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• .... ~" ·- :;.q · ::.,~ ;' .,../:-:a C 1 Ii ·'' .18RARV: • • REil!iAR.KS OF ALLAN SPROUL, PRESI:OENT, FEDERAL R~SERVE BANK OF NEFv YORK, BBFORE THE NElv YORK STATE CHAf.JillER. OF COMMERCE TiilJRSDJ\Y, JUNE 12, 191.,.7 . SEP 2 8 1M Last lfa.rch you had the pleasure of hearing a talk, 11 Too Much Honey, 11 by your former president, Thomas Parkinson. Some of the newspapers, in reporting the talk, gave it a little more spice, even though it was already pretty hot in spots, and presented it in a way which caused me to ask ·Peter Grimm for a copy of Mr . Parkinson's remarks, Your president, sensing a debate, I think, asked me if I wouldn't talk to you on the same subject. I don't want to debate with j\Jir. Parkinson, -- but I was much interested in his address. He ably set forth a point of view which, I suspect, is shared by many others; and I think it may be helpful to present to you rrw views of the problem of II too much money, 11 so that you may see wherein we agree and wherein we disagree . The burden of Nr . P~rkinson' s argument was , if I mar take the risk of summarizing: 1. There has been a tremendous increase in the money supply during and since the war, and the present supply of money bears no proper relation to the volume of production and business. 2. This has been and still is the most important inflationary influence in our economic situation -- it presses prices upward ., and is the reason for the increased cost of living and the resultant demands for wage increases. J. The principal reason for the disproportionate increase in the money supply has been commercial bank purchases of Government securities -- funds used to finance the destruction of war, not the production of goods for peacetime consumption. (Mr. Parkinson indulged in a little hyperbole when he said this was precisely liko counterfeit money -- fiat money, perhaps, but surely not counterfeit money.) 4. The supply of money will have to be reduced, or at l east prevented from increasing further, if its inflationary effects are to be avoided. This can be done in only two ways - 1;.)y achieving a surplus in the Federal budget and paying off debt, or by refinancing ban.l<-held debt with longer term bonds and a higher coupon attractive to permanent non-bank investors. 5. To accomplish this, astute, skillful, patriotic, far- seeing management of the credit supply is needed. This is the job of the Federal Reserve System, but the Federal Reserve System is not doing its job because it has fallen under the control -0f the Treasury. The redundant money supply forces prices up and interest rates down, and the maintenance of lmv- interest rates especially for Government oblj_gations is the heart of whatever financial policy there is in the administration of the Federal Reserve System today, https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ~ • 2 6. This matter is of so much importance to all citizGns that the time has come .for a _re-examination of the whole -vmrking of our Federal Reserve System by a monetary commission or some similar committee, created by the Congress to do the same sort of job as was done by the National I·.Ionetary Commission which evolved the Federal Resorve System in 1913, · I don ' t believe I have done violence to .rJr . Parkinson's views -- certainly not consciously -- and I think his bill of particulars reads very -rrell as I have set it down. Why, then_. do I take up your time and my ov-m :i.n going over the same ground? On1y ·bf,cause there were certain simplifications i.n his remarks which seemed to me to obs cure rather than to cl9-rify, because there were certain inferences or implications which I cannot accept, because I do not agree with pa.Ft of his solution of our immediate problem, ~nd because I think it important that these matters be clearly understood by the business corrnnunity. 1 I have another reason, also . It seoms to mo that it is time that vm neighbors of Liberty Street were getting a littlo better acquainted . _ A few weeks ago I read in the papet 1 that the Chamber had declared that. Regulation W, which relates to consumer credit, had outlived its us efulness and should be eliminated. The F'ederal Res8rve System, includ:ing the Federal Reserve Bank of New York, administers Regulation Wand yet, so far as I know, no one from the Chamber "talked with us about the rogulation and heard our point of view· . At about the same time, I read that a committee of .the Chamber is considering the quGstion of a return to the gold standard. That is a pretty complex question and we central bankers have given it quite a bit of attention -- it might be useful to consult us as well as the gold miners . I am moved to suggest that if your committees which are concerned vd.th monetary and credit problems care to talk with us at any time, they will find good neighbors a.t 33 Liberty Street. Now let me address myself to the points of Mr, Parkinson ' s indictment of present monetary and credit policy . I share fully hjs concern about our overgrown money supply . It is an actual and a potential menace . Despite the possibility of a decline, or a recession, or a mild readjustment in business this year we still have an explosive situation on our hands . The public 1 s holdings of money -- currency and deposits -- are at the hi1hest point on r~cord in relation to the gross national product, and the velocity of these funds is still low_. It may well be that we haven ' t yet seen the last of the monetary co sequences of the war. This swollen money supply did not come into existence, however, solely or even p:rimarily because of the .failures of particular men in pa!.!ticular positions o.f resp onsibility during the wa:r years, Expam'lion of the money supply, given our kind of economic system, is an inevitable result of war . No country, anct · certainly not ours, was ready,willing, and able to .finance its recent war expenditures without an increase in the money supply -- without some borrowing from the banks . Despite increases in tax rates which seemed pretty burdensome, only a little more than li0% of our Government ' s wartime expenditures was met out of tax revenues. Of the remaining 60%, borrowings from non-bank investors accounted for 32%, and borrowing from banks, including savings banks, to 28%.. Maybe we could have increased taxes further; but there comes a point where you run the risk of gross inequities and impaired: productive effort . Probably we should have sold more Governrnent securities to non--bank investors; certainly some aspects of vmr-drive financing contributed to the large bank purchases of Government securities. But within the realm of practical possibilities , the overall picture at the end of the war wouldn ' t have been greatly different. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis • I • 3 If you Hant to place the primary blame for our now having ntoo much money, 11 plac;e it on war, If you w-ant to be sure it will ncvor happen again,_ abolish war. It is also true- that this great volume of monoy -- of purchasing power is an important inflationary influence in our economic situation. But the relationship betvmc.m the quantity of money and prices is not so direct and causal as is often implied. The volume of production of goods and services and the velocity of money are important parts o,f the equation. If the volume of money unrestrainedly expressed its elf in terms of a s·tatic volume of production, vm should indeed be in a mess. Bu..t the expansion of output nas the outstanding economic f oature of tho Yfar, ctnd the view is vr:i.dely hold among students of money, in other countries as /woll as ours, that the wartime monetary expansion vras an essential contr:Lbuting factor in th -:~ expansion of production. For our present relative well•being> we must give credit also to the horse sense of that part of the Ame-rican public which has preferred, in some measure, to maintain idle balances rather than to engage in a spending spree which could only bid up prices. We must hope that this good sense will continue to prevail until rising peacetime production•~ rising production per unit of capital equipment and per man hour comes to help redress the balance and to bGgin to offset our snollen money supply. 1 I have already indicated the extent of my agreement 1v:Lth Mr . Parkinson's statement, in so far as it relates to the war period, that the principal reason for our excessive money supply has been commercial bank buying of Government seeurities. It remains for me to take up what has been happening since. Thero was a furth~r increase jn the total of currency outstanding and of bank deposits belonging to the public during 1946, although the rate. of increase was considerably below that of the war years. The significant fact is, hmvevcr, that this postwar incr0ase was not due to bank buying of Government securities, During the first months of 1946 there was-, to be sure, a further "monetization" of the public debt through bank purchases of Government securities from non-bank investors. For the year as a ·v.rhole, however, such transactj.ons had little net effect on the money supply. Bank purchases of Treasury bonds were offset by sales of short-term securi tie·s by the banks to non-bank investors. Tho principal factor in the grovrth of the money supply during the past year was the rapid increase in hank loans other than loans on securities. Business loans increased by an amount greater than in any previous year, and ther o were also substantial increases in consumer loans and loans on real estate, In so far as thes·e loans were necessary to finance expansion of peacetime production, which is essential to a better balance botvrnen the supply of and demand for goods , they were desirable, even though they di d result in a .further increase in the money supply. It m:i.ght be argued, however, that the increase in the money supply due to business and commercial l ending in 1946 could have been offset, or more than offset, if we were really intent on avoiding the inflationary effects of an excessive money supply inherited from our war financing. That would encompass Mr. Parkinson's next point~• the necessity for reducing or at least preventing a further increase in the money supply. To accomplish this, tw0 methods were suggested: (1) achieving a surplus in the Federal budget and paying off debt; (2) refinancmg bank-held debt with longer term bonds and a higher cou,pon at• tractive to permanent non-bank investors,· In effect, that is just what was done, so that evidently it is the speed of the operation or the method of its accomplishment which is called into question, I think that most of us realized that the first problem of mpnetary https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis . . • 4 • and credit policy in 1946 was to try to keep the enormous supply ~f purchasing powBr , which had been created during the war, from increasing further in undesirable ways which would accentuate inflationary pressures . During the year three restraints were put upon the banks by means of credit policy, debt management, and talk - what has been referred to as an open mouth operation as distinguished from an open market operation. In April and May the Federal Reserve Banks eliminated the preferential discount rate of 1/2 of 1 per cent on borrowing collateraled by Government securities maturing within one year, so that all borrowing thereafter was at the regular discount rate of 1 per cent. That was a small move in itself 1 but larger in its implications. It carried the very important implica:tion that the pressure for easj_er credit and lower interest rates was ' off. Vfo were left, hovvever, with a commitment to support the 7 /8 per cent rate on certificates of indebtedness, which tied our hands with respect to any increase in short-term interest rates and, more important, left the availabilit7 of Federal Reserve credit largely to be determined by our member banks. Despite this handicap, the volume of Federal Reserve credit outstanding was reduced by approximately $1 billion during the year -- the principal offset being a decline of $900 million in the excess reserves of member banks. The admitted gap in our defenses was partially plugged by debt management. During the last ten months of 1946 and the first five months of 1947, the Treasury redeemed a substantial amount ($29.9 billion) of its outstanding market securities, ·first out of balances accumulated during the Victory Loan in December 1945 and, this year, out of budget surpluses. The debt retirement program exerted recurrent pressure on the reserve positions of member banks, as it involved the withdrawal of funds from these banks to redeem securities held by the Federal Reserve Banks. These periodic squeezes on the reserve positions of member banks tendGd to limit their ability or, rather, restrain their eagerness, . to make further purchases of Government securities or to extend credit in other ways. Even such a program can be overdone, however. I should not want to continue a program involving net cash receipts, by the TreasuryJ at the rate of :jp6 billion each three months, as was the case during the first quarter of 1911-7 -- that is too brisk a deflationary pace, But there is, of course, no prospect that the Treasury will continue to have net cash receipts of this magnitude, so \hat we probably need not worry about excessive deflationary pressure from this source. In the field of debt management ther e remains the qusstion of the refinancing of bank-held debt with lonr:e r term bonds and a higher coupon attractive to per manent non-bank investors. I think it is too often overlooked that the retirement of bank-held Government debt during 1946 was an operation of this sort. This is not surprising since the cart seemed to be pulling the horse, The fact is, of course, that the Treasury overborrowe d vory heavily in the Victory Loan drive of December 1945, a.nd that most of the overborrovfing was r epresented by sales of 2 1/2 per cent long-term bonds to insurance companies and other non-bank investors, As Government receipts and expenditures came more nearly into balance, thes e superfluous funds were used during 194.6 to pay off short-term debt, mostly held b~r the banking system. This was a r efunding operation in reverse. Since furth er replacement of maturing debt with long rather than shortterm issuos will result in a high(~r . cost of carrying the debt, such a program must be tested against broad objectives of credit and debt management policy. I think the proposal can meet this test, but care must be taken that we do not merely provide a 0 safe haven" for institutional and savings funds which should be placed in private investment; that we do not recreate the ''rollover racket", and that we do https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis • I 5 • not ups et the balance in the market for existing long-term Government obli gations. These caveats suggest, first, that the issue should not b o too attractive; that b1~siness and. mortgage borrowers should have first call on our sav:ings for investm:mt. They suggest, second, that the new issue should not be a fully marketable issuo, and that it should not enco11+age sales of outstanding issuGs, in order to obtain .funds for its purchase . That sort of rollover was one of the headaches of the war loan drives, and one of the reasons t hat too many Government securities went into the banking system. Institutional and other investors > in order to pad their subscriptions and to make a profit, sold large amounts of outstanding issues, at a prGnrl.um, to the banks and subscribed for n<:;W issues of long-ter m s ecurities in an1 ounts in excess of their currcmtly accumulating cash. The rosul t was, a nd could easily be ' aga:i.n, increased rather than reduced monetization of the public debt . Finally, these cav3ats suggest that to broach the 2 1/2 per cent rate on long-term Government securities, except in the case of a bond of the typo of S8ries ~~, would have r esults in terms of prices of outstant3ing obligations which wo ' have no reason to precipitate, and which private investors, or investing institutions should have no r eason to desire . Finally, in our bat tlc to hold down the supply o.f monc~y, there was the third restraint I mentioned earlier -- talk:- talk about possible changes in policy which would l ead to the defrosting of frozen short-term interest rates on Government securities which would, in turn, narrow the spread rates between short and long-term securities, and rointroduco some el ement of unce:rtainty into the interest rate picture, I think this discussion of the problem had a salutary effect , largely because tho action proposed soemcd logical and desir~ble to the business and banking community, and because the discussion gave evidence that the I monetary authorities wore thinking in terms of shifting the emphasis from main taining a wartime pattern of rates to preventing an unnecessary expans ion of bank credit, The continuance of the debt r etirement prog:ram, out of .net cash receipts of the Treasury, during r ecent months, 2..nd changes in the immediate business outlook, have made action on this front loss ur gent , but meanwhile steps have been taken to clear the ground for action when the time comes, It would be unprecedented if, after the tremendous dislocations of the vrar and immediate postwar period, some readjustment in our f3 conomy wore not necessary to providG a firm basis for an extended period of high l evel production and employment. It is unlikely that this adjustment can be achi oved. without temporary curtailment of business activity, and some loss of employment and income in some occupations . I woul d not want monetary policy or action to accentuate these dc1flationary tonduncies, because while they should be t0mporary and mild., thG incrce.sed rigidities in our economic system do enhance the danger of a recession f eeding on itself. in Up to novv, I havG tried to tell you what vre in the Federal Reserve System have been doing, in cooperation vdth the Treasury, to discharge our r esponsibilities in these postwar months. We have not clone all I should like to have done , and we; have done some things I would not have done, but I sµbmit that we have done something even though it has not been as "astute) skillful, patriotic and far-seeing" as Mr . Parkinson might have wished. He goos on to say that our failures arise from the fact · that we have fallen under the control of the Treasury . That is an opinion that is quite viridely held, I know, · and t o a c ertain extent it is true. Indeed, properly stated and understood, to a certain extent it should and must be .true . But it carries a false connotation -- a · connotation that the Federal Reserve System has become a sort of bureau of the Tre~sury without vrill or purpose of its ovm . That is not tru,3. The Federal Res 8rve System develops its mm indepondont views about credit policy, advocates them strongly, and carries s ome of https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis • 6 / • them through indopondontly, but the fact is that you cannot now discuss credit policy without discussing debt managomont. That is one of the major facts of our econorrry- growing largely out of the financing of the war. W"ith an interest-bearing Federal debt of approximately ~250 billion, with the gross servkc on that debt t otaling $5 billion, or around one-seventh of the Federal budget (more or loss), and with commercial banks of the country holding about %8 billion, or 40~; of the $170 billion of ma.rketable United States Government securities outstanding, you 1 cannot get very far away from debt management in considering credit policy. It isn't a question of abject subservience of the central banks to the Treasury -it is part of the economic landscape. What it should m~an is that the Treasury and the central banking system have to work to gether on this problem, with due regard for one another's powers and responsibilities. This has been difficult, at times, but it is not impossible; in my judgment, the difficulties at present are being overcome . I hope I have made it clear that the questions which were raised by rnr. Parkinson about credit policy and debt management a.re precisely the questions which have demanded and received the attention of the Treasury and the Federal Reserve System, and I think I have made it clear that we have been moving in the direction in which he 1JYould have us go. Evidently, in his view, we have not moved far enough nor fast enough. That is a matter of opinion and judgment. I can only say that his mood might be less uncompromising if he were charged with the fateful decision of determining how much of a decrease in the money supply is compatible with continued high production and high employment, how rapidly it should be attempted, and how it can best be brought about. These questions, which f,!3,ce us here and now, ' cannot be solved by the appointment of a national monetary commission such -as preceded the establishment of the Federal Reserve System in 1913. That commission took four years to complete its job. Yet I would agree that it is time for a similarly conceived study of the organization a.nd operations of the Federal Reserve Sys tem, and of our whole credit mechanism and Government lending m2.chine~J• Probably because of the intrusion of two world wars , we have gone too long without a thorough and objective study of our central banking sys.tern, and its r elations to Government agencies and private business •. Amendments to the original law, s-weep:i,.ng as some of ther..1 have been, have not represented an overall appraisal of performance in the light of original conceptions and subsequgnt developments. It is time we had a new statement from the people> through the Congress , of our responsibilities and of our powers, · L And novr, having taken up a good deal of your time, I should like to try to bring my remarks into focus. I woul d not want you to gain the ;impression that I think monetary and credit policy :i.s controlling in our economic affairs, nor that monetary and credit policy combined with debt management and fiscal policy have gi ven us the power to control economic fluctuations. These weapons can be used .for good or ill, but they are at best only part of a well-rounded economic policy. Nor can we find domestic shelter, by .whatever policies, in a world swept by unrest and hunger. Repair of the political, social and economic dislocations of war proceeds with maddening slowness. The burdens we must bear are larger and will ho..ve to be borne longer than the more sanguine among us anticipated . These matters i mpinge upon our domestic economy with brutal force, and knock awry the little ad justments we may make in i nterest r at es or in our management of the public debt. It is high time that we. again took stock of the world situation and of our position in it, for admittedly the schedules originally set dmm for the https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis • ? • postwar period are not being met . It is reassuring to know that the Government has t8.ken cognizance of this problem, and th:=it the Secretary of State has called for a world-wide survey of economic conditions to determine what are the present demands upon the United States for reconstruction aid: the light of that survey we shall }:lave to determine ho1:i thos e demands can best be met ., and ·what 1Nill be the repercussions in our domestic situation. Ono thing seems obvious - - we cannot be effective oveIJ'l·-rhere, in the same strength, at the same tin1e , We must decide what are our major objectives and what are minor objectives . We must clear our minds of slogans and redefine our purpose in fighting the war . I think the kernel of the ansvver can be found in the vrnrds of Professor Robert Warren of Princeton, vrhcm he said a year and a half a.go tha.t the war /Jas primarily a war for tho salvation of European integrlty, and. that until European inte~rity has been r estored and the continued existence of European cultur0 and civllization has been assured> the war is not over. This overriding task to which vve put our hand;, and to which we sacrificed hundred$ of thousands of ],ives and billions o.f dollars , cannot nmv be approached in a niggling spirit. Great generosity and great sacrifice still lie ahead . https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis In 1 /
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