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ADDKriSS BY BENJ. STROiJG DELIViCi\ED NOV. 16, 1322, BEFORE REL1S5ELAER CGUiiTY 3ALJ:ffiI.£, at dinner at Troy, Hew York. The opx>ortunlty for bankers to become more intimately acquainted with the detailed operations of the reserve banks have multiplied recently to such an extent that any discussion of what they do and why they do it has become almost unnecessary. The literature both from within and without the System has recently been most illuminating as to the principles which have governed the managers of the organization and as to the policies they have adopted, and the reasons for doing so. It seems to me, however, that there is still one aspect of the Fed eral Reserve System which has not been very fully discussed or even inquired into, - and that is - very broadly expressed - the position vihieh. it has come to occupy as a part of that complicated organization which we may describe as the country's economic machine. All ban'ars know that v/e act as the government1s fiscal agents and about what we do in that capacity. They know that we discount eligible paper - issue the principal currency of the country - hold the reserves of the member bonks collect checks - and effect the great bulk of tho domestic transfers, commonly called exchange payments, between different sections of the country. Beyond this the reserve banks perform a great variety of collateral and subordinate service for the government, the member banks and the public. V/ith most of these things you are familiar. Youmay not, however, have given thought - as we are now required to do - to some of the broader aspects of tho Federal Reserve System in its relation to the economic welfare of the country as a whole. In a general way it can be stated that the most important function perfo.med bythe Fedaral reserve banks in an economic sense is that of regulating the volume of "money" - and I use the word "monqy" in its broad sense, meaning all types of credit instruments which perform the function of money, including bank deposits upon vshich checks are drawn. Permit me, therefore, to introduce a discussion of the Federal Reserve -2 System along these lines by a few words of a theoretical charactcr in regard to money. For many years now economists have accepted as a general principle that the quantity of "money" has a direct relation to the prices of everything - that is, of the things that we buy and sell, including the wages of labor, the salary of clerks, rents, etc. There are, of course, many reservations and many modifica tions which apply to this theoryj for instance, the function performed by money in its relation to prices may be either static or tynamic according to the state of mind of the people. I f all of the people of the country because of fright, distrust, political disturbance, or for one or another reason, quit buying goods, prices for a time might even decline in the face of an increasing volume of money, although tiie chances are that under r* well regulated banking system such a state of mind would result in a very prompt reduction in the amount of money in circu lation . In other words, it would bring about a period of liquidation when bank deposits and currency would be applied to paying off loans, so that deposits and loans would be reduced and would be retired. On the other hand, without any In crease in the quantity of mo^ey, an optimistic outlook and a speculative state of mind might result in very considerable advances in prices without any increase in the quantity of money giving rise to it at all. When that happens, however, the quantity or efficiency of money must increase or price advances will usually be arrested. These illustrations must allow for that reservation in regard to the absolute or narrow quantity theory which economists refer to as velocity of circu lation of money. (illustrate by the beer story) The conditions which may arise where in fact a given quantity of money may be made to work more efficiently and perform a greater service, in an economic sense, than it had formerly performed, and so give rise to or result from advancing prices, is exhibited in the change in our banking loans since the establishment of the Reserve System, which has in effect reduced reserve requirements and permitted a «lnrt 1«i» amount of gold tosupport a larger total of deposits, currency and loans* I am reviewing these very obvious economic principles in order to sum them up in a rather hypothetical statement which will illustrate somewhat the new economic aspect of the country's affairs resulting from the organization of the reserve banks. This brief hypothetical statement may do so. If a given quantity of goods that is being produced, sold and consumed requires the employment of a given amoubt of money and bank credit, then in the inng run we may say - for purpose of illustration - that the quantity of goods . multiplied by the price of those goods would give a figure which would be repre sentative of the amount of credit and money required to conduct that volume of business at that price level* Of course, there are an infinite number of modify ing factors to be taken into account, so I am stating this equation only hypo thetically in its barest forms* But upon this; principle you will observe that if the quantity of good^ is being much increased it will soon require an increase in the amount of money and credit required to produce and distribute them* On the other hand, with the same quantity of goods, if the price is much increased neces sarily an increase in the amount of money and credit will again be required. But there is still a third possibility and that is that there might be an increase in the quantity of money and credit without any change in the quantity of goods, in which event the result would be simply an increase in price. mind that ny equation is for purposes of illustration. Now please bear in I am leaving out of account in this equation many subordinate but nevertheless important factors, such as the psychology of the people, the velocity of circulation, increases or decreases in the efficiency with which money and credit are employed* You will at once observe, therefore, that Congress has created a great organization known as the Federal Reserve System, which has in its power the actual creation of an increase in the volume of money and credit, but it has likewise the power somewhat to restrain that increase in money and credit '.vithin certain limita tions* This to ny mind is the greatest responsibility and a very grave one -4 resting upon our Reserve System, and creates a situation so different from any which has existed in our countryfor the last 30 or 90 years that I shall hope to interest you by elaborating upon it somewhat. Before doing so, I must,digress to the extent of*pointing out wherein lies the difference between real\ progress A in our economic welfare - which in a broad sense means improved standards of M living, which in turn means more and better food ?nd clothes and shelter, steady work, higher standards of education, more healthy enjoyment for all the people. The establishment of higher standards of living, which is the basis of all econ omic effort and strife is brought about by increased production and consumption of things that are necessary for and which promote the welfare, physical, moral and intellectual of all the people. Such an elevation of the standard of living or economic well being is not promoted by misdirected effort which results in the wasteful production of useless things and in the cultivation of habits of extra vagance and laziness; - that is what happens to the people, - those are the habits which people cultivate at a time when prices are sharply rising but when the pro duction of useful things is not increased. (Illustrate here by stoiy of the use of iron ore.) ?his digression is intended to emphasize the fact that the economic well being of the people of this country can be promoted by a sound direction of the affairs of the Federal Reserve System, and, on the other hand, that the economic .veil being can be undermined and impaired by unsound policies which attain no other result than to cause speculation, advancing prices and no real advance in economic well being. To return to ray theme. Under our old banking system there was no means by which the general vo,ume of credit of the country might be increased bqynnd a given point without an impairment of the minimum reserves which banks are required by law to maintain, unless it resulted from the importation of gold or the domestic production of golc vdiich went into bank resources. Of course, I leave out of -5 account such expansion as might result from changes in our monetary standards such as was attempted in the early 90s, or by changes in the statutory reserve require ments for banks. When, under the old system, as, for instance, in the early 90s, an:? again in 1907, we experienced a wave of liquidation and business depression, bank loans and deposits were very much reduced as a result, and in consequence surpluses of bank reserves were built up all over the country - interest rates sharply declined - and bond values rose. Then later, speculation would start in the money centers - usually in the stock market - and gradually the beginning of a new cycle of advancing prices resulted. Likewise, at the culmination of such a cycle of advancing prices, bank reserves would become impaired in various parts of the country, and i f any shock to confidence occurred - as it did in 1893 and again in 1907 - reserve requirements actually had to be suspended and even currency pay ments suspended. Such periods of advancing prices, with all the speculation which generally accompanies them, have in the past - whether^Ln this country or in other countries - always had one result: try the best selling m.'irket3. They have made the markets of that coun The ?orld at once would start to pour goods into a country where domestic prices get out of line with world prices. Thereupon the banking system would at once begin to lose gold to Europe in order to pay for these goods. That served as a natural check to the speculation - caused interest rates to advance - made people who were borrowing money get timid - and would usually bring about selling of goods and price reductions so that the country was again able to enter into the world's market as an exporter of goods, thus chang ing the international balance of payments, arresting tho gold movement, and restoring equilibrium again. wholly unregulated. Under our old banking system these movements were We had no bank of issue as they have in England, France, Germany and elsewhere, and no organized means of dealing with the money market, with foreign exchanges or with gold movements. Now we have such an organization, but tile consequences of the v/ar have resulted in almost universal embargoes upon the shipment of gold. Yte are the only important bankiig country which has no such -6 - embargo. The consequence of that is that we might indeed indulge in this country in a riot of extravagant speculation and of extravagant personal expenditure upon luxuries. We could cultivate habits of idleness, quie practicing thrift, and in fact go to almost any extreme of economic waste before it could be possible for any of the important nations of the world to take gold from us in such quantities as would imperil our bank reserves at all* Therefore, the natural check which had operated before the war to hold us to a certain accountability when our economic machine gets woricing badly has been lost and we have not only lost the povrer to lose gold - so to speak - but the amount of monetary gold A ic h we now hold nearly i f not quite one-half of the entire world's supply - is so vast that we have a capacity for over-undulgence in speculation and extravagance beyond anything ever known before in history, either in this country or any other country. You will, I hope, therefore, appreciate that if the premise of ny argument is sound, this instrument which we have created for the control of the volume of credit must rely more upon good sound management than would be the case under ordinary circumstances, because the usual checks applying in a smooth and orderly world system are no longer present. The question at once arises as to how these policies may indeed be con trolled and directed so as to escape the penalties which I believe would be inevit able were we either ignorant, or careless or wilfully wrong. I think it may be said that there are two chief reliances to which we must look - and hardly any of importance outside of those two: The first is a sound helpful and constructive point of view with regard to the Reserve System by thosi who own it - that is, the member banks. be vigilant to see that thesa banks are well managed. reports and their statements. They must They must scrutinize their They must examine carefully the qualifications of the men who are proppsed for directors and they must indeed satisfy themeelves that the directors choose competent officers. Here I believe lies the most direct responsibility as to the policies of the System. The other safeguard is an -7 intelligent public opinion generally which, on the one hand, will not tolerate a political domination or misuse of the System, and, on the other hand, will not consent to its becoming, through its financial power, a supcr-government. I do not refer to this situation as one Trtiich may be regarded as per manent, for if it were, no one would be more prompt than I in advocating that the general structure of the System should indeed be changed. going to recover its economic equilibrium. This world is It will bo a slow process, but it is now under way, despite the gloomy predictions of those prophets of disaster who are always with us no matter hov; affairs may be going. During this period, however, v/h :-n the gold standard and free gold payments have been suspended, human vdsdom, sound intelligence, and the highest type of integrity must be substituted for some of the automatic checks which normally work. I have left to the conclusion the real point that I wish to make. It is quite possible, due to mistaken notions of unenlightened people, that policies might be forced upon the Reserve Eastern to bring about a deliberate expansion of credit. You have read of the many proposals just to issue Federal reserve notes without any particular regard as to how it is done, to whom the notes should be issued, or v.-hat the effect vrould be. You have he'ird nu.nerous proposals that we should mako credit cheap, and although much less frequently expressed, I think thore -ire many ban-cars in this country v/ho still hold tho viev: that if any money c-au be made by borrowing at the Reserve ban!:, it is goo-.! e:.sy money and advantage should be taken o. it. It is just such doctrine as this that would lead - if unrestrained - to nn increase in the araou it of money and credit in the country that I have earlier referred to, without its being in response to an .increase in production and consumption of goods. That in turn rould le .d tqfcpeculative ad vances in the pricedpf everythin" which in tain •.•ould increase the cost of living and ajain le d to strikes and all of the disorders viiichrecult from the sense of injustice which such a policy of inflation always brings about. Behind the Federal Reserve System as a bulwark stands, I believs, first, - 8 - the sound and helpful and constructive friendship and confidence of most of the bankers of the country. Behind that stands the confidence and respect in general of most of the business interests of the country. Outside of these circles of protection lies tho enengr, and the eneny is ignorance, and the enemy consists in that body - how great we cannot estimate - that would have the Reserve banka manu facture credit ano print aonqr - just as ve did during the Civil »'?.r, - under the mistaken notion that that will make prosperity.
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