The governors were concerned because the gold imports were not having “their normal and natural effect on the loans and investments of member banks.” The banks were bidding for acceptances in the market and were offering a higher price (lower yield) than the System. There is no mention of the System’s open market sales. Table 5.11 shows that, between January and April, the expansive effect of a gold inflow was balanced by a reduction in acceptances (bills bought) and open market sales of government securities. Despite the increase in currency, the base fell as the banks reduced their discounts. The money stock continued to fall.
Harrison’s report to the Governors Conference argued again that recovery would not occur without an increase in borrowing by foreigners. His analysis of the monetary situation at this meeting differed substantially from those he had offered previously. He noted that the Federal Reserve’s policy between October 1929 and August 1930 had not provided a “vigorous stimulant” to the market and that, although recently “money rates have been at very low levels, there has not been over a period of months any consistent surplus of Federal Reserve funds pressing for use upon the market” (Governors Conference, April 23, 1931).
Friedman and Schwartz (1963, 378) interpret this passage as evidence that Harrison’s understanding of the effects of open market operations was superior to that of the other governors and as an indication that he was not bemused by the decline in short-term market interest rates. There is at best a tenuous basis for this interpretation. The statement probably refers to the failure of long-term interest rates to decline. First, Harrison’s analysis at most of the previous meetings—and particularly at the meeting in September 1930—differed little from the analyses offered by most of the other governors. Second, he did not press for large-scale open market purchases at the time of his statement but argued for open market purchases only if necessary and as a last resort. Third, between April and June he did not use existing authority to purchase securities, despite a renewal of the currency drain and a new wave of bank failures. Fourth, the proposal to purchase appears to have originated with Meyer and Miller. Both had come to the April 23 meeting of the New York directors and had argued for a change in policy. Miller said that a reduction in interest rates in New York would force a redistribution of reserves between New York and the rest of the country, thereby lowering rates generally. Meyer made a more forceful statement urging the bank to reduce rates “no matter how low rates already seem to be.” To the standard plaint that rates were “very low,” Meyer replied, “The whole history of investment showed that money would go from short-term into long-term channels at a price. The problem is to find the price.” Harrison expressed a supporting view only after Meyer’s strong statement and, characteristically, favored a cautious policy of reducing the buying rate on acceptances by 0.125 percent and observing its effect.58
Harrison had no difficulty obtaining approval for the proposed purchases. Because of the gold inflow, several governors spoke in favor of expansion. Governor Fancher stated that the “System can lend its efforts to make money so cheap as to put it to work.” Governor Talley said that he still had “confidence that gold will finally express itself in an expansion of bank credit” and that Harrison’s program would help to bring this about. Even McDougal supported the motion to purchase up to $100 million in the open market.
Why could the governors agree to purchase bills and securities at this meeting when they had been unwilling to consider purchases at earlier meetings? The minutes furnish a very clear and simple answer. The gold inflow was a “real” force that should have the effect of lowering market interest rates. Since the expected effect had not occurred, most of the governors were willing to help bring it about. Harrison summarized the widely shared belief. If the banks could be discouraged from acquiring acceptances from the System, they would make loans or acquire securities in the market and thus expand bank credit. Like the others, he regarded an expansion of bank credit and a reduction of interest rates as a “natural” response to the gold inflow, with different consequences than a reduction of interest rates brought about solely by open market purchases. Under gold standard rules, countries were expected to allow interest rates to fall and to encourage expansion in response to gold inflows. To do otherwise was a violation of the accepted rules.
58. The first hint that a policy of purchasing securities was being considered came at the New York directors’ meeting of April 9. Harrison was opposed. He noted that he had opposed purchases in the fall because of his fear of a gold drain to France; he now opposed purchases because member banks would not be able to use the reserves to retire indebtedness (a reference to the low level of indebtedness). Moreover, he viewed the risk of “inflation” as a serious danger: “In the absence of an ability to quickly reverse our position, inflation would probably do more harm than good.” Meeting with the officers of the New York bank on April 15, Harrison again opposed purchases of government securities but favored purchases of bills because they could be more quickly reversed.
Harrison’s argument for open market purchases of $100 million at the April meeting was based on the decline in the bill (acceptance) portfolio to about $175 billion at the time of the meeting. Harrison noted that “it was the purpose of the New York bank, if necessary, to reduce its bill rate as low as one percent in the hope of accomplishing its objectives of maintaining or even increasing the bill portfolio in the face of gold imports. . . . It was felt that this policy sooner or later would necessarily [sic], because of its effect upon the short time money rates, encourage banks and depositors, in spite of their present liquidity, to employ their money, which is now becoming relatively so unprofitable.” He repeated this argument to the New York directors on May 14, but as late as May 26 he opposed using the authority to purchase because of the danger of inflation.
Early in May, New York reduced the buying rate on acceptances, and during the month ten of the twelve reserve banks reduced their discount rates. The Philadelphia and Chicago banks, which had been most strongly opposed to expansive actions or to further reductions in interest rates, were among the first to approve reductions. Nevertheless, member bank borrowing remained virtually unchanged throughout May; the market’s acceptance rate fell below the Federal Reserve’s buying rate, and the System’s holdings of acceptances continued to decline. Although the gold inflow continued, the executive committee did not meet to discuss open market purchases until late in June.
One puzzling aspect of the discussion that took place during the spring concerns the relation of the currency drain, the deposit rates, and bank failures. The New York directors discussed several proposals aimed at reducing the interest rates New York banks paid on deposits. Most agreed on the desirability of reducing deposit rates, but there is no indication in the minutes that the probable reason the New York banks maintained deposit rates was to hold deposits in the face of a renewed wave of bank failures and a renewed currency drain. Nor is there evidence that the directors saw the relation between the public’s rising demand for currency, bank failures, and the growing spread between higher- and lower-quality bonds. By May, yields on Baa bonds were much higher than they had been at the peak of the expansion in August 1929, whereas Aaa yields were lower. Throughout the winter the two yields had moved in opposite directions until they differed by 2.78 percent (table 5.11).
At their March 5 meeting the New York directors considered the increased number of bank failures. Many banks had been forced to close because the decline in the market value of their bond portfolios made them insolvent. Among the proposals made to reduce or prevent failures, none involved open market purchases or monetary expansion.
From April to June $230 million in gold flowed into the Federal Reserve banks. Half of the increase in the base produced by the rise in gold holdings was taken as currency. Borrowing increased and excess reserves of member banks rose by $73 million. The rising demand for currency by the public had a contractive effect, so the money stock declined. The rise in currency
holdings and in excess reserves are related. Both reflect the increased number of bank failures during the period.
Interest rate changes also show the effect of the currency drain and the series of bank failures during the period. Rates on short-term securities fell to the lowest levels of the contraction. The rate on prime banker’s acceptances reached a level (0.88 percent) more than four percentage points below the rate prevailing at the NBER peak in August 1929. Yields on bonds rated less than Aaa continued to show the relatively large risk premiums that first appeared in the April 1931 data.59
Despite the decline in nominal rates on short-term loans, real rates continued to rise. Wholesale prices had fallen at an annualized rate of nearly 25 percent in two months and a 20 percent annual rate since the start of the year. Farm prices had fallen faster. In response to the high real rates and the declining economy, bank lending fell at an annualized 20 percent rate in the first six months of 1931.
At the June meeting, members of the executive committee commented on the changes that had occurred since the previous meeting. Harrison referred to the currency withdrawals, and several governors referred to the “banking situation.” Governor Meyer reported that the Board’s staff estimated that from $300 million to $375 million of currency “was now hoarded.”60 Moreover, none of the governors disagreed with Harrison’s appraisal of the economic situation or with his judgment that the prospects for a revival were now poorer than they had been only a few weeks before.
A new element was the “threat of a general moratorium and a possible breakdown of capitalism in Europe,” a reference to the series of coups in Eastern Europe and the rise of the Nazi Party in Germany.61 There was also a possible moratorium on payments by some South American countries. These comments, and other more explicit statements, show that the governors recognized that the gold inflows were not solely the result of short-term capital movements in response to interest rate differences but were indications of a flight of capital from foreign countries and signs of a possible breakdown in the international payments mechanism.62
Harrison proposed purchases up to $50 million to his directors on June 18, hoping that lower interest rates would slow the gold inflow.63 During May and the first half of June, the United States received $170 million in gold, with more on the way. The directors agreed that the gold inflow had not been put to work. They differed over whether additional purchases would help, but they voted their support.
59. Bank failures were so severe that the Governors Conference voted to seek legislation permitting Federal Reserve banks to make advances in emergencies against securities of Federal Intermediate Credit Banks. Governors Calkins, Martin, and Talley voted against.
60. This is approximately the result one would get by assuming a constant ratio of currency to money stock and measuring the decline from the peak in August 1929. Currency had increased by $75 million since the peak instead of declining as the money stock declined.
61. On June 4, Harrison discussed the problem of Credit Anstalt in Austria and its likely effect on Germany. He favored a loan to Germany (Harrison Papers, Memoranda, New York Executive Committee, June 4, 1931).
62. During 1930 Brazil lost its entire gold holding, more than $150 million when valued at $20.67 per ounce. From early 1929 to June 1931, Argentina lost $300 million in gold, half of its gold holdings. The outflow of gold from Germany during June had reduced the German stock by 40 percent, more than $200 million, and had prompted President Hoover on June 20 to propose a moratorium on intergovernmental payments for reparations and war debts.
63. Harrison said that “we should not heedlessly embark upon a program of purchasing Government securities . . . he thought that the arguments in favor of such purchases now outweighed the arguments against them. . . . [T]he Board was of the opinion that now is the time to purchase Government securities” (Minutes, New York Directors, June 18, 1931).
When the OMPC executive committee met in June, governors were divided about the action to be taken. Neither Black nor Meyer was a member of the executive committee, but both were present at the meeting and advocated purchases in the strongest terms. Meyer stated that the Board would be sympathetic to the purchase of governments and added that he personally favored a larger program than the $50 million Harrison proposed. Black regarded the purchase program as a “logical continuation of the affirmative policy” adopted at the April meeting. Harrison took an intermediate position. Although he had proposed the program of purchases and supported it at the meeting, he was doubtful about buying governments unless there was at least an informal understanding with the principal member banks concerning “the employment of excess reserves.” He hoped the banks would place bids for lower-quality bonds to prevent price quotations from falling.64 Talley supported Harrison’s proposal in the hope that the banks would be encouraged to “use their funds courageously.” McDougal, Norris, and Young believed that money was easy and that further purchases would make it even easier. All three agreed that something should be done in support of the president’s proposal for a one-year moratorium on reparations and intergovernment repayments of debt and interest. They did not believe further reductions in interest rates would accomplish much. McDougal voted to support the purchases because he believed positive action would have a beneficial effect on the public’s state of mind. Norris abstained, and Young (Boston) opposed the purchase program because he “believed that (gold) sterilization had been and was natural and inevitable under the operation of the Federal Reserve System” (Open Market Policy Conference, Board of Governors File, June 22, 1931).
On the same day, the New York directors agreed to make advances to the central banks of Hungary and Germany as part of an international central bank consortium. New York provided $2 million of the $10 million loan to Hungary and $25 million of the $100 million loan to the Reichsbank. Late in May, and again in June, New York agreed to participate in two $14 million credits to the Credit Anstalt, a private Austrian bank with large foreign liabilities, and lent $1.08 million to the Austrian National Bank. The loans were less than 10 percent of Germany’s short-term liabilities. The assistance proved insufficient to stem the flight of capital from any of the countries for more than a few days or weeks or to prevent these countries, and later the British, from suspending convertibility.65
64. Harrison thought the problem of falling bond prices on lower-quality bonds might be solved if the banks placed bids in the market. The difficulty, as he saw it, was not so much that bonds were “being pressed for sale as that in many cases, there are no bids whatsoever.” Meyer assured him that a program of open market purchases would “be more effective in preventing losses by the banks than anything that could be done to improve their income.” Meyer continued, “There is a question whether the Reserve System can be said to have done everything within its power, until it has tried that policy [purchases of securities] more vigorously.”
Although Eichengreen (1992) repeats the argument that international cooperation failed, there is a remarkable difference between the flurry of activity set off by the foreign exchange crisis and the continuing failure to respond to the domestic crisis.66 Harrison was willing to risk having some of the New York bank’s assets “frozen” in Central Europe to maintain the prevailing exchange rates and the gold exchange standard, but he had been unwilling to offer assistance to prevent bank failures at home (Harrison Papers, Conversation with Meyer, June 23, 1931). In the fall he refused to offer rediscounts to banks that were willing to participate in a lending pool designed to prevent the spread of domestic bank failures. The difference was not ignored at the time. One of the directors questioned Harrison about the difference in approach to domestic and international crises, but there is no record of an explicit reply (Harrison Papers, Meeting of the Executive Committee, June 22, 1931).
The contrast between domestic and international policy was particularly sharp during the summer. Although the executive committee of the OMPC approved purchases of up to $50 million on July 6, the
System purchased only $30 million. Harrison favored delaying further purchases, at first because the international monetary system had deteriorated and he believed the timing was poor, later because the banks held excess reserves. Although he fully discussed the rising rate of failure and insolvency among New York banks, he never mentioned the relation between rising excess reserves and rising failure rates. He believed that open market purchases would be useful only if the banks acquiring reserves used them to acquire lower-quality bonds, and he attributed the increased bank insolvency to bad management and more careful examination.67 He favored open market purchases to relieve a sudden change in pressure on the New York money market only after the Bank of France withdrew $50 million from the money market and only to the amount of $50 million (Harrison Papers, Open Market II, August 10, 1931).
65. Clarke (1967, 182–219) reports on the series of crises discussed in the minutes and the Harrison Papers. Eichengreen (1992, 265) lists public and private short-term debts of these countries. Central banks in Hungary, Germany, and Austria owed $25 million, $194 million, and $122 million. The Austrian figure includes banks, of which the Credit Anstalt amount was $100 million (Clarke 1967, 187). In his memoirs, President Hoover is critical of the Federal Reserve for being unhelpful and even obstructionist in arranging the moratorium on intergovernment debt payments (Hoover 1952, 73–80; Todd 1994, 9).
66. It is, of course, true that the United States, France, and Britain did not lend the $1 billion that Germany requested in July, but as Eichengreen notes (1992, 276), domestic German firms would not lend half that amount.
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