Full text of Minutes and Recommendations of the Federal Advisory Council : Meeting documents, November 16-17, 1936, Box 2, Volume 1936-1940

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MINUTES OF MEETING
of the
FEDERAL ADVISORY COUNCIL
November 16-17, 1936

M IN U T E S OF M E E T IN G OF T H E FED ER A L ADVISORY COUNCIL
November 16, 1936.
The fourth statutory meeting for 1936 of the Federal Advisory Council was con­
vened in Room 836 of the Mayflower Hotel, Washington, D. C., on Monday, November
16, 1936, at 10:15 A. M ., the President, Mr. Smith, in the Chair.
Present:
M r.
M r.
M r.
M r.
M r.
M r.
M r.
M r.
M r.
M r.
M r.
M r.
M r.

Thomas M . Steele
James H. Perkins
Howard A. Loeb
Arthur E. Braun
Charles M . Gohen
H. Lane Young
Edward E. Brown
Walter W . Smith
Theodore W old
J. J. Thomas (Alternate for Mr. W. T. Kemper)
Joseph H. Frost
M . A. Arnold
Walter Lichtenstein

District No.
District No.
District No.
District No.
District No.
District No.
District No.
District No.
District No.
District No.
District No.
District No.
Secretary

1
2
3
4
5
6
7
8
9
10
11
12

On motion, duly made and seconded, the minutes of the Council meeting of September
9-10, 1936, copies of which had been previously sent to the members, were approved.
It was decided that the Council should discuss first of all the subjects presented by
the Board of Governors of the Federal Reserve System, dealing with Subsections (E)
and (F) of Section 1 of Regulation Q.
M r. Young presented a memorandum on the desirability of the adoption by the
Board of Governors of the Federal Reserve System of a definition of interest in accordance
with Subsection (F) of Section 1 of Regulation Q. This memorandum was accepted and
made a part of the records of the Council.
M r. Young presented a resolution covering Subsection (F). After a lengthy dis­
cussion it was moved and seconded to adopt the resolution which appears as the first
paragraph of Recommendation 2 attached to these minutes. Mr. Loeb asked to be recorded
as voting no, all other members voting in the affirmative.
At 11:30 A. M . Dr. Goldenweiser, Director, Division of Research and Statistics,
appeared before the Federal Advisory Council and discussed the business situation and
also in some detail the recent agreement entered into between this country, Great Britain
and France regarding their respective currencies, etc.
The meeting adjourned at 1:00 P. M . for luncheon at which Chairman Marriner
S. Eccles was present.




1

The meeting reconvened in Room 836 at 3:30 P. M.
The Council discussed the answers to be made to the Board of Governors to the
queries presented to the Council in connection with Subsection (F) of Section 1 of Regu­
lation Q. The answers appear as part of Recommendation 2 which is attached hereto
and made a part o f these minutes.
The Council entered upon a discussion of Subsection (E) of Section 1 of Regulation Q
and voted unanimously to adopt a recommendation to the Board of Governors of the
Federal Reserve System which is attached hereto and made a part of these minutes as
Recommendation 1.
M r. Arnold presented his views on the competition of government lending agencies
in the fanning sections of several of the western states. It was agreed to discuss this
problem with Governor Davis and with Governor W. I. Myers of the Farm Credit
Administration.
A t 4:30 P. M . it was decided to discuss M r. Frost’s memorandum which is attached
to these minutes as part of the records.
After some discussion Mr. Loeb submitted letters of Professor F. Cyril James, of
the University of Pennsylvania, and Mr. Sienkiewicz, of the staff of the Federal Reserve
Bank o f Philadelphia, commenting upon Mr. Frost’s memorandum.
M r. Steele submitted letters from Professor Ray Bert Westerfield, of Yale University,
also commenting on M r. Frost’s memorandum.
M r. Steele desired to be recorded as in general accord with the statement presented
b y M r. Frost, although not in agreement as to all of its details.
It was voted to thank M r. Frost for his work in preparing the memorandum which
was accepted and ordered to be made part of the records of the Council.
It was decided to ask President Smith to inform the Board of Governors that the
Council had discussed inflation and wished to be informed as to the methods which the
Board contemplated employing to check such a movement if this became necessary.
The meeting adjourned at 6:30 P. M .




W A L T E R LIC H TE N STE IN ,
Secretary.

2

M IN U T E S O F JO IN T C O N FER EN C E OF T H E FED ER A L ADVISORY COUNCIL
A ND T H E BOARD OF GOVERNORS OF T H E FED ERA L RESERVE SYSTEM
November 17, 1936
At 10:00 A. M . a joint conference of the Federal Advisory Council and the Board
o f Governors of the Federal Reserve System was held in the Board Room, Washington
Building, Washington, D. C.
Present: Members of the Board of Governors of the Federal Reserve System:
Chairman Marriner S. Eccles; Vice Chairman Ronald Ransom; Governors Joseph
A. Brokerick, Chester C. Davis, John McKee, and M . S. Szymczak; also Messrs. Chester
Morrill, Secretary of the Board; L. P. Bethea and S. A. Carpenter, Assistant Secretaries
of the Board; Lawrence Clayton, Assistant to the Chairman of the Board; Walter Wyatt,
General Counsel for the Board; Dr. E. A. Goldenweiser, Director, Division of Research
and Statistics, Board of Governors; Carl E. Parry, Chief of Division of Bank Loans, Board
o f Governors; Leo H. Paulger, Chief of Division of Examinations, Board of Governors;
George B. Vest, Assistant General Counsel of the Board of Governors; and Elliott Thurs­
ton, Special Assistant to the Chairman of the Board of Governors.
Present: Members of the Federal Advisory Council:
M r. Walter W. Smith, President; Mr. Howard A. Loeb, Vice President; Messrs. T. M .
Steele, J. H. Perkins, A .E . Braun, C .M . Gohen, H. Lane Young, E. E. Brown, Theodore
W old, J. J. Thomas, J. H. Frost, M . A. Arnold, and Walter Lichtenstein, Secretary.
The Secretary of the Federal Advisory Council read the recommendation made by
the Council in respect to Subsection (E) of Section 1 of Regulation Q which is attached
hereto and made a part of these minutes.
Vice Chairman Ransom of the Board of Governors discussed the problems involved
at some length.
The Secretary of the Federal Advisory Council read the recommendation respecting
Subsection (F) of Section 1 of Regulation Q which is attached hereto and made a part
of these minutes as Recommendation 2.
Vice Chairman Ransom discussed this regulation after which a general discussion
took place.
The President of the Council raised the question of inflation and asked what means
could be used to check the drift.
In response to a question of Chairman Eccles as to what the Council recommended,
the President of the Council called on the various members of the Council to state their
views.
After this was done, Chairman Eccles stated that he believed:
(a) This country should not lend money abroad.
(b) Foreign funds should not be accepted in this country.
(c) Foreigners should not be allowed to purchase American securities.
He expounded these theses at some length and upon his request Dr. Goldenweiser
discussed the matter somewhat further.
At twelve o ’clock Governor Myers of the Farm Credit Administration joined the
meeting and discussed the whole problem of rural credits. He left the meeting at 12:45 P. M




3

In answer to a question raised by Governor M cKee several members of the Council
stated that they did not believe that increasing reserve requirements in August had
affected the market price of securities.




The meeting adjourned at 12:50 P. M .
W A LT E R LICH TE N STEIN ,
Secretary.

4

R EC O M M EN D A TIO N S OF T H E F E D E R A L ADVISORY CO U N C IL TO T H E
BOARD OF GOVERNORS OF T H E F E D E R A L R ESER V E SYSTEM
November 17, 1936.
T O P IC N o. 1.

Regarding Subsection (E) of Section 1 o f Regulation Q.

R E C O M M E N D A T IO N : The Federal Advisory Council would prefer that the
regulation governing savings accounts stand as it is now since most American banks
have become adjusted to it. If, however, there is to be a change, the Council prefers that
it be in the direction o f greater liberality, and in that case recommends the adoption o f
the more liberal interpretation omitting, however, the third clause reading as follows:
“ a corporation, association or other organization which is organized and operated
for the mutual benefit of its members and transacts more than half o f its business
with or for its members, and in respect to which d ep osit. . .

T O P IC N o. 2.

Regarding Subsection (F) o f Section 1 of Regulation Q.

R E C O M M E N D A T IO N : The Federal Advisory Council recommends to the Board
of Governors of the Federal Reserve System that it put into effect subsection (F) o f Section
1 o f Regulation Q as proposed by the Board in the memorandum submitted to the Federal
Advisory Council under date of October 27, 1936.
The Federal Advisory Council answering the queries of the Board in its memorandum
of October 27, 1936, addressed to the Council, states the following:
1. If made operative, what effect, if any, would the Board’s definition o f interest
have on:
(a) Membership in the Federal Reserve System?
The Federal Advisory Council is of the opinion there would be no material effect;
there might be a temporary one resulting in the withdrawal o f some banks from the
System but it is the belief of the Council that in the long run the Federal Reserve System
would be strengthened by putting into effect the proposed regulation.
(b) Correspondent bank relationships?
The Federal Advisory Council believes there would be no permanent adverse effect.
2. Assuming for the purpose of the question in this paragraph that the prohibition
against the payment of interest on demand deposits is in the interest o f sound
banking practice, does the Council feel that the Board’s definition o f interest
would effectuate the purposes o f the statutory provision that such interest shall
not be paid, directly or indirectly, by any device whatsoever?
The Federal Advisory Council replies in the affirmative.




3

3. T w o opposing views have been presented to the Board on one question connected
with this definition. It has been stated that making the definition effective will
cause nonmember banks now remitting at par to leave the par list, thus increasing
the cost o f banking service to the public. It has also been stated that it will have
exactly the opposite effect, and that non-par banks would be forced to remit at
par and such banks would be deprived of an important source of revenue. The
views of the Council are asked as to which, if either, of these suggested conse­
quences they would anticipate if the definition were made effective.
T he members o f the Federal Advisory Council are divided in their opinion. Some
members o f the Council believe that the regulation would drive nonmember banks on
to the par list while some are of the contrary opinion.
4. It has come to the attention of the Board that some nonmember banks have
withdrawn or are contemplating withdrawal from the par list in order to obtain
additional revenue from exchange and collection charges. The Board would ap­
preciate the Council’s comments as to the extent to which member banks are
bidding competitively for accounts of banks or others on the basis of the absorp­
tion o f exchange and collection charges and its opinion on the question
whether the making effective of the definition of interest contained in Reg­
ulation Q would correct this situation or whether the Board should take some
additional action.
In a very few of the Federal reserve districts some banks are bidding for accounts
on the basis of absorbing exchange and collection charges; in most of the districts, how­
ever, there is no such competition. The Federal Advisory Council believes the proposed
regulation will put a stop to the practice of competitive bidding for accounts of banks
or others on the basis o f the absorption of exchange and collection charges.




4

The Desirability Tor the Ado tion by the Board
of Governors o f the Federal liecerv© System of
a ±>efin itio . of "Interest* ia accordance with
Regulation
Section 1, Sub-3 ction ?•
Since tiie adoption o f the Backing Act o f 1952 Mwtor banks of the
Federal Seserve System have been prohibited fr o . aying any interest, d ir e c t ly
or in d ir e c t ly , by any d ev ice whatsoever, on any deposit which is payable on
demand (*ec* i l - b , Banking net o f 1J33).

The is due was taen

resented as to

whether the ab sorp tion o f o u t-o f-p o c k e t expenses incurred in the c o lle c t io n
o f non-par ite& s by a bank f o r i t s de positors con stitu ted an in d ir e c t payment
o f in te r e s t which was

roh ib ited*

Although the Banking ^ct o f i 35 contained

no d e fin itio n o f the term " in t e r e s t " , that tern gen era lly s ig n ifie s compensation
>aid by a borro?*er fo r the use o f money (Bouvier*s Law Dictionary)#

Some o f

the *ember Bansa, being o f the opinion that the absorption o f o u t-o f-p o ck e t

expense® incurred in the c o llo c t io n of non-par ite c s constituted an i n d r e c t
pa acnt of interest, discontinued that
Ban*iag

c t o f 1955*

raetiee upon tae effective date o f the

Other ^euber Banks, possibly feeling that a ;ix e u

er-

centa^e on the amount of deposit would have to be paid to constitute interest,
o r that the amount >uid vsould have to be paia direct to the deimsitor, oonti;ue
the practice of absorbing out-of-pocket collection expenses*

It is submitted

that suca absorption is more detrimental to sound bariking ractice ta n the
>ayment to depositors o f interest under a specific contract and that the language
of the Banking Acts o f 1355 and 1956 proh ibits both p ra ctices with respect
to demand deposits*

To i llu s t r a t e , in te re st i s paid a t a s p e c ifie d rate on

co lle cte d balances (c o lle c t e d ba l nces being those remaining a fte r deduction
o f reserves and o<tatanding item s), while exchange that i s absorbed, although
bearing a re la tio n to balances, i s not con trolled completely by the amount o f
the co lle c te d balance, and the

r a c t ic e o f abaorbin*j exchange *<-ay r e s u lt in the

W ^ e u t o f in te re st or consideration at a greater rate than would ord in a rily be



considered good business practice.
As though f o r the express purpose o f remedying th is lack o f uni­
formity o f p r a c t ic e the Ranking Act o f 1936 conferred express authority upon
the Board o f Governors " t o determine what s h a ll be deemed to be a payment o f
in terest" (S e c. 524, BarJdLng Act o f 1335) • Regulation Q, Sec# 1 ( f ) as
origins

ly w ritten i s s u f f ic ie n t ly broad in i t s language to compel a i l Member

Banks to adopt the p r a c tic e o f refu sin g to absorb o u t-o f-p o ck e t c o lle c t io n
expenses.

To f a i l to d efin e in te r e s t under the authority conferred by the

Banking Act o f

1935

i s to p en alise Member Banks which endeavor wholeheartedly

to comoly with the r e s t r ic t io n s inposed in the Banking Acts o f 1955

and 1956*

Failure to adopt the regu la tion s d efin in g in te r e s t to include the absorption
o f o u t-o f-p o ck e t expenses w i l l have the probable e f f e c t o f postponing the date
on which par clearan ce becomes u n iv ersa l.
I t has bean suggested that the postponement o f the e ffe c t iv e date
o f sub-section ( f ) o f Sec. 1 o f Regulation Q was caused by the fa ilu r e o f
F .D .I.C . to adopt a sim ila r regu la tion which would have been a p p lica b le to
insured non-aesber banks*

I t has a lso been stated that F .D .I.C . cor,tended

that i t lacked a u th ority to ado t a regulation as broad in i t s scope as sub­
section ( f ) .

L*et i t be said here that the au th ority o f the Board o f Governors

to determine what s h a ll be deeded a payment o f in te r e s t Is e n tir e ly independent
o f any rat io rity con ferred upon the Board o f D irectors o f F .D .I.C *, and that
t:ie Board o f Governors is vested with authority to a ct whether or not F*D*I*C*
prosaulgates any regu la tion upon the subject*

I t i s submitted, however, that

the authority o f the Board o f D irectors o f F.D.I*C* is s u ffic ie n t to enable I t
to adopt a r#gu in tion id e n tica l in language with the proposed subsection ( f )
o f k c t io a 1 o f Regulation Q, and that even though F .D .I.C . should adopt a




-

5

-

regu lation d i f f e r e n t fr o i that &do;*tsd by the Board of Governors, the
adoption o f iiub-s# e t io a ( f ) by th© iioarsi of Governors would u ltiu u te ly
have the e f f e c t o f causing a l l a o n -a ^ b e r banks to ©ease the p ra ctice o f
absorbing o u t -o f-p o c k e t ex eases involved ia the c o lle c t io n of i teais on
non-par ;joints*
tie w i l l cieal f i r n t with the au th ority o f the Board o f Direc tore
o f F# D. I* C*

Under S ection 101 (v) (y ) o f the Banking Act o f 1351 the

Board o f D irectors o f F«D*I*C* was d ire cte d to ir o h ib it *by regulation * * *
tiie oayiaent o f In te re s t on demand de >osits in in ured non—sioasber bands’* and
fo r juch purposes tiie Board m s given ex ress authority to d efin e the tera
■demand d e p o s it11.

I f Congress had not intended to con fer upon the Board o f

D irectors tne a u th ority to d efin e the term * KV/iaent o f in te re st* i t would not
have d ire c te d the Board o f D irectors o f F. D. X* C. to p ro h ib it b£ regulation
the

a .,ent o f in te r e s t on denand d e c e i t s *

I t ®oald be ne.inhi^Lnss f o r

Con ress to con fer any authority upon the Board o f D irectors in t is res e ct
to

d e s c rib e r e f l a t i o n s i f any regu la tion which th© Board aight adopt could

p ro h ib it no tiling which was not proh ibiten by tne i&ugua^e o f tiie Act i t s e l f .
Hor could Congress have intended that the Boai\i o f D irectors night at i t s
o tion p roh ib it

ayment o f in te r e s t on desjaad d e c e i t s sin ce tne language o f

the Statute s ta tes th at such Board " s n a il by regulation prohibit® such payment
o f in te r e s t.
in

That the Board o f D irectors o f F .D .I.C . construes the Statute

uestion to give i t au th ority to define the tens *in terest* i s evident froa

th eir Regulation 4# su b -section 1 ( f ) , in which is found th is language, "the
tem •interest* includes any a i r r c t or in d ire ct payment by the bunk o f tha
mrch se

r ic e o f

-rraniuus :'ivon to de o s lt o r s o r prospective dep ositors in

connection with obtaining dei^osits*’ .




I f the >urchase

r ic e o f a ;:re iun given

-

4 -

to a new depositor conatitutues & payment of Interest, is it not obvious

that an agreement on the >art of a bank soliciting new deposit accounts to
absorb out-of- ocket expenses in the collection of non-par itests deix>sited
in the account is a ls o a prohibited payaent of interest?
Suppose fo r th s .orient that F*D*I*C* should f a i l to Adopt a re*a»la tio . sim ila r to the

reposed au b-secticu i f ) o f Regulation <**

«hat would

be th® ef fe c t o f tiia auoptioa by the Board o f uovemors of tne Federal
Reserve S y s t e i o f su b -se ctio n ( f ) as o r ig in a lly drawn?

ba&ll insured non-

ee^ber banks in ou tly in g communities which habitu ally c o lle c t e d non-par items
through a ae&ber bank, the la t t e r absorbing o u t -o f -;» c k e t e x p o s e s in con­
nection with the tra n sa ctio n , would fin d themselves faced with the question
o f e ith e r absorbing such expenses themselves o r o f passing the expense on
to th e ir de;x>sltors s in c e the oesiber banks, by regulation woulc have been
prohibited fr o

continuing such absorption#

I t might be argued that the

s o a il non-jae-iiber bunks had in the _*ast been able to absorb such charges
without i l l e ffe c t *

however, in the ^ a jo r i t / o f instances the insured non-

ae ber bank did not i t s e l f absorb such costs, but was able to pass such
charges on to i t s c o lle c t in g bank*

It is f e l t that the increased burden

o f absorption which would be pi eed upon the insured non-ae&ber banks would

be sufficient in nost instances to compel thea to discoatiau® the p ra ctice
of absorbing out-of- socket ex tenses incurred la the colifcctioa of non-par
itc.iS and to

as«» such charges on to their depositors*

It night further be argued tnat the ado tion of sub-section (f)
by the Federal Heserve board and not by P*D*I*C* sdght affect injuriously
a

oecber bank located in a town in which there is found an insured n o n -s e b o r

competing bank, in that depositors of the zae&ber bank would at once transfer
their ccounts to tho non-t&e bcr bank in order to avoid Uie payment of col
lsetion charges*



This action, i f it occurred, would only have the effect of

further reducing the n et warnings o f the aon-iaeaber b&nke o r o f

coei

e llin g

t .e. * to d iscon tin u e the p ra ctice o f absorbing o u t-of-p ock et c o lle c tio n
ex leases*

I f in d iv id u a l de:>o5 it o r s o f in jured noa-eeruber ban s actu ally

f e l t the fin a n c ia l burden in cid en t to the c o lle c t io n o f itezas on non-par
join ts i t would tend towards a wider re cog n ition o f the advantages o f
un iversal .mivclc&rance and the ultiaiate attainment o f that goal*

I t Is respectfully urged that sub-section ( f ) of Section 1 o f
Beguletio

Q by the Board of Governors of the Federal Reserve System should

be &&de of Toll force*




]\Tow t h a t

the n a t io n a l

p a s t , and c o n s i d e r i n g t h e

fa ct,

e le ctio n s

fu rth er,

o f th e F e d e r a l A d v i s o r y C o u n c i l f o r
seem t o be an a p p r o p r i a t e

its

o f November 3 have b e e n

th at t h is

1936 t e r m o f o f f i c e ,

and a d e s i r a b l e t im e f o r

d i s p a s s i o n a t e an d n o n - p a r t i s a n ,

C o u n c il e n t e r t a in s w ith r e s p e c t

o f th e money o r

curren cy

stru ctu re

cre d it i s

fo r

w o u ld

a lth ou g h

S ystem o f t h e

t o th e p re se n t p o s i t i o n

o f t h e n a t i o n , w h i c h s e r v e s a s an

th e p e o p le

o f t h e c o u n t r y and w h ic h f u r ­

f e d e r a l b a n k i n g la w s a s t h e b a s i s u p o n w h i c h a l l b a n k

s u p e rim p o s e d .
T he C o u n c i l b e l i e v e s

p ro b a b ly in d e e d t h e r e

is

to th e B oard c o n c e r n i n g
fo r th e

a c le a r ,

o f the F e d e ra l R eserve

v iew s w h ic h t h e

a c t u a l medium o f e x c h a n g e

it

statem en t by the F e d e r a l A d v is o r y

C o u n c il t o t h e B o a r d o f G o v e r n o r s

ther s e r v e s u n der

i s th e f i n a l m eetin g

fu tu re w ith
In

C ou n cil w i l l

to

make may b e m ore

cle a rly

ap paren t,

co n n e ctio n w it h

le g is la tio n

In th e
bein g a s n e a r l y

firs t

p la ce ,

s a tis fa cto ry

w h ich

is

rency in th e U n ite d
means m oney o f

(o r

a sta b le v a lu e

in

money a s a p p l i e d

used

re fe r to

th e

by A .

co in
its

may b e
b a s ic

have

been

C o u n cil has
of

d e cid e d

as

red eem a b le
w o rld

v a lu e .

p r in cip le s
observed

to

in

S ystem .

accept

as

s o u n d m o n e y a s may b e

B a r to n H epburn i n h i s

o f th e

a d van ta geou s,

F ed era l R eserve

"H is to ry

fo llo w s :
in )

a

th e

of

C ur­

"S o u n d m oney

c o m m o d ity w h ic h h a s

in d e p e n d e n t

m ean s m o n ey w h e r e i n

c o in a g e

it

ce rta in

th e

and w h ich i s

m arkets

reco m m e n d a tio n s w h ic h t h e

seem t o

cre a tin g

u n q u e stio n a b ly

to

th e

a d e fin itio n

S ta te s ,"

th e

e q u a ls




b r ie fly

a sou n d c u r r e n c y w h ich
th e

B o a r d may a d o p t

th ese m atters.
fo r

to

and t h a t

make r e c o m m e n d a t i o n s

th e g e n e r a l p o l i c y w h ich th e

th at

step ,

d e s ira b le ,
to

reasons

w it h r e g a r d t o

the b u l l i o n

is

th e

as a p r e l i m i n a r y

fo u n d t h a t

it

an o b l i g a t i o n upon i t ,

respect

order

th en th a t

of

fia t.

Sound

co m m e rcia l v a lu e

Sound m oney as

a p p lie d

to

of
paper

- 2 or to k e n money o f an y k i n d means t h a t w h ic h i s
wherein t h e c o m m e r c i a l v a l u e

of its

b u llio n

r e d e e m a b le in money

eq u a ls i t s

co in a g e v a l u e . ”

The C o u n c i l b e l i e v e s t h a t t h e r e would be v e r y l i t t l e
l i h o o d o f an y d i s a g r e e m e n t
the s u g g e s t i o n t h a t ,
be d e s i r a b l e

fo r

in

so f a r as i t

o f any s t u d e n t o f money w i t h

is

th e U n ite d S t a t e s and,

c ou n try i n t h e w o r l d ,

to

a d m i t t in g ,

that

o f course,

time a r i s e w h ic h c o u l d
some v a r i a t i o n

on t h e p a r t

operate i t s

lik e ­

re a so n a b ly p r a c t i c a l ,
for

th at m atter,

econom y upon a b a s i s

i t w ou ld

f o r any
o f sound money

c i r c u m s t a n c e s and c o n d i t i o n s may fr o m tim e t o

ju s tify ,

o r i n d e e d make a b s o l u t e l y e s s e n t i a l ,

fr o m s u c h r e q u i r e m e n t ,

but b e a r i n g i n mind a lw a y s t h e

d e s ira b ility o f re v e rtin g ,

a t as e a r l y a d a t e a s i t

w ithou t s e r i o u s d a m a g e

a sou n d money s u c h a s d e s c r i b e d i n t h e d e ­

%

to

may be a c c o m p l i s h e d

fin it io n above.
W it h o u t a t t e m p t i n g t o g o i n t o a l l t h e r e a s o n s t h e r e f o r , we
may f u r t h e r assum e t h a t p r a c t i c a l l y a l l
that g o l d ,

or i t s

e q u iv a le n t,

which most n e a r l y f u l f i l l s
f o r th e U n it e d S t a t e s

is

i n d i s p u t a b l y t h e m a t e r i a l com m odity

the p u rp ose.

or fo r

sound e c o n o m i s t s w i l l a g r e e

In o t h e r w o r d s , an i d e a l money

any c o u n t r y w o u ld be a l l g o l d ,

or pa per

cu r re n cy r e d e e m a b le a t a l l t i m e s i n g o l d and r e p r e s e n t i n g an a c t u a l
h o ld in g b y t h e T r e a s u r y D epartm ent o f a c o r r e s p o n d i n g amount o f g o l d
a v a ila b le

f o r t h e r e d e m p t i o n o f t h e c u r r e n c y , w i t h , h o w e v e r , m a c h in e r y

a v a ila b le t o

fa cilita te

n e c e s s a r y or d e s i r a b l e

on a s a f e b a s i s and w i t h t h e

le a st p o s s ib le

e x p a n s i o n and c o n t r a c t i o n

d istu rb a n ce.

At t h e tim e t h a t t h e F e d e r a l R e s e r v e A c t v/as o r i g i n a l l y
acted i n t o

lav/ i n 1 9 1 3 , t h i s b a s i c

en­

i d e a seems t o have q u i t e d e f i n i t e l y

p r e v a i l e d i n t h e m in d 3 o f C o n g r e s s and a l l t h o s e who p l a y e d any m a t e r i a l
part in b r i n g i n g a b ou t t h e



le g is la tio n .

It

is

tru e,

o f c o u r s e , th at fo r

- 3

p ra ctica l pu rposes

it

is necessary,

-

in o rd er t o f a c i l i t a t e

cash t r a n s ­

a c t io n s o f s m a l l am ounts and f o r t h e p u r p o s e o f making c h a n g e , t o m ain­
tain an a d e q u a t e amount o f s u b s i d i a r y m oney, w i t h w h ic h t h i s
was at t h a t t i m e ,

an d s i n c e

At t h e tim e
fia t

then has c o n tin u o u s ly been , w e ll s u p p lie d .

o f th e passage

o f th e F ed era l R eserve A c t , the

q u a l i t y o f t h e a p p r o x i m a t e l y 340 m i l l i o n s

or g r e e n b a c k s , an d t h e a t

le a st

o f U n it e d S t a t e s n o t e s ,

th e o re tica l d e s ir a b ility

o f e lim in a tin g

them from t h e c u r r e n c y s t r u c t u r e , was g e n e r a l l y r e c o g n i z e d .
other hand,

it

On t h e

was e v i d e n t l y b e l i e v e d t h a t t h i s was n o t a s u f f i c i e n t l y

large amount t o
deem i n g o l d ,

country

endanger the a b i l i t y

it

b ein g

s e n tim e n ta l f e e l i n g
be b e t t e r n o t t o

o f t h e T r e a s u r y Departm ent t o r e ­

f u r t h e r r e c o g n i z e d t h a t t h e r e m ight s t i l l

i n c o n n e c t i o n w i t h t h e g r e e n b a c k s w h ic h i t

d istu rb u n le ss a b s o lu te ly e s s e n tia l*

those r e s p o n s i b l e

fo r

that th e 566 m i l l i o n
tain ed a f i d u c i a r y

be a

w o u ld

U n q u e stio n a b ly ,

t h e F e d e r a l R e s e r v e A c t must a l s o have r e c o g n i z e d
o f s ilv e r

e le m e n t,

in c lu d e d in th e c i r c u l a t i o n

to th e exten t that

it

i n 1913 c o n ­

d id not rep re se n t a

commodity h a v in g a v a l u e i n t h e m a r k e t s o f t h e w o r l d e q u a l t o i t s
v a lu e .

P rob a b ly t h i s

amount was l i k e w i s e c o n s i d e r e d t o be n o t

great m agn itu de t h a t t h e a b i l i t y
and, f u r t h e r ,

it

fa ce

o f su ch

t o redeem i n g o l d w o u ld be e n d a n g e r e d ,

may h a v e b e e n f e a r e d t h a t any a t t e m p t t o e l e i m i n a t e

t h is s i l v e r and s i l v e r

c e r t i f i c a t e s w o u ld have i n v i t e d a s t r e n u o u s o p ­

p o s i t i o n t o t h e w h o le r e f o r m p r o g r a m on t h e p a r t
In a d d i t i o n t o

these

con stitu tin g a p o r t io n o f th e

o f t h e TTs i l v e r b l o c ” .

a b ov e-m en tion ed f i d u c i a r y e le m e n ts,

e n t i r e money s t o c k deemed t o be o f s u f ­

to redeem i n g o l d at a l l t i m e s ,

endanger t h e a b i l i t y

t h e r e w ere in c i r c u l a t i o n

o f the T rea su r
slig h tly

over

?50 m i l l i o n o f N a t i o n a l Bank N o t e s s e c u r e d b y Government b o n d s , w h ic h ,
c o u r s e , do n o t r e p r e s e n t an y com m odity w h a t e v e r .



T h ese n o t e s , how -

► -'j

f i c i e n t l y m o d e r a te v olu m e as n o t t o

- 4

ever, w ere a d d i t i o n a l l y

s e c u r e d by a f i r s t

a s s e ts o f t h e i s s u i n g b a n k s ,
there was no d o u b t
e la sticity ,

o f th e ir

so th at

it

so lv e n cy .

and paramount l i e n

is

on th e

r e a s o n a b l e t o assume t h a t

N e v e rth e le ss,

due t o t h e i r

to th e

d e s ira b ility

in a sm u ch a s a d e f i n i t e

d e v is e d , bu t w h ic h m ethod i t
to d e s c r i b e h e r e .

is

an a c t u a l g o l d b a s i s ,

very l a r g e s c a l e

movements o f g o l d

out

ou r p r e s e n t p u r p o s e s

o f t h e N a t i o n a l Bank N o t e s , t h e

and t h e U n it e d S t a t e s N o t e s , we w e re on
e s s e n tia l fea tu re

- e la sticity .

o f c u r r e n c y on a

was v e r y f r e s h i n t h e m inds o f C o n g r e s s

and o f a l l b a n k e r s a n d m o n e t a r y e x p e r t s ,
wise p r e s e n t t h e r e a l i z a t i o n

form o f

g r a d u a l e l i m i n a t i o n was

o f 1 9 0 7 , when h o a r d in g

took p la ce ,

supply f o r t h e p u r p o s e

its

not n ecessa ry fo r

but w i t h o u t t h a t

The e x p e r i e n c e

o f e lim in a tin g t h is

m ethod f o r

W ith t h e e x c e p t i o n

s i l v e r c o i n and c e r t i f i c a t e s ,

and u n d o u b t e d l y t h e r e was l i k e ­

o f t h e s e a s o n a l s h o r t a g e s i n th e c u r r e n c y

o f m ovin g c r o p s and m e e t i n g sudden o r u n u s u a l
o f the co u n try .

C le a rly ,

it

was d e s i r a b l e t o have

an a u x i l i a r y c u r r e n c y o f an e x t r e m e l y and a u t o m a t i c a l l y e l a s t i c
which w ould s m o o t h l y ,
O bviously,

and w i t h o u t

s u ch an a u x i l i a r y

reason t h a t t h e
su fficie n t

in ­

t h e F e d e r a l R e s e r v e A c t made p e r f e c t l y c l e a r t h e v ie w o f

Congress w i t h r e s p e c t
c u r re n cy ,

-

stra in ,

in cre a s e

n a tu re

t o meet s u c h demands.

c u r r e n c y c o u l d n o t be g o l d ,

f o r t h e s im p le

i n t e r n a t i o n a l movement o f g o l d d o e s n o t t a k e p l a c e w i t h

r a p i d i t y t o meet s u c h r e q u i r e m e n t s , a l t h o u g h ,

run, g o l d w i l l move t o t h e
o f c a r r y i n g on t h e b u s i n e s s

c o u n t r y w here i t

in t h e l o n g

i s n e c e s s a r y f o r the purpose

o f s u ch c o u n t r y , p r o v i d e d t h e r e a r e no

i n t e r f e r e n c e s su ch a s t a r i f f w a l l s ,

em bargoes,

qu ota s,

and s u ch o t h e r

con triv a n ces.
The q u e s t i o n t h e n v/as t o p r o v i d e a m echanism b y w h ic h t h e
currency s u p p ly w o u ld a u t o m a t i c a l l y i n c r e a s e as n e e d e d ,
3ust as a u t o m a t i c a l l y d e c r e a s e when t h e n e e d had p a s s e d ,



but w h ic h w ou ld
so t h a t

it

- 5 would n o t becom e r e d u n d a n t and t h u s b r i n g a b o u t an unsound c r e d i t
pansion and r i s e

in th e p r ic e

le v e l.

The p l a n w orked out v/as as n e a r l y

p e r fe c t as human i n g e n u i t y h a s

ever yet d e v is e d ,

v ic tio n o f th e C o u n c il t h a t

w ill,

it

tion e f f i c i e n t l y and p r o p e r l y a t

and i t

in i t s

a l l tim e s.

th e fir m con
fu n c­

The m ethod o f i n c r e a s i n g
o f member banks i s

o p e r a t i o n , and t h e r e d u c t i o n o f t h e

currency s u p p l y a f t e r

th e need f o r

smooth and a u t o m a t i c ,

p ro v id e d ,

above th e market- r a t e

fo r

fu n d s.

is

under w ise a d m in is t r a t io n ,

the c u r r e n c y s u p p l y b y means o f r e d i s c o u n t i n g a s s e t s
simple, sm ooth an d f a c i l e

ex­

t h e i n c r e a s e has p a s s e d i s

o f course,

ju s t as

th a t the r e d is c o u n t r a te

T he C o u n c i l i s

the g e n e r a l p r a c t i c e u n d e r n o r m a l c o n d i t i o n s

is

o f the o p in io n th at

s h o u l d be t h a t t h e r e d i s ­

count r a t e s h o u l d be s l i g h t l y a b o v e t h e m arket r a t e i n s t e a d o f b e l o w ,
as has been t h e p r a c t i c e
always two f o r c e s

in th e p a s t .

T h e r e w o u ld th e n b e ,

o f course,

o p e r a t i n g u p o n t h e bank s w h ic h w o u ld in d u c e t h e r e ­

duction o f r e d i s c o u n t s an d t h e r e b y t h e r e d u c t i o n
rency ro r e s e r v e s c r e a t e d b y r e d i s c o u n t s
desire on t h e p a r t

o f th e s u p p ly o f c u r ­

- n a m e ly , t h e p e r f e c t l y n a t u r a

o f bankers t o a v o id the co n tin g e n t

lia b ility

of

t h e ir endorsem ent u p on r e d i s c o u n t e d p a p e r , a n d ,

s e c o n d l y , t h e more im­

p e l lin g d e s i r e

to th e F e d e ra l R eserve

t o a v o i d t h e paym ent o f i n t e r e s t

System a t a h i g h e r r a t e t h a n t h e p r e v a i l i n g
of g re a t s i g n i f i c a n c e ,

as in d ic a t in g

of extreme e l a s t i c i t y ,

that

open m arket r a t e .

th e r e a l i z a t i o n

o f th e d e s i r a b i l i t

s o lv e n t

currency,

f o r no

a b so lu te la ck o f e l a s t i c i t y .

The C o u n c i l now d e s i r e s t o d i r e c t
Board t o c e r t a i n

is

C o n g r e s s p r o v i d e d a m ethod f o r t h e e l i m i n a ­

tion o f the N a t i o n a l Bank N o t e s , a p e r f e c t l y
other r e a s o n th a n t h e i r

It

the a t t e n t i o n

o f the

im p o r t a n t a c t i o n s w h ic h have been t a k e n , w i t h c o r r e s ­

pondingly im p o r ta n t r e s u l t s .

The f i r s t

o f t h e s e a c t i v i t i e s w h ich t h e

Council d e s i r e s t o m e n t io n was t h e a c c u m u l a t i o n by t h e F e d e r a l R e s e r v e



- 6 Banks o f Government

o b lig a tio n s

of course,

e i t h e r in the

re su lte d

Federal

R eserve n o t e s

Reserve

Banks t o t h e

among t h e i r a s s e t s .
issu a n ce

or in a d e p o s i t
cre d it

o f an e q u i v a l e n t amount o f

on t h e b o o k s o f th e F e d e r a l

o f th e re se rv e account

The Board d o u b t l e s s v / i l l r e c o g n i z e

T h ese p u r c h a s e s ,

o f t h e member b a n k s.

t h e a n a l o g y w h ic h e x i s t s

Federal R e s e r v e n o t e s and t h e member bank r e s e r v e

d e p o sits,

b e tw e en
sin ce they

either s e r v e a s a medium o f e x c h a n g e i n t h e hands o f t h e p u b l i c
a base upon w h ic h bank c r e d i t
to c r i t i c i s e

the pu rchase

may b e i s s u e d .

nature where s u c h a c t i o n
with m o d e r a t io n ,

seem s t o

ease c o n d it io n s

order to

currency or an e n la r g e m e n t
ments o f t h e moment.
s a l agreement w i t h t h e

o f the

i s used

o f the o p in io n that g rea t

a v o id th e c r e a tio n

by the

o f an em ergen cy

be i m p e r a t i v e and w here i t

but th e C o u n c il i s

should be e x e r c i s e d i n

The C o u n c i l d o e s n o t w is h

o f Governm ent bon ds o r b a n k e r s 1 b i l l s

Federal R e s e rv e S y s te m i n o r d e r t o

o r as

care

o f a r e d u n d a n cy o f

c r e d i t base beyond th e a c t u a l r e q u i r e ­

The C o u n c i l b e l i e v e s t h a t t h e r e v /ou ld be u n i v e r ­
o p in io n th at th ere

is

a t t h i s tim e a s u f f i c i e n t

quantity o f g o l d i n t h e U n i t e d S t a t e s t o

s u p p o r t any c r e d i t

e x p a n s io n

which i s c o n c e i v a b l e a s a d e s i r a b l e

o r ev en a p o s s i b l e

one w i t h i n

any r e a s o n a b le l e n g t h

one,

o f t i m e , w i t h o u t making u s e o f an y o f t h e c r e d i t

base c r e a t e d by t h e h o l d i n g s

o f Government o b l i g a t i o n s b y t h e F e d e r a l

Reserve System .
N ext, th e C o u n c il w ish e s t o d i r e c t th e a t t e n t i o n
to the f u r t h e r im pairm en t
increase o f t h e h o l d i n g s

o f t h e B oarc

o f t h e q u a l i t y o f t h e money s t r u c t u r e b y t h e
of s ilv e r

b y t h e T r e a s u r y D e p a rtm e n t, a g a i n s t

which th e r e a re o u t s t a n d i n g a t t h i s t im e a p p r o x i m a t e l y a b i l l i o n
garter d o lla rs

in s i l v e r

c e rtifica te s .

Council th a t t h e s e c e r t i f i c a t e s
0 1
an o u n c e ,


It

and a

i s t h e u n d e r s t a n d i n g o f th e

are is s u e d a g a in st

v/h erea s t h e p r e s e n t m arket v a l u e

s ilv e r

on t h e b a s i s

of s ilv e r

i s ap~

p r o x im a t e ly 4 4 ^
c e r tific a te
th er,

it

ou n ce,

dependent

s h o u ld

p r e v a ilin g

an

in

above what i t
huge p r o g r a m

of

in

if

s ilv e r

Government p r o m i s e .
(if

of

fo r

It

is

S ta te s

so th a t

a ccu m u la tin g

is

a stock

th ere

is

a very

s i l v e r w h ic h h a s b e e n

c o in e d

been i s s u e d ,

th is

and t h a t

the T r e a s u r y D e p a r t m e n t ,
s ilv e r c e r t i f i c a t e s

at

fo r

is

is s u a n c e

th e r a te

ca rrie d

it

co n s is tin g

a v a ila b le ,

ury D epartm ent h a s n e v e r b e e n c l e a r l y

re v e a le d to

and volum e o f s i l v e r

is

o n e -th ird

th e u n d ersta n d in g

o f s ilv e r
o f the

b u llio n

se n io ra g e

have

d o lla rs

The C o u n c i l i s

b u llio n h e ld

or
not

by t h e T r e a s ­

the p u b li c ,

a p p ro x im a te ly estim a te i t

of

even

fr o m t h e p r i c e

p u r c h a s e s m ade.

a t t e n t io n o f t h e B o a r d i s

th e

Treasury D e p a rtm e n t, w h ic h i s

s ta b iliz a tio n

t h e b a la n c e o f t h e s o - c a l l e d

"g o ld p r o f i t r

o f a l l N a t i o n a l Bank N o t e s , and w h ic h , i t

that t h is fu n d h a s n o t y e t g o n e i n t o

th e

fu n d i n t h e hands o f t h e

stood , amounts now t o a p p r o x im a t e ly tv/o b i l l i o n

that i t i s

on

ce rtifica te s

The n e x t m a t t e r t o w h ic h t h e C o u n c i l w is h e s t o d i r e c t

a fte r th e r e t i r e m e n t

in

at th e d is c r e t io n

an o u n c e .

s ilv e r

to

equal to

i n th e form o f s i l v e r

o f $ 1 .2 9

d o lla r s .

It

is

t h e a c t u a l m oney s t r u c t u r e ,

i s u n der­
tru e
in

in th e h an ds o f t h e T r e a s u r y D epartm ent and n o t y e t a v a i l a b l e




./

out w it h r e g a r d t o

o f s ilv e r

inform ed as t o v/hy t h e am ount o f t h i s

though i t may b e p o s s i b l e

e m b a rk e d on t h e i r

la rg e r p ercen tage

o r a g a i n s t w h ich s i l v e r

b u llio n

co n s id e ra b ly

i n m in d t h a t t h e s i l v e r

l a r g e amount

the hands o f t h e T r e a s u r y D e p a r t m e n t

F ur­

be r e g a r d e d a s d e p e n d e n t u p on

our s o l d h o l d i n g s ) h a v e - o n l y j u s t begun. R a t h e r ,
o f th e C o u n c i l t h a t

s ilv e r

G o v e r n m e n t.

p ro b a b ly

had n ot

be b o r n e

o f C ongress

o f each

o f 4 4 -1 / an o u n c e now

an e v e n

m ig h t p r o p e r l y

s h o u ld a l s o

o f th e

th e p r ic e

silv e r

U n ite d

pu rchases,

t h e m andate

the r e q u i r e m e n t

m in d t h a t

th e

c e rtifica te s

tw o -th ir d s

u p on t h e p r o m is e

w o r ld m a rk ets

w o u ld be

o f th e s i l v e r

p u rch a s e s

s o le ly

be b o r n e

th e

t h u s m a k in g a l m o s t

of

- 8 for use i n m e e t i n g t h e

o p e ra tin g

i s , h ow eve r, a v a i l a b l e

fo r

e x p e n d itu re s

the purpose

o f t h e G overnm ent.

It

o f p u r c h a s i n g Government b o n d s ,

which w ould d e f i n i t e l y p u t t h e w h o le amount i n t o t h e money s t r u c t u r e .
It i s h a r d l y c o n c e i v a b l e t h a t two b i l l i o n

d o lla rs

the hands o f t h e T r e a s u r y D epartm ent w it h o u t
ing the t e m p t a t i o n t o o g r e a t
amount o f money f o r

course,

it

w ill

Assum ing t h a t i t

and r e s e r v e s

the hands o f t h e F e d e r a l R e s e r v e S y s tem .
it

s h o u l d be u s e d f o r

end up i n t h e money s t r u c t u r e , w h i c h ,

i n c l u d e s money i n c i r c u l a t i o n

gold, and sound m oney,

some A d m i n i s t r a t i o n f i n d ­

f o r them t o r e s i s t u s i n g t h i s trem en d ou s

some p u r p o s e .

any pu rpose w h a t e v e r ,

ca n a lw a y s rem ain i n

of

o f member banks i n

Even t h o u g h t h i s w o u ld be

c o u l d be t h e b a s i s

fo r

an i n o r d i n a t e and w i l d

c r e d it i n f l a t i o n .
The C o u n c i l d o e s n o t w is h t o t a k e t h e p o s i t i o n t h a t

every­

thing which h a s b e e n don e i n c o n n e c t i o n w i t h ou r m o n e ta r y a c t i v i t i e s
has been w rong.

On t h e c o n t r a r y ,

passed t h r o u g h an e m e r g e n c y ,

it

d e s i r e s t o r e c o g n i z e t h a t we have

o r s e v e r a l e m e r g e n c i e s , and t h a t t h e

things w hich h a ve b e e n don e h a ve seemed t o t h o s e i n a u t h o r i t y t o be p r o ­
per and n e c e s s a r y .
purpose o f e i t h e r

In o t h e r w o r d s , t h i s
con d em n in g o r p r a i s i n g

s t a t e m e n t i s n o t made f o r
past a c t io n s ,

but p u r e l y f o r

the c o n s i d e r a t i o n o f t h e B o a r d i n c o n n e c t i o n w i t h t h e i r
respect t o f u t u r e p o l i c i e s

a ffe ctin g

In c o n s i d e r i n g t h e f u t u r e
opinion t h a t human n a t u r e ,
2x 4
'<’ i

that a v a i l a b l e

orris, th e b a n k s ,

in i t s

d e c is io n w ith

t h e money and r e s e r v e

stru ctu re.

o u t lo o k , the C o u n cil i s

b a s ic c h a r a c t e r is t ic s ,

c r e d i t w i l l u l t i m a t e l y be pu t t o u s e .
w ith r e t u r n i n g

co n fid e n ce ,

o f the

has not

change i

In o t h e r ' ,

w i l l be w i l l i n g

t o in cre a s-

th eir lo a n s and d e p o s i t s t o t h e u l t i m a t e amount l e g a l l y p o s s i b l e
any giv en c r e d i t

th e

on

b a s e , and t h e b u s i n e s s men and p u b l i c g e n e r a l l y , w i t h


returning c o n f i d e n c e ,


v / i l l a v a i l th em selv es o f the d i s p o s i t i o n

of

-9tanlcers t o e x t e n d c r e d i t ,
^e0t that a ba n k c r e d i t

so t h a t ,

i n t h e e n d , we can r e a s o n a b l y e x -

or bank d e p o s it

£

s t r u c t u r e w i l l be b u i l t up t o

tiie l e g a l l i m i t .
In s u p p o r t
,al l the a t t e n t i o n
taken p l a c e

o f th is

a ssu m p tio n ,

o f th e Board t o

in t h e bank c r e d i t

from g o ld i m p o r t s a n d s i l v e r
siaSj^governmental d e f i c i t s
On June 30,

1933,

tota l

to 9 5 7 , 9 9 8 , 0 0 0 , 0 0 0 . 0 0 ,

some d e g r e e

fro m o t h e r l o a n s and i n v e s t m e n t s .

a n d on June 3 0 ,

that

to

o t h e r th a n i n t e r b a n k d e p o s i t s amounted

an in cr e a s e o f $ 1 3 , 3 3 7 , 0 0 0 , 0 0 0 . 0 0

the C oun cil b e l i e v e s

r e su ltin g

p u r c h a s e s b u t p r e p o n d e r a n t l y from f i n a n -

an d a l s o

in

m ight be w o r th w h i l e t o

t h e g r e a t e x p a n s i o n w h ic h has a l r e a d y

stru ctu re,

d e p o sits

plete c o n f i d e n c e was n o t

it

or 35$.

ev id e n ce

th e

1936,

t h e y w ere $ 5 1 , 3 3 5 , 0 0 0 , 0 0 0 ,

B e a r i n g i n mind t h a t com­

t h r o u g h o u t t h e w h ole o f th e p e r i o d ,

te n d e n cy t o put a v a i l a b l e

cre d it

t o work

is c l e a r l y e v i d e n t .
A s s u m in g ,
available c r e d i t

th en ,

the

correctn ess

w i l l u l t i m a t e l y be u s e d ,

o f th e

s ta te m e n t t h a t

t h e C o u n c i l w is h e s t o p o i n t

out to the B o a r d t h e a p p r o x i m a t e p o s i t i o n

o f t h e b a n k in g and r e s e r v e
*

structure w h ic h c o u l d c o n c e i v a b l y r e s u l t .

On June 3 0 ,

19 2 0 ,

deposits o f member b a n k s w e r e $ 1 , 8 3 9 , 0 0 0 , 0 0 0 . 0 0 and d e p o s i t s
than in te r b a n k o f a l l b a n k s we r e § 3 7 , 7 2 1 , 0 0 0 , 0 0 0 . 0 0 a r a t i o
On December 3 1 ,

1923,

*542,163,000,000.00,

a r a tio

o f 22 t o

On D ecem b er 3 1 ,

clearly d e m o n s tra te t h e

fa ct

Member ba n k s



to

tota l

On December 3 1 ,

o f 20 to 1 .

1928,

1926,

§ 5 0 * 1 - 5 5 ,0 0 0 ,0 0 0 . 0 0 ,

a r a tio

o f 2 3 .5 to

o f d e p o sits

reserves

re­
a ra tio

r e s e r v e s were $ 2 , 4 0 9 , 0 0 0 , 0 0 0 . 0 0
1.

T h ese f i g u r e s

t h a t u n d e r n orm al c o n d i t i o n s

suppose a r a t i o

R erbank d e p o s it s ,

1.

and d e p o s i t s

*£4 d e p o s i t s £ 5 6 , 7 6 6 , 0 0 0 , 0 0 0 . 0 0 ,

R ea son a b le to

oth er

r e s e r v e s w e re § 1 , 9 0 0 , 0 0 0 , 0 0 0 . 0 0 and d e p o s i t s

serves were § 2 , 2 1 0 , 0 0 0 , 0 0 0 . 0 0
°? 22.7 t o 1 .

reserve

o f a l l banks,

it

i s not

e x clu d in g

o f member banks o f a t l e a s t

now h a ve t o t a l r e s e r v e s

o f $ 6 ,7 5 0 ,0 0 0 ,0 0 0 .0 0 .

20

Assuming no l o s s

or g a in

o f g o ld ,

of $1,£ 5 0 ,0 0 0 ,000,00

tifica te s

Congress i s

ca rrie d

the s t a b i l i z a t i o n

o u t),

an i n c r e a s e

o f s ilv e r

( t h e minimum i f

and an i n c r e a s e

d o lla rs

or c e r ­

t h e p u r c h a s e mandate o f

of $2,000,000,000,00

from

f u n d , member banks w o u ld have $ 1 0 , 0 0 0 , 0 0 0 , 0 0 0 . 0 0

r e s e r v e s up on w h ic h a d e p o s i t
$ 2 0 0 , 0 0 0 , 0 0 0 , 0 0 0 .0 0 ,

stru ctu re

co u ld r e s u lt *

o f a l l b a n k s , am ounting t o

Even i f

t h e B oard o f G o v e r n o r s o f

the F e d e r a l R e s e r v e S yste m s h o u l d i n c r e a s e r e s e r v e r e q u i r e m e n t s t o t h e
maximum p e r m i t t e d b y la w , t o t a l d e p o s i t s
The f i r s t

fig u re

i s n e a r ly fo u r tim e s,

dou ble, t h e p r e s e n t
that a v a i l a b l e

d e p o sit

stru ctu re;

co u ld go t o

$ 1 0 0 , 0 0 0 , 0 0 0 , 0 0 0 .0 0

and t h e s e c o n d f i g u r e n e a r l y
b u t , a s s u m in g , as we h a ve d o n e ,

c r e d i t w i l l u l t i m a t e l y be u s e d , t h a t t h e T r e a s u r y D e p a r t ­

ment w i l l p e r f o r m t h e mandate o f C o n g r e s s w i t h r e s p e c t t o s i l v e r ,

and

that some A d m i n i s t r a t i o n w i l l make u s e o f t h e $ 2 , 0 0 0 , 0 0 0 , 0 0 0 . 0 0 o f
gold l y i n g u n u s e d i n t h e T r e a s u r y , n o t h i n g l e s s w i l l r e s u l t .
case, i t

is

d iffic u lt

to

im a g in e t h e

exten t

o f the r i s e

in the p r i c e

l e v e l , t h e e x t r e m e l y s p e c u l a t i v e a c t i v i t y w h ic h w i l l p r e v a i l ,
d i f f i c u l t y w h ic h t h e w a g e - e a r n e r w i l l h a ve i n s e e i n g t o
come w i l l i n c r e a s e w i t h s u f f i c i e n t
anything l i k e h i s p r e s e n t
it a l l ,

a f t e r the c r e d it

the c u r r e n c y s t r u c t u r e
element i n c l u d e d

in th e

ra p id ity to

sta n d ard o f l i v i n g .

In su ch

it

the

that h is in ­

e n a b le him t o m a in t a in
And t h e n ,

at t h e end o f

i n f l a t i o n h a s t a k e n p l a c e and a new f e a r

of

s h o u l d d e v e l o p , w i t h t h e tre m e n d ou s f i d u c i a r y
s ilv e r d o lla rs

and s i l v e r c e r t i f i c a t e s ,

e q u a lly tre m e n d o u s g o v e r n m e n t b o n d - h o l d i n g s

and t h e

o f th e F e d e ra l R eserve

System, what p o s s i b l e m eth od c a n be t a k e n t o

s u c c e s s f u l l y cope w ith the

s it u a t io n ?
The C o u n c i l h a s a t t e m p t e d t o d e p i c t ab ov e t h e p o s s i b i l i t i e s
inherent i n a p o l i c y

o f lib e r a l cre d it

and lo w r a t e s w it h o u t r e g a r d t o

the r i s k s i n v o l v e d i n b u i l d i n g bank c r e d i t
sound b a 3 e .

The C o u n c i l h a s no v o t e




on a n y t h in g o t h e r th a n a

o f d i s a p p r o v a l f o r a p o l i c y o f lo w

- 11 in t e r e s t

rates

and p r o v i d e d ,

or

lib e ra l

fu rth e r,

such & r a p i d r a t e

Board w h i c h ,

if

bank c r e d i t

o f a ll

th e

it

above,

to

cre d it

soever c u r b o r i n t e r f e r e
it

w ith

or

to

it

in the c r e d i t b a s e

stress

or

in

sound

in d u c e d

the p r i c e

m ovem ent t o

e s s e n tia lly

or

causes

built a bank d e p o s i t

(2 )

o p in io n t h a t ,
stru ctu re

P a r tia lly f o l l o w i n g i t s

r e co m m e n d a tio n s t o

th e

w ill

ten d to

in

that

a v o id

any d e g r e e w h at­

it

does not

In

deem

c o u ld c o n c e iv a b ly

co n d itio n *

the C o u n cil to

be a l l

o f e lim in a tin g

a ba n k d e p o s i t

th ree

T h is v e r y

e li m in a t e unsound e le m e n ts

or n e c e s s it y

the
them

stru ctu re

im p o s e d

The r e c o m m e n d a t io n s

elem e n ts

in fla tio n a r y .

of the F e d e r a l R e s e r v e S y s t e m .
o f the

to

its

such a c t io n

reduce

ca n be d a n g e r o u s ,

the C o u n cil w i l l be w i t h r e s p e c t

th at

c o n n e c t io n w ith any o f i t s

upon them s h o u l d becom e an a c c o m p l i s h e d f a c t .

o f the

cre d it

base,

( 1 ) G overnm ent b o n d - h o l d i n g s

S ilv e r.

(3 )

if

s h o u l d be p e r m i t t e d t o

th ere

of

S ta b iliz a tio n

fu n d .

t o t h e u l t i m a t e amount w i t h o u t a t

be

le a st

r e c o m m e n d a tio n s w i t h r e g a r d t o t h e s e t h r e e

^ems, v/e may l o o k i n t o t h e

fu tu re,

p o s s ib ly ra th er d ista n t

bu t p o s s i b l y

not so fa r away, t o a tim e v/hen v/e c a n e x p e c t an e c o n o m ic c o l l a p s e
//r‘ich cou ld be i n c o n c e i v a b l e



is

e x p a n s io n and r e c o v e r y .

even c h a o t ic

in a g r a d u a l and a p p r o p r i a t e way b e f o r e

The C oun cil i s

in

C ou n cil b e lie v e s

the p o in t

that

more im p r e s s e d w i t h t h e d e s i r a b i l i t y

each o f v/hich i s

base

be n o t

ris e

sh o u ld n o t

sound c r e d i t

re a liz e s

create an e x t r e m e l y d i s t u r b e d
fa c t , t h a t a d e f i n i t e

but

sudden a c t i o n

s in ce

th e

d iscre tio n ,

in fla tio n

w ish e s

ad visa b le a d r a s t i c
recom m endations,

e x p a n sio n

make d e f i n i t e

fo llo w e d w ith w ise

p la ce ,

th e u n d e rly in g

an u n s o u n d a n d s p e c u l a t i v e

re q u ire

dangerous o r w i l d

the f i r s t

th e

p ro v id e d

co n co m ita n t.

In v i e w
statu tory d u t i e s

th at

th at

le v e l i s a n a t u r a l

cre d it,

in i t s

d e v a sta tio n .

at

- 12 Government b o n g - h o l d i n g s .
The C o u n c i l b e l i e v e s t h a t

t h e s e s h o u ld be r e d u c e d t o an

amount n ot more th a n $ 4 0 0 , 0 0 0 , 0 0 0 * 0 0 b y g r a d u a l s a l e
to be p a id as t h e y m a tu re w i t h o u t
should ad opt s u ch a p o l i c y ,
caution t h a t no s e r i o u s

it

o r p e r m i t t i n g them

r e p l a c i n g by p u rc h a s e .

I f th e B oard'

c o u l d be done g r a d u a l l y and w i t h sueh

d islo ca tio n

ing th e s e h o l d i n g s by tw o b i l l i o n

s h o u ld r e s u l t .

d o lla rs ,

Even a f t e r r e d u c ­

some e x c e s s r e s e r v e s w o u ld

remain w it h o u t t h e a c c u m u l a t i o n o f any r e d i s c o u n t s fr o m member b a n k s .
S ilv e r
The p u r c h a s e s o f s i l v e r

s h o u l d be d i s c o n t i n u e d e n t i r e l y ,

which cause no d e c r e a s e w h a t e v e r i n t h e money s t o c k o r c r e d i t
a d d itio n , h o w e v e r , t h e s i l v e r
the emergency p u r c h a s e

c e rtifica te s

base.

o u t s t a n d i n g as a r e s u l t

In
of

s h o u l d g r a d u a l l y be r e t i r e d and t h e c o r r e s p o n d ­

ing s i l v e r be s o l d i n t h e m a r k e t s o f t h e w o r l d .
could not be done p r e c i p i t a t e l y ,
might be n e c e s s a r y t o a v o i d

bu t

T h i s s h o u l d n o t and

s h o u l d be done a s g r a d u a l l y a s

s e r i o u s d i s t u r b a n c e and s h o c k .

Even com­

p le tio n o f t h e o p e r a t i o n w o u ld l e a v e some $ 6 0 0 , 0 0 0 , 0 0 0 . 0 0 o f s i l v e r
d olla rs and c e r t i f i c a t e s

i n t h e money s t r u c t u r e

e x clu siv e

o f su b sid ia ry

coin.
S ta b iliz a tio n

Fund

R e a l i z i n g t h e p r a c t i c a l c e r t a i n t y t h a t two b i l l i o n
in g o ld cann ot p e r m a n e n t l y b e l o c k e d up i n t h e v a u l t s
and b e l i e v i n g t h a t an i n j e c t i o n

d o lla rs

o f the T rea su ry,

o f s u c h an amount o f a d d i t i o n a l money

into the c r e d i t b a s e w o u ld p r o d u c e a v e r y d a n g e r o u s and extrem e c r e d i t
in fla tio n ,

even t h o u g h b a s e d on g o l d , t h e C o u n c i l b e l i e v e s t h a t i t

^onld be in e v e r y way d e s i r a b l e t o r e v a l u e u p w a r d ly t h e g o l d c o n t e n t
the d o l l a r t o

s u c h an e x t e n t t h a t t h e e n t i r e

sta b iliz a tio n

Y;oiil(i be a b s o r b e d i n t o t h e money s t r u c t u r e w it h o u t i n c r e a s i n g

fu nd
or de­

c e a s i n g th e volum e o f t h e money s t r u c t u r e as e x p r e s s e d i n d o l l a r s .




-

IS

-

Such a c t i o n w o u ld be i n n o way d e f l a t i o n a r y o r i n f l a t i o n a r y ,
eliminate a p o t e n t i a l
country w ith a g o l d

source

stock

o f cre d it

I n f l a t i o n and i t w ou ld l e a v e th e

o f n in e b i l l i o n

increase or d e c r e a s e t h e p r e s e n t c r e d i t
A ssum ing t h a t
time a l l be s u c c e s s f u l l y

th ese th ree

base.

c o m p l e t e d , t h e member bank r e s e r v e s w o u ld be

two b i l l i o n

secon d ,

and n o t h i n g a t a l l b y t h e t h i r d .

d o lla rs

by the

of member banks a m o u n tin g t o

b i lli o n d o l l a r s ,

d o l l a r s b u t w o u ld n e i t h e r

recommended o p e r a t i o n s c o u l d i n

redu ced

a deposit s t r u c t u r e

but w o u ld

firs t,

fo u r b i l l i o n

s e v e n h u n d red m i l l i o n b y t h e
T h e r e w o u ld rem ain r e s e r v e s
d o lla rs ,

enough t o

support

o f a l l b a n k s i n t h e amount o f more th a n e i g h t y

o r an i n c r e a s e

o f tw e n ty -fiv e

b illio n

d o lla rs ,

n ea rly

50$ above th e p r e s e n t v o l u m e , w h ic h i s now a p p r o x i m a t e l y t h e maximum
for a l l tim e i n t h e p a s t .

I t w o u ld seem t h a t t h i s w o u ld be more th a n

enough r e s e r v e s t r u c t u r e t o

s u p p o r t any d e s i r a b l e

Farther, i t

i n mind t h a t t h e b a s e w i l l be a c o m p a r a t i v e ­

sh o u ld be b o rn e

ly sound b a se c o n t a i n i n g

cre d it

e x p a n sio n .

o n l y a r e a s o n a b l y m o d e r a t e amount o f G o v e r n ­

ment bonds, g r e e n b a c k s and s i l v e r ,

so t h a t i f we s h o u l d have s u c h c r e d i t

expansion as c o u l d b e s u p p o r t e d u p on i t ,

then,

i f th e b a la n ce o f i n ­

tern ational paym en ts s h o u l d t u r n a g a i n s t t h e U n it e d S t a t e s ,
sold e x p o r t s and t h u s m aking n e c e s s a r y a r e d u c t i o n

ca u sin g

o f o u t s t a n d i n g bank

credit, the b low c o u l d b e c u s h i o n e d b y l i b e r a l r e d i s c o u n t p r i v i l e g e s
teing extended b y t h e F e d e r a l R e s e r v e System - o r ev e n a r e p u r c h a s e
-

oh amount o f Governm ent

o b l i g a t i o n s as m ight seem t o be e s s e n t i a l .

How as t o t h e means a v a i l a b l e t o t h e Board f o r b r i n g i n g
&bout f a v o r a b l e a c t i o n upon t h e re co m m e n d a tio n s o f t h e C o u n c i l .
-oarfi. a lr e a d y has c o m p l e t e a u t h o r i t y t o a c t upon t h e f i r s t

recom m enda-

tj^ n , c o n c e r n in g t h e h o l d i n g s

o f Government

Council r e a l i z a e s t h a t a c t i o n

on t h e s e c o n d and t h i r d r e c o m m e n d a t io n s ,




o b lig a tio n s ,

The

but th e

I
- 14 (jonceiTJa^g s i l v e r a n d t h e

s ta b iliz a tio n

brought ab ou t b y l e g i s l a t i v e

a c tio n

fu n d , r e s p e c t i v e l y , ca n o n ly be

o f C on gress.

The f i r s t

tion t h e r e f o r e n e e d s no f u r t h e r comment fr o m t h e C o u n c il.,
to repeat t h a t a c t i o n

recom m enda­

o t h e r th a n

s h o u l d b e t a k e n w i t h g r e a t c a r e and t h a t t h e

prooess s h o u ld b e g r a d u a l .

E ven t h o u g h a c t i o n

on t h e s e c o n d and t h i r d

recommendations c a n o n l y b e t h r o u g h t h e medium o f c o n g r e s s i o n a l l e g i s l a ­
tion, the C o u n c i l d e s i r e s t o

c a l l the a t t e n t io n

o f t h e B oard t o

fact th at t h e s o u n d n e s s o f t h e c u r r e n c y and r e s e r v e s t r u c t u r e

th e

o f the

nation may becom e o f pa ra m ou n t im p o r t a n c e i n c o n n e c t i o n w i t h p r e s e r v ­
ing the s a f e t y o f t h e s a v i n g s o f t h e p e o p l e

t

and t h e C o u n c i l b e l i e v e s

that i t i s t h e d u t y o f t h e B o a r d t o g i v e c o n s i d e r a t i o n t o a n y m a t t e r s
which may h a ve an e f f e c t

thereupon .

The C o u n c i l i s

o f t h e o p i n i o n t h a t t h e r e s h o u l d a lw a y s be

the c l o s e s t r e l a t i o n s h i p an d t h e f u l l e s t

c o - o p e r a t i o n b e tw e e n t h e

Board o f G o v e r n o r s o f t h e F e d e r a l R e s e r v e S ystem and t h e U n i t e d S t a t e s
Treasury D e p a rtm e n t, an d i t

b e l i e v e s t h a t t h e B oard o f G o v e r n o r s i n

their r e l a t i o n s w i t h t h e T r e a s u r y D epartm ent s h o u l d , i n w h a t e v e r way
nay seem a p p r o p r i a t e t o t h e m , g i v e t h e b e n e f i t
Department, a s w e l l a s i n q u i r e

o f t h e i r v ie w s t o t h a t

in t o th e v ie w s o f the T re a su ry D epart­

ment upon su ch i m p o r t a n t s u b j e c t s a s t h o s e m e n t io n e d a b o v e .
Treasury Departm ent i n t u r n ,

The

o r e v e n i n c o n j u n c t i o n w i t h t h e B oard o f

Governors o f t h e F e d e r a l R e s e r v e S y s te m , i n t h e o p i n i o n o f t h e C o u n c i l ,
may with e n t i r e p r o p r i e t y make r e p r e s e n t a t i o n s t o t h e a p p r o p r i a t e
committees o f C o n g r e s s , w i t h a v i e w t o
priate t o sound and d e s i r a b l e
The e s s e n c e

e ffe ctin g

le g is la t io n appro­

en ds.

o f t h e th o u g h t w h ich t h e C o u n c il w is h e s t o c o n -

?ey to the B oard i s t h a t t h e B oa rd s h o u ld w ork t o t h e end o f a c c o m p lis h -




-15 i n

g

so much o f t h e

may be p o s s i b l e ,

o b je c tiv e s

em b o d ie d i n t h e s e r e com m en d a tion s as

and t h e C o u n c i l s u g g e s t s c o l l a b o r a t i o n w i t h t h e

Treasury D epartm ent a s t h e most n a t u r a l and f e a s i b l e p r o c e d u r e .

The

C ou n cil, h o w e v e r , b e l i e v e s t h a t t h e r e d u c t i o n o f t h e c r e d i t b a s e i n ­
volved i n t h e g r a d u a l d i s p o s i t i o n
the System i s

o f Government o b l i g a t i o n s h e l d by

o f pa ra m ou n t i m p o r t a n c e , a n d , w h i l e a t a l l t im e s c l o s e

c o - o p e r a t i o n w i t h t h e T r e a s u r y d e p a r tm e n t s h o u l d be m a i n t a i n e d , t h e
Board ca n n ot a f f o r d t o

f a i l t o take

should be n e c e s s a r y t o

do s o i n o r d e r t o p r e s e r v e t h e s a f e t y o f t h e

money and b a n k in g s t r u c t u r e .




sound,

in d e p e n d e n t m easure i f

it

Ray Sert Westerfield
professor of P o l i t i c a l Economy

jfoven, Connecticut,
November 10, 1956

Yale U n iversity

fcr. Thomas

tt. Steele,

President,

The F ir s t N a tio n a l Bank & T ru s t C o . ,
jjew mven, C o n n e c t ic u t .
Dear Tom:
I have gone o v e r th e F r o s t m a n u scrip t and w i l l comment p a r a era?h by paragraph r a t h e r than a tte m p t a com plete re sta te m e n t o f th e p r o u n c e nent. I t i s , as I s a i d i n
e a r l i e r l e t t e r , an ad m irable sta tem en t which I
could scarcely improve upon.
m

y

Page 2 . P ar. 2 : I r e p e a t my statem ent o f th e f a c t th a t F r o s t
masses from Hepburn’ s d e f i n i t i o n o f "sound money" i n t h i s paragraph. Hepburn
7-as content th at th e "paper money" o r "token money 11 was
i f i t was "redeem­
able in money " h e r e in the com m ercial va lu e o f i t s b u l l i o n equals i t s co in a g e v a lu e "
but Frost in t e r p r e t s t h i s t o mean "pap er curren cy redeemable a t a l l tim es in
and representing .an .actual h o ld in g by" t h e
..
t o f a. c o r resp ondi ng
--Q-int o f gold a v a i l a b l e f o r the redem ption .of the c u r r e n c y . Now t h i s
portion is in a d d it io n t o the Hepburn d e f i n i t i o n , and means th a t o n ly " g o ld c e r t i ­
ficates" are sound. I do n o t b e l i e v e th a t Hepburn meant that l i m i t a t i o n ; he d id
not say so; he d id n o t say th a t he wanted 1 0 0 $ r e s e r v e a g a in st a l l paper money.
All he 7/anted, and a l l th a t was o r i s n ecessa ry i s th a t a r e s e r v e s u r e ly s u f­
ficient to provide f o r redemption in g o ld be k e p t . The very f e d e r a l r e s e r v e n o te s
which the new Federal Reserve A ct p ro v id e d f o r 7/ere t o be p r o t e c t e d , n o t by
reserve, but 4C$ in ordin ary tim e s, l e s s in em ergencies.
s o u

n

d

g

T

r e a

s u

r y

V

e

m

r

i n

e

o

l d

n

u

n

d

e r

s c

o

lQ

O

fo

r e

Page 5. Par. 1 : I repeat my statement that the
the
elimination of the greenbacks was, n o t th at they d id n o t have
reserve,
but that they were e l a s t i c and th a t they
promises o f the Government,
the government in to the p o s i t i o n of banker and r e q u ir in g the Treasury to
then and thus u p s e ttin g the regimen o f treasu ry a d m in istra tion and threatenin g
the government c r e d i t . I t v/as d e s ir a b le to s h i f t the n o t e -is s u e fu n c t io n to a
central bank, and to provide f o r the ready expansion o r c o n tra ctio n accord in g to
business need.
IQ

w

O

jo

g

r

e a

o

l d

s o

e r e

n

f o

p

u

r e d

r

t t i n

g

e e m

The Federal Reserve Act did intimate how the framers expected
the greenbacks would be eliminated from the money o f the country, f o r it
that the Secretary of the Treasury might use the government's share o f the p r o f i t s
of tr^e Federal Reserve banks to pay o f f the greenbacks.
p

r o

v

i d

e d

The criticism of the silver certificates was quite like that of
the greenbacks. The government's promise to redeem v/as in this case written on a
'iece of silver (weighing 571.25 grains pure silver) or on a piece of paper (a
silver certificate having 100 $ silver reserve and circulating instead of the s ilv e r
dollar). The silver dollars and certificates (taken together) were a fixed amount,
coinage of the silver dollar had stopped in 1893. The Gold Standard Act of 1900
r*d required the Secretary of the Treasury to maintain all money at par one with
Mother; and while no method of accomplishing this duty, it was assumed that the




d

would stand ready to redeem all silver dollars in gold upon demand;
jji other words, that the gold reserve of the Treasury was also to support the
silver currency, along with the greenbacks. This also put the Treasury in the
position of banker, and it was generally regarded as desirable to substitute
federal reserve notes for the silver currency, that is, shift the note issue
function to the central bank* But this measure was not taken in the Federal
R e s e r v e Act for the reasons, among others, cited in the paragraph.
S ecretary

Page 5. Par. 2 The criticism of the national bank notes was
not that they did "not represent any commodity i7hatever", but that there was no
.-old reserve kept against them for conversion purposes and that they were almost
fixed in quantity and did not vary with the needs of business.
Page 4* Par* 1* last sentence - The existence of the national
bank notes, the silver coin and certificates, and the greenbacks did not in any
uroper sense keep us off "an actual gold basis". That is not an element of
being "on a gold basis". So long as all moneys were in law and fact redeemable
in gold we were on a gold basis. To be on a gold basis requires that the monetary
standard unit be defined in terms of a weight of gold, that there be free coinage
of gold, that there be maintained a redemption of all moneys in gold, and that
2 old be freely exported and imported, hoarded and dehoarded, and used in the
industrial arts.
Page 4 . Par. 2 - Besides the slowness of "international move­
ment of gold" are the slow changes in gold production, in gold consumption in the
arts, and in the conversion of bullion to coin and of coin to bullion. Moreover,
since the amount of gold money is the resultant of so many factors, independently
determined, it would be more or less fortuitous if the monetary demand for gold
was answered always by an equal supply of monetary gold. These are the factors
that prevent gold from answering well the requirement of being "elastic".
There could be no certainty that each country would even in
the long ran have the amount of gold "necessary for the purpose of carrying on
the business of such country"* For instance, nevr countries were chronically
cr/ing for more gold ; their adverse balances of payments made it almost impossible
to maintain a gold reserve; they lived beyond their means and v/ere borrowing
from the older countries, and gold left quite as soon as it arrived.
Page 5. Par. 1 - I previously called attention to the fact
that the scheme of regulating the volume of federal reserve notes through redis­
counting of commercial paper was not allowed to work long in a way untrammeled
by the direct issue of federal reserve notes for gold and by the use of paper
collateraled by government bonds and by the use of non—liquid (so-called) com—
nercial paper. Except for the seasonal variation, there is no consistent and
dependable relation between the volume of federal reserve notes and the volume
of rediscounting. The volume is highly variable, but the variation is not always
in the direction of business activity. Furthermore, there is nothing sure in the
capacity of rediscounting to check a business boom; for as the price level rises
the face value of the volume of commercial paper can be pyramided.
The whole purport of iny comments on page 5 of the Frost MSS
i- that it pictures the federal reserve note and rediscounting as more perfect
instruments than they are or have been in actual fact. Maybe the language might
*ell be tempered to avoid criticism.




Page 9. Line 7.

5

-

Typographical error: ’
’
financing", not "financial1*.

Page 11« line 8 from bottom and page 1 2 . — Title to first section*
Should say bond-holdin^s of the federal reserve banks» rather than of the federal
reserve system. The system includes the holdings of the member banks, (also on
page 15).
I believe it would be wise to make some pronouncement on
the desirability of the member banks gradually eliminating a considerable portion
of their government securities; or at least of not piling up further purchases.

There are split infinitives on pages 1,7,10, and maybe others.
Maybe Frost will want to eliminate these in the final draft.
I have no particular criticisms of the latter part of the -IS.
I still think the Council should add to their statement their position on Inter­
national Stabilization of the Currency, on the Gold Bullion Standard as against the
Gold Coin Standard, on the present scheme of having gold certificates rather than
gold the reserve of the federal reserve banks, on the matter of currency management
through open-market-gold-purch3.se or through other methods advocated by monetary
experimenters. A strong declaration against management, manipulation, experimenta­
tion, etc. might be helpful in obviating such experiences.




Sincerely yours,
(Signed)

Ray

&o P I
New Haven, Connecticut,
November 11, 1936

Ray Bert Yesterfield
professor of Political Economy
Yale University

"r. Thomas M. Steele, President,
The First National Bank & Trust Co*,
New Haven, Conn.
Dear Tom:
I just reread the Frost MSS and have a few more sug­
gestions, some awfully minute:




Page 6 line 10
Line 21

Federal reserve banks, not system
Ditto

Page 7 line 6

Its instead of their

Page 8 line 1

The present situation is that $200,000,000
only are set aside for the purchase of ex­
change, gold, and government bonds. Of
course, the government might jump this to
$2,000,000,000 at its discretion.

"

,1 line 6

Page 10 line 6

for it rather than for them
This calculation does not keep in mind that
reserves required are not the same as former­
ly. They have recently been jumped a half
above what they were bet7/een 1920 and 1928.
Neither the $200,000,000,000 nor the
$100,000,000,000 is correct therefore.
The figure $80,000,000,000 on page 12 line 10
should also be restated for same reason.

page 13 line 7

from botton.
system.

Federal reserve banks rather than

Sincerely yours,
(Signed) Bay

CRITICISi.i OF THE

m MQBANDUM

REGARDING PROPOSED ACTION BY

THE FEDERAL ADVISORY COUNCIL

The suggestions contained in the memorandum are subject to
criticism from two angles; (a) from the angle of the general policy involved and
(b) from that of the detailed suggestions embodied in it.
As to the general purpose, there is some reason for suggesting
the desirability of returning to an international gold standard at the present
time and this matter is dealt with in the attached proposals*

The ability of

the United States to restore a gold standard, hov/ever, is conditioned by the
willingness of other countries to take similar steps, since it is impossible to
conceive of an international gold standard unless the United States, England and
France, at least, should participate in it*

Moreover, the restoration of such a

standard requires the abolition of quotas and embargoes that now restrict inter­
national trade and a revision of tariff policies such as to permit increased
international trade in commodities and services.

Increased provision for inter­

national capital movements would also be a necessary prerequisite, and these
conditions should be emphasised in the memorandum suggesting the international gold
standard as an aim of monetary policy.
Assuming that, in the light of all these facts, it was still
thought desirable to recommend an international return to gold, the suggestion that
the gold in the Stabilisation Fund might be eliminated from the monetary picture
by an upvjard revaluation of the dollar is impossible, both theoreticalljr and as a
matter of practical politics.

Under any form of international gold standard the

foreign exchange oarities between the different currencies must measure both the
relative gold content of the monetary units and the purchasing power over commodities
°£ t .ose units in their respective countries.




Thus, before the war, a pound sterling

-

z

-

was worth approximately ^4.86 because the pound contained nearly five times as
much gold as the dollar by weight, and also because it would purchase in England
about five times as much as would the dollar in the United States-

This must

naturally be so since gold normally moves freely from one country to another and
would naturally move to the country .vhere it would purchase most.

All of this is

simply another way of pointing out that any attempt at restoring the gold standard
cannot succeed unless the ratio established legally among the several currencies
corresponds to the purchasing power parity.
While minor corrections may be necessary in one or other of the
countries involved, it is reasonable to suggest that at the present time the ex­
change rates between the dollar, the franc and the pound correspond approximately
to »urchasing power parities.

With a dollar weighing l/35 of an ounce of gold,

tlie pound is today worth approximately five dollars when measured by price levels
in the two countries.

Naturally if all the countries concerned should revalue

their currencies upward, the exchange relationship would not be disturbed.

Such a

proposal, however, is impracticable and if the United States alone should do it,
American business would be placed in the position that British business occupied in
1925.

Either a decline in the American price level or a rise in foreign price

levels of ^old standard countries would be necessary to restore equilibrium, and
the experience of England from 1925 to 1931 suggests that equilibrium is not easily
restored.
Xf the three nations above mentioned should agree to return to
tne gold standard with specific gold contents for their several monetary units
corresponding to the existing purchasing power parities, and if there were reason
to expect that such a restored gold standard 7/ould endure for some time to come,
t would be possible to use the gold in the Stabilisation Fund for the purpose of
r-t,_rin^ co.rie of the outstanding Government bonds.
the profits from devaluation in 1928.




This is what France did with

-

3

-

Regarding the other two proposals of

the

memorandum, the dis­

continuance of the silver purchase program would arouse no objections from any
economist,

although it might be politically inexpedient at present.

This latter

point is not of economic significance however and, in view of the fact that the
acquisition of silver by the United States Treasury does nothing to strengthen
the American monetary system, the immediate cessation of such purchases has very
much

to recommend it.
The suggestion that the Federal Reserve System reduce its hold­

ings of Government bonds to $400,000,000 is somewhat more controversial.
should balance the budget so that

Administration

it

If the

did not depend upon the capital

market for immediate financing, and if it should be willing to refund some of the
short term issues outstanding on the basis of somewhat higher interest rates, it is
probable that the Reserve System might safely and wisely over a period of time re­
duce
would
of

its present holdings by a policy of open market sales.

Such a policy, however,

need to be carried out very gradually in order to prevent any sudden rise

interest rates in the money market.

If the Administration should not be

willing

to adopt the fiscal policies suggested above, it is manifestly impossible for the
Federal R e s e r v e

Such sales
letter

would

of the

System to adopt any policy requiring substantial open market sales.
weaken the market for Government bonds and, whatever may be the
it is obvious that no government will allow its central bank

lav/,

continuously to pursue policies that

run

counter to its own.

Minor Points of Criticism
Some question can be raised regarding the definition of "sound
-oney" that appears on pages 1 and 2 of the outline.

While Hepburn1s definition is

suitable for his purpose and for the time at which he wrote, it is not theoretically
defensible,

'iore accurately, sound money would have to be defined as any type




-

4

-

0f money that satisfactorily serves as a standard of value and a medium of payments,
thereby facilitating the normal operations of business.
ceivable

It is theoretically con­

that an inconvertible paper currency might qualify as sound money if it

-ere perfectly managed by an omniscient and omnipotent authority, and all that can
be said in favor of Hepburn’
s statement is that, in the light of human weaknesses
and ignorance, it is probably better that the United States should base its money
uoon gold and so limit the need for management.

Perhaps this is not an important

criticism, because it is probable that Hepburn himself would have agreed with the
above statement, but the method in which the definition is presented in the memoran­
dum tends to color the whole discussion.
The second technical point of some considerable importance arises
in connection with the suggestion on page 5 of the memorandum regarding the redis­
count rate.

While it is a standard principle of English central banking practice

that "Bank Hate is normally above Market Rate”, it must be remembered that the
phrase market rate applies specifically to the rate of discount on first-class
bankers' acceptances.

Even in the United States the market rate on acceptances might

conceivably be below the Federal Reserve buying rate (although it usually is not),
xhile in England the rate charged by a commercial bank on customer loans is always
at least two percent above the Bank of England rediscount rate.

The difference in

the tvpe of paper rediscounted by the Bank of England and the Federal Reserve Banks
~akes it impossible to make any such general suggestion as the one that Federal
‘
rserve rediscount rates should be above market rates, because in this country, where
-ost of the paper presented to the Reserve Banks consists of single name customers1
■'otee, it would be intolerable to have central bank rates above the rates charged in
e7er7 part of the country.
^"▼ember 14
>CJ:ABR

1956




ALTMu^ATlVE ...Ei-aQRANDi:id CONCERNING RECOi/iivLLaTDATIONS OF POLICY
Improvements in the volume of business activity and sub­
s ta n tia l

increases in the prices of commodities and securities indicate that a

business revival is well under way in the United States.
merits have all

th e

Since these improve-

earmarks of a regular cyclical expansion in business, it may

be expected that business m i l continue to expand of its own momentum if nothing
is

done to interfere vith normal business operations in industry and commerce.
Such a condition of affairs would tend to indicate that the

easy money policies, adopted by the Reserve System in 1955 to encourage business
revival and price-increases, have served their purpose and should now be gradually
discontinued.

Naturally no sudden change of policy is desirable, since sudden

change might undermine the confidence of the money market, induce sharp increases
in interest rates, and retard the continued expansion of business activity.

The

change of policy must necessarily be very gradual, but it does seem that the
tine has nov: come when it is necessary to turn our attention to the problem of the
methods by which the Reserve System can prevent an undue expansion of credit and
a dangerous speculative boom.
This problem is not easy in the light of our present circum­
stances and of the limited experience that we have of monetary management, but an
effort must be made to find a solution since a continued expansion of business for
tT7o or three years might produce a very dangerous expansion in the volume of bank
ce;>osits even if no increase occurred in the stock of money in the United States
5.nc the present volume of member bank reserves.
If the Reserve Board should raise member bank reserve requirements
to the

axirourn amount permitted by law at present, the problem would not be completely

solved because substantial deposit-expansion might.still occur on the basis of
szcesa reserves and the aggregate volume o f reserves would be continually increased




by the silver purchases of the Treasury under the present program.

Moreover such a

step would make it impossible for the Board to raise reserves further without special
lecal enactment (which would be difficult to obtain promptly at a time when further
increases were considered necessary and desirable.)
Something might be done by raising rediscount rates, but this step
is rrobably undesirable at present since it would undoubtedly produce an early
rise of interest rates in the market and check the revival.

Nor are substantial

open market sales of government bonds a practical possibility until the government
has balanced the budget and refunded its short-term issues.

As long as the government

depends uoon the caoital market for current financing it is inconceivable that the
Board should, by raising rediscount rates or substantial open market sales, follow
policies calculated to make the task of financing the government more difficult.
Several of these problems arise out of the peculiar characteristics
cf our monetary system, and they also exist to a greater or lesser extent in several
other countries.

Joint international action in restoring a gold bullion standard,

at least in the United States, England and France, would go a long way towards provicing us with an effective solution, and, in vie?/ of the recent international
monetary agreements negotiated by the United States Treasury, it would appear that
such, a step is ■possible as well as desirable at this time.
If the gold standard should be restored in the three countries
'sntioned, with gold value for the dollar, franc and pound appropriate to the present
?archasing power parities betY/een these monetary units, and suitable collateral
easures were taken to encourage the international movement of goods and cf capital,
the problems of credit control would more closely resemble those with which we have
• - experience in the past.

Moreover such a policy would make possible the cessation

silver purchases (for the time being at any rate) and would make it possible to
iS' +-he gold in the stabilisation fund for the purpose of repaying some of the govern-




aeat bonds now held by the banking system - removing two of the potentially
^nflationary factors in our monetary system.
Naturally, it is assumed that if such a policy were followed,
the Reserve Board (in consultation with the Bank of England and the Bank of France)
7 ,-o u lo .

continue to study the methods by which credit control could be made more

efficient and the general level of monetary management improved.
such

Moreover, if

a policy were adopted now - when the danger of speculative inflation is not

•urgent - it would provide an ample opportunity for adjustment to the new scheme
of things and enable the Reserve System to perfect its control technique before
the need for retarding the rate of deposit expansion should become urgent.

To

postpone action until such a time arrives may have the effect of seriously impair­
ing the efficiency of the Federal Reserve Board in performing the tasks that have
been placed upon it.




Confidential

November 14, 1936

CjsLiLX.

TO:

Mr. Sinclair
CAS
SUBJECT: REVIE.7 OF Tffiii FROST ^ O R A I I D U M RELATING
TO CURRENCY IN THE UNITED STATES,

This statement attempts to set forth certain basic principles
relating to our currency and to make definite recommendations with respect to
the policy to be adopted concerning the present holdings of government securities
by the Federal Reserve System, buying of silver and issuing silver certificates,
and the so-called stabilization fund.

The memorandum calls for a critical

appraisal rather than alternative suggestions.

What follows therefore is mainly

in the nature of a critique based on established facts.
1.

The statement starts out with Hepburn's definiti

money and suggests that the Council accept this definition and thus its implica­
tions.

Hepburn's "A HISTORY OF CURRENCY IN THE UNITED STATES0 was first published

in 1903, then revised in 1915 and in 1924.

No later edition has appeared, though

one is planned to be issued in December this year.

The definition, therefore, was

formulated some years ago when conditions were different from what they are now.
Biit this fact does not necessarily impair the validity of basic principles, though
Hepbum himself states in the second paragraph to the one quoted in the memorandum
that: "The test of sound money varies with different periods, and is determined
by var/ing conditions.

The term has, however, a general significance easily under­

stood, is concise, cogent and seems to have found a permanent place in our economic
literature.0

Apparently this "general significance" varies according to prevailing

conditions over long periods.

The implication is that the static definition is

aot to be adhered to literally and that is precisely what the memorandum does.



Moreover, it is not true that all students of money today accept Hepburn's definition
of sound money, largely because of the difficulty of knowing the meaning of the
•jhra.se unless it may be taken literally in connection with the testing of coins which,
7711611

dropped, ring true or false.

Then, too, fundamental conditions have changed

very greatly since the definition v»as formulated.

Probably the best test of sound

currency is when the people believe in it and accept it in their ordinary transactions
and when that currency lias a standard of value which makes it also acceptable in
international payments.
The definition gives a clear implication that sound money is ,!unouestionably redeemable in" gold.

It also refers to the gold coin standard such

as existed in this country until a few years ago.
to the standard we now have.

Obviously, it is not applicable

Does it then mean that the Council virould suggest the

refrora to the gold coin standard, making our currency convertible into gold coin on
demand? For that is the meaning implicit in Hepburn's definition of sound money.
If it does, the statement should say so, otherwise this definition is beside the
loint and should not be a basis for further development of the case.
2.

Reference is made to certain basic principles obser

connection with the legislation creating the Federal Reserve System in 1913.

In

general, it should be remembered that the original Act was the result of many
compromises, attempting to adopt the best banking system possible for this country.
It 77as also intended to be a living and working organism.

YJhile it may not have

set all the exaggerated expectations of its sponsors, it lias been adapted to chang­
ing conditions either through administrative measures or through legislation, to
Tit: changes in reserve requirements, real estate loans, discounts and advances,
discount rates
of

bank

gone

a

credit.
Ion;~

and

other changes relating to measures of control and administration

In

way from




its efforts to meet changing conditions the reserve system has
both the conditions and the thoughts prevailing at the time

alien i t was founded.

3

-

The historic argument thus is hardly convincing.

If

s0nie hold that we have departed too far from the original intentions, this is
beside the point in any consideration of conditions as they now exist.
5.

An emphasis is placed on the fact that the Treasur

be able to redeem in gold at all times a large portion of currency so that it
w ould

be possible to maintain full confidence in such fiduciary elements as are

implicit in the subsidiary or representative money.

But it should be noted that

by far the greater part of our currency supply at present rests on the gold base.
The United States notes amounting to about $540 millions have back of them a gold
reserve fund of ?p.56 millions established under the Gold Reserve Act of 1900.
Federal reserve notes in actual circulation as of November 10 amounted to over

$4.1 billions and the collateral held as security for these notes consisted of:
54,396 millions in gold certificates, §5 millions eligible paper and $93 millions
United States government securities, making a total of 04,494 millions*
Silver certificates, Federal reserve bank notes, and national
bank notes, of which about ^1560 millions were outside of the Treasury, nave no
direct gold base.

But it must be remembered that all forms of money are legal

tender and must be kept at a parity in relation to gold.
In pointing out the presence of such elasticity on the side of
the reduction in the currency supply, the statement injects a controversial
feature by saying "provided, of course, that the rediscount rate is above the mar­
ket rate for funds”.

This rule of thumb is of British origin, often resorted to

'Without realizing the essential differences between the money market structures
in England and this country.

For example, the British banks make advances to

tjr.eir customers largely through overdrafts and do not require promissory notes as
is done in this country.

A British bank does not borrow directly from the Bank

-n^’
and but adjusts its position through bankers1 end Treasury bills as well
its loans to bill brokers.



TFnenever necessary these brokers sell bills to the

-

4

-

gank o f England a t the d is c o u n t r a t e o r borrow from the Bank on b i l l s .

The r a t e s

at which the B r i t i s h banks len d t o t h e i r customers are u s u a lly somewhat above the
Sank of England r a t e .

The discount rate in the Un ited States applies to promissory note s
T.h'.ch

member banks present w i t h their endorsement to the reserve banks, or to the

menber banks1 own notes secured by their customers' notes or by government o bliga­
tions.

"If a member bank lends its commercial customer on his note at 5 per cent,

tie value of this note with a b a n k endorsement ma y be represented by a rate no t f a r
from 5i to 4 per cent.

If at that time the Federal reserve bank rate is 4 pe r cent

it is really equal to or above the rate 7/hich represents the paper's true value."
These explanations are taken from the latest study by W. R. Eurgess of the F ed e r a l
F.eserve FknV of New York (The Reserve Banks and the Money Market).
The principle back of this controversial rule is that banks should
not be able to make money by borrowing at reserve banks and that by being above the
market rate the discount rate should be in the nature of a penalty rate.

This is a

subject that requires much closer study than the mere qualifying proviso used in the
nemorandum.
The truth of the natter is that by virtue of the fact that cash on
hyid does not count as reserve in the hands of member banks there] is always a strong
v-

tendency for currency to return to the reserve banks, thereby avoiding redundancy.
Taenever member banks have large excess reserves this may be less pronounced than at a
ti”
e Then they are forced to borrow in order to maintain their required balances.

If

banks crust borrow, then naturally they will return currency not needed to the reserve
banks in order to pay off their indebtedness, since by doing this they save interest
charges. This should hold true whether or not the Federal reserve discount rate is
above the rate charged customers.

Regardless of the backing of the currency, there­

fore, it appears that elasticity has been imparted to the whole currency structure
^ ?j° far ae elasticity may be construed to mean responsiveness of money to the needs



-

of trade and industry.

5

-

There is no question as to the ability of the reserve banks

to meet the current demand for money needed for:such important items as payrolls and
retail trade.
In any discussion of our currency problems it should not be forgotten
that probably about nine-tenths of all current payments for goods and services are
sade by the use of checks drawn against deposits at banks.
a deposit credit is utilized for domestic exchange purposes.

A check is a means by which
In practice, therefore,

deposit credits perform much larger functions as media of exchange than do actual
currencies, subsidiary coins and representative notes.
4.

An attempt is made to build up an argument against t

holdings of government securities by the Federal Reserve System.

Generally speaking,

it- ~oes •without saying that it would be much better if the distribution of government
debt could be widely made among our population but apparently this has not been the
case, as it is in other countries.

This is probably due in part to the adventurous

temperament of the American people to take risks and either lose or realize more than
the yield from government securities.

The largest concentration in holdings of

government securities in this country thus is in financial institutions and large
estates.

Maybe this is a question of long education, built up gradually on the basis

cf enduring confidence in our credit system generally and in government credit particu­
larly.
Specifically, the memorandum states that the purchases cf government
obligations by the Federal reserve banks have resulted either in the issuance
equivalent amount of Federal reserve notes or in reserve balances.

of an

The first part

of this statement is not true, since the Federal reserve notes at present are secured
practically 100 per cent by gold certificates.

The second part is true but is not

necessarily alarming, particularly since holdings are at the discretion of the Federal
Open Market Co ritteej in fact it may be quite desirable to hold the present amount as
instrument to be used in case of any undue credit expansion.



-

6

-

It must be recalled that after a very sharp increase in purchases
0f governments by the Federal reserve banks in the early part of 1932 and the latter
cart of 1935 there lias been virtually no change in the volume of these securities
held by the reserve banks*

It must also be remembered that so far there have been no

definite convincing signs that bank credit is being used to any large extent in either
the security or commodity markets.
If the reserve banks should sell |2 billions of their holdings of
rcvemment securities the effect on the market for these securities unquestionably

O

would be drastic; even a gradual reduction might easily result in an extreme con­
struction of the policy by those who watch the markets.

Unless the Treasury would

counteract such a step, as it readily can, the effect on the capital account of all
banks at present might be exceedingly serious.

Another effect, of course, would be a

reluctance to buy governments at present yields, so that higher rates of interest
-,7 ould have to be offered.

While Treasury refinancing within the next year or so

appears to be relatively small, about |8.7 billions of Treasury notes will mature
between 1937 and 1941.

This is an important factor to be considered from the stand­

point of both banking and Treasury financing.

Close cooperation betv/een the two is

essential.
5*

Little or nothing favorable could be said by any thoughtful

student with respect to our position as to silver*

Largely under the pressure of

special interests we have got ourselves into insuperable difficulties and now it is
probably a question of how to get out of them legally and gracefully.

Use of the

method

In the first

rooosed in the memorandum at this time would be questionable.

place it would reouire legislative action to modify the present law.

To retire a

large -art of the silver certificates and attempt to sell silver in the world markets
would seen to be doubtful expedients at ^resent.
offered?

Can the world absorb the silver so

hat would be the effect on prices, exchanges and trade?

It would lead

to even greater disorganization in the silver markets of the world than it did at the



when we v/ere buying silver*

7 -

It would certainly affect the silver interest in our

v.m country and this would produce another political howl.

In effect it would mean jump-

jrg out of the frying pan into the fire and the fire would indeed be white hot.
The best way out for the time being probably would be to make our silver
^ro^rsun passive, if this is possible under the law.

Certainly it would be advisable to

resist any attempt to issue notes against seigniorage.

The content of the silver dollar

also cay be increased, thereby changing the monetary value of silver as the President
car do under the present statute.

But whatever is done the foremost question should be:

is now the time to do it without embarrassing the administration and bringing adverse
criticism from the silver bloc?

Would not time help to expose the folly of the existing

measures and eventually help do something about meeting this problem rationally?
6.

The position taken in the memorandum with respect to th

tion fund seems peculiar to say the least, particularly in view of the latest monetary
developments.

In its remarkable simplicity, singularly unperturbed by the monetary events

that are now taking place, the statement takes no cognizance whatever of the recent
cooperative agreement entered into by the United States, France and Great Britain as well
as several other commercial nations to bring order out of chaos in world exchanges and
trade. All these nations have established stabilization funds for the purpose of moderat­
ing exchange fluctuations and ultimately attaining some workable level of currency relation*
s'.'ips so that trade and payments can once more become sanely operative.
After a most troublesome period, the leading industrial nations show a
3trong desire to relax and gradually remove the trade-choking folly of controls, restrict-'.ns, tariffs, quotas and other trade impediments.

Surely this would be to our interest.

- could then sell more freely such of our surpluses as cotton, automobiles, diverse
^rrofactures, and many farm and animal products; we could also buy more freely such
®EBentials as manganese, rubber, tin, silk, tea and coffee.

What the world needs today

*8 stability and until the present undertaking shows definite signs of success it is




-

8

-

necessary that we retain the means provided by the stabilization fund for safeguard­
ing the posit on of our currency in the international markets.

Is it the intention

of the memorandum to disregard the facts of this trend, assume a fatalistic attitude,
or expose ourselves to certain hazards that may not be foreseen at the moment?
Complete monetization of our large gold stock in one way or another
say be possible, though not probable, and might be considered as undesirable.
is the presence of foreign capital in this country to be ignored?

But

One of these

days night not the political and military situation abroad change suddenly and might
not the owners of this capital become shaky in their faith with respect to our own
situation and to our dollar?

Such tilings happened not so long ago.

What effect

Trould it have on our excess reserves if we had to part with a considerable portion
of our gold?

Those in authority already are conferring with the Executive on this

very subject.

The fact that the Secretary of the Treasury could stop shipment of

gold from this country would be of small consolation; rather it would be an admission
of monetary short-sightedness and consequent inability to cope with the problem.
Practical wisdom and financial statesmanship would seem to indicate that, if anything, the oresent stabilization fund should be continued beyond January next, at
least until world stabilization becomes more assured than it is at present.
Certainly our monetary position would be made doubly vulnerable
if we revalued the dollar upY/ard, as the memorandum proposes to do, in order to
absorb the two billion dollars gold or the so-called "gold profit".

By undoing the

former act of Congress at this time only confusion and great harm can be the result.

rjvei: such conservative monetary economists as Professor Kemmerer deny the advisa­
bility of going back to the former weight of the gold dollar.

One wrong cannot

right another, any more than misbehavior in one nursery means a like misbehavior in
another nursery.

??uch as some may like to return to the old gold coin standard, one

cannot soberly disregard the stark realities of the present situation.

No pious

*ish or spectacular oublic statement can remedy it without producing immeasurable
«..uage interna’
ly and externally.




No degree of assurance that "this statement is

not made fo r the purpose of* eith er condemning or praising past actions . . . " i s
a convincing and e f f e c t i v e safeguard against self-exposure and the ju s t ifi e d
criticism that would in evitably fo llo w should the memorandum in i t s present form
be given out to the country.
7.

In considering the future outlook, the memorandum

rave misgivings with respect to the immutability o f human nature and the w illin g ­
ness of bankers and business men to expand th e ir c re d it operations to the le g a l
limits when confidence returns.

In support o f th is statement, the memorandum shows

an increase in t o t a l deposits (other than interbank deposits) o f 35 per cent from
June 1933 to June 1936.

This comparision tends to exaggerate th is expansion at

least to the extent that the low point reached by deposits in the middle o f 1953
orobably was due in part to the f a c t that many banks at that time were s t i l l on the
restricted basis and were lice n se d a fte r that date.

But i t cannot be denied that

deposits since 1S33 have increased very greatly, r e fle c tin g in large part emergency
expenditures, financed by the issue o f new government s e cu ritie s which were acquired
in substantial amount by the banks.

Two things must be remembered, however; the

use of bank c r e d it by business and the stock market so fa r has not been la rge, as
shovm. I57 loans o f a l l types; and the continuous improvement in business is re su lt­
ing in larger incomes to corporations, individuals and consequently to the govern­
ment, which is to say that r e l i e f expenditures are declinin g, employment i s in­
creasing and the prospects f o r cu rta ilin g government expenditures may become more
hopeful.
The memorandum points out that in other years, from 1920 to 1928,
the ratio o f deposits to reserves fluctuated within a range between 20 to 1 and 23.5
to 1 .

From this the ,memorandum assumes that i t would be reasonable to expect a

—-tio of deposits o f a l l banks to member bank reserves o f 20 to 1.

Adding to the

total of reserves nov; held, a possible $ l j b illio n s through additional issues o f
e-*-lver currency and



% Z

billions through the use of the stabilization fund, i t

- 10 arrives at $10 b i l l i o n s o f reserves; applying the 20 to 1 ratio this would indicate
p o s s ib le

deposit expansion to $200 b i l l i o n s .

Of course 20 to 1 was based on reserve

requirements as they stood between 1920 and 1928.
h a lf

Since then an increase o f one-

in requirements has been made and the memorandum admits that i f the f u l l powers

0f the Board o f Governors were used, deposits might expand to §100 b i l l i o n s only.
This figure is much l e s s s t a r t lin g than the memorandum apparently intends to convey
in first arriving at $ 2 0 0 b i l l i o n s .
This portion o f the argument c le a r ly implies that at present we
are face to face with a d e f in it e p o s s i b i l i t y o f tremendous cred it in fla t io n and that
there is no possible method o f c o n t r o llin g i t under present conditions.

This asser­

tion *ould be quite serious i f i t could be borne out by established f a c t s , including
s o z e

heedless attitu de o f the a u th o ritie s toward th is problem.
There i s at present no clear evidence o f any undue use o f bank credit

in speculative channels or in trade and industry f o r th e ir legitimate requirements,
as has been indicated b e fo r e .

But i s there anything necessarily harmful in cred it

expansion as a r e su lt o f c y c l i c a l improvement in business which seems to be now in
progress?

I t should be remembered that the volume o f accumulated shortages in durable

and seni-durable goods during the depression appears to be s t i l l very large indeed.
Neither has the obsolescence o f consumers* goods been as y e t f u l l y met, disregarding
for the moment the new wants o f our growing population.
|o before reaching anything li k e a saturation point.

We have thus a long way to

True, the time may come when

credit begins to pyramid upon i t s e l f and cease to fo s t e r actual business expansion
along healthy lin e s .
in tine to

This o f course must be watched and controllin g means applied

revent the downward s p ir a l.

I t is also true that our c re d it base is un-

'jrecedently large, even i f allowance i s made fo r possible foreign withdrawals which
would involve a reduction in our monetary gold stock.

I t i s not to be forgotten , however, that very d e fin ite e ffo r t s
already have been, made to check any untoward developments with respect to injurious



- 11 credit expansion.

I t w i l l be r e c a lle d that as early as January this year the Federal

j^serve Board raised the minimum margin requirements on loans by brokers.
r applying to banks, also went in to e f f e c t in the f i r s t half o f this year.

Regulation
Another

evidence is afforded by the a c t io n o f the Treasury when i t shifted a portion o f i t s
balances from the commercial banks to the reserve banks, resulting in the reduction
of excess reserves.

The l a t e s t p roo f o f steps taken in the same d irection i s that

of the Board o f Governors in r a is in g the le g a l reserve requirement o f member banks
dy 50

per cent, e f f e c t iv e August 15.

*1,470 millions.

This a ct reduced excess reserves by about

I t would thus seem that the authorities are aware o f the potential

dangers and are prepared to a c t a t the time deemed proper.
Neither must i t be forgotten that the Executive consistently refused
to use the in flation ary powers granted him under the s o -ca lle d Thomas amendment, that
he vetoed the Patman soldiers* bonus b i l l c a llin g f o r the issue o f §2 b i lli o n s in
Greenbacks'1, and that he likew ise fought the Frazier-Lemke Farm Mortgage b i l l c a llin g
for the retirement o f the mortgage debt o f farmers by an issuance o f f i a t currency.
attitude was s ig n ific a n t then and most li k e l y continues to be so no?.r.

Would i t

therefore be wise to create an aggravating situation pre cisely at th is time, .just before
the Congress meets?

Prudent statesmanship does not necessarily mean a s a c r ific e o f

principles; i t may mean a speedier solu tion o f trying problems through wise coimsel
and cooperative e f f o r t s .
In making the t h r e e -fo ld recommendations relatin g to the government
:ond holdings by the Reserve System, s ilv e r and s ta b iliz a t io n fund, the memorandum makes
' considerable point o f the f a c t that the action should be gradual so as not to disturb
the existing conditions
folio-/

r e d

tore than necessary.

under any circumstances.

Naturally this procedure would have to

The objectionable feature o f giving out a s ta te -

;‘
^t 3uc:i as contained in the memorandum is the very suggestion o f what is proposed to
rj* done. The question is:




what can be accomplished at this time by taking the sug-

gestea steps at a l l ?

12

-

Would the a c tio n o f the kind proposed be timely or pre­

mature?
The s o le purpose o f this critiq u e i s to give an honest
appraisal o f the F rost memorandum with utmost frankness.

Lack o f time pre—

Vcats its revision which would undoubtedly resu lt in greater p recision and
comprehensiveness than i t now has*