Full text of Statements and Speeches of Karl R. Bopp : Transition from Government Credit to Private Credit : Robert Morris Associates, Union League

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TRAiNSITIQH FROM GOVERHIIBT CREDIT TO PRIVATE CREDIT
Address of Karl R. Bopp
Director of Research, Federal Reserve Rack of Philadelphia
before dinner meeting of Robert Morris Associates
Onion League, March 20, 1947

Since it Is obvious that most of the serious economic problems
we now face had their origin In the war, it Is desirable to review briefly
what has happened to our economy since 1939«
have their

Economists, like credit men,

owa. technical jargon* One tool that Is useful Is what econo­

mists call the gross national product and its components«

Gross national

product is simply a phrase which means the total production or output of
all goods and services*

It may be divided into three components*

first is governmental expenditures for goods and services.

The

That item Is

clear as long as we remember that expenditures of both federal and local
governments are included.

The second item has a forbidding title.

It is

called private $ross capital formation, and Is made up of the gross amount that is, allowing nothing for depreciation, etc. - of investment in build­
ings, machinery, inventories, and net exports*

The last item consists of

expenditures for consumers* goods and services«
In these terms the major economic developments of the war were
am enormous expansion in the total end a revolutionary change in the rela­
tive Importance of the three components*

Gross national product increased

from $89 billion in 1939 to $193 billion in 1944» the last full year of
the war*

One component» governmental expenditures, accounted for $81 bil­

lion of thla increase*




At the peak such expenditures were half of the

•2total*

In other words* roughly half of the entire output of the country

was purchased by government, both federal and local«

In contrast» pri­

vate gross capital formation declined fro« |11 billion in 1939 to $2
billion In 1944«

Considers1 expenditures for goods and services, how­

ever, Increased from $62 billion In 1939 to $99 billion In 1944«
■any economists «bo followed these developments concluded that
this country would be In for a. first-class depression shortly after
Day and especially If ?-J Say followed 'ihv v ffo after V-E Day*

Essentially

they based their conclusion on the answer they gave to one all-important
question»

The question was;

Bio will buy the products when government, a

single customer taking half of all production* reduces its expenditures
3S
90
from roughly $100 billion a year to, say, 4 M o p $gf billion a yeart *
Their answer was: Ho one*

Hence they confidently predicted \mwmp] oywont

of eight, of ten, of twelve ml lllan people within a few months after ¥-J
Day*
Vhat actually happened!

Xdu know In general terms, but It Is

worthwhile to review developments quantitatively*

first of all, gross na­

tional product last year, the first full year of peace, was $194 billion
or within a few per cent of the wartime maximam*

Governmental expenditures

for goods and serrices declined from $97 billion in 1944 to $35 billion last
year*

How did our economic system make up this difference?

About half ease

from private capital formation #ilch Increased by $30 billion*

The other

half name from consracr expenditures which increased by $ 3 6 billion»
B jb serious error of prediction Is accounted for largely fcy •& im­
portant omission In the analysis«

the omission of finance*

the mistake Is

shoem in the way many economists answered the question« there did the




government get the money that it spent!

The answer given tor eany was based

on a different breakdown of gross national product*

They said it came from

taxes* from savings of individuals and of corporations* and from business
reserves«

low there is a sense in which this is true*

After the event

one can make such a classification if he wishes«
For the problem with which they were dealing, however* I believe
it is much acre useful to admit frankly that we simply created new money
to pay for these expenditures and that such creation of money i* something
different from what we customarily call savings*
What do we find if we take a financial view of the war!
government spent approximately $380 billion«
$153 billion from taxes*

Of this amount it scoured

Kow that is a let of taxes* as we all realise

each time we make out our individual income tax returns.
40 per cent of the amount spent*
bank sources«

The

But it mas only

Another 35 per cent was borrowed from non-

Together thsse two account for three fourths of the total«

The remainder* of course* had to be raised somehow.
ing securities to banks*

It mas raised by cell­

This method provided something like one-fourth of

the cost of the war to the United States«

iou have heard this to the point

of being bored* but it bears repeating that every time a bank purchased
Government securities it increased the money supply*
tially the way we financed the wart

This* them* is essen­

40 per cent by means of income or taxes

for the government| 35 per cent by means of borrowing from people*» income
or from money that was already in existence! and the remaining 25 per cent
by creating new and additional money*
Bow* that new sad additional money was not blown up as were the
it mas used to purchase*




In large pert it is still with us*

Add to

-4a money supply of about $65 billion which we bad when the war broke out
another $95 billion that was created during the war period and I t.Mnk
you can reasonably expect a strong demand for go ds and services.
had it*

Ve have

We turned out more goods during the war but unfortunately , great

as was the Increase in the real things, it was nothing
the increase in the money supply.

as great as

He were wore effective a&nufacturers of

aoney than of many other things*
Qx dinarilv one would have expected enormous increases in prices*
During the war the government did not permit that to happen*

Ve had direct

oantrols over prices, wages, and distribution* so that the evidence of what
we ordinarily call inflation were kept submerged*

Even so the cost of

living went up 30 per cent and the wholesale prises went up 37 per cent*
When the controls were taken off we had further spectacular increases in
prices*
Mow* what al?out the year 1946 in banking?
developments into a number of parts«
States Treasury*

We can divide the

The first is the program of the United

It was the financial operations of the Treasury throughout

the war which was the m ost Important single aspect in the whole development*
It gave the drive to these inflationary developments that 1 have mentioned.
The Treasury happened to end the
in all history*

year^with the largest bond drive

In part because people were quite sure it would be the last

one and the last chance to get securities* the Treasury raised more money
in the December 1945 drive than it had any need for*
raised seme $25 billion more than they needed*

As it turns out* they

A fair share of this* of

course* came from a shift of deposits from private individuals to the
Treasury*

A large part came from the creation of new deposits* which had




not been in existence before«

What the Treasury did in 1946 vac to repay

eoccessive borrowings of Decenber 1945«

During the year 1946, the Treasury

repaid $23 billion of securities, and it called down its balance by about
that same amount*

Now it is easy to look at total figures of deposits and

to say that since the Treasury red«nption program has reduced deposits we
need no longer worry about inflation*
Before we do that, however, we should analyse the entire opera­
tion*

Remember that the decline has.come In deposits which otherwise would

net hare been spent*

Where did the money go?

to hold the securities that were redeemed*

That depends on who happened

To the extent that you as com­

mercial banks held them, what happened, although not precisely for each
«■>
bank, was that the Treasury drew on its War Loan Account with you, trans­
ferred funds first to the Federal fieserve Bank, and then to you as you pre­
sented maturing security for payment*

The net result on your balance sheet

was a reduction in War Loan Accounts offset by a reduction in your own
security holdings*

It reduced your earning assets, of course, but the War

Loam Account wms a deposit that otherwise wouldn’t have been spent*
Fart of the redeemed securities were held by nonbanks«

In that

ease the owner turned his security in and got his mooey from the Treasury«
The Treasury called on Its War Loan Aeoouat to pay the private individual,
who deposited the proceeds*

That had an effect on your reserves because

you were not required to keep a reserve against your War Loan Accounts bat
are required to keep a reserve against your private individual accounts«
So you had pressure on your reserve coming from that source«

If one analyses

inflation, however, he must reswmber that whereas the deposit of the Treasury
was an Inactive account, the account of corporations or individuals who held




- 6the security that «as redeemed is an active account.
securities «ere held by the Federal Reserve.

Finally, some of the

A call on your far Loan

Account to pay the Federal Reserve produced a corresponding reduction in
your reserves aa veil as in your deposits*
The redemption of securities held by the Federal Reserve and by
nonbank investors has produced periodic pressure on your reserveS*
has

fiat it

not been deflationary because whenever you needed reserves you «ere

able to get tham by selling Government securities*

When necessary, the

Federal Reserve purchased those securities.
The second major hanking development in 1946 ooncems bank loans.
Here there is both a long-term sad a short-term problem*

The Rational

Bureau of Economic Research has just published a book called Business Finance
and

The Bureau sails It the capstone study of seven years of mark

on trends in Aaeriosn banking.

In it, Beil H* Jacoby and R* J* Saulnlar

trace banking developments since 1900*
As one reads between the lines a little» one gets the impression
that banks may not have been aware of the importance to themselves of tbs
developments that «ere taking place*
financing the consumer*
sumer* s loan to speak of*

For example» banks did not go into

Even at the end of the last mar, they had no con­
Instead of that banks financed the institutions

created to finance the con timers*

Similarly» they vould not extend a loan

that «as a little longer than the ordinary term» but they did buy bonds of
long term*

Ve developed in our financial organisation new institutions to

meet the changing needs that developed in the period 1900 to 1940 and that
banks did not meet*

I point that oar merely ss background.

true of banks in the last year or year and a half*




It has not been

-7Am you know, ve at the Federal Reserve have recently asked you
to report to us the kinds of loans that you make*

One reason for asking

for that information is that we thought you noulxi be interested in the
results*

In the next issue of the Federal Beserve fal l e n there will be

an article smearlsing the results*
while to read that article*

I think it is very such worth your

The results for the Third District are given

in the monthly review of the Federal Reserve Bank of Philadelphia*

For

the country as a whole the year 1946 saw an increase of $5 billion in total
loans*

This is the largest increase for any twelve--month period going bade

to 1919*1920» and even that period wasn’t larger; it was as large but not
larger*

This increase raised total loans to $32 billion» which is the

highest voluae since 1930*
Bow» let’s look at the distribution otf those loans for a noment*
One type» loans on securities» declined*

Such loans are far less now than

after the First lorld far» in part because of different financing technique««
Of course at the sod of 1945» just after the war loan drive, we had an ex­
ceptional volume of loans on securities»
of $3§ billion*

In pert that explains the decline

What kind of loans went up?

First of all» business loans«

Hers tfce increase was widespread, over the entire country and practically
every type of business» at small banks and at large banks*
reasons» so far as they can be ascertained?

lhat are the

First» costs are up*

Prices

are up» wages are up, and so the costs of doing business have increased} and
firms have found it necessary to borrow a little more*
especially price-wise*

Inventories are up»

n t h the larger volume of business that firms are

doing» they find their customers need a little more credit, and so you have
some extensions of credit to customers» and an increase in that*




likewise»

-8locals for aooendzation and expansions loans to scne fircis because their
operations have been interrupted br strikes, transportation difficulties,
and 30 on * Now all of these tiling#, unless I read history wrong, are
evidences of inflation*

They fcre the very types of tilings that have oc­

curred every ti&e *e have had an inflationary development*

In other words,

we are in a typically inflationary period, as evidenced by the type of
business loan*

Consmer loans also ere up about

ago, a total of $1*5 billion*
or

50 per cent over a year

Real eatate loans are also up $2*5 billion,

50 per cent.
This gives se only a few minutes to go into the quandary about

the fixture, or where do we go fro» here*
Bituatiosi is this*

What pussies Be about the present

We have heard a great deal about the danger of banks

getting a’f&y from their true function.

Professor Robertson, an outstanding

Raglish. economist of the present day, gave a talk to London bankers recent­
ly on *Is thsre a future for banking?*
asking the question*

Be said that was a dramatic way cf

One thing that made him ask the question was the ap­

parent secular decline in the desire for the type of credit that banks like
best to provide*

*111 the decline continue?

tions and activities?

Will .banks develop new func­

If the only important decisions reselling for bankers

a decade hence concern the maturities of the Governments it holds, then you
cannot possibly ^©t as much fxax.out of banking as when you aake plans to
help build up your rfeminity*

That is one side of the picture.

As I look

at it, I say I an all for the extension of risk credit, the extension of
private credit by basks, because, in ay jwlg&ent, that is the m y in which
you build your coeumnlties and perfor* a real service, an indispensable
function.

If that were the only side I would be very happy about this de­

velopment 1a



-9Is there another side to it? Why not just be happy about it?
Well, there is another side*

It becomes evident when ve ask* Where is

the money cooing from that is being used to make the loans? In much earlier
days* if I am informed correctly, bankers usually asked themselves this
question before they made a new loan.

They thought "If I make this loan,

will I have to call a loan from somebody else?" There was an alternative,
especially after the establishment of the Federal Reserve System; namely,
borrowing, but no one wanted to borrow* You didn9t like to show borrowed
money cm your statements*

So you could either barrow or call in some other

assets, and there was always the question of where the money was

from*

It seems to me that question isn’t being asked very much any more*
It is assumed that the Government securities will be there and all that is
necessary is to sell them*
reasons

That apparent attitude bothers me for this

If banks sell their Governments and the Federal Reserve buys tham

to maintain the market, what we are doing is to add monetisation of private
credit on top of the great volume of public credit we have already monetised*
My quandary arises from the fact that I mould not like to see
happen in the short run what I think is desirable in the long run* If banks
extend private credit on a large scale now, I greatly fear much of it will
result in net additions to our money supply, which is already excessive*
Oli the other hand, if they do not extend such credit now, will they ever be
able to recapture this important function?
Some people are disturbed by loan volume because they are afraid
we are shortly going to have a business bust. I personally don’t think we
shall} but, more important, I don’t think that is the critical problem* I
^Mnk that

is faced with a much more serious problem in the long

nan, sad that is the problem of whether we have a first class inflation




- 10 from here on out* If we do» banking is in for really serious ’
trouble*
If, as we extend private credit, ve get the money by selling Government
securities to the Federal Reserve, that, in my opinion, is exactly what
we are going to have* So I am much more deeply disturbed than I would be
with an early transitory and not very significant break* I don’t think
are going to have that} but even if we did, it wouldn’t disturb me nearly
as much as this other possible development*
Veil, what’8 the way out? There is no easy answer*

I think me

as bankers should again ask the question as to where the money is coming
from* That is one of the reasons wby, for my part, I ^ m s teemed Mp^ajelU
the program that the Treasury has just announced to foster the purchase of
a bond a month from deposit accounts* I think we should all get behind
that program* As individuals buy bonds from the Treasury, the Treasury
will have funds with which to redeem securities held by banka and thus
reduce the volume of deposits* If every time a loan is made depositors
buy an equal amount of Government securities, the total volume of deposits
will not increase* In a broad sense» the depositors will provide the funds
that the bank lends* On the other hand, if the bonds go to the Federal
Reserve Banks, we shall have a further expansion of deposits*

To follow

this course will, in my judgment» lead to real trouble*
So I would say that when we make a loan we should ask ourselves*
there is the money coming from? Ve should also do everything possible to
see that the Government securities now held by banks are bought by nonbank
holders*

If we do that» we can have a real

from public to pri­

vate credit rather than an addition of private to public credit* If we do
it» banks earn perform a function not only in building their own communities,
bat aleo in protecting the eeoncey against the still serious threat and
dangers of inflatlem*



THE TRANSITION
FROM PUBLIC TO PRIVATE CREDIT

Outline
of talk

Karl R. Bopp

before
Philadelphia Chapter
Robert Morris Associates
at the
Union League
Thursday, March 20, 1947




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- 1 -

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a* Aston d# 8 ui » ihrnxd, i M i U i

b. Bob iilk e r t, Tale, story
Om a a ^
c. ty M if, Frinectom
*
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d. itt. tat bqr kittlag far * * a Bath
kUOW )M(V;flftMll S OMI
a.

Hot a Virgil Jordan
Can’t recite incomprehensible
numerical abacadabra that will fore­
cast precisely when the Knodratief,
Juglar, building, inventory, or
fountain pen that will write under
water cycles will turn.
I believe that where we go from here
depends on how we behave.

b.

May say things you already know
- "I«m color blind"
■Yo sho is!"

c.

My suggestions at the end may sound like
those of psychoanalyst.
G.I. and psychoanalyst
"Boy, is that guy confused I"




- 2 -

I.

Economic developments 1939-1945
A* How the money was spent

Annual totals
1939 19(40 1941 1942 1943

I.p................................
vt expend, for
;oods and services
Ivate gross cap­
tai formation...
assumer goods and
vices.«•......
iome payments to
Individuals......

1944

1945

88.6 97*1 120.2 152.3 187.4 197.6 199.2
16.0 16.7

26.5

62.7

93.5

97.1

83.6

10.9 14-3

19-1

7.6

2.5

2.0

9.1

61.7 65.7

74-6

82.0

91.3

70.8 76.2

92.7 117.3 143.1 156.8 160.7

98.5 106.4

B. • Where the money came from for govt, expenditures
and private capital formation
1.

Customary breakdown
a. Taxes
b. Savings of individuals
c. Savings of corporations
d. Business reserves
But that is merely what economists
call an ex post truism

2*

A more meaningful approach.
Emphasis on source of Federal Government
funds
- June 1940 to December 1945
a. Amount raised - $380 bil.
b. Tax»«
- 153 bil. - 40%
c. Borrowing
- 228 bil. - 60%
firea nonbaaks - $ 1 3 3 bil»
banks
95 bil.




fxm

- 3 -

C.

Some results
When you add $95 billion to a money supply of
$65 billion you are entitled to expect some
spectacular results. We got them.
1.
2.
3*

D.&E.

Increase in employment, output, etc.
Prices and vages held in check by direct
controls
Nevertheless C. of L. up 30% and wholesale
prices up 37% by 1945
Thè dire predictions and the results Xor 1946

1945

1946

199.2

194.0

83.6

35.0

9.1
106.4
160.7

32.0
127.0
163.7

Govt, expenditures for goods
Private gross capital
Consumer goods and services.•
Income payments to individuals

F.

The banking year 1946 in retrospect
1. Redemption by Treasury and its meaning
a. Repaid $23 billion
ca. equals decline in general fund
balance
b. Effect on reserves and total deposits
(1) Bank held debt
(2) Public held debt
(3) Reserve Bank held debt




-

F.

2.

u

-

Banks'loans
a. Long-term development
(I) Business finance and banking
Jacoby and Sauliner - NBER
Bank shifted only gradually from
commercial loans to financing
those who finance the consuaer
and then to direct consumer
financing.
Also bonds and real estate
b. Developments in the past year
Post-war revival in bank lending
March FRB
(I) Total loans
In 1946 increase of $5 billion
Largest in any 12-month period
since 1919-1920.
Raised total to $32 billion highest since 1930*
(II) Distribution of loans
(A) On securities
Drop from $7 to $3^ billion
(B) Business loans
Increase widespread despite
large liquid asset holdings.
Much at long term.
(1) Reasons - not needed to
maintain adequate demand
(a) Costs up - prices and
wages
(b) Inventories up especially price-wise
(c) Credit to consumers on
large volume of sales




- 5 -

F.

2.

b. (II) (B) (I) (d) Modernization and ex­
pansion
(e) Strikes, transportation
delays, shortages
In summary, typical of
inflationary period
(C) Consumer loans
up $l£ billion - 50%
(D) Real estate loans
up
billion - 50%




-6 -

Jl. What of the future?
A* Quandary:
1. Functionless banks In Governments
2. Builders of community through vise
and progressive attitude in extending
private credit
B. But where is the money coming from?
1* Earlier experience
a* Didn't want to borrow
b. Hence had to call other loans
2. Reallocation of resources
3« Creation of new money - sales of
Governments to Federal Reserve
Unfortunately individual bank can't tell
where money is coming from for particular
loan.
C. Reconciliation?
Aggressive sales of Governments to nonbank
holders
D. Remember each time we lend that it may be
necessary to create the money