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o f the

Federal Reserve Board
A Letter from Senator Robert L. Owen
Criticising Certain Policies of
the Federal Reserve System


Published by the
F ederal R eser ve B a n k


December, 1920

R ic h m o n d


Reply o f the Federal Reserve Board
November 29, 1920.
My dear Senator:
Your letter of the 18th instant was received
several days ago and has been given consideration by
the Federal Reserve Board.
You urge (1) that the rates of discount established
by the Federal Reserve Banks upon the approval and
determination of the Federal Reserve Board be lowered,
and (2) that the loans of the Federal Reserve Banks be
expanded “to the extent which may be required for
purposes of legitimate production and distribution.”
The Federal Reserve Board is reluctant to discuss
proposed changes in discount rates, and has consistently
cautioned all Federal Reserve Banks to refrain from
any announcement of recommendation made by their
directors until the rates have been approved and made
effective by the Federal Reserve Board. Premature
discussion of discount rates would have an unsettling
effect and would give those best in position to form an
opinion as to the probable action of the Board an
advantage over those not thus situated.
While the reserves of the Federal Reserve Banks
as a system are stronger than they were several weeks
ago, there is still a large amount of inter-bank redis­
counting being done, and several of the Federal Reserve
Banks would today have reserves much below the
normal minimum required by law— some less than
one-half— but for the fact that under the authority of
paragraph (b) of Section 11 of the Federal Reserve
Act they are permitted by the Federal Reserve Board
to rediscount some of their discounted paper with other
Federal Reserve Banks.


You have on several occasions expressed your
approval of the management and policies of the Bank
of England, and the Board regrets that up to this time
it has been impossible to adopt in this country the
well-established policy of the Bank of England under
which the Bank’s discount rate is fixed at a figure
slightly in excess of the current market rate. The
wisdom of such a policy is apparent, for as it eliminates
all profit in rediscount transactions, it gives the Bank
better control over its own reserves and causes the
joint stock banks to rely to a greater degree upon their
own resources in extending accommodations while
still affording them an outlet for any undue accu m u la­
tion of loans. The exigencies of war financing in this
country were such as to make necessary the adoption
of a policy just the reverse of the time-honored policy
of the Bank of England, and while the margin between
Federal Reserve Bank rates and current market rates
is not now as wide as was the case a year ago, the
average legal and current rate throughout the country
is still higher than the Federal Reserve Bank rate. It
is the expectation of the Board, however, that condi­
tions will ultimately adjust themselves so that Federal
Reserve Bank rates may be maintained at a level
slightly higher than current rates without any disturb­
ance to commerce and business. In fact tins adjust­
ment has already begun in some districts where
member banks have reduced their rates on commercial
loans. While members of the Board always keep in
mind the matter of discount rates and discuss the
subject freely among themselves, they realize that in
the determination of Federal Reserve Bank discount
rates recognition must be given to going rates and in
the rate revisions which the Board has approved from
time to time, the view has always been taken that
discount rates cannot be pegged or fixed arbitrarily for
there are always certain basic conditions affecting the
demand for and the supply of credit throughout this
country and throughout the world which must be
taken into account, and the formal establishment of a
Federal Reserve Bank discount rate is merely an inter­


pretation of these conditions. The whole question of
discount rates was discussed at length in my two letters
to you of May 3 and 24, 1920.
As to the expansion of loans of the Federal Reserve
Banks “to the extent which may be required for pur­
poses of legitimate production and distribution,** your
attention is called to the fact that at the close of busi­
ness Friday, November 26, 1920, the invested assets
of the twelve Federal Reserve Banks, including
bankers' acceptances discounted and bought, member
banks* fifteen-day collateral notes secured by Govern­
ment obligations, and eligible commercial paper dis­
counted for member banks, amounted to $3,303,747,000
as compared with $3,024,741,000 on Friday, November
28, 1919. Federal Reserve notes outstanding on
November 26, 1920, amounted to $3,325,629,000 as
against $2,852,277,000 on November 28, 1919. These
figures prove that during the past twelve months there
has been no curtailment or reduction in the aggregate
of the credits extended by or through the Federal
Reserve Banks, but on the contrary there has been a
very substantial increase which has been steady and
continuous all through the year, as is shown graphi­
cally by the chart to which I called your attention when
you were in my office a few days ago.
As you know, the Federal Reserve Banks are not
permitted by law to have direct dealings with the
public; they are allowed merely to rediscount for
member banks, upon their endorsement, eligible paper
as defined by the Act, representing loans or advance­
ments made by the member banks to their customers.
The discount powers of national banks are broadly
defined in those sections of the Revised Statutes of the
United States commonly known as “ The National Bank
Act,** and those of the state banks and trust companies
which are members of the Federal Reserve System are
governed by the laws of the respective states in which
these institutions are located. Thus the Federal
Reserve Board has no control over the discount policies
of individual member banks and cannot force them to


make loans which they do not desire to make, nor can
it restrain them from making loans which in the lawful
exercise of their discretion they may make.
The extent to which the discount facilities afforded
by the Federal Reserve Banks are now being used
shows that through the medium of. member banks the
Federal Reserve Banks are participating actively in
extending credits. On August 22, 1907, just before the
panic of that year, bills payable and rediscounts of all
national banks amounted to $59,177,000 against total
loans and discounts of $4,709,027,000, the percentage
of bills payable and rediscounts to total loans being
1.26%. On September 23, 1908, the percentage was
1.11%; on September 12, 1914, total bills payable and
rediscounts had increased to the then unprecedented
amount of $150,071,000, or 2.34% of the total loans,
which amounted to $6,417,910,000. This increase was
due to the disturbance incident to the outbreak of the
European war. On September 12, 1916, bills payable
and rediscounts had fallen to $91,893,000, or 1.16%
of the total of loans of all national banks. On Septem­
ber 11, 1917, the first year of our participation in the
war, bills payable and rediscounts amounted to $285,104,000, or 3.09% of the total loans, $9,234,289,000.
These figures, of course, reflect war financing. The
same observation will apply to figures compiled from
reports of condition of national banks on August 31,
1918, and September 12, 1919, when the percentages
of rediscounts to total loans were 12.8% and 13.04%
respectively. There has, however, been no new financ­
ing by the Government since the flotation of the
Victory Loan; the total volume of Government obliga­
tions outstanding has decreased since September 12,
1919, when rediscounts and bills payable of all national
banks amounted to $1,505,516,000, while on Septem­
ber 8, 1920, the national banks* liability for money
borrowed in this way amounted to $2,299,640,000, or
16.8% of their total loans of $13,723,611,000. The
figures for State banks and trust companies are not
available, but there is no reason to believe that the
proportion of money borrowed by these institutions


to their loans and discounts is any less than that shown
by the national banks. The foregoing figures demon­
strate clearly that the present discount rates at the
Federal Reserve Banks are by no means prohibitive
and the Board does not believe that if Federal Reserve
Bank discount rates should be lowered in advance of
a decline in the general level of interest rates there
would be any appreciable reduction in the rates mem­
ber banks would charge their customers.
You refer in your letter to the fact that “ the
Federal Reserve Board is approving a 6% rate on loans
secured by Treasury Certificates of Indebtedness/'
As you know, the rate of interest borne by these
obligations is determined by the Secretary of the
Treasury. Recent issues of Treasury Certificates have
borne interest at from $\% to 6% per annum according
to the length of time they have to run. It is the
Board’s understanding that it is the policy of the
present Secretary of the Treasury to offer certificates
at rates sufficiently high as to make them attractive to
investors, large and small, thus effecting their distri­
bution to the public instead of having them congested
in the portfolios of the banks or passed along by them
to the Federal Reserve Banks. The Federal Reserve
Board has approved for notes secured by Treasury
Certificates of Indebtedness rates corresponding with
the rates of interest borne by the certificates, thus
giving member banks an opportunity of carrying them
without loss pending their distribution but offering the
banks no inducement in the way of a spread in the rate
to retain them as an investment instead of passing
them on to the public. In this way the banks of the
country and the Federal Reserve Banks are better able
to respond to the requirements of agriculture, com­
merce and industry than would be the case if a larger
portion of their assets were invested in Government
You state that “it seems to be the policy of the
Board to raise the rates of interest for the purpose of
broadly deflating credits.” The rates were raised not


for the purpose of a broad curtailment or deflation of
credits, but with the object of bringing about more
moderation in the use of credits, which a year ago were
being diverted into all kinds of speculative and nonessential channels, and for the additional purpose of
conserving the resources and credit power of the
member banks and of the Federal Reserve Banks in
order that they might better respond to the seasonal
needs which arise every autumn.
The chart to which reference has been made shows
that on September 19, 1919, the total earning assets
of all Federal Reserve Banks were in round amounts
$2,350,000,000, while on January 27, 1920, the total
was nearly $3,300,000,000, an increase of almost
$1,000,000,000, or nearly 50% within a period of four
months. The chart shows graphically that the angle of
ascending credit during this time was forty-five degrees.
Certainly no banking system which permitted so rapid
an expansion of credit could long sustain itself, and
while no deflation was attempted, measures were taken
to regulate the credit expansion. Consequently the
Board approved a sharp advance in discount rates for
all of the Federal Reserve Banks between January 23rd
and January 30th. This advance brought about a
moderate amount of liquidation, and the chart shows
that by March 26th, the earning assets of the Federal
Reserve Banks had declined to $3,200,000,000. About
the middle of May, however, the tendency towards
further expansion again became marked and the
earning assets of the Federal Reserve Banks approached
the previous level of $3,300,000,000. On the 18th of
May the Board held a conference with members of the
Federal Advisory Council and the Class “A** directors
of the Federal Reserve Banks, at which it pointed out
- '^fa^ view of the essential credit requirements which
^thfe'jb^iiks had ahead of them later on in the year, it
„-V ^ fc^ $ sary to check the rate of expansion. Fol.kro^\t|§e conference the banks of the country were
1 " ^ ^<?*|ise more discriminating judgment in the
^extending credit and to give preference in
operation to essential credits, being

advised at the same time that they themselves must be
the judges of the essential character of the purposes
for which loans were asked of them. It is interesting
to note that a somewhat similar policy of credit
rationing has been urged by the French Government
upon French banks, and that the British banks under
the leadership of the Bank of England have for many
months past been exercising a discriminating judgment
in granting credit accommodations. At the beginning
of the present year, upon the previous recommendation
of the Royal Commission on Currency and Exchanges,
and at the instance of the Chancellor of the Exchequer,
a limit was fixed on the maximum amount of currency
notes which might be issued during the year 1920, not
to exceed the maximum amount outstanding during
the year 1919.
Following the conference on May 18th the earning
assets of the Federal Reserve Banks gradually declined
until July 23rd, when they were around $3,150,000,000.
Since that date they have advanced steadily with
occasional slight recessions until November 26th when
the total amount reached $3,303,747,000. The chart
shows that while the angle of credit from September 19,
1919, to January 27, 1920, was about forty-five degrees
upward, the angle from January 27, 1920, to November
26, 1920, shows an upward slant of only about two
In your letter you state that the Federal Reserve
Board has been pursuing for a year a policy of high
interest charges which has “brought on a condition of
industrial depression resulting in checking, and in some
cases absolutely stopping, legitimate production and
legitimate distribution.** You seem to lose sight of the
fact that the production of great agricultural staples
this year has been unusually large and that the price
recessions of which you complain are due in part to
world-wide conditions; and you also ignore the eco­
nomic forces governing the movement in prices which
for months past have been in evidence all over the


world. It was generally recognized many months ago,
following the collapse of the silk market in Japan early
last spring, that certain price readjustments were
inevitable. In fact, as early as August, 1919, the con­
tinuous expansion of credit and the constantly advanc­
ing costs of living became objects of grave public
concern, and the Senate addressed a communication
on the subject to the Federal Reserve Board on August
5, 1919. Shortly afterward the President in an address
to Congress called attention to the dangers of the
situation. From that time until the adjournment of
Congress last June these matters were the subject of
frequent discussions in both Houses. In the United
States an important factor has been the revulsion of
sentiment against the unnatural levels attained by
prices in the year 1919, when circumstances over which
the Federal Reserve Board had no control, prevented
the Federal Reserve System from exercising its impor­
tant function of regulating the flow and volume of
On the 17th of May last, the Senate adopted a
resolution (No. 363) directing the Federal Reserve
Board “to advise the Senate what steps it purposes to
take or to recommend to the member banks of the
Federal Reserve System to meet the existing inflation
of currency and credits and consequent high prices,
and what further steps it purposes to take or recom­
mend to mobilize credits in order to move the 1920
There were large importations of wool brought
into the United States just at the time when our
domestic wool clip was coming into the market, which
resulted in a slump in the price of wool, and in the utter
demoralization of the wool market. Sugar was
advanced by speculative manipulation until it reached
a price which checked domestic consumption and
virtually stopped exports to Europe while stimulating
imports into the United States from practically all
sugar producing countries in the world. Then followed


a drastic decline in the price of sugar. Imports of
rubber and coffee increased in like manner until the
accumulated stocks became so great that the markets
collapsed. The domestic production of other great
staples— cotton, com, wheat, rice and tobacco— proved
to be greater and the demand for them less than had
been expected, and the prices of these commodities
have declined sharply. Meanwhile there has been,
ever since the Board undertook to hold the tide of
expansion in check a year ago, a persistent campaign
of misrepresentation of the Board’s policies with
frequent misstatements or studied avoidance of basic
facts and figures. Not only have exaggerated ideas of
the powers of the Board been disseminated, but some
of the Board’s critics have published statements
repeatedly to the effect that its policies were ruinous,
that it was determined to bring about drastic deflation,
and that the inevitable result would be widespread
disaster. It speaks well for the common sense of the
country that the public has refused to be stampeded,
although perhaps the critics may have succeeded in
some cases in making conditions appear worse than
they really are.
The Board believes that the unfavorable condi­
tions which are now the subject of so much complaint
were inevitable and could not in any event have been
long deferred. It confidently asserts that but for the
precautionary measures taken several months ago,
conditions today would be far worse than they are with
the prospects of stabilization and revival much more
remote. The Board agrees with you, however, that in
some sections there has been a very substantial curtail­
ment of credits during the past twelve months, par­
ticularly in those credits which are related to non­
productive activities. This curtailment is particularly
in evidence in the City of New York, as pointed out by
you in your letter when you say “incidentally, the
individual deposits of New York City banks which
were NovembW 12, 1919, $6,313,998,000, were reduced
on November 10, 1920, to $4,916,375,000, a net loss of
deposits in New York City of about $1,400,000,000


and a net reduction of loans amounting to a similar
amount.” There has not, however, been a similar
curtailment in the country at large, for as you say in
your letter, “but while the individual deposits and
loans of New York City banks were coming down, the
total deposits of all the banks of the country, including
bank deposits, increased according to the Comptroller’s
letter of October 13, 1920, $4,045,164,000, and loans
increased $5,805,736,000 (including overdrafts and
discounts) for the fiscal year ending June 30, 1920, so
that this disparity of reduced deposits and loans in
New York City is all the more conspicuous.” You say
further that “ the New York City banks have above all
others pursued the policy of indiscriminate deflation,
and have deflated their own deposits accordingly.
The balance of the country’s banks, therefore, increased
their deposits, exclusive of New York, about $5,000,000,000.”
The Board has no information showing that the
banks of New York City have pursued a “policy of
indiscriminate deflation,” for although there has been a
substantial reduction in the volume of Street loans,
secured by stock exchange collateral, the facts are that
the falling off in the deposits of New York City banks
has been caused principally by withdrawals by interior
correspondents, and not only have banks in other
sections of the country checked heavily upon their
existing balances in New York City, but they have
increased considerably their discount lines with their
correspondent banks in that city.
You state “ the price of Government bonds has
been seriously depressed because the American market
of stocks and bonds is located in New York City, where
this policy of deflation is peculiarly in evidence.”
In my previous correspondence with you, I pointed out
that the decline in the market value of Government
bonds was no reflection upon their intrinsic worth, for
it reflected merely temporary conditions in the money
market. Government bonds are investment securities
payable at a fixed time in the future and bearing a rate
of interest lower than that borne by other high-grade


securities available for purchase by the public. With
the exception of the First Liberty Loan which bears
interest at the rate of only 3-2%, the Government war
obligations have very limited tax exemptions. The
investor can choose between Government bonds
bearing 4!% interest with negligible tax exemptions,
securities issued by private corporations bearing much
higher rates of interest, and municipal bonds bearing
interest at the rate of 5% or more which have full tax
exemptions. Your attention was also called to the fact
that the average price of Liberty Bonds in the market
declined to about 94 at a time when Federal Reserve
Banks were discounting at a 4% rate notes secured by
Liberty Bonds carrying a rate of 4\%.
In your letter of April 27th, you attributed the
decline in the market value of Liberty Bonds entirely
to the advance in discount rates at the Federal Reserve
Banks, giving no consideration to the possible effect of
the withdrawal from the market of the War Finance
Corporation as a daily purchaser. In my letter to you
of May 3rd, I ventured the prediction that “the policy
of the Federal Reserve Board to curb inflation will, in
the long run, result in improving the market value of
Liberty Bonds and a contrary policy of furnishing
credit at cheap rates at a time like this would impair
the market. The value of a promise to pay a sum
certain at a future date is impaired by the inflation
which the Board is trying to control.” In my letter to
you of May 24th, I stated “the obligations of the
Government of the United States offer the best oppor­
tunity for investment in the world today. They are
being sold now on a most attractive investment basis,
and as speculative tendencies are curbed, as the gains
of the profiteers are reduced, as commodity prices
decline, and as the business and industry of this
country settle down to a more normal peace basis, the
market value of these securities will rise very rapidly/’
A comparison of market quotations last May with
those of the past week will show that Liberty Bonds
have advanced several points.

You still appear to be inclined to the opinion
which you expressed in your letters to the Board last
spring, that Federal Reserve Bank discount rates
should be related to the earnings of the Federal Reserve
Banks. You say in your letter of November 18th
that “ the Federal Reserve Banks earned last year
over 100% and are earning now at a rate in excess of
150% per annum on its capital, contrary to a sound
public policy. This excess profit is all the more repre­
hensible because it goes to the Treasury, is made by
a Governmental instrumentality and puts the Govern­
ment in the position of profiteering, and setting a
national bad example.” I endeavored to point out in
in my letter of May 24th, that the earnings of the
Federal Reserve Banks were the result of their large
volume of invested assets, as much as the rate of interest
obtained from these investments, which include redis­
counts for member banks. The earnings of the Federal
Reserve Banks depend as much upon the volume of
loans and investments as upon the rate of discount.
The present large volume of invested assets of all
Federal Reserve Banks results in part from the demand
for currency which in the form of Federal Reserve
notes has been furnished by the Government through
the Federal Reserve Banks. The volume of these
notes now in circulation is about $3,300,000,000. A
direct interest charge of 2% on these notes against the
Federal Reserve Banks, which the Board is authorized
by law to impose, would bring a return to the Govern­
ment of $66,000,000, an amount approximately as
great as that which all the Federal Reserve Banks are
expected in January to pay to the Government as a
franchise tax out of their excess earnings. Had such
an interest charge been imposed this year the earnings
of the Federal Reserve Banks on their capital would
not have been regarded as abnormal.
The case, however, may be stated in another way,
and it is well that it should be, in view of your repeated
charge of “profiteering.” In an ordinary banking
corporation the sole contribution by the stockholders
is the paid-in capital stock plus accumulated and undis­

tributed earnings; the deposits, which are the principal
basis of the bank’s earning power, come from the
public. In such cases the earnings are measured in
terms of percentages of the bank’s capital, or its
capital and surplus. The Federal Reserve Banks on
January i, 1921, will have an earned and accumulated
surplus equal to about 200% of their paid-in capital.
They also hold the reserves of their stockholding banks,
which are deposits without interest contributed not by
the public but by the stockholding banks, and these
reserve deposits during the past year have averaged
about $1,800,000,000. If, therefore, the percentage
of earnings of the Federal Reserve Banks should be
expressed in terms related not to the capital stock
alone but to the total contributions of their stock­
holders, that is, capital plus reserve balances, without
taking into account the surplus which in the last
analysis is the property of the Government, the net
earnings of the Federal Reserve Banks for the present
year mil be, not 150% or more, but barely 7% on their
liability to stockholders.
The Board does not deem it necessary to enter into
a discussion of your analysis of the position of the Bank
of England. Our financial situation is distinctly
different from that of England, our laws and banking
practices are not the same, and it is difficult to make a
comparison of the statement of the twelve Federal
Reserve Banks combined with the statement of the
Bank of England. You say, “England is not on a gold
basis.” It is certain, however, that America is.
Restrictions upon the export of gold from this country
were removed by the President in June, 1919, and
since that time we have maintained an absolutely free
gold market, thereby enhancing greatly American
prestige everywhere and establishing a credit through­
out the world never before enjoyed. Our free gold
market is one of the chief influences which causes such
a world-wide premium on dollars, which incidentally
gives us a command of the world market for gold.
You point out in your letter that on a recent date,
“gold was at a premium of 45% in London while


selling at par in New York. This explains why the
paper pound Sterling in New York is selling on the
Exchange around $3.35 per pound.” Would it not,
however, be more accurate to state the case the other
way around and to say that because the paper pound
Sterling is at a discount and because the paper currency
of other countries is at a discount, gold is selling at a
premium in England and in other countries, while
selling at par in New York where American paper
currency has a value equal to that of gold?
The Board regrets to learn that in your opinion
public confidence in the wisdom of the Federal Reserve
Board and the Federal Reserve Bank management is
being impaired, but hopes that even though your views
and those of the Board as to the proper policy to be
pursued in the present circumstances may not coincide
in all respects you may later on reach the conclusion
in the light of subsequent events that the Board’s
policies are sound. It is impossible to forecast the
future accurately, but the recent past is an open book
and we should always strive to profit by experience.
You may remember that about eighteen months ago
you believed it possible to stabilize the principal
foreign exchanges and to maintain them at a parity
with each other and with the American dollar, and if
I remember correctly you urged the Board as a matter
of public duty to undertake this stabilization. In view
of the reference made in your letter to the embarrass­
ment that export houses are experiencing, the inference
may be drawn that you do not now regard the problems
connected with our foreign trade as being as simple as
you once did and that you realize how impossible it
would have been for the Board to maintain foreign
exchanges at their normal parity and what grave
disasters would have fallen upon the Federal Reserve
System and the country had the Board attempted to
carry out your suggestion.
Respectfully yours,
(Signed) W. P. G. H a r d in g ,
Hon. R o b e r t L. O w e n ,
United States Senate.