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CREDIT CONTROLS UNDER TODAY'S CONDITIONS An Address by Oliver S. Powell, Member, Board of Governors of the Federal Reserve System, Before Luncheon Session of The Third Annual Business Conference Rutgers University, New Brunswick, New Jersey Tuesday, June 5, 1951. CREDIT CONTROLS UNDER TODAY'S CONDITIONS The title of this talk might have been labeled, "Learning to Live National Defense". Outside of actual war-time conditions, the United States for generations has found it possible almost to forget defense against ou tside enemies and to devote its energies completely to developing a higher standard of living at home. Now we find ourselves the most powerful non- c omrnunist country in the World, able to depend on other countries for protec- t i o n 01ll y in very limited ways and faced with the problem of rebuilding a Str °ng national defense. The problem resolves itself into one of increasing the production defense items while maintaining the supply of civilian goods at as high a ievel a s possible. If the total demand for goods exceeds the supply, prices go up. ^hi ls inflation. delense program. It hurts the civilian economy and increases the cost of A considerable amount of price increase has already Cc Urred since the Korean war began. / The restraints against inflationary price advances must cover a br front. First of all is an adequate tax program. encouraged to increase their savings. discouraged. Then, people should Abnormal profit margins should be If commodity prices can be held in check, further rounds of wage iftcre^cpo should be avoided. Above all, individuals and businesses should encouraged not to buy more than their normal requirements. This address deals with one particular phase of inflation control. -2- As a beginning, I want to take you back to some elementary economics. Since we are dealing with the mechanics of inflation, we should recall that an increase in prices occurs (l) when the money supply increases wore rapidly than the volume of business or (2) when the rate of turnover money increases to a point where the monetary work done by the money supPly is greater tlian needed for the Nation's business. This story really starts back in 1934 with the devaluation of the do Uar. That event immediately created an enormous increase in gold re- serves which are the base of the bank credit pyramid. In the next few years a fter devaluation, world events caused a tremendous inflow of gold into the Ur *ited States, adding further to the basic gold reserves. the From that time on, problem of monetary authorities has centered largely around the manage- ment of these large gold reserves in such a way as to prevent undue manufactur e of credit and an inflation in commodity prices. This holds true today in s Pite of the gold exports in the last year and a half. Many of our monetary problems would probably not have happened v Hhout this plethora of gold reserves. The forced feeding of excess re- a v e s i n t 0 the banks to support the bond market would have been more difficu lt and doubtless would have ceased much sooner. What now appears to a b titanic struggle eon greatly reduced. against unneeded bank credit expansion would have There just would not have been the excess reserves banks would have automatically limited loans. of For most of the history modern finance this was the traditional situation in banking. There was a respite from the gold reserve problem during World War ll In fact we were very thankful to have such large gold reserves, for -3these reserves made it possible for the banks of the United States to purchase Government securities in huge quantities to provide for money for war, over and above the amount provided out of national savings and taxes. evQ How- r, at the close of the war the Nation found itself with bank investments bank deposits greatly increased. As these bank deposits went to work the purchase of civilian goods, price advances occurred as soon as consols were removed. These price advances would have been much greater except for a ^ttle-understood development in the behavior of bank deposits. the This was fact that the turnover of bank deposits had declined steadily from the 1920»S un tii 1945. In the 1920's an annual turnover of demand deposits from 31 to 37 times was considered normal for leading cities. By 1945 this turn- 0Ve r had been reduced to 16 so that a dollar of deposits was doing only half of the monetary work that it did in the 1920's. There was some increase in de Posit turnover during the post-war years, and a sharp increase since the Korean War to a turnover rate above 23 turns a year. However, if the owners ^fe§H^_deposits were to use these deposits with the efficiency shown in the ^ Q j s ^ r i c e s could increase substantially from present levels without any ^ther^increase in bank loans, investments or deposits. Thus, we have two difficult factors in the money supply to deal vi th: fi rs t j i a r g e basic reserves which make it possible to increase the ainount of bank credit and bank deposits, and second, a rate of turnover of ^ePosits which, as has beon demonstrated in former years, can grow substantial -ly above today's levels. Both bank credit and the turnover of bank ^oposits increased sharply in 1950 and in the early months of 1951. I have already mentioned the use of savings for current expenditure. Savings are in many forms. I shall mention only two and indicate the relation of "dis-saving" in those fields to the turnover of money and the volume of bank credit. The simplest illustration is the idle bank account. A phenomenom the last ten years is the extent to which personal and corporate savings ^ av e been allowed to remain idle in commercial bank accounts. Reposing there, with no checks drawn, the monetary work done by those deposits is Zer °* If suddenly people and firms decide to spend those funds, the money supply begins to work more actively, exerting a pressure toward higher prices, and mind you, without any increase in the amount of bank credit. This chain of events has played a large part in the rise of prices in the last ten Months. Another kind of dis-saving is the conversion of Government bonds in to cash, or more usually into bank deposits for current spending. I do n °t refer to tax notes and other short-term Government obligations, used for temporary employment of funds that have been earmarked for later use. r> r I re- to long-term securities bought by individuals as a means of employing ^eir savings; e.g., savings bonds. I also refer to Government securities k°u8ht with the savings of others by insurance companies, savings banks, Pensi °n funds and trust companies. In the case of savings bonds, the Government redeems the obligat i o n anc * sells a new security to obtain the redemption funds. If banks buy th e n ties ^w securities, bank deposits are created. If other Government securi- are sold before the redemption date to obtain funds for current spend0r f or other employment of savings, someone must buy the bonds. If a -5bank buys them, it creates deposits; if the Federal Open Market Committee buys them, it creates bank reserves. Thus, when we try to tighten the money supply as a restraint on credit we find that the rope has considerable slack—a potential increase in the turnover of money, gold reserves that Permit further credit expansion and a high level of liquid savings just one stage removed from cash. The monetary authorities have made important moves in their field of> action to counteract the inflationary effects of these factors. (1) Ver Last August, the discount rates of the Federal Reserve Banks e raised somewhat and short-term money rates were allowed to rise. (2) The consumer credit regulation was reestablished. While the ^establishment of this regulation has not brought about any marked reductio n in the total of consumer credit outstanding, it has served the purpose of preventing any further expansion in instalment credit since last October. (3) 11 ef A new regulation dealing with real estate credit was imposed. is commonly understood that it is too early to appriase the restraining fect of Regulation X since builders are still working on the backlog of orders received before Regulation X was announced. (4) In January 1951 reserve requirements of member banks were *aised to substantially their upper legal limits. One of the most important tools of inflation restraint was practically out of use for this purpose for several years. meil in This was the employ- t of open market operations, which were devoted almost solely to maintain- £ a pegged price for long-term Government securities. The Federal Reserve °Pen Market Committee first announced in the depression years that a major objective would be a stable or orderly bond market. This was at a time v hen the Federal Government was borrowing heavily to provide funds for var- ious kinds of relief. public debt. Then came World War II with its huge expansion of The Federal Reserve played an important part in this •financing by providing the banks with excess reserves with which to buy Government bonds. Then came the post-war years. Almost everyone expected a sharp depression as had happened in 1920-21 after World War I. Hindsight proves this to have been an error in judgment but it was a factor in causing the federal Reserve authorities to continue their easy money, excess reserves, Pe gged bond market policies. Vas With one or two minor exceptions this policy maintained until this spring when the pressure of inflation made a change to a more flexible attitude toward the bond market necessary. The pegging of the Government bond market had deep-seated and Per nicious effects. Holders of long-term bonds instead of treating those Se curities as true investments came to consider them equal to cash in liq- u idity. x n f QC t they were the equivalent of cash so long as they could be So:1 -d to the market at a fixed rate and the market could be sure that it c °uld sell them to the Federal Reserve Banks at the same price. the This caused Federal Reserve Banks to manufacture bank reserves at the whim of the Elders of Government securities. The recent reduction in prices of long-term Government bonds has far-reaching effects in the control of inflation. Holders of those Purities have been reluctant to dump them on the market and as a result Su Pplies of funds for mortgage loans and for many other types of credit hav e been reduced. Skeptics of this change in the administration of the Federal Open Market account have overlooked two aspects of the money market: First, low rates had been in force for so many years that they have been built into the financial structure. Any change to a higher level of long- term money rates forces far-reaching adjustment in financial commitments. Second, the direction of movement in the money market is an important factor entirely aside from the level of money rates. Whenever rates are rising, until the money market reaches reasonably firm ground at a higher level, it is natural that many financing plans are postponed. To complete the picture of moves toward inflation control in the Monetary and credit field, there is the Voluntary Credit Restraint Program. Th is program is in essence nothing but enlistment of the collective horse s ense of all kinds of lenders to sort out the kinds of credit which should kve priority under today's conditions and in that way to avoid Governmental •Regimentation of credit which, at best, must be a clumsy affair. The Board Governors of the Federal Reserve System and the managements of all of the Federal Reserve Banks are eager to have the voluntary plan succeed and are ^endins all possible assistance. As one banker who is taking a leading part in the Voluntary Program expressed it, "This is the greatest adventure in American finance." At the same time it is a prodigious undertaking. Recall that there are H,000 banks, more than 400 life insurance companies, about 3,000 investment inkers and dealers and many thousands of other types of lenders. All of these lenders must be educated in the fundamentals of the Program to a point vh ere they not only give their complete cooperation but so that they do not fittingly extend credit of an undesirable character. It is only by this -8somplete understanding that ve can overcome the "competitive drive" for business, which though desirable from the earnings standpoint of the lender, is nevertheless needlessly inflationary under today's conditions. This Program has been inaugurated under the provisions of Section of the Defense Production Act. The authority to set up the Program was delegated to the Federal Reserve Board, which body consulted with the Federal Tr ade Commission and obtained the approval of the Attorney General of the United States for the Program on March 9, 1951. The first step was for the Federal Reserve Board to request all lenders in the United States to take part in the Voluntary Program. For purpose a letter was sent to some 90,000 lenders, the broadest list Mailable to the Federal Reserve Banks. of The next stop was the appointment a national Committee by the Federal Reserve Board. The national Committee has set up regional committees to deal v ith problems in three major lending fields: commercial banking, life in- France and investment banking. Considerable progress has been made in other directions. The na tional Committee has issued three bulletins on credit problems in rela- tio Vi n to the Voluntary Credit Restraint Program. th the subject of inventory loans. The first bulletin dealt In view of the rapid increase in r.ies, particularly at the retail and wholesale level, the Committee Voided that this was its number one problem. Cr edit for plant expansion. According to Government estimates, business f ifnm were planning to spend about V/h v Bulletin No. 2 dealt with billion on plant expansion in 1951. Ue part of this money would come out of corporate savings, a large part °uid need to be financed by borrowing. Furthermore, regardless of the sources of funds, it seemed very doubtful to the Voluntary Credit Restraint Committee that expenditures of this magnitude, aside from those directly related to defense, could be carried through without exerting undesirable inflationary pressures. The third bulletin dealt with borrowings by states a nd municipalities. Progress has also been made in collecting better statistics to Measure the developments in the credit field. The largest banks in the United States have already begun reporting weekly to the Federal Reserve Ba nks a detailed breakdown of their loans so that the national Committee ca n ascertain periodically the cross currents due to the rising volume of defense lending and the desired decrease in other types of loans. You are all wondering what success the Voluntary Credit Restraint Pr ogram is achieving. I must confess that the national Committee and the federal Reserve Board share in this curiosity. The Program has not been in operation very long and much of its work has been organizational and educational. Furthermore, two other important restraining influences came to bear at the same time. to be apparent with the drop-off in retail sales before Easter and the March The top-heavy retail inventory situation began anc * April declines in the Government and corporate bond markets exerted a c hilling influence on credit expansion. tha However, I deem it something more n a coincidence that the sharp and counter-seasonal weekly increase in commercial and industrial loans at reporting member banks ceased with the Ve ek of March 21. The request by the Federal Reserve Board to all lending institutions to cooperate in the Voluntary Credit Restraint Program was lss ued on March 9. The national Committee's first bulletin dealing with inventory loans was issued on March 20. -10From my vantage point as Chairman of the national Committee, I °an attest to the tremendous release of energy in the field of credit restraint made possible by the Federal Reserve Board's request. I can also bear witness to the spirit of unified effort and the desire to be "on the team" which is evident in all parts of the country and among all groups of ienders. Perhaps it is significant of the growing effectiveness of the Pr °gram that commercial loans at weekly reporting banks during each of the lu st two weeks in April experienced the largest decreases for any week since April 1926 - 1950. The more detailed figures now available reveal that defense loans are rising, and loans to carry raw commodities are fallln g' However, loans to carry retail inventories continue to climb. In this Program of Voluntary Credit Restraint, the national Com- mi ttee earnestly bespeaks the active assistance and cooperation of businessThese same businessmen are the largest borrowers and their understand- in g and cooperation with financing institutions will ease the burden on the banks and go a long way toward assuring the success of the Program. We are the richest country on earth. Our standard of living is the highest. We are surrounded by comforts and conveniences that will tide Us over a long period of self-sacrifice without real hardship. b est educated nation in the world. We are the If we can not beat the forces of infla- tion, we are not worthy of the land handed down to us by the sacrifices and hoj, oism of our forefathers.
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