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Federal Reserve policy in World War II

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Federal Reserve policy in World War II

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Content FEDERAL RESERVE POLICY
IN WORLD WAR II
A Thesis
Presented to
the Faculty of the Department of Economics
The University of Southern California
In Partial Fulfillment
of the
Requirements for the
Degree of Master of Arts
f e y
Ching-yun Shih
February 1950
UMI Number: EP44701
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£c 'S O S s s - S
T his thesis, w ritte n by
■Ghing-.3r.UEL.-S1b.ih.
under the guidance of Ai_a... F a cu lty Com m ittee,
and approved by a ll its members, has been
presented to and accepted by the C o uncil on
Graduate Study and Research in p a rtia l f u lf ill
ment o f the requirements f o r the degree o f
MASTER OP ARTS
Dean
Date....June.i9.5O.
Faculty Committee
CONTENTS
CHAPTER PAGE
I INTRODUCTION .............................1
II CREDIT CONTROL. ...................... 12
Discount policy..... 12
Open market operations....... 17
Margin requirements. .... 19
Changes in reserve requirements............ 20
III TREASURY BILL POLICY................. 26
Treasury bills as outlets for idle funds.... 28
Transactions in Treasury bills,
volume and yield....... 30
Relation to Treasury financing............. 34-
Treasury bill policy as an adjusting
mechani sm......... 37
IV CONSUMER CREDIT CONTROL......... 40
The purposes and scope of the control...... 41
Consumer credit after control........ 45
V THE IMPACT OF WAR ON MEMBER BANKS.............55
The wartime deposit growth................. 57
Changes in the composition of
Government securities portfolio......... .62
The loan portfolio. ....... 66
CHAPTER PAGE
VI THE FISCAL FUNCTIONS' OF THE FEDERAL RESERVE
SYSTEM IN FINANCING WORLD WAR II.......... 72
Financing of World War I. .............. 73
Financing of World War II................. 79
Existing problem. .... 86
VII CONCLUSION.................................. 90
BIBLIOGRAPHY
TABLES
PAGE
1. Total outstandings and Banks Holdings of
Treasury Bills December 1940 to October 1946....32
2. Treasury Bills Held by Federal Reserve Banks
Subject to Repurchase Option................... 35
3. Total Consumer Credit, by Major Parts.............50
4. Growth in Deposit of 6,155 Member Banks, by
Federal Reserve District, 1939-1945............ 59
5. Distribution of 6,155 Member Banks, by
Size and Rate of Growth, 1939-1945............. 60
6. Ownership of Demand Deposits, 1941-1944...........61
7. Public Debt Holdings of All Member Banks
Compared with Outstanding Marketable
Public Debt Eligible for Bank Purchase
1939-1945......................................63
8. Federal Finances, 1940-1946..... 80
CHAPTER I
INTRODUCTION
War has played an extremely prominent role in the history
of central banking. Experience in various countries has proved
that wars produce circumstances which greatly influence central
banking. The duties of the central bank as fiscal agent, as
custodian of reserves, and as controller of credit are much
increased. In addition, the central bank must integrate its
activities more closely to the policies of the Treasury and
other branches of the government than is necessary in peace
time. While war has increased the importance and strengthened
the prestige of the central bank, it has also reduced its in
dependence.
The thirty-six years since the Federal Reserve Act was
passed In December 1913* have been characterized by three periods
of stress: World War I, the great- depression of the 1930’s,
and World War II. In order to lay a foundation for further
study, it is necessary to make a short resume of the policies
and the operations of the System in the years since its incep
tion.
When President Woodrow Wilson on December 23, 1913, signed
the Federal Reserve Act, which established the Federal Reserve
System, he promulgated a law which had three main objectives:
to give the country an elastic currency, to provide facilities
2
for discounting commercial paper, and to Improve the super
vision of banking. Over the years the objectives of the Sys
tem have been broadened to Include the control of inflation
and deflation and the creation of conditions favorable to
sustained high employment, stable prices, and a rising level
of consumption.
World War I and Its Aftermath Although the Federal Re
serve Act was passed in December 1913* it was not until No
vember 1914, three months after World War I began , that the
Federal Reserve System went into operation. Toward the close
of 1916 a general boom in industry had resulted from the in
creasing demand of the Allied nations for United States goods
and equipment. This Increase In business activity gave rise
to the first manoeuvering of the rediscount rate. Several
of the Federal Reserve banks raised the rediscount rate slight
ly in December 1916.
With the entry of the United States into the war In April
1917 there came an enlargement of the System’s objectives to
include aid in financing the government's expenditures. The
general policy of the Federal Reserve System during the period
of active United States participation was characterize d by
complete and cordial cooperation with the Treasury's policies.
It became one of the prime objectives of the System to sell
bonds and short-term certificates of indebtedness to nonbank
investors.
The selling of indebtedness in the government was stepped
up by an amendment to the Federal Reserve Act. This amend
ment permitted Reserve banks to discount directly the pro
missory notes of member banks which were secured by pledge
of bonds or notes of the United States government as well as
by eligible paper. Under the provisions of the original act,
reserve banks were only permitted to rediscount customer's
*
paper. Under the revised law, member banks could more easily
place bonds in the hands of actual investors who might not
otherwise have sufficient funds to pay for their subscription.
The Board of Governors, furthermore, announced its willingness
to approve three percent interest on the notes of member banks
with "war paper" as collateral. "It is clear that the bond
method of financing war finally resulted in an increasing money
demand for goods. Credit previously possessed by the subscri
ber was transferred to the government. To the extent that
this enabled the government to offer money for goods, the in
dividual's demand should have been lessened. Instead the
government merely took the place of the Individual, and the
conditions of demand were not greatly altered. The effect,
however, of an enlarged monetary demand for goods need not
necessarily result In higher prices."**'
1} Harold L. Read, The Development of Federal Reserve policy,
Boston and New Xork: Houghton Miffin Company, 1922,
pp. 180-181.
4
The end of hostilities caused a sharp contraction of credit
and created for the Federal Reserve officials the difficult
problem of choosing among conflicting objectives. The reserve
ratio of Federal Reserve banks was greatly increased. The
new ratio was low enough to guarantee ample funds for new
financing. The government expenditures for military purposes
had not ceased with the armistice. These continuing payments
were necessary' to make a new loan. The country was to ex
perience a rise in prices baaed on an expansion of currency
and credit and a boom In Industrial speculation which exceed
ed that of the war period. The frenzied activity of the first
years of the postwar period were followed in 1920-1921 by a
crisis. One cause of this crisis was the excessive commodity
speculation which was engendered by the belief that credit
would continue to remain cheap. By the end of 1919 the Board
came to the conclusion that a substantial advance in the dis
count rate was necessary and should not be delayed. Early
in November the rate at all Reserve banks was raised accord
ingly. The determination to raise the rate still higher was
indicated should the reserve ratio fall further. Even after
the increased rates went into effect, they remained consider
ably below the open market rates on commercial paper. The
authorities continued to exert" pressure in the early part
of 1921 and finally the discount rate at the Reserve banks
was above the market rate. The effect of this measure was
all but Ineffectual* “Except, in the financial centers of the
country these increased rates had little real effect in check
ing the continuous expansion of credits. By the end of April
1920, the total earning assets of Reserve banks were consider-
ably larger than in December 1919. But it had become evidentt
that the rate of credit and currency increase was falling,
and that, the speculative boom was collapsing. With the spring
of 1920, one stage in the postwar business cycle was drawing
to a close.
At the beginning of 1922, the Reserve banks were dissatis
fied with their limited holdings of paper and government
securities of a superior nature which might be employed on
the Reserve banks initiative rather than that of a member
bank. The continuing gold imports, the inflationary price
tendencies, and other unsound developments in business Indi
cated that the manipulation of the rediscount rate might not
yield the desired result. So in April of 1922, the Board of
Governors adopted a policy of buying and selling government
obligations In an orderly and systematic manner. They con
cerned themselves not only with the earnings, but with the
credit situation as a whole and the interest of the Treasury.
The establishment of the Open Market Investment Committee to
replace the Committee of the Board of Governors illustrated
20 Ibid. p. 315.
the dual viewpoint of Federal Reserve investment policy.
In some respect open market operations took precedence over
rate control.
The period of crisis was followed, from 1924 to a peak In
1929, by a period of considerable prosperity. The era was
keynoted by a highly optimistic attitude. Some spoke of the
business cycle as having a historical interest only, and
stated that a period of perpetual prosperity had been entered.
'In the second half of 1927, indications of decay were to be
seen. Credit was somewhat over-expanded. From January 28
to June 30, 1928, the volume of reserve credit increased
1264,000,000; similarly, the total loans and investments of
the member banks increased $570,000,000 from January to July.
For the most part, the member bank credit was in the form of
Investments and loans on securities. It may, therefore, be
concluded that in these months the Reserve banks succeeded
in reducing the amount of credit extended to member banks,
but that the member banks themselves could not resist the
growing demands for bank credit by the security market. In
an attempt to lessen the willingness of member banks to dis
count, the rate was raised by the New York Reserve Bank three
times In less than six months. On July 13, a five percent
schedule prevailed, the highest since 1921, indicating the
desire of the Federal Reserve banks to check the excessive
expansion in the aggregate of member bank credit. The sub
sequent decrease In demand by member banks for credits was
not paralleled by an increased moderation in the demand by
the securities market for funds. In 1929 the volume of shares
traded per month on the New York Stock Exchange exceeded the
monthly volume for the preceding year. Loans to brokers re
ported by member banks In New York City expanded to over a
billion dollars. This uncontrolled expansion Inevitably led
to the failure of the System’s policy and to the collapse of
the security markets.
The G-reat Depression The panic and collapse of the
securities markets were followed by a rapid recession which
ended in practically complete industrial stagnation. The
Reserve banks attempted to deal with the situation by lower
ing the interest rates by' any means whatsoever. To this end
the rediscount rates were lowered and extensive security pur
chases were made. In addition, a change was made in the
collateral eligible for backing Federal Reserve notes. Ori
ginally Reserve banks were permitted to issue Federal Reserve
notes only against eligible discounted paper and acceptances,
and they were required to maintain a reserve of at least 40
percent in gold against such nbtes. Although discounted paper
of member banks secured by United States government obligations,
were eligible as collateral for Federal Reserve notes, the
government obligations were not eligible. This limitation
seriously restricted the power of the System to cope with the
outflow of gold which resulted from the departure of the Unit
ed Kingdom from the gold standard in 1931. Under the provisions
of the Glass-Steagall Act of 1932, the Federal Reserve Act
was so amended as to permit the use of government securities
as collateral for notes.
When the storm abated in 1932, the Reserve banks once again
attempted to stimulate credit expansion by establishing low
money rates. The Federal Reserve Bank of New York had already
lowered its discount rate several times, so that- by May 8,
1931 it stood at one and one-half percent; thus the so-called
"easy money" policy was adopted. The first objective of the
above policy was to supply the member banks with sufficient
funds to repay their indebtedness to the Reserve banks. The
necessity of accomplishing this goal in the eyes of the Re
serve officials is indicated by the importance they attached
to the influence of such indebtedness on member banks. "Their
Tending and investing policy is very closely related indeed
to the amount of such indebtedness. . The principle of open
market- operations may be summarized by saying that purchases
of securities by Reserve banks tend to relieve member banks
from debt to the Reserve banks, and lead them to adopt a more
liberal lending and investing policy. Money rates become
easier; bank deposits increase. Such purchases tend to create
a borrower’s market."5 This assumption seemed justified by
3) W. R. Burgess, The Reserve Bank and the Money Market, New
York: Harper & Brothers, 1946, Rev. ed., p. 239,
9
experience during most of the period prior to 1932 . This
objective was accomplished through the purchase of government
securities from member banks. Purchases of government se
curities in the summer of 1933 virtually eliminated member
bank indebtedness.
Another method by which money was made easy to obtain was
the principle of direct lending, which was introduced in 1934.
Its purpose was to insure that recovery would not be impeded
by the inability of an established industrial or commercial
firm to obtain requisite financial assistance from the usual
sources on a reasonable basis. The Reserve banks were au-
!
thorized to make loans to, or purchase the obligations of
such businesses, or make other commitments which were deemed
necessary.
The aggravating influence exerted on economic fluctuation
by security speculation, especially that in 1928 and 1929,
caused a new power to be bestowed on the Board of Governors
of the Federal Reserve System. Under the Securities Exchange
Act of 1934, the Board was given the power to "prescribe rules
and regulations with respect to the amount of credit that may
be initially extended and subsequently maintained on any se
curity (other than an exempt security) registered on a nations*!
securities exchange." This new power given to the Reserve
System constituted an additional important instrument of credit
control.
10
The problem of reserves, however, remained of crucial
importance. The most significant function of member bank
reserve requirements is to control credit. The Board was em'r
powered by the Thomas amendment of May 1933 to change reserve
requirements if a national emergency should dictate that an
expansion of credit was necessary. The Banking Act of 1935
gave the Board exclusive power over reserve requirements of
member banks. Changes were restricted to a range of from one
to two times the rates stated in the law. Henceforth, the
Reserve administration could influence excess reserves either
through changes in total reserve balances or through changes
in required reserves.
An event- which led the Board to increase the reserve re
quirements in 1936 and again in 1937 was the reversal in the
direction of gold movements. An inflow into this country of
gold was occasioned by the devaluation of the dollar. As a
result, the monetary gold stock of the country was increased.
At this time the Board took action to increase the reserve
requirements, it announced that the Federal Reserve System pro
posed to continue exerting its influence toward the maintenance
of easy money conditions so as to encourage full economic
recovery.
World War II Although the European War began in 1939,
the United States did not enter actively until the Japanese
attack on Pearl Harbor in December, 1941. During this war
period, the System had two primary objectives, (1) to main
tain the stability of the market for government securities,
thereby assuring to the Treasury the availability of funds
at low interest rates, and (2) to restrict the creation of
purchasing power to a minimum consistent with the first- objec
tive. Pursuant to these objectives, the Board of Governors
announced on September 1, 1939, immediately after the begin
ning of the European war, that the Reserve banks would make
advance on equal terms and at par to member and non-member
banks on government obligations. This announcement was re
iterated on December 8, 1941, which also contained the fol
lowing statement of policy:
"The System is prepared to use its powers to. assure
that an ample supply of funds is available at all times
for financing the war effort and to exert its influence
toward maintaining condition in the United States Govern
ment security market that are satisfactory from the
standpoint of the Government requirements.”^
4) Board of Governors of the Federal Reserve System,
Bulletin. Vol. 28, p. 2, January 1942.
12
CHAPTER II
CREDIT CONTROL
Commercial banks can and do manufacture money by expand
ing their credit against demand deposits. Bank credit is a
function of increasing importance. While bank credit can stimu
late the development ofeconomic activity, its sudden contraction
or its over-expansion can cause much economic disturbance.
How to control bank credit so that it will be an obedient ser
vant in the development of a community is a major problem of
monetary management.
The underlying philosophy of the Federal Reserve System,
as designed by its founders, was qualitative control. For many
reasons, the Federal Reserve authorities gradually came to rely
upon quantitative controls also. The quantitative devices em
ployed were meant to restrict the total mass of credit. These
devices influence the volume of credit by changing its cost
and its terms, i.e., the rate of interest, charged, the amount
of margin required, and the excess of collateral needed. Ano
ther approach is for the central bank to change the minimum
reserve percentages of member banks, or to increase or reduce
the dollar amount of those reserves by open market operations,
DISCOUNT POLICY
One of the chief functions of the central bank, because of
13
Its monopoly of note Issue, is that of being the lender of last
resort. It was assumed that- when member banks had made all the
loans to customers that the reserve requirements permitted,
they would meet demands for additional funds by discounting
commercial paper at the Reserve bank in their district. Should
this occur, the Reserve bank could either encourage or dis
courage additional lending by raising or lowering the discount
rate. Many economists and bankers have come to realize that
subject to limitations the raising of the discount rate can
curb credit expansion, can even bring about a period of de
flation, and can to some extent rectify the exchange.
The Role Of Bank Rate The Bank rate, in the modern
sense, was originated In the discussion which followed the
monetary crisis of I836-I837 in England. The Bank rate was
defined as, that minimum which is charged for discounting first
class-three months bankers’ bills. The rule that the Bank
rate is a minimum Is. enforced whenever an excessive number of
bills are brought to the bank to be discounted. On such occa
sions the bills would be accepted only at a higher rate.
Thoughts concerning the traditional doctrine of the Bank rate
have been woven Into three distinct strands to which different
writers attach differing degrees of stress. f , The first of
these regard the Bank rate merely as a means of regulating the
quantity of bank money.
1) Keynes, J.M., A Treatise On Money, New York: Harcourt,
Brace and Company, 1935, Vol. 1, op. 187.
14
"The second strand is tha.t which is generally uppermost
in discussions by practical hankers. They regard Bank rate
policy primarily, not as a means of regulating thevprlce-level,
but as a means of protecting a country’s gold reserves by re
gulating the rate of foreign lending.
’ ’The third strand of thought conceives of the Bank rate
as influencing in some way the rate of investment, and perhaps
in the case of Wicksell and Gassel, as influencing the rate
of investment relatively to that of savings."^
The reason for the elevation of the Bank rate is the
desire on the part of the central bank to curb domestic specu
lation and Inflationary tendencies. The Federal Reserve
banks employed this procedure before the stock market crash
in 1929. At the nadir of this business cycle, one may expect
to find the rate being lowered in order to stimulate business
and commercial activity by means of a ’ ’cheap money” policy; a
low Bank rate may Include a feeling of optimism in the business
world. This was the policy adopted by the Federal Reserve
System during the depression of the 1930's.
The Bank rate may or may not be an index of the rate which
is actually being charged by the central bank. At best, this
rate is simply the minimum rate at which the central bank is
ready to discount certain types of bills provided financial
2) Ifold, p. 189.
3) Ibid, P. 190.
15
conditions warrant its doing so. Today, the Bank rate's im
portance, as compared with that which it enjoyed under the
international gold standard, has been reduced.
Easy Money Policy A leading policy of the Federal
Reserve authority after the recession of 1929-1932 was to
ease the money market in order to stimulate business reco
very and to encourage lending on the part of member banks.
Modern war as well as a depression poses grave economic
problems. It is, in reality, a struggle of economic poten
tials between the belligerants. Financing the war so as to
realize the greatest amount from that potential falls in the
main to the central bank as fiscal agent of the government.
The easy money policy was the dominant one of the Federal
Reserve System during the entire Second World War. Accumu
lation of funds necessary to finance huge munition contracts
and other wartime needs could not have been accomplished with
out the support of the Federal Reserve banks. Soon after the
beginning of World War II in 1939, several Reserve banks re
duced their discount rate to one percent on advances secured
by government obligations and to one and one-half percent on
other eligible paper (under section 13 and 13a of the Federal
Reserve Act). During March and April of 19^2, four months
after the United States entered the war, the discount rate on
loans to member banks secured by either government securities
or eligible paper was lowered to one percent at a number of
Reserve banks, a level which was to become uniform throughout
16
the System.
In response to amplified war needs and as a measure to
encourage the purchase by non-bank investors of government
securities, all Federal Reserve banks during October 194-2
established a preferential rate of one-half of one percent on
advances to member banks secured by United States Government
securities callable or maturing in one year or less. The
rates on loans secured by other obligations of the Unites
States Government or secured by eligible paper remained at
one percent. Discount rates on other advances to member banks,
and on advances to individuals, partnerships, and corporations
secured by direct obligations of the United States government
had also been reduced to two and one-half percent at some Re
serve banks and to two percent at others.
These reductions In discount rates provided an additional
means by which member banks could obtain reserve funds. When
they needed to, they could borrow from the Reserve bank at
low rates of Interest...Member banks were encouraged by the
reductions in discount rates to make fuller use of their avai
lable excess reserves; hence, this policy helped to finance
the war. Throughout this period the volume of discounts by
Reserve banks continued relatively small because of the tra
dition against borrowing by member banks arid because most of
them had excess reserves. If a member bank needed to meet a
temporary reserve shortage, it could sell Treasury bl^ls or
17
other government obligations to Reserve banks.
The preferential rate of one-half of one percent on loans
to member banks secured by government obligations was abolish
ed In May 1946 by New York, Philadelphia, and San Francisco
Reserve Banks in order to discourage the undue use of Reserve
bank credit by member banks.
OPEN MARKET OPERATIONS
The outbreak in 1939 of the war in Europe had a disturbing
influence on the securities market. Government securities in
particular appeared to decline slightly. At this juncture the
Federal Reserve Board outlined two major considerations under
lying their action regarding open market operations. The first
was the desire to exert a steadying influence over the entire
capital market. The second was the feeling that the Federal
Reserve System Hhas a measure of responsibility for safeguard
ing the large United States Government portfolio of the member
banks from unnecessary wide and violent fluctuations in price. , , 2 * ‘
With these sentiments in mind, the Reserve authorities announced
in May 194-2 that they would maintain a fixed pattern of interest
rates on Treasury obligations, i. e., 3/8 percent on short-term
securities and a rate not to exceed two and one-half percent
on long-term bonds.
4) Board of Governors of the Federal Reserve System, Annual
Report. 1939, p. 5.
18
Consequently, Federal Reserve open market operations were
directed toward the maintenance of orderly conditions in the
market at a time when^the Treasury was offering a large volume
of new government securities. These operations diminished the
effect of any temporary influence and gave stability to the
money market.
In line with the changes that had been made in the Treasury
financing technique, the Federal Open Market Committee directed
the twelve Federal Reserve banks to purchase all Treasury bills
offered at a rate of 3/8 percent per annum. The adjustment of
the money market to changing conditions was facilitated by es
tablishing a Reserve bank buying rate on Treasury bills. Member
banks could readily offset deficient reserves through the ex
pedient of selling Treasury bills to Reserve banks. Holdings
of government obligations by the Reserve banks were further in
creased under the Second World War Power Act, which authorized
the System to purchase government obligations from the Treasury
which were to be fully guaranteed as to principal and interest.
"From April 8, 194-2 to October 28, 194-2, the System's holdings
of all types of United States Governmnt obligations increased
by 2.2 billion dollars. Holdings of Treasury bills increased
by 460 million dollars, certificates of indebtedness by 680
million dollars, Treasury notes by 480 million 40llars*f ’^
5) Board of Governors of the Federal Reserve System, Bulletin,
November 1942, Vol. 28, p. 1074.
19
The liquidity of Treasury hills was further increased by
the introduction of the repurchase option as related to the
adjustment of member bank reserves. By’selling Treasury bills
to the Reserve bank under option to repurchase them, banks
could obtain reserves promptly as needed and could reacquire
the bills later if they had more reserves than required. Most
of these purchases and sales occurred in the money centers,
principally in New York and Chicago, where the bank reserves
had been maintained close to the legal requirements. Similar
transactions took place in all the Federal Reserve districts.
In this manner the Reserve bank holding of Treasury bills was
greatly increased. By November 194-4- the total holdings reached
11*5 billion dollars or 85 percent of the total Treasury bills
outstanding.
Largely as a result of the above transactions of the Re-
1
serve- System', the government securities market was relatively
stable throughout the war years. The average on new issues of
Treasury bills remained at 3/8 of one percent. While long-term
securities rates fluctuated to some extent, the general level of
yield was maintained.
MARGIN REQUIREMENTS
Under the Securities Exchange Act of 1934 the Board of
Governors of the Federal Reserve System was empowered to "pres
cribe rules and regulations with respect to the amount- of credit
20
that may be initially extended and subsequently maintained on
any security (other than an exempt security) registered on a
national securities exchange.” The Board of Governors.'was_given
the power to fix ”margin requirements” on security loans. By
altering the Jieight of margin requirements, the Board could, to
some extent, regulate the demand for loans on securities. By
means of an increase in these requirements, the demand for
loans of this type could be decreased.
It was the government’s expectation that the people would
buy as many government securities as they could. To this end,
the margin requirements which had stood at 50 percent on short
sales and 40 percent on others since 1937 were maintained at
this level. In 1945 there appeared some speculation in the se
curities market as a result of the Federal Reserve easy credit
policy. Consequently, on February 5, 1945, the Federal Reserve
officials raised the margin slightly to a uniform ratio of 50
percent. Again in July of that same year, shortly before V-J
day, the requirements were raised to 75 percent, the highest
wartime level on record. Finally, the ratio was increased to
100 percent on January 21, 1946 in an attempt to check the boom
in the securities market which occurred immediately after the war.
CHANGES IN RESERVE REQUIREMENTS
One of the basic principles of the Reserve System is that
the supply of credit should be elastic. Over a period of time
it was proved that- the original provision for regulating the re-
21
reserve requirements was not sufficient to effectively control
the volume of credit. With a view to strengthening this con
trol, the Banking Act of 1935 empowered the Federal Reserve
Board to raise rates as it saw fit, but never to exceed 14
percent for country banks, 20 percent for reserve city banks,
and 26 percent for central reserve city banks against demand
deposits and six percent against time deposits, and to lower
them by any amount, but never below seven percent, ten percent,
and thirteen percent against demand deposits and three percent
against time deposits. The changed reserve requirements were
designed to influence the volume of credit by altering the
amount for lending available to the member banks. Through a
change in the reserve ratio, while the total reserve remain
the same, the quantity available for deposit expansion is in
creased or decreased by the simple expedient of declaring that
a smaller or larger share of the total must be counted as
required reserves.
On November 1, 1941 the Board raised the reserve require
ments to the maximum allowed by law. This increase came at
a time when credit expansion related to the war was already
in progress. Excess reserves fell from seven billions in
November 1940 to under five billion in August 1941. As a re
sult of the growth of bank deposits and the consequent in
crease in required reserves, the excess reserves of member
banks declined further after the United States entered the
22
war. The decline in the excess reserves among the various
classes of* member banks showed little variation, with most of
the decrease taking place in New York City and Chicago.
The original device for changing reserve requirements as
an instrument of credit control had three defects: it lacked
precision, it entailed unwarranted discrimination among banks,
and it was inflexible. "The contention that it is a clumsy
instrument of credit- control rests primarily on the ground
that it is uncertain and inexact as regard both changes in
the amount of reserves and the place where these changes can
be made effective.
"The second major criticism - that changes in reserve re
quirements are in effect- discriminatory - is based upon the
point that, banks may seem to involve the maximum of uniformity
of treatment, some banks having small excess reserves, might
be hard pressed by the changes in reserve requirements, while
another group with a large cushion of excess reserves would
be entirely unaffected. "7
"The inflexibility of this instrument of credit control
is sais to be well illustrated by the inability of the Reserve
authorities to make more than very limited use of it to meet
6) Charles R. Whittlesey, "Reserve Requirements and the
Integration of Credit Policies," Quarterly Journal
of Economics, Vol. 58, p. 559, August 1944.
7) Whittlesey, oj>. cit. , p. 560.
23
the reserve stringency in New York and Chicago that arose out
O
of war financing."
On July 7, 194-2, in an attempt to rectify the unsatisfac
tory results of reserve requirement.changes, the Federal
Reserve Act was amended. The amendment gave the Board of
Governors the discretion to alter the reserve requirements of
member banks in central reserve cities, within the limits of
existing law, without altering those of member banks in reserve
cities. Under the earlier provisions of the law, both types
of banks were placed in one group, and separate action to
change rates could not be taken. Mr. M. S. Sccles, then chair
man of the Board of Governors, stated on July 17* 194-2, while
speaking before the House Banking Committee, that "Congress
should approve that discretion because prospective heavy with
drawals for tax payments and for financing the war deprived
the largest banks of the degree of flexibility that the cur
rent war situation demands.
Backed by this new amendment, the Board of Governors re
duced the percentage ratios of reserves required against net
demand deposits in central reserve cities. This reduction
from 26 to 20 percent was made in three stages of two percent
8) Whittlesey, op. cit., p. 563.
9) M. S. Eccles, "Favor Changes in Reserve Requirements,’ 1
Commercial, & Finance, Chronicle, 155: 2408, June
25, 1942.
24
each, which were effective August 20, 1942, September 24,1942,
and October 3, 1942. By the latter date, banks in central
reserve and reserve cities were required to maintain 20 per
cent reserve against net demand;depositand other banks were
required to maintain 14 percent against their net demand de
posits. Even though the ratio in central reserve cities was
reduced so that it equaled that maintained by reserve city
banks, reserves in the former appeared to be only slightly
above the legal minimum. Since it was not advisable to allow
the ratio applicable to central reserve cities to fall below
that required of reserve cities, no further use could be made
of reductions in reserve requirements to ease the situation
in New York City and Chicago. Consequently, the Federal Re
serve authorities resorted to open market purchases of se
curities and Treasury bills so as to provide reserves as they
were needed by the banks in these two cities.
In general, the power of the Federal Reserve Board to
control credit were more effective in preventing expansion or
*
bringing about contraction than in promoting necessary expan
sion. The dominent credit policy of the System was to main
tain its easy money policy throughout the war period. The
extension of credits encouraged member banks to make fuller
use of their reserves available for financing the war. The
policy found its justification In the desire to finance the
war as cheaply as possible, and to obviate any restraint on
war production which a tight money market might engender. The
outstanding Federal Reserve credit increased from #2,832
millions in October 1939 to #23,721 millions in March 1947.
The Reserve banks increased their holdings of securities from
#2,180 millions at the end of 1941 to #24,262 millions at the
end of 1945. The establishment of a preferential discount
rate and an open market buying rate on Treasury bills was
designed to make credit cheap. The result of the wartime
expansion was to cause the existance of an inflationary
tendency after the end of the war.
26
CHAPTER III
TREASURY BILL POLICY
Ni.nety-d.ay Treasury bills were introduced in the later
years of Secretary of the Treasury Mellon*s tenure of office,
the first issue being dated December 17» 1929* The Treasury
bills incorporated certain features not possessed by other
existing government securities. First, the bill could be sold
on a tender-of-bid basis; thus, the cost of borrowing could
frequently be reduced. Second, offering of Treasury bills
could be timed to coincide with the needs of the Treasury and
with a view to the condition of the money market. Third, matu
rity dates could be scheduled with regard to tax dates so'.that
the disturbing effects on the money market of large Treasury
receipts might be greatly reduced.
Prior to the Second World War, the amount of bills out
standing reached a peak of 2.5 billions in 1935 only to taper
off to approximately 1.5 billions in 1939. With the start of
defense financing this contraction was stopped, and Treasury
bills became the most distinctive feature of the Federal Reserve
credit policy. The sale of Treasury bills and their purche.se
at a fixed discount rate served as the chief means of providing
additional funds to meet Treasury needs. The buying and selling
of bills at fixed rates, so as to facilitate adjustments in the
volume of member bank reserves, virtually provided a new field
27
for Federal Reserve action. These sales and purchases worked
more effectively than other methods, i. e., discount policy,
open market operations, and regulation of the volume of avail
able Federal Reserve credits, because it overcame the defects
attendent- to them.
The role of Treasury bill's is somewhat analogous to that
performed by banker!1 bills during and after the First World
War. ^ The standing offer of the Reserve banks to purchase
Treasury bills at a discount of 3/3 percent was designed to
stabilize the bill market and facilitate prompt adjustment
of bank reserves to changing conditions. The volume of these
bills outstanding, on December 31, 1946, reached 17 billions
of dollars or about ten percent of the marketable public debt.
The practice of using Treasury bills as a device by which
to place reserves in the market may be shown to have accomplish
ed several things. It made possible the absorption of a great
volume of excess reserves. It left the banks, in the meantime,
1) During the First, World War and in the 1920’s, the Federal
Reserve Banks stood ready at all times to purchase bankers’
bills at the official discount rate. Member banks and
dealers made frequent use of the privilege dealers some
times sold bills under repurchase contracts whereby they
bound themselves to buy back the bills within fifteen
days. The preferred status given bankers' bills was partly
designed to facilitate the wider adoption of this financial
Instrument. At the same time it helped to provide a means
whereby"additional Federal Reserve credit could be obtained
in time of temporary stress and. could be returned when the
emergency had past. See:
W. R. Burgess, The Reserve Banks and the Money Market,
Revised Edition, New Xork: Harper and Brothers,
1946, Chapter X.
28
as liquid as they would have been with the equivalent amount of
excess reserves. It helped, further, to make up for the lack
of precision and automatism of the usual open market operations.
It provided, finally, an instrument, more simple and more auto
matic than discounting without, the tradition against borrowing.
TREASURY BILLS AS OUTLETS FOR IDLE FUNDS
In the pre-war years, member banks maintained a large amount
of excess funds. Short-term investment paper during that period
was scarce, partly because short-term rates were declining to
record low levels, and mostly because such short-term paper as
was to be had was taken up by the banks in the large money
markets. As a result, many medium and small sized banks failed
to find sufficient, outlets for their funds, large volumes of
which lay idle as excess reserves. The entry of the United
States into the war heralded a considerable decline of excess
reserves In the leading financial centers; nevertheless, a
relatively large proportion was held by banks in smaller cities
and was available for investment in short-term paper. Since
it was desirable that these idle funds be Invested in short
term government securities, Treasury bills were designed to
provide a sufficient supply of such paper. Their use made for
flexibility and liquidity of bank potfolios. By investing in
Treasury bills, banks, other corporations, and individuals
could earn a reasonable return on such funds as might be
29
temporary idle, and at the same time, could aid the Trea.sury
to finance the war.
In order to draw these idle funds into use for financing
the war, the Treasury, increased its weekly offerings from 150
millions to 250 millions and then 300 millions in mid 1942.
The attractiveness of the Treasury bill as a short-term invest
ment was increased when the Reserve Board established a buying
rate of 3/8 percent of one percent on all Treasury bills of
fered; thus, the holders of Treasury bills were assured of a
market and a set rate should they be forced to sell their
holdings before maturity. Couched in these terms Treasury bills
were as liquid as excess reserves.
The Treasury bills were traded in the open market and sold
on a cash basis to the highest bidders. The date of maturity
was stated in the offering announcement and was usually for a
period of three months. The Federal Reserve banks, On behalf
of the Treasury, accepted bids for the bills on a weekly basis.
Large bids were usually presented by the dealers and leading
investment houses guaranteeing to a certain extent, that the
entire issue would be taken. The dealers In government securi
ties underwrote, to the extent of their bids, each issue of
Treasury bills, and in turn, resold the bills to the Federal
Reserve banks if they were unable to distribute the bills they
underwrote. These purchases from dealers enabled the Reserve
banks to replace maturing Treasury obligations and thus affect
30
any tendency for the volume of Reserve credit to contract.
"in view of the excellent machinery provided for the market,
it is not surprising that short-term Government securities,
and especially Treasury bills, have come to occupy a prefer
red position over other types of open market paper. No other
secondary-reserve item can be purchased and sold with equal
readiness and ease. The market is provided weekly with a
fresh supply of raw material, so that at any moment of time
there is a known supply of this instrument with graded maturi
ties. Treasury bills are standardized as to form and terms,
so that the conditions of the perfect market of economic theory
are closely approximated."^
TRANSACTIONS IN TREASURY BILLS, VOLUME AND YIELD
In the period preceding the establishment of a uniform
buying rate by the Federal Reserve, the amount of Treasury
bills issued weekly fluctuated between 100 and 200 millions.
In line with the new policy, the Treasury increased its week
ly issue from 150 million to 250 millions. The following year
the rate of weekly issue was increased to approximately 900
million dollars, and by June 194-3 it had reached nearly one
billion each week. It remained at this figure until May 194-4
when it was raised to 1.2 billions, and It continued at that
2) Edward C. Simmons, "The Position of the Treasury Bill in
the Public Debt," Journal of Political Economy, Vol. 55,
August 1947, p. 340.
31
level for the rest of the year except during a seven weeks
period In which the rate stood at 1.3 billions of dollars.
The total volume of bills outstanding at the beginning of the
fixed rate period was about two billions. This volume rose
gradually and in September 194-3 reached 13 billions. An
increase in the rate initiated in May 1944 brought the total
to over sixteen billions in December 1944.
Preceding the establishment of the fixed buying rate, the
average rate of yield on Treasury bills was below one-fourth
of one percent. "Prevailing rates on current issues of Trea
sury bills had risen from .20 percent in. March to .34 percent
the last week of April; in May they averaged .36 percent."*'*
With the authorization of 3/8 percent rate, the average yield
on Treasury, bills rose toward this level. At one time a con
siderable portion of the bills issued were bought at a price
that yielded less than 3/8 of one percent, but from the middle
of 1943 onward, the average yield conformed closely to the
official rate.
The holdings of Treasury bills by commercial banks and by
the Federal Reserve banks changed significantly in this period.
(See Table l). At the end of April 1942, immediately before
the fixed buying rate became effective, commercial banks held
61 percent, of the total amount outstanding, and the Federal
3) Board of Governors of the Federal Reserve System, Bulletin,
Vol. 28, June 1942, p. 527.
32
Table 1- Total Outstandings and Banks Holdings of Treasury Bills
December 1940 to October 1946
(dollars figures in millions)
Federal Reserve Banks Commercial 'Banks
Total __________________________ _____________
End of Outstandings Dollar^ "of Total Bills Dollar % of Total
Volume Outstandings Volume Bills Out
standings
1940
December l,31o
1941
June
September
December
1,603
1,305
2,002
1942
March 1,652 • * • * #710 43.0^
April
1,953 #91 4.1% 1,191
61.0
June 2,508 244
9.7 1,557
62.1
September
4,619 657
14.2 2,884 62.4
December
6,627 1,010 15.2 4,497 67.9
1943
February 8,232
1,475 17.9 5,302 64.4
May 10,853
2,442
22.5 7,017 64.7
September 13,054
5,351
41.0 6,448 49.4
December 13,072 6,768 51.8 4,716 36.1
1944
February 13,112 6,354
48.5
5,484 41.8
May 13,766 8,466 61. 5 3,627 26.3
June 14,734 .8,872 60.2 4,894 33.2
October 16,060
11,551 71.9 3,091
19.2
1945
J anuary 16,403 11,376 69.3 3,931 23.9
June 17,041 12,962 76.0 2,798 16.4
October 17,026 13,172 77.3
1,978 11.6
1946
J anuary 17,042 12,866 75.5 2,387
19.8
June
17,039 14,466 84.9
1,142 6.9
Source: Treasury Bulletin and Federal Reserve Bulletin
33
Reserve Banks held less than five percent. 3oth Reserve and
commercial banks Increased their holdings as the amount issued
was increased. The amount of Treasury bills held by commercial
banks reached a peak of 7,091 million, which amounted to 65
percent of the total volume outstanding. On the same date,
the twelve Reserve banks held 2,442 million or 22 percent of
the total.
In June 1943 and again toward the end of that year, Trea
sury bills poured into the Reserve banks. The primary purpose
of the Treasury bill account of the Reserve banks was to act
as an adjusting mechanism. From the end of 1943 on, that
account was no longer primarily an adjusting mechanism. This
shift in the holdings of commercial banks was partially caused
by the issuance of Treasury certificates of indebtedness which
were more attractive than the bills. The growth of the Trea
sury bill account was primarily due to the need for additional
Reserve bank credits following heavy demands for liquid funds
by member banks and the public in general. Fromythe adoption
of the Treasury bill policy, Federal Reserve holrding of bills
fell into two classes: those which served as a cushion, and
those which constituted a more or less permanent addition to
the supply of reserves in the market. With the passage of
time, the latter category became of increasingly greater
importance.
34
The Reserve banks' holdings of Treasury bills were Increased
still further by the adoption of the repurchase option, which
allowed banks and individuals to sell Treasury bills to Reserve
banks under option to repurchase. Most of these purchases and
sales occurred in the money centers, principally New York City
and Chicago, where the member banks' reserve were maintained.
close to the legal requirements. The Treasury bills held by
Reserve banks on repurchase option constituted a high proportion
of the total reserve holdings. The greatest amount held on this
basis was reached in October 1944, with a total of 5,012 million
(See Table 2). This situation reflected the urgent need of
commercial banks for additional liquid funds so as to meet
the demand for currency for circulation and to satisfy rising
reserve requirements caused by the growth in deposits. The
pronounced short run fluctuations in the amount of reserves
necessary to satisfy legal requirements rendered the Treasury
bill policy doubly important, because this policy facilitated
adjustment to temporary changes in liquidity requirements.
RELATION TO TREASURY FINANCING
The financial needs of the war upset the stable pattern
of the public debt. On December 31, 1940, only 1.3 billions
of Treasury bills, then outstanding, represented less than
four percent of marketable public issues. Treasury bill
issues were enormously increased and reached a volume of 17
35
Table 2- Treasury Bills Held By Federal Reserve
Banks Subject to Repurchase Option
September 1942 to December 1944
(dollar figures in millions)
End of Amount Percentage of total Bills
Held by Federal Reserve Banks
1942
September |207 31.
October 96 20.0
December 576 57.2
1943
January 296 43.0
March 1,240 59.4
June 2,810 73.7
September 4,248 79.4
December 3,845 56.8
1944
January 3,617 52.1
February 2,908 45.8
March 3,398 52.0
April ' 4,001 52.4
May 4,093 48.3
June 3,655 41.2
July 3,564 39.4
August 4,583 4-5,5
September 4,829 47.8
October 5,012 43.6
November 4,584 38.6
December 3,984 35.7
Source: Federal Reserve Bulletin
36
billions in 1945. These bills had be-en utilized to facilitate
the absorption of the excess reserves held by member banks,
but by next- 1943, the magnitude of Federal Reserve holdings
of Treasury bills exceeded the amount which could reasonably
be called an adjustment fund.
A function of the increasing Federal Reserve holdings of
Treasury bills was to enable the Treasury Department to borrow
from the Reserve banks at a low rate of interest. These pur
chases constituted a form of borrowing that was less likely
to stir public criticism as would have direct borrowing.
In viewing the war period as a whole, the policy of the
monetary authorities which was directed toward encouraging
commercial banks to utilize Treasury bills Was a failure.
Member banks increased their holdings from approximately one
billion dollars in December 1941 to 4.4 billions in December
1942. The holdings -of member banks Increased in the follow
ing six months and then actually declined until, by June 1946,
member banks held only 1.1 billion while Federal Reserve hold
ings were 14.5 billions. A factor which explained the lack
of sueeess of the policy was the creation of Treasury certi
ficates of indebtedness, which were more attractive than the
bills. A bank had the choice of placing its funds in Treasury
certificates at 7/8 of one percent, backed by the assurance
that it could borrow on them at any time from its Reserve bank
at a preferential rate of one-half of one percent, or of placing
37
its funds in Treasury bills at 3/8 of one percent. It natural
ly chose the former course. There was no significant difference
in liquidity between the two. Investments and certificates,
furthermore, were purchasable on a credit basis? whereas, bills
were sold only for cash. The possibility of buying on credit
made the certificates the more attractive of the two, because
a bank could purchase them without losing its excess reserves
and without tying up required reserves. Even.the practice of
the Treasury, after May 19^3, of allocating the full amount
for tenderers of bills up to §100,000 at a stated price of
§99,905 failed to ease the sale of bills.
TREASURY BILL POLICY AS AN ADJUSTING MECHANISM
The introduction of the Treasury bill policy provided an
effective Instrument by which the Federal Reserve banks were
enabled to supply the added needs of the market. The mechanism
facilitated this automatic contraction of reserve balances
whenever and wherever they became excessive. The purchase
and sale of Treasury bills brought about more precise adjust
ments than did open market operations. They likewise permit
ted finer adjustments than were occasioned by changes In re
serve requirements. In other words, they were the most
sensitive to change in liquidity needs of commercial banks.
They had the further advantage that no administrative deci
sions were necessary; the initiative rested solely with the
banks. The greatest advantage of the Treasury bill policy
38
over the discount policy in meeting the liquidity requirements
arising out of the war was that the use of Treasury bills had
no popular prejudice with which to contend. The Treasury bill
policy displayed a means of educating banks away from their
dependence upon excess reserves to assure liquidity, since
they provided an effective means for adjusting the bank’s
cash position. The amount of Treasury bills offered for sale
to the Federal Reserve banks were indicative of the needs of
banks for currency and reserves. Under ordinary conditions
the volume of excess reserves are of considerable importance
in making adjustments for potential changes in the circulat
ing medium. The actual growth of deposits during the war was
governed by their use by the Treasury as a source of funds as
compared to other forms of income, rather than by the amount
of member bank reserves.
The development of an active market of governments during
the war lent more importance to open market operations. The
total of Treasury bills outstanding increased from one billion
on December 31, 194-0 to over 17 billions in 194-5, and composed
an important portion of the total public debt. According to
the traditional view of public financing, the amount of float
ing debt should be held to a minimum, and should exist only
in anticipation of revenue and possible in periods of deficit
for temporary needs until funding could be accomplished on
satisfactory terms. The proposed maintenance of approximately
39
the wartime amount of the floating debt for an indeterminate
period represented a departure from traditional practice.
This departure served to extend the increased importance of
open market operations into the post-war period.
"The Treasury bill market should be allowed to develop
into a full-fledged sector of the money market in which the
commercial banks will dominate. The central bank should
stand ready to absorb bills to a degree consistent with the
maintenance of the smooth functioning of the money market
machinery........ In other words, a pattern of money market
operation similar to that of the London market prior to the
war would be appropriate. With such a pattern, member bank
borrowing could be largely, if not entirely, eliminated, and
the central bank could actually assume its true function of
4
a lender of last resort."
4) Simmons, op. cit. , p. 34-5.
40
CHAPTER IV
CONSUMER CREDIT CONTROL
Consumers receive credit either through commodity sales
credit, which is extended by dealers and prodlicers, or through
inst&llment loans, which are extended by personal finance
companies, industrial banking firms, credit unions, and com
mercial banks. Practically all of commodity credit and a
large part of cash loans are used for the purchase of durable
consumer goods, mainly automobiles, furniture, and electric
appliances. Those who employ consumer credit are motivated
by the desire for satisfactions from the present use of goods
and services. Consumer credit fluctuations reflect primarily
the influence of changes or prospective changes in incomes
upon the consumer*s appraisal of the difficulty of future
payment and upon the credit grantor's appraisal of the diffi
culty of collection.
By 1920 even the most conservative retailers were begin
ning to sell on an installment basis.- The rise of the auto
mobile made installment buying big business, and the inven
tion of the finance company gave it access to the central
money market.
Several significant developments aided the expansion of
retail installment selling. First, with the urbanization of
population and the industrialization of the economy, a consi
41
derable number of people received their wages and salaries at
regular intervals which permitted the assumption of installment
obligations. Second, many new commodities were manufactured
which had great appeal and which lent themselves to install
ment financing. Third, the rise in real Incomes of the working
population made it possible for them to buy products of the
above type in a greater volume and variety. For these people
installment buying became a device for facilitating the ex
penditure of increasing Incomes in the ways most satisfactory
to the recipient. Fourth, after 1920 the greatly increased
number of short-term financial institutions like the sales
finance company, the industrial bank, and the credit union
provided a structure capable of handling a load of several
billion dollars. Just prior to our entry into World War II,
the total consumer installment credit outstanding reached
#5,455 millions.
THE PURPOSES' AND SCOPE OF THE CONTROL
An Executive Order, issued by the President on August 9,
1941, authorized and directed the Board of Governors of the
Federal Reserve System to regulate consumer credit during the
national emergency. Under this authority the Board adopted
and promulgated on August 21, 1941, Regulation W, effective
September 1, 1941*
The aim of this qualitative credit control measure was
42
stated in the Executive Order and was restated in the Forward
to the regulation issued by the Board. By way of explaining
the purpose of the regulation, Mr. Eccles, then chairman,
issued the following statement on August 25, 1941:
"It is important that the public know why they are
asked to accept and to cooperate in making effective the
President’s Executive Order calling for regulation of
installment credit. Employment and national income are
rapidly rising to new high levels primarily because of
the huge defense expenditures. This means that by and
large people have more money to spend than ever before.
This is happening at a time when more and more of. our
industrial plant must be used to produce defense mate
rials. To the extent that- plants can be expanded, or
can work longer hours, or that- shortages of strategic
materials or of skilled help, can be overcome, we can
produce both for defense and for civilian consumption.
And the aim of all policy should be to increase pro
duction to the fullest possible extent. But we know
that there are acute shortages of certain metals and
other strategic materials. We know that beyond a point
our plants cannot’ turn out more and more goods for the
public and at the same time produce more and more for
defense. The imperative demands of defense must, have
the right of war over civilian needs.
"If there are no restraints upon the public's spen
ding of increasing income for articles that cannot be
produced in sufficient quantity to meet the increasing
demand, the inevitable result is that the prices of
these articles will be rapidly bid up. The consequence
is what is commonly termed inflation.
"Accordingly, it is of primary Importance that
restraints be placed upon the wholesale extension of
credit, including installment buying. The volume of
installment credit has been expanding very rapidly, as
it always does In time of rising national income. Yet
when incomes are at high levels, that Is the time when
people should reduce their debts or get out of debt.
Our people cannot spend their increased incomes and go
into debt for more and more things today without pre
cipitating a price inflation that would recoil ruinously
upon all of us. Instead of an over-expanding volume of
consumer credit, we need to bring about a substantial
reduction in the total outstanding. Civilian demand
43
for goods must- be adjusted as closely as possible to
supplies available for consumption. Regulation of in
stallment- credit is a necessary measure to this end.
By deferring civilian demand at this time we can help
avoid inflation, we can aid in defense, we can store
up a backlog of buying power that will help offset a
post- defense slump. "1
Regulation W applied to any person who was engaged in a
business which sold certain articles of consumers' durable
goods (as listed in the Supplement to the regulation) on the
installment plan, which made cash loans repayable in install
ments, or which discounted or purchased obligations arising
out of credit of either type. As used in the regulation, the
term "extension of credit" included not only a loan but also
an installment purchase contract. Any extension of credit
which the obliger undertook to repay in two or more scheduled
payments, or which had a similar purpose or effect, constitu
ted an "extension of installment credit,"
If an extension of installment credit was made by a
seller or a listed article (an article listed in the Supple
ment to the regulation) and the extension of credit arose out
of the sale of such an article, it was referred to in the re
gulation as an "extension of installment sale credit." In
other words, if a customer purchasing a listed article agreed
to pay for it in two or more installments, the seller made an
"extension of installment sale credit." Similarly, an "exten-
1) The Board of Governors of the Federal Reserve System,
Bulletin, Vol. 27: 825-826, September 1941.
44
sion of installment loan credit!’ was made by a lender of funds.
An Installment loan in any amount which was secured by the
listed article purchased, and an installment loan which was
not so secured but was for $1,500 or less, were referred to
as ’ ’extension of installment loan credit.”
All persons engaged in installment business prior to
January 1, 1942 were required to file a registration statement
with the Federal Reserve Bank of the district in which their
main office was located. Subsequent to that date a general
license was issued to all such persons. A license could be
suspended for cause by the Board of Governors after reasonable
notice and opportunity for hearing.
On May 6, 1942 Regulation ¥ was amended so as to place a
great restraint on the extension of installment credit and
to broaden the scope of the regulation. The maximum permis
sible maturity for Installment sales credit was reduced to
12 months, and the required down payment for all listed arti
cles was increased 53 1/3 percent. The original regulation
did not apply to open accounts nor to any loan payable in full
on a fixed date. Under the amendment of May 6, 1942, the re
gulation was extended to cover, in addition to installment
sales and installment loans, charge-account sales of listed
articles and single payment consumer loans. With respect to
charge accounts, it was provided that unless payment was made
by the tenth day of the second calendar month following the
45
purchase, no further credit could be extended to purchase any
listed article until the items in default were paid for in
full or were placed on an installment basis for payment within
six months. Single payment loans of §1,500 or less were limi
ted to a maturity of 90 days, and where such a loan was made
to purchase a listed article costing §15*00 or more, a down
payment also was required. The Board, therefore, had the full
power to regulate any possible extension of consumer credit
after the revision.
CONSUMER CREDIT AFTER CONTROL
Prior to the issuance of Regulation W, the total of out
standing consumer credit reached an all time peak of approxi
mately ten billion dollars. Subsequent to the promulgation
of Regulation W, there was a sharp decline in volume of install-
ment- credit extended by sellers or producers of goods and
services and by various consumer lending.agencies. Although
this decline coincided with the inauguration of restrictions
on consumer credit, It was largely due to other causes. There
was a reduction, for one thing, in the available supply of
consumers’ durable goods, which usually constituted a large
part of goods purchased on credit. Also, the growth of income
enabled people to pay off debt and to make more purchases on
a cash basis. During the last four months of 1941, the decline
in the volume of consumer credit was at a rate of nearly 125
46
million dollars per month, and in 1942 the rate of decline
almost doubled. The seven months period from September 1941
through March 1942 witnessed a decline of nearly one and one-
fourth billions or a fifth of the maximum estimated to be
outstanding in mid 1941. Probably as much as two-thirds of
the decline noted above represented the liquidation of auto
mobile paper. This liquidation was due more to increased
incomes and to restricted production and sale of automobiles
than to consumer credit control. The amount of outstanding
installment credit receivables based upon sales of other
goods and upon cash installment loans made to consumers showed
relatively smaller declines. Some of these cash loans were
for the purposerof purchasing consumer goods. The decline
reflected a substantial reduction in loans for purchasing
automobiles with little decrease in other loans.
The volume of automobile paper outstanding, which in the
autumn of 1941 comprised about two-fifths of a‘ 11 consumer
installment debt, declined 35 percent in the aforementioned
seven months period while the amount of outstanding install
ment credit receivables, based directly upon sales of other
goods, showed a considerably smaller decline of around 15
percent. Cash installment loans to consumers, Including some
made for the purchase of automobiles, declined by only ten
percent. Charge account declined in the latter half of 1942,
more sharply than before subsequent to its inclusion in
47
Regulation W.
The rate of decline for all types of consumer credit stood
at 280 millions monthly and by the end of 1942, the total
volume of outstanding consumer credit was reduced by four and
one-half billion dollars.
In the following year the rate of decline, as compared to
that of 1942, slackened. A slackening in the rate of consumer
debt liquidation was inevitable as the hard core of indebted
ness approached. For example, the total credit on automobiles
at the end of April 1942 was only one-ninth the amount outstand
ing at the peak level. Charge account credit, after a sharp
decline in the latter half of 1942, stabilized in 1942. Single
payment loans declined slightly while service credit increa
sed somewhat.
As a result of the differences in the rate of liquidation,
there was a radical change in the composition of consumer credit
outstanding. Durable goods were the basis for consumer credit
at the peak in 1941, directly or indirectly, of approximately
2/3 of total consumer indebtedness. At the end of 1943 install
ment sale credit declined to 816 million dollars, a decline of
four-fifths from a height of over four billion in the fall of
194l, and installment cash loans of the principal consumer
lending agencies fell to 1,123 million dollars, a decline of
about 50 percent.
The spring of 1944 witnessed the almost complete liquidation
48
of the installment debt contracted in 1940 and 1941 as the
result of the active sales of automobiles and other consumers'
durable goods. The volume as well as the character of con
sumer credit became adjusted to the operation of Regulation W,
which prescribed stricter credit terms for consumer purchases.
The reduction of consumer credit from about ten billion dollars
in 1941 to about five billion dollars at the beginning of 1944
gave evidence of this adjustment.
Later in 1944 a small upturn in the volume of consumer
credit outstanding, which was largely concentrated in charge
accounts, occurred. Retail sales moved steadily upward to
new high levels in 1944, and along with them, charge account
sales rose but less rapidly relative to total sales. Aside
from the increases in charge account credit, the increase in
consumer credit was quite small.
Between the spring of 1944 and March of 1945 consumer
credit outstanding increased by a half-billion. Charge accounts
again showed the greatest amount of increase, i. e., 22 percent
over the year. Installment sale credit, ordinarily the most
important type of consumer credit, only increased five percent.
Installment cash loans were eight percent above and single pay
ment loans were six percent above their previous levels In the
spring of 1944.
After the end of the war with Japan, the rate of increase
became more rapid. At the end of July 1946 the total of
49
consumer credit outstanding stood at the eight 'billion level,
or only a billion and one-half dollars below the 1941 peak
(Table 3 shows the changes in total consumer credit outstan
ding during and immediately after the war).
Of the total growth from September 1945 to July 1946, about
30 percent, or 811 million dollars, was in the form of charge
accounts, which increased by more than one-half over the period.
Consumers were eager to purchase goods, and the types available
were mainly non-durables or minor durables. The above large
increase in charge account credit reflected that- if consumers
goods were purchased on credit Instead of for cash, they were
typically purchased on a charge account. Another 50 percent
of the total increase for this period was the 1,079 million
dollar Increase in consumer loans. This figure included both
installment loans and single payment loans with the later con
stituting about two-fifths of the increase. Installment sale
credit, which arises from the purchase of automobiles, furni
ture, and household appliances, increased by only 639 million
dollars, which demonstrated the fact that the major types of
durable goods such as those above, had not yet become available
in quantity. It was evident, therefore, that the sharply
Increased volume of credit after the war was widely spread over
various kinds of goods and services, that its inflationary
effect was correspondingly diffused, and that consumer credit,
after its halt during the war, increased quickly in the post-
50
Table 3. Total Consumer Credit, By Major Parts *
(Estimated Amounts Outstanding. In million dollars)
Instalment credit
End of T o t a l ____________________ Single Charge
month consumer Total Sale debt_______"Loans payment accounts
or year credit instal Total Auto. Others loans
1940... 8,767
ment
debt
5,434 3,450 1,729 1,721 1,984
1,123
1,650
1941
Sept...
9,717
6,241 4,008 2,215 1,793 2,233
1,168 1,712
Be c.*.. 9,509 5,921
3,747 1,942
1,805
2,174 1,200
1,783
1942
d an.... 9,118 5,604
3,503 1,806
1,697
2,101
1,197 1,709
Mar.. . . 8,580 5,110
3,105 1,514
1,591 2,005
1,180 1,680
June... 7,541
4,339
2,481 1,126
1,355
1,858 1,119 1,466
Sept. 6,560
3,513 1,871 777
1,094 1,642 1,091 1,336
Dec....
6,155
2,922 1,494 482 1,012 1,428 1,072
1,513
' 1943
d an....
5,703 2,660 1,314 404 910 1,346 1,058
1,333
April. .1
5,243 2,226 1,020 260 760 1,206 1,029 1,331
dune. ..
5,065 2,046 896 208 688 1,150 1,014 1,338
Sept... 4,909 1,917
786 186 600
1,131
1,038
1,275
Dee.... 5,158 1,939 816
175
641
1,123
1,034 1,498
1944
d an.... 4,8l8 1,836 745 169 576 1,091 996 1,294
Mar. . .. 4,836 1,804 696
167
529 1,108
955 1,376
dune. 5,209 1,882
707
192
515 1,175
1,241 1,370
Sept. .. 5,272 1,912 720 210 510 1,192 1,231
1,402
De c »•.. 5,791
2,084
836 200 636 1,248 1,220 1,758
1945
d an.... 5,482 2,014 778 192 586 1,236 1,206 1,528
Mar. . ..
5,575 1,991
1,987
731
184
547
1,260 1,181 1,662
dune...
5,697 719
188
531
1,268 1,420 1,544
Sept... 5,702 2,010
717
202
515 1,293
1,466 1,470
Dec.... 6,734
2,365 • 903 227 676 1,462 1,616 1,981
1946
d an.... 6,509 2,369 877 235
642 1,492 * 1,659
1,701
April.. 7,368 2,649 957 235
668 1,692
1,765
2,138
duly...
8,025
3,022 1,070
365 705
1,952 1,886 2,281
Sept... 8. , 631 3,288 1,177 425 752 2,111 2,000 2,494
* Source: Federal Reserve Bulletin
51
war period.
After V-J day most of the basic requirements of Regulation
W were left unchanged on the publicly announced ground that
until consumers' goods once more came into the market suffi
cient- quantities to meet demand, the use of credit should be,
as far as possible, discouraged. But Regulation W did not go
unimpaired; two changes were made. First, credit extended for
home-repalrs and home improvements was released from control.
Second, the limitation on the maturity date of one category of
consumer loans, viz., loans not for the purpose of purchasing
consumers' durable goods, was altered. The latter revision
lengthened the maturity period from 12 months to 18 months
thus enabling consumers to more easily obtain credit for such
miscellaneous needs as might arise in a period of rapid eco
nomic and solid adjustment. Regulation W was abrogated to
ward the end of 19A?.
Governmental concern with consumer financing as applied
to the selective instruments of credit control policy could
trace its history back more than 20 years. Special inquiry
into member bank holdings of installment paper was made through
the bank examiners in 1925-1926, and the machinery was set up
by Congress in 1934- for encouraging the use of installment
credit to finance home mortgages, repairs and improvements
to residential property, and to purchases electrical applian-
52
ces. In 1937 the Board of Governors of the Federal Reserve
System put in effect its Regulation A, relating to discounts
for and advances to member banks by Federal Reserve Banks.
Its provisions were designed to encourage both real estate
loans and loans for financing the sale of goods on an install
ment basis. The policy In consumer credit field during this
period was diametrically opposed to the wartime policy; the
pre-war policy was employed to encourage credit expansion so
as to aid recovery from the depression while the wartime policy
was designed to exercise restraint. The program from 1941 to
1945 incorporated the following features: that charge account
credits should be paid up within 60 days from their date of
origin, that installment credit would have a maturity of not
more than 12 months, and that a down payment on installment
purchases of consumers' goods (and loans to make such-pur
chases) must be obtained.
Federal regulation of consumer credit during the war was
a flexible one. When it first went into effect, in 1941 and
for some time thereafter, its primary function was to restrain
effective demand for consumers' durable goods and thereby
reduce the inflationary pressure on those goods. The secondary
function of control was to restrain the over-all growth of
consumer credit and the expansion of consumer buying power as
a whole, thereby reducing the inflationary pressure on goods
and services in general. "Whatever efficacy consumer-credit
53
regulation may have had in wartime was obviously dependent,
to a degree that is hard to estimate, upon circumstances of
the time which predisposed persons subject to the regulation
to comply with it, such as the public spirit characteristic
of wartime and the absence in an active "sellers1 1 market" of
inducements to promote sales by offering very easy credit
terms. This minimized immensely the problem of enforcement.
Under peacetime conditions, after goods are in supply again,
the disposition of the consumer-credit industry to comply
with any regulation would depend very largely upon the scope
and nature and stringency of the regulation? that is to say,
upon the prescience and judgment of the authorities res
ponsible for shaping and administering the regulation. An
important circumstance making for sustained cooperation from
the consumer credit industry could be the disposition of a
considerable part of the industry, in the light of its ex
perience over the past 30 years, to see in governmental regu
lation a safeguard against excessive relaxation of install
ment terms such as competition has heretofore engendered,
notwithstanding repeated cooperative efforts within the in
dustry to halt the trend.1 , 2
The large reduction after 194-1 in the volume of consumer
2) Carl E. Parry, "Selective Instruments of National Credit
Policy", Federal Reserve Policy, Washington D. C.,
Board of Governors of the Federal Reserve System, 194-7,
pp. 76-77.
credit outstanding, when viewed in relation to the higher post
war incomes, signified a building up of a large amount of.un
used credit capacity and an increase in capacity for consumer
spending. It represented a margin that could be used, as
saving can be used, when the supply of consumers1 durable goods
became more plentiful and when the need arose for large volume
buying to sustain full employment.
In summing up the beneficial effects of Regulation W, one
finds that it made materials, skills, and equipment available
for war production, promoted the purchase of war bonds, aided
in curbing prlee increases and inflation, created a backlog of
demand for goods and services in the post-war period, and gave
to the mass of the populace, blessed with enforced savings,
some peace of mind and a feeling of security.
55
CHAPTER V
THE IMPACT OF WAR. ON MEMBER BANKS
There were several substantial changes in the banking
structure in the United States during the war years. The
total deposits of all member banks were slightly less than 50
billion dollars at the end of 1939, but by the end of 194-5
they rose to 130 billion dollars. This increase of 80 billion
dollars was more t-han eight times the reserve base available
to member banks for creating credit during the six years. The
multiple expansion was mostly produced by bank purchases of
government securities. Government wartime expenditures were
so enormous that the commercial banks served primarily as
direct suppliers of government funds ra.ther than as suppliers
of private credit. As evidence of this fact, member bank
holdings of public debt rose by 64 billion dollars from 1939
to 1945, while in the same period loans increased by nine
billion dollars, one-half of which were loans for carrying
and purchasing government securities.
The growth in bank deposits to more than double the pre
war size was only one of several fundamental changes in the
banking structure which were brought about by the war. A
second was the one sided growth in assets. Government securi
ties constituted the most important earnings and assets in
bank portfolios and were expanded to 250 percent of the pre-war
56
bank holdings.
The distribution among classes of holders of new deposits,
which originally were created by government borrowing, repre
sented a third basic change for banking. Most of the increases
entered demand deposit-aecounts of businesses and individuals.
There was not the same concentration upon a single class of
liabilities as appeared among assets however. Time deposits
increased by 11 billion dollars from 194-0 to 1945. Private
demand deposits, on the other hand, rose from 25 billions at
the end of 1939 to over 60 billions at the end of 1945.
Some redistribution of banking concentration accompanied
the great growth of the System. The end of the war saw the
enlargement of the average size of banks in the United States.
In 1939, for example, there were only 8l banks in this country
whose total deposits exceeded 100 million dollars; 25 of these
were clustered togather in the two central reserve cities-
New York and Chicago, but at the end of 1946 there were 180
banks of this size, of which 34 were in New York and Chicago.
The proportion of extremely large banks located in these two
cities fell from one-third to one-fifth.
The pattern of changes in assets and deposits within indi
vidual banks varied among regions and among different sized
banks. The greatest expansion in deposits occurred in western
and south-western states. In nearly every district, the per
centage increase in deposits was greater at country banks than
57
at city banks. The great growth of private demand deposits
did not materially alter the deposit composition of the larger
banks, as they always dealt primarily with demand deposits,
but the deposit composition in the small banks wan changed,
as volume of business and individual demand deposits became
larger than the volume of time deposits.
The changes in the banking structure also affected the
methods and principles of bank operation. While the system
as a whole expanded one and one-half times, a number of banks
grew from small to medium size, and from medium to large.
They had to face much more than the traditional -problems of
adjusting to large-scale operations, for the character of
their operations also changed with the peculiar wartime na
ture of the growth. The new size and the composition of
deposits were certain to evoke problems of portfolio manage
ment.
THE WARTIME DEPOSIT GROWTH
Deposits in all member banks more than doubled in the six
years following the end of 1939, increasing by about 80 billion
dollars by 1946. When the sharp increase in United States
government deposits is excluded, the six year growth was about
50 billion dollars. Although all the member banks increased
their deposits during the war period, there existed some dif
ferences in growth among the regions and among different sized
58
banks.
Regional Differences In Deposit Growth All sections of
the country and most banks recorded increases in deposits, but
some had more growth than others. Even among such broad areas
as Federal Reserve districts there were marked differences in
the degree of deposit expansion. The distribution of wartime
government contracts, the placement of new plants, and the in
creases in farm incomes caused some industries to shift toward
the South and West. The effect of this shift was to increase
deposits in the South and West more rapidly than in the Atlantic
coast districts.
The accompanying table summarizes the growth of total
assets in each of the Federal Reserve districts from the end
of 1939 to the end of 194-5.
While the total deposits of the entire 6,155 member banks
increased 153 percent over the six years, the gain of the banks
located in the Dallas district was 247 percent. Atlanta and
San Francisco banks showed aggregated increases of 244 and
243 percent respectively. Whereas the above districts showed
enormous Increases, the New York and Philadelphia districts
each grew but 107 percent.
The evidence of disportionate percentage growth might be
misleading without comparison of the initial magnitudes in
each of these districts. In dollar volume, the Dallas growth
of from 1.5 billion dollars in 1939 to 5.3 billion dollars
59
Table 4. Growth in Deposit of 6,155 Member Banks, by Federal
Reserve District, 1939-1945 *
(Year-end data, dollar items in millions)
Demand deposits of
District individuals, partnerships Total deposits
and corporations
1939 1945 percent percent
increase 1939 1945 increase
1939-45 1939-45
Boston. ......
1 1
,518 |3,161 103
1 2,725
|6,288
131
New York..... 10,609 18,756 77
18,178 37,696 107
Philadelphia.. 1,359 3,123
130 3,on 6,236 107
Cleveland.... 1,810 4, 618
155 3,956 9,815
148
Richmond..... 859 2,745
220 1,946 5,478 182
Atlanta...... 728
2,787 283 1,726 5,930 244
Chicago......
3
,290 8,072 145 6,919 17,916 159
St.Louis..... 755
2,184
189 1,703
4,578 169
Minneapolis... 462 1,442 212 1,101
3,305
200
Kansas. City... 829 2,942
255 1,845 5,765 213
Dallas....... 794
3,031
282 1,534 5,321 247
San Francisco. 1,845 7,887 328 4,861 16,676 243
All Districts. 24
CO
in
CO
60,748 144
49,505
125,004
153
* E;r:R, Bopp, R. V. Rosa, et al. , Federal Reserve Policy,
Washington D. G, , Board of Governors of the Federal
Reserve System, 1947, p. 35.
in 1945 was still small when compared with the increase of
deposits in the New York district, which were from 18,2 billion
dollars to 37.7 billion dollars. As a share in the national
total, deposit in the Dallas area rose from about three per
cent to four percent while the banks in the New York district
dropped from thirty-seven to thirty, percent.
Differences Between Large and Small Banks In nearly
every district, percentage increase deposits were greater
60
at country banks than at city banks. The spread between the
rates of growth of large and small banks was considerably
greater when spread among districts.(see table 5).
Table 5. Distribution of 6,155 Member Banks, by Size and
Rate of Growth, 1939-1945. *
Size of
banks1
(Total
deposits,
in millions
of dollars
Number
of banks
Rate of growth2 (percent)
0-150 150-300 300-500 Over
500
All rates
of growth
Percentage distribution
within each size group
of banks
Under 1.... 1,250 2.8 26.4
49.5 21.3
100.0
1 - 2..... 1,628 2. 6 34.0 45.6 17.8 100.0
P -5...... 1,708 5.2 44.6 37.9 12.3
100.0
5 - 50.... .1,345
14. 6 55.8 23.9 5.7
100.0
50 and over 224 45.1 40.6 13.4
0.9
100.0
All sizes
6,155 7.5
40. 4
38.3
13.8 100.0
1) As of December 31, 1943.
2). Measured by increase of demand deposits of individuals,
partnerships, and corporations from December 31, 1939 to
December 31, 1945.
* K. R. Bopp, R. V. Rosa, et al., Federal Reserve Policy,
Washington D. C., Board of Governors of the Federal Reserve
System, 1947, p. 37,
The above table summarizes the growth characteristic
according to the size of the bank. It shows: that large num
bers of smaller banks grew by more than 500 percent over the
six years,, that fully one-half of the smaller banks grew by at
least 300 percent, and that the unequal rates of expansion of
large and small banks reduced the relative deposit position
of the largest banks.
To some extent this differential experience among banks
61
was merely another aspect of the area differences already dis
cussed. Banks in the areas showing the greatest gains were,
in general, smaller in size than those located in the areas
showing the smaller relative gains. The large relative expan
sion of deposits in the agricultural areas was also reflected
as a greater gain for small hanks since such hanks predominate
in farm areas.
Differences hy Type of Deposit Ownership Federal Reserve
System surveys of demand deposit ownership indicated that,
particularly in wartime periods, the percentage increase in
accumulated deposits hy the individual was greater than that
of business. Estimated rates of deposit growth hy hroad groups
are shown in the following tahle.
Tahle 6. Ownership of Demand Deposits, 194-1-1944 *
(Estimated: amounted in billions of dollars)
' ' July 31, “Deel 3lV "increase'
___________________1944 1941 Amount Percentage _
Domestic business 37.4 25.0 12.4 50
Personal 18.6 10.0 8.6 86
All others1 - 3.6 2. 6 1.0 38
Total 59.6 37.6 22.0 59
1) Includes nonprofit organizations, trust funds of hanks
and deposits of foreigners.
* Source: Federal Reserve 3ulletin.
The deposits surveys also appeared to demonstrate that the
amount of increase in deposit percentages for small business
62
was equal to or greater than for the large ones. In the early
war period the rapidly increasing volume of productive and
commercial transactions necessitated larger business deposits.
As war production approached its peak, and business balance
l
requirements were satisfied, a larger part of the available
funds of corporations were used to purchase Government bonds.
During the early war period, all of the deposit expansion
was in demand deposits, but after the beginning of 194-3 time
deposits, which were largely held by individuals, grew contin
uously and In 194-4 their growth exceeded that- of demand depo
sits. The expansion of time deposits was more evenly distri
buted throughout the country than the growth of demand deposits.
CHANGES IN THE COMPOSITION OF GOVERNMENT SECURITIES
PORTFOLIO
As the financial needs of the Government grew, holdings
of government obligations by the banks were bound to increase.
Member banks holdings of United States Government securities
Increased from slightly less than 40 percent of the total
obligation outstanding at the end of 1939 to more than 50 per
cent at the end of 1945. The subsequent changes in total
member bank holdings and.in the amount of outstanding issues
eligible for bark purchase, are shown in Table 7. During 1940
and 1941 the banks increased their holdings slowly. The bank-
held portion of each of the three types of debt form then
existing, bills, notes, and bonds, rose to about 50 percent.
63
Table 7. Public Debt Holdings of All Member Banks Compared
with Outstanding Marketable Public Debt Eligible
for Bank Purchase, 1939-194-5 • *
(Dollar items in billions)
End of year "Total Bills '''Cert£ 7 i cate s ""Notes ’ ’ ' ''Bonds
________ Eligible Issues outstand!ng~" ___
193 9 | 37.5 $ 1.5 $- $6.2 $29.9
194 0........ 35.4 1.3 - 6.2 28.0
194 1........ 41.4 2.0 - 6.0 33.4
1942.... 75.5 6.6 10.5 9.9 48.5
194 3........ 106.5 13.1 22.8 11.2 59.4
194 4....... 138.2 16.4 30.4 23.0 68.3
194 5 147.9 17.0 38.2 23.0 69.8
--------------------------------------------------------------- -p .
Member bank holdings
193 9..... ...$ 14.3 $ 0.6 $- $ 2.2 $11.5
194 0........ 15.8 0.7 - 2.6 12.6
194 1........ 19.5 1.0 - 3.0 15.6
194 2........ 37.5 4.4 6.3 5.4 21.5
194 3 52.9 4.4 12.1 6.9 29.6
194 4 67.7 3.7 14.0 14.1 35.8
194 5........ 78.3 2.3 17.0 14.3 44.8
Member bank holdings as a percentage of eligible
Issues outstanding _____________________
1939........ 38 39 - 36 39
1940........ 45 50 - 42 45
1941. ....... 47 49 - 50 47
194 2........ 50 66 60 55 44
194 3........ 50 33 53 62 50
1944......... 49 23 46 61 52
1945........ 53 13 45 62 64
1) Includes all guaranteed issues, and the amount of restriced
issues reported held by commercial banks in the "Summary of
Ownership of Government Securities," Treasury Bulletin.
Saving bonds are not included
2) Includes the fully guaranteed securities of Government
agencies, and also a small amount of the restricted issues
that came out after 1943 (the result of subscriptions per
mitted as a limited fraction of time savings deposits).
A negligible amount of savings bonds isalso included.
Source: Treasury Bulletin
64
In 194-2, with the Treasury's shift to all out war financing,
the banks added 18 billions of Government securities to their
holdings, the largest annual increase of the war years.
Certificates of indebtedness were reintroduced during 194-2
for the first time since 1934-. In the same year the rate on
Treasury bills was pegged, and a preferential discount rate
was established on advances secured by Government securities.^
By increasing bank reliance upon the reserve convertibility of
short-term Government obligations, these measures effectively
transformed bank reserve policy, as is clearly shown in Table
7. Prior to 194-2, bills were never more than one-twentieth of
the aggregate member bank portfolios of Government securities,
but during that year bills and certificates alone accounted
for over one-half of the member bank acquisitions, Including
notes, and the fraction of short-term, aequisitions was two-
thirds. The average term of combined bank portfolios of
Government securities, which was approximately seven years at
the end of 1941, fell to less than five years by the end of
1942.
During 1943 the Treasury issued an additional 19 billion
dollars worth of bills and certificates. The banks, however,
permitted all of the new bills they acquired to pass into the
Federal Reserve banks, as frequent short run needs for reserves
occurred, and by the end of the year their total bill holdings
stood at the level of the previous year. Member bank holdings
ll For discusiion7”*sie Chapters II and III.
of the higher-yielding certificates stood at six billions.
Bond acquisitions of eight billions, however, exceeded the
combined amount of additional certificates and notes held by
the banks.
The shift into certificates, as a basic instrument of
reserve adjustments, continued in 1944, but the major change
shown by the year reports was a rise of more than seven billion
dollars in the total of notes held. No change in principle was
involved, however, for during 1944 the Treasury began issuing
13-month notes to fill gaps in the maturity schedules, and the
notes were considered virtually equivalent to certificates as
secondary reserves.
Differences among Banks in the Composition of the Govern
ment Securities Portfolios. It is the date of maturity rather
than the type of Government securities which banks ordinarily
consider in dividing their holdings among various alternations.
Up to the end of 1943 the banks were in the process of be
coming adjusted to a "fully invested" position. The central
reserve city banks in New York and Chicago led the way, and
the other banks gradually followed, with the larger banks
generally preceding the smaller.
The great movement of reserves from the large eastern banks
into the West and South was largely completed by the end of
1943. The Treasury was able, thereafter, to relate the distri
bution of its new issues more closely to its regional pattern
66
of disbursements. Consequently, from 194-3 on, the smaller hanks
built up their total holdings of Government- securities more
rapidly, and acquired relatively more of the short-term Issues
than they had up to that time. This later growth in the short
term holdings of. the smaller banks reflected more than an adjus
tment to the reserve policy pioneered by the larger banks. The
smaller banks apparently found it increasingly expedient, during
1944 and 1945, to adjust to the rapid rise in their private
demand deposits by doubling.or trebling their holdings of short
term issues, as a precaution against possible deposit with
drawals at some future time.
The volume which increased greatest in volume was also the
most volatile, and the banks found it necessary to make more
extensive provisions for reserve shifts among themselves than
were made before the war. To the extent that increased vola
tility continues to characterize the behavior of demand depo
sits for individual banks, they will desire to retain sizable
holdings of short-term Government securities. Because these
securities have narrow price fluctuations, which minimizes the
danger of capital loss at the time of future sale, they will
likely remain the most attractive earning asset for use in
reserve adjustments.
THE LOAN PORTFOLIO
The essential function of commercial banking is to mobilize
67
private credit and to direct that credit into channels which
will best serve the ends of the national economy.
Under war conditions the primary function was to meet
wartime emergency needs; therefore, it became the duty of com
mercial banks to scrutinize with care all applications for
nondefense loans. Thousands of corporations all over the
United States were engaged in war production, either as prime
contractors or as subcontractors. In a considerable number
of cases the over-all volume of business of these concerns
was greater than ever before.
The loan portfolio of the combined member banks passed
through three distinct phases, during the war years. Prom the
end of 1939 to the end of 1941, while the Federal Reserve au
thorities followed first a policy of reserve ease and later
one of tightening, there was a general advance in all types
of business and consumer loans. The shift in policy back to
monetary ease after the United States entered into the war,
however, was not accompanied by a further increase in total
loans.
The period from the end of 1941 to autumn of 1943 marked
the second phase, which was one of general decline. About
four-fifths of the increase of the first phase were canceled
during the second. So-called non-war loans to business declined
under the pressure of production controls, which diverted more
and more of the economy into war channels. Businesses engaged
68
in producing goods and services for the government were able
to meet a major portion of their working capital requirements
through advance or progress payments* New plant requirements
frequently were met by direct government creation of production
facilities. Guaranteed loams were introduced early in 194-2
so as to encourage bank's financing of working capital require
ments. Working capital loans reached a peak of two billion
dollars by the end of 194-3, but were not sufficient to offset
the decline in non-war business loans.
From the end of 1943 to the end of 1945 the volume of
total loans moved upward and reached 22.1 billion in the 6,155
member banks. The reduction in commercial and industrial loans -
during this second phase was regained in the third; agricul
tural loans, however, declined, while real estate loans remained
steady, and consumer loans rose slightly. The major impetus
was provided by security loans, particularly loans on.govern
ment securities. These loans increased rapidly after the banks
were excluded from direct subscriptions to Treasury issues.
Loans on securities increased sharply and declined between war
loan drives. At- the end of 1945, immediately after the end
of the Victory Loan Drive, loans on securities were four bil
lion dollars larger than there were at the close of 1943.
Professors Jacoby and Saulnier give the following excel
lent analysis of wartime changes in the use of bank funds by
business. "Among the major industrial divisions of the economy,
69
large manufacturing concerns, particularly producers of war
goods, experienced a sharp increase in the use of bank fund
during the war years", just as they experiences a spectacular
expansion in assets and in value of output. ..... In view
of the fact that banks1 outstanding commercial and industrial
loans rose by 18 percent between the end of 1939 and mid-19^5,
it appears that there was a shift of bank credit out of every
major industrial division of the economy into manufacturing
and, to a lesser extent, into trade concerns........ Changes
in the geographical distribution of demand for bank credit
reflected changes in the location of productive activity;
outstanding bank loan balances Increased most in those regions
where war industries grew most rapidly.1 1
The greatest increases in loans over the war years as a
whole occurred at the larger banks. Not all small banks were
equally far behind, however; those which grew most rapidly
during the war also acquired relatively more loans than did
those which grew less rapidly.
The banking structure of the United States underwent con
siderable changes in the period from the depression through
the war years. The so-called "commercial" banks largely lost
their commercial character; old sources of Income declined
2) Neil H. Jacoby, and Raymond J. Saulnier, Business Finance
and Banking, New York: National Bureau of Economic
Research, 19^7, p. 185.
70
and new sources were tapped; changes in the character of assets
rendered many of the accepted rules and methods of bank manage
ment large inapplicable. These changes did not affect the
mechanics of commercial banking but the foundation upon which
the mechanism rested. Government debt was substituted for
loans and discounts.
Primarily as a result of their assumption of increased
amounts of government obligations, the member banks grew one
and one-half times in aggregate size from 1939 to 194-5. All
of the banks, whether they grew proportionately more or less
than this average Increase of 150 percent, experienced both
the problems of doing business on a larger scale and the ne
cessity of adjusting their operations to a decided shift in
the composition of their assets. Most of the smaller banks
also experienced a change in the character of their deposits,
as private demand deposits expanded relatively more than time
deposits.
The insertion of so large a volume of bankable govern
ment securities into bank portfolios during the war substituted
earning assets (several times greater in amount) for the excess
reserves which had served the banks, after 1933, as the cushion
between reserve drains and liquidation of bank loans. The in
creases of holdings of government securities by member banks
increased their liquidity so that the banksi were left relative
ly unrestrained by central bank action when extending new loans.
71
While the hanks necessarily judged loans by their usual stan
dards of credit risk, they had little motive to give primary
consideration to conditions that would protect their own
"liquidity."
72
CHAPTER VI
THE FISCAL FUNCTIONS OF THE FEDERAL RESERVE
SYSTEM IN FINANCING WORLD WAR II
Modern war Is expensive. The tremendous volume of spending
by the United States Government during World War II emphasized
this fact. Total funds raised by the Treasury in the period
from the middle of 1940 to the end of 194-5 amounted to 383
billion dollars. About 40 percent or 153 billion dollars of
this amount came from taxes, leaving about 230 billion dollars
that was obtained by borrowing.^ The Government, during the
war, made efforts, with a considerable degree of success, to
sell government securities to individuals and nonbanking cor
porations who buy them out of current Income,.thereby lessening
the inflationary pressure. But receipts from this source were
not enough to absorb all of the government issues so that the
Treasury again resorted to inflationary financing through the
banking system. Both the Federal Reserve and the commercial
banking system cooperated in creating new money for the Trea
sury to finance the war.
The Federal Reserve played an active part in creating new
money for war purposes during the Second World War. The Reserve
banks expanded their outstanding credit by more than 21 billion
dollars, mostly by purchasing government securities directly
1) All the figures see Table VIII on page 80.
73
from the Treasury and in the open market. The Federal Reserve
banks facilitated Treasury financing at low rates of interest
in two ways. (1) The Reserve Banks themselves purchased and
held out of the market more than $22 billion of government
debt. And (2) with each purchase, of securities Reserve Banks
created additional funds which the commercial banks could add
to their reserves and expanded their credit. It seems certain
that the Treasury would not have been to borrow such huge
amounts at such low rates of interest without t-his intimate
cooperation of the Reserve Banks.
From 1940 to 194-5 commercial banks increased their holdings
of United States Government securities by 78 billion dollars
compared with 16 billion in 194-0. War financing was respon
sible for a very rapid and large expansion of liquid assets
by the public. The holdings of total deposits and currency
by individuals and businesses Increased from 194-0 to mid-194-7
by 100 billion dollars or to 2§ times the prewar level. The
inflationary pressure accompanying this monetary expansion
was well known. It is true, of course, that some such presure
would unquestionably have developed even if the Treasury had
relied more on taxation and on types of borrowing that did
not entail the creation of new money.
FINANCING OF WORLD WAR I
When war broke out in 1914-, the Institutional frame-work
74
of finance in the United States was relatively undeveloped.
The Federal Reserve System, though authorized the year before,
did not begin operation until several months later after the
outbreak of the European war. After the United States de
clared war on Germany in April, 1917. the government was
obliged to float unprecedentedly large loans. Hence the first
important policy action of the System was war financing. The
position of the Federal Reserve banks as fiscal agents of the
Treasury gave them a central role in the financial operations
of the war.
Prior to the European war the chief sources of income for
the United States Treasury were customs duties and internal
revenues. The constitutional amendment legalizing the Federal
Income Tax was enacted in 1916, just in time to permit the
use of this form of taxation in financing the war. Notwith
standing a sevenfold increase in tax receipts between 1916
and 1920, the First World War was financed chiefly by 'bor
rowing, however. Most of the money borrowed came from indi
vidual investors. An important feature of war finance was
the policy where the public was encouraged to pay for bonds
by loans from banks, pledging the bond thus acquired as
security for the loans.
Since it was no longer possible to rely upon the income
from the internal revenue and customs duties, new sources of
income had to be found at once. Accordingly, Congress passed
75
an act, approved April 24, 1917, which authorized the Secretary
of the Treasury, with the approval of the President, to issue
bonds to the amount of $5,000,000,000 with interest not to
exceed percent. Provision was made also by the same act
for the issue of certificates of•indebtedness not to exceed
the maximum amount of $2 billion outstanding at any one time,
with interest not to exceed 3s percent per annum. This act,
therefore, made it possible for the Treasury to build up and
maintain the proper government balances in the various Federal
Reserve banks and other designated depositaries.
Government borrowing during the World War I was based
chiefly on Treasury obligations in the form of short-term
certificates of indebtedness and longer term bonds and notes.
The sale of short-term Treasury certificates was a way of
obtaining funds in advance of the elaborately planned Liberty
and Victory Loan drives. In large measure the drives were
in the nature of funding operations whereby short-term debt
was converted into long-term debt. It was intended that by
selling certificates at- intervals and having them mature at
a rate to correapond to the yield of bond sales, a fairly even
flow of funds into and out of the Treasury could be maintained.
However, this ideal adjustment of certificates to bond sales
was not fully achieved.
In the First World War, commercial banks were a minor but
by no means unimportant lender to the government. Between
76
the middle of 1917 and the middle of 1919, the Federal debt
increased by |22,5 billion. About $3.6 billion or 16 percent
of this amount was acquired by commercial banks. Between the
outbreak of war in Europe in 1914- and the United States entry
into the war in 1917, loans and discount of national banks
rose by 36 percent. The total continued to rise thereafter
at about the same rate until 1919, when the rate of incre.ase
became still more rapid. A considerable proportion, at times
a major proportion, of the increase in loans that took place
between 1917 and 1919 was in the form of loans on the col
lateral of government bonds. Loans of this type, which were
popularized under the slogan "Borrow and Buy," constituted
one of the distinctive features of the financial policy
during World War I.
During World War I the 'Federal Reserve Board and Federal
Reserve banks assumed their full share of the burden and co
operated in a very effective way in carrying on the work of
the Treasury Department. This was shown by the fact that the
Board adopted a . low discount rate which aided in the selling
of the liberty bonds and certificates of indebtedness. A
preferential rate of interest was offered to all member banks
which presented eligible paper secured by government obliga
tions, for rediscount. The discount rate was placed at 3
percent per annum on paper secured by certificates of indebted
ness and maturing within 15 days. This policy, therefore,
77
harmonized very closely with the low interest rates paid by
the government, both on certificates of indebtedness and on the
Liberty Loans, and .made it very easy for member banks to get
funds readily by rediscounting at- the Federal Reserve banks
to carry, at low interest rate, those customers who were bor
rowing to buy Liberty bonds.
The Federal Reserve Board explained its policy in assisting
the Treasury Department as follows:
The Board, however, is charged by law with the exercise
of a general supervision over the Federal Reserve Banks,
both as to their ordinary business and with respect to
their functions as fiscal agents of the Government. In
the later capacity they are undertaking grave duties and
responsibilities, and their activities are of such scope
that any administrative mistakes or errors of judgement
might entail serious consequences. This responsibility is
fully appreciated by the Board, which, while it has been
actuated by a desire to do all in its power to give the
country every advantage accruing from the financial resources
of the Federal Reserve System, has constantly realized
that its primary duty is to maintain the System in the
strongest possible position.
The discount policy of the Board has accordingly been
governed by these two considerations. It was necessary, in
order to facilitate the operation of the Treasury, that dis
count rates at the Federal Reserve Banks be maintained on a
basis in harmony with the low interest rates borne by the
Government loans during the period from the beginning of war
down to the completion of the second Liberty loan. It was
fortunate that this policy could be carried out without
infringing too greatly upon the resources of the Federal
Reserve Banks, for it is obvious that any advance in rates
paid by the Government on Its obligations was necessarily
gradual, moving up from 3 percent, the rate paid on the
certificates issued in May, to 3i percent and later to 4
percent, the rate carried by the second Liberty loan issue.
A more gradual advance might have end.angered the success
of the financial operations of the. Treasury, while a more
rapid movement might have brought about a convulasion in
78
the securities -market.2
During the war the sale of Liberty bonds and Victory notes
and of short-term certificates of indebtedness was organized
through the Reserve Banks, and these banks handles the proceeds
and -paid them out again from time to time at the direction of
the government. When banks made payments for Liberty bonds,
these payments took the form of deposit entries on their own
books to the credit of the Federal Reserve banks as fiscal '
agents of the Treasury. The banks lodged securities with the
Reserve Banks as collateral for these deposits. When indivi
duals bought bonds, the operation was in the main simply a
transfer of deposits on the books of the banks from the ac
counts of customers to the account of the Treasury. The
government drew down its balance only as the funds were needed
to be paid out, and by these payment for services, munitions
of war, loans to the Allies, etc., it created new balances to
the accounts of bank customers'. Back of all these operations
stood the Federal Reserve banks ready to make advances to the
member banks whenever necessary.
The most important feature of Federal Reserve financing
during and after the World War I consisted of granting advances,
i. e. , loans to member banks on the collateral of G-overnment
obligations. The total of such advances reached a peak of
2) Annual Report of the Federal Reserve Board, 1917, pp. 7-8.
79
nearly |2 billion in May 1919; at that time represented over
91 percent of all Federal Reserve loans and discounts. The
Reserve Bank credit made available in this way helped to pro
vide a substantial portion of the reserves upon which the
growth of deposit credit was based.
The Reserve Bank holdings of public debt increased not
very much in World War I. At- the end of June 1919, the
Federal Reserve banks held Treasury obligations amounting
to $232 million or just under 1 percent of the outstanding
federal debt.
FINANCING OF WORLD WAR II
In the six years from 1941, to the end of fiscal year 1946,
total expenditures by the United States Government amounted
to the tremendous volume of about §383 billion. Receipts from
taxes were a.lso tremendous, but they amounted to only around
$175 billion, leaving about $198 billion to be raised by bor
rowing. In the three fiscal years 1943 to 1945, close to a
half, respectively, 46, 49, and 49 per cent, of the gross
national product was devoted to federal expenditures (Table
VIII), compared with about a quarter at the peak of the First
World War.
In time of war, finance is the servant hather than the
master of economic policy. That is to say, policy does not
start with a consideration of what the nation can afford;
80
Table VIII. Federal Finances, 1940-1946 *
(In millions of dollars) Interest-
bearing
Fiscal
year
Total
expenditures
War
activities
Net
receipt^
Income and public
profits taxes debt°
1940 8,998
1,657 ' ' ' 5,387 2,125 42,376
1941
12,711 6,301 7,607 3,470
48,387
1942
32,397
26,011
12,799
7,960 71,968
1943 78,179 72,109 22,282 16,094 135,380
1944 93,744
87,039 44,149
34,655 199,543
1945 100,405 90,029 46,457 35,173 256,357
1946
65,019 48,542 43,038
30,885
268,111
a, Excludes social security payments.
b, End of fiscal year.
* Source: Treasury Bulletin.
instead, it becomes the task of the fiscal authorities to
provide whatever funds are required to assure victory. Of
the three traditional methods by which the government may
raise money- taxation, borrowing and the issue of paper cur
rency- only the first two given serious consideration.
Wartime Taxation While it is not feasible, political
or economically, to cover the entire cost of war by taxation,
it is generally agreed that taxation should cover as larger a
share as possible without imposing gross inequities and impair
ing productive incentives. For the fiscal years 1941 to 1945,
4l percent of total expenditures were financed out of taxation,
the highest rates being in the fiscal year 1945 with 46 per
cent. Net receipts from taxes in 1945 were nine times their
total in 1940 (Table VIII).
The enormous increase in total tax yields from $7.5 billion
81
In 1941 to $46.5 billion in 1945 -was accompanied by equally
drastic changes in the composition of the tax structure of
this country. The share contributed by the Individual income
tax rose from one-fifth to nearly one-half, while that- of
excise taxes declined from two-thirds to one-fifth. To some
extent the varying emphasis upon different tax sources re
flected differences in the budgetary situation before the war
and in economic development during the war, but it also re
flected conscious differences in wartime tax policies. Re
ceipts from taxes on individual and business incomes;-greatly
increased relative to excise taxes which reflected, in part,
the large increase in individual incomes and corporation
profits and thus the large expansion in the tax base. Also
it reflected a situation in which the over all level taxa
tion was still relatively low so that primary reliance on
income taxes constituted a . sound policy.
The late President Roosevelt in his Annual Budget Message
to Congress in January 1944 to explain the wartime tax policy
in the United States said "The time to impose high taxes is
now when incomes are high and goods are scarce. In this
situation, if we do not pay in taxes that we can, we shall , ,
be treating unfairly those who must face the accumulated bill
after the'war. Individual incomes will be approximately 40
percent higher in the calander year 1944 than in 1941, after
payment of all taxes, Federal, State and local. Corporate
82
profits after taxes are running at an alltime high. The time
to relax some wartime taxes will come when goods are again
plentful, after recoversion of industry to peacetime pro
duction.
The most important source of revenue consisted of income
and profits taxes which provided over 75 percent of total
revenue in 1945. Income from this source increased sixteen
fold from 1940 to 1945, from #2,125 million to 35,173 million
dollars. The rise in tax income is attributable in part to'
the great increase in national income and in part to a drastic
increase in rates. The excess profits tax introduced in 1940
was raised to a net rate of 85.5 percent. The standard cor
poration income tax was doubled, from 19 percent to 40 percent.
Personal income taxes were made more severe by reducing exemp
tions and increasing normal and surtax rates. The top rate
of 79 percent, which ha.d applied only to income'of #5 million
and above, was raised to 94 percent and applied to all incomes
of |200,000 and above. The fiscal authority sought to maxi
mize taxation in financing the war. To some extent, they accom
panied their aims yet- for the most part funds had to be raised
by borrowing.
Wartime Borrowing Public debt operations are bound to
reach enormous proportions in wartime because of the impossi-
3) President Annual Budget Message, Presented to Congress
in January 1944.
83
bility of meeting the entire money cost of large scale warfare
by taxation without disrupting the economy and interfering
with the output and flow of war materials. Reflecting the
heavy reliance on borrowing to finance war expenditures, the
national debt of the United States was 6 times as large in
1945 as in 1939.
A distinctive feature of borrowing in World War II was
the extensive resort to short-term securities. By the end
of the fiscal year 1944, about 54 percent of the United
States public marketable debt was due or callable within
five years. The computed annual interest rate on the national
debt had dropped steadily in this country. At the end of June
1940, the rate was 2.5 percent annum; five years later it was
a little over 1.9 percent. Since the rate on identical ma
turities remained unchanged, the decline in average rate was
largely the result of issuing a great proportion or relative
ly short-term, low-yield obligations.
In order to fit the borrowing program into a stablization
policy and to minimize undesirable shifts in income during the
postwar period, borrowing from individuals, in particular
from people with medium or moderate incomes, was the most
desirable form of wartime borrowing. For this purpose, pri
mary reliance had been placed on honmarketable, redeemable-
on-demand securities called savings bonds, savings certifi
cates, or defense bonds. The explanation of maintaining
84
such a policy, it was expected, in the first place, was to
exert a strongly antiflationary influence at the time of
borrowing and, in the second place, to provide a reserve of
individual savings which would contribute to the maintenance
of consumer demand in the years after the war.
A most important aspect of the national debt is its dis
tribution among various types of holders, for it is this
distribution which largely determines the effects of the debt
on the national economy. Of the total interest-bearing federal
debt, issued or guaranteed, of $257 billion at the end of June
1945, |84 billion was held by commercial banks and $22 billion
by the Federal Reserve banks, a total of $106 billion. The
remaining $151 billion was distributed between individuals
and other institutional investors.
The functions of the Federal Reserve System in Financing
the War It is impossible in a record of war finance to se
gregate the action of the Treasury and of the Federal Reserve.
It is clear from the record that they acted as a team serving
the nation's need. The Federal Reserve, while supporting the
Treasury's efforts in every way at its disposal, used its
influence for the use of methods of raising the money that
would result in the minimum of inflationary pressures.
One pivotal Federal Reserve policy in facilitating war
finance was the declared determination to provide banks with
easy access to a volume of reserves sufficient to enable them
85
ter absorb all newly issued Government, securities not taken by
other investors. This decision involved the necessity of
maintaining the interest-rate structure at approximately the
levels existing at the beginning of the war. The pattern of
interest rates on Government securities were maintained at
3/8 of one percent on three months Treasury bills and 2-fe per
cent rate on long-term bonds. This policy, besides facili
tating bank purchases of securities, served a fourfold pur
pose: (1) to encourage prompt buying of securities by inves
tors, who might- otherwise have waited for higher rates; (2)
to assure a strong and active market for outstanding securi
ties; (3) to keep down the interest cost on the Government’s
war debt; and (4) to limit the growth in bank and other in
vestors' earnings from their public-debt- holdings.
The establishment of a preferential discount rate of one-
half of one percent for paper which was secured by short-term
governments was another device to encourage the people to buy
Government securities. This established the right of way of
government securities over any other kind of paper, but was
not, in fact, used to any great extent because banks had little
occasion to borrow from the Federal Reserve.
The currency in circulation also expanded more than three
times during the war years which increases from $8.2 billion
at the end of June 1941 to over $25 billion four years later,
was almost entirely in the form of Federal Reserve notes.
86
The Federal Reserve bank holdings of Government securities
increased to $22 billion at the end of June 19^5» based on
this new currency was issued.
A new but important phase of the activities of the Federal
Reserve banks as fiscal agency for the Government had to do
with the administration of credit guarantees. The war and
Navy Departments and the Maritime Commission a,greed to guaran-
/
tee loan contracts entered into connection with war production.
While general rules were laid down, the Reserve banks were
given the responsibility, subject to approval by the guaran
teeing agencies, for arranging loans and establishing such
guarantees as might be suitable to the circumstances. The
broadened scope of Reserve Bank activities was shown by the
fact that they were instructed to deal with commercial banks
regardless of whether the banks were members of the Federal
Reserve System.
EXISTING PROBLEM
To a considerable extent inflationary developments after
the end of war financing had their seeds in war finance. Super
abundance of money, together with potential further expansion
in the money supply- resulting from wartime growth in the
public debt- presented a continuing problem for the postwar
period. The central problem that has confronted the Federal
Reserve System in the postwar period has been to re-establish
87
the System's primary function, which is the regulation of bank
credit expansion. At the same time the System must be able to
fulfill its new responsibility, inherited from war finance, of
maintaining a stable market for the public debt. With the
postwar level of commercial bank holdings of marketanle Govern
ment securities at 10 billion dollars and with 88 billion held
by businesses and individuals, it is difficult for the System
to exercise effective control over the total volume of bank
credit as long as these holdings can be readily sold to the
Reserve Banks. The additional bank reserves that can be thus
generated at the initiative of banks and others could be the
basis for an expansion in bank credit and deposits of from six
to ten times the newly created reserves.
The nature of the postwar monetary problem made it nece
ssary for central bank policy to place greater emphasis upon
the availability of credit in influencing expansion and con
traction of bank credit than upon the cost of credit. It was
difficult, however, except through certain types of selective
controls, to influence the availability of credit without
having an effect upon interest rates. Thus adherence to sta
bility of interest- rates as the prime objective of monetary
policy might prevent the adoption of policies to limit the
availability of credit at times when such limitation was or
is desirable.
This discussion of the relation of interest bates to
88
postwar'monetary policy led to the following conclusions:
Continuance of a pattern of interest rates in which short
term rates were stabilized at levels much below long-term
" rates was conducive to further decline in long-term interest
rates based on expansion of bank credit. Flexible policies
allowing some variation in the spread between, and levels of,
short- and long-term interest rates would help to re-establish
control over credit expansion as well as to prevent a contir
nuing downward movement in long-term interest rates growing
out of monetization of the public debt. Moreover, by permit
ting gradual adjustments to changed situations, moderate vari
ations in the pattern and levels of interest rates might fore
tell or mitigate unstabilizing tendencies in the money market.
Since the problem of postwar monetary policy was and is
so closely tied in with the value and distribution of the
public debt, proper management of the debt could do a great
deal to influence monetary development. Within the limits
of market demands the Treasury can influence the distribution
of the debt- among various groups of holders by its choice of
securities to be issued. It is clear that Treasury and Federal
Reserve authorities, through joint planning of policies and
operations, should carry forward a debt-management. program that
will maintain a low level of interest cost, provide the Treasury
with the necessary funds, and meet the legitimate: investment
needs of various investor groups.
For the correction of unsound conditions in special credit
areas, the Reserve System’s general instruments need to be
supplemented by special selective instruments. They include
particularly controls over stock-market credit and over con
sumer credit, which had been effectively used. Selective
instruments of'the type described are helpful adjunts to the
general instruments of Reserve System policy, since they per
mit application of policies of limited objective and also
differentiation in credit policy when forces of inflation or
deflation are present only In a particular sector of the
economy.
CHAPTER . VII
CONCLUSION
With the outbreak of war in Europe the Federal Reserve
System deemed it to be in the public interest to exert its
influence in a positive way toward maintaining orderly condi
tions in the market for United States Government securities.
Pursuing this policy, the Federal Reserve in September,1939,
entered the government-security market as a vigorous buyer
of bonds. Purchases in a short period after the outbreak of
the war amounted to nearly |500 million. There was no further
occasion for supporting the government security market until
the United States became a belligerent.
Increased war production and employment which were stimu
lated by the European war expanded civilian purchasing power
beyond the expansion in available civilian goods. The resul
ting inflationary pressures called for anticipatory restraint
and on September 23> 194-1, the Reserve Board increased reserve
.requirements to the maximum permitted by law. Meanwhile the
President, under his emergency powers, authorized and directed
the Reserve Board to exercise a . measure' of control over con
sumer credit. The technique devised was to prescribe minimum
down payments and maximum maturities applicable to consumer
credit extended through Instalment sales of certain listed
articles and instalment loans for the purchase of listed
91
articles. The total consumer credit outstanding declined
from about §10 billion peak in 194-1 to about §5 billion in
194-3 after the control. The consumer credit control achieved
considerable success in checking inflationary pressures re
sulting from the lack of available consumers’ goods during
the war period.
With the entry of the United States into World War II,
the primary objectives of the System were (1) to maintain
relative stability in the Government security market, there
by assuringto the Treasury availability at low rates of what
ever funds it- needed, and (2} to restrict the creation of
purchasing power to the minimum consistent with the achieve
ment of the first objective. As a contribution to achieve
ment of the first objective the System issued the following
statement when the United States entered the war in December
1941:
The System is prepared to use its power to assure that
an ample supply of funds is available at all times for
financing the war effort and to exert its influence to
ward maintaining conditions in the United States Govern
ment security market that are satisfactory from the stand
point of the Government’s requirements.
Continuing the policy with was announced following the
outbreak of war in Europe, Federal Reserve Banks ready
to advance funds on .United'States Government securities
at par to all banks.
The most important decision was, by agreement with the
1) Board of Governors of the Federal Reserve System, Bulletin,
Vol. 28, p. 2, January 1942.
92
Treasury, to establish a structure or pattern of rates that
the System would maintain. The decision to stabilize yields
was based on the desire to keep down the cost of borrowing
to the Treasury and. to remove any incentive that might exist
for delaying purchases in the expectation of higher yields.
The pattern of rates ranged from 3/8 percent on 90-day bills,
through 7/8 percent on certificates of indebtedness and 2 per
cent on eight- to ten-year bonds, to 2 - § - percent on the longest
bonds. In view of the necessities of the war a fixed pattern
of rates on government securities was unquestionably wise.
The 3/8 percent rate was maintained by means of the policy
adopted with respect to Treasury bills. On April 30, 194-2,
the Reserve Banks announced their readiness to purchase un
limited amounts of bills at 3/8 percent. In August 1942 they
agreed also to grant the seller a repurchase option at the
same rate. These commitments, in addition to pegging the bill
rate at 3/8 percent, were an inducement to banks to invest
their excess reserves in bills. Bills became as liquid as
cash and the policy in effect enabled banks to secure 3/8 per
cent on their excess reserves. The utilization of excess re
serves would reduce the amount of additional Reserve Bank
credit it would be necessary to create to finance the war.
As long as the Reserve System maintained the pattern, the
Reserve Banks of necessity became heavy purchasers of short
maturities. A consequence of maintaining the established
93
term was that the monetary authorities lost control over the
volume of money. The power of the market, which would have
been great if issues hah been necessary only for new money,
was reinforced by the continuous need to meet maturities.
The Federal Reserve also established a . preferential dis
count rate of § per cent, for paper secured by short-term
governments. This established the right of way of government
securities over any other kind of paper, but was not, in fact,
used to any great extent because banks had little occasion to
borrow from the Federal Reserve. The Federal Reserve authori
ties also found it necessary during the war to reduce reserve
requirements for banks in New York and Chicago from 26 to 20
per cent. Fund raised by the government in these financial
centers were being disbursed throughout the country wherever
war industries were operating or war contracts were paid for.
There was, therefore, a substantial loss of reserves by banks
in these cities, and to avoid tight conditions reserve re
quirements were reduced.
One of the inevitable consequences of war is an abnormal
ly rapid expansion in the supply of money and other liquid
assets such as Government securities and savings accounts.
Because of this financial heritage of war, the postwar eco
nomy was exposed to the risks of serious instability from
monetary causes. The accounts of new money and other liquid
assets generated during World War II surpassed all previous^
94
records. Unless absorbed or reduced In effectiveness by
serious price inflation, redundant monetary liquidity deemed
certain to persist for many a years.
As a result of the heritage of war finance, the Federal
Reserve System is greatly restricted in its capacity to per
form the functions for which it was established, namely, to
exercise an effective control over the volume of bank credit
and money supply. The re-establishment of the System's capa
city to influence credit and monetary conditions in the
interest of stable economic development is a primary postwar
problem.
Financing of war is Inflationary because people receive
Incomes for producing goods that are not’ available for general
consumption. War expenditures have to be paid for currently.
No country has ever imposed upon its citizens a tax burden
that would provide for war expenditures as much as half of
national income- the amount spent by this country during the
wa,r just ended- nor has any country in wartime been able to
borrow out of the people's savings the entire balance between
expenditures and taxes. Throughout the war, efforts were
made in this country to raise as much as possible of its cost
by taxation and by borrowing the people's savings. It seems
that the Treasury could not borrow such a huge amount— |230
billion at the end of 1945- without the intimate cooperation
of Reserve Banks,
95
Fiscal and monetary authorities were agreed that financing
through banks, which results in the creation of new money,
should be used only as a last resort and only to the minimum
extent necessary to provide the increased money supply needed
by the expanding and abnormal war economy. Nevertheless, the
banks had to be relied upon to a considerable extent. Although
for these reasons a sizable expansion of the banks' holdings
of Government securities and thereby in the money supply was
necessary, the actual amount that occurred was excessive.
Many of the financing procedures adopted encouraged banks to
purchase more securities than it was essential to have them
buy and thus complicated the problem of postwar adjustments
to monetary authorities.
In view of the banking and monetary heritage of war finance,
the Federal Reserve System is faced with a twofold responsi
bility for the long run: to prevent speculative or otherwise
excessive expansion of bank credit and at the same time to
assure reasonable stability in the prices of the large volume
of Government securities outstanding. It would not be possible
to accomplish both of these objectives through exercise of
existing powers of the Federal Reserve authorities. To assure
effective discharge of the System's basic long-run responsibi
lities, the Board asked more power in addition to the instru
ments of general credit regulation. The three basic plans
proposed by the Board for consideration by the Congress may be
96
designated by the following terms: (1) a primary reserve plan,
(2) a secondary reserve plan, and (3) a bond limitation plan.
These three proposals have many similarities and also
Important differences. In each case adoption would require
legislation that should permit considerable administrative
flexibility because of the wide differences between individual
banks and groups of banks. It would also be necessary to
apply the provisions to all commercial banks, not only to
member banks of the Federal Reserve System. Each of these
powers could be so applied as to leave banks adequate ability
to accommodate commerce, industry, and agriculture; in fact,
only-If applied in this way would the System’s credit opera
tions under the proposals be consistent with the purposes
of the Federal Reserve Act. At the same time, any one, or
some combination of the powers would help to restore the
System’s capacity to exert an over-all restraint on undue
expansion of bank credit by moderate but timely use of tra
ditional instruments.
The development of the Federal Reserve System during the
war drew attention to the swing away from the traditional
’ ’quantitative controls” and toward "selective credit policies."
97
BIBLIOGRAPHY
A. Book
Burgess, Warren R., The Reserve Banks and Money Market, New
York: Harper & Brothers, 1946 Rev. ed. , 380pp.
Chapman, John M., Fiscal Function of the Federal Reserve
Banks. New York: The Ronald Press Company, 1923. 213pp.
Chandler, Lester V., The Economics of Money and Banking.
New York & London: Harper & Brothers, 1948. 732pp.
Goldenweiser, E. A., Monetary Management. New York: McGraw-
Hill Book Company, inc., 1949. 175pp.
Hansen, Alvin H., Monetary Theory and Fiscal Policy. New
York: McGraw Hill Book Company, inc., 19491 235pp.
Hardy,- Charles 0., Credit Policies of the Federal Reserve
System. Washington D. C., The Brookings Institution,
1932. 374pp.
Harris, Seymour S. , Twenty-years of Federal Reserve Policy.
Cambridge, Mass., Harvard University Press, 1933*
Hart, Albert G. , Money, Debt and Economic Activity. New
York: Prentice-Hall, inc., 19451 558pp.
Reed, Harold L., The Development of Federal Re serve Policy.
Boston & New York: Houghton, Mlffin Company, 1922. 352pp.
, Federal Reserve Policies, 1921-1930. New York:
McGraw-Hill Company, inc. ~ 1930. 207PP.
U. S. Board of Governors of the Federal Reserve System,
Banking Studies. Baltimore: The Waverly Press, inc.,
l94TT49Spp:
Whittlesey, Charles R. , Principles and Practices of Money
and Banking. New York: The Macmillan Company, 1948.
358pp.
B. Periodical Articles
Conking, G-erald M. , "Loans for War Purposes," Federal Reserve
Bulletin, 30:1054-55, November, 1944.
Cravans, K. R., "Consumer Credit Outlook," Banking, 36:42,
June, 1944.
Delans, P., "Banking's Part in Inflation Control," Bankers
Magazine, 143:108-113, August, 1941,
Dolley, James C., "Ability of Banking System to Absorb
Government Bonds," Journa.1 of Political Economy,
51:23-31, February, 1943.“
Eccles, M. S., "Favors Changes in Reserve Requirements,"
Comm. & Fin. Chr., 155:2408, June 25, 1942.
, "Financial Problems of Defense," Federal Reserve
Bulletin, 27:506-510, June 1941.
, "War Bonds, Taxes, 'and Economic Stability," Federal
Reserve Bulletin, 29:393-396, May, 1943.
"Extent to which Reserve Banks can Finance Defense Expen
ditures," Federal Reserve Bulletin, 27:1104-5, November,
1941.
"Federal Reserve Bank Act to Aid in Financing of National
Defense," Comm. .& Fin. Chr., 151:3164, November 30, 1940.
Flora, C. M., "Banks Expanding Consumer Credit'Activities,"
Comm. & Fin. Chr. , 162:1707, October. 11, 1945.
Goldenweiser, S. A., "Federal Reserve Objectives and Policies
Retrospect and Prospect," American Economic Review, 37:
320-338, June, 1947.
Hersey, Arthur, "Historical Review of Objectives of Federal
Reserve Policy," Federal Reserve Bulletin, 26:279-289,
April, 1940.
Heimann, H. H., "Taxes Best Defense against Inflation,"
Bankers Magazine, 144:272, March, 1942.
99
Kriz, Miroslav A., ’ ’Central Banks and the State Today,"
American Economic Review, 38:565-580, September, 1948.
Leland, S. E., "Impact of the National Debt upon Banks and
the Capital Market," Comm. & Fin. Chr., 162:617, 729,
August 9, 16, 1945.
Lutz, H. C., "Taxation or Inflation," Trusts and Estates,
81:219-220, September, 1945.
Mass, E. L., "Defense Bonds and the War," Trusts and Estates,
73:544, November, 1941.
Melovin, C., "Wartime tax as a source of postwar funds,"
Journal of Account, 78:106-11, August, 1944.
Musgrave, R. A., and Seligman, H. L., "The Wartime Tax in the
United States, the United Kingdom, and Canada," Federal
Reserve Bulletin, 30:16-27, January, 1944.
Nadler, M., "A Wartime Investment Policy," Banking, p. 35,
September, 1942.
______, "How Purchases of United States Defense Bonds Fights
Inflation," Credit and Finance Management, 44:28-29,
February, 1942. ~
"Preferential Discount Rate Discontinued by New York and
other Reserve Banks," Comm. & Fin. Chr., 163:2417
May 2, 1946.
Rodkey, R. G., "How the War Affects Bank Investment Policy,"
Bankers Magazine, 144:495-503, June, 1942.
Seligman, Harold L., "Pattern of Wartime Borrowing in the
United States, the United Kingdom, and Cana,da," Federal
Reserve Bulletin, 30:1056-1068, November, 1944.
Sholt-en, W. A., "Government Bond in Wartime," Comm. & Fin.
Chr. 159:802, February.24, 1944.
Simmons, Edward C., "The Position of Treasury Bill in the
Public Debt," Journal of Political Economy, 55:333-345,
August, 1947.
Sly, J. E., "Consumer Credit Control," Manufacture Record,
114:126, September, 1945.
Spahr, W. S., "Federal Reserve Board Credit Control Proposals,
Comm. & Fin. Chr.,164:197, July 11, 1946.
Spero, H. , "Bank Investment. Policy and National Fiscal Re
quirement," Comm. & Fin. Chr., 159:892, March 2, 1944.
Spero, H. and Leavitt, J. A. , "War Bonds, a Solution Now, a
Problem Later," Bankers Magazine, 144:487-490, June, 1942.
Sprague, 0. M. W., "Defense Finance, Taxation or Inflation?"
Bankers Magazine, 142:408-410, May, 1941.
Szyiaezak, M. S., "Federal Reserve in World War II," Burroughs
Clearing House, 29:16-19, July; 18-20, August, 1945.
Targgart, J. H., "Credit Expansion and Interest Rates,"
Bankers Magazine, 138:384-6, May, 1939.
Treiber, W. F., "Federal Reserve Regulation of Consumer Credit
Journal of Account, 72:500-509, December, 1941.
Treschow, W. von, "inflation Pressure Slackens; Government at
present Obtaining Funds from the Public rather than Banks,
Barron * s, 23:3, August, 1943.
Whittlesey, C. R., "Reserve Requirements and the Integration
of Credit Policies," Quarterly Journal of Economics,
58:553-570, August, 1944.
__________, "New Instrument of Central Bank Policy; Govern
ment Bonds," Quarterly J ournal of Economics, 54:158-160,
November, 1939.
Willims, John H., "Economic and Monetary Aspects of the
Defense Program," Federal Reserve Bulletin, 27:95-98,
February, 1941.
Woolfson, A. P., "Monetary Control of Price Inflation through
Credit Restrictive Measures," Bankers Magazine, 140:477-80
June, 1940.
, "Defense Economy Monetary Management," Bankers
Magazine, 142:192-196, March, 1941.
Young, R. A., "Federal Reserve System and Credit Control,"
Comm. & Fin. Chr., 164:2080, October 24, 1946.

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Asset Metadata

Creator Shih, Ching-yun (author)

Core Title Federal Reserve policy in World War II

Degree Master of Arts

Degree Program Economics

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag Economics, General,history, United States,OAI-PMH Harvest

Language English

Contributor Digitized by ProQuest (provenance)

Advisor Garis, Roy L. (committee chair), Anderson, William H. (committee member), Phillips, E. Bryant (committee member)

Permanent Link (DOI) https://doi.org/10.25549/usctheses-c20-438005

Unique identifier UC11265591

Identifier EP44701.pdf (filename),usctheses-c20-438005 (legacy record id)

Legacy Identifier EP44701.pdf

Dmrecord 438005

Document Type Thesis

Rights Shih, Ching-yun

Type texts

Source University of Southern California (contributing entity), University of Southern California Dissertations and Theses (collection)

Access Conditions The author retains rights to his/her dissertation, thesis or other graduate work according to U.S. copyright law. Electronic access is being provided by the USC Libraries in agreement with the au...

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