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Lecture 5 of the 19Z.3

Philadelphia Chaptay A. 1. B.
Karl R. Bopp

To summarize eight hours of addresses by four experts, comments
ana questions by twelve members of panels and forty members of the audience
is a man-sized job.

But it is only a third of the topic assigned to me tnis

Another tiiird is to indicate some practical implications of our

four discussions,
things to come."

finally, I am expected to make some "prediction?


You have a right to question all judgments of any indivi­

dual who allows himself to be placed in my position.

I can assure you only

that I have made a genuine effort to aisciiarge my responsibilities because
I believe that bankers are going to be expected to accomplish great tilings
and because I believe that to attempt the impossible is preferable to doing
nothing at all.
To distill the essence of the several contributions, I have cornered each principal speaker, and we have continued the discussion - at times
into the next morning.

Nevertheless, I am fully aware that far better men

have failed at lesser tasks.

Four charts, which have been prepared to facili

tate discussion, will be distributed among you at this time.

With one excep­

tion, these charts contain new information of a ¿surprising character.
One conclusion on which Mr. Young and Mr. Sienkiewicz agree it that
deposits after the war certainly will not return to their pre-war or even to
their present level and probably will not experience any major reduction at

This conclusion is supported by both historical and analytical evidence

The historical evidence is presented in Chart I, which shows the of
national income and the growth of deposits over roughly the past century.

- 2 -


National income has increased from $2.2 billion in 1350 to an estimated $144 billion this
year or at a rate of 4.6 per cent per year, compounded annually.


Deposits have increased from $110 million to $56 billion over the same period or at a
rate of 7.0 per cent per year, compounded annually.


Only once in a century - during the Great Depression of the 1930* s - have deposits de­
clined as long as two years in succession. After the Civil War, after the Spanish
American far, and after World War I either there was no decline at all or the decline was
comparatively small and short-lived.

Alternating moments of optimism anci pessimism become Dlurred in
the perspective of a century which shows clearly
(1) that the most significant characteristic of both income ana
deposits is one of rapid growth;
(*0 that tiie rc-te of growtn ox c.epositt has oeei- xur more lapic than
the rate of growth of income;
(3) and most amazing, that only once in a centuiy - curing the Great
Depression of the 1930's - iiave deposits, declinea as long as t
years in succession. After the Civil Vtur,,after the Spanish
American, after Yvorld v
.ar I either there was no aeciine at
all or the decline was comparatively small or short-lived.
The purely statistical facts, therefore, support the conclusion that
deposits will not decline severely or permanently after this war.
tical grounds alone are inadequate.

But statis­

Vaxia conclusions must be supported by

Y.hat does the analytical evidence show?
In its study of markets After the TV r the Department of Commerce

estimates that if the universally accepted goal, a high level of productive
employment, is achieved after the war, net national income in 19-46 may reach
$135 billion in teinis of 1942 dollars.

This woulu be an increase of 75 per

cent over the $78 billion national income of 194-0*

Since deposits in June

194-3 were only 60 per cent above those in June 194-0, it is reasonable on tnis
ground also to expect that post-war deposits will not fall below present levels
even with a return of prices to their 1942 level.
The increase in deposits since the early 19^0’s i a been a result
of bank purchases of Government securities.

A consiaei-able decline could

occur only as a consequence of a reduction in earning assets oi the banks.
Let us examine the two major groups of tnese assets - loans ana Government
Mr. Young gave you reasons for believing that if bankers are pro­
gressive and forward looking, the post-war period may well be marked by con­

~ 4 ~

siderable expansion in loans though they may not be of the traditional type.

What is progressive and forward-looking banking?

It involves a critical

re-examlnation of the standards that have been applied to prospective bor­


lew standards should not foster policies on the part of prospective

borrowers that will drive the best of them away fraa the banks.
Some of our older standards did just that.

Let us look, for

example, at the most hallowed standard - the current ratio.

Broadly speaking,

a concern that is expanding can increase its current ratio only by increasing

its equity or its funded debt - in otter words, by getting funds from sources
other than 'tanks.

The applicant «ho had secured all M s funds fron equity

and funded debt would have the highest ratio and would be the ideal borrower«

Unfortunately, typically he would not need a bank loan.

Exaggerating, to

sharpen the point, indiscreet application of a current ratio test forced pro­
spective applicants outside the banks to secure funds.

Gradually they stayed

Obviously, this was not the only or even the most important influence in

the decline of bank loans, but it was a factor and shows that lending criteria,
should be devised that will not tend over the long run to drive the nost de­

sirable lenders from the bank.
Qrm ©ouBterpart of this ■
development is that banks continued to f i j p y
indirectly a considerable part - the funds that ^orrowws were getting ©i®®~
where in the first instance.

Banks bought bonds - including those of corpora­

tions whose current ratios would have excluded the» t r m securing loans.


-.tatt:mirV4 ^ n m d and the loan was only typed, but both were extensions of

' w M % ttrltanmvr» aad the m m fundamental standard© sight reasonably be

to both.

A r«>-e:m»ination of erniit standards is m iapera-

- 5 -

To return to our major topicl
tic viev; than

M r.

One might take a much more pessimis­

Young and still conclude that loans v.'ill show no consider­

able decline at least relative to total earning assets rather than to total

I know no informed person who anticipates any great decline in de­

posits resulting from declines in loans.
What are the prospects that the other major earning asset - bank
holdings of Government securities - will decline appreciably in the post-war

There are two circumstances under which such a decline could take
The first is in a reduction in total Government debt and the second is

a redistribution of the ownership of the debt.
As to the first, not even the most ardent optimist believes there
will be any considerable decline in Government debt inuaediately after the

On the contrary, for the reasons advanced by Mr. Sienkiewicz, it is

probable that it will increase, at least for a time, irrespective of the ad­
ministration in power.
As to changes in the ownership of Government securities, we may
assume that banks are the "residual" owners, adjusting their holdings to meet
the needs of other investors.
of these other holders?

What is the probable post-war absorptive power

They may be classified into two groups;

first, those

owners - primarily Government agencies and trust funds and insurance companies which may be expected to have regular additions to funds available for invest­
ment; and second, those groups - primarily corporations and individuals whose saving and investment patterns fluctuate widely from time to time*


us examine these two types of holders in turn.
Barring changes in legislation, the U» S. Government agencies and
trust funds may increase their holdings by approximately a billion dollars a

Over any considerable period of time — barring liquidation of other

- 6 -

assets — the maximum net addition of Government securities that insurance com­
panies coulc be expected to acquire would be an amount equal to their annual
increase in admitted assets, namely, $1^ to i 2 billion a year.

These sources,

therefore, cannot reasonably be expected to acquire more than about $2^ billion
of Government securities a year, and their actual acquisitions may be less.
What about individuals and corporations?

On balance, we cannot

expect them to increase their net holdings of Government securities in the
early post-war period.

On the contrary, it is extremely likely that they will

liquidate their holdings at a higher rate than
clusion of the war.

billion a year at the con­

Certainly many of the securities are n
ov. being acquired

for tr:is purpose.
The conclusion of Mr. Young and Mr* Sienkiewicz that there is little
likelihood that deposits will decline considerably in the post-war perioa,
therefore, is supported by both the analytical and the statistical evidence.
What are the implications of this conclusion for you as inaividual

In the first place, since there is no prospect that the total num­

ber of banks will increase appreciably, it is evident that on the average
individual banks will have permanently larger deposits.
At this point I part company from those advisers who urge that all
banks build and maintain a portfolio of Governments more or less equally dis­
tributed among maturities up to ten years.

If your problems were as simple

and as uniform as this recommendation implies, you would have very little
justification for a continuation of the traditional American unit bank.


unit bank is justified in part because problems confronting individual banks
are not the same.

In my opinion, each bank must devise a loan and investment

policy tailor-made to fit its own circumstances.

A universal, ready-made

policy would fit individual banks about as well as a standard uniform would
fit all the members of our armed forces.





also disagree with those who advise bunks to keep »11 of their

increase in deposits in idle cash, Treasury bills, or certificates of in­

This advice apparently is based either on the negative attitude

that since nobody can tell precisely what is going to happen we had better
assume the worst, or on the assumption that interest rates are going to rise
and that funds should not be invested until they do.

Many bankers, I am

told, have maintained an extremely liquid position on the expectation or in
the hope that higher interest rates were "just around the corner.” Without
attempting to predict the future of interest rates, I shoulc like to point
out that even though this second assumption turns out to be correct, it may
be very expensive to follow the advice presumably based upon it.

The mere

possibility that interest rates may rise is not sufficient ground to defer
investment in, say, ten-year bonds.

The crucial questions are (1) How fast

and how far must they rise to justify the delay? and (2) what is the likeli­
hood that they will rise sufficiently?
volves judgment.
this evening.

The answer to the second question in­

You will appreciate why I shall make no effort to answer it

The first question, however, is purely technical, and Chart II

has been constructed to answer it.

It shows how fast interest rates must

rise to enable a bank to retain liquid funds and still not lose money over the
next ten years.

(Discussion of Chart II)

It should be mentioned, incidentally, that it is not the ten-year
rate that must rise in the way indicated; it is shorter-term rates.

As an

illustration, the one-year rate must rise from 7/8 per cent to 21.9 per cent
at the end of nine years to warrant retention of funds for nine years as ex­
cess reserves.

In other words, even though the hope of some for a rise in

- 8 -

Per cent

This chart shows at the beginning of each year the rates at which "available" funds
would have to be invested to yield as much in 10 years as 2 per cent bonds, compounded, will yield,
Line 1 - that the fonds are held idle until they are invested.
Line 2 - that the funds are "placed" in Treasury bills at 3/8 per cent until they are
"invested" for the remainder of the period.
Line 3 - that the funds axe "placed" in certificates of indebtedness at 7/8 per cent
until they are "invested" for the remainder of the period.


A. If a bank invests $100.00 in 2 per cent 10-year bonds at par, it will have, with
compounding, $121.90 at the end of 10 years.

If a bank holds the $100.00 idle for 5 years, it will have to invest it at 4.1 per
cent compounded to have $121.90 at the end of 10 years.


If a bank places the $100,00 in Treasury bills at 3/8 per cent compounded for 5
years, it will have "available" $101.89 which must be invested at 3.7 per cent for
the remainder of the period to have $121.90 at the end of 10 years.


If a bank plaees $100.00 in certificates of indebtedness at 7/8 per cent compounded
for 5 years, it will have "available" $104.46 which must be invested at 3.1 per
cent for the remainder of the period to have $121.90 at the end of 10 years.

If the period prior to "investment" i* 8 years instead of 5, the corresponding
investment rates would be* for cash, 10.4 per cent; for bills, 8.8 per cent; for
cartifiomtes» 6.6 per oent.




rates materializes, they will still lose earnings unless the rise comes soon
and is comparatively large.
Of course, no one intends to keep funds idle for two years, five
years, or ten years,

i i n have intended not to for ten years - ten years

over which 20 per cent was not earned - always in the hope for the rise that
never came.
It should be mentioned that in constructing this chart I have made
the most unfavorable assumption for the investor in longer term securities,
namely, that neither the present general level nor the present structure of
rates will be maintained - in other words, that the securities must be held
until maturity.
If we assume that the present general structure ana level of rates
are maintained, the results will be even more favorable to those who buy longer
maturities at the present level.

Chart III, taken from the official Bulletin

of the United States Treasury, shows the structure of rates on September 30.
It shows the familiar pattern of 3/8 per cent at three months, 7/8 per cent
at one year, 2 per cent at ten years, 2% per cent at twenty years.


above the curve indicate issues that are technically "weak" in the market;
those plotted below the line are issues that are exceptionally strong.


general principles of purchase and sale of particular items in a general market
apply here also, and I needn’ go into the details.
If one assumes that this pattern of rates is maintained, he can
construct the price history of a bond.

A history of a 2 per cent taxable and

callable Treasury bond is shown in Chart IV.

If the present pattern of rates

is maintained - or if only that portion of it which exceeds two or three years
is maintained - it is possible to secure a minimum effective yield of approxi­

per cent irrespective of what happens to shorter term rates.




Based on Mean of Closing Bid and Asked Quotations
Per cent

Available to all investors;

Fixed maturity issues
(except notes at a discount)

* Notes at a discount
• Callable issues
Available to investors except coam«rri«.l banks:


Callable bonds

Bulletin of the Treasury Department, October 1943, p. 65.

- 11 -


N u m b e r


y e a r s



d a t e

The price of a Treasury bond is determined by:

The nomiaal rate
The yield


The maturity

This chart of the price equivalent of taxable Treasury bonds is based on (l) a
nominal rate of 2 per cent, \2) the existing structure of interest rates (see Chart III)» and
(3) the assumption that the bonds will be called. The bonds are issued and redeemed at par.
While they are outstanding, they are valued at various prices above par because the nominal
rate is greater than the yield.

- 12 -

It is against this general background that the individual banker
must shape his own policy.

No one can do that lor him.

Meetings such as

this can be helpful1in indicating some of the important factors that should
be taken into account and^in outlining a method of approach.

For the indivi­

dual banker the important thing is to analyze the position of his community
in the post-war world.

Just as the uneven stimulus given by the development

of war industries and military centers has resulted in an uneven distribution
of deposits - described by Mr. Sienkiewicz in his discussion - so the banker
must expect shifts of deposits after the war; some communities will gain,
others will lose.

His community will tend to gain deposits as its businesses

and individuals sell their products and services outside and will tend to lose
deposits as they buy elsewhere.

The community^ net position will be in­

fluenced by such factors as changes in population and working force, the
adaptability of local productive facilities to the satisfaction of post-war
demands, the expenditures of the inhabitants especially for durable consumers1
goods, and the needs of business establishments for reconversion to a peacetime
The first step for the individual banker, therefore, is to analyze
his deposit structure.

It is to facilitate this analysis that the Federal

Reserve System recently asked you to classify your deposits.

The analysis of

the information that you submitted to us appears in our Monthly Review that will
be sent to you the first part of next week.

The purpose of collecting this

information is not to keep us busy at the Fed, but it is to assist you in meeting
the very difficult problems that you face.
Along with the analysis of his deposits the individual banker will
wish to study his prospects for loans.

Although available evidence indicates

that business in general is becoming more liquid and that many concerns may be

- 13 -

able to finance post-v;&r conversion costs out of their own resources, the
banker will wish to study particularly those businesses which are low in cash
and securities and high in inventories and receivables as prospects for loan
After he has completed the analysis of deposits ana prospects for
loans, the banker will be in a position to determine his investment policies.
It is hoped that the charts and discussions which have been presented will be
of some assistance in formulating such policies.


I have spent considerable time to discuss Government securities
because they are of outstanding importance at the present time.

But I must

now travel with 'teeven-league boot^'to complete my assignment of predicting
things to come.

First permit me to catalogue some factors of outstanding

importance but concerning which only those who commune with the Burning Bush
dare prophesy:

The duration of the war in Europe and the Far East


Governmental policy with respect to renegotiation and cancellation
of contracts, including rapidity of settlement


Governmental policy with respect to stock 'piles


Governmental policy with respect to Government-owned plants ana


Governmental policy with respect to demobilization


The tax structure
Next there are factors about which we may be reasonably certain:


The total deposits will be far higher than before the war


Federal Reserve will have larger amounts of short-term Government





Taxes are bound to be on a permanently higher level
Total, say, $15-20 billion a year (interest charges $4-6 billion;
armed forces 5-6 billion)
In the 1930's expenditures never over $8 billion
In the 1920’s not over $4 billion


Prices probably will be higher than in the 1930’s


Large deferred demand in the post-war period


Controls will continue for a time
In time you nay prove me wrong on these predictions on the analysis.

In self defense, therefore, I shall make some predictions concerning which
you will not be able to prove me wrong - because neither you nor I will be
here at the time.

We are fighting this war not only for ourselves but for

our children and grandchildren.

It may, therefore, be worthwhile to consider

the economic possibilities of our grandchildren.

These possibilities, in

my opinion, are much less influenced than is commonly supposed b> the amount

4t O CiM,
f -e
of destruction that is now'going on.^


is true though incredible, that at the

present rate of saving we could raze physical America except for land and
people and could reconstruct it in two to three years.

The economic possibili­

ties of our grandchildren are more dependent upon the rate of invention and
its effect upon output per manhour.

Aamdni n^- ti*e possibilities, we find that

output per manhour in industry, in physical terms, practically doubled between
1923 and 1943 1 increasing from $2 to $4 in terms of 1939 dollars.
a rate of 3 per cent compounded annually.
cent per year.

This is at

In agriculture the rate was 1.2 per

Similar rates of growth have continued for well over a century

despite minor variations

between periods of war o.nd peace, prosperity and

depression, old deals and new deals.
Successful invention moves irreversibly in one direction, namely,
to reduce^costs.

The picture varies widely among various branches of activity.

In some, progress is sporadic with occasional revolutionary discoveries raising


output to new and nigher plateaus«



In others, smaller innovations are fre­

quent, and pro0ress is more regular.

But the effect on over-all activity is

a comparatively steady increase in human efficiency, which varies somewhat in
rate but not in direction.
Of course, there are always Cassandras who cry that this process
must stop sometime.

Henry L. Ellsworth, Commissioner of Patents, raised his

voice to this effect almost exactly a century ago in his report of January 31,
1844-, to Congress:

"The advancement of the arts, from year to year, taxes

our credulity and seems to presage the arrival of that period when human im­
provement must end.”

The war itself has demonstrated the possibilities

of increased efficiency have scarcely been tapped.

It l a demonstrated that

our population possesses latent abilities far beyond those that management has
utilized in the past.

Through careful training programs, skills that once

were acquired only after very long periods of apprenticeship

are now developed

almost literally overnight.
What are the economic possibilities of our grandehildren if we
capitalize on our war experience?
in twenty years.

In the past, output per manhour has doubled

If it continues to do so for forty store years, our grand­

children in 19B3 will have the following options:

Real incomes four times our own


Real incomes twice our own with a twenty-hour work week


Real incomes equal to ours with a ten-hour work week
At this point you may feel that you were born too soon.

not said our grandchildren will have no problems.

But I have

I have said merely that

with intelligence "the economic problem" as we have known it can be solved.
They will have to face the problems that arise from leisure.

are t y no means unreal.

These problems

One of the advantages of a long work week is that it

- 16 takes us out of ourselves far

considerable periods of tine.

Many people,
flMXAKtiM. *«+
I am told, could not live with themselves for any extended period.^ They ntm

concentrate on the real htnan problems: the problems of the good life*
In that era the economist may be permitted to perform his real
function which is analogous to that of the dentist*
will not wait until they have a toothache

His customers, we hope,

to visit him but will see him at

least twice a year/
In charting a course of action for the future I think we may be
guided by a statement of one of my early teachers, Ityron W. Watkins, then of
the University of Missouri, now of New York. University*
"Pursuing this middle-ground policy in this tentative, adaptive manner
will not appeal to those impetuous persons who, according to their
temperament, demand that either unrestricted freedom or unlimited
authority shall prevail* They foresee, moreover, only complete ruin
from a failure to adopt the favored principle forthrightly, and they
promise an earthly paradise 1Mediately that the right policy is
embraced* But centuries of experience have slowly been maturing in
the mind of the common man the conviction which philosophers reached
in old Greece when thought was first turned inward upon man himself
and hip social life, that visionaries and cynics alike are unsafe
guides on society's great adventure*■