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CONFESSIONS OF A NEW CENTRAL _____BANKER REMARKS BY John J. Balles PRESIDENT FEDERAL RESERVE BANK OF SAN FRANCISCO Dinner Meeting Federal Reserve Bank Directors and Commercial Bankers Los Angeles, California October 5, 1972 53* ^ ft \ 5 l'7'L' John J. Balles I t is a real pleasure to be here this evening with the Directors of the Federal Reserve Bank of San Francisco and its branches and with a group of leading bankers from the Los Angeles area. It is certainly an honor to serve in my new job as the ninth chief execu tive of the Federal Reserve Bank of San Francisco, which I have always regarded as one of the leading Reserve Banks. T o be sure, I cam e here from the East, and most of us recognize that there are some dif ferences between eastern and western banks and bankers. Nevertheless, the similarities are also im portant. Thus, I d o n ’t feel like a total stranger in this environm ent— especially since I have been closely acquainted with some of you for years. I am looking forw ard to getting better acquainted with the rest of you. I view my new position as an opportunity to becom e a part of the dynam ic and innova tive financial com m unity of the West. Having come from an area of the country ch aracter ized by lim ited-area branch banking, one of the m ajor differences I already have noted in this part of the country is that, despite the prevalence of state-wide branching, there is o b v io u sly an o p p o rtu n ity fo r sm all and medium-size banks to play a role in the regional econom y, particularly in quick ad ap tations to local circum stances. The num ber of such banks represented here tonight testi fies to the fact that they can prosper even in the shadow of large branch systems. Comm ercial to Central Banker It is certainly a challenge to share the plat form tonight with the illustrious Chairm an of the Board of G overnors of the Federal Re serve System. This is particularly true in view of the fact that I have not attended a meeting of the Federal O pen M arket Com m ittee since 1959 and am now about to begin a refresher course in central banking. Perhaps I could rise to the challenge and do som ething spec tacular for the Federal Reserve System if 1 could get the cooperation of an old friend who is here tonight. He is Lee A twood, a form er director of the Los Angeles Branch of our Bank and the retired President of N orth A m erican Rockwell C orporation, on whose Board of D irectors 1 was privileged to serve until I accepted my present position. When Rockwell-Standard was merged with North Am erican Aviation to form N orth A m erican Rockwell, a technology-transfer com m ittee was established, whose main purpose was to explore ways of applying spage-age technol ogy to com m ercial products. Now that Lee is retired and has a lot of time to think about such m atters, I may ask him to consider ways of applying space-age technology to the ad m inistration of a Federal Reserve Bank and to the form ulation of m onetary policy! Having so recently com e from com m ercial banking, where I was privileged to serve for the last thirteen years with Mellon Bank, I would have to adm it that I haven’t yet fully shifted back to the point of view of a central banker. In recent years, I have spent consid erable tim e on the affairs of the A m erican Bankers A ssociation, including service last year as C hairm an of the Special A BA C om mittee on the Presidential Com m ission on Financial Structure and Regulation, and also including service until recently as a m em ber of the A dm inistrative Com m ittee of the G ov ernm ent Relations Council and as a m em ber of the Econom ic Advisory Com m ittee. Just before resigning recently from the Trustees of the Banking Research Fund of the Association of Reserve C ity Bankers, I was m anaging trustee for a study, which I had p ro p o s e d , o f lo an c o m m itm e n ts by banks. This study is still in preparation and is being done by a well-qualified professor at H arvard, who was form erly on my staff at Mellon Bank. It was aimed at answering the general questions of w hat constitutes a p ru dent upper limit to loan com m itm ents and how such com m itm ents can be better m an aged. A m ong other things, we were attem pt ing to test the feasibility of a suggestion made by A rthur F. Burns, in an April 1970 address to the A ssociation of Reserve City Bankers, that banks should limit their loan com m it ments to am ounts they reasonably believe can be financed in periods of tight m oney and that banks should charge at least as much for take-dow ns under com m itm ents as they are paying for additional funds at that time. Needless to say, I will be very interested in seeing the study when it is finally published. The only purpose in m entioning my back ground in such an im m odest fashion is to make the point, for those of you who d o n ’t yet know me, that if I d o n ’t understand the problem s of com m ercial banks, it has not been for lack of opportunity. T here is the further point that your views and problem s will always receive a sym pathetic hearing at the Federal Reserve Bank of San Francisco — w hether or not we end up agreeing with you about any proposed course of action or remedies. In the same breath, I should also m ention— as C hairm an Burns rem inded me during a visit in W ashington before I as sum ed office— that I am now working for all the people, and should solicit views and opin ions not only from the banking and business com m unities, but from other segments of society as well. I am certain that you will appreciate the desirability of doing this. Role o f Federal Reserve Bank o f San Francisco In this age of specialization, I certainly don’t pretend to be knowledgeable on all phases of banking— far from it. But I believe that we have in the com bined staff of this Bank such knowledge and expertise as is necessary to carry out our functions. I know that if I can ’t answer your questions on some bank operating m atters, such as check col lections or cash operations, we have people who can— a group headed by our very able First Vice President, A. B. M erritt, and in cluding Paul W. C avan, Senior Vice Presi d e n t a n d M a n a g e r o f o u r L os A n g eles Branch, who is one of our hosts tonight. With the team we now have and will de velop, it is my hope to m ake the Federal Reserve Bank of San Francisco an active partner with the banking and business com munities in im proving the financial and eco nomic clim ate of the Twelfth District. I d o n ’t yet have a blueprint on how to do this, and it would be prem ature to even m ention some possibilities I have in mind until they have been studied m ore thoroughly. Pending com pletion of such studies, however, we would welcome now or at any time any suggestions or proposals which you might have along these lines. Federal Reserve System— Key Problems Let me now turn to several other m atters having to do with the Federal Reserve Sys tem. In so doing, I propose to dig back into past history, feeling that this offers valuable perspective on the present. It is especially appropriate to do this in view of the fact that the C hairm an of our Board of D irectors, Dr. O. M eredith Wilson, was a distinguished historian before he becam e President of the University of Oregon and later the U niver sity of M innesota. Incidentally, he inform s me (presum ably with tongue in cheek) that in his current position as President and Di rector of the C enter for A dvanced Studies in the Behavioral Sciences at Stanford, he is running a m onastery for scholars— but without celibacy! T here are two general points I w ant to make. First, to the extent that there have been “ m istakes” in past m onetary policy, as viewed by im partial observers, the m ost fre quent cause has been deficit financing by the U. S. G overnm ent. The second point has to do with the vital necessity of m ain taining an independent central bank. First, as to m onetary policy, second-guess ing the Fed is a popular pastim e. Some peo ple have even made a career of it. And I would have to adm it that I have done my share over the years, starting with a doctoral dissertation in 1950 on the subject of m one tary policy during W orld W ar II and the im mediate postw ar years. If there was one lesson that was indelibly impressed upon me in preparing that disser tation and in subsequent studies, it was that efforts to m aintain a predeterm ined and rel atively low level of interest rates necessarily immobilize m onetary policy as an instrum ent of econom ic stabilization— and indeed m ake the central bank an “engine of inflation.” F urther, the use of fiscal policy as an instru ment of restraint also becomes unw orkable under such conditions. It now seems so clear in retrospect. Yet, it was not so clear at the time, as I was rem inded recently when rem iniscing with Cecil E arhart, my predecessor twice rem oved, who served as President of the Federal Reserve Bank in those years. We recalled the agonizing debates which took place on the subject in the postw ar years— i.e., could the level of interest rates be al lowed to rise from the artificially low levels m aintained during the war w ithout serious risk of a financial and econom ic collapse? Along with many others at that time, I urged the necessity of restoring timely and flexible m onetary policy, in conjunction with fiscal and debt-m anagem ent policies, as indispens able in a broad program of vigorous eco nom ic growth w ithout inflation. W hen the G overnm ent securities m arket was finally u n pegged in M arch, 1951, in the now famous T reasury-Federal Reserve A ccord, the econ omy and the financial m arkets did not col lapse, and m onetary policy was restored to a viable role in com batting the inflationary pressures that arose with the K orean W ar. It was true then, and is true today, that if m onetary, credit, and fiscal policies are used in a coordinated m anner, they are ca pable of exerting a powerful influence on in com e, production, and prices. M oreover, since these instrum ents of policy operate to influence the general econom ic environm ent in an indirect fashion, they are m ore com patible with a private enterprise economy than the main alternative approach— namely, a system of direct econom ic controls involv ing detailed regulation of m arkets and prices. It seems that we have to keep re-learning the lesson th at the principal obstacle to suc cessful use of m onetary, credit and fiscal pol icies has been the failure to use them in a coordinated fashion. In that case, they are likely to offset and defeat each other. In deed, m uch of our econom ic history is m ark ed by inappropriate budget deficits defeating efforts to com bat inflation through credit re straint. The problem that we are faced with at present— nam ely, a huge Federal deficit in a period of strong econom ic expansion, is in fact new wine in an old bottle— and there have been m any such “ old bottles” over the years. Monetary-Fiscal Mismatch, 1965 By way of illustration, in the latter part of 1965, when the “ new econom ics” was still calling for expansive policies on aggre gate dem and, with a view to pushing the u n em ploym ent rate below 4 % , there were some observers who recognized the emerging in flationary threat. One of these was A rthur F. Burns, then President of the N ational Bu reau of Econom ic Research and John Bates C lark Professor of Econom ics at Colum bia University. In his Benjamin Fairless M em o rial Lectures in Pittsburgh at Carnegie In stitute of Technology (now Carnegie Mellon U niversity), Dr. Burns recognized the con tributions m ade by the “new econom ists.” But he observed that their favorite instru ments of policy, if pushed beyond a point, m ay bring on inflation and underm ine pros perity. Specifically, he observed th at such a point was close at hand, if not already reached, and he called for less liberal m one tary and fiscal policies, in the interests of both the dom estic econom y and our inter national balance of paym ents. Following a luncheon that M ellon Bank gave for Dr. Burns, I recall a discussion 1 had with some “ new econom ists” who believed that it was too early to start fighting inflation. T hat view proved clearly wrong, as illustrated by subse quent developm ents. M eanwhile, the F ederal R eserve System had also correctly diagnosed the emerging inflationary pressures stemm ing from the es calation of the V iet N am W ar in m id -1965 and from the concurrent expansion in “G reat Society” welfare expenditures. By D ecem ber 1965, the System increased the discount rate as a public signal. P rior to the increase, strong public statem ents were m ade by vari ous high-ranking m em bers of the A dm inis tration, including the Secretary of the T reas ury, w arning against such action. A fter the increase, there was strong denunciation of the move, including a statem ent by the C hair m an of the Council of Econom ic Advisers to the effect that it represented a serious breach in coordination of m onetary and fiscal policy. How ever, by the spring of 1966, it was clear th at the Council of Econom ic Advisers had seriously underestim ated the strength of the inflationary boom that was developing. N ot only did the A dm inistration fail to re vise its fiscal stance at the tim e, but it at tem pted to dissuade the Federal Reserve from m eeting the threat through a modest m easure of credit restraint. W ith the benefit of hindsight, it appears that the D ecem ber 1965 increase in the discount rate and the associated move tow ard credit restraint was not only appropriate but overdue. Lessons from Abroad. A t this point, I would like to digress for a moment. In 1959, I happened to be in London on M ellon Bank business at the time when the R eport of the Com m ittee on the W orkings of the M onetary System— better known as the Radcliffe R e port— was scheduled for debate in the H ouse of Com m ons. In the course of that debate, I heard the Chancellor of the Exchequer an nounce that one of the principal recom m en dations of the Radcliffe R eport had been im plem ented — namely, th at henceforth any proposed change in Bank rate by the Bank of England would have to be subm itted in writing by the G overnor to the C hancellor and approved by the Chancellor before be coming effective. A ctually, of course, this new procedure simply form alized a practice which had been followed since 1946 when the Bank of England was nationalized. C an there be any doubt of the outcom e had such a system prevailed in the United States in 1965— i.e., any doubt that the Sec retary of the T reasury would have refused to ratify the proposed increase in the discount rate by the Federal Reserve? C an there be any doubt that our econom ic situation would have ended up even m ore unbalanced than it did, in the “credit crunch” in the sum m er and fall of 1966? Perhaps this one illustration will serve to buttress the case of those of us who believe that the independence of the central bank within governm ent— but certainly not from the governm ent — is a vital protection to sound econom ic policy in a free society. The w orld’s largest debtor— i.e., the U.S. T rea sury— at times has not taken an unbiased and objective view on m easures affecting the cost and availability of money. Independence o f the Federal R eserve Sys tem. This point has special relevance in view of repeated efforts in certain quarters in the Congress to underm ine the indepen dence of the Federal Reserve within govern ment. M ost recently, this effort has taken the form of an am endm ent to an om nibus housing bill (H .R . 16704) which calls for an annual audit by the G eneral Accounting Office of the Board of G overnors and the F ederal Reserve Banks. It would give the G .A .O . access to all books and records of the Federal Reserve System. A t first blush, this appears to be som ething that is hard to argue about— who can be against audits? In point of fact, it happens that the B oard of G overnors of the Federal Reserve is already audited by a reputable private firm (Lybrand, Ross Bros. & M ontgom ery); in turn, the Board’s staff thoroughly audits the R e serve Banks. The real point of the am endm ent in ques tion is that it would not be confined to a fi nancial audit. Instead, it would include an appraisal of operations, not only in regards to com pliance with law, but also in reference to recom m endations “for attaining a m ore eco nomical and efficient adm inistration” of the Federal Reserve. The authority is so bro ad ly described that it could include a review of System open-m arket and foreign operations. In my judgm ent, this could lead to intim ida tion of the Federal Reserve and to efforts to influence its policy. Fortunately, it now ap pears that the am endm ent is dead for this session of Congress, mostly because of the clogged legislative calendar, but the p ro posal is almost certain to be raised again. Eternal vigilance is the price necessary to avoid “ political m oney,” and I urge that you be alert to such proposals in the future. Budget Deficits — the Main Barrier to M onetary Policy. T o return to the subject of Federal Reserve policy, I recall my p ar ticipation in President Nixon's pre-inaugural Task Force on Inflation in 1968. On this task force. I associated myself with the crit icism of “ stop-and-go” m onetary policy, as evidenced by the “credit crunch” of 1966 and the unduly rapid m onetary expansion in the second half of 1968— which, subse quent to our report, led to the “credit squeeze” of 1969. However, 1 m anaged to see that our report recognized the fact that large budget deficits are the most likely fac tor to pull m onetary policy off course tow ard over-expansion, leading later to the necessity of trom ping hard on the credit brakes. Politically, while it is not too difficult to use fiscal policy for purposes of econom ic stimulus, it is very difficult to use it on the side of restraint. Recently, we have again heard words of warning on this subject. In view of the huge deficit in the Federal budget, which threatens to get still larger, Chairm an Burns has stated before the Joint Econom ic Com m ittee his fear that the Federal budget is out of control, and has called for support of current A dm inistration and bi-partisan Congressional efforts to secure passage of a $250 billion ceiling on Federal expendi tures in the current fiscal year. I was pleased to note that the A m erican Bankers A ssocia tion also called for such a ceiling in its action of A ugust 22, and proposed other measures to arrest the alarm ing uptrend in G overnm ent expenditures. A vote on the expenditure ceiling is scheduled in the House this week, and a great deal depends on the outcom e. The fundam ental problem is to re-establish a sense of fiscal discipline in Congress, and especially to regain control over F ed eral spending. Otherwise, fiscal policy will not only fail to live up to its potential, but is likely to defeat m onetary policy as well. U nfortunately, some of those prom inently associated with the “new econom ics” are calling for a different approach than the one I have outlined. In a recent article in the Wall Street Journal, one such represen tative w arned against “ prem aturely” cutting off the m onetary and fiscal lifeblood of the current econom ic expansion, stating that we need not start throttling down until mid1973. In my personal judgm ent, this would be too late to re-establish fiscal discipline for purposes of econom ic stabilization, given current circum stances. In Conclusion In closing, I would like to indicate the challenge I see in my new job which drew me to it, despite the attractiveness of a ca reer in comm ercial banking. I see an o p portunity, which I hope I can fulfill, to serve the com m unity as a whole by accepting a po sition where I can work closely with bankers and businessmen from a huge and dynam ic region— the Twelfth Federal Reserve Dis trict— to help solve some of the trying finan cial and econom ic problem s now besetting society. The kinds of problem s I have in mind in clude: (1 ) the w orld’s apparent inability to come to grips with inflation; (2 ) the acceler ating need for capital, based on rising m a terial expectations, especially from those groups in society which have tended to be by-passed by the promise of technology; (3 ) the exacerbation of the capital shortage by the need to refurbish existing capital facili ties and to improve the quality of the envi ronm ent; and (4 ) the need to use financial institutions in our society in a way which will benefit all of the people, through in creasing opportunities for them to earn their own livelihoods and lead the “good life.” T hat is a tall order— and is a challenge to all of us. Unless we succeed, the future of private enterprise is in danger. In striving for these goals, let us recall the words of W oodrow W ilson's first inaugural address, which happen to be inscribed on a plaque at the entrance to the Federal Reserve Bank of C leveland, where I first began my tour of duty in central banking: “We shall deal with our econom ic system as it is and as it m ay he modified, not as it m ight he if we had a clean sheet o f paper to write upon, and step by step we shall m ake it what it should be”
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