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I N V E S T I G A T I O N
C O N D I T I O N
O F
O F
T H E
T H E
F I N A N C I A L
U N I T E D
S T A T E S
A N A L Y S IS O F
HEARINGS
BEFORE T H E
C O M M IT T E E O N F IN A N C E
U N IT E D S T A T E S S E N A T E
E IG H T Y -S IX T H
CO N GRESS
FIRST SESSION
PART 7
AN ANALYSIS OF PARTS 1 THROUGH 6 HELD DURING
THE 85TH CONGRESS
Prepared and submitted for the use of the Committee
CH A PTER I
A n a ly s is b y D r . J a m
es
W . F
ord
Associate Professor of Economics, Ohio State University
C h a p te r I I
A n a ly s is b y D r . S e y m o u r E . H a r r is
Chairman of Economics Department, Harvard University
C h a p te r I I I
A n a ly s is b y S e n a to r W a lla c e F . B e n n e t t o f U ta h
Member of the Committee on Finance
AUGUST 18, 1959
Printed for the use of the Committee on Finance
UNITED STATES
GOVERNMENT PRINTING OFFICE
43SM
WASHINGTON : 1959
COM M ITTEE ON FIN AN CE
H A R R Y F L O O D B Y R D , Virginia,
R O B E R T S. K E R R , Oklahoma
J. A L L E N F R E A R , Jb ., Delaware
R U S S E L L B . L O N G , Louisiana
G E O R G E A . S M A T H E R S , Florida
C L I N T O N P. A N D E R S O N , New Mexico
P A U L H , D O U G L A S , Illinois
A L B E R T G O R E , Tennessee
H E R M A N E . T A L M A D G E , Georgia
E U G E N E J. M cC a r t h y , Minnesota
V A N C E H A R T K E , Indiana
Chairman
J O H N J. W I L L I A M S , Delaware
F R A N K C A R L S O N , Kansas
W A L L A C E F . B E N N E T T , Utah
J O H N M A R S H A L L B U T L E R , Maryland
N O R R IS C O T T O N , New Hampshire
C A R L T , C U R T IS , Nebraska
E lizabeth B. Springeb, Chief Clerk
Samuel D. M cIlwain, Special Counsel for Investigation
n
C O N T E N T S
CH APTER I
P an
Introduction_____________________________________________________________2091
Part I. A review of the record:
A. The nature of the investigation___________________________________2093
B. Causes of the 1955-57 inflation and the subsequent recession_______2094
C. The Federal Reserve System, 1955-58__________________________ __2102
D. Fiscal policy and debt management_________________________ - __2108
E. Monetary and fiscal policy in the recession_____________________ __2111
F. Conclusion. ____ _______________________________________________ __2112
Part II. Summary of the testimony on the principal subjects of the
hearings:
A. Causes of the inflation and the recession________________________ __2113
B. The Federal Reserve and monetary policy______________________ __2116
C. Financial policies of the Federal Government___________________ __2118
Part III. Index of subjects treated by each witness in the hearings___ 2122
CH APTER II
Introduction_____________________________________________________________2125
Part I. Summary and conclusions______________________________________ __2127
A. Stability__________________ _____ _____________ _________ _______ __2127
B. The wage or cost push________ __________________________________2127
C. Monetary restrictions and the economy_________________________ _2129
D. Obstacles to monetary policy___________________________________ _2130
E. Federal Reserve and the recession______________________________ _2131
F. Fiscal policy___________________________________________________ _2131
G. Debt management________________________________________ _____ _2132
H. Selective controls______________________________________________ _2133
I. Another view of Federal Reserve policy and economic stability__ 2133
Part II. Hearings and compendium: Digest and comments_____________ _2134
1. The Hearings of the Senate Finance Committee on the Invests
gation of the Financial Condition of the United States-------------- 2134
2. Stability of the currency a major issue___________________________2134
3. A creeping inflation inevitably brings a galloping inflation?______2137
4. Wage push and inflation_______________________________________ _2140
5. Higher prices and excess capacity______________________________ _2142
6. Monetary restraints and unemployment----------- ------------------------ -- 2143
7. The Federal Reserve responsibility for the recession------------------- -- 2146
8. Rise of money rates and construction____________________________2150
9. Government spending, credit, and the recession----------------- *------ --2151
10. Dear money effects on different markets_________________________2153
11. Money rates, savings, and investment__________________________ _2154
12. The relation of money and spending____________________________ _2156
13. Financial intermediaries and increased spending------------------------- --2158
14. Higher rates and the market for Government issues------------------- --2159
15. Proposals to control intermediaries_____________________________ _2160
16. Federal Reserve not responsible for higher rates?--------------------------2160
17. Federal Reserve policy in the recession_________________________ _2162
18. Fiscal policy: Objectives and achievements______________________2162
19. The debt ceiling_______________________________________________ _2164
20. Integrity of the budget______________________________ _________ _2165
21. Spending policies--------------------------------------------- ------------- ----------- -2167
22. Administration's recovery policy_______________________________ _2168
23. Debt management: An improvement?__________________________ _2170
24. Debt management: Integration and relation to private markets.. 2170
25. Defense of debt interest policy_________________________________ _2173
26. Maturity of debt---------------------------------------------------------------------- -2175
xn
IV
CONTENTS
Part II. Hearings and compendium: Digest and comments— Continued
27. Issues of long terms in recession________________________________ _2178
28. Support of Government bond market.------- ----------------------------------2179
29. Independence of the Federal Reserve Board______________________2180
30. Selective controls______________________________________________ _2182
31. Another view on Federal Reserve policy and economic stability—_2184
Part III. Failures of the administration_________________________________ _2187
1. Federal expenditures________________________ ■__________________ _2187
2. The integrity of the budget______________________________________2188
3. Structure of expenditures_______________________________________ _2189
4. Deficits and debt________________________________________________2190
5. Debt management_____________________________________________ _2190
6. The President's proposals of June 1959 for lifting the ceiling on
the Federal debt and raising the interest rate ceiling__________ _2191
7. Inflation_______________________________________________________ _2193
8. The stock market boom________________________________________ _2195
9. Inflation and the international position of the United States— - 2195
10. Failures of monetary and fiscal policy____________________________2196
11. Integration of monetary and fiscal policy-------------------------------------- 2197
12. Financial intermediaries________________________________________ _2198
13. The independence of the Federal Reserve------------------------------------- 2198
14. Money and output_____________________________________________ _2199
Part IV. Legislative issues______________________________________________ _2201
1. The objective of price stability incorporated in the Employment
Act of 1946__________________________________________________ _2201
2. Measures to save the dollar______________ ______________________ _2201
3. A national economic council____________________________________ _2202
4. Selective credit control_________________________________________ _2202
5. Control of intermediaries_______________________________________ _2203
6. Administered prices------------------------------------------------------------------- -- 2203
7. Area development______________________________________________ _2204
8. Ceilings on Treasury debts and Treasury rates__________________ _2204
9. Budgetary integrity____________________________________________ _2205
10. A general directive on fiscal policy and debt management______ _2205
11. The cash vault bill_____________________________________________ _2205
CH APTER III
Views of Senator Wallace F. Bennett of Utah___________________________ _2207
I. The problems of inflation____________________________________________2208
II. Monetary policy and inflation______________________________________ _2217
III. Labor unions and inflation_________________________________________ _2228
Summary of statement No, IV.— Inflation and the recession (1957-58)__- _ 2238
CHAPTER I
A N A L Y S IS O F H E A R IN G S O N IN V E S T IG A T IO N O F T H E
F IN A N C IA L C O N D IT IO N O F T H E U N IT E D S T A T E S H E L D
B Y T H E C O M M IT T E E O N F IN A N C E P R E P A R E D B Y D R *
J A M E S E . F O R D , A S S O C IA T E P R O F E S S O R O F E C O N O M IC S
A T O H IO S T A T E U N IV E R S IT Y
I ntroduction
The following analysis of the hearings held by the Committee on
Finance on the investigation of the financial condition of the United
States was prepared for the assistance of the committee by Dr. James
W. Ford, temporarily assigned to the staff of the Joint Committee on
Internal Revenue Taxation.
Dr. Ford received his A.B. degree from Oberlin College, Oberlin,
Ohio, in 1947 and his M.A. degree from Harvard University in 1949.
From 1949 to 1951 Dr. Ford studied at Cambridge, England, on a
Fulbright grant. He received his Ph. D. degree in economics from
Harvard University in 1954.
Dr. Ford was assistant professor of economics at Vanderbilt Uni
versity, Nashville, Tenn., in 1953, and was associate professor of
economics at Ohio State University when temporarily assigned to the
staff of the Joint Committee on Internal Revenue Taxation.
Dr. Ford's special fields are: monetary theory and policy, commer
cial banking and other short-term credit, price theory, income theory,
history of thought, industrial organization and market structure,
business, price and related policies. He is a member of the American
Economic Association and is the author of the following books:
The U.S.A., 1943-1946.
Monetary Theory; the Financial System of the U.S.
Effect of Reserve Requirements on Bank Profits.
Although this material was compiled for informational purposes
and has not been considered by the Committee on Finance, it is my
opinion that it represents an accurate and constructive analysis of
the testimony presented to the Committee on Finance in connection
with the hearings on the investigation of the financial condition of the
United States. Dr. Ford’s comments as to the weight to be given to
the testimony are extremely helpful and I am in complete agreement
with his conclusions.
H
F. B
, Chairman.
a r r y
yr d
2091
PART I
A REVIEW OF THE RECORD
A. THE NATURE OF THE INVESTIGATION
When the Committee on Finance of the United States Senate began
hearings in its investigation of the financial condition of the United
States, in June 1957, the dominant condition was inflation, but when
the last hearings were held, in April 1958, the country was in a reces
sion. In his opening statement in 1957 the chairman of the committee,
Senator Byrd, said:
The immediate occasion for this study is the existing credit and interest situa*
tion and, more important, inflation which has started again with its ominous
threat to fiscal solvency, sound money, and individual welfare.1
In later stages of the hearings, the recession claimed a major share of
attention but concern over the possibility of renewed inflation also
shaped the course of the investigation.
The printed record of the investigation consists of 2,090 pages of
testimony—by 8 witnesses—and accompanying exhibits, and of 67
replies to a questionnaire that the committee sent to the presidents of
the Federal Reserve banks, businessmen, trade association officials,
and economists. The main theme that runs through this long recant
is the problem of short-run economic instability, inflation, and
depression, but much attention was given also to the question of the
effects of a long-run rise in the price level.
The projected scope of the study was very broad: To study, in the
words of the chairman's opening statement—
(1) The revenue, bonded indebtedness, and interest rates on all public obliga
tions, including contingent liabilities;
(2) Policies and procedures employed in the management of the public debt
and the effect thereof on credit, interest rates, and the Nation's economy and
welfare: and
(3) Factors which influence the availability and distribution of credit and
interest rates thereon as they apply to public and private debt.1
M a n y d iffe re n t aspects o f th ese su b je c ts w e re e x p lo re d ; h o w e v e r,
th re e g e n e ra l q u estio n s cam e to b e th e m a in fo cu s o f th e s tu d y :
(1)
What were causes of the inflation that began in 1955, and of
the recession that followed. In particular—
(а) Was the financial condition of the private economy sound?
(б) Did the price-setting power of big business firms or labor
unions cause the inflation?
(c) Did the financial and monetary policies of the Federal Gov
ernment exert a stabilizing influence on the economy?
(d) Did the Federal Reserve's tight money policy in 1956 and
1957 cause the recession?
1U. s. Congress. Senate, 86th Cong., 1st seas., Hearings Before tbe Committee on Finance, Inreatlgajfckm
of the Financial Condition of the United States, p. 1. This document is referred to below as hearings.
1 Hearings, p. 1.
2094
T H E FINANCIAL CONDITION OF T H E UNITED STATES
(2) Were the monetary policies of the Federal Government, includ
ing the policies of the Federal Reserve System, soundly conceived
and effectively carried out? In particular—
(a) What were the objectives of Federal Reserve policy?
(b) How was monetary policy related to Treasury debt man*
agement and the other financial policies of the administration?
(c) Did the restrictive monetary policy create special difficulties
for particular economic activities— such as housebuilding— or
particular business groups— such as farmers and small firms?
(d) Would the monetary system be improved by restoring gold
redemption of the currency? Should the statutory directives to
the Federal Reserve be supplemented or revised?
(3) W hat were the objectives of fiscal policy and debt management?
Were Federal financial policies effectively coordinated and successfully
carried out? In particular—
(а) Did fiscal policy contribute to the stability of the economy?
(б) What were the objectives of debt management? How
were specific operations decided upon? Were debt operations
harmonious with Federal Reserve policy?
(c) Was the public borrowing of such agencies as the Federal
National Mortgage Association coordinates with the Treasury's
debt management?
(id) Did rapid amortization allowances and the new leeway in
depreciation accounting for tax purposes allowed business firms
in the 1954 tax law contribute to inflationary levels of business
spending in 1955 and 1956?
The following detailed review of the record of the investigation falls
into 3 parts, corresponding to the 3 main headings above.
B. CAUSES OF THE 1956-57 INFLATION AND THE SUBSEQUENT RECESSION
The period of inflation and the beginning of recession
The Consumer Price Index began to rise in September 1956 but a
better date to take as the beginning of inflation is September 1955,
when the Index of Wholesale Prices began to rise markedly. The peak
in business activity is now tentatively dated by the National Bureau
of Economic Research at July 1957, However, employment did not
begin to fall off significantly until the autumn of 1957, so that the
beginning of the recession may be placed in the late summer or early
autumn of that year.
The meaning of “inflation” and “deflation”
Inflation means a general rise in prices, and is therefore a term
descriptive of an economic condition. The condition has a name
because it has long been observed that when many prices rise at the
same time important economic changes result. Upward movements
in price index numbers— in the United States mainly the Wholesale
Price Index and the Consumer Price Index— which measure the aver
age change in large groups of prices are usually taken to measure the
extent of inflation. Of course, it is never true that all prices change
together in the same proportion and therefore price indexes cannot
measure unambiguously change in the limited group of prices each
THE FINANCIAL CONDITION OF TH E UNITED STATES
2096
represents, let alone change in all prices. Nevertheless, the main
shortcoming of the price indexes as measures of inflation during short
periods is not inadequate coverage or the ambiguity of the underlying
idea of “ average change in prices” ; it is rather that the observations
of changes in individual prices are not satisfactory. As business condi
tions change, discounts from list prices, the “ extras” included in a sale,
and other features of the sale vary, so that changes in list prices are a
poor guide to changes in prices actually paid. Compilers of price
indexes are aware of this, of course, and they attempt to get informa
tion on prices actually paid, but this is sometimes difficult to do and
there is no doubt that price indexes are to some extent based on
fictitious prices. The result is that upward movements in price index
numbers cannot be interpreted without qualification as measuring the
magnitude of inflation in any period.
The word “ inflationary” is sometimes used not to describe an actual
rise in prices but to characterize a force that will make prices rise, or
will tend to make them rise. Thus an increase in the money supply
or a rise in Government spending is sometimes called inflationary,
which means not that these increases in themselves constitute inflation
but rather that they will cause prices to rise, or will do this unless some
counteracting force holds prices down. There is an important dif*
ference between saying that a given force— say, an increase in the
money supply-— will cause prices to rise and saying that it would
cause prices to rise if other conditions were different. Y et it is not
always clear which is meant, for example, when an increase in the
money supply is said to be “ always inflationary.”
A further problem about the meaning of these words arises because
they sometimes are used very loosely as synonyms for expansion and
expansionary, when, for example, any general upward movement in
the economy is called inflation, whether it includes price increases or
not. This usage is exceptional but the opposite meaning-— a general
economic decline-—is the one usually given to the word “ deflation.”
Deflation once meant a general fall in prices; with the increased a t
tention given to unemployment and declining production in the down
swing of a business cycle, deflation has come to mean usually a general
short-run economic contraction, and not simply the fall in prices that
forms a part of it. W ith reference to long-run economic change,
however, deflation is ordinarily used in its original sense— to mean a
general fall in prices.
Inflation and recession , 1955-68
Viewed against the background of the war and postwar period, the
behavior of money and prices durir
have attracted special attention.
sumer prices increased more rapidly from the middle of 1955 until the
middle of 1957, the period of “creeping inflation,” than they had in
creased on the average during the previous 3 years, the period of
“stable prices” from 1952 until 1955. But the experience of the past
year shows that this comparison is misleading. For the “creepiijp
inflation” period was the greater part of an expansion phase of aikiptness cycle while the “stable prices” period spanned a much sinrtdtet
part of an expansion (the preceding cyclical upswing had
2096
TH E FINANCIAL CONDITION
OF
TH E UNITED STATES
October 1949, and consumer prices rose considerably even after the
Korea boom stopped in 1951), and all of the ensuing contraction, when
prices were falling and the countercyclical action of the Federal Re
serve was causing the money supply to increase. It is true that
consumer prices continued to increase during the year following the
general downturn in business in the summer of 1957 and this makes it
appear that the recent period is different from earlier postwar years—
a period of steady inflation impervious to monetary control. How
ever, this interpretation, too, is false. In part, the continued
“ general” price rise in recession is an illusion created by looking only
at consumer prices. It was mainly business demand for those com
modities other than food that declined during the recession, and the
wholesale prices of such goods, which are much more sensitive than
consumer prices to changes in business demand, did decline. And the
behavior of this part of the wholesale price index is specially vulnerable
to the quotation of fictitious list prices, so that it surely understates
the actual decline in prices that occurred after the middle of 1957.
T
1 . — Annual percentage rate of growth of money supply, consumer prices,
and gross national product in constant dollars, selected periods, 19J+1-57
able
Period
1941-45average
u+ . ..
____ ____________ _____
1945-52 average____ _____________ ____________ _____ ___ ________
1952-55 average. - .......................................................... ..............................
1955-67 average-_ _____________________________________________
Consumer
pricesJ
M oney 1
Deflated
gross national
products *
20
5
7
3
6
0
2
3
2
0
2
2
* Demand deposits adjusted plus currency held by the public, Board of Governors, Federal Reserve
System.
* Consumer Price Index, Bureau of Labor Statistics.
* Gross national product in 1947 prices, Department of Commerce.
Source: Economic Report of the President, 1958.
The statistical illusion of a general rise in prices during the recession
is, however, only a minor reason for saying that the behavior of prices
in relation to the changes in money and output has not been markedly
different since the middle of 1955. Throughout the postwar period,
the velocity of money— the rate at which money is spent— has shown
a rising trend, which is sharply at variance with the falling trend that
prevailed for at least the 70 years prior to the 1930’s. The two big
economic disturbances of the past 30 years— severe depression in the
1930’s and war in the 1940’s— broke off the gradual long-run down
trend. The wartime change in velocity is especially striking— velocity
fell very sharply to a figure far below the level that would have been
produced by continuation of the long-run trend. It may be that the
rising trend of velocity since the war is merely a recovery from war
time disturbance. There is good reason to think that the earlier
falling trend in the rate at which money was spent was produced by
a general desire to hold a higher proportion of cash as real incomes
were increased by general economic growth.3 As growth continues,
then, this falling trend of velocity may be resumed. But regardless
of whether that will be the case or not, the sharp rise in velocity that
* The foregoing information on the behavior of the velocity of money was taken from a paper by Milton
Friedman in the Joint Economic Committee’s Compendium of Papers on prices and economic growth and
stability. See M. Friedman, The Supply of Money and Changes in Prices and output, in U. S. Congress,
85th Cong., 2d sess,, The Relationship of Prices to Economic Stability and Growth, papers submitted to the
Joint Economic Committee (1958).
THE FINANCIAL CONDITION OF THE UNITED STATES
2097
took place during the inflation of 1955-57 was generally^ similar to
parts of earlier postwar fluctuations around the prevailing rising trend*
Prices did rise at a high rate while the increase in the money supply
was slowed and brought virtually to a halt, but this has happened
more than once since the end of World War II. In short, the relations
among money, prices, and output during the recent period of infla
tion—and the recession that followed—are much like those observed
during the other business cycles of the postwar period.
Current theories o f inflation
One view of the causes of inflation in the postwar years puts the
blame for rising prices on the abandonment of the gold standard in
1934 and the continued though intermittent resort to deficit finance
during the past 25 years. According to this view, discretionary man
agement of the money supply and of Federal Government finance is
bound to permit inflation, if not actually to cause it through monetary
expansion, because business and labor will expect that the money
supply will be increased if ever price increases threaten to cause
unemployment.
A second explanation of the inflation stresses the importance of
private debt, especially consumer debt. According to this view, easier
credit terms led to a large increase in consumer purchases of nouses,
cars, and other durable goods and thus to a general boom. Further
more, consumer debt grew to unsound proportions and this precipi
tated the recession.
A quite different view, one that has been popular in recent years,
is that the cause of modern inflation is not monetary but instead is
to be found in the power of big business firms—as some have it—or
labor unions—as others argue—to set higher prices that are subiect
to very weak competitive pressure, if any. Those who hold that labor
unions cause inflation by obtaining wage increases in excess of in
creases in productivity say that unions nave thereby forced business
firms to raise prices in order to cover the increased costs. The other
variant of the monopoly theory of inflation holds that the market
power of big business firms precludes competition and allows these
firms to “ ad m in ister prices” ; that is, to set and maintain them above
competitive levels. Administered prices have been increased by more
than costs have increased, it is argued, and since many of the products
whose prices are administered—steel, for example—are used in the
production of other goods, the market power of big producers has
brought about general price increases. Though the two variants of
the monopoly theory of inflation differ on the source of the power
that causes prices to rise, they agree on the existence of a wage-price
spiral, a process in which cost increases push up the prices of finished
goods and these price increases in turn lead to wage increases, which
set off another round of price increases.
The three theories of contemporary inflation just described— the
managed money theory, the consumer debt theory, and the wage-price
spiral theory—challenge, each in a different way, the doctrine that
active monetary and fiscal policy can make the economy highly stable,
vulnerable to neither inflation nor mass unemployment. ^ T n isco n dusion has been widely accepted and the statement of i t in the l9J50
report of the Douglas committee4 was regarded as setting out themain
« V. S Congress, Senate, 81st Gang., 23 sess., Monetary* Credit and *boaI Policlffl, rep^t
oommlttee ooManetary, Credit, and Fiscal Policieeof the Joint Committee an the Economic Report (lVGqj.
2098
T H E FINANCIAL CONDITION OF 1 M B UNITED STATES
lines of stabilization policy and predicting the results that could be
expected from its operation. In the Senate Finance Committee's
study, the Chairman of the Federal Reserve Board, among others,
upheld this view, attributing the recent inflation not to a mistaken
diagnosis of the causes of inflation but rather to faults in the execution
of monetary and fiscal policy. The inflation was set off by excessively
easy money in the counterrecession effort of 1954, he said, and it con
tinued because limitation of the money supply came too late and fiscal
restraint was not strong enough; management of stabilization policy
was primarily responsiWe for the inflation.
Disagreement on the causes of the inflation and recession thus en
compasses a number of different issues. One of these, the question
how different types of monetary systems affect prices, can best be
discussed together with other questions about the monetary system
in the next section of this review. The remainder of this section will
examine the contentions that a wage-price spiral caused the inflation,
and the contention that excessive growth of consumer debt was
responsible for it.
The wage-price spiral
From 1955 to 1957, wages, the prices of raw materials and inter
mediate goods, and the prices of finished consumer goods and business
plant and equipment items rose together. But this fact is not, of
course, sufficient to establish that it was the push of labor costs or
other costs that forced prices up. It is plausible that union pressures
forced wage concessions in collective bargaining and indirectly drove
up wages in competitive markets so that costs increased and business
men were driven to protect profit margins by raising prices even at
the risk of reducing sales volume. But it is equally plausible that
employers agreed to higher pay scales, or offered higher pay in com
petitive markets because they had experienced, or expected to expe
rience, a rising demand for goods and services and it was necessary
to compete for the availaHe labor supply. Which of these two
possibilities was actually the case can only be established by further
examination of the facts. Table 2 presents some comparisons of
changes in prices and changes in expenditures for certain categories
of goods. The larger price increases—and those accounting for the
main part of the movement in the Consumer Price Index—are asso
ciated with still larger increases in dollar expenditures, indicating an
increase in the quantities purchased. In other words, the rise in
prices was mainly a rise in the prices of goods that were in greater
demand. The subgroups of goods and services shown in table 2 were
selected because they are the only groups for which both separate
price indexes and expenditure figures are available. Even for these
subgroups there is only a rough correspondence between the group
of goods to which the price index applies and the group of goods for
which the Department of Commerce estimates the amount of total
expenditures. Nevertheless, there is a strongly marked association,
for subgroups and for the four main groups, between expenditure
changes and price changes. It is not likely that such a pattern is
produced by the statistical crudity of this comparison. Detailed
figures for hourly wage rates in various industries (published in the
Monthly Labor Review) allow rough comparisons to be made of the
pattern of wage increases and the pattern of price increases. These
THE FINANCIAL CONDITION OF TH E UNITED STATES
2099
comparisons are less satisfactory than those shown in table 2, but
what they show is that average hourly wage rates in nondurable
manufacturing increased, from 1955 to 1957, by a slightly higher
percentage than wages in durable manufacturing, which, in turn,
increased by more than wages in industries producing services. In
detail, there is little or no difference, in general, between the per
centage increases of wages in industries whose product prices rose
considerably and the increases in industries whose prices rose only
slightly.
T
able
2 . —‘Percentage
increases in prices and expenditures, 1955-56 and 1966-57
Goods and services
Consumer durable goods..................................
Household furnishings____ ______________
Private transportation__________________
Consumer nondurables_____________________
Prices, 1955-56 Expendi Prices, 1956^57 Expendi
(percent in tures, 1955-56 (percent in* tures, 1956-57
crement of
(percent in
crement of
(percent in
1956 average crement of 1957 average crement of
1956 total
over 1955
over 1956
1957 total
over 1955
average)1
average)1
over 1966
total)*
total)*
0
n v
(-3 .0 )
3.5
4.8
(-14.0)
1.6
5.9
( - fll
10.0
1.3
5.3
3.3
S.0
Food..............................................................
Apparel________________________________
Men’s and boys’ apparel____________ _
Women's and girls’ apparel__________
Footwear___________________________
Solid fuel__ - _______ ____ _______________
.7
1.7
1.6
.7
5.3
4.4
4.0
4.7
5.9
6.1
4.1
2.7
3.3
1.3
1.5
.5
3.2
5.1
6,3
.4
Consumer services__ _________ ____________ _
2.2
7.6
3.8
R e n t ............ ................................................
Gas and electricity__ _____ ____ __________
Household operation____________________
Public transportation___________________
Medical care___________________________
1.8
1.0
3.2
3.9
3.6
2.3
10.7
9.6
3.6
6.1
1.0
1.1
3.7
3.S
4.1
Producer finished goods_____________________
7.5
14.4
6.2
M
(*)
®
M
4.7
(*)
11
1Source Consumer Price Index and Wholesale Price Index, Monthly Labor Review.
* Source: National Income and Expenditure, Survey of Current Business.
* Not available.
This pattern of wage, price, and expenditure changes casts doubt
on the assertion that rising labor costs pushed prices up. But there
is another sense in which rising wages are sometimes said to cause
rising prices. Higher wages, it is said, cause higher wage incomes^
higher demand, and hence higher prices, i. e., there is “ wage-incoms
inflation” rather than “ wage-cost inflation.” It is difficult to find
direct evidence that bears—one way or another—on this assertion but
there is indirect evidence against it. First, wage increases in them
selves cannot raise the total of incomes; at the most they redistribute
the total. To say that such a redistribution in 1956 and 1957 led to
increased demand and ultimately to higher total income does not fit
the fact that business demand for plant and equipment increased a$
much or more than any other category of demand. Secondly, “ wageincome inflation” could operate only if each employer individually
either believed that if he agreed to a wage increase the demand &£
his product would increase, or would pay Higher wages at the exjwedtf#
of ms profits. The first is highly implausible and tne second is raled
out by the fact that profit rates have not fallen as wages afad prices
have risen.
2100
TH E FINANCIAL CONDITION OF TH E .UNITED STATES
It cannot be shown conclusively that the recent inflation was not
either “ cost inflation” or “ wage-income inflation” but the foregoing
analysis gives reasons for thinking that neither of these explanations
fits and that it was a rising demand for goods and services—not origi
nating in wage increases—that caused prices to rise.
This leaves unanswered the question, What caused the general
increase of demand in 1955 and the fall in 1957? Many different
answers were advanced in the oral and written replies to the Finance
Committee's questions: easy money and low interest rates followed
by monetary stringency; an increase, and a reduction 2 years later,
in the rate of Federal expenditures; business optimism, later checked
by tight money; and so on. It is significant that no one claimed to
give a simple and clearly correct answer to this question; all the factors
mentioned were advanced as tentative and partial answers. This is
an accurate reflection of the state of knowledge on the subject, and
it shows how important is the basic research that is carried on in this
field.
Private debt in the inflation and recession
The implications of the rapid rise in private debt since 1954, con
sumer debt in particular, have attracted much discussion. In the
Senate Finance Committee's study, the question was repeatedly asked
whether an unsound increase in debt had been an immediate cause of
the inflation and, later, had set the stage for recession. It seems clear
that, for business debt at least, the answer to this question is “ No.”
The increase during 1955 in business debt was mainly an increase in
short-term debt, of which about half represented not additional bor
rowing but an increase in income-tax liability and other accruals.
Business borrowing from banks did increase unusually much, however,
in both 1955 and 1956 and these funds, together with the proceeds of
an increased volume of bond issues, were an important source of
finance for rising business investment outlays. But internal sources
of business funds—retained profits and depreciation quotas—also in
creased substantially, so that the boom in business investment spend
ing was by no means financed exclusively by borrowed money. Nor
does it appear that the volume of debt to banks on the books of business
firms rose to critical proportions. Bank loans to business grew only
moderately in 1957, as the volume of new* bond issues increased, and
there was no liquidation crisis, but only a moderate reduction of bank
loans, accompanying the recession. In brief, the sharp rise in business
investment spending in 1955 and 1956 was financed partly out of
borrowed money. Undoubtedly the easier terms on which business
was able to raise both debt and equity funds stimulated business spend
ing but it is doubtful that restrictions on the amount or terms of
business borrowing would have moderated either the inflation or the
recession.
With respect to consumer debt, the conclusion from the figures
themselves is not so clear. Noncorporate debt— the indebtedness of
families, farms, and unincorporated businesses and institutions—
increased by more than corporate debt in 1955 and the largest in
creases were in family borrowing—consumer debt and mortgages on
1- to 4-family houses. Although this latter type of debt had in
creased in every year since 1951, the 1955 increases were unusually
TH E: FINANCIAL CONDITION OF TH E UNITED STATES
2101
large, amounting to nearly $20 billion, as against $11.6 billion in 1952,
the largest previous annual total. In 1955 consumers in the aggre
gate apparently borrowed a larger portion than in previous years of
the purchase price of the goods and services they bought. There are
no comprehensive figures that show directly the fraction of consumer
expenditures financed by borrowing but there are strong indirect indi
cations that this fraction rose in 1955. Consumer debt increased in
that year by an amount equal to 2.5 percent of the year's consumption
expenditures; during the previous 5 years the yearly increase in debt
had averaged 1.4 percent of annual consumption expenditures. This
is not conclusive evidence that consumer borrowing constituted a
bigger fraction of expenditures, because the larger net increase in debt
during 1955 may have reflected mainly lower repayments of debt in
that year. It is not likely that this was the case, however, and there
is little reason to doubt that increased borrowing, attributable at
least in part to easier credit terms and lower interest rates in 1954 and
1955, stimulated consumer purchases of houses and durable goods.
Purchases of durable goods increased from 12 percent of totsS con
sumer expenditures in 1954 to 14 percent in 1955.
While it seems clear that increased consumer borrowing affected the
composition of total expenditures, it is not so certain that the amount
of expenditures, and hence the upward pressure on prices, would have
been less if consumers had somehow been prevented from borrowing
as much as they did borrow. If they had not borrowed and bought
durable goods, consumers might well have spent more for other kinds
of goods, or have exchanged more of their liquid assets for durable
goods. A lower volume of consumer borrowing would have meant
more favorable conditions for business borrowers, so that business in
vestment might have been still larger. Inflationary booms in the past
have been based on many different patterns of expenditure: commodity
speculation, security speculation, construction booms, and so on.
There is no reason to conclude that inflationary booms can no longer
arise in these ways, and therefore no reason to conclude that con
temporary inflation is caused by consumer borrowing, in the sense that
without an increase in consumer debt inflation would never occur.
Nor is there any evidence that a particular inflationary episode, such
as the recent one, could not have happened with a different pattern
of expenditure.
The belief that inflation would not happen, or would be less severe,
if the terms or volume of consumer borrowing were explicitly con
trolled has led to suggestions that controls be adopted. Such controls
would be more difficult to administer than present monetary controls
and they are advocated mainly because it is thought that present
controls are not adequate to prevent inflation. This conclusion is
premature in the present state of knowledge about business fluctua
tions. The evidence from the recent inflation and recession is at least
as strong for the opposite conclusion: that present controls cap be
operated to make the economy more stable than it has been. Neither
conclusion can be firmly established without further fundamental
study of business fluctuations. For the present it would seem to be
good policy to attempt to make a simpler set of controls work better
rather than to adopt more elaborate controls, when tne need for them
is not dear and their effects difficult to predict.
2102
THE FINANCIAL CONDITION OF TOE UNITED STATES
C. THE FEDERAL BESEBVtl SYSTEM, 1955-58
jfita M of &€ Federal Reserve’s powers
The Finance Committee's investigation raised fundamental ques
tions about the Federal Government's use of its monetary powers, as
well as questions about Federal Reserve policy itself. The committee
questioned Treasury officials, Federal Reserve officials, and others
about the present place of gold in the monetary system; about the
scope of the discretionary power held by the Federal Reserve Board
of Governors, and by the paid officers and the directors of the 12
Federal Reserve banks; about the effectiveness of Congress’ control
of the Federal Reserve; about relations between the Treasury, the
fiscal agency of the Government, and the Federal Reserve, the mone
tary agency. These are perennial questions about the proper exercise
of monetary powers and they have often been raised at a time of
monetary disturbance. That these questions continue to resist final
settlement is not surprising since a choice among alternative monetary
arrangements must be based on experience under different types of
monetary standards and rules. Such experience continues to accumu
late and, as it does, to demand new evaluations of existing monetary
arrangements and possible alternatives. In the present inquiry the
views expressed by Government officials and others did not support
the contention that a differently constituted monetary system would
have moderated or avoided altogether recent monetary disturbances.
Nevertheless, it may be that further experience will change the pre
vailing view, so that a strong demand arises for, say, a return to the
stricter discipline of pre-1933 gold arrangements, or, on the other hand,
for relaxation of the present centralized system of discretionary control.
Restoration o f gold redemption o f the currency
Under present international monetary arrangements, it is unlikely
that either restoring the circulation of gold coin or requiring the
Treasury to buy and sell gold bullion on demand at a fixed price would
make monetary policy very different from what it has been in recent
years. If the currency were redeemable in gold, the public could affect
Federal Reserve policy and the amount of money in circulation by
exchanging currency for gold, or vice versa, and thus changing the
gold reserve. In particular, if, when prices were rising, people decided
that holding gold was better than holding money, the demand for gold
in exchange for currency would compel the Federal Reserve to take
restrictive action. But under present international monetary condi
tions, the world price of gold is dominated by the United States
Treasury's official price and it would pay to hold gold rather than
money only if an increase in the official price were likely. Only a
very large monetary expansion—much larger than any experienced
since World War II—is likely to create the expectation that the
Treasury would be forced to raise its gold price. Therefore, it is only
a very large monetary expansion in normal times—in the extraordinary
circumstances of a war or a deep depression, it is likely that gold
redemption would be suspended—that would be ruled out if the cur
rency were redeemable in gold.
The essential effect of gold redemption is that it sets a limit on the
discretionary powers of the monetary authorities; gold redemption is
only one among many different way of doing this. It is an interesting
THE FINANCIAL CONDITION OF TH E UNITED STATES
2103
fact that gold redemption would not work as w e ll as would other
systems of more or less automatic control to prevent sharp changes in
the money supply. For example, the simple rule that the rate of
increase of the money supply should be kept within fairly narrow
bounds, say 3 to 5 percent per year, would avoid the larger movements
likely to occur occasionally under a gold standard, and would therefore
have better stabilizing effects.
The question of restoring gold redemption of the currency in the
United States is often dismissed as an out-of-date and unnecessary
question. But the essential issue raised—automatic versus discre
tionary control of the money supply—is an issue of great importance*
Therefore, serious consideration ought to be given to two questions:
(1) Would the economy be more stable if the element of discretion in
monetary policy were reduced or eliminated altogether? (2) If the
answer to (1) is “ yes,” which is a better system of automatic regulation
of money, one that is widely known but has technical drawbacks or
one that has better technical features but no popular appeal?
Federal Reserve policy , 1955-57
General concern over rising prices during the 1955-57 period evoked
much discussion of Government economic policy, especially monetary
and fiscal policy. Criticism of monetary policy ranged from the view,
at one extreme, that since the middle 1930's tne Federal Reserve has
allowed the creation of too much money in the name of economic
growth, to the nearly opposite criticism, that tight money in the
recent period has been ineffective against inflation, if anything it has
made inflation worse, and has raised interest rates, reducing residential
construction, and hurting small business by raising loan costs to small
firms more than to big firms. The first of these extreme views over
looks the fact, pointed out by the Chairman of the Federal Reserve
Board and others, that a growing money supply does not necessarily
lead to inflation in a growing economy, and tne fact that prices in
general have not increased continuously during the past 20 years*
The criticism of tight money during 1955-57 makes several different
points. One is that tight money had no effect against inflation.
This contention derives mainly from the belief, discussed in the
previous section of this review, that cost increases were responsible
or the inflation. But that belief is very likely wrong, for reasons
given above; in any case, the fact that increased demand for goods
and services was part of the process of inflation carries the necessary
implication that Federal Reserve control must have been partly
effective against inflation. As it was, the volume of bank loans
expanded sharply; had the banks been permitted to add more to their
loans and investments, clearly they would have done so and the
resulting increase in the money supply would have allowed prices to
rise more. There is abundant evidence from other experiences of a
similar kind that a greater rise in the money supply is associated
with a greater increase in prices. The conclusion is clear that the
tight money policy did restrain inflation. This is not to say, however,
that the choice of measures and their timing was perfect, but only
that what was done did work in the intended direction at the time ill
was done. The timing of Federal Reserve action is discussed befcw.
A closely related issue is the question of the effects of tight money
on interest rates. Increased demand for bank loans a n a for fu n d s
S
2104
THE
ttn an o al
c o n d it io n
of
th e
u n it e d
states
raised in financial markets forced interest rates to rise. Could the
Federal Reserve have prevented the rise in interest rates by permitting
the money supply to expand more rapidly? A more rapid expansion
of money would have, at least initially, prevented or moderated the
rise in interest rates, but only at the cost of a more rapid rise in prices
than actually occurred. Furthermore, once the expectation of in
creasing prices was established, additional upward pressure would have
been exerted on interest rates as lenders sought compensation for the
declining value of the dollars lent, and the rate at which money and
prices grew would have had to be increased further. It is question
able whether in fact the money supply could have been increased fast
enough to prevent interest rates from rising when the demand for
borrowed funds was increasing. The huge increase in money and
prices resulting from the Federal Reserve's support of Government
security prices during and after World War II was not sufficient to
keep interest rates from rising. Interest rates rose during the 3 years
after the end of the war despite the fact that a $25 billion reduction in
the national debt offset in part the increased demands of other bor
rowers. It is a characteristic of inflations that interest rates rise;
in 1956 and 1957 more money would have meant more inflation and,
in all likelihood, no reduction in interest rates.
As for the contention that the tight money policy had discrimina
tory effects, it is undoubtedly true that rising interest rates priced
some consumers and businesses out of the market for borrowed money
and reduced the amounts that others could afford to borrow. And it
may be true that the rates paid by certain groups—small business
firms, for example—rose by more than rates paid by other groups, big
firms taken together. Whatever the facts are, however, they do not
help to decide whether the tight money policy was sound. On the
evidence from previous episodes of “ cheap money” policy, expansion
of the money supply might have failed to keep interest rates from ris
ing, and, in any case, would have caused more inflation. Critics of
the tight money policy who say that its effects were discriminatory are
certamly not prepared to argue that the only alternative, a policy of
inflation, would have been more fair. The critics have not taken
sufficient notice of the facts that market pressures were forcing inter
est rates up and the Federal Reserve could have affected the situation,
if at all, only at the cost of more inflation.
7
The same comment applies to the contention that tight money
needlessly raised the costs of the national debt.
Federal Reserve policy in the 1955-57 period is more vulnerable to
the criticism that its timing was faulty. In his testimony, the
Chairman of the Federal Reserve Board of Governors said that in his
view the Federal Reserve had in 1954 made money too easy and had
waited too long in 1955 to take opposite action. Other witnesses
criticized the Federal Reserve for keeping money tight too long in 1957,
after signs of falling demand had begun to appear. In fact, as can now
(October 1958) be seen, business reached a turning point in the summer
of 1957, whereas it was October before the Federal Reserve began
open market operations designed to make money easier. Hindsight
validates these criticisms of tne Federal Reserve; at the time that the
decisions had to be made, it was not easy to know which way the
economy was going. However, the very fact that assessment of the
THE FINANCIAL CONDITION OP THE UNITED STATES 2105
current situation is difficult gives strong reason to question the sound
ness of a policy of alternating tightness and ease as the immediate
situation seems to require. Moreover, it is very likely, as Chair
man Martin said, that easy money in 1954 and early 1955 acted with a
delay on the economy, keeping inflation going in 1956 and 1957 even
while the growth of the money supply was reduced almost to nothing.
It is also likely that the spell of tight money exerted a delayed influence
during the recession, even while the money supply was growing at an
annual rate of 5 percent or more. Analysis of business cycles in the
United States shows that turning points in general economic activity
follow with a lag of many months, changes in the rate of growth of the
money supply.5 Apparently, the first effects of Federal Reserve
action are regularly felt some months after the action is taken; this
seems to have happened during the most recent business cycle.
The goals o f Federal Reserve policy
In the Senate Finance Committee's study, as in many recent dis
cussions of monetary policy, questions were raised about the general
objectives or goals of Federal Reserve policy: What are these goals?
Where are they specified? And what ought they to be? In answer
ing these questions, Chairman Martin referred usually to the Employ
ment Act of 1946, which declares that a principal objective of Federal
economic policy is the securing of “maximum production, employ
ment, and purchasing power.” The Federal Reserve Act of 1914
states the purposes of establishing the Federal Reserve System but
the objective stated there of providing an elastic currency seems
outdated and is seldom if ever referred to in discussions of monetary
policy. In today’s discussions, the question most frequently asked
is which of two goals that are said to be conflicting—full employment
or price stability—the Federal Reserve ought to pursue. The Federal
Reserve’s own view, expressed in the testimony of Chairman Martin
and in the joint reply of the Federal Reserve bank presidents to the
Finance Committee’s questionnaire, is that the two goals are not
conflicting. Mr. Martin said:
T h e re is no v a lid it y w h a te v e r in th e id e a th a t a n y in fla tio n , once accepted,
ca n be c o n fin e d to m o d e ra te p ro p o rtio n s * * *. I n th e p a st, a n in fla tio n once
s ta rte d , has c o n tin u e d u n t il i t was s to p p e d , u s u a lly e ith e r b y a p p ro p ria te m one
t a r y a n d fis c a l p o lic y o r, fa ilin g th e a d o p tio n o f such p o licie s, u n t il i t collapsed
fr o m im b a la n c e s i t h a d generated. * * * P rices as w e ll as e m p lo y m e n t are
lik e ly to re a c t w h e n a n in fla tio n sto p s as th e re s u lt o f m a jo r im b alan ce s.6
In fact, it is not true that moderate inflations, unless stopped by mone
tary or fiscal restraint, have always ended in runaway prices and a
crash. The United States experienced a 20-year period of “ creeping
inflation,” from 1895 to 1914. It is true that the period was in
terrupted by business-cycle downswings, but so also have been the
periods of long-run declining prices or constant prices— 1873-95 and
1921-29. Historically, creeping inflation has not been an unstable
condition. Nevertheless, the Federal Reserve is certainly right that
if the monetary authorities were willing to permit prices to increase
at any rate so long as unemployment was low, the economy would
experience a crash. There is abundant evidence that periods of
shaiply rising prices, such as 1919 and the first half of 1920 in the
United States, end in crisis and slump. The strongest proponents of
*See the paper by Milton Friedman cited above.
* Hearings, pp. 1228,1267.
2106 THE FINANCIAL CONDITION OF THE UNITED STATES
full employment as a goal of monetary policy recognize this and agree
that die price level cannot be left altogether out of account. On the
other hand, those who argue that price stability ought to be the prime
goal of monetary policy recognize the importance of stabilizing em
ployment; their position is that stable prices would insure full em
ployment. A useful way to interpret the controversy is to say that
the disagreement is not about goals but about the best strategy to
use in trying to achieve goals that both sides accept. The issue is
not whether unemployment of 6 percent is “ too much,” or whether a
price increase of 4 percent a year is “ too much.” The issue is whether
short-run business fluctuations, which are certain to occur in a pre
dominantly free enterprise economy, can best be limited by mone
tary— and fiscal—action aimed at preventing unemployment from
ever exceeding a predetermined figure, or by action aimed at prevent
ing prices from ever changing by more than some predetermined an
nual rate, or by action guided by some other criterion. What is
needed to resolve the issue is not some kind of formula expressing the
relative importance of stable prices and full employment but rather
more knowledge about the probable effects of different strategies of
stabilization. Claims made by tbe proponents of various rules for
monetary and fiscal action need to be analyzed carefully and checked
against available facts.
Despite the great interest in stabilization policy, in the voluminous
discussions much has been taken for certain that is not certain and
that could be tested. It is widely accepted, for example, that full
employment and price stability cannot exist together. Y et this con
tention is usually not made specific and examined in the light of the
facts. It is clear that economic change is bound to cause price indexes
to change and to cause the number of unemployed to fluctuate. No
one expects to achieve full employment or stable prices in the extreme
sense of eliminating all fluctuations. However, for admissible defini
tions of price stability and full employment, the evidence that the
two are inconsistent is not convincing. It is mainly the belief that,
at least in the postwar years, wage increases have caused prices to
rise which underlies the contention that price increases can be stopped
only if unemployment rises sufficiently to check wage demands. But
this view is probably wrong. Therefore, there is no need as yet to
conclude that strategies for monetary and fiscal action face the dilemma
that whatever is done to make prices stable will cause unemployment
and whatever is done to maintain a high level of employment will
cause prices to rise.
^Clarification of the facts about the effects to be expected from
different types of monetary and fiscal action is the primary require
ment for improving stabilization policy. Changing the statement of
goals or adding additional goals— making explicit the goal of price
stability, for example— is likely to do much less to clarify issues and
make policy sounder and more effective.
Independence o f the Federal Reserve
Questions were raised during the Senate Finance Committee's study
about the influence of private financial business on Federal Reserve
policy, and about the relation of administration policy to Federal
THE FINANCIAL CONDITION OF THE UNITED STATES 2107
Reserve policy. The answer to the first question appears to be that
no evidence has ever been advanced to show that Federal Reserve
policy has been made to serve private interests. It is true that dur
ing the tight money period, bank profits rose substantially. But the
increased demand for bank loans would, in the last analysis, have led
to higher bank profits whatever the policy of the Federal Reserve.
However, the decisive fact in tnis matter is that the Federal Reserve
had clear reasons for thinking, whether rightly or wrongly does not
matter in this connection, that tight money was in the general interest.
On the matter of the administration's influence on Federal Reserve
policy, the view was advanced that the Treasury in its management
of the national debt tried to raise interest rates and that the Federal
Reserve had helped in this. The evidence on the Treasury’s policy
will be presented below in the section on fiscal policy and debt man
agement. Whatever the Treasury’s policy was, there is no reason
to conclude that the Federal Reserve was trying to do anything other
than stop the rise in the price level. Chairman Martin said that the
Federal Reserve had no reason for wanting interest rates to be high;
on the other hand, it would do nothing that would permit prices to
rise faster. No evidence has been advanced that contradicts this
statement.
In a quite different wav, however, Federal Reserve action was
influenced by the financial problems of the Treasury. As officials
of both agencies testified, there was consultation on monetary policy,
fiscal policy, and debt management. Each agency ultimately maae
its own decisions but the Federal Reserve clearly was constrained,
at least in choosing times at which to take action, by the debt opera
tions of the Treasury. In the period between December 1954 and
July 1958, the Federal Reserve did not support new Treasury issues
by making purchases for its own account. However, Chairman
Martin stated that the Federal Reserve did both advise the Treasury
on money market conditions and seek to smooth the way for Treasury
issues by preventing any sudden or temporary tightening of the
market. Since the Federal Reserve felt obliged to do this, the
timing of its monetary measures was necessarily influenced by the
Treasury’s plans.
k* As a practical matter, the Treasury’s financial problems may not
have had any important effect on Federal Reserve action during the
lastjfew years. Nevertheless, the principle that Federal Reserve ac
tion should not be influenced by the Treasury’s financial problems is
important. It is sometimes said that the Federal Reserve ought not
to De independent of the Treasury since, as agencies of the Federal
Government, the two should work together. It is, of course, desirable
that different measures of stabilization policy be consistent with each
other. But it is important that the problems of financing government
not be allowed to bear on monetary policy. This is not to say that
Federal Government ought never to finance expenditures by monetary
expansion, but only that this ought to be done only when the interests
of the economy require it—not when the exigencies of government
finance make it convenient. Given the Federal Reserve’s present
wide powers of discretionary action, it is an important safeguard to
make the Federal Reserve independent of the Treasury.
2108
TH E FINANCIAL CONDITION OF TH E UNITED STATfcfc
D . F IS C A L P O L IC Y A N D D E B T M A N A G E M E N T
Fiscal policy and changes in the size o f the national debt
Whereas the record of the Senate Finance Committee's study con
tains much disagreement about the appropriateness of the Federal Re
serve's tight money policy, there is almost complete agreement, in
which the Secretary of the Treasury and the Undersecretary for
Monetary Affairs shared, that Federal Government cash surpluses for
the fiscal years 1956 and 1957 were too small. Table 3 shows that
during the fiscal years 1956 and 1957, the national debt was reduced
$3.8 billion, the portion of the debt held outside the Federal Gov
ernment fell by a much larger amount, $8.9 billion. However, it is
important to note that this reduction in Treasury borrowing was offset
in part by a $2.5 billion increase in the public borrowing of certain
Federal agencies—the Federal National Mortgage Association and
others empowered to borrow directly on their own account. The
overall result, then, was that during fiscal 1956 and 1957, total Federal
debt outstanding was reduced $6.5 billion. Commenting on part of
this record, the Undersecretary of the Treasury for Monetary Affairs,
Mr. Burgess, said:
T able 3.— Public debt of the United States: Total and amounts held outside
Government investment accounts on selected dates, 1955-57
[Billion? of dollars]
Date
1955—Juno 30—..............................................
Dec. 31............... ................................
1956—June 30.......... ...................................
Doc. 31...............................................
1957—June 30 .................. ...........................
Total public Amount held
debt
outside
................
274.4
280. S
272.8
276.7
270.6
223.9
229! 1
219* 3
222! 7
9 1* U
A
xIO.
Source: Treasury Bulletin.
We have had a $1.6 billion surplus this past year with a $2.2 billion debt reduc
tion. That is not very much. I would like to see it bigger.*
Why, then, was a larger surplus not achieved?
the reasons were:
In Mr. Burgess' words,
*
* * * the cold war * * * and * * * the various pressures for expenditure of
one sort or another.8
These statements are highly significant. It seems to be a lesson of the
recent period of rising prices that unless the Treasury is under a rigid
obligation to achieve a surplus of a specified size in time of inflation,
other considerations will inevitably crowd out the objective of a size
able surplus. The proposals for a “ balanced budget at a high level of
economic activity,” which carry the implication of a surplus increas
ing in amount as inflation mounts, gain added point in the light of
recent experience.
Borrowing by Federal agencies
As was pointed out above, the outstanding debt of certain Federal
agencies that borrow directly from the public increased sufficiently
during fiscal year 1956 and 1957 to offset about one-quarter of the reduction in the Treasury's own outside borrowing during the period.
* Hearings, p. 100ft.
•Hearings, p. 1007,
THE FINANCIAL CONDITION OF THE UNITED STATES 2109
An offset of this magnitude could seriously reduce the effect on the
economy of Treasury fiscal policy. At present the agencies consult
with the Treasury about their borrowing but the Treasury cannot
control the amount of their borrowing. The effectiveness of fiscal
policy would be increased if the Treasury were able to fix the total
amount of this outside borrowing.
R apid amortization o f defense facilities and the new treatment of depreda
tion
Although tax policy was not treated extensively in the study, two
provisions of tax law were discussed at some length, in relation to the
inflation. It was agreed, by Treasury officials among others, that
the Treasury's continuing to award the certificates that allowed rapid
writeoff of so-called defense-related facilities had contributed in some
measure to the incentive to build new business plants and had there
fore been inflationary. This was also the effect of the 1954 change in
the tax law that permitted firms a choice of methods of computing
depreciation on tax returns. The position of the Treasury on these
matters was that the rapid amortization allowances were no longer
useful and should be stopped, but that the new provision about de
preciation was sound and should be kept: the year 1955 turned out to
be a bad year in which to introduce the new depreciation option but
in the long run its effects would be desirable. This appears to be a
sound conclusion on both issues.
Treasury debt operations and interest rates
Since the Treasury is the largest single borrower in the United
States, its debt operations are bound to have marked effects on
financial markets. In the markets for short-term credit, the weight
of Federal borrowing is much greater than it is in long-term markets.
The volume of Treasury bills outstanding in recent years has been
about 10 times the volume of private short-term paper—commercial
paper and bankers acceptances. In the bond market, Federal debt
outstanding is a much smaller proportion of the total. But to show
the effect of Treasury borrowing on changes in interest rates it is
necessary to compare not totals outstanding but changes in the totals.
During the calendar year 1956 and the first half of 1957, increased
Treasury bill issues accounted for over half the total increase in short
term securities outstanding. The higher Treasury demand for
short-term credit must have contributed importantly to the rise in
short-term rates. Treasury intermediate and long-term securities
outstanding, however, declined below 1954-55 levels, while the total
of other obligations increased. Therefore, the change in Treasury
borrowing must have moderated the upward pressure on long-term
rates of interest.
It has been suggested that the Treasury may have influenced interest
rates in another way, by issuing securities with higher coupons, for the
purpose of forcing market rates up. This contention is not supported
by the facts. Issuing securities with higher coupons would not in
itself force bond yields up: a marketable security bearing a coupon
corresponding to a yield above the going market rate would simply
increase in price, the yield declining correspondingly. The Treasury
could have increased yields only by increasing its borrowing enough
to bring interest rates up. But total Treasury borrowing was reduced
during 1956 and 1957, as table 3 above shows.
2110 IBS FlKANCIAXi CONDITION" OF M b tfNTTED STATES
Another point in this connection is that in 1956 the initial prices
quoted on Treasury offerings of intermediate and long-term securities
averaged only one point over par, and in 1957 (through May) the
average was exactly par. This suggests strongly that the Treasury
was attempting to issue its securities at the lowest cost the market
would permit and was not seeking to force interest rates up.
Debt management and the maturity o f the debt
The objective of lengthening the maturity of the debt—by replacing
maturing short-term aebt with bonds and by issuing bonds with a
term longer than 10 years—has continued to influence debt manage
ment. In fact, however, the average time to maturity of the out
standing obligations decreased slightly in 1956 and 1957. In a period
of relatively nigh interest rates, the cost entailed in issuing bonds,
especially long-term bonds, seemed to the Treasury prohibitive. As
with the objective of reducing the size of the debt, other considerations
militated against stretching out the maturity. In order to evaluate
the seriousness of this fact, it is necessary first to be clear on the costs
and advantages of lengthening the maturity of the debt. As to costs,
there would probably De savings in marketing costs if issues were less
frequent and the lYeasury bill turnover were smaller. On the other
hand, the interest cost of a longer dated debt would be higher. If,
for example, 10 percent of the amount of Treasury bills outstanding
on the average in 1956—a figure of about $2.4 billion—had been
funded into bonds of 5- to 10-year term, the resulting increase in the
annual interest cost of the debt can be calculated, on certain assump
tions about the effects on interest rates of this change, to have been
about $19 million. This would have been an increase in the total
interest cost of the debt of about one quarter of 1 percent. Would
such an increase in costs have been excessive? Of course, this cal
culation gives only a rough approximation of the correct figure; and
the hypothetical “ funding operation” to which it relates was chosen
arbitrarily. The point is that some estimate of costs is necessary if a
judgment is to be made on the desirability of lengthening the debt.
The Treasury did not present such figures to support its contention
that issuing longer dated securities in 1956 and 1957 would have been
too expensive; the lack of such figures makes the contention in
conclusive.
As advantages of lengthening the debt, two chief points are claimed:
first, that reducing the frequency of Treasury issues would make the
Federal Reserve’s task easier; and, second, that to change to longer
dated securities during inflation would help to check private spending.
Undoubtedly, frequent large issues of Treasury securities poses awk
ward problems for the Federal Reserve. But were the problems dur
ing 1956 and 1957, for example, more than technical complications in
the Federal Reserve’s job? Did they actually inhibit monetary con
trol? As for the second point, replacing maturing short-term securities
with bonds during inflation probably would help to control the infla
tion. In fact, however, other pressures on the Treasury have often
led to the opposite change, as happened in the recent inflation. It is
interesting that the presidents of the Federal Reserve banks in their
joint reply to the Finance Committee’s questionnaire conclude that
countercyclical debt management is probably not feasible, and that
THE FINANCIAL CONDITION OF TH E UNITED STATES
2111
the objective should be rather to minimize the interference of debt
operations with other policy.9
The probable effects on Federal finance of lengthening the maturity
of the national debt are not clear, nor are the effects on monetary
control and the economy at large. It seems to be taken for granted
that the change would be desirable but the costs and advantages need
to be clarified if the case for a change is to be convincing.
E . M O N E T A R Y A N D F IS C A L P O L IC Y IN T H E R E C E SS IO N
M onetary policy in the recession
In the second phase of the Finance Committee’s study, attention
shifted from inflation to the recession that was by then under way.
Although the committee's questionnaire, sent out in March 1958,
related to inflation as well as to recession, the answers reflect the same
shift of interest to the problem then current. However, both the
answers and the testimony in the hearings themselves reflect concern
over the possible return of inflation.
Federal Reserve policy after October 1957 was much less contro
versial than the tight money of the previous 2 years. But some
expert observers criticized the Federal Reserve for not doing more to
expand the money supply. A comparison of the change in the total
of commercial bank deposits and currency held by the public during
the first 9 months of the recession with the behavior of tne same total
in 4 previous downturns shows that the Federal Reserve's action was
unusually strong:
Change in commercial bank deposits plus currency held by the public
First 9 months after downturn in—
June 1929_____________________________________________________
May 1937_____________________________ __________________ _____
November 1948.------- ---------------------------------------------- ------------- - July 1953______________________________________________________
July 1957_______________________ ______ _________________
B&Umt
—$1, 056
-6 9 4
—2, 000
H-3,100
+ 6, 400
These figures do not, of course, demonstrate that the Federal Reserve
took “ adequate” action to counter the decline. They do show,
however, that, compared to past recessions, these were unusually
strong measures.
Fiscal p olicy in the recession
Controversy over fiscal policy in the recession centered mainly on
the merits of a special tax cut, an emergency increase in expenditures,
or both. The official position of the administration was that the
effects of reduced tax rates or increased expenditures would come too
late to aid recovery and would, instead, give a strong impetus toward
renewed inflation. Critics of this position argued that the recession
was more severe than the administration and others who agreed with
it recognized, and that without special measures the decline would
continue for some time and would reach lower levels than the reces
sions that began in 1948 and 1953. Disagreement was mainly over
the correct diagnosis of the economy's condition, and only to a lesser
extent over the magnitude and timing of the effects of changes in
expenditures and taxes. At this writing, it is too soon to be certain
• Joint and Supplemental Comments of tbe Presidents of Federal Reserve Banks in Response to tbe
Questionnaire of tne Committee on Finance, pp. 50,61.
2112
TH E FINANCIAL CONDITION OF TH E TJNTTED STATES
about who was right. Present appearances are that an upturn came
in the spring of 1958 and that by the early autumn recovery was well
underway. If this turns out to be true, then the administration will
be proved correct: special tax or expenditure changes adopted in early
1958 would have produced their main effects only after recovery was
well underway. But it is too soon to know.
F. CONCLUSION
The Senate Finance Committee's study presents much relevant data
on the monetary changes and fiscal experience of the past 3 years and
raises a number of important questions about the period. Perhaps
the most important question concerns the nature of the recent inflation. It appears that the inflation, and the recession that followed,
were not different in essential respects from previous economic
fluctuations. Though it is not possible to show conclusively that
price increases resulted from the pressure of increased business and
consumer demand, it can be shown that demand increased early in
the inflation and that the pattern of price increases among different
industries is related to the pattern of demand increases. It is also
dear that when demand stopped rising and then fell, production and
employment declined and, with a lag, prices stopped rising and then
fell.
Both monetary and fiscal policy during the period were free of
manjr of the errors charged to them. However, important questions
remain unanswered about the soundness of presently accepted prin
ciples of stabilization policy. In the case of monetary policy, the
problem is mainly uncertainty about the timing of the effects of
Federal Reserve action. This uncertainty has important implica
tions for the fundamental question of the effectiveness of discretionary
control of the money supply.
PART II
S U M M A R Y O F T H E T E S T IM O N Y O N T H E P R IN C IP A L
SU B JE C TS O F T H E H E A R IN G S
IN T R O D U C T IO N
This summary of the views expressed by each witness on the
principal subjects considered in the hearings is arranged according to
subjects, to facilitate comparison of the views. Under each heading,
or subheading, the statements appear in the order in which the wit
nesses appeared before the Finance Committee.
At the end of each section there are brief comments on the main
issues raised in the statements. These comments are based on the
analysis presented in part I of this report, where the points are stated
more fully.
The witnesses were:
Hon. George M. Humphrey, Secretary of the Treasury
Hon. W. Randolph Burgess, Under Secretary of the Treasury
Hon. William McChesney Martin, Jr., Chairman, Board of
Governors of the Federal Reserve System
Hon. Bernard M. Baruch
Marriner S. Eccles, former Chairman of the Board of Governors
of the Federal Reserve System
Sumner H. Slichter, professor of economics, Harvard University
Seymour E. Harris, chairman of the economics department,
Harvard University
Charles C. Abbott, dean of Graduate School of Business Adminis
tration, University of Virginia
A.
C A U SE S OF T H E IN F L A T IO N A N D
TH E R E C E SS IO N
(1 ) The inflation
M r . H um phrey ~Inflation is now [June 1957] “ perhaps our most
serious domestic economic problem” (p. 8). Current price increases
are caused by the pressure of rising consumer and business demand,
financed by bank loans (pp. 13, 103-107, 112-118, 181-186, 188-194,
223-224, 340, 602, 634, 635). Rising interest rates have not been an
important cause of price increases (pp. 31-33,40). However, the high
level of Government spending has contributed to the inflationary
pressure (p. 6).
M r . Burgess .—Causes of the inflation are (1) the delayed effects on
rents and other prices of cost increases in earlier periods (p. 736);
(2) current cost increases (pp. 1050, 1051); and (3) rising demand for
capital goods (pp. 736-738, 831, 848, 1040, 1043, 1074, 1085)- The
high level of government expenditures, especially armament expendi
tures (pp. 1127-1130), has also caused inflationary pressure (pp. 738,
2113
2114 th e
financial condition of th e united states
7 3 9 ). H ig h e r in te re s t ra te s h a v e re s tra in e d ra th e r th a n s tim u la te d
p ric e in c re a se s (p p . 7 3 9 , 8 58 , 10 3 3 ).
M r . M a rlin .—A general increase in demands for goods and services
bid prices up, beginning in 1955 with the prioes of industrial goods
(pp. 1262-1264). An important cause of higher business and con
sumer demands in 1955, 1956, and 1957 was the easing of credit by
the Federal Reserve in 1954 (pp. 1304, 1305). Higher interest rates
have restrained inflation (pp. 1268, 1269); on the other hand, higher
labor costs were an independent cause of price increases, working
through a wage-price spiral (pp. 1848, 1872, 1873).
M r . Baruch .— “ The main cause of inflation today is the deficit
financing of war—the enormous borrowing in World War II and
Korea” (p. 1639). The wage-price spiral is the aftermath of inflation;
it has kept inflation going, though it was not an original cause. The
wage-price spiral will inevitably be checked by consumers’ refusal to
pay higher prices (pp. 1676, 1677).
M r. E ccles .—The four principal causes of the recent inflation were
(1) the excessive growth of consumer borrowing, resulting from easier
terms of credit offered in 1954 and 1955; (2) the boom in house pur
chases, also stimulated by easier credit; (3) an increase in capital
expenditures by business, which was induced principally by the auto
mobile and housing booms but which was stimulated also by the con
tinuation of accelerated amortization allowances and the new treatment of business depreciation allowed by the 1954 change in the tax
laws; and (4) higher labor costs, which have resulted from the strong
bargaining power of labor union monopolies in a period of high de
mands for goods and services (pp. 1694, 1695).
M r. Slichter. —Mr. Slichter did not make a direct statement on the
causes of the inflation but his remarks on wage-push inflation were
dearly intended to apply. He said:
* * * rising wages are a principal cause of rising prices.
They are not the only cause but the issue had been confused by the honest belief
of many people that rising wages simply reflected a strong demand for goods.
Wages have continued to rise throughout the recession in the face of falling
demand for labor and goods (p. 1843).
Mr. H arris .—Mr. Harris also did not make a direct statement on
the causes of the inflation. His testimony contains the following
remarks relating to the subject: An investment boom preceded the
recession (p. 2015); during the boom, the lending of Federal credit
agencies, life insurance companies, and other nonbank financial insti
tutions rose considerably (pp. 1989, 2004, 2005). Nonfinancial cor
porations also drew on large cash reserves to finance additions to
capital equipment (pp. 1990, 2005). Higher labor costs, which in
some industries led to price increases in excess of the rise in costs, were
a cause of the inflation (pp. 1990, 2014, 2037, 2038).
M r. Abbott ,—Current inflation is wage-push inflation. When the
money supply is flexible, “ * * * wage increases inevitably push up
prices” (p. 2061). Other causes of the increases in the price level since
the 1930’s are the Federal deficits, the increased national debt, the
rise since 1945 in the rate of turnover of bank deposits, farm price
supports, the increasing amount of services purchased by consumers,
and the larger fraction of national output going for military purposes
of foreign aid.
THE FINANCIAIi CONDITION OF THE UNITED STATES 2115
(J8) The recession
The witnesses who appeared in 1958 also gave their views on the
causes of the recession that was by then in progress.
Mr. Baruch .—The recession is the result o f inflation; consumers7
refusal to pay higher prices caused unemployment (p. 1637).
M r . E ccles .—The recession developed because high prices and the
redistribution of buying power caused by inflation reduced the volume
of goods and services purchased. Other causes of the fall in demand
were the high rate of durable goods purchases during the previous
2 years, the high level of consumer debt, and the overbuilding of
business plant and equipment (p. 1696). Restrictive monetary policy
brought on the recession sooner than it would otherwise have occurred
but, in any case, a recession would have followed the boom (pp.
1707, 1708).
Mr. Slichter.—The recession is concentrated in durable goods man
ufacturing, mining, construction, and transportation (p. 1818); it
came as a reaction to an unusually high level of investment spending
during 1956. The tight money policy, the reduction of Federal ex
penditures in 1957, and the unpopularity of the 1958 cars also were
causes of the recession (pp. 1822-1825).
Mr. M a rtin .—The recession was a reaction to the investment boom
of the preceding 2 years, in which business added to its plant and
equipment faster than the growth of consumer demand warranted
(pp. 1848, 1849). The excessive growth of private debt also finally
reduced consumers’ spending (p. 1863). Monetary restraint slowed
down the inflation but did not cause the recession (pp. 1892, 1918).
Mr. H arris .—The recession was caused mainly by excess capacity
but it was made worse by the Federal surpluses of fiscal 1956 and
1957, and by the tight money policy (pp. 1988, 2014, 2015).
Mr. Abbott .—The recession is concentrated in the heavy goods
industries (p. 2058); it was caused by declining business purchases of
plant and equipment and by a reduction of business inventories (p.
2060). The upward push of wages had made prices inflexible, so
that output and employment have decreased as demand has fallen
(p. 2061).
Comments on the causes o j the inflation and the recession
(1)
All the witnesses except Mr. Humphrey and Mr. Baruch
listed the push of labor costs—or both labor costs and admin
istered prices—among the causes of inflation. Mr. Baruch
described the wage-price spiral as an aftermath of inflation and
Mr. Humphrey did not mention it. There is strong evidence to
support the view, criticized by Mr. Slichter, that price increases
were the cause rather than the result of higher wages. This
evidence is the fact that the largest price increases, and the
increases in the most important segments of the Consumer Price
Index, were associated with increases in the quantities of goods
and services purchased. Furthermore, wages continued to in
crease during the recession only where demand continued high or
where there existed previous commitments, including escalator
clauses, to increases.
What caused demands to increase so rapidly and then to faH
sharply in 1957 is another question, to which, it appears, no
conclusive answer can be given in the present state of knowledge.
2116 THE FINANCIAL CONDITION OF THE T7NTT3ED STATES
(2) It is unlikely that government control of consumer credit
or of lending by nonbank financial institutions wonld have exerted
any additional restraint on spending. There is no evidence that
the amount of private debt was a cause of the recession.
(3) The inflationary effects of government expenditures, a
point discussed by several witnesses, needs to be clarified in two
respects. First, government expenditures for weapons—and for
many other purposes, e. g., paying the salaries of Federal judges—
are Uke private consumption expenditures in that they absorb
goods and services into uses that do not—in most cases—make
possible more output in the future. However, all increases in
today’s expenditures add to current demand and may raise
current prices—investment expenditures are potentially as infla
tionary as any other. Whether future prices will be lower because
of today’s investment is another question.
Secondly, there is a point in saying that weapons expenditures
are inflationary even when financed by increased taxes but the
point is often overstated. If consumption goods had been
produced instead of weapons, the additional goods on the market
would have tended to hold prices down. But, on the other hand,
higher taxes tend to reduce the private demand for goods and
services, because taxpayers are, in effect, compelled to purchase
weapons and their incomes available for purchasing other things
are reduced. So much must be subtracted, as it were, from the
statement often made, that weapons expenditures are inflationary
because incomes are earned in the production of weapons and
there is no corresponding production of goods for private markets.
However, a point still remains: experience shows that private
spending will not fall by the amount of the increased taxes (which,
by hypothesis, equals the increase in government spending),
therefore, total spending will rise and prices may rise. There
have been no attempts to compute the magnitudes involved,
allowing for all relevant factors, but it is clear that the increase
of prices, if any, must be less than is implied by the statement of
the point referred to above.
B. THE FEDERAL RESERVE AND MONETARY POLICY
( 1) The gold standard
M r. H um phrey ,—It would not be wise to return to unrestricted gold
redemption of the currency (p. 480); present arrangements for mone
tary control are sound (pp. 480, 529). Foreign governments can
purchase gold with their dollar balances and the total of such balances
is large in relation to the Treasury's gold stock (pp. 480-483, 524-525);
nevertheless, there is no danger that the gold stock will be inadequate
to meet the demands on it.
M r . Burgess .—Return to the gold standard should be an objective
of monetary policy, but unstable international conditions make it
unsafe to return to gold now (pp. 1021-1024).
M r . M a rtin .—It would not be safe to return to gold redemption of
the currency now, because of the danger that agents of unfriendly
countries would disrupt the monetary system by demanding large
amounts of gold (pp. 1461, 1474-1479). Ultimately, we ought to
return to gold, but the present monetary system is sound (pp. 1485,
THE FINANCIAL CONDITION OF THE UNITED STATES 2117
1488, 1494, 1495, 1550, 1555). The present gold reserve is adequate
(p. 563).
M r. Baruch .—Under present international political conditions, a
sound decision cannot be made on the long run question of returning
to the gold standard (p. 1684).
Comments on the gold standard
It is doubtful that if the currency had been redeemable in gold,
monetary policy and the behavior of the money supply would
have been very different during the past 7 years. However, the
fundamental issue raised by the question of restoring gold re
demption is whether the present scope of discretionary monetary
control ought to be reduced. This issue deserves serious con
sideration.
{2) Federal Reserve policy
M r. H um phrey .—Monetary control ought to be flexible, aiming at
ease during recessions and at restraint during inflations (p. 176). The
Federal Reserve System ought to be independent of the adminis
tration (p. 24); during the past 4 years, the Treasury and the Federal
Reserve have discussed monetary problems but the Federal Reserve
has been free to make its own decisions on monetary action (pp. 232,
233).
The recent tight money policy has been “ * * * in the best interest
of the great majority * * *” (p. 27). The Federal Reserve did not
seek to raise interest rates but the restrictive monetary policy was
one cause of higher rates. A more important cause was the increased
demand for credit (pp. 545, 546).
M r. Burgess. —The Federal Reserve should be independent of the
administration in reaching decisions on monetary policy, though it
should consult with the Treasury (p. 742). The Federal Reserve has
not sought to raise interest rates (p. 1051); rising demand for credit
rather than Government policy has been mainly responsible for rising
rates. The Federal Reserve's policy of monetary restraint has been
sound (p. 1056).
M r. M artin. —The Federal Reserve Act and the Employment Act
of 1946 prescribe the objectives that guide Federal Reserve decisions
(pp. 1898, 1899). Federal Reserve policy since 1955 has aimed at
stopping the rise in the price level (p. 1850); the Federal Reserve has
not tried to raise interest rates (p. 1327). The Federal Reserve has
regarded the control of inflation as essential for economic growth (pp.
1301, 1302).
M r . E ccles .—The general lines of Federal Reserve policy during the
inflation were sound (p. 1702). The Federal Reserve should have the
power to control consumer credit and mortgage credit (p. 1738).
M r . Slichter.— The Federal Reserve policy of restraint was correct
but restraints were kept on too long (p. 1844).
M r. Baruch. —The Federal Reserve did not try to raise interest rates
(p. 1669).
M r. H arris. —The primary objective of Federal Reserve policy now
is a stable price level (p. 2002). The Federal Reserve ought not to be
independent of the administration (pp. 2046, 2047). Federal Reserve
action against the recession has been too weak (pp. 1991, 1992).
M r. Abbott .—The correct objective of monetary policy is to offset
economic forces, including Federal fiscal operations, that create infla-
2118 THE FINANCIAL CONDITION OP THE UNITED STATES
tionary or depressive tendencies (p. 2064). The Federal Reserve
should be independent of the administration. The Federal Reserve
should be given power to influence the operations of Federal lending
agencies (p. 2080).
Comments on Federal Reserve p olicy
(1) The question whether price stability or full employment
should be the principal aim of monetary policy requires clarifica
tion. What is at issue is not what the aims of policy ought to be
(there is agreement about what is desirable in general), but how
the aims can beat be achieved. There is disagreement on the
probable effects of different strategies of monetary action; re
solving this issue requires further study of past experience,
(2) There is a strong case for separating monetary control from
government finance. During the hearings Treasury officials
admitted that fiscal expediency took precedence over control of
inflation in decisions on taxes and expenditures during the 2
previous fiscal years. It is difficult to avoid this when pressures
for expenditure are strong and decisions on expenditure and
taxation are not well coordinated. If the Treasury also exercised
control of the money supply, these pressures would bear on mone
tary policy as well as on fiscal policy. Therefore, the interests of
economic stability are better served by not allowing the Treasury
to have discretionary powers of monetary control.
(3) There is no evidence that the Federal Reserve tried to
raise interest rates during the inflation.
C. FINANCIAL POLICIES OF THE FEDERAL GOVERNMENT
(1) Taxes, expenditures, and fiscal policy
M r. H um phrey ,— The administration succeeded in reducing Govern
ment expenditures, reducing taxes, and eliminating planned deficits
(pp. 9-11). Present levels of taxation are too high (pp. 66, 67). The
principle of a limit on the national debt is sound and the [then] current
limit ought not to be increased, except temporarily (p. 86). It is no
longer desirable to allow rapid amortization of defense-related facili
ties; the issuance of new certificates has been curtailed (pp. 248, 249).
M r. Burgess .—The budget surpluses achieved in fiscal 1956 and
fiscal 1957 were too small; pressures for expenditures made it impos
sible to realize larger surpluses (p. 1007). Reducing expenditures is
better than increasing taxes as a fiscal measure against inflation. The
principle of a debt limit is sound (p. 1060). As a long-run measure,
the 1954 change in the tax law that allows firms an option in the
method of computing depreciation on tax returns is sound; the timing
of its introduction proved unfortunate and it has contributed to
inflation (p. 1093).
' M artin .—During inflation, the Government should reduce
expenditures and achieve a budget surplus (pp. 1271, 1272). The
surplus in fiscal 1957 and the prospective surplus (in April 1958) for
1958 are too small (p. 1271). Deficits during recession may be help
ful but their benefits are often overstated (p. 1317). A tax change
that increased incentives to produce would help to achieve economic
stability (p. 1856). A tax cut now would not aid recovery and its
later effects would be undesirable (pp. 1855, 1867, 1868).
THE FINANCIAL CONDITION OF THE UNITED STATES 2119
M r. Baruch.—In the present recession, taxes should not be cut and
any increases in expenditures should be paid for out of increased taxes
(pp. 1634, 1635). The Government ought to adopt a regular schedule
of debt amortization (p. 1638). Deficit financing during World War
II was unsound and has caused the subsequent inflations (p. 1639).
It is sound to issue Government bonds for certain purposes, provided
that taxes are increased to pay for the cost of interest and amortiza
tion (p. 1642). A statutory limit on the national debt is desirable
(pp. 1670, 1671). Congress should have the service of an expert staff
to study proposals for expenditures (p. 1643).
M r. Eccles .—Budget surpluses and a reduction of the national debt
ought to be used during inflation to offset the growth of private debt.
During depression, when private debt is contracting, there should be
deficits and an expanding public debt (p. 1703). The deficits should
be created by tax cuts rather than increases in expenditure (p. 1704).
In the present recession, tax collections should be reduced by 6 to 7
billion dollars through the elimination of certain excises, a reduction
in the rate of corporate income tax, and a reduction in the rate on the
first $2,000 of individual incomes (pp. 1698, 1699).
M r . Slichter .—Surpluses should be planned for periods of high pri
vate spending and inflation, and deficits for periods of recession
(p. 1833). Ideally, increased expenditures would be authorized in
advance and put into effect when a recession occurred. Procedures
for timing such authorizations correctly do not exist, however; it will
be 10 years before they can be developed and put into operation
(p. 1828).
It is now (April 1958) too late in the present recession to cut taxes;
the increased expenditures already authorized will produce a deficit
large enough, though timed too late, to do all that fiscal policy can
do to overcome the recession (p. 1838).
M r . H arris .—The budget should be in surplus during inflation and
in deficit during recession (p. 2032). Present (April 1958) expendi
tures ought to be increased and the tax rate applying to the first
$2,000 of individual income ought to be reduced, to give a deficit of
$7 billion for the calendar year 1958 (pp. 1996-1997). The adminis
tration has made changes in programs and accounting procedures for
the purpose of reducing current expenditures; it is questionable
whether the resulting reductions in the budget are genuine decreases
in spending (pp. 2048, 2049).
M r . Abbott .—Except in times of extreme crisis, the aims of fiscal
policy ought to be only (1) to protect the Government's credit and
(2) to make as small as possible the effects on the private economy
of Federal financial operations (p. 2064). Raising Federal expendi
tures is an inefficient remedy for unemployment, because the effects
are slow and because there is no direct provision of jobs for those out
of work (p. 2059). As a means of stimulating business spending now
and as a long-run reform, tax law should be changed to permit busi
ness firms to deduct depreciation according to any time pattern they
choose, provided that the pattern is not changed (p. 2062).
Comments on fiscal policy
(1)
The controversy over the merits of special fiscal action
against the recession was mainly about the seriousness and
expected duration of the recession; there was relatively little
43994—59---- 3
2120
THE FINANCIAL CONDITION OF THE UNITED STATES
disagreement about the timing of effects to be expected from
special action.
(2) Control of government expenditures is aided by main
taining the rule of a balanced budget but the rule has important
defects in the face of economic fluctuations. It is not likely
that the rule will be adhered to in a recession; if it were adhered
to, the recession would be deepened. During inflation, tax col
lections rise; if tax rates were reduced or government expends
tures increased, as the rule would require, prices would rise more.
On the other hand, recent experience shows again that to have no
fixed principle also is unsatisfactory, because it is difficult to
time ad hoc changes correctly and because fiscal expediency may
exert a strong influence on the relation between expenditure and
revenue.
One principle that has been suggested as a replacement for the
balanced budget rule is that the budget be balanced at a highemployment, noninflationary level of national income, and the
tax rates and expenditure level thus established be maintained
over the business cycle. As national income rose during in
flation, an increasing surplus would be generated; during reces
sion, the deficit would automatically increase as the recession
deepened.
{8) Debt management
M r . H um phrey .—The Treasury has tried to lengthen the maturity
of the debt, to reduce the fraction of the debt held by banks, and ta
increase individuals’ holdings of savings bonds (pp. 17-18). During
the recent period of high interest rales, however, it has been necessary
to sell more short-term securities in order to keep interest costs down
(p. 17). Though the large volume of Treasury borrowing inevitably
affects interest rates, the Treasury has not tried to establish any level
of market rates, but rather to borrow as cheaply as possible, in keeping
with the objective of lengthening the debt (p. 631).
M r . Burgess.-—The Treasury has tried to lengthen the debt and to
sell more savings bonds (pp. 668, 669); however, the average time ta
maturity of the outstanding obligations has increased only very
slightly (p. 671). In setting the rates to be offered on new issues, the
Treasury has been able to anticipate very closely actual market rates,
at the time of issue (pp. 683-687). The Treasury has not tried to
raise interest rates (p, 759). January 1954 was the last previous time
that the Treasury sold securities directly to the Federal Reserve
(p. 898); however, it is a regular practice for the Federal Reserve to.
aid the Treasury bv insuring that the bond market is not in a period
of temporary tightness at the time when a Treasury issue is sold. In
planning its issues, the Treasury receives advice from the Federal
Reserve and from private financial firms (p. 682).
M r . M a rtin .—In a recession, the Treasury sh uld issue mainly
short-term securities and during inflation it should emphasize long
terms (pp. 1232, 1233). The Federal Reserve advises the Treasury
on bond market conditions and attempts to avoid tightness in the
market at the time of a Treasury issue but the Federal Reserve does not
peg prices and, since 1952, only in exceptional circumstances has it,
bought securities directly from the Treasury (pp. 1422-1424),
THE FINANCIAL CONDITION OF THE UNITED STATES 2121
M r. Baruch .—The issue of a large volume of short-term securities
has made debt management difficult and expensive; during the period
of low interest rates, short-term securities should have been funded
into long dated debt (p. 1637).
Mr. E ccles .—The Treasury should issue long-term securities during
inflation, and short-terms during recession. In recent months, the
Treasury has issued intermediate and long-term securities that have
competed with private borrowing and tended to keep long-term in
terest rates high (p. 1697).
M r. H a r ris —By selling short-term securities during 1957 and in
termediate and long-term securities during the recession in 1958, the
Treasury worked against the monetary measures of the Federal Re
serve (p. 2004).
M r. Abbott .—The Treasury should provide the types of securities
needed by the economy. Debt management should not be made a
part of stabilization policy. The Treasury should try to sell its
securities to investors other than banks (p. 2064).
Comments o j debt management
(1) Although little or nothing is known about the actual magni
tude of the stabilizing effects to be expected from countercyclical
debt management, on general grounds it seems likely that the
effects would be weaker than the effects of monetary and fiscal
policy.
(2) On some occasions, notably in the spring of 1953 and again
in the spring of 1958, Treasury debt operations and the expecta
tions attending them have caused sharp fluctuations in the prices
of Government securities. Regardless of the techniques used by
the Federal Reserve and the Treasury, large, discontinuous
Treasury operations are very likely to cause the market to be
unstable from time to time. There is therefore a strong case for
making Treasury debt operations as regular and continuous as
possible. This improvement would probably do more than would
the adoption of cyclical changes in the maturities of new issues—
or any other change in debt management—to make the economy
at large more stable.
PART H I
IN D E X O F SU B JE C T S T R E A T E D B Y E A C H W IT N E S S IN T H E
HEARINGS
INTRODUCTION
listed here are the subjects on which each witness was questioned
or made a statement. For each witness, the subjects are listed in the
order of their first appearance in the record of the hearings.
M b, H u m p h r e y
1. Production, incomes, prices, and other aspects of the United States
economy, 1953-56_______________________________ 6-36, 251-257, 575-599
2. Taxes, expenditures, and changes in the size of the national debt and
related obligations________________________ 37-50, 54-60, 79-83, 119-126,
200-209, 247-257, 259-262, 271-273, 302-319, 427-430, 575-584
3. Debt management policies___________________________ ______________ 75-78.
86-89, 127-146, 157-175, 194-200, 210-220, 233, 234, 295, 296,
369-370, 413-416, 546, 547, 627-632, 639, 640.
4. The recent inflation: measurement, causes, and remedies------------------ 51-53.
60-70, 73-75, 86, 90-118, 176-194, 221-226, 234^246, 281-294,
296-302, 322-340, 350, 356-358, 362-369, 387-392, 544-567,
584, 585, 601-613, 621-624, 634-642, 649, 650, 654, 655.
[ 5. The monetary system; the Federal Reserve; monetary p o licy .,______71-72.
149, 175, 176, 230-232, 351-356, 408-413, 416-427, 430-437,
444-449, 452-466, 471-489, 509-516, 520-525, 528-532, 545, 546,
549-573.
6. Tax policy; economic effects of taxation— 83, 86, 246-250, 614-617, 625, 626
7: Federal credit agencies; private nonbank financial institutions_____ 569-573
8. Effects of high interest rates on particular economic g r o u p s . .............
322,
323, 341-349, 370-378, 561-568, 599, 600, 640
9. SmaU business.................... - ........................ - ............ 370-387, 392-404, 561-568
10. Foreign economic policy___________________________________ _____ _ 440-443.
467-470, 489-502, 517-520, 526-528, 532-536, 651
11. Foreign aid______________________________ _____ 430, 449-452, 502-506, 652
12. The civil service retirement fund------ ----------- ------------------ 273-278, 280, 281
M r . B u rg ess
1. Taxes, expenditures, and changes in the size of the national debt and
related obligations---------------------------------------- 660-668, 838-847, 898-900,
915-917,1006-1008,1012-1020,1059-1061,1080,1081,1146,1147
2. Debt management policies----------------------------------------------------------- 668-733,
759, 785-822, 857-859, 866-870, 884-898, 900-915, 917-966,
1057-1059, 1063-1072, 1098-1103, 1132-1140, 1148-1151, 11551166, 1202-1212.
3. The recent inflation: measurement, causes, and remedies_________ 733-743,
755-758, 771-774, 833-838, 848-857, 860-866, 1032-1056, 10721079, 1083-1090, 1094-1098, 1103-1111, 1129-1132, 1141, 1142,
1152, 1166-1168, 1175-1183, 1198-1202.
4. The monetary system; the Federal Reserve; monetary policy________
742,
758-770, 774-777, 822-831, 871-884, 967-971, 986-1000, 10021005, 1020-1028, 1051, 1056, 1057, 1079, 1080, 1112-1128,
1171-1174.
5. Tax policy; economic effects of taxation__________ 743, 831-833, 1090-1094
6. Federal credit agencies; private nonbank financial institutions____ 744-753,
1061-1063, 1142-1146, 1153
7. Effects of high interest rates on particular economic groups_______ 777-779,
1184-1188
8. Small business________________ ________ _______ ___________ 779, 1081, 1082
9. Foreign economic policy.................. .............................. 972, 973, 976-986, 1010
10. Foreign aid-------------- --------------------------------------------------973-976, 1000-1002
11. The civil service retirement fund_________________________ _____ 1169, 1170
12. Social security rates_______________ _______________________ _______ _ 1198
2122
THE FINANCIAL CONDITION OF THE UNITED STATES
M
2123
b. M a b tin
Page
1. Debt management policies_______________________ _____ _____ 1495
2. The recent inflation: measurement, causes, and remedies-- 1217-1248, 12621272, 1302-1313, 1316-1321, 1329-1360, 1364-1422, 1427-1438,
1528-1536, 1543-1544,1552-1555.
3. The monetary system; the Federal Reserve; monetary policy.. 1258-1262,
1272-1303, 1315-1316, 1321-1328, 1345, 1361-1363, 1422-1427,
1438-1463, 1460-1481, 1484-1486, 1488, 1490-1528, 1536-1543,
1545-1551,1556-1564,1566-1590, 1884-1951,1957-1984.
4. Effects of high interest rates on particular economic groups-. 1402-1405,1429
5. Small business_______________________________________________ 1405
6. Foreign economic policy-. 1463-1469, 1481-1484, 1486-1490, 1565, 1591-1595
7. The recession_______________ 1847-1882, 1892-1898, 1916-1940, 1951-1956
M r. B aruch
1. Taxes expenditures, and changes in the size of the national debt and
related obligations__________________ 1648,1649,1670,1671,1688,1689
2. Debt management policies_________ ___________________________ 1637
3. The recent inflation: measurement, causes, and remedies____________ 1634,
1635, 1639-1641, 1643, 1649-1651, 1666^1669, 1672-1678, 1686,1687
4. The monetary system; the Federal Reserve; monetary policy_________ 1675,
1683-1685
5. Tax policy; economic effects of taxation_________________ 1643,1679,1688
6. Foreign economic policy___________________________________ 1685,1686
7. The recession_______________ 1635-1638,1643-1647,1662-1666,1679,1687
8. Farm surpluses___________________________________________ 1657-1659
M r . E ccles
1. Taxes, expenditures, and changes in the size of the national debt and
related obligations________ 1703-1705, 1730-1733, 1742-1744, 1745-1751
2. Debt management policies_____________________________________ 1697
3. The recent inflation: measurement, causes, and remedies______ 1694-1696,
1702, 1703, 1721-1726, 1734-1738, 1759-1760, 1769-1775
4. The monetary system; the Federal Reserve; monetary policy__ 1701, 1702,
1717-1721, 1726-1729, 1738, 1743-1744, 1751-1768, 1782-1799
5. Federal credit agencies; private nonbank financial institutions______ 1738
6. Foreign economic policy_________ 1710, 1711, 1740, 1741, 1753, 1803-1810
7. Foreign aid______________________________________________ 1799-1803
8. The recession, 1696-1702, 1706-1717, 1730, 1734-1739, 1749,1750, 1775-1780
M r . Slighter
1. The recent inflation: measurement, causes, and remedies_______ 1841-1843
2. The recession__________________________________ 1818-1841, 1843-1846
3. Long run prospects of the American economy________________ 181&-1817
M r . H arris
1. Taxes, expenditures, and changes in the size of the national debt and
related obligations____________ ____ 2032, 2033, 2037, 2043, 2048, 2049
2. Debt management policies____________________________ 2004, 2033, 2042
3. The recent inflation: measurement, causes, and remedies----------------- 2030,
2031, 2037, 2038
4. The monetary system; the Federal Reserve; monetary policy_______ 2002,
2003, 2033-2035, 2039-2042, 2046-2047
5. Federal credit agencies: private nonbank financial institutions— 2004-2006,
2035, 2036, 2042, 2043
6. The recession________________________ 1986-2032, 2044-2047, 2050-2055
2124 rate
financial condition of the united states
M e. A bbott
1. Taxes, expenditures, and changes in the size of the national debt and
2.
3.
4.
5.
6.
7.
P**®
related obligations___ __________________________________ 2064, 2065
Debt management policies__ ________- ___________________________ 2064
The recent inflation: measurement, causes, and remedies______ 2087, 2088
The monetary system; the Federal Reserve; monetary policy_______ 2064,
2080, 2081
Tax policy; economic effects of taxation_____________________ ____ 2062,
2066-2069, 2071, 2072, 2078, 2079, 2088, 2089
Federal credit agencies; private nonbank financial institutions___ _____ 2080
The recession___ _________ ___________ _____205&-2065, 206^-2087
CH APTER
II
ANALYSES OF HEARINGS ON INVESTIGATION OF THE
FINANCIAL CONDITION OF THE UNITED STATES HELD BY
THE COMMITTEE ON FINANCE PREPARED BY DR. SEY
MOUR E. HARRIS, CHAIRMAN OF ECONOMICS DEPART
MENT, HARVARD UNIVERSITY
I ntroduction
U.S. S e n a te ,
Washington, D.C., July 22, 1959.
Hon. H a r r y F. B y r d ,
Chairman, Senate Finance Committee,
U.S. Senate, Washington, D.C.
D e a r M r . C h a ir m a n : W e hand you, herewith, “An Analysis of the
Hearings of the Senate Finance Committee on the Financial Condi
tions of the United States, 1957-58,” prepared and submitted by Dr.
Seymour E. Harris.
W e regard this document as being a very valuable contribution
both to the committee and to the Congress. W e do not submit this
as a documentation of our views. While we agree with much of it,
there are conclusions in it with which we do not agree.
W e do regard Dr. Harris as an eminent authority, and he was one
of the able witnesses who appeared before our committee during the
hearings.
In order that his analysis and conclusions may be made more readily
available both to the committee and the Congress, and to others in
terested in this very important matter, we recommend that his anal
ysis and conclusions be printed along with those heretofore submitted
by Dr. James W . Ford.
Sincerely,
C lin to n P. A nderson ,
R obert S. K err ,
U.S. Senators.
J u l y 1959.
To: Senators Clinton P. Anderson and Robert S. Kerr.
From: Seymour E. Harris.
Subject: An Analysis of the Hearings of the Senate Finance Com
mittee on the Financial Condition of the United States, 1957-58 1
Available since this original report was written: Parts I to III of
the Joint Economic Committee hearings on “ Employment, Growth
and Price Levels, 1959.”
i In conjunction with these hearings one should note the following relevant hearings: (1) "M onetary
Policy and the Management of the Public D ebt,” by the Joint Committee on the Economic Report, parts
I and II, 1952; (2) other hearings by the Senate Finance Committee: “ Saving? Bond Interest Rate Increase,1
April 1957, and "Hearings on the Debt Ceiling. 1958” ; (3) Hearings before the Joint Committee on the
Economic Report, aside from the “ Annual Hearings on the President's Report,” we should note “ Mone
tary Policy, 1955-56/' December 1956, ‘"Fiscal Policy Implications of the Current Economic Outlook,”
April and M ay 1958, the “ Relationship of Prices to Economic Stability and Growth/* compendium of
papers submitted by panelists appearing before the Joint Economic Committee. March 1958, and also
hearings on the “ Relationship of Prices to Economic Stability and G row th /' M ay 1958; (4) Senate Com
mittee on the Judiciary, Subcommittee on Antitrust and Monopoly, "Administered Prices, 1958” ; (5) Sen
ate Banking and Currency Committee, Senate Report N o. 2500, "Federal Reserve Policy and Economic
Stability, 1951-57,” report prepared by Asher Achinstein; (6) Subcommittee on Government Operations,
House of Representatives, “ Amending the Employment Act of 1946 T o Include Recommendations an
Monetary and Credit Policies and Proposed Price and W age Increases, 1958.”
2125
2126
th e fin a n cia l con dition
or
th e to o te d otatbs
I am indebted especially to Prof. Peter Kenen, of Columbia, for
research help in this project, to Irwin Boris for checking references,
to Mrs. Anna Thorpe for secretarial help, and to Mrs. Eliot Nolen
and Mrs. Gladys White for typing.
An
A n a ly s i s o f t h e H e a r in g s o f t h e S e n a te F in a n c e Com
m itte e on t h e F in a n c ia l C o n d itio n o f t h e U n ite d S t a t e s
In the summer of 1958, Senator Anderson asked me if 1 would not
help Him with an analysis of the hearings of the Senate Finance Com
mittee on the “Financial Condition of the United States, 1957-58.”
I spent several weeks in Washington during the summer when the
Government witnesses appeared, and I also appeared as a witness
myself in the spring of 1958. In the fall of 1958, after analyzing the
hearings of the committee inclusive of the compendium and joint sup
plementary comments of the presidents of the Federal Reserve banks,
who were responsible for the questionnaire of the Committee on Fi
nance, I wrote an 83-page report (mimeographed) for Senators Ander
son and Kerr.
In early June 1959, Senators Anderson and Kerr asked me if I
would not try to bring the report up to date. I have therefore in
serted numerous additions within the earlier manuscript where recent
developments have required additions or revisions. I have also in
cluded two additional parts, one (III) on the failures of the administra
tion and the second (lV) on proposed legislation resulting from the
hearings and recent developments.
I am very much indebted to Senators Anderson and Kerr for the
opportunity they gave me as well as their cooperation, and to Mr,
Samuel D. Mcllwain, who was special counsel for the investigation
and who also made many helpful suggestions for my revision.
The first witness was Secretary of the Treasury Humphrey, and he
was on the stand for 14 days. This must certainly have been some
kind of record for this kind of hearing. His evidence covers 658 pages,
inclusive of all kinds of exhibits.
Under Secretary Burgess required 10 days (and 550 pages) in the
summer of 1957 to complete his evidence (pt. 2). Chairman Martin,
of the Federal Reserve Board, was the third witness, and his interroga
tion required 5 days in August 1957 and more than 400 pages (pt. 3).
An index to parts 1 ,2 , and 3 accounted for part 4.
In the spring of 1958, Mr. Bernard Baruch appeared for 2 days
(pt. 5), and in 7 days in April 1958 Marriner S, Eccles, former Chair
man of the Board of Governors of the Federal Reserve System,
Sumner H. Slichter, professor of economics at Harvard University,
Chairman Martin, of the Federal Reserve Board, Seymour E. Harris,
chairman of the economics department, Harvard University, and
Charles C. Abbott, dean of the Graduate School of Business Adminis
tration, University of Virginia, all appeared.
In addition, there was a compendium of comments of presidents of
the Federal Reserve banks, executives of corporations, officials of
trade and business associations, professors and economists, in response
to a questionnaire.
The presidents of the Federal Reserve banks had a joint statement
Twenty-eight top corporation
officials also responded to the questionnaire. In addition, 19 econ
omists replied to the committee’s questionnaire.
as well as supplementary comment.
PART
I
S U M M A R Y A N D CO N C L U SIO N S
(Numbers relate to sections in Pt. II)
A.
S ta b ility
In the Senate Finance Committee hearings, the Government repre
sentatives emphasize especially the need of stability. They stress this
point much more than the need of maximum output, employment,
and growth. In fact, they were prepared to impose a recession in
order to be assured of stability. (See S i, S2, S3). They emphasize
especially the possibility of a creeping inflation becoming a galloping
inflation.
It is not clear that this is a sustainable position. Aside from the
Korean war, the increase in prices averaged only about 1 percent over
a period of 10 years. In this same period, output rose by 40 percent—
not a bad record.
It is not at all clear even that there has been a price rise of 10 per
cent in these 10 years aside from the Korean war. In the com
pendium before the Joint Economic Committee, Professor Ruggles,
of Yale, argued in fact (pp. 298-299) that improvements in quality
are not adequately measured by index numbers. Hence at the same
price the consumer gets increased value.
Along the same lines, for example, it is known that hospital daily
charges have increased greatly. This is shown in the index numbers.
But what is not shown is the fact that the average patient spends
about half as much time in the hospital, because of great improve
ments in medicine. The genuine rise in prices is less than indicated
by this part of the rise.
It is an interesting observation that, of the 47 economists who
appeared before the Joint Economic Committee in 1958 in the hear
ings on the “ Relationship of Prices to Economic Stability and
Growth,” few economists seemed to be reasonably sure, as were the
Federal Reserve officials and the Treasury, that a creeping inflation
would develop into a galloping inflation.
B. T h e W
age or
C ost P ush
In the Senate finance hearings, administration officials, and espe
cially the Federal Reserve bank presidents, stressed the relationship
between the rise of wages and the inflation. None of the govern
mental representatives or of the Reserve Banks tended to emphasize
other factors accounting for the rise of prices. (See S4.)
It is apparent from the evidence of the Government officials and
the Federal Reserve chairman that the way to deal with inflation
was to cut down the supply of money. But this was not the view of
many of the witnesses before the Joint Economic Committee. The
economists tend to emphasize the point that, when the inflation is a
2127
2128
THE FINANCIAL CONDITION OF THE UNITED STATES
demand inflation related to excessive purchasing power, then the
approach is to cut down the purchasing power. But they were con
siderably less sure that with a rise of costs this is the proper approach.
Tn fact, numerous witnesses emphasized the point that, since it was
impossible to reduce wages or that it was impossible or unwise to
reduce prices because wages could not be depressed, new techniques
for dealing with inflation had to be found.
Hence, it followed, an attempt to deal with a rise of prices associated
with higher wages or other costs through monetary policy would bring
about a recession. Indeed, a few witnesses argued that a small reces
sion might not be unwise, but they were opposed to a recession of the
order of 1958. They contended that a little uncertainty might per
haps contain, to some extent, the rise of wages and prices. If labor
and other factors of production were assured of passing on increased
costs in higher prices, then the inflation would be much more serious.
It is clear to many of the economists that, since wages in most indus
tries cannot be cut, the average wage rate must rise, because there
must be differentials in order to attract resources from one industry
or employment to another.
W hat the Senate Finance Committee hearings failed to show was
that the increase in costs per unit of product was iust as much non
labor cost as labor cost. This was shown clearly by a study by the
Bureau of Labor Statistics.
The unwisdom of a monetary policy that brings about unemploy
ment and reduced output is emphasized by another point; namely,
that in periods of recession, productivity falls and therefore not only
do wage rates rise, though not as much as in periods of prosperity,
but productivity falls and therefore there is a double cause of rising
prices.
In a survey of business cycles over a long period of time, Mr. Thor
Hultgren, of the National Bureau of Economic "Research, concluded
(hearings, “ Relationship of Prices to Economic Stability and Growth,"
pp. 97-98):
In expansions, the effect of declining man-hours per unit has been more powerful
than that of rising hourly earnings. Labor costs fell in most cases, although not
as frequently as man-hours per unit. In more recent contractions, changes in
man-hours per unit and changes in hourly earnings have worked in the same
direction and labor cost has usually risen. * * *
In a most interesting study, Mrs. Ruth P. Mack, of the research
staff of the National Bureau of Economic Research, has produced
some evidence to show that labor is not primarily responsible for
the rise of prices. Between January 1947 and tne 1956 or 1957
high point, she holds (compendium, p. 130), that the cost of raw
materials and labor rose by 15-16 percent and of manufactured goods
by 54 percent in the 10 years ending 1957. Her explanation is pri
marily large rises in overhead costs— marketing, administration, re
search, insurance, et cetera.
None of the 47 economists, with the exception of Prof. Abba Lerner,
before the Joint Committee hazarded to suggest a way out of this
dilemma of checking a cost-induced inflation without bringing on a
recession. Very few proposed the Federal Reserve medicine of
reduced supplies of money. Indeed, there was a general willingness
to use both monetary and fiscal policy and certainly a greater dispo
sition to use fiscal policy than was suggested by the administration.
THE FINANCIAL CONDITION OF THE UNITED STATES
2129
Professor Lemer alone, however, would deal with the problem through
controls of prices and wages. Elsewhere (“Review of Economics
and Statistics/’ May 1957), Professor Galbraith did indeed suggest
some restraints on rising wages and prices in crucial industries.
This is obviously one of the tough problems the Senate Finance
Committee should deal with. What should be the contribution of
monetary policy? Of fiscal policy? Of control, should fiscal and
monetary policy fail to achieve the objectives? I am sure that most
would agree that a rise of prices of 1 percent per year and a gain of
output of 3 or 4 percent would not justify the use of controls, or even
strong monetary policy. But if, for example, prices should continue
to rise at 3 or 4 percent per year, and output 1 or 2 percent, then
the pressure may be on for strong monetary and fiscal policy or
even some limited kinds of control.
The rise of wage rates did not bring a greater inflation, because to a
substantial degree the increase in wage rates was offset by a rise of
productivity. There is also some evidence that the labor groups
squeezed the capitalist groups to some extent. This does not mean
that capital did not very often increase prices much more than was
justified by the rise of wages. Professor Kendrick, of George Wash
ington University, argued that inflation would have been greater
had it not been for the rise of productivity and the squeezing of
capital, but contended that this particular squeezing of capital could
not go on for long (ibid., hearings, pp. 100-101). Ruggles (com
pendium, p. 301) argued in a somewhat similar vein. He found that
profits as a percentage of wages and salaries had fallen from 36 percent
in 1948 to 29 percent in 1956. This is subject to some reservations.
Of course, one should allow here for the relative rise of capital and
of numbers of workers. But the Senate Finance Committee hearings
(p. 1419) seemed to show no clear trend of corporate profits before
taxes as a percent of national income and a trend downwards after
taxes since 1930 (Chairman Martin).
C.
M o n e t a r y R estrictio ns and th e E conom y
It is clear from the discussion in part II (see S5-S10) that the
Federal Reserve policy contributed toward the recession. Moreover,
it is also clear that monetary policy is not an overall medicine; it
affects different markets in different ways, and in this sense it may
be as selective as selective controls.
One of the unfortunate aspects of the restriction of money is that
production was cut in fields where there was excess capacity. This is
clearly the case in the construction area.
In the Consumer Price Index the rise was largely in services and
notably in medicine, where productivity had not increased greatly and
where there were shortages of services. But a serious rise in manu
facturing prices is also to be found, and this is reflected in the whole
sale prices of finished goods.
For example, from 1955 to 1958 wholesale prices rose by 8 percent:
but those of metals and metal products by 12 percent, machinery ana
automotive products by 18 percent. These are industries with much
use of administered prices. But in another administered area, rubber
and rubber products, the increase was but 3 percent.
2130
THE FINANCIAL CONDITION OF THE UNITED STATES
But it should also be noted that there were oligopolistic markets in
some of these industries, and with strong trade unions and admin
istered prices these contributed to inflation.
D . O bstacles
to
M onetary P olicy
One of the objectives, according to the Federal Reserve, of the
dear-money policy was to increase savings and thus keep down the
pressure of demand. Unfortunately, the Federal Reserve was not
aware that the most important factor in determining savings is not
the rate of interest, but income. The response of savings to higher
rates of interest was disappointing throughout the period of aearmoney policy. (See S l l .)
Another obstacle to successful policy was, of course, the loose rela
tionship between the supply of money and the amount of spending.
In 1 year when the supply of money rose by 1 percent, the total
bank debits rose by 8 percent. Similar developments occurred
throughout the period of anti-inflationary policy. (See S12.)
A great obstacle to the achievement of Federal Reserve objectives
was tne presence of the financial intermediaries, that is, life insurance
companies, pension funds, etc. They had become more and more
important vis-a-vis the commercial banks over which the Federal
Reserve had restricted control. As commercial banks, under restrictionist pressure, tended to cut their lending, the financial intermedi
aries were in a position to expand even as commercial banks were
restrained. They could do this in part because they could take in
active cash from the public and make it more active, or they could
dispose of Government securities and make loans. (See S13.)
One of the surprises of the hearings was the failure of the Federal
Reserve to make any suggestions or for that matter the Treasury to
cope with the problem of intermediaries that made control of the
economic system so much more difficult. This is certainly a problem
for consideration for the Senate Finance Committee.
There are various possible attacks on this problem. For example,
since the intermediaries deal especially with consumer and housing
credit, any selective control of consumer and housing credit may be
an approach to the control of the activities of the intermediaries.
(Compare Prof. Warren Smith in the compendium, pp. 509-511,)
Another approach is direct control of the intermediaries, for example,
by requiring that they keep their assets in certain forms, or at least
that they would keep certain liquid assets behind their liabilities.
In his recent book, “ Prosperity Without Inflation,” Prof, Arthur
Burns, the former Chairman of the President's Council of Economic
Advisers, had this to say about financial intermediaries (p. 82; also
see S13-S15):
*
* * One suggestion is to require various financial intermediaries to hold
reserves against their liabilities on a basis similar to the requirements imposed on
commercial banks. Another suggestion is to free commercial banks from some
of the regulations that may have impeded their growth * * *. A third sugges
tion is to give the President or the Federal Reserve Board standby authority to
regulate the terms of consumer installment credit and perhaps also the terms of
conventional housing mortgages * * *.
One of the assumptions of the Federal Reserve and the Treasury
apparently was that an increase in rates and reduction in the supply
of money would not bring any trouble into the Government bond
THE FINANCIAL CONDITION OF THE UNITED STATES 2131
market. This proved to be an unjustifiable assumption. The banks
reacted to higher rates by disposing of Government securities and
lending under more favorable terms to others. The Federal Reserve
policy had the effect of forcing an abandonment of the Government
security market and a very large decline in the prices of securities.
The financial institutions were not deterred by the fall in the price of
bonds to hold on to their securities. Indeed, once the market price
reached a very low point, they then began to purchase. But this was
too late.
Surely, it is one of the responsibilities of the Senate Finance Com
mittee to consider the effects of monetary policy on the bond market,
and particularly the extent to which a general monetary restriction
tends to result in a serious depression io the prices of Government
securities. Has not the movement to leave the Government bond mar
ket to the free market forces gone too far since 1951? (See especially
S14.)
E. F ederal R eserve and the R ecession
Although the Federal Reserve increased rates substantially in the
years 1956 and 1957, on occasion they were inclined not to take the
responsibility for the higher rates, restrictive monetary policy, and
their aftermath. They claimed at times that they were merely fol
lowing the market. There is much evidence that this was not so.
(See S16.)
Unfortunately, the Senate Finance Committee did not have an
occasion to deal with Federal Reserve policy during the recession.
I hope that, if the hearings are continued, the Federal Reserve policy
during the recession will be given sufficient attention. It seems to
the writer that they tended to worry about inflation excessively right
in the midst of the recession. Only thus can we explain a continued
stability of excess reserves over a period of more than a year, and the
failure to increase the reserves of member banks after 1 year of re
cession. We might thus also explain the increase in the bank rate in
August 1958, when the reality of the recession was apparent to almost
everybody. The time to deal with inflation is when it comes, not in
the midst of a recession. (See S17.)
F. F iscal P olicy
In his opening statement (p. 10), the Secretary of the Treasury
charted the immediate tasks of the administration. The essential
items were: reduce the planned deficit and then balance the budget;
meet the huge cost of our defense; properly handle the burden of debt
and obligations; check the inflation; work toward the earliest possible
reduction of the tax burden. In every instance, the administration,
of course, has failed. They have now given us a $13 billion deficit, a
record for peacetime. They have not met the huge costs of defense
but rather have drastically cut defense expenditures. They have
failed to achieve their objectives in the handling of the debt, especially
in re the holdings by banks and the maturity of the debt. They
clearly have failed to check the menace of inflation, and the budget
which the President had promised at $60 billion in 1952 is now around
$80 billion.
With encouragement from Secretary Humphrey, the Government in
troduced a rigid debt ceiling as a means of cutting expenditures down.
2132
th e fin a n cia l con d ition o f th e united sta tes
Unfortunately this debt ceiling has had serious effects. In order to
maintain the debt ceiling and not spend in excess of it, the Govern
ment has endangered the integrity of the budget. By all kinds of
devices the debt has been kept down for accounting purposes, but only
by selling assets, refusing to make payments that were parts of a
contract, pulling items out of the regular budget, and the like. Even
the defense effort has been seriously jeopardized by the debt ceiling.
(See S19 and S20.)
In the recession period, the Government refused to use antirecession
policies adequately- As a matter of fact, by the second quarter of
1958, when the GNP had fallen by $17 billion, Federal spending had
increased by only $1 billion. Indeed, there has been a substantial
recovery since. But the question still remains whether we would not
have had a much greater recovery had the Government introduced a
tax cut in 1958, even a small one, and also had substantially lifted its
spending program. With higher incomes the deficit would un
doubtedly have been cut. The Government still had not learned that
in periods of recession the appropriate policy is to increase spending
and reduce taxes. They seemed to have a glimmer of this idea in 1954,
though it is not at all clear but that the objective at that time was to
keep the promise of a tax cut and not exactly to stimulate the economy.
Indeed, we must recognize that fiscal policy directed toward stabil
izing the economy and achieving greater growth is only one objective
of the economic system. Indeed, the need of expenditures for security
may be a more important objective than the stability of the currency.
Furthermore, there are questions of equity that must be considered.
(See S22.)
G. D ebt M anagem ent
Little evidence is available that the Eisenhower administration has
improved the structure of the national debt. In fact, the commercial
banks held larger amounts of securities in December 1958 than at the
end of 1952. Furthermore, they have not lengthened the maturities,
as we shall see. (See S23.)
Why did the Government fail to issue long-term securities in the
anti-inflationary period and why did they issue long-term securities
in the recession? Almost all economists agree that the job of the
Federal Government, when the objective is higher money rates, is to
issue long-term securities and absorb excess money; and in a period
of recession the one thing the Federal Government must not do is to
compete with the money market when the authorities through other
measures are trying to bring about monetary ease. Yet the Federal
Reserve and the Treasury between them operated in a perverse
manner. They issued short-term securities in the boom and long
term ones in the recession until quite recently. This is a matter for
investigation by the Senate Finance Committee. The only defense
offered by the Treasury was that they did not like to interfere with
the private market when the private market was anxious to expand
its activity. But surely the objective of stability is more important,
(See S24 and S27.)
When confronted with the increase in the rate of interest on Govern
ment securities. Secretary Burgess' defense was that this would involve
the transfer of income from one group to another. But Senator Long
made it quite clear that those who receive the interest are not neces
sarily those that pay the taxes. In fact, he showed that most mem
THE FINANCIAL CONDITION OF THE UNITED STATES 2133
bers of the population did not hold savings in any substantial amounts.
(See S25.)
One of the hottest issues in the course of the hearings was that of
the lengthening of the maturity of the debt. Actually, the record of
the Treasury was not as good as Secretary Burgess claimed. He was
able to show a decline in the floating debt, but only by excluding
E and H bonds. In other words, he excluded E and H bonds and
included other savings bonds. If he had been consistent and excluded
all savings bonds or included all of them, he would have shown an.
increase in the floating debt. (See S26.)
In 1951, an agreement had been made for reducing the support of
the Treasury security market. Another innovation by the Federal
Reserve was the bills only policy, which tended to weaken its hands
in the control of the economic situation. It is of some interest that
despite the earlier criticism of the Truman administration, the Federal
Reserve has supported the Government bond market at crucial
moments and has also abandoned the bills only policy when the
pressure was too great*
Finally, we have the problem of independence. Should the Federal
Reserve be independent? In the hearings before the House Com
mittee on Government Operations in 1958, this issue was fully
thrashed out. The Federal Reserve has contended, as has the
President, that the Federal Reserve should be independent. The
President has gone so far as not to make recommendations in his
annua ;report on monetary policy. This seems an absurd position
when it is realized that the responsibilities of the Government for the
economic health of the Nation are great. In view of this fact, it is
very important that the Federal Reserve should integrate its policies
witn other agencies and departments of the Government, and this
cannot be done so long as the Federal Reserve is independent* An
independent Federal Reserve means independent agencies all over,
with disastrous effects on a well integrated policy.
H. S elective C ontrols
Much evidence is available that, had the authorities in the adminis
tration been willing to support selective credit controls, they might
have been made available. But the Federal Reserve and the Treasury
spurned such offers. Their position seemed to be that selective
controls involved meddling in the system. But they failed to note
that general measures in the monetary field were uneven and in
equitable in their incidence; and the net effects, in contrast to selective
controls, could be much more damaging to the economy.
I. A nother V ie w
of
F ederal R eserve P olicy
S tability
and
E conomic
Late in 1958, the Senate Banking and Currency Committee released
a report on Federal Reserve policy which was very critical of Federal
Reserve policy in both 1953 and 1957—58. The writer of this report,
with the minutes of the Open Market Committee available, found no
such concern for inflation in 1957 in that Committee as Chairman
Martin reflected in his statements and policies. Again, the report
was critical of the Federal Reserve for raising rates in August 1957
when, at the very least, it was clear that the boom had lost its potency
and a downward movement was on its way.
PART
II
HEARINGS AND COMPENDIUM: DIGEST AND COMMENTS
1. The hearings of the Senate Finance Committee on the investigation of
thefinancial condition of the United States.
The investigation of the financial condition of the United States
used up 29 days in the summer of 1957 and 9 days in the spring of
1958, the total pagination amounting to 2,090 pages, exclusive of a
758-page compendium based on replies to questions. In what follows,
the pages will be given and those in the compendium will be prefaced
by a “ C ”
I have tried to summarize the hearings, to bring out the major
results and to suggest where we should go from here,
2. Stability of the currency a major issue
I sssx reasonably sure that the American people are very much
interested in financial policy. They realize that the stability of the
price level depends upon financial policy in no small part, and they are
aware of the fact that financial policy also has a considerable effect on
Ojutput. All of us want as high an output as possible in a growing
economy, but we want it, insofar as possible, consistent with relatively
stable prices. These are, of course, relative terms. A rise of prices
of 10 percent with a rise of output of 1 percent is not a very good
record. But an increase of output of 10 percent and a rise of prices
of about 1 percent is not a record to be ashamed of.
In the hearings of 1957-58 on the financial condition of the United
States by the Senate Finance Committee, under the chairmanship of
Senator Byrd, perhaps no issue attracted more attention than that of
the instability of the value of the dollar. This had been a very im
portant issue in the 1952 campaign and undoubtedly contributed to
the Democratic debacle. It is not surprising, therefore, that in the
hearings of 1957-58 the Democratic members of the senatorial com
mittee stressed greatly the failure of the Eisenhower administration
to provide the country with a stable currency. It seemed shocking
to many members of this committee that in the period of recession
price rises should average 3 or 3^ percent per year.
Without a doubt, the No. 1 problem for the Republican administra
tion and its spokesmen was inflation. This was clear from the hear
ings. Indeed, the Chairman of the Federal Reserve Board, Mr.
Martin, and others suggested that we now have the responsibility
for growth; but what they emphasized above all was the need of con
taining or even stopping inflation. Mr. Martin not only sees the
usual dangers of inflation, that is, injustices to those with fixed in
comes, distortions in the production process as the residt of inflation,
but he and his supporters emphasized especially the point that a
creeping inflation must inevitably become a more violent inflation;
that is, a galloping inflation. Above all, the job of the Federal
Reserve, in his view, seems to be to stop any inflation. Since 1957,
2134
THE FINANCIAL CONDITION OF THE UNITED STATES 2135
Mr. Martin and members of the administration have been seeking
congressional support for a clear-cut mandate that stabilization of
the currency should be a fundamental objective of policy. On other
occasions, for example, in the 1920's and 1930’s, when Congress
wished to thrust upon the administration of the Federal Reserve the
objectives of a stable price level, the Federal Reserve has protested
on the grounds that they were not capable of stabilizing the price
level. Now they seem to come out for such a responsibility to be
imposed on them by Congress.
At the opening hearings, Senator Byrd made the point that every
body was concerned over the rise of prices.
The committee cannot overlook the fact that responsibility for sound currency
is a prime responsibility of the Central Government.
*
*
*
*
*
*
*
Actually, confidence in the American dollar is the principal deterrent in the
world today to Russian aggression. The pages of history detail the stories of
nations which have been wrecked by unsound fiscal policies and debased currencies.
If the value of the dollar continues to drop at the rate of 2 cents a year, as it has
in the past year, it will be worth only 25 cents in 12 years, as compared to the
1940 dollar.
This committee wants to know the causes of this new inflation, and it wants to
find the remedy before the consequences become disastrous (pp. 3-4).
Witnesses before the committee repeatedly echoed these sentiments.
In his opening statement, Chairman Martin asserted (p. 1262):
The objective of the [Federal Reserve] System is always the same— to promote
monetary and credit conditions that will foster sustained economic growth
together with stability in the value of the dollar.
This goal may be thought of in human terms and should be. The first part
may be considered as concerned with job opportunities for wage earners; the
latter as directed to protecting those who depend upon savings or fixed incomes,
or who rely upon pension rights. In fact, however, a realization of both aims
is vital to all of us. They are inseparable. Price stability is essential to sus
tainable growth. Inflation fosters maladjustments.
According to Mr. Martin, the Federal Reserve Act and the Employ
ment Act of 1946 supply the Federal Reserve with a mandate to seek
price stability in conjunction with economic growth (p. 1518):
Mr. M artin. I think if you read the Federal Reserve Act, and take it in con
junction with the Employment Act of 1946, which was also the law, that those
objectives are quite explicit.
Senator M alone. You go beyond the Federal Reserve Act. The 1946 Employ
ment Act is where you get this objective. You did not get it out of the Federal
Reserve Act, did you?
Mr. M artin . Well, not line for line out of it. I supplemented it.
Later, Mr. Martin conceded that his mandate to pursue price
stability is not as explicit as he would like (p. 1520):
Senator M alon e. Would it not be more desirable to state the objective of the
System is to maintain the integrity of the U.S. dollar, its honesty and soundness?
* Mr. M artin. I think you could have stated it more explicitly than in the
present act.
Senator M alon e. You think it would be a good addition to the act?
Mr. M artin. I do not think it would be necessary. I think the most necessary
amendment is to make clear what I believe to be implicit in the Employment
Act. * * *
Of the several witnesses who dealt with this issue, only Prof.
Howard Ellis seemed satisfied that present legislation provides the
43994—59------4
2136
THE FINANCIAIi CONDITION OF THE UNITED STATES
Federal Reserve System with a mandate concerning price stability
(p. C599):
All three of the objectives [price stability, growth, and stability in production
and employment] are important for the economic policy of the United States;
all three have, in my judgment, quite correctly, been so designated in the Employ
ment Act of 1946.
Most of the other witnesses urged that the Employment Act be
amended to direct the pursuit of price stability; they did not seem
satisfied with its present preamble. In the words of Mr. Alfred
Hayes, president of the Federal Reserve Bank of New York (p. C76):
There has been much discussion during recent years on the merits of inserting
a clause in the declaration of policy in the Employment Act of 1946 making the
maintenance of price stability a stated objective of Government economic policy.
The closing phrase of the declaration, which refers to promoting “ maximum
employment, production, and purchasing power,” has been interpreted as meaning
maximum sustainable levels, and we believe that requires avoidtwice pf, either,
inflation or deflation in any marked degree. I would, therefore, favor the proposal
that the declaration of policy be amended to include explicitly stability of the
value of the dollar among the objectives of national economic policy.
By January 1959, the President was echoing the views of Mr.
Martin. In his annual Economic Report, he also urged the need of
stable prices. He appealed to the consumers to shop around carefully,
to businessmen to be aware of the relation of lower prices and increased
market, but he appealed especially to labor; and he, like Martin,
would make reasonable price stability a goal of Federal economic
policy and amend the Employment Act of 1946. Accordingly:
Leaders of labor unions have a particularly critical role to play, in view of the
great power lodged in their hands. The economic actions must reflect awareness
that the only road to greater material well-being for the Nation lies in the fullest
realization of our productivity potential and that stability of prices is an essential
condition of sustainable economic growth.
The terms of agreements reached between labor and management in wage and
related matters will have a critical bearing on our success in attaining a high level
of economic growth with stable prices. It is not the function of Government in
our society to establish the terms of these contracts, but it must be recognized
that the public has a vital interest in them. Increases in money wages and other
compensation not justified by the productivity performance of the economy are
inevitably inflationary. They impose severe hardships on those whose incomes are
not enlarged. They jeopardize the capacity of the economy to create jobs for
expanding labor force. They endanger present jobs by limiting markets at home
and impairing our capacity to compete in markets abroad. In short, they are,
in the end, self-defeating.
Self-discipline and restraint are essential if reasonable stability of prices is to be
reached within the framework of the free competitive institutions on which we rely
heavily for the improvement of our material welfare. If the desired results
cannot be achieved under our arrangements for determining wages and prices,
the alternatives are either inflation, which would damage our economy and work
hardships on millions of Americans; or controls, which are alien to our traditional
way of life and which would be an obstacle to the Nation’s economic growth and
improvement.
The chief way for Government to discharge its responsibility in helping to
achieve economic growth with price stability is through the prudent conduct of its
own financial affairs. The budget submitted to the Congress for the fiscal year
I960, which balances expenditures with receipts at a level of $77 billion, seeks to
fulfill this responsibility. If Government spending is held within the limits set
in the proposed budget, the growth of our economy at the rate that may be
expected would make it possible in the reasonably foreseeable future to provide,
through a significant further step in tax reform and reduction, added incentives
and means for vigorous economic growth and improvement.
Governmental actions in other areas can also help to maintain price stability as
our economy expands. The Congress will lie requested to amend the Employ
ment Act of 1946 to make reasonable price stability an explicit goal of Federal
THE FINANCIAL CONDITION OF THE UNITED STATES 2137
economic policy, coordinate with the goals of maximum production, employment
and purchasing power now specified in that act. Steps will be taken within the
executive branch to assure that governmental programs and activities are ad
ministered in line with the objective of reasonable price stability, and programs
for the enlargement and improvement of public information on prices, wages, and
related costs, and productivity will be accelerated.
But by June 1959, the President had not made much progress in
getting across his recommendation for a revision of the Employment
Act of 1956. Actually, over a period of 10 months there had been no
net change in the Consumers Price Index.
This does not mean that important rises did not occur—largely
offset by reductions in foods. Especially striking was an increase in
the price of solid fuels and fuel oil of 6 percent in 8 months, of trans
portation of 4 percent, of medical services of 3% percent. The first
two suggest the importance of administered prices and the last the
shortage of medical services, inclusive of hospitals, under the rising
pressure of demand in turn related to the advance of insurance. A
very large rise in the wholesale index for metal and metal products
also points to the significance of the administered prices.
3. A creeping inflation inevitably brings a galloping inflation?
Especially fearful of the conversion of a creeping inflation to a gal
loping inflation, many of the authorities stressed the dangers of creep
ing inflation. Thus Hugh Leach, president of the Federal Reserve
Bank of Richmond, puts it (p. C103):
*
* * The whole concept of creeping inflation is dangerously misleading, for
a chronic inflation cannot be either mild or controlled. If the public in general,
and business in particular, should become convinced that a continuous lose of
purchasing power were inevitable, the incentive to save would be greatly reduced,
the incentive to spend sharply increased, and the end result could only be an
acceleration of inflationary pressures. The process would tend to feed upon itself
and eliminate any possibility that the pressures could be controlled within narrow
limits.
Even among economists, Dr. G. Colm (p. C591), Prof. H. Ellis
(p. C601), Prof. G. Haberler (p. C624), and Prof. T. Yntema (p. C754)
there was some fear of a long inflation blossoming out into a large
inflation.
It is not exactly clear why this position was taken. Actually, over
a period of 10 years, aside from the effects of the Korean war, the rise
of prices did not average more than about 1 percent a year. This rise
of prices of 10 percent, aside from the effects of the Korean war,
should be compared with an increase in gross national product at
stable prices of about 40 percent. Even if the Korean war were
included, the rise of output would be twice as great as that in prices.
It would have been better if prices could have been stablizea, but
surely the history of the last 10 years does not give strong support for
the view that a creeping inflation must inevitably result in a great
inflation.
It is now more than a year since the hearings of the Finance Com
mittee were concluded, and more than half a year since my original
report was written. The Federal Reserve authorities still emphasized
especially the dangers of inflation—despite the remarkable stability
of prices for almost a year.
The President, the Secretary of the Treasury, and the Chairman of
the Federal Reserve Board continue to harp upon the great dangers of
inflation. One of the first to bring back reports on the weakness of
2138
THE fin a n cia l con d ition o f th e un ited sta tes
the dollar was Mr. Martin. The implication was: Why should the
dollar be weak except that wages and prices were rising too rapidly
here? This threat to the dollar is also presented as an excuse for
cutting expenditures for defense and welfare. How much would our
dollar be worth if our defenses are cut so that we lose the cold or the
hot war?
Losses of gold and dollars to foreign interests have indeed been a
matter of speculation, and possibly o f concern. In a period of a year
we lost $2 billion-plus of gold, a record loss; and the losses continue*
Also, there have been substantial rises in short-term liabilities o f
American banks to foreigners.
After a period of 40-50 years in which the dollar was scarce, this
sudden reversal arouses anxiety. It is easy to put the blame on the
rise of wages and prices that tend to make the United States less
competitive. But for many years prices have been rising much more
abroad than in this country, and losses of competitive position then
being corrected at least in part by devaluations. But even in the
years 1955-58, when infaltion was of special concern, inflation in the
united States was not out of line:
Percentage rise of cost of living, 1955-58
United States______________________________________________________
8
Brazil.--------- ---------------------------------------------------------------------------------------------
64
Germany_____________________________________________________________ ____
Italy______________________________________________________ _____ __________
8
8
France----------- ------- ------------------------------------------------------------------------United Kingdom_____________________________ ______________________
8
12
Inflation, which leads to a loss of competitive position, may suggest
to many the need of balanced budgets, anti-high-wage policies, and
higher rates of interest. W hy the last? Because with higher rates
of interest capital would flow in instead of out, and therefore the out
ward flow of gold would be reduced or stopped.
But it is clear we have not experienced a relative inflation and more
recently any inflation. There may be a weakening of our competitive
position; but the explanation lies primarily in the continued recovery
of our competitors from the ravages of wars. Our competitive posi
tion has been abnormally strong since the war.
That we continue to lose gold is explained also in part by military
expenditures abroad of $3.3 billion in 1958, of unilateral transfers
(gifts) of $2.3 billion, and capital exports of $4 billion, or outflows of
$9 billion plus as compared to gold, etc., losses of about $3 billion.
An examination of world exports suggests that the United States is
far from being in a weak position. From the table below, we note
that her export position improved abnormally in 1957, in part because
of the Suez crisis, and hence had to deteriorate in 1958. But she
maintained well her export position from 1950 to 1958 with her share
of world exports being 18.6 percent in 1958 as against 18.0 percent in
1950. Her ratio of exports to world exports in 1950 was larger than
before the war. But as might be expected, in part under the stimulus
of American aid, the relative share of world exports increased relatively
and notably for Germany, Japan, and Continental Europe, in that
order (American aid strengthened these economies). The United
Kingdom actually experienced a relative decline in her share of world
exports. But these large relative gains for our major competitors
reflects largely the low position held in 1950 as compared to prewar
THE FINANCIAL CONDITION OF THE UNITED STATES 2139
In one sense, the U.S. position is weak. The IMF reveals that
imports of the United States and Canada, which were 17 percent of
world imports in 1937, had increased to 25 percent in 1957* Exports
in the same period had increased from 16 to 18 percent.
In this connection, note the following:
From 1913 to 1954, U.S. exports of manufactures rose more than
twice as much as those of all major industrial countries—a reflection
of rising competitive power.
Her total exports increased from 22 percent of exports of 10 major
industrial countries in 1913 to 26 percent in 1938 and 34 percent in
1954, an indication of larger gains than suggested by the IMF com
bined figures of the United States and Canada in relation to world
trade.
But against this we note a rise in the percentage of imports for the
United States among 10 leading industrial nations from 15 to 24
percent in these years, respectively.
Exports, world and various sectors and countries, billions of dollars and percentage
of world, 1950, 1955, 1957, and 1958
1955
1950
1957
1908
Billions Per Billions Per Billions Per Billions Per
of
of
of
centage
centage
of
centage
centage
dollars world dollars world dollars world dollars world
W o rld ..........................................................
United States......... ..................................
Continental Europe................................
United Kingdom................ ....................
Germany.....................................................
Japan.......................................................... .
57.23
10.28
14.31
6.32
1.98
.82
18.0
25.0
11.1
3.4
1.4
84.79
15.55
26.06
8.47
6.13
2.01
18.3
30.6
10.0
7.2
2.4
101.0
20.86
31.75
9.68
8.6
2.86
96.0
17.86
31.75
9.39
8.81
2.88
20.6
31.4
9.6
8.5
2.8
18.6
33.1
9.8
9.2
3.0
Source: I M F , International Financial Statistics, M a y 1959 (m y calculations).
Undoubtedly, a factor reflecting the problems for this country is
the relative decline of exports of raw materials and food, drink, and
tobacco, as well as the large increase of imports. To this changing
composition of trade, this country will have to adjust by producing
more raw materials and food at home, economizing on their use,
increasing exports of manufactured goods or (and) cutting down on
loans ana aid programs and travel abroad.
Percentage trade, United States, among 10 major industrial currenciesf 1918, 1938,
and 1954
Exports
Raw ma
terials
1 9 1 3 ...................................................................................
1938.....................................................................................
2954
......................................................... .........
40
25
19
Imports
Food, drink,
and tobacco
23
20
12
Raw ma
terials
11
16
24
Food, drink,
and tobacco
11
14
a*
Increased imports of raw materials are the rule among industrial
countries. Thus, the 10 important industrial countries had an adverse
balance on raw material accounts of $2,834 million in 1938, and $9,650
2140
THE FINANCIAL CONDITION OF THE UNITED STATES
million in 1952, as compared to an overall deficit of $1,272 million in
1938, and a credit of $106 million in 1952.1
Hence, I conclude that it would be a mistake to justify higher
interest rates, monetary restraint, and balanced budgets irrespective
of our security and welfare needs, on the grounds that our dollar
position has deteriorated dangerously. Our annual losses of gold are
still a fraction of our loans and gifts.
4- Wage push and inflation
In the discussion of the inflationary problem, the contribution of
rising wages did not receive a great deal of attention. This may un
doubtedly be explained by the fact that the politicians who testified
were fearful of putting the blame on the trade unions or laborers.
Indeed, there were moments when Secretary Humphrey came pretty
close to saying that a significant amount of unemployment might
contain the demands of the workers and therefore keep prices down.
But he did not say so directly. In the current discussion of the
inflation, many authorities in Washington and elsewhere have held
that trade union wage policy was the fundamental factor in raising
prices. Obviously, if the workers send wages way up beyond the
point justified by higher productivity, then it does become more
difficult for the Federal Reserve to contain the inflation. If they cut
supplies of money so that the increase in wages is not validated by
an adequate rise in the supply of money, then the only result can be
a reduction of demand and a reduction of output. Higher wages are
reflected in reduced output. Professor Angell (p. C531) has put the
issue as follows:
*
* * a “cost-push” is not itself an independent factor forcing prices up.
We must look further for the explanation of “inflation” * * * this explanation
must obviously lie in the expansion of aggregate monetary demand. If sellers
try to put up their prices but monetary demand has not increased proportionately,
either buyers will not pay the higher prices, and prices will fall back again; or
they will pay the higher prices, but will buy smaller physical quantities. On a
nationwide scale, the latter alternative means falling output and unemployment
It is not at all clear that the wage inflation has been the fundamental
factor in the recent rise of prices. In fact, a study by the Bureau of
Labor Statistics, issued by Mr. Clague, shows that the nonwage ele
ments contributed as much to the rise of real costs per unit from 1947
to 1957 as the wage element.
Another indication of the net movements is given by a study by
Mr. Murray Wemick, senior economist of the Federal Reserve Board,
who showed that, from a base of 1947-49, unit wage costs rose by
15,7 percent by 1957, whereas the wholesale industrial price index
rose by 25.6 percent. Again, between 1947 and the spring of 1957,
unit labor costs in the iron and steel industry had increased 35 per
cent, but the steel industry had raised priced by 96 percent, or 2 to 3
times the increase in labor cost. The cost per unit of other materials
and services purchased by United States Steel, aside from some direct
labor costs, increased 37 percent in a period of 10 years. Obviously,
prices rose considerably more than was justified by the rise of wages
or even of other costs.
In its careful study, the Council on Prices, Productivity, and In
come of the United Kingdom in its first report (p. 24) emphasized
1 Statistics in table and last few paragraphs from R , E . Baldwin, “ The Commodity Composition of Trade:
Selected Industrial Countries, 1900-1954,’ ' Review of Economics and Statistics, February 1958, pp. S50 to
871.
THE FINANCIAL CONDITION OF THE UNITED STATES
2141
especially as a factor accounting for a rise of prices and income the
view—
that the main cause has been an abnormally high level of demand for goods and
services in general, maintained for an abnormally long period of time.
In this period, there have been many large programs, partly as the
result of the war and partly in order to assure high levels of em
ployment.
Monetary systems “have evolved in such a way as to make easier the expansion
of the flow of transactions to match the so-called needs of trade— whether these
reflected a growth in the volume of goods and services exchanged or merely a
general rise in their prices. Firms and individuals emerged from the war with
abnormally large holdings of money and other liquid assets. Further, for a
number of years after the war the general tendency of monetary policy was to
permit ready expansion of the money supply and to maintain relatively low
rates of interest. Thus the state of high liquidity persisted for a long time.”
In other words, though this committee does emphasize the con
tribution of rising wages enforced by powerful trade unions, they
also make the point that the availability of a high degree of liquidity
and the willingness to expend large supplies of money made possible
the great inflation of prices and income.
Along somewhat similar lines, Professor Haberler has argued, in
the “ Review of Economics and Statistics,” that the Federal Reserve
has to restrict the supply of money in order to impose upon the
economy a substantial amount of unemployment. This is the price
that has to be paid in order to prevent a great inflation.
In the hearings many of the witnesses blamed the trade unions for
the inflation. See, for example, the following in the compendium:
pages 201, 221, 227, 233, 245, 250, 273, 294, 304, 311, 332, 349, 410,
445, 451, 474, and 576. Mr. Ralph J. Cordiner, president of General
Electric (p. C192), had this to say:
Union officials do not appear to be concerned with protecting the economy
from inflation. They disclaim responsibility for the inflationary effects of their
excessive wage demands, and seek to shift the burden to other groups in the
economy. They claim special protection for their members, in the form of
escalator clauses to provide automatic wage increases to offset the tax of inflation
which shows up the increasing cost of living, and they demand further inflationary
increases in pensions, insurance, and other benefits. They seek political support
by demanding increased social security and unemployment benefits to make up
for the declining value of the dollar, and a topheavy tax structure which reduces
their share of the inflated costs of government. Relying on these special privi
leges, they ignore the fact that the wage earners suffer more than any other
group from the periodic recessions that come from inflation, because they bear
theprimary burden of unemployment.
When Congress originally granted union officials the privileges on which their
monopolistic powers have been built, the Nation consented in the hope that these
powers would be used with such wisdom and sense of responsibility as to con
tribute toward greater economic growth and stability. Experience has shown,
however, that these powers have been abused in an irresponsible attempt to
gain special privileges at the expense of the Nation as a whole, while the penalty
for these abuses has fallen most heavily on the group which was presumed to
benefit from them.
It is abundantly clear that by these abuses the union officials have forfeited
whatever right they may ever have claimed to the enjoyment of such special
privileges and immunities. Curbing the monopoly power of unions is a necessary
first step if the economy is to be effectively protected against the cycle of infla
tionary spirals and business recessions, by the use of sound Government fiscal
and monetary policies and the exercise of sound business judgment.
2142
THE FINANCIAL CONDITION OF THE UNITED STATES
A similar view was expressed by Marriner Eccles (p. 1700):
Finally, we must recognize that future inflation cannot be prevented so long
as the Government is willing to let the monopolistic powers of labor organizations
go unchallenged. These organizations, which have grown immensely in size and
power (about 25 percent of the entire labor force), must be made subject to the
antimonopoly laws of Government to which business has always been accountable.
Without such control, there is no limit to their demands, all of which, in the
final analysis, must be paid ior by the entire American public through higher
prices.
Prof. Arthur Burns, the former Chairman of the President’s Council
of Economic Advisers (p. C527), wanted to regulate the trade unions
to a greater degree and offered a threat of further regulation if their
monopolistic policies continued to be inflationary.
Although I believe that inclusion of reasonable stability of the price level
among the objectives of the Employment Act would help to reshape the wage
policies of our trade unions and both the wage and price policies of business firm
it would be desirable for the Government to go further at this time. Business
monopoly is prohibited by law, and the enforcement of our antitrust laws has
of late been very vigorous. Trade unions, however, enjoy immunities under the
law that are denied other groups or individuals. Our antitrust laws need strength
ening in their application to the business world, as the President and many leaders
in the Congress have repeatedly pointed out. The least that we can do with
regard to trade unions is to subject their finances, as well as the election of their
omei&ls, to standards defined by law. Such legislation would of itself have no
effect on what happens at the bargaining table; but it should help to remind the
leaders of our trade unions that unless they practice greater restraint and fore
sight, the Government may need to take drastic steps to curb their power to
push up costs and prices.
In his statement, George Terborgh argued that the increase in wages
cannot come out of profits except in a temporary manner. A large
drain of profits would result in serious effects on production (pp.
C678-C679).
S. Higher prices and excess capacity
Secretary Humphrey was certain that plenty of competition existed
in the iron and steel industry and that therefore the industry could not
regulate prices and send them up in excess of a rise given by costs.
The Secretary had this to say (p. 613):
Senator G ore. Do you really contend, Mr. Secretary, that the classical law
of supply and demand operates now and does operate normally in the
steel industry?
Secretary Humphrey. Well, it was operating very normally 4% years ago.
Senator G ore, Well, I think that would require a definition of what you call
normal. In view of your prior knowledge of the steel industry, not current-----Secretary Humphrey. Weil, it was operating the way I have indicated, when
I was in it.
Senator G ore. With a very few who control the supply in an item which the
Nation must have to sustain its industrial economy, you think that the operation
of the law of supply and demand is normal?
Secretary Humphrey. I think so. I think that, in my experience, you can have
just as difficult competition and just as effective competition with a small number
of strong companies as you can with a large number of weak ones.
In reply to Senator Kerr, Secretary Humphrey contended that it was
the increase in demand for all kinds of goods which was exceeding
supply that explained the upward pressure on prices (pp. 102-103).
Chairman Martin took a similar position (pp. 1218—1219):
In the second half of 1955 and in the course of 1956, aggregate demand appeared
sufficiently strong to permit increases of wages and other costs to be recovered
through price advances. With the demand-cost price spiral well underway,
expectations of continued inflation became widespread. These expectations, as
THB FINANCIAL CONDITION OF THE UNITED STATES
2143
well as the advanced level of prices, are major influences on continued strong
demand for funds. * * *
The factors wliich contribute to inflation are those which lead to a
rate of spending in the economy greater than the rate at which goods
and services are being made available on the market at existing prices.
But Senator Kerr showed quite clearly, in discussions with Secretary
Humphrey (pp. 103 and 108) and with Under Secretary Burgess that
they could not reveal many items that were scarce in the summer of
1957, that is, when there was an excess of demand. This, in fact,
was the beginning of a long discussion of the possibility of inflation in
conditions of excess capacity. The following is germane (pp. 772-773):
Mr. Burgess. * * * That is one interesting part of this thing, that it is not a
shortage of individual commodities.
Senator K err. Are there shortages in other things than specific items?
Mr. Burgess. I just enumerated them. We seem to think we are short of
utility plants and short of tankers and office buildings, because we are spending
enormous sums to build them.
Senator K err. There is no shortage of materials out of which they are building
them, Mr. Secretary.
Mr. Burgess. I did not say they were short. There are shortages of teams of
workers in the technical skills required for the finished product.
*
*
*
*
*
*
*
Mr* Burgess. I did not say general shortage of labor. I say the skilled teams,
of the skilled teams that build some of these things. I think it is more a matter
of managerial crews, and so on.
But in a later discussion (p. 1388), Chairman Martin was not
so clear.
In my statement, I made clear what out thinking on it was, which is that there
are no specific shortages or bottlenecks, but there is a broad general pressure on
all of our resources.
Chairman Martin did not explain how, without any specific short
ages and a broad, general pressure of demand, there should be a general
rise of prices.
For the Presidents of the Federal Reserve Banks, the crucial point
was that wage rates contribute toward the inflationary process. The
wage increases were induced, in their view, by excess demand and a
shortage of labor (pp. C6, C7, and C17).
Some of the positions taken by the Federal Reserve authorities
seem to lead nowhere. For example, Mr. Riefler, the Assistant to the
Chairman of the Federal Reserve Board said (p. 1359):
The consumer is spending his money, and prices are going up. Ihere is no
question that prices are high. Prices could not go up unless they were spending.
In Mr. Martin’s view (p. 67), the consumers were spending money
they did not have and that was sending up prices.
6. Monetary restraints and unemployment
Of course, one of the major issues was the effect of monetary policy
on employment. The charge made against the Federal Reserve was
that by its excessive concern with inflation it had brought about,
through the reduction of the supply of money, much unemployment.
This greatly worried Senator Kerr. He wanted to know why the
country should not have maximum employment as well as a stabilized
value of the dollar.
THE fin a n cia l con d ition o f th e united sta tes
2144
Senator K e r r . All right. Now I want to ask you this question: Which do
you regard as the more important, stabilized value of the dollar or stabilized
maximum employment?
Mr. M artin. Maximum employment every time. No question about it.
Senator K e r r . Well, do you think we have that today (1958)?
Mr, M artin . No, I do not think we have it today. But when we talk about
employment, and the mandate of the Employment Act, we intended jobs that
«ould be sustained, not jobs that are temporary in nature.
Later, this exchange occurs (pp. 1914-1915):
Senator K e rr. There are the words “maximum employment.”
Mr, M artin . Also maximum purchasing power.
Senator K err . How can you have maximum purchasing power without
maximum employment?
Mr. M artin . Well, do you want to describe full employment as being that
level of employment which is consistent with maximum purchasing power?
*
*
*
*
*
*
*
Mr. M artin . I think the dollar should never be our master. It should be our
servant; but I do not believe you can get away from the fact that the business
machine depends upon a dollar that has integrity and value, saving and invest
ment, and all of the factors that go into this machinery, the lubricating——
Senator K err . H ow about employment that has integrity and value?
Mr, M artin . That comes from this. That is a part of this.
Incidentally, Chairman Martin did not interpret the term “ maxi
mum, purchasing power” in the correct manner. This term really
means maximum aggregate demand and does not mean a stability
in the price level.
The presidents of the Federal Reserve banks (p. C29) said:
It is extremely difficult, if not impossible, to keep aggregate demand strong
enough to maintain full employment without spilling over into rising prices,
especially with the close interrelationship between wages and prices under our
present institutional structure.
And Chairman Martin told the committee (p. 1301):
Now in terms of the situation we have been struggling with in the last 6 years;
the only possible means of attaining the objectives of the Employment Act, in my
judgment, are to resist inflation.
What comes first is inflation, and then deflation. In other words, we are
fighting deflation all the time.
Many, of course, have been concerned with the relationship between
full employment and the price level. With high levels of employ
ment it is likely that labor demands higher wages. But it should be
noted that actually this country has not had full employment in the
real sense. In the 1950’s, unemployment averaged more than 4 per
cent, compared to roughly 2 percent, the full employment level of the
British. This may possibly explain the greater rise of prices in
Great Britain than in the United States, a rise in recent years of about
three times as great as our rise in prices.
Along these lines, Professor Haberler has argued, in the “ Review of
Economics and Statistics,” that if the price rise is to be kept to a creep,
it is necessary to bring about unemployment,
_ I expect that after a short breathing spell the price creep will begin again; but
since the money illusion has worn thin and since the breathing spell, if it comes
at all, will be too brief to revive it sufficiently, I do not believe that the price
creep can be kept for long without becoming a trot. Then if steps are taken
to keep the price rise to a creep, unemployment will again increase.
Thus what I foresee is a period with a somewhat greater average volume of
unemployment than we had in the early fifties— something like 5 and 6 percent.
That much unemployment may be needed to keep the wage push to a level
compatible with stable prices. This is the price we have to pay for permitting
THE FINANCIAL CONDITION OF THE UNITED STATES 2145
labor monopolies to push up money wages in excess of the gradual rise in overall
productivity of labor.
But Professor Haberler says nothing about all the other inflationary
factors in the economic situation, including the strong position of
semimonopolistic business units.
In his statement before the committee (p. C623), Professor
Haberler wrote as follows:
The unusual phenomenon of rising unemployment and sagging production
combined with rising prices, which we are experiencing at the present time
(early 1958), is a very dangerous development. It means that we have the worst
of two worlds.
The main reason for this disquieting innovation must be sought in the down
ward rigidity of, and upward pressure on, wages.
Chairman Martin, confronted by some questions from Senator
Martin (p. 1302) had to admit that there must be some bloodletting
in this system; in other words, monetary restraint was required in
order to correct the abuses that had crept into the system.
Senator M artin. * * * If you were faced with the choice between price
stability and temporary cessation of economic growth on the one hand, or creep
ing inflation and continuing economic growth on the other hand, which would
you choose?
Mr. M artin. * * * I do not want a recession of any sort at any time. I do
not want any man to be unemployed in this country if it is possible to avoid it.
But I still think you have to come face to face with the reality that under con
ditions of excess, extravagance, waste, incompetence, and inefficiencj—-under
those conditions somebody has to take a loss.
A t one place, Chairman Martin made it quite clear that he was
prepared to bring about unemployment if the pressure for increased
supplies of money were sufficient. In other words, he would not
tolerate increases in wages that were in excess of productivity
(pp. 1309-1310):
Senator M artin. If the productivity equals the increased cost in wages, there
is no danger, so far as inflation is concerned?
Mr. M artin. That is right. And if we can spread that productivity. What
we want to do is to spread that productivity through the entire economy as far as
we can, and not get it imbalanced and in the hands of a relatively few people.
Senator M artin. Are not more and more contracts including escalator clauses?
Mr. M artin. They are; and cost-plus contracts have become quite common,
also.
Senator M artin. Are not fringe benefits being extended by both Government
and in industry?
Mr. M artin . They are.
Senator M artin. In all of this, has the supply of money and credit been fuUy
adequate to support these increasing demands?
Mr. M artin. I do not know whether it has been fully adequate to support
them, but it is our intention to keep a steady flow of money, as steady a flow of
money as we can have. And if that flow of money does not cover the increases
that are unwarranted, there should be no pressure on us to increase the money
supply just to validate some imbalance which occurs in the economy which is not
warranted by productivity.
On two issues discussed in this section we can now add some material
not available in 1958. First, the fact is that wages do not rise as
rapidly relatively in recession as in prosperity even if inflation prevails.
Thus,"compare the rise of wages in 1948-58 and in 1958. (The rise
in 1958 was much less than one-tenth of that in 1948-58.)
2146
the financial condition of the united states
Percentage rise hourly wages
1MS-58
fmnfap.tnring _____________ ________ _________________________________________
Bituminous coal
________ __ ______________ ___ . . . _______ ____________ _____
Building construction__ _____ . ___________ ________ ______________ __________
___
.
__
__ ____ _____ _____________
Railroads (class 1 ) __
1958
60
59
67
87
3
0
4
7
The second point is that monetary expansion undoubtedly as a
result in part of Federal Reserve policy in recent years has been sur
prisingly restrained. Thus, from 1955 to 1958, demand deposits
rose from $110 billion to $114.5 billion, or 3-4 percent in 3 years. It
is not surprising, then, that as compared to an annual average in
crease of G N P of 4 percent in the years 1948-58, from 1955 to 1958
there was no increase at all.
In this connection I also present a table constructed by Profs.
J. G. Gurley and E. S. Shaw. This table reveals that in real money
(money corrected by the price level) the per capita amounts had
fallen from $484 to $453. This decline should be compared with the
steady rises (with one exception) throughout out history. Ordinarily
per capita supplies of money rise more than per capita income, in
part because with rising income people tend to hold much more in
cash relative to income.
The nominal and real money supply, 1799-1958
[In billions of dollars; dollars]
June
1700............. ............... ............. .............
1819............. ........... ................. .............
1839....... ............................................. .
1849,......................................................
1859................. ......................... .............
1869..................... ..................................
1879..................... ..................................
1889............... - ......... ..........................
1899....................... - _______ _________
1909................. ......... .......................... 1919 . . .
..............................
1929.......................................................
1939_________ _____________ _______
1949......... ................................ .......... .
1958............................................... .......
Nominal
money
supply
Demand
deposits
Currency
outside
banks
Real money
supply
Billion*
Billions
Billions
Billions
0.03
.08
.24
.27
.58
1.66
2.09
3.05
5.61
9.83
22.61
26.80
37.66
111. 19
144.65
$0.09
.09
.26
1.08
1.46
2.16
4.43
8.14
19.02
23.16
31.65
85,92
116.86
$0.15
.18
.32
.58
.63
.89
1.18
1.69
3.59
3.64
6.01
25.27
27.79
$0.03
.09
.29
.45
.95
1.78
3.55
5.31
10.75
14.54
16,31
28.12
48.85
72.20
78.83
Beal money
supply per
capita
$5.8
9 .6
17.4
19.9
31.0
45.6
72.1
86.0
143.7
160.7
155.2
230.9
373.2
484.0
452.9
For sources, see ‘ 'American Economic History, I960,’ ' edited by S. E . Harris.
7. The Federal Reserve responsibility for the recession
In 1957-58, the country experienced a rather serious recession.
There have been all kinds of estimates of the cost of this recession.
I would estimate the cost at least at $50 billion. This is the difference
between what output might have been in the absence of a recession.
This is the cost that was paid in no small part for trying to stop
inflation, though without great success.
Indeed, the recession may be associated with an excess of invest
ment. Undoubtedly investment had increased at a very rapid rate
ever since the end of the war, particularly in 1955 and 1956. This
rate could probably not be sustained. But it is well to remember
THE FINANCIAL CONDITION OF THE UNITED STATES 2147
that excess capacity is related to the demand. In turn, demand is
related to the monetary policy; and if monetary policy cuts down the
total supply of money, then demand suffers and to that extent excess
capacity becomes greater than otherwise.
Expert on the Federal Reserve, Mr. Marriner Eccles, a fo*rmer
Chairman of the Board, observed as follows (pp. 1694-1695 and also
pp. 1700, 1702, 1707, and 1711):
The action of the Federal Reserve curbed the growth in the supply of money
causing the demand to exceed the available supply. Hence, the cost of money
was bid up. This tightness had the effect of increasing the velocity, or use, of
money about 15 percent— a record. This tended to compensate temporarily for
the curbing of its growth. The Federal Reserve was confronted with an unhappy
choice— to permit the supply of bank credit to increase to satisfy demands would
continue the wage-price spiral. To do otherwise would curb the growth of pro
duction and employment, and risk bringing about an economic recession.
We are now witnessing the result of the courageous action which they have
taken.
*
*
*
*
*
*
*
The Chairman. In your judgment, did the policies of the Federal Reserve
System contribute to that recession?
Mr. E ccles. I think so. I think they prevented the growth of the money
supply.
*
*
*
*
*
*
*
Mr. E ccles. I think the Federal Reserve System acted wisely. Had I been
Chairman of the Federal Reserve Board I would have undertaken, I think— would
have supported the same type of policy that they pursued.
The C h a i r m a n . Y o u do not think the high interest rates that existed prior to
October was the main cause of this present recession?
Mr. E ccles. Yes; I do. I think the high interest rates that were brought
about tended to bring about the recession. But I think you had the alternative
of whether you bring about a recession or whether you support and feed an
inflation.
*
*
*
*
*
*
*
Mr. E ccles. Well, I do not think it was deliberately produced. I think that
the Federal Reserve knew they were taking a risk, but I think they were hopeful
that by restricting the growth of the money supply for the purpose of curbing the
inflationary development that was taking place, that the economy could be leveled
out.
Senator K err. That means that the degree of activity reduced-----Mr. E ccles. That is right. But I am not sure that they expected or thought
that it wrould lead to the recession that it has led to. I think they took the risk
all right. They took the risk but I do not believe-----Senator K err. They deliberately took the risk?
Mr. E ccles. Oh, yes, they took the risk because I am sure they felt that it
was their obligation to do it. It was their responsibility.
It is quite clear from these excerpts that the Federal Reserve had
taken the risk of bringing on the recession in order to contend with
the dangers of inflation. It may be recalled that in 1953, when almost
no economist saw any dangers of inflation, the Treasury in cooperation
with the Federal Reserve introduced a dear-money policy which
helped bring on a recession.
M any economists also shared this view that the tight credit policy
helped bring the recession or tended to aggravate it. For example,
Professors Slichter, Harris, and Colm presented this viewpoint in the
following.
Prof. Sumner Slichter (p. 1823):
*
* * Tight credit policy tended to aggravate the tendency of the economy to
contract because it retarded growth in new areas which might offset to some extent
the drop of investment in business plant and equipment.
2148
THE
financial condition of the united states
Harris (p. 2 0 1 4 ):
I was just going to say, of course, that this present recession is partly a cyclical
phenomenon and I don’t put the whole blame on the Federal Reserve.
I think that we might have had some reaction even if they had done nothing,
but actually they helped to accelerate the process and so to that extent, I hold
them responsible.
Dr. Gerhard Colm (p. C579):
The orthodox view is that if cost inflation exists it does not require any other
countermeasures than the old-fashioned demand inflation. As pointed out in
response to question 1 [of the Finance Committee questionnaire], cost inflation
requires an injection of money in order to become effective. Representatives of
the orthodox view, therefore, conclude that to avoid cost inflation the creation
of the credit needed to finance transactions at the higher cost level should be
prevented. There is some logic to this argument. If in the light of cost and
price rises credit expansion is denied by the monetary authorities, then business
activity will contract and if the policy is pursued drastically enough prices will
eventually come down. We got a relatively mild dose of that medicine in 1957.
It contributed to the recession but not enough to bring prices down.
In his 1958 statement, Chairman Martin was inclined to explain the
recession by the investment boom of 1955 and 1956. He would only
accept responsibility in that he had not succeeded in stopping the in*
flation, and the recession generally follows an inflation.
Martin (pp. 1848-1849):
Now the current recession is a reaction to both the investment boom and the
inflation which accompanied it. The growth of business capital spending begin
ning in early 1955 was at a rate that was unsustainable. An economy with a
longrun upward growth trend of about 3 or 4 percent per year cannot sustain for
long an increase in business investment of about 10 percent per year in real terms,
such as we experienced in 1955-56. The investment spending, even if prolonged
by inflationary trends, had at some point to slow down.
*
*
*
*
*
*
*
In the 1955-57 investment boom, inflation aggravated the tendency toward
overexpansion as well as the subsequent decline. Inflation, as I have said, was
the result of an excess of total demands at existing prices over what the economy
was producing, and apparently able to produce under the existing organization
and use of resources. But once prices started up and expectations of additional
price and cost increases were engendered, spending was stimulated further. With
prospective costs rising, business had every incentive to enlarge its productive
capacity at today’s rather than tomorrow's prices. And when investment plans
are made on this basis, a certain amount of uneconomic productive capacity is
likely to be created; that is to say, capacity which does not reflect a basic pattern
of demands undistorted by expectations of rising prices.
The best way to fight a recession is to fight the preceding inflation, and we were
not successful (p. 1858).
I am sorry— but I don’t believe that tight money brought on this recession, and
I do not really think, again we are getting into terms— 1 don’t think it was tight
mone3% I think it was loose money that was the precursor of the present situation
that we are in (p. 1892).
In an exchange with Senator Kerr, Chairman Martin was not very
effective in putting across the position that Federal Reserve policy
had not interfered with production and had not reduced output below
where it would have been. The only blame he would take was that
they had not been restrictive enough. He did not explain that a
greater degree of restriction might have cut employment and output
even more (pp. 1920-21);
Senator K e rr. You thought that [higher interest rates] would be one of the
brakes on the situation, didn't you?
Mr. M artin . One of the governors on the economy, right.
Senator K e rr. Well, one of the governors; that was one of the- things that
would slow it down, is it not?
THE FINANCIAL CONDITION OF THE UNITED STATES 2149
Mr. M artin. That is right.
Senator K err. And that slowing down resulted in the unemployment, did it
not?
Mr. M artin. I do not think so.
Senator K err. Well, didn’t it result in building fewer houses?
Mr. M artin . It resulted in building fewer houses.
Senator K err. Didn’t it result in producing less goods?
Mr. M artin. Not quite— you see, one of the problems we have today is over
capacity.
Senator K err . N o ; one of the problems we have got today is overproduction.
Mr. M artin. Overproduction; all right.
Senator K err. But you see the capacity that was built, Mr. Martin, was built
on the assumption that men had a right to think we would have an economy
geared to full employment.
Men did not know this Federal Reserve Board was going to impose theserestraints, turn that screw tighter and tighter and tighter*
*
*
*
*
*
*
*
Mr. M artin . This is a free country and we have only one apology to make,
and that I made— that is, along with other Government agencies, we should have
been tighter. We should have been more restraining than we were.
Now, on that score, I accept a portion of the blame for the current recession.
But on no other score.
I n e a r lie r p a g e s (1 8 9 6 -1 8 9 7 ) M a r t i n a d m it t e d t h a t th e o b j e c t i v e
o f b a n k c r e d it e x p a n s io n w a s t o s lo w d o w n t h e t e m p o o f th e e c o n o m y ;
b u t h e a r g u e d t h a t th is h a d n o t b e e n a c h ie v e d .
Senator K err. Well, it is a fact, now, Mr. Martin, and we are going to stay
with this until we either prove it or fail, that the restraints on bank credit expan~
sion were calculated to slow down the tempo of the economy.
Mr. M artin. That is correct.
Senator K err. All right.
Mr. M artin. That is correct. No question about that.
Senator K err. And it succeeded?
Mr. M artin. No, I do not think it succeeded-----Senator Kerr. That is what it was done for and that is what happened.
*
*
*
*
*
Mr. M artin. But not as a result of tight money.
slowed down because of the inflationary excesses.
*
*
The tempo of the economy
O n e o f t h e in t e r e s t in g a s p e c t s o f th is e x c h a n g e b e t w e e n C h a ir m a n
M a r t i n a n d S e n a t o r K e r r is t h a t t h e fo r m e r s tr e s s e s e x c e s s iv e e x p a n
s io n , a n d r e la t e s it in n o s m a ll p a r t t o a n in v e s t m e n t b o o m . U n
d o u b t e d l y th e e x p a n s io n o f in v e s t m e n t w a s a f a c t o r t e n d in g t o b r i n g
in fla t io n . B u t th r e e a s p e c t s o f t h is p r o b l e m s h o u ld b e n o t e d a s I
s u p p le m e n t th is d is c u s s io n in J u n e 1 9 5 9 , th e fir s t b e in g t h a t u n lik e
t h e P r e s id e n t a n d th e S e c r e t a r y o f th e T r e a s u r y , M a r t i n w a s n o t e m
p h a s iz in g th e u n b a la n c e d b u d g e t in h is e x p la n a t io n o f t h e r e c e s s io n .
P e r h a p s h e w a s a w a r e , a s th e r e s t o f t h e a d m in is t r a t io n d id n o t s e e m
t o b e , t h a t t h e F e d e r a l d e fic it s d id n o t c h e c k w e ll w it h th e in fla t io n a r y
tren d s.
From the table below, it is difficult indeed to infer that Federal
finance was the cause of inflation.
2150
THE
f in a n c ia l
c o n d it io n
of
the
u n it e d
sta te s
Net cash receipt*, Federal Government, and change* in consumer prices
Calendar year
Excess of
receipts ( + )
aymenl
or payments
Change in
consumer
prices
Percent
1957.
1958.
Source: Economic Report of the President, 1959 (m y calculations).
The second point is Mr. Martin’s excessive concern with the in
flationary dangers. He regrets that stronger and earlier action had
not been taken. Yet the consumers’ price level was 1 1 4 .4 in 1 9 5 3 ,
1 1 4 .8 in 1 9 5 4 , and 1 1 4 .5 in 1 9 5 5 . In 1 9 5 4 , G N P in stable prices
(1 9 5 8 dollars) had fallen by $ 8 billion, or 2 percent or a decline from
trend of about $ 2 5 billion; in 1 9 5 5 , the rise was $ 3 2 billion, or 8 per
cent; for the 2 years, $ 2 4 billion, or about $ 8 billion below the average
for the 8 years, 1 9 4 8 -5 6 , and even more below 1 9 4 6 - 5 2 average. In
view of this history, it is not easy to support the Federal Reserve
position that they had not been sufficiently vigorous in stopping the
inflation.
Finally, Mr. Martin should be reminded that one reason the invest
ment rate could not be sustained was the discouragement of consump
tion induced in part by monetary restraints and recession. Investment
depends upon spending for consumption; the ultimate objective of
investment is increased production and sale of consumption goods.
T h e “ F e d e r a l R e s e r v e B u l l e t i n ,” in A p r i l 1 9 5 9 , h a d t h is t o s a y :
Improvement in general economic conditions by the summer of 1958 created
an environment favorable to renewed expansion of installment credit. Better
incomes and expectations strengthened the willingness and ability of consumers
to use credit as well as their demand for goods purchased on credit. Competition
among lenders and better collection experience encouraged the expansion of credit
operations. On the other hand, relatively large pockets of unemployment and
rising costs of funds to lenders were unfavorable factors.
Extension of installment credit turned up early in the second quarter of 1958
about the time of the upturn in general business activity. They regained pre
recession levels by December and rose to new highs in the early months of this
year.
8. Rise of money rates and construction
A n t i c i p a t i n g t h a t m a n y o f h is o p p o n e n t s w o u l d c r it ic iz e t h e h ig h
m o n e y r a t e p o l i c y a s a f a c t o r c o n t r ib u t i n g t o w a r d d e c lin e s in c o n
s t r u c t i o n , S e c r e t a r y H u m p h r e y d e a lt w i t h t h is in h is o p e n i n g s t a t e
m e n t (p p . 2 7 - 2 9 ) . I n g e n e r a l, h is p o s i t i o n w a s t h a t m a n y n e w
p r o g r a m s h a d b e e n i n t r o d u c e d b y t h e a d m in i s t r a t i o n a ft e r 1 9 5 2 , a n d
th e s e h a d c o n t r ib u t e d t o a l i b e r a liz a t io n o f fin a n c in g p r o v i s i o n s a s
w e ll a s a r is e in t h e t o t a l n u m b e r o f h o m e s b u ilt . N o t o n l y h a d
g u a r a n t e e s g r e a t ly r is e n , b u t t h e F N M A s p e c ia l- a s s is t a n c e p r o g r a m s
“ h a v e b e e n in n o v a t e d s in c e 1 9 5 2 t o p r o v i d e m o r t g a g e s u p p o r t f o r
r e lo c a t i o n , r e d e v e l o p m e n t , a n d r e h a b i li t a t i o n h o u s in g u n d e r s e c t i o n s
2 2 0 a n d 2 2 1 o f th e N a t i o n a l H o u s i n g A c t , f o r h o u s in g f o r t h e e ld e r ly ,
a n d f o r C a p e h a r t m ilit a r y h o u s in g .” H e a ls o p o i n t e d t o t h e p u r c h a s e s
o f m o r tg a g e s b y F N M A a n d s e c o n d a r y m o r tg a g e m a r k e ts w h ic h h a d
b e c o m e v e r y la r g e . T h e g e n e r a l p o s i t i o n w a s t h a t t h e f a c t o r in
THE FINANCIAL CONDITION OF THE UNITED STATES 2151
depressing demand for housing was not primarily the rate of interest
but rather the increased costs of building, inclusive of taxes. Note
the following (pp. 3 3 and 2 6 5 ) :
This shows that the $10,000 house in the spring of 1946 cost $19,000 in the
spring of 1957; and of the amount of increase in monthly payments, $55.07,
$46.46 was due to other costs and $8.71 was for interest.
*
*
*
*
*
*
*
Which has been the major factor in discouraging construction? The $9,000
increase in building cost ($46.36 per month), or the 1-percent increase in the cost
of interest ($8.71 per month)?
While interest is an element in the cost of mortgaged homes, the increase in
interest rates has not been the major factor in delaying home construction.
Mortgage interest rates were higher in 1955 than in any prior recent year; yet
new nonfarm housing starts were the second highest in history; at more than
1,300,000
*
*
*
*
*
*
*
Senator F rear. Now, Mr. Secretary, if we use that yardstick, how do you
claim your current monetary and fiscal policies are resulting in success in the
field of housing?
Secretary Humphrey. I think that during this period housing was in very
large volume, the largest volume that it has ever been*
Now, I think that our policies and during that same period the cost of housing
was rising, the latter part of the period, the cost was rising very rapidly. I think
our policies are tending to stabilize and will tend to stabilize the cost so the price
of the house will not go up so much, and in that way it will again stimulate the
development of additional housing.
Housing was getting to a place where it was beginning to price itself out of the
market.
In general, the point was made frequently during the hearings that
what was keeping housing down was the low rate on VA guaranteed
housing. The relative absorption of this market was less than other
markets, because the rate of interest had been kept down. Of course,
this does not deal with the general problem of why rates in general
rose. In competition with other markets, obviously a market that
keeps its rate down may fail to attract the necessary supplies of cash*
9. Government spending, credity and the recession
Throughout the hearings, Secretary Humphrey did not discuss the
problem of the Government contribution through reduced spending
to the recession. For example, in the calendar year 1955, the Federal
Government's deficit on a cash basis was $729 million; but in 1956,
this was converted into a surplus of $5,525 million and in 1957, one
of $1,194 million. The Government had become an absorber of
potential spending funds instead of a net disburser and hence con
tributed toward inadequate buying. In this connection a large cut
in new defense contracts in the second half of 1957 should not go
unnoticed.
Its dear money policy cut the increase of active money to 3 percent
in 1956 and to 1 percent in 1957. This is indeed a low percentage
increase for an economy that is supposed to grow several pereent a
year and an economy in which an increased proportion of the total
supply of cash is hoarded as incomes rise.
The following table indicates the effects of the Federal programs.
It will be noticed that the contribution of consumer credit and mort
gage debt tended to decline from 1955 on. Once the economy gets
accustomed to substantial increases in this kind of credit, a reduction
in the contribution tends to have a depressing effect. This, in turn,
is of course related to the rate of interest.
2152
THE FINANCIAL CONDITION OF THE UNITED STATES
Millions of dollars change, 1955, 1956, and 1957
Consumer credit__________ __________________ ____________________
Mortgage debt ________ ___________________________ _____________
19$T
im
1055
+ 6 .4
+ 1 6 .2
+ 3 .4
+ 1 4 .7
+ 2 .7
+ 1 1 .6
Senator Long (p. 1402) showed that an increase in interest rates
from 4 to 5 percent raised the total interest cost on a $10,000 20-year
mortgage by $1,294.91 and increased the monthly payment by 8,9
percent. That raised the total interest charge on a $10,000 30-year
mortgage by $2,149.78 and increased the monthly payment by 12.4
percent (p. 1402).
In an exchange between Senator Anderson and Secretary Humphrey,
the following occurred (pp. 548 and 556). Senator Anderson obtained
some telling admissions by Secretary Humphrey.
Senator Anderson. The National City Bank has a publication which I read,
which comes to me from another source out in my country, the First National
City Bank monthly letter for June, and I notice on page 63 “tightness in the supply
of money and credit and the rise in interest rates hit the homebuilding industry
harder than most other lines.”
Secretary Humphrey. I think that is true.
Senator A nderson. You would agree, then?
Secretary Humphrey. I think that is so. It is operative there more rapidly,
because homebuilding does not take as much preliminary work; it does not take
as long in planning, and does not take as long in development as building a
plant or a factory. In other words, the commitment in plant expansion has to
be done over a longer period than it does in home expansion.
*
*
*
*
*
*
*
I think, as I said before, Senator, I think that it does take effect, and it has
taken effect more in building, small building, and residential building than it
has in large capital construction because of the fact that the former is done over
a shorter period, planned over a shorter period, and the financing is provided for
over a shorter period. So that we have had quite a demonstration, this experi
ence that housing has been more affected than capital expenditure; the figures
demonstrate that.
In this particular passage, the Secretary failed to note that the
interest rate has a greater effect in housing than in industrial invest
ment, because housing mortgages are for longer periods of time, and
therefore the costs are higher and interest rates are greater. Obvi
ously, if the Government increases the rate of interest through its
monetary policy and if the mortgage market is more inflexible, this
results in the diversion of money from the mortgage market to other
areas of lending.
In a sense, the high money rate policy has resulted in cash being
diverted from the mortgage and housing market into industry. This,
of course, contributed to the investment boom. Senator Anderson
(p. 548) made this dear in a colloquy with Secretary Humphrey.
Senator Anderson. On new plant and equipment, the rise (in expenditure^
was about $8.6 billion, or more than a third in those 4 years.
Secretary Humphrey. Yes.
Senator A nderson. And from the first quarter of 1956 to the first quarter of
1957, the rise was at the rate of about 13 percent. But residential construction
is down 7 percent in the 4-year period and 18 percent from the peak. Would that
indicate that the money has been pouring into plants and equipment and away
from housing?
Secretary Humphrey. I think that is right. I think that is exactly what has
happened.
THE FINANCIAL CONDITION OF THE UNITED STATES
2153
A t one point, Under Secretary Burgess admitted that the tight
money policy had seriously affected the mortgage market. In fact,
he pointed out that the billion dollar F N M A operation in 1966-57
was inspired by these conditions (p. 1061).
*
* * We were hit by a situation where we had to buy a lot more mortgages
than we would have preferred, and I think it was right to do so because as I think
I have stated before, when you do have a credit restraint in an inflation, it hits
some people more than others, and it hits some people who are not in a position
to bear the flow as readily, and you have a social responsibility to try to ease that
blow a little here and there.
In turn, of course, the decline in new housing starts would affect
the market for durable goods, and smaller amounts of refrigerators,
television sets, washing machines, et cetera w’ould be required.
10. Dear money effects on different markets
One of the disturbing aspects of the dear money policy and one to
which the Government authorities and the Federal Reserve authorities
had little to say was the fact that different markets were hit in different
ways. There is much to be said for the general idea that the large
business corporation was not hurt very much by higher money rates
and in fact improved its competitive position as its smaller competitors
were confronted with difficulties. Other victims of the dear money
policy were, of course, State and especially local governments that
were trying to raise large sums of money especially for schools.
Senator Kerr submitted evidence to this effect during the interrogation
of Secretary Humphrey (pp. 463-464).
In a statement of the National Education Association (pp. C 400C401) the following was said:
All public school expenditures are ultimately paid from tax revenues, largely
those of States and local governments. Annual current expenditures are met by
current tax revenues of school districts or by appropriations from the State and (to a
small extent) from the Federal Government. The payment of capital expendi
tures from tax revenues is largely deferred by school districts, by the issuance of
bonds which are a first obligation on the local tax revenues. These bonds are
then retired over a period of years from local tax revenues.
The workability of this system of capital financing is currently threatened by
high interest rates and congestion in the tax-exempt bond market. This comes
after a decade of increased construction and borrowing activity with no period of
diminishing activity in sight.
School bond yields, even those with attractive tax-exempt interest feature*,
have been forced to move closer to the yields of non-tax-exempt securities te
attract investors. In 1946, high-grade tax-exempt bonds, including school
district bonds, were 0.89 percentage points below corporate bonds of the highest
grade. By 1957 these tax-exempt yields were only 0.29 percentage points below
the corporate bonds.
It is hoped that your committee will give attention to the precarious state of
capital financing of public school plants. Questions are raised here of how publie
education can compete in the money market with private borrowers m times
when, partly by Government action, the supply of money is limited. Educational
needs frequently cannot be deferred until the school districts can afford to borrow.
Hence, many school districts borrow at high rates—the payment of the principal
and interest of which may jeopardize the future of the educational program should
economic conditions reverse.
A t earlier hearings, for example before the Joint Economic Com
mittee, on monetary policy, 1955-56 (pp. 23 et seq.), the Congress
had been warned about the increased costs of borrowing. For ex
THE FINANCIAL CONDITION OF THE UNITED STATES
2154
ample, Mr. Arthur Levitt, comptroller of the State of New York, said
as follows;
The cost of borrowing to finance school construction has been rising alarmingly.
In 1951-52 capital outlay for the schools was $170 million, and the average rate,
of-interest on the money borrowed by the school districts was 2,85 percent.
In June 1956 the average interest rate on school borrowings was 2,760. Evi
dence of the tight money policy playing more and more pressure upon the money
market is found in the interest rate which prevailed in school borrowings the
past month.
In November 1956 the average rate was 4.078 over the life of the bond issue.
It cost districts and taxpayers $2,8 million more for the $13.8 million borrowed in
November than it would have cost them in June. * * *
The $5.5 million bond issue of Union Free School District No. 5 in the town of
Hempstead was sold on November 15 at an interest rate of 4.3 percent.
Four years ago this same district sold its bonds at 2.7 percent. If the 1952
rate had continued, the difference in interest payments over the life of the bond
issue would be $1,383,767—enough to build a school for 900 pupils.
Secretary Burgess was not very sympathetic with the problems of
&tate and local governments (pp. 1040-1041). Indeed, as he argues,
the demand was great, and the tax-exempt feature was becoming of
less importance because of the need of appealing to those to whom the
tax-exempt feature meant less than to the very high income groups.
But, nevertheless, the high-money-rate policy of the Government and
the Federal Reserve certainly was a contributing factor.
A great deal of unhappiness among State and municipal people exists about the
interest rates they are paying, and I sympathize with them. But the fact is,
they have borrowed more money in these 3 years than ever before in their history,
and there just is not that much money of that sort available.
Their demands have overflowed the bounds of the tax-exempt market, so they
have to sell their bonds to people for whom the tax exemption is not of great
value, so their rates have gone up faster than interest rates in other places.
But they cannot blame the Federal Government for that. They are just
trying to borrow more money than there is available.
*
*
*
*
*
*
*
And some of these buildings that are being built, schoolhouses and courthouses,
and so forth are— * * * are somewhat more expensive than they need to be,
to put it mildly,
11. Money rates, savings, and investment
One objective of higher interest rates was increased savings. This
oint was made time and again. In fact, at one point Chairman
lartin forgot his earlier discussion of excess capacity and insisted
that an increase in savings was necessary even if the effect was to
reduce the total amount of consumption. Senator Long cornered the
chairman at this point (p. 1357):
J
Mr, M artin. I think the important thing at the moment is to increase savings
That has to come out of the consumers.
Senator Long. Since you mentioned that subject of increased savings, do you
believe that it would be desirable to increase consumer savings even in order to
finance plant expansion, even though this means a considerable reduction in con
sumer spending resulting in a considerable reduction in production of consumer
goods at a time when we have a large amount of industrial expansion, that is,
industrial facilities, to spare?
Mr. M artin. I do not think we have a large amount to spare, I think you
have got to recognize the size of this economy.
The chairman did not seem to realize that the volume of savings
depends much more upon income than it does upon the rate of interest.
The most important effect of the rise in the rate of interest is to re
duce investment, and a reduction of investment tends to bring about
THE FINANCIAL CONDITION OF THE UNITED STATES
2155
unemployment. Actually, despite the substantial rise in the rate of
interest, personal savings in the third quarter of 1957 were $20,4 bil
lion and in the third quarter of 1958, $22.5 billion, or a rise of $2.1
billion at the same time that the disposal personal income rose from
$308.7 to $314 billion.
Surely this small rise in personal savings is an inadequate offset to
the very large increase of unemployment and the deficiency of gross
national product, which is to be associated in no small part with the
higher interest rates and Federal Reserve policy.
Where the Federal Reserve was unwilling to validate an increase
in wages and an increase of output, there were other alternatives for
the corporation. Senator Gore made this clear in showing from
numerous statements of the various corporations that an alternative
to external financing which was being depressed by monetary policy
was to pass on the cost of expansion to the consumer (jp. 603):
The chairman of the board of United States Steel advised the stockholders at
the annual meeting on May 7, 1956, that a projection of the financial needs of the
company showed that they would need an additional $140 million. He then pro
posed to the stockholders that the method to use to get expansion capital “ is by
raising prices from time to time— as circumstances require and permit.”
Similarly, the minutes of the Standard Oil Co. of New Jersey for the meeting
of the board of directors on December 13, 1956, showed that “ for the first time
in many years” the company was faced with the probability that they would have
to use something more than internal financing to “ cover replacements, moderniza
tion, and expansion.”
However, as it inevitably turned out, this company was able to increase its
prices to the extent that it was unnecessary for the company to resort to external
financing.
This type of price inflation primarily to finance expansion, is actually encour
aged, not discouraged, by current Government policies. High interest rates and
diminished possibility of competition, both created by current policies, encourage
and invite big business concerns to finance their capital expansion and im prove
ment in large part from inflated prices and consequent swollen profits.
P*The Democratic Senators in particular were impressed by the fact
that, despite the high money rate interest by the summer of 1957t
there was little evidence of a depressive effect upon private business
investment. This was, of course, part of the whole problem. The
incidence of high interest rates and unavailability of money affected
various groups in different ways. M any had suggested that some
control of investment, some control of consumer credit and credit in
other areas might be desirable in order to get the better distribution*
But the Federal Reserve opposed accepting responsibility for the con
trol of consumer credit, or any other new area of credit control.
A t the time, that is, in the summer of 1957, Senator Long and
Senator Kerr were quite right in pressing Secretary Humphrey and
Secretary Burgess in re the failure of the high rate of interest to
reduce investment. They pointed to the high level of interest cur
rently. (See, for example, pp. 340-341, 758, and 813.)
M r. Burgess (p. 759) even conceded that the increased interest
rates may have accelerated business borrowing:
I think there is some anticipation borrowing here. I think if the people wbo
borrow these funds once got the feeling that they could borrow cheaper next
year or the year following and build cheaper or not pay more that this thing would
be over, this thing would level off, you would have a balancing off.
In a discussion with one of the Senators, Secretary Burgess insisted
that the important thing was (pp. 1166 and 1089) the availability of
credit rather than its costs.
THE fin a n cia l con d ition o f th e un ited sta tes
2156
I make a distinction between money rates and credit availability. I do not
admit that the present less ease in credit availability has not affected investment.
I think it has postponed some investment and put other investment forward in
the future, so I think it has had an effect.
* * * The thing that affects it is not the rate, but the availability of the money.
It is working with the supply of money that largely has the effect.
*
*
#
*
*
*
*
* * * It is a question of whether they can get the money on the kind of terras
they want, apart from the rate. The rate is not the big thing here. People often
overlook that.
But this is really evading the question. A higher rate of interest
which results in a reduced supply of money does, of course, affect
the availability of money. W hat the Secretary was saying here is
that as an increase in the rate of interest reduces the supply of money,
then the banks begin to ration their credit on the basis of relations
with borrowers, quality of loans, and the like.
Since 'writing the above, we have had an analysis of member bank
loans to business. From 1955 to 1957 (October), loans to all borrowers
rose by 47.5 percent. But note the expansion by size of assets,
d early, despite the great advantages held by big business through
self-financing they are also in a favored position vis-a-vis the banks.
Size of borrower (total assets $1,000)
Assets
Percentage rise
of term loans
from member
banks, 1955-57
AH_____________ _______________________________ _______ - _______ ________ ___________ ____________
Less than $50,000.......... ......... ................................................. ..............................................- ......................_
$50,000 to $250,000..................................... ................. ..................... ............................................ .................
$250,000 to $1,000,000,........... ....................... ....................... .............. ......................................................... -
47.5
15.9
44.3
48.2
$5,000,000 to $26,000,000..
37.3
$100,000,000 and over.
50.6
Source: “ Federal Reserve Bulletin,” April 1959.
This article also reveals easier financing obligations for the larger
borrowers. Installment repayment, with interest, of borrowers with
assets of less than $50,000 was 9.96 percent; then costs decline with
size of firm until for those with $5 million of assets or over the charge
is 5.51 percent. The small borrower also much more frequently has
to provide security. The percentage of loans (in dollars) secured
from small to large borrowers was as follows in October 1955: 94
(less than $50,000), 95, 90, 74, 51, 35, 22.5 ($100 million and over).
12. The relation of money and spending
Indeed, a reduction in the supply of money does not necessarily
result in a cut in spending. On this point, the Federal "Reserve was
inclined to be too optimistic. Their failure to stop the expansion and
the inflation is explained in part by the fact that they were not as
effective as they otherwise would have been because of the great
liquidity of the economic system. Business units, for example, had
large supplies of liquid funds. As the monetary authorities reduced
the supply of money, these funds could be used more effectively, that
THE FINANCIAL CONDITION OF THE UNITED STATES 2157
is, much more often. All the various financial intermediaries, for
example, the savings banks, the insurance companies, pension funds,
and the like, also had large resources which could be put into use.
These resources, of course, made it possible for a given supply of
money to be much more active and, therefore, to bring about an
increase in spending. Ultimately, of course, this liquidity would be
greatly reduced, but not before the total amount of spending had
greatly risen.
Actually the intermediaries (savings banks, savings and loan associa
tions, etc.) increase the amount of credit by offering higher rates of
interest. The result is a transfer from demand deposits which require
relatively large reserves to liabilities requiring smaller reserves.
From 1952 until 1957 the rise in the supply of money was 7 percent,
a very small rise indeed; but the rise of banking debits was 40 percent.
In other words, the activity of money was increasing greatly as a
result of the liquidity of corporations and also of the ability of the
financial intermediaries to operate independently of the Federal Re
serve. This was a point about which the Federal Reserve had very
little, if anything, to say. In fact, throughout the Federal Reserve
was reluctant to acknowledge its impotence in many of these matters.
It did not refer to the great liquidity of the economic system, nor
its lack of control over the financial intermediaries, nor its increased
difficulties in view of current wage and price policy. The Bank of
England authorities, on the other hand, were very quick to admit
that the possibility of control was much less than it used to be. Per
haps it is fortunate for the economy that the powers of the Federal
Reserve have been restrained by these various institutional
developments.
Just to give an indication of the quantitative aspects of this prob
lem, note that over a period of at least 4 years the total amount of
money had increased by about 7 percent, banking debits by about
40 percent, insurance company assets by almost one-fourth, Federal
credit agency assets by about three-fourths, consumer credit by close
to one-half, and mortgage debts by one-half. These certainly indi
cate a rather loose relationship between the total supply of money
and the total amount of credit made available in the economy.
(These figures were presented before the Joint Congressional Com
mittee on the Economic Report on February 1, 1957, in a paper on
the effectiveness and relationship of fiscal and monetary policy.)
In fact, expansion can take place with very little increase in the
supply of money. Banks tend to accumulate short-term securities
in recession and dump them in prosperity. They can then substitute
loans and investments in non-Federal Government securities. Thus,
during the restrictive period from the end of 1954 to the middle of
1957, commercial banks increased their stake in loans and non-Federal
securities by $22.5 million, though demand deposits and currency
actually declined. Prof. Warren Smith, one of the leading experts
in this area, pointed out that in this period the banks obtained $14.5
billion by selling Treasury securities and $7 billion from an expansion
of time deposits, which require less reserves than demand deposits.
There was a certain amount of inconsistency in the evidence pre
sented by the governmental representatives. Their intent was to cut
down the supply of money, even if it might bring about a recession.
When they were accused of having reduced the supply of money,
th e fin a n cia l con dition o f th e u n ited sta tes
2158
their reaction was: but is there really a shortage of money when
velocity obviously can go up? I quote a statement from Under
Secretary Burgess (pp. 1103 and 1174).
I w o u ld r e m in d y o u o f o u r d iscu ssio n y e s te rd a y w it h re s p e c t t o th e r a te o f
tu r n o v e r o f m o n e y , t h a t in c o n s id e rin g th e a v a ila b ilit y o f m o n e y y o u h a v e to
co n s id e r n o t ju s t th e a m o u n t o f m o n e y , b u t th e r a te a t w h ic h i t is u tiliz e d , t h a t
is, th e v e lo c ity .
A n d i f y o u d o t h a t, th e re is p le n ty o f m o n e y , because th e r a te o f v e lo c ity has
gone u p 10 p e rc e n t in th e p a s t ye a r,
*
*
*
*
*
*
*
S e n a to r C a rlson . I t h in k th a t is one t h in g t h a t h a s g o t to be m a d e a b u n d a n tly
d e a r, because th e re is a n im p re s s io n o u t in th e c o u n tr y t h a t th e y lik e to caU i t
a t ig h t m o n e y p o lic y ; a n d w h e n th e y use th o se w o rd s , th e in fe re n c e is t h a t w e d o
n o t h a v e s u ffic ie n t m o n e y, a n d t h a t th e F e d e ra l R e se rve o u g h t to , th ro u g h
d is c o u n t ra te s a n d o th e r m e th o d s, increase th e s u p p ly o f it .
B u t I t h in k y o u r te s tim o n y p ro v e s c o n c lu s iv e ly th e re is s u ffic ie n t m o n e y th ro u g h
v o lu m e a n d a m o u n t.
M r , Burgess. I a m sure of t h a t S e n a to r, t h a t th e re is p le n ty o f m o n e y fo r
e v e ry so u n d a n d le g itim a te o p e ra tio n in th is c o u n tr y .
IS. Financial intermediaries and increased spending
Senator Anderson confronted Under Secretary Burgess with the
general position that there had been a very large increase in the assets
of financial intermediaries, a factor contributing to the rise of credit.
M r. Burgess’ reply was inadequate. He explained that this kind of
expansion of assets was the counterpart of an increase in savings
(p. 1143).
S e n a to r A nderson. * * *
W h ile y o u w ere h a v in g th is r e s tr a in t b e tw e e n 1952 a n d 1956, th e assets o f these
c o m m e rc ia l b a n k s o n ly increased 13 p e rc e n t; b u t th e sa vin g s a n d lo a n associations*
assets increased 90 p e rce n t.
M r . Burgess. O f course, t h a t is aU to th e good, because th e y a re d e a lin g w it h
s a vin g s m o n e y , t h a t is, th e y are ta k in g th e m o n e y fr o m th e sa ve r a n d p u t t in g i t t o
w o rk . N o w , th e re is n o th in g in fla tio n a r y a b o u t th a t.
T h a t is, th e doU ar th e y p u t to w o rk is p a ra lle le d b y th e d o lla r th e y ta k e a w a y
f r o m th e m a n w h o saves it . T h a t is w h a t we w a n t. T h a t is th e w a y A m e ric a is
g o in g t o g ro w . B y one m a n s a v in g a d o lla r a n d le n d in g i t to a n o th e r m a n to w o r k
w it h , one m a n p o stpo n e s h is use o f t h a t m o n e y . H e w a its .
*
*
*
*
*
*
*
S e n a to r A nderson. T hese c r e d it agencies w e re in c re a s in g th e t o t a l s u p p ly o f
c re d it, w ere th e y n o t?
M r , Burgess, I w o u ld n o t say th e y w ere in c re a s in g th e c re d it. T h e y w e re
in c re a s in g th e a m o u n t o f savings. * * *
I t is c re d it in a c e rta in sense, b u t i f th e c r e d it is d e riv e d f r o m savings, i t has
a n e n tire ly d iffe re n t e ffe ct th a n i f y o u c re a te d i t o u t o f th e a ir.
Unfortunately, it is not necessarily true that the net purchases of
assets by these financial intermediaries, inclusive of Government
credit agencies, all reflect current savings. They may, in fact, reflect
for example, accumulations of cash which are then put to work be
cause the markets are good. Ultimately, of course, there may be
some relationship between the total supply of money and the activities
of the intermediaries. But the relationship is a very loose one.
Inactive money becomes active. Also, the process includes transfers
from demand deposits with high-reserve requirements to time deposits
with low-reserve requirements.
There is much reason to believe, as several witnesses before the
Finance Committee suggested, that the increase of velocity has
undermined Federal Reserve policy in recent years. Where, for
example, one transfers to an intermediary cash that was being hoarded
THE FINANCIAL CONDITION OF THE UNITED STATES
2159
and the intermediary puts that cash to work, this is inflationary.
(See pp. C169, C294, C298, C645.)
On some occasions, the Federal Reseive seemed to argue that they
could control in a very precise way not only the supply of money
but the velocity of money. On the other hand, their failures to stop
the expansion of velocity and the accompanying inflation suggest
their inability to control velocity. The following is of some interest
on this score (Chairman Martin, p. 1307):
We have let the balance of the 2 percent on our 3-percent growth take place
out of the velocity of money, the turnover of money, and we have felt that that
was about right, though I think sometimes we felt that perhaps we have erred
a bit on the side of letting the velocity accumulate faster— it is very difficult to
measure— than the situation warranted.
14. Higher rates and the market for Government issues
One of the effects of the higher interest rates is a depression in the
price of existing bonds. Such increases especially affect the price of
Federal securities. But this apparently did not worry the Federal
Reserve authorities, and Chairman Martin quotes an article from the
Federal Reserve Bulletin (pp. 1237-1238).
At the lower prices and higher yields, Government and other short-term
securities will be more attractive. Nonbank investors may be induced to buy
more of them, using temporarily idle deposit balance. * * *
With prices lower and yield higher on short-term paper, banks are less likely
to reduce their holdings of secondary reserve assets, notably short-term Govern
ment issues. Some banks may continue to do so, but others will stop selling
or many [sic] buy. In the aggregate, the secondary reserve position of banks
wiU tend to stabilize. This development is brought about in several ways.
Many banks and other potential lenders are reluctant to sell securities at a loss.
As the potential loss becomes greater, this reluctance deepens. * * *
*
*
*
*
*
*
*
Thus in a period of tightening credit, long-term lenders and investors, while
at first attracted by the higher yields available on assets of less than top grade,
gradually become more restrictive and selective. They become less willing
to sell prime securities to acquire higher yielding but more risky assets, partly
because they can sell the prime securities only at a loss, which they hesitate
to accept. * * *
The fact is that the high rates of interest have been a signal to the
financial intermediaries, and especially the commercial banks, to
desert the Government bond market and to turn to their customers,
who borrowed at high interest rates.
In the years before 1951 the Federal Reserve and others were
critical of the Treasury for insisting upon the support of the Govern'
ment bond market. According to the accord of 1951 the support of
the Government bond market was to end and monetary policy was
to be determined on the basis of the general needs of the economy.
Undoubtedly, the Government bond market had attracted too m um
attention in the determination of policy up to that point.
The Federal Reserve policies of 1956-58, however, had a somewhat
different result. Instead of supporting the Government bond
market, the authorities in fact encouraged a desertion of the bond
market by financial institutions. Despite the above quotation, it
is clear that this has been the net result. For example, from 1954 to
1957 financial institutions, under pressure of induced higher rates and
unavailability of credit, disposed of $19 billion of public securities*
Purchases of $15 billion by Federal agencies, State, and local govern
ments, individuals, etc., required a substantial drop in prices, that is,
2160 THE
financial condition of the united states
a large
increase in rates that increased the annual cost of financing
the debt by a billion dollars in 3 years, or about 15 percent.
On the issue of whether the banks were losing money on the falling
prices of Government securities, Senator Kerr made it quite clear
that this was not so (pp. 918-919).
Senator K e rr. Let us talk about that loss they [the commercial banks] sus
tained.
I know some bankers who, in December of 1956, sold substantial quantities of
the long-term holdings they had at a loss of about 10 or 11 points. They told me
that in so doing they could charge that up against operating income and ieduce
their tax liability by 52 percent of that loss.
Mr. B urgess. I would say that is right.
Senator K e rr. And that then they immediately went into the market and
bought other long terms of comparable maturity. * * *
*
*
*
*
*
*
*
Now if he went out and bought another long term at the same price-----Mr. B urgess. Yes,
Senator K e rr. He could carry it until maturity and only pay a capital gain
on the increment.
Mr. B urgess. That is right.
Indeed, as the price of Government securities declined, the banks
tended to take advantage of the low prices and purchased in larger
amounts. From September 1957 to September 1958, holdings of
commercial banks of the U.S. Government securities increased from
$56.2 to $66.1 billion.
W ith the yield on U.S. Government bonds falling from 3,73 in
October 1957 to 3.12 in April 1958 and then rising to 3.76 by October
1958, the banks were at a loss concerning the appropriate policy.
Actually, they tended to purchase at the wrong time. They pur
chased, for example, heavily from January to M ay. In January, the
yield was 3.24 and by M ay, 3.14. These, on the whole, were high
prices. B y October, when the yield had risen to 3.76, they were begin
ning to sell. Financial intermediaries did not show the same interest
in Government securities in 1957-58, as the commercial banks.
15. Proposals to control intermediaries
One of the striking features of the hearings was that not a single
suggestion was made about the control of the intermediaries. Indeed,
there were hints that through the control of the supply of money the
intermediaries were controlled. But in admitting that velocity may
move in a way different than the total supply of money, the Federal
Reserve authorities, in fact, were admitting that they had only limited
control over the intermediaries. It is difficult to explain this silence.
It may be that the Federal Reserve was not anxious to introduce
reforms that might upset the financial intermediaries with whom
they were generally on good relations.
16, Federal Beserve not responsible for higher rates?
Another interesting aspect of the Federal Reserve viewpoints relates
to the frequent announcement that they were not really responsible
for higher rates of interest: They were merely following the market.
Demand had gone up and therefore the rate of interest had risen.
This, of course, was the result of the great pressure put upon the
Federal Reserve, and they found it convenient to deny any inter
ference with the free market forces. If the central bank merely
follows the market, one may ask the question why a central bank is
needed. On the whole, the Federal Reserve policy was a courageous
THE FINANCIAL CONDITION OF THE UNITED STATES
2161
one; but in denying any net effects on the rate of interest the Federal
Reserve was, in a sense, taking the same position as the Treasury
when it insisted that by issuing long-term securities at 3 % percent in
1953 they were having no effect on the market. Typical of the Federal
Reserve position here is the following reply of Chairman Martin to
Senator Williams (p. 1316):
* * * There may be circumstances where it would be desirable for the redis
count market [rate?], if we thought there was heavy pressure building up, to lead
the market just a little bit.
But generally speaking, we recognize that the market forces are the ones that
are controlling— that we can influence the market. We never want to take the
position that we do not have any influence at all— that market forces just produce
all these changes. Otherwise, there would not be any reason for our existence.
We influence them. We lean against the wind when we can determine which
way the wind is blowing. But we never try to usurp the function of making the
wind. Whenever we think we can make the wind, we think we are in trouble.
In insisting that the Federal Reserve followed the market, Chairman
Martin was virtually abandoning responsibilities of a central banking
system for leadership. Actually, of course, through its bank rate ana
especially through its ability to indulge in open-market operations,
the Federal Reserve can, of course, to a considerable extent determine
the amount of money available and therefore the rate of interest.
There have been numerous experiences when the Federal Reserve
clearly did try to influence the rate of interest and the total supply of
money, and sometimes with success. We can go back to the late 1920*8
episode, the great open-market operations in the early 1930-s, and the
making available of billions of dollars of credit to finance the Govern
ment during World War II. But here is Chairman Martin's position
(pp. 1424-1425):
This is a technical problem, in my judgment, and it seems to me that the problem
Is that the banks are closer to the loan demand than we are—we follow it very
closely, but after all, banks are the first line on the matter of judging loan demand,
and they decided to go up in their prime rate to 4^ percent.
Now, with a Wt percent prime rate and a discount rate of 3 percent—and we
have had a bill rate in excess of 3 percent for nearly 9 months— it means that the
policing of the discount window by the individual reserve banks has a good bit
more strain with a VA percent spread than it had with a quarter of 1 percent spread.
I believe you can police the window effectively, but our judgment in the Board
and throughout a good portion of the System was that this was a technical situa
tion; we would have just as much difficulty explaining not going up in the rate as
we would explaining going up in the rate; and we recognized it as a technical
operation and therefore increased the rate.
Now, if the expected demand for loans this fall does not materialize, then the
commercial banks were in error in raising their prime rate. If there should be a
decline in loans of a substantial amount this fall, and business should taper off, we
might want to consider reducing the discount rate.
In a later period, in the fall of 1957, it is quite clear that the Federal
Reserve actually led the money market in the decline of rates. Many
have, of course, criticized the Federal Reserve for increasing its rates
in August 1957, when it was already clear to many that the recession
was well on its way. (See, for example, pp. C271, C330, C410, C384,
C335, C537, C620, C630, C661.) Chairman Martin’s defense of the
August increase (p. 1849) was not very impressive.
* * * Federal Reserve discount rates were raised one-half percentage point in
August in order to relate them more closely to market rates which had been rising
for some time and in this way to maintain their effectiveness in restraining bank
credit and monetary expansion. That action also served as an indication to the
business and investment community that the Federal Reserve rejected the idea
that creeping inflation was inevitable.
2162
th e fin a n cia l con d ition o f t h e u n ited sta tes
17. Federal Reserve policy in the recession
While we are discussing the Federal Reserve policy, we should say
a word about the recession policy. The Byra committee had not
really had an opportunity to deal with this problem, and I hoped it
would in the next session. After a year of recession, member bank
reserves had declined, and excess reserves had increased by the neg
ligible sum of $100 million. In fact, in June 1958, after a year of
recession, the volume of demand deposits and currency was exactly at
the level of a year earlier. Though we are supposed to have learned
much about monetary policy since the early thirties, this program
should be contrasted with the vigorous open-market policy o f the
Federal Reserve in treating the recession of the early thirties. Even
by September 1958, the total amount of demand deposits and currency
was only $136 billion, as compared to $139.7 billion in 1956, $138.6
billion in 1957, and $133.3 billion in September 1957. From August
1957 to October 1958, excess reserves varied generally between a half
billion dollars and $600 million, though in M ay 1958 the figure was
$700 million. This does not suggest any aggressive measures to deal
with the recession. Throughout this period, the Federal Reserve was
still worried about the oncoming inflation. Indeed, the total in
debtedness of banks at the Federal Reserve had fallen from about
$1 billion to $400 million. But, in my opinion, the Federal Reserve
puts altogether too much emphasis on the volume of indebtedness as a
factor in determining policies of commercial banks.
Since writing the above, material has become available through
April 1959. This period from October 1958 to April 1959 has been
one of expanding business activity. From the third quarter of 1958
to the first quarter of 1959, seasonally adjusted G N P has risen by
$23 billion (with prices virtually stable) or 5 percent in one-half a
year, a very satisfactory rate of growth. But during this period of
6 months (November to April, inclusive) unemployment averaged
about 1.5 million above the 3 millions that may be considered a
reasonable achievement.
Federal Reserve policy, with the Board still concerned over in
flationary dangers, was cautious. In October 1958 and March 1959,
the Reserve banks raised their rediscount rates. In this period of 6
months, member bank reserves increased only by less than $200
million, or about 1 percent; demand deposits and currency by $3
billion, or 2 percent, loans and investments by $5 billion, or 2 X
percent, and Government securities held declined by $2.5 billion, or
about 4 percent. Consumer prices were virtually unchanged. Later
we shall evaluate more fully the Government's policies in 1958-59.
18. Fiscal policy: Objectives and achievements
In the course of the Byrd hearings, considerable space was given to
the issues of fiscal policy. It is well to remember that before the 1952
election President Eisenhower had promised us a $60 billion budget.
The budget estimated in the summer of 1958 for the fiscal year 1959
was $79 billion, and current estimates for the 1960 budget are a few
billion dollars below that figure. At any rate, the promise of a
$60 billion budget seem to be largely forgotten now.
In his opening statements, Secretary Humphrey made it clear that
he was going to present a political document which would show that
THE FINANCIAL CONDITION OF THE UNITED STATES
2163
the Republican administration had improved greatly on Democratic
policy. He said (p. 10):
Our immediate task is to chart a fiscal and economic policy that can—
First, reduce the planned deficits and then balance the budget, which
means, among other things, reducing Federal expenditures with a safe
minimum;
Second, meet the huge cost of our defense;
Third, properly handle the burden of our inheritance of debt and obli
gations;
Fourth, check the menace of inflation;
Fifth, work toward the earliest possible reduction of the tax burden^
Sixth, make constuctive plans to encourage the initiative of our citizens.
It is clear that these objectives have not been achieved. Not since
the budget of 1946, which included large war expenditures, has there
been a deficit like $12 billion, the deficit planned for fiscal year 1959.
In the 8 years of the Republican regime, it looks now like 6 years of
deficit and 2 years of surpluses.
In 1952, the national debt was $259 billion, as against $269 billion
in 1946. But by fiscal year 1959, the national debt had risen to
$283 billion and legislation has now been enacted authorizing a tem
porary limit of $295 billion. Clearly the promise of a reduced debt
had not been achieved, and that despite the fact there had been a
large reduction in defense expenditures, which may prove disastrous
to the country. Major national security, which cost $50 billion in
fiscal 1953, had fallen to $41 billion in fiscal 1955 and is estimated
at $46 billion in fiscal years 1959 and 1960. At prices of 1959, the
security program has been cut from $60 to $46 billion, or roughly
by one quarter.
Later we shall see whether the national debt has been handled ade
quately as the Secretary promised. His fourth objective was to check
the menace of inflation. Indeed, in the first few years of the adminis
tration the stability of prices was well maintained. But the same
cannot be said for the years 1956-58. To have had an inflation in the
midst of a recession is an achievement.
The fifth goal, work toward the possible reduction of the tax burden,
is clearly out of the picture. The tax burden has continued to increase.
The Secretary of the Treasury and the Chairman of the Federal
Reserve were quite clear on the disastrous effects of deficit spending.
Said Secretary Humphrey (p. 65):
I think that there is nothing that wiU push you along the road to inflation much
faster than large government deficit financing.
M r. Martin (p. 1317) had this to say:
I think that— I never favor deficit financing, although I recognize that it oaa
sometimes have an impetus on our economy.
But again, it is like debt, that I commented on yesterday: It is not a situation
to be desired. Under certain circumstances it may be useful, but—-and I do not
want to make a blanket statement on it, but I never favor deficit financing. I
think it is wrong in principle; and I think it is not really the benefit, even when It
is used, that those who claim it has the benefits think it has.
For M r. Burgess the important point was that the creation of eredit
by banks for private enterprise produced goods which satisfied hum an
needs; but a creation of money for the Government was wasteful, an d
the debt unproductive (pp. 1129-1130):
*
* * that is a point we always try to make, that when the Government spemfti
money, it does not produce goods which the people can buy.
2164
THE FINANCIAL CONDITION OF THE UNITED STATES
On the other hand, if we have an increase in commercial loans of banks, the
mechanical effect at the borrowing window may be just as inflationary as with the
Government, but the people who borrow use the money normally to produce
goods or services which meet human needs, so it tends to balance off the additional
creation of money,
*
*
*
*
*
*
*
May I put it another way: that we ought to draw a distinction between pro
ductive debt and nonproductive debt. One comfort that I take out of the present
inflation, which is a capital goods inflation, is that it is producing this great ex
penditure of capital for machinery to produce goods which will meet the demands
of the people, so it contains within itself, I think, some of the seeds of its correction.
The Chairman (Senator Byrd). Government debt certainly is not productive
debt; is it?
Mr. Buroess. Government debt is not productive; therefore, it is the worst
kind of debt.
Obviously, the distinguished members of the Government were not
exactly correct here. Expansion of investments through the creation
of money can also bring a great deal of inflation. In fact, the extension
of credit to business in the years before the recession contributed to
ward the inflation. Nor does it follow that a government borrowing,
for example, to build schools or roads is providing unproductive credit,
whereas the individuals who obtain money to gamble or to buy
television sets are productive borrowers.
19. The debt ceiling
So strong was the administration against debt and growing public
debt that Secretary Humphrey (p. 258) had this to say about the debt
ceiling:
*
* * I think that the restraint the present debt ceiling gives to the Executive,
to the. Congress, to everyone concerned is a very wholesome thing to have, and
I think that it is like breaking through a sound barrier; there is an explosion when
you go through it; and there ought to be one.
On the whole, the debt ceiling was an unfortunate episode in
American economic history. The support in Congress for a rigid
ceiling would have been much less without the encouragement of the
Treasury.
In an excellent article, to be published in the National Tax Associa
tion Bulletin, Prof. Walter Heller, of the University of Minnesota,
makes clear the dangers of the debt ceiling. He shows that the
ceiling has been a major factor in prompting—
(1) manipulations to remove certain spending items from the budget entirely
(e.g., in 1953, $1.3 billion of price support loans), (2) proposals in 1955 for highway
financing outside of the conventional budget and outside the debt limit, and (3)
substitution in 1957 of costly agency borrowing for cheaper Treasury borrowing.
In periods of prosperity when the debt should have been reduced*
the debt ceiling had very little effect. But in recessions like 1953 and
1957-58, the ceiling was a serious obstacle to proper financing by the
Government. In 1953, the Commodity Credit Corporation sold
$1.2 billion of certificates of interest to commercial banks, against a
nationwide pool of support loans on grains. This episode was related
to the debt ceiling, but I believe also to a general tendency on the
part of the administration to conceal its real credit situation.
How serious the situation may become is brought out in an article
in the Wall Street Journal of September 7, 1957, as quoted by Professor
Fiscal chiefs struggled to stay under the debt limit. They seized on new
tactics. The defense officials postponed every postponable spending item beyond
THE FINANCIAL CONDITION OP THE UNITED STATES
2165
the critical next few months. They confer with major contractors on delaying
payments. Thus urgent operating, maintenance outlays will wait until after
January. The Budget Bureau holds hack funds to keep other agencies from ex
panding employment as much as Congress allows, at least for now. Other
weapons are on reserve. Farm officials consider selling private hank certificates
representing shares in a pool of price support loans; the cash would ease the cur
rent squeeze. The Federal National Mortgage Association can sell more se
curities privately, pay off some of debt owed to Treasury. Money men talk of
last-ditch moves of escape if the deht ceiling gets desperate. Defense officials
say they could stop paying all bills until January tax receipts roll in.
Professor Heller well says:
The debt limit, then, has served as an ethical shield behind which assaults have
been made on the fidelity of our Federal budget. I put it this way because some
of the manipulative practices described above were attractive in serving quite a
different purpose, namely, to make the budget look smaller than it really was—
sort of an incredible shrinking budget—but they might not have been dared
without protective casuistry of the debt ceiling.
Perhaps the most serious aspect of the debt ceiling was the fact that
the administration cut back its program for its long-term national
security in the second half of 1957. According to Business Week
(Nov. 2, 1957):
Here are some major Defense Department actions in recent months that are
related to the campaign to save the debt ceiling: (1) the service has stretched out
production schedules for at least 19 big plane and missile projects. (2) Overtime
for defense contracts was restricted. (3) Installment buying of weapons was
banned. (4) A $38 billion spending ceiling for fiscal 1958 was clamped on,
stimulating a new round of program reshuffling. From this action came the
5 percent reduction in progress payments; an order to contractors to cut payroll
costs 5 percent; the Air Forced limitations on monthly payments to contractors,
creating new stretchouts; a 200,000-man cut in the Armed Forces.
In view of what has been said above, the June 1959 request of the
administration for a rise in the debt ceiling was reasonable and was
quickly approved by the Congress. Government spending should
be determined on merits, not through artificial pressures exerted by
debt ceilings. Certainly our experience with the debt ceilings in the
1950’s does not suggest the wisdom of new ceilings.
20. Integrity oj the budget
Since the Eisenhower administration lias come in, what has been
most disconcerting is the attempt to give a misleading picture of the
budgetary situation. There seems to be more interest in balancing
the budget account rather than balancing the budget. Where the
effects on the present budget are not serious, there is a greater inclina
tion to spend. For example, the enthusiasm of the administration,
which might not have been expected on the old-age and survivors
insurance program, can be traced to the fact that the budgetary
effects of this particular program would be felt later rather than
currently.
I wrote recently (“ Review of Economics and Statistics,” November
1956, pp. 3 5 9 -3 6 i):
B alance B udget A ccounts or B udget
Actually the budget has not improved so much as the administration claims.
Early in the Eisenhower administration, the practice was introduced of trying to
balance the budget account rather than the budget. For example, large sums
due to the civil service reserve funds were not diverted to these reserves: CCC
paper and housing mortgages were disposed of to private financial interests. In
4 fiscal years (1954-57), the Eisenhower administration disposed of $1,780 million
2166
T H E FIN AN CIAL C O N D m O N O F CTPB TOOTSD 8T A T S S
of certain capital assets; in the 4 preceding years the Trum an administration had
disposed of but $364 million of corresponding aaseta. These sales yield castLftjgr
the budget, and the income rises relatively to outlays. But though the budget
comes nearer to a balance, the net effect is no genuine improvement: one capital
asset is sold and the income used to pay off debt or keep debt from rising. The
above figures are only part of the story.
Even m 1956 the practice continues. I quote instances below.
1fP U B C H A.SES
OF SOM E M O RTG AG ES
ARE
K E P T O U T OF TH E B U D G E T
“In addition, purchases of mortgages by the Federal National Mortgage Asso
ciation under its secondary market program are expected to increase in 1957 to
$290 million. Except for temporary Treasury loans, the funds required will be
obtained from sale of debentures and stocks to private investors, and the pur
chases are shown as trust expenditures, rather than budget expenditures. By the
end of the fiscal year 1957, private purchases of stock will have made an excellent
start toward the goal of replacing a Government activity with a private
company.”
Again, instead of building post offices, the Government now proposes to rent
from private builders. The current budgetary outlays are thereby greatly re
duced; but whether this is wise or even economical in the longer run is not raised.
“ While these recommendations involve substantial appropriations of Federal
funds, most of the Federal building improvement program will be financed with
private funds under the lease-purchase authority of the General Services Admin
istration and the Post Office Department. Already 53 projects involving private
financing of construction costing $105 million have been approved, and additional
projects involving about $250 million are under consideration.”
An excellent statement of the mythical nature of many of these reductions is
given in the following:
‘‘But the recent estimate of $2.8 billion for this year is perhaps deceptive in that
it does not represent a real decline in aid operations, from the previous year, but
only a shift in their financing from the Government (Commodity Credit Corpora
tion) to the banking system in the amount of $1.2 billion. The further reduction
in expenditures indicated for fiscal 1955 may prove illusory also. A leveling off
of agricultural exports together with acreage limitations on wheat and cotton
planting are exacted to reduce price support operations only slightly, and the
main reduction in dollar expenditures thus hinges on a fairly large turnover of
funds previously invested in loans and commodities; if this should not materialize,
larger disbursements or increased private financing will be required. In this
connection it is to be noted also that the shift from Government to private financ
ing represents a postponement rather than a reduction in the ultimate cost of
price support operations for the Government.
*
*
*
*
*
*
*
“The decline in expenditures * * * for public works and housing between
1953 and 1955 reflects partly a drop of $300 million or 30 percent in reclamation
and rivers-and-harbors projects, together with the transfer to private financing
of over $700 million in housing mortgages and obligations previously financed
by the Federal National Mortgage Association and the Public Housing Adminis
tration. Here, as in the case of agriculture, while the shift from Government to
private financing is reducing expenditures as they are conventionally accounted,
it evidently represents a different kind of reduction than that of the defense pro
gram which involves a smaller consumption of real services and materials. In
the category of 'all other1 programs * * * the reduction from 1953 to 1954 is
again largely nominal: the Government deferred its annual contribution of $300
million to the civil service retirement fund pending further study; and much of
the reduction in the post office deficit by over $200 million was achieved by raising
postal rates rather than by reducing (gross) expenditures. The further reduction
m expenditures held out for 1955 also hinges largely on further action by the
Congress in increasing postal rates.”
An indication of trends in acquisition of assets is suggested by a table not
reproduced here. The tendency to acquire less in the way of assets or even to
dispose of assets (net) and to depend on guarantees and insurance rather than
loans or investments, the latter being reflected in budgetary expenditures and
guarantees and insurance only to a very small degre so reflected—this is evident
in the table.
This table shows the recent trend of cutting down of the acquisition of assets
inclusive of loans, public works, and other physical assets. In 1957 the acquisi
tion of civil assets is $1,426 million less than in 1955. Tne decline in loans is
THE FINANCIAL CONDITION OF THE UNITED STATES
2167
almost $2 billion in 1956 and more than $1,300 million in 1957 (vis-a-vis 1955).
The details concerning reductions in loans are indicated for the Federal National
Mortgage Authority, CCC, and RFC. Not only are assets not acquired, but
they are disposed of net. The resultant improvement in the budget—the ap
proach to balancing—conceals the relative decline of assets. The Government
credit expenditures decline substantially—by about 5 percent, fiscal 1955 to fiscal
1957—even as guarantees and insurance rise by one-third. Again, the budget
looks much better when guarantees rise and loans decline.
Related to this issue is the tendency of the administration to go in
much more heavily for guarantees and insurance than for loans and
investments. W hy this shift in policy? Undoubtedly, one explana
tion is that guarantees and insurance do not appear as a budgetary
expenditure, whereas loans and investments do. From fiscal year
1953 to fiscal year 1959 (estimated), the rise of loans and investments
was 23 percent; of guarantees and insurance, 132 percent, the latter
rising from 28 to 66 billion.
21. Spending policies
We do not want to give the impression that it follows from this
analysis that the Government has been spending too much money.
It may well be that the Government has not been spending enough
money. We are critical, however, that the Government made a
promise which it far from kept. From 1952 to 1957, consumer spend
ing increased by nearly 30 percent. During that same period, the
national income increased by nearly 25 percent, but the supply of
Government services declined by about 6 percent. This raises the
kind of question that Professor Galbraith has raised in his “ Affluent
Society/' namely, whether we have a proper proportion of expendi
tures on the services that Government alone can provide, particularly
in the social welfare field, as against many of the luxurious and rather
dubious expenditures of the private economy. Is there something
not to be said for a change in this pattern of spending?
The contrast m policies is suggested by the following:
The rise of GNP
B O U ant
1948~52________ ______________________________ _________________
1952-56-------- ----- ------- -------------------------------------- -------------------------
$88
65
The rise of cash receipts, Federal Government
B U
i o
i n *
1 9 4 8 -5 2 ........................... ..................... ............ ...................................... - ................... * 2 6 .0
1952-56------------------------------------------------------------------------------------- - ...................
7 .S
Percentage tncrease in cash payments toincrease *» GNP
1948-52................................................................. - .......... ........ .......... — .......... ..........
1952-56......................... ....................... ................... - .......... - ...............- .......................
30
11
Statement before the Joint Economic Committee, January 1957.
These figures do suggest that the Truman administration tended to
share with the public the increase of GNP by absorbing a large per
centage, actually 30 percent of the increase in GNP as against 11
>ercent under the Eisenhower administration, and using a much
arger part of the GNP for the benefit of the people. Indeed, part
of this rise is explained by the Korean war. Prof. Henry Wallich,
now in the Treasury (p. C701) stated the issues wellIn general, J believe that our standard of living has reached a point where the
consumer can get more value in many cases for a dollar spent by tne Government,
f
48M 4—» ------ «
2168
TH B FINANCIAL CONDITION OP THE UNITED STATES
than for a dollar spent for himself. I based this upon m y relative appreciation of
education, research, health, and cultural projects, as against tail fins, TV's, and
soft drinks.
This brings up the issue of the general use of fiscal policy. There
is a widespread view among economists that the Government has
depended excessively on monetary policy and has made inadequate
use of fiscal policy. Thus, Chairman Martin (p. 1856) had this to say:
I would accept the risk of the current deficit that we are running, but I would
not want at this time to undertake to accept the risk of a greater deficit than that
by cutting taxes until the situation is considerably clearer than I think it is at the
present time.
22. Administration’s recovery policy
The administration, of course, held that there should not be an
increase of spending or a reduction of taxes in order to contend with
the recession. As I write these lines, there has been a substantial
recovery, though we are far from having attained the high level of the
peak of 1957. In fact, unemployment is at a high level compared to
the postwar average.
M y criticism of policy is not that recovery is not on its way without
the aggressive measures recommended by most economists, that is,
cuts in taxes and increased spending to meet the problems of the
recession, but rather the failure to act has slowed recovery and, there
fore, increased losses of output much above what they had to be.
Recovery would have been much quicker, and we would have saved
billions of dollars each month had we attained the 1957 level of output
and 4 percent of unemployment, say, by the third quarter of 1958.
Instead of, as seems likely now, in 1959 or 1960. W e are still awaiting
a full recovery. I need not add here that the level of output in 1960
has to be substantially above that in 1957 if we are to attain anything
like full employment, because we have to raise output to make up for
the increase of productivity and the increased numbers entering the
labor market net. That we have had any recovery at all is to be
explained largely by extraneous factors. Among these are the
increase in wage rates, which increased the total amount of spending,
the rise of transfer payments, which are related especially to the
welfare program of the New Deal, and also the increase in military
and severance pay in 1958. Another factor has been the automatic
reduction of taxes as income has fallen. This is another result of tax
policies introduced under earlier administrations.
Actually, the Government contribution was small. As against a
decline of G N P from the third quarter of 1957 to the second quarter
of 1958 of $17 billion, the Federal Government contributed $1 billion
of purchases of goods and services, and State and local governments,
$3 pillion. Indeed, in the third quarter the Government contribution
was larger.
In general, the Government did not use fiscal policy. Indeed, in
1953-54, the recession that was largely brought on by unwise policy
was to some extent reversed by a large cut in taxes. This was the
appropriate policy at that tune. But it should be remembered that
the Government also drastically cut expenditures and therefore the
reduction of taxes was made necessary. From the broad viewpoint
of our defense and security, it is not quite clear that the reduction of
expenditures, which helped bring on the need for a tax cut, was a wise
policy.
THE FINANCIAL CONDITION OF THE UNITED STATES 2169
It is of some interest that the U.S. Chamber of Commerce (p. C504)
did not take the administration's position on these issues.
As a fourth step, the national chamber has recommended a tax cut and tax
reforms to provide greater incentive, both to buy and invest. Even though this
will involve a shortrun, temporary deficit, we think the growth which will be
stimulated by such tax cuts and tax reforms will, in a short time, cause revenues
to increase and again bring the budget into balance.
I argued before the Senate Finance Committee for both a rise of
expenditures and a reduction of taxes (pp. 1993 and 1996):
The case for expenditures rests on higher multiplier than tax cuts and the
distorted pattern of spending by the American people. By the larger multiplier,
I mean only that a dollar of public expenditures yields a larger total rise of income
than a dollar of tax remission, in part hoarded in the first instance.
In re spending patterns, I note this point, that since 1940, the country has
tended to move in the direction of increased relative private expenditures and
reduced public welfare outlays relatively, e.g., on education, health, urban redevel
opment, unemployment.
*
*
*
*
*
*
*
The CED proposes a $7 billion tax cut and rescheduling of outlays. I would
not rely exclusively on a tax cut but would choose first rescheduling and expan
sion of spending programs. I take this position because on the whole tax cuts
favor the “ haves’’ against the “ have nots” and because there is some wastage in
tax cuts. In part the increased income left to the private economy as a result of
a cut is not spent.
The contrast of views is also given by the position of Mr. Erickson,
the president of the Boston Federal Reserve Bank (p. C69). H e was
opposed to tax cuts or increased spending. Mr. Marriner Eccles
(p. 1700) had a somewhat different view:
The course of the recession to date would suggest that if substantial deficit
financing were undertaken, either through temporary tax cuts or increased ex
penditures, inflationary pressures might soon reassert themselves. Restoration
of full employment by means of fiscal policy could lead to the resumption of pres
sures toward higher wages, and they might again rise more rapidly than output
per man-hour.
*
*
*
*
*
*
*
I do not believe that because there is a later danger, which I recognize, of
inflation, that we should do nothing about deflation. I think we have got to deal
with the problem we have now, recognizing that there is a later danger of inflation
and doing something about it, being prepared to deal with the inflationary situa
tion when you get recovery.
*
*
*
*
*
*
*
W ith the lapse of 6 -9 months since writing this, the business situa
tion has greatly improved. Here are the trends from the low of the
recession to the first quarter of 1959.
GNP and components, 1st quarter 1958 to the 1st quarter 1959
[Annual rates in billions of dollars]
GNP
1st quarter, 1968.-................ .......
1st quarter, 1959,.—....................
427.1
467.0
Source: Bconomtelndteators, May1959.
Consumer
expendi
tures
Gross pri
vate do
mestic in
vestment
386.2
400.6
GO. 9
70.2
Federal
Net expend Govern
itures good? ment pur
chases
and serv
goods and
ices
services
1.7
-.3
49.7
54.3
State and
local gov
ernment
goods and
services
3& 6
42.3
2170
THK FINANCIAL CONBTOON OF THE TJOTHSP STATES
Federal contributions were substantially larger than in the early
period of recovery. The major gains came after the midyear 1958.
The striking improvement was in investment: an absolute increase of
almost $20 oillion and almost 40 percent as compared to one of $14
billion or 5 percent for consumption. Inventories accounted for twothirds of the gains in investment. A tapering off of inventory decumu
lation more than any contribution of Government accounted for the
recovery, once tli ■automatic tax relief, substantial rise of transfer pay
ments, and wage increases broke down the deflationary forces.
$8, Debt management: An improvement
During the Truman administration, the financial community was
very critical of the management of the national debt. The view widely
held was that the interest rate had been kept too low through the
creation of money, that the debt was too much in short-term issues,
and that it was held too largely by banks and therefore tended to be
inflationary.
It is not at all clear that the new administration had improved
matters in the last 6 or 7 years. For example, in July 1958, the
commercial banks held $1.3 billion more of Government securities
than at the end of 1952. W e shall also see that the average maturity
of the debt has not been increased as the new authorities hoped that
it would be. Moreover, in order to sell Government securities the
Federal Reserve on numerous occasions had to interfere in the market
just as the Federal Reserve had in preceding years. It was not easy
to allow market forces to determine the price of Government securities.
2J+. Debt management: Integration and relation to private markets
One of the troublesome problems was on integration of policies
between the Federal Reserve and the Treasury. For example, in the
summer of 1957 the Federal Reserve was responsible for a dear money
policy. It is widely held that on such occasion the issue of Govern
ment securities by the Treasury should be long term so that the
excess funds are absorbed by these Treasury issues and therefore
rates tend to harden. But here is what Under Secretary Burgess had
to say (pp. 686-687):
With an unprecedented heavy demand for funds in the private area we were
convinced quite early in our studies that there was no substantial demand for
long-term Government securities. The package offering that we decided upon
included two certificates and a note, to be issued on August 1: a 3^-percent
certificate maturing in 4 months (Dec. 1, 1957), a 4-percent certificate maturing
in 12 months (Aug. 1, 1958), and a 4-percent note maturing in 4 years (Aug, 1,
1961), but redeemable at the option of the holder in 2 years (Aug, 1, 1959).
The choice of aU three issues was given to the holders of the August maturities
but the October holders were allowed to choose only between the two longer
issues. It did not make much sense to give an October 1 holder an option of
converting into December 1, you see, only 2 months, so we let them spread it out.
This package was designed to provide a very short security for corporations
and other short-term investors who want their money before the end of the
year, an attractive*4-percent 1-year security for other short-term investors, and
a longer 4-percent issue which would appeal to two somewhat different groups
of buyers: (1) those who were not sure that they wanted to invest funds for as
long as 4 years in case interest rates continued to rise and, therefore, liked the
idea of being able to redeem at the end of 2 years, and (2) those who felt that the
present heavy demand for money is perhaps close to its peak and were anxious
to get part of their portfolio invested for a longer period than 2 years at a 4-percent
rate on the theory that a 4-percent rate might not be available again for a long
time.
THE FINANCIAL CONDITION OF THE UNITED STATES
2171
The chairman made it clear to Under Secretary Burgess that the
Treasury had been fortunate in that large issues were held by the
Federal Reserve and therefore the attrition, that is, the failure to sell
new issues for maturing ones rather than for cash, was less than it
otherwise would have been (pp. 722-723).
The Chairman. Would you venture a guess as to what would have happened
if this amount of bonds were offered to the public?
Mr. Burgess. I could not imagine anything more stupid than making an
offer of $24 billion worth of bonds to the public at one crack.
The Chairman. You would have to offer them if they matured and you had
to refund them.
Mr. Burgess. If the public held $24 billion.
The Chairman. Yes.
Mr. Burgess. And then you offered all of them----- The Chairman. What I am getting at is, if the public had held the $14 billion
that the Federal Reserve [and trust funds] held in this instance, what would you
have done? You had to refund them. It is not a matter of voluntary action
on your part. They came due August 1, August 15, October 1.
Mr. Burgess. That is right.
*
*
*
*
*
*
*
The Chairman. You cannot assume that, in refunding all of these bonds, the
Federal Reserve will own 60 percent each time, as it did in this case.
Mr. Burgess. They do not in most of the issues, of course.
The Treasury had a peculiar view of the problem of issuing Govern
ment securities. They were terribly concerned about the state of the
private financing market. Perhaps this is consistent with the general
ideology that the Government does not interfere with the private
economy. But unfortunately the Government has serious responsi
bilities in this time and age, and therefore the job of the Treasury
should be to take cognizance of the important interests of the
Treasury. But apparently Mr. Burgess believed that the Treasury
must always yield to the demands of the private market. In other
words, if there was a great demand for funds on the part of the private
market, even if it were highly inflationary or expansive, the Treasury
should yield to that pressure and not issue long-term securities. The
needs of the Treasury were to take second place to those of the private
market. This position was held even though it was generally believed
in such periods the correct policy is to absorb excess funds and dis
courage private demands through higher rates. M r. Burgess said
(p. 728):
Well, sir, the difficulty of selling long-term Government bonds is simply that the
lenders of money, whose position Mr. Mayo has very thoroughly charted, are
under enormously heavy pressure for funds. The life insurance companies
are having offered to them corporate securities, mortgages, at very attractive
rates; the savings banks are having mortgages offered to them more than they can
absorb; savings and loan associations have their resources thoroughly absorbed
by the mortgages they make.
There just is not any volume of long-term funds seeking investments, and the
borrower is seeking the lender, and under those cirsumstances if the Government
were to try to seU long-term bonds, you would have to offer a competitive rate
that would be very high.
You could not justify offering Governments at a rate so competitive that these
people would take it instead of the things they are absorbing.
So that they simply do not want long-term Government bonds. They regard
Government bonds as a secondary reserve at the moment. The demands of
their customers are so great that they are trying to meet them as their first
responsibility.
Since writing the above, we have had an interesting statement
From Dr. Henry Wallich, tne then Assistant to the Secretary of the
2172
the financial condition of the united states
Treasury. (The Second Duke American Assembly, on “ U.S. Mone
tary Policy,” March 1959, pp. 44-46.) Wallich’s position is more
sophisticated and more tenable than Burgess1. He at least allows
that the Treasury has some responsibility for the proper functioning
of the economy. But I am not convinced by his argument in support
of the large issues of long-term securities in recession, namely, that
this is the only occasion on which long-term issues are possible. Thus
he assumes that future threats of inflation are dealt with by slowing
up the recovery, the current problem. Nor is it made clear why
the Treasury does not have a genuine responsibility to issue long-term
in booms as an anticyclical technique,
♦ * * Should the Treasury abstain from long-term financing in recessions? Or
should it on the contrary seize these opportunities? If the Treasury had perfect
control under all conditions with regard to the securities it wants to issue, the
doctrine of anticyclical debt management would have considerable merit. This
doctrine says that public debt management should be used as an instrument of
economic stabilization, much as monetary policy and fiscal policy are used. To
implement a stabUization policy, the debt managers would sell long-term securities
in a boom to reduce the liquidity of the economy, while the monetary authorities
tightened credit and while fiscal policy aimed at a budget surplus. All these
policies would be pulling in one direction. In a recession, contrariwise, monetary
policy would ease credit, fiscal policy would run a deficit, and debt management
would aid liquidity by short-term financing. By distributing the load over three
instruments of policy, the pressure against any one of them would be reduced and
success attained more speedily.
This pretty picture of three coordinated policy instruments is misleading. In
a boom, the managers of the public debt may encounter serious difficulties, under
present conditions and with present techniques, in the long-term refunding that
they are supposed to do. Contrary to the countercyclical doctrine, the Treasury
is compelled in a boom to engage in substantial short-term refunding of its matur
ing obligations. In a recession, the Treasury has no difficulty in financing either
long or short. According to the doctrine it should finance short to increase
liquidity of the economy. But if it does so, the result is that in fact it never does
any long-term financing. There then is never a good time for the Treasury to do
long-term financing—in a boom it cannot, in a recession it must not.
The anticyclical doctrine of debt management evidently finds its limits in
these realities of the Treasury’s position. If long-term financing remains in
adequate in a boom, it must be pushed at some other time. Perhaps it could be
undertaken during some intermediate period, i.e., during a recovery, as was done
in 1955. In any case, unless the Treasury finances long at some time, a large part
of the debt eventually wiU become very short. Then a new danger appears—
the danger of inflation through excess liquidity and monetization of the debt by
the banks. When this danger appears, the need to forestall it becomes overriding.
No permanent advantage would be gained by trying to accelerate the recovery
from recession, if the result is subsequent inflation followed very likely by renewed
collapse.
It is on grounds like these that a policy of lengthening the debt in recession,
such as was pursued during the 1958 dip, must be justified. One need not go so
far as some, however, who argue that the Treasury should conduct its debt opera
tions with total disregard of the needs of anticyclical policy. Those who believe
this argue that by financing long in recessions and short in booms the Treasury
wiU simply be doing what comes naturally. Moreover, they say, the Treasury
wiU also finance in the cheapest possible way, because permanent financing would
then be undertaken when interest rates are lowest. Countercyclical debt manage
ment, to the extent that it is possible, would be expensive. If the policy of financ
ing cheaply and easily should have adverse effects upon the business cycle,
aggravating both boom and recession, the proponents of this theory suggest that
corrective action should be left to the Federal Reserve.
This, it seems to me, puts too heavy a burden upon monetary policy. It also
sets a dangerous precedent in suggesting that the Treasury be virtually absolved
from the broad considerations of economic stability. The proper solution, it
would seem, lies in the middle: The Treasury must make sure, first of all, that the
debt does not get into unmanageable short-term form. But to the extent com
patible with this goal, the Treasury, like every other agency of the Government,
must be conscious of the impact of its policies upon the business cycle.
THE FINANCIAL CONDITION OF THE UNITED STATES
2173
25. Defense of debt interest policy
In the course of this discussion of proper debt financing, the question
of the 3 long-term issue of early 1953 was raised. It will be recalled
that this issue was not a very successful one. No long-term bond had
been issued for many years and the 3 % percent rate was much above
the going rate at that time. In fact, the issue was such a surprise
that a considerable collapse in the Government bond market followed.
That particular approach to the problem resulted from the desire of
the incoming administration to lengthen maturities and to take se
curities out of the banks. Here is Secretary Burgess’ rather weak
defense of this issue (pp. 684-685).
Now, let me take up the 3)^8 that have been discussed at considerable length
on the floor of the Senate and the House over a period. * * *
This was not only the first long-term marketable bond that the Treasury had
offered since 1945, but it was also the first to be put out without Federal Reserve
market support for a much longer period. * * *
*
*
*
*
*
*
*
Our offering of the 3K’s presented as difficult a pricing problem as the Treasury
has ever had to face. We had to set the interest rate on the new issue in a market
in which prices were moving gradually lower—a market which was still in the
process of adjusting to freer market conditions.
Our longest outstanding bond, the victory 2%’s of December 1967-72, had fallen
from almost three-quarters of a point above par—2.45 percent yield—to 95^—
2.80 percent yield—between the Federal Reserve-Treasury accord in March 1951
and the end of 1952.
*
*
*
*
*
*
There were no long-term Treasury issues outstanding which would serve as a
real guide to the interest rate such an issue should carry. The victory 2^’s were
10J4 years shorter than the new issue, and the market curve of rates, if you plot
out a curve, rose as maturities lengthened. * * *
Therefore we took the market curve on outstanding Treasury issues and ex
tended it parallel to the curve on high-grade corporate issues, retaining, of
course, a proper spread between the two types of obligations.
M
That curve produced a rate of 3.08 percent as of June 15, 1978, which was the
call date on the new bonds, and 3.12 as of June 15, 1983, the maturity date of the
new bonds. ’
The 3H coupon would appear to offer a rate, therefore, approximately 15 base
points—fifteen one-hundredths of 1 percent—above the market curve, but the
spread would be much less than that if you take into consideration the fact that
we were issuing the bond in competition with outstanding issues available in the
market at a discount, another technical point, which had a capital gains advantage
for tax purposes.
In an exchange with Senator Anderson, Secretary Burgess reluc
tantly admitted that they had influenced the long-term rate. But on
many other occasions, both Secretary Humphrey and Secretary Bur
gess had insisted that they had merely followed the rate (p. 1164):
So it was an operation which had its effect in the market. But it was the fact
of our selling a bond at the market rate rather than the fact that we priced it
above the market, which we did not do. * * *
Now, were [sic] we right in selling a bond? Should we have sold short stuff
and waited for rates to go down in the autumn before we sold a bond?
Well, you can pass your own judgment on that. Our belief was we were under
very strong compulsion to get started in dealing with this debt.
Senator Anderson. I am trying to find a chart, and I seem to have lost it, but
it pointed out that the rate on Government bonds rose in a pretty dramatic fashion
you are undoubtedly familiar with this fact, in the last part of 1952.
Mr. Burgess. That is right.
^
Senator Anderson. And early 1953. And then declined pretty^drastically
thereafter.
Mr. B u b o e s s . Yes.
2174
th e
tt& A seua,
c o n d e tk w
o r th e
u o ttb b
e ttA ttta
Senator A n o k b s o n . Did not the Treasury have something to do with that b y
its own operations?
M r. B u r g h s s . We bad something to do with it, Senator, b y the fact that we
put out a long-term bond. Th a t undoubtedly had an effect on the market.
In defense of his position in support of higher rates of interest on
Government securities, M r. Burgess had presented the following
position:
Money used to pay the interest is collected from many people in taxes, and the
money is paid out again partly to the same {>eople and partly to others. I think
it is fair to say that about as many people will benefit directly or indirectly from
these interest payments as are hurt by them.
In reply, Senator Long had this to say (p. 1109):
It seems to me that we should attempt to determine who is hurt and who is
helped. According to the 1957 consumer finances survey by the Federal Reserve
Board, 25 percent of aU consumers in the United States had no savings; 55 percent
had less than $500 in savings; and 77 percent had less than $2,000 in savings.
Would you contend that rising interest rates would flow to those 77 percent of
families, even in relation to the size of their income, in the same way that rising
interest rates would benefit families who have large savings?
The Under Secretary was especially anxious to show that the
Treasury, in issuing new issues, always came very close to guessing
the market situation. H e compared the new issue coupons with the
1-year market rate from 1951 to 1957 and also the interest cost on new
corporate long-term bond and comparable market yields (pp. 716-717).
This is, however, not a very fair comparison, because it is always more
difficult to gage the market for long term than for short term issues.
In deciding on new issues, the Treasury takes the financial leaders
of the Nation into its confidence. Obviously, some help from pro
fessionals is necessary if the Treasury is to have a successful issue.
M r. Burgess describes the process as follows:
It should be noted, however, that some discussion with those who are not
particularly involved in the process might be advisable.
Indeed, the Treasury does have a few economists in its own organiza
tion. But would it not be wise also to include a number of outstanding
economists without any ax to grind in these matters who might be able
to give the Treasury objective advice? A t any rate, here is what the
Treasury had to say (p. 682):
Each Treasury financing represents an important event in the money markets
of the country. It is, therefore, essential that the Treasury take every precaution
to get information from every useful source in making decisions about these
operations.
In the course of exploring the facts relating to a new Government issue, the
Treasury consults a great many people. We get valuable help from the Federal
Reserve Board and the 12 Federal Reserve banks, with their offices throughout
the country which are in contact with a large number of people and with the
money and capital markets. I might add that the Federal Reserve Bank of New
York is particularly helpful. They have a group of very able officers, and their
help to us in deciding about Treasury issues has been invaluable, and I say that
notjust because I was an officer of that bank for 18 years, Mr. Chairman.
We maintain contact with the people who handle investments of commercial
banks, savings banks and insurance companies, pension funds—State, municipal,
corporate, and other private funds—security dealers, and trust companies which
have money to invest.
Of course, this leaves the Treasury open to severe criticism. Senator
Kerr took advantage of this situation and showed the possibility of
insiders making large gains as a result of these consultations with the
Treasury (p. 945).
THE FINANCIAL CONDITION OF THE UNITED STATES
2175
Senator Kebb. You do not think those meetings are one-way meetings, do you,
Doctor?
Mr. Bubgess. No. I think we keep them informed of the broad national
situation as far as we are concerned.
Senator K erb . D o you think they get as much impression from you as you do
from them?
Mr. Burgess. I think they do on certain broad outlines of Government policy.
Senator K err. They have as much a stake in this as you do.
My successor can be critical of me, because, using this measuring stick, we have
not made the improvement that I would like to have made.
In these times of great demand for money, we have not been able to extend our
debt and to put out as much long-term paper as we had hoped we might do, and
as I think it is very desirable to do whenever the opportunity will permit its being
done*
Professor Kenen has pointed out to me that a statement on the part
of prospective purchasers that they will buy or be interested at one
rate or one maturity does not necessarily mean that if another rate
or maturity is offered they will not purchase. The fact may be that
the former rate and maturity may be their preference but does not
really reflect their reactions to another rate or maturity.
In this connection, it is of some interest to note that the failure of
the Treasury to issue long-term securities in a period of great prosperity
and inflationary tendencies is associated in part with this fear of dis
turbing the private financial interests. The Secretary of the Treasury
may argue that sometimes a market will take long-term securities
and sometimes it will not. But the important point is that the long
term securities can be issued at a price. The Secretary of the Treas
ury, in a reply to one of the Senators, remarked as follows (pp. 163-164):
Now, you can do it sometimes. Sometimes the market will take the long-term
securities, and sometimes the market will not.
We have had markets during a substantial part of the time—because of the
large demand for money and the high rate of prosperity—where the long-term
obligations could not be put out, and where it was not desirable to put them out.
We have made progress, Senator Kerr, but not as much as I hoped we would be
able to make. * * *
26. Maturity of debt
Under Secretary Burgess was also very proud of his record (pp.
670-676). He was, for example, proud of his record in maintaining
the average maturity of the debt. Actually, all that he really claims
is that the loss in average length during his regime was considerably
less than in earlier years.
There are a number of ways of measuring the changes in the debt structure over
the years. Some of them refer only to the marketable debt, such as figures on the
average length of the debt. Others—more comprehensive—take into account
not only the maturity distribution of the marketable debt, but also the demand
character of other portions of the debt.
AH of these ‘‘yardsticks’’ show that we have moved forward in improving the
structure of the debt during the past 4% years, especially in comparison with the
record of the earlier postwar period.
Average maturity of the marketable debt: One measure of the structure of the
debt is the average length of time that the marketable debt has to run to maturity.
The amount outstanding of each1security making up the marketable debt is
multiplied by the number of months it still has to run.
These amounts are then added up and divided by the amount of marketable
debt outstanding to give a figure on average length of maturity.
Although the average length of the marketable debt does not reflect changes in
other types of debt like savings notes and savings bonds, it is stiU useful as a yard
stick since it encompasses nearly 60 percent of the total debt outstanding, includ
ing the most volatile areas of the debt.
THE FINANCIAL CONDITION OF'TEtB UNITED STA'ffiS
2176
The average length of the marketable debt to maturity—calculated to first call
date on callable bonds—amounted to 7 years and 2 months in December 1939.
*
*
*
*
*
*
*
This record indicates a loss in average length of 3 months during a period of
the past A% years, as against a loss of 29 months during the 6 preceding postwar
years. The loss since December 1952 is even less when only publicly held secur
ities are considered, since Federal Reserve-held securities, many of longer maturity
originally, are being refunded into short-term issues under the present policy. * * *
Secretary Burgess was also optimistic about the great improvement
in the floating debt. I am not sure that his optimism was justified
(pp. 163-164):
The floating debt: A more accurate measure of changes in the structure of the
Eublic debt from the point of view of the job of the debt manager is a comparison
etween the floating debt on the one hand and intermediate and longer issues on
the other, basing the figures on publicly held debt.
This means excluding securities held by the Federal Reserve banks and Gov
ernment investment accounts, but including in the floating debt the most volatile
part of the nonmarketable debt payable on demand.
*
*
*
*
*
*
*
This type of debt, the floating debt, was reduced by more than $10 billion
between December 1952 and December 1956, and the figure at the end of last
year Was more than $25 billion below the all time peak in 1953, which reflected
largely the inheritance of scheduled maturities from earlier years and financing
growing out of the 1953 deficit.
M r. Burgess was reminded, however (p. 1158), that Secretary
Humphrey had not been as optimistic as he had been, when he
replied:
Now, I would also say, I am making a double answer to this, your suggestion
about Mr. Humphrey—in the first place, he was directing his remarks specifically
to replying to Senator Kerr’s remarks about that one measure, that he was using.
Second, I think he was too modest. I think we have done a little better than
he wanted to claim.
But Burgess' statistics were rather questionable. He found a
decline in the floating debt of $4.3 billion. But the table below
(p. 941) shows that this is not really correct. Actually there had
been an increase in the floating debt, though his table shows a decline.
[Billions of dollars]
Dec. 31,1952
Oct. 1,1957
Marketable issues maturing or callable within 1 year...............................................
Less issues held by trust accounts and Federal Reserve banks............. ...............
57.8
14.9
76.5
21.9
Equals marketable issues in hands of p u blic,..................................................
42.9
£4.6
Savings notes........................................................ .................... ........... ..........................
F, G , Jf and K savings bonds................................. ........... .......................................
Miscellaneous demand d e b t .. .________ ___________ _________________ _____
5.8
22.6
3.4
12.7
3.0
Total floating debt......................................................................................................
74.6
70.3
Pins:
Senator Anderson was quick to see the dubious statistics presented
by M r. Burgess, and M r. Burgess had to give ground (pp. 1159-1160).
Senator A n d e b s o n . The only reason you put F, G, J, and K bonds in was that
they are sensitive to market conditions?
Mr. B u r g e s s . Well, the only reason I put them in is that we have been plastered
with them, we have been hit with them because they have the right to come to us
for redemption and are very sensitive. It is two things together, and they have
proved themselves to be floating debt. The proof of the pudding in is the eating.
Senator A n d e r s o n . Then you included the E and H savings bonds with the
longer term debt?
THE FINANCIAL CONDITION OF THE UNITED STATES
2177
Mr. Bubgess. Because they have acted that way. They have behaved that
way. They have been very stable.
Senator Anderson’. Is one of the reasons the fact that there has been an
increase in them in an amount of about $6 billion?
Mr. Burgess. That is right. But if you take-----Senator Anderson. If the amount of bonds declines, they become floating
and if they build up they become long term?
Mr. Burgess. Well, no. The behavior— actually they have not declined.
The total outstanding have not declined of the E’s and H ’s if you include the
accumulation of interest.
Senator Anderson. Are they not just as redeemable as the G, J, and K bonds?
Mr. Burgess. Legally, yes; actually------
*
*
*
*
*
*
*
Senator Anderson. Now, actually the E and H savings bonds have not kept
pace with redemption? It is only the accumulated interest that makes them look
larger; is it not?
Mr. Burgess. That is right.
Senator Anderson. Then they do not behave any differently than the others;
do they?
Mr. Burgess. Yes, they do. We have had actually to pay out in the past $3
billion on the F’s and G’s.
If we include the total of E and H bonds in the floating debt, the
1952 total rises to $109.9 billion, and the 1957 total rises to $111.8
billion. Hence, there is a real increase in the floating debt. If we
exclude both sorts of savings bonds from the floating debt, the increase
is $5.6 billion. That the Federal Reserve, for example, had changed
its policy and included Treasury bills only in its portfolio had a con
siderable effect on Mr. Burgess' results. Professor Kenen pointed
out to me that at the end of 1952 marketable securities maturing within
1 year accounted for only 60 percent of the Federal Reserve portfolio
of Government securities. At the end of September 1957, they
accounted for 90 percent. Had the composition of the Federal
Reserve Board portfolio in 1957 been the same as in 1952, the com
bined short-term holdings of the reserve and trust accounts would
have totaled approximately $16 billion rather than $21.9 billion in
October 1957. Hence the total floating debt would have increased.
In this connection, it would be of some interest to indicate what has
happened to the structure of the Government debt from the end of
1956 to June 1958.
Government securities structure, 1956-58
[Billions of dollars]
All
December 1956.......................... ..... ............. ............... .
April 1957.........................................................................
September 1957*____ _
______________ _______
June 1958................................... .............................. .......
276.7
274.1
274.5
276.8
Bonds
82.1
83.9
80.8
90.8
Bills
25.2
25.3
26.7
22.4
Certificates
19.0
19.0
35.0
31.1
This table is revealing because it shows the perversity of the
Federal Treasury policy. Compare, for example, December 1956 and
September 1957. This was a period in which the authorities were
worried about inflation. Did they issue long-term securities? No,
there was an actual decline in bonds outstanding. But the certificates
outstanding rose from $19 to $35 billion. These, of course, are
short-term issues.
2178
th *
wawwm, owmmas or t b s mamt twam
S7. Issues of long terms in recession
By September 1957, the recession had set'in. Hence it is of some
interest to compare the issues of securities from September 1957 to
June 1958. This was a period when you might expect the Treasury
would not issue bonds but would issue short-term securities. Actually,
there is a great increase of long-term bonds of $10 billion in these
9 months, and the issue of both bills and certificates dropped for a
total decline of about $8 billion. Mr. Marriner Eccles, an authority
with long experience in these matters, made it quite dear that the
failure of the long-term rate of interest to decline by the spring of
1958 was to be associated in no small part with the large issues of
Treasury long-term bonds (p. 1697).
The rate on bills has gone down from an average of 3.59 in October [1957] tor
1.14 at the end of March [1958]; at the present time it is down below that, whereas
the average rate on long-term Government bonds has only gone down from
3*73 in October to 3.21 at the end of March.
*
*
*
*
*
*
*
Concurrently, the Treasury's financing has been through the issuance of inter
mediate and long-term securities which have largely competed with the private
bond and mortgage markets, thereby tending to hold up long-term rates.
*
*
*
*
*
*
*
It would appear that no matter what the economic situation is, the Treasury
feels that it should lengthen maturities of the public debt. It is my view that
during periods of inflationary pressure, Government financing, whether refunding
or new issues, should be lengthened and sold in the investment market so far
as possible.
Conversely, during a recession, an effort should be made to increase the holdings
of Government securities by the commercial banks by issuing short-term securities
and thereby increasing the money supply*
In the compendium (p. 675), Professor Samuelson, one of the lead
ing economists in the country, had this to say:
Public debt management is closely connected with monetary policy. Now that
the Fed tends to operate in short-term bills only, it is the Treasury’s decision with
respect to stretching out the debt that have many effects on the pattern of bond
yields that open-market purchases of bonds by the Fed used to have. If one
wishes to make long-term credit easier to get and cheaper, one forgoes stretching
out the debt. Conversely, in times when fixed investment is overbrisk, and the
market will not buy new long-term Government bonds except at a very high yield,
then, unpopular as this may seem to the Secretary of the Treasury, that is the
time to issue new long bonds.
The Federal Reserve does not have the duty to keep Government bond yields
low through thick or thin. But it does have the duty to make sure that the com
bined impact of the Treasury debt-management policy and its own policies are
conducive to aggregate stability.
It is clear from the remarks of Secretaries Humphrey and Burgess
that the policy of issuing securities with a view of stabilizing the
economy is not very popular. One reason for this is that in periods of
prosperity the competing borrowers are very much annoyed by the
issue of long-term securities at higher rates by the Treasury. Again,
the Treasury and the Federal Reserve seem to be excessively concerned
about the coming inflation and therefore do not want short-term issues
sold at the banks in periods of recession. This is made adequately
dear by the Presidents of the Federal Reserve Banks (p. C51).
The experience of recent years, however, has raised questions concerning the
feasibility and, to some extent, the desirability of such a debt-management policy.
In the first place, the heavy demands for capital in a period of high activity tend
to make the financial markets unreceptive to long-term Treasury securities and to
require the Treasury to bid up interest rates progressively if it is to be successful
THE FINANCIAL CONDITION OF THE UNITED STATES
2179
in diverting funds from other uses. The Treasury is likely to be severely criticized
by potential borrowers (such as builders and municipalities) who find it most
difficult to compete, and by others who object to the increased service charges on
the public debt.
Furthermore, the increased liquidity of the banking system that results from
large sales of short-term Treasury securities to the banks in a period of recession
(such as 1953-54) delays and limits the effectiveness of restrictive monetary
policies when inflationary tendencies again become a problem * * *.
The above takes the story back to June 1958. Since that month,
recovery has been on the way. But whereas issues of bonds had
risen by $9 billion in the first 6 months of 1958, a recession period,
the bonds outstanding in the next 10 months actually declined by
$6 billion. In other words, the Treasury obstructed recovery by
issuing large quantities of bonds in the midst of recession, and once
recovery was well on its way reduced its bonds outstanding. The
Treasury pursued anything but a proper anticyclical policy. It put
its own interests far above those of the economy.
U.S. Government security by type of security
[Billions of dollars]
Total gross Total pub
lic issues,
debt
marketable
June 1958______________ . ___
276.4
285.5
Bills
Certificates
of indebt
edness
22.4
32.9
166.7
34.4
312
April180.7
1950........................................
Notes
20.4
27.2
Bonds
90.9
810
Source: Federal Reserve Bulletin, M ay 1959.
W hat is more, despite its strong criticisms of the rising floating
debt in the Roosevelt and Truman administrations, it had failed not
only to reduce floating debt but actually increased it absolutely and
relatively.
The record has been particularly bad for the period beyond that
covered above. In the 10 months ending April 1959, Treasury bilk
outstanding rose by $12 billion, or from 13K percent of public mar
ketable issues to 19 percent. Certificates of indebtedness outstand
ing also rose, though not in proportion to public marketable issues.
Treasury notes and intermediate maturities also expanded absolutely
and relatively. Clearly, the average maturity had experienced another
slide downward.
28. Support oj Government bond market
It has been a policy of the present administration to interfere in
the money market as little as possible. The accord of 1951, which
was introduced in the preceding administration, but in part is the
result of pressure from the Federal Reserve, assumed that the money
market would not be operated on behalf of the Treasury. It is
interesting, however, that on several occasions since the new adminis
tration came in the Federal Reserve System has supported the
Government bond market. In 1953 and 1954, the Federal Reserve
reduced reserve requirements, partly to relieve seasonal stringency in
the money market but also to encourage bank purchases of new Gov
ernment securities. In November 1955, the System deviated from its
bills only policy in its purchase of $167 million of new Treasury
certificates. This action was taken because of the pressure of the
2180
THE FINANCIAL CONDITION OF THE UNITED STATES
Treasury in a conversion operation (p. 875). In 1958 also the Federal
Reserve abandoned temporarily the bills-only policy.
A word about the bills-only doctriiie. This is a policy which many
economists find difficult to understand. In this particular manner,
that is, by depending on the purchase and sale of bills rather than of
long-dated securities, the Federal Reserve ties its own hand in its
attempts to control money and the rate of interest. Obviously, the
effects are greater if the central bank operates directly on the long
term securities. One major reason for this policy of bills only seems
to be that, if the Federal Reserve deals with long-term securities, this
introduces an element of uncertainty into the market, and the market
must be protected against all elements of uncertainty. In my opinion,
however, the objective of stability is much more important than
protecting the market and the speculators against any uncertainties
in the purchase and sales of Treasury issues.
29. Independence of the Federal Reserve Board
In the course of the hearings, many times the issue of independ
ence of the Federal Reserve came up. It seemed that both the
Federal Reserve and the Treasury were satisfied with the present
arrangement even though there had been some serious disagreements.
Secretary Humphrey, for example (pp. 232-233), was clear that he
was satisfied.
Well, as to the way we work, it is just the simple ordinary way in which two
groups of people with independent responsibilities would normally attempt to
cooperate.
We have a system which has worked all the time we have been here in which
Mr, Martin comes over to the Treasury and we have a visit every Monday at
lunch; and then on Wednesday, as a rule, Mr. Burgess and two or three of our
people go over and visit with the Federal Reserve Board and their staff.
So that we have a constant contact between the two organizations all up and
down the line, so that each knows what the other is talking about and what the
other is planning.
Now, then, in our movements we discuss, each of us with the other, what we
plan to do and how we plan to do it. We hear what the other has to say about
it. Sometimes we can take into account criticisms; sometimes we get very
worthwhile criticisms that lead us to alter our opinion somewhat.
Other times, we find that we stick to the opinions that we originally had and
proceed.
But we operate together, each with his own final responsibility, but each
knowing what the other is doing and each hearing the position of the "other before
final determinations are made.
Chairman Martin (pp. 1258-1259) contended that Congress had
had many opportunities to deprive the Federal Reserve of its inde
pendence but on numerous occasions, in reconsidering the Federal
Reserve System, Congress had implicitly approved of the idea that
the Federal Reserve should be independent.
This question of independence has been thoroughly debated throughout the
long history of central banking. On numerous occasions when amendments to
the Federal act were under consideration the question has been reexamined by
Congress, and it has repeatedly reaffirmed its original judgment that the Reserve
System should be independent— not independent of Government, but independ
ent within the structure of the Government. That does not mean that the Reserve
banking mechanism can or should pursue a course that is contrary to the objec
tives of national economic policies. It does mean that within its technical field,
in deciding upon and carrying out monetary and credit policy, it should be free
to exercise its best collective judgment independently.
THE FINANCIAL CONDITION OF THE UNITED STATES 2181
The members of the Board of Governors and the officers of the Federal Reserve
banks are in a true sense public officials; the processes of policy determination are
surrounded with carefully devised safeguards against domination by any special
interest group.
Broadly, the Reserve System may be likened to a trusteeship created by Con
gress to administer the Nation’s credit and monetary affairs—a trusteeship dedi
cated to helping safeguard the integrity of the currency * * *.
Despite serious disagreements with the Treasury, for example in
the spring of 1956, Chairman Martin was satisfied (pp. 1361-1363).
Well, we feel ourselves bound by the Employment Act and by the Federal
Reserve Act. And in the field of money and credit we consider ourselves to be,
regardless of what the decisions of the administration may be—we consult with
them, but we feel that we have the authority, if we think that in our field, money
and credit policies, that we should act differently than they, we feel perfectly at
liberty to do so.
Senator Long. In other words, you feel that you have freedom in promoting
what you believe to be the full employment policy of the law?
Mr* M artin. That is right.
*
*
*
*
*
*
*
Senator Long. Could you give us some indication of recent decisions and
recent actions that the Board has taken which you feel were not the policy that
was recommended or was, perhaps, contrary to the attitude that you believed
that the administration would have taken if it had been charged with the same
responsibility that you have?
Mr. M artin. Well, I think the most glaring instance of that was in April of
1956. Pursuing our method of cooperation, I began discussions with Secretary
Humphrey. In February of that year Governor Balderson and I had a meeting
with Secretary Humphrey and there was a disagreement as to the nature that the
economy was developing * * *.
*
*
*
*
*
*
*
We finally reached a point where there was no meeting of the minds that could
be had, and there was nothing for the Federal Reserve to do except to go and
act. And we acted.
During the hearings of the Finance Committee, numerous com
plaints were made of the independence of the System. Senator
Malone proposed that the powers of the System be returned to the
Congress (pp. 426-427). Professor Harris suggested that the System
ought not to be independent of the executive (pp. 2046-2047). Sena
tor Anderson repeatedly proposed the creation of a national economic
council that would deal with the monetary as well as the economic
aspects (p. 1146). Professor Angell made a similar proposal (p. C542).
The coordination of credit, monetary, and economic policies was
not what it should have been. Anyone who views the expansion of the
numerous Government credit agencies and operations during those
eriods of recession and prosperity would wonder whether there had
een any discussion among these various agencies— for example, the
F N M A , the FHA. the COC— with the Treasury and the Federal
Reserve (see pp. 569, 1144, 064. 0224, C597). The indeDendent
myth had developed to such a point that the President himself failed
to make recommendations in his annual report to the Congress on
what monetary policy should be. Indeed, he did hold some informal
conferences with various leaders in the monetary field.
Perhaps at one time there was a place for the independence of the
Federal Reserve, when the Federal Government did not have much to
say about economic developments. But the situation is entirely
different now. The Federal Government spends a large part of the
total income of the Nation and takes a considerable responsibility
under the 1946 act for maximum employment, output, and purchasing
E
2182
T H E FIN AN CIAL CONDITION 0 F T H E
TJOTTBl^ STATES
power. In view of these responsibilities, the Government certainly
cannot allow the Federal Reserve to operate in any way it pleases.
By insisting upon its independence, the Federal Reserve has not
only failed to make its maximum contribution but has encouraged
other agencies and departments to move in many directions at the
same time. Obviously, the independent Federal Reserve also means
an independent Treasury, an independent Housing Agency, and so
forth.
This independence and the failure to achieve integration among the
various agencies has resulted in a number of disastrous errors. For
example, m 1953, Secretary Burgess, overimpressed by academic dis
cussions, pushed through high money which demoralized the bond
market and helped bring on a recession. The Federal Reserve mildly
acquiesced.
In 1956-57, the Federal Reserve introduced an anti-inflationary
policy which other agencies frowned upon but did not stop.
In the midst of the peak of the anti-inflationary period, the Treas
ury sold billions of short-term issues. Had the independent Treasurybeen willing to cooperate with the independent Federal Reserve, it
would have sold long-term issues and thus raised the long-term
rates—in accordance with the high money rate policy of the Federal
Reserve. But perhaps the Treasury was annoyed with the dearmoney policy which hit first and foremost the market for Government
securities.
In 1958 the Federal Reserve introduced a moderate cheap-money
policy. W hat did the independent Treasury do? It issued billions
of long and intermediate term issues. When the Federal Reserve
tried to cheapen money, the Treasury made it more expensive and
vice versa.
One wonders if Messrs. Martin, Humphrey, Anderson, Cole, Burns,
Saulnier, and other heads of the financial departments and agencies
were and are on speaking terms.
The test of the pudding is in the eating. The independent Federal
Reserve and the independent Treasury and the hands-off White
House succeed in giving the Nation not only a recession but a recession
accompanied by substantial inflation. This is unique.
SO. Selective controls
On a number of occasions the Washington authorities were asked
about the desirability of selective controls, for example, on consumer
credit. The answer was invariably no. Chairman Martin made
this clear on a number of occasions. The Federal Reserve did not
want consumer credit control. This is surprising in view of the fact
that there had been such control. Moreover, the British showed in
the last few years that by control of installment buying they could,
to a considerable degree, reduce inflation. They used this kind of
control despite the fact that the Government was also in a position
to tell the commercial banks directly to cut down on loans, and the
commercial banks would respond. Such moral suasion is not used
to any great degree in this country. Had consumer credit, for ex
ample, been contained to some extent in 1956 and 1957, the backlog
would have contributed to getting the country out of the recession in
1958.
THE FINANCIAL CONDITION OF THE UNITED STATES
2183
An exchange between Senator Anderson and Secretary Humphrey
reveals the attitude of the administration. It will be noted that
Secretary Humphrey’s objection to selective credit controls is largely
on ideological grounds. He does not like Washington telling the
people how to spend their money. Apparently he would rather have
inflation (p. 558).
Senator A nderson. Then his [Mr. Elliott Bell, editor of Business Week] con
cluding sentence in that first paragraph is:
This overall restraint should be supplemented by selective credit controls
directed toward particular areas of the economy which appear to be advancing
at too rapid a pace.
Have we tried any selective controls?
Secretary H umphrey. No, and I am opposed to that. I just do not believe
that— I said a minute ago, I just do not believe there is any group of men who are
so smart that they can tell everybody in America what to do and be wiser than
the great bulk of our people who are actuated by an incentive free choice system.
I believe with all my heart in an incentive free choice system. I believe it is
what has made this country. * * *
*
*
*
*
*
*
*
So I just do not think you can run this economy entirely from Washington.
I think Washington has a place. I think it can do some things, and try hard to
do them properly, but I do not think you can do the whole job here, and I would
much rather trust the American people to limit within some reason their borrow
ings and decide how much is proper expansion and how much is not, than I would
have to have somebody here in Washington sit and put some arbitrary controls
on what you can do.
As might be expected most of the businessmen replying to the com
mittee's questions took a similar position. Typical was the U.S.
Chamber of Commerce statement (p. C 482):
We endorse the general position of the Federal Reserve Board in holding that
general, indirect monetary controls are the appropriate means of restraining
inflationary and deflationary movements in the money market. Direct controls,
except for regulation of stock market credit and providing minimum standards
for prudent commercial bank operations, are not consistent with a free market
system. Selective controls over terms of particular kinds of credit—for example,
consumer installment credit— are administratively not feasible and are inimical
to freedom of consumer choice and efficient resource allocation. * * *
But the great majority of economists, however, seem to favor such
controls. Of eight economists making explicit mention of them in
their answers to the committee questionnaire, seven gave selective
controls full or qualified endorsement (see pp. C542, C619, C630,
C642, C662, C700, and C704). Only one categorically opposed them
(p. C599). Prof. Sumner Slichter also favored them in his oral pre
sentation (p. 1834), as did Marriner Eccles (pp. 1738, 1739, and 1790).
As has been often true in recent years, the Federal Reserve Bank of
New York revealed a much more sensible position than the Federal
Reserve Board on this issue. They were, as a matter of fact, much
more sensible in their attack on the bill's only policy as well, but had
lost this battle. The Federal Reserve banks seem to be receptive
to the idea of selective consumer credit control (p. C73).
But it is at least conceivable that the capital goods boom since 1955 would
not have been of the same magnitude, that inflationary pressures would have been
less strong, and that there would now be less need for readjustment, if it had been
possible to take direct measures to restrain the expansion of consumer credit and
mortgage credit, and thereby restrain the housing and consumer durable goods
boom of that year. Despite the voluminous and exhaustive study of consumer
2184
t h e fin a n cia l con d ition o f th e UNITED sta tes
credit controls that was completed only a year ago, and the vociferous objections
from interested parties to such controls, perhaps the issue should not be considered
closed if we are really serious about minimizing economic instability. I can
assure you, however, that there exists in the Federal Reserve System no bureau
cratic urge to administer such controls—quite the contrary. Perhaps if considera
tion should again be given the question of giving the System standby authority
to apply such controls in the future, it might be worth while to study the experi
ence of other contries, where enforcement, as distinguished from policy formulation,
is, in many cases administered by an agency other than the central bank. I do
not question the usefulness of consumer credit in facilitating the purchase of items
of substantial cost, nor am I disposed to pass judgment on the question of whether
the absolute level of consumer indebtedness at any given time is too high. My
concern, rather, is with the effects of rapid acceleration or deceleration of the
growth of consumer credit on the stability of production and employment.
31. Another view on Federal Reserve policy and economic stability
In October 1958, the Senate Committee on Banking and Currency
released a report entitled “ Federal Reserve Policy and Economic Sta
bility, 1951-57,” a report prepared by Prof. Asher Achinstein (S. Rept*
2500).
The report starts with a statement from the Douglas subcommittee
report of 1950 on monetary, credit, and fiscal policies. I quote:
(1) We recommend that an appropriate, flexible, and vigorous monetary policy,
employed in coordination with fiscal and other policies, should be one of the
principal methods used to achieve the purposes of the Employment Act.
: -(2) The essential characteristic of a monetary policy that will promote general
economic stability is timely flexibility. To combat deflation and promote re
covery, the monetary authorities must liberally provide the banking system with
enhanced lending power, thereby tending to lower interest rates and increase the
availability of credit. To retard and stop inflation they must restrict the lending
power of banks, thereby tending to raise interest rates and to limit the availability
of credit for private and government spending. These actions must be taken
promptly if they are to be most effective (p. VII).
In re the policies in the first 6 months of 1953, the author of this
report points out—
that the monetary authorities based their credit policy on the assumption of
continuation of business expansion and the intensification of inflationary pres
sures. There were others who pointed out early in the spring of 1953 that the
Federal Reserve Board’s preoccupation with inflation resulted in its minimizing
unfavorable developments indicative of an impending downward readjustment in
business activity.
In its policy of contending with inflation, the Federal Reserve also
had the support of the Treasury, which launched its long-term issue
with a view to raising interest rates and getting securities out of the
commercial banks (p. I X ).
Then the authors are quite critical of the Federal Reserve for not
contending with the great inflation in 1955 at an early point. They
point out that between the third quarter of 1954 and the first quarter
of 1955 the gross national product advanced at an annual rate of
over $22 billion, and the largest part of the increase was reflected in
rising outlays for consumer durable goods, purchases of new homes,
and the shift from liquidation to accumulation in business inventories.
Installment credit was rising at a very rapid rate, and the mortgage
debt on one to four family houses increased by $6,5 billion during the
first 6 months of 1955; but the reaction of the Federal Reserve was
very slow. In explaining the tardiness and lack of vigor in the
THE FINANCIAL CONDITION OF THE UNITED STATES 2185
restrictive policies, the Chairman of the Federal Reserve Board
emphasized—
th e h u m a n fa c t o r o f h e s ita n c y t o e x e r cise cu r b s th a t m ig h t c h e c k t h e p a c e o f
b u sin e ss e x p a n sio n .
Apparently, another explanation of the slow reaction of the Federal
Reserve was the fear, quite justifiable, that a dear-money policy
might result in large disposals of Government securities by banks.
Actually, the Federal Reserve apparently accepted the theory that
small increases in rates would make it unlikely that the financial
institutions would dispose of securities because of the losses involved.
But their theories proved to be wrong, for from April 1955, to August
1956, when discount rates rose from 1% to 3 percent in six moves,
the banks disposed of more than $12 billion of Government securities
(pp. X and X I).
Having failed to adopt strong measures in 1955, they were con
fronted with the alternative of a liberal policy which would have
accelerated the price rise or a restrictive policy which had the danger— ■
o f in itia tin g a d o w n w a r d sp ira l o f b u sin e ss a c t iv it y in c e rta in o f th e k e y s e c to r s
w h ic h h a d u sh e re d in th e b o o m a n d h a d b e e n s h o w in g c o n s id e r a b le w ea k n ess fo r
s o m e tim e (p . X I I ) .
The authors of this report support the Federal Reserve in not
relaxing the restraints in 1956 and the first half of 1957, but they are
very critical of Federal Reserve policy in the summer and fall of 1957.
A rise of the discount rate from 3 to 3^ percent in August 1957 came
despite increasing signs that the boom might end soon. And from
August until November, when the discount rate was finally lowered,
the Federal Reserve apparently had in mind only the threat of
inflation and not the possibility of a declining economy.
The authors of the report are especially perplexed by the records
of the Open Market Committee, which have since been revealed.
During all these 18 meetings held throughout the year—
th e r e a p p e a r e d t o b e an a b s e n c e o f t h a t c o n fid e n c e in th e b u sin ess o u t lo o k a n d
in th e c o n t in u a tio n o f in fla tio n a r y p ressu res, w h ic h w ere m a n ife s te d in p u bU c
s ta te m e n ts b y t o p s p o k e s m e n fo r th e S y s te m .
T h e c o n t r a s t b e tw e e n th e r e c o r d
o f th e d e lib e r a tio n s o f th e O p e n M a r k e t C o m m it te e a n d th e p u b lic sta te m e n ts
a n d a c t io n s o f th e F e d e r a l R e s e r v e r e q u ir e e x p la n a tio n (p . X I I I ) .
The authors, then, hold the Federal Reserve in no small part respon
sible for the large decline in the postwar period.
In its reply to the Senate Banking and Currency Committee report,
members of the staff of the Federal Reserve emphasized the point
that the recession had actually not been as serious as the authors of
this report had assumed. The Federal Reserve also emphasized at
this point something that they were not very olten inclined to say
during the hearings of the Finance Committee, namely:
*
* * are F e d e r a l R e s e r v e a c t io n s t h e so le fa c t o r fo r s t a b ilit y o n t h e sid e o f
p u b lic r e s p o n s ib ilit y o r is e c o n o m ic s t a b ilit y a lso a ffe c te d b y ta x in g a n d s p e n d in g
p o licie s , b y a g r icu ltu r a l p o licie s , a n d b y o t h e r p u b lic p o lic ie s s u ch a s th o s e t h a t
g o v e r n th e te rm s a n d c o n d it io n s in t h e in s u ra n ce a n d g u a ra n te e o f h o m e m o r t g a g e s ?
In defense of its 1956-57 policy, the Federal Reserve staff empha
sizes that the Nation was in the grip of an active wage-price spiral
and a universal tendency to hedge against inflation—
2186 THE financial
condition of teds united states
by incorporating in longer term contracts, escalator clausea for higher wages
and other costs and a consequent speeding up of the wage-price spiral.
Business also was anticipating future rises in costs and therefore
expanding excessively. The staff also now points out, as it has not
before, the complications caused by Treasury debt management
problems and the—
relation of Treasury refinancing and financing operations to the timing of monetary
actions.
The staff pointed out that the dangers of inflation were just as great
now as they were early in the summer of 1957 (pp. 84-85).
P A R T III
FAILURES O F T H E AD M I N I S T R A T I O N
In the investigation of the financial condition of the United States,
the Senate Finance Committee was interested in revenue, public
expenditures, management of the debt, credit facilities, and also in
the effects of these variables upon the economy. In fact the hearings
proved to be an overall examination and appraisal of the economic
policies of the Eisenhower administration. Hence it may be worth
while to run over some of the major issues and to examine the failures
of the administration in these areas.
1. Federal expenditures
In the famous meeting with Senator Taft at Morningside Heights
in 1952, Candidate Eisenhower had made it clear that Federal ex
penditures would be down to $60 billion, In fiscal year 1953, ending
June 30, expenditures had risen to $74.3 billion, but it must be noted
that this was in the midst of the Korean war. By 1955, the adminis
tration had reduced expenditures to $64.6 billion, a notable achieve
ment, though of course demobilization following the Korean war and
large cuts in expenditures on defense, which may in the long run prove
very costly, were the major factors in this decline. But by 1959
(fiscal year) expenditures had risen to $81 billion; and planned
expenditures for fiscal year 1960 were $77 billion. What is more,
in 1950, just before the Korean war total Federal expenditures were
only $40 billion. Now they have doubled by 1959-60. It is clear
that the administration has not achieved one of its major objectives,
namely, a substantial cut in Federal expenditures. Rather the
reverse: expenditures have steadily risen, except for a decline in
1953-55 and this, as I said, is associated in part with the demobiliza
tion following the end of the Korean war.
It can be said to the credit of the administration that the percentage
of Federal purchases of goods and services in relation to the gross
national product declined from 1952 to 1958. But this decline is
explained in no small part by the rise in the percentage of purchases
of goods and services by State and local governments from 6.7 percent
in 1952 to 9 percent in 1958 (calendar years).
These trends suggest that the Federal Government has increasingly
tried to put the burden of public expenditures on State and local
government, even though the tax structure of State and local govern
ment is not exactly capable of standing this increased burden. Though
State and local government account for about one-third of all taxes
collected, they provide only 11 percent of the individual and corpora
tion income taxes. Note that the Federal Government collects about
89 percent of the individual and corporation taxes, though the Federal
Government accounts for only about two-thirds of aU taxes; State
and local government account for all the general sales and gross
receipts taxes and 65 percent of the motor fuel taxes. In other
2187
2188 THE fin an cial CONDITION o f th e united states
words, the dirett taxes which measure ability to pay are largely in
the control of the Federal Government, and other taxes in the control
of State and local government. The tax burden has been rising
disproportionately for State and local governments in the last 10
to 15 years;
JB, The integrity o f the budget
Increasingly, the evidence shows that the administration has
tended to be more interested in balancing its accounts than in bal
ancing the budget. B y that I mean that the administration pursues
financial methods that reveal a budget smaller in appearance than in
fact. For example, the administration has favored policies of selling
assets as a means of obtaining cash (receipts) and therefore showing
an improved budget. A striking case is the civil service retirement
fund, an issue fully discussed between Senator Frear and Secretary
Humphrey in the hearings (see pps. 273-277). On the pretext that a
study was being made of the civil service retirement fund, the 1955
budget provided $30 million to be applied to the civil service retire
ment fund instead of the $427 million of the preceding year. In the
year following, again the fund was deprived of funds to be transferred
from the Federal Government. Later on the Secretary admitted
that the deficit would be made up over a number of years. The fact
is that the budget position was improved by about a billion dollars
over several years as a result of this particular kind of manipulation.
A t least temporarily the Government was using trust funds to keep
appropriations down.
Along the same lines the administration has shown great enthusiasm
for guarantees as against loans. In many respects guarantees can
be supported as substitutes for loans. But there is no doubt about
the fact that part of this enthusiasm is engendered by the fact that
guarantees are not listed as Government spending. From fiscal
year 1953 to fiscal year 1959, the rise of loans and investment was 23
percent, of guarantees and insurance 132 percent, the latter rising
from $28 to $66 billion. For fiscal I960, direct loans and investments,
that is, new commitments, amount to $5.7 billion and guarantees and
insurance $21.8 billion. In fact, from 1958 to 1960, the last an
estimate, the increase of direct loans and investments was to be only
about $400 million (budgetary item), but for guarantees, not included
as expenditures, a phenomenal rise of $9% billion (the Budget, fiscal
year 1960, p. 958). No one has been able to get an estimate from
the Treasury as to what these commitments mean in terms of possible
future losses.
Obviously, a disposal of assets also improves the budget. For
example, the Federal Government may sell its mortgages to private
banking interests. In the 4 fiscal years 1954 to 1957 the Eisenhower
administration disposed of $1,708 millions of certain capital assets.
In the 4 preceding years, the Truman administration had disposed of
about $364 millions of corresponding assets. Here is an apparent
improvement in the budget (rise of receipts), but is there really an
improvement since the gains are in fact achieved through living on
capital?
In 1959 an interesting episode occurred. In order to show a balanced
budget for 1960, the President was prepared to transfer obligations for
an expansion of international lending from the 1960 budget, where the
expenditure would really occur, to the 1959 budget.
THE FINANCIAL CONDITION OF THE UNITED STATES 2189
Another example of this kind of dubious accounting is given by an
episode in the 1959 Congressional Record. Senator Gore had raised
the question as to the propriety of the proposed action of the Federal
National Mortgage Association to trade 4 percent mortgages held in
its portfolio, maturing at an average of 6 to 10 years or 12 years at
the most, for Government bonds bearing an interest rate of 2% percent
with a maturity date of 1980. On June 8, Senator Clark, on behalf of
12 Democratic Senators, offered Senate Resolution 130:
Resolved, T h a t it is th e sen se o f th e S e n a te t h a t th e p o lic y t o e x c h a n g e m o rtg a g e s
h e ld b y t h e F e d e r a l N a t io n a l M o r t g a g e A s s o c ia t io n fo r G o v e r n m e n t b o n d s , as
p r o p o s e d b y th e P re s id e n t in th e b u d g e t fo r th e fisca l y e a r I9 6 0 , is n o t in th e
n a tio n a l in te re st a n d s h o u ld n o t b e c a r rie d o u t b e c a u s e o f (1 ) loss o f in c o m e fr o m
t h e m o r t g a g e lo a n s, (2) lo ss o f ta x r e v e n u e s , a n d (3 ) a d v e rs e e ffe cts u p o n th e h o m e
m o r t g a g e m a r k e t.
The administration seemed to be interested in this procedure in
part because in this way they could dispose of about a biUion dollars
worth of mortgages and thus show a corresponding improvement in
the condition of the budget. Private interests were also very much
interested because this would mean that they could get rid of long
term Government bonds that were a drag on the market and could
obtain in exchange profitable mortgages yielding 4 percent. The 2%
percent bonds, of course, were selling at a large discount. (See Con
gressional Record, June 8, 1959, pp. 9174-9176). Private holders
would also have certain tax advantages from this exchange.
Finally, I shall just mention two other items. First, the Govern
ment obtained large additional resources for the post office budgets
and thus kept deficits down, not through economies but through
higher prices.
Second, the penchant for renting rather than building physical
facilities also reflected the desire for window dressing and probably
in the long run, diseconomies.
3 . Structure of expenditures
When one compares the budget of 1954 and 1960, one is struck by
the very large proportion of increase of expenditures on agriculture
from 3.7 to 7.8 percent of total Federal expenditures. Yet despite
these large rises, the problem of surpluses is more serious than ever
before. Clearly, agricultural policy does not point to any large gains.
Of the welfare programs, a large category, only housing shows a large
increase, namely from 1.2 to 2.9 percent. Here the administration
has continued, though at a pace in some areas (e.g., public housing)
less accelerated than had been planned by the Truman administration,
the policies of the previous administration. Note also that the major
buraen of housing increasingly was reflected in a nonbudgetary
category, namely guarantees.
Perhaps the most striking aspect of the budget is the decline from
69 to 59.5 percent for major national security programs. Actually,
if allowances are made for the change in the price level, the security
program has been cut by about one fourth under the Eisenhower
administration.
This large increase of expenditures has then been consistent with
very large cuts in defense outlays and with the provision of no new
maior program in the social welfare program. Indeed, many of the
earlier programs were continued and in some cases expanded.
2190
THE FINANCIAL CONDITION OF THE UNITED STATES
One surprising early policy of the Eisenhower administration was
the liberalization of old age insurance. The explanation of this move
ment is without a doubt that these increases do not show up in the
budget since they are in fact financed through a trust fund.
Finally, it should be noted that expenditures are also understated
for another reason, namely, that road expenditures are in a trust fund,
or at least the interstate program, which will cost at least $56 billion
in 13 years, and is included not as an ordinary budgetary expenditure,
but is diverted from a regular budget and to be financed, presumably
by a gasoline tax, though the attainment of this objective is not
sufficiently clear today.
4- Deficits and debt
It has been one of the most pronounced objectives of the adminis
tration to stop deficit financing and reduce the Federal debt. Yet in
the first 6 years of its administration, there were deficits in 4 years and
surpluses in 2. In the fiscal year 1959 the deficit was $13 billion, a
record for peacetime period. Even in World W ar I, the deficit had
not exceeded this figure in any 1 year except in 1919, the expendi
tures in which year reflected both the cost of the war and the aftermath. The debt itself rose from $259 billion in fiscal 1953 to $266
billion in 1954 and $285 billion by fiscal 1959. Only in 2 years was
the debt actually reduced and that only by $4 billion in the fiscal
years 1956 and 1957.
Actually, the deficit and the debt are really much larger than they
seem to be on the basis of these figures. Had the Eisenhower admin
istration pursued the same accounting principle as the Truman ad
ministration and also pursued the same policies vis-a-vis capital assets,
the debt would have been much larger. But it may well be said that
through excessive sale of assets, through diverting funds from the
civil service retirement, through large uses of guarantees and similar
practices, the debt has increased several billion dollars, as a minimum,
above the figures that are given by the Budget Bureau.
6 . Debt management
One of the best indices of debt management is the price paid for
money by the Federal Government. At the end of the Truman ad
ministration, the average cost of the national debt was 2.48 percent.
B y fiscal year 1960, the average is estimated by the administration at
2.84, an increase in the rate of about 15 percent. But this is not nearly
so significant as the yield on long-term bonds at 2.68 at the end of the
Truman administration and 4.09 in early M ay 1959, or an increase of
more than one-half.
Another objective of the administration was to reduce the floating
debt. This was made clear in the very beginning of the administra
tion when Mr. Burgess issued his famous Humphrey-Dumptys (3#
percent) which, of course, were a complete flop. As we have shown, the
floating debt has tended to increase, and especially in the last year or
so. It is larger absolutely, and relatively to the total debt. Here is
a clear failure.
Again, and related to the issue of floating debt, the administration
was anxious to get Government securities out of the banks on the
theory that when they are held by the banks they are inflationary and
contribute toward an expansion of money. Actually, from the end of
1952 to the end of 1958, the debt had increased by about $16 billion.
THE FINANCIAL CONDITION OF THE UNITED STATES 2191
Where did these additional issues go? The Federal Reserve increased
its holdings by $1.7 billion and commercial banks by $3.8 billion.
These increases are larger than the proportionate rise in total debt
publicly held. But by putting pressure on financial institutions to
dispose of debt as they increased money rates through restricted
monetary policies, the Federal Reserve in fact forced other financial
institutions to dispose of their Federal securities. This was true
especially of mutual savings banks and insurance companies, which
reduced their holdings from $25.6 billion in 1952 to $19,4 billion by the
end of 1958. Fortunately State and local governments, which in
creased their holdings from $11 to $17 billion and other investors from
$11.1 to $17.3 billion filled the void, but only through the incentive of
higher rates. Hence again the administration had failed to take the
securities out of the commercial banks, and in fact actually increased
the inflationary holdings.
6. The President*s proposals oj June 1959 fo r lifting the ceiling on the
Federal debt and raising the interest rate ceiling
The current discussion gives us an opportunity to appraise the
President's request for lifting the ceiling on the debt, and raise the
rate on long-term Federal securities.
I see no serious objection to raising the ceiling on the debt. As the
earlier arguments suggest, the debt ceiling had the effect of inducing
dubious accounting practices to keep the debt below the ceiling and,
more important, stimulating unwise policies such as slowing up the
defense program, failure to pay contractors. Economies in Govern
ment should be achieved directly, not through such devices.
The President's proposal for lifting the interest rate ceiling is another
matter. Difficulties in selling long-term issues in competition with
other seekers of funds are the occasion for this demand. But the
high rate on long-term Federal issues stems to a considerable degree
from the high money rate of the Federal Reserve, and also from the
failure of the Federal Reserve to give reasonable support to the
Government bond market. At the same time that the Federal
Reserve denied adequate support of the bond market, the wide
publicity given to inflationary dangers by the President, Secretary of
the Treasury, and the Board resulted in diversions of funds from the
bond to the equity markets. Should the Federal Government
reduce loopholes in taxation, had they issued more long-term securities
in the boom periods of 1955-56, should they not be excessively fearful
of short-term issues, and should the reserve assume proper responsi
bilities for the Government bond market and abandon excessively
restrictive monetary policies, then the raising of the interest rate
ceiling would not be necessary.
In detail, here is the case against the raising of rates.
First, I think it would be a mistake to give this permission now.
Senator Douglas, in his excellent statement in the Senate on June 8,
pointed out that long-term money is not needed for more than a year.
This is a relevant consideration.
Second, it is well to note the continued absolute and relative rise
of short-term issues of the Treasury. These are not nearly so danger
ous as is supposed in orthodox circles. In fact, the current^ issues of
short-term securities would have been considered fantastic in the
1920’s. But there is a real demand and need for these short-term
2192
the financial condition of the tooted states
issues which provide the economy with liquidity. Even in the year
ending April 1959, short-term issues rose by $11 billion and yet the
price level was stable.
In this connection, it should be noted that in many ways our
economy is less liquid than it used to be. For example, in the last
8 years per capita money in real terms (money adjusted by the
wholesale price level) has actually declined.
Third, a policy of giving the Treasury freedom in this area would
also be a signal for the Federal Reserve to increase their rates without
having to worry about Federal finance. But the Federal Reserve
has been too anxious to raise rates and excessively concerned over
inflation. They increased rates in 1957 when signs of a depression
were clear and again in October 1958 at the beginning of a recovery.
This is not smart central banking.
Fourth, the President, the Treasury, and especially Mr. Martin
talk too much about inflation, and with their great influence in the
financial world they hastened the dumping of bonds and the purchase
of common stocks.
Fifth, the present difficulty of selling long-term bonds is the result
in no small part of the stock market boom; but note that at the end
of 1958 for the first time in a generation stocks were yielding less than
bonds and values were up above those justified by profit prospects;
and hesitation in the rise of the stock market could easily improve
the bond situation. (Funds obtained by the sale of stocks would
be used to buy bonds.)
Sixth, the Treasury has inflicted upon itself excessive competition
from bonds guaranteed by the Treasury. W hy buy Treasury bonds
at 4 percent when Treasury guaranteed housing bonds can be had at
5 or more percent?
Seventh, in the boom period 1955-57, the Treasury failed to issue
long-term securities, though this is considered sound anticyclical policy.
Yet in the first 6 months of 1958 in the beginning of a recovery, when
the Treasury is supposed to issue short-term issues and not compete
with the market, they issued $9 billion of long-term securities. In
other words, the Treasury could have issued more long-term issues in
1955-57 if it had not been excessively concerned over the effects on the
private market.
In this connection, a statement by Henry Wallich, then the Assistant
to the Secretary of the Treasury, before the Duke American Assembly
early this year, is of some interest:
I n a b o o m , th e m a n a g e r s o f th e p u b lic d e b t m a y e n c o u n t e r s e r io u s d iffic u lt ie s ,
u n d e r p r e s e n t c o n d itio n s a n d w it h p r e s e n t te c h n iq u e s , in th e lo n g -t e r m r e fu n d in g
t h a t t h e y a re s u p p o s e d t o d o .
C o n t r a r y t o t h e c o u n t e r c y c lic a l d o c t r in e , t h e
T r e a s u r y is c o m p e lle d in a b o o m t o e n g a g e in s u b s t a n t ia l s h o r t -t e r m r e fu n d in g o f
it s m a tu r in g o b lig a t io n s .
I n r e c e s s io n , t h e T r e a s u r y h a s n o d iffic u lt y in fin a n c in g
e ith e r lo n g o r s h o r t.
A c c o r d i n g t o th e d o c t r in e it s h o u ld fin a n c e s h o r t t o in c r e a s e
t h e liq u id it y o f th e e c o n o m y .
B u t if it d o e s so , t h e r e su lt is t h a t in f a c t it n e v e r
d o e s a n y lo n g -t e r m fin a n c in g .
T h e r e t h e n is n e v e r a g o o d t im e f o r th e T r e a s u r y
t o d o lo n g -t e r m fin a n c in g — in a b o o m it c a n n o t , in a r e c e s s io n it m u s t n o t .
Eighth, the need for higher rates would be considerably reduced if
the Federal Reserve supported the Government bond market ade
quately. That does not mean excessive support like in the late
forties. But it does mean that the Federal Reserve has a responsi
bility to help provide an adequate market for Government securities.
After all, the Federal Govrnment is 20 percent of the economy, and
THB FINANCIAL CONDITION OF THE UNITED STATES 2193
with its responsibility for defense and welfare is a most important part
of the economy. Ever since 1953, the Federal Reserve has been
neglecting its responsibilities here, and this also holds for financial
institutions generally. Senator Douglas, in his statement, put well
the responsibility of the Federal Reserve for the Government bond
market. At any rate, in restricting monetary supplies, to which
the first response is heavy dumping of Federal issues by financial insti
tutions, the Federal Reserve in fact take inadequate account of the
effect of its policies on Federal securities.
In this connection, we find it difficult to accept the Federal Reserve
policy of bills only. This policy is based in part on the theory that
the private dealers in the market should not be embarrassed by uncer
tainties imposed on the market through Federal Reserve purchases
and sales of long-term Government securities. But is not an orderly
market more important? And what success has the Federal Govern
ment had? Note the gyrations in long-term rates: 3.73 percent in
October 1957; 3.12 percent, April 1958; 4.09 percent, M ay 1959.
In this connection I cannot help pointing out that, whereas the
Democrats reduced the long-term rate of interest from 5 to less than
3 percent on first-class corporate bonds, the Republicans have been
instrumental in 7 years in increasing it to close to 4K percent.
Ninth, it is also important to point out that the cost of financing
the Federal debt by fiscal 1960 will be up $2 billion, or one-third over
1952. Yet the debt has risen by less than 10 percent. This result
from an administration wed to economy is disconcerting.
Finally, it is important that if the rate does go up, it should be up
especially for savings bonds. These are held largely by low-income
groups, and they have not shared fairly in the gains from higher rates.
7. Inflation
This country has experienced fairly steady inflation ever since the
beginning of the 20th century. There have been few years when
prices have actually declined, except for the substantial decline in the
great depression. In 1900-13 there was a steady rise of prices. Then
came the war. In the 1920’s, prices were relatively stable, that is,
commodity prices. In the early 1930’s there was a substantial
decline and a small increase in the latter part of the 1930's. Then
the war through 1948 brought a rise of prices. In 1948 the consumer
price level was 102.8, in 1950 it was still 102.8 (1947^49=100). The
Korean war brought further increases in prices so that by 1952 the
cost of living had risen to 113.5. But in the next 3 years, prices had
only risen by 1 percent, that is, to 114.5 in 1955.
The record of the current administration in these first few years
was very good. They had justified their promises to stabilize the
price level. But unfortunately, in the next 3 years they experienced
a rise of prices of 8 percent, a large rise in peacetimes. As a matter
of fact, throughout our history from 1900 on we have had no such
increases in prices except as an aftermath of World War I and World
War II, rises that should be associated with the wars. There is only
one exception to this— the substantial rise from the very low level of
1933 to 1936.
One of the striking aspects of this rise of prices in 1956-58 was
that it was accompanied by a substantial recession as well. In the
discussions before the Senate committee there was an interesting inter
2194
THE FINANCIAL CONDITION OF THE UNITED STATES
change between Senator Kerr and Secretary Humphrey on the con
comitance of rising prices and relatively small number of shortages.
(See hearings, pp. 184-194.) Senator Kerr was one of the first to
show this unusual concomitance of rising prices and capacity in a
period of much excess.
Another aspect of this problem, which should be stressed, is that
despite the repeated statements from the Federal Reserve that creep
ing inflation inevitably brings galloping inflation, we have had a long
experience with modest inflation in peacetimes and large inflations in
wartimes, and yet we have not, except in wartimes, haa the galloping
inflation that worries the authorities in Washington so much.
An excessive emphasis on inflation has, of course, resulted in re
duced emphasis on growth, and also on the Government doing what is
required to serve the people.
In the discussions before the Senate Finance Committee, very little
was said by the various authorities that was consistent with what the
other authorities said. For example, Chairman Martin was inclined
to discuss the inflation in terms of the classical pattern of excess of
demand related to an excess in the supply of money. He, therefore,
was inclined to operate through increasing rates of interest, which in
turn would restrict the amount of borrowing, and money. Under
Secretary Burgess emphasized especially the investment boom of 1955
and 1956.
The administration, and notably Secretary Humphrey and the
President, tended to put the greatest emphasis on fiscal policy and
especially the large Government deficits. But in 1959 the President,
and to some extent other members of the administration, tended to
stress much more the cost-push and especially the rise of wages.
In his testimony before the Kefauver committee, Gardiner Means
pointed out that the large increase of 8 percent in wholesale prices
in 1953 to 1958 was largely determined by the price policies of the
larger corporations. He emphasized especially the contribution of
steel, automobiles, machinery, paper, and other market-dominated
prices.
Obviously, we shall not have an adequate attack on the inflation
problem until the administration produces an acceptable theory of
the causes of inflation. If the explanation is excess of supplies of
money, then of course monetary restriction is required. This is on
the assumption that the restriction does not seriously affect the total
output.
If the explanation is Federal deficits, as the President and Secretary
Humphrey have stressed, then of course it may be necessary to have
a more cautious spending policy, and increased taxes for the Federal
Government.
If the explanation is risiug wage rates beyond levels justified by
increased productivity, and administered prices, with prices rising in
excess of costs, then of course the attack might very well be in trying
to control the rise of wages and of administered prices. Attempts to
put too much emphasis on mouetary policy in dealing with wage
pushes and rises of administered prices may very well bring about a
serious decline of output. What is disconcerting about administered
prices is that they rise even in periods of excess capacity*
THE FINANCIAL CONDITION OF THE UNITED STATES 2195
8. The stock market boom
The average weekly price of common stocks was 195 in 1952, 341
in 1958, and 427 in May, 1959. It is of some interest that in 1952'
corporate profits before taxes were $36.7 biUion as they were in 1958.
Undoubtedly some increases in the stock market prices were justified
but now they have risen to a price which results in a yield beiow that
available in bonds. Furthermore, the Federal Reserve and other
Washington authorities by stressing the inflationary dangers gave a
strong impetus to the desertion of the bond market and the large
purchases of common stocks. Insofar as this rise has been overdone,
with trouble later on, the administration and the Federal Reserve
may to some extent be held responsible. It should be said, however,
in defense of the Federal Reserve that any restrictive monetary
policies probably have the reverse effect.
9. In flatio n and the international 'position of the United States
From 1950 to 1957 foreigners acquired short-term claims on $10.3
billion, but they only converted $2.6 biUion into raid. But in 1958
total accumulation of foreigners was $2.3 biUion of our gold and $1.3
biUion additional of short-term doUar assets. In other words, whereas
in the preceding 7 years they had taken only about one quarter of
their dollar assets in gold, in 1958 they took more than two-thirds.
This suggests that the large outflow of gold and the accumulation of
doUars by foreigners in 1958 reflect some doubts about the doUar.
Insofar as the inflation of 1956-58 reduced the competitive position
of the United States, then to that extent the administration should
be held responsible for the current scare about the dollar. I think
they might also be held responsible in the sense that we do not have
a weU-integrated international economic policy. Undoubtedly, one
factor accounting for the large outflow of gold has been the con
tinued amount of foreign aid, inclusive of loans and grants. Our
total contribution to foreigners through the private finance market
and Government loans, military spending, and unilateral transfers
are of the order of $10 biUion a year. Obviously, a loss of $3 billion
should be put against these contributions of dollars of about three
times as much.
I am not arguing for a reduction in the amount of foreign aid, but
merely suggesting that this general problem should be tied to the
problem of our monetary policy at home, our rate of interest, and
other international policies. Undoubtedly, in part the gains of
foreigners of gold and doUars reflect the fact that their competitive
position has improved as it well might in view of their weakened
competitive position at the end of the war. They are now more or
less establishing a normal relationship to the United States.
M any are concerned by virtue of the fact not only that our com
petitive position has declined, but also that against our $20 biUion of
gold, foreigners had net short-term dollar claims of about $14 biUion.
Should the excess of gold and the accumulation of doUars here
proceed at anything like the rate of 1958, which was a record year in
aU our history, then the administration might weU have to consider
its policies in "re private capital movements, foreign aid, foreign grants,
travel, imports, and also take strong measures to increase exports
through rise in productivity and increased outlays on research and
the like.
2196
THE FINANCIAL CONDITION OF THE UNITED STATES
In re the strength of the dollar, there was a long discussion between
Chairman Byrd and Secretary Humphrey and then between Senator
Malone and Secretary Humphrey (hearings, pp. 71-72 and 444 et
seq.). A t first the Secretary did not seem to be aware that in case of
a large drain gold could be stopped from moving abroad. In the long
discussion with the Secretary, Senator Malone expressed great
concern about the large claims on our gold held by foreigners.
JO. Failures of monetary and fiscal policy
A more effective monetary and fiscal policy might have reduced the
rise of prices, and also have moderated fluctuations in output and
kept output at a higher level.
In general, the administration depended too heavily on monetary
policy. The Federal Reserve policy was based on the general theory
that supply of money determines prices. But this is an outmoded
theory. Chairman Martin at times went further and contended that
though a rise in the velocity of money might offset any restriction in
supply, that they also took into account the effects of their policy on
velocity, and their general policies, therefore, provided the amount of
banking debits that was appropriate for the situation. But as is
well known, over a recent period of a few years when the supply of
money increased by 6 percent, total debits increased by 40 percent and
this, of course, suggested ineffective monetary policy.
Obviously, the Federal Reserve at times was trying to bring about
dear money, and also at times cheap money. But when the country
was confronted with restrictive monetary policy and dear money, the
Federal Reserve was often inclined to deny its influence and suggest
that it was merely following the market.
One effect of the dear money was, of course, an uneven incidence on
different classes of borrowers. It is quite clear that the large corpora
tion, paying out perhaps only 40 percent of its profits, is in a strong
osition to substitute its own capital for the loans not made available
y banks. This, of course, puts them in a favorable position. There
has also been revealed in the text of this report that on the whole the
larger corporations tend to increase their loans from banks much more
percentagewise than the smaller corporations.
Another category of borrowers which suffers from the higher rate is,
of course, the State and local government. In view of the large de
mands being made on State and local government and with their debt
increasing by $3 billion or more per year, the increased cost of money
is a serious matter, especially in view of their straitened fiscal position.
A rising money rate is especially costly to these governments,
because the advantage of tax-exempt securities is not nearly as great
as it used to be. With the large additional issues outstanding, State
and local governments find that they have to issue their securities at
much higher rates in order to market them. The reason for this is
that with much larger supplies outstanding, the appeal has to be
made to lower income groups for whom the advantage of tax exemp
tion is much less than for the high income groups these securities
used to appeal to almost exclusively before. Therefore tax exemp
tion is worth less, and the governments have to issue their securities
at lower prices, that is, higher yields.
E
THE FINANCIAL CONDITION OF T^g UNITED STATES 2197
11, Integration of monetary and fiscal policy
Perhaps one of the greatest failures of the administration is in the
failure to integrate monetary and fiscal policy. Of course, there have
been differences of views between the Treasury and the Federal
Reserve, as, for example, in 1956, for in the spring of that year the
Treasury objected strenously to the dear-money policy. On top of
that there are all kinds of credit agencies that issue securities, and
though they have to operate through the Treasury, they have a con
siderable amount of independence. The absence of integration is
suggested effectively by the fact that throughout the Eisenhower
administration, the advances of the Federal credit agencies continued
to increase even as the Federal Reserve was trying to restrict credit
in 1953 and also in the 1956 and 1957 period.
It is especially in fiscal policy and debt management that serious
mistakes were made. Secretary Humphrey never had much faith in
fiscal policy, and, at any rate, his major objective was to obtain
cash from the market with a minimum cost to the Treasury. It
could, therefore, well be expected that in the period of the boom he
would not issue long-term securities, first, because he did not want
to interfere with the needs of private enterprise and, second, because
if he issued securities at that time the interest rate would be higher.
Nor would he, as one might expect, issue short-term securities at the
beginning of a recovery. This was the period when he would issue
long-term securities. Throughout the hearings, the Secretary and
his assistants never did give a clear indication of what the additional
cost would be of issuing Government long-term securities in periods
of prosperity and short-term in periods of recession. Nor did he tell
us what the additional costs to the economy would be because of the
failure to issue long-term securities in prosperity and short-term in
recession as a sound anticyclical theory required.
But perhaps even more reprehensible is the failure to use fiscal
policy in any serious manner. Indeed, in 1954 in the midst of a
recession, the administration introduced a large tax cut, and this had
a beneficial effect on the economy. But it should also be recalled that
this recession would not have occurred or would have been much less
serious had not the Government reduced its expenditures by about
$10 billion. Moreover, it is clear from the vantage point of history
that the administration did not introduce a tax cut in order to improve
the economic situation. Rather, the tax cut was a fulfillment of a
promise made in the campaign of 1952.
In contrast to the 1954 tax cut, the administration fought vigor
ously against any tax cut in the recession of 1957-58. Indeed, we
have had a recovery since then and a good recovery. But the country
would have been saved tens of billions of dollars had the Government
recommended a tax cut as well as substantial rise in expenditures. On
the whole, from the third quarter of 1957 to the second quarter of
1958, the period of major decline, the contributions of Federal spend
ing to the decline of investment and export balance was a minimum.
That the recession ended so soon can be explained in part by the
automatic reduction of tax receipts in response to declining income,
the product of a tax structure for which the preceding administration
could take credit. Again the large rise of transfer payments asso
ciated mainly with the social security program of the 1930's was also a
factor in achieving a relatively quick recovery.
2198
THE financial condition of the tooted states
12. F in an cial intermediaries
One of the mysteries of the thousands of pages of evidence produced
by the Treasury and Federal Reserve in the last year or so is that no
suggestions have really come up on how to deal with financial inter
mediaries. A view held in the Federal Reserve apparently is that
by controlling the total supply of money, the Federal Reserve controls
the financial intermediaries. But this is a very loose and indirect
control. For example, the total assets of the financial intermediaries
from 1952 to 1957 increased by 59 percent as against a rise of financial
assets of commercial banks by 17 percent. Indeed, the Federal
Reserve has plenty of difficulty in controlling the assets of the com
mercial banks because they have found it possible to dump Govern
ment securities in periods of great demand for money, and to substitute
other assets and particularly bank loans. They can do this even
though the total money supply rises little as is evident in the history
from 1954 to 1957. But the expansion of assets of the financial
intermediaries is much greater. They contribute toward inflation
in a period of rising demand by accepting cash and putting it to use.
Often this cash represents a transfer from demand deposits where the
reserve requirements are high.
IS . The independence of the Federal Reserve
Indeed, the independence of the Federal Reserve has been debated
many times, as Chairman Martin noted in the hearings (p. 1258):
I t (t h e C o n g r e s s ) h a s r e a ffirm e d its o r ig in a l ju d g m e n t t h a t t h e F e d e r a l R e s e r v e
s h o u ld b e in d e p e n d e n t — n o t in d e p e n d e n t o f G o v e r n m e n t , b u t in d e p e n d e n t w it h in
t h e s t r u c tu r e o f G o v e r n m e n t .
T h a t d o e s n o t m e a n t h a t t h e r e s e r v e b a n k in g
m e c h a n is m c a n o r s h o u ld p u r s u e a c o u r s e t h a t is c o n t r a r y t o t h e o b j e c t i v e o f
n a tio n a l a n d e c o n o m ic p o lic ie s .
I t d o e s m e a n t h a t w ith in t h is t e c h n ic a l fie ld
in d e c id in g u p o n c a r r y in g o u t m o n e t a r y a n d c r e d it p o lic ie s it s h a ll b e fr e e t o
e x e r cis e its b e s t c o lle c t iv e ju d g m e n t in d e p e n d e n t ly .
Unfortunately, there have been serious differences between the Federal Reserve and the Treasury. There is need for coordination and
integration of policy, and as long as the Federal Reserve is independ
ent, the path to coordination is rough. In fact, one may argue that
failure to use fiscal policy adequately is the result of the independence
of the Federal Reserve and hence excessive trust in monetary policy.
It is important to have a national economic council as has been sug
gested by Elliott V. Bell, editor and publisher of Business Week, and
also by Senator Anderson. Mr. Bell, for example, said:
I v e n t u r e * * * t o s u g g e s t t h e d e s ir a b ility o f a n a tio n a l e c o n o m i c c o u n c il
w h ic h w o u ld fu n c t io n in r e s p e c t t o e c o n o m i c p o lic ie s s o m e w h a t a s t h e N a t io n a l
S e c u r ity C o u n c il fu n c tio n s w it h r e s p e c t t o d e fe n s e p o lic ie s . * * *
If the Federal Reserve is independent, one can be sure that other
agencies and departments of the Federal Government will be more
independent. Note, for example, the independent policy of the Treas
ury in early 1953 when they introduced a dear-money policy through
the issue of long-term securities. It is not clear to what extent the
Federal Reserve supported this policy or rather merely acquiesced.
Or again, consider the failure of the Treasury to issue long-term secu
rities which were required bv the monetary situation in 1956 and early
1957. Or consider the conflict of policy in 1958 between the Federal
Reserve that had reversed its dear-money policy and the Treasury
which issued large volumes of long-term securities.
THE FINANCIAL CONDITION OF THE UNITED STATES 2199
The failure to make recommendations of fiscal policy and complete
independence of the Federal Reserve have resulted in excessive em
phasis on monetary policy, and a growing feeling that monetary policy
is more potent than it really is and, therefore, in a failure to use al
ternative weapons of control. These failures may be a result of the
difficulties of the agencies and departments in keeping up with modern
economic trends; but the results are also related to the great powers
that have been bestowed upon the Federal Reserve as an independent
agency.
The powerful Bank of England long ago recognized that it could
not operate independently and that the potency of its instruments
had been considerably dulled by fiscal policies. It is time for the
Federal Reserve to make a similar admission. The President’s in
ternal committee for discussion of monetary and fiscal issues with
the Federal Reserve is not an adequate substitute for a genuine
national economic council which would rob the Federal Reserve of
its complete independence. Even the periodic needling by congres
sional committees of representatives of the Federal Reserve is not
sufficient. The Federal Reserve still continues to operate independ
ently of the wishes of Congress. The power to manufacture money
and determine its value rests with the Congress and not with the
Federal Reserve. So long as the operation of the Government is
such an important matter in our economic life, it is preposterous to
expect to have an independent Federal Reserve, which through its
policies may jeopardize or delay recovery or reduce output.
14- Money and output
Perhaps the most striking aspect of the hearings and particularly
of the public officials who appeared before the Senate Finance Com*
mittee, namely, Secretary Humphrey, Under Secretary Burgess, and
Chairman Martin, was how little attention was paid to the problem
of output. The emphasis was on inflation, stability of prices, rates
of interest, and the like. An example of the lack of attention to
G N P growth and the like is had from the index of the first three
volumes, which deal with the three Government witnesses. Of about
2,500 entries in the index, 14 relate to gross national product, none
to growth, and 10 to other aspects of income. The explanation, of
course, is that the representatives of the Government and the Federal
Reserve were primarily concerned with the stability of currency and
were pretty much unaware of other aspects of economic policy.
In one significant discussion of the issue, Chairman Martin showed
that physical output had increased by 7 percent in the year ending the
second quarter of 1955, 3.3 percent in the year ending the second
quarter of 1956, and 2.2 percent in the year ending the second quarter
of 1957. He also showed that in these 3 successive years the per
centage rise of gross national product in current dollars, explained
by rise of prices, was 14, 45, and 62 percent, implying that the in
flationary effect had become increasinglv important (hearings, p.
1218).
The effects of monetary policy on output are very important.
Indeed it is important to have a monetary unit that serves adequately
as a measure of value. In this connection, it is of some interest that
Dr. Goldsmith recently pointed out to the Joint Economic Committee
hearings on “Employment, Growth and Price Levels” (pp. 242-243)
2200
THE FINANCIAL CONDITION o f th e UNITED STATES
that in a period of 120 years, that is, from 1839 to 1959, the average rise
in prices per year had been slightly above 1 percent, and from 1919 to
1959 the increase was 1.4 percent. He also noted that relative pres
sure of rising output on prices had been more pronounced in 1879 to
1919 than it had been in the last 40 years. In other words, we have
had creeping inflation now for 120 years and yet we have not had
disastrous inflation, although undoubtedly uncomfortable inflation
during war periods.
It is a fair assessment of Federal Reserve policy to say that fearing
inflation, the Federal Reserve reduced the supply of money, raised
interest rates, and contributed toward a recession. This policy is
based partly on the premise that when wages, and so forth, rise too
much, the medicine is to reduce the supply of money, and reduce
output, and increase unemployment and therefore reduce the bar
gaining power of labor. The history of wages in the depression years
of 1957-58 also suggests that this medicine works to some extent.
But the price, of course, is a good deal of unemployment.
In this connection, we should compare the rise of G N P in recent
years.
1 9 4 8 -5 8 a v e r a g e in c r e a se in s t a b le d o l l a r s .______________________________________
1 9 4 8 -5 2 a v e r a g e in c r e a s e in s t a b le d o lla r s _______________________________________
1 9 5 2 -5 8 a v e r a g e in c r e a s e in s t a b le d o lla r s _______________________________________
1 9 5 3 -5 9 a v e r a g e in c r e a se in s t a b le d o lla r s (a n a s s u m p t io n o f 8 p e r c e n t rise
in 1 9 5 9 )__________________ _____________ ______________________ ________ _____________
Percent
3. 5
5. 0
1. 7
2 .5
We cannot afford to have a rise in G N P of only 2 percent a year.
With the Russians expanding at the rate of 7 percent, and our earlier
history suggesting at least a reasonable goal of 4 or 5 percent, we are
likely to get into serious difficulties if our rise is not at least 4 percent.
Actually, with a rate of 2 percent and the Russians gaining at the
rate of 7 percent, inside of about 15 years Russian G N P would be as
large as that of the United States. In view of their greater control of
the distribution of resources, this would have very serious security
implications.
P A R T IV
LEGISLATIVE ISSUES
In this part, I raise relevant legislative issues that arise from the
hearings on the financial condition of the United States. I start with
a few legislative proposals that probably should not be supported.
1 * The objective of price stability incorporated in the Employment Act
of 1940
I think it would be unwise to incorporate this provision in the
Employment Act of 1946— not that price stability should not be an
important objective of government, but largely for strategic reasons
we should not make price stability an objective under the Employment
Act of 1946. The point is that the administration and the Federal
Reserve in particular tend to put excessive emphasis on price stability
against other objectives of economic life. Hence with this provision
in the Employment Act of 1946, the Federal Reserve would be
encouraged in its excessive fear of inflation, and its penchant for re
strictive monetary policy.
.2. Measures to save the dollar
In the hearings there was very little attention paid to the gold
problem except by Senator Malone in long discussions with Secretary
Humphrey and Chairman Martin. Malone expressed great fear
about the shortage of gold and stressed the rights of the Treasury to
withhold gold demanded by foreigners in exchange for their dollar
balances. Since that time the problem has become much more
serious with the loss of $3.3 billion in 1958, inclusive of an increase of
dollar balances held by foreigners of $1.3 billion. As the result of
these losses, there has been much urging of a devaluation |>olicy which
would increase the price of gold, or general import restrictions or a
reduction of foreign aid or other measures to improve the balance of
payments of the United States.
Though the dollar problem should be watched and the losses in 1958
and 1959 so far are serious, they may very well reflect nothing more
than a normal competitive relationship between the United States
and other countries.
A devaluation policy would be unwise, expecially since the net
result would be to increase the dollar resources of gold-mining coun
tries, and expecially of South Africa. Our aid would then be given
primarily to sellers of gold, and not on the basis of our own interests.
This is only one argument against the devaluation program. Nor is
the situation serious enough yet to justify general import restrictions
•or even a reassessment of our foreign aid and foreign investment
policies. But I do believe strongly that all these policies should be
watched carefully and expecially in relation to our gold reserves and
foreign holdings of short-term dollars.
2201
2202
THE FINANCIAL CONDITION OF THE UNITED STATES
S. A N atio n al Economic Council
The Employment Act of 1946 provided for an economic council
which is largely a planning agency which advises the President on theeneral economic situation, and suggests policies to the President,
hit we also need a national economic council composed of the^
operating agencies that are in the areas of money, credit, and fiscal
policy. A suggestion along these lines has been made by Elliot Bell
as well as by Secretary Anderson. Such a council should include
representatives of the Treasury, the Federal Reserve, all credit
agencies such as the National Housing Administration, F N M A , IC A r
the Commodity Credit Corporation, Veterans’ Administration,, etc.
The major objective of this organization would be to integratecredit and fiscal policies within the limits set by the Congress in such
a manner as to give the country the maximum output consistent with
a reasonable degree of stability of prices. This council should be
strong enough to prevent the Treasury going one way and the Federal
Reserve going another, or the Treasury and Federal Reserve agreeing
on restrictive policies, and all other credit agencies expanding greatly.
Indeed, to some extent the credit agencies are not absolutely free
to operate in such a manner as to satisfy our major objectives of
economic policy. A credit agency, for example, may be required by
the Congress to buy surpluses or to issue housing mortgages or guar
antees of certain amounts. But within these limits credit agencies
should conform in that policy to the general objectives of the Federal
Government. These, of course, should include not only maximum
employment and reasonable stability of prices but also effective
exploitation of anticyclical policies. A t the present time the Housing
Administration has certain rights to change conditions of mortgages,
downpayments, and the like, but these should be more closely inte
grated with the policies of other agencies and the Federal Reserve.
The Congress might also take into account the need of this kind of
integration, and give the credit agencies somewhat greater latitude
in their lending and guarantee policies.
f
4* Selective credit control
There is much to be said for general credit control, that is, control
through raising rediscount rates, open-market operations, and changes
in reserve requirements. But these have an overall effect, and often
are unequal in their incidence. It may be desirable to avoid increas
ingly these general measures that increase the general rate of interest
in a period of restriction, and deal with the problem more through
selective measures. For this reason, there is much to be said for con
sumer credit control and also, of course, for housing credit control.
The latter is already to some extent in the hands of the administration.
But Congress might seriously consider giving to the Federal Reserve,
though they do not seem to be anxious to have it, control over con
sumer credit. In hearings before the Senate Finance Committee,
Secretary Humphrey was against this type of credit control on the
grounds that it means too much operation from Washington. I see
little difference between general control of a credit mechanism from
Washington and another type of control which is more selective and
therefore not quite so pervasive in its incidence. In this connection,
it should be noted also that the Government does control the credit
going into the stock market through margin control, and that in the
THE FINANCIAL CONDITION OF THE UNITED STATES 2203
past we have had control of consumers' credit. Nothing exactly
revolutionary is in these proposals, and they might avoid unnecessary
rises of unemployment in periods when the Federal Reserve has occa
sion for restriction,
5. Control of intermediaries
For many years now the financial intermediaries other than com
mercial banks have become increasingly important in the financial
market. They control a much larger percentage of assets than they
•did 10, 25, or 50 years ago. They also make it more difficult for the
Federal Reserve to control the money market, because the Federal
Reserve has only limited and indirect control of an intermediary
through control of the total reserves of member banks. It is, there
fore, important to suggest legislation in this area. Obviously since
the intermediaries deal to a considerable extent with housing and
consumer credit, any control over these might indirectly affect the
activities of the intermediaries. Another approach is to set up re
serve requirements for intermediaries, especially since their growth
of activity reflects in part transfers of funds from demand deposits
that require relatively small reserves to time deposits. It has also
been suggested that one approach is to increase the profitability of
member banks through reducing the requirements of reserves against
demand deposits. This would, however, have the effect of making
banking even more profitable than it is at the present time. (More
on this later.)
6. A dm inistered'prices
M any have proposed that Government discourage rising wages and
rising prices in a number of crucial industries where prices are adminis
tered; that is where there is not free competition and the control of
the market lies in a relatively small number of sellers. The implica
tion is that monetary policy cannot treat administered prices. Infla
tion in the last 5 to 10 years, as, for example, Dr. Means claimed before
the Kefauver committee, is held to be the result of the administered
prices. Then obviously the proper approach would be to deal with
prices and wages in the administered areas. Behind this is the view
that monetary control, that is, control of the supply of money, does
not prevent a large corporation from increasing their prices beyond a
level set by increasing wages and other costs. A really restrictive
monetary policy, however, might discourage many of these rises in
prices because they have to be validated by adequate supplies of
money. But the effects on the employment situation of a policy that
really stifles rising prices in the administered area might have a con
siderable adverse effect on the whole economy.
I am not convinced that the rise of prices is primarily explained by
increases in the administered area. For example, in consumer prices
the increase from 1955 to’March 1959 was 8 percent (1947~49 equals
100), but among 13 categories the only ones that were much above the
average were solid fuels and fuel oils, a rise of 12 percent; transporta
tion, 15; medical care, 16; personal care, 13. Solid fuels and fuel 08s,
and transportation alone may be considered areas in which administered prices are very important. But I hasten to add that such
overall price studies conceal to some extent the genuine incidence of
administered prices.
2204
THE FINANCIAL CONDITION OF THE UNITED STATES
In the wholesale price index the increase from 1955 to March 1959
was from 110.7 to 119.6, or an increase of about 8 percent. Large
rises were in hides, skins, and leather products, 16 percent; pulp, paper,
and allied products, 11 percent; metals and metal products, 13 per
cent; machinery and automotive products, 17 percent; nonmetallic
minerals (structural), 11 percent. The evidence is not too clear that
the major rises are in the administered areas. For example, in rubber
and products where there is a considerable amount of monopoly the
increase was only 2 percent.
But undoubtedly the administered area does make some contribu
tion to rising prices. It might be wise to introduce experimental
legislation, a bill which would require compulsory publicity for any
substantial increase of wages or prices that is likely to affect the econoomy in a serious way. This publicity might very well discourage
excessive increases of wages or prices though without sanctions the
likelihood does not seem great. Unless the general price level keeps
on rising considerably more than it has in recent years, I do not th ink,
that a case for price control is strong.
7, A rea development
An area development program, which has once been vetoed by tne
President and is now up again for his consideration and now known
as the Douglas bill, is relevant legislation, because this is one way of
reducing the importance of monetary and fiscal policy. Once we
reach 3 or 4 millions of unemployed then the transitional and hard
core of unemployment are the major residual. B y the latter I mean
unemployment in depressed areas, and also in the depressed in
dustries which are likely to be located in depressed areas. A sub
stantial part of total unemployment then is this depressed area un
employment, One way of dealing with this problem is to pour out
more and more money and more and more Government spending
as well as tax reduction as a means of improving the overall situation
sufficiently so that excess purchasing power will spill over and wipe
our a large part of this stubborn form of unemployment. Tnis is
not the most effective, and is a very wasteful method because it is
like treating the whole circulatory system in order to cure a local
infection. The area development program is an attempt to deal with
this problem by direct attack on tne areas involved and not through
ouring out vast sums of money or Government expenditures in the
ope that they will ultimately reach these specific areas.
E
8. Ceiling on Treasury debts and Treasury rates
I see little use for the debt ceiling. In the past it has interfered
with the integrity of the budget. It is not the most effective way of
keeping spending down. It forces the Treasury into rather dubious
accounting methods and insupportable trading practices.
The removal of the ceiling on the interest rate to be paid on long
term securities is another matter. At the present time it would be a
mistake to grant the Treasury request. This would be an invitation
for the Federal Reserve to pursue dear money policies irrespective of
the effects on the Treasury, because the absence of a ceiling on rates
would give the Treasury virtually unlimited access to the security
market. The policy is also unwise since it is unnecessary at the
present time and since much could be accomplished by a stronger
THE FINANCIAL CONDITION OF THE UNITED STATES 2205
support of the Federal market by the Federal Reserve, and continued
reliance on the short-term market for sales of securities.
9. Budgetary integrity
The present situation of the budget is anything but defensible. It
is almost impossible to compare the budgetary situation in one year
with another because of the great changes in practices and policies.
The Congress should require an honest accounting of the budget.
The Budget Director should be required to present expenditures and
receipts, as he does now, as well as cash expenditures and receipts.
But in the budget presentation, as is now practiced, the total volume
of guarantees should be indicated, as well as insurance, both currently
and the preceding years, trust receipts and expenditures— not on
pages 877 et seq., and 957 et seq., but early and as prominently as the
regular budget account.
Again tax receipts should be distinguished from receipts from sales
of capital items such as mortgages and supplies.
The growing practice of setting up trust funds which disguise the
actual budgetary situation should either be discouraged or else an
honest accounting be made. For example, even from fiscal year 1955
to 1958 trust fund receipts have risen by $6.8 billion or more than 70
>ercent and expenditures by $7.5 billion or by 88 percent. Particuarly dubious is the practice which prevailed in the early years of the
Eisenhower administration of not appropriating all the cash received
from civil service retirement payments. For example, $500 million
are received and less than $100 million are spent. Economic policy
may indeed suggest that it might be wise instead of increasing taxea
by $400 million to use $400 million of the civil service receipts of this
particular vear. But the budget should show expenditures of $500
million and not $100 million, even though it may be indicated these
expenditures were withheld for the time being.
10 . A general directive on fiscal policy and debt management
It would be helpful to have a resolution from the Congress suggesting'
or telling the administration that in its fiscal policy ana debt manage
ment it should take account of the effects of these policies on the
economy, and should weigh the net effects on the economy as against
alternative policies. The Government generally should estimate the
costs of particular policies for the economy and also for the Govern
ment.
!
11. The cash m u lt bill
This bill has unfortunately already (June 28) passed both Senate
and House of Representatives. The bill makes possible a reduction
of reserve requirements for member banks of more than $10 billion,
with the net effect that Government securities now yielding income
to reserve banks and hence to the Government, may now become the
property largely of the banks, thus increasing their profits substan
tially. This follows as reduced reserve requirements have to be offset
by sales of securities by the reserve banks to control inflationary
effects of more free reserves.
Is this a supportable windfall? Another effect would be a rise in
rates on Treasury issues. To sell billions more requires higher rates.
CHAPTER III
VIEWS OF SENATOR WALLACE F. BENNETT
A t the conclusion of the Finance Committee hearings on the
financial condition of the United States in April 1958, and in the ab
sence of a formal committee report at that time, I made a series of four
statements (during the summer months of 1958) in which I summarized
in a lengthy manner, my impressions of the committee’s investigation.
In my opinion, the principal topic of discussion during the hearings
was the problem of inflation; and accordingly, my statements center
around that problem. In these statements I discuss four aspects of
the topic:
I. The problem of inflation.
II. Monetary policy and inflation.
III. Labor unions and inflation.
IV . Inflation and the recession (1957-58).
Much of my supporting data and all of my supporting statements
came from the committee record— from both witnesses who testified
in person and from respondents to the committee questionnaire. All
references are footnoted in the text of each statement.
With the permission of Senator Byrd, I am submitting the first
three of these statements to be printed in full with the committee anal
ysis Because the fourth statement was so specialized and so closely
tied to the recession of 1957-58, which is now past, I am not asking
that the text of that statement be included. However, I would like
to include the summary paragraphs from the fourth statement because
of their timeliness and because they summarize my whole series.
2207
I. T H E P R O B L E M O F I N F L A T I O N
It is interesting to note that the two sessions of the Finance Com
mittee investigation in 1957 and 1958, were held under entirely differ
ent economic conditions. The setting during the 1957 hearing was
one of inflation, characterized by full utilization of the labor force
and a capital goods boom. While the April 1958 hearings were in
progress we were in the midst of a business downturn, characterized
by a slump in private capital investment and some unemployment.
In setting for itself the problem of investigating so many aspects
of the financial conditions of the United States, the committee left
the door open for a discussion of a wide variety of issues. Therefore,
it is not surprising that virtually every question or topic bearing on
the Nation's finances was encountered and discussed. Nevertheless,
in reviewing the printed record, I have been impressed by the fact
that running through all the discussions was a single unifying thread,
namely, the problem of inflation.
During the 1957 sessions, when prices were rising fairly rapidly and
most of our resources were fully utilized, much of the discussion cen
tered around two questions: First, how could inflation be stopped;
second, was the anti-inflationary action then being taken necessary or
harmful? Concern over inflation did not diminish during the hearings
this spring, despite the business downturn and a slowing down of the
rate of the price rise. A scrutiny of the testimony and questioning
during these later sessions will indicate that the major issues were,
first, whether the anti-inflationary policy of 1957 was primarily respon
sible for the current business downturn; second, the extent to which
antirecession action should take into account the danger of further
inflation.
Because the general problem of inflation ran through all the hearings,
it has naturally become the central theme of these reports. In fact,
I am convinced that it has become our basic, longtime economic
problem, and that until we, as a people, understand the danger it
creates and take the necessary steps to stamp it out, we cannot count
on a future of sound growth and prosperity.
The committee gathered a great variety of material on the general
nature of the problem of inflation. I shall begin by reviewing this
background information. Without such a review, it seems pointless
to consider the separate, basic issues developed at the hearings.
To me, the most serious aspect of inflation is the moral one. Infla
tion is essentially a process by which someone attempts to get some
thing for nothing, a disguised form of theft, in which the poor and
helpless are the first victims, but which can eventually engulf a whole
economy. It is a narcotic which produces the illusion of prosperity
and growth, and conceals the real damage. The committee devoted
little or no time to this aspect of the problem, probably because most
of its members are in agreement that inflation is an evil, whether it be
judged on moral or on economic grounds. Instead, most of the time
was devoted to the definition and mechanics of inflation.
2208
TH E
F IN A N C IA Ii C O N D IT IO N
OF TH E
U N IT E D
STATES
2209
In its search for information in this field, the committee literally
began at the beginning. Throughout the entire course of the hearings,
the committee sought to find a workable definition of inflation. Most
of the witnesses were asked for, or volunteered, a definition. In addi
tion, a request for a definition was included among the questions sent
to business and university economists and to the presidents of the
Federal Reserve banks. *The committee never attempted to make a
final selection from all the answers; but I think it probably true that
by the end of the hearings the simplest of all the definitions gained
the most acceptance; namely, that inflation is simply a general rise
in prices.
In looking over all the definitions of inflation suggested at the
hearings, I am impressed by the fact that many of the witnesses
agreed that inflation is basically a phenomenon of money. For
example, Mr. Baruch defined inflation as an abnormal and dispropor
tionate increase of money and credit in relation to the production of
goods and services. At other times during the hearings, inflation was
defined as a flow of spendings in excess of the flow of goods and
services, or too much money for the goods and services offered, or
too many dollars chasing too few goods* On the other hand, it
should also be noted that inflation was described by some witnesses
as being a result of pressure on costs, particularly wage pressures.
Thus, Professor Slichter, of Harvard, rejected the monetary definition
as inaccurate, and added that the recession is helping the public see
more clearly than ever that rising wages are a principal cause of
rising prices.1 Similarly, Dr. Abbott, dean of the graduate school of
business administration, of the University of Virginia, emphasized
that our current problem is a wage-push inflation.
Personally, I believe it is possible to oversimply the statement of
any specific cause of inflation. For that reason, I was impressed
with the statement on the inflationary process, which was made by
-Chairman Martin, of the Board of Governors, in his appearance
before the committee last summer. It was supplemented by an
excellent account of inflationary processes, given by Mr. Edward
Wayne, first vice president of the Federal Reserve Bank of Richmond.
Neither of these presentations attempted to attribute the blame far
inflation to one specific element. As Chairman Martin pointed out:
I n fla t io n is a p r o c e s s in w h ic h r isin g c o s ts a n d p r ic e s m u t u a lly in t e r a c t u p o n
-each o t h e r o v e r t im e w it h a s p ira l e ffe c t. A t th e sa m e t im e , d e m a n d m u s t a lw a y s
b e s u ffic ie n t t o k e e p t h e s p ir a l m o v in g .*
Although they were greatly concerned with the causes of inflation,
the committee members spent very little time on questions having
to do with its consequences. It is precisely here that its greatest
danger lies. A ll of us are against it in theory, as we a.re against sin;
but in practice some of us think we can profit by it. Too often
Pope’s lines on vice can also be used as an accurate description of our
attitude toward inflation.
V ic e is a m o n s t e r o f s o fr ig h t fu l m ie n ,
A s t o b e h a te d n e e d s b u t t o b e s e e n ;
Y e t s e e n t o o o ft , fa m ilia r w it h h e r fa c e ,
W e fir s t e n d u re , t h e n p i t y , th e n e m b r a c e .
1"Investigation of the Financial Condition of the United States,*’ bearings before the Committee on
2210
TH E
F IN A N C IA L
C O N D IT IO N
OF
TH E
U N IT E D
STATES
It is a simple fact that inflation results in a transfer of economic*
resources. Perhaps in thiory we can imagine a situation in which
as prices rise, all incomes rise at precisely the correct rate, and all
money contracts change to just the right degree, so no loss is suffered
by anyone. But in real life, such a situation does not, and could not,
exist. There is simply no way to avoid the fact that in an inflationary
process, some gain, on net balance, while others lose; and the losers
are those least able to protect themselves or to make their voices
heard: pensioners, savers, white-collar workers, small businessmen,
the great body of unorganized workers. One great trouble is that the
transfer is involuntary. Resources are literally stolen from those
who have no way of protecting themselves, and they are left without
any claim to future output, or even the satisfaction of knowing that,
if the levy had been in the form of a tax, others would also be sharing
the burden.
If the only consequence of inflation were the slow, but insidious,
transfer of resources from one group to another, some of us might
possibly resign ourselves to the process, and might provide for relief
by way of legislation, for those affected by it. But inflation has other
consequences. It provides a misdirected stimulus for business. Any
one who has been in business knows that sound business decisions are
made within a framework of price stability; and that the principal
beneficiaries of inflation in the business world are speculators and
gamblers. Also, by destroying the use of money as a store of value,
inflation stimulates the production of other items which can serve the
same function, Thus, we must devote a part of our energies to the
production of articles which we would not have needed in the absence
of inflation. A good current example is the concentration of invsstment in partly filled office and apartment buildings in some Latin
American countries— which capital is withheld from productive in
dustry.
Finally, a creeping inflation must, in the absence of specific controls
or other unwarranted interference by Government, become a runaway
inflation. Even the inflationists fear this. When the time comes
that a majority of the people throw up their hands in resignation and
accept the inevitability of rising prices, inflation will immediately
cease to creep, for just as soon as those who have a stake in inflation
can be absolutely certain that society has become resigned to the
process, we see the inevitable development of a completely destructive
wage-price spiral. Said Ralph J. Cordiner, president of General
Electric, in his reply to the committee:
I f c r e e p in g in fla tio n w e r e a c c e p t e d as a p e r m a n e n t fe a tu r e o f A m e r ic a n e c o n o m i c
life , it w o u ld n o t c r e a te j o b s ; it w o u ld o n ly f e e d o n it s e lf in a r is in g s p ira l o f c o s ts
a n d p r ic e s .
T o a c c e p t c r e e p in g in fla tio n , in s te a d o f u s in g e v e r y p o s s ib le m e a n s t o
c o m b a t it, w o u ld b e t o a p p l y t o o u r e c o n o m y t h e g r e a te s t o f a ll in fla t io n a r y p r e s
su re s— th e p re s su r e o f in fla tio n p s y c h o l o g y .
E x p e c t in g c o n t in u e d p r ic e in c r e a se s,
b u sin e ss e s a n d in d iv id u a ls w o u ld h a v e a c o n t in u in g in c e n t iv e t o s p e n d t h e ir m o n e y
b e fo r e its v a lu e d e p r e c ia t e d fu r t h e r , a n d w o u ld t h u s b e t e m p t e d in t o a flig h t f r o m
m oney.
T h e in a d e q u a t e v o lu m e o f p u r c h a s in g c h a r a c t e r is t ic o f t h e c u r r e n t r e c e s
s io n w o u ld b e r e p la c e d b y a n in c r e a s in g ly e x c e s s iv e r a t e o f s p e n d in g , w it h fa r
m o r e d e s t r u c t iv e e ffe c ts .
T h e v o lu m e o f s a v in g s w o u ld c o n t in u a lly d im in is h ,
c u t t in g o ff th e o n ly re a l s o u r c e o f in v e s t m e n t fu n d s .
T h e e ffo r t s o f b u s in e s s e s
t o c o n t in u e e x p a n d in g t h e v o lu m e o f p r o d u c t i o n a n d im p r o v in g t h e a t t r a c t i v e
n ess o f th e ir p r o d u c t s , s o as t o m a in t a in h ig h le v e ls o f e m p lo y m e n t , w o u ld require*
TH E
F IN A N C IA L
C O N D IT IO N
OF T H E
T7N ITED S T A T E S
• con tin ued e x p a n s io n o f m o n e y a n d c r e d it. T h u s th e in fla tio n a r y sp ira l
p ro fitle s s p r o s p e r ity w o u ld b e a c c e le r a te d t o w a r d in e v ita b le eoU apse.’
2211
and the
Professor Haberler, of Harvard University, had this to say regard*
ing the dangerous creeping inflation:
I a d m it t h a t th e p re s e n t m e th o d o f w a g e fix in g a n d th e a t tit u d e o f th e p o w e r fu l
t r a d e u n io n s, w h ic h e x p e c t e v e r y y e a r a la r g e w a g e rise e x c e e d in g th e a v e r a g e
a n n u a l in c r e a se o f l a b o r p r o d u c t iv it y , p o se s a se rio u s d ile m m a .
B u t t h e p r o b le m
c a n n o t b e s o lv e d b y a c q u ie s c in g in a c o n t in u o u s rise in p rices. T h e t r o u b le is
t h a t w h e n p ric e s rise b y o n ly 2 o r 3 p e r c e n t p e r y e a r fo r a fe w v ea rs in s u cc e s s io n ,
m o re a n d m o r e p e o p le b e c o m e a la rm e d a n d t a k e s te p s t o p r o t e c t th em se lv e s.
The
la b o r u n io n s th e m s e lv e s , w h o s e p o lic y is la r g e ly r e sp o n sib le fo r t h e c o n t in u in g
rise in p ric e s , w ill a s k fo r la r g e r w a g e in cre a se s (o r in sist o n e s c a la to r cla u ses)
w h e n t h e y see t h a t th e ir w a g e rises are s w a llo w e d u p b y risin g p rices. H e n c e
s o o n t h e p r ic e c r e e p w ill b e c o m e a t r o t a n d t h e t r o t a g a llo p . T h is is s im p ly an
a p p lic a t io n o f th e h o m e ly t r u t h t h a t w h ile y o u m a y f o o l all p e o p le so m e o f t h e
tim e a n d s o m e (t h o u g h n o t t h e s a m e ) p e o p le all th e tim e , y o u c a n n o t fo o l all
p e o p le a ll t h e tim e .
I t h a s b e e n o b j e c t e d t o t h a t a r g u m e n t t h a t a g a llo p in g in fla tio n is im p o s s ib le
in t h e U n it e d S ta te s.
I a m in c lin e d t o a c c e p t th is p r o p o s it io n , b u t I s u b m it th at
i t m isses t h e p o in t .
W h y is g a llo p in g in fla tio n im p o s s ib le ? B e c a u s e th e F ed era l
R e s e r v e w ill k e e p m o n e y su ffic ie n tly tig h t t o p r e v e n t in fla tio n fr o m g a llo p in g
a w ay.
B u t w h a t t h e a d v o c a t e s o f c r e e p in g in fla tio n o v e r lo o k is t h a t a fte r a w h ile
t h e m e re a t t e m p t t o k e e p in fla tio n a t a c r e e p in g Dace ( t o p r e v e n t tfte c r e e p
b e c o m in g a t r o t o r a c a n t e r ) w ill b e su ffe r in g [sic] to b r in g a b o u t
A n d d e p r e s s io n .
T h is is a fte r a ll w h a t h a p p e n e d la st y e a r .
■creeping in fla tio n th e m s e lv e s b la m e t h e t ig h t -m o n e y p o l ic y
de
p re s s io n .
I p e r s o n a lly w o u ld s a y t h a t it w a s a c o n t r ib u t in g fa c t o r — bu t let tne
f o r a r g u m e n t 's sa k e , a c c e p t t h e p r o p o s it io n t h a t it w a s th e m ain cause. T h e n
it is in d e n ia b le t h a t a p o l i c y w h ic h h e ld t h e in fla tio n a t a c re e p — it d id n o t d o m o re
t h a n t h a t — b r o u g h t o n u n e m p lo y m e n t a n d d e p re ssio n .
I f m o n e y h a d been
t ig h t , p r ic e s w o u ld o b v i o u s l y h a v e risen e v e n fa ste r . S o o n e r o r la te r t h e p r ic e
tise h ad t o b e s t o p p e d o r s lo w e d d o w n . I t s h o u ld b e o b s e r v e d th a t if it h a d been
s t o p p e d b y fisca l m e a su r e s (t a x in cre a se s o r lo w e r G o v e r n m e n t e x p e n d itu r e s)
s o m e e x p e r t s h a d r e c o m m e n d e d , t h e r e a c tio n w o u ld h a v e b e e n tlie sa m e. In t h a t
r e s p e c t m o n e t a r y a n d fisca l p o lic ie s a re n o t d iffe r e n t in t h e ir o p e r a tio n . I f d e
m a n d is c o n t r o lle d e it h e r b y m o n e t a r y o r fisca l m e a su res a n d w ages con tin ue to
b e pu shed u p , t h e c o n s e q u e n c e m u s t be u n e m p lo y m e n t.4
from
unemployment
Tlie advocates of
for the present
lees
as
When I say there seemed to be general agreement over the propor
tion that inflation is a situation which must be avoided, I do not meaa
to be understood as saying that there was total agreement on the
degree to which it should be avoided. For example, the testimony a t
Professors Harris and Slichter quite clearly indicated only slight con
cern over inflation so long as the rate was slow. In addition, question
ing by some of the members of the committee suggested a similar
attitude. I shall expect to discuss this issue in more detail later.
To return now to the consideration of the general nature of inflation
as it was developed during the hearings, I must say that one of the
most significant conclusions I drew from the testimony is that infla
tion today as a problem is a great and increasing threat to our econ
omy, with several new aspects.
1 do not mean that the present inflation itself is of some hitherto
unknown variety, but, rather, that the conditions under which we
must combat inflation today are very different than anything we have
faced before in this country.
s 5**
The conclusion that our present inflation is dangerous wasMreliiforced, in my opinion, by the testimony of Bernard Baruch. In the
’ “ Zntestfeatioa <rf the Financial Condition of the United S t * C o M m e n t o a f g r tq fty e t Of Carper*
to the Questionnaire of the Committee on Finance* U.S.
Stth Oodj., A .
p . 197.
*IbKL( ch. 5, p. (KM*
ffradi tn
%
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midst of a business downturn, when he could easily have been expected
to direct his attention toward other matters, M r. Baruch made the
flat statement:
I n fla t io n , g e n t le m e n , is t h e m o s t i m p o r t a n t e c o n o m i c f a c t o f o u r t im e — t h e
sin g le g r e a te s t p e r il t o o u r e c o n o m i c h e a lt h .8
I think it is important that we look behind this statement to see
why inflation remains our No. 1 problem.
If there is one thing which stands out above all else with respect to
our recent history, it is the persistency of inflation and inflationary
pressures. This development must reflect the fact that we are now
facing new economic problems, for, contrary to some opinions, this,
country has not had a continuing and persistent inflationary condition
until recently. I was happy to see this point developed by Chairman
Martin during his questioning by the Senator from Oklahoma (Mr..
Kerr). Mr. Martin placed in the record information on prices which
reveal that over the period from 1800 to 1930, the trend of prices was
generally downward. In other words, during the major portion of
the life of this Nation we have had stable or declining prices. I refer
my colleagues to page 1938 of part 6 of the hearings.
Although we did not have a persistent inflationary problem during
the most of our history, I do not mean to imply that we had no
problems at all. The basic difficulty was that the price level changed
too suddenly and swiftly— first in ond direction, and then in another.
The erratic movement of prices was terribly serious. On some oc
casions price increases and consequent declines were so sharp as to
stimulate the wildest and most reckless kind of economic activity.
When this happened long periods of depression and economic distress
always followed and we had panics, of which the years 1873 and 1893
are tragic examples.
It is noteworthy that during those periods prior to 1930 when we
had price stability— and there were a number of such periods— as
well as during some of the periods in which the price level drifted
downward, this Nation enjoyed a remarkable rate of economic
growth. Today we hear much loose talk about the necessary relation
ship between inflation and growth, as if we needed the first in order to
have the second. I challenge any one to find any period in the
history of this country when we had price stability which was not.
accompanied by substantial economic growth.
If it is true— as I believe it to be— that we are today facing the old
problem of inflation in a new and more dangerous setting, let us see
what this setting consists of. In the first place there is the role of
organized labor, a factor not present to any important degree before
the 1930’s, and which has only become really significant since W orld
War II. Because of the growth in size and power of labor unions, we
are now faced with continuous upward pressure on wage costs and
thus prices, regardless of productivity increases. This development
was cited by most of the committee’s witnesses. For example, Dean
Abbott noted that wage increases in excess of productivity “push up
prices when, as is the case in this country, there is a flexible money
supply.” 6 Professor Slichter also took note of this situation, as did
* Investigation of the Financial Conditions of the United States,” hearings before the Committee oo’
Finance, U.S. Senate, 85th Cong., p. 1636.
• Ibid., p. 2061.
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former Chairman of the Board of Governors of the Federal Reserve.
Marriner Eccles, who said:
T h e m a in ca u s e o f r isin g p r ic e s h a s b e e n th e use w h ich la b o r u n io n m o n o p o lie s
a r e m a k in g o f t h e ir p o w e r t o fo r c e u p w a g e s a n d n u m erou s c o s t ly fr in g e b en efits
fa r in e x c e s s o f in c r e a s e d p r o d u c t i v i t y .7
There are several other aspects of this problem which, I believe,
warrant notice. For example, it is important to note that if orgnaized labor were required to depend only on its bargaining power to
force wage increases in excess of productivity, the program would
eventually fail. That is to say, costs and prices can be pushed up
only so far before the public would become unable to purchase afi
the output and there would be resulting unemployment. Recog
nizing this, much of organized labor has placed itself squarely in the
camp of the new inflationists, supporting monetary programs which
will validate higher wages. Thus we have a two-pronged attack on
price stability on the part of organized labor; and I think that we have
perhaps paid less attention to labor's devotion to inflation than we
should have done.
I do not wish to give the impression that all the blame for the
wage-price spiral must rest with organized labor. Industry pricing
policies and attitudes must also carry their part of the responsibility.
As Mr. Eccles pointed out:
B u sin e ss g e n e r a lly h a s b e e n w illin g t o g r a n t e x c e s s iv e d e m a n d s o f la b o r r a th e r
t h a n fa c e a strik e , s o lo n g a s i t w a s a b le t o p a ss o n t o t h e p u b lic t h e in cre a se d
c o sts .*
Also, we must recognize that some business firms, because of their
dominant positions, have the power to set prices which, within limits,
are not immediately subject to traditional competitive forces.
It goes without saying that the entire question of the relationship be
tween wages and prices deserves more attention than I can give it here.
I am concerned only with the development of relatively new factory
which have made inflation a major problem, and one such factor is
the rise in the economic power of organized labor, unchecked by the
traditional rules applied to business. This is a most significant new
development.
Second among the factors contributing to our new inflationary
problem is the changed role of Government. In many quarters the
Employment Act of 1946 is interpreted as a virtual commitment on
the partvof the Federal Government to undertake expansionary pro
grams at the first sign of a downturn, The act quite naturally
reflected the fears of many people that the long depression of the
1930’s would be resumed in the postwar period. Unfortunately the
goal of price stability was not included in the objectives of the act,
and because this was not done, the act seems to have had the effect
of requiring the Government to act more vigorously when prices
need to be raised, and less vigorously, if at all, when prices need to be
towered. As Dean Abbott put it:
I t se e m s c le a r t h a t b o t h th e s e o b je c t i v e s (m a a a m u m e m p lo y m e n t a i g j w i e e
s t a b i l i t y ) w ill n o t b e a c h ie v e d s o l o n g a s o n e h a s t h e b le s s in g o f t h e
G o v e r n m e n t a n d t h e o t h e r d o e s n o t .9
Federal
2214
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Another facet of the changed role of Government is the large place
which Government expenditures occupy in the stream of our total
national expenditure. Because so much Government spending is of
a nature which cannot easily be changed, a business downturn always
results in disproportionately lower tax receipts, and automatically
produces a substantial Government deficit. On the other hand, dur
ing periods of prosperity in which inflationary pressures may be strong,
it is difficult lor the Government to have much of a surplus, since
there are always strong pressures for still larger Government expendi
tures of tax reductions.
The third factor in our new inflationary problem is in many ways
the most important, for it relates to the public attitudes which, in &
democracy, ultimately determine our course of action. To put it
plainly, inflation seems to be becoming acceptable. We had several
illustrations of this attitude during the hearings held by the Committee
on Finance. For example, Professor Slichter argued that inflation—
as long as it proceeded at a slow rate— was not a particularly worri
some problem. As he put it:
I d o n o t t h in k it is v e r y d a n g e r o u s .
I t h in k w e a r e lik e ly t o h a v e it a n d I t h in k
i t is a n i m p o r t a n t p r o b le m , b u t I w o u ld n o t u s e t h a t e x p r e s s io n “ v e r y d a n g e r o u s ."
I w o u ld d e s c r ib e i t a s u n fo r t u n a t e .10
Professor Harris went even further when he appeared before the
committee, indicting that he would be more or less content with a
slow inflation so long as there was a larger proportional increase in
output. H is words were:
I w o u ld b e v e r y h a p p y w it h a 1 -p e r c e n t r ise o f p r ic e s a n d a 5 - p e r c e n t r is e in
o u t p u t .11
On another occasion he made it clear that he was unconcerned
over the loss which will be suffered by savers in inflation when he said:
I w o u ld n 't b e u n h a p p y a b o u t a 1 -p e r c e n t in fla tio n , e v e n i f it d o e s , s a y , o v e r 4 0
y e a r s , w ip e o u t 5 0 p e r c e n t o f y o u r s a v in g s , as it w o u ld .12
I might remark that although such a development might not make
Professor Harris unhappy, the same cannot be said for the millions
who depend on fixed incomes, many of them already at minimum
levels. I am reminded of a remark made recently by Malcolm Bryan,
president of the Federal Reserve Bank of Atlanta:
I f a p o l i c y o f a c t iv e o r p e r m is s iv e in fla tio n is t o b e a f a c t , t h e n w e c a n s e c u r e
t h e sh re d s o f o u r s e lf-r e s p e c t o n l y b y a n n o u n c in g t h e p o lic y .
T h is is t h e le a s t
o f t h e c a n o n s o f d e c e n c y t h a t s h o u ld p r e v a il.
W e s h o u ld h a v e t h e d e c e n c y t o
s a y t o t h e m o n e y s a v e r , “ H o l d still, lit t le fish .
A ll w e in t e n d t o d o is g u t y o u . ”
The importance of this changing attitude toward inflation was
reflected in many ways during the course of the hearings. I am sure
that I do injustice to no one when I say that the Federal Reserve
Board was quite severely criticized by some of the Senators during
the questioning last summer. M any of these criticisms reflected
legitimate differences of opinion, but it was, nevertheless, quite ap>arent that in the eyes of some members of the committee the major
ault of the Federal Reserve Board was that it was even attempting
to fight the inflationary price rise which was then occurring, using the
only means at its disposal. It is significant, also, that during the most
{
*•IH d„ p. 1844.
« Ibid., p. 2030.
*« Ibid., p. 2038.
THE FINANCIAL CONDITION OF THE UNITED STATES
2215
recent committee sessions the only criticism which we heard from
these same people with respect to the present policy of monetary ease
now being followed by the Federal Reserve is that it had not gone far
or fast enough. Thus, we had the ironic situation of hearings, held
to determine what could be done to stop inflation, which devoted a
large part of the time to criticism of a responsible agency which was
attempting to do exactly that.
The increasing acceptability of inflation, or the opposition to any
anti-inflationary program, was also illustrated by the frequent dis
cussion during the hearings of the question of the compatibility of a
policy of price stability and a policy of maximum employment. For
my own part, I am of the firm opinion that the two goals are not only
compatible, but go hand in hand; that we cannot have one without
the other. I would agree, for example, with former Chairman Eccles,
who said:
I th in k t h e y are e q u a lly im p o r t a n t * * * I w o u ld u n d e r ta k e t o m a in ta in a
s t a b le e c o n o m y r a th e r th a n h a v in g r u n a w a y in fla tio n w h ic h w ill w re ck e m p lo y
m e n t a n d p r o d u c t io n * * * y o u h a v e g o t t o use s u ch to o ls as y o u h a v e th ro u g h
m o n e t a r y a n d fisca l p o l i c y t o p r e v e n t in fla tio n * * * in th e lo n g ru n [this] will
c r e a te m o r e p r o d u c t io n a n d e m p lo y m e n t th a n i f y o u d o n o t d o it .1*
I believe that this viewpoint is shared by most of the witnesses and
most of the persons submitting answers to the written questions pre
pared by the committee. Nevertheless, it was quite evident that
there were some members of the committee, and perhaps one or two
witnesses, who assign a secondary role to the goal of price stability
and who believe that any attempt to achieve price stability will result
in frequent or continuous unemployment. I merely observe that if
one believes that price stability can only be achieved at the cost of
unemployment and also believes that maximum employment should
be the only goal towards which we should be striving, it must follow
that one also is willing to accept inflation as a permanent fact of our
economic life.
I have not given a complete list of all the factors which h a v e ap*
peared in recent years to give the old problem o f inflation a n e w f a c e .
One which was raised by some witnesses, and partially d e v e l o p e d i n
limited questioning, referred to the role of the modern financial i n t e r *
mediaries outside the banking system; savings and loan associations,
insurance companies, and finance companies. Dr. Abbott described
these generally as “important financing institutions often govemmentally sponsored, not subject to the credit policies or influence o f
the Reserve System.” Dr. Abbott also called our attention to the
problem created by the fact that a large segment of the huge Federal
debt has found lodgment in the banking system.
In other statements, I plan to discuss the role of the Federal Reserve
Board in dealing with inflation through its responsibility for monetary
policy, the effects on inflation of the policies of organized labor, and
the impact of the present recession on the continuing inflation.
As I conclude this, the first statement, I want to say again, that tie
one thing that concerns me above all others is the apparent belief
on the part of so many Americans that “easy money” wnich encour
ages “easy debt” is a sound and constructive policy. Those wbo are
attracted by this idea denounce any attempt to control inflation by
« Ibid., pp. 1777-1778.
43994— 59— .0
2216
THE FINANCIAL CONDITION OF THE UNITED STATES
restraining the too rapid growth of the money supply, particularly
if it coincides with the heady exuberance of an inflationary boom.
The resulting recession is then blamed on the restraint, which actually
had dulled its potential damage, rather than on the boom, which had
made recession inevitable.
The sad fact is that inflation is no economic fairy godmother. There
is no magic in money to produce something for nothing, and when
government creates money faster than its citizens create value, it
aoes not create wealth, it only creates inflation, which is the illusion
of wealth. While inflation may seem at first to provide some people
something for nothing, it is only transferring value from one group
to another, and if continued, eventually robs everyone— even the
“smart” boys.
When the American people can courageously face up to the fact
that there is no such tiling as something for nothing; that there is
no real security without risk; that money cannot be manipulated to
produce wealth; that there is no substitute for human endeavor and
individual wisdom and responsibility; then, and only then can we
bring America back to economic reality, which in turn will put our
feet on the path to sound growth and true prosperity.
II. M O N E T A R Y P O L I C Y A N D I N F L A T I O N
Despite the wide variety of topics covered during the Finance
Committee hearings, monetary policy claimed the major share of
attention. The committee inquired closely into the activities of the
Federal Reserve System during two appearances of Mr. Martin,
its Chairman, and much of the questioning of other witnesses related
to Federal Reserve operations.
Before discussing recent Federal Reserve policy and the issues
developed from it, let me review the high points of our monetary
history during the past 5 years. Throughout 1954, monetary policy
was directed toward encouraging recovery from the recession of that
year. Discount rates were twice reduced, and reserve requirements
lowered. Early in 1955 it became evident that recovery was turning
into a boom. Hindsight evidence shows consumer credit rising $6.4
billion in 1955, the largest rise in a single year in our Nation's history.
With increasingly strong credit demands the Federal Reserve Board
began its change in direction. Margin requirements on loans for
purchasing and carrying listed securities were raised twice during
that year, to a high of 70 percent in April, while discount rates were
raised three times. When it was seen that these restrictions had failed
to dampen the inflationary overtones of tin boom, more stringent
measures were introduced in 1956 and up to August in 1957. Discount
rates were raised twice again, to a high of 3J/% percent in August
1957. Open market operations were directed toward the objective of
“restraining inflationary developments in the interest of sustained
economic growth.”
Yet even early in 1957 there were signs of an approaching business
slowdown. This was shown by a fall off in new orders for machinery
and equipment in the earlier months of that year and by the develop
ment of a margin of excess capacity in many key industries. When
an expected business upturn failed to develop in the fall of the year,
it became evident that the economy had reached a typical cyclical
turning point, and the Federal Reserve began to alter the course
of its policies.
As Chairman Martin stated in the hearings:
I n t h e la t te r p a r t o f O c t o b e r a n d e a r ly N o v e m b e r , o p e n m a r k e t o p e r a tio n s
w ere u s e d t o r e la x s o m e w h a t p re ssu re s o n c o m m e r c ia l b a n k re s e r v e p o s itio n s .
I n m id -N o v e m b e r , a o n e -h a lf p o in t r e d u c t io n in d is c o u n t ra te s sig n a led a d e cis iv e
ch a n g e in S y s te m p o lic y . F r o m th is p o in t o n , restra in ts o n b a n k c re d it e x p a n sio n
w ere p r o g r e s s iv e ly r e la x e d .1
Within 5 months the discount rate was dropped from V/<i to 1%
percent. Margin requirements on loans for purchasing or carrying
securities were reduced from 70 to 50 percent of market value. Ait
additional reserves were provided by two reductions in reserve re
quirements and through open market operations, member banks re
duced their indebtedness at Reserve banks. The easing in bank
i “ Investifa lion of the Financial Condition of the United States,” hearings before the Committee on
TiMoee, TLS. Senate, 85th Cong., p. tasi.
2217
2218
THE FINANCIAL CONDITION OF THE UNITED STATES
reserve positions was reflected in a sharp expansion in bank credit
and an exceptionally sharp drop in interest rates.
Federal Reserve actions which attracted most attention during the
course of the hearings were the restrictive actions taken during 195657. These were bitterly attacked as harsh hard money policies, and
yet as I look back upon that period one impression seems unmistak
able: The restrictive monetary policy pursued by the Federal Reserve
was about as mild a policy as could have been adopted if the System
was to make any attempt at all to combat inflation. This is clearly
apparent when we realize that prices rose considerably during 1957—
and are still creeping upward today— -despite the fact that the Federal
Reserve has always had it within its power to enforce a contraction
in prices.
The changes that occurred both in circulating medium and in
interest rates are indicative of the lack of severity in Federal Reserve
olicy during 1956-57. If we take as a measure of circulating meium, total deposits— adjusted— plus currency in circulation outside
of the banking system, we find that during 1956 and 1957 the rate
of increase was about 2% percent in each year. Since the rate of use
of money— its velocity— was increasing fairly rapidly during this time,
these increases were more than sufficient to provide for sustainable
economic growth with price stability.
So far as interest rates are concerned, it was made clear during the
hearings that at their peak in 1957 rates were still substantially below
levels which had prevailed as late as the 1920’s and the very early
1930’s. As Sumner Slichter pointed out in his testimony this April:
S
A lt h o u g h o n e h a s h e a r d m u c h a b o u t t h e s c a r c it y o f s a v in g s in r e c e n t y e a r s ,
in t e r e s t ra te s h a v e b e e n e x tr a o r d in a r ily lo w b y h is t o r ic a l s t a n d a r d s .2
A chart showing long-term interest rates since 1920 was placed into
the record as part of Secretary Burgess’ statement last summer, and
I refer my colleagues to that chart, on page 720 of the published
volumes, for a graphic illustration of Professor Slichter’s appraisal.
In summary, therefore, Federal Reserve policy during 1957, while
restrictive, cannot be classed as severe. The very fact that it was
not expansionary, but was directed toward combating inflation, quite
naturally resulted in a situation in which more persons and firms than
usual were unable to borrow all of the funds which they desired.
Therefore we had the cries of “tight” money and “hard” money,
which presented a far more harsh picture of the policy than was true
in fact.
Federal Reserve policies in general were subjected to a wide variety
of criticisms during the course of the hearings, both from Senators
and from some witnesses. Some of these complaints were, in my
opinion, frivolous; others should receive our full attention. I should
like to list and discuss each of these major criticisms.
First. The first issue in my informal tabulation is one that to me
is the least serious, although a surprising amount of time was devoted
to it. Briefly stated, this issue arose out of the charge that- the re
strictive monetary policy of the Federal Reserve was the cause of the
inflation, and that, therefore, the way to stop the rise in prices was
to adopt an easy money policy. This claim seemed to rest upon two
pieces of evidence: first, that the period during which prices were
* Ib id ., p. 1816,
THE FINANCIAL CONDITION OF THE UNITED STATES
2219
rising coincided roughly with the period in which the Federal Reserve
was following a restrictive monetary policy; and second, that the pro
nounced rise in interest rates affected business costs and therefore
prices.
This contention with respect to Federal Reserve policy was most
frequently heard during the sessions of the committee last summer.
I was therefore interested to observe that none of the witnesses in
the spring session— including some who were quite critical of one or
more aspects of Federal Reserve policy— adopted this particular brand
of “Alice in Wonderland” logic.
If inflation in 1957 was indeed due to the restrictive monetary
policy of the Federal Reserve System and the way to bring prices
down was to increase the money supply, then it would seem to follow
that in a deflation, as prices are falling, the way to bring prices up
is to contract the money supply. In the spring of 1958 we were in a re
cession and there was indication that the price level is about to de
cline, but I heard no suggestion from the proponents of the view I
am discussing that the Federal Reserve should now begin to con
tract the volume of credit.
So far as the effects of interest costs on prices are concerned, the
answer given by Secretary of the Treasury Humphrey was, I believe,
never successfully challenged, namely, that interest charges comprise
only about one-third of 1 percent of the average sale price of manu
factured goods. Of course interest is a cost, but it is ridiculous to
attribute a broad inflationary movement such as that of 1956-57 to
a rise in this almost insignificant business cost element in the price
structure.
I do not think it is necessary for me to devote any time to the con
tention that the Federal Reserve program caused the inflation because
it was being; carried out at the same time as prices were rising most
rapidly. Tnis is equivalent to saying that if a disease continues to
persist after a course of treatment is begun and the two exist together*
then this coincidence is accepted as proof that the cure actually caused
the disease. I will agree that a restrictive monetary policy, in its
first stages at least, will increase the rate of turnover of money,
as firms and individuals attempt to make more efficient use of the
circulating medium available to them. To that extent, the job of
the central bank is made much more difficult, but it is an anticipated
consequence in the early application of a restrictive monetary policy*
In the final analysis increases in velocity can proceed only so far during
a restrictive monetary policy, and they can always be overcome 2
sufficient pressure is placed on the money supply.
In summary, these arguments that the Federal Reserve's policy
caused the inflation fall of their own weight.
Second. The second issue I observed developed out of the fact that
prices continued to rise during 1957 and into 1958, and relates to the
ability of the Federal Reserve to exercise decisive influence over the
price level. The claim was advanced that a restrictive monetaiy
policy, which necessarily applies temporary brakes to the expansion of
the economy, is indefensible if it cannot at least attain the objective of
price stability.
The validity of this claim is hard to appraise. The basic difficulty is
that we do not know— as we can never know in such instances— -what
would have happened if the Federal Reserve had not followed a re
2220
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strictive policy. The weight of opinion in the testimony was clearly
to the effect that if the Federal Reserve had not followed such a policy
in 1956 and 1957, the rise in the price level would have been much more
severe. As former Board Chairman Marriner Eccles put it:
T h e m o n e t a r y a n d c r e d it p o l i c y d id n o t p r e v e n t a c e r t a in a m o u n t o f in fla tio n
f r o m t a k in g p la c e , b u t it c e r t a in ly c u r b e d t h e s p r e a d o f in fla tio n a n d t h e e x t e n t t o
w h ic h it w o u ld h a v e t a k e n p la c e .3
Even Professor Slichter, who has been critical of some aspects of
Federal Reserve policy, agreed that restraint was desirable. As he
put it:
C e r ta in ly in 1 9 5 6 a n d p r o b a b l y in t h e e a r ly p a r t o f 1 9 57 c r e d it r e s tr a in t w a s
d e s ira b le .
A b o u t t h e m id d le o f 1957, a r e la x a t io n , n o t a s h ift t o a n e a s y c r e d it
p o l i c y b u t s o m e r e la x a tio n , w o u ld h a v e b e e n d e s ir a b le .4
As I have already noted, this relaxation did occur at the end of
October, so that Professor Slichter’s criticism with respect to this point
apparently involves a question of timing, rather than of direction.
Of the witnesses, only Professor Harris seemed to adopt the view
that Federal Reserve was largely ineffective in preventing price in
creases. He attributed tliis ineffectiveness to the increasing im
portance of financial intermediaries, the high liquidity of business
concerns, and the tendency of wage rates to rise faster than pro
ductivity. All these are important points and I discussed some of
them in my previous remarks. It is perhaps regrettable that the
committee was not able to devote more time to each of them. How
ever, it appears to me that Professor Harris weakened his point when
he claimed that the Federal Reserve possesses sufficient power to
cause a business contraction, thereby implicitly agreeing that the
System and its policies are far from ineffective.
M y own view is that Federal Reserve policy definitely prevented the
inflation from becoming far more severe than it has been. I am aware
that during his questioning the Senator from Oklahoma [Mr. Kerr]
preferred to dismiss such claims as speculation; but in this case, as in
many others in life, such speculation is all that is available to us.
Third. The third issue in this tabulation arises out of the charge
that Federal Reserve policy hurt only small business, and did not
affect large corporations. On occasion, this charge was broadened to
the claim that the restrictive monetary policy hurt the / ‘little man,”
both business and individual, but did not affect the wealthy.
Before discussing this issue, I should like to call attention to one
apparent inconsistency in this charge. Those who maintain, along
with Professor Harris, that the Federal Reserve policy “on the whole
favored corporations against small business” 5 are generally those who
also attribute the current business downturn to the same restrictive
monetary policy. I plan to discuss in a later speech the relation of
inflation and recession; but I pause here to observe that the large
corporations which produce durable goods have suffered great shrink
age in volume, and this has produced the greatest areas of unem
ployment. We have seen this reflected in the first-quarter earning
reports of large corporations, which are down significantly. I do
not much care which horse the critics of the Federal Reserve policy
THE FINANCIAL CONDITION OF THE UNITED STATES
2221
prefer to ride; but I do say that they cannot at one and the same time
claim that monetary policy did not bear to any extent upon large
corporations, and also say that it was the cause of the present down
turn, which is quite obviously working a hardship on the same
corporations.
So far as the charge itself is concerned, I feel that the evidence
presented during the hearings was insufficient to support the conclu
sion that restrictive monetary policy during 1956 and 1957 was directed
at, or bore more heavily upon, small business, as compared with large
business. During the questioning of Secretary Humphrey by the
Senator from Florida [Mr. Smathers], for example, there were pre
sented numerous tables which purported to show that small business
was suffering. But as Secretary Humphrey pointed out, in most
instances the figures used to illustrate small-busini ss distress could
not be related solely to the years of restrictive monetary policy, but,
instead, showed long-term trends, running through several periods
of easy-money policies, as well as restrictive policies. As a matter
of fact, in a number of instances the Secretary was able to point to
the fact that the position of small business improved subsequent to
the introduction of the restrictive monetary policy. For example,
the data of the Senator from Florida [Mr. Smathers] showing the
percentage of sales going to manufacturing corporations with assets
of less than $1 million, as well as the data showing profits after taxes
for companies of the same size, revealed that the position of smaller
sized business firms had improved in 1956— a year of restrictive
monetary policy— over their position in the years immediately pre
ceding. I refer my colleagues to pages 370-372 of the printed
hearings.
So far as business failures are concerned, the trend for small firms
has been generally upward ever since the end of World War II; but
this is a development which is to be expected, in view of the rapid
growth in our economy and the increasing number of business firnis.
As a matter of fact, in the 2 years of so-called tight money, 277,472
new business incorporations occurred, compared with 257,000 during
1954-55, 2 years of so-called easy money. And, of course, the total
number of businesses operating in this country has continued to
increase during recent years, totaling 4,232,300 as of June 30, 1955;
4,297,200 as of June 30, 1956; and 4,322,000 as of June 30, 1957.
The question of increasing personal bankruptcies was also raised.
The overextention of credit, of which they were the inevitable harvest,
most probably occurred during earlier periods when credit was too
easy. I have learned this out of my 30 years of experience with
retail credit. This is another instance where the cure is confused
with the cause.
There is one very important and significant set of facts which often
is overlooked by those who charge that restrictive monetary policy
bore most heavily on small business. The truth is that the effects of
this* policy were felt most severely in the large financial centers and
in the large banks, and were felt least in small communities and afflflag
small banks. All of us know that a very important part of the bank
financing of small business is done by our small country banks, whieh^
indeed— because of statutory loan limits— are unable to loan to any
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but small businesses. During my questioning of Secretary Burgess,
for example, the Secretary called my attention to the fact that—
D u r in g t h e p a s t y e a r , fr o m M a y 1 9 5 6 t o M a y 1 9 5 7 , t h e N e w Y o r k C i t y b a n k s ,
t h e C h ic a g o b a n k s , a n d t h e R e s e r v e c i t y b a n k s , w h ic h a r e t h e o t h e r la r g e c i t y
b a n k s , s h o w a m in u s p o s it io n o n t h e ir fr e e r e s e r v e ; o n t h e o t h e r h a n d , d u r in g
t h a t e n t ir e p e r io d t h e c o u n t r y b a n k s , m o n t h b y m o n t h , h a d fr e e r e s e r v e s , w h ic h
is a v e r y in t e r e s tin g in d ic a t io n t h a t t h is s q u e e z e h a s c o m e m u c h m o r e in t h e m o n e y
c e n te r s t h a n it h a s in th e c o u n t r y banks,®
Differences in the impact of restrictive monetary policies are also
reflected in the deposit changes of Federal Reserve member banks over
the period during which such policies prevailed. For the 22 months
beginning with January of 1956, and ending with October 1957, total
deposits in central Reserve city banks in New York City declined by
well over $2 billion; and in Chicago, by three-quarters of a billion
dollars. In the smaller member banks— those classified as country
banks— total deposits during the same 22-month period of restrictive
monetary policies rose by well over $2 billion. While the capacity of
big banks to make loans was restricted, that of the small banks was
increased. For them, money became easier, not harder.
I should also like to observe that Professor Slichter called our at
tention to the fact that during the period of restrictive monetary
policies, the interest charged on large-sized loans went up much faster
than did the interest on small loans. This is to be expected, in view
of the fact that the monetary stringency was being felt primarily by
the large banks. As Professor Slichter pointed out, the spread be
tween the two rates “narrowed during the period of credit restraint.
In 1955 there was a 1%-percent difference. B y 1957 the difference
had dropped to 1 percent.” 7
I am, of course, aware that connected with small business there are
special problems which may deserve attention. A ll I want to say
here is that there is no evidence to show that a restrictive monetary
policy during 1956-57 either added to or took away from these prob
lems. It may be of interest to note that during his testimony Pro
fessor Slichter made the following observations on this matter:
T h e a ss e rtio n t h a t th e n e w e n te r p r is e s as a w h o le a re fa ilin g in s u b s t a n t ia l
m e a su re t o g e t t h e a m o u n t o f c a p it a l w h ic h t h e y c o u ld p u t t o g o o d use is u n p r o v e d .
* * * T h e r e is s o m e s h o r t a g e o f m e d iu m -t e r m lo a n c a p ita l, b u t th e r e is a g r e a te r
s h o r t a g e o f a t t r a c t iv e risk s.
* * * A t t r a c t i v e in v e s t m e n t o p p o r t u n it ie s s u it a b le
f o r sm a ll, m e d iu m ,t e r m lo a n s are m o r e s c a r c e t h a n in v e s t m e n t fu n d s ,8
It was Dr. Slichter’s strong contention that there are more funda
mental problems than money shortages standing in the way of a more
rapid business growth. He made this statement in his testimony:
^ T h e h ig h in fa n t m o r t a lit y r a te a m o n g n e w e n te r p r is e s s h o w s t h a t a la rg e p r o p o r
t io n o f bu sin e ss sta r te r s h a v e m o r e c o u r a g e a n d h o p e t h a n ju d g m e n t a n d s k ill.1
The fourth in this tabulation of issues is one of the most important.
This issue was present, but was more or less dormant in the hearings
last summer, and did not break out into the open until the sessions
this year. This is the question whether the Federal Reserve has any
responsibility at all with respect to the maintenance of price stability.
For example, the Senator from Oklahoma [Mr. Kerr], in his question
ing of Chairman Martin this spring, made it quite clear that he doubted
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the Federal Reserve had such responsibility, for after reading the
declaration of intent in the Employment Act of 1946 the Senator
stated:
Y o u c a n n o t p o in t t o a n y s p e c ific la n g u a g e t h a t sa y s t o th e F e d e r a l R e s e r v e
b a n k , “ m a in ta in th e sta b le v a lu e o f th e d o lla r .” 10
Professor Harris made the charge more specifically when he said:
I m ig h t sa y , M r. C h a irm a n , t h a t I o n c e w r o te an 8 0 0 -p a g e b o o k o n th e F e d e r a l
R e s e r v e S y s te m a n d h a v e n o t d is c o v e r e d , a n d h a v e n o t still, th a t th e F e d e r a l
R e s e r v e Is g iv e n a n y a u th o r it y t o s ta b iliz e th e p rice lev el. Its j o b is t o a c c o m
m o d a te tr a d e a n d c o m m e r c e .11
Perhaps I was wrong in stating that this is a single issue, for it is
quite apparent that a number of very important issues come to focus
at this point. For example, what is the duty of the Federal Govern
ment as a whole with respect to price stability? Few would quarrel
with the statement of the Senator from Virginia [Mr. Byrd] at the
opening of the hearings:
T h is c o m m it t e e c a n n e v e r lo s e s ig h t o f th e f a c t t h a t th e G o v e r n m e n t ’ s in te g r ity
d e p e n d s u p o n a s t a b le c u r r e n c y .1*
I,
for one, am in hearty agreement. Yet if it is to be seriously
maintained that the Federal Reserve has no duty in this field, is it
not the same as saving that the Government itself has no such duty?
Personally, I did not expect, prior to the hearings, that the right
and duty of the Federal Reserve to fight inflation would ever become
an issue. As I saw it, there could well be disagreement over the man
ner in which the Federal Reserve was acting, but not over the goal it
sought. In the past, congressional committees have concluded that
the goal of price stability was so well accepted it would be almost
redundant to provide for it by legislation. In view of the Appearance
of this issue, however, I believe it has become of the utmost importance
that the Congress add the goal of price stability to the various other
objectives of the Employment Act of 1946, and to the basic Federal
Reserve law, in order that there may no be question on this funda
mental point.
M y fifth issue relates to the independence of the Federal Reserve
System. It was a big issue 8 years ago, and I shall not take much
time with it now. However, I do not wish to imply that it is un
important today. During the entire hearings the question of the
independence of the Federal Reserve System was never far below the
surface. Like the question of the proper function of the Federal
Reserve, it really came out into the open during the spring sessions,
when Professor Harris stated flatly he did not believe that Federal
Reserve should be independent, a statement which seemed to be con
curred in by the Senator from Oklahoma [Mr. Kerr] and the Senator
from Louisiana [Mr. Long].
M y own belief is that it would be a tragedy if the Federal Reserve
should be made subordinate to another agency or branch of the Gov
ernment to such an extent that it would not lie free to take quick and
effective action when faced with the prospect of either inflation or
deflation. I always thought that the fight carried on by the Senator
from Illinois [Mr. Douglas] and others, which culminated in the restor-
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afcion of the Federal Reserve’s independence in 1951, was one of the
most praiseworthy accomplishments in the financial field within recent
years. I do not believe that the Federal Reserve can be completely
outside of Government, but I am firmly convinced that, within Gov
ernment, it must retain a maximum degree of independence if it is to
accomplish its objectives.
M ost of the questions I have discussed up to this point were opened
up in the 1957 hearings. Let me now turn to the monetary policy
issues which dominated the 1958 sessions of the committee. There
were two, which would become Nos. 6 and 7 in my tabulation. First,
there was the question of the extent to which Federal Reserve policy
in 1956-57 was responsible for the current business downturn.
Second, there was the charge that Federal Reserve policy today has
not gone far enough in providing monetary ease. Let me deal with
these one at a time.
Sixth. The question of Federal Reserve responsibility for the cur
rent downturn has one very interesting aspect, since Chairman Martin
and his critics are in some measure of agreement, although for quite
different reasons. The critics claim that the Federal Reserve was
responsible because, to quote Seymour Harris again:
U n d o u b t e d ly m o n e t a r y p o l i c y c o n t r ib u t e d t o t h e r e c e s s io n . * * * »
T o s t a b i
lize p r ic e s w it h a la r g e c o s t in fla tio n c o u ld o n l y b e d o n e b y in d u c in g u n e m p l o y
m e n t t h r o u g h a r e s tr ic tiv e m o n e t a r y p o l i c y .
T h is t h e F e d e r a l R e s e r v e a c c o m
p lis h e d .14
On the other hand, Chairman Martin indicated in his testimony
before the committee that he, too, felt the Federal Reserve should
bear a part of the blame for the downturn, but not because its policies
during 1956-57 were too restrictive. Rather, as he put it:
T h e rea l c r it ic is m * * * is t h a t w e w e re n o t m o r e a g g r e s s iv e a n d d id n o t m a k e
m o r e o f a n e ff o r t t o s lo w (th e e c o n o m y ) d o w n in 1 9 55 a n d e a r ly 1 9 5 6 w h e n t h is
g o t o u t o f h a n d .15
If Federal Reserve policy in 1956-57 did in fact make a significant
contribution to the current business downturn, then we should be
able to trace the influence of that policy to the various segments of
the economy which are presently causing the most trouble. The
significant characteristics of the current downturn are probably three :
First, a slump in the manufacture and sale of durable goods, par
ticularly automobiles; second, a decline in new private capital expenditures; and, third, a decline in inventories. I doubt that anyone could
seriously argue that the restrictive Federal Reserve policy of 1956-57
was reflected a year later in the decisions of consumers to hold off the
purchase of automobiles and other durables. Despite the recession,
both disposable personal income and the rate of savings remain high;
credit was eased before this year began— the buying power is there.
There has been no significant change in the interest rates applicable
to automobile or appliance loans, nor has there been any change in
the terms of payment which prevail. It appears to me tliat the real
reasons for the slump in this sector of the economy are: First, high
prices; second, some disenchantment with the product ; and third, a
shift in buying habits, reflected in the fact that consumers have
apparently decided to spend less on durables and more on other
things.
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So far as the downturn in private capital expenditures is concerned,
other factors seem to be of more importance than Federal Reserve
policy. We should remember that the high level of business expendi
tures since 1954 led to a situation in which many firms acquired all
the facilities necessary for the next few years, so that some slowdown
was inevitable. As Professor Slichter pointed out in his testimony:
T h e h ig h le v e l o f in v e s t m e n t a c t iv it y * * * m a d e th e e c o n o m y v u ln e ra b le t o
c o n t r a c t io n , sin ce it w a s n a tu ra l fo r e n te rp rise s t o s lo w d o w n th e in crea se in
th e ir in v e s tm e n t s p e n d in g .16
Somewhat the same thing can be said with respect to inventories.
A rapid buildup of inventories is a natural consequence of inflation.
What we are witnessing today in this sector is a readjustment to a
more normal level.
In short, my own view of the particular issue is that Federal Reserve
policy necessarily had some effect on the business downturn, but that
by no stretch of the imagination can it be assigned the sole, or even a
major, role. It seemed to me that Professor Slichter provided the
committee with perhaps the most thoughtful and well-rounded dis
cussion of the causes of the present recession. In that presentation
he assigned, if I understood him correctly, major responsibility to the
dropoff in business capital expenditures; that is, expenditures for
plant and equipment. This decline, he felt, reflected decisions made
in 1956-57 and was attributable not to Federal Reserve policy but
to the perfectly natural tendency for business to take a breather after
maintaining a particularly high level of such expenditures. Professor
Slichter then went on to point out that other factors, such as Federal
Reserve policy, Government fiscal policy, and consumer reluctance
to accept the new automobiles, were aggravating rather than casual
forces. And, in answer to a U.S. News & WTorid Report interview
on this same point, Professor Slichter said:
N o , I th in k th e fu n d a m e n t a l ca u se s o f th e re ce s sio n lie d e e p e r t h a n F e d e r a l
R e s e r v e p o lic y .
Seventh. M y last issue is one which could only have appeared
during the spring of 1958 sessions, since it involves the claim that the
Federal Reserve has been halfhearted in its recent policy of monetary
ease. Tliis charge was made by Professor Harris, who pointed to the
fact that since the change in policy in the fall of 1957 the bank reserves
have fallen slightly and holdings of Government securities by the
Federal Reserve have risen by only 2 percent. Prolessor Harris also
cited the activity of trie Federal Reserve in 1930-32 with respect to
the purchase of Government securities as an illustration of what he
considered to be a genuine policy of monetary ease and suggested (h#
Federal Reserve today follow in the same course.
B y the time Professor Harris appeared before the committee it was
quite dear that the major tool which the Federal Reserve was using
to provide monetary ease was its authority to change reserve require
ments. There had been three successive decreases m reserve require
ments beginning on February 27 of this year. The last decline tdofe
effect on the day Professor Harris testified, although it had been an
nounced much earlier. The professor must certainly have known of
tl^ese reductions, just as I am sure he knows full well that the powerfcl expansionary effect of a reduction in reserve requirements is
*IM d ., p . is o .
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through the release of existing reserves for credit expansion and not
through a change in the dollar volume of reserves. Thus I am at a
loss to understand why Professor Harris mentioned the reduction in
reserve requirements only briefly— and then only the first of the three
reductions— and chose to appraise current Federal Reserve policy in
terms of purchase of Government obligations and the dollar volume
of reserves. The only explanation I can think of is that perhaps his
statement was written when only the first reduction had taken place,
but if this was the case he did nothing to clear it up in his oral testi
mony. As a matter of fact, in his oral testimony he did not mention
even one of the three reductions in reserve requirements, and empha
sized again that the dollar amount of reserves had not grown.
As I said earlier, we cannot yet pass judgment on whether the Fed
eral Reserve has gone too far or not far enough in its present course,
but we can at least review factually what the system has done. Since
the decision to ease credit in November, the discount rate has been
lowered in four steps, from 3% to 1 % percent. These are, presumably,
what Professor Harris had in mind when he referred to “a few rather
inconsequential cuts in rates,” a phrase I find somewhat amusing in
view of the furor of last summer when these same rates were being
raised. Moreover, the three successive reductions in reserve require
ments against demand deposits have released roughly $1.5 billion of
reserves, or three times the amount mentioned in Professor Harris'
prepared statement. This, plus the effect on open market operations,
Has permitted an easing in the free reserve position of member banks
of almost $1 billion since the end of October, in addition to providing
the base for a $7 billion expansion in bank assets and deposits. The
trend in free reserves has been steadily upward, moving from a nega
tive figure of about $550 million last October to a positive figure
slightly more than $600 million in April. Free reserves are excess
reserves less member bank borrowings.
The easing of bank reserve positions has been reflected in a sub
stantial expansion in bank credit and an exceptionally sharp drop in
interest rates. The total of bank loans and investments increased
almost $5 billion in the 6 months ending in March. This expansion
of bank credit has been mainly in the form of U.S. Government secu
rity holdings, and its effect has been to enlarge holdings of cash balances
and to increase the economy’s overall liquidity. Business loans out
standing at banks have tended to decline with economic activity.
However, loans on securities, which provide important support to the
capital markets, have risen.
As Federal Reserve policy shifted from restraint to ease, the financial
markets reacted vigorously. The recent drop in interest rates has
been as rapid as any in the Nation's financial history. For example,
the rates on short-term Treasury obligations— maturities under 1
year— have declined about two-thirds since last fall. In contrast,
after the onset of recession in mid-1953, such rates fell only about 45
percent over a 7-month period from their mid-1953 peaks. Similarly,
the rates on prime commercial paper have fallen over 50 percent re
cently, but in the comparable 1953-54 period declined only about 20
percent. Long-term rates, too, have declined more rapidly in the
current than in the earlier recession; for example, the yields on highgrade municipals declined about 25 percent and 20 percent, respec
tively, in the 2 periods.
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The drop in the price of money during the recession was a good deal
faster than was the rise under the preceding conditions of heavy credit
demands and restrictive monetary policies. Money market rates—
the yields on such instruments as short-term Treasury issues, prime
commercial paper and directly placed finance company paper— were
last at current levels back in the winter and spring of 1955. It took
these rates 30 months or more to rise as much during the boom as
they have fallen during the last 7 or 8 months. Market rates on
money market instruments are now quite generally less than half as
high as they were at their peaks.
Market yields on longer term securities issued by the Treasury,
State and local governments and corporate borrowers have not fallen
nearly so far as money market rates, but, nonetheless, have declined
much faster than they rose in 1955, 1956, and early 1957. Bond
yields have dropped one-half to three-quarters of a point, representing
a decline of about one-sixth for long-term Treasury issues, one-eighth
for high-grade corporate issues ana nearly one-fourth for high-grade
State ana local government bonds. Most, if not all of these declines
had occurred by late January. Thus, in 4 or 5 months, bond yields
declined as much as they had risen in the previous year.
Before leaving this question of present Federal Reserve policy I
cannot refrain from commenting on another of Professor Harris'
claims, to the effect that the Federal Reserve today can profit by
the example of action taken by the System in 1930-32, action char
acterized by Professor Harris as “tremendous” and worthy of emula
tion. I do not pretend to be a student of monetary history but
I am aware of no responsible study of that period which attributes a
policy of monetary ease to the Federal Reserve between 1930 and
1932. As a matter of fact, even the 1932 annual report of the Federal
Reserve itself implied regret over having kept banks short of reserves.
What Professor Harris did, of course, was to select one of many factors
bearing on reserves— purchases of Government obligations— and
with the selection of appropriate dates and a bit of statistical manipula
tion he came up with the conclusion that an equivalent policy today
would require officials to purchase Government securities in excess of
$50 billion. Both the illustration and the conclusion were to me utterly
ridiculous— as the professor himself seemed to imply— but if so, why
mention the subject at all, unless it was calculated to leave the com
mittee with the impression that there had been a true policy of mone^
tary ease in 1930-32 and that present policy suffers by comparison.
Surely the committee deserved better than this on such an important
question.
With the discussion of this issue I should like to conclude my in
formal presentation of monetarv policy issues raised during the hear
ings before the Committee on finance. I am aware that there were
other issues and that I have not even covered all of those which
properly fall in the area of monetary policy. Nevertheless, I have
attempted to cover those monetary issues which seemed, in my
opinion, to be fundamental. If I have succeeded, it is my hope tM t
this summary will be of some use to those who have not been able to
attend what has been a most interesting and important series of
meetings.
III. L A B O R U N I O N S A N D I N F L A T I O N
This is third in my series of statements summarizing my impressions
gained from the testimony developed in the hearings of the Finance
Committee on the financial condition of the United States.
In the first statement I discussed inflation as the general theme of
the hearings. In the second I reviewed the testimony presented with
respect to the role played by the Federal Reserve System in our present
economic situation. In this speech I shall try to develop the relation
ship between increases in wages and the rise of prices. I am focusing
attention on the wage problem because this seems to be one of the
more important of the recent economic developments making this
inflation different from previous ones.
When we define inflation simply as a rise in prices, we are guilty of
inadequacy and oversimplification. We need to look deeper at the
elements of current price rises to discover what forces play on them to
force them up. Each inflation is the result of the interaction of many
forces, both psychological and economic. But regardless of the refine
ments, there are fundamentally two forces at work: First, a demandpull force, involving excessive spending on the buyers’ side of the
market, and second, a cost-push force, operating from below on the
supply of materials and labor. Today I shall concentrate on the latter,
the cost-push force.
First, however, let us look at the interaction of the two forces. The
demand-pull involves excessive spending by business, Government,
and consumers for the economy’s goods and services. Likewise, as
the buyers of the productive services bid in competition for these
resources, secondary demand-pull elements, which raise prices, are
set up. On the supply side, higher wage rates, rising raw material
prices— which again may be attributed in large part to wage in
creases— taxes, and some other factors all operate as cost-push forces
to raise prices. B y far the most important of the cost-push forces is
wages, which account for 78 percent of the national income originating
in manufacturing.
While most of the witnesses and questionnaire respondents to the
Finance Committee named demand-pull chief villain in inflation
causes, it was recognized by all who testified on this point that costpush forces aggravate or amplify the inflation generated by excessive
spending, while many said that the cost-push forces may themselves
even initiate or be the direct cause of the current inflation.
I think it is significant that the recent wave of inflation, though
probably originating in the capital boom of 1955, and in other condi
tions earlier, has gone on in the face of what was up until last fall a
tight monetary policy. It has persisted in fiscal years 1956 and 1957,
in the presence of a Federal surplus although it has required a huge
Federal deficit to produce past historic inflations. It was not touched
off by a speculative fever in either consumer or producer goods or in
stocks and bonds. Rather than an expansion of profit margins which
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panied by a shrinkage of profit margins. Consumer stocks were high
rather than depleted by wartime scarcity or rationing. And finally
the current recession has not stopped the steady upward climb of
prices.
Is there some new force in this inflation which has not received
sufficient attention? I think there well may be. To me it is signifi
cant that practically every witness who appeared before the Finance
Committee made reference to the inflationary power of labor unions.
This was the case regardless of the background, philosophy, or politics
of the individual witnesses. Practically every respondent to the
questionnaire made the same observation about labor. Certainly
such an array of testimony is more than mere casual coincidence and
deserves more than casual attention.
T H E R O L E OF W A G E COSTS IN IN F L A T IO N
Before referring to the testimony of the witnesses themselves, I
shall outline the understanding I have gained of the general role of
wage costs in inflation.
Wage rates may operate in several direct and indirect ways tp
initiate or sustain inflationary conditions.
First. Wage rate increases, not fully offset by improved productivity
in the industries concerned, increase costs per unit which producers
will attempt to recover through higher prices. I shall take a look at
this in detail in a few minutes.
Second. Increased labor costs and prices, particularly if they occur
in basic or supplier industries, will spread as higher nonlabor costs—
cost of material and components— to other industries, in later stages
of production, thus forcing up the prices of these industries as well.
Third. Because of wage leadership in collective bargaining and the
influence of widening wage differentials on other workers, higher
wages will be demanded in the industries not directly involved in the
original wage-push.
Fourth. The prevalence of long-term labor contracts even in seg
ments of the economy remote from cach other tends to produce general
rigidity and prevent offsetting downward adjustments of cost, and
therefore, even though these wages have not risen, they contribute
indirectly to the general upward pressures of the wage-price structure.
Fifth. As prices rise, upward wage pressures become cumulative
and self-reinforcing. New wage and salary demands in all sectors
are made to offset the rising cost of living. Escalator clauses in
wage contracts tying money wage rates to the Consumer Price Index
have become widespread in recent years. These wage increases are
significant cost-push forces, whatever the initial or generating cause
may have been. It is significant that these escalator clauses are
most prevalent in the so-called strategic industries— industries which
can cause repercussions throughout the rest of the economy. Ex
amples are the steel, automobile, railroad, trucking and transit, elec
trical machinery, aircraft and parts, agriculture machinery, meat
packing, aluminum, and iron ore mining industries.
How likely is it that these five direct and indirect wage factors will
pi&h prices up in a particular situation? Referring to separate action
m a single industry, if wages are increased without the creation of
additional demand for the products of that industry, one 01 more of
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these three things will probably occur: (1) There will be increased
unemployment iQ that industry; (2) there will be a downward pressure
on wages in other industries; or (3), there will be a downward pressure
on prices in the softer or more flexible parts of the economy.
If we are to speak of the effects on these five factors on the economy
as a whole, our answer depends on the vigor and elasticity of the de
mand and on the direction and strength of current monetary and fiscal
policies. If the demand is not expansive, increased unemployment
will probably occur. Some authorities lay the present recession to
this very situation. While the relative importance of the demand-pull
and cost-push forces differ from one inflationary period to another
and from one phase of each inflation to another, the two always exist
when inflation is present, as it is now. Referring to the present infla
tion, Gerhard Colm, chief economist of the National Planning Asso
ciation, had this to say in response to the committee questionnaire:
T h u s, I would explain the price rise of 1957, in p art as a delayed afterm ath of
the preceding dem and inflation; in part, as a cost inflation resulting from the rise
in administered prices and increase in w age rates in excess of p roductivity gains.1
That both elements are usually mutually present in each inflation
was made clear by Federal Reserve Board Chairman Martin when
he appeared last August before the committee. He said:
T h e s e d is tin c t io n s p r e s e n t a n o v e r s im p lific a t io n o f t h e p r o b le m . I n fla t io n is a
p r o c e s s in w h ic h r isin g c o s ts a n d p r ic e s m u t u a lly in t e r r a c t u p o n e a c h o t h e r o v e r
tim e w it h a s p ira l e ffe c t . I n fla t io n a lw a y s h a s a t tr ib u te s , t h e r e fo r e , o f a c o s t*
p u s h . A t t h e s a m e t im e , d e m a n d m u s t a lw a y s b e s u ffic ie n t t o k e e p t h e s p ir a l
m o v in g . O th e r w is e t h e m a r k in g u p o f p r ic e s in o n e s e c t o r o f t h e e c o n o m y w o u ld
b e o ff s e t b y a r e d u c t io n o f p r ic e s in o t h e r s e c t o r s .2
W A G E S , PR O D U C TIV ITY, A N D PRICES
W ith the above discussion as benchmark and background, let us
turn to labor's role in the cost-push inflation. It is my considered
opinion, based in large part on my review of the Senate Finance Com
mittee hearings, that a primary factor in the rise of consumer prices
since early 1956 has been the increase in payroll costs in excess of
increases in productivity. The same testimony was borne out by
such men as Marriner Eccles, Dr. Sumner Slicnter, and others.
Said Marriner Eccles:
I b e lie v e th e m a in c a u s e o f r is in g p r ic e s h a s b e e n t h e u se w h ic h la b o r u n io n
m o n o p o lie s a re m a k in g o f t h e ir p o w e r t o fo r c e u p w a g e s a n d n u m e r o u s c o s t l y
fr in g e b e n e fits fa r in e x c e ss o f in c r e a s e d p r o d u c t i v i t y .8
And Dr. Sumner Slichter, of Harvard, pointed out that the recent
rise of prices reflects more than the typical strong demand for goods.
He related his comments more specifically to the present recession:
W ages have continued to rise throughout th e recession in the face of falling
dem and for labor and goods. T h u s the recession has given the public a clearer
picture than ever of the responsibility of rising wages for rising prices. T h e m ore
plainly the public sees the relationship betw een wages and prices, the more carefullv it will appraise the dem ands of unions.4
1 “ Investigation of the Financial Condition of the United States," comments of economists, professors,
and others in response to the questionnaire of the Committee on Finance. U.S. Senate, 85tb Cong., ch. 5*
p. 584.
* “ Investigation of the Financial Condition of the United States/’ hearings before the Committee on
Finnnce, U.S. Senate, 85th Cong., p. 1210.
» Ibid, p. 1695,
4 Ibid., p. 1843.
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These are the opinions, and I could cite several others;
What are the facte?
At this point, I ask unanimous consent to have printed in the
Record a table showing the increases in hourly wages' in manufactur
ing and productivity in manufacturing from 1947-57. This same table
is found on page 2088 of part 6 of the Finance Committee hearings.
T able I
Year
Average
hourly
earnings
in manufac
turing i
Indexes of
output per
man-hour
(index: 194749=100) a
$2.07
1.98
1.88
1.81
1.77
1.67
134.5
133.5
130.0
125.6
119.7
115.3
1957....... - ...................
1956,...........................
1955____ _______ ___
1954......... ..................
1953............................
1952.............................
Year
1961__
1950......................
1949...
1948 ............
1947
___
Average
hourly
earnings
in manufac
turing i
Indexes of
output per
man-hour
(index: 194749=100) *
$1.59
1.47
1.40
1.35
1.24
111.6
111.8
105.4
99.8
90.5
» Manufacturing employment totaled 26 percent of total civilian employment in 1957.
* Computed from data prepared by Department of Labor.
Over the period 1947-57 hourly wages in manufacturing increased
from $1.24 to $2.07, a percentage rise of 67.3 percent. Productivity
in manufacturing— the output per man-hour— during the same period
increased only 41 percent, or a difference of 26.3 percentage points.
Professor Slichter, of Harvard, and A. D. H. Kaplan, of the Brookings
Institution, refer to this spread between wage and productivity in
creases as the inflationary gap. It is interesting to compare this
so-called gap with the rise in industrial wholesale prices over the
same period. These increased from an index of 95.3 to an index of
125.6 from 1947 to 1957, or a rise of 32 percent.
The changes since the beginning of the latest wave of inflation show
hourly wages increasing 10.1 percent in the 2 years from 1955 to 1957,
while productivity increased only 3.5 percent over the same period,
thus creating a gap of 6.6 percent. This corresponds to a wholesale
industrial price increase of 7.3 percent over the period. In 1 year,
from 1956 to 1957, manufacturing wages increased 4.5 percent, while
output per man-hour increased only 0.7 percent, creating a gap of 3.8
percent. This compares with an industrial price increase of 2.8
percent during that year.
Obviously, the increase in labor costs in excess of productivity will
not nearly match the rise in prices every year. As noted above,
demand and other complex conditions enter in. In showing year-toyear changes, we find some cases where productivity moves ahead of
wage increases, where prices lag behind costs, and where prices take
the lead. We can also find that this pattern will vary from industry
to industiy within the same year. The purpose of the comparison
here is merely to prove that cost-push forces are present in the overall
inflationary process.
COST-PUSH INFLATION AND THE DISTRIBUTION OF INCOMK
Another important aspect of the cost-push inflation deserve* some
careful attention. This is founded in the intense desire of unions and
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workers in every industry and firm to match their particular wage
increases with the increase in productivity for their own industry or
for the economy as a whole, whichever is higher. Thus, the figure for
the whole economy becomes the irreducible minimum for all woikers
in wage negotiations with their employers. To outline the problem
created by such misuse of statistics, let me refer to the response of
Professor Haberler to the committee:
T e c h n o lo g ic a l p r o g r e s s a n d t h e r is e in o u t p u t p e r m a n - h o u r is, o f c o u r s e , n o t
u n ifo r m o v e r t h e w h o le e c o n o m y . S o m e in d u s tr ie s , le t m e s a y , c e r t a in b r a n c h e s
o f m a n u fa c t u r in g a n d p e r h a p s a g r ic u ltu r e , d is p la y fa s t e r t e c h n o lo g ic a l a d v a n c e s
t h a n s o m e o t h e r s — le t m e s a y m o s t s e r v ic e in d u s tr ie s . H e n c e , if t h e o v e r a ll p r i c e
le v e l is t o r e m a in s t a b le , t h e p r ic e s o f t h e p r o d u c t s o f t h e m o r e p r o g r e s s iv e in d u s
t r ie s m u s t fa ll a n d t h e p r ic e s o f t h e le ss p r o g r e s s iv e in d u s tr ie s m u s t rise. T h is p r e
s u p p o s e s , h o w e v e r , t h a t w a g e s in t h e m o r e p r o g r e s s iv e in d u s tr ie s c a n n o t r is e as
fa s t as p r o d u c t i v i t y in t h o s e in d u s tr ie s . I f s t a b ilit y o f t h e p r i c e le v e l a n d fuU
e m p l o y m e n t a re t o b e m a in t a in e d , w a g e s in t h e s e in d u s tr ie s c a n n o t b e a llo w e d
t o r is e fa s te r t h a n a v e r a g e p r o d u c t i v i t y o f la b o r in t h e w h o le e c o n o m y .
S u p p o s e t h a t la b o r in t h e p r o g r e s s iv e in d u s tr ie s is o r g a n iz e d in p o w e r f u l u n io n s
w h ic h fo r c e u p w a g e s in p r o p o r t i o n t o t h e rise in p r o d u c t i v i t y in t h o s e p a r t ic u la r
in d u s tr ie s — a n a s s u m p t io n w h ic h d o e s n o t se e m u n r e a lis tic — t h e n , it is t r u e ,
p r ic e s o f t h e p r o d u c t s o f th e s e in d u s tr ie s n e e d n o t rise . B u t s in c e t h e A m e r ic a n
e c o n o m y is s u ffic ie n t ly c o m p e t it i v e t o g e n e r a liz e , s o o n e r o r la t e r , s u c h a w a g e rise ,
i f n o t fu lly , t h e n a t le a s t t o a la r g e e x te n t, o v e r m o s t o f t h e e c o n o m y , in c lu d in g th e
le ss p r o g r e s s iv e in d u s tr ie s w h ic h c a n n o t a b s o r b t h e h ig h e r w a g e c o s t w it h o u t a
r is e o f p r ic e s a t w h ic h t h e y sell, t h e o v e r a ll p r i c e le v e l w ill g o u p .
I t f o llo w s t h a t t h e p o l i c y o f w a g e in c r e a s e s in p r o p o r t i o n t o (le t a lo n e t h o s e in
e x c e s s o f) t h e r is e in p r o d u c t i v i t y in e a c h p a r t ic u la r in d u s t r y is h ig h ly in fla tio n a r y .4
The problem of the wage-price spiral, then, includes the conflict
over the distribution of real income, not so much between labor and
nonlabor elements, but among various labor groups themselves.
Human nature demands that the various groups try to protect them
selves by pressuring for higher money incomes. The workers in the
least progressive industries will not settle for less than the average,
and those in the most progressive industries will certainly not reduce
themselves to the average. Strategically placed, highly organized
unions usually play a special role as catalysts in this mad scramble.
And the union leaders are right there on the spot with the figures
for their particular situation, using every device and skill to raise the
hopes of every worker— and thus create more cost-push pressure.
In our present collective bargaining society, therefore, inflation
becomes almost a matter of arithmetic. There is an almost inevitable
persistent upward pressure on the cost-price structure. The con
stantly increasing power of organized labor will continue to put an
increasingly heavy burden on our monetary and fiscal policy unless
we can find acceptable means of controlling the wage-push factors of
inflation.
P R O F IT S A N D W A G E S
The rather popular claim is frequently made that increasing profits,
rather than increasing wage costs, are the real cause of rising prices.
None of the witnesses who appeared before the Finance Committee
or submitted statements for the record made this red-herring argu
ment, but it was freely offered by labor leaders and other witnesses
related to labor who appeared before another Senate committee while
our finance hearings were going on, and is frequently presented in
speeches by labor leaders and appears in reports of major labor nego
* Questionnaire, ch. 5, p. 625.
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tiations. Because a few companies have large profits, this is fre
quently used as an argument to apply to business as a whole. Those
who accept this fallacy then build a whole economic philosophy on
the idea that to increase profits is to diminish purchasing power, and
that the way to cure our economic problems is to increase purchasing
power by increasing wages, regardless of related increases in produc
tivity.
Before turning to the facts of the case, I wish to point out that the
subtle false logic of this argument has great appeal to the ordinary
citizen. On the surface this reasoning has its foundation in a sound
economic doctrine— the purchasing power concept— but in reality, it
merely perverts the idea. For an answer to this false reasoning, I
turn again to the able testimony of Professor Haberler:
I t is o n e o f th e m o s t p e r n ic io u s fa lla cie s t h a t a b o o s t t o w a g es is a n e ffe c t iv e
m e t h o d o f in cre a sin g p u r c h a s in g p o w e r a n d th u s a lle v ia te d ep re ssio n .
A ta x c u t
o r in cre a se in p u b lic e x p e n d itu r e s stre n g th e n s p u r ch a s in g p o w e r . O n th e o t h e r
h a n d , a rise in w a g e s m a y o r m a y n o t in cre a se p u r ch a sin g p o w e r o f th e w o r k e r s
(d e p e n d in g o n w h a t it d o e s t o e m p lo y m e n t ).
B u t in a n y ca se, w h e th e r it d o e s
o r d o e s n o t raise th e p u r ch a sin g p o w e r o f th e w o r k e r s c o n c e r n e d , it b o o s t s c o s t o f
p r o d u c t io n , it p u sh e s u p p ric e s (o r p r e v e n ts p ric e s fr o m fa llin g ) a n d s o r e d u c e s
th e re a l p u r ch a s in g p o w e r o f a ll c o n su m e r s, in c lu d in g la b o r itself, a d d s t o t h e
fires o f in fla tio n a n d th u s m a k e s it m o r e d iffic u lt f o r t h e m o n e t a r y a u th o ritie s t o
re la x c r e d it restrictions.®
What do the facts say with regard to wages versus profits as an
inflation force? I wish to have printed in the Record at this point
another table which I had inserted in the hearings. It shows the
percent increase to 1957 from preceding years of total corporate
profits, and total compensation of employees, both, of course, before
taxes.
It will be seen by examining the table that the increase in wages of
employees exceeded the increase in corporate profits before taxes for
each year from 1947 to 1956.
T a b l e I I .— P ro fits a n d wages fo r 1 9 4 7 -5 7
[Dollars in billions]
Total wages
Profits
Year
1967
__
................................
1956...................................................................
1955....................... - ........................... ......... ........
1954...................................- ......... -.......................
1953......................................................................
1958............................ - .......................................1961......................................... .............................
1950......................................... ...........................
1949. .....................................................................
m .....................................................................
1947 .............................................. ......................
Total corpo
rate profits
before taxes
$41.0
43.0
42.5
33.5
37.0
35.9
41.2
40.0
26.2
32.8
29.5
Percentage
increase
from speci
fied year
to 1957
-4 .7
-3 .5
22.4
10.8
14.2
—. 5
2.5
56.5
25.0
39.0
Total an
nual com
pensation
of employees
$254.4
241.4
223.1
206,8
208.1
195.1
180.4
154.3
140.9
140.9
128.8
Percentage
increase
from speci
fied year
to 1957
5.4
14.0
23.0
22.2
30.4
41.0
64.9
80.6
SO. ft
97. b
It will be noted that during the years of the latest inflation, 1955-57,
profits increased slightly from 1955 to 1956, but decreased from 1956
to W57. Profits in 1957 were lower than in both 1955 and 1956.
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On the other hand, employee compensation increased dollarwise and
percentagewise between 1955 and 1957. Referring to the table in
serted earlier, it will be seen that the same is true for hourly earnings
in manufacturing.
Although unincorporated business and professional incomes are not
shown in the table, I might point out that from 1955 to 1957 these
incomes increased from $27,3 billion to $28.7 billion for a percentage
rise of 5.1 percent. This is less than half of the increase in compensa
tion of employees over the corresponding years.
Yet the question may still be asked: Could not a general wage
increase come out of profits? It might for a few companies and for
a few years, but it could not be true for all companies or for every
year. This should be clear from the data already presented; but for
additional evidence, I have shown in table I I I the national income
by years from 1947, and the percentage which corporate profits before
taxes and compensation of employees are of that income.
T able III
[Dollars in billions]
Year
1957—___
1956____
1955____
1954____
1953 .......
1952
National
Income
$358.2
343.6
324.1
209.0
302,1
290,2
Compen
sation of
employees
as a percent
of national
income
Corporate
profits before
taxes as a
percent of
national
income
71.1
70.3
68.8
69.2
68.9
67.2
11.5
12,5
12.4
12. 2
11.1
12.4
Year
1951........
1950____
1949____
1948 ____
1947 ___
National
income
$277.0
240.0
216.2
221.6
197.2
Compen
sation of
employees
as a percent
of national
income
Corporate
profits before
taxes as a
percent of
national
Income
65.1
64.3
65.2
63.6
65.3
14.4
16.7
12.1
14.8
15.0
N ote.—T he remainder of the distribution within 100 percent is made up of farm business and profes
sional, rental, and net interest income.
From this table it is obvious that wages have in fact increased their
relative share of the national income during the past 3 years from
68.8 percent in 1955 to 71.1 percent in 1957. Corporate profits, on
the other hand, have correspondingly declined from 12.4 percent to'
11.5 percent of national income during the same period.
A general wage increase of even 5 percent in 1957 not compensated
by an increase in productivity or prices would reduce non wage income
by one-eighth, and if it all came out of corporate profits it would mean
a reduction of 31 percent in this sector— nearly one-third. A 16percent wage increase would wipe out all profits. Thus, it does not
take much imagination to see what an additional profit squeeze would
do to the economy.
On the other hand, one of the most potent factors in our economy
to damper inflationary forces is increased productivity. If produc
tion is increased as fast as demand is enlarged, price inflation will
probably not occur. I submit that productivity will be increased
only if profit margins are large enough to provide businessmen with
incentive to borrow, and savers with incentive to invest or to lend the
funds to finance the new capital improvements. In this sense,
therefore, profit margins are an indirect defense against inflation
rather than a cause of inflation.
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From the pamphlet, the “Mechanics of Inflation,” published by
the U.S. Chamber of Commerce, I borrow this paragraph:
I f te m p o r a r ily h ig h p ro fits in e x p a n d in g in d u s trie s b e c o m e th e ba sis fo r m o n o p o
lis tic w a g e d e m a n d s, a n d th o se p r o fits are r e d u c e d b e fo r e t h e y can p e r fo r m th eir
m o s t im p o r ta n t e c o n o m ic fu n c tio n , th e e x p a n sio n o f th e in d u s tr y d e sired b y
c o n s u m e r s is c u t o ff.
T h e w h o le c o m m u n it y is th e r e b y r o b b e d in h ig h e r p rices,
u n e c o n o m ic use o f o u r re so u rce s a n d fo r e g o n e im p r o v e m e n ts in liv in g sta n d a r d s.
I f a fr e e m a rk e t is t o b e p re s e rv e d , w e e n fo r c e c o m p e t it io n a n d rely o n c o m p e t it io n
t o g r in d d o w n t e m p o r a r ily h ig h p ro fits.
T h is is n o t th e fu n c tio n o f th e la b o r
lea d e r, h o w e v e r sin ce re a n d p u b lic s p irite d h e m a y b e .7
Another point is worth noting here. Normally, profits, being a
residual share of national income, increase faster than other income
shares in a boom period. On the other hand, they fall more rapidly
in a recession— for example, 1931 and 1932. They are not inflexible
downward, as are wages; nor on the rise do they establish higher rigid
cost plateaus, as do wages.
Before I leave this discussion of the relative inflationary effect of
rising wages and rising profits, I wish to turn briefly to a philosophical
comment on the subject made by Mr. Theodore O. Yntema, vice
president and economist of Ford Motor Co., which appears in his
testimony before the Subcommittee on Antitrust and Monopoly.
He said:
W e w o u ld lik e t o se e th e p r o d u c t iv it y a d v a n c e s in th e e c o n o m y d is tr ib u te d
m o r e in lo w e r p rice s a n d less in h ig h e r m o n e y w a g es o f r e d u ce d p u rch a sin g
pow er. * * *
C e r ta in ly , w e s h o u ld n o t to le r a te a t te m p ts b y a n y p o w e r g r o u p t o g r a b su ch
b e n e fits fo r th e m se lv e s. * * *
T h e p r o d u c t iv it y o f s o c ie t y is r e fle c te d in th e p h y s ic a l v o lu m e o f o u t p u t p e r
m a n -h o u r w o r k e d .
T h is o u t p u t p e r m a n -h o u r is u su a lly ca lle d th e p r o d u c t iv it y
o f la b o r .
T h e te rm , h o w e v e r , is a m isn o m e r b e c a u se la b o re rs are n o t resp o n sib le
fo r m u c h o f t h e in cre a se in p r o d u c t iv it y .
T h e in crea ses in p r o d u c t iv it y c o m e
m a in ly fr o m m a n a g e m e n t ’s u t iliz in g c a p ita l a n d p u t tin g in t o o p e r a tio n th e im
p r o v e m e n t s d is c o v e r e d b y s c ie n tis ts , e n g in e e rs, a n d o th e rs.
I t is s o m e w h a t ir o n
ic a l t h a t p r o d u c t iv it y s h o u ld b e e x p r e ss e d as o u t p u t p e r m a n -h o u r , a n d it is m o s t
u n fo r tu n a te t h a t th e t e r m *'‘p r o d u c t iv it y o f la b o r ” s h o u ld b e m is in te rp r e te d a s
p r o d u c t iv it y a ttr ib u ta b le t o la b o r .8
C O N C LU SIO N S---- R E C O M M E N D A T IO N S
If the owner of labor to exact wage increases in excess of produc
tivity is a major cause of inflation, what course should the Govern
ment pursue to stem this inflationary force? The monetary author
ities, and those responsible for fiscal policy— and a major responsibility
for these rests squarely on this body— have a mandate to control the
demand type of inflation. What forces or agencies have the respon
sibility to stem the cost-push type of inflation? Fiscal and monetary
policy could handle this type of inflation, too, but only at the cost of
increased unemployment.
I have not as yet reached any conclusions for myself as to the best
course to follow. However, the witnesses to the Finance Committee
offered some individual suggestions which are worth considering.
I think it should be obvious to everybody that the place to begin,
and in the long run perhaps the only source of a solution, is with the
public itself— through a program of economic enlightenment, Sumner
* P . 30
'ftep ared testimony of Theodore O. Yntema before the Subcommittee on Antitrust and Monopoly of
(be Committee on the Judiciary, U.S. Senate, Feb. 4-6,1958, pp. 40-41.
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Slichter concluded his testimony before the committee with these
words:
T h e m o r e p la in ly t h e p u b l i c s e e s t h e r e la t io n s h ip b e t w e e n w a g e s a n d p r ic e s , t h e
m o r e c a r e fu lly it w ill a p p r a is e t h e d e m a n d s o f t h e u n io n s . T h e p u b l i c is o b v i o u s l y
g e t t in g t ir e d o f t h e s t iff a n n u a l r o u n d s o f w a g e in c r e a s e s t h a t fa r e x c e e d t h e c o n
t r ib u t io n o f t h e w o r k e r s t o p r o d u c t i v i t y .
A n a t m o s p h e r e is b e in g b u ilt u p in
w h ic h e m p lo y e r s w h o t a k e lo n g a n d c o s t l y s t r ik e s in a n a t t e m p t t o h o ld w a g e
in c r e a s e s d o w n t o in c r e a s e s in p r o d u c t i v i t y w ill h a v e s t r o n g p u b l ic su pp ort.®
Gerhard Colm offered these suggestions:
1. D e v e l o p m o r e fa c t s o n p r ic e s , w a g e s , a n d p r o d u c t i v i t y ,
a n d a b e tte r u n d e r
s t a n d in g o f t h e s e fa c t s .
. I m p le m e n t t h e p r ic e s t a b iliz a t io n o b j e c t i v e o f t h e E m p l o y m e n t A c t .
3 . G i v e c o n s id e r a t io n t o a n a n n u a l in fo r m a l c o n fe r e n c e o f b u s in e s s a n d l a b o r
le a d e r s a n d r e s e a r c h e c o n o m is ts , f o r t h e p u r p o s e o f d is c u s s in g a lo n g g e n e r a l lin e s
p r ic e a n d w a g e p o l i c y w h ic h w o u ld g iv e s u p p o r t t o h ig h a n d r is in g e m p l o y m e n t
a n d p r o d u c t i o n w it h o u t c a u s in g in fla t io n o r d e fla t io n .
W h e th er o r n o t agree
m e n t o n p r ic e a n d w a g e p o l i c y is r e a c h e d a t t h e s e se ss io n s, t h e r e s u lt in g p u b l i c
in f o r m a t io n w o u ld le a d a t le a s t t o a c le a r e r u n d e r s t a n d in g o f t h e a r e a s o f d is a g r e e
m e n t . “ A b e t t e r in f o r m e d p u b l i c o p in io n in it s w ill e x e r t a r e s tr a in in g in flu e n c e
o n p r ic e a n d w a g e p o l i c y .”
4 . S e t u p a s p e c ia l G o v e r n m e n t c o m m is s io n o n p r ic e a n d w a g e p o l i c y . R e q u i r e
p r o d u c e r s a n d la b o r le a d e r s t o i n fo r m t h e C o m m is s io n o f c o n t e m p l a t e d p r ic e
in c r e a s e s a n d n e w c o l l e c t i v e b a r g a in in g a g r e e m e n ts b e f o r e t h e y b e c o m e e ff e c t iv e .
A f t e r s t u d y b y t h e C o m m is s io n , a n d r e v ie w b y t h e C o u n c il o f E c o n o m i c A d v is e r s ,
t h e P r e s id e n t c o u ld t h e n a p p r o v e o r s u s p e n d t h e e ff e c t iv e d a t e f o r a p e r io d o f s a y
6 0 d a y s i f t h e y a re d e e m e d t o b e c o n t r a r y t o t h e p u b lic in t e r e s t.10
2
Though M r. Colm’s first three suggestions merit further study,
I hope we can reach a solution more in keeping with private free enter
prise than his fourth suggestion.
There is one other suggestion which received only a little attention
in the committee hearings, but which also deserves some careful
study. The idea has been suggested by many responsible men in
other places. It is a call to extend present antitrust laws to cover labor
union activity, or in some way limit the size of unions. George
Romney, president of American Motors, in testimony before the Sub
committee on Antitrust and Monopoly, called for a dividing of the
power of national unions. Two of this specific proposals were:
1
. T h e c o m b in in g o f t h e n a tio n a l u n io n s f o r t h e e s t a b lis h m e n t o f c o m m o n
b a r g a in in g d e m a n d s o r u se o f e c o n o m i c p o w e r , s h o u ld b e p r o h ib it e d .
. A ffilia te d u n io n s s h o u ld b e fr e e t o c o m b in e in b a r g a in in g w it h e m p lo y e r s
h a v in g less t h a n 1 0 ,0 0 0 e m p lo y e e s , b u t o n l y w it h in p r e s c r ib e d g e o g r a p h ic a l lim it s .
H o w e v e r , t h o s e r e p r e s e n tin g m o r e t h a n a b o u t 1 0 ,0 0 0 e m p lo y e e s o f a s in g le
e m p lo y e r s h o u ld b e p r o h ib it e d fr o m c o m b i n i n g t o e s t a b lis h c o ll e c t iv e b a r g a in in g
d e m a n d s o r e x e r cis in g jo i n t e c o n o m i c p o w e r a g a in s t m o r e t h a n o n e c o m p a n y .11
2
Theodore O. Yntema in his response to the Finance Committee
questionnaire gave it as his opinion that the most desirable solution
to wage inflation, and its cause— the labor monopoly problem— is the
development of antimonopoly laws comparable to those which govern
business.
I quote in length from Mr. Yntema’s words, both because of their
vital nature, ana because they summarize my feelings on this matter:
C o m p e t i t i o n in b u s in e s s is n o t p e r f e c t — in t h e e v e r y d a y s e n s e ; it c a n b e a n d
n eed s t o b e im p r o v e d .
B y a n d la r g e , h o w e v e r , th e r e is e n o u g h c o m p e t it i o n in
m o s t in d u s tr ie s t o k e e p p r ic e s a n d p r o f it s d o w n t o le v e ls r o u g h ly e q u a l t o t h o s e
* Hearings, p, 1843.
10 Questionnaire, ch. 5, pp. 680-681.
11 Prepared testimony of George Romney before the Subcommittee on Antitrust and Monopoly of the
Committee on the Judiciary, U.S. Senate, Feb. 7, pp. 38-39.
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n e c e s s a ry t o c o m p e n s a te f o r t h e risk s o f t h e bu sin ess. * * * A n d th e r e are laws
o n t h e b o o k s p r o h ib it in g m o n o p o ly a n d m o n o p o lis tic p r a c tic e s — la w s th a t have
m a in ta in e d r e a s o n a b ly w o r k a b le c o m p e t it io n in bu sin ess.
A d iffe r e n t s itu a tio n e x ists in la b o r .
L a b o r u n io n s a re m o n o p o lie s e sta b lish ed
u n d e r t h e a eg is o f la w .
T h e y a r e g iv e n sp e c ia l p r o t e c t io n a n d e v en im m u n itie s
a n d p riv ile g e s t h a t a re n o t a c c o r d e d o r d in a r y citiz e n s. T h e y are n o t s u b je c t to
su ch r e g u la tio n o r r e s tr a in t in th e u se o f th e ir m o n o p o ly p o w e r.
D u r in g th e b o o m o f 1 9 5 5 -5 7 a n d in t h e r e ce s sio n o f 1 9 5 7 -5 8 th e u n ion s h a v e d is
p la y e d th e ir p o w e r t o d r iv e u p w a g e s fa s te r th a n p r o d u c t iv it y a n d t o sq u e e ze p r o fit
m a r g in s.
T h e r e is n o re a so n t o e x p e c t d iffe r e n t b e h a v io r in th e fu tu re fr o m la b o r
u n io n s u n less th e ir p o w e r s are r e d u c e d .
W e c a n lo o k fo r w a r d , th e re fo re , t o c o n
t in u e d a n d p r o b a b ly a c c e le r a te d c o s t-p u s h in fla tio n in th e fu tu re un less a p p r o p r i
a t e a c t io n is ta k e n . * * *
T h is p r o b le m o f la b o r m o n o p o ly a n d c o s t-p u s h in fla tio n c a n n o t b e s o lv e d merely
b y in c r e a sin g t h e d e g r e e o f c o m p e t it io n in bu sin ess. * * *
I n d u s t r y w id e o r g a n iz a t io n o f b u sin e ss t o o p p o s e in d u s tr y w id e o r g a n iz a tio n o f
la b o r is n o t a h a p p y s o lu tio n . * * *
W a g e a n d p r ic e c o n t r o ls a re stiU w o r s e as a s o lu tio n .
Cost-push inflation, though relatively new, is an American economic
problem of major proportions. It is a complex problem, and likewise
the solutions to it are still beclouded. But the difficulty of our task
should not deter us from tackling it.
S U M M A R Y OF ST A T E M E N T N O . IV— IN FLATION AN D T H E
SEC E SSIO N
To summarize this’particular statement on the relationship between
the present recession and the continuing inflation: After analyzing all
the ideas suggested by the Committee witnesses as being causes of
the recession, I believe they all bear out the basic assumption that
this has been a typical period of readjustment following an economic
boom. Of course, it is different in detail from the other two postwar
cycles of boom and recession. This one has been spotty, with re
spect to certain industries, and clearly reflects a change in the buying
pattern of consumers. While the personal disposable income has
dipped only very slightly, consumer use of it has so changed as to
bring a serious drop in the volume of consumer durables. While this
was going on, industry, after an investment boom, was reacting with
a drop in expenditure for capital durables. From these, and other less
important factors, consequent recession touched most of the economy.
In spite of this, inflation has persisted even in the face of the down
turn, and though dormant since the upturn, has not permitted the
downward price adjustments which usually occur in times of lowered
economic activity.
The presence of both these economic diseases at the same time has
posed a serious problem for us, and apparently we have decided that
the short-time, close-range recession was more serious than the infla
tion, because we have embarked on a vast new Federal spending pro
gram and created our greatest peacetime deficit, totaling more than
$12 billion, which will not be felt until after the economy has turned
upward. Recent statistics from the National Bureau of Economic
Research show that the “lead” indicators have been rising for 2 months
now, yet the large Government deficit is still to come.
The time has come to fit this statement into the whole picture of
this series. In the first statement, I identified inflation as the most
serious problem revealed by the hearings, and their central theme.
In the second, I discussed the monetary policies used to check the
force of the inflation, and discussed the reasons they were not com
pletely successful. In the third, I reported on the role of wage poli
cies in producing the cost-push force in the inflationary spiral, and
tried to focus attention on the central problem here— the fact that
over the past dozen years, wages have risen faster than productivity.
And in this fourth discussion, I pointed out how inflation helped
create this recession, how it persists in spite of the economic down
turn, how it is being started off again, under the guise of a cure for
the recession. Through all this it must be obvious to those who read
these statements that I believe inflation has been, and still is, our
No. 1 economic problem, and that unless we face it and control it
soon, it will do immeasurable damage to our economic future.
What can we do about it? Where shall we begin?
First. We cannot find our answer entirely in Government policies
and programs. We cannot pass laws to cure inflation. Rather than
curing it, increased Government interventions tends to sustain and
intensify it. Certainly, that is the record of the last quarter century;
and I believe that will be the result of many actions taken by this last
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session of the 85th Congress. When we try to give help without cost,
greater spending without added taxes, special privileges for special
groups, we are not creating something out of nothing. Rather, wo
are being political Robin Hoods in reverse, creating inflation which
robs the poor for the purpose of rewarding political supporters.
Inflation robs the past and future for the present. Once we intervene
for one group, we are soon called upon to equalize this inequity by
another intervention. Thus, we are always giving, but seldom count
ing the cost. The elected representative who tries to stem this tide
risks being swept out of office by it. And the man who has courage to
stand up to it is scorned and castigated.
Second. The fires of inflation can only be brought under control by
the people themselves, beginning in the management of their own lives
and money.
While some Members of Congress have been trying to whip this
current mild recession into an excuse for a whirlwind of frantic
Government economic action, there has been no great supporting
public outcry. Of course, there have been some special-interest
groups who have tried to take advantage of the apparent mood of
Congress to push their particular programs, either tax cuts or spending
programs beneficial to them. But while this has been going on, the
ordinary people have been quietly going about their individual a n d
personal programs, putting their own economic houses in order.
These people have been stepping up the payments on their debts,
saving more, and stretching out the life of their cars and other durables.
B y these policies and by exercising caution, prudence, and self-reliance
in their buying of consumer goods, they are using the safest and most
powerful kind of inflation control in the world. Perhaps we might
call their actions the only true and effective method. At least we
can be sure that unless backed up by such personal programs, no
Federal programs will ever work successfully.
Since June 18, 1957, when the Finance Committee started on its
hearings on the financial condition of the United States, we have seen
both phases of the third postwar business cycle. We saw it rise to /
its peak in the third quarter of 1957. From then until April of this
year, we lived through the natural adjustment which followed, which
we call a recession. Now it looks as though we have begun the longer
and slower climb to another summit— either in steady, sustainable
growth or in a headlong rush to another boom and bust. What lies
ahead we cannot tell. But so far as the cycle of 1954-58 is concerned,
we can now feel that the worst is over. But while we may be on our
way out of the woods on the current recession, the greater of our twin
problems is still with us. The inflation born in World War I I has
persisted through three such cycles of both boom and recession— and
while its fires seem dormant now, the deficits created by this very
Congress may well be storing up the fuel which will cause them to
flare up again soon in a wilder and more consuming flame.
As the hearings developed, the risks and problems of inflation
became their central theme. Wow as they close, it remains our domi
nant economic threat. If our country is to continue to grow in sound
prosperity, control of inflation must be our chief economicgoal. To
me, this is the ultimate meaning and lesson of the Finance Committee
hearings of 1957-58.
@FedFRASER