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Inflation the Result\
not the Cause,
of High Prices.








To the Bank addressed:
It is believed by many that one of the prime
reasons.of high prices is the amount of money in circulation.

As a result of a resolution recently passed

by the Senate directing that an investigation be made as
to the advisability of enacting legislation to provide for
a gradual reduction of the amount of money in circulation,
a letter was addressed by the Chairman of the Committee
on Banking and Currency to the Federal Reserve Board asking
for its expression.
Governor Harding's reply is so comprehensive and
convincing a statement of the amounts and kinds of currency
in circulation, and its relation to high prices, that I am
placing a copy in the hands of every banker in this District.
I trust that his reply will receive your very
careful reading.


. H 1


August 8, 1919.
Dear Sir:
T h e Federal Reserve Board acknowledges receipt of your letter of the 5th instant
asking for an expression of its views as to the advisability of legislation providing for the
gradual reduction of the currency in circulation as proposed by Senate Resolution 142.
T h e Board would suggest that in determining whether or not legislation is necessary
or desirable to regulate the volume of currency in circulation, consideration be given to
the various forms of money which make up the sum total of our volume of currency.


distinction should also be drawn between the stock of money in the country and the amount
actually in circulation.
W i t h respect to gold coin, gold certificates, standard silver dollars, silver certificates,
subsidiary silver and T r e a s u r y Notes of 1890, the Board assumes that it is recognized that
no legislation is necessary.
T h e United States notes, or legal tenders, which have remained at the fixed amount
of $346,681,016, since M a r c h 3 1 , 1878, have not been a disturbing factor since the passage
of the act of M a r c h 14, 1900.

An adequate gold reserve of more than 4 5 % is now held against

these notes, most of which are in the form of small bills of $1, $2, and $5 denominations.
Notes of these denominations are needed in the daily transactions of the public, and were
the United States notes to be retired, the issue of an equal volume of small bills in some
other form of currency would be necessary.

T o effect the retirement of the United States

notes, funds wouM have to be withdrawn from the Treasury to be supplied either by taxation or b y the sale of interest-bearing obligations.

T h e Board does not believe that any

legislation with respect to United States notes is necessary or desirable at this-time.
T h e national bank notes outstanding 011 A u g u s t 1, 1919, amounted to $658,118,555,
a reduction of nearly $60,000,000 since July 1, 1914.

T h e greater part of these notes is

secured by United States 2 % bonds, and provision has already been made in Section 18
of the Federal Reserve A c t for their gradual


Federal Reserve bank notes, which are secured by United States obligations and are
taxed j u s t as national bank notes are, have been issued only to replace in part national bank
notes retired, and standard silver dollars melted or broken up and sold as bullion under
authority of the act of April 23, 1918, known as the Pitman A c t .

T h e issue of these notes

has, therefore, brought about no increase in the circulating medium.
T h e amount of Federal Reserve notes outstanding has increased from $357> 2 39>°°°
on April 1, 1917, to $2,504,753,000 on August 1, 1919.

It appears, therefore, that those

who see in the larger volume of circulation in the United States the prime cause of increased
costs of living and who seek a remedy by a forced contraction of the currency must have
in mind the Federal Reserve note and Section 16 of the Federal Reserve Act as amended
June 21, 1917, which provides for its issue and redemption.

In analyzing our present monetary situation, and in considering the causes which
have led to the expansion of credits and note issues during the war, we should not lose sight
of some of the developments of the pre-war period and of their effect upon credits and prices.
V e r y h e a v y purchases of supplies of all kinds were made in this country by


beligerents during the years 1915 and 1916, p a y m e n t for which involved the shipment to
us of large amounts of gold.

T h e stock of gold in the United States 011 July 1, 1914, was

T h i s amount increased steadily until April, 1917, the date of our own

entry into the war, when it reached $3,088,904,808, an increase of about $1,200,000,000.
B a n k deposits likewise show a large increase, the net deposits of national banks having
risen from $7,495,149,000 on June 30, 1914, to $10,489,217,000 on M a r c h 5, 1917,


the net deposits of all banks in the United States increased from $17,966,150,000 in June,
1914, to $24,891,218,000 in June, 1917.

N e t deposits of national banks had further in-

creased up to M a y 12, 1919, to $11,718,095,000, and those of all banks in June, 1918 (the
latest date for which figures are available) to $26,769,546,000.

Shortly after April 6,

1917, when the Congress declared war, the T r e a s u r y began to sell bonds, notes and certificates

in large amounts, resulting in a net increase in the public debt to A u g u s t 1, 1919,

of $24,518,064,840.
On July 1, 1914, the total stock of money in the United States, exclusive of that held
by the United States T r e a s u r y , was $3,419,168,368.

On April

1, 1917, the stock of

money, estimated on the same basis, was, $4,702,130,941, an increase of $1,282,962,573,
of which increase $883,481,028 was in gold.
On July 1, 1914, there were no Federal Reserve notes in existence, while on April 1,
1917, there were outstanding $357,239,000.
T h e amendment to the Federal Reserve A c t approved June 21, 1917, changed substantially the original reserve requirements for member banks and provided
lawful reserve should be carried with the Federal Reserve banks.

that their entire

T h e same amendment

authorized the Federal Reserve banks to exchange Federal Reserve notes for gold.


result of these two changes in the law was to transfer immediately large sums of gold from
the vaults of the member and non-member banks and from general circulation to the
Federal Reserve banks, and this caused a change in the methods of accounting for gold by the
Federal Reserve banks and Federal Reserve


In order to avoid confusion in determining the volume of money in actual circulation, it is necessary to distinguish between tables showing the total stock of money in the
country, and tables showing the circulation outside of the Treasury and Federal Reserve
agents' vaults, and to limit our view to amounts held by member and non-member banks
and the public, which are exclusive of amounts on hand at Federal Reserve banks, held
by Federal Reserve agents, and held in the T r e a s u r y .
T h e reserve money held by or for the Federal Reserve banks serves, of course, as a basis
for credit, but it forms no part of the currency in circulation.

Upon this basis, the amount

of money in circulation on July I, 1914 (there being no Federal Reserve banks in operation at that time) was $3,419,168,368, made up as follows:
$55 2 >-°3>6io;

Gold coin and certificates

silver dollars and silver certificates, including Treasury notes of 1890*
all other currency $1,217,188,955, being circulation per capita $34.53.

T h e corresponding amounts of money in circulation on April 1, 1917, December


and A u g u s t 1, 1919, are shown in the following table:

Amount of Money Outside the Treasury and Federal Reserve Banks

Gold coin and certificates

April 1,

December 1,

A u g u s t 1,







357> 2 39>°°°


->5 0 4>753) 000







Silver dollars and silver certificates (including
Treasury notes of 1890)
Federal Reserve notes
Federal Reserve bank notes
All other currency

$4,100,976,000 $5,129,985,000 $4,796,890,000

A m o u n t per capita outside the Treasury and
the Federal Reserve B a n k s




Assuming that the date December 1, 1918, marks the beginning of the post-war period,
the table shows changes during this period up to August 1, 1919, as follows:
and certificates in circulation decreased $133,199,000;

cates, including Treasury notes of 1890, decreased $130,984,000;
decreased $102,692,000;

Gold coin

silver dollars and silver certifiFederal Reserve notes

Federal Reserve bank notes increased $78,552,000;

all other

currency decreased $44,772,000, being a net decrease in circulation for the post-war period



$ 2 - 9 7 P e r capita.

In considering the question of currency in circulation, there should be taken into
account the various factors which have entered into the demand for currency, among which

T h e gradual enlargement of payrolls, both as to the number of workers and amount

paid to each; the effect of higher wages upon deposits in banks and upon the amounts of
money carried by shopkeepers in their tills and by individuals in their pockets; the amounts
of money locked up or carried on their persons by workmen who have been receiving high
wages, and who, especially in the case of ignorant foreigners, are unwilling to deposit their
savings in banks or to invest in Government bonds;

the amount of money carried a w a y

by workmen returning to their homes in foreign countries;

and the fact that the circula-

ting media of the Philippine Islands, Hawaii, C u b a , Porto Rico, Santa Domingo, Haiti,
Honduras, P a n a m a , and, in part, Mexico, includes United States paper currency and subsidiary silver.

T h e amounts required in these countries, most of which are very prosper-

ous, have greatly increased in the last few years.
T h e total foreign circulation of United States currency cannot be stated accurately,
but is estimated to be at least one hundred and fifty million dollars.
T h e difficulty, indeed the impossibility, of keeping in circulation an excessive volume
of Federal Reserve notes should be understood.

T h e issue of these notes has been care-

fully safeguarded by the Federal Reserve A c t , and ample provision has been made for their

Federal Reserve notes are redeemable in gold;

they cannot be forced into

circulation in payment of the expenses of the Government, or for any other purpose, as they
can be issued only in exchange for gold or against a deposit of negotiable paper growing
out of a legitimate commercial transaction, plus the required gold reserve of not less than
40 per centum.

Upon payment of commercial paper which has been deposited to secure

Federal Reserve notes, there results either an immediate return of an equal amount of notes
to the bank, or an automatic increase in the percentage of gold reserve available for their

Federal Reserve notes are not legal tender, nor do they count as reserve money

for member banks.

T h e y are issued only as a need for them develops, and as they become

redundant in any locality they are returned to the Treasury at Washington, or to a Federal
Reserve bank for redemption.

T h u s there cannot at any time be more Federal Reserve

notes in circulation than the needs of the country at the present level of prices require, and
as the need abates the volume of notes outstanding will be correspondingly reduced through

T h e increased volume of Federal Reserve notes in circulation during the

past three years, in so far as it is not the result of direct exchanges for gold and gold certificates which have been withdrawn from circulation, is the effect of advancing wages and
prices, and not their cause.
There has undoubtedly taken place during the last two years a certain amount of
credit expansion which, under the circumstances connected with our war



inevitable, but this will be corrected as the securities issued by the United States Government for war purposes are gradually absorbed by investors.

T h i s credit expansion is equal

to the difference between the total of the war expenditures of the Government on the one
hand, and on the other, the total amounts raised by the Government through taxation
and by the sale of its obligations so far as paid for out of savings.

N o reliable estimate

can be made of this difference, which must be gradually absorbed through future savings
for the reason that banks are lending and will always lend freely on Government bonds
as collateral.
T h e principal cause of the advance of prices before and during the war was the urgent
need of the governments of the allied world for goods of all kinds for quick delivery in
large volume, and the competition of this buying by governments

with purchases


private individuals who failed to contract their expenditures at a rate commensurate with
the growing expenditures of these governments.

In the post-war period, through which

we are now passing, the country has experienced rising prices owing, in part, to a general
relaxation of the war time regime of personal economy, resulting in an increased demand
for commodities by individuals who restricted their purchases during the war, but who are
now buying in competition with export demand.

In addition, accrued incomes and increased

wages have led to h e a v y demands for commodities not of prime necessity, which have resulted
in diverting labor and material from essentials to non-essentials.
T h e Federal Reserve Board believes that any currency legislation at this time is
unnecessary and undesirable, and would suggest that whether viewed from an economic
or financial standpoint, the remedy for the present situation is the same, namely to work and
to save; to work regularly and efficiently in order to produce and distribute the largest
possible volume of commodities; and to exercise reasonable economies in order that money,
goods, and services m a y be devoted primarily to the liquidation of debt and to the satisfaction of the demand for necessities, rather than to indulgence in extravagances or the
gratification of a desire for luxuries.

T h e war is o v e r , — i n a military sense—and while

the bills have been settled by loans to the Government, these obligations, so far as they
are carried by the banks, must be absorbed before the war chapter of the financial history
of the country can be closed.
Very truly yours,
W . P. G .


Hon. Geo. P . M c L e a n , Chairman,
C o m m i t t e e on Banking and Currency,
United States Senate,
Washington, D . C .