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Selected Papers ofAllan Sproul Edited by Lawrence S. Ritter Selected Papers ofAllan Sproul Edited by Lawrence S. Ritter Federal Reserve Bank of New York D ecem ber 1980 Library of Congress Catalog Card N um ber 80-67915 Book Design: Joseph Penczak Design, Inc. P rinted in U nited States of A m erica Table of Contents Preface by Anthony M. Solom on..................... ix Foreword by Paul A. Volcker............................. xi Chapter 1 Allan Sproul, 1896-1978 A Tower of Strength” 1 Chapter 2 M onetary Policy and Inflation In tro d u c tio n ............................................................................................... 23 1. L etter to W inthrop W . A ldrich (1 9 5 1 ).......................................... 25 2. L etter to Alfred Hayes ( 1 9 6 4 ) ......................................................... 27 3. L etter to Henry H. Fowler ( 1 9 6 5 )...................................................29 4. L etter to Alfred Hayes ( 1 9 7 0 ) ......................................................... 31 5. T alk to W ells Fargo B oard of D irectors (1 9 7 4 )...........................33 6. “ M onetary Policy and G overnm ent Intervention” (1968)......... 37 Chapter 3 Postwar Treasury-Federal Reserve Conflict and the Accord In tro d u c tio n ............................................................................................... 49 1. The “ A ccord” —A L an d m ark of the Federal Reserve System (1964).................................................................. 51 2. L etter to R obert T. Stevens ( 1 9 5 0 ) .................................................74 3. L etter to C .F. Cobbold (1 9 5 0 )......................................................... 78 4. L etter to Thom as B. M cCabe (1951)...............................................81 5. L etter to Jam es E. Shelton (1 9 5 1 )................................................... 83 6. L etter to M urray J. R ossant (1 9 6 3 ).................................................86 7. L etter to M urray J. R ossant (19 6 6 ).................................................88 V Chapter 4 Human Judgment and Central Banking In tro d u c tio n ............................................................................................... 89 1. “ Policy Norm s and C entral B anking” (1 9 7 0 ).............................91 2. Congressional Testim ony on “ Bills Only” ( 1 9 5 4 ).................... 105 3. L etter to M urray J. Rossant (1 9 6 1 ).............................................. 112 4. Letter to Alfred Hayes ( 1 9 6 1 ) ....................................................... 114 5. L etter to H enry A lexander (1 9 6 1 ).................................................116 6. “ Money W ill Not M anage I ts e lf ’ ( 1 9 6 3 )................................... 120 Chapter 5 Deposit Interest Rate Ceilings In tro d u c tio n .............................................................................................129 1. L etter to Alfred Hayes ( 1 9 6 0 ) ....................................................... 131 2. L etter to Alfred Hayes ( 1 9 6 0 ) ....................................................... 133 3. L etter to Alfred Hayes ( 1 9 6 6 ) ....................................................... 135 4. E xcerpt from “ C oordination of Economic Policy” (1966) . . . 139 Chapter 6 Federal Reserve Structure and M onetary Policy In tro d u c tio n .............................................................................................141 1. S tatem ent on Federal Reserve “ Independence” ( 1 9 5 2 ) .........143 2. “ Reflections of a C entral B anker” (1 9 5 5 ) ................................. 149 3. L etter to Alfred Hayes ( 1 9 5 8 ) ....................................................... 165 4. L etter to Alfred Hayes ( 1 9 5 8 ) ....................................................... 168 5. L etter to Alfred Hayes ( 1 9 5 8 ) ....................................................... 170 6. Statem ent on the R eport of the Commission on Money and Credit (1961)............................................................171 VI Chapter 7 Foreign Aid In tro d u c tio n .............................................................................................185 1. L etter to Alfred Hayes ( 1 9 6 0 ) ....................................................... 187 2. “ India and Pakistan: Critical Testing G round of Foreign A id” ( 1 9 6 0 ) ..............................................................188 3. Statem ent on Foreign Aid (1 9 6 3 ) ................................................. 198 Chapter 8 International Financial Problems In tro d u c tio n .............................................................................................205 1. “ G old, M onetary M anagem ent, and the B anking System” (1949)..................................................... 207 2. T alk to Wells Fargo B oard of D irectors (1 9 7 5 )........................ 221 3. T alk to Wells Fargo Board of D irectors (1 9 7 7 )........................ 227 4. T alk to W ells Fargo B oard of D irectors (1 9 7 7 )........................ 230 Portfolio of Photographs of Allan Sproul and his handw ritten notes about an offer of the presidency of the W orld B a n k ..........................................148-149 VII Preface J L h e im petus for this volume to honor the memory of Allan Sproul cam e from Paul A. Volcker. As a young econom ist in the early fifties, M r. Volcker worked at this B ank und er M r. Sproul. He rem ained in touch with him after he, in tu rn , becam e the B an k ’s President in 1975. Preparation of the volume, und er M r. V olcker’s direction, was initiated several m onths before he was appointed C hairm an of the B oard of G overnors of the Federal Reserve System. M any people contributed to the p reparation of this book. The Bank is particularly indebted to Lawrence S. R itter, Professor of Finance at New York University, who m ade the final selection of the m aterial to be included, edited where necessary, and arranged the papers. He wrote the introductory biographical sketch of M r. Sproul and the chapter in troductions. In the process of gathering inform ation for the introductory biography, Professor R itter was generously assisted by several people whose help was invaluable. They include Charles A. Coombs, R obert V. Roosa, R obert G. Rouse, W illiam F. T reiber, and Thom as O. W aage, all of whom had been colleagues of M r. Sproul at this B ank; R ichard P. Cooley, C hairm an of the B oard, W ells Fargo Bank; M urray J. R ossant, D irector, The Tw entieth Century Fund; and last, b u t by no m eans least, M ary C. Regan, M r. Sproul’s secretary at the Federal Reserve Bank of New York for twenty-five years. Carl W . Backlund, Chief, Central Records and Archives Division of this B ank, undertook the initial sifting and winnowing of the large volume of M r. S proul’s p ap ers—including his speeches, articles, C on gressional testim ony, internal m em oranda, and letters. Stephen V.O . Clarke, Research Officer and Senior Econom ist, then reduced this m aterial to m anageable proportions, organized it in term s of subject m atter, and m ade a prelim inary selection of papers for inclusion in the book. To all of them , we owe a deep debt of gratitude. A nthony M. Solomon President Decem ber 1980 IX Foreword A M ■Lllan Sproul was the th ird chief executive officer of the Federal Reserve B ank of New York, having been its President from January 1941 until he retired in June 1956. He cam e to this Bank as Secretary in 1930, after serving during the twenties at the Federal Reserve Bank of San Francisco. His interest in public policy and central banking was lifelong. Those who knew him were invariably im pressed with the b readth of his vision com bined with technical com petence, the strength of his convictions com bined with a grace and tem perance in intellectual com bat, the sense of dignity and position com bined with a w arm th of personal friendship. D uring his presidency of the “ New York F ed” , he stim ulated a whole generation of Federal Reserve officials to find their careers in central banking and related professions, fostering m onetary stability in this country and international economic cooperation. T hroughout his “ retirem ent” , he continued to support those causes, con sulting with those from Presidents on down who sought his judgm ent. The volume of his w ritings—published and unpublished—bears testim ony to the scope of his interests and the quality of his thought. A representative selection from these w ritings is of more th a n historical interest, and a fitting m em orial for a great central banker. Paul A. Volcker Decem ber 1980 XI Chapter 1 Allan Sproul 1896-1978 “A Tower of Strength” A M m l l a n Sproul, president of the Federal Reserve B ank of New York from 1941 to 1956 an d one of history’s m ost talented central bankers, died in California on April 9, 1978, at the age of eighty-two. His passing was widely m ourned, even though he had been in sem iretire m ent for over two decades, for few who h ad come in contact with him ever forgot him . He m ade an im posing first im pression: in his prim e a ruggedly built 200-pound bear of a m an, somewhat under six feet tall, with a disarming smile and a vigorous tone of voice. “ He looked as solid” , someone once said, “ as the Federal Reserve Bank itself.” However, it was his intellectual vitality th a t m ade a m ore lasting im pression on those who got to know him for any length of tim e. He had a finely honed sense of hum or and an almost instinctive feel for the English language—an uncanny ability to turn a phrase with style and grace. These qualities, combined with a deep devotion to what might be called oldfashioned ideals and principles, including the work ethic, made him a for midable adversary. A voracious reader, especially of classical literature, history, and biography, he was constantly bringing his learning to bear on current policymaking problems, constantly searching for general prin ciples th at might help explain current developments by putting them in perspective against the broad sweep of history. Nor did this change in the twenty-two years following his prem ature retirem ent from the Federal Reserve Bank of New York in 1956, at the age of sixty. For central banking was more than a vocation to him —it was a passion, and it rem ained so until the very day of his death. 1 The pride he took in his profession, which he was usually too reserved to show, was inadvertently revealed during Hearings of the Senate Committee on Banking and Currency in 1945. Senator Tobey, intending to be complimentary, said at one point: “You are approaching this thing as a ban k er, as you should, backed by all the conservatism and good ju d g m ent th a t you have acquired by years of experience.” But Sproul was m ore irritated th a n flattered. “ I appear here not as a b a n k e r,” he responded, “ b u t as a central banker. There is quite a dis tinction. I have no years of conservatism behind me. I have years of try ing to improve and develop and liberalize the functioning of the dom estic and international banking m achinery.” 1 Allan Sproul was born in San Francisco on M arch 9, 1896, the sec ond son of R obert and Sarah E lizabeth Sproul. His father had been born in Scotland and em igrated in the 1880s to California, where he found em ploym ent as a freight auditor for the Southern Pacific R ailroad. His older brother, R obert G ordon, born in 1891, rose to the presidency of the University of C alifornia, a position he held from 1930 until his retirem ent in 1958. Like his b rother, Allan always considered him self a C alifornian, despite the q u arter century he spent in the New York financial com m unity. New Y ork was challenging and exciting, b u t it was never hom e. A llan’s youth and early adulthood were spent alm ost entirely in the San Francisco Bay A rea. He went to elem entary school first in San Francisco and later in Berkeley, after the family moved across the Bay, and in due course attended high school there and then the University of C alifornia at Berkeley. His college career was interrupted by A m erica’s entrance into W orld W ar I. He prom ptly enlisted in the Army Air Force and excitedly learned to fly rickety fighter planes at M ather Field near Sacram ento— a b are fourteen years after the W right B rothers’ first flight at K itty Hawk in 1903. “ Aviation used to have a chivalrous asp ect,” he recalled years later. “ W e flew by feel and touch, enjoying the rush of wind in our faces. Now I look at the instrum ent panels in airplanes and w onder how we ever did it.” 2 1 United States Senate Committee on Banking and Currency, Hearings on Bretton Woods Agreements Act (June 21, 1945), p. 310. 2 The Fed, Federal Reserve Bank of New York (September 28, 1955), pp. 7-8. 2 He arrived in E ngland with his squadron late in 1918, b u t hostilities ended before he flew any com bat missions. The war over, he returned to th e University of C alifornia and g rad u ated in 1919 with a degree in agriculture. He went to work briefly with the C alifornia Packing Com pany, which dealt in farm produce, and then as an agricultural adviser for two sm all b an k s in S outhern California. In 1920, however, he ac cepted a position as head o f the research departm ent at the Federal Reserve B ank o f San Francisco, thereby beginning a career in the Federal Reserve System th a t would last for thirty-six years. Given his background, how did he get such a job in the first place? Fortunately, Sproul’s own recollections o f his start in the Federal Reserve System have been preserved in the form of a tran scrip t of an after-dinner talk he gave in San Francisco in 1976, shortly after his eightieth b irth d ay :3 This will not be one o f my offbeat reports on the elusive aspects o f dom estic m onetary and fiscal policies, nor on the m ore intricate aspects of th e in ternational m onetary system. I th o u g h t a personal m em oir on th e triu m p h of serendipity (discovering by chance things one has not sought) over ra tional determ ination in finding and following a career w ould be m ore in keeping with th e occasion. About fifty-six years ago, I entered the fringe of banking. I h ad recently been graduated from the College of Agriculture at the University of California at Berkeley, clutching a B.S. degree in pomology, which is fruit growing for those of you whose Latin is a little rusty. I had learned one thing, at least, in earning my degree. I was not cut out to be a farmer. Fortunately, as things tu rn ed out, a friend of m ine had recently becom e assistant to the chairm an of the fledgling F ederal Reserve B ank of San Francisco. He allowed him self to be deceived into thin k in g I m ight know som ething about ban k in g because I was tem porarily m asquerading as a bank agriculturalist at two small b anks in Southern California, am ong th e orange an d lem on groves and w alnut orchards. He lured me away from th a t rural scene with the offer of a 3 Talk at Wells Fargo Bank Directors Dinner, April 19, 1976. 3 job as head o f th e Division of Analysis and Research at the Reserve B ank. It really d id n ’t m atter to him , nor to me, th at I knew little about b anking and nothing about central b anking. In fact, I did not know w hat a central b an k was, which is not so strange as it m ight now seem. No one else hereabouts knew m uch about central ban k in g then, and even now not m any people know w hat it is all about. All th a t I really had to do, to get started, was to develop a nascent facility for assem bling facts an d figures, and for presenting them to my superiors in readable fashion and, through them , to the F ederal Reserve B oard a t W ashington, concerning agricultural, business, and credit conditions in the seven W estern states which then com prised the Twelfth Federal Reserve D istrict. Now, with greater sophistication and with the w orkings of P ark in so n ’s Law, squadrons of people and phalanxes o f com puters do the sam e thing. Later, I becam e the assistant to the chairm an and Secretary o f the B ank, which enabled me to hire the equivalent of a couple of present-day M .B .A .s to do the analysis and research, while I devoted myself to learning how policy is m ade, an d other loftier pursuits. This includ ed m aking the acquaintance o f some notable San F ra n ciscans who were directors of the B ank. My most rewarding contact, however, was with my im mediate boss, John Perrin, the chairm an of the board, which was then a full-time job. He was a testy old gentleman about ten years younger than I am now, who had come out of retire m ent to help get the Reserve System started. He had a real in terest in developing the art of central banking, and he dem anded th at I become a serious student of the occult call ing. He also dem anded th at I pay scrupulous attention to the niceties of the English language. It was not always an easy relationship, but it was a rewarding one. 4 S proul’s position as Secretary of the San Francisco B ank, which he assum ed in 1924, entailed occasional cross-country trips to W ashington for m onetary policy conferences. At those m eetings his abilities a t tracted th e attention of B enjam in Strong, head of the Federal Reserve B ank o f New Y ork, and George L. H arrison, Strong’s deputy. Early in 1928, H arrison, on S trong’s behalf, discreetly sounded out the young Californian: would he be interested in transferring to the Federal Reserve B ank of New Y ork? A lthough Sproul was intrigued by th e possibility of w orking in the natio n ’s financial center, he was reluctant to leave the W est Coast. In 1921 he h ad m arried M arion Bogle. They h ad m et as classm ates at the U niversity of C alifornia, and by 1929 they had three sons— A llan, Jr., G ordon, and D avid— and were happy in th eir Bay A rea hom e. Late in 1928 B enjam in Strong died b u t H arrison, his successor as head of the New Y ork B ank, continued to renew the invitation. W ith Sproul hesitant an d H arrison persistent, negotiations dragged on for over a year. Finally, in 1930, with the stock m arket in disarray and the economy sliding downhill, th e opportunity to get into the thick of things becam e too tem pting to tu rn down any longer: the 33-year-old Sproul accepted H arriso n ’s offer and b rought his family east. T he thirties were years of desperation and frustration for most A m ericans, b u t for A llan Sproul they were years of developm ent and grow th. He joined the New Y ork B ank on M arch 1, 1930, spent his first few years as Secretary, the sam e position he had held at the San F ra n cisco B ank, and was assigned to the foreign departm ent. In the latter role he began to get deeply involved for the first tim e in international m onetary affairs, an area th a t soon fascinated him and was to rem ain a m ajor interest th ro u g h o u t his life. The old international financial order was collapsing, an d repeated efforts to prop it up were proving fruitless. Along with H arrison, Sproul p articipated in international m onetary conferences and cam e to know m any of his counterparts abroad, including the fabled M ontagu N orm an, long-tim e head of the B ank of E ngland. He also cam e to know Professor John H. W illiam s of H arvard University, a m an whose advice and counsel he grew to value im m ense ly. W illiam s becam e an officer of the Federal Reserve B ank of New Y ork in the early thirties, and continued as such for over three decades, all the while retaining his professorship a t H arvard. Nine years Sproul’s senior, W illiam s was a world-renow ned authority on international 5 finance, com bining theoretical expertise with a bent for the p ra cti calities of the everyday world. There developed between them a m utual respect and fondness th a t ripened with the years. At first with W illiam s as teacher and Sproul as pupil, and later as equals, the two conducted a continual dialogue on international finance—in corridors, over lunch, after business h o u rs—th a t lasted for m ore th a n twenty years. In 1934 Sproul becam e H arriso n ’s assistant, a newly created posi tion; w hat H arrison had been to Strong, Sproul now becam e to H a r rison. In 1936 he was prom oted again, this tim e to first vice president. In Septem ber 1938, however, W . R andolph Burgess accepted an offer to becom e vice chairm an of the N ational City B ank of New Y ork and resigned as m anager of the System O pen M arket A ccount, a position in which he h ad been responsible for conducting open m arket operations on b eh alf of the entire Federal Reserve System under the direction of the Federal O pen M arket Com m ittee. Sproul was rushed into the gap and, while rem aining first vice president, spent the next fifteen m onths conducting the F ederal Reserve’s open m arket operations— an ex perience th a t, although he could hardly know it at the tim e, would stand him in good stead not too m any years later. Shortly thereafter, in 1940, George H arrison decided to call it a day. W ith the enactm ent of the B anking Act of 1935, which H arrison had not favored, the balance of power in the Federal Reserve began shifting from the n atio n ’s financial capital to its political capital. The New York B ank no longer dom inated the System, as it had in the heyday of B en jam in Strong, and H arrison chafed u n d er w hat he considered undue in terference from W ashington. In addition, he had never gotten along with the peppery M arrin er Eccles, since 1934 chairm an of the Board of G overnors in W ashington and principal architect of the B anking Act of 1935. Friction between them h ad only increased with the passage of tim e. T hus after twelve years at the helm George H arrison resigned in 1940, at the age of fifty-three, to becom e president of the New York Life Insurance Com pany. The m an chosen to replace him was the m an he him self had persuaded to leave C alifornia a decade earlier. O n January 1, 1941, A llan Sproul becam e the th ird president of the F ederal Reserve B ank o f New York and shortly th ereafter vice ch air m an of the Federal O pen M arket Com m ittee, the System’s m ain policym aking body. Sproul h ad hardly assum ed his new positions before he becam e im m ersed in the com plexities of war finance. Early in 1942 the Federal Reserve, after consultation with the T reasury, announced th a t it would assure am ple funds for the w ar effort by m aintaining a fixed p attern of 6 interest rates on G overnm ent securities for the d u ra tio n —ranging from 3 /8 percent on three-m onth T reasury bills to 7 /8 percent on one-year certificates, through abo u t 2 percent on ten-year bonds, and on out to 2Vi percent on the longest m arketable issues. The purpose of m ain tain ing a fixed p attern of rates was to m ake clear to potential buyers th a t they h ad nothing to gain by postponing purchases of G overnm ent securities, since none would be issued later at higher yields. The yield p attern would be m aintained, of course, by the Federal Reserve itself acting as a residual buyer, thereby keeping securities prices from fall ing and interest rates from rising. Both Eccles and Sproul preferred higher rates at the short end th a n 3 /8 percent an d 7 /8 percent, feeling th a t the spread between short and long rates was too great. Nevertheless, with the country at war, the System, u nder pressure from Secretary o f the T reasury Henry M orgenth a u , Jr., h ad no choice b u t to agree to th e details o f the program . As Eccles and Sproul h ad w arned, however, the excessive spread resulted in m ost of the short-term securities eventually being dum ped on the Federal Reserve, while ban k s and others held the higher yielding long term issues instead. Looking back, several years later, Sproul w rote:4 If m istakes were m ade in this period, as they were, the principal one was the too rigid m aintenance of the pattern of rates and unwillingness to let the short rate fluctuate (rise) som ewhat. A m odest rise in short-term rates could have fu rth er m obilized unused reserves in banks outside the money centers and in the h ands of nonbank investors; would have tak en account of th e fact th a t as the w ar pro gressed the am ount of idle funds declined, dem ands grew, and stability of long-term rates becam e accepted; would have narrow ed the spread between short and long rates and the consequent riding of the p attern ; and m ight have preserved a slight b u t healthy degree of unpredictability in the short and interm ediate rate area. Since some movem ent of short rates could probably have taken place w ithout m uch, if any, overall increase in cost to the T reasury and w ithout disturbing the m aintenance of long rates, it was and is difficult to justify dogged adherence to a “ fixed” rate p attern , b u t th a t was th e final decision of the war period. 4 Allan Sproul, “Changing Concepts of Central Banking”, in Money, Trade, and Economic Growth„ Essays in Honor of John Henry Williams (New York: Macmillan, 1951), pp. 304-5. 7 In general, the w ar was financed m ore by the creation of new money th a n Eccles or Sproul th o u g h t advisable or necessary, resulting in the build u p of an inflationary potential th a t was to cause grave problem s after th e cessation of hostilities. In his 1951 autobiography, Eccles recalled th a t Sproul was “ particularly helpful and constructive” in devising less inflationary m ethods of w ar finance— m ost of which, u n fortunately, were not adopted by the Treasury. “ W e som etim es disagreed over policy m a tte rs,” Eccles said of Sproul, “ b u t our differences were never m arked by personal acrim ony. Sproul was an d is first and forem ost a representative of the public in terest. He has been and is a tower of strength in the Reserve System .” 5 As the w ar gradually tilted in the Allies’ favor, Sproul began to devote m ore of his attention to the num erous plans th a t were in the air for postw ar dom estic and international economic reform . For the most p art, he was against them . In 1945 he wrote to the Senate B anking and Currency C om m ittee opposing the Full Em ploym ent Act, expressing concern with respect to excessive G overnm ent interference in the economy: “ Just as there seems to be a lim it of tolerance of the woes and evils of altern ate boom and depression, there is probably also a lim it of tolerance of G overnm ent intervention in w hat we call private en ter prise, if it is to rem ain private en terp rise.” 6 He was also skeptical about the proposed In ternational M onetary Fund (IM F), believing it to be prem ature and self-defeating, and caused som ewhat of a stir when alone am ong Federal Reserve officials he testified in th a t vein before the Congress in 1945. But he endorsed its com panion In tern atio n al B ank for R econstruction and D evelopm ent (the W orld B ank), viewing it as a m ore ap p ropriate vehicle for easing the severe dislocations in the im m ediate postw ar period. Som ething like the IM F, he suggested, would be b etter left until a postw ar transition period h ad enabled the world economy to get on its feet again, at which tim e exchange rates could be established on a m ore realistic basis. Even th en , he felt, the in ternational financial system would be b etter served by agreem ents am ong the principal trad in g and financial nations, with the sm aller countries adapting to those agreem ents, ra th e r th an in a forum th a t p erpetuated the illusion th a t all nations are equal insofar as in ternational com m erce is concerned. To him , the “ dem ocratic” organizational structure of the IM F all b u t 5 Marriner Eccles, Beckoning Frontiers (New York: Knopf, 1951), pp. 363-64. 6 United States Senate Committee on Banking and Currency, Hearings on Full Employment Act o f 1945, p. 1219. 8 g u aran teed “ a diffusion of authority and responsibility which is alm ost fa ta l” .7 In fact, the IM F tu rn ed out to be far more successful th an Sproul h ad expected, as he later adm itted, and he eventually becam e an advocate of m any of its ten ets—although never of its organizational structure. O ne of the features of the IM F th a t particularly appealed to him was the relative stability of exchange rates th a t it fostered. (His earlier opposition was partly because he th o ught its ch arter encouraged excessive rate flexibility.) Floating exchange rates, cham pioned by m ost academ ic econom ists, left him unim pressed. He viewed floating rates as an im pedim ent to the free flow of international com m erce and a spurious solution to the underlying dom estic problem s they were sup posed to resolve; by helping nations postpone the h ard decisions they often h ad to m ake to live within their m eans, floating rates frequently m ade m atters all the worse. Indeed, he was frequently at odds with the conventional wisdom of econom ists, and over the years found him self in w hat can only be described as a love-hate relationship with economic theory. He adm ired and respected econom ic analysis th a t was firmly grounded in reality, and for th a t reason built up the research d ep artm en t of the Federal Reserve B ank of New Y ork to the point where its prestige rivaled th a t of the economics d epartm ents of the top universities. It was by far his favorite d ep artm en t in the B ank, the one where he felt m ost at hom e. It was not unusual for him , after reading a m em orandum prepared by an econom ist in the research departm en t, to am ble down to the surprised m em o-w riter’s office for a chat about the issues involved. Y ears later, speaking before the A m erican Econom ic A ssociation and the A m erican Finance A ssociation in 1966, he recalled those days:8 Paul Sam uelson once said th a t the econom ists of the Federal Reserve System h ad only one idea, which he d id n ’t th in k was enough, although he said they were b etter th an the econom ists of the B ank of E ngland who had only h a lf an idea. T h at is funny b u t not factual. At the Federal Reserve B ank o f New Y ork we were draw ing on some of the best econom ic brain s com ing out of H arv ard — and other in stitu tions of higher learning—before the governm ent at 7 Talk at Board of Directors meeting, Wells Fargo Bank, August 16, 1977. 8 Allan Sproul, “Coordination of Economic Policy” , Journal of Finance (May 1967), pp. 137-38. 9 W ashington fully w aked up to the possibilities of such recruitm ent. The “ Age of th e E conom ist” , which W alter H eller hailed in his G odkin lectures at H arvard this spring, cam e early to the New Y ork Reserve B ank. Ideas flowed freely, balances governing problem s of choice were struck by econom ists “ in term s a decision m aker could sink his teeth in to ” , and I was a beneficiary of this sort of fruitful collaboration for m any years. I miss it. At the sam e tim e, he was im patient, even disdainful, of idealized abstractions, no m atter how finely spun, th a t he felt neglected the nuances an d com plexities of the real world. T he intim ate fam iliarity he had developed with the foreign exchange m arkets when he was in the foreign d ep artm en t in the early thirties, and with the dom estic money an d capital m arkets when he m anaged the Federal Reserve’s open m arket operations, left their m ark in the form of a lasting u n d e rsta n d ing of and respect for the m any ways financial m arkets function and evolve. As a result of these experiences, he grew increasingly restive with m uch of form al econom ics, feeling th a t it ignored or m isconstrued m ark et realities and was therefore a naive (and often m isleading) guide to public policy. O nce, w riting from retirem ent in C alifornia to a young form er col league still at the New Y ork Federal Reserve B ank, he expressed th a t skepticism in his typical pungent fashion. R eferring to a m utual ac quain tan ce who h ad p u t forth certain proposals with respect to m onetary policy, he w rote:9 . . .he has a strong tendency tow ard cosmic thinking and m etaphysical round ab o u ts. B eneath all of the wordy em broidery he is really distrustful of the money m arket and the people who operate it. . . .This is a legacy, perhaps, of a fund am en talist religious slant as b ent and twisted by the University of Chicago, b u t it is also a consequence of his having h ad no experience in a money m arket. W hatever your own fu tu re may be, I th in k you can be th ankful th a t, at one stage, you had to rub your nose in the m arket. 9 Letter from Sproul to Robert V. Roosa, April 27, 1959. 10 W orld W ar II h ad hardly ended before Allan Sproul faced a difficult decision. In 1946 he was offered the presidency of the W orld B ank, and he and M arion spent weeks agonizing over w hether or not he should ac cept it. As usual, he wrote down all the argum ents, pro and con, on a legal-sized yellow p ad before com ing to a final decision. Long ago, he had found th a t the best way to crystallize his thoughts was on paper, so th a t whenever he faced a com plex or difficult problem , professional or personal, he would sit at his desk and m ethodically write down the issues, point by point, before m aking up his m ind. Finally, he decided to rem ain at the Federal Reserve B ank. His notes m ention, am ong other things: “ A pproaching critical opportunity in life of FR System and would like to play out th a t strin g .” Also: “ The W orld B an k ’s operations may well be m ore political (in broad sense) th an economic. I do not like and am not too good at the sort of politicoeconomics and politico-adm inistration which seems inevitable.” 1 0 He could not have been m ore correct in his assessm ent th a t the Federal Reserve indeed faced a critical ju n ctu re in its history, a crossroads th a t was to have m ajor im plications for its fu ture role in the economy. B ut little did he realize how “ political” the entire m atter would becom e—h ad he known, he m ight well have chosen the W orld Bank! W ith the w ar over, m any in the Federal Reserve felt the tim e had come to begin term in atin g the interest rate pegs th a t had been m ain tained since 1942. By standing ready to buy securities at any and all tim es solely to keep th eir prices from falling and yields from ris ing—buying at the m ark et’s initiative ra th e r th an its own—the central b an k h ad lost control over b an k reserves and the money supply. It had becom e, in M arrin er Eccles’ fam ous words, “ an engine of inflation” . T he Treasury, however, saw things in a different light: tighter money and higher interest rates would raise the cost of servicing a swollen F ederal debt an d m ight possibly precipitate another depression. W hy not, therefore, continue to keep money am ple and interest rates low? It was not until m id-1947 th a t the F ederal Reserve was able to secure T reasury perm ission to remove the 3 /8 percent peg on T reasury bills, and then the 7 /8 percent peg on certificates. The 2 Vi percent long rate rem ained sacrosanct, even though a Congressional subcom m ittee chaired by Senator D ouglas, after exploring the controversy, recom m ended in January 1950 th a t th e Federal Reserve, not the Treasury, should be responsible for and determ ine m onetary policy. 1 Sproul handwritten notes, “Considerations Involved in Offer of 0 Presidency of World Bank” , dated December 22, 1946, Federal Reserve Bank of New York. 11 B ut the D ouglas C om m ittee’s recom m endations only heated up the dispute. U nconvinced, Secretary of the T reasury John W . Snyder con tinued to insist on having the final say in m onetary m atters, a final say th a t effectively aborted anti-inflationary actions by the central b ank. The controversy cam e to a head on W ednesday, January 31, 1951, when P resident T ru m an asked the m em bers of the Federal O pen M arket C om m ittee (of which Sproul was vice chairm an) to m eet with him at the W hite House. O n T hursday and Friday the press was in form ed through W hite House and T reasury sources th a t at W ednesday’s W hite House m eeting the Federal Reserve had agreed to the P resid en t’s request to support G overnm ent securities prices and to m aintain stable interest rates. This was at variance with the O pen M arket C om m ittee’s im pression of w hat h ad occurred, and to set the record straig h t M arriner Eccles, over the weekend and on his own in itiative, hastily released to the press the Federal Reserve’s m em oran dum of w hat h ad tran sp ired . Eccles clearly exceeded his authority in taking it upon him self to release the Federal Reserve’s version of the W hite House m eeting. He was still a m em ber of the Board of G overnors and of the O pen M arket Com m ittee, b u t no longer chairm an (having been relieved of th a t posi tion in 1948 by President T ru m an and replaced by T hom as B. M cCabe). N orm al procedure would have been to wait until the w eekend h ad passed and leave the decision to C hairm an M cCabe and the full Board. W h at followed im m ediately thereafter was related by Eccles in his au tobiography:1 1 By M onday m orning the fat was in the fire. R ather th an w ait for the scheduled m eeting on February 13, M cCabe called the O pen M arket Com m ittee to meet on the next day, Tuesday, F ebruary 6. The purpose was to consider w hat should be done in view of the weekend developm ent. W ith the exception of A llan Sproul, no one at the m eeting either approved or criticized my action in releasing the m em oran dum . Sproul expressed the view th a t w hat goes on at a P residential conference should not be disclosed until the President gives it out, b u t when the P resident does th a t he should give an accurate report of w hat has happened. It was 1 Eccles, op. cit., p. 497. 1 12 the B oard’s m em orandum th a t accurately represented what was actually said and the spirit in which it was said. For this reason, Sproul continued, he was glad I had taken in dividual action in releasing the m em orandum ; it tem p o rari ly retrieved our place in the financial com m unity and with the public. In my reply I expressed regret th a t the situation had developed to the point where releasing a confidential docu m ent seemed absolutely essential. I purposely avoided tell ing anybody w hat I was going to do because I did not want to involve anyone else in any way. At Sproul’s suggestion, the O pen M arket C om m ittee thereupon agreed th a t letters would be drafted to President T rum an and Secretary of the T reasury Snyder to get the issue back on an official basis. L ater in the week M cCabe and Sproul, as chairm an and vice chairm an of the O pen M arket Com m ittee, m et with leaders of the Senate B anking and Currency C om m ittee and of the Joint Econom ic Com m ittee, all of whom advised, in Sproul’s words, “ th a t it was no tim e for feuding and no tim e for a Congressional hearing, b u t a tim e for the T reasury and the Federal Reserve to try again to com pose their differences” . 1 2 Several weeks of difficult negotiations followed, including another m eeting of M cCabe and Sproul with the President on February 26. However, on M arch 4, 1951, the T reasury-Federal Reserve “ A ccord” was finally announced. T he effect of the agreem ent was to restore the independence of the Federal Reserve to pursue flexible m onetary policies for the first tim e since 1942. Purchases of short-term securities were prom ptly discontinued and, although the Federal Reserve con tin u ed to buy longer issues for a b rie f period, they were bought at gradually declining prices (gradually rising yields) and in a few m onths ceased altogether. The pegged 2 V2 percent long rate had finally passed into history. But, if Allan Sproul th o u g h t th a t the A ccord m eant th a t his unwill ing involvement in “ politico-adm inistration” was over, and th a t the painful stom ach ulcers he h ad acquired would now subside in a period of goodwill and tranquillity, he was sadly m istaken. 1 Allan Sproul, “The ‘Accord’—A Landmark in the First Fifty 2 Years of the Federal Reserve System” , Monthly Review of the Federal Reserve Bank of New York (November 1964), p. 231. 13 Shortly after the Accord, T hom as M cCabe resigned as chairm an of the B oard o f G overnors an d was replaced by W illiam M cChesney M ar tin, who until then h ad been assistant secretary of the T reasury. In July 1951 M arrin er Eccles also resigned, after m ore th a n sixteen years on the B oard, to retu rn hom e to U tah . As the O pen M arket C om m ittee began to grow fam iliar with conducting open m arket operations freely once again, it appointed an Ad Hoc Subcom m ittee to explore the func tioning of the G overnm ent securities m ark et and to exam ine its effec tiveness as a conduit for central b an k policies. T he Ad Hoc Subcom m ittee subm itted its report late in 1952. Its principal findings were th a t the G overnm ent securities m arket lacked sufficient “ depth, b read th , and resiliency” to be an effective tra n s m ission m echanism for the im plem entation of m onetary policy and th a t these characteristics should be im proved and strengthened. To ac com plish those ends, it recom m ended th a t henceforth the Federal Reserve confine its open m ark et operations strictly to Treasury bills, except to correct disorderly m ark et conditions. In Septem ber 1953, after a b itte r nine-m onth b attle w ithin the O pen M ark et Com m ittee, the “ bills only” policy was duly adopted as operating procedure for the conduct of open m arket operations. The vote was nine to two, with A llan Sproul leading the opposition. The m ajority position was th a t the constant th re a t of Federal Reserve open m ark et intervention th ro u g h o u t the m aturity structure introduced a capricious elem ent th a t prevented the G overnm ent securities m arket from functioning as well as it m ight. A policy of m inim um in ter vention— confining open m ark et operations to Treasury bills—would perm it the m ark et to grow and develop and thereby enable it to reflect m ore accurately underlying supply an d dem and forces. “ Bills only” would not h am p er th e effectiveness of m onetary policy, because an in itial change in short-term yields would soon spread over the entire m aturity range thro u g h the m a rk e t’s own arbitrage. In fact, it would enhance the effectiveness of m onetary policy, because the greater the “ depth, b re a d th , and resiliency” of the m ark et the m ore prom ptly changes in yields at the short end would spread throughout the m a tu ri ty structure. Sproul argued vehem ently against this position on the grounds th a t with experience the m ark et would grow and develop on its own, learn ing by itself how best to ad ap t to open m arket operations in all areas. Confining operations to T reasury bills could on occasion reduce the effectiveness o f m onetary policy because changes in short-term yields 14 do not always spread to other sectors speedily enough. W hen in term ediate and longer yields respond sluggishly, some direct operations in longer issues may be necessary to sta rt them moving or to keep them moving once they have started. O ther issues com plicated the debate an d gave it an em otional u n d er tow th a t perhaps dragged the leading p articipants fu rth er th an they h ad originally intended. O ne was the trad itional suspicion between W ashington and New Y ork, a tug-of-w ar th a t had considerable prec edent in Federal Reserve history. The very appointm ent of the Ad Hoc Subcom m ittee, in S proul’s words, “ h ad been conceived by m em bers of the staff of the B oard of G overnors (and of the O pen M arket C om m it tee) who not only were interested in the operation of the G overnm ent securities m arket as a channel through which to reach and regulate the reserve position of the m em ber banks, b u t who also were dissatisfied with the perform ance of the m anagem ent of the System O pen M arket A ccount at the Federal Reserve B ank of New Y ork and with the power d istribution involved in the linkage between policym aking by the F ederal O pen M arket C om m ittee at W ashington and the execution of policy by the New Y ork B ank” . 1 3 As if th a t were not enough, a disagreem ent th a t began over practice soon took on the m antle of principle for both sides. T he m ajority spokesm an, W illiam M cChesney M artin, viewed m inim um interven tion (“ bills only” ) as the philosophical opposite of m axim um in ter vention (outright pegging of G overnm ent securities prices and interest rates, as h ad been the practice prior to the Accord). If m axim um in ter vention was b ad central banking, then m inim um intervention m ust be good central banking. W h at b etter way to prove th a t the Federal Reserve was no longer in the business of determ ining, fixing, or sup porting interm ediate and long rates th a n total abstention from those sectors? The im plication, which Sproul resented, was th a t anyone who op posed “ bills only” was somehow philosophically in league with the pro ponents of pegging and support operations. It was an im plication he found particularly odious, since he h ad been in the forefront of the Federal Reserve’s fight with the Treasury over th a t very m atter. Indeed, he found it ironic th a t he h ad to defend him self on this issue against M artin, who as assistant secretary o f the T reasury at the tim e had been 1 Allan Sproul, “Policy Norms and Central Banking” , Men, 3 Money, and Policy, Essays in Honor of Karl R. Bopp (Federal Reserve Bank of Philadelphia, 1970), pp. 72-73. 15 one of the T reasury’s chief representatives in the negotiations leading up to the Accord. F or Sproul also, the controversy took on broader significance. He felt th a t to replace the rigidity of m aintaining a p attern of rates with the rigidity of “ bills only” was only to move from one straitjacket to another. C entral bank in g cannot be reduced, he said, “ to an unchang ing form ula with ‘rules of the gam e’ which can be published, say, like the rules of b a se b a ll” .1 4 T here are no wholly “ free” money and capital m arkets so long as a central b an k exists and does its job under m odern conditions. T here m ust be private m arkets— unpegged m ark ets—the pulses of which can be taken in determ ining central b an k policy, b u t the actions of the central b an k , no m atter how or in w hat section of the m ark et they take place, will always be a m ajor influence on the private m arket and a m ajor factor in its expectations. T he search by a central b a n k for some m echanical guide to autom atic action, for some norm of behavior, in order to avoid the risks of fallible h u m an judgm ents, ends up as a form of self-deception. T he central b a n k should exert its influence on the cost and availability of capital an d credit openly and directly, as circum stances may require, in w hatever areas of the m arket it can reach. To do less is to abdicate a responsibility and to forfeit a power which has been g ran ted for public u se .1 5 The continual struggle was getting to him . His ulcers had becom e so b ad th a t it would tak e a week of m ilk and blan d foods following the tension of every O pen M arket Com m ittee m eeting before he began to feel well again. In D ecem ber 1954 he testified head-on against C hair m an M artin on the subject o f “ bills only” , before a subcom m ittee of the Joint Econom ic C om m ittee— a painful experience for a long-tim e organization m an who respected an d believed in the hierarchical stru c tu re of the Federal Reserve System. He was getting m ore public a tte n tion then he sought or felt com fortable with. 1 Allan Sproul, “The Federal Reserve System—Working Partner 4 of the National Banking System for Half a Century” , Banking and Monetary Studies (Irwin, 1963), p. 66. 1 Allan Sproul, Statement Submitted to the Royal Commission on 5 Banking and Finance, Ottowa, Canada, September 27, 1962, pp. 22-23. 16 Som etim e in 1955 he began for the first tim e to th ink seriously about possibly leaving the Federal Reserve System. It h ad been his hom e for thirty-five years, b u t things were no longer the sam e. W as the role he found him self playing helpful or h arm ful to the System’s objectives? P erhaps both he and the System would be b etter off if they parted? It took him a year to m ake up his m ind. W hen he finally did, in late April 1956, he called his senior colleagues into his office, one by one, and told them of his decision. None h ad h ad any p rior inkling of w hat had been going through his m ind. He then issued the following statem en t:1 6 It is with real regret th a t I have resigned my post as presi dent of the F ederal Reserve B ank o f New York. I have done so only because M rs. Sproul and I feel th a t personal needs and wishes can now tak e precedence over public duties. I have spent thirty-six years in the Federal Reserve System, all b u t ten of th em in New Y ork. For the last fifteen years an d a few m onths I have served as head of the New York Federal Reserve B ank and as vice chairm an of the Federal O pen M arket C om m ittee. I am grateful to the directors of the B ank and to my associates on the C om m it tee for having given me the opportunity to serve in these im p o rtan t posts. The p roper functioning of the Federal Reserve System is o f enorm ous im portance, not only to our economy b u t to the whole fabric of our com m unity life; the broadly based struc tu re of the System is an outstan d in g accom plishm ent of our dem ocratic an d federal governm ent. I have always been proud th a t I have been able to play a p a rt in the form ulation and execution of the System ’s policies during critical years of war and peace. I expect to continue to be one of the System’s firm est friends after I sever my form al connection with it. I have no im m ediate plans for the future beyond re tu rn ing to C alifornia an d reestablishing my hom e there, with th e hope th a t the opportunities for enjoying the pleasures of fam ily life will be g reater th a n they have been in recent years. 1 Press Statement, Federal Reserve Bank of New York, April 30, 6 1956. 17 His resignation was effective June 30, 1956, and shortly thereafter he and M arion drove cross-country to the W est Coast. A fterw ard, he wrote back to a friend describing the exultation they both felt when they reached th eir hom e state. They m ade sure to note the exact tim e when they crossed the b order from N evada into California! The Sprouls settled in K entfield, a small com m unity in M arin Coun ty, some twenty miles northw est of San Francisco. Now he had tim e to rest, to unw ind, to reflect, and both of them had a chance to enjoy each o th er’s com pany once again. B ut retirem ent from the B ank, at the age of sixty, did not m ean in activity. A fter a while he becam e associated with the A m erican T rust C om pany— and later with the W ells Fargo B ank, after the two institu tions m erged in 1960—first as a director and then as a consultant. As p a rt of th a t association, he began m aking regular m onthly talks at directors’ m eetings on current m onetary and fiscal policies, in ter national financial affairs, and related subjects. He prepared for these as painstakingly as he h ad form erly prep ared for O pen M arket Com m ittee m eetings, researching m eticulously and w riting out everything beforehand. (He never spoke to any group extem poraneously, if he could avoid it.) These talks were so enthusiastically received th a t he continued to deliver them regularly until a couple of m onths before he died. W ith some leisure tim e at his disposal for a change, he also perm it ted him self the luxury of fully gratifying his desire to write. Always a prolific letter w riter, he now indulged him self, and regularly at length com m unicated his views on cu rren t econom ic developm ents to the host of friends and form er colleagues he h a d left behind on the E ast Coast. Typically, his letters were carefully tho u g ht through and com posed with a flair for expression th a t flowed w ithout seeming effort. In ad d i tion, he wrote a num b er o f articles on various aspects of central b a n k ing. However, to the very end he steadfastly refused all efforts to get him to w rite his m em oirs. N or did his career in public service come to an end. T hroughout the 1960s he served, from tim e to tim e, in an advisory capacity to various governm ental bodies and private public-interest organizations, such as the Com m ittee for Econom ic D evelopm ent and the Tw entieth Century F und. In early 1960 he traveled to In d ia and P akistan, as a m em ber of a three-m an com m ission appointed by the W orld B ank, to exam ine the role of foreign aid in the econom ic developm ent of those countries. 18 A nd in early 1961 he chaired a three-m an com m ittee, nam ed by then President-elect K ennedy, charged with advising the new adm inistration on m easures to strengthen both th e dom estic economy and this country’s balance-of-paym ents position. T he Com m ittee’s report, tran sm itted to President-elect K ennedy on January 18, 1961, was w rit ten jointly by all three m em bers (Roy Blough, Paul M cCracken, and Sproul), b u t it was not difficult to identify the one responsible for a prom inent section th a t recom m ended m ore flexible m onetary policies in term s of the range of open m ark et operations. T he following m onth, on F ebruary 20, 1961, the O pen M arket Com m ittee suddenly announced th a t it was discarding “ bills only” because of a conflict between dom estic objectives and balance-of-paym ents goals. C onfronted by a recession and a paym ents deficit, the Federal Reserve began to conduct open m ark et operations throughout the m atu rity structure, in an attem p t to lower long-term rates (to stim ulate dom estic business expansion) while sim ultaneously raising short-term yields (to prevent an outflow o f money m arket funds abroad). The ab andonm ent of “ bills only” in February 1961 tu rn ed out to be a p erm anent change in the conduct o f m onetary policy. At the tim e, however, it was not clear w hether th e change was perm anent or tem porary. In response to one of m any congratulatory messages, Sproul replied with a b rief note: “ As you surm ised, I am delighted th a t tim e an d circum stance have com bined to dem onstrate th a t it is folly to tie your hands with an inflexible rule. A lthough the boys are still talking about a retu rn to chastity when th e present com bination of dom estic recession and a balance-of-paym ents deficit is no longer with us, it will be h a rd to regain a state of virginity. I hope the idea will be allowed a quiet b u ria l.” 1 7 As the 1960s unfolded, he becam e increasingly concerned about A m erica’s involvement in V ietnam . In 1966 he wrote to a friend: “ I am glad th a t you have attain ed a certain status am ong the A dm inistra tio n ’s policym akers as an ‘objectionable ch aracter’—i.e. , one who does not accept the party line w ithout question. W ith respect to the dom estic econom ic situation— and the V ietnam w ar— I th ink they have backed into policies which they now do not know how to change, and have descended to calling those who disagree uncom plim entary n am es.” 1 8 1 Letter from Sproul to James Coggeshall, Jr., March 5, 1961. 7 1 Letter from Sproul to Murray J. Rossant, February 11, 1966. 8 19 As the w ar heated up, so did his feelings. “ I am so m uch against our involvement on the Asian m ain lan d ” , he wrote to a friend in 1968, “th at I place it at the core of much of our domestic and international political, social, and economic difficulties.” 1 9 His opposition to V ietnam was intim ately related to his long standing apprehension over the acceleration of inflation. A fter the war ended, his concern deepened over the ap p aren t incom patibility of high em ploym ent with price stability. He expressed his anxieties in letters in 1974 and 1975. I am not. . .sanguine about the present world m alaise, the principal outw ard m anifestation of which is worldwide inflation. In my m ore depressed m om ents I see the basic cause of persisting long-run inflation as being the infinite desires of hum an beings o u trunning their finite willingness to defer present consum ption for the sake of future benefits.20 As a person who was influenced by O rtega y G asset’s R evolt o f the M asses in his youth, I am beginning to have global forebodings. The essential principles of capitalism and of dem ocracy are on a collision course, although the tim e of final im pact approaches slowly. O r have I grown old and is my vision obscured? There h a sn ’t been a president of the U nited States I could be en thusiastic about since I p u t on long pants, although I did like K ennedy as a person!2 1 A nd, of course, he was indeed growing old, M arion as well. In the 1970s th eir health, which h ad not been robust, began to deteriorate fu rth er. Late in 1973 M arion entered the hospital for surgery; it was not successful, and she died on the operating table. They had been m arried alm ost fifty-three years. Afterward, he continued to work, but without the same enthusiasm. He lunched often with M arriner Eccles, who by then made his home primarily in San Francisco. They had always gotten along well personally, despite frequent doctrinal disputes, and their m utual friendship became even 1 Letter from Sproul to Robert V. Roosa, February 13, 1968. 9 2 Letter from Sproul to Robert V. Roosa, June 25, 1974. 0 2 Letter from Sproul to Robert V. Roosa, September 19, 1975. 1 20 warm er as they grew older. And he thought frequently of his years at the Federal Reserve Bank. “ One of the things in my life which I cherish m ost” , he wrote in a 1977 letter, “ is th at when I was at the Federal Reserve Bank of New York I earned the respect and became a friend of some younger men of superior ability who went on to great accomplishment.” 2 2 He gave his last scheduled talk to the W ells Fargo directors on F ebruary 21, 1978. Less th a n seven weeks later, on April 9, at the age of eighty-two years and one m onth, he died. Following M arion’s death, he h ad tho u g h t about ending his associa tion with W ells Fargo because it was too dem anding. However, he finally decided to continue because, as he wrote to a friend, “ keeping in touch with current economic developm ents will help me in m aking the adjustm ents to life w ithout M arion which I face. ‘W e have to struggle on, even if the idea of the ultim ate pointlessness of everything hovers on the edge of our thoughts, even if we know th a t there will never be a final answer to m an ’s questionings.’” 23 2 Letter from Sproul to Robert V. Roosa, March 16, 1977. 2 2 Letter from Sproul to Robert V. Roosa, January 26, 1974. 3 21 Chapter 2 Monetary Policy and Inflation T MLwo principal them es were never far from the surface of Allan S proul’s thinking from early in his career until the very end. O ne was the need to exercise hu m an judgm ent, with all its adm itted im perfec tions, in the conduct of m onetary policy. The other was the need to take m eaningful action, m onetary and otherwise, to prevent inflation. T his chapter contains six “ p ap ers” bearing on the subject of infla tion, spanning alm ost a q u arter century of his thinking (from 1951 to 1974). He was never insensitive to the attainm ent of other national economic objectives— such as high em ploym ent and balance-ofpaym ents equilibrium —b u t in his view the goal of reasonable price stability was generally at least as im p o rtan t as any other objective and frequently m ore so. Indeed, he felt th a t, w ithout price stability, the a t tain m en t of any other goals would be short-lived at best. To th a t end, he on occasion advocated selective controls over con sum er and m ortgage credit (as during the K orean war) and flirted from tim e to tim e with various form s of G overnm ent intervention in the w age-bargaining and price-setting process. M onetary and fiscal policy, he felt, had to be aided an d abetted by some form of “ incomes policy” — not as a substitute for m onetary and fiscal policy, b u t as a supplem ent—if there was to be any realistic hope of stopping the wageprice spiral. “ So far as G overnm ent is concerned,” he wrote to Secretary of the Treasury H enry Fowler in 1965 (in a letter reprinted below), “ I have always argued th a t the stool we use to get the most m ilk from the economic cow should have three legs—fiscal policy, m onetary policy, and wage-price policy.” 23 W hen he cam e right down to the point, however, he could never real ly settle on a satisfactory form th a t such w age-price intervention should take. A lthough he advocated an incomes policy in principle, he could never find a version in practice th a t would be effective and at the same tim e be consistent with the preservation of the economic and political freedom s he so greatly cherished. Because of this conflict, he was forever on the horns o f a dilem m a with respect to approval or disap proval of G overnm ent involvement in private wage-price bargaining and decision m aking. O f one thing, though, he was always certain: regardless of the stance of fiscal policy, or the presence or absence of an incomes policy, w ithout courageous m onetary policies there was no hope of stopping the m om entum of inflation. M onetary policy, by itself, m ight not be sufficient to do the job, b u t it was definitely a necessary com ponent of any genuine anti-inflationary policy. He could never take seriously anyone who urged an incomes policy as a su b stitute for a firm and vigorous m onetary and fiscal policy. As a general rule, the papers reprinted in each section of this book are presented in historical order. In this chapter, however, Sproul’s 1968 talk on “ M onetary Policy and G overnm ent Intervention” has been placed at the end o f the chapter, since it gives his views in depth and serves as a capstone to the four relatively short letters and one brief talk which precede it. M ore effective anti-inflationary m onetary and fiscal policies, he concluded, are not “ the narrow concern of m en who are m ore interested in financial sobriety th a n in social progress, m ore interested in the growth of our m aterial resources th a n in the im prove m ent o f our environm ent, m ore interested in money th an in people. These concerns are inextricably in tertw in ed.” 24 Letter to Winthrop W. Aldrich November 7, 1951 M r. W inthrop W . A ldrich, C hairm an The Chase M a n h attan B ank 18 Pine Street New Y ork 15, N.Y. D ear W inthrop: I have been thinking about your talk on inflation at A ustin, Texas, next week, and particularly about your statem ent th a t all th a t is needed is the courage to do the job. Perhaps I am a little sensitive on this point, having had some responsibility for m onetary and credit policy in the anti-inflationary struggle. At any rate I thought I would jot down some notes for your consideration. 1. Inflation can arise from a variety of causes even though the end result is too m uch money chasing too few goods. 2. Inflation can arise from the push of increased costs as well as from the pull of increased dem and. (a) It can hardly be avoided if wages often go up b u t never come down, an d if all the fruits of increased productivity go to favorably situated workers and stockholders, none to consum ers. A lthough our goal is a high level of em ploym ent, there m ust be the possibility of dism issal for the inefficient worker. Even full em ploym ent c an ’t and shouldn’t m ean security for everyone in his present job, or preferred work in the place where th e w orkers prefer to live. (b) Inflation will gain strength if we try to keep in efficient m anagem ent afloat, and in destructive com petition with efficient m anagem ent, by the use of G overnm ent or G overnm ent-guaranteed credit. T here m ust be th e possibility of b an k ru p tcy for the ineffi cient firm , large or sm all. 3. Inflation can arise from a farm price policy which m atches every rise in industrial wages and prices with increased support for farm prices. T h at is alm ost built-in inflation. 25 4. The principal elem ents of an anti-inflation pro gram in a country such as the U nited States are not unknow n. They em brace fiscal policy, debt m anage m ent, credit policy and, in tim e of w ar or great defense program s, such direct controls as will channel essential and scarce m aterials into defense produc tion, and prevent the developm ent or continuance of a wage-price spiral. All of these things m ust be w orking in the same di rection and tow ard the sam e end if there is to be any chance of success in an economy in which the m ainte nance of a high level of production and em ploym ent is necessary to meet our dom estic needs and our in te rn a tional responsibilities. 5. I am not trying to m inim ize the im portance of credit policy nor the responsibilities of the m onetary authorities. I believe th a t credit policy has a big role to play in com bating inflation even though the doses of credit restrain t m ust be hom eopathic. A nd I believe th a t a central bank in g system, independent alike from narrow political control (or T reasury dom ination) and from private pressures, is essential. But if you are go ing to call for courage you m ust call on a lot of people—the executive bran ch of the G overnm ent from which leadership should come, the Congress which preaches economy and appropriates lavishly, the m onetary authorities, the bankers and in stitu tional investors, the labor unions, the businessm en who, for exam ple, sponsor escalator clauses in labor contracts, the farm ers who dem and “ parity” prices, and a lot of other people. The problem is not merely a lack of courage on the p art of D em ocrats, or of m onetary authorities working alongside a D em ocratic ad m inistration, and I hope and expect th at you won’t present it as such. You probably had all this in m ind b u t I thou g h t it would do no harm to send you these notes. 26 Sincerely, Allan Sproul Letter to Alfred Hayes* M arch 1, 1964 D ear Al: T hank you for sending me so prom ptly the annual report of the Bank for 1963. It is a fine job; I thought the opening section “ 1963: Achievements and Unfinished Tasks” was particularly effective in its presentation of the economic posi tion of the U nited States, nationally and internationally. I have been glad to see, too, th a t it has not gone unnoticed, publicly, th a t the tenor of the report indicates th at you are not a m em ber of the chorus which has been singing “ don’t offset the tax cut by being stingy with credit” . The underlying them e of the “ sing along with M itch” group seems to be th at there is still slack in the economy and th at, until the economy is operating at full capacity and some predeterm ined m inim um rate of unem ploym ent has been achieved, we must rely on “ statesm anship on the p art of business and labor” to protect us from inflationary pressures; th at we have suffered enough from w hat is now becoming internationally labeled a “ stop and go” m onetary policy. This is a variation of the them e th a t we should not let our domestic economic aims be thw arted by unnecessary concern about the international balance of paym ents and the position of the dollar. It really suggests a flexible m onetary policy which doesn’t flex until the economy is about to burst or the dollar is about to bust, or both. It was kind of dram atic and instructive that, on the day the annual report of the Bank was released , the Bank of England raised its discount rate. It would be stupid, of course, to restrict credit merely because there has been a relaxation of fiscal restraint on the economy, b u t surely the rationale of the use of fiscal policy as an economic stim ulant m ust, in our present state, include perm itting monetary policy greater leeway for dealing effectively with developments in our domestic affairs or our international position which threaten sustainable growth or currency collapse. * President, Federal Reserve Bank of New York, 1956-75. 27 I think President Kennedy understood this. I am not at all sure th a t President Johnson understands it or th a t he is even really m uch interested in the rationale of fiscal and monetary policy. This may m ean a troubled tim e for the System if infla tionary pressures at home or another worsening of the balance of paym ents should call for m onetary action. President Kennedy, partly because of the belief or suspicion am ong m any businessm en th a t he was loose on Governm ent spending and credit policy, was concerned to show th a t he was not an easy money crank, and his attitude tow ard the System reflected this concern. President Johnson, on the other hand, because he talks somewhat like a businessm an and because of his recent budget perform ance (which con tained at least the usual am ount of budget legerdemain) has gained a lot of kudos in the banking and business com m uni ty. It may be, therefore, th at his political view of the role of m onetary policy may be overlooked, in the m onths ahead, and a possible shield of the System may be lacking. If the difficulty of such an attitude in high places is com pounded by a m ixed-up situation in the Board of Governors and in the Federal O pen M arket Committee (as Bill M artin has seemed to imply in recent conversations of which I have heard reports), there may be stirring times ahead. It is also true, I think, th a t the opinion th at the System will not be will ing or able to act, if and when action may be desirable, because of political pressures or internal differences, is already beginning to contribute to the view th at an infla tionary period lies ahead. If this view feeds on itself, it will help to bring about w hat it purports to fear. Y our rem inder th a t the System m ust be allowed to play its proper role in the changing mix of fiscal and m onetary policy, therefore, is m ost constructive. 28 Sincerely, Allan Letter to Henry H. Fowler D ecem ber 1, 1965 The H onorable H enry H. Fowler Secretary of the T reasury T reasury D epartm en t W ashington, D .C. D ear M r. Secretary: Please excuse the formality, but this is serious. W hen you kindly let me come in to see you two weeks ago, you gave me a copy of a talk you were going to m ake in Chicago and asked me to tell you what there was in it with which I m ight not agree. I have read the talk and thought about it, and I have read the reports of talks which you have subsequently m ade, and it seems to me th a t we agree pretty completely on objectives b u t disagree on how best to attain these objectives under present circum stances. W e both w ant a continuance of steady vigorous growth of the economy and a m inim um of unem ploym ent with generally stable prices. W e both believe in a Governm ent-business partnership working tow ard these objectives at all tim es and, especially, when our country is engaged in a war. I think we both agree th at we can accom m odate the dem ands of the war in Vietnam and th at we have the capacity to m eet its economic burdens without resort to m easures which a global war m ight entail. W e disagree, in the circum stances of today, as to the m eans of assuring an effective partnership of Government, business, and labor in m eeting our responsibilities. So far as Governm ent is concerned, I have always argued th a t the stool we use to get the most milk from the economic cow should have three legs— fiscal policy, m onetary policy, and wageprice policy. O ur present position is one in which, as you say, most of the previous slack in the economy has been taken up and there are now upw ard pressures on wages and prices which should be restrained if we are to continue the healthy economic growth of the past five years. Recent budget estim ates show th a t we are faced with increasing budget deficits, so th a t fiscal policy will be providing a stim ulant 29 rather th an the restraint which is needed. O ur wage-price policy is a jerry-built affair which will have increasing dif ficulty in meeting the requirem ents of such a policy in a situa tion of high employment and optim um use of productive capacity in many lines of business. But there is one power of G overnm ent, long established by the Congress with an effec tive Governm ent agency charged with its execution, which I think is m ade to order for use in the present situation. T hat is general m onetary policy. Here a m easure of restraint can be applied which will help to sift out m arginal and speculative dem ands for credit, to relieve some of the upward pressures on wages and prices, and to offset some of the stim ulant from the fiscal side which is not now appropriate. Yet, use of this power by the Federal Reserve System has been put under wraps by repeated public statem ents which are interpreted as a freeze on action with respect to the availability and cost of credit. Nor should the bearing of such action on our balance of paym ents be overlooked. It is neither necessary nor possible to try to bring into equilibrium interest rates in this country and in other money centers, in order to assert a favorable influence on— although certainly not to cure—the deficit in our balance of paym ents. The likelihood of a ratcheting upw ard of rates abroad has now decreased, some additional funds would stay home with higher rates here, and confidence here and abroad in our will to restrain inflationary pressures and to rem ain competitive in our own and foreign m arkets would be in creased. W hat all this adds up to is th at I think the discount rate should be raised, the existing ceiling under Regulation Q should be raised, the availability of reserves should be re duced somewhat, and the prime rate of the commercial banks should be increased. You hold an opposite view. I think th at, if there is ever going to be a tim e to use general m onetary policy to restrain excesses in the economy and to contribute to sustained economic growth, this is it. I am sorry th a t you have not been able to see it this way. But I am sure th at you will not charge me with putting profits above patriotism in advocating it. 30 Yours sincerely, Allan Sproul Letter to Alfred Hayes D ecem ber 13, 1970 D ear Al: Y our statesm anlike talk to the Savings Bankers struck the right notes. I hope th a t your views will be influential in the form ulation of the fiscal and m onetary policies which will become clearer when the budget estim ates and the economic reports to the Congress come along next m onth. The President bothers me on a lot of counts. One count is his glibness on fiscal and m onetary m atters. His change from an initial position of balancing the unified federal budget to a position of balancing a full em ploym ent budget is too facile. The theoretical full em ploym ent budget has its place and a t traction in the present state of the economy, but unless we have an expenditure ceiling which the Congress will accept and observe it also has its dangers. I am for it in theory, b u t I worry about it in practice. The statem ent he m ade in New York recently about a com m itm ent from A rthur Burns on m onetary policy seemed to me to be disingenuous at best. I suspect th at Burns may have said som ething to the effect th a t the Federal Reserve will con tinue to do its job, which is to meet the productive m onetary needs of the economy at all tim es while trying to avoid adding to inflationary pressures. The President’s statem ent, however, implied: (1) th a t monetary policy would become m ore aggressively easy, working along with a stimulative full em ploym ent budget policy to hasten economic recovery and a decline in unem ploym ent without too many qualm s about in flation, and (2) th at Burns, personally, could deliver a bind ing com m itm ent on future Federal Reserve action. 31 This sort of m isunderstanding is one of the dangers of talk ing with presidents on such m atters (shades of T rum an). They tend to hear w hat they want to hear, and they may claim to have com m itm ents from the Federal Reserve System which have not been given, b u t which it is hard to deny publicly without seeming to imply th at the president is a liar or an economic ignoram us. It is significant th at Burns avoid ed this issue in his Los Angeles appearance, and concen trated on anti-inflation measures which m ight be taken, now or soon, in support of fiscal and m onetary policies. A central b an k er’s lot is not an easy one! 32 Sincerely, Allan Excerpts from the remarks of Allan Sproul at the Board of Directors Meeting, Wells Fargo Bank, San Francisco, California, April 16, 1974 In these rem arks I do not want to quarrel with the overall forecast for economic activity during the rest of this year nor to enter into the debate on the particular means and methods of trying to m ake the forecast come true. The forecast is still the best we have at the m om ent, and it has achieved some m om entum of its own through widespread acceptance. Dif ferences in the prescriptions for helping to keep the economy on course are im portant b u t will not determ ine the outcome. No one of them is likely to be fully accepted and given political life, and they are all subject to modification in the light of future developments. Interest rates already have in dulged in a tem porary zig when they were supposed to be in a continuous zag. The question which disturbs me is more fundam ental. It is whether we are not being forced to grapple with a problem which is not only intractable b u t may be insoluble; whether within the limits of our political institutions and economic knowledge we can com m and a m ixture of government in tervention and m arket freedom which will provide an accept able degree both of price stability and so-called full employ m ent, especially if full employment always is the top priority. W e have been trying to combine these two objectives, under the m andate of the Em ploym ent Act of 1946, for over a q uarter of a century. A nd we have only come close when, in February 1966, our indexes showed a satisfactory rate of economic growth, with a 4 percent rate of unem ploym ent and an inflation rate of 2 percent on an annual basis. Ever since then we have been fighting a losing battle, with small victories on one front or the other but with m ajor defeats overall. Prices and wages have risen in times of slackened dem and as well as in times of active dem and; in tim es of underutilization of our productive capacity as well as in times of overutilization. Unemploym ent has been above the level which had been given political blessing (commonly 33 4 percent of the civilian labor force) most of the time. And m onetary and fiscal policies have been dragged in or moved in to validate the rising level of prices (and wages). An in creasing public belief th a t our attem pts to achieve an ar bitrary unem ploym ent goal (the m eaning of our employment and unem ploym ent statistics is still suspect in term s of the em ploym ent quality and availability of a substantial p art of our population) has too often erred on the side of stim ulating dem and pressures, has widened public expectation of con tinuing inflation, and accentuated the bias tow ard inflation which already existed in our economy. It is easier to raise prices th an to lower them ; the average level of all prices seldom declines, and wage rates alm ost never go down. M ore than anything else, it was this increasing expectation of continuing inflation, and the acceleration of inflation which such expectations fostered, which forced an adm in istration which professed an abhorrence of wage-price con trols, to resort to a wage-price freeze in A ugust 1971. This ac tion had a brief success as an emergency m easure widely ac cepted on a tem porary basis. Subsequent attem pts to ease off into an institutionalized incomes policy failed, however, and are now headed tow ard em asculation if not abandonm ent. If we have found out anything from this experience, it is th at our economy under a system of government wage-price controls does not m ake the necessary adjustm ents in supplydem and relationships required by changing domestic and in ternational conditions—changes in relative prices and relative wages, changes in technical progress, changes in the availability and use of natural resources, changes in public dem ands, and on and on. W hatever acceptance the program had by business, which initially was surprisingly w idespread, has evaporated. A nd it never had m uch acceptance by organized labor which is wed ded to free collective bargaining, and the leverage which it provides to push up wages and benefits so long as govern m ent, in effect, is trying to guarantee “ full employm ent” , and m anagem ent can expect to recoup increased costs by in creasing prices. 34 And so we are pretty m uch back where we started, faced with an inflationary situation which we don’t know how to check unless we are willing to run the risk of a further slowing down of economic growth and increased unemployment, which is a risk no one intrinsically desires and which the ad m inistration says it won’t take. My own view is th at in a situation in which all choices are risky, priorities m ust be established to deal with the greater risk more firmly than with the lesser risk. And I believe th at in our present situation curbing inflation should be our top priority. W e have been in an upw ard surge of inflation w ithout recent precedent except in time of war. O ur fiscal and m onetary policies should be directed tow ard checking th a t surge, not to provoke a recession b u t to prevent a con tinuing and possibly accelerating inflation which would lead to greater problems of reduced economic growth and in creased unem ploym ent than we now face. As C hairm an Burns of the Board of Governors of the Federal Reserve System said recently, if rapid inflation continues this year, it could underm ine confidence in the capacity of government to deal with the problem and seriously dim inish our chances of regaining stable and broadly based prosperity. There are those, however, who have become discouraged by recent failures in dealing with inflation and who have begun to seek radical solutions (on the Brazilian model). If you can’t lick it, join it, they say. And then to protect as many as possible of those who may be h u rt in the process, they sug gest th at escalator clauses be affixed to wages, pensions, long-term interest rates and contracts or wherever, which would com pensate for increases in prices. This is another m anifestation of the recurring search for some m echanical cure-all, or “ cure-m ost” , which would avoid the hazards of hum an fallibility in struggling to m aintain the dynamic equilibrium of a complex society subject to the rational and irrational actions of millions of hum an beings. W hat price in dexes might be chosen for the suggested compensatory ad justm ents to inflation in a dem ocratic and complex economy 35 such as the parts of the w hat would the answers U nited States, what would be the fate of those economy which would not fit into the program , be the effect on our international relationships— to these and other questions are not divulged. W e can leave such proposals to be threshed out in the academ ic groves. In the present state of our economic knowl edge, and in our present circum stance, we m ust grapple with inflation with our existing monetary and fiscal powers. If this m eans tem porary acceptance of a slower rate of eco nom ic grow th th a n we desire, th a t is the price of previous excesses. We have enough built-in stabilizers in our econ omy to prevent a severe and prolonged recession—a depression. We have no built-in stabilizers to prevent inflation. 36 Talk before Business Economists Conference Graduate School of Business Administration University of Chicago, May 9, 1968 Monetary Policy and Government Intervention The last tim e I addressed myself publicly and specifically to the subject of “ Inflation: How G reat An Issue?” was in an article which appeared in Fortune m agazine in July 1959, when I still retained fresh memories of my experience as an official of the Federal Reserve System during the inflationary period following W orld W ar II. At th at time I took a rather dim view of our ability to m aintain the purchasing power of the dollar while hitching national politico-economic policy, by law, to the m aintenance of m axim um production, employ m ent, and income, if we were not ready, willing, and able to curb the possible misuses and abuses of such a policy by government and by business, labor, agriculture, and a host of m inor pressure groups. I ended my lam ent for the dollar by saying th at, unless we com m itted ourselves to the hard things which would help elim inate upside rigidities and restore downside flexibility in costs and prices, the expectation and the actuality of rising costs and prices would persist, the one reinforcing the other. The only hedge I perm itted myself was th at deterioration of our international financial position m ight force or shock us into taking the necessary measures. My gloomy assessm ent of the inflationary outlook was followed by a rem arkable period of relative stability of prices accom panied by generally vigorous economic growth during the early sixties, precious little of which could be a t trib u ted to an adequate response to a deteriorating in tern a tional position. In fact, we tended to com fort ourselves, as the deficit in the balance of paym ents persisted, with the tho u g h t th a t our international accounts eventually would be self-correcting if we continued to m aintain a competitive in ternational trad in g position in the private sector, n o t w ithstanding the effects of heavy governm ent spending abroad and the uncertainties of the ebb and flow of capital and credit. My confidence in my ability to discern the shape of things to come reached a new low. 37 If one lives long enough, however, and rides with a forecast which contem plates th at hum an myopia, government short comings, and unforeseen events such as the Vietnam war are likely to thw art or deflect rational hopes and aspirations, you quite often turn out to be right eventually. Governm ent in tervention in economic affairs is accident prone—it seems to have an affinity to “ M urphy’s law—if it can fail, it will fail, and if it does fail, it will fail at the worst possible tim e and p lace” . Right now, at a tim e of national peril at home and abroad, our goal of m axim um production and high employment, w ithout inflation, has been placed beyond present reach. In flationary pressures are in the ascendant. O ur bright hopes of development of flexible fiscal policies to help counter economic fluctuations, which m asqueraded for a tim e under the nam e of the “ new economics” , have been destroyed at least tem porarily, and it has become questionable whether a governm ent of divided powers such as ours can achieve this kind of fiscal flexibility. M onetary policy, deprived of the assistance of fiscal policy, perhaps assailed by inner doubts, and in the face of the frequent and large dem ands of deficit financing by the Federal Government, has lost much of its flexibility and has tem porized with inflationary pressures while it has flirted with selective controls of credit and the in ternational movement of funds. A ttem pts to devise and apply an incomes or wage-price policy through governm ent guide lines have becom e a series of retreats, covered by ineffective governm ent pleas for economic statesm anship on the p a rt of organized labor and big business. Nor would a com pulsory program prom ise b etter results, even if it were politically possible and privately tolerable. The problem of productivity which is the h eart of the m atter cannot be solved by wage-price controls; you cannot legislate laborm anagem ent cooperation for increased efficiency. W hether we look at our domestic economy or our interna tional financial relationships, then, there are ominous signs th at the apparatus of government intervention in economic affairs is in disarray. We are being forced tow ard and into the use of selective and direct controls because we have allowed ourselves to be overtaken by events for which we have not p repared or have p repared inadequately. 38 Recent experience, if one deplores a proliferation of selec tive direct controls, is almost enough to throw one into the arm s of Milton Friedm an; to m ake one look for m echanical guides or free floating m echanism s to replace fallible hum an discretion in the guidance of economic intervention by government. Let me give one or two examples which may serve to il lustrate my thought. On the domestic side, we have seen how the adm inistration of general m onetary policy has been p a r tially diverted from broad pervasive measures, which in terfere as little as possible with the decisions of reasonably competitive m arkets, tow ard attem pts to channel credit into the housing industry. By using the power to fix ceiling rates on the interest which banks can pay on savings and tim e deposits, and especially on large-denom ination certificates of deposit, the authorities have sought to prom ote the com petitive position of those nonbanking institutions which have been large investors in hom e mortgages. The government has a legitimate concern for the quality and cost of housing in the U nited States, b u t the source, availability, and cost of m ort gage credit is only one aspect of the problem. U ndue em phasis on this one aspect, particularly as it relates to general credit adm inistration, serves to distract attention from a more deep-seated and persistent industrial sickness. Here is an industry of the greatest social and economic im portance which suffers from fragm ented operating units addicted to mediocrity or worse in subdivision development, guild-like practices of the building trades unions relating to the use of equipm ent and m aterials and the training of apprentices, m unicipal building codes which are often obsolete in term s of today’s technology and which vary widely from place to place, and m ortgage instrum ents which seem to be less than perfect for purposes of long-term lending of potentially short-term money. As a social priority, governm ent intervention in and subvention of the housing industry should be more direct, and should take account of the whole state of the industry. It should not rely so heavily on the evasive m ethod of selective credit control which may pervert general monetary policy, while it largely ignores basic defects in the industry itself. 39 On the international side, we have had the actions which government has taken to control the outflow of private capital and credit from the U nited States, in its attem pts to right the international balance of payments without paying adequate attention to government outflows and to the use of general fiscal and m onetary policies to help achieve the objec tive. The interest equalization tax on purchases of certain foreign securities was proposed as a tem porary m easure in 1963, enacted in 1964, and is still with us five years later in expanded form . We are now in the fourth year of voluntary and mandatory regulation of bank lending and direct invest ment abroad, there has been a suggestion that such controls be made perm anent and more detailed, and the executive branch of the government recently burned its fingers trying to get the Congress to clamp down on tourist travel to certain foreign countries. Each one of these selective direct controls has been precipitated by a crisis situation, and has served as cover for the fact that, at the core of the problem of the balance of payments, have been our increasing military expenditures abroad and our lax fiscal-monetary policies at home, which have finally eroded our competitive trading position and which have progressively weakened confidence in the dollar and in the whole interna tional system of fixed parity convertible currencies. I deplore most selective, direct controls of the economy by government because they smack of totalitarian methods, and because I do not think they ever have or possibly can equal the performance of private m arkets, imperfect though such m ar kets may be, in organizing and operating an advanced, com plex economy. I deplore them because of their tendency to pro liferate and to live beyond the crisis which brings them into be ing, until they have invaded and destroyed healthy organisms in the private m arket. I deplore them because of their insidious effect on those who try to operate the levers of control and are seduced into seeking greater and greater power because of the imperfect performance of the powers they already have. Final ly, I deplore them because so often they represent an attem pt to paper over cracks in the economic structure and defects in general economic policies, which we haven’t had the wit or the will to attack directly. I am rem inded of a W orld W ar II regulation which said that “the D epartm ent of Agriculture and the W ar Production Board have issued an order cutting 75 40 percent of the jelly bean production to preserve sugar. The W ar Production Board previously stopped the m anufacture of chocolate Easter eggs and chocolate rabbits.” This resounding order caused M argaret Fishback, a mistress of light verse, to write: Farewell to chocolate Easter rabbits A n d other pleasant peacetime habits. Egg rolling on the W hite House lawn That springtime revel too is gone. A n d although jelly beans remain They 're definitely on the wane. While those who color eggs fo r baby Will eat them, and I don't mean maybe. At the other end of the spectrum of opinions on govern m ent intervention in economic affairs, and more specifically such intervention by way of fiscal-monetary policy, I cannot accept the view of those who want to eliminate or drastically reduce the element of flexibility and discretion in these m at ters by prescribing some norm for intervention, to be fol lowed without deviation through tim e and circumstance. G etting a little closer to my assigned subject, “ M onetary Policy and Governm ent Intervention”, I dislike this prescrip tion, particularly, because it tends to deny the direct im por tance of fiscal policy and to exalt the im portance of monetary policy in sm oothing cyclical fluctuations of the economy. Massive statistical com pilations have been assem bled— Friedm an and Schwartz, M onetary History o f the United States, 1867-1960, has 700 pages plus appendixes—in an a t tem pt to show th a t the rate of change of the money supply is the overriding determ inant of fluctuations in business and in national income and prices; th at to the extent th at the central bank can control the money supply it can control the business cycle with m inim al deviations in the tim e lag be tween cause and effect; and th at the best policy for the central bank is to m aintain a steady rate of growth of the money sup ply at a rate which corresponds roughly to the growth of the economy’s productive capacity. In their use of discretion, proponents of this view suggest, the m onetary authorities of the U nited States have most often been wrong in the direc tion or tim ing of their actions, and when they seemed to be right it was usually by m istake. 41 I used to rely on a quotation from Paul Samuelson to ex press my view of this position. He once wrote concerning it th a t “ a definitive m echanism which is to run forever after, by itself, involves a single act of discretion which transcends, in both its arrogance and its capacity for potential harm , any repeated acts of foolish discretion th at can be im agined”. M ore specific refutation of the money supply thesis, insofar as the asserted prevailing relationships between monetary cycles and cycles of general business are concerned, is not lacking, however. Just recently an article appeared in the M onthly Review of the Federal Reserve Bank of New York, w ritten by R ichard Davis of the B ank’s economic research departm ent, which exam ined the relevant statistics and con cluded th a t the relationship between the two kinds of cycles has certain attributes of a chicken and egg relationship, but does not provide real support for the view th at the behavior of money is the predom inant determ inant of fluctuations in business activity. At the same time, the study finds th at the historical relationships between cycles in money and in business cannot be used, accurately, to dem onstrate th at discretionary m onetary policy is, in its effects, so long delayed and so uncertain in its tim ing as to be an unsatisfac tory countercyclical weapon. The coincidence of the results of this careful piece of research with my own pragm atic views m akes it easy for me to accept M r. Davis’s findings. I do not want to seem cavalier in dismissing the idea of autom atic guides or form ulae for government intervention in econom ic affairs. I believe, however, th a t, except for the in tellectual enjoyment of debating the issue, the idea is sterile in the present state of our economic knowledge of where we are, how we got here, and where we are going. The live issue today is whether we are going to continue to strive for better perform ance in the use of general and pervasive discretionary powers of government intervention to deal with a variety of complex economic situations, or whether we are going to become enm eshed in a thicket of selective controls. I suggest th a t we can preserve more of the advantages of decision by the private m arket if we follow the form er course. 42 W here does all this leave me? I have said th at discretionary governm ent intervention in our economic affairs by generally pervasive fiscal-monetary action has failed us rather badly during the past three years, the period of our increasing military involvement in Southeast Asia. At the same time, I have rejected the idea of more specific and selective govern m ent intervention in our economic system, and I have re jected the idea of autom atic guides or controls of such government action. Well, it leaves me where anyone is likely to be left in dealing with hum an affairs through government agencies— considerably short of perfection but not without hope for a better future. I still think th at the governm ent’s role as intervenor in our economic life should be by way of flexible, discretionary, contracyclical fiscal and monetary policies with, perhaps, an assist from a continuing educa tional program with respect to the relationship between n a tional and individual productivity and real income, hoping th at at some future tim e we might be able to establish condi tions which will be favorable to a general and viable incomes or wage-price policy which will work in periods of high employment and strong consum er dem and. I do not think th a t we can do better th an this, at least until economists know more th an they now know about future economic developments, and until governm ent and community accep tance of w hat they know is greater th an it now is. To fortify our hopes for a better future, however, we m ust be critical of our past failures. We m ust refute the dictum of an old colleague of mine th a t what separates m an from the anim als is th a t the anim als learn by experience. W e have to adm it th a t our perform ance since mid-1965, when we began the tragic escalation of our m ilitary involvement in V ietnam, has not been good at hom e and th a t internationally it has brought us close to disaster. At the core of our failure has been our approach to the economic dem ands of the war. We bem used ourselves with aggregates, th at the war and its related costs would only dem and a small percentage of the gross national product, and th at we could massively enlarge our o utput of goods and services w ithout strain, even though the new dem ands were being injected into an economy already operating in the upper range of its rated capacity. We slipped and slithered into a larger and more costly war than 43 we h ad anticipated, while we refused to adm it th a t because of the war we m ight have to slight serious domestic needs and problem s, th at we m ight have to dem and sacrifices of more th an chewing gum by the civilian population, and th a t we m ight have to cut back some of our other government com m itm ents abroad to avoid continued w eakening of our inter national financial position. It was a tim e of testing of the so-called “ new economics”. It was a tim e of testing w hether we could not only speed up the economy with tax cuts, increased government spending, and easy money, b u t also w hether we could slow it down with tax increases, reduced governm ent spending, and credit restraint. A coordinated, two-way fiscal-monetary policy was needed, and it failed to come through the barbed wire en tanglem ents of our governmental procedures. The executive branch of the governm ent m ade some of the right motions with respect to fiscal policy in fiscal 1965-66, b u t never with enough vigor and follow-through to impress the Congress or the public. At the same time the executives used influence and the pressures of high office to deter the monetary authorities from reducing the availability and increasing the cost of credit, so as to keep dem and from pressing too heavily against the upper limits of supply. W hen the monetary authorities finally applied the brakes without the assistance of adequate fiscal action, a banking crisis threatened— the “ crunch” of the fall of 1966—and signs of a possible business decline appeared. This provided a more congenial occasion for governm ent intervention and a coordinated fiscalm onetary policy. Tax incentives for investment, which had been removed, were quickly restored, government spending was speeded up, and easy money again became the order of the day. On the whole, the response of the economy was enlivening, and it resum ed its upw ard course but, unfor tunately, unit costs were now beginning to rise more widely, prices were rising more rapidly, the deficit in the federal budget was seen to be getting badly out of control, and the international m onetary system which leans so heavily on the dollar was being seriously frayed by the continued substantial deficit in our balance of payments and the methods we were using to try to correct it. 44 Again the need was for a coordinated policy of fiscal and m onetary restraint which, while it could not erase the infla tionary pressures already in being, and in prospect as dem ands for large wage increases multiplied, could help restrain the further excesses which m ight otherwise develop. Again the executive was moving tow ard fiscal action in the tax side, having proposed a surtax increase of 6 percent and then having raised the ante to 10 percent, a display of fiscal resolve which was weakened by accompanying increases in proposed federal expenditures. Again the m onetary authorities watched and waited to see how the fiscal cat would jum p while the cat drowsed on the Congressional hearth. There was the distressing debate over whether the Ex ecutive or the Congress should appear to be responsible for an increase in taxes and a reduction of expenditures in an election year. There was the resort to statistical aggregates to support the view th at the nation’s productive plant and labor resources were not overextended, even though increased prices were adulterating the apparent rate of economic growth. There was the specious claim th at these increases in prices were of the cost-push variety and therefore not am enable to fiscal-monetary action, although cost-push soon depends on dem and-pull for continued life. The result was no significant fiscal action, a worsening budgetary situation, and a m onetary policy which rem ained unduly expansive, even though interest rates rose to historically high levels, until a near breakdown of confidence in the dollar and in the international m onetary system precipitated the beginnings of a less extravagant program . In brief, fiscal-monetary policy was found lacking, and again we approached the boundaries of unsustainable, unbalanced economic growth, accom panied by increased unit costs and increased prices, again we dissipated opportunities to im prove our balance-of-paym ents position and to protect the in ternational value of the dollar by preserving our competitive stance, and again we teetered in the direction of a widening circle of direct, selective controls. 45 If one cause of this current failure, in the im portant m atter of government intervention in economic affairs, is to be elevated above all others, I would say th at, aside from a general failure in determ ining national priorities, it has been the failure of coordination between the executive and the legislative branches of government in m atters of fiscalm onetary policy. W alter Heller has said th at what is new in the “ new econom ics” is th a t for the first tim e two presi den ts—President K ennedy achieving the breakthrough and President Johnson consolidating our position—have pressed the lessons and tools of m odern economics into full-tim e use in national policy. U nfortunately, the executive pressure faltered when restraint was desirable, and the Congress h a d n ’t m astered the lesson or h a d n ’t been given the tools, and W ilbur Mills w asn’t consulted or convinced. I have no starry-eyed plans for reforming the organization of the Congress, nor for changing the committee and sub com m ittee arrangem ents and the ordinary procedures of the A ppropriations Com m ittee and the Ways and M eans Com m ittee of the House of Representatives, and I recognize th a t the role of the Executive in the area of fiscal policy involves Constitutional questions of political power. If, however, we are eventually to achieve success in using a small part of the governm ent’s spending and taxing powers alongside mone tary policy, as a constructive and m oderating influence on the short-run fluctuations of business, the Congress and the Ex ecutive will have to devise a better m ethod than now exists for m utual appraisal of the strategy and tactics of flexible contracyclical fiscal action, and a better means than now exists of reaching timely decisions in accord with national and in ternational economic needs. If we really want to use a mix ture of flexible fiscal and m onetary policies in prom oting sus tainable economic growth, m axim um employment, price stability, and international balance, it should not take years from the tim e the executive proposes a tem porary increase (or a decrease) in taxes to reach a legislative decision on the pro posal. T h at is a contribution to confusion and disorder in our economic affairs which we cannot afford at this critical stage of our national life. 46 Let there be no m istake. Em phasis on improved fiscalmonetary perform ance by government is not the narrow con cern of men who are more interested in financial sobriety th an in social progress, more interested in the growth of our m aterial resources than in the im provement of our environ m ent, more interested in money than in people. These con cerns are inextricably intertwined. Right now, in a significant sense, achievement of our social and environm ental goals, as well as our national and international economic well-being, have become fiscal and financial hostages of the race between de-escalation of the war in Vietnam and escalation of the domestic war against urban blight, poverty, and racial discrim ination. If we do not regain control of the federal budget, and if we are not able to devise some means of coor dinating flexible fiscal-monetary policies, we shall be risking all our long-term economic and social objectives, and w eakening the defenses of our national security. 47 Chapter 3 Postwar Treasury-Federal Reserve Conflict and the Accord T A h e postw ar dispute betw een th e T reasury and the Federal Reserve, culm inating in th eir fam ous 1951 “ A ccord” , was discussed at some length in the introductory chap ter of this book. The first of Allan S proul’s papers reproduced in the present ch apter is the only full-length treatm en t of th a t episode he ever com m itted to p rint. He wrote it in 1964, and even then he probably would not have done so except for the urging of Alfred Hayes, his successor as president of the New York Reserve B ank, who asked th a t he write it for a special issue of the B ank’s M o n th ly R eview com m em orating th e fiftieth anniversary of the Federal Reserve System. T h a t article is followed by six letters, four w ritten in the m onths or days p rior to th e A ccord and two w ritten m ore th an ten years later. The four letters w ritten shortly before the A ccord recapture the sense of im m ediacy and urgency th a t was in the air at the tim e. They are to R obert T. Stevens, C hairm an of the B oard of D irectors of the Federal Reserve B ank o f New Y ork; C .F. C obbold, G overnor of the B ank of England; T hom as B. M cCabe, C hairm an o f the B oard of Governors of the Federal Reserve System; an d Jam es E. Shelton, President of the A m erican B ankers A ssociation. However, there is some question w hether the letter to Shelton was ever m ailed; there is a notation “ Not Sent” on the carbon copy in the B an k ’s files. In any case, it is a mystery how he ever found tim e to write such lengthy letters in late February 1951, when negotiations with the T reasury were at their peak. T he two letters w ritten m any years later, to M urray J. Rossant, then of th e N ew Y ork Tim es, are typical A llan Sproul post-1956 letters: live ly, inform ative, an d com posed with a flair few could equal. 49 The ch ap ter’s introductory article on the Accord, w ritten for the B an k ’s M o n th ly R eview , illustrates Sproul’s typical thoroughness. He begins the story th a t ends with the 1951 Accord not in 1941 or 1942, as m ost would, b u t ra th e r in 1917 an d 1918. A nd, ju st as typically, he does not stop with the Accord itself b u t goes on to draw from the ex perience the m any lessons he sees it as providing for the future. O ne of these lessons is th a t the Congress should “ include a reference to price stability am ong the general guides to economic well-being in the pream ble of the Em ploym ent Act, and to add a general directive with respect to price stability and the in ternational position of the dollar to the Federal Reserve A ct”. Tim e has validated the wisdom of these recom m endations. B ut in no sense did he view the Accord as a “ victory” for the Federal Reserve over the U nited States G overnm ent. “ The Federal Reserve challenge to the T reasury’s assertion of dom inance in the area of their overlapping responsibilities” , he concluded, “ had its ultim ate justifica tion in the achievem ent of coequal status in these m atters, and not as an assertion of a false independence. The Federal Reserve does not have, never has had, and never has claim ed to have an independence in m onetary affairs which divorces it from the general economic policies of the G overnm ent.” 50 From Monthly Review of the Federal Reserve Bank of New York, November 1964 The “Accord"—A Landmark in the First Fifty Years o f the Federal Reserve System Personal recollections of the history of institutions may range widely, following the broad avenue of the development of the institution itself, or the high road of the careers of in dividuals who served it, or they may focus on episodes which stand out in historical perspective as having a special significance. Such an episode in the history of the first fifty years of the Federal Reserve System is the web of events which found its denouem ent in the “ Accord” of the Treasury and the Federal Reserve System in M arch 1951. Having chosen to write about this controversial episode, because of special fam iliarity with it, I faced certain hazards which I have tried to avoid. One such hazard is th at episodes of historical significance do not spring into being without a past and, inevitably, they have a future. So it is with the “ Ac cord” ; its roots go deep into the past of the Federal Reserve System and its influence is still being felt and its results are still being challenged. Yet, in an article such as this, if one is to avoid the trap of trying to write a history of the Federal Reserve System in a few thousand words, it is possible only to brush over the past of the “ Accord” and touch only lightly on its future. A second hazard is that, in treating an episode in which one has participated, there is a tendency to em brace the benefits of hindsight. Recourse to records written at the time, and not since “ im proved” , has helped me to avoid this hazard, I hope. But even if the advantages of hindsight are elim inated in this way, there rem ains the fact th at most of the contem porary records I have consulted are the records of in dividuals or groups who were in the contending forces and only on one side— my side. I have had to try to avoid the hazard th at my recollections, refreshed by a reading of writ ten records, are subject to institutional and personal bias. 51 A fundam ental cause of the controversy which led to the “ Accord” was the growth in the im portance of the overlap ping responsibilities of the Treasury and the Federal Reserve during the years 1914-51. On the one side, the deficit financ ing of two world wars had m ade the m anagem ent and cost of the Federal debt a m atter of m ajor economic and adm inistra tive concern, and the proliferation of Governm ent securities of various m aturities brought the Treasury to the m arket, for financing and refinancing, with increasing frequency. On the other side, the development of credit policy as one of the prim ary m eans of Governm ent influence on the total economy, and the open m arket techniques which the m onetary authorities evolved to discharge their respon sibilities under law, m eant th at an overlapping area was created in which understanding and accom m odation took the place of rigid legislative directives. The first sprouting of the conflict inherent in such a situa tion appeared when the young Federal Reserve System was plunged into the problem of financing the participation of the U nited States in W orld W ar I. The then Secretary of the Treasury notified the Federal Reserve, early in 1917, of his desire to float an issue of certificates of indebtedness at a rate well below the m arket, which m eant th at the issue would have to be bought by the Federal Reserve Banks. Subse quently, the Secretary “ undertook not to unload anything further on the Federal Reserve Banks, certainly not without notice, and in consideration of his attitude in the m atter it was agreed th at every effort should be m ade to bring about a satisfactory organization for shifting Treasury requirem ents to m em ber banks and, through them , to the public” .1 A working entente was arranged by the System and the Treasury and, eventually, preferential discounting ar rangem ents and preferential discount rates were established to facilitate Treasury financing through the banks of the country. These arrangem ents—the “ bank-borrow -and-buy policy” —persisted for a year after the armistice in November 1918, at the insistence of the Treasury, and were an increas ing source of friction between the Treasury and the System as inflationary pressures built up in the postwar economy. The 1 The Federal Reserve System by H. Parker Willis (New York, 1923), pp. 1117-18. 52 System, in the euphem istic words of the A n n u a l R eport o f the Federal Reserve Board fo r 1920, was prepared during 1919 to “ resort to the well-known m ethod of advancing the rate of discount, as soon as Treasury exigencies perm itted”. Perhaps the Federal Reserve System further m ingled the areas of responsibility in 1937-38, when the fledgling Federal O pen M arket Committee, created by the Banking Act of 1935, announced in April 1937 th at “ with a view to exerting its influence toward orderly conditions in the money m arket. . . it was prepared to make open m arket purchases of U nited States G overnm ent securities, for the account of the Federal Reserve Banks, in such am ounts and at such times as may be desirable”. Since Treasury bills and other short-term T reasury paper had already become bellwethers of the money m arket, this was an acceptance of responsibility for orderly conditions in the G overnm ent securities m arket. In fact, the A n n u a l R eport o f the Federal Reserve B a n k o f New York fo r the Year 1938 stated th a t “ the open m arket operations in which this bank participated during the past year were not undertaken prim arily with a view to affecting the reserve position of m em ber banks, b u t rath er with a view of exercis ing an influence tow ard the m aintenance of orderly condi tions in the m arket for Governm ent securities”. This assum ption by the credit authorities of a m easure of responsibility for m aintaining orderly conditions in the G overnm ent securities m arket hardened into a com pact with the Treasury for the m aintenance of a “ pattern of rates” in th a t m arket to facilitate the financing of the U nited States participation in W orld W ar II. It was recognized by the p a r ties to the com pact th at, insofar as it was politically and economically possible, the war should be financed out of taxes and th at, for the rest, borrowing from nonbank in vestors (borrowing of savings) would be preferable to borrow ing from the commercial banks. It was also recognized, however, th a t a substantial residue of borrowing would have to be done through the banks, and th a t this would involve an increase in the money supply (and in the liquidity of the economy) which would not be m atched by an increase in goods and services available for civilian use. There was an in 53 evitable inflationary factor in war financing, which was held in check but not removed by direct controls, such as m aterials priorities and price ceilings. At the time th at this general approach to the problem s of financing the war was adopted, it was also agreed th at, to the extent the Treasury had to borrow from the banks, it should borrow at stable, not rising, rates of interest such as the financing m ethods of W orld W ar I had produced. This led to the establishm ent of a fixed “ pattern of rates” which ranged from 3 percent on /8 ninety-day Treasury bills to 2Vi percent for 20- to 25-year G overnm ent bonds (excluding Savings Bonds). As a by product of this pegging of prices of Governm ent securities, the initiative with respect to the creation of reserve credit was shifted from the Federal Reserve to the m em ber banks. In the reconversion period, at the end of the war in 1945, the problem facing the Federal Reserve System was how to proceed, and at what speed, to recapture from the banks of the country this initiative, and to restore the ability of the Federal Reserve Banks to place a price upon reserve credit and a check on its availability which could be varied to meet changes in economic circum stances. The Treasury, which h ad a proper concern for the functioning of the Government securities m arket, which had become habituated to the con venience of the m ethod used to finance the war, which still h ad the problem s of rolling over the war-swollen debt, and which was dubious of the scope left for a flexible monetary policy in the existing circum stances, was reluctant to ab an don support prices and a “ pattern of rates” for Government securities. In a situation of overlapping responsibilities and on the basis of seniority in the W ashington hierarchy, the Treasury assum ed the role of final decision. The System wished to discontinue before the end of 1945 its preferential discount rate on G overnm ent securities m aturing within one year. Treasury acquiescence was not forthcom ing until April 1946. From the closing m onths of 1945, all through 1946, the System was pressing for an end of its artificially low buying rate— % percent— on ninety-day Treasury bills, but the Treasury would not agree until July 1947. 54 These small changes, im portant in themselves in term s of improving the structure of interest rates, were even more im portant as an indication of the intention of the Federal Reserve System gradually to restore its control over bank reserves and their availability. It was deemed to be an in evitable consequence of the great wartime increase in the money supply and in the total liquidity of the economy (of business, of consumers, and of the banking system) th at in flationary pressures would assert themselves in time, and from tim e to time, as direct economic controls were removed. An appropriate credit policy would require restraint in the creation of additional bank reserves and would result in in creases in short-term interest rates, including rates on shortand interm ediate-term G overnm ent securities. The hesitations and refusals of the Treasury m eant th at the defrosting of the wartim e “ pattern of rates” took place distressingly slowly, and then only in steps to a higher fixed rate curve ending with the 2Vi percent long-term Govern m ent bonds. The supported rate of 7 percent on one-year /8 Treasury obligations was not raised to 1 percent until August 1947, to iy8 percent in November 1947, and to IV* percent in O ctober 1948. The discount rates of the Federal Reserve Banks had to be kept in line with these rates, and were raised equally slowly from 1 percent to 1V* percent in January 1948 and to W i percent in August 1948. A slight business recession beginning in the fall-winter of 1948-49 provided an opportunity to em phasize the change which was gradually taking place in credit policy and, it was thought, in debt m anagem ent. An official statem ent was published, couched in term s of the credit relaxation ap propriate to a business dow nturn, th at the “ pattern of rates” had finally been abandoned. This was the statem ent issued on June 28, 1949: The Federal Open M arket Com m ittee, after con sultation with the Treasury, announced today that, with a view to increasing the supply o f fu n d s available in the m arket to m eet the needs o f com m erce, business 55 and agriculture, it will be the policy o f the Com m ittee to direct purchases, sales and exchanges o f Govern m ent securities by the Federal Reserve B anks with prim ary regard to the general business and credit situa tion. The policy o f maintaining orderly conditions in the G overnm ent security market, and the confidence o f investors in G overnm ent bonds will be continued. Under present conditions the m aintenance o f a relatively fix e d pattern o f rates has the undesirable ef fe c t o f absorbing reserves fro m the m arket at a tim e when the availability o f credit should be increased. U nfortunately, the acquiescence of the Treasury in the m aking of this statem ent by the Federal O pen M arket Com m ittee was not m eant to em brace a policy of flexibility in credit availability and interest rates, except when the flexibili ty was on the downside. As the economic clim ate changed and business moved up from the trough of recession, the System -Treasury debate over the coordination of debt m anagem ent and credit policy resum ed. The persisting differences between the two agencies, of course, h ad not gone unnoticed in the Congress and in the public press. A subcom m ittee on M onetary C redit and Fiscal Policies (C hairm an, Senator D ouglas of Illinois), of the Joint C om m ittee on the Econom ic R eport, held hearings during the latter p art of 1949 and, subsequently, m ade a report to its p aren t com m ittee which discussed m onetary and debt m anagem ent policies and took special cognizance of the dispute between the Treasury and the Federal Reserve System. Among other things, it recom m ended ‘ th a t an / ap p ro p riate, flexible and vigorous m onetary policy, employed in coordination with fiscal and other policies, should be one of the principal m ethods used to achieve the purposes of the Em ploym ent Act [of 1946]”. And it went on to recom m end, as a m eans of prom oting monetary and debt m anagem ent policies th a t would contribute most to the p u r poses of the Em ployment Act “ . . .that Congress by joint 56 resolution issue general instructions to the Federal Reserve and Treasury regarding the objectives of monetary and debt m anagem ent policies and the division of authority over those policies. These instructions need not, and in our opinion should not, be detailed: they should accomplish their p u r pose if they provide, in effect that, (1) in determ ining and ad m inistering policies relative to money, credit and m anage m ent of the Federal debt, the Treasury and the Federal Reserve shall be guided prim arily by considerations relating to the effects on employment, production, purchasing power and price levels, and such policies shall be consistent with and shall prom ote the purpose of the Employment Act of 1946; and (2) it is the will of Congress th at the prim ary power and responsibility for regulating the supply, availability and cost of credit in general shall be vested in the duly constituted authorities of the Federal Reserve System, and th at Treasury actions relative to money, credit and transactions in the Federal debt shall be m ade consistent with the policies of the Federal Reserve.” 2 The press, on the whole, also was favorable to the position of the Federal Reserve. Bankers, in sofar as they expressed themselves, were reluctant to take sides. The unfortunate failure of the Treasury and the Federal Reserve to find common ground for meeting the respon sibilities delegated to them by the Congress, where their fields of responsibility overlapped, was now approaching a climax. The economy was rapidly recovering from the slight dow nturn of 1949, when the outbreak of hostilities in Korea, in June 1950, “ transform ed the tone and the tem po of American economic life” .3 An already buoyant economy becam e surcharged with inflationary pressures; anticipatory spending by consumers and business reflected expectations of increased Government spending and Government dem and 2 It should be noted that one member of the subcommittee, Con gressman Patman, stated that these proposals did not make the Federal Reserve sufficiently responsible to the Executive Depart ment of the Federal Government and that the Joint Committee in its reference to these recommendations of the subcommittee recom mended “further careful study” . 3 Federal Reserve Bank of New York, Thirty-sixth Annual Report fo r the Year Ended December 31, 1950, p. 5 57 for m aterials for m ilitary purposes; commodity prices were advancing rapidly; b ank loans were rising, including business loans, as well as consum er loans and mortgage loans. Confronting this situation, President T rum an, in a message to the Congress on July 19, 1950 concerning the K orean crisis and the defense program , called for prim ary reliance upon strong fiscal and credit measures to reduce the volume of private purchasing power competing with the G overnm ent for available goods and services. And, in his m idyear Economic Report (July 26, 1950) there was this statem ent: “ First of all for the im m ediate situation, we should rely in m ajor degree upon fiscal and credit measures. . .the m ore prom pt we are with these general measures the less need there will be for direct controls. . . . ” So far as the Federal Reserve was concerned, these statem ents of overall national policy confirmed its view of what it should be doing to help counteract the forces of infla tion, not only by way of selective controls of consumers and m ortgage credit but, more im portant, by general credit measures without which selective controls would not be effec tive. The Federal Reserve view, reaffirm ed and reinforced in the light of the K orean crisis, h ad been given to the Secretary of the Treasury earlier in July, when it was stated th a t the System could not m aintain the existing rate structure in the Governm ent securities m arket while going forward with the general policy of regaining control of the initiative with respect to b an k reserves which it deem ed essential; either short-term rates would have to rise or the long-term rate would have to come down, and both from the standpoint of countering inflationary pressures and correcting an artificial interest rate structure, it preferred the first alternative. The Treasury reply counseled delay until the situation became clearer, and em phasized th at the nation was waiting to learn what domestic program s might be needed in order to utilize the full strength of the country in national defense. The Federal Reserve System believed th at the messages of the President h ad now answered the question. The action question, which rem ained on the agenda of the Federal O pen M arket Committee, was what contribution it 58 would m ake to the general program in its sphere of prim ary responsibility; w hat it would do about m aking further reserve funds available to the banking system in an inflationary situation which could quickly become critical and in which the effectiveness of m oderate general credit measures of re straint would depend upon the prom ptness of their use. The Federal Reserve felt th a t it was under the compulsions of statutory responsibility to meet a present danger, and th at it h ad exhausted the possibilities of devising a mutually agreeable program with the Treasury which would have per m itted credit policy and debt m anagem ent to go forward in tandem . So it was, on A ugust 18, 1950, the Board of Governors of the Federal Reserve System approved an increase in the dis count rate of the Federal Reserve Bank of New York from IV 2 percent to 13 percent (effective August 21), which had A been held in abeyance for about a m onth, and the Federal O pen M arket Com mittee adopted a general policy of m aking reserves less readily available to the banks of the country, and then informed the Treasury of what it was doing. U p to this point, the Federal Reserve h ad presented its views con cerning an appropriate combination of credit policy and debt m anagem ent to the Treasury; the Treasury had decided what it was going to do and h ad then informed the Federal Reserve; and the Federal Reserve had followed along, a t tem pting to adjust its open m arket operations, as best it could, to the debt m anagem ent decisions of the Treasury. The August 1950 decision reflected the Federal Reserve’s belief th at the facts of the economic situation and the general economic program of the G overnm ent dem anded th a t it break out of th a t pattern. Advice of the actions taken was immediately given, orally, to the Secretary of the Treasury by the C hairm an and Vice Chairm an of the Federal O pen M arket Committee (after noon of A ugust 18, 1950). A delayed response without fur ther conference came within the hour. The Treasury had decided to announce its Septem ber-O ctober refunding— a $13.5 billion operation— at once, m aintaining the existing rate of IV* percent for one-year obligations. (The actual of fering was a thirteen-m onth note.) The result was an issue 59 which was a m arket failure—the Federal Reserve had to p u r chase the larger part, upw ard of 80 percent—of the m aturing securities in order to m ake sure th a t the Treasury would not have an em barrassing cash redem ption. At the same tim e, as an offset to the effect of these purchases on bank reserves, the Federal Reserve sold other securities from its portfolio at prices and yields in line with its actions on discount rates and open m arket policy. There followed a period of confused and confusing attem pts to reestablish a working form ula for coordinating debt m anagem ent and credit policy. The President of the U nited States was early brought into the em barrassing dispute by the Treasury. A tem porary truce was evolved which perm itted tim e to observe the results of the actions taken by the Federal Reserve and, in November 1950, there was a fairly am icable agreem ent em bracing credit policy and the Treasury refunding of its Decem ber and January m aturities with a 1V* percent five-year note. As it turned out, the new note did not fare well and, in term s of the am ount of the m aturing issues which the Federal Reserve had to buy and the am ount which the m arket redeemed for cash, the financing was not a success. The Treasury evidently felt th at it had been let down, and th a t some public statem ent had to be m ade to restore con fidence in the G overnm ent securities m arket. In a speech at New York, on January 18, 1951, the Secretary of the Treasury declared th a t “ the delusion th a t fractional changes in interest rates can be effective in fighting inflation m ust be dispelled from our m inds” ; th at “ any increase in the 2 Vi percent rate for long-term G overnm ent securities would seriously upset existing securities m arkets” ; and th a t “ the Treasury D epartm ent had concluded, after a joint conference with President T rum an and C hairm an McCabe of the Federal Reserve Board, th a t refunding and new money issues of the Treasury will be financed within the pattern of th at rate”. This attem pted reestablishm ent of a “ pattern of rates” in G overnm ent financing, and the implication of a com m it m ent by the Federal Reserve to support the 2 Vi percent long term rate on new as well as outstanding issues of Treasury securities, was immediately challenged, most notably by Marriner Eccles, a m em ber and form er C hairm an of the Board of 60 Governors, in testim ony at a hearing of the Joint Committee on the Economic Report which was then in session. Amid a rising volume of public com m ent on, and Govern m ent concern over, the differences between the Treasury and the Federal Reserve System, it was announced on January 31, 1951, th a t President T rum an had asked m em bers of the Federal O pen M arket Com mittee to come to the W hite House th a t afternoon. There followed a bizarre exchange of contradictory reports on w hat had taken place at the meeting. A W hite House press secretary said th a t the Federal Reserve had pledged its support to President T rum an in m aintaining the stability of Governm ent securi ties as long as the emergency lasted. A T reasury spokesm an said th at the W hite House statem ent m eant that the m arket for Government securities would be stabilized at their present levels and th at these levels would be m aintained during the emergency. These press reports, which left a cloud of doubt as to what had happened at the W hite House meeting, were given official sanction in a letter from the President to Chairm an McCabe which was released to the press on February 1, 1951. In it the President wrote, “your assurance th at you would fully support the Treasury defense financing program, both as to its refunding and new issues, is of vital im portance to me. As I understand it, I have your assurance th at the m arket on Government securities will be stabilized and m aintained at present levels in order to assure the successful financing re quirements and to establish in the minds of the people con fidence concerning Government credit.” This was at variance with what the Federal Open M arket Committee believed had been said and done at the W hite House meeting. In a m em orandum prepared immediately after the meeting, the Federal Reserve recorded that there had been no references to recent disputes with the Treasury; and th at at no time had the President indicated that he had in m ind support, or a pledge of support, of the financing pro gram recently outlined by the Secretary of the Treasury (January 18, 1951 at New York). Shocked by the public letter of the President to Chairm an McCabe, Governor Eccles released the Federal Reserve record to the press on his per sonal responsibility, on February 3, 1951. 61 An intolerable situation had been created in which, as the Federal Open M arket Committee said in a letter to the Presi dent on February 7, 1951, “You as President of the United States and we as members of the Federal Open M arket Com mittee have unintentionally been drawn into a false position before the American public—you as if you were committing us to a policy which we believe to be contrary to what we all truly desire, and we as if we were questioning you and defying your wishes as the chief executive of the country in this critical period”. The letter went on to say th at “ in accordance with our assurance to you, we shall seek to work out with the Secretary of the Treasury as promptly as possible a program which is practical, feasible and adequate in the light of the defense emergency, which will safeguard and m aintain public con fidence in the values of outstanding Government bonds and which, at the same time, will protect the purchasing power of the dollar” . Concurrently with the sending of this letter to the Presi dent, a m eeting of the C hairm an and Vice C hairm an of the Federal O pen M arket Comm ittee was held with Senate leaders of the Banking and Currency Committee, a subcom m ittee of which had been nam ed to inquire into the TreasuryFederal Reserve controversy. The general tenor of the senatorial advice was th a t it was no tim e for feuding and no tim e for a Congressional hearing, b u t a tim e for the Treasury and the Federal Reserve to try again to compose their dif ferences. The same advice was given by the Senator Chair m an of the Comm ittee on the Joint Economic Report, the following day. This counsel from m embers of the Congress, from which the Federal Reserve System derives its authority and powers, coincided with the wishes of the Federal O pen M arket Com mittee, which on the same day (February 7, 1951) th a t it had written to the President drafted a letter to the Secretary of the Treasury expressing a desire “ to discuss credit policy and debt m anagem ent program s which would assist in the highly im portant fight against inflation and improve public con fidence in the m arket for Governm ent securities” , and sug gesting a program as the basis for such a discussion. This let ter was handed to and discussed with the Secretary of the 62 Treasury by the C hairm an and Vice C hairm an of the Federal O pen M arket Committee. (At this meeting, for the first time, M r. W illiam McC. M artin, A ssistant Secretary of the T rea sury, took p a rt in the discussion.) The m atters at issue were now back on the track of respon sible discussion by the two agencies of G overnm ent whose overlapping responsibilities had erupted into controversy, although there were still a few detours to be traversed. Before the proposed discussions could begin, the Secretary of the Treasury had to enter a hospital to recuperate from an opera tion and the Treasury sought a com m itm ent from the Open M arket Com m ittee th a t there would be no change in the ex isting situation in the Governm ent securities m arket during the period of his hospitalization. This was a com m itm ent which the Committee felt unable to give in the face of mount ing inflationary pressures, and a Government securities m arket which was dem anding heavy purchases by the Federal Reserve, contrary to the policy and program which it thought the economic situation required. The Committee asked the Secretary to nam e someone at the Treasury with whom it could talk, in the interim , and the Secretary nam ed M r. M artin. Negotiations now took a tu rn for the better. M r. M artin suggested th at m em bers of the staff of the Treasury D epart m ent and of the Federal Reserve meet as soon as possible to go over the proposals contained in the February 7 letter of the Federal Open M arket Com m ittee to the Secretary of the Treasury, and such other ideas as m ight be brought forward. (C hairm an M cCabe had previously suggested such staff con ferences, b u t the Secretary of the Treasury had said he preferred to settle m atters at the policy level and then have the details worked out at staff levels.) A working party was created4 and progress began to be m ade toward understand ing at the “ technical level” for referral to the “ policy level” , as the Treasury phrased it, although the negotiation faltered at times. 4 Mr. Martin, Mr. George Haas, Director of Technical Research, and Mr. Edward Bartelt, Fiscal Assistant Secretary, from the Treasury, and Mr. Winfield Riefler, Assistant to the Chairman of the Board of Governors and Secretary of the Federal Open Market Committee, Mr. Woodlief Thomas, economist of the Committee, and Mr. Robert Rouse, Manager of the System Open Market Ac count and Vice President of the Federal Reserve Bank of New York. 63 W hile these discussions were going on, the W hite House again intervened. A meeting was called by the President on February 26, 1951, including the D irector of Defense M obilization, the U nder Secretary of the Treasury (in the absence of the Secretary), the Assistant Secretary of the Treasury (M r. M artin), the C hairm an of the Securities and Exchange Commission, the C hairm an and Vice C hairm an of the Federal Open M arket Committee, the m em bers of the Council of Economic Advisers and the special counsel of the President. At this meeting the President began by reading a m em orandum (which was also released to the press), in which he expressed his concern with the problem of reconcil ing the need to m aintain stability in the Governm ent securities m arket and the need to restrain credit expansion; outlined the general economic program of the A dm inistra tion; and requested the Secretary of the Treasury, the C hair man of the Federal Reserve Board, the D irector of Defense M obilization, and the C hairm an of the Council of Economic Advisers to study the problem of the overlapping respon sibilities of the Treasury and the Federal Reserve System. He also expressed the hope th at “ while this study is under way, no attem pt will be m ade to change the interest rate pattern, so th at stability in the Governm ent securities m arket will be m aintained”. This intervention was different in form from previous interventions and came more nearly to grips with the problem , but it also failed to recognize th at the Federal Reserve has duties laid upon it by the Congress which cannot be abandoned to the arbitration of ad hoc committees. For tunately, the Treasury-Federal Reserve “Accord” was reached while the Presidential com m ittee was still pondering the problem , and when its report was later com pleted it ap parently was “ filed” . The tenor of inform ed thinking in the Congress, which was the only place the dispute could be decided, in default of agreem ent by the two agencies directly involved, was in dicated in a powerful speech by Senator Douglas in the Senate cham ber on February 22, 1951, which he concluded with a plea “ th a t the Treasury abate its policies and yield on this issue” and th at “ the Federal Reserve gird its legal loins and fulfill the responsibilities which I believe the Congress in tended it to have”. 64 Meanwhile, the negotiations of the principals in the dispute regained their m om entum . On February 28, the staff negotiators felt th at m atters were sufficiently well in hand to w arrant presentation to their principals and, th at evening, the Secretary of the Treasury was consulted by M r. M artin and the request was m ade by the Secretary th at Mr. M artin and M r. B artelt be perm itted, orally, to present to the Federal Open M arket Committee the response of the Treasury to the Committee letter of February 7, 1951. Con sideration of this report by the Committee evoked a generally favorable response, and the staff group of the Committee was requested to resume its discussion with the Treasury group, in the light of the views expressed by the m embers of the Committee. The Federal O pen M arket C om m ittee m et again on M arch 2, and Mr. Riefler reported the results of the final staff conference with the Treasury representatives. There ensued a fu rther discussion of all the points on which agreem ent was being sought, and a concise statem ent of a program accept able to the O pen M arket Com m ittee was w ritten and given to Messrs. M artin and Bartelt for their consideration, and later discussed with them at length by Messrs. M cCabe, Sproul, Riefler, and Thom as. A meeting of m inds was achieved along the following lines: 1. P urpose—to reduce to a m inim um the creation of b an k reserves through m onetization of the public debt, while assuring the financing of the G overn m e n t’s needs. 2. A conversion offering by the T reasury which would be designed to remove a substantial am ount of the long-term restricted5 2 Vi percent bonds from the m arket. 3. S upport of the m arket for the outstanding restricted 2 Vi percent bonds by the Federal Open M arket C om m ittee at p ar or slightly above for a lim ited am ount and only during the b rief period of the conversion offering. 4. W ith the exception of this support, the m aintenance of orderly m arket conditions, hereafter, 5 I.e., purchase restricted to noncommercial bank investors. 65 to be w ithout reference to the m aintenance of the par value of any Treasury issues. 5. Reduction or discontinuance of purchases of short-term Governm ent securities by the System Open M arket Account, so as to perm it yields on such securities to fluctuate around the discount rate {VA percent) and thus to m ake th a t rate effective, with the understanding th at it would not be changed during the rem ainder of the year, except in compelling cir cum stances. 6. Prior consultation between the Treasury and Federal Reserve on changes in debt m anagem ent or credit policy, unless extraordinary circum stances made such prior consultation impossible. 7. The public statem ent of agreem ent to be brief, financial, and nonpolitical. The term s of agreem ent were taken by M r. M artin to the Secretary of the Treasury, at the hospital, and the program was cleared with him and then with the m em bers of the Federal Open M arket Committee on M arch 3, 1951. The following statem ent and announcem ent appeared in the press on Sunday, M arch 4, 1951: Joint announcem ent by the Secretary o f the Treasury and the Chairman o f the Board o f Governors and o f the Federal Open M arket C om m ittee o f the Federal Reserve System. The Treasury and the Federal Reserve System have reached fu ll accord with respect to debt m anagem ent and monetary policies to be pursued in furthering their com m on purpose to assure the successful financing o f the G overnm ent 's requirem ents and, at the same tim e, to m inim ize m onetization o f the public debt. Simultaneously, the Secretary of the Treasury announced th at there would be an offering for a limited period of a new investm ent series of long-term nonm arketable Treasury bonds in exchange for the two longest outstanding restricted Treasury bonds (the 2 Vi percent bonds of June and Decem ber 1967-72). The details of this offering were an nounced M arch 19. The offering was a 2 3 percent bond of A 1975-80 which, while nonm arketable, could be converted 66 at the holder’s option into five-year m arketable notes carry ing a coupon of IV 2 percent. More th an two thirds ($13.6 billion) of the outstanding 2Vi percent bonds of 1967-72 were turned in for the new 2 V a percent bonds in this first offering. (A year later another $1.8 billion of the new bonds was issued in exchange for the four longest issues of outstanding restricted bonds.) D uring the transition period, over the next six weeks, the System O pen M arket Account and some of the Treasury in vestment accounts purchased substantial am ounts of long term Treasury bonds at declining prices, in order to ease the adjustm ent in the m arket to the final abandonm ent of the “ pattern of rates” and its long-term anchor of 2Vi percent. By April 12, 1951 the initial price adjustm ents were com pleted and the m arket “ bottom ed out” . Happily, the infla tionary pressures which h ad brought m atters to a head be tween the T reasury and the Federal Reserve subsided after the first q u a rte r of 1951, and for this the release of m onetary policy from the shackles of a “ p attern of rates” received a m odicum of credit. If it is too m uch to say th a t the Treasury and the Federal Reserve have lived happily ever after the “ Accord” , they at least have learned to get along together with a m inim um of m arital friction. There could be discord again, of course, but it is less likely if the experience and lessons of the “ Accord” period are rem em bered. As a contribution to this rem em brance, here are some gleanings. 1. In situations and areas where debt m anagem ent and credit policy overlap, neither the Treasury nor the Federal Reserve System should m ake final decisions without responsive consultation and w ithout due regard for the responsibilities and views of its partner. 2. Continuous com m unication provides the basis for such sharing of responsibility. In the pre-“ Accord” pe riod there was a failure of com m unication which helped to lead to the breaking of this rule. The Federal Re serve thought it understood the position of the Treasury, b u t it may not have. There is good reason to believe th at the Treasury did not understand the posi- 67 tion of the Federal Reserve. For the latter lack of u n derstanding, the Federal Reserve bore some blame. Al though its basic objective was to regain the initiative with respect to the creation of bank reserves, m uch of its argum ent with the Treasury was couched in term s of interest rates. The interest rate structure, of course, was the place where Federal Reserve policy would directly and obviously impinge on debt m anagem ent, but con centration on small changes in interest rates tended to reduce discussion to a question of “ hat sizes” in the m inds of the Treasury and, to some extent, of the Con gress and the public. The Federal Reserve had come to believe, however, th a t with a greatly enlarged Federal debt and a nearly homogeneous national money m ar ket, an opportunity had been created for effective ac tion with lim ited variation in interest rates and th at, for the tim e being, its objectives could be achieved by restoring m odest rate flexibility at the short end of the rate structure. 3. In the absence of understanding and acceptance of this belief, the Treasury viewed with some doubt the strength of purpose of the Federal Reserve to m aintain the 2 V2 percent rate on outstanding long-term Treasury bonds, since the m aintenance of this ceiling on the rate structure limited the permissible variation of rates lower down the m aturity schedule. The Federal Reserve was aware of this restriction, b u t was willing to accept it for a tim e because of its belief th a t there would need to be an extensive shifting in the portfolios of investing in stitutions out of long-term Governm ent securities and into corporate bonds, m ortgages, and other debt in strum ents of the private sector of the economy in the re conversion period, and th at this shift would have to be eased along if serious m arket unsettlem ent was to be avoided. In perform ing this orderly m arket service, the Federal Reserve tried to offset the effect of its bond purchases on bank reserves by selling equivalent am ounts of short-term Governm ent securities, and had considerable success. Continued success in this m aneuver, however, needed the assistance of higher in terest rates on the short-term securities being sold. 68 4. Finally, in the catalogue of m isunderstanding, there was the general Treasury opinion th at the credit program which the Federal Reserve wished to follow would be of little use in com bating inflationary pres sures, particularly in the K orean period, and th at “ ex perim enting” with the interest rate structure could weaken faith in the Governm ent securities m arket and in the credit of the Governm ent at a time when m ajor war financing might be necessary. The Federal Re serve, on the contrary, believed th a t faith in Govern ment credit and confidence in Governm ent securities would be destroyed if it became apparent that monetary policy was to be prevented from fighting inflationary pressures and th a t a dollar invested in Government securities would be a shrunken dollar when the securities m atured. U p to the tim e of the Korean crisis, the Federal Reserve was content to carry on a holding operation. It joined with the Treasury in opposing those who, in the im m ediate postwar years, counseled ab rupt and vigorous use of credit policy to reduce the swollen money supply, inherited from the war, and to wring ex cess liquidity out of the economy. R ather, it took the position th at the economy would have to grow up to the money supply (which it rapidly did) and that, m ean while, release of inflationary pressures suppressed by direct control during the war period would be partially offset by increases in the national product (as they were). In the face of the economic repercussions of the Korean crisis, however, such an approach was no longer practical. 5. The K orean confrontation focused attention on the core of the problem . Coequal Governm ent agen cies, with certain overlapping responsibilities, had been unable to arrive at a common policy other than by the subordination of one agency to the other. Various answers to this problem were suggested. (a) A clearer Congressional m andate. There is no clear m andate to the Treasury with respect to the broader economic im plications of debt m anagem ent 69 and no clear m andate to the Federal Reserve System with respect to the m aintenance of price stability and the international position of the dollar. As m entioned earlier, a subcom m ittee of the Joint Economic Com m it tee—in 1950—recom m ended th at it be expressed as the will of the Congress th at transactions with respect to money and credit and transactions in the Federal debt be m ade consistent with the policies of the Federal Reserve. This recom m endation followed the dictum of Senator Douglas th at “ good fences m ake good neighbors” , but when the location of the property line is uncertain and the line may change at times, “ good fences” are not an adequate answer. Both the Treasury and the Federal Reserve have af firm ed th at, in addition to Congressional directives ap plying to them specifically, they consider themselves bound by the declaration of policy set forth in the Em ployment Act of 1946. W hat rem ains to be done, in term s of a Congressional m andate to the Federal Reserve System, it seems to me, is to include a reference to price stability am ong the general guides to economic well-being in the pream ble of the Employ ment Act, and to add a general directive with respect to price stability and the international position of the dollar to the Federal Reserve Act. This will not satisfy those who believe th at a central bank should pursue a prim ary objective—stable p u r chasing power of the m onetary u n it—without being diverted by a wider range of economic objectives such as are set forth in the Employm ent Act of 1946. Cer tainly the Federal Reserve System m ust have its own objectives in the field of m onetary policy and realize its capacities and lim itations, but I do not believe th at it is possible in the light of the Em ploym ent Act, and what it reflects of national purpose, for the central bank to be completely free. (b) Another suggestion for resolving conflicts of the Treasury and Federal Reserve, where their interest and duties overlap, and which usually draws considerable support, is the establishm ent of an interagency con 70 sultative com mittee or a national m onetary and credit council, which would bring together the heads of a num ber of Governm ent agencies having responsibilities related to credit policy and debt m anagem ent. This would be expected to provide for informal collabora tion, although the body would be without directive powers, which most agree would be an usurpation of Congressional authority. This sort of thing sounds good in conversation and looks good on paper, but the only people who can resolve differences arising out of overlapping statutory responsibilities are people who bear the responsibility and know what it is all abo u t—th at is, the people at the Treasury and in the Federal Reserve System in this case. A committee or council of the sort proposed either languishes on the vine because of a lack of authority, or becomes a means of exerting executive pressure on a body (the Federal Reserve) which draws its powers from the Congress. (c) There are some who think, of course, th at the Federal Reserve System should be made more respon sive to the Executive Branch of the Government and, presum ably, th at the President by virtue of his office or the power of his presence should be able to order a composition of contrary views held by Treasury and Federal Reserve officials. W hether as a three-m an body, with the President holding the balance between Treasury and Federal Reserve, or as a council m ade up, on one side, of a num ber of individuals holding Presidential appointm ents and owing Presidential loyalty as a part of a political adm inistration and, on the other side, by a representative of the Federal Reserve System, this kind of proposal has little to recom m end it. In the words of a witness (Beardsley Ruml, formerly Chairm an of the Board of the Federal Reserve Bank of New York) at the hearing of the Patman subcom m ittee of the Joint Committee on the Economic Report in 1952, bringing the President in to settle differences between the Federal Reserve and the Treasury would m ean th at one or both parties to the disagreem ent would devote their efforts to procuring a 71 favorable opinion from the President, and would lead to the use of force rather than reason in dealing with an agency of the Congress which has statutory duties. “ Nothing b u t harm to public confidence in both money and Governm ent would result.” This is not to say th at the C hairm an of the Board of Governors should not discuss the problems of the Federal Reserve System with the President, alone or with the Secretary of the Treasury. T hat is natural and, at times, desirable. But to m ake this a regular means of coordination of policies can lead to dictation instead of persuasion, as the experience of the pre-“ Accord” period attests. (d) Then there are those who would substitute an invariable form ula for fallible hum an judgm ent or weak hum an resolve in directing m onetary affairs and, so long as the Federal Reserve followed the form ula (if it retained its job at all), the Treasury (and everyone else) would have to accom m odate its objectives to the working of the form ula. Ideally, one exponent of this theory says6 “ the surest way to achieve the aim of a stable m onetary structure is. . .to legislate a rule spec ifying the behavior of the quantity of money. The rule I favor is one which specifies th a t the quantity of money shall grow at a steady rate from week to week, m onth to m onth, and year to year” . But when this in variable form ula is related to an existing and future state of affairs, and when account is taken of the lag between m onetary action and its economic effects, he says that “the problem of lag in reaction and the fact that the effects are spread over a period is not a problem that can be solved by ju st looking at the quantity of money. In order to solve th a t problem or in order to elim inate th a t difficulty it would be necessary to forecast w hat is going to hap p en m uch b etter th a n we now c a n .” So, in point of fact, except as an assertion th a t an invari able form ula would have m ade fewer m istakes th an have been m ade w ithout such a form ula, he says we do 6 Professor Milton Friedman at the hearings on “The Federal Reserve System after Fifty Years” , held by the Subcommittee on Domestic Finance of the Committee on Banking and Currency, House of Representatives, March 3, 1964. 72 not “ know enough now to set up a form ula . . .which would do m ore good th a n h a rm ” . I am willing to wait, at least until we have m ore persuasive argum ents th a t a rigid invariable form ula can ride through the continuing changes in the economic environm ent, w ithout the benefit of hu m an jud g m ent and w ithout causing m ajor errors instead of m inor ones. My own conclusion is th at the experience of the “ Accord” leads to a more hum an and natural solution of the problem of the overlapping responsibilities of the Treasury and the Federal Reserve th an any of the corrective devices which have been suggested. It is the solution which has been working since the “ Accord” . It involves the recognition th at Treasury and the Federal Reserve are coequals in the area of their overlapping responsibilities. It is based on the assum ption th a t inform ed and responsible men recognize that, in our form of Governm ent, such sharing of responsibility requires thorough discussion of divergent views and every effort to merge them into a common purpose. It dem ands th at there be open and frequent com m unication between those who determ ine policy, th a t the m akers of policy have staffs of the highest competence which also are in open and frequent com m unication, and th a t the policymakers have a sufficient understanding of the theory and practice of their art to be able to add wisdom to knowledge when positions show signs of becoming unyielding. Finally, it assumes th a t the Con gress, presum ably through the Joint Economic Committee on the Economic Report, will continue to m onitor perform ance and to provide evidence of the attitude of the Congress tow ard perform ance because, if irreconcilable differences do arise, the Congress m ust be the final arbiter in m atters con cerning the power to regulate the “ people’s money” . The Federal Reserve challenge to the Treasury’s assertion of dom inance in the area of their overlapping responsibilities prior to the “ Accord” had its ultim ate justification in the achievement of coequal status in these m atters, and not as an assertion of a false independence. The Federal Reserve does not have, never has had, and never has claimed to have an in dependence in m onetary affairs which divorces it from the general economic policies of the Government. 73 Letter to Robert T. Stevens A ugust 28, 1950 M r. R obert T. Stevens C hairm an, B oard of D irectors Federal Reserve B ank of New York D ear Bob: Your letter of August 24 rem inds me th at I had a vacation. I had alm ost forgotten it. I returned to New York in tim e to attend the directors’ meeting on August 17, and then went to W ashington for a meeting of the Federal Open M arket Committee on Friday, the 18th. At th a t meeting I was in the chair most of the day as Tom was fogbound between N ortheast H arbor, M aine, and W ashington. It was the view of the Committee, which I m ust adm it I steered in th a t direction, th at inflationary pressures were strong and increasing, th at announced Government policy is to restrain these pressures by fiscal and credit measures rather th an by all-out direct controls, and th at it was high time we did som ething to restrain the rapid expan sion of bank credit. We knew, of course, th at legislation was in the works to fix controls over m ortgage credit and con sum er credit—two sore spots—but we also knew th at it would take tim e to pass this legislation and time to set up its adm inistration. In addition, we felt th at selective controls would not be enough in any case, th at bank credit of all sorts was expanding, and that general credit controls should be used. W e decided, therefore, to act in our sphere of prim ary responsibility, the control of credit, by refusing to provide further reserves to the banking system at existing rates. We also decided to tell the Treasury what we had done, rather than to formulate our action in terms of a recommendation to the Treasury as to the rates it should place on its SeptemberO ctober refundings, its action in its prim ary sphere of responsibility. The fact th at these two spheres of responsibili ty are the opposite sides of the same coin is what causes the difficulty. 74 Tom was in agreem ent with all this when he joined the meeting, and he and I saw the Secretary th at afternoon and told him what we had decided to do and why, both with respect to the New York Bank discount rate and open m arket operations. The Secretary was brief and abrupt, indicating th at since we had told him what we had decided to do there was nothing for him to say. Tom asked him if he agreed with us, and he again said there was nothing for him to say. I said I did not think we should ask his blessing—th at we should take sole responsibility for our action—b ut we could hope for his acquiescence and, perhaps, his later approval if our ac tion worked out well. We then told him we had a statem ent for the press in preparation which we had hoped would reach him before we left his office, and th at we would telephone it to him as soon as it was ready. Tom and I returned to the Board building and in a few m inutes a call came through from the Secretary. He told Tom th a t he was announcing his Septem ber-O ctober financ ing immediately and th at it was 13-month lV is for all m aturities, totaling $13 billion plus. This was contrary to all the advice he had received from any source I know of; and, of course, ran directly counter to our program . Tom read him our statem ent and pointed out the conflict, but the Secretary had m ade up his m ind. This is the way, on two recent occa sions (last winter and late this spring), he had throttled us by early announcem ents of forthcom ing refundings. This time we had decided we m ust stick to our course, even though he again tried this maneuver. The result is a messy situation both in term s of our rela tions with the Treasury and with the m arket, and in term s of our broad objective. We are trying to im plem ent what we understand to be Governm ent policy by trying to restrain ex cessive expansion of bank credit, as a holding action, until the stronger weapon of higher taxes can be brought into play in the battle to control inflation. At the same time, we cannot perm it a large Treasury refunding to fail completely, par ticularly in tim e of war. As a consequence, we are buying very large am ounts of the Septem ber-O ctober m aturities at par to protect the Treasury’s refunding, while letting the yields in the rest of the m arket rise above a rate of 1 V a percent for one 75 year. Obviously, few will w ant to exchange their m aturing holdings for 13-month 1V4S when they can buy shorter m aturities at higher yields or improve their earnings position by buying longer m aturities. To offset our purchases of the m aturing issues, we are allowing some of our bill m aturities to m ature without replacem ent and selling other securities as and when we can at the higher yields which have developed. A large p art of the public reaction to all this has been, of course, th a t it is a flare-up of an old fight between the Treasury and the Federal Reserve. T hat makes the most striking news story. The public attitude on th at may well be th a t “ W e don’t know who is right, b u t this is no tim e to be fighting am ong ourselves” . It is im portant, therefore, th a t we m ake it clear as and when we can (without engaging in a b a t tle of statem ents with the Secretary) th at there is more to this th an a clash of personalities or agencies on the question of whether short-term rates should be an eighth or a quarter higher or lower. The fundam entals are two: (1) Is inflation in the present circum stances going to be controlled by adequate credit and fiscal measures or are we going to let it go, perhaps later moving into direct controls? (2) Are we going to have a central banking system which has some power and authority with respect to interest rates, within the term s of general G overnm ent policy, or is this no longer possible in view of the T reasury’s debt m anagem ent problem s and the G overnm ent’s debt position? The Congress may have to render the decision on these points, and an inform ed public opinion will be most im por tan t. I think th at, if we can m ake it clear th at confidence in the credit of the Governm ent and in the dollar can be preserved, not by freezing interest rates and prices, but by giving evidence of a will to restrain inflation, we can win. There is a growing feeling th at Government securities are a poor investment because the dollar you get back isn’t the same dollar you put in, and there is a dangerous chance th at people m ight begin to change dollars for “ things” if they become convinced th a t another substantial rise in prices of “ things” is inevitable. 76 So far as the New York B ank’s discount rate is concerned, I was not distressed by it as I recognized th a t the tide was running strongly for action when I left on vacation. As it turned out, it was fortunate th a t we were ready with a higher discount rate at the tim e of the O pen M arket Committee meeting, a week ago Friday. This gave the Board of Gover nors something specific on which to act immediately, and gave us a peg on which to hang our public statem ent. There are difficulties about m aking a public statem ent with respect to specific open m arket operations, because you may tip your hand before you are ready. O ur directors were a little im pa tient, I think, but in the end their action fitted in very nicely. I hope you are having a fine vacation and will be ready for anything when you return on Septem ber 7. It will be good to have you back. W ith best regards, Yours sincerely, Allan 77 Letter to C.F. Cobbold Septem ber 18, 1950 M r. C.F. Cobbold Governor, Bank of England My dear Cobbold: I find I am a little behind in my correspondence as a result of a holiday in California (which I enjoyed thoroughly), and the events which began to take shape as soon as I returned to the Bank at m id-August. First, with regard to our studies of the general balance-ofpaym ents position and particularly with reference to your let ter of July 20, the K orean situation and the rearm am ent pro gram of the W estern world have obviously m ade all previous estim ates and hopes out of date. Presently I don’t think we can foresee what deterioration in previous trade expectations may develop, over time. Nor can we see what the balance-ofpaym ents effects of the rearm am ent program may be. The only thing th at emerges clearly, so far as I am concerned, is th at some form of m utual aid will be necessary after 1952 and that, while hope is deferred, we can nevertheless keep our ultim ate objectives in mind. I am not surprised th at you are bewildered by the position in this m arket. It really is an old story, however, and one with which you are fam iliar. It seemed to us in the Federal Re serve System, and to most others in Governm ent and out, th at inflationary pressures were building up and th at w hat ever steps could be taken to dam p them down should be ta k en. The Governm ent, both in its executive and legislative branches, decided that reliance in this effort would be placed, at least for the present, on fiscal and credit measures. Direct controls were not to be used, at least for the present, except in special circum stances. T here was, therefore, no attem pt at central b an k defiance of G overnm ent policy, as we understood it, in what we have done. W e felt, rather, th at 78 our continuing responsibility to prom ote stable progress in the economy had been given an added weight. W e knew, of course, th a t increased taxes were in process of enactm ent and we believe this to be the country’s m ain reliance. We also knew th at powers of selective control of credit—instalm ent credit and mortgage credit—were in the works and th at these would be helpful, since m uch loose lending was going on in these areas. W e could not, however, ignore the excessive ex pansion of bank credit in other fields and this called for general credit controls, however modest. In the circum stances, instead of trying to recom m end to the Treasury what term and rate it should put on its Septem ber and O ctober refundings, which obviously is prim arily its responsibility, we advised the Treasury of what we were going to do to m ake it a little more difficult and a lit tle m ore costly for the banks to get additional reserve funds, which is prim arily our responsibility. Since these powers and responsibilities overlap, or are the reverse sides of the same coin, one would hope for agreed and coordinated action. This we had sought, in one circum stance or another, over many m onths, with meager results. This time we went our separate way and the Treasury went its way. The result was a rise in short-term rates which m ade the T reasury’s offering of §\2>Vi billion of 13-month lVi percent notes (in exchange for m aturities of 2Vi percent bonds, 2 per cent bonds, and 1 % percent notes called or due Septem ber 15 and O ctober 1) largely unacceptable to the m arket. We then set ourselves to buy as m uch of the m aturing issues as we could so th at the Treasury m ight not have a complete failure in these difficult times, and to sell as m uch of our ex isting holdings as we could, so th at we would not be forced to put funds into the m arket, contrary to our avowed objective. The result was Alice in W onderland in some ways, but we have been able to come out fairly well so far. The Treasury got its money, or most of it, at VA percent, short-term rates have gone up to about 1% percent for one year, and the money m arket has been on the “ tight” side m uch of the time. This sort of thing can’t go on. M aybe minds will be clearer and agreem ent more likely as a result of what has happened, 79 or maybe anger or resentm ent will prevent calm consider ation. I don’t know. The Treasury doesn’t believe th at small changes in interest rates can have any effect on strong infla tionary pressures, such as we are now exposed to, and no one thinks of drastic action such as m ight have been taken in “ olden days” . O n the other hand, it is quite sensitive about increases in the cost of servicing the debt. W e shall have to try again to work out a coordinated program . Failing that, the Congress m ight have to take a hand in deciding how our overlapping authorities and responsibilities are to be exer cised. This m atter was discussed last D ecem ber and com m ented upon in the report of hearings of the Douglas Sub com m ittee of the Congressional Joint Committee on the Economic Report. Despite the encouragem ent of this report, experience would suggest th at the odds are against us, but tim e and circum stance could be in our favor. In any case, we h ad a present responsibility we felt we m ust meet. W ith best regards, Yours sincerely, Allan Sproul 80 Letter to Thomas B. McCabe February 20, 1951 M r. Thom as B. M cCabe C hairm an, B oard of Governors Federal Reserve System D ear Tom: At the meeting of the Executive Committee of the Board of Directors of this bank on February 8 (at which I was not pres ent because I was attending a m eeting of the Federal O pen M arket Committee at W ashington), and again at a meeting of the Com mittee on February 15, there was extended discus sion of credit policy and debt m anagem ent, of the differences which have developed and persisted between the Treasury and the Federal Reserve System, and of the responsibilities of the directors in the circum stances. It was the consensus of the directors present th at positive action should now be taken by the System to restrain the further expansion of bank credit, and th a t they, as directors, h ad perhaps been remiss in not urging more vigorous action, during the past several m onths, while inflationary pressures have been m ounting. At the same time, the directors find themselves somewhat at a loss in defending the Federal Reserve System and in pro moting its policies, in the absence of definitive word from the Board of Governors and the Federal O pen M arket Com m it tee as to what their policy is, whether support of policy within the System is unanim ous or divided, and whether the policy will be pursued over Treasury opposition or not. I have told the directors, in the past, of my own personal views and I have now told them what I could of our present situation and about the efforts we are again m aking to reach an accom m odation with the Treasury, short of abandoning those policies which we think are essential to help prevent further inflation and consequent loss of confidence in the credit of the Governm ent and in the dollar. The difficulties of m aking a clarifying public statem ent in these circum stances were recognized, b u t the idea th a t such a statem ent is not desirable was reluctantly accepted, if at all. 81 On the basis of these discussions, I am sure th at the direc tors strongly support the kind of program we have in m ind, which is to deprive the banks of further ready access to reserve funds, assum ing the possible risks of the rise in short term rates and the decline in prices of long-term bonds which would follow. They would urge us only to put the program in to effect as prom ptly as possible, doing what we think is right in term s of our statutory responsibilities and the present economic situation. I think they would want us to do this regardless of Treasury opposition, if th at continues, leaving to the Congress the final determ ination as to whether or not we have perform ed our duties faithfully and well. Because they feel this strongly, and because they believe th at you and your fellow m em bers of the Board of Governors have a right to know their views, they have asked me to write you in this vein. 82 Yours faithfully, Allan Sproul Letter to James E. Shelton February 28, 1951 M r. Jam es E. Shelton President, A m erican B ankers A ssociation c /o Security - First N ational Bank Los Angeles, C alifornia D ear Jim: I see th a t you are going to speak at the A nnual Savings and M ortgage Conference of the A .B.A ., here in New York on M arch 5. Your subject is listed in the program as “ 1951 — A Critical Y ear” . It is alm ost certainly going to be a critical year for the Federal Reserve System and for the whole banking system. It looks as if there is going to have to be a determ ination, prob ably by the Congress, as to whether we are to have a central banking system, such as we thought we had, or w hether it is to become, in essence, a bureau of the Treasury; whether we are going to be able to have a credit policy somewhat di vorced from the stark needs of Treasury borrowing and unilateral decisions as to debt m anagem ent, which directly and indirectly involve credit policy. This is a great banking issue, and I would be sorry to see you ignore it during your term of office as President of the Am erican Bankers Associa tion. Please do not let anyone tell you th at all this commotion is just so m uch buildup by the Board of Governors preparatory to another “ grab for power” over reserves of the m em ber banks. I do not know whether or not the Board of Governors will ask the Congress for additional powers over m em ber bank reserves, nor whether the Treasury will support such a request, but th at isn’t the m ain issue. The m ain issue is whether credit policy is to m ake its contribution—now—to restraint of the trem endous inflationary pressures in the 83 economy. We are completely serious about the need to curb any further expansion of bank reserves, through open m arket operations and the discount rate, and I should think you would be equally serious about curbing any further aggregate expansion of bank credit. We can’t do our job if we have to support Governm ent securities at their present levels or at any fixed level, and 14,000 individual banks, even with a voluntary agreem ent, can’t do their job if we don’t do ours given the competitive situation which exists. The Treasury has dem anded, in effect, th a t we give fixed support to the Governm ent securities m arket at present levels as part of what it calls financial m obilization for defense. T hat means the abandonm ent of all control over bank reserves, as was the case during the war, and it helps to expose the country to another round of dollar debasem ent such as we inherited from our war finance. I should think the banks of the country would w ant us to use all our powers to help prevent such a tragic encore, since under present circum stances it can be done without risk to the defense program , full production, and employment, and since it should contribute to greater confidence in the credit of the Governm ent, which m eans the dollar, rath er th an the reverse. T hat is why I was sorry to see you spend so much tim e in a recent talk berating the idea of increased Board powers over reserve requirem ents, and raising the cry of socialism, while consigning to the fine print your rem arks on what I consider to be the real issue. I don’t care m uch w hether you, or the A .B .A ., are for or against increased powers over reserve re quirem ents, so long as you take a stand in favor of effective action to com bat inflation, including action to curb further expansion of bank credit and the money supply which feed the inflationary fires. I care mightily whether you, the A .B .A ., and the many fine bankers of the country really discuss the issues involved in the controversy between the Federal Reserve System and the Treasury and reach objective conclusions. I continue to hope th a t you will prom ote such discussion, so th a t if and when the issue comes before the Congress the b ankers of the country will not be unprepared to take a stand on principle, rath er than on expediency and 84 tem porary political advantage. This is not an argum ent about eighths or thirty-seconds. It is an argum ent about a fundam ental question of economic and financial policy. If you have any tim e when you are in New York, I should be glad to talk with you about all this. Y ours faithfully, A llan Sproul President P.S. I haven’t m entioned the m ore arbitrary controls over bank lending, which some are suggesting, as a way to restrict credit and peg interest rates at the same time. I assume we would all abhor this kind of Governm ent control. If you are afraid of state socialism, this would be it. 85 Letter to Murray J. Rossant New York Times February 10, 1963 D ear M urray: The trial balloons having been launched and having floated quite well, the reappointm ent of Bill M artin has now been m ade official. He can leave whenever he wants, with colors flying, which is as it should be. Meanwhile, as a sym bol of the m onetary conscience of the adm inistration, he is useful at home and abroad and, to paraphrase his favorite phrase, he can lean with as well as against the wind. In the prelim inary stories concerning the president’s inten tions, however, there was one historical note to which, as a m em ber of the society against creating history by constant repetition, I take exception. The W estern edition of the Times for February 6, in a brief sketch of Bill M artin’s career, said th at “ In the ‘Accord’ drafted primarily by Mr. M artin and W infield Riefler of the Board’s staff, the pegging was discontinued.” The “ Accord” was not drafted primarily by M artin and Riefler. The general basis for the “ Accord” was laid down by the Federal Open M arket Committee, itself, in a letter from the then chairm an of the Committee to the then Secretary of the Treasury early in February 1951. The term s of the specific program , which becam e the “ Ac cord” , were set forth in a statem ent prepared by the Federal O pen M arket C om m ittee, in m eeting assem bled, and sub sequently han d ed to the w aiting representatives of the Secretary of the Treasury. In between these events, the Secretary had gone to the hospital, and had appointed Mr. M artin and two associates at the Treasury to carry on ex ploratory conversations “ at the technical level” with representatives of the FOM C. The “ Accord” was only an accord by courtesy. Actually, it was alm ost entirely a statem ent by the Federal Open M arket Comm ittee of what it was prepared to do and not to do in the related fields of m onetary policy and debt m anagem ent, so as 86 to free itself of any obligation to support fixed prices of Governm ent securities. The unique feature of the program was the offering of a long-term nonm arketable 2 3 percent A bond in exchange for outstanding 2Vi percent bonds of 1967-72, with a provision for conversion of the non m arketable bonds into m arketable five-year IV 2 percent notes. This was a proposal advanced by M r. Riefler. It pro vided a bridge over which the Treasury could retreat from its insistence on the m aintenance of a ceiling rate 0 H V 2 percent for Treasury bonds. At the same time, it offered a means of removing from the m arket a large am ount of 2Vi percent bonds which the holders were pressing for sale so th a t they m ight invest their funds in higher yielding obligations. M r. M artin’s contribution to the “ Accord” , I think, was to get the Secretary of the Treasury to accede to the term s laid down by the Federal O pen M arket Committee, as the best way out of a bad situation. As they say, I wanted you to have this bit of lore, in case anything happens to me. Sincerely, Allan Sproul 87 Letter to Murray J. Rossant New York Times Septem ber 3, 1966 D ear M urray: I see th at form er President T rum an has gotten into the act. His concern is proper, although his reasoning leaves something to be desired and his recollections are faulty. As one who has entered the age of reminiscence, my attention was drawn to the latter aspect of what he said. The “ th reats” from the Federal Reserve during the latter p art of his adm inistration, to which he refers, were really threats against the Federal Reserve coming from his office, his advisers, and the Treasury. The “ G overnm ent prevailed” , as he claims, in the sense th at the Federal Reserve had the backing of strong Congressional opinion and refused dictation from the President. The System even had to give out a statem ent (by M arriner Eccles) saying th at a report of our meeting with the President, given out by his office and the Treasury, was incorrect. Or, as he would say, false. Your editorial on his statem ent was easy on him , as it should have been. After all, he was President of the U nited States, he is in his eighties, and he never did know anything about economics. I am going to attend the Bank and Fund meetings at W ashington at the end of the m onth, an invitation from George W oods having overcome my resolution of about fif teen years’ standing to forego these mass celebrations. After the meetings I shall be in New York for a couple of weeks and I shall hope to see you. 88 Sincerely, Allan Chapter 4 Human Judgment and Central Banking A M m s id e from the need to do som ething about inflation, no sub ject was dearer to Sproul’s h eart th an w hat he viewed as the closely related need to exercise hum an judgm ent, however fallible, in the con duct of m onetary policy. He rarely let an opportunity go by w ithout calling attention to one or the other, m ore likely both. The first of his papers reprinted in the present chapter, “ Policy Norm s and C entral B anking” , is the m ost com plete treatm en t of the “ bills only” or “ bills preferably” controversy he ever published. It was this conflict, of course, th a t eventually led to his d ep arture from the F ederal Reserve System. He went about writing the paper with his usual historical thoroughness: starting with 1880 and putting “ bills on ly” in the context in which he h ad always visualized it— as a p articular instance of the eternal search for a m echanical rule to replace hum an ju d g m en t and discretion in economic policym aking. “ P racticing central bankers (and the governm ents to which they are responsible)” , he concluded, “ cannot afford to be confined by for m ulae which attem p t to cope, in precise m easure, with the actions and anticipations of millions of h um an beings exercising a high degree of econom ic freedom of choice. M onetary policy can continue to m ake its contribution to the goals of vigorous sustainable economic growth, m axim um attain ab le production and em ploym ent, and reasonable stability of prices, if its practitioners continue to sharpen their analyses of com plex econom ic developm ents and continue to base their actions upon a balanced view of total situations. They cannot be relieved of this difficult task by doctrinaire policy n o rm s.” T his article is followed, in the present chapter, by his historic 1954 Congressional testim ony on “ bills only” , when he opposed C hairm an M artin head-on before the Subcom m ittee on Econom ic Stabilization of the Joint Econom ic Com m ittee (then known as the Joint Com m ittee on the Econom ic R eport). It was not an easy task for a long-tim e organiza tion m an, and he could hardly avoid frequent misgivings. 89 Three 1961 letters and a 1963 address at New York University con clude the chapter. T he first two of the letters (to M urray Rossant and Alfred Hayes) are replies to com m unications received shortly after the Federal O pen M arket C om m ittee abandoned “ bills only” in February 1961. The th ird letter, to H enry A lexander, C hairm an of the B oard of M organ G uaran ty T ru st Com pany, was w ritten and m ailed from Zurich, Sw itzerland. A day before the Sprouls were to leave on a threem onth trip to Europe, M r. A lexander h ad handed him a copy of the A pril 1961 issue of the M organ G uaranty Survey, containing an article entitled “ A Closer Look at Interest R ate R elationships” . The article a t tem p ted to show by various statistical techniques th a t there is a high degree of covariation between short-term and long-term interest rates, with m inim al tim e lags, leaving the im pression th a t the ab an d o n m ent of “ bills only” a few weeks earlier by the O pen M arket Com m ittee h ad been a m istake. A lthough Sproul was on vacation, he found it im possible to postpone a response until his retu rn hom e. He wrote the letter by hand in Zurich and m ailed it to A lexander in th a t form , although he knew th a t his handw riting was alm ost illegible. “ I hope you can and will read th is” , he wrote; “ Miss Regan at the Reserve Bank will decipher and type it for you if necessary, I am su re.” 90 From Men, Money, and Policy, Essays in Honor of Karl R. Bopp Federal Reserve Bank of Philadelphia, 1970 Policy Norms and Central Banking From the earliest days of central banking in its primitive forms to the present era in which central banks, as the na tional m onetary authorities, are charged with prom oting the general economic interests of the nations they serve, domestically and internationally, there has been a continuous pursuit of a will-o’-the-wisp— a policy norm which would guide the operations of such banks with a m inim um intru sion of fallible hum an judgm ent. The theory has been th at a central bank, or any m onetary control, m ust have a supreme norm of reference; th at it cannot use more than one norm of reference.1 The m odern beginnings of this passionate pursuit of an elusive object may be traced to misconceptions which have grown up concerning the operation of the international gold standard during the period 1880 to 1914. Prior to th at period, the forerunners of present-day central banks were designed prim arily to finance governments or acquired a tinge of public responsibility because of the m agnitude of their private banking operations. In the years following 1880, however, most of the principal trading nations of the world h ad linked th eir currencies to gold—either they were on a “ full” gold standard or a “ lim ping” gold standard or a “ gold exchange” standard or some com bination of these stan d ards—and the central banks of the financially developed countries h ad taken prim ary responsibility for m aintaining the international convertibility of their national currencies, directly or indirectly, into gold at a legal parity. Responsibility for a system of fixed exchange rates necessarily focused attention on international movements of goods and services, capital and credit, and on the rise and fall of the country’s international reserves (gold or other legal reserves) which could be used as a buffer to confine fluctua 1 Unpublished paper of Robert B. Warren, Institute of Advanced Study (Princeton, New Jersey). 91 tions in the exchange rate within a narrow band around pari ty. The central b a n k ’s response to a fall in the exchange rate and a loss of reserves was usually an increase in its discount rate designed to reverse the movement and, with less unifor mity, the response to a rise in the exchange rate and a gain of reserves was a reduction of the discount rate. But the tim ing and extent of such changes were m atters of judgm ent and their effect on the domestic economy, while secondary to the prim ary objective, did not always go unattended, particularly in tim es of loss of public confidence and financial crisis. The whole working of the system depended upon a complex of in stitutions and techniques and economic conditions, domestic and international, favored by a period of relatively m oderate shifts of trade and capital movements around m ultilateral balance, and fostered by the absence of great wars. To describe the system as an autom atic gold standard, hardly touched by hum an hands, is to m isrepresent it. As the studies of A rthur I. Bloomfield have indicated, “ Not only did central banking authorities, so far as can be in ferred from their actions, not consistently follow any simple or single rule or criterion of policy, or focus exclusively on considerations of convertibility, but they were constantly called upon to exercise, and did exercise, their judgm ent in such m atters as w hether or not to act, the kind and extent of ac tion to take, an d the instrum ent or instrum ents of policy to use. . . .Discretionary judgm ent and action were an integral p a rt of central b anking before 1914, even if m onetary m anagem ent was not oriented tow ard m aintenance of dom estic econom ic growth and em ploym ent and stabiliza tion of prices in the broad er m odern sense.” 2 The discussion in the U nited States concerning the crea tion of a central b an k , or a central banking system, during the years before the passage of the Federal Reserve Act in 1913 took place in a period when belief in the autom atic ch aracter of the international gold stan d ard was little ta r nished by later heresies; and gold redeem ability at hom e an d internationally was a widely accepted article of faith in this country. A ttention was centered on changes in the n a tional m onetary system which would correct weaknesses in 2 Monetary Policy Under the International Gold Standard, 1880-1914, published by the Federal Reserve Bank of New York. 92 the dom estic b anking structure, b u t which would not in terfere with dom estic adjustm ent to “ autom atic” in tern a tional m onetary arrangem ents under the gold standard. The principal purposes of the Federal Reserve Act in a m onetary sense and, aside from m atters of bank supervision and the pyram iding of bank reserve funds in New York, were as stated in the pream ble to the Act: “ . . .to furnish an elastic currency and to afford a means of rediscounting com mercial p a p e r.” The panic of 1907 had focused attention on these problem s. S ubsequent studies h ad pinpointed the dif ficulty as being inherent in a currency largely in the form of gold certificates and national b an k notes and in bank reserve requirem ents which placed a limit on bank loans and investments more or less regardless of the appropriate and changing needs of the economy. Although there was little specific reference in the final Federal Reserve Act to the prom otion of general economic stability and stability of prices, there was a thread of theory running through the consideration of various drafts of the bill which saw in the legislation a m eans of autom atically con trolling the volume of currency and bank loans and in vestments in a way which it was thought would go far to ac complish these purposes. This theory found expression in the so-called “ eligibility” provisions of the Act. The paper which the Federal Reserve Banks could discount or purchase or dinarily had to be, in the terminology of the time, “ selfliquidating commercial p aper” —th at is, it had to be based on short-term agricultural, industrial, or commercial tran s actions which gave assurance of paym ent at m aturity. This was the kind of paper which the Federal Reserve Banks could pledge as collateral (in addition to gold) for Federal Reserve notes, which were to become the elastic p art of the currency, and this was the kind of paper which m em ber banks could present to the Federal Reserve Banks for rediscount in order to acquire additional reserve funds with which to support ad ditions to their existing loans and investments. Since the volume of such paper would rise and fall with the transaction needs of the economy, w hether in the form of currency or 93 bank deposits subject to check, excessive increases or decreases of currency circulation and excessive expansion or contraction of bank loans and investment would not occur. O r so it was believed. This experim ent in a species of autom atic control of cen tral banking operations did not long survive its inclusion in the Federal Reserve Act. It was first eroded because it proved to be im practical in the day-to-day operations of the Reserve Banks, and then was voided by am endm ent to the Act (in 1916) which perm itted Reserve Banks to m ake advances to m em ber banks on their promissory notes secured by deposit or pledge of U nited States Governm ent securities. This was done partly in preparation for financial needs which m ight arise if the U nited States entered the war then raging in Europe, b u t the perm anence of the change was the result of an acquired awareness th at the concept of eligibility was unrealistic. As stated by Goldenweiser: “ M em ber banks borrow from the Federal Reserve Banks almost exclusively for the purpose of building up their reserve deposits (with the Reserve Banks) to the necessary (required) level. The banks lend money to such customers (and make such investments) as they choose and meet the currency requirem ents of their depositors. If, as a net result arising out of all their opera tions, they find themselves short of reserves, they borrow from the Reserve B anks. . . .T here is thus no relationship between the character of the discounted paper and the use to which the funds are p u t.” Furtherm ore, “ . . .the theory disregards the fact th at banks can expand at a multiple rate on the basis of Federal Reserve credit; consequently, paper representing the movement of goods to m arket, when dis counted with the Federal Reserve Banks, can become the basis of several times its value in loans of an entirely different character.” 3 Self-liquidating commercial paper as an autom atic means of controlling the expansion and contrac tion of bank credit or adjusting the money supply to the pro ductive requirem ents of the economy was a theoretical and m echanical failure. It provided neither a quantitative nor a qualitative norm of central bank policy. 3 American Monetary Policy (1951), p. 126. 94 Along this chronological road, the idea th at central bank policy should find its norm al guide in stability of prices was never far from the surface of discussion. It had been around for a long time, b u t it received increased attention in the U nited States following W orld W ar I, when there was a sharp increase and then a sharp fall in prices, and when Pro fessor Irving Fisher of Yale became a cham pion and ar ticulate advocate of a dollar of “ invariable purchasing power” . He held th at the only unstable unit of m easurem ent in civilized countries was the unit of money, th at this was a sur vival of barbarism , and th at it was manifest th at an economic system which is largely based on agreements m ade at one date to pay money at another date would have to find a way to adjust its contracts to changes in the purchasing power of money. (The problem is still with us.) This, he argued, had become possible because a m eans had been devised for m easuring the aberrations of an unstable monetary unit, to wit, a representative index num ber of prices. And his specific proposal was th at the m onetary authorities should use such an index num ber of prices as a guide for adjustm ents (perhaps every two months) in the weight of the gold content of the dollar so as to keep its purchasing power invariable. If prices tended to rise or fall, the movement would be corrected by “ loading” or “ unloading” the gold in the dollar. This idea of a “ goods dollar” or a “ m arket basket dollar” or a “ com pensated dollar” , in the form suggested, sounded academic and impractical in a country (or a world) which had become accustomed to the idea (if not the practice) that, if ex ternal price levels were unstable, it could not keep both its domestic price level and the exchange rate of its currency stable and th a t (under whatever form of the gold standard it adhered to) it m ust put stability of the external exchange ahead of stability of the internal price level. The idea was opposed on other grounds th an those grow ing out of habit and custom, however. It was argued th at (a) no price index, no m atter how comprehensive, could include all of the things for which money is spent; (b) th at the rela 95 tion between the volume of credit and the level of prices is not precise and determ inable but is indirect and inconstant; (c) th at things which do not enter into the price-money relation ship, such as an increase or decrease in the efficiency of pro duction and distribution, and changes in quality of product would affect an index of prices; and (d) th a t the movements of a price index which might be used to trigger monetary counteraction would usually be late, since they would refer to past rises or falls in prices, whereas it would be future price moves which should be counteracted. D espite its break with gold-standard thinking and the defects of the proposal itself, it h ad a simple and direct ap peal which led to its consideration by the Congress at hear ings of the Committee on Banking and Currency at the House of Representatives. The proposal was put forward and was the subject of hearings of the Committee in 1926, th a t all the powers of the Federal Reserve System should be used to prom ote stability of the price level. A principal witness opposing such a statutory instruction to the Federal Reserve System was Governor Benjamin Strong of the Federal Reserve Bank of New York. Governor Strong was aware of and used the various agreements which had been advanced in opposition to legislation th at would order the Federal Reserve to use all its powers to stabilize price levels, b u t the m ain thrust of his testimony was th a t there could be no m athem atical form ula for the ad m inistration of Federal Reserve policy or for the regulation of prices. He accepted the view th at credit is a m ajor influence on prices and th a t the prom otion of price stability should be a m ajor policy objective of the Federal Reserve, but his views h ad a broader scope, comprising ideas later finding expres sion in the Em ploym ent Act of 1946. They were th at the Governm ent, through its various agencies, has a responsibili ty for m aintaining m axim um employment and production and prom oting economic growth, and th at the objective of credit policy should be to insure th a t there is sufficient money and credit available to conduct the business of the nation and to finance not only seasonal increases in dem and but also the annual norm al growth of the economy. He was willing to have the powers of the Federal Reserve System used to pro 96 mote stability of the price level, but he also recognized th at choices and compromises h ad to be m ade between various objectives at various times and th at, in the end, hum an judgm ent has to govern the decisions which are made. Stability of prices as a norm of central bank policy as a suprem e norm of reference did not survive (although the Em ploym ent Act of 1946 does include prom otion of m ax im um purchasing power in its policy declaration). O ther can didates for th a t honor have arisen or persisted, however. The doctrine of “ bills only” (common name) or “ bills preferably” (botanical name) may be placed in this category, not because when viewed as a technique of Federal Reserve open m arket operations it deserves this prominence, b u t because its pro ponents came to place so m uch stress on the avoidance of price and yield effects of open m arket operations th a t they finally asserted (and m ade it a p art of the operating directives of the System Open M arket Account) th at the sole purpose of open m arket operations is the provision and absorption of reserves (excepting the correction of disorderly m arkets in G overnm ent securities). This was an attem pt to elevate what first h ad been advanced as a m atter of technique to the eminence of a m echanical rule of Federal Reserve policy— a “ suprem e norm of reference” for the principal element of flexible and effective central bank policy in the U nited States. The controversy which this doctrine aroused for several years until it was ab andoned in 1961 resulted in a consider able literature and involved emotions which seemed to widen and distort the differences of those who favored and those who opposed the policy. In a broad survey such as this, no extended discussion of all the argum ents which were brought forw ard on both sides can be attem pted. Only a sum m ary presentation of its life history from birth to death is possible. The formal birth certificate was recorded in May 1951 when the Federal O pen M arket Committee voted to authorize its C hairm an (W illiam McC. M artin) to appoint a committee to m ake a study of the Governm ent securities m arket. But the idea had been conceived earlier by m em bers of the staff of the Board of Governors (and of the O pen M arket Com m it 97 tee) who not only were interested in the operation of the Governm ent securities m arket as a channel through which to reach and regulate the reserve position of the m em ber banks, b u t who also were dissatisfied with the perform ance of the m anagem ent of the System O pen M arket Account at the Federal Reserve Bank of New York and with the power distribution involved in the linkage between policymaking by the Federal O pen M arket Committee at W ashington and the execution of policy by the New York Bank. The study com mittee, which becam e known as the Ad Hoc Subcommittee, was set up and began its work in May 1952, and its findings and recom m endations becam e a subject of discussion at a meeting of the Federal Open M arket Committee in M arch 1953, after a delay which was reported to have stem m ed from the fact th a t it h ad become apparent th at “ the issues involved in the Com m ittee’s term s of reference are of a most fun dam ental and far-reaching character. They involve not only the most com plicated problems of technique and organiza tion, b u t profound problems of a more theoretical or philosophical n a tu re .” A nd yet, at the M arch 1953 m eeting of the Federal O pen M arket Com m ittee there was unanim ous approval of the two most im portant statem ents of policy with respect to the operations of the System Open M arket Account which had been suggested by the Ad Hoc Subcom m ittee. (U nderlining supplied.) (1) U nder present conditions, operations fo r the System account should be confined to the short end o f the m a rket (not including correction o f disorderly markets); (2) I t is not now the policy o f the Com m ittee to support any pattern o f prices and yields in the G overnment securities m arket, and intervention in the G overnment securities m arket is solely to effectuate the objectives o f monetary and credit policy (including correction o f disorderly markets). 98 The second of these ordinances, which really should have been first, put a seal of disapproval on any future pegging of prices of Governm ent securities such as had been practiced during W orld W ar II, and in the postwar period of readjust m ent in the Governm ent securities m arket while the conse quences of financing the war were being unwound. The first ordinance represented a consensus th at, in m ost cir cum stances, the O pen M arket Committee would be able to attain its policy objectives by operating in the m arket for Treasury bills and other short-term Government securities. The apple of discord became apparent later when there was a creeping movement to give constitutional perm anence to the doctrine which had become known as “ bills only” , and to engrave it perm anently in the public m ind, and particular ly in the m inds of Governm ent securities dealers, by a dribble of statem ents of individuals concerning the “ ground rules” for all future open m arket operations, even though the ques tion of publicizing ground rules h ad been deferred by the Open M arket Committee for fu rther study. At the Septem ber 1953 meeting of the Open M arket Com m ittee4 the phrase “ under present conditions” was dropped from the directive th a t operations for System Account be confined to the short end of the m arket, and replaced by the clause “ until such tim e as (it) may be superseded or modified by further action of the Federal Open M arket Com m ittee” . And, at the Decem ber meeting of the Committee in 1953, the 4 There was a June meeting of the Open Market Committee at which there were five presidents of Federal Reserve Banks and four members of the Board of Governors, and at which the March direc tive relating to confining operations for System Account to the short term sector of the market was rescinded, with the understanding that the Executive Committee of the Federal Open Market Commit tee (which was later abolished) would be free to determine how operations should be carried on in the light of the current general credit policy of the full Open Market Committee. The five presidents voted for the motion to rescind and the four Board members voted against it (following the meeting, the Executive Committee, con sisting of three Board members and two presidents, decided to con fine current operations to Treasury bills). By the time of the September meeting of the Open Market Committee, three of the presidents had changed their minds concerning preserving such limited freedom of action and the March pronouncement, as amended, was restored by a vote of nine to two. 99 general statem ent with respect to System intervention in the Governm ent securities m arket was changed to read “ transac tions for System account in the open m arket shall be entered into solely fo r the purpose o f providing or absorbing reserves, except in the correction of disorderly m arkets” . 5 The m ajor differences of opinion, at least within the Federal O pen M arket Committee, had now become (1) w hether it was misleading and undesirable to prom ulgate a capsule version of the whole theory of central banking, and the whole purpose of open m arket operations, which m en tioned only the providing and absorbing of reserves and om it ted the essential linkage between such actions and the cost and availability of credit; (2) whether it was unnecessary and undesirable to endow the doctrine of “ bills only” with an air of perm anence as a norm of System open m arket operations, no m atter what changes in economic conditions and in the m arket structure of interest rates m ight occur; (3) whether it was desirable to attem pt to provide the Government securities dealers with a continuing set of “ ground rules” for System open m arket operations, which would seek to protect the m arket from the hazards of there being a central banking system whose policy decisions, and whose every action to m ake its policy decisions effective, m ust influence the cost and availability of credit throughout the economy and, therefore, the movements of interest rates and prices through the whole range of m aturities in the Government securities m arket. In the running debate which followed, a great deal of discussion was devoted to elucidating the obvious necessity of having a properly functioning Government securities m arket in which to conduct System open m arket operations; to try ing to prove th at confining such operations to the short end of the m aturity scale would improve, or had improved, the “ breadth, depth, and resiliency” of the m arket; and to assert ing th at substitutability was more im portant than arbitrage in carrying impulses throughout the whole range of m aturities. But the m ajor questions involving the prom ulga 5 This change had a special application to so-called “swap” trans actions in connection with Treasury financing, but it also was an at tempt to nail down permanently a general philosophy of open market operations. 100 tion of a norm of central banking and the publication of per m anent “ ground rules” for the conduct of open m arket operations tended to be neglected, while the Federal Open M arket Committee annually voted to perpetuate the views of its satisfied majority. It is ironical, perhaps, th a t the so-called “ bills only” policy, which was hailed by one of its chief ar chitects in O ctober 1960 as “ the greatest advance in central banking technique in the last decade” , was overtaken by events and abandoned in February 1961. The Federal Open M arket Committee then announced th at the System Open M arket Account was purchasing Governm ent notes and bonds of varying m aturities “ in the light of conditions th at have developed in the domestic economy and in the U.S. balance of paym ents” . The question of “ bills only” may arise again, of course; its abandonm ent can be endowed with no more real perm anence th an its adoption, b u t it is unlikely th a t it will ever be revived as the basis for the sweeping asser tion th at transactions for System Account in the open m arket shall be entered into solely for the purpose of providing or ab sorbing reserves. It is reassuring on this score th a t the latest Joint TreasuryFederal Reserve Study of the U .S. Governm ent Securities M arket (April 1969) recom mends th at “ System purchases of interm ediate- and long-term U .S. Governm ent coupon issues should be continued—even ap art from use in correction or forestalling disorderly m arket conditions— as a useful sup plem ent to bill purchases in providing reserves to the banking system and, when compelling reasons exist, for affecting to the extent consistent with reserve objectives interest rate pressures in specific short- or long-term m aturity sectors of the debt m arket” . The m echanical purpose form ula for Federal Reserve open m arket operations which grew out of the doctrine of “ bills only” is a not too distant relative of what is, at the m oment, the most virulent form of norm addiction, the “ money sup ply” addiction. Both would rely wholly on m arket forces to produce desired effects flowing from Federal Reserve action affecting a single m onetary aggregate. The present virulence of the money supply proposal for getting rid of the fallible judgm ent of central bankers, and substituting a mechanical 101 form ula for their gropings, may be ascribed to the existence of a “ school” for the propagation of the faith and to a com bination of circum stances relating to the respective merits of fiscal and m onetary policy in helping order our economic affairs which has stirred up academic dispute and endowed the views of the “ school” with a m odicum of public attention and political acceptance. Once an energetic and forensically form idable economist assembles a massive collection of empirical historical evidence to provide apparent support for his opinions, and indoctrinates enough disciples who then go forth and preach the gospel, a “ school” becomes established. If there happens to be another “ school” of followers of another leader whose views have found wide professional and political acceptance in the past, and which now may be attacked with some hope of success, the stage is set for a rash of academ ic and jo u r nalistic coverage of the battle. The whole subject then comes to the attention of a growing group of men of affairs in politics and in business, and the risk arises th at a shaky hypothesis may become something more th an a source of academ ic argum ent and journalistic enterprise. We are not concerned here, however, as to whether Keynes or Friedm an is the economic messiah of our time, but with the claim of the m onetarists th a t the money supply should be the sole or, at least, the suprem e norm of reference of m onetary policy. We are concerned with the proposal th at the Federal Reserve should content itself with attem pting to increase the money supply at a fixed annual rate (4 or 5 per cent a year is suggested) calculated on the average to be con sistent with stable prices, thus providing a stable monetary framework in which other economic goals may be realized and avoiding the hazards of trying to use monetary policy as a flexible and sensitive instrum ent for influencing our economic affairs. In the more restrained versions of this theory, it is adm it ted th at m onetary growth is not a precise and infallible source of future economic stability b u t that, on the average (which conceals much variability in both the time delay and the m agnitude of the response), there is a close relationship 102 between the rate of change in the quantity of money and the rate of change in national income (at current prices) some six m onths or more later. This is an appealing doctrine which “ rolls up into one simple explanatory variable all of the many complex forces which determ ine aggregate dem and” . No wonder political in terest has been aroused and a public following has emerged. But the economic peers of the m onetarists are skeptical. They have raised many questions concerning the money supply theory which the m onetarists have yet to answer convincingly. Drawing on the work of those who have addressed themselves to the problem and are com petent to discuss it as professional economists, I shall list some of these questions. First and foremost is the question of whether the asserted causal connection between cycles of growth of the money stock and cyclical movements of the economy runs from money to business activity or from business activity to money. It is akin to the question phrased by a British writer: “ Did m an begin to lose his general covering of hair when he began wearing clothes, or did he begin wearing clothes when he noticed he was going into a perm anent m oult?” Second, w hat m onetary aggregate is to be used as the guide of m onetary policy; is it the money stock narrowly defined as currency in circulation and dem and deposits at banks, or is it currency and dem and deposits plus time deposits at banks, or is it the “ m onetary base” , or is it the money supply which is “ currently most meaningful in in dicating m onetary influence in economic activity” ? Recent revisions of the most commonly used money supply series, and the patent sketchiness of such series stretching back into the historical and statistical past (“ over a century” ) add point to this basic question. Third, are the econometric models which the m onetarists use to dem onstrate how the transm ission process proceeds from money to business activity adequate for the purpose? Fourth, are not both price and quantity of money im por tant; do you not have to take into account shifts in dem and and in interest rates? 103 Fifth, do the observed variations in m onetary tim e lags and m onetary velocity cast doubts on the suggested simple causal relationship between the money supply and general economic activity; do they not suggest th at there are unpredictable variables other th an the money supply which influence the level of economic activity and which m ust be taken into ac count in devising m onetary policy? Sixth, the suggested m onetary framework for the economy is put forw ard most precisely in term s of a closed economy, although it is adm itted th a t it should involve a free foreign exchange m arket (floating exchange rates) in the open economy of which this country actually is a part. Is this a practical directive for monetary policy? Even if some of these m urky areas are cleared and the m onetarists become less rigid in their form ulations, ex perience suggests th a t the money supply norm of central b ank policy eventually will take its place on the library shelves along with the policy norms of the past. W ith im provem ent of our knowledge and understanding of the pres ent state of the economy and its likely future course, the money supply norm may leave a trace; the use of annual rates of change in the money supply as a navigational aid for cen tral bank action (channel m arkers indicating m axim um and m inim um rates of growth to be sought) cannot be ruled out, b u t the discretionary b and would have to be wide enough to accommodate the flexible requirements dictated by experience. Practicing central bankers (and the governments to which they are responsible) cannot afford to be confined by for mulae which attem pt to cope, in precise m easure, with the actions and anticipations of millions of hum an beings exer cising a high degree of economic freedom of choice. M onetary policy can continue to m ake its contribution to the goals of vigorous sustainable economic growth, m axim um a t tainable production and employment, and reasonable stabili ty of prices, if its practitioners continue to sharpen their analyses of complex economic developments and continue to base their actions upon a balanced view of total situations. They cannot be relieved of this difficult task by doctrinaire policy norm s. 104 Testimony on “Bills Only” before the Subcommittee on Economic Stabilization of the Joint Committee on the Economic Report, December 7, 1954 I am going to speak of som ething which I am sure is not the m ajor concern of your hearing, just as it is not the m ajor concern of the Federal O pen M arket Committee, b u t never theless it is som ething which I do not think was covered, from my point of view, in the answers subm itted to you by the C hairm an of the Board of Governors and, therefore, if I may take your tim e, I would like to refer to it. It is, perhaps, what m ight be called th e negative, in answer to your question n um ber th ree.* Y our subcom m ittee addressed five questions to the C hair m an of the Board of Governors, and his answers have been m ade available to other participants in these hearings, as well as to the public. W ith respect to the answers to questions 1, 2, 4, and 5 , 1 am in general and substantial agreem ent, even though there m ight be some shades of difference of opinion or degrees of em phasis in answers to the same questions which I might prepare. This suggests the first point I would like to make: So far as general credit policy is concerned, there has been a high degree of unanim ity within the Federal Reserve System throughout the period covered by your inquiry, th at is, since M arch 1951. O ur differences, or my differences with other m em bers of the Federal O pen M arket Committee, have related to the techniques of open m arket operations, not to general credit policies. * Editor's note: Question 3 was: “What is the practical significance of shifting policy emphasis from the view of ‘maintain ing orderly conditions’ to the view of ‘correcting disorderly situa tions’ in the securities market? What were the considerations leading the Open Market Committee to confine its operations to the short end of the market (not including correction of disorderly markets)? What has been the experience with operations under this decision?” 105 It is to these questions of techniques th a t your question No. 3 is directed. Here again I can express a good deal of agreem ent with m uch th a t is included in the answer of the chairm an. It is a persuasive and stim ulating discussion of the issues involved. Yet there is also a good deal with which I disagree, and my conclusions as to the most effective use of open m arket operations, to im plem ent credit policy and to prom ote economic growth and stability, diverge quite sharply from those set forth in the answer of the Chairm an. His answer is, of course, responsive to the question of the subcom m ittee, which asked for affirmative support of the ac tions of the Federal O pen M arket Committee to which it refers, not for the argum ents for and against such actions. Obviously, there is not tim e here for a full-dress presenta tion of the negative side of the question. I should like to m ake certain points which, I th in k , are significant to an u n d er standing of the problem , however, and I should be glad to subm it to the com m ittee later, if it so desires, a written statem ent of views which might m atch the answer of the chairm an in completeness and, I would hope, in per suasiveness. First, as a m atter of background, I think I should say th at I am not for pegging Governm ent securities prices nor for trying continuously to determ ine the structure of interest rates by m eans of open m arket operations. As one of the principals in the fight to free the Federal Reserve System from the pegging of prices of Governm ent securities, throughout a difficult period of controversy on this point, beginning in 1 9 4 6 ,1 think I have the right to m ake this clear. And, as one who has a great deal of respect for the operations of the m arketplace, I would not want to be classed with those who believe th at a continuously better result can be obtained, so far as the structure of interest rates is concerned, by com pletely substituting the judgm ent of the Federal Open M arket Committee for the m arketplace. If we want to find out how the patient is doing, there m ust be some place where we can take the p atient’s pulse. Now, taking up the real issues in this m inor problem. The least controversial issue was dropping from the directive of the Federal Open M arket Committee the clause authorizing 106 open m arket operations to m aintain orderly conditions in the m arket for Governm ent securities, and substituting for it a clause authorizing operations to correct disorderly situations in the m ark et. I voted in favor of this change, and thought it desirable, not just as a question of semantics. But I would stress the avoidance of disorderly situations rather than their correction after they have happened. One of the virtues of credit control is supposed to be its ability to take prom pt action to head off financial distur bances which might otherwise have harm ful repercussions throughout the economy. If open m arket operations in longer term Governm ent securities can be used to this end, I would use them rather th an wait until a disorderly situation or a crisis has developed, and only then depart from operations solely in Treasury bills. The most controversial issue was the instruction by the Federal O pen M arket Com m ittee th at open m arket opera tions m ust be confined to the short end of the Government securities m arket, except in correcting disorderly situa tions which, in practice, has come to mean confining opera tions to Treasury bills. I did not get the impression th at the action was merely an assertion of the power of the Federal Open M arket Com m ittee to determ ine whether and when the System Open M arket Account should engage in transactions outside the short end of the m arket. There need not be any question of the power of the full com m ittee to determ ine the conditions and the general tim ing of operations in the longer term areas of the m arket. I was concerned with the strong em phasis which I thought was given to perm anence of the “ bills only” doctrine. Sugges tions for publishing a set of rules of the game, references to a constitution for open m arket operations, and the repeated argum ent th at G overnm ent securities dealers could not create a broad, continuous m arket if we did not forego opera tions in long-term securities—except to correct disorderly conditions—gave me the disturbing impression th a t we were in danger of placing ourselves in a straitjacket which would not perm it us to accomplish w hat the Congress and the public m ight expect us to accomplish in term s of monetary m anagem ent. 107 I, therefore, welcomed the statem ent in the answer of the chairm an to your question No. 3 th at the door is being kept open to a change in the present basic technique of open m arket operations, and the recognition in his answer th at the present approach to open m arket operations is still ex perim ental and th at insufficient tim e has elapsed to draw firm conclusions as to its perform ance. The publication of these views should help dispel the idea th at present tech niques have been adopted for all tim e, and should help to avoid further hardening of the dangerous opinion th at any future operations by the System in the long-term m arket will be the signal of a critical situation. I also welcome the repeated references, in the answer of the chairm an, to the concern of credit policy with developments in the long-term sector of the m arket and the assertion of the particular concern of the Federal Open M arket Com m ittee th at its policies be reflected in the cost and availability of credit in the long-term m arkets. It has been, and still is, my contention th at this concern can find its best expression, at times, in open m arket operations specifically directed at these longer term m arkets. This is, perhaps, the variant approach to open m arket operations briefly com m ented upon, and summarily dis missed, beginning on page 20 of the answers of the chairm an to your question No. 3. As set forth there, it is described as a m ethod of operation in which— the Federal Open M arket Com m ittee would normally p erm it the interplay o f m arket forces to register on prices and rates in all o f the various securities sectors o f the m arket, but would stand ready to intervene with direct purchases, sales, or swaps in any sector where m arket developm ents took a trend that the com m ittee considered was adverse to high-level economic stability. T hat seems to me to be an eminently reasonable approach to our problem , but it has never really been tried—not even in the period 1951-53 to which the chairm an refers. A nd now it has been dismissed on what I believe is the shaky assum p tion th at it “ did not appear to offer real promise of removing obstacles to im provem ent in the technical behavior of the m arket” . 108 This probably brings us down to the nub of the differences. The C hairm an’s answer to your question No. 3 em braces the view, with which I agree, th at the “ depth, breadth, and resiliency” of the Governm ent securities m arket, or its “ con tinuity and responsiveness” , should be furthered by all m eans th a t are consistent with a credit policy of m axim um effectiveness, and that, in general, the greater the “ depth, breadth, and resiliency” of the m arket, the greater will be the scope and opportunity for effective credit control through open m arket operations. But the proof of th at pudding m ust be found in the actual m arket, not in a theoretical discussion of a supposedly ideal m arket. The answer of the C hairm an asserts th at the m arket has become increasingly stronger, broader, and more resilient since the Committee adopted the “ bills only” technique. It suggests most persuasively why, theoretically, this should be so. But it does not prove th at it has actually happened. In fact, I wonder w hether we are talking about the same m arket, and what are the definitions of “ strength” and “ b read th ” th at are being used. It is my inform ation and observation th at the m arket for longer term securities has re m ained at least as “ th in ” , under existing open m arket pro cedures, as it was before these procedures were adopted. I think it has lost depth, breadth, and resiliency, whether you view it in term s of dealer willingness to take position risks, volume of trading, or erratic price movements. We m ust not be misled by the claims of one or two dealers who urge the present techniques and now proclaim th at they are helping to create a b ro ad er m arket for G overnm ent securi ties. I do not think we have helped to create such a m arket. And, therefore, I do not see how the responsiveness of cost and availability of credit in all sectors of the m arket since June 1953 can have been the result of a progressive strengthening of the Governm ent securities m arket growing out of the actions of the Open M arket Committee with respect to the open m arket techniques. M uch of the success of the System’s actions during this period has derived from the prom ptness of adaptation of overall credit policy to 109 changes in the economic situation, and to a high degree of coordination of Federal fiscal policy and debt m anagem ent with credit policy. For the rest, it has sometimes taken massive releases of reserves, under the techniques adopted or in support of those techniques, to accomplish what might have been accomplished more economically with the help of lim ited direct entry into the long-term m arket. I am hopeful, therefore, th at the present period of ex perim entation will not be too long extended, and th at we shall soon have an opportunity to experim ent with the middle way—the variant approach—which I m entioned earlier. One final com m ent should be m ade, perhaps, in connec tion with your question 3 on the discontinuance by the Federal O pen M arket Committee of direct supporting opera tions in the G overnm ent’s securities m arket during periods of Treasury financing. I would agree th a t the System Open M arket Account should not, as a m atter of routine, provide such direct sup port, bu t I would also say th at we cannot, as a m atter of routine, tu rn our back on such support. The em phasis in the present approach to Treasury financ ing is good. The Treasury should meet the test of the m arket, in relation to other credit needs of the economy, to the fullest possible extent. But too rigid application of this doctrine is questionable as a m atter of m arket procedure and TreasuryFederal Reserve relationships. In periods of credit ease, when policy considerations point to the need of keeping Treasury dem ands from draining credit away from desirable private use, reliance on bill purchases alone may lead to unwanted consequences. The flooding of funds into the bill m arket, in order to assure adequate credit in the areas tapped by the Treasury, may produce an undue enlargem ent of bank reserves, or an extreme distortion in Treasury bill prices and yields, or both. There will also be times, particularly in periods of credit restraint, as distinguished from the recent period of overall credit ease, when rigid application of the present rule may result in serious collisions of debt m anagem ent and credit policy, which m ight have been avoided without jeopardizing the overall public interest. 110 Now, let me repeat, what I have been discussing are disagreem ents over techniques of open m arket operations, not over general credit policy. It is good to have these dif ferences opened up, and I hope th at this hearing will result in more discussions of the problem s involved by an informed public. We in the Federal Reserve System cannot consider ourselves to be the sole repositories of knowledge in these m atters. W hat I have been most afraid of is th at we m ight come to think th at we can indulge in the luxury of a fixed idea. There is no such easy escape from specific and em pirical decisions in central banking. W e cannot have a general form ula, a kind of economic law, which will serve the ends of credit policy under all sorts of economic conditions. I ll Letter to Murray J. Rossant February 28, 1961 D ear M r. Rossant: Y our letter of February 24 was a welcome rem inder th a t there are some people who rem em ber the “ bills preferably” controversy of a few years ago and my p art in it. I am delighted th a t tim e and circum stance have now com bined to persuade the Federal Open M arket Committee to do w hat I failed to persuade it to do by repeated votes of eleven to one. The chairm an has been fond of saying th a t the task of a cen tral b an k is to lean against the wind. The Federal Reserve System is now leaning with the wind. I think th a t the proponents of “ bills preferably” painted themselves into a corner with the idea th a t there m ust be a “ norm ” to guide a central bank in its decisions and th at “ bills preferably” provided the key to such a norm . Having adapted this b it of economic lore to their needs, they were hell-bent to publish “ the rules of the gam e” so th a t change would not be easy. This was vetoed by the Federal Open M arket Com mittee, b u t it was soon leaked out th a t there were “ rules of the gam e” which destroyed the residue of flex ibility which was piously proclaim ed. The argum ents th a t the alternative to “ bills preferably” was pegging, and th a t to deal in longer term securities m eant trying to establish the whole structure of interest rates, were trotted out to silence the op position by trying to m ake its position one of subservience to the needs of the Treasury or an absurdity. I think th a t the in dependence of the Federal Reserve System has been dam aged, b u t not irreparably, by its intransigence in this whole business. It is now believed to be following the election returns as well as changing economic conditions. The m oaning of the Governm ent securities dealers I would attribute largely to the sounds em anating from Lanston and Co., which h ad quite a bit to do with the adoption of “ bills preferably” . The rest of them talked out of both sides of their m ouths, and went ahead m aking money in the Governm ent m arket, as is their business. The banks, of course, kept m um for fear of offending somebody. 112 I shouldn’t think anyone would expect miracles of this change in the operating techniques of the System, but I do hope th at the revived freedom to operate in all sections of the m arket will be used effectively in situations in which it can be useful, such as the present. Com bined with appropriate debt m anagem ent, quite a bit can be accomplished. I am still working on the 1952, 1953, and 1955 wines, b u t I have no doubt th at some of the 1959 whites are now ready for drinking and good, and I shall be into them shortly. W ith best regards. Sincerely, Allan Sproul 113 Letter to Alfred Hayes M arch 14, 1961 D ear Al: T hank you for your letter of M arch 3, and now for your let ter of M arch 10. I am glad to know th at one of the brethren supported you “ most of the way” in the Federal Open M arket Committee, but the vote was always eleven to one, as I recall. The problem of imaginary history, one-sided explanations, eith er/o r presentations, and dubious allies, in the battle of “ bills only” has bothered me over the years, as it has you. I still think th a t you were right, as an individual and in setting policy for the Bank, not to engage in a public debate on the m atter, after my abortive attem pt to stir up public interest in what was being done. I think I was right not to take up the argum ent, again, after leaving the System. I had two reasons. One, I did not wish to be an em barrassm ent to the New York Bank, which had to m ake up its m ind and then press its views within the Committee, under your direction. Two, I have observed th at, usually, he who continues the attack after he has left the fighting forces is likely to lose his au diences pretty quickly. T hat has not m eant th at I did not feel free to m ake my views known, and thus to keep them alive, whenever they were sought by individuals, publications, com m ittees, and commissions. As one result of the partial blackout of conflicting views during the past few years, the present reversal of policy, as you point out, has been the subject of new distortions by the uninform ed (e.g., A rthur Krock) and violent attacks by the inform ed partisans of “ bills only” , and it has encouraged em barrassing allies. There were some monetary analysts who opposed “ bills only” in the past, however, and I would expect them and others to be more vocal in opposing a return to th at doctrine if it is attem pted. I would also expect th at you and others would have a chance to oppose it within the System, 114 and before Congressional committees, with a m uch better chance of success th an in the past. I shall certainly now feel free to say and write what I think about the past and about the future for whatever th at may be worth. I have a lot of m aterial which I have been collecting during the period of silence! Q uite ap art from the technical m erits or demerits of “ bills only” , I think it was a great m istake for the Federal Open M arket Committee to let itself become enam oured of socalled “ rules of the gam e” , which were to be the ten com m andm ents of central banking—carved in stone. These rules m ade a pious fraud of protestations of flexibility and con tributed to intellectual dishonesty in pretending to study and discuss the question of “ bills only” . I am disturbed, therefore, th at some defenders of the Federal Reserve are saying th at the abandonm ent of “ bills only” is a tem porary expedient and an experim ent, and th at the System will return to “ bills only” as soon as we are rid of a domestic recession and a balance-of-paym ents deficit. I would hate to see the System get back into the straitjacket. W ith best regards. Sincerely, Allan 115 Letter to Henry Alexander Zurich April 17, 1961 M r. Henry Alexander C hairm an of the Board M organ G uaranty T rust Company D ear Henry: It is a partial holiday in Zurich and so this letter. I have read the exercise in statistical calisthenics which was includ ed in the April Survey of your bank, which you gave me when I had the pleasure of dining with you last Thursday noon. It seems to me th a t it shows considerable ingenuity in dem onstrating th at if you resolve all, or nearly all, of the in fluences which affect interest rates at short and long term in the actual money and capital m arkets, both as to tim ing and am plitude of savings, there is convincing evidence of a high degree of “ covariation” . Even then, there was a lack of “ covariation” in 1955 and early 1956, which had to be ex plained— an exception to prove the rule, I suppose. As an attack on the decision of the Federal Reserve System to abandon the doctrine of “ bills preferably” , which this arti cle will be considered by many, it is less than convincing no m atter what its excellence for other purposes may be. It sets up a misleading basis of debate, namely the degree of linkage between short and long term interest rates over the whole of the business cycle, and then proceeds to show “ the realities of the case” by its own variety of statistical analysis. The first general rule of central banking is th at statistical analysis can never carry you to the heart of an economic problem requiring prom pt decisions before all the statistics of the past have been gathered and analyzed over days, weeks, and months. You need all the inform ation you can get, analyzed as competently as possible, and then you need to m ake some hum an judgm ents which are still beyond the range of electric computers. 116 To be more specific, the discussion of m onetary policy, as it relates to “ bills preferably” has not centered in the degree of linkage between short and long rates over the whole of the business cycle, and it has not been assum ed th at long-term rates have been continuously sluggish in their response to changes in the business cycle and to the force of monetary policy. It has been claimed th at, at times, the linkage may be less rapid th an would be desirable in term s of effective m onetary policy, and th a t the Federal Reserve System should be free, at such times, to intervene directly in the intermediate- or long-term m arket for Government securities, to try to ascertain if there is some tem porary friction or if it is m isjudging the force of fundam ental factors—in which case it can withdraw. If the m onetary authorities are properly concerned with the whole interest rate structure, as it may affect the flow of credit and capital into productive use, as I think they m ust be, it accomplishes little to prove a high degree of “ covaria tio n ” over periods as long as the ordinary business cycle, or to extract “ obscuring influences” which are themselves obscured by actions of the m onetary authorities. For exam ple, on page 3, where the article says seasonal patterns of in terest rates have been gradually reemerging and “ reflect for the most p art the extent to which the central banking system does not elect to cancel out the rhythm ic changes within the year in the credit dem ands of business and governm ent” . The dog is chasing its tail! As I see it, the m onetary authorities responded to a com pelling set of circum stances in announcing on February 20 th a t they had abandoned the doctrine of “ bills preferably” . A nd the circum stances were properly more compelling than the “ volatility pattern characteristic of each (short and long rates) over a prolonged period of observation” . Those who have spoken for the System have m ade it clear th at they have no preconceived or fixed rate relationships in m ind, and th at they do not intend to try to force the m arket in a direction counter to th a t determ ined by the underlying dem and and supply conditions, and they have shown th a t they have a problem of the rate structure growing partly out of the con centration of their open m arket operations in the bill m arket. 117 In the relatively new world of widespread currency convert ibility, which encourages the flow of short-term funds be tween international money m arkets in response to interest rate differentials, and in the light of a balance-of-payments position which showed substantial deficits and triggered a flight from the dollar, and in the face of a domestic economic situation which called for an easy money policy, the monetary authorities needed to free themselves from their self-imposed rule of dealing only, or largely, in Treasury bills. At the same tim e, they were justified in seeking to find out if operations in other sectors of the m arket m ight beneficially hasten “ covariation” even though the frictions in the m arket “ are m inim al under norm al circum stance” whenever th a t is. It is significant th at, even with free reserves in the banking system m aintained at a level of about $500 million, short term rates have rem ained at figures which, together with some reduction of rates in foreign money centers, have removed most or all of the incentives to send short-term funds abroad for interest rate reasons. Equally significant, perhaps, is the fact th at open m arket operations in the in term ediate area have facilitated some extension of the Federal debt, which becomes shorter all the tim e if you don’t do som ething about it. And, finally, despite a num ber of in fluences which m ight readily have pushed up long-term rates, such rates have rem ained fairly steady during the past two m onths, suggesting th at they have rem ained as low as was consistent with underlying m arket factors, without inter fering with the flow of savings into productive use as witnessed by the heavy calendar of securities flotations. This is what the discussion of “ bills preferably” has been about; not about buying “ to force the movements (of rates) a p a rt for any prolonged p erio d ” . Quite apart from the m erits or demerits of “ bills preferably” under “ norm al” circumstances, I think the Federal Reserve System should not again paint itself into a corner so th at responses to “ abnorm al” circum stances re quire elaborate explanation and m ake changes in a tech nique of operation seem to be an im portant change of policy. 118 The elevation of “ bills preferably” to a great new principle of central banking which m ust be engraved on tablets of stone, for all time, was a presum ptuous thing. The undoing of this presum ption is no m atter of experim ent or expedience, b u t a return to the real world. The episode should be buried. I hope you can and will read this (Miss Regan at the Reserve Bank will decipher and type it for you if necessary, I am sure). W ith all the best, Sincerely, Allan P.S. How about getting the statisticians to study the “ covariation” of the prim e rate and other short-term rates? From the 1959-60 high to early April 1961, it had declined from 5 to AVi percent while three-m onth Treasury bills were going down from 4.67 to 2.47 and one-year issues from 5.15 to 2.97. Stickiness seems to be more th an m inim al here! 119 The Second Annual Arthur K. Salomon Lecture delivered at the Graduate School of Business of New York University on November 7, 1963 Money Will Not Manage Itself It is a sobering circum stance for me to find myself speak ing from this platform from which my friend, the late Per Jacobsson, delivered the first A rthur K. Salomon Lecture a year ago. T hat vigorous and wide-ranging Swedish interna tionalist talked of m onetary m atters in term s of tim e and place, of theory and practice, with a com m and which only he could bring to the discussion of world m onetary problems. I think it appropriate on this occasion to register my respect for his accom plishm ents and my affection for the m an. The thoughts on monetary m anagem ent which I shall place before you will be narrower th an his in compass and less extensive in time. They will relate prim arily to central banking in the U nited States now and during the past fifty years, although the title I have given my talk comes from a “ foreign” book, the writing of which was begun nearly a h u n dred years ago. You will have recognized it as the catchline from the most fam ous book on central banking, W alter Bagehot’s “ L om bard Street” . Just as any economist worth his salt will m ention the nam e of Adam Smith sometime in his discourse or in his writings, so a central banker gains character by associating his views and reflections with those of a m an who wrote about the London money m arket and the Bank of E ngland in 1870-73, especially if he agrees with the dictum th at “ money will not m anage itse lf’ as he almost m ust by reason of his calling. I have two other reasons for launching my rem arks with Bagehot’s words. O n another occasion, when I delivered myself of opinions which questioned the sanctity of the “ old” Gold Standard, a disputatious m erchant of this city p u b lished a pam phlet with the intriguing title “ Sproul Ignores Common Honesty” . In it he included this priceless definition of m onetary m anagem ent: “ A high-sounding euphemism; it m eans constant lying to support constant sw indling.” I rath er liked th at or I would not have rem em bered it. 120 And, finally, there is the fact th at it is just fifty years since the Congress of the U nited States passed the Federal Reserve Act, which created the Federal Reserve System. A semicentennial bow to monetary m anagem ent in the U nited States suggests itself as appropriate to this gathering. Perhaps it will advance the clarity of my discussion if I quickly sketch in a little banking history. And here I shall re ly largely on what others have written, because I am going back one hundred years and my own association with these m atters does not go back th at far. The National Currency Act, signed by President Lincoln in 1863, which authorized the incorporation of national banks; and the N ational Bank Act of 1864, which am ended and improved the Currency Act; and the Federal Reserve Act of 1913 are the high m arks of progress in our banking legislation over the past century. The national banking legislation of one hundred years ago knitted together the badly raveled banking system of the country and provided us with the beginnings of a controlled circulating m edium which the U nited States h ad lacked since the Jacksonians destroyed the Second Bank of the U nited States in the 1830s. M en’s m inds in the 1860s were concentrated on b ank notes, however, and the national banking legislation did not take m uch account of the role of bank deposits, and the b ank check, in the money supply of the nation. It left the Federal Governm ent with powers less th an its responsibilities and its needs. The Federal Reserve Act of 1913 moved to complete what had been started fifty years before, namely the provision of a uniform and generally acceptable currency and national regulation of the money supply. The issuance of our principal form of currency, the Federal Reserve note, and the m eans of regulating the money supply, by way of the volume of dem and (and time) deposits in the commercial banks of the country, were placed in the hands of the Federal Reserve System. T h at was a determ ination th a t there was to be a degree of m onetary m anagem ent in the U nited States. But, because of ancient prejudices and still lively suspicions, and because of an awareness of the fallibility of hum an foresight and hum an judgm ent, it was thought th a t this power could be substan 121 tially divorced from acts of discretion. The reserve creating and destroying powers of the Federal Reserve System, which are the m eans by which it controls bank deposits, were to re spond to changes in the country’s gold supply and to the dis count by m em ber banks of self-liquidating paper. Changes in the production of gold, the international balance of paym ents, and the rise and fall of the self-generated credit needs of agriculture, commerce, and industry were to deter mine, pretty largely, the am ounts of Reserve Bank credit which would come into being or go out of existence. This groping for an autom atic means of m onetary in fluence on economic affairs sometimes changes its form, but never its substance. And so long as hum an beings disagree as to what has been done, and what m ight have been done, and what should have been done, in a variety of particular cir cum stances, it probably never will be abandoned. It is now generally accepted, I believe, th at monetary policy has power to stim ulate, stabilize, and restrain the economy and should be used to these ends. But, since the reasons for action are seldom clear and conclusive, and the conflicting currents in the economy m ust be analyzed and interpreted by men who lack perfect foresight, the quest for an autom atic guide to af firmative action goes on. The simplest form of this yearning is the nostalgic belief of many people th at a return to the Gold Standard, as they believe it existed during the years 1880 to 1914, would be the m eans of our salvation. They seem to think, and I have to confess to having shared the opinion in my salad days, th at m onetary policy as it existed in the brief thirty-four years of the “ golden era” was essentially autom atic (except, perhaps, to some extent in the case of the Bank of England), involving mostly m echanical responses to in tern atio n al gold movements and a m inim um of discretionary action directed toward influencing such movements or toward influencing domestic economic conditions. As Professor A rthur Bloom field, of the University of Pennsylvania, has developed in his notable studies of this period, this is a misconception. Although we know much less than we used to think we did 122 about the actual functioning of the pre-1914 Gold Standard, Professor Bloomfield’s studies of central bank action in th at period suggest strongly th at the m onetary authorities “ did not consistently follow any simple or single rule or criterion of policy, or focus exclusively on considerations of convertibili ty, b u t they were constantly called upon to exercise, and did exercise, their judgm ent on such m atters as whether or not to act in any given situation and, if so, at what point of tim e to act, the kind and extent of action to take, and the instrum ent or instrum ents of policy to use” . A nd they had to contend with many of the problems with which central bankers have to contend today including, in the international sphere, disrup tive movements of short-term funds from country to country, destabilizing exchange speculation, capital flights threaten ing the m aintenance of convertibility, and concern as to the adequacy of international reserves. All they lacked to be m odern, it seems, were the directions which central banks have now received from their governments, explicitly or im plicitly, concerning national economic objectives (such as the Em ploym ent Act of 1946 in our case), and some of the statistical inform ation and analytical tools which central bankers now have to help them discharge their respon sibilities, and some m eans of executing policy, domestic and international, which central bankers have devised by way of open m arket operations in Governm ent securities and cooperative arrangem ents for stabilizing the foreign ex changes. A return to the m ixture of the variants of the Gold Standard which existed in m uch of the W estern world from 1880 to 1914 could not free us from the m istakes of men. And this would hold, whether we m aintained the present price of gold, or doubled it, or tripled it in order to increase interna tional liquidity with one hand, while we destroyed it with the other by destroying confidence in the dollar and sterling (or any currency) as an international reserve currency. The search for a more effective and practical guide than the old Gold S tandard to m onetary autom ation under present-day conditions is m ost ardently pursued, I suppose, by Professor M ilton Friedm an of the University of Chicago who has said th a t “ what we need is not a skilled driver of the 123 economic vehicle continuously turning the steering wheel to adjust to unexpected irregularities of the route, b u t some means of keeping the m onetary passenger, who is in the back seat as ballast, from occasionally leaning over and giving the steering wheel a jerk th a t threatens to send the car off the road” . The steering device which he suggests, in lieu of this back seat driver, is a steady 3 or 4 percent week-by-week and m onth-by-m onth increase in the stock of money (not easily to be defined accurately) to accom m odate an expanding need which arises from a growing population, increases in per capita o utput and income, and increases in the proportion of income directed to liquidity, all of which call for an increase in the money supply to prevent a continually falling price level. Professor Friedm an has assem bled massive statistical sup port, chosen by him , to show th a t the m onetary authorities in the U nited States have most often been wrong in their acts of discretion, and th a t when they seemed to be right it was usually by mistake. I find it impossible to swallow his prescription which would reduce m onetary m anagem ent to the definitive act of forcing a constant drip of money into the economic blood stream . It seems to me to be patent th at the uncertain h and of m an is needed in a world of uncertainties and change and hum an beings, to try to accommodate the per form ance of the m onetary system to the needs of particular tim es and circum stances and people. I here agree with Pro fessor Samuelson, of the M assachusetts Institute of Technology, who has w ritten th at a “ definitive mechanism, which is to run forever after, by itself, involves a single act of discretion which transcends, in both its arrogance and its capacity for potential harm , any repeated acts of foolish discretion th a t can be im agined” . It is not my purpose to argue th at the Federal Reserve System has not m ade m istakes in the past fifty years, nor th at it may not m ake m istakes in the future. The early attem pts of the System to preserve a distinction between essential and nonessential, or between speculative and constructive, uses of Federal Reserve credit now appear naive. The attem pt to preserve a distinction between the elasticity of the com 124 ponents of the money supply, currency and dem and deposits, was misguided. The exercises in m oral suasion and direct pressure were largely futile. The resort to “ bills only” or “ bills preferably” as a technique of open m arket operations, thus trying to forswear action to influence directly any p art of the interest rate structure except at the short end, was an eight-year aberration. There has been tim idity approaching irresolution with respect to selective credit controls, and many recurring actions designed to stim ulate or restrain or stabilize the economy can be and have been criticized. W hat I am say ing is th a t over the past fifty years there have been im provements, and I am confident there will be more. Some primitive beliefs concerning money have been discarded, the collection and analysis of economic statistics have steadily improved, the organizational arrangem ents and the decision m aking powers of our central banking system, despite some b ad stretches, have evolved in the right direction. I m ake the latter statem ent with full realization, I think, of the hazards which beset such arrangem ents and processes, especially when the political capital of the country and the private financial capital of the country are 220 miles apart on the m ap, and sometimes m uch further ap art in their thinking about money m atters. Per Jacobsson used to tell some of his central banking friends abroad th at we have a funny central banking system in the U nited States; th a t most of the power is lodged in W ashington and most of the knowledge in New York. He was indulging his wit at the expense of tru th , of course, b u t it is wise to rem em ber th a t the first and most direct point of contact between the policies of the m onetary authorities and national and international money and capital m arkets is in New York. As I have said before, this is no device of greedy men and no mere accident of geography which can be changed by legislative or adm inistrative fiat, even if the fiat be called “ driving the money changers from the tem ple” . It reflects the necessity in a money economy, such as ours, of having a m arketplace where the final and balancing transactions of our national and international financial accounts can be car ried out by a variety of financial institutions, with connec tions which span the country and the world. A nd the operating arm of the Federal Reserve System in this money and capital m arket is the Federal Reserve Bank of New York. 125 Fortunately, it seems to me, we have been largely suc cessful in overcoming this organizational hazard by one of those strokes of evolutionary genius which, more often than flashes of pure inspiration, bless our kind of society. O ut of early attem pts to find a way to use and coordinate the open m arket powers of the Federal Reserve Banks and to bring these powers within the am bit of the Board of Governors at W ashington, the Federal Open M arket Committee evolved. It has become the heart of the Federal Reserve System, although the shorthand of the press has created a public im age of a Federal Reserve System wholly dom inated by its W ashington center. On the contrary, the Federal Open M arket Comm ittee recognizes a Federal association in a n a tional authority, without sacrificing the ability to form ulate and to execute necessary national policies. It is the forum where representatives of the constituent parts of the Federal Reserve System meet as individuals and equals, having iden tical responsibilities under law, to decide questions of high m onetary policy with respect to open m arket operations in Governm ent securities and foreign currencies, and to con sider the coordination of these operations with discount rate policy and other policy measures. And, finally, the present constitution of the Federal O pen M arket Committee, with the President of the Federal Reserve Bank of New York as a statutory perm anent m em ber, observes a cardinal principle of central banking th a t those who determ ine m onetary policy should not only coordinate their actions with the general economic policies of the government, but should also have direct contact with the private money m arket— a contact which comes from living in the m arket, and being able to feel the pulse of the m arket by dealing in it, and by keeping in personal touch with the individuals and institutions whose composite actions help to determ ine how m onetary policy will be transm itted to the whole economy through the m arketplace. I reaffirm , then, my belief in the art and practice of money m anagem ent, and I place my hopes for the future in im provem ent of the tools we have to use in practicing the art, and in the experience we gain in using them . 126 And now, in conclusion, let me return to my general them e: “ money will not m anage itself”. It needs m anagers who are aware of the fact th at they are dealing prim arily with problem s of hum an motivation and hum an reactions, and th at some public understanding of what they are trying to do is a necessary ingredient of success. It needs m anagers who realize th at “ scientific analysis, unaided, can never carry the inquirer to the heart of an economic situation” . It needs m anagers who “ operate in the light of all the inform ation they can get” and have it “ organized and analyzed in such a way as to give the m axim um am ount of illum ination” , so th at the available alternatives are clearly presented. And it needs m anagers who then rem em ber th at their tasks require “ that practical wisdom which comes only from experience” . As I recall the past fifty years of development of the Federal Reserve System, I am reasonably sanguine about the future of money m anagem ent in the U nited States. The system has proved to be a constructive public invention and a useful public servant. It has had a variety of experience. It should be ready for the work ahead. An economist, who has achieved the rare distinction of having one of his books become a “ best seller” , gave a chapter in th at book to the “ m onetary illusion” , in which he expounded “ the charm which this mysterious thing called monetary policy has for those who are privy to its practices, and whose affection for it is translated into claims for its ef fectiveness which invade the supernatural” . “ No other economic policy” , he wrote, “ has ever shown such capacity to survive failure, to be hailed as a success.” This may be witty, but I reject the indictm ent. The practitioners of monetary policy are not exorbitant in their claims of effectiveness and usefulness. The prim ary function of m onetary policy, with due allowance for the liquidity of the economy, is to regulate the total supply of money and to influence its cost and availability so as to help keep m arginal dem ands—govern m ent and private—from spending themselves in speculation and increased prices in times of prosperity, and from being stifled in times of recession. In this way, it contributes im por tantly to stability of the price level and stability of the ex change rate of the dollar, and to the attainm ent of m axim um 127 employm ent and sustainable growth. M onetary m anagem ent cannot reach all the causes of economic instability, nor can it insure sustained high levels of employment and high rates of growth. But, com bined with fiscal policy and wage-price policy, it is our best hope of preserving our freedom from the straitjacket of more direct governmental control of economic affairs. W e m ust not cross over into the barren lands of the enemy. 128 Chapter 5 Deposit Interest Rate Ceilings T M h is chap ter contains three o f S proul’s letters and an excerpt from one of his talks, all on the subject of deposit interest rate ceilings. By way of b ackground, when the Federal Reserve Act was passed in 1913, it contained no provision of any sort fixing m axim um perm issible interest rates th a t banks could pay on deposits. At th a t tim e, this was not considered an ap p ro p riate area of regulation. Twenty years later, however, in the B anking Act of 1933, the Congress instructed the Federal Reserve to set rate ceilings on com m ercial ban k tim e and sav ings deposits (R egulation Q), an d prohibited entirely the paym ent of interest on dem and deposits (a rate ceiling of zero). The ceilings were im posed on the grounds th a t alleged excessive in terest rate com petition for deposits during the 1920s had underm ined the soundness of the bank in g system. It was believed th a t com petition to a ttra c t depositors h ad driven deposit interest rates up so high th a t the ban k s, b u rd en ed by the higher costs, were led to acquire highyielding b u t excessively risky low -quality assets. It was held th a t this contributed to the collapse of the banking system in the early 1930s. Sim ilar argum ents were responsible for the im position of com parable ceilings on m utual savings ban k s and savings and loan associations starting in 1966. U ntil the early 1960s, the ceilings on tim e and savings deposit in terest rates were hardly noticed, since they were always raised by the Federal Reserve whenever they becam e m eaningful—th a t is, when short-term m arket interest rates th reaten ed to rise above the ceilings. Above-ceiling short-term interest rates would tem pt depositors to shift funds out o f savings deposits an d into money m arket instrum ents, such 129 as T reasury bills. In 1966, however, the ceilings were not raised: in stead, sim ilar ceilings were im posed by the Congress on m utual savings b anks and savings and loan associations and the ceilings were lowered despite rising open m ark et rates. Since then, deposit interest rate ceil ings have been one of the m ore controversial elem ents on the A m erican b anking scene. Sproul began to question the wisdom of deposit rate ceilings rather early. In May 1960, in a letter reprinted below, he wrote to Alfred Hayes, his successor as president of the New York Bank: “ It seems to me th at it is tim e to assume th at the banks are grown up and able to determ ine how m uch they can safely pay on savings deposits without going wild in m ak ing loans and investments . . . .1 am thinking th at it is time the System recom m ended to the Congress th at the power to fix this ceiling be rescinded, leaving the banks free to m ake their individual decisions. M any bankers may not like this, for one reason or another, but they shouldn’t expect to snuggle under Governm ent coverlets when it pleases them and to howl about Governm ent interference with business when it doesn’t . ” By 1966 his position had become even stronger. In a speech before a joint session of the A merican Finance Association and the American Economic Association, reprinted below, he concluded: “ These attem pts to fix interest rates and to direct savings flows have helped cause some of the most rapid and disruptive shifts in rates and in savings flows th a t we have ever experienced. It is hard to see how m arket forces could have done a worse job. Now we have our hand in a pocketful of fish hooks and it is going to be impossible to get it out without pain and discom fort.” 130 Letter to Alfred Hayes May 8, 1960 D ear Al: I am assum ing th at you are back from your European trip, full of vigor and new ideas. I have some ideas about the statutory and regulatory con trol of interest rates paid by commercial banks th at I would like to put up to you people before I stick out my own neck. The rate ceiling on savings deposits. It seems to me th a t it is tim e to assume th at the banks are grown up and able to determ ine how m uch they can safely pay on savings deposits without going wild in m aking loans and investments. Given the changes in the condition of the banking system and in the climate of banking, since this regulatory power was given to the Board, the quality of bank supervision, and the favored competition of other thrift institutions, the commercial banks should not be forced to climb into the ring with one hand in a sling. Continuance of the present sluggish m anipulation of the regulated ceiling is not fair to them , and a more flexible use of the ceiling would be tantam ount to having the Board fix the rate. I am thinking th at it is time the System recom m ended to the Congress th a t the power to fix this ceiling be rescinded, leaving the banks free to m ake their individual decisions. M any bankers may not like this, for one reason or another, b u t they shouldn’t expect to snuggle under Governm ent coverlets when it pleases them and to howl about Govern m ent interference with business when it doesn’t. Paym ent o f interest on dem and deposits. The passage of time, with its changes in conditions and climate, affects this statutory control also. O f particular significance are the rise in the Treasury bill to the position of the chief liquidity in strum ent of the economy, the large volume of foreign short term funds in this m arket, and the awakening of the treasurers of large corporations and of state and municipal financial officers from their long slum ber. As you well know, 131 funds now flow in and out of deposits at banks and into and out of Treasury bills with alm ost the predictability of the tides. The G overnm ent securities dealers, with their corporate repurchase deals, have stepped into the picture. Why shouldn’t banks m ake repurchase deals with their depositors who are interested in Treasury bills, or why shouldn’t they buy and sell Treasury bills for their customers for a small fee? This sort of thing seems likely to get going and, since it has some of the appearance of paying interest on dem and deposits, it may raise a question for the supervisory authorities. If you can give me any light and leading on these ques tions, I would appreciate it. W ith best regards. 132 Sincerely, Allan Letter to Alfred Hayes June 26, 1960 D ear Al: T hank you for letting me in on some of the thinking at the Bank on the question of interest rate ceilings, a confidence which I will respect, of course. I thought the m em orandum read as if it were a joint product of Research and Bank Supervision, and th a t it had some of the virtues and some of the defects of such joint ventures. Being footloose and fancy-free, I can wave my arm s and raise my voice. I think the m em orandum too readily accepts the role of operating within existing law and too easily kisses off m arket freedom. My own ram pant view is th at there is no longer necessity for having a government body at W ashington fix ceilings on the rate of interest which can be paid by banks on tim e and savings deposits. In term s of asset quality, liquidity, and banks with less than adequate m anagem ent, there is no com parison between 1930 and 1960. The problem of banks m aking speculative loans and il liquid investments, in order to be able to pay high rates of in terest, to the extent th at it persists, seems to be almost wholly a problem of small banks with weak m anagem ent. Super visory authority should be exerted to eradicate such weakness, or its results in bank assets, not to keep the whole banking system under wraps in order to protect the weakness of the few. The weak small banks are probably pockets of monopoly, anyway, hiding behind the sanctity of the small, independent bank. And they probably are carrying some of the costs of their commercial business and their dem and deposits, by shortchanging their savings depositors. Even tually they will be wiped out by m erger, branch banking, or holding company banking, and inability to survive in com petition with other thrift institutions. But the fact th at we are not writing on a blank sheet of paper is not sufficient justification for the supervisory authorities to cling to a power which has outworn its usefulness, and which may have become positively dangerous to the health of the whole commercial banking system. If this all-out approach is wrong, or im practical, the ideas about greater flexibility expressed in the m em orandum cer 133 tainly point in the right direction. But do they go far enough? Using the distinctions between fixed time and savings deposits, and their use by banks, developed in the m em oran dum , how would it be to m atch the characteristics of the two kinds of deposits and of bank portfolios with the perfor m ance of short- and long-term interest rates, to get the following pattern? (a) The ceiling rate on savings deposits should be fixed largely on the basis of w hat b anks can earn on long-term investm ents over tim e, rath er th an in rela tion to current rates of interest in the m arket, and changes in the ceiling should be m ade infrequently. (b) The ceiling on fixed tim e deposits should be higher at tim es and at tim es lower than the ceiling on savings deposits, and should be changed m ore fre quently. This could be more readily done th an in the case of savings deposits, especially when rates are go ing down, because the rate on fixed tim e deposits is a negotiated rate. (c) Ceilings should not fix rates and, therefore, should not try to follow m arket rates too closely. M aybe this merely shows how com plicated a logical solu tion of the problem of fixing ceiling rates by adm inistrative regulation can become, and how adm inistrative difficulties can multiply. But a rule snch as we have, simple enough to be applied to all banks in all circumstances, is procrustean. I am piping down so far as the payment of interest on de m and deposits is concerned. I would still like to know, however, whether bank buying and selling of Treasury bills for customers, for a fee, as distinguished from repurchase ar rangem ents, would have any merit. W ith best regards. Sincerely, Allan P.S. I liked your statem ent before Subcom m ittee N um ber 3 of the House Banking and Currency Committee for two reasons. I agreed with what you said and the way you said it, and I was warmed by the mention of my name. 134 Letter to Alfred Hayes Bolinas sur M er July 18, 1966 D ear Al: I am typing this by the shore with inferior m aterials and equipm ent, and it may not be my usual im m aculate job. I am rushing into correspondence because I am wondering whether you are as distressed as I am about recent developments with respect to interest rates, and by the pro posals which are being put forward to deal with the situation. It was distressing to me, first, when the A dm inistration perpetuated its wrongheaded attitude toward Federal Reserve policy by having Joe Fowler recommend to the Con gress the fixing of interest rate ceilings on certain classes of tim e deposits at banks and savings and loan associations. It is hard for me to see why he should have picked up the ball th at P atm an ’s committee had to drop so recently unless, in addition to concern about the position of the savings and loan associations, there is a rankling resentm ent which harks back to the action of the Federal Reserve in increasing the discount rate and raising the ceilings on time deposit interest rates last December. I noted that, in his letter to Representative U llm an, the Secretary recalled “ th at the Adm inistration op posed the action of the Federal Reserve last D ecem ber” , and th at he also presses a weak claim th at the A dm inistration has not been remiss in striving for a “ healthy balance of m onetary and fiscal policy” . And now comes the action of the Board of Governors reducing to 5 percent the ceiling rate which can be paid by banks on so-called m ultiple m aturity CDs which m ature in 90 days or more, and 4 percent on such deposit instrum ents which m ature in less than 90 days. This rapid response to Adm inistration and Congressional pressure (as well as to the difficulties of the existing situation) is a descent into the bog of price fixing by ineffective inches. The descent is becoming like the U nited States involvement in Vietnam; the more we struggle to get out, the deeper we sink in. 135 The way we got into the present mess was by setting in terest rate ceilings, by legislation and regulation, which banks can pay on tim e deposits, while an aggressive savings and loan industry, without such restraints, was using every available m eans to provoke a shift of bank deposits into the shares of such associations. And then, when the banks were unleashed, their retaliatory actions in trying to attract deposits from their nonbank com petitors, and their rapacity in trying to steal deposits from one another—as well as to ob tain a measure o f relief fro m the restraint being im posed upon them by Federal Reserve policy— com pounded the dif ficulties in a difficult situation. W hatever slight amelioration of the im m ediate political and economic pressures the latest action of the Board of Governors may obtain, I suggest it represents another step in the wrong direction. I start with the proposition th at our present practice of m onetary m anagem ent rests mainly on our ability to regulate the availability of reserves in a banking system based on the m aintenance of fractional reserves against deposits. T hat is the fulcrum of our m ain lever. And I proceed with the belief th at trying to fix (or peg) m arket rates of interest beyond use of the discount rate, by statute or regulation, is tricky, dangerous, and habit forming. Pegging m arket rates of in terest and pegging m arket prices of Governm ent securities are two of a kind. They are both incom patible with a properly functioning money and capital m arket and with the proper functioning of the Federal Reserve System. W ith these premises, and recognizing th at the present situation is com plicated by short-term political and economic pressures which seem to dem and some action, I think th at the action should be geared to the control of reserves and not to further control of interest rates. In this context, I thought th at the earlier action of the Board of Governors in raising reserve requirem ents on certain time deposits at certain banks moved in the right direction (even though it appeared to me to be based on some slippery legal logic and even though it apparently did nothing to appease the critics of the System). 136 If a uniform reserve requirem ent on all deposits at all banks could be legislated, so as to preserve the aggregate total and without seriously disrupting the affairs of individual banks, it would approach the ideal of a prim ary reserve re quirem ent geared to the needs of m onetary policy and m anagem ent, instead of a requirem ent geared to the historical accident of reserves related to the assum ed liquidity needs of different kinds of deposits at banks in different places. Such legislation isn’t in the realm of the possible at present, of course. A lesser step in the appropriate long-term direction, which would also take account of the short-term problem , would be a gradual increase in the reserve required against tim e CDs to the level of reserves required against dem and deposits. It seems to me th at the banks— and particularly the banks in New York City and some other large centers—have played a dangerous gam e since last D ecem ber with the difference between reserve requirem ents for dem and and tim e deposits. W hen I was at the Bank at th at time, some of your economists told me th at there are a lot of leaks in the “ cir cular flow of money” . But I can’t get it out of my head th at most of the large figure CD funds were in the banks as somebody’s dem and deposits before the CD business took hold. This would suggest th at the banks, in rapidly raising the rates on their CDs since D ecem ber 1965, were seeking not only to meet aggressive com petition from the savings in stitutions, b u t also were avoiding in some m easure the restrictive policy of the System by prom oting a switch from dem and to tim e deposits. R apid and massive shifts of this sort can be disruptive of m onetary m anagem ent and unbri dled competition for deposits doesn’t necessarily mean th at funds are flowing to the place where they can be used most effectively. The response of interest rates to the course of the economy and to Federal Reserve action in recent months seems to me to have been excessive. Rates appear to have been ratcheted upw ard by the action of the banks with respect to CD funds, apart from the pressures of monetary policy and m arket supply and dem and. 137 Action such as I am playing with, of course, would recreate some questions of fair competition as between banks and the savings institutions, but th at is a relatively m inor m atter so far as overall m onetary policy is concerned. The answer to th at problem should be sought in equity of treatm ent of the banks and the savings institutions with respect to reserve re quirem ents, taxes, and other things by the governments which charter them , and not in the fixing of interest rates (ceilings) by the Federal Reserve, the Home Loan Bank Board, or anyone else. I realize th at there is a lot more th at could be said about all of this, but I had become so interested th at I had to get som ething on paper quickly in order to seek your calm view. Am I lost in a thicket, or are the banks and the System? W ith all the best. Sincerely, Allan P.S. This is a long letter, b u t I forbore m entioning sterling which I am sure is on your m ind these days. Those who say th at this is an interesting tim e to be alive usually have little responsibility for anything big, or they would not be so chip per. 138 Excerpt from Coordination o f Economic Policy, a paper presented before a joint meeting of the American Finance Association and the American Economic Association on December 23, 1966. (The entire paper appears in the Journal of Finance, May 1967.) O f special concern, also, in the m onetary sphere is the un fortunate situation into which we have drifted in the fixing of ceiling rates which commercial banks, m utual savings banks, and savings and loan associations may pay on savings and time deposits or share holdings. Originally introduced to try to protect commercial banks from their presum ed folly, the authority to fix such ceilings has been stretched to serve as a handm aiden to general monetary policy in bringing pressure to bear on commercial banks to restrict their lending, and as a yo-yo device to shift funds from one type of thrift institution to another in accordance with the ideas of the authorities as to who should get what. This is a heady but dangerous business. The history of such regulation of m aximum rates of in terest to be paid on tim e and savings deposits of various kinds and m aturities is a journey down a road paved with good in tentions and bad practices. They were first used by com m er cial banks as an excuse for not paying depositors as high a rate of interest on such deposits as m arket conditions might have w arranted. Later they became a halter on the com m er cial banks when the savings banks, and particularly the ag gressive savings and loan associations, began luring away bank customers with offers of interest rates much higher than the banks were allowed to pay. This hot money was invested by the savings and loan associations largely in long-term mortgages, a hazardous proceeding. Then the banks were periodically let loose by a lifting of the ceiling on the rates they could pay, and they immediately tried to reverse the flow of funds by quickly moving their rates up to the new ceilings. Finally this upward ratcheting of rates got out of hand and 139 the savings and loan associations were least able to compete profitably for new funds at the new rates. Funds flowed out of these associations, but not so much into the banks as into securities, open m arket paper, and Government and Govern m ent agency obligations. At this stage, all financial in term ediaries were being ill served by the rate ceilings, but the plight of the savings and loan associations was such that special legislation was sought and obtained which authorized the Federal regulatory authorities to get together and to give a rate advantage, for the tim e being, to some of these institu tions. These attem pts to fix interest rates and to direct sav ings flows have helped cause some of the m ost rapid and disruptive shifts in rates and in savings flows th at we have ever experienced. It is hard to see how m arket forces could have done a worse job. Now we have our hand in a pocketful of fish hooks and it is going to be impossible to get it out without pain and discomfort. 140 Chapter 6 Federal Reserve Structure and Monetary Policy A M m l l a n S p ro u l, as m ig h t have been ex p e cte d from his b ackground, for the m ost p art believed strongly in the existing struc tu ral organization of the Federal Reserve System—both internally (a regional federation with central supervision) and externally (“ indepen d e n t w ith in th e g o v e rn m e n t b u t n o t in d e p e n d e n t fro m th e governm ent” ). The present chapter begins with his statem ent to a Congressional subcom m ittee in 1952; it is the fullest and most com plete exposition he ever m ade on the question of Federal Reserve “ independence” . Next is a p ap er entitled “ Reflections of a C entral B anker” , presented in D ecem ber 1955 before a joint m eeting of the A m erican Finance Association and the A m erican Econom ic Association. Three 1958 let ters follow, all related to his m em bership (and then his nonm em ber ship) on the Commission on Money and C redit. The final paper is a com m unication to the Congressional Joint Economic Com m ittee op posing m uch of the Com m ission on Money and C redit’s final report. Ironically, it was Sproul him self who was largely responsible for the creation of the Commission on Money and Credit in the first place. He concluded “ Reflections of a C entral B anker” in 1955 by calling for “ a fresh and thorough exam ination of our existing banking and credit m achinery and our money and capital m ark ets” . At th a t tim e he was still president of the Bank and the appeal struck a responsive chord in influential circles. Slightly over a year later, now no longer president, he enlarged on the them e in a talk before the Econom ic Club of D etroit on February 18, 1957: “ We have had a succession of relatively narrow official inquiries into this or th a t phase of our m onetary arrangem ents and our fiscal and 141 credit policies since the war, some of which were constructive and bore good fruit and some of which assum ed the ritual character of the m ating dance of the fiddler crab without apparent results. Now we need a b road study, or an inquiry by an objective panel of citizens, divorced from partisan public and special private interests, who will develop a comprehensive picture of the structure of our financial system and the ways in which it operates.” The Commission on Money and Credit produced his “ broad study” — b u t not one, in his view, sufficiently “ divorced from partisan public and special private interests” . A lthough he had initially accepted an in vitation to become a m em ber of the Commission, he withdrew before it began its deliberations on the ground th a t too m any of its m em bers had been chosen because of their special interest point of view—thereby foreclosing the opportunity to get an objective report devoted prim arily to the public interest. W hen the Com m ission’s report finally cam e out, in 1961, he opposed m any of its recom m endations and strongly com m unicated those views to the Congress (see below), despite the fact th a t his old friend M arriner Eccles h ad been a leading m em ber of the Commission and one of its foremost spokesmen. This caused a tem porary estrangem ent between the two th a t was not fully healed until the late sixties, when they once again found common cause in their shared opposition to Am erican military in volvement in Vietnam . 142 Statement from Monetary Policy and Management o f the Public Debt, Hearings before the Subcommittee on General Credit Control and Debt Management of the Joint Committee on the Economic Report, 1952. April 22, 1952 H onorable W right P atm an, C hairm an Subcom m ittee on G eneral Credit Control and D ebt M anagem ent of the Joint Com m ittee on the Econom ic R eport House of R epresentatives W ashington 25, D .C . D ear M r. P atm an: In the course of the recent hearings of your committee there were certain recurring questions which were never definitely answered, so far as I know, and which perhaps cannot be definitely answered. Nevertheless, the fact that they were not answered or, perhaps, cannot be answered definitively and categorically, should not be taken to mean th at they contain proof of argum ent by default or opposition. I have in m ind such questions as the following, which may not have been asked in exactly this form but contained this substance: Is not the argum ent for an “ independent” Federal Reserve System a denial of our dem ocratic ability to function properly through the legislative and ex ecutive branches of the G overnm ent? W hy should m onetary policy be treated differently from , say, foreign policy or defense policy, in term s of the adm inistrative arrangem ents and relations with the Congress and the executive? 143 H asn ’t the tren d in all other countries been to “ n a tionalize” the central banks where they were not al ready “nationalized” and to make them directly respon sible to the “governm ent” through the “Treasury” ? Does not the growing interest of governments in economic affairs, and their growing participation in such affairs, m ake this trend logical and necessary? These are questions which compel thought and analysis, even though one may feel, as I do, th a t the right answer does not follow the lead of the questioning. In the first place, I think it should be continuously borne in m ind th a t whenever stress is placed upon the need for the “ independence” of the Federal Reserve System it does not m ean independence from the G overnm ent b u t independence within the G overnm ent. In perform ing its m ajor task —the adm inistration of m onetary policy—the Federal Reserve System is an agency of the Congress set up in a special form to bear the responsibility for th a t particular task which con stitutionally belongs to the legislative branch of the Govern m ent. It is in no sense a denial of our dem ocratic form of Govern m ent to have the Reserve System set up the way it is. It is rath er an expression of the ability of our dem ocratic powers to meet new or changing conditions. The Congress, as the sovereign power in this area, has developed a special means of perform ing a function with respect to which it has final authority, b u t which it cannot adm inister from day to day. The Congress has, of necessity, had to delegate some segments of its power to agencies of its own creation which, in tu rn , are responsible to it. The Federal Reserve System as one of these agencies attem pts, as does the Congress itself, to m aintain close relations with the executive branch of the Governm ent, for the purpose of achieving a coherent and generally unified economic program . But th at does not m ean th a t physical m erger of the Congress or its agencies with the executive branch of the G overnm ent is necessary or desirable. It really takes us little way along the road to understanding to ask why m onetary policy should be treated differently from foreign policy or defense policy in term s of adm inistrative ar 144 rangem ents. The form of the question implies th a t here are m atters (defense policy and foreign policy) of greater im por tance to the country th an m onetary policy which are ad m inistered by the executive branch of the Government, through the State D epartm ent and the Defense D epartm ent, and not by an independent agency. No one, of course, would want to enter into a footless argum ent about the relative im portance of policy in these areas to the citizens of the coun try—they are all of vital im portance. It may suggest a dif ference between them , however, to rem em ber th a t the Federal Reserve is trying to help guide, regulate, and to some extent control the functioning of the private economy, and prim arily the domestic economy, whereas foreign policy and military policy, while they affect our private and domestic af fairs, deal largely with our relations with other countries and governments. It is in the general area of regulation of domestic economic affairs th a t the Congress has found repeated use for “ independent” agencies. The underlying question is w hether it is better to have the legislative branch in full and final control of the purse and the money of the country, directly and through an agency responsible to it, or w hether these m atters should be turned over to the executive branch for adm inistration along with most other governm ental affairs. The Constitution, insofar as its language may be applied to present-day conditions, leaves this m atter with the Congress. W isdom and experience sup port this early separation of powers. Over the years and within our C onstitutional fram ework, the people have pre ferred to keep all aspects of the money power as the prerogative of their duly elected representatives in the Con gress. The tem ptation to tam per with money for tem porary gain or narrow purpose is always present, and particularly in tim es of economic stress. The power to do so should be kept where it can be most readily observed and its abuse most quickly punished. T h at place is not under the protective wing of the chief executive or hidden in one of the big departm ents of the executive branch of the Government. It may be instructive in this regard to com pare the role of the Congress with respect to debt m anagem ent with its role in relation to m onetary policy during the past three or four decades. It is significant, I think, th a t the Congress, at fre 145 quent intervals, has conducted comprehensive and useful in quiries into the conduct of monetary policy by the Federal Reserve System. It has not m ade sim ilar inquiries into debt m anagem ent; even during the investigations of this com m it tee, which have been m ost far-reaching, debt m anagem ent has been considered only in its broadest aspects and, essen tially, only when it has becom e intertw ined with credit policy. Yet debt m anagem ent is a concern of the Congress, particularly under present-day conditions. To be sure there are specific acts of the Congress which authorize whatever is done in the nam e of debt m anagem ent, but the economic ram ifications of the decisions taken with such legal authority are generally unobserved or unexam ined. There seems to have been a gradual and more or less tacit acceptance of the assum ption th at debt m anagem ent is a function of the ex ecutive branch of Governm ent with which the Congress need not concern itself once it has passed the enabling legislation. T hat is what m ight happen to m onetary policy if it became im bedded in the executive branch of the Government. That would, I think, be a disservice to the country. The inquiry of this com m ittee, and other Congressional investigations which have preceded it, would seem to provide a clear-cut dem onstration of the contributions which can be made to the nation’s economic welfare by arrangem ents which lead the Congress to appraise performance of its own agent from time to time. The particular forms and adm inistrative arrangem ents which have worked in foreign countries for the adm inistra tion of m onetary policy are not a usable guide for us. In most such countries, of similar economic m aturity and with similar economic systems, the “ governm ent” comprises both the executive and legislative branches in one responsible body or parliam ent. The executive must explain and justify policy from day to day, and is exposed to legislative questioning and the possibility of legislative repudiation without the protec tion of a fixed term of office. The trend of relationship in such countries between governments and central banks has been a process of evolution. No m atter what their beginnings the central banks have evolved as “ public” institutions. Changes from private ownership to public ownership, where 146 they have occurred, have quite often confirmed what had already happened. They have been changes of form rather th an of substance and have usually tended to perpetuate some independence (as I would define independence) for the central bank rath er than to snuff it out. It is more useful, as a guide, for us to observe that in most of these countries, and certainly in the economically more m ature countries, central banking is regarded as a field re quiring special technical competence and continuity of m anagem ent rather than complete subordination to the government of the day. The head of the central bank in these countries is not brought directly into the government and does not necessarily change with changes in the government. The central bank is still a place where views on economic m atters and m onetary policy can be independently developed and candidly put forward no m atter what the precise rela tions to the government may be. It is chiefly in the countries which are less advanced economically, where monetary policy is likely to be less developed, and where the central bank is prim arily the fiscal agent of the government, th at central bankers are political appointees responsible to and changing with each new executive. I come back to the conclusion th at neither our form of government nor the experience of foreign countries requires or recommends the placing of the Federal Reserve System in the executive branch of the Governm ent. It is the pursuit of a doubtful logic and of neatness in adm inistrative chart m ak ing which suggests this solution of our problem. The fact that there have been unfortunate differences of opinion between the Treasury and the Federal Reserve during recent years does not require the Congress to abandon its agent to the ex ecutive branch in order to bring about a better coordination of powers. It has already been pointed out that the Congress, through its specialized committees, reviews from time to time the m anner in which the powers it has delegated to the Federal Reserve System are exercised. If, in the course of such reviews, the Congress finds th at relationships between its delegated agent and the executive branch of the Govern m ent are not what it wishes them to be, it has remedies at 147 hand. It can define more fully and more clearly what it ex pects these relationships to be, an approach which recom m ended itself to the Douglas Subcommittee of the Joint Committee on the Economic Report when it reviewed the problem . On the basis of my experience which now comprises over thirty years in the Federal Reserve System at two Federal Reserve Banks, and attem pting to make allowance for the bias which such long association can foster, I believe that the Federal Reserve System is an expression of an adaptable creative governm ent. The System is by no m eans perfect; it needs im provem ent. But it can provide a competent mechanism , and a continuity of able personnel, which will enable us to cope with the day-to-day intricacies of m onetary policy, while rem aining responsive to the general economic purposes of the Governm ent. The inquiry of your committee, and the Congressional investigations which have preceded it, provide a dem onstration, I believe, of the advantages of con tinuing the existing direct relationship of the Federal Reserve System to the Congress, which causes the Congress to under take periodic comprehensive appraisals of System perfor mance. If there is still tim e and if you think it would serve a useful purpose, I would like to have this statem ent added to my testimony before the committee. 148 Yours faithfully, Allan Sproul A board the S. S. Europa, returning fr o m Europe, in 1934: left to right, George L. H arrison, head o f th e F ederal R eserve B a n k o f N ew York; M ontagu C. N orm an, governor o f the B a n k o f E ngland; A lla n Sproul; ship's captain, Oscar S c h a r ff In L o n d o n in 1949, with R t. Hon. H ugh D alton (left), Chancellor o f th e E xchequer, a n d others. A **> I ^ h - r d / 'f'^ ^ c ? tk j+ K ^ / / r* ^ ****** v f 4& + 4*J*+ *0 I & ?r/ ' ~ r f r d f /* * U - ^ /it df ^ tfrfcy 6++/ jb/h J-dnif J | )ttf& M p n f m / t a / / to J*/dudj/stUlt/ 0 L tL ? < . .' / s * t^ /^ ?■&*** / / /S te tsh o /^% fK ihsM si£fot> 4.^) # L~ , f c f . i n 4 f. ■ /% & < / $ //} / S S ts i^ J tU 'y ^ ' / f t f, /M ( ^b+ & *dt»r • /4 s fr? fo - 0 t4 6 ^p # & t* 9 * * iy s f f M ' * * * / *? /**&<. ^ . d . ._ ± V A * y y s . r . J k u i v C fr C /h “~ # * 4 * s £ » * & * ■ /J " * .y Z4t U . / x d ts ' J<? $ < &u * f / i^ 'M sy ^ / u i y * &< w e * ^ d p i /- fJ ^ ~b? /ti- w ft r ld 4/ J& jfrf& d '^ P ' A U v / ^ - /£st*Q44>*W**k~«o - 4 sd h fH -} M S $ Jh ^ n t f , M, fy t Vw-M*' "if m / M d s? & n + ^ % 7 r jC f ^4 * * $ M y / t # t i , / Hi {& *** ^ *x ......... ■■» " •> * ? ....... ....'......" i ■ ^ .r ^ r / s /u t >■ > & J$ik tf*nif-/ g b r t /l J /C w rn 4tf Jc d k /u t( ) ***?/ W illiam M cC hesney M artin, Jr. (left), Chairm an o f the B oard o f Governors o f the F ederal R eserve System , a n d A lla n Sproul, shortly a fter their testim ony on “bills o n ly " before a C ongressional su b c o m m itte e in 1954. A lla n S p ro u l in the early 1950s. A lla n S p ro u l in 1960. Paper read at joint meeting of American Finance Association and American Economic Association, New York City, December 29, 1955. Published in Journal o f Finance (March 1956). Reflections of a Central Banker W hen you invite someone who is not a professional economist to speak on an occasion of this sort, there is always the danger th at he will try to talk like a professional economist, and thus m ake a fool of him self while failing to fool his audience. I am not a professional economist. I hate to m ake a fool of myself. And I know I could not fool you. I may have to skate pretty close to what is, for me, the thin ice of theoretical economics, however, because although I am not a professional economist I am a practitioner of an art which m ust draw inspiration from the work of professional economists. Central banking is largely practical economics, a sort of laggard son of theoretical economics, and I have been practicing central banking for the past thirty-five years. My long apprenticeship in the field is the excuse for the title which has been given to my talk, “ Reflections of a Central B anker” . Maybe th at sounds as if I were going to give you some rocking-chair stories of my experience, but th at is not my intention. I think it would be pretty dull. W hat I would like to do is to discuss a few of the things I have observed and thought about while I have been an officer of the Federal Reserve System, and which I think m ight merit a larger m easure of interest and attention from you. M onetary policy was in the doldrum s for a num ber of years prior to and during W orld W ar II. It had been running fast before a brisk breeze for quite a while prior to th at time, and then the wind died down and its sails went slack. Big claims had been m ade for it as a solvent of our economic ills, and when it couldn’t support these claims there was a tendency to discard it in favor of more direct and what m ight seem to be more powerful economic controls. I suspect th at somewhat the same pattern could be traced in the interest of econ omists, and particularly the younger economists, in the prob lems of central banking. For a time, preceding and following 149 the passage of the Federal Reserve Act in 1913, such prob lems attracted a lot of men. Then it began to appear th at more im portant work could be done, in other branches of economics, while interest in central banking suffered a relative decline. Now there has been something of a renaissance in the use of m onetary policy as one of the means of achieving greater economic stability, without sacrificing too much economic freedom. If we are careful not to claim too much for it, it may hold its place. And I am hoping that central banking problem s will similarly recapture the interest of a new generation of economists. Let me speak first and most particularly about the Federal Reserve System, its organization, its policies, and its tech niques. You all know the general organization of the System, but you may not all be aware of the evolutionary changes which have been taking place within the general organiza tion. The m ain outlines of the System are much as they were when the System was established forty-one years ago: a regional system, federal in character, with a national coor dinating and supervisory body at W ashington and twelve regional Federal Reserve Banks which are the operating arm s of the System in their respective districts. W ithin this framework, however, there has been a definite tendency for power and influence to gravitate toward the center, a corollary of developments in other areas of social, political, and economic organization, as well as a result of growing fam iliarity at the center with the means of ac complishing things at the periphery. Fortunately, I think, for the development of the System and the good of the country this tendency has not gone so far as to destroy either the federal character of the System in terms of policy formation or its regional character in term s of policy execution. T hat this is so is largely due to the development of the Federal Open M arket Committee and its evolution as a body in which the various parts of the System are represented not by blocs, not by opposing groups of members of the Board of Governors on one side and presidents of Federal Reserve Banks on the other, but by individuals having equal authority and equal statutory responsibilities with respect to one of the most im portant functions of the System, namely, open m arket operations. 150 It is true th at the m eans of credit control, other than open m arket operations, are scattered about the System in what seems to be an illogical m anner. Discount rates are fixed by the board of directors of the individual Federal Reserve Banks, but are reviewed and determ ined by the Board of Governors, and the setting of reserve and margin re quirem ents is wholly a charge of the Board of Governors. But all of these measures of credit control m ust be integrated and used as a common kit of tools. The Federal Open M arket Committee provides the forum where discussion of their coordinated use can take place without unnecessarily infring ing upon the rights and duties of other parts of the System. The illogical, in term s of organization charts and precisely drawn lines of authority, becomes logical in term s of the evolution of a body which appropriately and effectively represents all parts of the System. It may be useful to recall how this unique arm of the System developed, not from some sudden inspirational a t tack on the problem of bringing national unity to a regional central banking system, but by trial and error during a shakedown cruise of about twenty years’ duration. In the beginning, adjustm ents of the reserve positions of m em ber banks were m ade entirely through the discount window. E ar ly open m arket operations emerged in the form of an attem pt by individual Federal Reserve Banks to supplem ent their earnings. It soon became apparent th at the effect of these purchases and sales of Government securities (and bankers’ bills) was to put reserves into the banking system or to take them out without regard for what might be credit policy at the time. The first informal attem pt to correct the situation was the adoption by the Conference of Governors (presidents now) of Federal Reserve Banks, in 1922, of a policy of buying and selling Governm ent obligations in an orderly and systematic m anner, and the appointm ent of a committee of five governors to see th at this was done. This loose arrange m ent was tightened up somewhat by the Federal Reserve Board in 1923, and the rule was adopted, which has since become a statutory principle of open m arket operations, th at the time, character, and volume of such operations m ust be governed with prim ary regard to the accom m odation of com merce and business and to their effect on the general credit 151 situation. In 1930 an open m arket policy conference was created which included a representative of each of the twelve Federal Reserve Banks. Statutory recognition of and restraint upon this particular m ethod of conducting open m arket operations was legislated in 1933, when the banking act of th at year created a Federal Open M arket Committee and prohibited open m arket operations of Federal Reserve Banks except in accordance with the regulations of the Federal Reserve Board. The Federal Open M arket Com m it tee in its present form came into being with the passage of the Banking Act of 1935, which also m ade it m andatory for Federal Reserve Banks to engage in open m arket operations in accordance with the directions and regulations of the Committee. So far so good. Evolution has proceeded by a process of natural selection toward a higher form of organism, which retains some of the desirable characteristics of regional organization within a federal system, while acquiring the powers necessary to a coordination of national policy under present-day conditions. This organism has survived for twen ty years and given evidence of being able to adapt itself to en vironmental change. There are those, however, who see in the persistence of present regional representation on the Federal Open M arket Committee a serious flaw in our credit control machinery. They appear to believe that this has enabled the poachers to rem ain on the Committee along with the game wardens, in the person of the five presidents of Federal Reserve Banks who are members of the Committee along with the seven members of the Board of Governors. The presidents of the Federal Reserve Banks, they say, are selected by the directors of the banks—to be sure, with the approval of the Board of Governors. The nine men who serve as directors of Federal Reserve Banks include six men elected by the m em ber banks of their D istrict, and three of these men are bankers. Ergo, the presidents of Federal Reserve Banks are the represen tatives of the m em ber banks and, in political term s, m ust be responsive to the wishes of their constituents or they won’t be presidents very long. And so, it is claimed, the group which is supposed to be regulated and controlled has at least five fingers in the pie. 152 This line of chain reasoning has its appeal if you believe th at the presidents of Federal Reserve Banks are so beholden to commercial bankers for their jobs, and so lacking in awareness of their statutory responsibilities th at they cannot honestly serve the public interest as m em bers of the Federal Open M arket Committee. The fact is, however, th at the rela tion between a president of a Federal Reserve Bank and the bankers of his District is not th at of an elected representative and his constituents or an employee and his employer. The present somewhat complicated arrangem ents for the election and appointm ent of directors of Federal Reserve Banks, and for the appointm ent of presidents of Federal Reserve Banks by these directors, have instead a double virtue. First, they inject into the System’s conduct of its everyday affairs the standards of efficiency and practical judgm ent th at wellchosen business executives can provide from their own ex perience— and th at includes everything from judging the fitness of a man to adm inister the complex operations of a Federal Reserve Bank to the m aintenance of its plant and equipm ent. This has contributed to an operating perfor m ance which has protected Federal Reserve Banks from m uch of the criticism which is leveled against other institu tions not prodded toward efficiency by the profit motive. Sec ond, these electoral arrangem ents keep the presidents of Federal Reserve Banks directly in touch with men who are aware of banking and credit conditions and economic developments in their Districts, and who can help to interpret credit policy to the banking, business, and agricultural com m unity, without m aking the presidents subservient to whatever may be the selfish interests of any group in the com munity. On the even more im portant level of policy form ation, the problem is not com parable to th at faced by a government regulatory body fixing rates and conditions of service under monopoly or semimonopoly conditions, nor to the problem of an adm inistrative tribunal watching over observance of the law. The main problem of the central banking system is the appraisal of m ajor developments affecting the whole economy and the form ulation of a policy which will influence 153 the money and credit sector of th at economy so as to con tribute to the stability of the economy as a whole. This is a public service which requires of its practitioners continuous contact with economic processes, and with people in the m arketplaces of the country as well as with the represen tatives of governm ent at its political center. It requires practi tioners with an awareness of the problems of an economy which is neither wholly private nor wholly public in character. It requires practitioners who are insulated against narrow partisan political influence on the one hand, and against narrow selfish private influence on the other, but who are responsive both to broad government policies and to the im portance of private initiative and private enterprise in giv ing support to those policies. In my view there has been developed in the Federal Reserve System in general, and in the Federal O pen M arket Committee in particular, a unique contribution to the dem ocratic adm inistration of such a task. There is no conflict of interest in this adm inistration. I have spoken of this m atter of organization at some length because I think it is vital to the preservation of a Federal Reserve System which retains regional vigor in a national set ting, and because attem pts to destroy the Federal Open M arket Committee, as presently constituted, have been m ade from tim e to time. In fact, a bill has been resting in a Congressional com m ittee for the past year, which would abolish the Federal Open M arket Committee and transfer its functions to an enlarged Board of Governors of the Federal Reserve System. T hat way lies a revolution in the organiza tion of our credit control machinery. I believe th at this is a question which goes well beyond the mere mechanics of organization, and which needs and deserves your closest scrutiny as citizens, as well as economists and men of finance. So m uch for organization. Now for reference to policies. The pream ble to the Federal Reserve Act says th at the Federal Reserve System is to be concerned with the provision of an elastic currency, affording a means of rediscounting commercial paper, and establishing a more effective supervi sion of banking in the U nited States, and for other purposes. Well, the “ other purposes” have long since stolen the show, as m ust be the case when the manifold objects of an 154 economic experim ent are compressed into a few words, no m atter how well chosen. We are all now engaged in an at tem pt to prevent the occurrence of wide and deep economic fluctuations and to m itigate the hardships of the smaller cyclical functions and the necessary internal adjustm ents of a dynamic, growing, relatively free-choice economy. The role of the central banking system in this attem pt to achieve better balance in our economy has never been spelled out specifically, and probably cannot be. We were not specifically mentioned in the Employment Act of 1946, which gave expression to the present general concept of the economic role of government, but our share of the general responsibility derives largely from th at expression of national policy. I have always felt, however, th at if we are to be true to the explicit requirem ents of our own charter we m ust em phasize the implicit requirem ents of this broader charter by combining stability of the purchasing power of the dollar with the promotion of the most effective possible utilization of our resources. We m ust be alert to oppose both infla tionary and deflationary pressures, either one of which can upset the precarious balance of a high-employment, highproduction, high-income economy. We are pretty much all of one m ind, I take it, when it comes to opposing deflationary forces which threaten a waste of hum an and m aterial resources. But there is no such unanim ity when inflation— usually trotted out as mild infla tion—is in prospect or in being. Here is a central banking problem with respect to which we should, perhaps, have had more help from you than you have so far given us. Are we right in the belief th at stability of the dollar and a growing high-level economy are com patible? Or, at least, are we right in our belief that there are so many forces in the economy which now exert inflationary pressures as to make it likely th at our role will generally be to resist those pressures in the interest of sustained economic growth? The siren song of gradual modest inflation, if it be th at and not the music of the spheres, appeals to many groups, political and economic. There is a tendency to relax and enjoy the sound of more money in the cash register and the appearance of more dollars in the balance sheet and in the pay envelope. The 155 problem has become a fundam ental one in the adm inistra tion of m onetary policy, and your advice and counsel and, in deed, your leadership are needed. There are those, of course, who think the answer has already been given, and th at our powers have been reduced to exerting a gentle tug on the reins from time to time, which is really adm inistered by the horse. W ith th at I cannot agree; I cannot bear witness to the impotence of our central banking system. It still has considerable power, even though we recognize, as I think we m ust, th at general monetary controls can no longer be used so drastically as to bring about a severe restriction of the money supply with restriction of income, production, and employment in its wake. In this we would only find support if we were faced with a runaway inflation due solely or prim arily to m onetary causes. T hat is an emergency we have not had to face, and certainly do not have any desire to face, even though the actual experience of such a catastrophe might subsequently m ake for broader public understanding of the anti-inflationary steps we m ust take from tim e to time. In developed countries which have ex perienced hyper-inflation the central bank has only to m en tion the word “ inflation” to bring a large m easure of public support to a restrictive credit policy. W hen we m ention infla tion as a reason for trying to restrain a boom, which shows signs of tem porarily exhausting physical capacity to increase the supply of goods and services, and in circum stances when further injections of bank credit are likely to show up largely if not entirely in increased prices, we are apt to be charged with crying wolf when there is no wolf, to be denounced as apostles of deflation. And, if actual inflation does not develop, perhaps because we have done our job of helping curb its development, the accusation against us seems to gain increased validity. You can see why I would like to have aid and comfort in resolving doubts about our ability to combine a stable dollar with a growing, expanding, high-level, peacetim e economy. A nother aspect of policy form ation which concerns me is whether or not undue reliance is now being placed upon the judgm ents of m en, and whether we should seek some 156 autom atic or m echanical guides to policy action. I do not think th at we have been led too far astray by reading our press clippings. W hen it is said of the Federal Open M arket Comm ittee th at “ these twelve men have more financial power than any other official body in U nited States history” , we may think it will impress our children and grandchildren, but we are also hum ble enough to recognize th at the power we wield is a circum scribed one which cannot be wielded ar bitrarily or capriciously. In the first place, it is a power exer cised by a group of individuals of differing backgrounds and talents, and with differing approaches to the policy actions upon which they m ust finally agree. There are checks and balances such as are characteristic of our whole concept of government, which give assurance th at decisions will be reached by a deliberate process, and th at power will not be wielded by an individual who m ight acquire the habits of a despot. In the second place, it is power exercised in the white light of full disclosure: weekly, monthly, and annually our ac tions are publicly reported for all to examine and to judge. Finally, it is power exercised within the limits of national ob jectives and public tolerance, which would not perm it the Comm ittee to indulge a sense of power or to experim ent rashly with it, even if it were so inclined. But to recognize the lim itations of our powers is not to deny their im portance. We m ust and do take them very seriously. We realize th at we are trying to measure and adjust the flow of credit in a money economy, and we are steeped in the belief th at whether the economy works well or poorly depends in p art on our success or failure in discharging our responsibilities. A nd therein, I think, lies a danger. The op pressive character of such a heavy responsibility leads men to seek some autom atic or mechanical device as a guide to policy action, in order to remove the risk of exercising fallible hum an judgm ent. The gold standard, as it existed during the latter p art of the nineteenth century and the early years of the present century, largely perform ed this role in those countries which had central banks and which looked first and almost entirely to the state of their balance of payments and the size of their gold reserves in form ulating central bank policy. 157 Those “ good old days” began to pass into history, however, when central bankers began consciously to interfere with the effects of inflows and outflows of gold upon the domestic credit situation and, through it, upon the domestic economy. They receded further into limbo as national policy became more and more oriented toward the m aintenance of high levels of production and employment at home, and tried to fit together the international and the domestic situation without subordinating one to the other. And yet there have been and no doubt are serious students of central banking who believe th at it cannot function prop erly without a “ norm ” of behavior, or a m athem atical equa tion, which will tell its hum an guides what to do and when to do it. In the present state of our knowledge of the functioning of the economic world, and despite the flood of available statistics which never seems to be out of spate, I do not believe that we can now devise a “ norm ” or an equation which will relieve us in any substantial and consistent way of the necessity of exercising hum an judgm ent in discharging our responsibilities. W hat we need is not just a catalogue and synthesis of symptoms, but an appraisal of a whole situation, in c lu d in g th e co m p lex re a c tio n s o f h u m a n b e ings—businessmen, labor leaders, consumers, politicians. Early in my career in the Federal Reserve System I read a statem ent by Allyn Young which impressed me then and im presses me now: In fact, we can be certain that reliance upon any sim ple rule or set o f rules would be dangerous. Econom ic situations are never twice alike. They are com pounded o f d iffe r e n t e le m e n ts —fo r e ig n a n d d o m e stic , agricultural and industrial, monetary and non m onetary, psychological and physical— and these various elements are com bined in constantly shifting proportions. “Scientific" analysis, unaided, can never carry the inquirer to the heart o f an economic situation. Judg m ent and wisdom— the power to take a com plex set o f considerations into account and come to a balanced view o f them — are quite as much needed as fa cts and theories. The Federal Reserve System needs to operate in the light o f all the inform ation it can get, and it 158 needs to have this inform ation organized and analyzed in such a way as to give the m axim um am ount o f il lumination. B u t it also needs the guidance o f that prac tical wisdom which is born only o f experience. If in our time, however, with increasing knowledge of how credit policy works, we can discover a “ norm ” of action, or a m athem atical guide to policy, our task would be greatly simplified. To do that, we shall have to know more than we yet know about how m onetary and credit policy actually af fect the economy as a whole and in its various parts, and with what leads and lags. This will m ean deep probing into the operations of our money and bank in g system as it is now constituted, and into the effects of changes of monetary and credit policy upon the whole economy working through the banking system. U ntil this job is fu rther along, a good motto for central banks may continue to be the lines of the poet: O ur stability is b u t balance A n d wisdom lies in m asterful A dm inistration o f the unforeseen. I am now going to turn to one of the techniques of execu tion of central bank policy, partly because it has im portance from a general economic standpoint which transcends its purely technical trappings, and partly because it has been the subject of some public com m ent and discussion during the past year or two. I refer to the range of open m arket opera tions: whether such operations should be rigidly confined to short-term G overnm ent securities except under the most unusual circum stances or whether a willingness at times to operate over the whole range of m aturities of Government obligations would provide a better means of m aking credit policy effective. I am not going to reiterate all of my own views which are already in the record and which are distinctly minority views within the Federal Open M arket Committee. There are as yet no absolutes in this business, however. Those who advocate, and I who oppose, the present techniques of the Federal Open M arket Committee are merely climbing the hill on opposite sides, trying to reach the same sum m it of knowledge and effectiveness. But I do think th at the question is one worthy of the atten tion of at least some of you who are here today, not merely as 159 a m atter of casual com m ent in panel discussions, or writings on other subjects, b u t as som ething which has real economic significance and deserves serious study. A nd I am encour aged in this opinion by the articles which have appeared in the journals during the past year. If the present technique derives from a too rigid application of supposed classical economics to problem s of money and credit, we need enlightenm ent from you. I had supposed th at the classical economists, the men of private property and free m arkets, did not think th at free m arkets could provide everything necessary to the public good, and th a t if they were our contem poraries they might have th o u g h t of the m arket for money and credit as som ething separate and apart from other m arkets, and as an appropriate area of intervention by government or agencies of governm ent—intervention at th at cross-section of the economy where the public need for some overall economic guidance toward stability could be provided with a m inim um of direct intrusion into the details of production and distribu tion. And I had supposed th at this would mean central bank action to help the m arket in determ ining the significant characteristics of the m aturity structure of interest rates im plied by the kind of credit policy being pursued— not to try to set decimal points on daily quotations, nor to peg a curve, but to nudge the m arket in the direction sought by credit policy. And finally I had supposed th at the effects of increases or decreases in capital values, arising from changes in long-term rates of interest, were becoming more and more im portant in an economy in which public as well as private debts have become so large a part of our so-called assets, and th at some direct intervention in this area m ight at times be appropriate. W hether or not these or contrary suppositions are true, it seems to me th at this m atter of open m arket techniques in volves problem s of economic significance beyond its im m ediate technical application, and th at it deserves your study and your published findings. There is another area of credit adm inistration which can be brought under the loose heading of techniques. T hat is the problem of selective credit controls, and particularly the con trol of consum er instalm ent credit. I suppose th at all of us 160 who have a bias against detailed planning “ from above” would prefer th at credit policy accomplish its m ajor aims by general quantitative controls which work impersonally but pervasively, and without interfering directly with individual transactions. But if there has grown up a form of credit ex tension which, no m atter how prodigious its contribution to mass production and mass consum ption, is also introducing a dangerous elem ent of instability in our economy, and if it is difficult to reach this credit area by general credit measures without adversely affecting all of the less avid users of credit, is there not a case for a selective credit control? Thackeray says in Vanity Fair: “ Everybody m ust have observed how well those live who are comfortably and thoroughly in debt; how they deny themselves nothing; how jolly and easy they are in their m inds.” Well, I am not jolly and easy in my m ind. I am disturbed by the present situation in consum er instalm ent credit, just as I was concerned, under different conditions and for dif ferent reasons, about stock m arket credit until the Board of Governors was given power to establish, and to vary, margin requirem ents. I am disturbed not by the total am ount of con sum er credit, b u t by the fact or the indication th at successive relaxation of term s has been largely responsible for keeping the ball in the air. This is a process which cannot go on in definitely, and when it ceases there will come a time when repaym ent of old debt will catch up with new extensions of credit. The special stim ulus of a rapidly increasing net supply of consum er credit, which has contributed so much to the record production and distribution of consumer durable goods during the past year, will then be gone, at least tem porarily. Will it then become clear th at we drove our produc tive capacity to unsustainable limits—for the present—by borrowing consum er dem and from the future? This is a subject on which many voices have expressed many views, but usually they have not been views which seemed objective enough to help resolve the question in the best interest of society as a whole. I know th at there are those who believe th at selective credit controls are a dangerous step on the road to general overall planning, and I have no desire to become a fellow traveler on th at road. But I do believe th at there is a tem ptation to abuse consum er credit in boom 161 times, th at it can thus become a serious source of instability in our economy, and th at we would not jeopardize our general freedom from direct controls by giving the Federal Reserve System perm anent authority to regulate consumer credit. I freely adm it, however, th at this view would be better held if it were based more firmly on objective study and research into the place of consum er credit in our economy and less on observation and opinion. T hat is the sort of basis for consideration and action which you could provide. The same or something similar might be said of m ortgage financing, but I shall not try to go into that. Economics and social objectives become interm ingled so fiercely when hous ing is discussed as to m ake calmness and objectivity a h an d icap, if not a badge of moral delinquency. The basic question involved in both cases is whether an a t tem pt should be m ade through regulation of these specific types of credit to exert a stabilizing influence on areas of the economy which, in the past, appear to have been major sources of instability of employment and production, or whether we should be content with efforts to regulate the overall availability and cost of credit, hoping that fluctua tions in the m ajor areas of the economy will balance out. O ur experience thus far suggests to me th at general credit con trols can exert an effective influence on these particular types of credit only with a considerable lag, and that we cannot rely upon countervailing forces in the economy to m aintain overall stability. Perhaps you can see where I have been heading in these somewhat random rem arks, which have touched on a few aspects of central banking organization, policies, and tech niques, while not m entioning others of equal or, perhaps, even greater im portance. In general my purpose has been to fram e a plea for help— a plea that theoretical economics come more steadily and effectively to the aid of practical economics in such fields as central banking. I recognize th at theoretical economics is the basis of prac tical economics. And I recognize that theoretical economists, in our time, seem mostly to have preferred to work on general principles, or on building models of economic perform ance, rather than on economic policies and their effects. I have not the competence to challenge the value of their work, but I 162 question whether it is enough. I question whether economists individually and as a group can fulfill their obligations as citizens, as well as students and scholars, if they do not try to bring these interests together. I would say we need a revival of political economy, and I would invite you to look on central banking as a good place to start. The economists of an earlier day did not hesitate to jum p into the thick of battle over cur rent issues, and it did not seem to lower their academic standing then nor should it now. They were pam phleteers, they organized and participated in public meetings and discussion groups, they brought their influence to bear in any way they could on public officials and private citizens. They were pungent and provocative in debate. M acaulay said of Jam es Mill and his followers on one occasion, “ These smatterers whose attainm ents just suffice to elevate them from the insignificance of dunces to the dignity of bores.” Perhaps th at sort of thing is a little too violent for our present mood and condition. But it might be better than withdrawing com pletely into a realm of esoteric jargon, or indulging in an ex cess of politeness in dealing with your peers and your public, so th at issues are seldom drawn clearly enough to attract public attention and prom ote public understanding. By your studies and your research and your application to the prob lems of economic theory, you have earned the right to be heard, and to give some sense of continuing direction to of ficial action and to public opinion. I would like to see that right more vigorously exercised. I feel th at it could be exercised more vigorously and to ad vantage in the field of central banking. We have excellent research staffs in the Federal Reserve System: able economists and statisticians and devoted students of money and banking problems. But their work needs more cross fertilization and critical analysis by thoughtful and disci plined minds outside the System who can apply their talents to this special field without the bias of an organizational viewpoint. Not enough work has been done, I would say, on the m onetary problems of a mixed government-private economy, on the functioning and form of a fractional reserve banking system in such an economy, on the growing im por tance of other financial institutions, which crisscross both the fields of commercial banking and investment banking, and 163 on the perform ance and characteristics of our money and capital m arkets. These are subjects which are becoming critical in the development of central banking. You have tended, I venture to say, to occupy yourselves too m uch with the refinem ent of old ideas which are no longer wholly relevant, with the cataloguing of new economic pro cesses, with the application of m athem atical equations to situations too dependent on hum an behavior to be am enable to such treatm ent, or with building utopian models of the dream world of the future, while neglecting the hard but rewarding task of studying the present in a way which would contribute ef fectively to public policy and private well-being. If you will not use it against me, I would say th at you have left the latter task to the improvised judgm ents of practitioners who have lacked the tim e or the equipm ent needed to work out a coherent and con sistent basis for the actions which they m ust take. It is said th at there has been a renaissance of monetary and credit policy in recent years. In fact, some extravagant claims are again beginning to appear concerning the power and in fluence of m onetary measures in curing or am eliorating our economic ills. Governments may be tem pted to commit or condone economic errors, in the hope that m onetary policy can redress the balance, and in the hope th at the central banking system will stand as a buffer between the govern m ent and an electorate which chafes at restraint. We shall have to guard against asking too much of monetary policy. But it is a fact th at m onetary measures have reestablished themselves, and rightly so, as one of the principal means used by governments to try to keep national economies in order without the stifling restrictions of more direct physical con trols. W hat I would now like to see is a renaissance in the study of money and banking in general and of central banking in particular. I would like to see a fresh and thorough exam ina tion of our existing banking and credit machinery and our money and capital m arkets. I would hope th at out of such study and exam ination would come new ideas and new pro posals which would give shape and direction to future public policies and private actions. It would be a task worthy of the best talent you can bring to bear on it. 164 Letter to Alfred Hayes February 21, 1958 D ear Al: I want you to know th at I have been asked and have agreed to serve as a m em ber of the Commission on Money and Credit which is being set up by the Committee for Economic Development, with the financial support of the Ford F ounda tion. Although I consider this commission distinctly second best, as com pared with a commission which might have been nam ed by the President, if the Congress had been so in clined, I practically chiseled out the niche in which I have been placed. It would have been difficult for me to decline to serve, even if I had wished to do so, and I had no such wish. I think this way of attacking the problems involved is better than not attacking them at all, or attacking them piecemeal. The personnel of the Commission is not going to be what I would have considered ideal, either; th at is, a group of men with sufficient general knowledge of the field to enable them to use “ experts” wisely, and sufficiently objective to be able to hear and consider all points of view, and to determ ine w hether and to what extent differing points of view should be reflected in the findings of the Commission and its recom m endations for action. This was never a realistic hope, I sup pose, and it may not even have been a good idea. W hether it was or not, the Commission is to be made up of people rep resen tativ e of d ifferen t in terests an d d ifferen t geographical areas—big business, small business, big banks, small banks, other financial institutions, labor, agriculture, etc., coming from the northeast, the southeast, the middle west, the far west, etc. I shall now have to hope that the m em bers of the Commission do not consider themselves as having been selected to “ represent” these various interests and places, in the sense of being bound to support the views and interests of their “ constituents” , whether they serve the broad national interest or not. W ho knows, maybe my col leagues on the Commission will prove to be as objective as I think I am! 165 As you know, the studies of the Commission are to go for ward during the three years ending December 31, 1960, and it is anticipated th at the Commission will meet, on the average, about once a m onth and will have lots of homework, too. No doubt the Federal Reserve System will be called upon to help the Commission in many ways. As an individual m em ber of the Commission, I shall also need help, and I hope th at I can call upon the people at the New York Bank from time to time, if I am not too greedy in my calls. This would be a happy arrangem ent for me if it is agreeable to you. I was interested, of course, in the announcem ent W ednes day afternoon th at the Board of Governors had reduced the reserve requirem ents of mem ber banks. It had seemed to me, with the sharp deepening of the recession, the System was be ing a little niggardly in increasing the reserves of the banks through open m arket operations, even though the effect of the actions it has taken has been dram atic in term s of the in terest rate structure. It now looks as if, following the pattern of last November when open m arket action was preceded by discount rate action, the System has taken action on reserve requirem ents rather than through the more gradual pro cesses of the open m arket. This has the advantage of bring ing moves toward credit ease quickly to the attention of a m uch wider public, I suppose, than would open m arket operations. And this first hom eopathic dose probably com forts a Board which is still worrying about a revival of infla tionary pressures, and convinced it erred in 1953 when a massive dose of new reserves was adm inistered. On the well-established principle th at economic situations are never twice alike, however, I am wondering whether the lesson the Board sees in 1953 can be applied in 1958. There is an equal danger, I think, th at this recession is not 1953-54 (or 1948-49) over again, but a downturn which contains a m uch greater risk of going deeper and lasting longer than the two preceding postwar recessions. If this be so, it will be possible to wait too long to take more vigorous credit action, and we may then find th at our medicine doesn’t work as well 166 as it m ight have earlier. It can be said th at a tax cut will do the job if more vigorous action is needed, but I would like to have credit policy play its proper role, too. Nor am I con vinced th at we can turn the economic spigot on and off by fiscal means, as easily as now seems to be assumed; certainly not without inflationary risks which equal, if they do not ex ceed, those which m ight attend a more vigorous relaxation of credit. The banks out here are disappointed, of course, in the small size of the reduction in reserve requirem ents. The am ount of the im m ediate reduction for individual banks seems to them to be picayune, and bankers never have been much impressed by the effect of such a reduction on the lend ing and investing power of the whole banking system, even when they have understood it. They want something which enables them directly and immediately to increase their earn ing assets substantially. This latest move, therefore, is getting less credit than it deserves. (It leaves the Federal Reserve Bank of San Francisco further out on the limb; a case of mis placed independence which I believe must have been forced on H erm ann Mengels by his directors.) I hope th at you don’t m ind my writing you in this way. I stay away from the San Francisco Bank, but I don’t do so well when it comes to the New York Bank. W ith best regards. Sincerely, Allan 167 Letter to Alfred Hayes March 20, 1958 D ear Al: T hank you for letting me know about the rum ors which are going around about CED ’s Commission on Money and Credit. They had not reached me (nor had any direct infor m ation from headquarters), but I am not surprised and I suspect th at they are true. It is now over a m onth since Don David telephoned me and then wrote me, asking me if I would serve as a m em ber of the Commission. At th at time I think he expected to be able to announce the m em bership of the Commission on or about M arch 1, a hope later deferred to m id-M arch. The delay in m aking the announcem ent had led me to wonder whether some of those invited were not will ing to serve, and the labor people (two of them) would seem to be the most likely candidates. This rem inds me of our conversation, when I last saw you, about trying to get representatives of labor interested in Federal Reserve policies and operations. I told you, I think, of my failure to get anywhere with them , and expressed the hope th a t you would be more successful. Their suspicion of bankers (W all Street?) is deep-seated and uninform ed, and the more dangerous for th at reason. It is tim e they realized that, if they are going to live and work in a money economy, they should know more about how such an economy works and should be eager to take p art in attem pts to improve its workings. I can’t believe th at they really want to do away with the private sector of our financial machinery. I do come back, however, to the mistake which I think CED m ade in trying to have the m em bership of the Commis sion representative of various economic and geographical areas of the community. My idea was to have a commission which would carry its own credentials of competence in the field, and which would rely on its studies and hearings to bring out all points of view. I can’t say that CED came close to this ideal in its proposed Commission (so far as I have had 168 names), and some of those proposed really surprised me, and caused me to have second thoughts about serving. I still cling to the hope th at a good job will be done, but not with the en thusiasm I once had. I try to rem em ber, too, th at I am in clined to think th at my way of doing things is best! W ith best wishes. Sincerely, Allan 169 Letter to Alfred Hayes June 13, 1958 D ear Al: I think th a t you should know th at I have decided to withdraw from the M onetary Commission, and have so ad vised Don David. The original prospectus of the Commission said th at “ It is of the utm ost im portance th at the m embers of the Commis sion be persons of unquestioned reputation for competence and objectivity. The m em bers should be chosen for their in dividual qualities, not as representatives of organizations or sectors of the community. A balanced representation of philosophies and approaches should be sought.” The Commission of fifteen members, on which I agreed to serve last February, did not wholly realize these ideals but came close enough, I thought, to make my m em bership useful and rewarding. The enlarged Commission, the m em bership of which was unknown to me until the CED press release came out at the end of May, departs so far from these ideals as to m ake my m em bership unpalatable. It comes down to a personal judgm ent as to the conditions and circum stances under which you can do your best work and hope for the satisfactions which a workman requires. I decid ed th at I could not hope to find these conditions and cir cum stances as a m em ber of this mixed and unwieldy Com mission. It has been a tough decision for me to make. I have tried to m ake it calmly and without rancor. Now th at I am home again, there are many things I would like to talk over with you, which we didn’t have time to get in to when I was at the Bank. I think th at my visits have been too hurried, but th at I may write oftener to share ideas and views with you. W ith best regards. 170 Sincerely, Allan From Review o f the Report of the Commission on Money and Credit, Hearings before the Joint Economic Committee, August 1961 A ugust 16, 1961 H onorable W right P atm an, C hairm an Joint Com m ittee on the Economic Report U nited States Congress W ashington, D .C . D ear M r. Patm an: I regret th at I could not accept your invitation to appear at the current hearings of the Joint Committee on the Economic Report, to testify regarding the recom m endations of the Commission on Money and Credit concerning the structure of the Federal Reserve System. I realize th at a m em orandum of views is not a wholly satisfactory substitute for an ap pearance before the Committee, with its opportunity for questioning by interested Committee members. Nevertheless, since the subject is one in which I have a keen interest, and a degree of knowledge based on thirty-six years spent in the Federal Reserve System, I have thought it worthwhile to use this m eans of placing my views before the Joint Committee. To identify myself in the m anner which has become custom ary at hearings of the Committee, my nam e is Allan Sproul, I am a director of the Wells Fargo Bank and American T rust Company of San Francisco and of the Kaiser Alum inum and Chemical Corporation of O akland, Cali fornia, and I was president of the Federal Reserve Bank of New York and vice chairm an of the Federal Open M arket Committee for fifteen years from 1941 to 1956. In presenting my views, however, I represent no one b ut myself; neither the private business community, the commercial banks, nor my form er associates in the Federal Reserve System. 171 I should also m ention, I think, th at I was nam ed as a m em ber of the Commission on Money and Credit when it was first being organized in February 1958. In preceding years I had been am ong those who had advocated a study of our financial system by a national monetary commission established by the government, and composed of a small num ber of men com petent in the field, experienced in economic m atters, and with a reputation for objectivity. This official or governm ent commission did not come to pass. As a second choice, the private commission sponsored by the Com m ittee for Economic Development seemed to offer a p a r tially satisfactory means of bringing our financial machinery under scrutiny and suggesting possible ways of improving it. W hen I accepted appointm ent to the Commission in February 1958 it was to be a Commission of fifteen members “ chosen for their individual qualities, not as representatives of organizations or sections of the com m unity” with a “ balanced representation of philosophical approaches” . In mid-April 1958 I was advised th at it had been decided th at “ for more ideal balance the Commission should be expanded to a m inim um of twenty-five, bringing about representation of areas, points of view, and interests which were not ade quately provided for in the Commission of fifteen as originally planned” . I learned of the m em bership of the enlarged Com mission by way of a press release on May 29, 1958. On June 12, 1958 I withdrew from the Commission. My resignation was announced in a press release of the Commission on January 22, 1959. So m uch for identification. As you requested, I now ad dress myself to th at p art of the recently published report of the Commission on Money and Credit (CMC), which has to do directly with the structure of the Federal Reserve System. In this area, at least, I suggest th at the CMC, in its efforts to compromise the various points of view and interests of its m em bers, produced a doubtful package of recom m enda tions. Some of them are good but, in the aggregate, they represent an attem p t to pacify those who would “ nationalize” 1 the Federal Reserve System by destroying its Federal character, and they tend to water down the symbols of support of the System by the private financial community 1 A vague general term used to frighten conservatives. 172 to the point of poisoning rath er than preserving a relation ship which has m ade successful evolutionary progress for half a century. I directly challenge, therefore, so far as the struc ture of the Federal Reserve System is concerned, the state m ent of the CMC in the introduction of its report, th at it has tried to “ confine its recom m endations and suggestions for change only to situations where the present structure has not worked well” . W hat are the recom m endations and suggestions of the CMC for changes in the structure of the Federal Reserve System? 1. The FRB (Board of Governors of the Federal Reserve System) C hairm an and Vice C hairm an should be designated by the President from among the B oard’s m em bership, to serve for four-year term s coterminous with the President’s. 2. The FRB should consist of five m em bers with overlapping ten-year term s, one expiring each oddnum bered year; m em bers should be eligible for reap pointm ent. 3. The FRB C hairm an should be the chief executive officer of the B oard, empowered to handle ad ministrative m atters. The law should be clarified to authorize the Board to delegate to Board committees or to B oard m em bers individually, or to senior staff of ficers of the Board, any of its functions in the ad m inistration of its powers in regard to the supervision of the banking structure, etc. Any actions so delegated should be subject to review in the B oard’s discretion. 4. O ccupational and geographical qualifications for Board m em bers should be elim inated. Instead, the statute should stipulate th a t m em bers should be positively qualified by experience or education, com petence, independence, and objectivity com m ensurate with the increased responsibilities recom m ended for them in the achievement of low levels of unemploy m ent, an adequate rate of economic growth, and reasonable stability of price levels in the economy. Salaries of top officials throughout the Governm ent 173 should be sharply increased and, in view of the gravity of their responsibilities, FRB mem bers should be com pensated at the highest salary level available for ap pointive offices in the Government. 5. The present statutory Federal Advisory Council should be replaced by an advisory council of twelve m em bers appointed by the Board from nominees presented by the boards of directors of the Federal Reserve Banks, etc. 6. The law should formally constitute the twelve Federal Reserve Bank presidents as a conference of Federal Reserve Bank presidents, to meet at least four times a year with the Board, and oftener as the Board finds necessary. 7. The determ ination of open m arket policies should be vested in the Board. In establishing its open m arket policy, the Board should be required to consult with the twelve Federal Reserve Bank presidents. The deter m ination of the rediscount rate (the same for all Reserve Banks) should be vested with the Board. In establishing this rate, the Board should be required to consult with the twelve Federal Reserve Bank presidents. The determ ination of reserve requirem ents should continue to be vested in the Board. In establishing these requirem ents, the B oard should be required to consult with the twelve Federal Reserve Bank p resid en ts.2 The first five of these recom m endations, which I would characterize as the trim m ings of this section of the report of the CMC, might be accepted, I think, as moves in the right direction. The suggestion th at the term s of office of the C hairm an and Vice C hairm an of the Board be m ade coterm inous with the term of office of the President has been attacked by those who see this as an attem pt to introduce partisan politics into the functioning of the Board, which is a sin we all deplore. 2 In veering toward centralization of power within the Reserve System, the CMC rightly avoided the recommendation sometimes put forward that the Board as well as the Open Market Committee should be abolished, and our monetary affairs placed in the hands of a single executive. This country has shown a wise aversion to “czars” , and still likes the idea of some checks and balances. 174 The facts of the m atter as I have observed them , however, are th a t the C hairm an of the Board really serves largely at the will or pleasure of the President now. The C hairm an of the Board is the chief point of contact between the Board and the President, the Secretary of the Treasury, the Council of Economic Advisers, and all the most im portant officers of the executive branch of the G overnm ent, and only to a slightly lesser degree with the Congress. If he is persona non grata at the W hite House, his ability to carry out the duties of his of fice is so gravely dam aged as to m ake it im practical and un wise for him to continue as Chairm an. The present wording of the law concerning the term of office of the C hairm an seems to me merely to mask this fact of life. I do not mean, however, th at the C hairm an of the Board m ust become a subservient political appointee; he retains the right and the duty to represent the Board fairly and forcefully in expound ing its views and m ethods, and preserves the individual right of resignation without disloyalty to the President, or party, if he decides th at his service as C hairm an is no longer com pati ble with the economic policies being followed by the Govern ment. A reduction in the num ber of m em bers of the Board from seven to five, and in the term s of office from fourteen to ten years, with eligibility for reappointm ent, should m ake a modest contribution to improving the quality of the Board m em bership. And, as the report of the CMC says, it is a sug gestion which retains stability of m em bership, protects in dependence in expressing views and advocating policies which may not be popular, and provides some safeguard against superannuation. The recom m endation th at a m eans be sought to make clear th at the Board, as a whole, is not to be enmeshed with routine adm inistrative m atters, to conserve its m em bers’ tim e, and to arrange for the more expeditious disposition of its caseload of business, has merit. The success of the sugges tion is bound up, however, with questions of the qualifica tions for Board m em bership, the size of the Board, and the extent to which the individual m em bers participate with the Chairm an in working out coordination of m onetary policy 175 with the general economic policies of the Governm ent. One reason for the im plied “ congestion of detailed business at the to p ” at the B oard is the druglike attraction of such business when sitting in your office pondering the broad issues of m onetary policy becomes tedious. There is no question in my m ind th at the present occupa tional and geographical qualifications for Board m em bers have outlived whatever sound purpose they ever had. They represent an embryonic phase of thinking concerning the role of a central banking system in this country. The general statem ent of qualifications suggested by the CMC is m uch m ore in tu n e with the responsibilities of the Federal Reserve System, present or proposed, and with the need to abandon ideas of finding effective national m onetary policies in an a t mosphere of representation of special interests. The com pan ion recom m endation of increased salaries for Board m em bers has become a standard item in all considerations of the m em bership of the Board. The consistency with which this recom m endation has been ignored by the executive and legislative branches of the Governm ent suggests th a t there is a roadblock to its acceptance which does not have to do with the specific merits of the recom m endation. The suggestion of the CMC concerning the Federal A d visory Council appears to be an attem pt to rescue from possi ble eventual extinction a body which was established in the early days of the Federal Reserve System as a sop to the bankers who had been ruled off the B oard on the theory th at you don’t m ake game wardens out of poachers. Although the B oard can seek advice from whatever individuals or groups it chooses under its general powers, there is some m erit in re taining a statutory body, outside the Governm ent and the Federal Reserve System, with which the Board m ust consult from tim e to time, and which has statutory authority to ask questions, seek inform ation, and proffer advice. I do not think, however, th at it is necessary or desirable to change the m ethod of election of m em bers of the Federal Advisory Council. W hat is necessary and desirable is to smash the tradition, growing out of the early history of the System, that the m em bers of the Council elected by the boards of directors 176 of the Federal Reserve Banks should be commercial bankers. Relieved of this anachronism , the boards of directors of the D istrict banks are m uch better able to select representatives of their Districts th an is a board at W ashington, and the privilege is a desirable one in the relations between the Board and the Districts. T urning the present election process around, so as to m ake the Board the final appointing authority, seems to me to be a picayune obeisance to an obsession with what the CMC calls the influence of the “ private base” of the System. Now we begin to get down to the m eat in the coconut. The recom m endation th at the law should formally constitute the twelve Federal Reserve Bank presidents as a conference, to m eet at least four times a year with the Board, is an un necessary and spurious attem pt to seem to increase the stature of the presidents of the Federal Reserve Banks, who are to be deprived of their most im portant function by the next recom m endation of the Commission. The conference of presidents of Federal Reserve Banks has been in existence for years; it meets regularly to discuss m atters of credit policy and Federal Reserve adm inistration; it consults with the Board as a necessary corollary of their joint responsibilities. The sanctions of tradition and long practice have given it a place and stature in the working of the Federal Reserve System, to which statutory recognition can neither add nor detract. Having paid a left-hand com pliment to the presidents of the Federal Reserve Banks in this recom m endation, the CMC in its next recom m endation relegates them to the role of branch m anagers by proposing th a t all the main powers of the System in the field of m onetary policy should be lodged in the Board, with only advisory participation by the presidents of the Reserve Banks. It does this, first, on the ground that these powers— determ ining rediscount rates, deciding open m arket policy, and fixing reserve requirem ents— “ should be com plem entary and governed by the same considerations, th at is by the same people in the same forum ” . And, second, the CMC says th at the exercise of these powers belongs ex clusively in the hands of public officials: th at is, the Board, and th at there should be no ambiguity about where this responsibility lies. 177 The Commission is right, of course, in saying th at these powers should be and are com plem entary, and it is right in saying th at they should be exercised by public officials, but the fog of compromise evidently concealed from the Commis sion the logical suggestion, based on successful experience, th at the place to lodge these complem entary powers is in the Federal Open M arket Committee (as it would be constituted on the present form ula, if the size of the Board were reduced from seven to five members). The Federal Open M arket Com m ittee has become the heart of the Federal Reserve System; cut it out and you have a skeleton. It is a unique development in central banking which has evolved out of the experience of the System with the needs of a country of the size and character of the U nited States.3 It is m ade up of men having statutory responsibilities, who serve on the Committee as individuals under law, and who are public officials and public servants in every real sense. Finally, the present con stitution of the Federal Open M arket Committee observes the cardinal principle of central banking that those who determine m onetary policy should not only coordinate their actions with the general economic policies of the Government, but should also have a direct contact with the private money m arket— a contact which comes from living in the m arket, operating in the m arket, knowing the people in the m arket, and being able to feel the pulse of the m arket by hand from day to day, and not by random telephone calls or reviewing cold statistics. Here, I think, is a tender point with some m embers of the joint com m ittee and indeed of the whole Congress, and with some people in the Federal Reserve, but it cannot be avoided. The first and most direct point of contact between the policies of the monetary authorities and our national and in ternational monetary systems is the New York money m arket. This is no device of greedy men and no accident of geography which can be changed by legislative fiat. It reflects the necessity, in a money economy such as ours, of having a m arketplace where the final and balancing transactions of 3 This argument should not be confused with the ideas prevalent in the early days of the Reserve System concerning regional dif ferences in monetary policy. Monetary policy must be national, ex cept in minor degree, but the whole is still the sum of its parts, and regional conditions are important in formulating national policy. 178 our national and international accounts can be carried out by a variety of delicately constructed financial institutions. And the operating arm of the Federal Reserve System in the principal money m arket of the nation, and of the world, is the Federal Reserve Bank of New York. The Banking Act of 1935 recognized th at inescapable fact, and the need for a liv ing link between m onetary policy and the money m arket, by requiring th at the president of the Federal Reserve Bank of New York m ust be a continuing m em ber of the Federal Open M arket Committee. All Federal Reserve Banks are equal, but the Federal Reserve Bank of New York is first among equals. I can only surmise why the CMC decided th at the Federal Open M arket Committee should be dism antled. The state m ent th at the “ distinction between the Board and the Federal Open M arket Committee has outlived its usefulness” raises questions, but answers none. From the language of other sections of the report, I would guess th at those m em bers of the CMC, who m ight have argued for the reten tion of the Federal Open M arket Committee if they had known more about it, were lulled into acceptance of its aban donm ent as a “ package deal” by those who were united in prom oting the idea th at private influence still perm eates the Federal Reserve System, and m ust be elim inated if the System is to discharge its public functions properly and merit the complete confidence of the Government and the nation. The report first constructs a neat word pattern to describe the structure of the Federal Reserve System, and it then states th at a basic issue concerning the System is the “ degree of independence of the Federal Reserve . . .from the b an k ing com munity which it both serves and regulates” . It is my view th at the word p attern —a System with a regulated private base, a mixed m iddle com ponent, and a controlling public apex— is neat, but inaccurate. In all of its operations in the area of m onetary policy I assert th at the Federal Reserve System (Board and Reserve Banks) is a public institution, as it m ust be to discharge the public func tions vested in it by the Congress. Clearly, the Board is a public body. It is equally clear to me th at the Federal Open M arket Committee, on which the presidents of the Federal Reserve Banks serve, as individuals, by statutory appoint 179 m ent, is a public body and not a “ mixed middle com ponent” . The report of the CMC seems to rest its con trary view on the statem ent th at the presidents of the Federal Reserve Banks are not Governm ent appointees, but are elected by and have their com pensation fixed by the boards of directors of their Banks, subject to the approval of the Federal Reserve Board. If the Commission had pursued this lead further, it would have known th at approval by the Board of appointm ents and salaries of presidents of Reserve Banks is not a perfunctory power. The Board has dem onstrated on num erous occasions th at it is an active veto power, so th at there is final public control. But this is more quibbling with words than meeting the real issue. The real answer is th at you do not achieve honesty and integrity and unswerving devotion to the public interest by way of appointm ent procedures, but by charging com petent men with an undivided responsibility for public service. T hat is the case with respect to the presidents of the Federal Reserve Banks as they serve by statutory appointm ent on the Federal Open M arket Com m it tee. They have no allegiance to private business in these m at ters, except as they try to contribute to the attainm ent of high level production and employment, sustainable economic growth, and a stable price level by m onetary means. The report of the CMC goes on to fill out its pattern of the “ public-private category” within the Federal Reserve System with a brief discussion of the Federal Reserve Banks, b u t it quickly adm its th a t “ very tangibly as well as legally the Reserve Banks are public service institutions, and th at their private ‘ownership’ is a highly attenuated right” . In a rather odd “ on the other h an d ” the report goes on to say, however, th a t the salaries of Reserve Bank presidents and their staff salary scales are set at going m arket rates rather than Government levels; the Reserve Bank presidents are not public servants in the usual sense. In my book this is no more th an pandering to confused public ideas about conflict of in terest. The salaries of Federal Reserve Bank officials and staffs are set at going m arket rates so th at the Banks can a t tract the quality of adm inistrators and personnel needed to assure the qualities and services necessary for constructive 180 participation in determ ining monetary policy, and efficient operation, in the com munities in which they live. I would say th at it is fortunate and in the public interest th at they are able to do this, so th a t num bers of capable, com petent men can m ake a career of service in the Federal Reserve System, away from the hazards of political appointm ent, without the support of family or personal wealth, and without engaging in outside activities of any kind to supplem ent their regular compensation. There is no entering wedge for conflict of in terest here. The only specific suggestion which the Commission makes concerning the Federal Reserve Banks is th at the present form of stock ownership of the banks should be retired, and th at m em bership in the System be continued by a non earning certificate of, say, $500, the same for each m em ber bank. This seems to me to be knocking down an already “ a t tenuated” straw m an, insofar as it represents a belief or a suspicion th at somehow private interests have a nefarious in fluence in, or derive special benefits from, the Federal Reserve System. As my previous rem arks have indicated, however, I would be concerned if insistence upon the present form of stock ownership were to be interpreted as supporting such belief or suspicion. I would rath er have the stock subscription changed to a certificate of m em bership than to have any cloud over the character of the Reserve Banks as public institutions. There is one other point here th at is worth m entioning, however. I have referred to the statem ent in the report of the CMC th at a basic issue with respect to the Federal Reserve System is its degree of independence from the banking com m unity which it both serves and regulates. This statem ent tends to confuse the m onetary powers of the Federal Reserve System and its bank supervisory powers. In discharging its duties as a bank supervisor the Federal Reserve System may be a Governm ent agency with an agency-clientele relation ship with the business concerns it both serves and regulates, in the words of the Commission, b u t in the vastly more im portant realm of m onetary policy the Federal Reserve has no agency-clientele relationship with any one but the American people as a whole. If the bank supervisory powers of the 181 Federal Reserve System are the reason for concern about the “ ownership” of the stock of the Federal Reserve Banks by the m em ber banks, consideration should be given to con solidating the regulatory functions of Federal banking authorities outside the Federal Reserve System, as suggested in a footnote by some m em bers of the CMC. The “ regulated private base” of the System (the commercial banking system), in the word pattern of the Commission, is not the base of the System as a m onetary authority. It is the private m onetary m echanism which serves as a channel through which the m onetary actions of the System spread out through the whole community, pervasively but without unnecessary intrusion upon private transactions between citizen and citizen. Now let me close by coming back to the question of the Federal Open M arket Committee, which is by far the most im portant question to which the CMC addressed itself in the section of its report on the structure of the Federal Reserve System. I do not believe th at many of the m em bers of the Commission realized the full im port of what they were doing when, actively or passively, they acquiesced in recom m ending th at the Federal Open M arket Committee be abolished. I have said it is the heart of the Federal Reserve System as it has evolved over the years, and it is. It is the forum where representatives of the constituent parts of the System—the Reserve Board and the Reserve B anks— meet as individuals and equals, bearing identical responsibilities under law to decide questions of high m onetary policy. It is the group within the System which brings to the consideration of policy knowledge of what is going on in Government, in the money m arket, and in commerce, industry, and agriculture throughout the country.4 Its m em bers take back to the Governm ent, to the money m arket, and to the country, an understanding of what has been decided which is an essential ingredient of effective monetary policy. 4 This form of words does not exclude labor or the consumer or any other group within the body economic, although organized labor has ordinarily been suspicious of the Reserve System, and has generally refused to become better acquainted, even when invited to do so. 182 I have said th a t if you remove the presidents of the Federal Reserve Banks from continuous (in the case of New York) or periodic (in the case of the others) participation in this high function you will tear down the spirit and morale of the twelve Banks, and I believe it. The men who are the most capable and imaginative officers of Federal Reserve Banks, and who staff their outstanding economic research depart ments, are not primarily interested in counting coin and cur rency, in sorting checks, and in exam ining m em ber banks. They and their successors won’t be attracted to jobs in which these operating chores are their only direct and prim ary responsibility: jobs in which they are only called upon as con sultants and advisers in m atters of m onetary policy. P a r ticipation in the work of the Federal Open M arket Com m it tee, with authority and responsibility—the right to vote as well as to talk —is what attracts the best men to the chief of fices of the Federal Reserve Banks, and it is this contact which fills their official staffs with a sense of dedication and high purpose. I sincerely hope th at the Congress of the U nited States will never reverse itself on this im portant m atter. I sincerely hope th at it will go forward to complete the ingenious work of the Banking Act of 1935, by combining in law in the Federal Open M arket Committee the com plem entary powers of the Federal Reserve System with respect to open m arket opera tions, rediscount rates, and reserve requirem ents. T hank you for giving me this opportunity to present my views to your committee. Yours faithfully, Allan Sproul 183 Chapter 7 Foreign Aid A M m lla n Sproul was not by background an expert, at least no more th an anyone else, in the field of foreign aid. Nevertheless, in early 1960 he visited Ind ia and P akistan as a m em ber of a three-m an team appointed by the W orld B ank. W ith him were H erm an Abs, C hairm an of the D eutsche B ank of F ran k fu rt, and Sir Oliver F ranks, C hairm an of Lloyds B ank of London. T heir mission was to exam ine the role of foreign aid in the economic developm ent of India and P akistan, and they came to be known as “ The T hree W ise M en” . This chap ter contains a letter he wrote to Alfred Hayes from New D elhi in the m iddle of his trip, an address he delivered to the W orld Af fairs Council shortly after he retu rn ed , and his testim ony in the spring of 1963 before a com m ittee appointed by P resident Kennedy to advise the G overnm ent on foreign aid. On his trip to India he m et with Prim e M inister Jaw aharlal N ehru, and his reactions are of historical interest as well as providing insight with respect to Sproul himself: “ Ind ia has had the good fortune—one m ight say the providential good fo rtu n e—to have as its leader in all of the years since partitio n , M r. N ehru. M any of us have blown hot and cold on M r. N ehru as a result of w hat seemed to be his H am let-like in decision in m atters involved in a world collision of totalitarianism and dem ocracy, and because of w hat we h ad read of his economic views, which seemed to derive a great deal from M arxism . After m eeting with him an d after seeing som ething of his people and country, however, I am willing to accept the ju d g m en t th a t his intelligence and integrity have usually overcome political and economic dogm a. His favorite label for his economic program new seems to be ‘pragm atic’ and, unlike some of his associates, I believe he has dem onstrated his ability to change course when necessary in order to abandon untenable positions. So far as I am concerned, he has perform ed a political m iracle in 185 holding his country together and bringing it along the path of dem ocratic accom plishm ent as far as it has now progressed.” * Sproul’s overall views on the subject of foreign aid were sum m ed up in a letter he wrote on July 6, 1965 to M urray J. Rossant, then of the N ew Y ork T im e s: “ P erhaps the two m yths which need m ost to be dispelled, if we are to move tow ard a b etter public appreciation of the program , are th a t foreign aid is prim arily a hu m an itarian exercise and th a t dollars will do the job in the absence of an adequate organization in this country to adm inister th eir allocation and in the absence of peo ple in the recipient countries who can effectively and usefully m anage th eir expenditure. A .I.D . [Agency for International Developm ent] of ficials have long argued th a t they are spending about as m uch as can properly be spent, while the mushy fringe of the liberal com m unity talks about the niggardliness of spending anything less th an , say, 1 per cent of our GN P. A nd the take-off advocates have sidestepped the fact th a t it is p rim a rily p eople th a t have to ta k e off in th e less developed countries; th a t the shortages have been more hum an than financial. There is significance in the fact th at the Peace Corps is the most imaginative and relatively the most effective thing we have done in this a rea.” * Excerpt from a talk by Sproul before the World Affairs Council, June 23,1960. This excerpt is contained in a part of the talk which is not included as reprinted. 186 Letter to Alfred Hayes A shoka Hotel New Delhi M arch 15, 1960 D ear Al: T hank you for your birthday letter! We had been out of touch on a ja u n t around India and East Pakistan for two weeks, and mail from home was most welcome. This has been an exciting, interesting, strenuous, tiring trip. Fourteen-hour days were not unusual, with frequent plane hops and overnight stops. I have stood up well, however, except for a two-day layover and lie-down in K arachi, where I contracted the “ disease of the east” . Charlie Coombs has been a great help and a good traveling com panion. He too had one brief bout with the abovem entioned ailment, b u t usually has m anaged to come through with nothing more than a tired feeling. O ur col leagues have been pleasant and stim ulating and so have our hosts. The countries we have visited are, as you know, coun tries of almost unbelievable contrasts. We are spending this week in New Delhi, pulling ourselves and our ideas together and we hope to finish up at the weekend. After a stop in London, it looks as if I shall be get ting to New York about the tim e you leave. I am sorry th at this is so, but maybe I shall get in a day or two early and catch a few m inutes with you. T hank you for the press copy of the A nnual Report. It is surprising how quickly one can forget the affairs of a country which have occupied most of his life, when he becomes im m ersed in the affairs of a country such as India. I had almost forgotten net borrowed reserves. W ith best regards, Sincerely, Allan 187 Address delivered before the World Affairs Council, San Francisco, California June 23, 1960 India and Pakistan: Critical Testing Ground o f Foreign A id I am not an expert on India and Pakistan, as anyone with any knowledge of these two countries, uneasy neighbors on the Indian subcontinent, could quickly find out. In fact, after visiting them , I have what I believe is a healthy skepticism of any outsider who thinks he is an expert on countries with such com plicated backgrounds and diverse problems. They do not lend themselves to easy analysis and facile generaliza tion. Nor am I an authority on foreign economic aid to so-called underdeveloped countries. A considerable literature has grown up around this subject, and there has been a lot of sophisticated theorizing about it. But the factual inform ation needed to support the theories is not available and won’t be for a long time, if ever. The one clear fact is th at theory has run quite a bit ahead of practice. Meanwhile, decisions with respect to foreign aid and development are being made large ly on the basis of what appear to be the im m ediate political, military, and economic factors directly involved. Well, if I am not an expert on India and Pakistan, and if I am not an authority on foreign economic aid, you might ask w hat I was doing on the Indian subcontinent last February and M arch, as a m em ber of a three m an bankers’ mission, familiarly known as “ The Three Wise M en” , which attem pt ed to gain some useful impressions concerning the economic progress of the two countries and the contributions of foreign economic aid to th at progress. It is a somewhat involved story, but I shall try to tell it briefly as an illustration of policymaking in this field. It all began in February 1959, when Senator John F. K en nedy, now aspiring to higher office, and Senator Cooper, a form er U nited States A m bassador to India, introduced a resolution in the Senate, recom m ending th at a mission com posed of representatives of the U nited States and other 188 friendly, dem ocratic countries consult with the governments of South Asia on their economic problems. The Senate Com m ittee on Foreign Relations considered the resolution and, in Septem ber 1959, it was passed by the Senate, as am ended.* The resolution stated th at it is the sense of the Congress th at the President of the U nited States should explore with other friendly and dem ocratic countries, and appropriate interna tional organizations, the desirability and feasibility of establishing an international mission to consult with the governments of countries in the area of South Asia on their needs in connection with the fulfillment of currently planned and anticipated development program s, and to consider and recom m end ways and m eans of jointly assisting in the im plem entation of these plans in cooperation with the govern ments of South Asia. This was a pretty tall order. The area of South Asia was th o u g h t of as including In d ia, P ak istan , B urm a, A fghanistan, Nepal, and Ceylon. The friendly democratic nations, besides the U nited States, presum ably included n a tions of the Common M arket in W estern Europe, nations of the British Commonwealth, and donor members of the Colombo Plan, including Japan. Meanwhile, India and Pakistan, the key m embers of the South Asia group, had got ten well into the development of their respective third and second Five Y ear Plans. The conception of a high-powered mission from aid-granting countries, which would be able to “ m ake a deal” with aid-receiving countries in South Asia regarding the size and shape of their development program s and regarding the volume and character of Western aid, ran out of tim e and support. A more m odest idea then began to take shape. It confined the survey of economic problems and progress in South Asia to India and Pakistan; it narrowed down the members of the mission to nationals of three of the principal industrial and aid-granting countries—the U nited Kingdom, W est G er many, and the U nited States—and the mission became a private mission which would neither represent nor be authorized to speak for governments. * A similar resolution was introduced in the House of Represen tatives by Congressman Chester Bowles, another former United States Ambassador to India, but failed to reach a vote because of lack of time before adjournment of the session. 189 There was still some difficulty, however, as to who would take the initiative in appointing the m embers of the mission and arranging for their reception in India and Pakistan. The governments of these countries, I believe, indicated their will ingness to receive such a mission and their unwillingness to request th at it be sent. It was finally decided th at the Presi dent of the International Bank for Reconstruction and Development, M r. Eugene Black, should invite three bankers, one each from the U nited Kingdom, W est G er many, and the U nited States, to visit India and Pakistan in February and M arch of this year. The three governments welcomed M r. Black’s initiative, and the governments of Pakistan and India indicated their willingness to receive the mission as guests of government and to give it every oppor tunity to learn about their economic development program s and their use of foreign aid. T hat is how Mr. H erm an Abs, C hairm an of the Deutsche Bank of F rankfurt, Sir Oliver F ranks, Chairm an of Lloyds Bank Limited of London, and I happened to go to the Indian subcontinent. As missions go, and they go often to such countries as India and Pakistan, we were unique. Since officially we represented nobody, in a sense we represented everybody. In the letter which we wrote to Mr. Black at the conclusion of our visit on M arch 19, 1960, we phrased our assignment in this way: The proposal that we should visit India and Pakistan was sponsored by you, as President o f the International B a n k fo r R econstruction and D evelopm ent, and was w elcom ed by the G overnm ents o f India and Pakistan. We accepted the invitation as independent and private individuals. We received no terms o f reference or in structions either fr o m the International B a n k or fro m the G overnm ents o f our own countries. We have, therefore, had to consider what an independent mission o f this kind, with a lim ited am ount o f tim e at its disposal, could m ost usefully attem pt. You told us that we were not expected to su b m it a fo rm a l report: and, indeed, it would have been im possible fo r us in the 190 course o f a m onth to undertake any detailed assessm ent o f the econom ic situation and developm ent program s o f India and Pakistan. We have concluded that the m ost useful task which we can set ourselves is to try and fo rm broad general im pressions about the problem s o f developm ent in these two countries. In doing so, we have approached the question o f the scale and balanceof-developm ent plans in qualitative rather than q u a n titative term s, and we have tried to see how the k in d o f proposals f o r developm ent which are at p resent under consideration in these two countries f i t into the broad pattern o f w hat has already been achieved. We hope th a t the bundle o f im pressions which we have fo rm e d will help toward the understanding o f som e o f the p ro b lems o f policy which seem to us to confront both the countries which we have visited and those countries and international institutions which are, or m ay be, con cerned with providing fin a n c e fo r developm ent. W hat I have to say, now, will be based on the impressions of this mission, and its advisers, because we each had an ad viser known variously as “ the three wise guys” and the “wise men, second class” and known by us as our good right arms. I shall add to my report on these impressions one or two p er sonal opinions based on my trip but not included in the letter which the mission wrote and signed without individual reser vation or dissent. And let me inject one such opinion right here. The cynical response to the observations of such a mission as ours is th at the Indians and Pakistanis showed us only what they wanted us to see. O f course they showed us what they wanted us to see, and we w anted to see what they thought were favorable examples of their development and their use of foreign aid. You can’t see everything in six weeks, even though your days are filled from early m orning to late at night, seven days a week, as our days were. But you can’t travel about for hu n dreds of miles in the cities and through the villages and farm lands of India and Pakistan w ithout seeing the pitiful condi tion of m ultitudes of hum an beings, the poverty, dirt, and disease, and the primitive methods still in use in agriculture 191 and some industries, which m ake hopes of progress seem alm ost doomed. These things had to be seen—not to be believed. We saw them . Now, in order that you may have some basis for judging my personal views, as well as my report on some of the views of the mission, I should also tell you my general attitude with respect to foreign economic aid. So far as the countries we aid are concerned, I agree with those who say th at the purposes of our aid, broadly, are to develop constructive forces th at will fu rther political and social stability in these countries, to support their military strength, and to enlarge the productive and technical bases of their economies so as to improve the standards of living of their people and thus to dem onstrate th at expectations of a better life can be realized w ithout resort to totalitarian methods. So far as we are concerned, I think th at the prim ary justification for foreign economic aid is our national security which includes survival of our national values—th at we have no moral obligation to raise the standard of living of other nations up to our own. I think th at whatever economic ad vantages we derive from such aid, and I believe there will be such advantages in the long run, are supplem entary. I think th at, if foreign aid coincides with the hum anitarian instincts of our people, th at is fine and contributes to our strength as a nation, but it is not the purpose and province of government continuously to distribute the resources of this country for hum anitarian purposes. Nor do most foreign peoples believe th at governments do things for hum anitarian purposes. As has well been said, “ If we do not reveal a good, solid motive of self-interest, they are apt to invent one for us and this can be more sinister than anything we could even dream of ourselves.” Finally, I do not belong to the school of roving economists and international philanthropists which believes that, if a billion dollars of foreign aid is good, two billion would be twice as good or maybe four times as good. Men are more im portant than money in a foreign-aid program and able and available men are even more scarce than money in both the aid-giving and the aid-receiving countries. You can go badly wrong giving too m uch money to men of too little capacity. 192 W ith th a t testam ent in the record I can get on with my task. Despite the many differences and contrasts between India and Pakistan, there are also im portant economic similarities and I am going to talk first of the two countries, together, in order to keep my rem arks within the confines of your tim e and patience and in order to try to keep the thread of my exposition clear. The basic economic problem of both countries is the short age of capital resources in relation to investment needs. There is the fam iliar vicious circle of low income, low invest m ent, and continuing low income, which can only be broken effectively and in tim e by an inflow of help, of capital, from abroad. And right there you may well ask why this vicious circle m ust be broken by foreigners, and relatively quickly—why Indians and Pakistanis m ust try to ac complish, in say thirty or forty years, what it took us a hu n dred or a hundred and fifty years to accomplish. To this I can only say th at times and circumstances have changed. These people, recently come to independence after a long period of colonialism, with the strident claims of what can be ac com plished quickly by totalitarian m ethods flooding across their borders from Russia and China, are putting democratic or nontotalitarian processes to the test of relatively swift ac com plishm ent in term s of economic progress. They may be trying to go too far too fast, but it would take a curious kind of simplicity, in the face of a most complex political and economic problem , to rely completely on this judgm ent, and to condem n their efforts wholly because of it. Perhaps equally as im portant as the shortage of capital in their economic dilem m a is the sheer size of their economic problem . Not only are the real incomes of the people low but, with a population of 500 million in the two countries, the capital resources required to generate even modest increases in real income are very large. And the problem is made more intractable by the rate of population growth. The govern m ents are confronted with the task of trying to provide the additional food and services required by increases in popula tion in the order of 2 percent per annum , while at the same tim e struggling to bring about an increase in per capita in come. 193 It is the size of the task, as well as the need for swift ac com plishm ent, which has m ade it more of a government undertaking, involving a larger degree of economic planning than we m ight think desirable. But here it is fair to say, I think, th at there is a definite purpose in Pakistan to have as m uch business as possible take place in the private sector; and in India there seems to be a growing realization th at both the public and the private sectors of the economy have their proper contribution to m ake to economic progress, and that a doctrinaire socialist approach is not the way to the economic heavens. . . . Most of us know something of the handicaps of the Indian nation in achieving economic progress. The religious taboos— it is a commonplace th at at least one third and perhaps one half of the cattle in India are surplus in relation to the feed supply. The caste system which still survives. The persistent elements of feudalism. The linguistic nationalism or regionalism. The illiteracy. The disease. The pitiless climate which saps energy. The cultural emphasis on im m aterial things. The live-and-let-live philosophy which can mean an unhealthy tolerance of inefficiency and corruption. There are countervailing assets, however, if we are going to do double-entry bookkeeping. India has probably m uch the best adm inistrative organization for political, economic, and social development of any nation in Asia outside the RussoChinese bloc, except Japan. It has geographic unity and agricultural diversity. It has a relatively homogeneous governing class, both in power and in opposition, giving it a workable parliam entary system. Its people will work hard and have a shrewd common sense in most m atters not af fected by religious scruples. It is technically the most ad vanced country in Asia next to Japan, and possibly China. In the long run, it should be able to become a m ajor m anufac turing country, supplying industrial goods and equipm ent to Asia and Africa, and even farther afield. I cannot give you an unequivocal answer to this problem in relativity, in justifiable self-interest, and in chances of suc cess, nor do I think, can anyone else. The m argins of error are great. The likely existence of items of lesser urgency in 194 any such development program as th at of India suggests strongly the possibility of trim m ing down the need for foreign aid. The requirem ents of prudence, because of possible bad harvests or faulty industrial planning and the thin layer of m anagerial talent, suggests th at there may be smaller ag gregate development plans which would provide sustainable progress. O r it may be th at, for bargaining purposes and en couraged by the advice of some of the more enthusiastic plan ners from this country, the Indians have projected a larger figure of foreign aid than they expect to realize in their Third Year Plan. W hen you have said and weighed all this however, you will still be faced with a value judgm ent. Given the key position of India in the whole Asian-African complex, and recognizing the inevitable comparisons which will be made between the economic progress of a democratic India and a totalitarian China, my own judgm ent is th at the course followed by the 400 million people of India will have direct and indirect repercussions on the security of the U nited States. T hat is why I have come to the opinion that the risks and hazards of investing heavily in Indian develop m ent are justified, and for equivalent reasons in Pakistan also. We have been doing just th at, and I do not know th at the increased size of India’s T hird Five Y ear Plan and P akistan’s Second Five Y ear Plan would require an increase in the am ount of foreign economic aid extended by the U nited States. The tim e has come when other industrial nations of the Free W orld can and should participate more heavily in this investment, and there are indications th at this is being recognized and given effect. In this case I also welcome the assistance which the Russians and some of their satellites are giving to India. I do not think th at such assistance will outweigh, in the aggregate, the aid given by the free nations, and I do not think it will sway the political development of India, one way or the other, but it will share the burden and the risk of India’s need for foreign assistance. It is my guess, and it can be nothing more, th at there will be no left turns in India if dem ocratic processes and program s can, within some reasonable period of time, bring about a modest increase in the standard of living of the Indian people. Left turns have always been unpopular in Pakistan, of course. 195 There should be no m istaking, however, th at our program of aid to India, and Pakistan too, is a project of long term as well as huge size. W e have all heard a great deal about socalled “ take-off points” in countries such as India and Pakistan; the theoretical concept that, if enough investment funds are poured into a country over a relatively short period of time, self-sustaining growth will develop and eliminate the need for further foreign aid. I have doubts about the prac tical application of this whole concept, and I am certain that we would be fooling ourselves if we approached the develop m ent problem s of India—and of Pakistan— in term s of a M arshall Plan designed to reach certain targets of viability and self-sustaining growth within a fixed period of years. The simple fact th at per capita income in both countries is so low will almost inevitably m ean th at development will be a slow laborious process probably extending many years into the future. As in other facets of the contest between communism and democracy, we should be girding ourselves for a pro tracted conflict, not expecting to win quickly like the “ good guys” in a television western. A necessary ingredient of a successful attack on these longrange problem s, I think, is th at as a nation and as individuals we should understand th at it will require sacrifices to achieve our objectives. This year, 1960, would be a good year to try to achieve th at understanding. We shall be choosing our na tional leaders and our national legislators for another elec tion period. We should be dem anding leaders and legislators who will dare to tell us th at great achievement may dem and great sacrifices. So far I have not detected the clear sound of this note in the cam paign oratory and literature. Instead there is a good deal of juggling with figures of na tional production and income, apparently intended to con vince us th at our rate of economic growth can be readily in creased so th at there will be plenty of available resources with which to do everything we might want to do at home and abroad, without anybody having to give up anything. Mil itary needs and domestic civilian needs will be met handily out of the same ever-normal treasury. Foreign economic aid will be increased, while the current deficit in our balance of 196 payments will wither away without check to our habits of conspicuous consum ption. Such a prospectus is a fraud in the face of bitter and protracted conflict which lies ahead with those who talk peaceful coexistence while they seek to destroy us. A provocative writer on these m atters, B arbara W ard, has written that: “ W estern economies cannot make a fetish of a 3 percent rate of growth if real, demonstrable hum an needs call for a higher rate; and there seems little doubt such needs exist.” The implications of such statem ents as this, for most of those seeking political office, seems to be th at an increase in our rate of economic growth is what is needed and possi ble, in order th at we may be spared the necessity of m aking hard choices in attacking our current economic problems. This is not a m atter of fetishes, however, but of what the National Bureau of Economic Research calls a respect for facts. We know something about our past rate of economic growth, and something about the present rate, and our knowledge does not encourage too sanguine hopes of an early and substantial increase. We do not know anything about our future rate of economic growth, although there is no lack of fancy as to what the potential rate could be. We may be able to do better than we have done in the past, and we hope we shall, but it won’t be easy and it won’t be quick. M eanwhile, if we are going to continue to m aintain our military security, increase the resources we devote to socially desirable objectives at home, provide foreign aid in the m agnitudes which can be effectively adm inistered, and preserve our international solvency and our domestic stabili ty, we shall have to postpone some of our ideas of increased leisure, and curb some of our desire for an ever-increasing volume of consum er goods and services, in favor of our longer term goals. From what I know, and have seen and heard, I would counsel m aking such sacrifices in order to do our share in aiding the economic development of India and Pakistan. 197 Aide-memoire on foreign aid prepared as background for testimony before the Committee to Strengthen the Security of the Free World, headed by General Lucius Clay, and appointed by President Kennedy on December 10, 1962. A note transmitting the document to Alfred Hayes is dated April 19, 1963. I realize th at foreign aid policy is a “ complex com bination of military, political and economic measures which m ust be com plem entary and reinforcing” , and th at it cannot be treated fully in a brief m em orandum . I realize th at the President recently appointed a new chief of the A .I.D ., who seems to have excellent qualifications for the job, and th at the A .I.D . has been working on a plan which would concentrate our aid in fewer places, with greater operating efficiency and more com petent personnel. I realize th at your committee is composed of men with a special range of experience in these m atters and special means of determ ining “ whether the level and distribution of the foreign aid program is contributing to the security of the U nited States, and is directed to specific and attainable goals of economic and political stability in the Free W orld” . Nevertheless, it has seemed to me th at the views of an in dividual who has a general knowledge of what has been done and what is now being done m ight be of help to you, p ar ticularly as you may be concerned with foreign economic aid insofar as it can be separated from military aid. At least I suf fer from no restraints of appointm ent in expressing my opin ions. My questions about our foreign aid policies go well beyond the adm inistration of the foreign aid program , susceptible as its adm inistration has been to a variety of organizational and executive changes over the past fifteen years which might well have disrupted a more substantially based operation. It has seemed to me th at our present policies have suffered from our first success, from a faulty em phasis on the virtues of economic development of backw ard countries as a shield against com m unism and a contribution to our military 198 defenses, from the mixing of vague moral and hum anitarian motives with the vital interests of the U nited States, and from our inability to explain clearly to the Congress and to the public exactly what we are doing, what we have done, and why. O ur first foreign aid success was the M arshall Plan, which contributed so m uch to the rebuilding of the w ar-shattered economies of W estern Europe. T hat success offered no guide to subsequent program s, unless it was a misleading one. The economies of the nations we were then helping were a p art of the social fabric of countries with stable political institutions, and their economic systems were m anned by people with m anagerial talent and technical skills equivalent to our own. And, most im portant, their values and their aspirations were m uch the same as ours. But the public image of foreign aid has continued to be distorted by the success of the M arshall Plan; by the belief that, given certain efforts at social reform and self-help by the recipient countries, injections of capital (and technical assistance) from abroad will put backw ard countries on the road in a relatively short time (say the ten years of the Alliance for Progress) to a viable economic ex istence. This false guide was supported by the political use of p a r tially hedged theories concerning so-called take-off points in the economic development of nations. It is only recently th at there has come to be some public criticism, by people who have been exposed to the practical problems of foreign aid, of those persuasively presented views. W hat was om itted in the popular version of the theory was th at economic take-off depends, fundam entally, on peoples’ values—what they want, and the m eans of getting what they want in accordance with their capacities, their traditions, their religious beliefs, and their moral codes, if any. Capital and technology are now being dem oted to the bottom of the list of basic needs for economic development and growth, being preceded by general literacy, a reliable ap paratus of government and public adm inistration, a clear development of objectives toward which the mass of the people is willing to work, and pride in the attainm ents necessary to reach those objectives. Admittedly, the values of whole peoples are not easy to deter 199 mine and, over time, they may be modified, but to attem pt to impose our values on a variety of foreign cultures smacks of im pertinence and is doomed to failure. (It rivals and draws sustenance from the missionary spirit which conceives of the Jewish-Christian ethic as the only revealed religion.) Even if preoccupation with the capital needs of people in the underdeveloped countries is not an invitation to failure, the philosophical idea th at foreign economic aid will yield desirable results in term s of freedom, stability, democracy, and peace has a shaky foundation. The dynamics of in dustrial development, and the movement of peoples from villages to cities which it entails, create tensions and ferm ent (somewhat as it did in W estern Europe and the U nited K ingdom during the industrial revolution). The revolu tionary progeny of these tensions and ferm ents may take on the wrong coloration. Leaders in new nations, or those who overthrow governing groups in older but underdeveloped na tions, usually gain much of their popular support by oppos ing foreign influence and foreign dom ination, call it Yankee im perialism , or neo-colonialism, or whatever. If they haven’t the ability or the m eans to m ake good the im provement in the lot of the people, which they have also prom ised in their revolutionary phase, and if anti-foreign attacks begin to lose their power, they usually try to hold on by force and by deny ing those freedoms and those forms of democracy which they formerly espoused. This sort of thing is likely to lead to endemic political and economic instability. O ur existing pro gram s have been exposed to and have not shown much ability to deal with this sequence of events. The vague moral and hum anitarian motives, which have confused past aid policies, have ranged from the presidential dictum in his inaugural address th at rich nations should help poor nations “ because it is right” , to the advice of a host of official and unofficial advisers th at one of the two most im m ediate problem s of worldwide scope facing m odern m an is the disparity between the “ have” and the “ have not” nations, and th at we “ need the challenge of world development to im prove the quality of our national life” . (A m bassador Steven son m ight have said this although I don’t know th at he did.) A bout these noble sentim ents there can certainly be two 200 points of view, depending somewhat on whether you believe th at we m ust still rely on the nation state to bond masses of people under civil discipline, or whether you think the nation state is becoming obsolete, th at we should be leading the way to the millenium of the world state, and th at we can move in th at direction by shuffling off some of the problems of foreign aid to world organizations. My own view is th at we m ust still get along, largely, with the nation state. The government of a nation state, in order to “ do good” abroad, has to do most of it directly or in a consortium with other nation states, and has to find th at what it proposes to do serves the interests of the state itself in term s of security or trade or something more specific than “ improving the quality of the national life” . Meanwhile the advice of, say, a B arbara W ard th at devoting 1 percent of the national product to foreign aid is lit tle enough to do, or of, say, an Oliver Franks th at the north ern hemisphere should now do for the southern hemisphere what the eastern hem isphere (northern branch) did for the western hem isphere in the nineteenth century is of little use or relevance. The first generalization is like saying th at if we spent less on chewing gum we could spend more on education and health—it dodges the question of how choice is to be ex ercised in a democracy. The second generalization avoids the fact th at the success of the injection of European capital into the northern p art of the western hem isphere was due to the virtual exterm ination of the native population and its replacem ent by Europeans. In the southern part of the western hem isphere, where the native population was assim ilated, or vice versa, the problem of underdevelopm ent is still with us after four centuries and the outlook for democracy and stability is still uncertain. Nor can clothing this sort of vague aspiration in the cloak of “ enlightened self-interest” get us out of our difficulties of precision in defining objectives, devising means of attaining them , and establishing criteria for cutting off aid when a t tainm ent becomes unlikely. Taking the simplest argum ent in support of self-interest, it is said th at in building up the economies of the underdeveloped countries we are creating wider world m arkets and thus widening of the range of our 201 own economic development. This can only be true if in creases in population do not equal or outrun increases in pro duction in the backw ard areas. There is no present evidence th at this will be the case in many of them . Birth control “ in volves the whole adult population of a country and dem ands forethought and directed will power” . It is “ unlikely to be carried out successfully in the countries th at need it most urgently” . I realize th at this catalogue of faults of our foreign aid pro gram is largely based on subjective reasoning, and I realize th at we could not (and I would not) abandon our foreign aid efforts. I do think, however, th at it is past time for us to sub ject the program to a more vigorous exam ination as to its fundam ental premises than it has had thus far, so th at we can begin modifying it in substance in the light of the find ings of such an exam ination. This is what I hope your com m ittee has in m ind. My own suggestions are: (1) T hat we recognize th at we are not going m ateri ally to better the lot of millions of people in the underdeveloped countries over the next few decades—it is a long-term process at best. (2) T hat the im portant question for us is not whether the Congress appropriates $4.9 billion or some lesser figure for foreign aid in a given year, but whether we can put together a program which has sufficiently clear and definite objectives and sufficient chances of a m oderate success, so th at it will com m and the vigorous support of the public and the Congress. Here I realize th a t the power of the central government has come to depend, to a considerable extent, on appeals to the people by the President couched in lofty term s and con sisting of unsupported generalizations, but it seems clear th a t the effectiveness of this approach is wearing out in the case of foreign aid appropriations (or your com m ittee would probably not exist). (3) T h at such a program , geared to a tim e factor of the rest of the century, say, instead of a decade, and taking more account of the values of the peoples of dif- 202 ferent countries and less of theories of economic tak e off based on our own values, will shift the emphasis from aid dollars of which we have a lot, to com petent people in this country and in the recipient countries, of which there are not too many. An A .I.D . organization, conceived in these term s, should be developed on a career basis. W e would give up the idea of trying to do it in a relatively few years with tem porary or borrowed personnel. And, in my opinion, it should be an organization with autonomy, directly under the Presi dent, and coordinating its affairs with the State D epartm ent and Defense and Treasury as they now coordinate with one another. (4) T h at it is neither possible nor desirable to develop an d service such a program effectively when it covers upw ard of 100 countries. This is an invita tion to random decisions on a shotgun basis aim ing at a vague general target. A nd it is likely to result in a lot of foreign governm ents being encouraged to u n d ertak e tasks beyond their capabilities, which leads to w aste through incom petence and to an extension and tightening of governm ent authority over the in dividual. W h at is needed, I would say, is a clearer definition of objectives, a clearer understanding of the m eans and the chances of attaining them , and a culling out of the countries which are receiving aid. T he priorities should be d eterm ined on the basis of selecting countries where the stakes are high, where the scale of our real interests is great, and where the chances of aid being used effectively are moderately good (India for example). In the case of these coun tries, we should aid them with whatever it takes, within their capacity to absorb aid, and not niggle about the degree of their alignm ent with us. (I find it hard to justify the am ounts of economic aid we have been ex tending to Korea, Form osa, V ietnam, Laos, Turkey, and Spain, quite apart from military aid, and I think in some cases it may have been a disservice to them .) (5) If anything could be done, at this late date, to pull the President back from his hasty alliance with the 203 Alliance for Progress, it would be a blessing. It has such a slim chance of success overall in the ten years allotted th at it is becoming a weight in the whole foreign aid program and a symbol of failure. Yet, we do not seem to have any interm ediate objectives to insert in place of those which have begun to dem onstrate a lack of validity. (6) If it appears, on exam ination, th at our failures have been failures of a concept of foreign aid based on faulty generalizations and inapplicable expressions of high moral purpose, th at we do not blam e such failures on not having done enough, or not having done it effec tively, or not having been firm enough in dealing with recipients, or not having the right sort of organization. T hat is the way a program which contains some good and had some hope has become a near casualty. As it stands, our foreign aid program is reminiscent of G reat B ritain’s first embassy to China by Lord M acartney in 1793-94. The British government w anted to remove the restrictions to which trade with China was subject and to establish a perm anent embassy in Peking. The mission ac complished neither of these ends. Lord M acartney was taken to be an envoy bearing tribute and was sent home with a message from Em peror Chiien Lung to George III: “ We have never valued ingenious articles, nor do we have the slightest need of your country’s m anufactures. . . .You, O King, should simply act in conformity with our wishes by strengthening your loyalty and swearing perpetual obedience so as to ensure th at your country may share the blessings of peace.” 204 Chapter 8 International Financial Problems F M ro m his earliest days at the Federal Reserve Bank of New York, where his first assignm ent was in the foreign departm ent, Allan Sproul was intrigued by the intricacies of international finance. By all accounts he was m ore interested in the international im plications and ram ifica tions of m onetary policy, especially the interrelations between dom estic and international policies, th an in any other aspect of central banking. In light of th a t interest, frequently expressed in private, it m ight be considered surprising th a t he did not write m ore about international m atters for public consum ption during his years as head of the New York B ank. However, during th a t period—with the war, the peg, the Accord, and then the “ bills only” controversy— serious thinking about international financial problem s necessarily had to give way to more im m ediate concerns. If he had rem ained at the B ank beyond 1956, it is likely he would have had m ore to say publicly on the subject. As it was, it becam e a m ajor topic in his personal correspondence and in his talks to the W ells Fargo B oard of D irectors. T he first of his papers reprinted in this chapter is an address he delivered to the annual convention of the A m erican B ankers Associa tion in 1949, entitled “ G old, M onetary M anagem ent, and the B anking System ” . It a ttracted wide attention at the tim e, mostly favorable, but also provoked a p am phlet entitled “ Sproul Ignores Common H onesty” th a t he enjoyed m aking reference to for years thereafter. The 1949 address to the A m erican B ankers A ssociation is followed by three talks delivered to the Board of D irectors of the W ells Fargo B ank, one in 1975 and two in 1977. The last of these, in m id-N ovem ber 1977, was delivered only m onths before he died, on April 9, 1978, at the age of eighty-two. 205 In th a t talk he sounded a note th a t he h ad expressed on a num ber of occasions: “ Sum m it m eetings and m eetings of finance m inisters from R angoon to R am bouillet, and pronouncem ents of the IM F, have ex horted the nations to coordinate their dom estic economic policies with their in ternational econom ic responsibilities. The overall result has been a surplus of com m uniques and not m uch concrete action. Now, in its own defense, the U nited States should take the lead in seeking a con tribution to the solution of this general problem . It will have to bring about a m ajor im provem ent in its own international position, and in the strength of the dollar which is still the center of the w orld’s m onetary m achinery. It will have to quit dragging its feet and get on with the business of adopting an effective energy policy. . . .we shall have to move quickly and decisively to adopt an energy policy which will begin the process of curtailing the enorm ous volume and value of our oil and gas im ports. There are grave dom estic questions involved in existing energy proposals. B ut so far as the balance of paym ents is concerned the evidence is unam biguous and clear. The bargains and com prom ises m ust be struck. Tim e is running o u t.” 206 Address to the Seventy-fifth Annual Convention of the American Bankers Association San Francisco, California, November 2, 1949 Gold, Monetary Management, and the Banking System As a native Californian— and a native San Franciscan— I have tried to think of som ething I might discuss which would be of special interest to our generous hosts at this convention. The fact th a t this is 1949, and th a t the whole State of Califor nia has been engaged in a two-year round of celebrations of the 100th anniversary of the discovery of gold in California, and of its im m ediate consequences, gave me an obvious lead. Gold is something in which we are all interested. Nor is this an untim ely topic on other grounds. The recent wave of cur rency devaluations which swept around the world, following upon the devaluation of the British pound sterling six weeks ago, has fanned into modest flame the always smouldering fires of the gold controversy. In addition, I was eager to review the gold question because it is a good starting point for an understanding of the place of the Federal Reserve System in the m onetary and economic life of the country. As central bankers, of course, charged with responsibility for our m onetary and credit policies, we have the question of gold under more or less constant surveillance. Most of the tim e, in recent years, we have been under attack from two sides because of our attitude tow ard gold. Those interested prim arily or initially in the price of gold, and in what they call a free gold m arket, have fired from one side. Those interested prim arily and eternally in gold coin convertibility—in a full and autom atic gold standard domestically and interna tionally—have fired from the other. More recently, we have h ad a brief respite from attack while these two groups fired at each other, each group arrogating to itself responsibility for the only true gospel according to St. M idas. W hat I have to say will probably bring th at brief respite to an end. The fire will again be concentrated on the m onetary authorities, for whom I cannot presum e to speak except as one individual engaged in the practice of central banking, but who will, no doubt, be blam ed for my views. 207 Let me take account of each of these two groups separate ly; those who concentrate, at least initially, on a free gold m arket, and those who will have none of this heresy, b u t who w ant a fixed and im m utable gold price and convertibility of currency—and therefore of bank deposits—into gold coin. The first group, which includes the gold miners, makes its argum ent on several grounds, trying to combine economics and psychology with self-interest. Let me paraphrase their principal argum ents as presented at hearings on bills to per mit free trading in gold in the U nited States and its ter ritories. In this way I may avoid the fact as well as the ap pearance of building straw opponents. The argum ents most frequently presented in favor of these bills were: 208 (1) In the face of rising production costs and fixed selling prices, the gold mining industry has been forced to curtail its operations, and to the extent th at it has operated, its profits have been reduced. The higher gold prices which would presum ably prevail in a free m arket would correct this situation. This is the “ do something for the gold m iners” argum ent at its baldest. W hen this argum ent is em broidered a little, it is claimed th at, since the prices of all goods and services have increased so substantially during the past ten or fifteen years, it is necessary to open the way for an in crease in the price of gold so as to be sure there will be enough gold to carry on the country’s business; to bring the price of gold into adjustm ent with the prices of everything else. (2) A second group of argum ents expresses concern over the unsettling effects of the “ prem ium ” prices which are paid for gold abroad, and claims th at a free gold m arket in the U nited States, with no gold export restrictions, would cause these prem ium m arkets abroad to disappear, with beneficial effects upon world trade and international relations. (3) T hird, there is an argum ent in equity—th at gold miners should be allowed to sell their product at the best price they can obtain, as do producers of other products; and th at American citizens, like the citizens of most other countries, should be free to hold or to buy and sell gold. (4) Finally, there were those who viewed and favored a free gold m arket as a first step in the direction of a full gold coin standard, and who held th at even a free m arket would act as a “fever ch art” of the economy and lead to reform of extravagant Government fiscal policies, remove inflationary tendencies fostered by a m anaged currency, and lead to sounder conditions, generally. To take these argum ents up in order, it should be pointed out right away th at it is quite possible th at a free m arket for gold in the U nited States would not result in a rise in the price of gold, if for no other reason than th at the Secretary of the Treasury is required, by law, to m aintain all forms of U nited States money at parity with the gold dollar which con tains y3 of an ounce of fine gold. This means th at the 5 Treasury should m aintain the price of gold at $35 a fine ounce in legal gold m arkets in the U nited States. To do this, if there were a legal free m arket for fine gold, the Treasury should sell gold to the extent necessary to maintain the m arket price at $35 a fine ounce. We might, therefore, get what would be in effect gold convertibility by way of a free m arket, but not a rise in the price of gold. Aside from this possible outcome of the establishm ent of a free m arket for gold, what is it we are being asked to do? In effect we are being asked to do something to benefit the gold mining industry, to encourage a shift of productive resources, in this and other countries, into gold production, in order to provide gold for hoarding. This, I subm it, would be a witless proceeding, in term s of the welfare of the whole economy, m atched only by our bonanza provisions for the special benefit of the miners of silver. As for the economic embroidery of this request for aid to the gold m ining industry, there is no lack of monetary means of carrying on the business of the country, nor is there likely to be. It is the economics of perpetual inflation to argue th at a rise in the commodity price level should be followed by an arbitrary increase in the price of gold and hence in the reserve base, thus perm itting and perhaps prom oting additional deposit expansion and a further upw ard movement of prices. Even on the basis of statistics, which are not always reliable or com parable, it is interesting to note th at the increase in the 209 price of gold in the U nited States, in 1934, raised the price of gold by 69 percent, whereas wholesale prices in the U nited States are now only 60 percent above the 1927-29 level. We have been plagued, if anything, with an oversupply of money in recent years, and the U nited States gold stock, at the pres ent price, is large enough to support whatever further growth of the money supply may be needed for years ahead. The second group of argum ents has to do with the desirability of knocking out of business the prem ium m arkets in gold which have existed and still exist in various foreign countries. I share the general dislike of these m arkets because they are parasites on the world’s monetary system and help to siphon into gold hoards the resources of people who need food and clothing and equipm ent— and who w ouldn’t need so m uch help from us if they didn’t use scarce foreign exchange to buy gold for private hoards. But I don’t think the soundness nor the stability of the U nited States dollar is actually brought into question by these prem ium m arkets. At our official purchase price for gold—$35 a fine ounce—the U nited States has been offered and has acquired more gold than the total world production (excepting the U .S .S .R . for which reliable data on gold production, as on everything else, are not available), since 1934, the year of our devaluation. D uring those years— 1934 to 1948 in clusive—estim ated world gold production, valued at U nited States prices, was about $13.5 billion and U nited States gold stocks increased $16 billion. Most of the producers and holders of gold have been quite willing to sell us gold for $35 a fine ounce despite the quotations of $45 and $55 and so on up in the prem ium m arkets. The fact is th at these prem ium m arkets represent insignificant speculative adventures around the fringe of the world supply and dem and for gold. They reflect mainly the urgent and often illegal dem ands of a small group of hoarders, together with some private dem and for gold to be used in relatively backw ard areas, or areas where the forms of civilized government have broken down, and where the m etal serves the needs of exchange—or hoard in g - b e tte r th an a paper note. I do not think there would be any appreciable stim ulus to U nited States gold production, if we opened the doors of this largely clandestine trade to our 210 domestic gold miners. But, by legalizing it, we m ight well create what we are trying to destroy—uncertainty about the stability of the dollar and our own intentions with respect to its gold content. The third argum ent—th at the m iners of gold should be free to sell their product at the best price they can get— is probably the giveaway. It is the argum ent th at gold should be treated as a commodity when you think you can get a higher price for it, and as a m onetary metal and an international m edium of exchange when you want a floor placed under its price. I would say th a t you can’t have it both ways. If you want the protection of an assured m arket at a fixed price, because gold is the m onetary m etal of the country, you should not ask permission to endanger the stability of the m onetary standard by selling gold at fluctuating prices (the gold producers hope higher prices) in a fringe free m arket. U nder present conditions, the only real price for gold is the price the U nited States Treasury is prepared to pay for it. So long as th a t is the case, there is no sense in a “ m ake believe” free gold m arket, in which possible tem porary or short-run deviations from the fixed price of the Treasury m ight have disturbing consequences. Nor is the argum ent th a t citizens of the U nited States should have the same privileges as the citizens of other coun tries, when it comes to holding or trading in gold, at all con vincing to me. It is true th a t in a num ber of foreign countries the holding of gold by private citizens is legal, and in some foreign countries strictly internal free trading in gold is per m itted. In m any cases, however, this merely represents the shifting around of a certain am ount of gold which is already being hoarded in the country, since in practically all these countries the export and im port of gold on private account is either prohibited or subject to license. And, in m any coun tries where gold is produced, some percentage, if not all, of the newly m ined gold m ust be sold to the m onetary authorities, a requirem ent which fu rther limits the am ounts available for trading and hoarding. These restricted and cir cum scribed privileges in other countries are no reflection of a loss of inalienable rights by our people. They are attem pts by these foreign countries to adjust their rules with respect to 211 gold to their own self-interest and, so far as possible, to the habits of their people, all under the sheltering um brella of a world gold m arket and a world gold price m aintained by the Treasury of the U nited States. We have deemed it wise to m aintain such a fixed point of reference in a disordered world. W e have decided by dem ocratic processes and by Con gressional action th at this policy requires, among other things, th at gold should not be available for private use in this country, other than for legitimate industrial, professional, or artistic purposes. We have decided th at the place for gold is in the m onetary reserves of the country, as a backing for our money supply (currency and dem and deposits of banks), and as a m eans of adjusting international balances, not in the pockets or the hoards of the people. If we want to reverse th at decision, the means of reversal are at hand, but it should be a clear-cut and clean-cut reversal, restoring convertibility. Pro viding a dependent free gold m arket, in which gold miners and a little gold group of speculative traders or frightened gold hoarders (such as those who now take advantage of a provision in the regulations to buy and sell “ gold in the natural state” ) could carry on their business is not the way to m eet the problem . I do not propose to get in the cross fire of those who claim th at a free gold m arket would be a step toward convertibility and those who claim th at a free gold m arket, without free coinage at a fixed price, would cause us to lose whatever m odicum of a gold standard we now have and lead to m onetary chaos. T h at is one of those doctrinal argum ents in which the subject abounds. I will merely say here th at I think authorization of a free gold m arket in this country, with no change in the present responsibility of the Secretary of the Treasury to m aintain all forms of money coined or issued by the U nited States at parity with the “ gold dollar” , would probably lead indirectly to convertibility. The desirability of doing this is another m atter, which I shall now try to discuss briefly and dispassionately. This is a hazardous attem pt because there is no subject in the field of money and banking which so arouses the passions, and which so readily defies b rief analysis. 212 Two groups of argum ents for the reestablishm ent of a gold coin standard may, perhaps, be distinguished in the writings and speeches of those who propose it, one group relating prim arily to the domestic economy and one to the probable effects on international trade and finance. In the first group the argum ents run about as follows: (1) Replacem ent of our “ dishonest” , inconvertible currency with an “ honest” money having intrinsic value would prom ote confidence in the currency and en courage savings, investment, long-time comm itm ents, and production. (2) Irredeem able paper money leads to inflation, whereas the upper limits imposed upon currency and credit expansion by a thoroughgoing gold standard serve as a restraining influence on irresponsible politi cians and overoptimistic businessmen. (3) Present Governmental taxing and spending policies are wrong, and dangerous. The gold standard would put a brake on public spending. (4) As a corollary of the preceding argum ent, since the gold standard would hinder further extension of Governm ent control and planning, it is a necessary im plem ent of hum an liberty. The second group of argum ents, relating to the interna tional advantages of a gold coin standard, generally makes no distinction between the effects of a unilateral adoption of such a standard by the U nited States, and the m ultilateral establishm ent of an unrestricted gold standard by many countries, and of exchange rates fixed by such a standard. The argum ents run somewhat as follows: (1) The existence of prem ium m arkets in gold abroad and the lack of gold convertibility at home creates—and is representative of—lack of confidence in the gold value of the dollar. In the absence of a thoroughgoing gold coin standard, we cannot convince anyone th at we may not devalue the dollar. (2) Restoration of “ norm al” patterns of interna tional trade is being retarded by the inconvertibility of currencies in term s of gold and, therefore, one with another. This inconvertibility has led to tariffs, quotas, exchange controls, and to general bilateralism . 213 (3) U nder a m anaged paper currency system there is always the tem ptation to solve national problem s by devices which lead to international disequilibrium . This, in tu rn , has led to domestic devices restrictive of foreign trade. The international gold standard, by elim inating the need for restrictive commercial policy, would increase the physical volume of international trade, resulting in an improved division of labor and higher standards of living for everyone. First, let me say th at I perceive no moral problem involved in this question of gold convertibility. Money is a convenience devised by m an to facilitate his economic life. It is a standard of value and a m edium of exchange. Almost anything will serve as money so long as it is generally acceptable. M any things have served as money over the centuries, gold perhaps longest of all because of its relative scarcity and its intrinsic beauty. In this country we still retain some attachm ent to gold domestically, and more internationally, but to carry on our internal business we use a paper money (and bank deposit accounts) which has the suprem e attribute of general acceptability. There is no widespread fear of the soundness of the dollar in this country, no widespread flight from money into things. The constant cry of wolf by a few has aroused no great public response. Savings, investment, long-term com m itm ents, and the production and exchange of goods have gone forward at record levels. M uch of the nostalgia for gold convertibility is based, I believe, on fragrant memories of a state of affairs which was a special historical case, a state of affairs which no longer ex ists. The great period of gold convertibility in the world was from 1819 to 1914. It drew its support from the position which G reat Britain occupied, during most of the nineteenth century and the early p art of the twentieth century, in the field of international production, trade, and finance. The gold coin standard flourished because the organization of world trade under British leadership provided the conditions in which it could, with a few notable aberrations, work reasonably well. The ability of the British to sustain, to provide a focal point for, this system has been declining for m any years, however, and the decline was hastened by two world wars which 214 sapped the resources of the British people. The heir apparent of G reat Britain, of course, was the U nited States, but up to now we have not been able to assume the throne and play the role. A nd until some way has been found to eliminate the lack of balance between our economy and th at of the rest of the world, other th an by gifts and grants-in-aid, we won’t be able to do so. This is a problem of unraveling and correcting the influences in international trade and finance, which have compelled worldwide suspension of gold convertibility, not vice versa. The job before us now is to attack the problems of trade and finance directly. W e should not deceive ourselves by thinking th a t gold convertibility, in some indefinable but inexorable way, could solve these underlying problems for us. Nor is it true, of course, th at gold convertibility prevented wide swings in the purchasing power of the dollar, even when we had convertibility. W ithin my own experience and yours, while we still had a gold coin standard, we had trem endous movements in commodity prices, up and down, which were the other side of changes in the purchasing power of the dollar. W hat happened to us in 1920-21 and 1931-33 under a gold coin standard should prevent a too easy acceptance of th at standard as the answer to the problem of a money with stable purchasing power. W hen you boil it all down, however, and try to eliminate mythology from the discussion, the principal argum ent for restoring the circulation of gold coin in this country seems to be distrust of the money m anagers and of the fiscal policies of Governm ent. The impelling desire is for something auto m atic and impersonal which will curb Government spending and throw the money m anagers out of the temple, as were the money changers before them . To overcome the inherent weakness of hum an beings confronted with the necessity of m aking hard decisions, the gold coin standard is offered as an im p erso n al an d a u to m a tic solution. T h ro u g h this m echanism the public is to regain control over Govern m ent spending and bank credit expansion. It is claimed th at whenever the public sensed dangerous developments, the reaction of many individuals would be to dem and gold in ex change for their currency or their bank deposits. W ith the 215 monetary reserve being depleted in this way, the Government would be restrained from deficit financing through drawing upon new bank credit; banks would become reluctant to ex p and credit to their customers because of the drain on their reserves; and the Federal Reserve System would be given a signal to exert a restraining influence upon the money sup ply. In this way, the Congress, the Treasury, and the Federal Reserve System would be forced by indirection to accept policies which they would not otherwise adopt. In effect, u nder a gold coin stan d ard , therefore, the in itiative for overall monetary control would, through the device of free public withdrawal of gold from the monetary reserve, be lodged in the instinctive or speculative reactions of the people. No doubt some people would take advantage of their ability to get gold. There would be many reasons for their doing so. Conscientious resistance to large Government spending, or fear of inflation, might well be among these reasons. But speculative motives, a desire for hoards (however motivated), and such panic reactions as are generated by unsettled international conditions or tem porary fright concerning the business outlook or one’s individual security—all of these, and m ore—would be among the reasons for gold withdrawals. The gold coin m echanism does not distinguish am ong motives. W henever, for any reason, there was a dem and for gold, the reserve base of the m onetary system would be reduced. Moreover, if only the U nited States dollar were convertible into gold while prac tically all other currencies were not, hoarding dem ands from all over the world would tend to converge upon this country’s m onetary reserves. Circumvention of the exchange controls of other countries would be stim ulated, and dollar supplies which those countries badly need for essential supplies or for development purposes would be diverted to the selfish in terests of hoarders. Even if a particular reduction of the reserve base did occur for useful “ disciplinary” reasons, the im pact of such gold withdrawals upon the credit m echanism is likely to be crude and harsh. Since the present ratio between gold reserves and the money supply is about one to five, and since some such ratio will be in effect so long as this country retains a frac 216 tional reserve banking system, a withdrawal of gold coins (once any free gold is exhausted) will tend to be multiplied many times in its contractive effect on bank credit and the money supply. In a business recession, the Reserve System might undertake to offset this effect as it does now in the case of gold exports but, if the gold withdrawals attained suffi cient volume, the shrinking reserve position of the Federal Reserve Banks would eventually prevent them from coming to the rescue. It was, in part, to offset such arbitrary and extreme in fluences upon the volume of credit, and to m ake up for the inflexibility of a money supply based on gold coins (in responding to the fluctuating seasonal, regional, and growth requirem ents of the economy), th at the Federal Reserve System was initially established. D uring the first two decades of its existence, the System devoted m uch of its attention to offsetting the capricious or exaggerated effects of the gold movements associated with continuance of a gold coin stan dard. We had an em barrassing practical experience with gold coin convertibility as recently as 1933, when lines of peo ple finally storm ed the Federal Reserve Banks seeking gold, and our whole banking m echanism came to a dead stop. The gold coin standard was abandoned, an international gold bullion standard adopted, because repeated experience has shown th at internal convertibility of the currency, at best, was no longer exerting a stabilizing influence on the economy and, at worst, was perverse in its effects. Discipline is necessary in these m atters b u t it should be the discipline of com petent and responsible men; not the autom atic discipline of a harsh and perverse m echanism . If you are not willing to trust men with the m anagem ent of money, history has proved th at you will not get protection from a m echanical control. Ignorant, weak, or irresponsible men will pervert th at which is already perverse. Here, I would emphasize my view th at the integrity of our money does not depend on domestic gold convertibility. It depends upon the great productive power of the A merican economy and the competence with which we m anage our fiscal and monetary affairs. I suggest th at anyone who is wor ried about the dollar concentrate on the correction of those 217 tendencies in our economic and political life which have brought us a deficit of several billion dollars in our Federal budget, at a tim e when taxes are high and production, employment, and income are near record levels. I suggest that, going beyond the im m ediate situation, they address themselves to the difficult problem of the size of the budget, w hether in deficit or surplus or balance. At some point the mere size of the budget, in relation to national product, can destroy incentives throughout the whole community, a dilem ma which is even now forcing curtailm ent of Governm ent ex penditures by the Labor governm ent in G reat Britain. These are problem s gold coin convertibility cannot solve under pres ent economic and social conditions. Gold has a useful p u r pose to serve, chiefly as a medium for balancing international accounts am ong nations and as a guide to necessary disciplines in international trade and finance. It has no useful purpose to serve in the pockets or hoards of the people. To expose our gold reserves to the drains of speculative and hoarding dem ands at home and abroad strikes me as both unwise and im provident. Perhaps before I let go of this subject, which has held me and you overlong, I should say a word about merely raising the price of gold, without doing anything about a free gold m arket or gold coin convertibility of the currency. This is something which has intrigued Europeans and others who are “ short of dollars’’, has interested some of our own people, and has become a South African war cry. An increase in the price the U nited States pays for gold would have two major results. It would provide the gold producing countries (and domestic producers), and the countries which have sizable gold reserves or private hoards, with additional windfall dollars with which to purchase American goods. And it would provide the basis for a manifold expansion of credit in this country which m ight be highly inflationary. We have been engaged in an unprecedented program of foreign aid for the past four years. The Congress has authorized this aid at such times and in such am ounts as were deemed to be in the interest of the U nited States. This is m uch to be preferred, I suggest, to the haphazard aid which would be granted by an increase in the price of Rold, which 218 m ust be on the basis of a more or less accidental distribution of existing gold stocks and gold producing capacity. If we raised the price of gold, every country which holds gold would autom atically receive an increase in the num ber of dollars available to it. The largest increases would go to the largest holders which are the Soviet Union, Switzerland, and the U nited Kingdom . Every country which produces gold would autom atically receive an annual increase in its dollar supply, and its gold m ining industry would be stim ulated to greater productive effort. The largest increases would go to the largest producers which are South Africa, Canada, and prob ably the Soviet Union. T hat would be an indiscrim inate way to extend our aid to foreign countries, both as to direction and as to timing. The domestic results of an increase in the price of gold would be no less haphazard. This country, as I have said, is not now suffering from a shortage of money and it has large gold reserves, which could form the basis of an additional money supply if we needed it. An increase in the dollar price of gold would increase the dollar value of our existing gold reserves in direct proportion to the change in price. There would be an im m ediate “ profit” to the Treasury. The “ profit” could be spent by Congressional direction or Treasury discretion. This would provide the basis for a m ulti ple expansion of bank credit which, unless offset by ap propriate Federal Reserve action, would expose our economy to the threat of an excessive expansion of the domestic money supply. The arbitrary creation of more dollars in this way would certainly be inappropriate under inflationary condi tions, and would be an ineffective method of com bating a deflationary situation. At the m om ent, also, we should have in m ind th at there has just been an almost worldwide devaluation of currencies. Using the fixed dollar as a fulcrum , individual foreign coun tries have taken action designed to improve their competitive position vis-a-vis the U nited States, and to m aintain their competitive position vis-a-vis one another. An increase in the dollar price of gold, which is devaluation of the dollar by another nam e, would undo the possible benefits of a venture in improved currency relationships which already has its doubtful aspects. 219 For all of these reasons it is encouraging to know th at the Secretary of the Treasury has recently reiterated th at the gold policy of the U nited States is directed prim arily toward m ain taining a stable relationship between gold and the dollar, and th at for all practical purposes only the Congress can change th at relationship. W e have m aintained an international gold bullion standard by buying and selling gold freely at a fixed price of $35 a fine ounce in transactions with foreign govern ments and central banks for all legitimate monetary p u r poses. This has been one fixed point in a world of shifting gold and currency relationships. W e should keep it th at way as another contribution to international recovery and domestic stability. 220 Remarks of Allan Sproul at the Board of Directors Meeting, Wells Fargo Bank, San Francisco, California, August 19, 1975 Having exhausted, at least tem porarily and at least so far as I am concerned, the possible variations in treatm ent of a domestic economic situation which is struggling out of the rough and on to the fairway, I have assumed the task of bringing together some of the threads which m ake up the present pattern of the international m onetary situation. The international monetary system given form by the Bretton Woods Agreements of 1945, and based on convertible currencies at fixed parities and on the pedim ent of a reserve currency, the U nited States dollar, which was also the prin cipal transactions currency of the world, served rem arkably well for about a quarter of a century in term s of meeting the needs of expanding world trade and commerce. But developments am ong the nations in a growing m ultinational and interdependent world probed the weak spots of the system, so th at instead of building up stability over the years it moved toward instability and finally lost credibility. The necessary appearance of simple, effective perform ance, which causes people to think they know how the system works and to have faith in its workings, was lost in a series of financial crises which had to be patched up with ad hoc measures. The final breakdow n of the system was precipitated in A ugust 1971, when the U nited States announced th at it was no longer willing to buy and sell gold, freely, from and to foreign m onetary authorities, the linchpin of the system. Subsequent attem pts to prop up the Bretton W oods ar rangem ents failed and, by early 1973, most of the countries of the world h ad abandoned fixed rates, the U nited States dollar h ad been devalued for the second time in fourteen months, and the world was awash on a sea of “ m anaged” floating currencies. Meanwhile, in view of the obvious deterioration of the old arrangem ents, the International M onetary Fund, or IM F, in Septem ber 1972 had set up a Committee on the 221 Reform of the International M onetary System, the so-called Comm ittee of Twenty. It represented all of the 126 constit uent m em ber states of the IM F at the technical level. Its assignm ent was to consolidate earlier work on the problems which had developed and to design, as had been done at Bretton W oods, a new structure of international monetary cooperation, a task which was expected to take about two years to complete. But the situation had so changed since Bretton Woods, and was continuing to change, and the war-engendered spirit of international cooperation of 1945 was so diluted, th at the Committee had to adm it in June 1974 th at events—including a worldwide inflation, large and fitful international capital flows, the lack of a dom inant currency such as the U nited States dollar formerly had been, and the sudden increase in oil prices with a consequent distortion of the whole interna tional balance-of-paym ents netw ork—had overtaken its deliberations. It decided th at reform of the international m onetary system in the existing situation would have to be a m atter of evolution under political as well as technical economic guidance. Having m ade this decision the Committee of Twenty fold ed up its papers, presented its recom m endations for im m ediate action on certain subsidiary m atters to the Executive D irectors of the IM F, and adopted a final report containing an outline of longer term principles of international monetary behavior to be subm itted to the Board of Governors of the IM F at its annual meeting in Septem ber 1974. The Com m it tee of Twenty then ceased to exist. The various actions or recom m endations of the Committee subsequently adopted, or approved for further consideration, by the appropriate bodies of the IM F are too num erous and detailed to recount here, nor is it necessary to recite them all in order to appreciate the difficulties which a technical com mittee, such as the Committee of Twenty, found it impossible to surm ount. They had to be passed on for ministerial con sideration by finance ministers and such, who could take ac count of the political as well as the economic aspects of this whole exercise in political economy. 222 Two or three of the proposals for im m ediate action can be m entioned, however, to carry the story forward. They are: (1) T h at an Interim Com m ittee of the Board of Governors of the IM F, m ade up of m inisterial m em bers of the B oard, should be established to advise the Board with regard to the m anagem ent and a d a p tation of the international m onetary system through the present troubled tim es, and until a perm anent and representative Council of Governors with decision m aking powers can be brought into being by am end m ent of the Articles of A greem ent of the Fund. This would be, in essence, an executive com m ittee of the Board of Governors which would meet several tim es a year between the annual m eetings of the full board. A necessary adm inistrative im provem ent. (2) T h at guidelines be set forth for the m anage m ent of floating exchange rates since the Fund, under the present articles of agreem ent, cannot legally prom ulgate and enforce rules for this purpose. The guidelines, which were later approved by the IM F, are based on the assum ption th a t in a situation of floating exchange rates it may be desirable (a) to smooth out very short fluctuations in m arket rates, (b) to offer a m easure of resistance to m arket tendencies in the slightly longer run when they are leading to unduly rapid movem ents in the rate, and (c) to the extent possible to form a reasonable estim ate of the m edium term norm for a country’s exchange rate, and to resist m ovements in m arket rates th a t appear to be deviating substantially from th a t norm . But the guidelines also take into account th a t national policies, including those relatin g to dom estic stabilization, should not be subjected to greater con straints th an are clearly necessary in the international interest. A nd if th a t sounds like a lawyer or an econom ist or a spokesm an following a Sum m it Con ference kicking up a lot of dust to obscure a lack of content, it is. 223 (3) T h at the m ethod of establishing the value of special draw ing rights which can be created by the IM F (in order to increase international liquidity in m uch the same way th at national governm ents or cen tral banks create dom estic reserves) be changed from a direct link with the U nited States dollar and, through it with gold, to a link with a basket of c u rren cies of sixteen countries th a t have a substantial share in the w orld’s export of goods and services. This change, which has been m ade, resulted in a partial divorce of special draw ing rights, an international reserve unit, from the U nited States dollar which had become an unsteady reference point. The Board of Governors of the IM F at its meeting in Septem ber 1974, formally established the Interim Committee of Governors, recom m ended by the Committee of Twenty, to pick up where the Twenty left off. For the rest, the Board took note of the finding of the Committee of Twenty th at it will be some tim e before a reform ed international monetary system can be agreed upon and established, and endorsed the Com m ittee’s proposal that, in the interim , the F und and its m em ber states should pursue the general objectives and observe the general principles outlined by the Committee. These objectives and principles envisage a reformed inter national m onetary system which will include: (1) An effective and sym m etrical adjustm ent pro cess, including a better functioning of the exchange rate regime based on stable b u t adjustable par values, b u t with floating rates recognized as providing a useful technique in p articu lar situations. A neat straddle of a sticky point; (2) Cooperation in dealing with disequilibrating capital flows. A pious hope; (3) The introduction of an appropriate form of con vertibility for the settlem ent of im balances am ong the countries of the world, which m eans allowing as m uch freedom as possible for individual countries to choose the composition of their reserves, whether gold, special drawing rights, or reserve currencies such as the United States dollar; 224 (4) An obligation laid upon all countries, both those in surplus and those in deficit in their paym ents balances, to assure effective and timely paym ents a d justm ents. A nother pious hope; (5) Better international m anagem ent of global li quidity, with special drawing rights becom ing the principal reserve asset, the role of gold and reserve currencies being reduced, and the official price of gold being abolished. A tough nut still uncracked. In term s of the bright hopes or, perhaps, the enforced show of confidence in finding early solutions of difficult prob lems, when official reform of the international monetary system was first undertaken in 1972, this catalogue of frustration might be said to be where we came in. T hat, of course, would not be wholly fair. The ground work for a sec ond phase of discussion and negotiation at the m inisterial or politico-economic level has been put in place by the technical committee, and some of the underbrush surrounding the more im portant issues has been cleared out. Nevertheless, the difficulties in the way of reaching acceptable solutions, or compromises, of the hard-core m ajor problems which are at the center of our international monetary difficulties cannot be minimized. Too many vital concerns of individual nations and groups of nations are involved, motives of self-interest and self-protection are strong, and the leadership of the more powerful nations in prom oting international cooperation is at a low ebb. To sum m arize: The most intractable issues which still will face the annual meeting of the Board of Governors of the In ternational M onetary Fund in W ashington next m onth are: (1) Finding an international adjustm ent process with respect to balances of paym ents of individual countries, and gaining acceptance of the joint respon sibility of all countries for the correction of im balances, both countries whose paym ents are in surplus and countries whose paym ents are in deficit, while preserving the independence of each nation to conduct its dom estic economic affairs w ithout in ter national constraint. 225 (2) Deciding the question of whether stable b u t a d justable p ar values or floating rates for national cu r rencies are to be the system norm . The hopes th at floating rates would provide an autom atic or m arket solution of the adjustm ent problem have not been realized in practice. T heir ap p arent success in avoiding periodic m onetary crises during the past two years has derived more from an overlay of continuing all-em bracing crisis rath er th an from their inherent contribution to stability. (3) M anaging the problem of international liquidi ty, including the volume of such liquidity and its com position as between gold, special drawing rights, and national currency reserves, which includes the im m ediate problem of shrinking the trem endous in crease in international reserves during the recent years which contributed to a worldwide inflation. Essentially these are the same problems which brought down the Bretton Woods Agreements and which the Interna tional M onetary Fu n d set out to correct in 1972. A bicycle theory of m onetary reform appears to have emerged from these deliberations. We have avoided falling flat, but the em phasis so far has been on staying erect; the bicycle h a sn ’t really been going anywhere. This may be the correct posture in the present disordered state of world economic affairs, and it appears to be the posture which has been publicly assum ed by our government. Nevertheless I would like to see the bicycle discreetly devel oping some forw ard m otion, and I think the U nited States, W est G erm any, and Japan (with possibly the U nited K ing dom and France) should now take the lead in bringing this about. These three (or five) nations have the financial, trading, and industrial muscle and the developed financial m arkets necessary to form the core of any new or reformed international m onetary system. Their approach at this stage could be low-key, as was the case before Bretton W oods when com petent senior officials of the U nited States and the U nited Kingdom were quietly and more or less informally assigned the task of developing plans which later were placed before the wider world community for consideration. I do not think it wise or prudent to rely wholly on evolution to do the job for us. 226 Excerpts from the remarks of Allan Sproul at the Board of Directors Meetings, Wells Fargo Bank, San Francisco, California, August 16, 1977 Beneath the welter of economic statistics which are published alm ost weekly, reflecting various developments in the national and international business and credit situations with varying degrees of accuracy, at least two m ajor problems have thus far defied the solvents of m arket forces and the m inistrations of governments. O n the domestic front we are still groping to find a way between the dangers of inflation and the dangers of unem ploym ent. These two economic scourges, which in earlier and simpler times were supposed to be antithetical, have now been in cohabitation for several years, and we have yet to find a remedy for their behavior, a remedy which is socially, politically, and economically acceptable. Both the rate of inflation and the rate of unem ployment in the U nited States rem ain at historically high and disturbing levels. Internationally, we do not have a m onetary system which will respond quickly and adequately to the inevitable ups and downs of international trade and capital movements, while m aintaining a degree of exchange stability which is necessary for the most effective accommodation of world trade, and the m aking of sound com m itm ents in real term s to move finan cial capital or to m ake direct investments outside one’s own country. Floating exchange rates have not proved to be a panacea in a world of nation states in which wide disparities of national econom ic perform ance exist and persist. . . . The utopian international m onetary system would consist of a single world money, and a world central bank which would provide the necessary liquidity to accommodate the growth of world trade, and would act as a lender of last resort in the case of individual countries facing tem porarily severe b u t not necessarily fatal economic strains. The infringem ents of national sovereignty which such a system might involve, and the interference with national economic and social pro gram s with which its requirem ents m ight conflict, provide assurance th at the emergence of such a system is impossible in the present world of nation states. 227 We have always had to get along with m uch less. In the nineteenth century the British were the dom inant factor in world trade and finance, and the Bank of E ngland more or less m anaged the so-called gold and gold exchange standards of international m onetary intercourse. This system disap peared between the two world wars, with the decline of British influence and power in world trade and finance. In the im m ediate post-W orld W ar II period, the U nited States and the U nited States dollar partially assum ed the privileges and burdens of this hegemony, but the U nited States tired of the role when it was deemed to be working against our na tional interests in the early 1970s and shucked it. The nearest thing we now have to an international a r biter— an institutional apparatus which can try to balance the scales between national policies of price stability and m axim um employment, and the international need for com petitive trade expansion, reasonably stable exchanges, and interlocking credit and capital m arkets (including the Eurocurrency and bond m arkets)— is the International M onetary Fund. But th at organization, somewhat like the U nited Nations, is beset by an organizational structure which, in deference to the power of the great industrial coun tries and the “ dem ocratic” dem ands of the less powerful, less developed countries, is enm eshed in a variety of veto provi sions which practically deprive it of the attributes needed for its m ajor tasks. Veto power on im portant actions has been given to the U nited States, to the E uropean Economic Com munity, to the O rganization of the Petroleum Exporting Countries, and to the “ Committee of 77” which now num bers about 140 lesser countries. This is a recipe for diffu sion of authority and responsibility which is almost fatal. W hat we are left with, in term s of an international m onetary system, are periodic meetings of the finance ministers of the principal countries, and periodic statem ents of intent to keep their countries in phase so far as economic growth and price stability are concerned, and to keep the values of their currencies in some sort of equilibrium . Such international good intentions falter, however, in the face of disparate economic perform ances of the various coun tries, widening foreign trade and current account deficits and 228 surpluses, and substantial fluctuations in currency values. There follows debate as to who should take action to defend the shaky structure, i.e., should it be West Germany and Japan and other countries with large trade surpluses and strong currencies or should it be the U nited States and other countries with large trade deficits and relatively weaker cur rencies. M eanwhile nontariff im port and export restrictions for protectionist purposes proliferate, leading to losses in in ternational efficiency and economic well-being. This is economic retrogression on a world basis. My own opinion is that, eventually, the international m onetary system will have to move back toward a regime of fixed rates, or strongly m anaged rates which approxim ate fixed rates, in a world which apart from the com m unist states is more and more becoming one large international economic entity. In such a development the U nited States, as the largest trading nation and the largest capital m arket, should play a leading part, and the U nited States dollar which is still the principal transactions currency of the world and the prin cipal reserve currency of much of the world should have a leading role. “ Benign neglect” of the exchange value of the dollar, which the U nited States Treasury still seems to espouse from time to tim e, is not a tenable policy. 229 Remarks of Allan Sproul at the Board of Directors Meeting, Wells Fargo Bank, San Francisco, California, November 15, 1977 The domestic economy is in partial disarray, a situation which is disturbing b u t not fatal. It is in disarray politically and it is in disarray economically, rem inding us th at our field of concern is political economy, not just economics in a text book sense. Politically, too many difficult and contentious problems have been heaped by the President on a Congress conditioned by years of feuding with the executive branch of government. This has m eant th a t the first nine m onths of our first ad m inistration in eight years, in which the two branches of government have been controlled by the same political party, have been spent more largely in Byzantine m aneuvering of Congressional committees than in bringing to passage im por ta n t measures dealing with urgent economic problems. The energy problem , and the tax changes needed to put new life into the ongoing recovery from the 1974-75 recession, have been left dangling. H arried by a m ixture of contending political and economic forces, and with the persistent problems of unem ploym ent and inflation still inflicting social and economic costs on business and consumers, the underlying strength of the domestic economy is overlaid with a fog of uncertainty. And th a t is where I am going to leave it, in the hope th a t during the next few m onths the fog will lift and the future will become less obscure. Meanwhile our international economic position is plagued with its own uncertainties. It is misleading, of course, to separate sharply our foreign and our domestic affairs. They intermingle with and react on one another in a m ultitude of ways. But, for purposes of exam ination, it is possible to focus on certain international aspects of our trading and financial situation so th at we can look more closely at m atters which recently have forced themselves on our attention. I am refer ring to the large deficit in our trading accounts with the rest of the world and to the signs of incipient weakness of the dollar in the foreign exchange m arkets. 230 Balance-of-payments statistics are tricky. The various com ponents of the total balance react on one another in a variety of ways at different times and in different cir cumstances, and detailed interpretation of the figures is an arcane accom plishm ent of specialists, which I am not. Even the conception itself--a double-entry system of international bookkeeping, in which assets an d liabilities m ust balance—has its weaknesses as a reflection of the real world. Nevertheless the figures do offer guides to opinion and to policy. The m ain em phasis, recently, has been on the develop m ent of a massive deficit in our balance of trade during the past nine m onths, which it is now estim ated will be $25 billion or more during the calendar year. A more significant figure, perhaps, is our balance of paym ents on current ac count which, in addition to trade, includes net revenues on services, m ilitary transactions, and investment income from abroad. Together, a favorable balance on these latter items may offset about h alf our deficit on trade, but the deficit thus reduced will still be of record and disturbing proportions. The figure needed to offset the rem aining half of the trade deficit—th at is to balance the books—is an inflow of foreign capital, including some long-term funds, but probably con sisting to a large extent of short-term funds seeking employ m ent in our broad financial m arkets, while serving as tran s action balances and reserves of the countries of origin and their nationals. This is in part, of course, our contribution to the process of recycling the petrodollars continuing to pile up on the books of the OPEC countries. The OPEC surplus with the rest of the world is estim ated at $37 billion this year, and is expected to continue at about this annual rate for sometime ahead. For our m arkets to help recycle some of these funds is constructive, but to become too largely in volved in the process is dangerous. This im balance is the m onetary face of the energy crisis and is at the core of our balance-of-payments problem. It bears seed which could sprout into serious international 231 m onetary instability. At worst, it could degenerate into per sistent weakness of the dollar, creating the kind of monetary crisis which developed in the late 1960s when other nations (and their nationals and some of our nationals) developed a growing reluctance to add to or even m aintain their dollar holdings. On th at occasion the movement finally led to the complete breakdown of the existing international monetary arrangem ents. Floating or freely flexible exchange rates, according to their more fervent advocates, were supposed to correct such m aladjustm ents in the future by bringing about equilibrating m ovem ents of trad e and capital between nations. They were to be the lubricant of the international adjustm ent process. But the exchange rate flexibility of the past four years does not seem to have played much of a role in reducing external im balances. These im balances have been dom inated by other factors. This is not surprising. The difficulties of the international adjustm ent process have always been at the center of weakness of international m onetary arrangem ents. Politically and economically such adjustm ents collide with domestic realities. They impinge upon national rates of economic growth, of inflation, of employment and unemployment; they impinge on the survival of critical national export and im port interests; and they foster trade and speculative responses to disparate national monetary and fiscal policies. National governments have been unable or unwilling, or both, to sur render their prerogatives in these m atters wholly to the foreign exchange m arkets. Summit meetings and meetings of finance ministers from Rangoon to R am bouillet, and pronouncem ents of the IM F, have exhorted the nations to coordinate their domestic economic policies with their international economic respon sibilities. The overall result has been a surplus of com m uni ques and not much concrete action. Now, in its own defense, the United States should take the lead in seeking a contribution to a solution of this general problem . It will have to bring about a major improvement in its own international position, and in the strength of the 232 dollar which is still the center of the world’s m onetary m achinery. It will have to quit dragging its feet and get on with the business of adopting an effective energy policy. The need for such a policy has existed for four long years, at least, since the A rab oil em bargo and the subsequent in crease in OPEC oil prices from $2.53 to $13.25 a barrel in 1973, and nothing equal to the task has been accomplished. United States net imports of fuels during 1977 have been running at an annual rate of about $40 billion, and this is by far the biggest cause of our overall trade deficit. O ur record of response to the problem has been the worst of the principal in dustrial countries. Since 1973, oil consumption in the United States has increased substantially while consumption in other principal industrial countries such as the United Kingdom, Germany, France, Italy, and Japan has decreased by effective amounts in term s of need. To get some real mileage in reversing present trends in our balance of paym ents, and in preventing further weakness of the dollar, fu rther disturbances in the international monetary system, and further slippage of the world into restrictive trade practices, we shall have to move quickly and decisively to adopt an energy policy which will begin the process of cur tailing the enorm ous volume and value of our oil and gas im ports. There are grave domestic questions involved in existing energy proposals. But so far as the balance of payments is con cerned the evidence is unam biguous and clear. The bargains and compromises m ust be struck. Time is running out. 233