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THE VOLUNTARY CREDIT RESTRAINT PROGRAM

An Address by Oliver S. Powell, Member,
Board of Governors of the Federal Reserve System,
Before the Bank Management Clinic
of the South Dakota Bankers Association,
Marvin Hughitt Hotel, Huron, South Dakota.

Wednesday afternoon, March 12, 1952.

Mar •

THE VOLUNTARY CREDIT RESTRAINT PROGRAM

The title of this talk might have been labeled, "Learning to Live
with National Defense".

Outside of actual war-time conditions, the United

States for generations has found it possible almost to forget defense against
outside enemies and to devote its energies completely to developing a higher
standard of living at home.

Now we find ourselves the most powerful non-

communist country in the World, able to depend on other countries for protection only in very limited ways and faced with the problem of rebuilding
a

strong 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

level as possible.

Prices go up.

If the total demand for goods exceeds the supply,

This is inflation.

It hurts the civilian economy and in-

creases the cost of the defense program.
You will recall the panicky buying that followed the Korean illusion.

We rushed to the stores and bought abnormal quantities of merchan-

dise—everything from sheets and coffee to television sets and autos.
Was

also an unprecedented increase in residential building.

There

This buying

rush caused retailers and manufacturers to step up their inventory purchases
a

hd production rates, and there was a sharp increase in employment.

The in-

s t a b l e result of all this was a sharp rise in prices, and another round of
increases.

These forces had spent their power or were checked in March

^ 5 1 and in the year since that time there has been no important advance in
Prices.

It is important to analyze the sources of buying power which made
possible this abnormal buying movement which was superimposed on a high level
of peacetime trade.

There were three principal sources of buying power:

First, current income:

The sum total of wages, rents and income

from 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,
cashing savings bonds and spending funds which had remained idle in checking accounts awaiting a suitable time for use.
Third, borrowing against future income:

Consumers' borrowings to

buy automobiles, household appliances and houses; business firms' borrowings
to increase inventories or to pay higher prices for inventories or to extend credit to consumers, or to expand plants.
The combination of these three sources of buying power, when used
to purchase a quantity of goods and services that could not expand with
equal rapidity, caused a sharp price rise.
Having analyzed the sources of buying power which caused the upsurge in commodity prices in 1950 and early 1951, it is important to explore
the restraining influences which have resulted in a sidewise movement of
Prices for the past ten months.

The principal factors are found in some

widely varying fields.

Certainly the rapid expansion of inventories caused

Part of its own cure.

Just before Easter in 1951 merchants decided that in-

ventories at retail were too high.

They have been scaling their inventories

- 3 down as occasion permitted ever since until, according to the most recent information, inventories are not much higher than normal for today's volume of
business.

Manufacturing inventories, on the other hand, have continued to in-

crease steadily, probably as a result of defense production requirements.

An

over-hang of inventories always spells caution to the lender and the businessman.

Later, when inventories of raw materials are being reduced, the use of

those materials will reduce the demand for market supplies and, hence, reduce
inflationary pressures.
The increase in taxes has undoubtedly had a restraining effect.
is as it should be.

This

The bill for national defense is not a proper inheritance

to pass on to our descendants.

Individually, we want protection, and we should

Pay the bill out of our current income, no matter how it hurts.

Business firms

faced with higher taxes are finding the remainder of income after payment of
taxes and dividends to be shrinking sharply, leaving them with less funds for
expansion of plant and business unless they borrow the money for the purpose.
Individuals are also finding with the higher tax rates that there is less money
ieft over after paying current living costs for the purchase of items of household equipment or for embarking on programs of instalment purchase.
tioing two important things:

Taxes are

they are deterring private spending and borrowing,

and they are providing the national government with funds so that our national
defense is more nearly on a pay-as-we-go basis.
There seems to be a lack of an urge to buy on the part of consumers.
T

his is probably a composite result of a number of factors.

Many people over-

bought in the excitement after the Korean incident, and those goods have not

-u yet worn out.

There has not, in recent months, teen any dramatic move against

the democratic nations which might have touched off another buying wave.

Pro-

ductive capacity in the United States has been steadily increasing so that
most kinds of goods are in adequate supply on dealers' shelves.

Then, there

is the sobering effect of having to meet monthly payments on homes purchased
in the last two years.

It is well to recognize that some two and one half

million housing units were constructed in 1950 and 1951.

As families buckle

down to the grind of monthly payments over a long period of years for a home,
while meeting normal living costs and higher taxes, they are obviously less
able or inclined to increase their spending.
Finally, we come to the banking and monetary moves that were made
following the start of the Korean trouble to counteract inflationary forces.
(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.

(3)

A new regulation dealing with real estate credit was imposed.

(/f)

In January 1951> reserve requirements of member banks were

raised to substantially their upper legal limits.
(5)

One of the most important tools of inflation restraint was

Practically out of use for this purpose for several years.

This was the em-

ployment of open market operations, which were devoted almost solely for
several years to maintaining a pegged price for long-term Government securities.

This program was modified early in 1951. The reduction in prices of

•^°ng-term Government bonds has had far-reaching effects in the control of

- 5 inflation.

Holders of those securities have been reluctant to d i . them on
urp

the market find as a result, supplies of funds for many types of credit have
been reduced.
The credit policies of the Federal Reserve System have been reinforced by a Program of Voluntary Credit Restraint among private lenders.

The

general credit policy of the System is intended to put a brake on the expansion of credit in the aggregate and to make it unnecessary for the System to
add to bank reserves by the continued purchase of Government securities; the
selective credit controls are designed to restrain the extension of credit in
a few lines where standard lending practices prevail.

Reliance has been

placed upon the voluntary credit restraint effort to foster a spirit of caution and restraint in lending policies in general, but especially in credit
fields not suited to selective credit controls, and equally to assist in
channeling the available supply of credit into the defense program and essential civilian activities.
We have now come to the principal part of my talk—the credit standards appropriate for an inflationary period.

The first statement of such

standards appeared in the Statement of Principles issued to all lenders when
the Program started.

Credit men in all branches of finance were asked to

screen their loans not only as to credit-worthiness but as to consistency
with our national efforts to contain the inflationary pressures.

Listen to

this sentence from the Statement of Principles:
"It shall be the purpose of financing institutions to extend
credit in such a way as to help maintain and increase the strength
of the domestic economy^through the restraint of inflationary tendencies and at the same time to help finance the defense program
and the essential needs of agriculture, industry and commerce."

- 6 The Voluntary Program does not attempt to override the Federal agencies in. the field of inflation control.

It does not have to do with such

factors as inflationary lending by Federal agencies, which the Statement of
Principles * stated "should be vigorously dealt with at the proper places."
Neither does the Program seek to restrict loans guaranteed or insured by a
Government agency, on the theory that they should be restricted, in accordance
with national policy, at the source of guaranty.
Here in South Dakota where agriculture plays such an important part
in banking activities, you will be particularly interested to know that the
central organization of the Federal Farm Credit agencies is giving
Voluntary Credit Restraint Program excellent support.

the

Repeatedly, they have

sent messages to the various field offices explaining the principles of the
Credit Restraint Program.

The examiners who inspect the affairs ox the

field offices review their operations to see whether they are conforming to
our Program.

I have a standing invitation from Governor Duggan to submit to

him any cases of criticism which are sent to me and his promise to review
such cases and attempt to obtain correction.

I am happy to relay this invi-

tation to you and to offer to act as your intermediary if there are cases
which you believe need to be corrected.
At the center of the Voluntary Credit Restraint Program there is a
national Committee appointed by the Federal Reserve Board.

This Committee is

composed of men chosen from the principal kinds of lending institutions, with
a Federal Reserve Board Member as Chairman.

The national Committee has set

up regional committees to deal with problems in five major lending fields:
commercial banking, life insurance, investment banking, savings banking, and
the savings and loan system.

- 7 There are nineteen regional commercial banking committees, one or
more in each Federal Reserve District, composed of leading bankers from institutions of varying sizes.

These regional comiaittees are set up to answer

your questions if loans are presented to you about whose propriety under today's inflationary pressures you are in doubt.

There are inquiry forms which

you may obtain and which will enable you to submit full information about the
problem case so that a prompt and informed opinion can be rendered by the committee.
Right from the start the national Committee recognised 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
nation.

The national Committee has issued a series of bulletins to all lenders

on credit problems in relation to the Voluntary Credit Restraint Program.

These

refer to specific credit areas such as inventory loans, credit and securities
for plant expansion, municipal credit and conventional real estate credit.
Perhaps the most significant and abiding contribution of the Voluntary Credit Restraint Program is that it has given lending officers new benchmarks for use in their appraisal of loan applications.

The Program has made

them increasingly aware of the importance of credit policy in an economic stabilization program, and it has contributed to prudence in lending.

Equally

important, these goals have been achieved without shutting off the supply of
credit to borrowers with needs in accord with today's part-defense, partPeacetime, economy, and without imposing upon lending operations a burdensome
harness of detailed and specific rules and regulations.

- 8 The application of the Voluntary Credit Restraint Program in the
agricultural regions has been puzzling to many bankers.

A year ago in New

York an up-State banker said that his town was not in a defense area.

He

wondered whether he should stop making loans altogether to comply with the
Program.

Of course he had misunderstood the nature of defense and defense-

supporting activities.

Certainly a well-rounded farm program is essential

and should have banking support. Oil the other hand, there are many things
which bankers in the farming regions can do to support the Program.

For

example, the pyramiding of farm real estate holdings by an owner is of doubtful desirability at any time and certainly should be discouraged today.

You

can counsel your municipalities to use conservatism in expenditures and to
hold their borrowings to a minimum.

You can withhold credit for less desirable

business construction, such as new store fronts, which will provide useful
employment later on and are unnecessary at the present time.
courage farmers from over-investing in farm machinery.

You can dis-

In fact, with the

general principles of the Voluntary Credit Restraint Program in mind, I believe that you will have no difficulty in applying the principles either for
0r

against practically every type of loan which you are offered.
Returning now to the over-all national picture, the threat of in-

flation has not been removed, although it is not possible to oredict when
^he next upsurge in inflationary pressures will occur or what proportions it
ma

y assume.

Business inventories are at peak levels and the pressure to reduce

them still continues.

When these inventories stop rising, the effect will be

" o reduce the spending stream.
t

In other words, that development would wipe

,

- 9 -

out one of the most important inflationary factors which have been in the picture since the Korean incident in June 1950.

The productive capacity of the

country is tremendous and the record levels of plant and equipment spending
are augmenting that capacity month by month bringing us closer to an ability
to satisfy all demands.
Nevertheless, it is not clear that production can be increased
sufficiently fast to cover the increased takings for military equipment that
are in prospect, without some reduction in supplies available for the civilian market.

Defense spending is rising rapidly and a growing percentage of

our defense outlays is going into "hard" goods for which basic materials are
short.

This rise in defense spending, with unemployment at very low levels,

poses the prospect of continuing upward pressures on wage rates and increases
in personal income.
It looks now that in the second half of 1952 the Treasury may unwillingly add to the problem of inflation control.
ing will in all probability exceed cash income.
provide these needed funds to bridge this gap.
and are definitely inflationary.

Federal government spend-

Either savers or banks must
Bank loans add to deposits

It will be wise for the savings institutions

and individuals and corporations to buy Treasury securities to provide the
extra funds for defense.

Ve in the Voluntary Credit Restraint effort can do

our part by urging the postponement of the use of savings for other less essential purposes, so that today's high level of savings will flow to the Treasury.
I should be failing in my duty if I left this discussion of inflation and the Voluntary Credit Restraint Program hanging in the air.

In addi-

tion to screening new credits according to the inflation restraint principles,

• •

- 10 -

i

there is one job which bankers can do right now.

You can see that the money

loaned last fall for seasonal purposes is repaid when it has performed its
usual function.

The older heads among,credit men know that there is some-

times a tendency on the part of the borrower to drag his feet when it comes
to repaying a loan.

There is always something else which he can do with the

money, and that secondary use of the funds may or may not meet with the approval of the banker.

Unless the banker is willing to go into partnership

with the borrower, he should insist on the repayment of the loan and then
negotiate another credit if the borrower needs money for further operations.
In this way, the bankers of the nation will be doing their full
part to carry on the Program on which you have all been working so conscientiously for nearly a year, to provide essential credit for defense and to avoid
over-extension of credit in nonessential lines.

This is your part in the ef-

fort to protect the future value of the dollar under today's emergency conditions .