r 9 1 5

X-202U

( C O P Y ) CHAMBER OF COi /tEHCE

OF THE UNITED STATES OF AMERICA WASHINGTON, D. C.

October 9> 1920

Honorable William P. G. Harding, Governor, Federal Reserve Board, Washington, D. C.

My.dear Governor:

Desi r ing to measure the e f f e c t of the declared pol icy of the Federal Reserve Board to r e s t r i c t the undue use of the rediscount p r i v i l e g e by advancing the discount r a t e , we have had under considerat ion an ana lys i s of the e f f e c t of the r a t e changes in the increase of the general bank r a t e , the changes i n the loan account ind ica t ing a decrease Of loans on government war ob l iga t ions and other bonds and stocks, and the increase of the volume of loans to discounts of member banks and of a l l s t a t e and na t iona l banks during a per iod from October, l $ ig , to September 1, 1920.

We have a l so had under considerat ion the decrease in market values of s e c u r i t i e s a r i s i n g from an advance in i n t e r e s t r a t e , the purpose being not to under-vaiue the b e n e f i c i a l e f f e c t s tha t may have r e su l t ed from the p o l i c y but r a t h e r to a s c e r t a i n the cost to the publ ic of t h i s country in the i n t e r e s t b i l l on the one hand and the decreased market value of s e c u r i t i e s on the other as represent ing the o f f s e t t o the safeguards t h a t may have been included in carrying out the Board's pol icy . The ana lys i s s tudied by our Board of Directors was not prepared in a s p i r i t of c r i t i -cism but r a the r of open and f r i e n d l y inquiry and the f igu res compiled have, with very few exceptions, been taken from the s t a t i s t i c a l records of the Federal Reserve Board as published in the monthly b u l l e t i n s from l a s t November to date .

If we may venture t o suggest anything to the considera t ion of the Federal Reserve Board i t would be to express the convict ion tha t a second d e f i n i t e instrument should be provided by law to be used in con t ro l l i ng the volume of red iscounts when the log ica l and usual instrument, the increase in the discount r a t e , f a i l s in i t s e f f e c t i v e n e s s .

We have a f e e l i n g tha t the Phelan ac t , passed in April of t h i s year, provides t h i s other instrument t o l i m i t rediscounts , but the exerc i se of t h i s power on the p a r t of the Federal Reserve bariks being opt ional i t does not a t present provide p o s i t i v e l i m i t a t i o n s vAiich ind ica te the bas ic volume of rediscount operat ions sub jec t to increase upon app l i ca t ion with v a l i d reasons t h e r e f o r .

We co rd i a l l y commend to your considerat ion the expression of our

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Board t h a t the rediscount r a t e may be placed upon a lower l eve l in the 'near f u t u r e , f e e l i n g conf ident t ha t t h i s ac t on the p a r t of the Federal Reserve Board w i l l immediately lower the general i n t e r e s t f a t e in the same r a t i o t h a t the advancing rediscount r a t e has served to s tep up the general bark r a t e .

We are not unmindful of the danger or d i f f i c u l t y tha t may a t tend a reduct ion of the rediscount r a t e in i t s e f f e c t upon the s e c u r i t i e s market and we a r e no t urging ac t ion in t h i s d i r ec t ion u n t i l such time as the safeguards have been extended uniformly throughout a l l of the Federal Beserve banks to make impossible a per iod of speculat ion, as the market values of s e c u r i t i e s move upward in keeping with the lower p r i c e of money. We a re desi rous of continuing our analys is of the e f f e c t s of t h i s po l i cy upon commerce and wi l l gladly tender to the Board any ass i s tance which the Chamber of Commerce may be able t o o f f e r in solving what we f e e l to be an i n t r i c a t e and d i f f i c u l t problem. We should a l so g rea t l y appreciate your c r i t i c i s m of our pos i t ion i f we have mis in te rpre ted the Board 's po l i cy in i t s r e s u l t s . w@ are a t t ach ing here to a copy of the memorandum which has had the a t t e n t i o n of the Directors and upon which the d iscuss ion of the subject has been pred ica ted .

Very t r u l y yours,

(Signed) JOSEPH H. DEPRESS

Pres iden t .

Inc losure :

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9 1 7

" ( C O * Y) X^2024a

TO THE BOARD OF DIRECTORS OF THE CHAMBER OF COMMERCE OF THE UNITED SPATES:

For eleven months the declared po l icy of the Federal Reserve Board

to cont ro l c r e d i t expansion, discourage speculat ive operat ion in s e c u r i t i e s

and commodities,bring about de f l a t i on , and r e t u r n to normal p r i c e l eve l s

has been in e f f e c t *

The extent t o which the po l i cy has been successful i s not ye t c l e a r . •

The instrument chosen, an increase in the rediscount r a t e operat ing i n

normal times, would surely have brought about the con t ro l s sought, but

normal times are no t wi th us ye t and adjustments have been p a r t i c u l a r l y

d i f f i c u l t because world complexities inf luence them. Channels of com-

munication are not a l l open arid running smoothly. Transportat ion on land

and sea i s s t i l l s u f f e r i n g from the s t r a i n of war condi t ions . In t e rna t iona l

c r e d i t i s s t i l l chaot ic ahd the exhausted surpluses of the n e c e s s i t i e s of

l i f e have not yet been regained. Perhaps experimentation with t h i s ins t i l l*

ment was des i rab le i f only to ingufe tke Maintenance of the lawful reserves

of gold agains t the deposi t and note c i r c u l a t i o n l i a b i l i t y of the Federal

Reserve system, but whether the r e s u l t s hoped f o r have or have not bean

r e a l i z e d the value of these r e s u l t s must be measured by the disadvantages

su f fe red to secure them, and the po l i cy of the Federal Reserve Board has

had such a marked e f f e c t upon the i n t e r e s t r a t e f o r cur ren t and time c r e d i t

operat ions , and upon the values of outstanding s e c u r i t i e s , and even in

some measure upon the general p r i ce l e v e l , t h a t I have been l e d to make

an ana lys i s f o r your considera t ion t o permit you t o determine whether a

change of nol icy i s advisable or necessary, or whether a f u r t h e r amend-

ment t o the Federal Reserve law should be made to provide other i n s t r u -

ments of control than the one used in t h i s ins tance .

In p r e sen t i ng t h i s ana lys i s I wish i t d i s t i n c t l y understood t h a t I

am not c r i t i c i s i n g the Federal Reserve Board nor the boards of the Federal Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

— 2 - X-20?4a

Reserve banks. I am simply asking a cons idera t ion of the apparent r e s u l t s

of the Board's p o l i c y to determine, perchance, whether the Chamber of

Commerce of the United S t a t e s has a duty i n connect ion wi th the f a r t h e r

continuance of t h i s p o l i c y .

We may assume t h a t the c o n s i s t e n t operat ion of the p o l i c y has develop-

ed c e r t a i n r e s t r a i n i n g i n f l u e n c e s . Hie e x t e n t t o which d i s a s t e r has been

averted i s d i f f i c u l t t o measure. The unknown q u a n t i t i e s may compensate

f o r a l l c o s t s . I s h a l l not t r y t o speculate regarding them, but only to

s e t f o r t h such comparative f a c t s as are a v a i l a b l e from the records of the

Federal Reserve system.

1 . We must admit t h a t the r e s t r a i n t s of an increased red i scount rate

he lped t o maintain t h e m e t a l l i c reserve a g a i n s t d e p o s i t s and note c i r c u l a -

t i o n . Hie va lue of t h i s as ho ld ing the p u b l i c conf idence i n the Federal

Reserve system i s very grea t . The same r e s u l t might have been obtained by

a broader i n t e r p r e t a t i o n of the power of the Board to l i m i t r ed i s count s ,

but the law i s not mandatory or even s p e c i f i c on t h i s quest ion of l i m i t a -

t i o n and, t h e r e f o r e , the instrument chosen was the natura l and l o g i c a l on6*

2 . Hie investment account of e i g h t hundred report ing member banks

has been reduced from November, 1919» t o Ju ly , 1920, by something over

$450,000, OCX).

3 . The l o a n s on Uni ted S t a t e s bonds and c e r t i f i c a t e s f l u c t u a t e d

from $1 ,061 ,000 ,000 on October 4 to a high of $1 ,189 ,000 ,000 i n March to

a low of $1 ,000 ,000 ,000 i n Ju ly , a n e t decrease f o r the per iod of

$61 ,000 ,000 .

4 . Loans on s tocks and bonds other than United S t a t e s s e c u r i t i e s

l i k e w i s e f l u c t u a t e d from $3 ,200 ,000 ,000 i n October to a h igh of $3 ,350-

000 ,000 i n January to a low o f $3 ,046 ,000 ,000 i n J u l y , a n e t decrease f o r

the p e r i o d of $156 ,000 ,000 . Undoubtedly the h i g h i n t e r e s t r a t e de ferred

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- 3 -X-2064a

some capital investnients where the earning power of s u c h investments

was low, and bond and stock operations and commodity purchases were

curtai led. Operations of a highly prof i table or speculative nature,

however, probably proceeded, notwithstanding the rate; for speculation,

e spec ia l ly in abnormal titii68* playti fbr a stake and the pride of money

becomes a secondary consideration.

I wish to d i scuss in t h e i r order the changes s ince the Federal Re-

serve po l i cy was announced in

The p r i ce of money; The general s tock of money; The index f i g u r e s f o r wholesale 'pr ices; The loans and discounts of r epor t ing banks and

a l l s t a t e and na t iona l banks; The p r i c e of war obl igat ions of the United

Sta tes Government; The p r i c e of a l l other bonds; The volume of s e c u r i t i e s issued.

The ftrice of Money:

The Federal Reserve Board i n i t s Bu l l e t in dated October 1, 1919,said:

"The disappearance of the Treasury from the long term loan market and the rapid reduct ion of i t s requirements f o r short term accommodation foreshadow the approach of the time when the f i n a n c i a l operat ions of the Government wi l l cease t o be the important f a c t o r in shaping Reserve bark p o l i c i e s which they have been, and Federal Reserve bark r a t e s once more w i l l be f ixed sole ly with a view of a id ing commerce and b u s i n e s s . "

In the November Bu l l e t i n the Board sa id :

"A review of a l l the condi t ions in the banking s i t u a t i o n has confirmed the Board i n the view tha t in the app l i ca t ion of i t s discount po l i cy an advance of r a t e s should no longer be d e f e r r e d . "

Also, in the December B u l l e t i n the Board sa id :

"The usua l method of r e s t r i c t i n g the undue use of the rediscount p r i v i l e g e i s t o advance r a t e s . This po l i cy would have been put i n t o operat ion several months ago except f o r i t s bear ing upon government f inanc ing . The f a c t tha t the Treasury had sold more than twenty b i l l i o n s

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X.2024a - 4 -

i n bonds and Victory notes , magp of which had been taken by persons who had been unable to pay f o r them in f u l l but were obliged to car ry them a t banks, l i q u i d a t i n g t h e i r ob l iga t ions from time to time, ma te r i a l ly a l t e r e d the po l icy which would otherwise have been adopted by the Board. That a r e l a t i v e l y low r a t e was maintained f o r the purpose of accom-modating bona f i d e subscr ibers to government ob l iga t ions opened an opportuni ty f o r other borrowers t o obta in funds f o r t h e i r own purposes a t comparatively low c o s t . "

For more than twelve months preceding these e d i t o r i a l announcements

rediscount r a t e s had been maintained a t from 4-1/4$ to 4-3/4$, and t h i s

r a t e served to anchor the r a t e charged by member banks to customers, and

in the open market a t 5 -1 /4$ to 5 - l / 2$ , a d i f f e r e n t i a l of from 3/4$ to

1$ above the rediscount r a t e .

Quoting from the Board1 s March B u l l e t i n :

" I t was the Board's view a l so tha t as a r u l e the discount r a t e s of the Federal Reserve Banks should be higher than cu r -ren t market r a t e s , thus o f f e r i n g no incent ive to member banks to rediscount f o r the sake of making a p r o f i t in the t r a n s a c t i o n . "

However proper t h i s view may be, the operat ion does not seem to

proceed tha t way, and the argument most f r equen t ly advanced when the

Federal Reserve law was under d iscuss ion was t h a t the power of the Federal

Reserve Board t o meke a rediscount r a t e would serve t o s t a b i l i z e bank r a t e s

upon a reasonable and favorable l e v e l .

From September t o November 29, 1$19, the rediscount r a t e was f r a c t i o n -

a l l y advanced and the general bank discount r a t e moved up f r a c t i o n a l l y to

a maximum of 6$. Under normal condi t ions t h i s f r a c t i o n a l advance would

have re ta rded loan expansion but the contrary was the r e s u l t and up to

January 16, 1920, the loans and discounts of some e igh t hundred r epo r t ing

banks increased $500,000,000. On January 21, 1920, the f i r s t consequential

rediscount increase was made, t o a maximum of 6$. Hie r e s u l t to May 14

was an increase in loans and discounts of $1,500,000,000. Subdivided, the

loans changed as fo l l ows :

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- 5 -X-20"Ua

On U. S. s e c u r i t i e s , increase $87,000,000; On stocks and bonds other than U. S. s e c u r i t i e s ,

decrease $250,000,000; Other loans , p r i n c i p a l l y commercial paper and d i s -

counts, increase $1,600,000,000.

Comment e d i t o r i a l l y in the March and April Bu l l e t i n s of the

Federal Reserve Board was as fo l lowst

"The normal and t r a d i t i o n a l method of c r e d i t control has been the discount r a t e . I t s e f f i c i e n c y , however, p r e -supposes normal condi t ions. The advance in r a t e operates in normal condi t ions not only to diminish the demand f o r c r e d i t by making ce r t a in a c t i v i t i e s unp ro f i t ab l e but as well i t increases the supply of c r e d i t by a t t r a c t i n g i t from other cen te r s or count r ies . The condi t ions t h a t make t h i s t r a d i t i o n a l control e f f e c t i v e do not a l l e x i s t a t the present time. The expansion of c red i t s e t in motion by the war mast be checked. Credit must be brought under e f f e c t i v e control and i t s f low must be regulated and governed with ca re fu l regard f o r the economic welfare of the country and the needs of the producing i ndus t r i e s . Def la t ion , however, merely f o r the sake of d e f l a t i o n and the speedy r e tu rn to normal, d e f l a t i o n merely fo r the sake of r e s to r ing s e c u r i t i e s and commodities to t h e i r prewar l e v e l s without regard to other a f f a i r s ,wou ld be an insensate proceeding in the ex i s t i ng posture of na t iona l and world a f f a i r s .

"The influencesof the discount r a t e po l i cy of the Federal Reserve banks upon the investment market has i f anything been l e s s obvious than in the commercial banking f i e l d . As money r a t e s have increased the inf luence tending to maintain c a p i t a l operat ions a t comparatively low leve l have been correspondingly l e s sened . "

On May 29 a f u r t h e r subs tan t i a l increase was made in the rediscount r a t e , t o a maximum of 7%, Comment e d i t o r i a l l y in the June, Ju ly and August Bu l l e t i n s was as fo l lows:

"In view of the steady pressure f o r funds and by way of emphasizing the necess i ty f o r continued moderation in rediscount app l i ca t ions , advances not exceeding f i f t e e n days, secured by e l i g i b l e commercial paper, are f i xed a t the r a t e of 7 per cent , May 29th.

"Seven pef cent r a t e f o r commercial paper, which has j u s t been e s t ab l i shed , s u b s t a n t i a l l y r e f l e c t s condi t ions in the com-mercial loan market of t h i s country, where during the pas t month there has been a decided upward tendency, due to the increased pressure f o r commercial banking operat ions. The new r a t e s , t h e r e -f o r e , b r i ng the rediscount charge p r a c t i c a l l y into l i n e with the movements of commercial r a t e s .

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X-202Ua 9 2 2 - o -

"The ques t ion c o n s t a n t l y asked w i t h i n the l a s t few months has been the r e l a t i o n s h i p noted between the contro l of c r e d i t , the a p p l i c a t i o n of h igher d i scount r a t e s , and the a c t u a l ex -pans ion of opera t ions . On t h i s subjec t the ev idence i s s t i l l c o n f l i c t i n g and l a c k i n g i n c e r t a i n t y as to d e t a i l s . Die gen-e r a l c o n c l u s i o n to be drawn i s unmistakably t o the e f f e c t t h a t the o p e r a t i o n of c r e d i t contro l through h igher d iscount r a t e s has had a marked s u c c e s s . I t i s true that during the e a r l i e r per iod of i t s a p p l i c a t i o n , November, December, January, and February, an abso lu te check to the growth of r e d i s c o u n t i n g was n o t e f f e c t e d . This f a c t , however, should not be i n t e r p r e t e d i n the l i g h t of abso lu te f i g u r e s but rather i n the l i g h t o f r e l a -t i v e c o n d i t i o n s . "

"Summarizing the outcome, Governor Harding expres se s the op in i on:

•Further expansion of bank c r e d i t s has apparent ly been checked, though the volume of l oans and d i s c o u n t s of n e i t h e r member batiks nor Federal Beserve Banks has been m a t e r i a l l y reduced. 1

"The r e s u l t i n quest ion i s be ing a t t a i n e d on ly i n p a r t through the d i r e c t i n f l u e n c e of h igher r a t e s of i n t e r e s t and d i scount and i n part through the a p p l i c a t i o n cf j u d i c i o u s methods of l i m i t i n g u n e s s e n t i a l and unnecessary c r e d i t s . "

The e f f e c t of t h e s e i n c r e a s e s on the general bank r a t e was t o s t e p up customers' r a t e s to 7$ and open-market purchases to 8$ . The r e s u l t to J u l y 16 of the e f f o r t to c u r t a i l d i s count s and r e d i s c o u n t s was a s f o l l o w s :

Total l o a n s of e i g h t hundred report ing banks i n c r e a s e d $1,950,OTO,OOO.

The changes i n the loan account were as f o l l o w s :

Loans secured by U.S. o b l i g a t i o n s decreased $61 ,000 ,000 . Loans secured by s tocks and bonds decreased $156 ,000 ,000 . A l l o ther loans increased $2 ,195 ,000 ,000 .

and the f i g u r e s f o r September 17 show but a s l i g h t v a r i a t i o n from these

t o t a l s .

The r e s u l t on r e d i s c o u n t s h e l d by the Federal Reserve Batiks was t o

i n c r e a s e the t o t a l r e d i s c o u n t s to $350,000,000> but the d i s t r i b u t i o n was

markedly d i f f e r e n t i n that l o a n s on U.S. s e c u r i t i e s decreased $444,000,000,.

wh i l e other r e d i s c o u n t s , p r i n c i p a l l y commercial paper, i n c r e a s e d $79 5»000,000-

I t must be borne i n mind t h a t the t r a n s a c t i o n s here r e f e r r e d to represent

only the o p e r a t i o n s of about e i g h t hundred r e p o r t i n g member banks. On

February 28 ,1920 , the l o a n s and d i s c o u n t s of a l l Nat ional and State banks

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9 2 . 3

_7- - x-aosit a

were $26 ,685 ,000 ,000 . On February 13th the l o a n s and d i scounts of the r e p o r t i n g

banks whose f i g u r e s make up our comparison were $13 ,931 ,000 ,000 .

I t would appear from the forego ing that the p o l i c y adopted by the Federal

Beserve Board d id not decrease loans and d i scounts nor r e d i s c o u n t s , although

had no r e s t r a i n t been imposed we do not know how f a r the gold reserve might have

been impaired nor can we e s t i m a t e the ex tent to which d i s c o u n t s might have been

increased. We do know that the operat ion of the Board's p o l i c y served to i n -

crease the average i n t e r e s t ra te on current short time borrowings by at l e a s t

l - l / 2 % on $26 ,000 ,000 ,000 of c r e d i t , or an annual c o s t , i f the p o l i c y i s pursued,

of $400,000,000 more than would have been the case had the general bank ra te

and the red i scount remained a t or about the f i g u r e s of October, 1919* Perhaps

we may r a i s e the quest ion whether the choice of another instrument of contro l than

the r a i s i n g of the red i scount r a t e would n o t have been qui te a s e f f e c t i v e

and l e s s c o s t l y .

Stock of Money :

I f the p o l i c y of the Federal Re serve Board did not decrease r e d i s c o u n t s

i t must l i k e w i s e have f a i l e d t o reduce the general stock of money i n the

United S t a t e s and the amount i n c i r c u l a t i o n . The general s tock of money in

the United S t a t e s increased $430,000,000 from September 1 , 1919, to September '

1 , 1920, and the money i n c i r c u l a t i o n increased in t h e same per iod $464,000,000.

The per c a p i t a c i r c u l a t i o n , which was $54.03 on September 1 , 1919, increased

to $57*88, al though an e s t i m a t e of the i n c r e a s e in populat ion was a p p l i e d

in t h i s l a s t computation#

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X-2024 a

: 924

Index Figures of Wholesale P r i c e s :

I should not care to a t t r i b u t e to the p o l i c y of the Federal Reserve

Board the r e s p o n s i b i l i t y f o r the p r i c e advances of t h i s per iod , although

increased i n t e r e s t r a t e s would hardly br ing about p r i c e d e f l a t i o n . The

Bureau of Labor S t a t i s t i c s submits index f i g u r e s f o r a l l commodities show-

ing a steady advance from 220 i n October to 272 in May wi th a r e c e s s i o n

s ince May t o 262 f o r the month of July , whi le the index numbers of a l l

commodities provided by the S t a t i s t i c a l Department of the Federal Reserve

Board range from 212 i n October to 264 i n May with a r e c e s s i o n to 251 i n

Ju ly , 1920.

I t seems p e r f e c t l y obvious that n e i t h e r the money i n c i r c u l a t i o n nor

the l oans and d i s c o u n t s could be reduced i n the f a c e of such p r i c e advances,

which would demand l a r g e r c a p i t a l and c r e d i t to f inance the same number

of u n i t s produced and d i s t r i b u t e d ; n e i t h e r could i t be l o g i c a l l y argued

that the general stock of money or the volume of loans and d i scounts was

out of range wi th the increase in p r i c e s . Taking the n a t i o n a l banks as a

f a i r guide, the l o a n s and d i s c o u n t s doubled between December 31, 1914, and

May, 1920, whi l e commodity p r i c e s increased from 100 to the maximum of 272

during the same per iod .

jiflaps and, Discounts of Reporting Batiks and of a l l Banks :

I think I have r e f e r r e d s u f f i c i e n t l y to t h i s i tem i n the paragraph

an the p r i c e of money. Loans on Government War o b l i g a t i o n s and on other

stodks and bonds were decreased $217,000,000, but other l oans were increased

$2 ,195 ,000 ,000 to cover the requirements of commerce owing t o p r i c e advances,

and i f a l l Nat ional and S t a t e banks are cons idered, i n s t e a d of only .the

eight hundred banks Used i n the comparisons, the t o t a l s would be g rea t ly

increased.

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7 X2024 a

Pr ice of U. 8. T7ar Obligat ions; .

The if f ee t of an increased rediscount r a t e upon the outstanding

war ob l iga t ions of the Government was f irmly in the mind of the Federal Res-

erve Board, and a s long as the Government was a l a rge borrower r a t e s were

anchored down to low l e v e l s . Perhaps other inf luences beside the discount

r a t e a f f e c t e d the market value of .these s e c u r i t i e s , but the g rea tes t de-

c l ines followed the r a t e changes under the Federal Reserve Board po l i cy .

On October 10, 1919/ the market value of a l l outstanding war ob-

l i g a t i o n s was $19, *+75,000,000. Af ter the f r a c t i o n a l r a t e advances of Nov-

ember and December the market value declined to $19,251,000,000. Af ter the

l a r g e r increases in the rediscount r a t e in January and in May, the market

value was reduced to $17,641,000,000, while on September 1 of t h i s year

the market value was $17,308,000,000, a t o t a l l o s s in market value from

October, 1919* t o September,. 1920, of approximately $2,166,000,000.

Other Bonds: z

At the beginning of 1920 the par value of r a i l road bonds out-

standing was subs t an t i a l l y $12,$00,000,000. The market value was $9# 079/

000,000. On May 31 the market value approximated $8,484,000,000, a l o s s

of $595>000,000, while on September 1 a gain was r eg i s t e r ed , probably due

to favorable l e g i s l a t i o n , making the market value $8,631#000,000, a l o s s

for the f u l l period of $448,000,000.

On publ ic u t i l i t i e s s e c u r i t i e s the f i n a l f i g u r e s a r e not compiled

but the l o s s from October, 1919, t o September, 1$20, w i l l surely exceed

$500,000,000.

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• " 9 2 6 I n d u s t r i a l bonds have l ikewise been se r ious ly a f f e c t e d . The t o t a l s

of t he se and the l o s s i n market value can be obtained. Su f f i ce i t t o say

t h a t , a s an i n d i c a t i o n i n market value , four of the most s t ap le i n d u s t r i a l

bond i s s u e s l o s t from October 10, 1919# t o September, 1920, 5-1 /2 p o i n t s .

No e f f o r t has been na.de t o compute the l o s s i n market value of the

great volume of municipal boiids outs tanding, but t h i s w i l l probably closely

p a r a l l e l the l o s s sus ta ined i n the Government's war ob l iga t ions and produce

a t o t a l shrinkage i n market values i n excess of $5* 000>000,000. Of course,

t h i s i s not a l l a l o s s , f o r t he market values w i l l be r e s to r ed wi th im-

proved condi t ions and a s the prospect f o r lower r a t e s becomes assured , but

the l o s s t o i nd iv idua l s and corpora t ions can be measured by the t r ansac t ions

i n these i s s u e s and w i l l , i f computed, show s u r p r i s i n g f i g u r e s . Here agpiin

I r a i s e the ques t ion whether the choice of some o ther instrument than the

l a r g e increase i n the rediscount r a t e might not have been a s e f f e c t i v e in

r e s t r a i n i n g and much l e s s cos t ly .

S e c u r i t i e s Issued;

Bond, stock and note i s sues during the per iod under cons idera t ion

must a l s o be considered i n c a l c u l a t i n g the r e s u l t s of t he Federal Reserve

Beard ' s p o l i c y . From January t o August inc lus ive , 1919, new i s s u e s amounted

t o $1,850,000.000. From January t o August i nc lu s ive , 1920, new i s sues

amounted to $2,444,000,000, These f i g u r e s would not i n d i c a t e t h a t the

po l icy of t h e Federal Reserve Board had grea t ly r e s t r a i n e d the issuance of

s e c u r i t i e s , but the a d d i t i o n to the overhead cos t s a r i s i n g from a g rea t ly

increased i n t e r e s t r a t e w i l l be presen t f o r some years and c o n s t i t u t e a

tax upon t h e pub l i c which, i n the l a s t ana ly s i s , must assume the burden,

We have been cons ider ing up to t h i s poin t only s e c u r i t i e s bought and

sold on the exchanges, bu t re fe rence must be made t o t h a t grea t mass of

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other loans , including r ea l e s t a t e loans, the market value of which has

been a f f e c t e d and t o the cost of new or refunding f inancing grea t ly i n -

creased by the general i n t e r e s t l e v e l . Cotild another instrument than,

a r ad i ca l increase i n the rediscount r a t e have been chosen?

Section 5202 of the Revised S ta tu tes provides t h a t

"No na t iona l banking as soc ia t ion shal l a t any time be indebted, or i n any way l i a b l e , t o an amount exceeding the amount of i t s c ap i t a l stock a t such time ac tua l ly paid i n and remaining undiminished by l o s s e s or otherwise, except on account of demands of the nature fol lowing:

Notes of c i r c u l a t i o n .

Moneys deposited with or col lected by the a s soc i a t ion .

B i l l s of exchange or d r a f t s drawn aga ins t money ac tua l ly on deposit to the c red i t of the assoc ia t ion , or due there to .

L i a b i l i t i e s to the stockholders of the a s s o c i a t i o n or dividends and reserve p r o f i t s . "

In September, 1916, t h i s sect ion was amended t o make poss ib le

f u r t h e r expansion of l i a b i l i t i e s incurred under the provis ions of the

Federal Reserve Act.

In the March Bu l l e t in the Governor of the Federal Reserve Bank i s

reported a s follows:.

"Although there a re no s p e c i f i c l i m i t a t i o n s imposed upon the

amount of borrowings by member banks a t the Federal Reserve banks,

the re i s a p o t e n t i a l l i m i t a t i o n provided f o r i n the Act. In tha t

pa r t of sec t ion 4 which r e l a t e s t o the du t i e s of the board of

d i r e c t o r s of a Federal Reserve Bank there i s the fol lowing:

'Said board sha l l adminis ter the a f f a i r s of said bank f a i r l y and impar t i a l ly and without d iscr iminat ion i n favor of or aga ins t any member bank or banks and s h a l l , subject to the p rov is ions of law and the orders of the Federal Reserve Board, extend t o each member bank such discounts , advancements,and accomodat ions a s may be sa fe ly and reasonably 'made with due regard f o r the claims of other member banks ' . Digitized for FRASER

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"Therefore, i t i s p o s s i b l e t o determine t h e o r e t i c a l l y what

a f a i r l i n e of accommodation f o r any member bank would be; that i s ,

what amount of accommodation can be granted 1 s a f e l y and reasonably

wi th due regard f o r the claims of other member banks 1 .

"Any attempt, however, t o contro l cred i t by t h e a p p l i c a t i o n

of t h i s ru l e i s subject t o s e r i o u s admin i s t ra t ive d i f f i c u l t i e s .

If t h e paper o f f e r e d i s e l i g i b l e arid good, i t would be b e t t e r f o r

a r e s e r v e bank t o grant accommodation a t a p r i c e rather than t o

r e f u s e i t e n t i r e l y , but t h e a c t , subd iv i s ion (d) , s e c t i o n 14, pro-

v i d e s t h a t a Federal Reserve Bank s h a l l have power t o e s t a b l i s h

from time t o t ime, subjec t t o review and determinat ion of the

Federal Reserve Board, r a t e s of discount t o be charged by the

Federal Reserve Bank f o r each c l a s s of paper, which s h a l l be f i x e d

wi th a view of accommodating commerce and b u s i n e s s . There i s no

a u t h o r i t y , however, f o r e s t a b l i s h i n g graduated r a t e s based upon

the t o t a l borrowings of a member bank, and consequently when i t

becomes necessary t o advance the d iscount rate i n order t o curb

demands of those banks red i scount ing wi th the Federal Reserve Banks

i n very l a r g e amounts the same rate would have t o apply t o t h e

moderate requirements of other member banks who nay rediscount wi th

the Federal Reserve Banks in frequent ly and rover e x c e s s i v e l y . Thus

a p p l i c a t i o n of r a t e advances a s a c o r r e c t i v e or de terrent t o c e r t a i n

banks tends t o r a i s e the l e v e l of current r a t e s t o a l l .

"The Board, t h e r e f o r e , recommends t o Congress t h a t an a d d i t i o n a l

power be granted i t , by adding t o subd iv i s ion ( d ) , s e c t i o n 14,

a p r o v i s o that each Federal Reserve Bank may, w i t h the approval of

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the Federal Reserve Board, determine by uniform r u l e , a p p l i c a b l e

t o a l l i t s member banks a l i k e , the normal maximum rediscount

l i n e of each member bank and that i t may submit f o r the review

and determinat ion of the Federal Reserve Beard graduated r a t e s

on an ascend ing s c a l e t o apply equal ly and ra tab ly to a l l i t s

member banks r e d i s c o u n t i n g amounts i n e x c e s s of t h e normal l i n e

so determined. In t h i s way, i n the opinion of the Board, i t would

be p o s s i b l e t o reduce e x c e s s i v e borrowings of member banks and t o

induce them t o hold t h e i r own l a r g e borrowers i n check without

r a i s i n g the b a s i c r a t e . The Federal Reserve Banks would thus be

provided wi th an e f f e c t i v e method of d e a l i n g w i th c r e d i t expansion

more near ly a t t h e source than i s now p r a c t i c a b l e and without

unnecessary hardship to banks and borrowers who are conducting

t h e i r a f f a i r s w i t h i n the bounds of moderation.

"Congress on Apri l 3 f i n a l l y completed i t s work upon the

Phslan b i l l which had been recommended by the Board, and the

Pres ident on Apri l 13 s igned the measure, thus making i t law.

The Act a s now on the s t a t u t e books fur ther extends the Beard's

power i n connect ion wi th the approving of discount r a t e s by pro-

v i d i n g t h a t these rates *subject t o the approval , review, and

determinat ion of the Federal Reserve Board, may be graduated or

progressed on the b a s i s of the amount of the advances and d i s -

count accommodations extended by the Federal Reserve Bank t o the

borrowing bank' . The new p r o v i s i o n i s thus permiss ive and not

mandatory, i t s purpose being t h a t of au thor i z ing Federal Reserve

Banks w i t h the approval of the Board t o e s t a b l i s h a ' l i n e of c r e d i t 1

or d iscount accommodation f o r each member bank, s u b j e c t i n g those

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which p a s s beyond t h i s l i m i t i n t h e i r a p p l i c a t i o n s t o a pro-

g r e s s i v e l y growihg rate designed t o r e p r e s s the undue e n l a r g e -

ment of such a p p l i c a t i o n s . "

From the August B u l l e t i n we take the f o l l o w i n g :

"Under the terms of t h e Phelan Act adopted by Congress

on Apri l 13, 1920, p r o v i s i o n was made f o r the a p p l i c a t i o n of

graduated r a t e s of red iscount , r i s i n g from a base ra te t o be

e s t a b l i s h e d a t the opt ion of the board of d i r e c t o r s of the

Federal Reserve Bank, according a s the a p p l i c a t i o n s f o r r e -

d iscount f i l e d by member banks exceeded a s p e c i f i e d or base

l i n e t o which the normal or b a s i c discount ra te was a p p l i c a b l e .

S ince the adopt ion of t h e Phelan Act the new plan has been put

i n t o e f f e c t by four Federal Reserve Banks. The b a s i c l i n e which

has been adopted by the At lanta , S t . Louis , and Kansas City banks

i s two and one-half t imes a sum equal t o 65 per cent of the

member bank's average reserve balance p l u s i t s p a i d - i n s u b s c r i p -

t i o n t o the c a p i t a l s tock of the Federal Reserve Bank, both c a l -

cu lated over a f i x e d per iod e i t h e r preceding or i d e n t i c a l wi th

the per iod t o which the b a s i c l i n e a p p l i e s . For the D a l l a s

d i s t r i c t , however, a b a s i c discount l i n e was adopted equal t o

the p a i d - i n c a p i t a l and surplus of the member bank. At lanta

and S t . Louis apply the normal ra te , i , e . , the general e f f e c t i v e

ra te t o a l l o f f e r i n g s f o r rediscount and apply a p r o g r e s s i v e

• s u p e r - r a t e ' a t the end of the reserve computation per iod t o the

average borrowings i n e x c e s s of the b a s i c l i n e , wh i l e Kansas City

and D a l l a s impose the ' s u p e r - r a t e ' upon such part of the current

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o f f e r i n g s a s may, t o g e t h e r wi th outs tanding borrowings, be

i n e x c e s s of the b a s i c l i n e . As a s c a l e o i r a t e s , a l l four

banks have adopted an increase of one-half of 1 p s r cent

f o r anyth ing up t o 25 per cant i n exces s of the b a s i c

l i n e , w i t h 1 per cent f o r the second 25 per cent e x c e s s ,

and so on upward. Exceptions to t h i s progres s ive rate

p l a n were genera l ly made i n case of member bank c o l l a t e r a l

n o t e s secured by Government o b l i g a t i o n s , a l though some

v a r i a t i o n i n method of making except ions has been

introduced i n the four banks where the p lan has been

i n e f f e c t . As i l l u s t r a t i v e of the working of the p lan

a concrete example nay be c i t e d . A bank with a normal

l i n e of $100,000 and borrowings of $200,000 would be

charged an excess , or super-rate of one-half of 1 per

cent on $25,000, 1 psr cent on an equal amount, a 1 - 1 / 2

per cent on a l i k e amount, and 2 per cent on the f i n a l

$25 ,000 . A l l paper under discount on the date the

p r o g r e s s i v e r a t e s became e f f e c t i v e was exempted from

the a p p l i c a t i o n of the super-rate , a l though counted a s

part of the general c r e d i t s tructure i n determining the

s c a l e of s u p e r - r a t e s a p p l i c a b l e t o new l o a n s or to

renewals . The working of the p l a n i s of cons iderable

i n t e r e s t because of • the f a c t t h a t i t has not been app l i ed

to a l l d i s t r i c t s , w h i l e there has been d i f f e r e n c e of op in ion

a s t o the t h e o r e t i c a l advantages of i t . "

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This r e c i t a l i s not made f o r the purpose of fau l t—f ind ing . Water once over

the dam cannot be brought back. Disadvantages s u f f e r e d or l o s s e s sus ta ined

through the p o l i c y adopted by the Board cannot be recovered.

The cpiestion would appear to be whether another instrument than a r a d i c a l

increase of the rediscount r a t e could have been chosen that would, have e f f e c t -

i v e l y appl ied needed r e s t r a i n t s and proved l e s s c o s t l y t o the commerce of the

country.

I t i s ev ident that the Governor of the Federal Beserve Board b e l i e v e d that

the boards of the Federal Reserve banks had the power t o l i m i t r e d i s c o u n t s , but

they did not see f i t t o e x e r c i s e i t , probably because the power was permiss ive

only and un i formi ty of a c t i o n was d i f f i c u l t to secure .

When the r a i s e i n the discount r a t e i n November and December d id not produce

the des i red r e s u l t s , some other expedient could have been t r i e d , but again the

prov i s ions of the law were not mandatory and even the p r o v i s i o n s of the Phelan

Act l e f t i t t o the d i s c r e t i o n of the boards of the Federal Reserve banks to adopt

a b a s i c l i m i t of red i scounts and a progress ive ra te f o r the e x c e s s of such l i m i t s .

So long as the power to s e t l i m i t a t i o n s and t o impose e i t h e r the maximum

r a t e approved by the Federal Reserve Board or the p r o g r e s s i v e r a t e of the Phelan

Act i s o p t i o n a l , there w i l l cont inue to be a measure of u n c e r t a i n t y and lack of

cohes ive and uniform a c t i o n among the Federal Reserve banks.

A c e r t a i n measure of f l e x i b i l i t y must be r e t a i n e d , f o r the demands upon the

Regional Banks d i f f e r m a t e r i a l l y , but more uni formity can be had without des troy-

ing the f l e x i b i l i t y .

( l ) The Chamber of Commerce of the United S t a t e s could suggest to the Federal

Reserve Board a r e s t o r a t i o n of the red i scount r a t e to a l e v e l which a l l of the

Regional Banks could adopt wi thout impairing the f l e x i b i l i t y of t h e i r own a c t i o n

or make f o r d i s c r i m i n a t i o n as between the member banks.

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Acting under the p r o v i s i o n s of the Phelan A c t a b a s i c l i m i t a t i o n of

red i scounts could be s e t f o r a l l member banks.

Rediscount p r i v i l e g e s required i n e x c e s s of t h i s l i m i t a t i o n could be

granted by the boards of the Regional Banks upon a p p l i c a t i o n and a t a r a t e

i n keeping with the e s s e n t i a l character of the e x c e s s requirements and the

need to maintain the l e g i t i m a t e commercial operat ions of the Region.

(2 ) When next opportunity o f f e r s , there could be proposed an

amendment to the law that the b a s i c l i m i t a t i o n be f i x e d as a mandatory p r o v i s i o n .

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