone tary history. Through most of the late 18th and early 19th centuries, when central banking was in its formative stages, the basic money commonly in use was primarily metallic. The earth supplies such money and metal even further. Central banks were bankers’ banks, and ordinary commercial banks were encouraged to deposit their metallic reserves in the central bank. This deposit served as a base on which the banks could extend credit and create de posits. The separation of media of exchange and metal was by this time almost a full estrangement; money at a cost, and anyone willing to give up the and while a final decree has yet to be granted, the necessary resources can get as much of it out of divorce is all but complete. the earth as he wishes. exists; in fact, it is more important to the functioning Precious metals are scarce commodities, and the decision to prospect for them is However, money still of economic society than ever before. not fundamentally different from the decision to ac At times in the past, the link between the quantity quire them by engaging in some other kind of busi of gold and the quantity of money has been broken 13 temporarily. (O n e example is the period in the supplied in an institutional vacuum. A gold or bi United States between 1862 and 1879.) Always this phenomenon called forth principles from governing the first place a formal framework that operates bodies— Congress and the Executive— on how the automatically. quantity of money should and could be regulated some other arrangement must be made. until the metallic connection was reestablished. Now banks are one such alternative arrangement. that the relationship is forever gone, principles for metallic standard is such a set of principles. It is in W hen such systems are abandoned, Central The function of a central bank in today’s world regulating the quantity of money are even more com is to supply money to the economy even though the pelling. Economists have responded with intensified original purpose of such institutions was largely to research on various aspects of the linkages and lags make the money stock more responsive to seasonal of money creation, and on the question of whether variations in the demand for money. the creation of money begins with the central bank bank is in a position to supply new money without Once a central or by indirect stimulus from the commercial banking reference to the rules of a gold standard, some other system and the private economy. rules should be established to govern its operations. In recent years, m on e That the supply of money should be under the tary thought and research has examined at length general control of government is specified in Sec the demand for money and, as a corollary, the defini tion 8 of the Constitution (Pow ers of Congress) tion of what to include in the category of “ money.” where it states: “ The Congress shall have power . . . W h ile all the returns on these issues are not in, to coin money [and] regulate the value thereof. . . .” tw o principles have been fairly well estab lish ed : This principle was established further by Supreme (1 ) Court decisions, and was made even more explicit The Definition of Money Changes in the stock of money have been es tablished empirically as a fundamental factor initiat in the great debates on monetary affairs in Congress ing changes in general spending; and during the 19th century. (2 ) The John C. Calhoun, whose definition of money must include currency and de ability as a monetary policy theorist has been over mand deposits subject to check, and it may include shadowed by the drama of other social issues in as well time deposits in commercial banks. which he took part, stated authoritatively in 1834: Other principles describing and defining the behavior of money have been conjectured and still others are being formed— for example, the demand for money in the framework of inflation; but the provisional conclusions summarized above bring the status and knowledge of the demand-for-money function to the point where similar knowledge and principles for the supply function are necessary and pertinent. W h a te v e r the G overn m en t receiv es and treats as m on ey, is m o n e y ; and if it be m on ey, then they have the right, under the con stitu tion , to regulate it. N ay, they are boun d, b y a high ob liga tion , to adopt the m o st efficien t m eans, a cco rd in g to the nature o f that w h ich they have recog n ized as m on ey , to give to it the u tm ost stability and u n iform ity o f value. N o present day economist or jurist could state the matter more clearly or more logically. Discussions of the supply of money necessarily presume a definition of money. For the sake of Early Central Banking Institutions A great deal simplicity if nothing else, the classification adopted of controversy developed in Congress over the con here rests on a narrow definition of money, one that stitutionality of chartering the First and Second includes: (a ) currency outside commercial banks, the Banks of the United States— the first institutions central bank, and the federal government, and (b ) that came to have some central banking character private demand deposits subject to check, exclusive istics. of interbank deposits. The principles governing the able to the creation of these Banks, was that Con The W hig view, which was generally favor supply of this stock can be applied without much gress could commission other institutions to assist qualification to “ wider” stocks of money that include it with specific duties, such as, in this case, regula some amount of time deposits. tion of the monetary system. The opposing view, espoused by the Jacksonian Democrats during the Central Bank Control A n y specification of the sensational struggle between Jackson and the Second supply of money must be circumscribed by principles Bank, was nowhere better given than in Jackson’s governing the creation of money. veto message on the bill to recharter the Second 14 Money cannot be Bank in 1832. The constitutional power of Con gress, he held, could not be delegated. “ It was con correspondents. Collectively, these larger national banks thus had some of the characteristics of a cen ferred to be exercised [by Congress],” he concluded, tral bank. “ and not to be transferred to a corporation.” W hile mercial enterprises and had neither the facility nor the charters of the First and the Second Banks were the responsibility to behave as a central banking system. allowed to lapse, subsequent Congresses have never shown much eagerness to exercise direct responsi bility over the supply and value of money. practical matter, Congress has been As a content to specify rules for policymaking agencies to follow and goals for them to aspire to. Soon after the demise of the Second Bank, Con gress created the Independent Treasury. This insti tution was supposed to be what its name implied— independent of banks and the monetary system. It However, they were fundamentally com Contemporary Central Banking T h e form ation of the Federal Reserve System was both a reaction to Treasury intervention in the money market and an attempt to develop a monetary system that would operate less erratically than it was currently operat ing with a national system of commercial banks. Stability was to be achieved through the Federal Reserve Banks’ manipulation of the discount rate. could not remain aloof for long, however, and ulti Such policy was supposed to synchronize seasonal mately grew into central banking clothes of an ad variations of the money supply with fluctuating vanced order. It was the Treasury Department ex seasonal demands. tended to include enough sub-Treasury offices to The explicit charge of the A ct itself only called carry out all the fiscal affairs of the federal govern for the Federal Reserve Banks “ to furnish an elastic ment without recourse to commercial banks or a cen currency, to afford means of rediscounting com tral bank. mercial paper, [and] to establish a more effective It was under the direction of the Secre tary of the Treasury who, in effect, became a policy supervision of banking in the United States.” making central banker. means of furnishing an elastic currency was through But the Secretary was and The His intervention into Reserve Bank discounting of “ notes, drafts, and bills monetary affairs, was regarded as exceeding the of exchange arising out of actual commercial transac is an Executive appointee. tions.” Discount rates charged by the Reserve Banks prerogatives of his office. Some 25 years after the Treasury was declared to were to be set “ with a view of accommodating com be “ independent” of banks and the monetary system, merce and business.” Under the original Federal Congress attempted to reform the banking system by Reserve Act, the rules of the gold standard, together passing the National Bank Act. This A ct was begun with the commercial credit doctrine for discounting as a Civil W ar measure by the federal government bank paper, were assumed to fix limits to the scope but did not become fully operational until after the W ar ended. It was designed to bring all banks under of central bank policy. federal charter so that the currency they issued The early 1930’s saw the end of the gold standard as an operational constraint on Federal Reserve would have uniform appearance and value. policy. Since By the Banking Acts of 1933 and 1935, the not even half of all commercial banks came into this technical controls o f the Federal Reserve System system, a prohibitive tax on state bank note issues over the quantity of money were greatly extended. was added to the original Act. The state banks These acts formally established open market opera thereupon eschewed note issues, but they continued tions in government securities and discretion over to operate outside the national banking system by reserve requirements for member banks (in addition issuing demand deposits for all of their commercial to discounting) as the legitimate province of Federal lending activities. Reserve action. The national banks thereafter exclusively issued However, precise specifications for the use of this machinery were still lacking. Without They also served rules or directions, the Federal Reserve System was as depository banks for the Treasury thus reintroduc extremely vulnerable to Treasury and Executive ing some interdependence between the commercial domination. currency (National Bank notes). Finally, the The general deemphasis of monetary policy in the national banks in the larger commercial centers came to act as seasonal depositories for their “ country” eral rules for its policies, saw Federal Reserve banking system and the government. 1930’s, in conjunction with the inattention to gen 15 policies subordinated to the Treasury’s debt-management policies. This relationship continued through the war years and was only ended by a Congressional resolution of 1950. By this resolution, both the Federal Reserve Sys tem and the Treasury were charged with carrying out policies that “ shall be consistent with and shall promote the purpose of the Employment A ct of 1946.” This resolution also led in 1951 to the famous Accord. During the remainder of the decade, the Federal Reserve System was allowed relative autonomy in using its technical powers to further the provisions of the Employment Act. T h e C on gress shou ld advise the Federal R eserve S ystem that variations in the rate o f in crease o f the [n a r r o w ] m on ey stock ou g h t not to be great o r to o sharp. In n orm al tim es, for the present, the d e sirable range o f variation appears to be w ithin the lim its o f 2 to 6 per cen t per annum , m easu red on a qu a rter-by-q u a rter basis— a range that cen ters on the rate o f lon g-ru n increase in the p otential g ro s s n a tional p rod u ct in con stant dollars. Renewed interest in control over the quantity of money has raised empirical questions for research with regard to the supply of money. What basically determines the quantity of m oney? Another phase of central bank development became discernible in the 1960’s. of the Joint Economic Committee made in June 1968 states: The quantity of money, sured? What H ow is it mea What are the tolerances of measurement? are the operational problems of control ? which had been relegated to a passive role by aca Central to these questions is the framework in which demic analysts, was reappraised both theoretically the genesis of money takes place. Such a framework and will be presented as Part II of this article in the empirically. Federal Reserve research and policies, as well as Congressional discussion, reflect this new prominence of money. 16 Another resolution next issue of the M onthly Review. Richard H . Timberlake, Jr.