A History of the Federal Reserve, Volume 1

by Allan H. Meltzer

  This was not a new view. Miller had written much the same in an article explaining Federal Reserve operations (Miller 1928). There he restated the “needs and reluctance” view of borrowing. The economy required “a credit control device less leisurely in character and less openly deliberate than that of the discount rate” (75). This was an “expedient solution” to a temporary problem. With the restoration of the international gold standard and recovery of the world economy, “primary reliance in the future will be [on] the discount rate rather than the open market operation” (75).

  Other Testimony

  The committee heard from many other witnesses, including other Federal Reserve officers and officials, economists, and bankers. Irving Fisher supported the bill but urged the committee to attach the Goldsborough bill for a compensated dollar.82 Price stability could not be achieved without a rule of that kind. Fisher argued that the Federal Reserve had worked to stabilize the price level but refused to admit it. Oliver M. W. Sprague opposed the bill but favored “avoidance of considerable advance in the general level of prices” (House Committee on Banking and Currency 1926, 415). He opposed Fisher’s rule, or any other, on the usual ground that good policy required judgments not formulas.83

  Governor Norris (Philadelphia) and Emanuel A. Goldenweiser were two of the more interesting witnesses. Their testimony suggests the level of understanding reached by officials and advisers outside New York. Norris testified against the bill. He regarded the bill as a doubtful and dangerous experiment (ibid., 395) The Federal Reserve dealt with currency and credit. Why was it asked to stabilize the price level? (384). Price stabilization, if it were to be done, should be left to the Commerce Department or the Bureau of Labor Statistics (395). Though a permanent member of the OMIC, he thought open market operations were too small to have an effect on credit supply. A committee member questioned his judgment:

  Mr. Beedy: You would not deny that the purchase of Government securities, or the refraining from purchase . . . would either accelerate or retard the tendency [of prices and interest rates to change]?

  82. Fisher paid the salary of John R. Commons, who stayed in Washington to work on the Strong (Kansas) bill (Fisher 1946, 8). I am indebted to Wayne Angell for providing a copy of Fisher’s 1946 letter to Clark Warburton.

  83. Sprague defined inflation as “a rapid rise in prices continued for a number of years,” thereby distinguishing persistent from temporary price level movements much more clearly than his friend Benjamin Strong (House Committee on Banking and Currency 1926, 404). Like Strong, he recognized that real bills failed as a regulatory principle because the type of collateral could not change the (marginal) use of credit.

  Mr. Norris: It has an immediate effect on the volume and, therefore, to a certain extent on the price.

  Mr. Beedy: It has a consequent proportional effect on the price.

  Mr. Norris: I think before you translate those operations into an effect on credit and further dilute it by considering the effect of the cost of credit upon the cost of goods, it is very much like the homeopathic prescription of putting a drop of medicine in the Mediterranean and then a drop of that mixture in the Atlantic Ocean.” (Ibid., 391)

  Other members of the committee joined the discussion, reminding Norris that changes in reserves increased credit by a multiple of the change in reserves. At last Norris admitted that open market operations could have an effect on credit supply, but he said they had been used “to take care of more or less temporary or local conditions” (ibid.).

  Goldenweiser was the longtime director of the Board’s research division and one of its leading economists. Like Norris, he doubted there was any relation between open market operations and the price level. Asked by a committee member if supplying more credit would have “no appreciable effect on the price level,” Goldenweiser replied: “In general, I should say that is correct” (House Committee on Banking and Currency 1928, 46).

  The 1928 Act

  Irving Fisher wrote that Governor Strong favored the principle of the 1926 Strong (Kansas) bill but feared that legislation would be harmful. Fisher reported on a private conversation with Strong in which Strong threatened to resign if the bill became law: “If you will let me alone, I will try to do the best I can, but if you make me do by law what I am trying to do without legislative control, I will be so afraid that I cannot fill the bill that I will not accept the responsibility” (Fisher 1946, 3).84

  Strong changed his mind in 1928, according to Fisher.85 He worked with Congressman Strong to redraft the 1926 bill and remove his three principal objections. As a result, the preamble to the revised bill included “to further promote the maintenance of a stable gold standard” and “to assist in realizing a more stable purchasing power of the dollar.” The bill itself directed the Federal Reserve to use its powers “to maintain a stable gold standard . . . [a]nd a more stable purchasing power of the dollar, so far as such purposes may be accomplished by monetary and credit policy” (House Committee on Banking and Currency 1928, 1, 5, 6). Congressman Strong met with the Reserve Board accompanied by Professor John R. Commons and, after discussion, made other changes to meet their objections.

  84. Fisher claims to have responded: “I will trust you as long as you live but you will not live forever and when you die I fear your policies will die with you.” Fisher says that Strong replied: “I have trained my assistants so that they know these policies and they will be continued” (Fisher 1946, 3). Hetzel (1985, 8) reports very similar statements in Fisher 1934, 151. Fisher’s recollection is probably correct. Very similar statements were made by Congressman Strong in the 1926 hearings (House Committee on Banking and Currency 1926, 569, 601).

  85. Fisher (1946, 5) claims that Strong could not favor the bill in public without the approval of the Federal Reserve Board. Strong asked the Board if he could favor the legislation, but they refused.

  Congressman Strong concluded his opening remarks at the hearings with a warning that was prophetic: “There is but one principal objection . . . that I would not meet in this bill. . . that the American people will not understand what is meant by the powers that they have given to the Federal Reserve System. . . . To my mind. . . that is not to be compared with the danger that may result from the failure to use these powers for the stabilization of the purchasing power” (ibid., 8).

  The Board resolutely opposed the bill. Governor Strong began his testimony by noting that he spoke only for himself, not the System. He recognized that the new bill removed many of his earlier objections. Nevertheless, he did not endorse it. He preferred “a scientific application of the well-known principles of the gold standard” (ibid., 13). This would achieve “everything in the act” (17). He favored the gold standard because it was a rule that did not depend on human judgment: “When you are speaking of efforts to stabilize commerce, industry, agriculture, employment, and so on, without regard to the penalties of violation of the gold standard, you are talking about human judgment and the management of prices which I do not believe in at all” (21).

  Governor Young of the Board testified for the Board, opposing the bill as requiring a central bank instead of an association of regional banks; reversal of the increases in agricultural prices that had recently occurred; and price fixing by the Federal Reserve. His arguments were superficial and showed little understanding. The first two arguments, however, appealed to widely held political views about a central bank and to the representatives of agricultural districts. Congressman Strong answered at length, denying Young’s claims by reading from the bill (ibid., 413–22). Young also defended the 1927 policy as “purely an American policy” to assist exports (415).

  Miller’s testimony repeated many of the ideas he advanced at great length in the 1926–27 hearings. He continued to oppose the Strong (Kansas) bill. At one point he accused Governor Strong of not understanding the relation of Federal Reserve policy to price stability:

  Mr. Strong: [T]he language you refer to has been dictated and suggested by memb
ers of the Federal Reserve System.

  Doctor Miller: . . . The Federal Reserve System is a pretty big organization. There are many persons in it. We have a considerable number of amateur economists, and from my point of view they constitute one of its dangerous elements. . . . I venture to say that some of the men you have consulted do not know what this is all about. These are high sounding and captivating words you are using in your proposed statement.

  Mr. Strong: Of course, one of them has been Governor Strong.

  Doctor Miller: Of course, he is a very able man. But when it comes to economic insight and understanding . . . that is very unusual in any group of men anywhere. (Ibid., 212–13)

  Miller’s views prevailed. The committee did not report the bill to the House. It is an understatement to say this was a missed opportunity. If the mandate for price stability had been passed and followed, the Federal Reserve could not have permitted deflation during the Great Depression of 1929–33 or inflation during the Great Inflation of 1965–80. Possibly a recession would have occurred in 1929, but the United States and the world would have avoided the deflationary policy and its consequences. The Federal Reserve would have had to choose price stability over the real bills doctrine and to lose gold, thereby reducing or preventing deflation elsewhere.

  PERSONALITIES AND CONFLICTS

  Miller’s testimony about Governor Strong suggests some of the rivalry and animosity between the two. As is often the case, the causes of the dispute were both substantive and personal, but it is not clear from the record which came first. Some of the differences had roots in the Federal Reserve Act itself. Miller resented Strong’s leadership in domestic and international policy, but he also believed that the Board, not the reserve banks, should lead the System. Only the Board considered the whole system.

  Some of the substantive issues were the type that arise in many organizations. Particularly when discount rates were reduced, reserve bank governors often announced the changes, or leaked them to the press, before the Board acted. The Board believed that it was its prerogative to make these announcements. The governors complained that the Board acted as if it controlled rate changes, while the Board complained that the governors blamed the Board for discount rate increases when talking to member banks. The Board often irritated Strong and some of the other governors by delaying or modifying decisions about open market purchases.

  The governors complained that the Board was not well organized, delayed decisions, failed to answer questions, and lost communications. Governor Crissinger, appointed by President Harding to head the Board, had no knowledge of central banking. William McChesney Martin Sr., who served at first as chairman and then as governor of the St. Louis bank from 1914 to 1941, described Crissinger as a “good natured man” but added that that was the only good thing that could be said of him (CHFRS, Martin, August 4, 1954, 2). Strong complained to Mellon about the Board’s functioning, but nothing was done until Crissinger resigned in September 1927 (Chandler 1958, 257).

  Three more substantive issues underlay the antagonism between Strong and Miller. First, Miller was a firm believer in the power of the real bills doctrine and the importance of the quality of credit for controlling the quantity of credit and inflation. Strong recognized early in the decade that the marginal use of credit was unrelated to the type of paper a bank discounted. Second, Miller opposed reliance on open market operations to control the amount of credit and money. He favored reliance on discount policy and classical (British) central banking. Strong regarded the discount rate as a secondary instrument. He preferred to force bank borrowing and repayment by using open market operations. The Riefler-Burgess doctrine, with its emphasis on open market operations and quantitative control, could be called the Strong-Riefler-Burgess doctrine, to recognize Strong’s role in developing a policy framework based on observation and experience. Third, both Strong and Miller favored the restoration of the international gold standard, but Miller was skeptical about the relationship between Strong and Governor Norman of the Bank of England. He believed that Strong at times altered United States policy to benefit Britain, allowing the quantity and quality of credit to change unfavorably and inappropriately.86 This probably meant that Strong did not wait for banks to borrow or repay.

  Oral transcripts of the recollections of Federal Reserve officers show Miller and Strong with powerful personalities. It is not hard to see why they would clash even if there had been no substantive issues. Both wanted to dominate decisions, but Strong was a decisive leader and Miller was not.

  Charles J. Rhoads, the first governor at Philadelphia, who admired Miller, described him as “didactic,” “quite sure he knew the answer to every question” (CHFRS, Rhoads, June 29, 1955, 3). George L. Harrison, who worked at the Board as an attorney from 1914 to the mid-1920s before moving to New York, described Miller as unwilling “to admit that he was ever wrong” and difficult to persuade about the worth of an idea that was not his own (CHFRS, Harrison, April 19, 1955, 2).87

  86. Chandler (1958, 255) reports Herbert Hoover’s references to Strong as a “mental annex to Europe” and “Strong and his European allies.” Hoover was friendly with Miller. Chandler claims that Hoover took these views from Miller.

  Unlike Miller, Strong had not gone to college and had not formally studied economics, but he had learned a great deal from his experience as a banker and central banker and from discussion with leading economists. Miller distrusted and possibly disdained this type of learning, and he envied the respect and acclaim that Strong received from economists such as Fisher, Sprague, and Bullock.

  William McChesney Martin Sr. described Strong as ambitious personally and determined to make the New York bank the dominant force in the system. According to Martin, if the Aldrich bill had passed, Strong would have been the head of the central bank. The Glass bill created a regional system instead of a central bank, but Strong succeeded for a time in getting control (CHFRS, Martin, August 5, 1954, 2). Jay Crane, who worked in the New York bank from 1913 to 1935 and later became its chairman, described Strong as a powerful leader. He talked frequently about central banking with the junior staff who “sat at his feet and worshipped him” (CHFRS, Crane, March 5, 1954, 1). He was the only governor who tried to learn about central banking from European experience. Another officer of the New York bank, Leslie Rounds, referred to Strong’s great influence over policy and his clashes with Adolph Miller. But he also described Strong as certain that “he knew what was right” (CHFRS, Rounds, January 29, 1954, 3).88

  George Harrison, who replaced Strong as governor, had a very different personality. Rounds described Harrison as diplomatic and thoughtful. Strong, he said, “moved directly from thought to speech,” whereas Harrison “thought first and talked afterward” (CHFRS, Rounds, January 29, 1954, 4).

  On the critical question of whether Strong would have forced a change in policy in 1929 or after if he had lived, his contemporaries have mixed opinions. Rounds (CHFRS, May 2, 1955, 3) was uncertain whether Strong could have changed policy in 1928–29, but he believed that Strong would have insisted on an increase in the discount rate in 1929 (13).89 Roy Young was doubtful. Strong “thought he had more power in the System than he really had” (CHFRS, Young, March 1, 1954, 3). J. Herbert Case, one of Strong’s deputies, asserted the opposite (CHFRS, Case, February 24, 1954, 7). Several governors, led by Miller, blamed Strong’s policies, particularly the 1927 open market purchases, for the increase in speculative activity and the growth of stock exchange credit.90 He would have had difficulty persuading them to follow his (nonreal bills) policies again.91

  87. Young described Miller’s love of argument: “If no one on the Board started arguing with Mr. Miller, he would argue with himself” (CHFRS, Young, March 1, 1954, 2).

  88. Eugene Meyer, governor of the Board from 1930 to 1933, did not share in the adulation. He described Strong as “an ignoramus in international banking” (CHFRS, Meyer, February 16, 1954, 3). Irving Fisher thought highly of Strong and believed he would
have prevented the deflationary policy of the 1930s. Fisher had contempt for Meyer. He claimed that in 1931, when told that demand deposits were falling, Meyer did not know what a demand deposit was and did not know that they had fallen (Fisher 1946, 4).

  Other active members of the Board and the banks at the time included Charles S. Hamlin, the first governor, who served on the Board from 1914 to 1936; Roy A. Young, governor of the Board from 1927 to 1930 and governor at Boston from 1930 to 1942; James B. McDougal, governor at Chicago from 1914 to 1934; and George R. James, a member of the Board from 1923 to 1936. Contemporary descriptions of these men give no evidence of leadership, understanding, or an ability to resolve the conflict between Miller and Strong.

  Paul Warburg described Hamlin as a “second class Governor” (quoted in Yohe 1990, 479). Young reported that Hamlin seldom spoke at Board meetings: “He sat with his diary at hand and made notes” (CHFRS, Young, March 1, 1954, 1). Chester Morrill, in the Board’s Secretariat (secretary after 1930), claimed that Hamlin’s diary is “far from accurate as he grew older” (CHFRS, Morrill, May 20, 1954, 9). Others described him as “a man of no particular force who usually went with the majority” (CHFRS, Morgan, April 23, 1954, 5).

  Harrison described Young as extremely stubborn and very vocal, and Young described James as “a diamond in the rough.” Meyer thought James lacked financial ability but was otherwise all right. Morrill held a very different view. He thought James had great respect for authority. Since Meyer was governor, James took Meyer’s word and spent no time studying issues. In return, Meyer sponsored his reappointment (CHFRS, Harrison, April 19, 1955, 2; Young, March 1, 1954, 1; Meyer, February 16, 1954, 6; Morrill, May 20, 1954, 6).92