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INFLATION CONTROL: BANKING ASPECTS An Address by Oliver S. Powell, Member, Board of Governors of the Federal Reserve System, Before the 27th Annual Convention of the National Association of Bank Auditors and Comptrollers, The Roosevelt Hotel, New Orleans, Louisiana. Wednesday, October 2U> 1951. 8:30 p.m. Mi , INFLATION CONTROL: BANKING ASPECTS It is a genuine pleasure to come before this great convention to discuss a topic somewhat unrelated to the immediate problems of your membership but one which is of great importance to all of us as American cities. Having worked with members of your organization for many years, I know tbrt your discussions center around accuracy, honesty and efficiency in bankto the end that bank earnings will be well maintained and the reputation of - banking will be high. Some of you also have the duty of allocating funds th Achieve maximum earnings while serving your communities adequately. ever ^ > there is a time to make money and a time to conserve real wealth. HowTo- banks and other lenders are foregoing maximum earnings in the campaign safeguard the buying power of the dollar. Monetary authorities are also ^P^ying mild pressure toward the same goal. The title of this talk might have been labeled, "Learning to Live 1 th National Defense". Outside of actual war-time conditions, the United for generations has found it possible almost to forget defense against ,SCu and to devote its energies completely to developing a higher t't3ide .v* 1 enemies retard of living at home. Now we find ourselves the most powerful non°'®iunist country in the Vorld, able to depend on other countries for protect4 '^on only in very limited ways and faced with the problem of rebuilding ft st» i^ong national defense. The problem resolves itself into one of increasing the production o£ defense items while maintaining the supply of civilian goods at as high a] as possible. go up. Ct If the total demand for goods exceeds the supply, This is inflation. It hurts the civilian economy and in- 3es the cost of the defense program. - 2 - The restraints against .inflationary price advances must cover a broad front. First of all is an adequate tax program. encouraged to increase their savings. discouraged. w Second, people should Abnormal profit margins should be If commodity prices can be held in check, further rounds of ^ e increases should be avoided. Above all, individuals and businesses should be encouraged not to buy more than their normal requirements. This address deals with one particular phase of .inflation restraint, -that a dministered by the Federal Reserve Board and the related Voluntary Credit Restraint Program. Early in 1950 the recovery of business from the minor recession had brought the level of production, consumption and employment to high plateau. .Production was almost at capacity, a point beyond which it ls difficult to expand except by the slow processes of population growth, more factories and improved industrial techniques. Then came the Korean Evasion and it set off a rush of panicky buying. Remembering the short- ages that developed during World War II, we rushed to the stores and bought f o r m a l quantities of merchandise—everything from sheets and coffee to ^•Qvision sets and autos. v inter. There were two waves of buying—autumn and There was also an unprecedented, increase in residential building, 'i'ah-3 ' buying rush caused retailers and manufacturers to step up their purci '-;Ses and production rates, and there was a sharp increase in employment. Th • c inevitable result of all this was a sharp rise in prices, and another °und of wage increases. It is important to analyze the sources of buying power which made this abnormal buying movement which was superimposed on a high level of r<)e&cetime trade. There were three principal sources of buying power: - 3 - First, current income; The sum total of wages, rents and income trom invested capital which normally just about equals the production of goods and services at stable price levels. Second, the use of savings by drawing down savings accounts, cashln o savings bonds and spending funds which had remained idle in checking ae counts awaiting a suitable time for use. Third, borrowing against future income: V Consumers' borrowings to automobiles, household appliances and houses; business firms' borrowings increase inventories or to pay higher prices for inventories or to extend Cr ^dit to consumers, or to expand plants. The combination of these three sources of buying power, when used Purchase a quantity of goods and services that could not expand with equal ra Pidity, caused a sharp price rise. This situation would have called for restraining action at any time, became much more essential to invoke restraints under today's conditions of Moving national defense. The gap between available goods for civilian con- Uln Ption and the supply of purchasing power may continue for many months. ' ^hin a year we may see a million fewer employees engaged in making civilian The amount of raw materials available for civilian goods production v less next year than today because of defense requirements. Already Srnji 2 -I ier allocations and greater restrictions in many strategic materials Ve Prod-,been jp • announced. Yet with full employment, counting as employees those "tang civilian goods, the workers in defense industries and people in mUn. service, the national income might be many billions above current The probable gap between income and available civilian goods would - u - cause tremendous pressure for higher prices, even with no expansion in bank Cr edit and various forms of consumer borrowing against future income. In addition to the inflation gap in current income versus the supply of civilian goods there has also been much use of savings for current ex Penditure. Savings are in many forms. I shall mention only two. The simplest illustration is the idle bank account. A phenomenon "the last ten years is the extent to which personal and corporate savings been allowed to remain idle in commercial bank accounts. Reposing there, ith no checks drawn, the monetary work done by those deposits is zero. oU <Jdenly people and firms decide to spend those funds, the money If supply be- to work more actively, exerting a pressure toward higher prices, and ^ind you, without any increase in the amount of bank credit. eVents ha This chain of s played a large part in the rise of prices in the last year. Another kind of dis-saving is the conversion of Government bonds cash, or more usually into bank deposits for current spending. riot v I do pi e r to tax notes and other short-term Government obligations, used for ^Porary employment of funds thrt have been earmarked for later use. I r ef er . ™ long-term securities bought by individuals as a means of employing thgn Y-> savings; e.g., savings bonds. I also refer to Government securities bought - 1X- with the savings of others by insurance companies, savings banks, nSj -on funds and trust companies. In the case of savings bonds, the Government redeems the obligation Xla a new security to obtain the redemption funds. securities, bank deposits are created. If banks buy the If other Government securities - 5 a re sold before the redemption date to obtain funds for current spending or f °r other employment of savings, someone must buy the bonds. If a bank buys ttam, it creates deposits; if the Federal Open Market Committee buys them, creates bank reserves. Now, let us turn to the third source of buying power—borrowing Against future income. Korean incident. The use of credit increased sharply after the Loans at all banks in the United States increased $11 bil- l o n between June 30, 1950 and March 28, 1951. ^-1/2 billion in the last half of 1950. Consumer credit increased Residential mortgage lending in- °reased by £2 billion, using annual rates, between the spring of 1950 and ifcVtt spring of 1951. ob Security issues by municipalities and corporations to tai n new capital have been floated at an annual rate of $3 billion. Of c ourse there is overlapping in these figures, and some mortgages and secu- r H i e s are bought with savings, which does not increase the money supply, bub ln the figures serve to point out that borrowing for the purpose of spend- S has been an important factor in the rise in commodity prices. So far I have spoken of increasing loans and investments which in- Cj O; the money supply. However, there is another way in which the money Uf 'Piy can be used to accommodate an increase in the volume of business or ^ i1 f nQr ' Prices. is 6 I refer to an increase in the turnover of deposits. little understood phase in the behavior of bank deposits. SUr This However, I e that you will recognize the phenomenon when I refer to it in terms internal bank operations. Your bookkeeping departments and transit deIne nts have been plagued during the last year with a tremendous upsurge in ^e volume of checks handled. This increase was not due to an increase - 6 - in the level of deposit balances, but rather to a more active use of existing deposits. Measured in national terms, this is what has been going on. The money supply in private hands, including deposits and currency, increased about 3 per cent from June 1950 to June 1951. Meanwhile, debits to individ- 110 1 accounts at banks rose more than 20 per cent in the first half of 1951 °ver the .first half of 1950. Such wide swings in deposit activity are inherent in the commerbanking system. They arise from the fact that depositors have com- plete freedom of action in deciding whether to leave their accounts idle 0r de to draw checks against them when the spirit moves. Posits declined steadily from the 1920»s until 1945. The turnover of bank In the 1920's an a nnual turnover of demand deposits from 3-1 to 37 times was considered normal 0r leading cities. By 194-5 this turnover had been reduced to .16 so that a °llar of deposits was doing only half of the monetary work that it did in th -> '"e 1920's. There was some increase in deposit turnover during the post- years, but a sharp increase occurred after the Korean War broke out, to a turnover rate above 23 turns a year. e r subsided to about 22 turns a year. In the last few months the turn- However, if the owners of bank p o s i t s were to use their deposits with the efficiency shown in the 1920's, would increase substantially from present levels without any further Wcrease in bank loans, investments or deposits. The monetary authorities have made important moves in their field of ac tion to counteract the inflationary effects of the many factors which I 'luVe described. - 7 - (1) In August 1950, the discount rates of the Federal Reserve Banks were raised somewhat and short-term money rates were allowed to rise. (2) The consumer credit regulation was reestablished. The re- e stablishment of this regulation has not brought about any drastic reduc- t,i °n in the total of consumer credit outstanding. Although the total has Qe cl.ined by $300 million since last December, the amount of consumer credit ^standing on August 31, 1951, vas still $19 billion. lio n in August (annual rate of $2 billion) after Congress eased the restraints. (3) ^ It rose (171 mi.l- A new regulation dealing with real estate credit was imposed. is still impossible to appraise the restraining effect of Regulation X s ince builders are working on the backlog of orders received before ftegulaX was announced, and on public housing projects as well as on private instruction under the regulation. in Moreover, Congress liberalized the terms August. (4.) In January 1951, reserve requirements of member banks were r °ised to substantially their upper legal limits. One of the most important tools of inflation restraint was prac- ti • Ca -Lly out of use for this purpose for several years. This was the employ- of open market operations, which were devoted almost solely for several to maintaining a pegged price for long-term Government securities. The r (! - erai Reserve Open Market Committee first announced in the depression years & major objective would be a stable or orderly bond market. This was at -iine when the Federal Government was borrowing heavily to provide funds for Va riJ-ous - kinds of relief. Then came World War II with its huge expansion of ic debt. The Federal Reserve played an important part in this financing by i-rovirling the banks with excess reserves with which to buy Government bonds. PUbl ~ 8 - 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, pegged bond market policies. With one or two minor exceptions this policy v *-s 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 effects. Holders of long-term bonds instead of treating those securities as true ^vestments came to consider them equal to cash in liquidity. Vere L In fact they the equivalent of cash so long as they could be sold to the market at fixed rate and the market could be sure that it could sell them to the Federal Reserve Banks at the same price. This caused the Federal Reseive Er 'nks to manufacture bank reserves at the whim of the holders of Government securities. The reduction in prices of long-term Government bonds last spring B far-reaching effects in the control of inflation. Holders of those Securities have been reluctant to dump them on the market and as a. result supplies of funds for mortgage loans and for many other types of credit uV e been reduced. Skeptics of this change in the administration of the ^ e r a l Open Market Account have overlooked two aspects of the money ^ket; b First, low rates had been in force for so many years that they een 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 ^Portant 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. 0l One the most fundamental results of this recent action has been to restore in the rest of the world a confidence that we can control our own inflationary Problems. In a very real and tangible way, the credit policies of the Federal ^serve System and the Program of Voluntary Credit Restraint among private lenders are complementary in character; each supplements and increases the ef fectiveness of the other. The general credit policy of the System is in- tended to reduce the availability of credit in the aggregate and to make it Necessary for the System to add to the credit base by the continued purchase Government securities; the selective credit controls are designed to ^strain the extension of credit in a few areas where the formulation of s Pecific end generally applicable lending standards is feasible. Jfl Reliance been placed upon the voluntary credit restraint effort to engender a ^i^it of caution and restraint in lending policies in general, but especially y "cbors not amenable to selective credit controls, and to assist in chanIIp ]ln • " g the reduced supply of credit so as to meet the needs of the defense Pl'Qi'O" and of essential civilian activities, vhile at the same time re~ str•• fining or curbing the use of credit for nonessential purposes. - 10 - The Voluntary Credit Restraint Program is in essence nothing but enlistment of the collective horse sense of all kinds of lenders to sort out the kinds of credit which should have priority under today1s conditions and in that way to avoid Governmental regimentation of credit which, at best, must be a clumsy affair. This Program was inaugurated under the provisions of Section 708 of the Defense Production Act. The authority to set up the Program was delegated to the Federal Reserve Board. That body requested a group of financial lead- to draw up a statement of principles and procedures for the voluntary Progr rm. The Federal Reserve Board then consulted with the Federal Trade Commission and obtained the approval, of the Attorney General of the United S tctes 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 this purpose a letter was sent to some 90,000 lenders, the broadest list ^ l i a b l e to the Federal Reserve Banks. n °t a Government Program.) The next step was the appointment of a national Committee by the Federal Reserve Board. e (I repeat, however, that this is This Committee is composed of men ho sen from the principal kinds of lending institutions, with a Federal ^serve Board Member as Chairman. The national Committee has set up regional committees to deal with ^oblems in five major lending fields: commercial banking, life insurance, - 11 - investment banking, savings banking, and the savings and loan system. Right from the start the national Committee recognized the need for direct contact with lenders to explain the Program, to answer the most pressing Questions without delay, and to insure uniform interpretation throughout the na tion. The national Committee has issued six bulletins to all lenders on cr «dit problems in relation to the Voluntary Credit Restraint Program. first bulletin dealt with the subject of inventory loans. The In view of the ra P^d increase in inventories, particularly at the retail and wholesale level, ' e Committee decided that this was its number one problem. edit with credit for plant expansion. Bulletin No. 2 According to Government estimates, s J-ness firms were planning to spend about $24 billion on plant expansion in tqct While part of this money would come out of corporate savings, a rge p a r t w o u l d Of j.,e need to be financed by borrowing. Furthermore, regardless ^rces of funds, it seemed very doubtful to the Voluntary Credit Sol Re • &tr L a m t Committee that expenditures of this magnitude, aside from those °txy related ie to inflationary pressures. The third ^ defense, could be carried through without exerting un- ^ H e t i n dealt with borrowings by states and municipalities, f °urth with real estate loans, and the others with loans to foreign owers and loans on securities. Summarizing the statement of principles and the bulletins, it can be Sa ia th ° the recommendations are of two sorts: first, as to desirable and ^SiraM • -oie purposes for credit and second as to maximum limits for certain nds of credlt t - The Program was inaugurated on the theory that the purpose ° h ° U l d determine whether or not a loan should be made. ln the However, verv operation of the Program it became evident that it must be ... - 12 - dovetailed with the Regulations of the Federal Reserve Board in some fields of credit and so maximum credit limits were recommended in the fields of real estate and securities loans. In the latter cases, the objective was still to r educe the amount of credit to a point where speculative price increases v 'ould be discouraged. You are all wondering what success the Voluntary Credit Restraint Program is achieving. much of Se The Program has not been in operation very long and its work has been organizational and educational. Furthermore, veral other important restraining influences came to bear at the same time. For example, the top-heavy retail inventory situation began to be BP- S' rent with the drop-off in retail sales before Easter; and the March and %rii declines in the Government and corporate bond markets exerted a chilling ln fluence on credit expansion. However, the fact is clear that bank credit has not been as freely this summer as a year ago. You will recall the startling increase in loans that followed the North Korean attack in June of last year. fi ln *een June 28, 1950 and October 11, 1950, business loans at weekly report- S member banks increased by $2,540,000,000. b In the corresponding weeks .Year the business loan expansion at these banks has been only $1,094 °n, less than half of last year's increase in the same weeks. Putting the ' r another way, it is expected on a seasonal basis that bank loans in the thir<j ' quarter of the calendar year should grow by 6 per cent; this year, the thijvj u c quarter increase has been only 4-1/2 per cent. It would be more re- Ssurir n g 11 this increase in bank credit were not being added to a high level ^hed this spring, but it must be recalled that business is also at a high ^nd requires a great deal of credit for normal operations. - 13 - Buried in these statistics of increasing loans since mid-year are a number of cross currents. Loans to manufacturers of metals and metal products, petroleum, coal, chemicals and rubber and public utilities have increased by #800 million. These industries include most of the defense industries, although not all of these loans are defense loans. Many of loans have been increasing, not because of seasonal requirements, but ^cause of abnormal or defense demands. ta It remains to be seen whether they P e r off after the first of the year, following a seasonal pattern. Mother group of loans has been increasing for purely seasonal reasons. Se are the loans to finance the marketing of the crops—loans to com- modity dealers and food, liquor and tobacco manufacturers which have risen ^ million. fined. Taking all of the latter groups together, the borrowings of which ariVy t h e mil Loans to textile, apparel and leather manufacturers have de- crops until they are consumed, the seasonal expansion was about lion. The net change in other business loans has been a decrease of *•> la out $150 million. The over-all picture would seem to indicate expert unship in the handling of the nation's bank credit in this period of Per cent defense and 85 per cent peace activities. In interpreting these trends in the credit field, it is important kt:e P in mind that the purpose of credit policy in general, and of the ar Uqp y pCredit Restraint Program in particular, has not been to prevent oi private credit. The objectives of credit measures are rather tCcnij 'Gmpt to stop the use of credit for speculative purposes, to channel +• •into defense and defense-supporting activities, to reduce the credit "Mailable for postponable and less essential civilian purposes, and - u to - engender a more cautious and careful lending policy on the part of lend- iri g officers. The Voluntary Credit Restraint Program is making an important Contribution to the attainment of these objectives. The Voluntary Credit Restraint Program has provided the financial Action of our economy with a vital rallying point. Even though the in- flationary possibilities of credit expansion were fully understood, there. still "was needed some mechanism for joint action. No lending institution ^ e s to be known up and down main street as being out of step with its Corn poti tors. News of that sort travels rapidly. As one North Dakota banker s t^ted it, "I can now discourage a borrower whose loan is not essential under pre sent conditions, to postpone his borrowing by referring to the National V °luntary Credit Restraint Program, with the full assurance that my competitor ^nks are following the same Program." Perhaps the most significant and abiding contribution of the Vo'luntar y Credit Restraint Program is that it has given lending officers new bench- ^rks for use in their appraisal of loan applications. It has broadened th eir horizon beyond the fairly limited objective of appraising the credit•ness of a prospective borrower. The Program has made them, increasingly of the importance of credit policy in an economic stabilization program, dtlci it has contributed to prudence in lending. Equally important, these have Achieved without shutting of'f the supply of credit to borrowers with in accord with today's part-defense, part-peacetime economy, and with°Ut: imposing upon lending operations a burdensome harness of detailed and pe cific rules and regulations. JUst This has helped keep to a minimum the in- ices and inequities which are inescapable under a set of detailed rules - 15 - knd regulations, no matter how carefully drawn, and has preserved the flexibility of movement required by financial institutions if they are to serve the needs of the economy. Returning now to the over-all national picture, the threat of inflation has not been removed, although it is not possible to predict when the nG *t upsurge in inflationary pressures will occur or what proportions it may a ssume. Business inventories are at peak levels and the pressure to reduce them still continues. The productive capacity of the country is tremendous and the record levels of plant andequipmerrb spending are augmenting that c&pacity ^Qnth by month. Nevertheless, it is not clear that production can be increased Efficiently fast to cover the increased takings for military equipment that are in prospect, without some reduction in supplies available for the civilian a i'ket. It is significant that steel output is already 2 per cent above c, -ted capacity and unemployment is the lowest since World War II. Defense E n d i n g is rising rapidly and a growing percentage of our defense outlays £omg into "hard" goods for which basic materials are short. This rise ^efense spending, with unemployment at very low levels, poses the prosi t of continuing upward pressures on wage rates and increases in personal riCorns ' Business spending for plant and equipment, at record levels, will in high for some time to come. The consumer remains a big unknown in the outlook. Following the tv 0 "scare" buying waves of mid-1950 and early 1951, consumers reduced their ^dirig and increased their savings substantially in the second and third Oi] a Il ers o f ' this year. Currently, consumers are spending a significantly Siuali p portion of their income than was customary in the postwar years. - 16 - But it is not certain how long it will be before money will again start to burn holes in the pockets of consumers. The large inventories of goods consumers' hands, resulting from the overbuying during the past year, ^ill gradually disappear. With personal income at record levels, and like- ly to increase further, and with large holdings of liquid assets widely distributed, the basic ingredients for an upturn in consumer spending are Present in the economy. Even without adverse developments on the interna- tional front, consumer spending is likely to increase; given deterioration the foreign situation, the rise in consumer spending might assume large Proportions. May I close with a word to you as representatives of private fi~ n '-nce? There are those who say "Why should we restrain credit and turn down Pr°fitable business when there is a strong possibility that some Government Cr<5 dit agency will step in and make the same loan?" Others say, "Why re- strain credit at all, when extravagance is still evident in many places?" Th e 0 answer to such thoughts should be obvious. The failures of others to their utmost in the restraint of inflation does not relieve us of the ligation to do our best. tion of a job well done. If we do our part, we shall have the satisfacIn years to come the finger cannot be pointed at Pi*' ivate finance for having failed in its part of the fight against inflaand we shall have set an example to be emulated by all others charged u Parts of this important campaign.
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