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THE ECONOMIC OUTLOOK FOR 1951
Talk "by Dr. Edison H. Cramer to the Philadelphia Conference of the National
Association of Bank Auditors and Comptrollers, Philadelphia, Pennsylvania,
December 12, 1950
THE ECONOMIC OUTLOOK FOR 1951
Three months ago when Mr. Schultheis asked me to speak to this Con
ference on the topic "The Economic Outlook for 1951"> I presume he had in mind
the international situation and its probable effect on our domestic economy-particularly banking and finance.
For obviously it is necessary to appraise
the current international situation before making observations about the future.
You will recall the events during the second half of 1950«
When the
Red forces of North Korea invaded South Korea last June, it was decided that
the United Nations could not permit this unprovoked act of aggression to go
unchallenged*
Soon American Soldiers, under the banner of the United
were fighting side by side with the South Koreans.
Nations,
After five months of bitter
battle, it appeared that the struggle in Korea was drawing to a successful con
clusion.
Then the Chinese communists struck in force across the Manchurian
border, and world peace now seems farther away than
ever.
The Korean episode has confirmed the fear that has been growing since
the end of World War II.
The ruthless men of the Kremlin are determined to
extend their domination over the free nations of the world.
By common consent,
the United States has been chosen as the chief defender against them.
For our
own self protection, to say nothing about the rest of the world, we must accept
this responsibility.
We must transform our country into a garrison state and
prepare to defend ourselves and our friends against communism.
To a traditionally
free nation like ours, this will be an almost intolerable burden.
What can we
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do to mitigate the evil and to fortify our strength?
The way we answer this
question will in a large measure determine the outlook for 1951,
The nature of the conflict.
now engaged has two important phases.
This worldwide conflict in which we are
In part it results from an attempt by
one nation to extend its domination over the rest of the globe.
us that this is not the first time such an attempt has been made.
History teaches
However, all
previous conquests of this sort have eventually failed, although some of them
have been successful over wide areas and for substantial periods of time.
The
other aspect of this great struggle is a conflict between two contrasting types
of economic organization— the free enterprise system of the United States and
Western Europe on the one hand and the centralized totalitarian system of
communism on the other.
If this worldwide conflict were solely a question of determining
which nation is to become the dominant power of the globe, the result would
de
pend upon military planning and strategy and the ability to provide the imple
ments of war.
But in view of the fact that the struggle involves far more than
military dominance, the final outcome will depend upon the question of whether
our system of private business enterprise or the communist system of centralized
governmental authority proves to be the more acceptable method of organizing
economic activity.
That is to say, our economic system must be made to work
under any and all conditions.
Whether we have a hot war or a cold one, a
combination of both as we are having now, or no war at all, our system must
continue to demonstrate its superiority.
The leaders of the communist block of nations are convinced that the
private enterprise system is inherently weak because of its instability.
They
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believe the economy of the United States will he so weakened by recurrent periods
of feverish business activity followed by depression and stagnation that it will
in e v ita b ly collapse*
It has been my judgment that, because of
this belief, the
Soviet leaders were not likely to initiate a worldwide hot war in the immediate
future.
However, the events of the last two weeks have
made me wonder if I
might be wrong.
The record of business instability.
The belief that capitalism is
inherently unstable and subject to alternating periods of depression and
prosperity is held not only by communists but also by most Americans who abhor
communism.
There are two important reasons for this belief.
One of these is
the historical fact that during the past two centuries our economy has been
subject to frequent breakdowns.
All of us recall the early 1930‘s when millions
of people were without work in the midst of vast productive powers and unused
resources.
We had what appeared to be an anomalous situation of people going
hungry because too much food was produced and
going cold because too much
coal was mined, too many clothes were manufactured, and too many houses were
built.
Because some economists called it an "over production-under consumption
depression”, we tried to cure it by paying farmers to plow under every third
row of cotton and by butchering the sows that were about to farrow a litter of
Pigs.
It sometimes seems to me that we actually enjoy recalling the great
depressions of the past.
We discuss them with nostalgia, like a gossip describing
her operation in all its lurid details.
We have a business cycle chart under the
glass top of our desk or framed and hanging in a prominent place in our office.
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It shows primary post war depression, secondary post war depression, debt re
pudiation depression, the rich man's panic, and the long depression of the
70’s.
Moreover, almost all of us are guilty of the fatalistic belief that depressions
are inevitable.
Professional economists, business men, bankers, and government
officials are in general accord on this point, even though they may disagree on
everything else,
I dare say that if I were to call for a show of hands, every
one present would indicate his belief that depressions are unavoidable in a
peace time capitalistic economy.
If we have so little faith in our own ability
to avoid depression, is it any wonder that the disciples of communism also
believe our system will wreck itself— particularly if they give it a push or two
to help it on its way?
The function of prices.
The other reason for the belief that capital
ism is inherently unstable has its roots in the very nature of the economy,
with its apparent lack of coordination, direction, and control.
In a totali
tarian state, basic plans and decisions are made by a few people, and these
plans and decisions are directed and controlled by governmental machinery.
In
a competitive private enterprise economy, the government exercises very little
conscious direction and control.
Decisions regarding production plans and the
operations of factories and other types of producing enterprises are made by a
multitude of persons, either on their own account as individual businessmen or
as officers of business enterprises.
Isn't it inevitable, some people ask,
that these plans and decisions will be poorly coordinated and will result from
time to time in the kind of a mess we call a business depression?
The question does indeed arise as to how the multitude of decisions
by hundreds of thousands of separate business enterprises are coordinated so
that there is a reasonable degree of order in the economic system.
To see how
this coordination takes place we need to look at business arrangements for
the purchase of materials, the hiring of labor, and the sale of goods and
services.
Those arrangements, or contracts, are made in terms of prices and
promises to make payments in money.
The prices represent the number of units
of money, in the form of currency or of checks on a bank account, which will
be paid for a given amount of materials or labor or a given quantity of goods
or services.
The system of prices which these contracts produce becomes a
kind of impersonal central regulator of the economy.
If businessmen make in
appropriate decisions and base their contracts upon them, they find that their
goods remain unsold or can be sold only at a loss.
They discover that other
types of goods which are comparatively scarce command relatively high prices.
Consequently the prospect of making profits as a result of producing such
goods acts as a force inducing businessmen to shift labor and materials to
their production and away from making those types of goods which are relatively
abundant and have been found to be unprofitable.
The prices which eventually govern these decisions of businessmen are
those which individuals are willing to pay for the final products of the economy.
As economists have often remarked, consumers cast their votes for some goods
and services and against others as they go shopping every day in the market
places.
Thus the choices and decisions not merely of business enterprises but
of all the people, expressed as preferences in the market, produce a price
system which becomes the governor or regulator of production.
Professor Wallis
of the University of Chicago in a talk before the Citizens Board of the University
of Chicago made this statement:
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"The price system has two outstanding features. First it
is by all odds the most efficient system of social organization
ever conceived. It makes it possible for huge multitudes to
cooperate effectively, multitudes who may hardly know of each
other’s existence, or whose personal attitudes towards one
another may be indifference or hostility. Second, it affords a
maximum of individual freedom and a minimum of coercion. And
since people can cooperate effectively in production even when
their attitudes on other issues are hostile, there is no need
for unity and conformity in religion, politics, recreation, and
language--or even in patriotism and good-will except in the very
broadest senses," l/
Instead of calling this economic order "Capitalism" or "Individual
ism" or "The American Way of Life" it is much more appropriate to call it
the "Prices and Profits" system.
The supply of money.
As we think about the importance of prices in
this economic system, the question arises in our minds as to why they sometimes
get out of order.
We know from experience that in depression, as in time of
inflation, prices do not seem to function well as a regulator of our economic
activity.
Why not?
Could it be that there is something wrong with our
monetary system rather than with the price system itself?
That is to say, is
the well-known erraticism in the quantity of money the cause rather than the
result of business instability?
Certainly it is worthwhile to examine this
hypothesis.
In making an examination of this hypothesis we may start with the
fundamental economic principle, the law of supply and demand, and ask the
question:
Is this principle applicable only to the various types of goods
and services which are bought and sold in the economy, or is it applicable
also to the circulating medium or money which is used in making payments and
1/ W. Allan Wallis, "The Mechanism of a Free Enterprise Economy,"
Marquette Memo. Sept., 1950.
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contracts?
The answer to the latter question is yes.
When money
I is in great supply relative to the need for it, as measured in an appropriate
I manner, it tends to fall in value and each unit becomes worth less and less in
buying goods and services; if money becomes scarce relative to the need, it
tends to rise in value and fewer units will be required to buy a suit of clothes,
an automobile, or a television set.
That is to say, a decline in the value of
money due to an excessive increase in its quantity is the same as a general
jrise in prices.
This is what we call inflation.
Similarly, a rise in the
!value of money due to a decrease in its quantity is simply another way of
;describing a general fall or deflation of prices.
Neither inflation or deflation occurs instantaneously.
In each case
isome prices go up or down and this produces pressure on other prices.
More
over, many prices are fixed by contract or custom or for other reasons are
rigid and do not move readily.
This creates distortions in the price structure.
Generally speaking, in inflation these distortions are such as to make business
unusually profitable and thereby to stimulate businessmen to feverish activity.
Likewise, the distortions of the price structure during deflation tend to
make business unprofitable, whereupon businessmen find it necessary or at least
expedient to reduce their working forces,
thus producing unemployment.
These remarks on the role of the price system as a governor or regula
tor of a private enterprise economy, and on the character and impact of inflation
and deflation, lead us back to the problem of business instability.
If the
money supply, which nowadays consists primarily of bank deposits but also in
cludes the currency which we carry around in our pockets, does not remain
stable in quantity with a reasonable increase in line with the growth of the
economy, occasional periods of inflation and boom on the one hand, and of de
flation and depression on the other, appear to be inevitable.
Some economists
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who have studied the operations of our banking and monetary system have con
cluded that the banking system has been responsible in the past for many
erratic changes in the money supply, and that those changes in the quantity of
money have been the basic cause of business instability.
Consequently, they
have concluded that maintenance of monetary stability with a reasonable rate
of growth is the key to economic stability,
X would like to quote here from
two books published during the past few months.
Professor Lloyd W. Mints of the University of Chicago is the author
of a recent book dealing specifically with the problem of monetary policy for
a competitive society.
Professor Mints says:
"Monetary stabilization is needed as -one of the rules of a
competitive society. It is needed to prevent undue fluctuations
in the expectations of the business community. For this purpose
stability in the general level of prices is the essential require
ment." 2/
Mr, Ralph G. Hawtrey is probably the foremost English economist who
has studied the relation of banking and monetary policy to business instability
He has written several books dealing with this problem, and has recently re
written a book on currency and credit which was first published more than
thirty years ago.
He closes the new edition of this book with these remarks:
"Monetary stability is an essential condition of the survival
of competitive private enterprise. Nowadays that economic system
is challenged. The challenge ought to be met on its merits. It
would be regrettable, not to say, contemptible, if the case for
capitalism went by default because the monetary authorities of the
world do not know how to rise to their responsibilities or to take
advantage of their opportunities." 3/
2/ Lloyd W. Mints, Monetary Policy for a Competitive Society (McGraw-Hill
Book Co., 1950), page 171.
3/ R. G. Hawtrey, Currency and Credit, fourth edition, (Longmans, Green
and Co., Ltd., 1950), page 1*35.
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Bank reserves.
If an unstable quantity of money is the leading
factor in producing business fluctuations, what forces initiate changes in
the quantity of money?
Since bank deposits form the bulk of the money supply,
this is a question of what forces affect bank operations and result in
fluctuations in the amount of bank deposits.
Without taking time to go into
a detailed examination of this question, I will simply say that banks find
it profitable to maiiitaih their operations close to the limit permitted by
their reserve position.
When banks have excess reserves, they can acquire
additional assets and increase their incomes; when they have insufficient
reserves, they have to dispose of assets even though income is lost in doing
so, When banks increase their assets, they automatically increase their
deposits; and when they dispose of assets, they thereby decrease their deposits.
That is to say, the quantity of bank deposits depends almost exclusively on
the quantity of reserves available to banks.
The only exception to this is
when reserves expand with great rapidity, as in the latter half of the 1930's,
and the sequential expansion by the banks is at a slower pace.
Since 1917, Federal Reserve policies have largely determined the
amount of reserves available to banks.
When the Federal Reserve banks
acquire additional assets, the reserve balances of member banks are thereby
increased; and when they dispose of assets, member bank reserve balances are
decreased.
Moreover, the Federal Reserve banks have enormous powers of
acquiring additional assets, or of relinquishing assets which they hold; and
the amount of assets actually acquired or relinquished is dominantly in
fluenced by the terms set by the Federal Reserve authorities themselves.
If
the Federal Reserve is going to be held responsible for controlling inflation
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and deflation, it must be left free to set the terms on which it will acquire
or relinquish assets.
Postwar adjustment.
The theory that business fluctuations are the
■result of inappropriate variations in the quantity of bank reserves and that
these variations in reserves result from Federal Reserve policies is supported
by the course of events since 1917.
To illustrate, let me review the changes
in reserves, prices, and business during and since the close of World War II.
In 1942 Federal Reserve authorities announced that the System would provide
the banks with all the reserves they might need as a result of increasing
|their holdings of Government obligations.
During the war years banks acquired
a huge volume of Government obligations, and the amount of bank reserves and
|the quantity of bank deposits increased rapidly.
Reserves continued to in
crease, though more slowly, for two years after V-J day.
From the end of 1941
to the end of 1947 Federal Reserve bank assets nearly doubled, and member bank
reserves, adjusted for changes in percentage requirements and other factors
affecting their effectiveness as a base for deposit expansion, increased by
about 60 percent.
The money supply, measured by the Federal Reserve series of
deposits adjusted and currency, ” more than doubled.
The money supply expanded
more rapidly than effective reserves, because the extraordinarily large gold
imports immediately preceding the war permitted the banking system to enter
the war with substantial excess reserves.
This great increase in the money
suppiy between 1941 and 1947 led to some rise in prices during the war and to
a rapid rise when wartime controls were removed.
The wholesale price level
rose about two-thirds and the consumers price index by about one-half from the
■first six months of 1942 to the first six months of 1946.
This increase in
■Prices reflects the impact of the excess of monetary expansion over the growth
|°f production.
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In the latter half of 19^7 and the early months of 19^8 various
measures were taken for the purpose of preventing any further increase in the
money supply.
These measures impinged on bank reserves.
By the end of 19^7
the expansion of bank reserves was halted and turned into contraction.
Be
tween that date and the end of April 19^9> the effective amount of bank
reserves was reduced by
15
percent relative to the normal rate of growth.
Bank deposits also declined substantially though not by so large a percentage.
The price level turned down and business activity slackened in the fall of 19*+8,
several months after the peak in reserves, repeating the typical sequence and
lag which prevailed between the World Wars.
By the Spring of 19^9 fears were arising that a serious postvrar
depression was at hand.
At this point the Federal Reserve authorities reversed
their pressure on reserves.
Early in May they started a series of reductions
in percentage reserve requirements, thus stopping the contraction in effective
reserves and in deposits.
In the summer and autumn business sentiment became
more favorable, several of the leading indicators of revival appeared, and
fear of a deep- depression disappeared,
creased
reached
’’Deposits adjusted and currency” in
billion during the second half of 19^-9 and at the end of the year
$170
end of 19^7.
billion, which was the peak in the money supply reached at the
During the first half of 1950, the Federal Reserve put pressure
on bank reserves and stopped this expansion in the money supply.
At the end
of June, just at the outbreak of hostilities in Korea, "deposits adjusted and
currency,” after a slight decrease during the first quarter, were again $170
billion.
The Federal Reserve authorities had stopped the postwar inflation
and at the same time avoided a postwar depression sufficiently deep to be a
serious threat to our economy.
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Controlling inflation.
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Before commenting on events since Korea, I
want to review briefly some cf the suggestions that are being made to control
inflation.
Many economists who have been engaged in the study of business cycles
!have paid little attention to the role of changes in the quantity of money.
They assume that business booms and depressions originate in forces outside
the banking system, and that changes in the quantity of bank deposits and
currency in use are the results of changes in the ups and downs of business
rather than the cause of them.
They explain a business depression like that of
|the early 1930's in terms of a postwar adjustment, the propensity to save,
our mature economy, or the lack of investment opportunity.
have been offered as an explanation of business cycles.
Even sun spots
Likewise, th^se
economists esqolain the inflation of the 19^0's in terms of the demand created
hy the war and the government deficit that accompanied it.
Consequently, they
believe that the war-time pressure on prices can be held to a minimum only by
a decrease in nondefense and nonessential federal expenditures and by higher
taxes.
While I agree with these programs, they are not the basic issues.
Nonessential government expenditures should always be eliminated.
But if we
depend upon this to control inflation in our defense economy, we are doomed to
disappointment.
as-you-go policy.
the sole issue.
Likewise, I think we should make every effort to adopt a payBut we must not allow this desirable objective to become
In my judgment, inflation can be avoided during the years
ahead only if the proper authorities exercise appropriate control over bank
reserves,
if banks are given ample reserves, they will acquire additional
Identities of government obligations and other assets, and thus increase their
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d ep o sits.
This is the road to inflation.
On the other hand, if reserves are
held to a reasonable rate of growth, bank deposits, the largest segment of
our money supply, will be held stable, and inflation will be avoided.
Under
this condition, the Treasury will do its financing by taking purchasing power
away from those that have it both by taxing and borrowing from nonbank in
vestors,
Very likely the Treasury will have to change the terms of its issues
if it is to attract sufficiently large amounts of the savings of investors,
A brief review of events since June indicates that the Federal
Reserve banks are being successful in preventing an excessive rate of ex
pansion in the aggregate amount of bank reserves.
Member bank reserve
balances averaged $16,2 billion during the month of June, $16.3 billion dur
ing July and August, $l6.6 billion during September, $16.7 billion during
October, and $16.8 billion during November.
This is slightly more than a
normal rate of growth, but a part of it is probably seasonal.
Meanwhile, the widespread belief that the prospect of a government
deficit means inflation has led to a vast amount of anticipatory and specula
tive buying.
This, together with hurried acquisition of supplies by the govern
ment to pursue a military campaign for which it was unprepared, has produced a
substantial rise in wholesale prices, which has now been carried through to
retail prices.
The same upsurge of buying has led to requests for additional
bank loans, to which the banks have responded by expanding as much as is
feasible in the face of their reserve position.
The money supply, as measured
by "deposits adjusted and currency" has increased from $170 billion at the end
of June to approximately
$173
billion at the end of October.
This change, like
that in reserves, is slightly more than the estimated normal rate of growth, but
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it also is probably partly seasonal.
Further expansion in the money supply is possible only with in
creased reserves.
If member bank reserves continue to remain reasonably
stable, we can expect stability in the volume of bank assets and bank de
posits, and hence in the money supply.
If this stability is maintained during
1951 the upsurge in buying by consumers and speculators initiated by develop
ments in Korea will subside.
As consumers and speculators meet the commitments
they have already incurred, they will find their cash balances abnormally low
relative to their spendings and will begin to reduce their expenditures to a
normal volume in order to replenish their cash.
If the Federal Reserve
authorities continue to hold bank reserves around the $l6|r to
$17
billion
level, they will have demonstrated their ability to prevent inflation, except
for some temporary price fluctuations, even in the face of an increase in de
fense expenditures and in the government deficit.
With respect to the longer-run outlook, it has now been a long
enough period of time since the peak in the money supply at the end of I 9V 7
for the economy to become adjusted to the $170 billion of "deposits adjusted
and currency" in existence on that date and also at the middle of this year.
As soon as the present speculative flurry dies down, it would be an appropriate
policy to resume a rate of growth at or close to the estimated normal, which
is about
5
percent per year.
For maintenance of prosperity and a stable price
level we need a reasonable growth in bank deposits and with appropriate bank
ing and monetary policies this will be achieved.
Conclusion.
In conclusion, I acknowledge I have made few specific
comments on the economic outlook for 1951*
Rather, I have tried to sketch a
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simple outline of the essential characteristics of our economic system.
was done because the outlook for
1951 >
This
as well as for all future years, will
be determined not only by the economic system itself, but in large part by
how well society understands it.
Few of us need to understand military
science and strategy, international politics, or the hydrogen bomb and all its
implications, but in our democracy it is essential that all of us have an
understanding of the basic characteristics of our economy if it is to survive.
Let me summarize, then, the points I have emphasized.
Our economic
society based on competitive private business enterprise is not inherently un
stable,
On the contrary, competitive capitalism is an extremely flexible and
adaptable type of economic organization.
making is an aid in this adaptability.
Its decentralization of decision
Adjustments to changing demands, to
changing methods and techniques of production, and to changing sources of
materials do not have to be funnelled through a single set of decision-makers.
This is our nonsecret but most important weapon.
But there is one essential
condition if this method of decision-making is to work well, and that is
stability in the value of the monetary unit or level of prices of the output
of the economy.
All business decisions are made in terms of money, and insta
bility in the value of the monetary unit creates vast uncertainties and upsets
business planning.
Maintenance of monetary stability is a governmental function and the
powers of accomplishing it have been given by Congress to the authorities who
determine Federal Reserve policy.
Only if these powers are appropriately
exercised, can we avoid serious price inflation during the awful emergency that
faces us.
If inflation is to be stopped, it must be stopped at the source; and
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We must not increase bank deposits
hy financing the necessary expenditures through the sale of government obliga
tions to banks.
They must be financed through higher taxes and borrowings from
nonbank investors.
This is the key to mitigating the afflictions of war and to
fortifying the inherent strength of our democratic economy.
Then when the war is over and the ruthless dictators that would
enslave humanity are defeated, monetary controls can be used to prevent defla
tion, and we will never again have a depression like that of the 1930's.
As
time goes by, our experience with continuous prosperity will show the world
that our system of individual liberty and competitive business enterprise is
not inherently unstable.
B y eliminating this historical weakness, we will make
possible the survival of the American Way of life.
@FedFRASER