A History of the Federal Reserve, Volume 1

by Allan H. Meltzer

  He regarded the depression as “inevitable” given the distribution of income. The depression might have been deferred or delayed by increasing the stock of money in 1929, but it could not have been prevented: “As long as we had such an inequitable distribution of wealth production. . . a depression was inevitable” (ibid., 210).

  The cure was therefore mainly fiscal. Eccles thought that “there is only one way by which we will get out of the depression, and that is through the process of budgetary deficits until such time as private credit and private spending expands. . . . Until private borrowing and spending expands, and puts people to work, the Government must do the borrowing and spending” (ibid., 403).

  This view does not seem unusual now, but at the time it struck many of his listeners, both in and out of Congress, as radical. Eccles coupled his view with his belief that depressions were inevitable under capitalism. Debt built up in periods of expansion. Investment expanded production faster than consumption. When depression came, there were two choices: deflation, bankruptcy, and debt reduction or reflation to lower the real value of the debt (ibid., 346–48).127

  The most quoted line in Eccles’s testimony is “you cannot push on a string” (House Committee on Banking and Currency 1935, 377). Congressman T. Alan Goldsborough (Maryland),128 a supporter of Eccles and the bill, introduced the phrase. Eccles accepted it immediately: “That is a good way to put it, one cannot push a string. . . . [T]here is very little, if anything that the reserve organization can do” (377). He had expressed the same pessimism earlier in his testimony several times. Monetary action was asymmetric; it was easier to stop an expansion than to end a contraction.129 An attempt to flood the economy with currency by paying off the debt, as some congressmen proposed, would just create excess reserves (322).

  Eccles’s views fit well with those of Goldenweiser, Riefler, and other Board staff. Monetary expansion did not work in the depression because “you must have borrowers who are willing and able to borrow” (ibid., 216). Although he mentioned interest rates, and the effects of policy action on interest rates, these were far from central to his analysis. The liquidity trap—pushing on a string—dominated his view.130 Hence the only role for monetary action was to keep rates low and to be alert to the risk of inflation inherent in the large volume of excess reserves held by the banking system. Several times Eccles warned about this problem and mentioned the large potential expansion in loans and money.

  Eccles differed from his predecessors in his belief that government had to take responsibility for the economy. He devoted much of his time to advocating fiscal measures, especially increased spending on investment financed by government borrowing to expand demand.131

  127. Elsewhere in his testimony, he reaches the same conclusions by arguing that an inequitable distribution of wealth results in “excessive savings” in the expansion phase, hence too little consumption (House Committee on Banking and Currency 1935, 241). Government can help to stabilize by taxing away the excess saving, thereby increasing monetary velocity and spending.

  128. In the 1920s, Goldsborough proposed Irving Fisher’s rule for price stability. See chapter 4. In 1932 he proposed expansive operations to raise the price level. He took an active part in the hearings on the Banking Act of 1935. Commenting on Federal Reserve purchases in 1932, Goldsborough said, “They continued [purchases] until the danger of the passage of the Goldsborough bill was over, and then it immediately stopped” (House Committee on Banking and Currency 1935, 209).

  129. This is a remarkable shift from the hand-wringing in 1928–29 about inability to stop the “speculative” excesses. Before testifying, Eccles held a press conference. Contrary to his testimony, he gave as two main reasons for the banking bill “to accelerate the rate of economic recovery . . . [and] to prevent the recurrence of conditions that led to the collapse of our entire banking structure” (Eccles 1934–37, press conference, February 8, 1935, 1).

  130. Although the idea of a liquidity trap is now associated with Keynes (1936), Eccles’s 1935 testimony shows that the idea was older. Keynes may have acquired the idea from bankers.

  the bill in the senate Senator Glass intended to defeat the bill by separating title 2, containing Eccles’s proposals, from the sections the bankers wanted.132 July 1 was the critical date on which bankers would have to repay their loans and the (temporary) FDIC would expire. Glass hoped to delay passage until that time, get an agreement to separate the sections, pass titles 1 and 3, and later defeat title 2.

  When the House in April appeared ready to pass a version of the bill, Glass held brief hearings on Eccles’s nomination, hoping to defeat the nomination and be rid of Eccles.133 The subcommittee approved the nomination four to three, with Glass opposed. On April 25 the Senate confirmed Eccles as governor. Glass then started hearings on the bill.134

  The Republican minority on the House Banking Committee had objected to the bill on three main grounds. First, the minority claimed that the bill ended the private-public compromise arrangement in the 1913 act by changing the Board from a supervisory agency to a managing partner and by giving the Board authority to approve the appointment of reserve bank presidents. Second, the bill gave the Board control of open market operations and forced the reserve banks to buy or sell securities at the Board’s initiative. Third, since there was no emergency, there was no reason to pass title 2 without further study. The last was Glass’s plan, and the objective of the bill’s opponents.

  131. Currie seems to have shared this view. Although he analyzed the Federal Reserve’s failure to expand as a consequence of adherence to the real bills doctrine and neglect of the falling money stock, he does not seem to have pursued this view at the Federal Reserve. He devoted much of his research after 1935 to developing measures of fiscal thrust and the case for unbalanced budgets (Sandilands 1990, 68–78). Later, he described his 1934 book as “partly obsolete when it was published” (Currie 1971). The reason he gave was that money (deposits) depend on member bank borrowing, and there was no borrowing. This is an odd conclusion.

  Currie worked as Goldenweiser’s deputy, but he reported directly to Eccles. Goldenweiser could (and did) prevent him from publishing some of his work, but he could not prevent him from urging expansive monetary policies or avoiding the doubling of reserve requirement ratios in 1936–37 if he had chosen to do so. Currie described Goldenweiser as laying down “a rule that nothing can be published by the division which he does not understand, which limits the possibilities seriously” (Currie 1971, 79). It is difficult to understand why Eccles retained Goldenweiser in his position and adopted many of his ideas about excess reserves. Currie noted in a 1934 letter to Eccles that Goldenweiser believed that the Federal Reserve had been too inflationary in 1931. They (the staff) are “not interested in money and have never completed a series on money” (68–69). Of course, Goldenweiser disliked Currie’s criticism of policy from 1929 to 1933 and thought it tainted by what would later be (loosely) called “monetarism.” In a 1935 letter to Viner, Currie complained that Goldenweiser vetoed publication of an article on income-increasing government spending.

  132. Roosevelt worked behind the scenes, but not openly, to assist passage. He had the Senate add three new members to the banking committee and secretly encouraged Senator Duncan Fletcher (Florida), chairman of the whole committee, to hold hearings with the whole committee instead of Glass’s subcommittee. The latter effort failed. It violated the spirit and possibly the letter of the agreement under which Glass gave up the chair of the Banking Committee to take the Appropriations Committee.

  133. He also began an investigation of whether Eccles remained connected to his banks and therefore ineligible (Hyman 1976, 174–75).

  134. At first he ignored Eccles and invited Chairman Leo Crowley of the FDIC and Comptroller J. F. T. O’Connor. Both favored separating title 2 and promptly passing titles 1 and 3. Both Crowley and O’Connor opposed title 2. Morgenthau disliked both of them, but both had support in Congress (Hyman 1976,
345–46). O’Connor had been a law partner of Senator William G. McAdoo (California) and was a friend of Glass and the president’s son, James. Crowley had the support of James A. Farley, head of the Democratic Party. Eccles did not testify until May 10, a month after hearings began.

  Eccles’s testimony before Glass’s subcommittee responded to the main criticisms in the minority report on the House bill, so it was largely defensive in character. He repeated the arguments he had made to the House committee about income redistribution, but most of his statement defended the shift of power to the Board. He claimed the shift did not increase political control over the financial system: “There is nothing in this bill that would increase the powers of a political administration over the Reserve Board” (Senate Committee on Banking and Currency 1935, 280).

  Glass interrupted repeatedly. He disputed Eccles’s claim that proposals to place the regulation of monetary policy under government control retained the spirit of the 1913 act. The 1913 act gave the Board supervisory responsibility, he said, not control of policy (ibid., 281).

  Eccles offered to compromise. The American Bankers Association had proposed that five reserve bank governors should join with the Board to set open market policy. Eccles accepted this proposal in place of his earlier recommendation that the banks have only an advisory function (ibid., 287–89).

  Senator James Couzens (Michigan) raised the most intriguing question: What would the Federal Reserve have done differently if the proposed changes had been law in 1928–29? Eccles first tried to evade the issue, but Couzens, joined by Glass, persisted. Eccles could not answer at the hearing but submitted his response in a letter to Senator Couzens.

  “The banking bill of 1935 is not primarily proposed for meeting a situation such as existed in 1928 and 1929” he responded (Senate Committee on Banking and Currency 1935, 673). The Banking Act of 1933 and the Securities Act strengthened the Board’s power to meet such situations. Then he added two arguments that reflect hindsight, not the views held at the time. First, despite the dominant view at the Board denying any ability to affect economic activity or prices, Eccles claimed, “The Federal Reserve Board felt that there was nothing in the business situation that required restraint” (674). Second, “It was not in 1929 that the powers contained in this bill would have been valuable but in 1931. . . . The System would have been in a much stronger position to adopt a vigorous open-market policy if this bill had been in effect” (674). Eccles added that the bill also would give the Federal Reserve power to counteract inflation if banks expanded based on their current excess reserves.

  Adolph Miller was the next witness. Miller supported Eccles’s argument about (August) 1931: “In 1931 some of the Reserve banks and the Reserve Board had reached the conclusion that it would be desirable to relieve the situation by an open-market operation of considerable extent. Strong opposition was encountered on the part of two or three of the reserve banks. . . [A]n open market operation was undertaken, but to a very much more limited extent” (ibid., 750).135

  Miller defended the main provisions of the bill. He had favored, and worked for, Board control of open market operations since 1924. In his view the bill did not cause a massive redistribution of powers within the System (ibid., 699). His main objection was to the section making the 1932 Glass-Steagall provisions permanent. Limited powers to change eligibility requirements in an emergency would be sufficient.136

  A colloquy with Glass brought out a main substantive issue between opponents and proponents. Glass viewed the reserve banks as acting in the interest of stockholders and depositors. He opposed giving the open market committee “the right to compel [reserve] banks to use their resources and the resources of their depositors, whether they thought it was prudent to do it or not” (ibid., 751). Miller responded that centralization was critical not only to affect the public interest but to concentrate responsibility: “Open market policy is peculiarly a national policy, and if it be kept as a national policy and operated only . . . when the indications of its need are clear, I do not think there is anything to fear in the way of bad action through withholding from any individual reserve bank the power of veto so far as itself is concerned” (751).137

  135. Hamlin’s testimony confirmed that the reference was to August 1931 (Senate Committee on Banking and Currency 1935, 945–46). At that meeting, Meyer urged purchases of $300 million, and Harrison agreed. The committee voted to make seasonal purchases of only $120 million. Governor Young (Boston) opposed any purchases; Calkins (San Francisco) argued that not all the banks could participate because some lacked sufficient gold reserve. See chapter 5. Another occasion, not mentioned here, is November 1931, when Miller wanted a “bold” program of purchases, but the committee made only seasonal purchases. Hamlin also mentions the refusal by Boston and Chicago to participate in purchases in 1933, most likely a reference to 1932.

  136. Glass, a former treasury secretary, observed that the Treasury would always consider it an emergency when it had bonds to sell (Senate Committee on Banking and Currency 1935, 729). With respect to the 1932 Glass-Steagall Act, he observed that “I never would have agreed to have reported that bill but for the fact that we were assured . . . that they did not expect to use it” (685).

  Citing the Federal Reserve’s inability to offset gold inflows in 1916, Miller favored increased power to change reserve requirement ratios. Like Eccles, Miller called attention to the problem of excess reserves and potential inflation that had begun to concern the Board. Glass opposed the change.

  Miller proposed that the name of the Federal Reserve Board be changed to Board of Governors with the members as governors, as a “matter of prestige” (ibid., 756). He also proposed that the Board be permitted to elect its chairman and vice chairman, but the final bill gave the president that right, subject to Senate approval.

  Harrison decided not to testify, but he helped Glass find witnesses who opposed the bill. Many of them urged the subcommittee to pass the bill without title 2. H. Parker Willis reaffirmed Glass’s view that the bill subverted the Federal Reserve Act. Title 2 negated “everything in the theory of the Reserve Act” (ibid., 864). He thought open market operations should be phased out. An expanded definition of eligible paper would make it more difficult to enforce provisions against speculative credit. In Willis’s view, “the Reserve System has been in the hands of Philistines a great deal of the time and has not lived up to its early promise. . . . [That] has nothing to do with the validity of the principles under which it was organized” (873).138

  137. It is likely that Miller’s statement was more persuasive than Eccles’s had been. He was a proponent of the gold standard and real bills, had been a member of the Board from the start, and was a friend of many senators and of both Hoover and Roosevelt. He had opposed the increase in “speculative credit” that many senators blamed for the depression. Senator McAdoo, another former treasury secretary on the subcommittee, agreed with Miller’s statement at the time (Senate Committee on Banking and Currency 1935, 751), but later in the hearing he proposed to give the Board authority to excuse a regional bank from participation in an open market operation (761).

  138. A sample of views conveys some of the strong beliefs of the time. James Warburg of the Bank of Manhattan left the Roosevelt administration because of its gold policies. Like Willis, he was against open market operations and favored a return to the principles of the 1913 act that his father had helped to write. Oliver M. W. Sprague, of Harvard, testified that decentralization was no longer possible. There is one money market. The Federal Reserve Board should have more control, but the Board should be independent of the administration. Edwin W. Kemmerer of Princeton opposed the bill as too large a transfer of authority to the president over the Board and the Board over the reserve banks. He also opposed provisions to lower the quality of bank assets by abandoning real bills. Kemmerer ended his statement by reading a statement signed by the sixty-two members of the Economists’ National Committee on Monetary Policy urging defeat of
title 2.

  Board members George R. James and Charles S. Hamlin testified also. James saw no need for a central bank or title 2. The present arrangement worked well. Bankers had caused problems by creating deposits “against prices rather than values” (Senate Committee on Banking and Currency 1935, 925). Hamlin favored several of the changes, including substitution of “sound assets” in place of the needs of trade as a criterion for discounts and centralized control of open market operations. He preferred to leave the power to appoint reserve bank governors to the directors, to leave the treasury secretary on the Board, and to keep current restrictions on changes in reserve requirement ratios. Hamlin concluded by affirming support of the Eccles bill.139

  In all, Glass called about sixty witnesses. Most opposed title 2 as unnecessary. Several made the same argument that Eccles used to respond to Senator Couzens—that the important changes in powers were in the Banking Act of 1933 and the Securities Act.140