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ADDREüfc' > T THE
29th ANNUüL MEETING
OF TEE
CHAMBER OF COMMERCE OF THE UNITED STATES
AT
WASHINGTON, D. C., M Y 1, 1941

BY
M A S R U m S. ECCLES
CHAIRMAN OF THE BOüfíD OF GOVERNORS
OF THE
FEDERAL RESERVE SYGT33«

FOR KSLBhSB IK APgHBWOOK II&7SPAPERS OF

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FINANCIAL PROBLEMS OF DEFENSE
The problem of financing defense is not solely the responsibility
of Government. The business interests of the country have a very important
role to play.

For this reason I appreciate the opportunity, as a public

official having some responsibility for the conduct of public affairs, to
spealc on this subject at this meeting of leading business executives from all
parts of the country.
The financial problems of defense arise from the unprecedented size
of public expenditures, concentrated mainly in the field of heavy industry,
and the necessity for calling forth in tho shortest possible time the maximum
amount of defense production both for ourselves and for those ’ wish to aid.
vc
The financial problem is not hov? to provide an adequate supply of money but
how to direct tho use to which money and credit arc put in Such a way as to
further the success of the enterprise and to avoid inflationary consequences.
The avoidanco of inflation is as essential for the preservation of our
political and economic system as the defense effort itself.

I am U3ing the

word inflation in the popular sense of disruptive price risos, whether con­
fined to some segments of tho economy and due bo non-monetary causes or of e
general nature and due to oxccssive monetary and credit expansion.
We can meet defense needs and supply our civilian population only
to the extent that we utilize our man power, materials and productive facili­
ties.

Defense must come first.

What is left over will determine the extent to

which we can meet civilian requirements.
ample supply of money is concerned.




Me have no problem insofar as an

The volume of demand deposits and currency

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now in existence approximates $45 billions, or 50 per cent in excess of the
peak amount of the twenties.

The present volume could be increased almost

indefinitely by further expansion of bank credit in loans to corporations,
to individuals and to the Government. Merely to increase the supply of money
would not in itself bring about needed production, but might result in in­
flationary development s.
Rather, a ©rimary concern of defense financing is to avoid an in­
crease of the means of payment, that is, of money in the hands of those who
would spend it faster than our economy could produce goods.
in a rapid bidding up of prices.

This would result

The problem in general terms is simple, but

in detailed application it becomes difficult and complex.

In general terms, it

means that we should aim to finance defense entirely out of taxation and
savings, preferably taxation as full employment and production arc attained.
It means priorities in certain fields where both civilian and defense require­
ments cannot be immediately supplied out of available raw materials, existing
capacity, or available skilled labor supply.

It means price controls in cases

where demand for essential basic materials exceeds present supply.

It means a

program of taxation that will transfer back to the Government in the aggregate
a substantial portion of the funds spent by Government, thus reducing the funds
available to the public for private expenditure.

It means encouraging a

maximum amount of savings by all groups and classes of the population.

It means

avoidance of unneeded expansion of bank credit which adds to the supply of
money and thus of purchasing power.




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It is evident that the general problems of defense financing, which
I have enumerated, are interrelated and must be dealt with by a coordinated
series of measures.

For instance, inflation cannot be dealt with solely by

monetary and credit measures.

As a matter of fact, at this stage of our

defense effort such measures aro of secondary importance.

Fiscal policy, in­

volving both the type of Government financing and taxation, and dircct controls
are far more important at present.
Let us consider briefly some of the more important aspects of this
general summary.
In order to limit the need for price controls and priorities every
means possible should be used to increass the output.

This can bo done by

expanding the facilities of production, by increasing the available labor supply
where there is a shortage of certain skills, by tno working of longer hours, by
preventing strikes and unjustified wage end salary increases, and by utilizing
to the fullest possible extent existing plant and facilities wherever they may
be.

To be sure, this is a difficult and a complicated task, requiring full

information and full cooperation on the part of Government, industry end lab'ir.
In my opinion, taxation is tho most important single means of main­
taining stability in tho economy and of preventing either general inflationary
or deflationary developments.
a means of securing revenue.
the primary consideration.

We must abandon the idea that taxation is merely
The effects of taxation on the economy should be

For a tax system to be equitable, ability to pay

should be the guiding principle.

For this reason, a general sales tax, which

has been strongly advocated by business groups, would be a great mistake because




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-4 it would fall heaviest on those least able to pay.

Selective sales taxes

which would have the effect of reducing demands for certain products, such as
automobiles, mechanical refrigerators and other articles that use resources
greatly needed for defense, are justifiable and necessary at this time.

Sales

taxes on foodstuffs, clothing and other necessaries are wholly unwarranted,
particularly when surpluses exist.

Taxes on such items would tend to diminish

consumption, thus reducing effective demand. This, in turn, may create
localized unemployment as well as idle capacity that cculd not be used for
defense.
The firct source of defense revenue should bo the corporation tax
and the excess profits tax booause, in general, corporations arc the greatest
beneficiaries, directly and indirectly, from defense expenditures.

In other

words, the surplus accruing from the expanding national income tends to be­
come concentrated in the first instance in the possession of business
corporations.

The most certain way to insure against inflation is for the

Government to levy on these earnings and divert the proceeds directly into the
defense program before they are distributed into tho general income stream
through higher wages and higher dividend payments.
Thus, the most direct way to attack the inflation problem is through
heavy corporate income and excess profits taxation.

If these surplus funds

are not thus collected in the first instance at the source, but are later
distributed through large wage increases and large dividend payments to the
community, it becomes necessary subsequently for the Government to abstract
excess incomes through the personal income tax, excise taxes, and other forms




2.-544

of mass taxation.

The problem is not avoided but only delayed and made more

difficult by failure to tap the profits at the source.
High taxation of personal incomes and excise taxation will be
necessary in any event, but the amount needed from these sources will be re­
duced by a prior collection at the points where the profits originate, namely,
in tho business units.

If excess profits are not tapped, they will lead to

demands for higher wages.

Apart from the question of equity and the problem

of allaying industrial unrest, is the question of going directly to the source
of the increased flow of income and diverting it into the defense program be­
fore it spreads out into the community end adds private mass purchasing power
on top of the Government’s demands springing from the defense program.
With greatly incroased surtax rates, especially in the middle income
brackets, and in the absence of an undistributed profits tax, there will be a
tendency on the part of some corporations to hold back disbursements of divi­
dends.

This is a further reason for heavy normal and excess profits taxes on

corporations.
In addition, the tax progre®, to bo effective and equitable, should
close important loopholes in the gift and inheritance tax laws.

Similarly, the

setting up by corporations of annuity and pension plans which are charged to
expense and provide large benefits to individuals in lieu of increasing salaries
and paying bonuses, should not be permitted to become an cvenue of tax avoidance.
With reference to the individual income tax, the normal tax and sur­
taxes on individual incomes have been moderate, compared with other countries,
except in the very highest income groups.




They can and must be substantially

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increased.

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With expanding employment and payrolls resulting from defense ex­

penditures, it is equitable.and necessary that some of the benefits be recovered
by the Treasury.

Exemptions should be reduced, thereby spreading the base and

increasing the number of income taxpayers. This is a more diroct and equitable
way of raising revenue from the lower income groups than by imposition of
certain indirect excise and sales taxes.
To the extent that wages are increased and prices aro controlled,
corporation profits are loss than they would be otherwise, and Federal revenue
from this source is accordingly diminished.

Under these circumstances, it is

only fair that this loss of revenue bo made up by taxing directly tho bene­
ficiarios of the increased wages.
The tax system should bo so designed ns to prevent any group from
profiting out of this groat national emergency at the expense of others.
Neither industry nor labor should be permitted to trike advantage of the
emergency.

Men drawn into tho Arngr and Navy are called upon to make groat

personal sacrificoa.

Neither unity nor morale can be built upon inequality

of treatment of our citizens.
It is a perhaps natural but none the less false notion that either
capital or labor can make up now for lean years.

If they were to reap great

profits and higher wages, they would be inviting inflated prices and in the
end the added profits and wages would buy fewer goods.

I think it is of great

importance that we grasp fully the fact that wo as a nation cannot profit out
of world calamity.

We cannot turn our industrial machine largely to making the

things of war rather than the things of peace and have a higher standard of
living.




Z—544
- 7We have to start from the first principle —

and I believe that

mo3t of us accept it — that the burdens to be borne and the sacrifices to
be made should be equalized so far as possible.
particularly to taxation.

And that principle applies

Therefore, those corporations and individuals who

profit most should be the first to be taxed.

They must bo the primary ones

from whom the Government recaptures the proceeds of its expenditures.
I am wholeheartedly in accord with the objectives of taxation policy
recently announced by the Secretary of the Treasury when he appeared before
the Ways and Means Committee in advocacy of measures to raise an additional
#3-1/2 billions.of revenue.

As ho stated then, the purpose is to design our

tax program, first, so that we may pay as we go for a reasonable proportion
of our expenditures; secondly, so that all sections of the people shall bear
their fair share of the burden; third, so that our resources may be mobilized
for defonse while reducing the amount of money that the public can spend for
comparatively less important things; and finally, so that a general rise in
prices may be avoided by keeping the- total volume of monetary purchasing power
from outrunning production.
The Secretary of the Treasury has proposed that we raise at least
two-thirds of the sums necessary for defonse out of taxation, and with that
purpose 1 am likewise heartily in accord.

The rest should, so far as possible,

be raised by the aale of Government securities to the public, thus utilizing
existing funds, instead of by the sale of securities to the commercial banks
since the latter method creates additional bank deposits,

as

cated, we need to use existing funds, which are abundant.

Expansion of bank




I have indi­

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credit which ci'eates nen funds would only tend towards inflation.
The Treasury’s three new types of savings bonds, together with
savings stamps, are being offered to the public beginning today.

They arc

excellently designed to give ell of our people an opportunity to participate
in the financing of the defonse program.

They are designed to attract tho

smallest savings of the people as well as those up to $50,000 a year.

Apart

from that patriotic purpose, however, they aro important in helping to protect
the country against inflation and they aro a store of buying power for the
future when supply can again be matched to demand.
Another very largo store of savings which should also be tapped
consists of idle balances in banks held by corporations, by wealthy individuals
and by trustees as well as by various public and private bodies.

These funds

are frequently not of the type that can or will go into long-torn Government
securities, nor can they be attracted into short-term Government securities now
available because practically no return can be obtained upon them.

I believe

many of than would be invested in registered short-term issues (not available
to banks) of two years* maturity, if such issues were made available at interest
payable semi-annually, of from cne-half to mo per cent, depending upon tho
length of time thoy are held, and wore redeemable on any interest payment date
on 30 days notice.

So far as long-term retos arc concerned, I think thoy are

fair and that the Government would not bo justified in paying mnro than t;«> and
one-half por cent for long-tora money on fully taxable securities.
To the extent that wo pay for defense out of taxes and through
borrowing from savers rather than from tho commorcial banks, thus using ex­
isting funds and not creating new funds, we help protect- the country against
the hazards of monetary and crcdit inflation. To the extent that people pay



Z-544
-9 taxes or invest in Government bonds, such as the new savings bonds, these
funds will not be available for the public to bid up prices in the market
place and they will aid in financing defense, thus avoiding inflationary
effects.
This is the time for the public to build up a backlog of future
requirements, especially of consumers' durable goods, such as automobiles,
housing, etc., that now are using some of tho materials needed in defense.
Instead of spending existing funds and mortgaging future income for these
goods, it would bo far better to defer these expenditures until tho time when
the Government’s defense outlays can bo reduced.

At such a time the backlog

of buying power coming into the market will bo an offset to the reduced
Government expenditures and help to sustain employment and national income.
Wo should consider the advisability of providing a method of con­
trolling the volume of forward buying on installment credit.

Further expansion

of installment credit at this time would be an inflationary factor.

Install­

ment credit has tended to expand as employment end payrolls expanded and to
contract when both wero declining.

It has thus tended to be an unstabilizing

influence on the econowy vrhen it might have been made a stabilizing influence.
I have said that monetary and credit factors are .at this time less
important than other factors in the situation.

Nevertheless, with the exist­

ing large volume of deposits and the vast roservoir of excess reserves which
could serve as u basis for doubling the existing volume of deposits, it will
probably becone necessary at some future time to absorb into required reserves
a portion of tho idle funds hold by the banks.




This would diminish the

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pressure on the basks to find outlets for their funds in Government securities
and would facilitate the placing of a larger part of the new issues with nonbanking investors.

It would also make the banks more careful about avoiding

unsound or speculative extensions of credit and would restrain further growth
in the already abundant volume of bank deposits.

Consequently it would diminish

inflationary dangers.
There is one additional matter of importance in connection with
defense financing that should be given consideration.
public expenditures for purposes other than defense.

It is the subject of
I do not believe that

agricultural benefits should be curtailod, particularly in those fields where
agriculture does not profit as other groups do from defense expenditures or is
adversely affected as the result of the present international situation; nor
do I believe that wc should abandon social efforts on the part of the Govern­
ment in those cases where the problem is not adequately met by the improved
employment situation resulting directly or indirectly from defense expenditures.
We are hardly justified in spending billions to aid other countries
and billions more in our own defense effort if at the seme time we shut our
eyes t > urgent social needs at home that must depend upon government assistance.
*
However, reductions should be made wherever this cen be brought about through
increased efficiency as well as in those fields of Government activity which
utilize men or materials needed in private enterprise or in dofonse.
I have attempted t: outline briefly the general public policies
'which I feel should be pursued




facilitcto the financing ^f defense

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effectively with a minimum of economic dislocation now and after the defonse
effort has been completed.
I have discussed —

The successful carrying cut of such a program as

and it is a program designed to preserve all of the

essentials of our democratic system —

depends primarily upon the under­

standing of and acceptance by the people of this country, particularly the
leaders in business and industry.
We have every reason to succeed.
than any nation in the world today.
sources.

We ore in a much stronger position

We have a va3t endowment of natural re­

We hove abundant and iiigh-calibre man power.

potentially great productive facilities.

We have existing and

We can provide, without inflation,

all of the monetary and credit resources re. require.
We will fail only if wo aro ignorant of the s'-ciol and economic
problems confronting us or if through blind self-interest wo imagine that
we can make others bear the sacrifices and burdens which all must share in
the greatest undertaking upon which our nation has ever embarked.




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