In brief, the matter may be put this way. Debt incurred by individuals and by business concerns does, to a substantial extent, represent credit advances to facilitate production, and to this degree enhances supplies of commodities and services bidding for the consumer's dollar. In any case, debt incurred by nongovernmental borrowers, whether or not it be commercially self-liquidating in character, must sometime be repaid on penalty of bankruptcy; and this repayment, if it does not arise from sale of goods, must at least involve a “tightening" of the debtor's consumption belt.

With a sovereign government, however, it is otherwise. Debts incurred by the Federal Treasury evidence budgetary deficits. Notably in war, largely also in peace, Government outlays exceeding revenues make comparatively little direct contribution to the country's flow of products which the consuming “all of us" are interested in buying and for which we will part with our money.

Furthermore the Government is under less pressure to repay; it may and it does, in fact, refund and cumulate debt, not experiencing at once the penalties of extravagance which are visited upon Micawber-like persons. This holds so long as Government is able to dominate the market for its bonds and notes-and even to repudiate them in part as it did with the devaluation of the dollar in 1933-34, and as it has been doing ever since by releasing and failing to control inflationary tendencies further depreciating our nonredeemable currency.

This ability of Government to put off indefinitely the day of reckoning, especially if it dominates the banking system through control of the central banking machinery, high lights the contrast between private and public debt in their effects upon money and credit. Our most important circulating money, Federal Reserve notes, may be backed up to 75 percent by United States Government securities, whether or not "eligible paper" arising primarily from economic activities is available. Similarly, the Federal Reserve banks, which at the end of last year owned the prodigious total of nearly $24 millions in "Governments," may use these as backing for their own deposit liabilities up to three-quarters of the whole.

As deposit liabilities of the Reserve banks constitute the reserves of member banks, the latter may make loans, under existing reserve requirements (24, 20, and 14 percent for "central reserve city banks," "reserve city banks" and "county banks" respectively against their "net demand deposits") approximately $5 for every dollar of deposit credit built up for them directly or indirectly, by sale of "Governments" to the central banks. To the extent that these bankheld Government obligations merely represent the failure of the Treasury to take in as much as it pays out, the Nation's bank deposits, circulated by checks as currency, rest in part on nothing more substantial than air.

This situation is of course aggravated if a guaranteed automatic market for "Governments" at par or above, regardless of prevailing interest rates, is maintained by the Federal Reserve banks, through direct purchase from the Treasury, open-market operations, or both. Open-market transactions are a proper and accepted part of the fiscal agency services rendered by the Reserve System to the Treasury; they are in indispensable instrumentality in central bank regulation of reserves and credit. However, if Treasury fiscal demands are allowed to dictate and freeze prices of Federal obligations at artificially low-interest costs to the Government, the holders of such securities, individual and institutional, may regard them as cash, borrow against them or dispose of them without risk whenever expenditures are incurred, more attractive investments desired, or added bank reserves called for.

In brief, then, Government debt differs from private debt, in its influence upon money and credit: (1) in the circumstance that Government bonds and notes generally represent deficits rather than production and tangible assets; (2) in the fact that private debt must be paid off, from producing and selling commodities, from the debtor's reducing expenditures, or both, while Governments may indefinitely delay repayment, may refund and increase debt and even repudiate it in whole or in part; (3) in the substitution of "governments" for "eligible paper" as backing for bank reserves and Federal Reserve notes; and (4) in artificial markets maintained by the central banks for Government debt, to the extent that they are under obligation or pressure to do so.

The chart here submitted pictures changes in the sources of our money supply from 1920 to the end of 1951-the upper chart in dollar, the lower in percentage, breakdowns.

Prepared by the research staff of the Economists' National Committee on Monetary Policy,

The huge increase in United States debt held by Federal Reserve banks, and by other banks, appears both quantitatively and proportionately.

The substitution of Federal-deficit-evidencing debt for eligible commercial paper (in "other factors, net") as the principal source of our currency, especially evident from the outbreak of the Second World War, may be compared to a stretched rubber band which lost its elasticity. Or, to change the figure, the decline of resiliency in responsiveness of the Nation's currency supply to its current business and economic needs (which is another way of saying that money has increased far faster than goods to absorb it), may be diagnosed as a hardening of the currency arteries.

However we put it, the malady is due to our abandoning the fully convertible gold standards; to unprecedented deficits in Government spending in both war and peace since the early thirties; to monetizing of Federal debt in the banking system; and to avoidance of the individual and national self-disciplining realism which banking, credit, and monetary policies actuated by economic needs rather than political considerations would have imposed.

The thought has been advanced in some quarters that unbalanced Federal budgets and a subservient Reserve System are desirable means of assuring increases in the volume of money required over the years to accommodate a growing population and a rising volume of business. This is like recommending to a vigorous youth that he have periodic plasma injections to make certain his bloodstream will adequately serve the larger frame and stepped-up activities of later years. It is even worse than that. It is like prescribing a diluted plasma, or blood of a type alien to the patient. Converting Government debt into money, necessary though it may prove in times of national emergency when confidence lags and savings drag; becomes in time a pollution of the Nation's economic bloodstream and should be recognized and treated as such.

So small were Federal Reserve holdings of United States Government obligations in the twenties that the charts hardly show the (for then) large-scale purchases of governments by the Reserve System, later in that period, to ease credit

in the United States and to help Great Britain and other European countries in efforts to establish or maintain firm gold standards. Later sales of Government bonds, coupled with successive rises in discount rates from 3 to 5 percent in 1928, and (for the New York district) to 6 percent in August 1929, proved wholly insufficient and too late to stem the tide of stock-market inflation. Government debt held by the Reserve System has risen rapidly and fairly consistently since that time.

The modus vivendi reached by the Federal Reserve Board and the Treasury in March 1951, which freed the former from responsibility for "pegging" prices of Government obligations has brought down the price of the (bank eligible) Federal 22 percent ('67-'72) bonds (due September 15) from a high of $109 in 1946, and a price of about $100 on the eve of the agreement to less than $98 in latter March 1952. A wholesome and long-overdue strengthening of basic interest rates, and of control of credit is resulting. It is to be greatly hoped that no "integration," or "coordination" of Federal Reserve-Treasury policy, whatever these much-bandied words may mean, will lessen the independence of action and the responsibility of the central banking authorities in protecting the Nation's economy. That this requires careful planning and continuous concern for the Goverment's credit and fiscal needs may be taken for granted. A wise view will place the latter within the broad framework of the former, and not the other way about.

STATEMENT OF WALTER E. SPAHR, PROFESSOR OF ECONOMICS, NEW YORK UNIVERSITY, EXECUTIVE VICE PRESIDENT, ECONOMISTS' NATIONAL COMMITTEE ON MONETARY POLICY

THE INDEPENDENCE OF THE FEDERAL RESERVE SYSTEM VERSUS THE INTEGRATION OF MONETARY AND FISCAL AFFAIRS UNDER THE EXECUTIVE BRANCH OF OUR GOVERNMENT

The basic issue involved in the hearings conducted by this subcommittee is whether the people of the United States are to have an independent Federal Reserve System, designed to operate in the interests of the people as a whole, or whether it is to be made an instrumentality of the executive branch of our Federal Government.

The world's experiences with central banking systems teach the importance— indeed, the necessity-of establishing and maintaining their independence, if the people of a nation are to preserve representative government and their freedom. The only valid exception to that principle arises in time of severe war when a central government is compelled to utilize every resource at its command. Under such conditions lives, property, freedom, and valuable institutions, including a nation's money and banking structure, may be impaired or destroyed in the effort to defeat a national political enemy. But the necessities of war do not provide criteria as to what are good peacetime institutions.

Various and persistent efforts have been made in this country in recent years to impair or to destroy the independence of our Federal Reserve System as a part of the widespread movement toward socialism and a variety of dictatorshin by the executive branch of our Federal Government.

Typical of the movement in this direction have been the activities of those who have been advocating a Federal monetary authority and what some designate as fiscal and monetary integration or coordination under the Federal Executive. Sometimes the proposals for “effective coordination," or integration, of monetary and fiscal affairs have been stated in terms so broad or vague that they probably do not reveal to the casual reader the fact that, if made effective, they would involve Executive dictatorship over the monetary and fiscal affairs of this Nation. An example of a recommendation of this type is Recommendation X offered by 17 economists in Monetary Policy To Combat Inflation (National Planning Association, 800 Twenty-first Street NW., Washington 6, D. C., January 21, 1952), page 9, reprinted in part II of this subcommittee's Monetary Policy and the Management of the Public Debt (February 29, 1952). That recommendation reads: “Full and effective utilization of monetary powers requires coordination of the policies of the various Government agencies whose actions affect the volume and availbility of credit-especially the Treasury Department and the Federal Reserve System. We recommend, therefore, that steps be taken immediately to establish an effective coordinating mechanism to insure that all agencies concerned with monetary problems follow consistent and mutually supporting economic policies."

The nature of the mechanism which would provide the effective coordination recommended is not described. But since the Treasury would be involved, and

since it is part of the executive branch of our Federal Government, it would seem to follow as a matter of course that the coordinating agency, or "mechanism," would be an instrumentality of the Executive.

In 1946 a recommendation of this same general nature, but stated in more concrete terms, was offered by a research staff of the Committee for Economic Development in a publication called Jobs and Markets (March 1, 1946). The recommendation then was that a central monetary authority, under the President, be established and that it "should be charged with developing and directing a unified program of fiscal, monetary, and price control action to maintain price stability and high employment * *

That recommendation, if enacted and made effective, would establish in this Nation a centralized, dictatorial, and totalitarian form of executive control over monetary, price, and fiscal affairs. Two of the signers of that recommendation were also signers of the less specific "Recommendation X," quoted above.

These are typical examples of the many and persistent pressures which have appeared in recent years in behalf of Executive dictatorship in the monetary and fiscal affairs of this Nation.

This proposed integration of fiscal and monetary policies and procedures, involving an irredeemable currency and the destruction of the proper independence of the Federal Reserve System, is a feature of the theory of "the compensatory economy" in accordance with which the managers of the fiscal and monetary affairs of this Nation are to compensate for expansions and contractions by private enterprise in production, consumption, exchange, creation, and distribution of income, prices, investment, employment, and so on.

Such a program, if "successful," would require Executive dictatorship despite the widespread lack of discussion of this fact. Not only is dictato ship required; the dictator would, of necessity, need to know what to do and when to do it, and he would have to have the power to make his will effective. Congress would be compelled to surrender its powers and responsibilities in the fiscal and monetary fields and to become a passive instrumentality of the dictator.

The theory of a compensatory economy, and its integral part, fiscal and monetary integration or coordination, are unworkable in practice in this or in any other nation. No dictator has ever made a success of such a plan. And so long as we maintain the three major divisions in our United States Government, that Government cannot make such a program effective. Beyond this system of checks and balances lie the governments of our 48 States and private initiative. This economy of a nation, the mechanism of government, and the behavior of people-particularly those who have known and cherish freedom-are not as simple in operation as the theory of a compensatory economy implies.

The theory of a "compensatory economy," with fiscal and monetary management by the Executive, is the theory of the would-be dictator. It has no proper place in what is supposed to be our type of economy and government. The principles and lessons of good central banking have perhaps never been stated better than by Sir Cecil H. Kisch and W. A. Elkin, in their book, Central Banks (Macmillan & Co., Ltd., London, 1932), fourth edition, with a "foreword" (to the first, 1928, edition) by the Right Honorable Montagu C. Norman, then Governor of the Bank of England.

They state (pp. 20–21), regarding the proper relation between the government and the management of a central banking system:

"The theory underlying the conception of a state bank centers on the proposition that since a wise central banking policy is the basis of a sound national economic life, the bank should be under the control of the national government. But the dangers of this course are great. Just because the decisions of the bank react on every aspect of the economic activities of the country, it is essential that its direction should be as unbiased as is humanly practicable, and as continuous as possible. But clearly if the bank is under state control continuity of policy cannot be guaranteed with changing governments, nor can freedom from political bias in its administration be assured. In most economically developed countries the probabilities are that the national government will be the largest individual customer of the local money market. In such circumstances it is evident that, if it also controls the administration of money market policy, it may easily find itself in an equivocal position where it may be called upon to decide between two courses, one of which may be immediately convenient to itself and the other conducive to the ultimate interests of the country as a whole. The creation of such dilemmas should be avoided."

They continue (pp. 22-23):

"Such extreme abuses of government power [illustrated in the text] are, of course, only possible when a country has ceased to be on a gold basis. As long as convertibility is maintained the worst evils resulting from government intervention in banking and currency control are avoided. Doubtless the governments which have laboriously dragged themselves out of the morass of inflation will not readily slip back; nevertheless, if the control of the operations of the central bank lies directly or indirectly with the government, it becomes fatally easy for the government to finance itself for a time by means of book entries and short loans from the bank, a course which is the first step toward currency depreciation and inconvertibility.

"Even apart from such risks there are other serious dangers from a govern. ment-controlled bank. The network of financial and commercial life is so intricate, and the decisions of the bank on important points have such widespread results, that all interests are not affected in the same way. A change in the rate of discount, for example, which benefits some may be unwelcome to others. But if the government has a controlling influence over the bank, there are obvious ways by which the more powerful interests in the country can try to enforce their wishes. The road is open for political intrigue, and there can be no safeguard that the policy of the bank will be carried on without bias as national interests require. It seems a paradox that when the object is to secure the execution of a national policy, this should not most readily be achieved by the creation of a state bank under official control; but even in the countries where the capital of the bank is held by the state, steps have been taken in certain instances to remove its administration from political influences and to give it a measure of independence from the government." Kisch and Elkin say (p. 13): "Precautions are necessary to insure that the administration of the [central] bank shall not be dominated by the interests of any particular section of the business or industrial world or by political influences."

46

* *

*

They say (p. 28): "The complete independence of the bank is perhaps an ideal to which countries can only approximate in different degrees according to their state of economic development and the sense of responsibility inherent in their public and particularly their commercial life." And, on page 37: * * It is of cardinal importance that it should be made as difficult as possible for the governments to resort to the expedient of borrowing from the bank, a practice which, if continued, can lead to a repetition of past disasters." After World War I, the various nations, whose officials understood the principles and lessons stated by Kisch and Elkin, tried to free their central banking systems from that government domination which was recognized to be unsound in principle, except, possibly, in times of a serious war. The Brussels Conference resolution (III) of 1920 crystallized this general belief. It said: "Banks, and especially a bank of issue, should be freed from political pressure and should be conducted solely on the lines of prudent finance." The same statement was issued by the Genoa Conference in 1922.

The experience of Germany with the Reischbank, when it was placed under government control, was so disastrous that the German Bank Act of 1924 opened with this sentence: "The Reischbank is a bank independent of government control."

Regarding the unhappy experiences of the Bank of France under the domination of the Treasury, Kisch and Elkin had this to say (p. 22): "There can be no question that the power of the government to force increased loans from the Bank of France intensified the depreciation of the franc and contributed to the financial crisis that culminated in 1926."

During and immediately after World War I our Federal Reserve System was under the domination of the Treasury, the System's policies were controlled by the fiscal interests of the Government rather than by those of sound commercial banking, and the result was a gorging of the banks with Government bonds, a credit expansion until the price level reached its highest point between 1914 and 1921, and an exhaustion of bank reserves with eight of the Reserve banks forced to pay tax penalties for deficient reserves in 1920. With the restoration of the independence of the Federal Reserve System in 1920, it became necessary to force a contraction of credit in order to save the reserves and the monetary and banking structure of the country. A result was the business contraction and liquidation of 1920-21.

1 Kisch and Elkin, op. cit., p. 17.