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394 A meeting of the Board of Governors of the Federal Rese rve System was held in Washington on Frid ay, April 8, 1938, at 11:30 a.m. PRESENT: Mr. Mr. Mr. Mr. Mr. Mr. Eccles, Chairman Ransom, Vice Chairman Szymczak McKee Davis Draper Mr. Bethea, Assistant Secretary Mr. Carpenter, Assistant Secretary Mr. Clayton, Assistant to the Chairman Consideration was given to each of the matters hereinafter referred to and the action stated with resp ect thereto was taken by the Board: The minutes of the meeting of the Board of Gove rnors of the Federal Reserve System held on April 7, 1938, were approved unanimously. Telegrams to Mr. Kimball, Secretary of the Federal Rese rve Bank of New York, Mr. Leach, President of the Federal Reserve Bank of Richmond, Messrs. McCravey , Young, Stewart and Powell, Secretaries of the Federal Rese rve Banks of Atlanta, Chicago, St. Louis and Minneapolis, respectively, Mr. McKinney , President of the Federal Reserve Bank of Dallas, and Mr. Stewart, Chairman of the Federal Reserve Bank of San Francisco, all stating that the Board approves the establishment without change by the Federal Reserve Banks of St. Louis and San Francisc o on April 5, by the Federal Reserve Bank of Dallas on April 6, by the Federal Reserve Bank s of New York, Richmond, Chicago, Minneapolis and San Francisc o on April 7 and by the Federal Rese rve Bank of Atlanta 395 4/8/38 -2- on April 8, 1938, of the rates of discount and purchase in their existing schedules. Approved unanimously. Letter to Mr. Young, President of the Federal Reserve Bank of Boston, prepared in accordance with the actio n taken at the meeting of the Board on April 5, 1938, and reading as follows: "Mr. Ransom has advised the Board of his telephone conversation with you on April 2, 1938, during which you stated that you planned to present to the board of direc tors of your bank at its next meeting the advisabili ty of a reduction from 4% to possibly 2% or in the rate in effect at your bank on advances to individuals, partn erships and corporations secured by direct obligation s of the United States under the provisions of the last parag raph of Section 13 of the Federal Reserve Act, as emended, and that you would like to have an expression of the views of the Board with respect to the reduction. "It is noted that while you have received inquiries recently from corporations with respe ct to such advances and while, in the event a reduction in the rate were effected, you would issue a public state ment to the effect that your bank was prepared to make advan ces to individuals, partnerships and corporations on Government securities at par, you do not believe the bank would be called upon to make any substantial amount of loans, since member banks would be willing to make such advances at their current rate of from 1% to 4%, and that the reduction in the rate would be made merely for the purpose of bringing the rate into line with the other existing rates at the bank. "As you know, the rates now in effect at other Feder al reserve banks on advances under the autho rity of the last Paragraph of Section 13 of the Federal Reser ve Act range from 311 to 4%; the disco unt rate at all Federal reserve banks is li%, with the excep tion of the Federal Reserve Bank of New York where the rate is 1%; and the rate at all Federal reserve banks on loans made under section 10(b) of the Federal Reserve Act is 2%. In view of these circumstances and the level of money rates generally, the Board feels that a reduction in the rate on advan ces under authority of the last paragraph of Section 13 of the Feder al Reserve Act would be 396 4/8/38 -3- "desirable, and, therefore, would be willing to approve a reduction of as much as 2% in the existing rate of your bank if such reduction were voted by your directors." Approved unanimously. Memorandum dated April 7, 1938, from Mr. Morrill stating that, for the reason set forth in the memorandum, Chairman Eccles desired to have an additional messenger assigned to his offic e and to the offices of Messrs. Clayton and Thurs ton and that he would like to have Bishop Hart, a messenger in the Division of Bank Operations, transferred for that purpose. In accordance with Chairman Eccles' request, the transfer of Bishop Hart was approved unanimously, with no change in his present salary at the rate of 960 per annum, effective immediately. Letter to Mr. Thomas, Chairman of the Federal Reserve Bank of Kansas City, readi ng as follows: "The Board of Governors of the Federal Reserve System decided some time ago that surveys should be made of the Bank Examination and Auditing Departments at all of the Federal Reserve Banks. There is attached a copy of a report of the survey of the Auditing Department of the Federal Reserve Bank of Kansas City recently condu cted by the Board's Examiners Jones and Cagle. An additional copy of the report is inclosed for Presi dent Hamilton. "Thile the survey indicates that the auditing function at the Federal Reserve Bank of Kansas City in general is being performed in substantial conformity with the standards recommended by the Conference of Auditors of the Federal Reserve Banks held in Washi ngton in November 1936, the conclusions set forth by the examiners indicate a number of matters which merit consi deration. "It will be appreciated if you and any of your directors whom you may designate and President Hamilton will review this report of survey and give the Board the benefit of your reactions to the matters referred to above and any other statements concerning which you would like to 397 4/8/38 -4- "express your views. "The footnote of the letter transmitting the recommendations of the Conference of Auditors to Mr. George L. Harrison, Chairman of the Conference of Presidents of the Federal Reserve Banks, called attention to the confidential nature of the material contained in that repor and t other information relative to the auditing activities at the Federal Reserve Banks. As the inclosed repor t refers frequently to the Auditors' recommendations and also contains other information of a confidential natur conce e rning the activities of the Auditing Department of your bank, it will be appreciated if the report itsel f is not made available to the bank's employees and the officers direc tly in charge of the operating department s. Of course, the Board sees no objection to the report, or parts there of, being submitted to, or discussed with, your direc tors and such of the bank's officers as you and President Hamilton deem advisable." Approved unanimously. Letter to Mr. Sproul, First Vice President of the Feder al Reserve Bank of New York, readi ng as follows: "Reference is made to your letter of March 25, 1938, in regard to the program of the Feder al Reserve Bank of New York in connection with the coming summer session of the Graduate School of Banking at Rutge rs University. "It is noted that the bank expects to pay the expenses of Messrs. H. L. Sanford and S. A. Miller who enrolled in the Graduate School in 1976, but that three other prospective students from your bank, one of whom attended the school for the first time last year and two of whom have not previously atten ded the school, will pay their own expenses. "Since it appears from your letter that, when Messr s. Sanford and Miller first enrolled in the Graduate School, it was the policy of your bank to pay the expenses of the officers and employees of the bank atten ding the Graduate School; thwt, because of circumstan ces beyond their control, neither of these men can complete the course at his own expense; and that you think it will be of benefit to the bank to have these men complete the course; the Board will interpose no objection to the payment by the bank of all fees and expenses of Messrs. Sanford and Miller in 398 4/8/38 -5- "connection with their attendance at the coming summer session of the Graduate School of Banking at Rutgers University." Approved unanimously. Reference was made to the statement which had been prepared in accordance with previous discussion s by the Board with respect to Bill H.R. 7230, introduced by Representa tive Patman, to provide for Government ownership of the twelv Feder e al reserve banks and for other purposes. The last revision of the statement had been reviewed by the members of the Board and, in accordance with their suggestions, had been changed to read as follows: "The fundamental purpose of H.R. 7250 is to establish a mechanism that would control the volume of money with a view to maintaining a fixed price level. "The mandate "In an amendment the Board of Governors is instructed to raise the all-commodity index until full employment of all persons able and willing to work shall have been achieved, and until the price level shall at least reach the all-commodity index of 100, as established by the Department of Labor, for the year 1926. The Board is further directed to maintain this price level with variations not to exceed 2 per cent. To accomplish this the Board is directed to expand and contract demand depos its by engaging in open-market operations. "The position of the Board of Governors on the problem of monetary objectives was indicated in a statement issued on August 2, 1957, in response to a Congressional inquiry. The Board is in full agreement with the ultimate objective of proposals to promote economic stability, which means the maintenance of a volume of business activity and of national income adequate to assur e as full employment of labor and of the productive capacity of the country as can be conti nuously sustained. The Board is aware that commodity prices are an important element in the Nation's economic life and that violent fluctuations 399 4/8/Z8 -6"of prices have disastrous effects. It believes , however, that price stability does not necessarily lead to economic stability and, therefore, should not be the principal objective of public policy. In its opinion the objective of economic stability cannot be achieved by monetary means alone, but rather should be soug ht through coordination of monetary and other major policies of the Government which influence business activity. "The principal difficulty vith a stable price level as the objective of economic policy is that it is not in itself a satisfactory indicator of a continuously smooth working of the economic machine. Ther e have been periods in the past when the price leve l was stable and nevertheless there were developing nume rous maladjustments which led to an economic collapse. For example, from the latter part of 1927 to the latter part of 1929 the index of wholesale prices showed litt le change, but other developments were threatening economic stab ility. Prices and activity on the stock market were rising rapidly, and brokers' loans grew at an unprecedente d rate. Construction of office and apartment buildings was bein g promoted with a view to quick profits at a rate that endangered the longer-time outlook in the building industry. Loans were being made for enterprises abro ad without careful investigation of credit risks, and business activity in general was incr easing, Partly as a result of speculative developments to , a level that could not be sustained. The use of the commodity price level as a guide to credit policy in thes e circumstances would have been entirely unsa tisfactory. There is no assurance that it would be satisfactory in the future. "The proposal is that the Board of Governors bring the commodity price index up to at least the 1926 level. The average for that year is about 25 per cent above the present level and an adva nce of that magnitude, except over an extended period, would cause specu lative buying and viould lead to boom cond itions which would culminate in a break and a depression. Furthermore, in Periods of rapid advance disparities between prices of different groups of commodities generall becom y e more pronounced and yet, both from the point of view of justice and of economic stability, the most important 400 4/8/38 -7- "thing in regard to prices is the maintenance of proper relationships between prices of different commodities that are exchanged for each other. Activity of producers depends on the relationship between their costs, including principally prices of materials, labor, taxes, and debt service, and the prices at which they can sell their products. In the last quarter of 1936 and in the first quarter of 1937, for example, building costs and prices of new houses rose so rapidly and so far as to discourage buying, and this resulted in a decline in residential building. Moreover, the rise in prices of industrial raw materials at that time was much sharper than the advance in finished goods, and this was a factor in causing speculative purchases, forward orders, and building up of inventories, all of Ihich contributed to the subsequent collapse of business. "Present prices of individual commodities in the Bureau of Labor statistics index, compared with 1926, range from a decline of 75 per cent to an increase of 100 per cent. A restoration of the 1926 level could be achieved through an advance of all commodities, including those that are too high, as well as those that are too low, or through a rise in one or the other group of these commodities. There is nothing in monetary polic:, that could determine which of the commodities would rise, and yet this would be all-important from the point of view of the effects that the rice in prices mould have on the economy. "In the Board's view the essential objective of monetary policy is to contribute to the maintenance of a flow of money and income throug h the channels of trade, Industry, and acriculture that would tend to utilize to the full the country's human and material resources. This is the Board's understanding of the broad mandate stated in the Federal Reserve Act as 'accommodating commerce and business'. To this end and to the maintenance of sound banking conditions the Board devotes Its efforts, and there is nothin in the proposed mandat g e that would add to the Board's desire or ability to achiev e these objectives. "In directing the Board to achieve price stability and 401 4/8/38 -8- "full employment through open-market operations, the proposed mandate disregards the limitations on the effectiveness of this instrument of credit policy. It assumes that open-market operations can always create or destroy deposits, and that changes in the volume of deposits in turn are immediately reflected in the price level. The fact is that open-market operations do not always create deposits, since purchases of securities from the banks do not increase deposits. Whether open-market purchases result directly in an increase in deposits or not, they do result in the creation of a corresponding amount of reserves. These reserves may or may not result in the creation of deposits, depending on whether conditions are favorable for the expansion of loans and investments by banks. The great bulk of deposits in the banks of the United States are created through such an expansion. A given volume of reserves created by Board action, therefore, might result in no increase in deposits at all, or on the other hand might result in a growth of deposits several times as large as the reserves. Which of these developments would actually occur would depend on forces that are largely, if not wholly, outside the control of the Board of Govern ors. "It is not true, furthermore, that the creation of deposits necessarily results in an equivalent rise in prices. We have had increases in deposits without corresponding increases in prices. The volume of deposi ts at the present time is greatl-,,, in excess of the amount that existed in 1929 and yet the price level is much lower. Nor is it clear that a rise in prices necess arily results in an increase in employment. An unbalanced advance in prices may, on the contrary, be an influence in decreasing employment, as was the case early in 1937. "Aside from many factors that are not under the control of the Government, there are numerous phases of Government activity other than monetary action by the Federal Reserve System that have effects on prices and on economic activi ty. Among such factors are the actions of the United States Treasury in relation to the inactive gold account and the stabilization account; policies in regard to taxation, exchange rates, the volume and character of Government spending; its action in regard to the capital market, to railroads and utilities; the Government's housing program, its agricultural policies, and its policies in regard to labor. All of these Govern ment activities have a distinct bearing on the volume of business activity and on the price level. They are beyond the influe nce of the Federal Reserve System, 402 4/8/38 -.9- "and yet without them and their coordination with monetary policy the System would be powerless to achieve either an advance in prices or the restoration of full employment, as would be required under the proposed mandate. "The Board of Governors, therefore, does not favor the adoption of the proposed mandate. "Federal Reserve System operates in the public interest "In addition to prescribing a mandate for the Federal Reserve policy, the bill proposes a reorganization of the Federal Reserve System. The reasons offered for this reorganization are that the System has not been operated in the public interest; that it has been dominated by bankers; that it has been conducted in the selfish interests of a small group, and that it has made large profits at the expense of the community. The Board of Governors does not believe that any of these assertions can be sustained by the record. "Ownership of stock by member banks does not enable the bankers to control the Federal Reserve System. It is more nearly in the nature of a compulsory capital contribution than stock ownership. Although the member banks elect two-thirds of the directors of the Reserve banks, the large banks elect only two out of nine directors. The small banks elect two, the medium-sized banks elect two and the Board of Governors in Washington appoints three. Only a third of the directors can be bankers and all directors and officers are subject to removal by the Board of Governors. The Board in Washington appoints the chairman and deputy chairman of each Reserve bank, and the appointment of all presidents and first vice presidents, as well as the salaries of all officers and employees, are subject to its approval. "Complete authority over all matters of major national policy, such as the determination of discount rates, reserve requirements, margin requirements on security loans, and maximum rates of interest to be paid on time deposits, is vested in the Board of Governors. Authority over open market operations is vested in an open market committee consisting of seven members of the Board of Governors and five members elected by the Reserve banks. "It is clear, therefore, that in matters with which the bill is primarily concerned the System is dominated not by hanks, but by the Board of Governors, a Governmental body whose members are appointed by the President and confirmed by the Senate. "Federal Reserve banks not operated for profit "During the twenty-three years of its existence the 403 4/8/38 -10- "Federal Reserve System has earned approximately one and a quarter billions of dollars, of which about one-half has been used for operating expenses incurred largely in performing public services, such as the clearing and collection of checks, the supplying of currenc:i to the banks and to the public, the performance of many duties for the United States Government, and in furnishing rediscount facilities for the member banks. "Earnings of the Federal Reserve banks above these expenses and reserves for contingencies amounted to 00,000,000. Of this amount approximately $150,000,000 has been paid to the Government as franchise tax, about $140,000,000 has been appropriated by Congress for the Federal Deposit Insurance Corporation as capital, $160,000,000 has been paid as the statutory dividends to member banks, and the remainder is held in a surplus account which in case of liquidation becomes the property of the Government. "Member banks contribute 3 per cent of their capital and surplus to the capital of the Reserve banks and receive 6 per cent annually on this contribution. In addition, member banks are required to keep balances with the Reserve banks amounting on the average to 16 per cent of the member banks' deposits and receive no return on these balances. For example, a member bank having a capital and surplus of $100,000 and deposits of $1,000,000 contributes $3,000 to the Reserve bank's capital and, on the average, would be required to hold $160,000 on deposit with the Reserve bank as legal reserves, on which it receives no interest. The dividends such a bank would receive on its stock in the Reserve bank would be $160 a year. "The System was established and is operated in the public interest and dominated by public officials; it performs a service that saves the people of the country far more than the cost of the System; and it makes no profit s for any private interest other than the amount paid annually to stockholders at a fixed rate, which has been prescribed and can be changed by Congre ss. "12.122posals would not improve banking system "Proposals in the bill for reorganizing the Reserve System would transfer owners hip of the stock in the Federal Reserve banks to the Government and would have all the directors of the Reserve banks appointed by the President and approved by the Senate. It would enlarge the membership of the Board of Govern ors to fifteen, including three ex-officio members -- the Secretary of the Treasury, the Comptroller of the Currency, and the Chairman of the Federal Deposit Insurance Corporation. 4/8/38 -11- "A Board of Governors of fifteen members proposed in the bill would be too unwieldy to func tion promptly and effectively. The proposal in the bill to offer all the privileges of membership to nonmember banks so long as they choose to keep their reserves in a Federal Rese rve bank would remove all incentive to become members of the System. It would enable all banks to profit by the services of the System so long as it suited them, without cont ributing anything to its strength or complying with its regulations, and to withdraw their reserves when to maintain them woul d seem to be burdensome. It would make futile the proposed enlargem ent of the power to increase reserve requ irements. It would remove all incentive to membership and would make it impossible for the System to discharge its responsi bility for maintaining sound credit conditions. "Dnction between monetary and fiscal authorities shou ld be maintained "The primary function of the Treasury is to coll ect taxes, borrow money, and provide fund for the s various agencies of the Government in accordance with Congress ional appropriations. The primary function of the Federal Reserve System is to influence the flow of mone y and to contribute to the soundness of the banking situation. In a broad sense the objectives of both agen cies are the same, namely, to serve the public interest, but their points of view and experience, and their approach to current prob lems may at times be different. The maintena nce of an organization for the regulation of credit separate from the fiscal arm of the Government has been found advantageous in most coun tries of the world, and its aban donment, which is proposed in the bill, would, in this Board's opinion, be a backward step. "Local autonomy in local matt ers should be preserved "Since its establishment in 1914, the Federal Rese rve System has undergone many changes in the direction of increased control by the Boar d of Governors. With the passage of the Banking Act of 1935 this control has been greatly strengthened in so far as national policies are concerne d. In regard to loca l matters, the maintenance of local autonomy under general supe rvision and close Government regulation is advantageous in a country like the United States, consisting of various regions with diverse economic interests. The maintenance of locally elected directors on Federal Rese rve bank boards is of great advantage in creating local pride and local interest in the System and in inspiring the business community with confidence in its management. This advantage would be lost if the appointments of all local directors were handled enti rely from Washington. Consequently, the System's ability to render a disinterested public 405 4/8/38 -12- "service to all classes of the community would be grea tly diminished. "To gam up, the Board is convinced that improvement in our banking system is needed but sees nothing in this bill that would tend in this direction. The Board is convinced that the main objective of the bill is not practicable; that the evils which the reorganization feat ures of the bill propose to correct do not exist; that the organization which it proposes to establish would resu lt in less satisfactory service to the country; and that enactment of the bill would be a backward and not a forward step in the development of the banking syst em in the public interest." The statement was approved with the understanding that it would be presented by Chairman Eccles at the hearings on the Patman Bill, which he expected to attend on April 12, 1938, as expressing the general position of the Board on the bill. Thereupon the meeting adjourned. Assistant Secretary. Chairman.
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