The Independence of the Federal Reserve System [Reprint 2016 ed.] 9781512801347

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The Independence of the Federal Reserve System

The Independence of the Federal Reserve System A. Jerome Clifford

Philadelphia University of Pennsylvania Press

© 1965 by the Trustees of the University of Pennsylvania

Published in Great Britain, India, and Pakistan by the Oxford University Press London, Bombay, and K a r a c h i

Library of Congress C a t a l o g u e C a r d N u m b e r : 6 3 - 7 8 6 2

To Mary and Ray ". . . forsan et haec olim meminisse iuvabit." {Aeneid I : 203)

7388 Printed in the U n i t e d States of A m e r i c a

Contents I.

II.

THF. I S S U E O F I N D E P E N D E N C E

19

Background Considerations Need for New Monetary System Dangers of Monopoly

20 20 21

Provisions for Independence Agency Function Buffer Against Governmental Domination Limitation on Private Control

23 24 26 27

Adaptations to Governmental Activities Cooperation with Treasury Promotion of Governmental Policies

28 29 31

Problems of Independence Governmental Control Adequate Explanation Accountability

32 33 35 37

Plan for Discussion of Independence

38

THE NECESSITY

FOR INDEPENDENCE

40

Fear of Domination by Private Banks Money Trust Investigation Aldrich Plan

41 42 44

Distrust of Control by Treasury

48

Tennessee Loan Incident

51

Issuance of New Currency

54

Reform Statements in Party Platforms

55

Structural Arrangement for Independence Dispersal of Internal Authority Internal Unity

57 60 62

THE INDEPENDENCE OF T H E FEDERAL R E S E R V E III.

SYSTEM

THF. W E A K N E S S E S O F T H E S T R U C T U R A L A R R A N G E M E N T

66

Obstacles to Internal Unity

67

Autonomy of Individual Reserve Banks Division Between Reserve Banks and Board Extent of Treasury's Authority

73

Monetary Powers

75

Control of Government Deposits Overlapping Authority

75 76

Other M e a n s of Treasury Control Legal Ruling on Independence of the Board Exposure to Political Pressures

IV.

68 71

78 80 81

Particular G r o u p Interests

82

Appointment of Federal Reserve Officials

83

Governmental Policies

84

THE OPERATIONAL P R O B L E M S

OF I N D E P E N D E N C E —

1914-1930

86

Early Struggle for Unified Authority

88

Attempted Reduction in N u m b e r of Banks

89

Disagreement A m o n g Board Members

90

Intervention Policy of President Wilson

92

Failure at Unification T h r o u g h Governors Conference

93

Independence and the Treasury — First World W a r Subordination to Treasury's Needs

97 99

Hindrances to Unity of Board and Banks

102

Internal Struggle over Authority —Open-Market Operations

103

Initiative T a k e n by Banks

104

Assertion of Authority by Board

108

Compromise Between Board and Banks

111

Internal Struggle over Authority — Discount Determination

Rate

112

CONTENTS

Early Control Action by Board

112

Intervention of Treasury

114

Support from Congress for Independence

116

Public Disagreement and Political Pressures

118

Criticism of Federal Reserve Actions

119

C h a n g e in Leadership

121

Further Weakening of Responsibility

V.

FEDERAL R E S E R V E RELATIONS WITH T H E

122

GOVERNMENT

IN T H E T H I R T I E S

125

Extension of Federal Reserve Powers

127

Increased Authority for Board

129

New Open Market Committee

131

Public Character

131

Group Authority

133

Agency of Government

134

Obligation for Public Report

135

Formal Separation from Treasury

138

Extension of Treasury Powers T h o m a s Amendment Emergency Banking Act Cooperation of Federal Reserve with Government Increased Public Responsibility Influence of Treasury Policy

141 142 144 147 148 150

Problem of Support for Bond Prices

152

Segregation of New Gold Pressure for Support Operations

153 155

Intervention of President Roosevelt Liaison Activities of Board Chairman Other Attempts to Strengthen Authority

156 159 161

T H E INDEPENDENCE OF T H E F E D E R A L R E S E R V E VI.

FEDERAL R E S E R V E

RELATIONS

WITH THE

SYSTEM

GOVERN-

M E N T DURING W O R L D W A R II

VII.

163

Preparations for War Finance Program Early Market Support Operations Promotion of Orderly Market Doubts about Pegging the Market Proposals for Increased Authority

164 166 166 168 170

Establishment of Rate Structure Purpose of Rate Structure Long-Term Rate Short-Term Rate Encouragement of Bank Participation

173 174 175 176 178

Attitude Toward Cooperation Acceptance of Restrictions Criticism of Details Willingness to Cooperate

180 180 183 184

Operational Relationships with Treasury Board Chairman as Critic Conflict over Bond Sales Organization Results of Conflict

188 188 190 194

FEDERAL R E S E R V E RELATIONS WITH T H E GOVERNM E N T IN T H E E A R L Y P O S T W A R P E R I O D

197

Modification and Continuation of Support Program Attitude Toward Continuation Modification of Short-Term Rates Acceptance of Modified Program Concurrence of Treasury

200 201 203 204 207

Reduction in Influence of Board Chairman Rejection of Proposals for New Authority Loss of Position as Chairman

208 208 210

Adoption of More Flexible Policy

212

CONTENTS

Meaning of New Flexibility

213

Reliance on Persuasion-Appeal Approach

215

Renewed Concern for Independence

216

Proposals of Sproul

218

Concentration of Power in Open

Market

Committee

219

Adjustment of Relations with Treasury Proposals of McCabe

VIII.

221 223

Feasibility of Cooperative Procedures

224

Changes for Improved Cooperation

227

THE RENASCENCE OF THE INDEPENDENCE

ISSUE—

T H E 1 9 5 1 ACCORD

229

Events Leading to the 1951 Accord Attitudes Toward Continued Consultations Conflict over Policy in 1950 Unilateral Action on Discount Rate Continuation of Restrictive Policy Dissatisfaction over November Refunding Climax of Disagreement in 1951 Public Announcement by Secretary Snyder Reaction to Announcement Meeting of Open Market Committed with President Further Attempts to Settle Dispute Inter-Agency Conferences Discussion on the Senate Floor Formation of Special Committee

230 231 232 233 235 237 238 239 240 242 245 246 248 249

Agreement on Cooperation—the Accord Proposal of Joint Resolution by Congress Principle of the Accord Treasury's Emphasis on Cooperation Co-equality as Requisite

252 253 255 257 260

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

Limitations on Independence Responsibility for Government Securities Market Pressures from Executive Reaction of Federal Reserve Officials Chairman as Object of Pressures IX.

THE CONSOLIDATION OF INDEPENDENCE AFTER T H E ACCORD

273

Proposals for Changes in Operating Procedures New Rules for Open-Market Operations Reduction in Authority of New York Reserve Bank Responses of President Sproul

274 275 279 282

Decision for New Operating Procedures Content of the Decision of March, 1953 Disagreement on Open Market Committee Reasons for Split Vote Reaffirmation of March, 1953, Decision Changes in Control Arrangement

284 285 287 288 289 290

Further Action on Consolidation —Centralization of Control Control of Operations —Bills and Repurchase Agreements Control of Operations — Agency Functions Effect on Federal Character of System X.

263 264 266 268 270

TREASURY-FEDERAL

R E S E R V E RELATIONS AFTER

291 292 295 298

THE

ACCORD — T H E O R Y AND P R A C T I C E

300

Treasury's Promotion of Federal Reserve's Independence

301

Cooperation Between the Treasury and the Federal Reserve — Theory Agreement on Free Markets Change in Treasury's Emphasis on Free Markets

303 303 305

CONTENTS

Opposition to Federal Reserve Control of Debt Management Viewpoint of Treasury Viewpoint of Federal Reserve

308

Necessity for Intercommunication

310

Cooperation Between Treasury and Federal Reserve—Practice Assistance to the Treasury — November, 1955 Answer of Federal Reserve to Congressional Criticism Problems of Cooperation Opposition to Treasury —April, 1956 Meaning of "Independence Within the Government" Quick Reversal of Policy by Federal Reserve XI.

307 307

T H E CONGRESSIONAL C A S E FOR CONTROL OF

312 313 314 316 318 319 320

THE

FEDERAL RESERVE SYSTEM

322

Congressional Interest in Monetary Affairs Delegation of Monetary Power Frequent Consideration of Control Purposes of Investigations Importance of Investigations for Independence

323 324 326 326 327

Reasons for Congressional Control Concern for Public Interest Opposition to Control by President Restraint on Private Influence Coordination of Governmental Policies Prevention of Abuse of Monetary Power Risks of Abuse Retention of Basic Monetary Power Response of Federal Reserve Existing Limitations on Authority

328 329 329 330 333 335 335 336 338 339

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

Involvement of Other Agencies Basic Control by Congress Importance of Trusteeship XII.

THF. C O N G R E S S I O N A L

MEANS

FOR

CONTROL

339 340 342 OF

THE

FEDERAL R E S E R V E SYSTEM

XIII.

345

Greater Specification of Methods and Goals The 1938 Mandate Proposal Mandate Proposals in the Fifties Promotion of Monetary Policy Mandatory Open-Market Operations

347 347 348 349 351

Control Through General Accounting Office Audit Procedure of Federal Reserve Congressional Proposals for Audit by Government Agency Source of Information About Federal Reserve Use of Information for Control by Congress Response of Federal Reserve Results of Congressional Pressure Refusal by Federal Reserve Changes Proposed by Federal Reserve Implications of Government Audit

353 353 356 357 358 360 364 364 365 366

THF, O W N E R S H I P O F F E D E R A L R E S E R V E BANK S T O C K AS AN I S S U E O F I N D E P E N D E N C E

Historical Background of Ownership Issue View of Founders on Stock Ownership Later Congressional Challenges of Ownership Feature Congressional Arguments against Private Ownership of Stock Obstacle to Congressional Control of Federal Reserve Public Misinterpretation of Stock Ownership

369

371 372 375 377 377 379

CONTENTS

Federal Reserve Defense of Status Quo Ownership of Stock as Distinct from Control Separation from Proprietorship Complexity of Ownership Issue Further Attempts at Clarification No Necessary Reason for Change Instrument for Cooperation Between Business and Government Risks Involved in Change XIV.

T H E INDEPENDENCE OF T H E F E D E R A L S Y S T E M — R E T R O S P E C T AND P R O S P E C T

379 380 381 382 384 385 387 390

RESERVE 392

I ndependence — Retrospect

392

I ndependence — Prospect

398

BIBLIOGRAPHY

400

INDEX

417

"To suffer either the solicitation of merchants or the wishes of government, to determine the measure of the bank issues, is unquestionably to adopt a very false principle of conduct." —Henry Thornton, 1802

"An independent Federal Reserve System is the primary bulivark of the free enterprise system and when it succumbs to the pressures of political expediency or the dictates of private interest the ground work of sound money is undermined." —William McChesney Martin, Jr., 1952

I The Issue of Independence

T H E F E D E R A L R E S E R V E A C T BECAME L A W ON D E C E M B E R

23,

1913. It provided for a Reserve Bank Organization Committee consisting of three members : the Secretary of the Treasury, the Secretary of Agriculture, and the Comptroller of the Currency. This committee did three things. First, it divided the United States into twelve districts and designated one city in each district a Federal Reserve city. Second, it supervised the subscription by private commercial banks to the stock in the proposed Federal Reserve Banks to be located in the designated Federal Reserve cities. Third, the organization committee chose five subscribing banks in each district to act as incorporators and to transmit to the Comptroller of the Currency an organization certificate. The proper filing and acceptance of these certificates marked the start of the corporate lives of the twelve Federal Reserve Banks. Boards of directors and officers were chosen, stock was issued, and deposits were received. Meanwhile the President of the United States appointed the seven-man Federal Reserve Board. Five of these appointees had to be approved by the United States Senate; two other members served ex officio—the Secretary of the Treasury and the Comptroller of the Currency, the former being the ex 19

20

THF. I N D E P E N D E N C E O F T H E FEDERAI. R E S E R V E

SYSTEM

officio Chairman of the Board. The Federal Reserve Board took office on August 10, 1914. Shortly thereafter, on November 16, the Federal Reserve Banks opened for business. Thus began the Federal Reserve System, a unique organization in the history of the United States.

Background Considerations The background for the establishment of the Federal Reserve System was filled with the plans of those who wanted a more efficient monetary system for the nation. Most of the planners agreed that there was urgent need for a new authority arrangement in the banking and currency fields and not just for shoring up or refurbishing the old system. Ultimately bright hopes settled on a system of reserve banks as the most feasible means for satisfying that need. Bright as the hopes were they had to take into account two contrasting fears : the new organization might be part of a growing socialism or it might be dominated by the private Money Trust. In the establishment of the Federal Reserve System much attention was given to placating these fears.

Need

for New

Monetary

System

The need for a new monetary system was traceable to the frequently stated causal connection between crises and failure in the banking and currency system and crisis and failure in commerce, industry, and agriculture. Hence the reformers quickly won public support for their political and economic arguments that continued prosperity and growth for the nation demanded that the monetary malfunctions be cured. How the new system of reserve banks would, or could, steer a careful

THE

ISSL'F. O F

INDEPENDENCE

21

course between government and private-banker domination, the Scylla and the Charybdis on its course, was not clearly seen. Or, perhaps, only the blind believers in the Federal Reserve mechanism could envision how the whirlpool of socialism and the jagged rocks of monopoly would be faced and successfully avoided. Nonetheless, the nation in all its parts strongly desired a remedy for the malfunctioning of its banking and currency arrangements. That much was clear. T h e need for a new system was also related to the very buoyancy and nervous expectation of the times. T h e Panama Canal was about to be opened, and the linking of New York and San Francisco by transcontinental telephone was near completion. The remarkable automobile industry was soon to start a five-dollar day. These were buoyant times, and the nation had to move on to greater things. It was not to be hindered by the fears of those who had divergent views on how the banking and currency system should be organized. The followers of William Jennings Bryan and the proponents of conservative Wall Street interests had to find some common plan of action. Besides, there was war-breathing unrest in all of Europe. Dangers of Monopoly As full of unrest and impatient as were those who sought to change the nation's monetary system, they did not write their law except after long and tedious years of hearing the testimony of experts. The solution which they finally proposed was unique in concept. The powers and responsibilities given to the new system were enveloped in structural arrangements designed to assure the organization itself as well as the nation that there would be competent, adequate, and independent authority to provide for a more efficient monetary system.

22

THF. INDF.PF.NDKNCK O F THF. FF.DKRAI. RF.SF.RVF.

Although unique, the solution structure or operation.

was not

SVSTF.M

simple in either

Besides protection against the dangers of government or private-banker domination, another essential element had to be taken care of : winning and keeping the help and cooperation of both government and private banks. A federal reserve banking system, while fearful of domination, could not avoid contact with government and private banking interests. It had to be designed to work with both for a common goal. Constant cooperation and harmony were as necessary as the avoidance of domination. In achieving its purposes the new system could not help but expose itself to a wide range of pressures, from flagrant to subtle. How it promoted cooperation and harmony and withstood the pressures would be its glory and its cross. The founders of the Federal Reserve System took unto their own the caution of Henry Thornton. This m a n of vision in the field of central banking wrote a book in 1802 to justify the restrictive control measures taken by the Bank of England to protect its country's paper currency. He said : " T o suffer either the solicitation of merchants or the wishes of government, to determine the measure of the bank issues, is unquestionably to adopt a very false principle of conduct.'" The founders of the Federal Reserve System endeavored to follow the advice of Thornton by setting u p an organization of authority which would be protected enough and strong enough to make and execute its own decisions. Their achievement did not make the advice obsolete, rather it impressed the advice on the thinking of Federal Reserve proponents down through the years. In 1952, 150 years after Thornton, the Chairman 1 Henry T h o r n t o n , An Enquiry into the Nature and Effects of the Paper Credit of Great Britain (New Y o r k : R i n e h a r t a n d Co., Inc., 1939; originally published in L o n d o n , 1802), p. 259.

THE ISSUE

OF

INDEPENDENCE

23

of the Board of Governors of the Federal Reserve System, Williams McChesney Martin, Jr., echoed Thornton's words : "When the Federal Reserve System succumbs to the pressures of political expediency or the dictates of private interest the ground work of sound money is undermined."' When Martin added the words, "an independent Federal Reserve System is the primary bulwark of the free enterprise system," he had a statement of what he considered not only the basic modus operandi but also the broader raison d'être of the Federal Reserve System. The founders of the Federal Reserve System did not express themselves in the words of either Thornton or Martin, but they understood the analysis and the warning. They showed this in the structure they founded, the goals they proposed, and the powers they gathered together. In so doing they provided the initial expression of the independence of the new banking and monetary authority. Provisions for independence The independence of the Federal Reserve System derived from relationships established between the System, on the one hand, and the government and the private financial system of the nation, on the other. The initial emphasis was on separation, not allocation, of functions. While certain factors put the Federal Reserve System within the government, and others gave it the aspects of a private system, there were essential elements of distinction and independence. First of all, the Federal Reserve System found its fundamental meaning in the function, frequently called the "governmental" function, which was delegated to it by Congress : the formation and execution of credit and monetary policy for public purposes. " Address at the E i g h t e e n t h A n n u a l C o n v e n t i o n o f the I n d e p e n d e n t B a n k e r s Assr>ciation, M i n n e a p o l i s , M i n n e s o t a , M a y 1 9 , 1 9 5 2 .

24

I H K I N D E P E N D E N C E O F THF. F E D E R A L R E S E R V E

SYSTEM

Yet it was set apart from the ordinary legislative and executive departments of the government. Second, the Federal Reserve System worked to achieve its purposes by acting through and with the cooperation of the nation's private financial interests. Yet it was separate from those interests. T h e Federal Reserve System in its entirety could not be called the government "in action," nor could it be labeled the arm of the private banking system. Agency

Function

T h e independence given to the System was comparable to the autonomy exercised by a responsible agent who is not obliged by his agency powers to accept day-to-day changes in the charge made to him. Once delegated by Congress to form and execute credit and monetary policy for designated public purposes, the System was to make its own judgments and to take its own actions about appropriate policy goals, policy instruments, and methods of achievement. T h a t is, in these matters the Federal Reserve System was to be free from specific dictation by Congress except through the passage of new laws. This independence also referred to the separation between the System and the President of the United States. T h e System was not to be subject to orders from the Executive Department of the government, whether they emanated from the Secretary of the Treasury, the Chief Executive himself, or any of his agencies. Cooperation, of course; but not orders. T h e contrast between cooperation and order-taking did not establish a complete or lasting definition of the autonomy of the agent, but it pointed the way to a deeper and more troublesome problem. What constituted cooperation

which

was compatible and order-taking which was not compatible, with a responsible agent performing a governmental function ?

THE ISSUE OF INDEPENDENCE

25

The Federal Reserve Act attempted to provide an answer in various automatic and structural ways. Cooperation was assumed within the framework of recognized principles of the gold standard and the commercial-loan theory of banking. This automaticity was expected to reduce the need for specific guidance by the government. On the other hand, the government participated in the management of the Federal Reserve through its rights, first, of appointing certain officials with supervisory and management powers and, secondly, of assigning the broad purposes of the actions taken by the System. By exercising these rights the government would receive the cooperation which it required. What this cooperation would mean as the government expanded its functions and operations remained to be spelled out. The Federal Reserve Act simply supposed that capable men operating with these checks on their activities—organizational as well as market disciplines— were to be trusted to work for the public good. Hence there would be no need for order-taking. In the light of later operations and enhanced objectives of the Federal Reserve System, this emphasis on structural arrangements seemed naively inadequate; however, in the context of a new and urgently needed monetary organization, it seemed naive only if considered fixed and immutable. There were some advocates who so considered it, but others took a different view. As the latter saw the Federal Reserve System face evolving economic and political conditions, they recognized that the supposed framework of accepted banking principles had changed and so had the power and interest of the government. The meaning of cooperation and order-taking expanded and became more crucial and complicated. Those who promoted responsive changes in the Federal Reserve System met with resistance, even within the System. Part of the explanation of this struggle was bound up in politics and

26

THF. I N D E P E N D E N C E O F T H E F E D E R A L . R E S E R V E

SYSTEM

personalities. Some of it was related to the participation of private interests in the System's authority arrangement. T h i s participation gave another important dimension to independence.

Buffer The

Against

Governmental

Federal

Reserve

Domination

Banks,

as distinguished

from

the

Federal Reserve Board, did not consider themselves to be direct agents of the government, even though they received their charters from Congress. T h e y recognized that they were performing banking and monetary functions under the aegis of the government and more directly under the supervision of a central board appointed by the President. T h e y

tended,

however, to stress their autonomy, t o emphasize the word " f e d e r a l " rather than " s y s t e m . " Especially in their early years, the Federal Reserve Banks were not supple instruments in the hands of the Federal Reserve Board or of executive departments of the government. T h e founders of the Federal Reserve System seemed

to

design the Reserve Banks as a buffer against an absorption of banking by the government. T h u s private banks were given power to elect a majority of each Reserve B a n k ' s board of directors, and the directors in turn choee the officers who managed the B a n k ' s day-to-day affairs. T h i s participation of private banks was supposed to introduce the value of private business care into the running of the Reserve B a n k s and to keep out the vacillations of politics. T h e limitation on the government's control through

the

introduction of elements of private business control was considered necessary for the cooperation of private banks in the Federal Reserve

System. T h e

System was to operate

and

achieve its objectives principally through the private banking

27

THE IS .S U Κ OF INDEPENDENCE

system. Giving the private banks a voice in the management, thus assuring them that the System was not an inexorable first step in the direction of government monopoly, was the means designed to win the needed confidence and cooperation. Although

the new System wanted the participation

of

private interests in its affairs, it did not want to be operated for the private benefit of commercial banks, except insofar as this was subordinated to the public good as stated in the Federal Reserve Act. Hence it was also important that neither the Reserve Banks nor the System as a whole be forced into a course of action because of the wishes of the private banks apart from any broader considerations.

Limitation

on Private

Control

When the founders of the Federal Reserve System provided for the unique organization of the Reserve Banks, they were aware of feelings, popular within the government and among the public, against the powers of private banks. Since they wanted to use the expert knowledge and experience of private banks, they incorporated into the System an offset against the monopoly

danger

of

private

banker

control.

This

offset

embraced an organizational arrangement and an educational project. In the organizational structure of the Reserve Banks, the private banks elected six out of the nine directors. Only three of these directors were to be representatives of the banks; the other three were to be elected by the banks as representatives of non-banking fields. T h e remaining three directors were to be appointed by the Federal Reserve Board. 3 They likewise could not be bankers, though one of them was appointed ' T h e three groups of directors were designated respectively as Class A, B, and C Directors.

28

THF. I N D E P E N D E N C E O F T H E

FEDERAL R E S E R V E

SYSTEM

Chairman and official representative of the Washington Board. T o prevent the larger private banks from controlling the election of the six banker-elected directors, each member bank was given only one vote for each of two directors, one a representative of the banks and one a non-banker. T o increase the assurance against private aggrandizement at the expense of the public good, the Reserve Banks were restricted on the amount of retained profits and on the payment of dividends to stockholders. T h e educational project which acted as an offset to private monopoly was a reciprocating arrangement. T h e presence of directors from industrial,

various backgrounds—banking,

agricultural,

commercial,

and other areas—provided for

the

exchange of viewpoints from the different parts of the district's economy. T h e influence of the directors on each other was expected to broaden their local or individual viewpoints. M o r e over, supervision

by the

Federal

Reserve Board

put

the

directors under the educational influence of an organization designed to have a national viewpoint. Here also the education was reciprocal. T h e

Board

would learn from

as well

as

influence the directors so that the System—Board and Banks— : more likely would be managed for the good of both

the

respective districts and the nation as a whole.

Adaptations to Governmental Activities Independence took on new meaning and new problems as the context in which the Federal Reserve System operated came

to include

economic

life of

enlarged

government

the nation.

The

operations

earlier,

in

the

straightforward

problem of setting up the Federal Reserve System to avoid the dangers of government monopoly or socialism, on the one

THF. ISSUE OF INDEPENDENCE

29

hand, and of private monopoly, on the other, was restated in more complicated terms : how to maintain the sovereignty of the government with new powers and goals while at the same time keeping the distinctiveness of the Federal Reserve System as a responsible and effective agent of the government ? Originally independence was considered largely a m a t t e r of separating various monetary functions within the System and between the System and the government; later it was sought through an allocation of function which would provide unity and strength. T h e new approach to independence resulted principally from the altered economic and political environment to which the System adapted, partly under the direction of specific laws and partly under the influence of its own management and of government officials.

Cooperation

with

Treasury

In 1951, a Congressional committee asked the Secretary of the Treasury to write out what he considered " t h e important economic changes since 1913 which affect the efficiency and appropriateness of traditional Federal Reserve System operations." In reply Secretary J o h n Snyder summarized five such changes as follows : 1. 2.

3.

4.

The huge increase in our public debt, which has magnified the problems of debt management. The increase in secondary reserves of the commercial banks (i.e., short-term United States Government securities), which helps to make banks relatively free to resist general credit restraint by the Federal Reserve. The rapid growth of lending institutions other than commercial banks, together with an important increase in their reserves in marketable Federal securities. The improved financial position of American business and

30

THF. IΝI ) Ε Ρ F. ΝI ) F. Ν C Κ O F THF. F E D E R A I . R E S E R V E

SYSTEM

consumers, which makes increased "self-financing" 5.

possible.

T h e m u c h l a r g e r role in e c o n o m i c a f f a i r s b y t h e G o v e r n m e n t . '

These changes also affected the independence of the Federal Reserve System : its authority and freedom to carry out its functions. Particular attention had to be paid to the evolving role of the government in the economic life of the nation : growth in government debt-instruments and their monetary uses, in government debt-management and fiscal operations, and in government responsibilities for the economic welfare of the nation. Almost from its beginning the Federal Reserve

System

shared in the Treasury's concern for the market status of government debt securities. With the growth in the amount and variety of these securities, it became increasingly evident and important that there was no escaping the effects of money market influences on Treasury debt-operations and that there was no escaping the effects of the Federal Reserve's operations, or lack of them, on that market. At a minimum,

both

organizations had to recognize the need for using their respective powers in a cooperative, mutually helpful way. They both were concerned with a common goal—the welfare of the nation—and they both used some of the same means—operations in government securities. Hence they could not live in isolation. They had to consider the ramified and interrelated effects of their respective actions; they had to particularize the common goal in a compatible way. All the economic changes affecting the independence of the Federal Reserve System brought closer together the operations of the Federal Reserve and those of the Treasury. As a conse' U.S., Congress, Subcommittee of the Joint Committee on the Economic Report, Monetary Policy and the Management of the Public Debt, Part 1, 82d Cong., 2d Sess., 1952, pp. 1 1 1 - 1 1 2 . Cited hereafter as Patman Compilation, Part 1, 1952.

THE ISSUE OF INDEPENDENCE

31

quencc the crucial question was repeated but now in a new context : how is cooperation achieved without complete subordination of the one organization to the other and with due respect for the sovereignty of a government responsible under law ? Promotion

of Governmental

Policies

There were also political changes which affected the independence of the Federal Reserve System, but they were not adequately distinct from the economic. This lack of distinction was acknowledged by the Governor of the Federal Reserve Board at a Congressional hearing in 1935 : An administration is charged, when it goes into power, with the economic and social problems of the nation. Politics are nothing more or less than dealing with economic and social problems. . . . It would be extremely difficult for any administration to be able to succeed and intelligently deal with them entirely apart from the money system. There must be a liaison between the administration and the money system—a responsive relationship. That does not necessarily mean political control in the sense that it is so often thought of." In the new political environment the Federal Reserve acted not just as an advisory organization. It made and executed policy for the welfare of the nation. T h e Federal Reserve acted not just as a technician concerned only with the mechanics of the monetary and banking system. It became vitally involved in the politics of the government. In promoting what it considered sound economics, it impinged upon areas of political interest : the policies of the Administration, of the Treasury Department, and of those other agencies of the government ! U.S., Congress, House, Committee on Banking and Currency, Hearings, on H.R. 5357 (Banking Act of 1935), 74th Cong., 1st Sess., 1935, p. 191. (Testimony of Marriner S. Eccles.)

32

THE I N D E P E N P E N C E

OK I H R

IT.DERAL R E S E R V E

SYSTEM

which engaged in financial operations in carrying out their responsibilities. The relationship of the Federal Reserve with the government could not avoid political overtones. The political and economic changes did not make for easier living for the Federal Reserve System. Its adaptation to the changes did not steadily evolve into closer and closer harmony between the System and the government. Over the years, the Federal Reserve System vacillated between forced subordination and asserted independence. This vacillation was due, in part, to the men who exercised authority within the Treasury Department, Congress, and the Federal Reserve System; it was due also to the changing emphasis on policy objectives and financial necessities of the government. All the variations, however, pointed to the interrelationship of politics and economics, including banking. A m o n g the proponents of various economic programs there had to be agreement not only on economics but also on politics. Here was the need for the master—intellectual and psychological. Since he was not always at hand, the Federal Reserve found it difficult to find its place according to the terms of the Federal Reserve Act and every law which went with it.

Problems of Independence In 1954, Allan Sproul, then President of the Federal Reserve Bank of New York, described the problems and the adversaries of independence in this way : The possibility that there might be a "money power" able and willing to flout the economic policies of elected Government, or exposed to the coercion of special private interests, disturbs many men and attracts demagogic assault.' * Address at the mid-winter meeting of the N e w Y o r k S t a t e B a n k e r s Association, J a n u a r y 25, 1954.

T H E I S S U E OF

INDEPENDENCE

33

Congressional hearings and the writings of scholars and other interested parties provided many examples to illustrate the interpretations of Sproul. The problems faced by the Federal Reserve System in explaining and defending its independence were complicated by the difficulty in clarifying the significant details of monetary affairs. T o the uninitiated it was full of shadows and darkness. Even to well-intentioned and otherwise well-informed people, there seemed to be something here which was mysterious, something suspect. Others who ignored the shadows felt that those who exercised control in this area of money and credit had a tremendous power which might misfire. Suspicious Congressmen and suspicious private bankers echoed in their statements the forthright admonition of Isabella (in Shakespeare's Measure for Measure) to the Lord Deputy who had condemned her brother to death : O, it is excellent T o have a giant's strength ; but it is tyrannous T o use it like a giant.

Here was a growing giant in the field of banking and credit. Would he act like a tyrant? Congressmen and other critics, friendly and otherwise, wanted no tyrant, even though they had a giant. Their good intentions sometimes led them to rush into the midst of the problems. Although not completely accurate in what they said, they apparently were confident of uncovering some abuse or even ignorance in the giant's exercise of his powers, the beginning of tyranny. Governmental

Control

From one point of view, as already mentioned, the Federal Reserve System was constructed on the general principle that the government could not be trusted to exercise directly,

34

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

through ordinary executive or legislative channels, the monetary power which was part of its sovereignty. Three reasons might explain the adoption of this principle. First, the government was not to be expected to pursue a monetary policy in vigorous fashion, especially when a restrictive policy was demanded. Hence, it would not oppose sufficiently a strong upsurge of inflationary forces. Second, wisdom and prudence seemed to demand that the borrowing and lending functions involved in the financing of the government should not be combined in a government organization directly responsible to the electorate. Such an arrangement would make it very difficult for the government to carry out actions which in their immediate effects would be unpopular with the electorate. The government was not likely to pay a relatively high current market rate of interest when it had authority as lender to bring the rate down to a more popularly acceptable level. Accordingly, a buffer organization was needed. Third, the area of money and banking required a specialized and erudite knowledge traditionally not expected of the government. As the Federal Reserve System grew in experience and stature, it did not reject this principle of no-trust in the government. In fact, the Federal Reserve frequently was somewhat doctrinaire in upholding the principle. At the same time the System became more aware that it was not selfsufficient. It could not properly coordinate its actions with those of the government unless it recognized and accepted the power, the interest, and the honorableness of the Treasury and the Administration in monetary affairs. Only by so doing would its independence be recognized and accepted. In addition, Congress was ever fearful lest the Federal Reserve would try to go its own way, promote the interests of special groups, and neglect the welfare of all other groups and sections of the

THE

ISSUE

OK

35

INDEPENDENCE

nation. T h e dangers of government abuse were no greater than those of neglect of the wishes of government. Hence questions were raised whether the Federal Reserve provided an institutional arrangement which was a happy medium between the conflicting dangers. T h e answers had to provide for adequate control by the government. Adequate

Explanation

T h e questions of adequate control by the government led on to the more specific problems of explanation and accountability. Like a determined social climber in a novel, the independent Federal Reserve System started out with an initial acceptance and lived on in expectation. Its early life became a succession of minor adaptations, cautious revelations, and rearrangements of protective devices. Only slowly did these contrivances diminish in importance as the

System

acknowledged that its operations were meant to affect the public interest and to be subject to public criticism. In no other way could an independent Federal Reserve be fully acceptable. Once this truth was recognized, its social-climbing life was finished and its serious life of public responsibility grew strong. T h e struggle for acceptance, however, never ended. While doubts and confusion about the policies and actions of the monetary authority seemed almost inevitable, they also led

to demands

for

explanations.

Questions

were

raised

whether in the light of the powers it had for national good or evil, the Federal Reserve System was sufficiently accountable to the Congress, which had to answer directly to the electorate. Moreover, it was not clear who settled disputes between the Federal Reserve and other parts of the government, nor on what terms.

36

THF. IN DE P F Ν DF. NC F. O F THF. F E D E R A L R F . S E R V F .

SYSTEM

For a number of reasons it was not easy for the Federal Reserve System to explain and justify its position. The actual formation of its decisions came through a complex arrangement of authority. Sometimes the Board of Governors or the Federal Open Market Committee was considered the fountainhead, but even they were not organizations with simple authority sources. Other times, reference was made to the authority of the twelve presidents and of the 260 directors of the Federal Reserve Banks and their branches. All of these— Board, Committee, directors, and officers—were part of the decision-making process; on occasion they could make it difficult to pinpoint the decision-maker. Four other reasons can be mentioned for the difficulty of explanation. First, the explanations had to do with intricate and complicated details of monetary operations. Second, insofar as they were definite and detailed, they were concerned more with past than with future actions. Monetary and credit policy was based on a calculated set of expectations, which could not be spread out without fixing the course of future policy. Allied to this difficulty was the need for confidence, a very nebulous sort of requirement. As William McChesney Martin, Jr., explained : "At some point economics becomes theology—you have to introduce the element of faith.'" Contrapuntal confidence went with the difficulty of explaining complex, past actions which could not be extrapolated as such. The listener was asked to trust that the future would be handled with competency. The fourth reason for the difficulty of explanation concerned proper respect for the sovereignty of the government : the explanation could not be so meager or so complex that the government remained without a knowledgeable ultimate control, or even proximate control when neces1

©

Interview in U.S. Neu/s and World Report, 1955 by U.S. News and World Report.

February 11, 1955, p. 130.

THE

ISSUE

OF

INDEPENDENCE

37

sary for the good of the nation. At times the Federal Reserve may have avoided making its explanations simple in order to hold representatives of the government at arm's length. More often, however, it seems to have made sincere attempts in vain because of the technical ramifications of its decisions and actions. Accountability Difficult as was the explanation and defense of the independence of the Federal Reserve System, the need for adequate accountability remained. The issue of accountability involved not only the principle of sovereignty—the risk of obstruction to the government—but also the danger of harm to the nation. T h e Federal Reserve officials in their response explained that accountability involved more than giving an account or description of the System's performance; it was bound up with the processes of democratic organization. There were four main points in the Federal Reserve's answer. First, the System had built-in checks and balances which assured its competency, safeguarded the public interest, and prevented its being dominated by special-interest groups. Second, the monetary and banking powers of the Federal Reserve were only part of the means for the national welfare. T o o much weight should not be placed upon them; on the other hand, the System should be allowed to exercise its authority and take action when necessary even if unpopular. Third, the Federal Reserve operated under a trust indenture. Accordingly it recognized its duty to give an account of its actions which would be reasonably satisfactory in detail and in timing. Fourth, the government was not helpless. It had powers of appointment over authorities within the System. It could change the System's course of action by insistent persuasion or by direction

38

T H E I N D E P E N D E N C E OF T H E F E D E R A L R E S E R V E

SYSTEM

given in law, even to the point of forcing the resignation of officials of the System. The answer of the Federal Reserve was reassuring to its friends, but it was not completely satisfying to either its friends or its critics. Accordingly, counter proposals for greater accountability perdured, ranging from tightening the System's ties with the government to the extreme of fundamental reorganization or abolition. Through the course of its history, the Federal Reserve became increasingly aware that its independence could not be upheld unless it was made meaningful for current as well as past monetary problems and policies. Tradition was important, but it had to be updated to satisfy the changing meanings of a responsible and responsive monetary authority. At the cost of survival, the Federal Reserve had to make itself acceptable as competent and well-ordered within the current framework of government. Plan for Discussion of Independence The following chapters will treat various aspects of the independence of the Federal Reserve System already briefly mentioned. The treatment will start with the organization of the System and the early manifestations of independence. Proceeding in a historical sequence, it will cover interpretations, problems, and defenses of independence. Emphasis will be on the issue as it manifested itself in six different ways involving the relations of (1) Reserve Banks to each other, (2) Reserve Banks to the Board, (3) Reserve Banks to owner banks, (4) the System to the Treasury, (5) the System to the Administration, and (6) the System to Congress. The historical treatment will highlight certain events in the period 1913-1960. It will be followed by consideration of Congressional control of the System and of private ownership of the stock in Federal Re-

THE

ISSUF. O F

INDEPENDENCE

39

serve Banks. Monetary policy as such will not be treated in terms of its wisdom or its achievements, except in so far as these affect the independence issue. Principal reliance for source material will be placed upon (1) various Congressional reports and hearings, (2) Federal Reserve publications, and (3) analyses and accounts of participants in the birth and growth of the System. The Congressional reports and hearings have the wonderful ability to disclose guarded information and opinion provided not only by Federal Reserve and government officials but also by scholars and other observers of the problem. Likewise, many of the Federal Reserve publications which were helpful were related to actions of Congress aimed at full or partial disclosure by officials of the Federal Reserve System.

II The Necessity for Independence

WHEN

THE

FEDERAL

RESERVE

ACT

WAS

PASSED

IN

1913,

leading Democrats considered the passage a triumph for their party. They had used the caucus system to unite their party in favor of the Act; moreover, Republicans had been excluded from participating in decisions of the conference committee which produced the final legislation. Nevertheless, both President Woodrow Wilson and Representative Carter Glass insisted that although the Federal Reserve Act was of necessity a party measure it was not a partisan measure1 As a matter of fact, one of the purposes of the Act was to provide an arrangement which would remove partisan influences from the nation's money and banking system. Government influence would be present, but in a way designed to be free from personal or party politics. This was one of the initial concerns ' C a r t e r Glass, An Adventure in Constructive Finance (New Y o r k : Doubleday, Page and C o . , 1927), pp. 2 3 0 , 2 5 0 . T h e House of Representatives approved the final version of the Act on D e c e m b e r 22, 1 9 1 3 ; the Senate, on the following day. T h e vote in the House of Representatives was 2 9 8 to 6 0 (16 not voting); only two D e m o c r a t s voted against the measure, while 3 5 Republicans voted in favor of it. In the Senate, the vote was 4 3 to 25 (27 not voting); no D e m o c r a t i c S e n a t o r voted in opposition, but only three Republicans and one Progressive sided with the majority.

40

THE NECESSITY

FOR

INDEPENDENCE

41

which guided the provisions made for the independence of the Federal Reserve System. Another of the initial concerns centered on the influence of private banks on the new organization. President Wilson praised the way the Federal Reserve Act handled this problem. He referred to the Act as an example of "democracy in action." The people and institutions to be governed by the new law would participate in the administration of the Federal Reserve System. The Act did not intend, however, to place control entirely in the hands of private banks. It specifically wanted to avoid this happening. Yet it did not ignore private interests. President Wilson, in his surprise at the quick public acceptance of the Federal Reserve Act, described it as a "constitution of peace" for the private businesses of the nation.* He judged that it give a better picture of what the Administration intended by its opposition to monopolies and its proposals for "new freedom"—the national goal proposed by Woodrow Wilson in the campaign of 1912. The Federal Reserve Act provided no facile way to prevent control over the nation's currency and banking system by either partisan political interests or private banking interests. The organization resulting from these two concerns was complicated but not haphazard. Of necessity it was a compromise measure, designed to avoid both so-called dangers. T o do so it placed great emphasis oil the organizational structure of the Federal Reserve System and built into the structure certain safeguards for independence. Fear of Domination by Private Banks At the time of the passage of the Federal Reserve Act, the Democratic Party emphasized the need for the organization of 5

Ibid.,

pp. 2 2 7 ,

230.

42

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

a monetary and banking system free from the danger of domination by relatively few of the large private banks. Although this type of system was considered politically most important, it did not mean that the government was to take the position of just an interested spectator. Congressional hearings and reports, statements by the proponents of a new system, and President Wilson's strong approval of the Federal Reserve Act emphasized the importance of new organizational arrangements for both private banks and the government. An independent Federal Reserve System was to be for commerce, industry, and agriculture a source of "new freedom." T h e "new freedom" did not signify that the government was withdrawing completely from participation in the economic life of the citizens. The Underwcod-Simmons Tariff Act, the formation of the Federal Trade Commission, and the Clayton Anti-Trust Act were some of the signs pointing to the "new freedom." Private monopoly control and gains were to be avoided; the participation of the government was to ensure the growth of economic freedom. Unfortunately there were no Hamiltons, Jays, or Madisons to discuss the issues involved. Consequently, the complexity and the uniqueness of the authority lines in the new organization were left somewhat in the background. What was considered most important was that the authority arrangements would provide for the desired independence.

Money

Trust

Investigation

After the Federal Reserve Act was passed by Congress, but before the System began operations, President Wilson publicly expressed his satisfaction with the new legislation. In his view the Act would be a great liberating force which promised even greater hope for the future. On October 7, 1914, he

THF. N E C E S S I T Y

addressed

FOR I N D E P E N D E N C E

a letter to Representative O .

W.

43

Underwood,

Democratic leader in the House of Representatives, to congratulate the Sixty-third Congress on its achievements.

In

speaking about the Federal Reserve Act, he stated that it harmonized with the program enacted by Congress which had: . . . a single purpose, namely, to destroy private control and set business free. . . . That purpose lay at the very heart of the currency bill. . . . Private control had shown its sinister face . . . in a virtual domination of credit by small groups of men. . . . By the currency bill we have created a democracy of credit. . . . The power to direct this system of credits is put into the hands of a public board of disinterested officers of the Government itself who can make no money out of anything they do in connection with it. No group of bankers anywhere can get control; no one part of the country can concentrate the advantages and conveniences of the system on itself for its own selfish advantage. . . . I think we are justified in speaking of this as a democracy of credit. Credit is at the disposal of every man who can show energy and assets. Each region of the country is set to study its own needs and opportunities and the whole country stands by to assist. It is self-government as well as democracy. 1 President

Wilson, in advocating

the importance of

"a

democracy of credit," had in mind his program for the "new f r e e d o m " and, more specifically, the revelations and conclusions of a Congressional investigative committee headed by Representative Pujo, which filed its report on February 28, 1913. This Committee reported on the existence and operations of a "money trust" which it defined as : . . . an established and well-defined identity and community of interest between a few leaders of finance which has been created 1 Commercial 1180.

& Financial

Chronicle,

X C I X (Octobcr 17, 1914), 1179-

44

THF. I N D E P E N D E N C E

OF THE

FEDERAL R E S E R V E

SYSTEM

a n d is held t o g e t h e r t h r o u g h s t o c k h o l d i n g s , i n t e r l o c k i n g d i r e c t o r ates, a n d o t h e r f o r m s of d o m i n a t i o n o v e r b a n k s , trust c o m p a n i e s , r a i l r o a d s , p u b l i c service, a n d i n d u s t r i a l c o r p o r a t i o n s , a n d w h i c h h a s resulted in a v a s t a n d g r o w i n g c o n c e n t r a t i o n of c o n t r o l of m o n e y a n d c r e d i t in t h e h a n d s of a c o m p a r a t i v e l y few m e n . '

This "money trust" used its powers of control to promote its own selfish welfare by restricting the flow of credit and thus limiting the force of competition among industrial companies. So said the Pujo Committee. Prior to the passage of the Federal Reserve Act, President Wilson stated that as long as this "money trust" existed : O u r old v a r i e t y a n d f r e e d o m a n d i n d i v i d u a l e n e r g y of d e v e l o p m e n t a r e o u t of t h e q u e s t i o n . A g r e a t i n d u s t r i a l n a t i o n is c o n trolled b y its s y s t e m of c r e d i t . O u r system is p r i v a t e l y

concen-

trated.5

Hence any program of reorganization of the nation's money and banking system would be required not only to offset but also to oppose the power of large private banks. In the President's view it was clear that the Federal Reserve Act fulfilled this requirement and therefore was desirable legislation. The same reason explains, at least in part, why the Democratic members of Congress opposed and defeated the enactment of what was called the Aldrich Bill. Aldrich Plan T h e Aldrich Bill was related to an intensive and lengthy investigation conducted by the National Monetary Commission. This commission was organized by Congress in June, 1908, to inquire into and report necessary and desirable * U.S., Congress, House, Committee on Banking and Currency, Report, Concentration of Control of Money and Credit, Report No. 1593, 62d Cong., 3d Sess., p. 130. 5 Glass, op. cit., p. 79.

THE NECESSITY

FOR

INDEPENDENCE

45

changes in the nation's banking and currency system. It was composed of nine Senators and nine Representatives; its chairman was Senator Nelson W. Aldrich. Over a period of three and a half years the Commission conducted public hearings and investigations in a dozen or more large cities, visited various European banking institutions, and employed experts to write reports on the United States banking system.' In January, 1911, Senator Aldrich presented to a group of business men in Washington a plan for reform of the nation's banking and currency system. This became known as the Aldrich Plan; it was the Senator's personal proposal and not the direct product of deliberations of the National Monetary Commission.' After revision and redrafting, this plan was accepted by the Commission and, along with a report on the Commission's work, was submitted to Congress in January, 1912. No action was taken on the bill at that time nor in 1913, when the bill was reintroduced. Part of the opposition to the plan was based upon the role of private bankers both in the origin of the plan and in the proposed organization. In addition, the Aldrich Bill failed to win adequate support because it was identified with a Republican Senator (the father-in-law of John D. Rockefeller, Jr., and the co-author of the protectionist Payne-Aldrich Tariff Act of 1909) and submitted to a Congress with a Democratic majority.' " As a result of the Commission's work, twenty-three volumes (more than 15,000 pages) w e r e issued u n d e r the general title of Publications of the National Monetary Commission. Most of the material was a reprint of previously published material, in some cases revised a n d b r o u g h t u p to date. (N. A. Weston, " T h e Studies of t h e N a t i o n a l M o n e t a r y C o m mission." The Annals, X C I X [January, 1922], pp. 18-19.) ' Ibid., p. 21. Also, J. Lawrence Laughlin, The Federal Reserve Act — Its Origin and Problems (New Y o r k : T h e M a c m i l l a n C o m p a n y , 1933), p. 15. " W e s t o n , op. cit., p. 23. Laughlin, op. cit., pp. 15-16, 38. Paul M . W a r b u r g , The Federal Reserve System —Its Origin and Growth (New Y o r k : T h e M a c m i l l a n C o m p a n y , 1930), I, pp. 6 0 - 6 2 , 6 6 - 6 8 , 7 6 - 7 7 , 79.

46

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

The main feature of the Aldrich Bill provided for a centralized control of banking and currency. There was to be a national reserve association with fifteen regional branches. The main bank would control (1) the issuance of currency based on cash reserves as well as government bonds, (2) the rediscounting of commercial paper presented by member banks, and (3) the disccunt rate. It would acquire its capital through stock subscription of member banks, hold deposits of member banks and of the government, and engage in open-market operations. All profits exceeding the 5 per cent to be paid as dividends on its stock would be turned over to the United States Treasury. The controlling board of directors would have forty-six members. Of these, thirty would be elected by the fifteen branch banks, and nine by the subscribing banks (with a voting power in proportion to their stock subscriptions). The governor, however, would be appointed for a ten-year period by the President of the United States from a list of three suggested choices submitted by the association. He would have two deputies chosen by the board of directors. Three Cabinet members (Secretaries of the Treasury, of Agriculture, and of Commerce and Labor) as well as the Comptroller of the Currency would be ex officio members of the central board. The House Banking and Currency Committee, under the Chairmanship of Carter Glass, objected to the Aldrich Bill on numerous counts, the principal ones being: (1) it did not provide for adequate governmental or public contrcl of the banking system which it set up; (2) it tended to give voting control to the larger banks in the system and to promote their interests, thereby abetting their already existing monopoly in the banking business; (3) its currency reform was inherently and dangerously inflationary; (4) its organization of the new sysLawrence E. Clark, Central Banking under the Federal Reserve (New Y o r k : T h e Macmillan Company, 1935), p p . 2 4 , 28-29.

System

THE NECESSITY

FOR I N D E P E N D E N C E

47

tem was clumsy.' Although Chairman Glass thus spoke against the control arrangement and expediency of the Aldrich Bill, he acknowledged that it did not provide a "scheme to create a central bank which would absorb all banking functions to itself," inasmuch as the bank to be established did not do a general banking business. It was, however, " a central bank m many of the aspects that are usually regarded as characteristic of that term.'" Senator Robert Owen, Chairman of the Senate Banking and Currency Committee, was equally opposed to the centralizing and private control aspects of the Aldrich Bill. In speaking about this, he said : The comparative independence of the various districts of the country was ignored, the concentration of banking power was very extreme, and . . . the national credit system was placed in the control of private persons, without adequate supervision or control by the government of the United States." The criticisms of Glass and Owen were, in part, echoes of strong words used by a former Secretary of the Treasury, Leslie M . Shaw, a Republican. Shortly after Senator Aldrich made his plan public, ex-Secretary Shaw denounced it as vicious. He judged that the National Reserve Association was : . . . the same central bank which Mr. Aldrich and all the interests, Wall Street in the lead, have favored for years. . . . Is any* U.S., Congress, House, Committee on Banking and Currency, Report, Changes in the Banking and Currency System of the United States, Report No. 69, 63d Cong., 1st Sess., September 9, 1913, pp.10-11. (This report and other reports on major banking acts were republished, February 10, 1958, by the House Committee on Banking and Currency, 85th Congress.) Cited hereafter as the Glass Report, 1913. 10 Ibid. " U.S., Congress, Senate, Committee on Banking and Currency, Report, Banking and Currency, Report No. 133, Part 1, 63d Cong., 1st Sess., November 22, 1913, p. 6. Cited hereafter as the Ówen Report, 1913.

48

THF. I N D E P E N D E N C E O F THF. F E D E R A L R E S E R V E

SYSTEM

one credulous enough to suppose that Wall Street will be unable to control each and all of the fifteen groups? . . . Such an institution, whatever its name, puts the business of the United States of America absolutely and irretrievably in the hands of Wall Street." Opposition to the Aldrich Bill, therefore, was based on resistance to control by the private banks as well as to a centralized organization which would be conducive to a monopolistic control by a few large banks. T h i s was only one part of the opposition to centralization. A monetary system unified under a central bank was more susceptible to absorption by the government. Hence, a centralized banking organization was opposed also because it increased the danger of a government monopoly. Distrust of Control by Treasury William G. M c A d o o was Secretary of the Treasury at the time the Federal Reserve Act was passed. Writing in his reminiscences (in 1931) about the need for banking and currency reform, he criticized the monetary control actions of the Treasury : An enormous amount of idle money was held in the United States Treasury. At times the Treasury deposited funds, in varying amounts in certain national banks to help business, but this aid was erratic and whimsical. Many banks received no government deposits at all, and large sections of the country were neglected. The entire system was the victim of a kind of irregular and vicious centralization. In the course of time the Treasury became a helpless and pathetic spectator of the course of finance. T h e money power of the country passed into the hands of a few financiers and big bankers, Laughlin, op. cit., pp. 38-39.

THE NECESSITY

FOR I N D E P E N D E N C E

49

a n d the T r e a s u r y itself, t h r o u g h politics a n d m a n i p u l a t i o n , a c t e d in s y m p a t h y w i t h t h e m . "

The new banking and currency law was to remedy these faults, but it was not readily agreed on all sides that the cure was better than the defect. In November, 1914, when the Federal Reserve Banks were beginning their operations, President Woodrow Wilson sent a happy letter to his Secretary of the Treasury about the Federal Reserve System. He reminded his Secretary that "supervision and control" in the new system was "in the hands of a responsible agency of the government itself."" He specified this idea further : In the anxious times through which we have been passing, you have, my dear Mr. Secretary, been able to do many noteworthy things to strengthen and facilitate the business operations of the country. Henceforth, you have a new instrument at hand which will render many parts of your task easy.15 These words of the President evoked fear on the part of bankers and the financial press. The Commercial & Financial Chronicle commented : "It is from endeavoring to make the new banking system an instrument in the hands of a " William G. McAdoo, Crowded Years (New York : Houghton Mifflin Company, 1931), pp. 211-212. Later in the same reminiscenses, Secretary McAdoo took a different view- of his own monetary actions as Secretary : O n June 30, 1913, there was approximately $165,000,000 in the general fund of the Treasury. According to the best estimates this amount was much more than would be needed to move the crops. I determined to deposit the necessary money, not in New York, but in the leading cities in the agricultural states. . . . It was necessary of course, for the banks to give security for these deposits. . . . I decided . . . to accept commercial paper fin addition to government, state, and municipal bonds] as security. . . . By taking such paper the Treasury was, in effect, rediscoenting for the national banks, thereby giving an object lesson in the benefits which the new banking legislation would provide. . . . T h e operation was highly successful. (Pp. 246-247.) "Commercial & Financial Chronicle, X C I X (November 21, 1914), 1497. 15 Ibid.

50

T H E I N D E P E N D E N C E OF THF. FEDERAL R E S E R V E

SYSTEM

Government official like the Secretary of the Treasury that the most is to be feared.'"" T h e content of this " f e a r " was expressed in an earlier editorial by the same financial journal : A few years ago, when the United States Treasury was burdened with excessive revenues and the money market depended upon the whim of the Secretary of the Treasury, practically all public men, of whatever shade of political belief, were agreed that the Government ought to be taken out of the banking business. Today, with a new banking system enacted, what do we find? T h e Secretary of the Treasury omnipotent and supreme, and everything dependent upon his discretion; also, he is a dispenser of favors. . . T h i s distrust of control by the Treasury was discussed by others. In a book published in February, 1 9 1 4 , two writers expressed a similar judgment about the Federal Reserve Act. For many years criticism has been leveled against the policies of Secretaries Shaw, Cortelyou, and McAdoo, concerning the large amount of power and discretion lodged in the hands of these officials over the vast sums of money representing the balances in the general fund of the government. . . . However great may have been the power of the Secretary heretofore, it pales into insignficance as contrasted with the authority vested in him by virtue of the Federal Reserve Act. He is a power supreme and unaccountable to any authority other than the President, Congress, and, indirectly, the people of the nation." In their opinion the Secretary could use his power to ruin the Federal Reserve System and wreck the entire banking system of the country. Like so many other judgments about future actions of the government, this criticism had to be tempered by an allowance at some point for trust in the integrity of "Ibid., 1481. " Ibid., O c t o b e r 17, 1 9 1 4 , 1 0 8 7 . 1S T h o m a s C o n w a y a n d Ernest M . Patterson, The Operation of the New Bank Act ( P h i l a d e l p h i a : J . B . L i p p i n c o t t C o m p a n y , 1 9 1 4 ) , p. 197.

THE NECESSITY

FOR

INDEPENDENCE

51

the people who act as officers of the government. Accordingly, the judgment about possible abuse of the sort mentioned was qualified by the statement that the harm would not occur "if the right type of men [were] appointed to the office of Secretary of the Treasury.""

Tennessee-Loan

Incident

The qualification allowing for integrity did not satisfy those who challenged the wisdom of control by the Secretary of the Treasury, no matter what they thought about the possibility of his being the "right m a n " for the office. T h e political pressures were too great, and they were false principles of action. As an example of what was feared, financial writers referred to the "Tennessee loan incident." This occurred just shortly before the Federal Reserve Banks started operations. The episode illustrated how the Treasury could be influenced and in turn could exercise its power to put pressure on private banks. In an article in a Memphis, Tennessee, newspaper, dated September 26, 1914," one of the United States Senators from Tennessee related how the Secretary of the Treasury and the Comptroller of the Currency "saved the credit of Tennessee . . . by enabling [the State] to obtain in New York, at the rate to which the State was entiüed, the funds necessary to meet the State's October maturities." T h e State's officials, said the Senator, were unable to obtain these funds on "reasonable" terms and asked him to intercede with the Treasury to cooperate in this financial deal. H e wrote of his success as follows : "Ibid., p. 201. ™ Quoted in Commercial & Financial Chronicle, XCIX (October 3, 1914), 935.

52

THE INDEPENDENCE

OF THE

FEDERAL R E S E R V E

SYSTEM

I h a d a c o n f e r e n c e with the S e c r e t a r y of the T r e a s u r y . . . a n d was assured

t h a t , according

Department,

he w o u l d d o e v e r y t h i n g he could legitimately to

to

assist those w h o were entitled to

the

custom

financial

of

the

Treasury

credit a n d assistance.

[Emphasis supplied.] A t t h e s u g g e s t i o n of t h e T r e a s u r y D e p a r t m e n t , t h e

Senator

m e t w i t h t h e P r e s i d e n t of t h e N e w Y o r k b a n k w h i c h a c t e d a s t h e S t a t e ' s fiscal a g e n t . S i n c e h e w a s n o t a b l e t o o b t a i n

the

l o a n o n a s t r a i g h t b u s i n e s s basis, h e . . . proposed

for the T r e a s u r y D e p a r t m e n t

to c o o p e r a t e by-

m a k i n g a deposit of gold with the N a t i o n a l P a r k B a n k , a n d M r . Delafield [President of the b a n k ] a g r e e d to m a k e the loan 6 per c e n t . . .

if such a deposit was m a d e by the

at

Treasury

D e p a r t m e n t . . . . T h e S e c r e t a r y of the T r e a s u r y a g r e e d to m a k e the necessary deposit . . . a n d the m a t t e r was settled. 11 T h e S e c r e t a r y of t h e T r e a s u r y

confirmed this deal after a

s t o r m of p r o t e s t b r o k e i n t o p u b l i c p r i n t : T h e N a t i o n a l P a r k Bank a g r e e d to take $1,400,000 o n e - y e a r six per cent notes of the S t a t e of T e n n e s s e e at p a r w i t h o u t c o m mission, a n d I a g r e e d to give the b a n k , w h i c h is a r e g u l a r U n i t e d States depository, a special deposit of $400,000, w h i c h is s u b j e c t to call at a n y time. I was glad to d o this in o r d e r to save the S t a t e f r o m a possible d e f a u l t u p o n its obligations w h i c h I w a s told w o u l d h a v e h a p p e n e d if the S t a t e h a d been u n a b l e to effect t h e loan. 13 Although

a resolution

was introduced

in

the

House

of

Representatives by a K a n s a s C o n g r e s s m a n to require t h e Secr e t a r y of t h e T r e a s u r y t o f u r n i s h i n f o r m a t i o n a b o u t all T r e a s ury deposits at the N a t i o n a l P a r k B a n k in a previous threem o n t h p e r i o d , it d i d n o t r e s u l t in a n y

action.

T h e p r e s s u r e e x e r t e d b y t h e T r e a s u r y in t h e ·' Ibid. Ibid., October 10, 1914, 1020.

"Tennessee

T H E N E C E S S I T Y FOR I N D E P E N D E N C E

53

loan" incident was part of a pattern of actions taken by it to enable a n d / o r force commercial banks to modify their loan policies. At the time of the "Tennessee loan" revelation, the Secretary of the Treasury made public charges that banks were hoarding money (by keeping unusually high excess reserves) and were charging unjustifiably high rates of interest. He sent telegrams of complaint about this practice to the clearing house associations of New York, Boston, Chicago, and St. Louis. He published a list of 247 national banks which he declared were hoarding money. O n September 30, 1914, as a further pressure to secure a change in bank policy, the Treasury made the following announcement : Secretary McAdoo today recalled from various banks throughout the country which are maintaining excessive reserves $3,000,000 of Government deposits, to be re-deposited in the Treasury in two installments on the 10th and 20th of October, respectively. These funds will, in the Secretary's discretion, be re-deposited in banks throughout the country which will employ them in the movement of crops and for the benefit of the business situation. The fears that such actions aroused in banking circles were not so much that they portended a growth of the power of the government in the banking business, though this was a matter of deep concern to private bankers. Rather, the fears were that the Treasury would act to promote partisan political goals and to grant favors on a partisan basis. What if the Treasury had control not only of its own funds but of all banking resources? Money and the banking process were too potent for good or evil to be controlled by a partisan governmental organization. This opposition to regulation of the money market by the Treasury Department, "a dispenser of favors," tended to unite various parties interested in reform. For example, in DecemIbid.,

October 3, 1914, p. 938.

54

THE INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

ber, 1912, the outgoing Republican Secretary of the Treasury (Franklin MacVeagh) urged that restrictions on Treasury operations be part of the reform. His proposals included a central agency which would be "free from political or trust control" and at the same time be subject to "adequate and intimate supervision" by the government. This arrangement, he stated, should achieve the desirable objective of "taking the Treasury out of the banking business."" What he wanted to avoid was illustrated at the time by a resolution in the House of Representatives calling on the Treasury to deposit $50,000,000 in national banks "to relieve the stringency in the money market." 5 There was not sufficient support for this resolution. Rather, there was widespread and strong agreement on the Secretary's viewpoint. Later discussions on an allied matter, the issuance of a new type of currency, added a further example of the attitude restrictive of the role of the Treasury.

Issuance

of New

Currency

As already noted, the early proponents of the Federal Reserve Act referred to it as the "currency bill." In their estimation, the provision of an elastic currency was a prime desideratum in any reform scheme. Here also some of them showed their distrust of the Treasury in their discussions about the currency provisions of the Act. Early proposals by Representative Glass did away with national bank notes collater&led by a particular kind of government bonds. In their place the regional banks would ·* Annual Report of the Secretary of the Treasury on the State of the Finances for the Fiscal Year Ended June 30, 1912 (Washington: U.S. Government Printing Office, 1913), p. 3. M Commercial & Financial Chronicle, X C V I I (December 7, 1912), 1508.

THE

NECESSITY

FOR

INDEPENDENCE

55

issue a currency based on short-term commercial paper, backed by a gold reserve fund as well as the assets of the regional banks, and redeemable in gold at the Treasury or the regional banks. These notes (currency) were not to be government notes. T o placate Democrats, such as William Jennings Bryan, then Secretary of State, President Wilson insisted that this currency, even though it did not consist of "government notes," be made also an obligation of the government. T o Representative Glass, and to others, this increased liability, though never likely to be used, was wrong in principle. They did not want the Treasury to have any possible opportunity for claiming control over the issuance of the new currency. They had no answer, however, to the President's insistent persuasion : "The Government liability is a mere thought. And so, if we can hold to the substance of the thing and give the other fellow the shadow, why not do it, if thereby we may save our bill?" M The significance of this "Government liability" feature was complicated by the fact that the currency was issued by the central Board using the facilities of the Treasury but only through the regional Banks and on their initiative. Discretionary control of this procedure was given to the Reserve Banks and the central Board, not to the Treasury. Hence, President Wilson's words about the "substance" and the "shadow.". Later on this arrangement evoked political complaints that the "sovereign function" of the government to issue currency was being improperly handed over to nongovernment authorities in the new system. Reform Statements in Party Platforms The discussion about the structure, powers, and responsibilities of the new banking and currency system took place "''Glass, Adventure

in Constructive

Finance,

p. 113.

56

T H E I N D E P E N D E N C E O F THF. F E D E R A L R E S E R V E

SYSTEM

under the shadow of the platform statements in 1912 of the Democratic, Republican, and Progressive Parties. All three Parties were concerned with the goal of freeing the nation from panics and from the malfunctioning of the banking and currency system which was tied in with unemployment, business depression, and farm marketing problems. Beyond this essential agreement there were differences. The

platform of the

Roosevelt

Progressive

as its leader) declared

Party

(with

Theodore

its position in a section

entitled " I m p r o v e m e n t of the C u r r e n c y " : We believe there exists imperative need for prompt legislation for the improvement of our national currency system. . . . T h e issue of currency is fundamentally a government function and the system should have as basic principles soundness and elasticity. T h e control should be lodged with the government and should be protected from domination or manipulation by Wall Street or any special interest. We are opposed to the so-called Aldrich Currency Bill because its provisions would place our currency and credit system in private hands, not subject to effective public control. 2 ' T h e platform of the Democratic Party emphasized (1) its opposition to the "so-called Aldrich Bill or the establishment of a central bank,""' (2) the importance of "protection from control or domination by what is known as the Money T r u s t , " and (3) the "complete protection from the misuse of the power " Q u o t e d in Warburg, op. cit., p. 78. '"Quoted in Owen Report, 1913, p p . 5 , 105. When Representative Glass made his report to Congress on September 9, 1913, he quoted the Democratic platform as stating opposition to the "Aldrich Bill for the establishment of a central b a n k . " (Glass Report, 1913, p. 7.) Later, in his memoirs, he insisted that the correct reading was " o r th? establishment of a central b a n k . " (Glass, Adventure in Constructive Finance, pp. 31—32, 34, 71, 8 5 - 8 6 . ) According to Warburg, it was widely stated at the time (1912) that the plank as adopted read "/or a central b a n k . " Later, when printed, " e i t h e r by inadvertence or by a Machiavellian trick," the plank was made to read " o r a central b a n k . " (Warburg, op. cit., p. 79.)

THK

NECESSITY

FOR

INDEPENDENCE

57

that wealth gives to those who possess it." Thus, it stressed opposition to private control of any organization formed to revise the nation's banking and currency system. The Republican platform seemed to take a broader stand on the issue. It did not espouse the Aldrich plan or a central bank. As mentioned, its goals in the reformation process were similar to those of the Democratic party. T h e difference was in emphasis on the way to achieve these goals : In attaining these ends the independence of individual banks, whether organized under national or State charters, must be carefully protected, and our banking and currency system must be safeguarded from any possibility of domination by sectional, financial, or political interests.™ It might be said that the Federal Reserve Act, in its original form as well as in its early development, was aimed at preventing private control of the Federal Reserve System, but it also attempted to prevent "domination by sectional, financial, or political interests." From this viewpoint it was more a fulfillment of the Republican platform of 1912 than it was of the platform of the party in power at the time. Structural Arrangement for Independence Representative Glass and Senator Owen, though opposed to the creation of a central bank, willingly conceded that there were advantages to a scheme of centralization. They thought, however, that these advantages could be obtained through a federation of existing banks into groups sufficiently large to provide for the combined use of the banking resources of the nation, thus giving "the strength or cooperating power which is the chief advantage of the centralization." 30 This federation " Q u o t e d in Otven Report, 1913, Glass Report, 1913, p . 12.

10

p. 1 0 6 .

58

THE INDEPENDENCE OF THE

arrangement,

Representative

FEDERAL R E S E R V E

SYSTEM

Glass maintained, would be

theoretically sound and workable : In the United States, with its immense area, numerous natural divisions, still more numerous competing divisions, and abundant outlets to foreign countries, there is no argument, either of banking theory or of expediency, which dictates the creation of a single central banking institution, no matter how skillfully managed, how carefully controlled, or how patriotically conducted.31 The regional groupings proposed by Representative Glass and his committee were to be largely autonomous organizations, which, however, were to be supervised and somehow harmonized by a central authority. In one of the earliest proposals of Glass, this authority was given to the Comptroller of the Currency because of the coordinating work he already performed for the national bank system. When this arrangement was proposed to President Wilson for his approval, the President "laughingly said he was for 'a plenty of centralization, but not for too much.' " 3 J As a counter proposal, the President suggested that a central board be set up as a "capstone" for the new system. One of the early boards proposed by Representative Glass was to have forty-three members. Twenty of these were to be elected by twenty regional banks (National Reserve Banks), and twenty were to be elected by the stockholding member banks. The other three members of the board would be ex officio : the Secretaries of the Treasury and Agriculture and the Comptroller of the Currency." A later proposal by Glass reduced the control board to nine members : three were Government officials (the same ex officio members as the previous plan), three were to be chosen by the President, and " Ibid. " Glass, Adventure in Constructive " McAdoo. op. cit., p. 221.

Finance,

p. 82.

THE NECESSITY

FOR I N D E P E N D E N C E

59

three were to be designated by the Federal Reserve Banks (but these three members were to break off all bank connections before qualifying)." President Wilson objected to the minority representation given to the banks. Although Representative Glass urged the "essential injustice and political expediency" of excluding the banks from representation on the central board, he had to capitulate. As an offset to this all-government central board, President Wilson proposed a new organization which would give advisory voice to private bankers. This advisory council would be elected by the regional banks, and it would meet with the central board in Washington to exchange information with it and on occasion to make recommendations to it. When Representative Glass made his report to the House on September 9, 1913, he proposed a Federal Reserve Board with seven members : the same three ex officio members as previously and, in addition, four members chosen by the President. He also made a proviso for bipartisanship : no more than two of the four appointed members should belong to the same political party. In defense of this proviso he declared : It can not be too emphatically stated that the committee regards the Federal reserve board as a distinctly nonpartisan organization whose functions.are to be wholly divorced from politics. In order, however, to guard absolutely against any suspicion of political bias or one-sidedness, it has been deemed expedient to provide in the law against a preponderance of members of one party." Despite this strong defense, the bipartisan requirement was not included in the Senate version and later was stricken from the bill. The fear of partisan domination evidently was counterM H . Parker Willis, The Federal Reserve System: Legislation, Organization and Operation (New Y o r k : T h e Ronald Press Company, 1923), p. 1538. 13 Glass Report, 1913, p. 43.

60

THE INDEPENDENCE OF THE

FEDERAL R E S E R V E

SYSTEM

balanced by insistence on other norms of selection : experience in banking or finance, and representation of special groups and of special regions of the country. 3 ' Carter Glass and others, inside and outside the government, interested in reform struggled over the structure of the internal safeguards of independence for the new banking and currency system. T h e important organizational

problems—centraliza-

tion versus regionalism, the role of the government, the type of currency to be issued—by necessity were settled through a compromise arrangement. T h e compromise was required to satisfy, in a politically and economically feasible way, those who had a voice in the establishment of the reformation. T h e internal safeguards had to placate both those who held for a central bank as against strictly regional associations and those who were for exclusive government control as opposed to exclusive private control.

Dispersal of Internal

Authority

T h e compromise arrangement for avoiding the accusation of private monopoly or of undue governmental interference relied mainly on a dispersal of internal authority within the new system. Neither the government nor the private banks would be the sole custodian of power. Rather, their powers would be channeled together to work effectively for public purposes as well as for the individual welfare of the private banks. This dispersal of internal authority was evidenced in the plan proposed by Carter Glass and adopted by Congress. T h e pertinent features of the Federal Reserve plan were mainly three. First, Reserve Banks would be established in various regions of the nation. These Banks were to be individ" R. E. Cushraan, The Independent Regulatory York: Oxford University Press, 1941), p. 154.

Commissions

(New

THE NECESSITY

FOR INDEPENDENCE

61

ually organized and controlled as separate corporations so that they ordinarily would not be dependent upon any other part of the country for assistance. Their organization, officers, and powers would be similar to those of national banks." They would, however, function only as "bankers' banks" : doing "for existing banks what an ordinary bank does for its customers.""" They would hold deposits of member banks, the government, and Federal Rese i v e Banks (for exchange purposes)." Members of the boards of directors at the Reserve Banks would be chosen both by the stockholding banks and by the government. Second, a "general board of management" would be set up to provide for the effective inspection of the Reserve Banks and to make sure that they pursued "a banking policy which [would be] uniform for the country as a whole."*0 This central Board would be a government organization and would regulate relationships between Federal Reserve Banks and between them and the government itself. To give effect to its harmonizing and centralizing functions, this Board would have the authority "to compel the joint application of bank resources to the relief of dangerous or stringent conditions in any locality."" Third, a new type of currency would be issued. This currency was designed to respond automatically to business needs expressed in commercial paper. The controlling feature would not be the availability or investment attractiveness of certain government bonds ncr the exclusive judgment of the Treasury or of private banks. Four representative parties would cooperate in the issuance of currency : private banks and the Glass "Ibid., Ibid., "' Ibid., 41 Ibid.. 11

Report, 1913, pp. 32, 36. pp. 16, 32. p. 48. p. 16. p. 18.

62

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

Federal Banks as well as the government agencies, the Federal Reserve Board and the Treasury. All would be acting in response to the "legitimate needs of business." The resulting currency would be the obligations of the discounting bank, the Federal Reserve Bank, and the government. These three arrangements—the regional banks, the central management board, and the currency based on commercial paper and backed by the government—were characteristic features of the new system. They arose out of compromises among the various parties interested in reformation. As such, they were the sources as well as the justification of the independence of the Federal Reserve System.

Internal

Unity

The characteristic features of the new system provided the bases for what might be called a horizontal and a vertical unity. The horizontal unity was based upon the interconnections and similarities of the various Reserve Banks with each other. This type of unity was considered a means of strength for the Reserve Banks lest they be unduly controlled by the "political" Board in Washington. At times it was exploited by the Treasury in its disagreements with the Board; at other times it was denounced by the Treasury as a private power organization which mobilized opposition to the government. The vertical unity, on the other hand, concerned the union of the Board and the Reserve Banks into one working organization. Such an organization was expected to give the System the unified strength and responsibility required for the promotion of its public purposes. It did not deny a place to the government in the functioning of the System. Nonetheless, a strong vertical unity made less likely the weakening of the System by divisive tactics of the Treasury and more likely the exercise of

T H E N E C E S S I T Y FOR INDEPENDENCE

63

its independent judgment in areas of common concern with the Treasury. The interconnections and similarities of the various Reserve Banks were shown in several ways. Each of the Reserve Banks had the same charter, with identical structures, powers, and responsibilities. With the help of the Board they began their corporate existence with the same definition of eligible commercial paper, the same general discount policy, and the same internal management organization. Horizontal unity among the various Reserve Banks also was traceable to two subsidiary organizations. The Federal Advisory Council was made up of representatives from the various regions, who were private bankers and who were chosen by the Reserve Banks. They provided an organization for the sharing of knowledge of the conditions and problems in the various regions with the central Board as well as with their respective Reserve Banks. The second unifying organization, which more directly affected policies and operations of the Reserve Banks, did not have any particular legal basis as did the advisory council just mentioned; but it was perhaps even more effective as a unifying force. The Conference of Governors was made up of the chief executive officer, called a "Governor,"42 from each of the Reserve Banks. These officials started their meetings even before the Reserve Banks began actual operations and worked together for a strong unity which, however, seemed at times to be aimed at reducing the influence of the Federal Reserve Board. The vertical union in the new system was based upon the relationship established between the regional Banks and the central Board. In addition to its supervisory and control 42 T h e title of "Governor" was applied by the Federal Reserve Act to the "active executive officer" (as distinguished from the Chairman) of the Federal Reserve Board.

64

THF. I N D E P E N D E N C E O F T H E

FEDERAL R E S E R V E

SYSTEM

functions the Board was to act as a mediator between the Reserve Banks themselves and also between the Reserve Banks and the government. As mentioned previously, Representative Glass spoke of the Board as ' regulating relationships between the Federal Reserve Banks and between them and the Government itself." Moreover, the Board was to act as an educator. It was expected that the Reserve Banks, though daily concerned with the working details of their operations in their own regions, would acquire a " b r o a d viewpoint" from their contacts with the Federal Reserve Board. As the matter turned out, the first Federal Reserve Board took this role of educator seriously. I n its first annual report (covering the last half of 1914) the Board laid down certain imperatives for the Reserve Banks : be a steadying influence on the nation's business operations, provide leadership where needed, never be an instrument for promotion of the special interests of any private or sectional group. In what might be considered a mandate the Board stated : It should never be lost to sight that the Reserve Banks are invested with much of the quality of a public trust. They were created because of the existence of certain common needs and interests, and they should be administered for the common welfare—for the good of all. T h e more complete adaptation of the credit mechanism and facilities of the country to needs of industry, commerce, and agriculture—with all their seasonal fluctuations and contingencies—should be the constant aim of a Reserve Bank's management. T o provide and maintain a fluid condition of credit such as will make of the Reserve Banks at all times and under all conditions institutions of accommodation in the larger and public sense of the term is the first responsibility of a Reserve Bank." T h e words of instruction given by the Board were also backed "First Annual Report t o n , 1915), p. 17.

of the

Federal

Reserve

Board,

1914

(Washing-

THE

NECESSITY

FOR

INDEPENDENCE

65

up with a threat of enforcement. In the words of the report, the evident duty of each Reserve Bank : . . . is not to await emergencies but by anticipation, to do what it can to prevent them. So also if, at any time, commerce, industry, or agriculture are, in the opinion of the Federal Reserve Board, burdened unduly with excessive interest charges, it will be the clear and imperative duty of the Reserve Board, acting through the discount rate and open market powers, to secure a wider diffusion of credit facilities at reasonable rates." Thus, through its role as an educator the Board was intent on instilling a " b r o a d viewpoint" and thereby unifying the system : the Reserve Banks and the Board.

Ibid.

III The Weaknesses of the Structural Arrangement

THE

FEDERAL

RESERVE

ACT

WAS

PRINCIPALLY

AN

institutional act. It included references to governmental policies and procedures, but its emphasis was on establishing new institutions for reforming the banking and currency system of the nation. Much of the Act was concerned with the delineation of the structure, powers, and responsibilities as well as the actual working of these institutions. Every detail, however, was not spelled out in clear fashion so that all ambiguity was removed. The actual case was quite the opposite. While much attention was paid to the details of the retirement plan for national bank notes and to the workings of the commercial loan theory of banking, a like attention was not used to make clear-cut the authority lines of the several new institutions and the actual objectives and means to be used by these institutions in the reform process as well as in their continuing operation. This lack of definition can be traced to several sources. One was the pressing need, as felt by the legislators and the Executive Department of the government, for action along with the concomitant desire to keep any reform set-up "flexible 66

THE

WEAKNESSES

OF T H E

STRUCTURAL

ARRANGEMENT

67

and adaptable.'" Another source of the vagueness was the lack of knowledge of just what the new organization should do and how it should proceed in this matter. Perhaps the people involved in setting up the new organization did not fully understand what they were doing or what were the potentialities of the organization. A third explanation was found in the "give-and-take" aspect of legislation in an area like banking and currency where feelings and controversy held sway and had to be compromised. President Woodrow Wilson put the point this way : Only a very slight examination of the measures which originate with the Committees is necessary to show that most of them are framed with a view to securing their easy passage. . . . The manifest object is to dress them to the liking of all factions/ Whatever the reason, many of the essentials of the Federal Reserve System waited for later definition by the President or the Congress or by the administrative rulings of the leaders in the System. The precise objectives and tools to be used required time for their specification. So also did the lines of authority. As a result there were perduring weaknesses in the structural arrangement which had been designed to provide independence for the Federal Reserve. Obstacles to Internal Unity Some of the structural weaknesses were manifested in the relationships established between the Federal Reserve Board and the Reserve Banks. Although the Board and the Banks were meant to form one System anc^ to work as one, they separately had control features which made unity difficult in practice. 1 Lester V. Chandler, Benjamin Strong, T h e Brookings Institution, 1958), p. 4.

J

Ibid., p. 5.

Central

Banker

(Washington :

68

THE INDEPENDENCE OF THE

FEDERAL R E S E R V E

SYSTEM

T h e resulting problem could not be solved by appeal to tradition or to practice in foreign countries. Nor could answers always be found by searching ouf the intentions of the lawmakers who wrote the charter legislation. T h e Federal Reserve System developed in new and useful ways, but in ways unexpected and unplanned for. At the outset and through the years much development work in the building of effective cooperation had to be done. In the process, internal frictions, public misunderstandings, and the need for clarification of the respective rights involved became evident. T h e Federal Reserve Board and the Reserve Banks were each a kind of buffer against the independent operation and expansion of the other. Hindrances to the effective cooperation within the one system became manifest when the "buffer" aspects of the organizational arrangement were stressed at the expense of internal unity and responsible control in operations. T h e way was opened for a struggle between the Board and the Banks over their independence within the System and over the expression of the independence of the System in its relations with the Treasury Department. This added a serious complication. Without unified

control over policy in the

public interest it was likely to be difficult to establish the adequacy of the public responsibility of the System which was required for safeguarding its independence.

Autonomy

of Individual

Reserve

Banks

T h e establishment of independent regional banks, that is, banks which were more or less autonomous, was designed to be a key safeguard for the independence of the System. It protected the System in two ways. First, sufficiently strong regional banks prevented one region of the country (especially

THE W E A K N E S S E S OF THE STRUCTURAL ARRANGEMENT

69

New York City) from dominating the nation's banking system. This preventative removed or significantly weakened the danger of private monopoly. Second, the regional arrangement lessened the threat of government domination. A highly centralized organization, one not built upon the regional idea, was considered more susceptible to a takeover by the government. At the outset both the Board in Washington and the Reserve Banks emphasized the regional idea. In 1915, shortly after he became Secretary of the Federal Reserve Board, H . Parker Willis wrote in generous terms about the autonomy of the regional Reserve Banks : The banks, in short, have all those banking powers that are not expressly mentioned in the Federal Reserve Act or directly implied as having been invested in the Federal Reserve Board. . . . Except insofar as limited by this expressed authority, each Federal Reserve Bank is an autonomous institution, responsible for its own acts and conducting its business in its own way. It is neither a branch of a central organization nor of any other Federal Reserve Bank. There is nothing, either in the Federal Reserve Act or in the regulations of the Federal Reserve Board, to indicate that the reserve banks are to be operated in groups or through communication with one another, resulting in the establishment of a single policy as to detail. Neither is there anything to prevent officers of the Federal Reserve Banks from communicating with one another, getting such information as can be exchanged by that means, or adopting their own policies as the circumstances and business needs of each district or of all appear to require." W. P. G. Harding, a member of the original Federal Reserve Board and Governor from 1916 to 1922, agreed with Willis. In 1921, the Governor stated publicly that each 3 H . P a r k e r Willis, The Federal Reserve day, Page a n d Co., 1915), p. 128.

System

(New York : Double-

70

THE INDEPENDENCE OF THE

FEDERAL R E S E R V E

SYSTEM

Federal Reserve Bank was "almost wholly independent of the others in operation as well as in local p o l i c i e s . T h i s independence was cited as proof that "the Federal Reserve Act did not establish a central bank." Later when Harding became Governor of the Reserve Bank in Boston, he continued his defense of the autonomy of the individual Federal Reserve Banks.5 Several powers, or restrictions on powers, of the Federal Reserve Banks, as given in the original Federal Reserve Act, pointed in this direction of autonomy for the separate Banks. First, the discount rate was fixed by the Reserve Bank in cooperation with the Federal Reserve Board, not necessarily in conformity with the other Reserve Banks. Second, the Reserve Bank had the authority to engage in open-market operations on the basis of its own judgment. Here again it did not have to consult any other Reserve Bank. Third, Federal Reserve notes issued by one Federal Reserve Bank could not be used by any other Reserve Bank which might receive them unless it paid a penalty tax. In other words, the currency issued by a given Reserve Bank was intended to circulate only in its own district. When it got out of the issuing district and came back for redemption it was supposed to be retired, since it supposedly had performed its original purpose.' These three banking functions (discount rate, open-market transactions, and currency issues) were the sources of the designation of "independence" or "autonomy" applied to the individual Reserve Banks. This localized control over bank credit was considered to be sufficient to deny the applicability of the title of "central bank" to the Federal Reserve System. At the same time, such ' W. P. G. Harding, The Formative Period of the Federal Reserve System (Boston and New Y o r k : Houghton Mifflin Co., 1925), pp. 2 3 2 233. 5 Chandler, op. cit., pp. 2 2 4 - 2 2 6 , 3 1 4 . ' Glass Report, 1913, p. 55.

THF. W E A K N E S S E S

OF T H E

STRUCTURAL ARRANGEMENT

71

localized control seemed to create a barrier to a unified, centralized reserve banking system. Division Between Reserve Banks and Board The original Federal Reserve Act gave the board of directors of each Reserve Bank the power to choose its own operating officials, subject to approval by the Federal Reserve Board of all salaries paid.' At the time of the organization of the Reserve Banks some members of the Board in Washington thought that the Chairman of each Reserve Bank's board of directors should be made the operating head of the Reserve Bank. Since the Chairman by law was the representative of the Federal Reserve Board, his assumption of executive operating duties would provide an intimate connection with the central Board in Washington and would give it a direct control over operations of the Reserve Banks." Even though one of the Reserve Banks attempted to install its Chairman as chief executive officer, the procedure was not approved by the Federal Reserve Board. The main argument used by the Federal Reserve Board in opposing this organizational arrangement was the apparent reasoning behind Section 4 of the Federal Reserve Act which emphasized the regional as opposed 7 Section 11 of the Act also gave the Federal Reserve Board the authority to remove or suspend any officer o r director of a Reserve Bank, provided the Board c o m m u n i c a t e d in writing to the individual a n d t h e Bank involved the cause for its action. * In 1935, M a r r i n e r S. Eccles w a n t e d the Federal Reserve Act changed to provide that the C h a i r m a n of t h e board of directors at e a c h Bank should b e the Governor. H e m e n t i o n e d two reasons for the change. First, it would strengthen the control of t h e Federal Reserve Board over the Reserve Banks. Second, "it appears to have been the intention of the framers of the Federal Reserve Act t h a t t h e c h a i r m a n of the b o a r d of directors be t h e principal executive officer of each b a n k . " (U.S., Congress, Senate, S u b c o m m i t t e e of the C o m m i t t e e o n Banking a n d C u r r e n c y , Hearings on the Banking Act of 1935 [S. 1715], 74th Cong., 1st Sess., 1935, p. 181.)

72

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

to the central banking system. T o have the Federal Reserve Board choose the chief operating officer of the Reserve Banks would be to restrict unlawfully the powers of direction of the boards of directors at the various Reserve Banks." This decision of the Board agreed with that of a group of experts who had been appointed by the Organization Committee to examine into details of organization for the new Reserve Banks. Among the proposals offered by the experts for further discussion was a judgment against combining the two offices : In no case should the president or executive head chosen by the stockholders be designated by the Government as reserve agent. The intent of the act is distinctly opposed to any such fusion of functions, the agent being intended to be a Government representative and to spend his time in furthering the interests of the public at large—a position he could hardly preserve were he to become an active operating officer, anxious to increase profits and advance given private interests.10 While the Federal Reserve Board decided it could not directly control the daily operation of the Reserve Banks, it did not in any way deny the importance and the need for its being represented on the boards of directors of the Reserve Banks and its right to give the necessary approval of all salaries paid. Thus, indirectly, the Federal Reserve Board kept tab on the boards of directors through its appointees and held the determining power of tenure through its salary-control right and its authority to remove or suspend directors and officers. " First Annual Report of the Federal Reserve Board, 1914 (Washington, 1915), pp. 120-124. 10Ibid., p. 121. Although none of the Reserve Banks installed their Chairmen as Governors, three of the Banks had other members of their boards of directors as their first Governors. T h e Banks in Philadelphia and Dallas chose a Class A director, and the Bank in Richmond, a Class Β director, as their first Governors.

THF. W E A K N E S S E S

OF T H E S T R U C T U R A L

ARRANGEMENT

73

Another factor connected with the provision for the separation between the Reserve Banks and the Board was pointed out by the Secretary of the Treasury in an early recommendation he made for a change in the Federal Reserve Act. He wanted the law amended so that the Federal Reserve Board would receive money needed for its own operations from direct appropriations by Congress, which appropriations the Treasury Department would receive from the Reserve Banks through an assessment for this purpose. The reason he gave for this proposal was the desirability of keeping the Board in Washington independent of the Reserve Banks." In his opinion there seemed to be a danger of the undue influence on the part of the Reserve Banks if they were the sources of the operating funds needed by the Federal Reserve Board. Again, this type of reasoning assumed an independence and autonomy for the Reserve Banks; and it did not indicate a desire for a unified system with clear lines of hierarchical authority. This tended to be a hindrance to unified responsibility within the System and a shortcoming in the organizational safeguards of independence.

Extent of Treasury's Authority Prior to the banking crisis of 1907, the Treasury Department under Secretaries Shaw and Cortelyou developed and expanded its monetary control operati cms. The subsequent crisis and evident failure of the Treasury to secure an efficient and stable banking and credit system provided an argument for those who wanted to restrict the monetary powers of the " According to W. P. G. Harding, a member of the Board at the time, this was part of the Secretary's plan to take over the Federal Reserve Board and make it an adjunct of the Treasury Department. Cf. Harding, op. cit., pp. 7 - 9 .

74

THE INDEPENDENCE OF THE

FEDERAL R E S E R V E

SYSTEM

Treasury. The authority of the Treasury to manage the deposits of its general fund should be handed over to the authority in the new Federal Reserve System. Others argued that the failure of the Treasury to prevent the recent monetary crisis was due to arbitrary limitations on the authority of the Treasury and to the way the national banking system was organized, not to essential weaknesses or improprieties in the Treasury's procedures." A new banking act could provide the reorganization

needed

to assure

the effectiveness

of

the

Treasury's procedures. Carter

Glass

accepted

in

principle

the

independent

Treasury system. T h e shifting of government deposits from place to place could be helpful. T h e existing system, however, produced a ''vicious and wholly artificial state of things."" What was needed was a government authority better informed about banking and credit conditions as they existed in the various sections of the country. T h e Federal Reserve Banks should be made the fiscal agents of the government, and the management of the Treasury's general fund should be controlled by the Federal Reserve Board and the Secretary of the Treasury.

The

Federal

Reserve

Banks,

which

would

be

involved in this management, would not be motivated by considerations of private profit. T h e Treasury, moreover, would benefit by the banking contacts it would acquire in this cooperative arrangement. Senator Robert Owen,

however,

argued effectively for the independence

Treasury

of the

through the continued management of its deposits and, in general, the maintenance of its existing authority." T h e posi'" Paul Studenski and Herman E. Krooss, Financial History of the United States (New Y o r k : McGraw-Hill Book Company, Inc., 1952), pp. 2 5 0 - 2 5 2 . Class Report, 1913, p. 29. " Owen Report, 1913, pp. 2 6 - 2 7 .

THE

WEAKNESSES

OF

THE

STRUCTURAL

ARRANGEMENT

75

tion of Owen was the basis of the compromise which, in the end, was adopted. The Federal Reserve Act did not take away all monetary and banking power from the Treasury. It retained for the Treasury a significant amount of authority and seemed to add to the strength of that authority. Thus the Treasury Department had certain areas of discretion which could hamper the operations of the Federal Reserve and help the Treasury enforce its own judgments. Despite the early fears, this overlapping of authority, of itself, did not make the Treasury Department supreme and omnipotent in its relations with the Federal Reserve. At a minimum, however, it limited the independence of the Federal Reserve. Monetary

Powers

The Federal Reserve System did not begin operations with an organization totally distinct from the Treasury Department. Three of the original members of the Federal Reserve Board had a connection with the Treasury : (1) the Secretary of the Treasury (ex officio Chairman of the Board); (2) the Comptroller of the Currency; and (3) the Governor of the Board, Charles S. Hamlin, who at the time of his appointment was Assistant Secretary of the Treasury. The monetary and banking powers already held by the first two of these members greatly enhanced their position and influence on the Federal Reserve Board. Control of Government Deposits. One of the important powers kept by the Treasury was control of its deposits of the general fund of the government. Probably due to the influence of the Secretary of the Treasury and the "Bryan faction" in the Administration, the Federal Reserve Act did not require the Treasury to maintain its deposits at the Federal Reserve

76

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

Banks. Deposits of this sort were considered very important for the initial soundness of the System. Hence, the option gave the Treasury a great leverage factor in enforcing its point of view about banking and credit conditions. A few weeks prior to the opening of the Federal Reserve Banks, Secretary McAdoo announced that as soon as the Reserve Banks were in operation he would transfer to them as large amounts as possible of the government's general f u n d . He expected that this procedure would increase the resources available to private banks and thus enlarge the availability of credit for business. The Treasury would be more flexible in the use of its deposits, and the Federal Reserve Banks would be better able to grant credit to member banks." Later, the Secretary changed his mind. Shortly after the opening of the Federal Reserve Banks rumors of a disagreement between the Treasury and a minority on the Board concerning the monetary manipulation of the Treasury's funds broke into public print."· Although the rumors were officially denied, the action of the Treasury seemed to support them. T h e Treasury made no deposits in the Federal Banks until almost a year had passed since the beginning of the Banks' operations, and it did not give u p its subtreasury system until seven years later (1921). Overlapping Authority. Section 10 of the Federal Reserve Act, concerned with the Federal Reserve Board, had something to say about the relations between the Board and the Treasury Department. First of all, this Section of the Act stated that the Federal Reserve Act took away none of the powers then held by the Secretary and, further, that if any powers granted to the Board appeared to conflict with those of the Secretary, then "such powers shall be exercised subject to 15

Commerciai & Financial Chronicle, XCIX (October 31, 1914), 1261. "Ibid., November 28, 1914, 1566.

THE W E A K N E S S E S

OF T H E S T R U C T U R A I . A R R A N G E M E N T

77

the supervision and control of the Secretary." Second, Section 10 attempted to clarify and strengthen the position of the Comptroller of the Currency in the Treasury Department : There shall be in the Department of the Treasury a bureau charged with the execution of all laws passed by Congress relating to the issue and regulation of national currency secured by United States bonds and, under the general supervision of the Federal Reserve Board, of all Federal Reserve notes, the chief officer of which bureau shall be called the Comptroller of the Currency and shall perform his duties under the general directions of the Secretary of the Treasury. Thus the Comptroller was responsible for the execution of laws relating to the issuance of Federal Reserve notes (which were provided by the Treasury and issued by the Federal Reserve Board, through the Federal Reserve Banks and on their initiative). This he was to do "under the general supervision of the Federal Reserve Board" and "under the general directions of the Secretary of the Treasury." Truly, he might have to become a Janus, watching over the doorway to the nation's currency : one face toward the Board and one face toward the Treasury. In the context of the previously mentioned rule set down in Section 10, if any conflict arose, the Secretary's directions would prevail. In addition to this currency supervisory function, the Comptroller of the Currency also had the power of approving the establishment, and of supervising the operation, of national banks. This directly pertained to the Federal Reserve System and to the powers of the Federal Reserve Board, since national banks were expected to become member banks of the System. It happened in the early years of the Federal Reserve that the Comptroller of the Currency failed to accommodate his procedures and policies to those of the Board. For example, he at times refused to pass along to the Reserve Banks the full

78

THF. I N D E P E N D E N C E

OF T H E FEDERAL R E S E R V E

SYSTEM

results of his examinations of national banks and preferred to carry on his work with a good deal of independence. More importantly, he at times contravened the Board on the matter of membership in the System. There were cases where the Board refused to accept certain state banks as members, only to have their decisions overturned when the Comptroller of the Currency granted these same banks charters as national banks and thereby enabled them to become members."

Other Means of Treasury

Control

A further circumstance which tied in the Board with the Treasury was the auditing and supervision of operating funds which the Board obtained through assessments on the Reserve Banks. Shortly after the Banks began operations the Attorney General of the United States ruled that these assessments constituted "public moneys" within the meaning of the auditing statutes of the government. At about the same time, the solicitor of the Treasury ruled that these funds should be deposited in the Treasury and could only be withdrawn by following ordinary Treasury procedure." This ruling further meant that the Federal Reserve Board subjected itself and its actions to government audit and examination. Commenting on the results of this ruling, the Secretary of the Board stated : " T h e worse effect of it was found that it tended more and more to give the Board the character of a regular routine bureau or office organized and operated like other government bureaus."" " Harding, op. cit., p. 6. " Willis, The Federal Reserve System: Legislation, Organization and Operation, p. 673. Also, First Annual Report of the Federal Reserve Board, 1914 (Washington, 1915), pp. 5 4 - 5 7 . " Willis, The Federai Reserve System: Legislation, Organization and Operation, p. 674.

THE WEAKNESSES

The

OF T H E

STRUCTURAL ARRANGEMENT

Secretary of the Federal

Reserve B o a r d

also

79

con-

d e m n e d , a n d with surprising vigor, another procedure relating to the authority of the T r e a s u r y over the B o a r d . T h i s w a s a physical a n d psychological factor which in historical perspective would be j u d g e d of little importance, but which at the time l o o m e d large in the m i n d s of the original B o a r d m e m b e r s a n d a p p a r e n t l y circumscribed their actions in an annoying, if not contravening, way. T h e first h e a d q u a r t e r s f o r the F e d e r a l Reserve B o a r d a n d its staff were in the T r e a s u r y building. T h i s w a s in keeping with Section 10 of the Federal Reserve Act which stated : " T h e S e c r e t a r y of the T r e a s u r y m a y . assign offices in the D e p a r t m e n t of the T r e a s u r y for the use of the F e d e r a l R e s e r v e B o a r d . " A s a matter of fact, the Secretary of the T r e a s u r y insisted on the B o a r d ' s being located in the T r e a s u r y building, even though the quarters he provided were hardly to the liking of the B o a r d . H . Parker Willis saw a significance in this a r r a n g e m e n t which went beyond the inconvenience it entailed : During the first year or two of its tenancy of the rooms in the Treasury, there was constant complaint on the part of members and from time to time a proposal to take quarters in some other building. O n e member of the Board even called attention to the fact that there was nothing in the act compelling the retention of the head office at Washington and proposed that it be moved to Chicago. Such a course would have effectively prevented the Secretary of the Treasury from attending any of the meetings and the suggestion was never very seriously urged. . . . T h e organization itself never had the courage to act upon its own instincts and the result was that as time passed it gradually became more and more dependent upon Treasury dictation and less and less able to assert itself independent of the Treasury authorities. This was perhaps the most fundamental error in the process of organization, since it forever condemned the Board to a position of subordination and definitely established it as in fact,

80

THE INDEPENDENCE OF THE FEDERAL R E S E R V E S Y S T E M

e v e n if not in theory, a portion of the organization of

the

Department.'"

Legal

Ruling

on Independence

of the

Board

Nearly all the various items mentioned as tending to make the Federal Reserve Board subservient to, or a part of, the Treasury Department were actually used by the Attorney General of the United States in making a ruling on the status of the Federal Reserve Board at the request of the Secretary of the Treasury. In the light of the history of the Federal Reserve Act, the general scheme of the Act, the powers and duties of the Federal Reserve Board, and the manner of their fulfilment, he ruled that the Board was a government establishment, independent of the Treasury and not a bureau or division of the Treasury. This ruling rested upon two sources: (1) explanations of the status of the Board which appeared in reports made by Representative Carter Glass to Congress on the proposed Federal Reserve Act and (2) Section 10 of the Act as amended and passed. All these references pointed to the facts that the Secretary of the Treasury and the Federal Reserve Board were "distinct entities," "coordinate officials," and that the Federal Reserve Board had powers independent of the Secretary in cases where there was no conflict with the Treasury's already existing powers." Thus there were two separate parties involved : the Treasury Department and the Federal Reserve Board, but the independence which existed had limits when its implementation or fulfillment conflicted with the Treasury's exercise of its own powers. Supposedly, therefore, the Secretary of the Treasury shared in a new power but did not necessarily lose any of his old power. Ibid. Ibid., pp. 681-686. Also, First Annual Report Board, 1914 (Washington, 1915), pp. 54-57. M

11

of the Federal

Reserve

THE

WEAKNESSES

OF

THE

STRUCTURAL

ARRANGEMENT

81

Exposure to Political Pressures There was another type of weakness in the structural arrangement for independence which could have considerable influence on the policies and operations of the Federal Reserve System. It was not to be expected that any organizational arrangement would preclude any exposure to political pressures. Political influences of various sorts would have to be lived with and, in some cases, actively cooperated with. The most that could be hoped for was that such influences would be channeled to help rather than hinder the Federal Reserve in its work. The System exercised a government power, it had public purposes, and it was responsible for its performance. It was, therefore, connected with the government and subject to the influence of the government and to some degree subject to those influences impinging on the government itself. In its early days, when the Federal Reserve System was seeking to establish itself as an integral part of the functioning of the economy, it was blessed with freedom from the pressure of government officials seeking to secure a loan arrangement for themselves or their friends. This was true because the Federal Reserve Banks did not do business with individuals but only with banks. Thus, the System did not repeat some of the history of the unsavory loan arrangements entered into by the only other banks designed to perform central banking functions—the first and second Bank of the United States. There were, however, other manifestations of political influence. Three types of political pressure expressed themselves almost from the start of the Federal Reserve System. They can be called (1) sociological, (2) compensatory, and (3) environmental.

82

THE INDEPENDENCE

Particular

Group

OF THE

FEDERAL

RESERVE

SYSTEM

Interests

T h e "sociological" type of influence which early expressed itself had its origin in the desire of Congressional and lobby representatives to have the System shape its policy, especially its discount policy, in the interests of a given class or group which they represented. H. Parker Willis, as guardian of the fulfillment of the Act he helped to write, explained

and

criticized this type of influence. The thought of those who have urged concessions in discount rates has no doubt been that the particular interests which they represented were so closely identified with national welfare as to warrant the adoption of every kind of pressure with a view to securing exceptionally favorable treatment for them. Such an attitude is, of course, wholly foreign to the concept of a scientific banking system, and is undoubtedly to be classed as an exemplification of that "political influence" which has been so greatly feared in times past. Should such efforts be continued and extended, as there is reason to fear that they may be, the result might easily be the adoption of policies which would result in serious unsoundness in the banking system, and might operate largely to vitiate the entire structure of finance upon which it is founded." Although the Secretary of the Board wrote this opinion early in the second decade of the history of the System, his words might apply to the very beginning. From its start the Federal Reserve was intended to permit the Treasury to withdraw from operating in the money market. Before this the Treasury, as mentioned previously in this chapter, at times intervened in the market to procure special treatment for "particular interests," especially those of farmers and cotton producers. Willis, The Federal Operation, p. 1500.

Reserve

System:

Legislation,

Organization

and

T H E W E A K N E S S E S O F T H E STRUCTURAL ARRANGEMENT

83

The withdrawal of the Treasury from such operations left a tradition behind, and some people expected that the new arrangement provided by the Federal Reserve System would not ignore the tradition and so would not hesitate to step into the Treasury's former role. There was, of course, more than tradition involved here ; there was also the recurring appeal to the government for help in setting aright local disturbances. From such influence the Federal Reserve System was never free, even in its earliest days. Appointment

of Federal

Reserve

Officials

Another type of political influence, called "compensatory," was concerned mainly with political appointments to the various offices available in the Federal Reserve System, both in the Reserve Banks and the Washington Board. At the very start of the System the unavailability of such appointments was misunderstood and condemned : From the beginning rich "pickings" were recognized by politicians as existing in the federal reserve system, and mulitudinous applications for "places" not only in the Board and its staff but in the banks and practically throughout the system were received. It was to the credit of the [Wilson] administration that it yielded so little to this heavy pressure and maintained practically from the beginning the view that the federal reserve system was to be regarded as absolutely immune to political preference or favoritism—a thing wholly isolated and apart from the usual considerations affecting appointments. . . . This attitude, however, had not been assumed without arousing the anger of politicians. Their attitude was promptly evident in various speeches and outgivings as well as in attempts to embarrass the administration in various ways. Even within the very first few weeks after the organization of the Board had been set up, there came to it memoranda and letters from politicians hinting at the

84

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

desirability of concessions when the Board's annual

appropria-

tions came before Congress for adoption. T h o s e w h o w r o t e in this manner had o v e r l o o k e d the fact that the F e d e r a l Act

had

Federal

carried Reserve

expenses by

an

inconspicuous

Board to obtain

assessing

the

provision

the

necessary m o n e y

federal reserve

Reserve

authorizing

banks. . . .

the

f o r its It

may

tie doubted whether Congress or the administration had r e c o g nized the importance of this provision and

the significance of

the independence that it might bestow upon the B o a r d , but it served an excellent purpose in the early years of

the

system

b y enabling the Board to withstand much of the pressure both f r o m Congress and the executive branch of the G o v e r n m e n t . "

Thus, the breaking of one of the links between a government agency and the government—namely, the need for Congressionally appropriated funds—gave the initial Federal Reserve Board some power to resist the efforts of the Congressmen and the Executive Department

of the government

to use the

System as a source of patronage for the satisfaction of political debts. This power of resistance, of course, was not complete; but it was significant and effective to a considerable extent. Moreover, it had the auxiliary result that the relationship of the System to the government was clearly different from that of other government agencies.

Governmental

Policies

A third type of political influence might be called "environmental"; that is, it arose out of the political and economic circumstances and forces which surrounded a monetary agency of the government. Its importance depended upon how the government particularized its political programs in economic action. As the area of operations of the government in the :3

Ibid.,

pp. 557-558.

THE

WEAKNESSES

OF T H E

STRUCTURAL

ARRANGEMENT

85

economic life of the nation expanded, the relationships of the government to the Federal Reserve System changed, and the idea of isolation for the monetary authority became politically unfeasible and even undesirable. At the start of the Federal Reserve System, Treasury operations which were concerned with the management of the government's cash, of the government's debt, of the nation's currency, and of foreign-trade relations affected the powers and responsibilities of the new System. As these operations increased in scope they brought into sharper focus the limits, as well as the content, of the independence of the System. Such pressures, of course, were not political influences in any sinister or improper sense. Whatever else might be said about these influences, they came to be tied in with the growth in the specification of the policies and objectives of a sovereign and responsible government. This became clear in the early days of the Federal Reserve System when war broke out in Europe and finally engaged the United States. T h e effect of wartime financial exigencies on the Federal Reserve System's independence with respect to the government—an environment totally changed from that envisioned for the start of the new banking and currency system—was to emphasize in the minds of some Federal Reserve officials the importance of learning how to live with certain political pressures.

IV The Operational Problems of Independence—1914-1930

MOST

OF

THE

IMMEDIATELY

PATENT

PURPOSES

OF

THE

Federal Reserve System—the providing of an elastic currency, the marshaling of bank reserves, the establishment of a more efficient check-clearance system, and a more effective supervision of commercial banks—were achieved early in its history. O t h e r purposes, such as the development

of a

market

of

for

acceptances

and

the

growth

flourishing independent

monetary centers apart from New York, were never fulfilled. O n c e certain tangible evidence of achievement was manifest, there was a kind of pause in the rapid growth of the Federal Reserve. T h e System did not readily acquire the strength of internal unity and external support for broader

action in

keeping with its objectives. Fundamentally, what was lacking was a clear-cut and universally accepted agreement on the powers it had, and how they could or should be used. Hence the meaning of cooperation as distinguished from domination, as it applied to working with the Treasury and the private banks, and the difference between responsibility and responsiveness, as it applied to relations with Congress, were not clearly seen or acted upon. 86

T H E O P E R A T I O N A L P R O B L E M S OF I N D E P E N D E N C E

— 1914—1930

87

As the Federal Reserve System acquired experience, the influence of the Treasury, of private banks, and of Congress on its independence came to be expressed in new and different ways. For one thing, the early dominating fear of private monopoly tended to diminish : J. Pierpont Morgan, who epitomized the Wall Street threat, died in 1913, about the time the Federal Reserve System prepared to begin operations ; the Money Trust lost its most prominent symbol and apologist. In addition, the fear of private monoply was overshadowed by the expanding participation of the Treasury in the money market öfter the outbreak of the first World War. In working for an independent status in a national economy gradually being dominated by the necessities of war, the System became concerned about the effectiveness of the structural arrangement for maintaining its power and responsibility. The growth in magnitude of government financing operations, however, did not remove all concern about private influences. Even during the war period when such influences were in the shadow, they still complicated the picture. Likewise the calls from Congress, though less frequent and less urgent than when the System was struggling to be born, kept reminding the officials of the System that they did not have complete freedom to carry on their work as they pleased. What was done in a negative way to protect independence tended to hinder what was done in a positive way to promote independence. In the cycle of depression and prosperity of the Twenties, when the Federal Reserve System exercised a newlyfound independence in monetary control operations, it was sometimes weak in unified leadership. An internal struggle over the prerogatives of authority and the fulfillment of responsibility hindered clearly-directed and effective action. The lack of unity here, in turn, abetted a resumption of

88

THF. I N D E P E N D E N C E O F T H E

FEDERAL R E S E R V E

SYSTEM

leadership in monetary affairs by the government through its expanded fiscal operations and monetary powers. Early Struggle for Unified Authority The lack of unity and strength within the Federal Reserve System resulted in part from a divisive attitude among its leaders. Such division was encouraged by the System's underlying complicated structure and power elements. For example, the two main organizations within the System did not work together as one. T h e Federal Reserve Board did not provide the strength of union, within itself or within the System. At times it was held at arm's length by the Reserve Banks because it was considered to be a government agency with general power of supervision over Federal Reserve Banks which were not government agencies in the same way. What this supervisory power meant in terms of coercive and initiatory power was not clearly set forth in the law and consequently not readily acted upon by the Board or accepted by the Reserve Banks. This situation presented the Treasury with the opportunity to exercise its rights not to cooperate fully with the Board and even to bypass it. On the other hand, the Federal Reserve Banks embraced governmental and private elements in their structure, powers, and responsibilities. They were legally under the supervision of the Federal Reserve Board, but they were also the depositories of broad banking powers which they could use, or try to use, apart from any instructions from the Board. Moreover, they tended to ally themselves with private banks and to cooperate closely with the Treasury Department. The law was not clear that they should act otherwise, that is, with any necessity to wait for any particular or general authorization or initiative from the Federal Reserve Board. At the same time

THF. O P E R A T I O N A L P R O B L E M S O F I N D E P E N D E N C E —

1914-1930

89

there was an awareness that Congress could change the law. Shortly after the Federal Reserve System began operations two attempts were made within the System to strengthen its internal unity and thereby its control arrangement. T h e expected result would make the System more effective and enable it to manifest greater responsibility in working toward its objectives. The first of these attempts concerned the power of the Federal Reserve Board over the Reserve Banks. Here the proposal was to tighten the control power of the central organization. The second of the attempts at increasing unity was to promote a working unity among the Reserve Banks apart from the Board.

Attempted

Reduction

in Number

of Banks

According to the Federal Reserve Act, the Organization Committee had authority to arrange for the establishment of no less than eight and no more than twelve Federal Reserve Banks. Twelve were organized. After the first full year of operation (1915), the operating losses of several of the Banks were large enough to cause the Banks as a group to operate at a loss. Already in November, 1915, four of the appointive members of the Federal Reserve Board seriously considered reducing the number of Reserve Banks to eight and maybe to six.' This was to be accomplished, not by liquidating any Reserve Banks, but by changing certain ones into branches of the remaining ones. Paul M . Warburg, one of the Board members who sponsored the change, stated that these Reserve Banks, by becoming branch banks: 1 T h e Banks to be dropped were those in Atlanta, Dallas, Kansas City, and Minneapolis. Action on the Richmond and Boston Banks was deferred to a later date. (Glass, Adventure in Constructive Finance, p. 257.)

90

T H E INDEPENDENCE OF THE FF.DERAI. R E S E R V E

SYSTEM

would, in consequence, deal with a parent office instead of adding to the complications of the Board by c h a r g i n g the latter with the duty of m a n a g i n g what in size and scope, were, in fact, merely branches. 2

In explanation of the proposed resolution, Warburg judged that he and his colleagues: h a d seen enough of the petty point of view resulting from

a

twelve-headed system, a n d of the difficulties of its administration, to convince them that, with regard to banking standards

and

efficiency of service, it would clearly be for the benefit of the c o u n t r y if the n u m b e r of the reserve banks could be reduced. 1

To them the arguments were strong. Certain Federal Reserve Banks had failed to develop into self-sustaining units. Consequently they hindered a workable unity for the System. The federal idea had been applied too widely; it would now be better to retrench. The unnecessary Banks should be subordinated in order to save the general idea of the Federal Reserve System as a grouping of useful Reserve Banks in various parts of the nation. Disagreement Among Board Members. The opposition of the other three Board members was looked upon as mostly political. The four appointive members considered themselves "the non-partisan trustees of the country at large" and judged that their opponents "dealt with the question from the viewpoint of the interests of their party."4 The proposed redisricting admittedly would be embarrassing to the Organization Committee which had determined the boundaries of the original twelve districts. This was significant for the matter at hand because the two ex officio members of the Federal Reserve Board (the Secretary of the Treasury and the Comptroller of Warburg, op. cit., p. 428. 'Ibid., p. 427. 4 Ibid., pp. 4 4 0 - 4 4 1 . :

THF. O P E R A T I O N A L P R O B L E M S O F I N D E P E N D E N C E — 1914-1930 91 the Currency) had been on that committee. These ex officio members could count on support from the Governor of the Board because he had been an Assistant Secretary of the Treasury and would show his "loyal allegiance" to the Secretary.5 Bound together in these ways, the three opposing members of the Board were not likely to admit that mistakes had been made in the past. Although Warburg saw the opposition in this somewhat emotional light, he did admit that the political feasibility had another aspect. If the idea spread that the changes would increase the "power of New York," the political pressure against them would be very great."

Carter Glass had a different view about the division among the members of the Federal Reserve Board : " T h e Board was arrayed in two factions, . . . the one side assuming to be trustees for the [member] banks and viewing the other as representing the Government.'" T o him this was the root erf the difficulty. Accordingly, the proposal for redistricting was a renewal of the old fight over centralization and an attack on the integrity of the Federal Reserve Act. Glass argued that a reduction in the number of Reserve Banks was unwarranted in the circumstances and would lead to bitter resentment and unfavorable action by Congress." It was unwarranted, first, because the Reserve Banks whose existence was threatened had not had sufficient opportunity to prove themselves. Second, and more important, the Federal Reserve Board did not have authority to disestablish any Reserve Bank. Moreover, politi' Ibid., p. 427. ' Ibid., p. 432. ' Glass, op. cit., p. 270. s Carter Glass stated that he had preferred the original organization of the minimum rather than the maximum number. (Cf. ibid., p. 261.) This was a noteworthy change from his proposal in the first bill his committee presented for banking reorganization. At that time (April, 1913) he considered the proper number to be twenty, "with possible increase later." (Cf. Warburg, op. cit., p. 93.)

92

THE INDEPENDENCE OF THE

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cians would interpret the proposed action as an attempt to establish centralization in the hands of a few Banks, or even one. This would arouse in Congress all the arguments against the Wall Street money powers who were not to be trusted as the ultimate custodians of the nation's currency and banking system. Drastic changes in the Federal Reserve Act, perhaps the destruction of the System, might be the final result. Further consideration of the proposed changes was dropped after the Attorney General of the United States ruled that the Federal Reserve Board did not have the authority to change the number of Reserve Banks; an act of Congress was required for this special purpose." Intervention Policy of President Wilson. Before the Attorney General made his ruling, both sides appealed to President Wilson. He opposed the Board's action. T o secure the acceptance of his viewpoint about the value of the larger number of Reserve Banks, he considered dissolving the Federal Reserve Board and reorganizing it. This clearly was his right if the Board acted against the law. Furthermore, such action would not be contrary to his avowed policy of avoiding formal contact with the Federal Reserve Board. That policy was designed to allow the Board "to feel perfectly free to pursue its course within the law without a particle of constraint or restraint from the Executive." President Wilson, however, did not intervene in this case because he did not want to be "accused of trying to bring political pressure to bear" on actions of the " This ruling did not bring a sudden and quiet end to the discussion. Feelings ran high at the meeting of the Board when the Attorney General's opinion was presented. When Warburg wrote about this in 1930, he considered obtaining permission from the Board to publish minutes of the meeting. He hoped to dispute the published opinions of Carter Glass and H. Parker Willis by showing the "acrimonious debate" over the "unauthorized request for the Attorney General's opinion made by the Secretary of the Treasury and the Governor." On second thought, he judged that "such publication would constitute a dangerous precedent which, in the interests of the Board, should be avoided." (Op. cit., p. 445.)

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Board. This expression of restraint was readily approved by Carter Glass : The President held to the obviously proper view that commercial credits and banking processes were matters which should be as far removed from all sinister influences as one pole is from the other. It was to insure just this thing that the federal reserve system was devised.10 At the same time, non-intervention could have unfavorable results. Both Glass and the majority of the Board did not consider the position taken by the President in this case to be the ideal for all cases. They judged that a "more candid recognition and sympathetic cooperation of the President" in place of his "indifference to the Board and its transactions"" would produce greater unity and strength for the Board and the whole System. A policy of non-intervention was not the best policy if it meant no contact with the President. What was hoped for was not just the respect of the President but also his understanding and cooperation. T h e attempt to reduce the number of Reserve Banks undoubtedly was directed toward a stronger and more effective unity within the System. Its failure postponed the building of clearer lines of authority and the demarcation of responsibilities of a unified System. This was only a postponement because the utility of greater specification remained to encourage other modes of achieving it. Failure

at' Unification

Through

Governors

Conference

Some of the Reserve Bank officials judged that their organizations were entitled to form policy and execute it apart from G l a s s , op. " Ibid.,

cit.,

p. 2 7 1 .

p. 2 7 2 .

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any advice or coercion by the Federal Reserve Board. One of the ways this attitude manifested itself was the formation of an organization of the chief executive officer at each of the Reserve Banks." T h e organization elected a chairman and hired a secretary, both of whom were officers of the Federal Reserve Bank of New York. Benjamin Strong, the Governor of the New York Bank, was the chairman of the Conference and its forceful leader. T h e Governors Conference tended to act and speak as though the Governors did not accept the principle that the Federal Reserve Board had the guiding responsibility for all Federal Reserve policies which were national in their purpose and effects. On the contrary, they were disposed to discuss and act upon System-wide matters as though they had the right to make the decision and the Federal Reserve Board had the right only to ratify what they had done. T h e Governors showed this disposition in various ways: (1) by reaching their own agreement, without consulting the Federal Reserve Board, on changes to be made in policy executed by the Reserve Banks, (2) by making directly to Congress recommendations for, or objections to, new legislation, and (3) by being reluctant to take orders from the Board which they did not consider proper or beneficial for the Reserve Banks. For example, in 1915 several members of the Conference openly complained that the Board was acting beyond its authority when it made rulings about the purchase of acceptances by the Federal Reserve Banks and when it suggested, or insisted upon, particular discount rates to be charged by the Banks. On occasion after the Board made certain regulations or rulings, the Governors informed the Board that such actions were out of " U n d e r the aegis of the Federal Reserve Board, the Governors met in Washington before the Reserve Banks began operations. T h e y discussed not only procedural matters, such as accounting methods, but also policy questions, such as open-market operations.

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harmony with a given order or resolution of the Conference and that they would prefer to hold off compliance with the Board's action until after the next session of the Governors Conference. 13 In January, 1916, the Federal Reserve Board, though not always of unanimous opinion concerning the authority of the Governors Conference," decided to check the authority of the Conference. Accordingly the Board, under the leadership of its second Governor, W . P. G. Harding, announced that it would not authorize any future meetings and therefore would not approve any expenses incurred by members for such meetings. Although this action aroused bitter protest from the Governors of the Banks and resulted in the resignations of two of the twelve Governors, it was enforced and maintained until after the war. Then, in 1922, the Governors demanded the right to meet as an official body, when and where they wanted, for the purpose of independent consultation and deliberation, and apart from supervision by the Federal Reserve Board. In reply, the Board proposed a compromise : on occasion it would call a conference in Washington of Reserve Bank Governors and at these meetings one or more Board members would be present. Gradually, the significance of these meetings for defining the independence of the Reserve Banks diminished as they developed into conferences between the Governors and the Board on technical matters, not on policy formation. Benjamin Strong, the Governor of the Federal Reserve " Willis, op. cit., pp. 7 0 4 - 7 0 5 ; and Chandler, Benjamin Strong, Central Banker, pp. 70-71. " Willis stated that one of the original members of the Federal Reserve Board was an early promoter of the Conference. (Cf. op. cit., p. 703.) Also, in 1914, the Chairman of the Federal Reserve Board, William A. McAdoo, who was the Secretary of the Treasury, recommended that there be meetings of the Governors, "either with or without the presence of members of the board . . . to discuss their duties and the best way of fulfilling them." (Fifi Annual Report of the Federal Reserve Board, 1914 [Washington, 1915], p. 73.)

T H E INDEPENDENCE O F T H E FEDERAL R E S E R V E

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SYSTEM

Bank of New York, saw the Governors Conference not as a divisive force but as a means for bringing together the Governors and the Federal Reserve Board as partners to give strength to the Federal Reserve System. In his opinion, the Governors were wiser in the ways of technical bank detail (to which he apparently gave a very wide interpretation), and the Board had a "better general point of view of the whole System.'" 5 How the two could be brought closer together was a problem for which he had no complete answer. Initially the difficulty was, as he saw it, that the "general point of view" was not considered to be a mark of the Federal Reserve Banks in the eyes of member banks, of Congress, or of the public. The Reserve Banks were looked upon as the servants of the member banks : This is in part a result of the current view which, in fact, we ourselves cultivated in the early days of the System to some extent, to regard the Federal Reserve Banks not only as the property of the member banks, but as having been created primarily to serve their interests, promote their welfare, and protect their earnings, without at the same time having proper regard for broad questions of general welfare of the domestic and foreign business of the country." H. Parker Willis viewed the episode of the Governors Conference as a manifestation of the problem whether there could be "real public participation in the management" of the whole System : Representing, as they naturally have, the purely banking interests of the districts, the governors at reserve banks have invariably tended to minimize the public functions of their institutions. It has always been evident that some body upon which the nation at large was specifically represented must exercise a share in the C h a n d l e r , op. cit., "Ibid., pp. 9 - 1 0 . 15

p. 7 5 .

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management of the enterprise in order to insure public confidence, if for no other reason." Accordingly, he looked upon the Governors Conference as a specification of the desire by private banks to create "a central bank or the equivalent thereof, operated by bankers or their representatives." He did not consider it as a step toward a "partnership" as hoped for by Governor Strong. Rather, he judged it to be an organization which tried not only to be independent of, but also to supersede, the Federal Reserve Board. The formation and demise of the Governors Conference highlighted the cleavage between the members of the Federal Reserve Board and the Governors of the Reserve Banks. This lack of unity led to a further strengthening of the judgment that the Board was representative of the government and, therefore, a political agency, while the Reserve Banks were representative of the private banks and, therefore, not part of the government. As a consequence there was no easy positioning of the Federal Reserve System and all its powers and responsibilities in relation to the government and to the private banking system. After 1916 the importance of this problem waned as the necessity of financing the war became dominant. This shift in emphasis highlighted the powers and the demands of the Treasury Department. Effective control of the Federal Reserve System—the Board as well as the Reserve Banks—came to be exercised by the Secretary of the Treasury. Independence and the Treasury—First World War Part of the struggle between the Federal Reserve Board and the Reserve Banks was traceable to the presence of the Secre" Willis, op. cü., pp. 710-711.

98

THF. I N D E P E N D E N C E O F T H E

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tary of the Treasury and the Comptroller of the Currency on the Board. These officials did not necessarily lose any of their powers by the Federal Reserve Act, and they tended to resist any control or check by the Federal Reserve Board. At the time of the organization of the Federal Reserve System, the Secretary carried out his fiscal operations through the subtreasury system and chosen national banks. Accordingly, it was natural for him to look upon the Federal Reserve as a type of fiscal agent similar to the others over whom he had firm control as principal and consequential control as a large depositor. T h e other officer of the Treasury, the Comptroller of the Currency, still had the supervision of national banks, including their chartering. As mentioned previously, he frequently worked at odds with the Federal Reserve Board on these matters. With the advent of world war, and with the increasing involvement of the United States in the conflict, the powers and importance of the Treasury Department increased considerably. This changed the attitude of the Secretary toward his function as a member and Chairman of the Federal Reserve Board. When the Treasury Department was faced with the problem of raising wartime funds through debt transactions, the Secretary might have been expected to operate through the Federal Reserve Board since he was Chairman of that organization and it was considered a government agency. As a matter of fact, he did act in that way at first; gradually, however, he changed his course of action and worked directly with the Federal Reserve Bank of New York and thus by-passed the Federal Reserve Board. This meant not only a loss of prestige but also a loss of control for the Board. After the war-financing was completed, the Federal Reserve Board did not acquire the dominant authority in the Federal Reserve System. Rather that authority, with the support of the Treasury Department,

THF. O P E R A T I O N A L P R O B L E M S O F I N D E P E N D E N C E —

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99

continued to be lodged with the Federal Reserve Bank of New York. Subordination

to Treasury's

Needs

At all times, it must be remembered, the Federal Reserve authorities had to use their powers with an eye to the problems of the Treasury in raising money to take care of expenditures authorized by Congress and in managing any debts contracted in that process. Reasons for this modus operandi were expressed succinctly by the head of the Washington Board in 1956. They were equally valid and persuasive in 1917. These reasons were : One, the Federal Reserve has the duty to prevent financial panics, and a panic surely would follow if the Government, which represents the people as a whole, could not pay its bills. [Two], it would be the height of absurdity if the Federal Reserve were to say in effect that it didn't think Congress was acting properly in authorizing expenditures, and therefore it wouldn't help enable the Treasury to finance them.™ This political theory was true a fortiori in time of war. While the fact of cooperation was necessitous, the manner of cooperation was considered by Federal Reserve officials to be open to some initial discussion. Just before the actual declaration of war by the United States Government, the Secretary of the Treasury asked the Federal Reserve Board to arrange for its borrowing $50,000,000 directly from the Federal Reserve Banks for ninety days at 2 per cent in anticipation of the collection of taxes. Both the Board and the Reserve Banks objected to the low rate of interest; they thought it should be at least one-half per cent higher. T h e objection produced " William M c C h e s n e y M a r t i n , Jr., Address at meeting of the Pennsylvania Bankers Association, M a y 4, 1956.

100

T H E I N D E P E N D E N C E OF T H E F E D E R A L R E S E R V E

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no change in the Treasury's decision; so the Board allotted the securities, and they were accepted by the Reserve Banks. This was later followed by a $250,000,000 loan at a 3 percent rate.'* Further Treasury war-financing was not done directly through the Reserve Banks, but indirectly through them in the sense that the Reserve Banks cooperated in providing the member banks with the necessary reserves by discounting their notes collateraled with government securities. The Federal Reserve Board objected not only to the low rates the Treasury Department proposed for its securities but also to the amount of the borrowings; the Board argued that more should be raised by taxes. When Secretary McAdoo threatened to enforce his viewpoint by having the Treasury Department take over all the funds of the Federal Reserve Banks in order to gain immediate control of all the reserves of the country, the Federal Reserve Board's argument vanished.™ The Secretary had the authority to do something like this because of the Overman Act. This wartime law authorized the President : . . . for the national security and defense, for the successful prosecution of the war . . . to make such redistribution of function among executive agencies as he may deem necessary, including any functions, duties and powers hitherto by law conferred upon any executive department, commission, bureau, agency, office or officer. . . Although the law was concerned with "executive agencies," it was considered to apply to the whole Federal Reserve System, the Reserve Banks included. The Governor of the Federal Reserve Bank of New York expressed this viewpoint (in a letter " H a r d i n g , op. cit., p p . 8 7 - 8 9 . Willis, op. cit., p p . 1 2 0 4 - 1 2 0 5 . U . S . , Statutes al Large, X L , 556.

M

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he wrote in 1922) when he considered the alternative t o cooperation with the Treasury D e p a r t m e n t : Supposing during the war, or the period immediately subsequent to the Armistice, the managers of the Federal Reserve Banks, or the Federal Reserve Board itself, should have found what they believed to be just ground for disagreement with the policy of the Secretary of the Treasury, and should have positively declined to develop a policy reasonably synchronizing with the Treasury's policy : What would have happened to the Federal Reserve System? Would we have remained in existence? Would the Federal Reserve Act have been materially modified by legislation? Would the provisions of the Overman Act have been invoked? Would the direction of the Federal Reserve Banks be under the control of the Secretary of the Treasury ? Would the members of the Federal Reserve Board have been removed from office and new members appointed?"

Benjamin Strong did not answer his own questions one by one, but he gave the general answer that the Federal Reserve System ("this creature of Congress") could not defeat policies sanctioned and made mandatory by Congress, that it could not dominate the policy of the Secretary of the Treasury. What it could do was twofold: (1) frankly express its views to the Secretary, and then (2) accept his decision and carry out the plans he proposed. On many occasions Governor Strong expressed his views on proposals made by the Treasury Department, and his position and reputation won him a hearing. The Treasury at the time did not seek the advice of, nor operate through, the Federal Reserve Board. Rather, it communicated directly with the Reserve Bank Governors and usually only with the New York Bank's Governor who then passed along the proposals of the Treasury to the other Reserve Banks. The cooperation 22

C h a n d l e r , op.

cit.,

pp. 120-121.

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T H E I N D E P E N D E N C E O F T H E FEDERAL R E S E R V E

SYSTEM

between Governor Strong and the Treasury resulted in dominance for the Federal Reserve Bank of New York and the loss of power and influence for the Federal Reserve Board. Hindrances

to Unity

oj Board and

Banks

Neither the Federal Reserve Board nor the Secretary of the Treasury foresaw this development of one of the Reserve Banks into a place of dominance in the Federal Reserve System, and neither desired that this should be the way of evolution for the System. In 1917, just after the United States had formally declared a state of war, the Secretary of the Treasury wanted the Federal Reserve Board to strengthen its control over the Federal Reserve Banks and to keep them "well in hand." He proposed a change in the Federal Reserve Act which would authorize the Board to appoint five additional "Government" members of the board of directors at each of the Reserve Banks."3 Since the Federal Reserve Board, however, was opposed to this change, the Secretary dropped the proposal. Instead, as has been seen, he worked directly with the Federal Reserve Bank of New York; and by his actions he tended to increase its power relative to the Board and the other Federal Reserve Banks. The dominance of the Federal Reserve Bank of New York in the Federal Reserve System carried over into the post-war period. This resulted in resentment on the part of some members of the Federal Reserve Board who talked about resigning because of the way the Treasury Department had promoted this shift of power. When the war was over and the nation faced its peacetime problems of finance, adequate income, and employment, the Board members did not immediately " H a r d i n g , op.

cit.,

pp. 8 - 9 .

T H E OPERATIONAL P R O B L E M S OF I N D E P E N D E N C E —

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work to restore their own place in the System. In part, their remaining in their changed position was caused by the routine they became accustomed to follow : " a minutiae of operations . . . often under order or direction of the T r e a s u r y . A n o t h e r factor was the attitude and the operations of the Secretary of the Treasury. At the end of the war the urgency of government financing ceased being the main influence in the policy considerations of the New York Bank and the System. The resulting possibility of a new location of initiative within the System was a source of disharmony and sharpened the potentialities of conflict between the New York Bank and the Washington Board. In a sense, this was an unequally matched struggle, because the Secretary of the Treasury more often than not promoted and defended the policies of the New York Bank before the Federal Reserve Board.

Internal Struggle over Authority—Open-Market Operations In two areas of Federal Reserve power, the use of openmarket operations and the determination of the discount rate, the Board and the Banks struggled with each other for control and dominance in the postwar period. There were two general reasons for the struggle. First, the Federal Reserve Act was not clear on the location of the power of initiative in either area. As the operations of the System expanded, the need for clarification grew in importance. Based on the words of the Act, both the Banks and the Board could claim that they had the power of initiative and the responsibility for its use. Second, it was only during the postwar period that the idea of positive control of the monetary process was accepted and used on a large scale by the Federal Reserve System. Before this, Karl R. Bopp, The Agencies of Federal Mo. : University of Missouri, 1935), p. 19.

Reserve

Policy

(Columbia,

104

T H E I N D E P E N D E N C E OF T H E F E D E R A L R E S E R V E

SYSTEM

Federal Reserve officials were inclined to be followers of the money market rather than its leaders." This lack of tradition in the exercise of control as well as the legal ambiguity about the source of control led to a power struggle. The resolution of this struggle, in turn, produced a stronger and more cohesive Federal Reserve System and made clearer the importance of independence and its definition for the System as a whole.

Initiative

Taken

by

Banks

Section 14 (entitled "Open-Market Operations") of the original Federal Reserve Act empowered the Reserve Banks to "purchase and sell in the open market . . . cable tranfers and bankers' acceptances and bills of exchange." These operations were authorized "under rules and regulations prescribed by the Federal Reserve Board." Moreover, each Bank was given the power to "deal in gold coin and bullion," and "to buy and sell" government securities and what, in general, later came to be called "municipals." About a month after the Banks began functioning, the Federal Reserve Board authorized them " t o purchase Government bonds within the limits of prudence, as they might see fit."" The poor profit picture of the Reserve Banks in 1915 and 1916 and the consequent inability to earn the stipulated divi:s Related t o t h e a b s e n c e of a d e v e l o p e d c o n t r o l p o l i c y w e r e t w o f a c t s . (11 P r i o r t o t h e i n v o l v e m e n t o f t h e U n i t e d S t a t e s in t h e w a r , m e m b e r b a n k s h a d r e l a t i v e l y l a r g e e x c e s s r e s e r v e s , p a r t l y as a c o n c o m i t a n t o f t h e o r g a n i z a t i o n of the F e d e r a l R e s e n e S y s t e m a n d partly b e c a u s e of gold i m p o r t s . T h e e x i s t e n c e o f s u c h r e s e r v e s s e e m e d to i n d i c a t e a p o l i c y of not deliberately increasing the R e s e r v e B a n k s ' e a r n i n g assets, even though o p e r a t i n g e x p e n s e s w e r e n o t b e i n g m e t . ( C f . W a r b u r g , op. cit.,1,448-451.) (2) D u r i n g t h e w a r , t h e c o o p e r a t i v e a c t i o n o f s u p p l y i n g m e m b e r b a n k s with reserves n e e d e d for p u r c h a s i n g g o v e r n m e n t securities largely determ i n e d the a m o u n t of the R e s e r v e B a n k s ' e a r n i n g assets. ^ First Annual Report of the Federal Reserve Board, 1914 ( W a s h i n g t o n , 1 9 1 5 ) , p . 16.

T H E OPERATIONAL PROBLEMS OF INDEPENDENCE

— 1914-1930

105

dends were projected into the future and considered a likely perennial failing of the Banks. This prospect brought forth several proposals from members of the Federal Reserve Board. One proposal was to have the Federal Reserve Banks make more extensive use of open-market powers which in the first months of their existence some of the Banks had already used to purchase acceptances and municipal warrants. The Federal Government debt securities were largely not available until the wartime government-finance operations increased their amounts. It was feared by some of the Board members, however, that such action would tend to depress artificially market rates, would stimulate inflation, would give the Reserve Banks unwarranted power to lead the market rather than follow it, and would result in undesirable competition with member banks who also engaged in similar operations. Another proposal was offered as a solution for the lack of earnings as well as for the fears of competition. The capital contribution should be largely (95 per cent) returned to the member banks. Such capital was no longer needed as a buffer against possible losses; the deposits of the Reserve Banks, it was said, were adequate for all operating contingencies. Thus the anxiety of the Banks about earning dividends and paying their own way would be diminished." Meanwhile, the Governors Conference considered the complaint of some of its members that the Board did not have the authority to promulgate certain of its rules about the purchase of acceptances by the Reserve Banks. The advent of the government war-financing program, however, changed the problem of open-market operations; the concern for profits and the argument over the authority of the Board were put aside for the duration. After the war-finance program was completed, the earnings " W i l l i s , op.

cit.,

p p . 8 9 9 ff.

106

T H E I N D E P E N D E N C E O F T H E FEDERAL R E S E R V E

SYSTEM

problem of the Federal Reserve Banks again appeared. Accordingly, the Reserve Banks purchased government securities to enlarge their earning assets. The Treasury Department, in 1922, complained that the Reserve Banks were creating a false structure of market rates of interest and providing fuel for inflation by acting only on the purchase side of the market. Since the Reserve Banks were the fiscal agents of the Treasury, they should be a help rather than a complicating factor in the Treasury's debt-management operations and in its handling of trust accounts. These complaints could not be ignored. The Governor of the Federal Reserve Bank of New York felt that if the Reserve Banks did not adopt some coordinated policy about transactions in government securities which took into account the wishes of the Treasury Department somebody else would step into the picture. He cautioned the Governors Conference in May, 1922 : "If we do not do something they [Treasury officials] will. The Federal Reserve Board has the power to regulate this matter."1" Following this advice, the Governors decided to limit their transactions to the need for earnings and to establish a committee of four Governors to execute orders from the Reserve Banks in such fashion that the Treasury would not be hampered in its desired program. The Committee elected Governor Strong as its permanent chairman and decided that its operating office should be located at the New York Reserve Bank. In October, 1922, the Governors Conference added a fifth member to the Committee and increased its responsibilities. The Committee was authorized to make recommendations to each Reserve Bank concerning open-market transactions in government securities. (In practice, recommendations were extended to include discount rates and acceptance-buying rates.) These recommendations were to be made within the framework of a general M

C h a n d l e r , op. cit.,

p. 2 1 3 .

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policy statement adopted by the Conference and approved by the boards of directors at the various Reserve Banks. The new responsibilities were not delegated to the Governors Committee without any dissents. Some of the Governors were concerned about the effect of this new authority arrangement on the independence of the separate Reserve Banks. For example, the Governor of the Richmond Reserve Bank complained about the "control of the Federal Reserve System as a whole" being assigned to a committee "whose suggestions may, perchance, be so conclusive as to override the independent judgment of any particular Federal Reserve Bank."2* In addition, A. C. Miller, a member of the Federal Reserve Board who attended the meeting, insisted that the Board should have a more active voice in the formation of any System-wide policy for open-market operations in government securities.80 Although the chairman of the Committee denied that the Committee either had or should have the power to decide a System-wide policy, the possibility of the authority of the Committee being so used, at least in subtle ways, was clearly present. Both the Governors and the Board were aware of the strength of leadership provided by the New York Governor whose Bank was located in the nation's principal money market. Moreover, it was fairly obvious that a Committee composed of the Governors of the five largest Reserve Banks would have a prestige element which would give the Committee a dominating influence in the decisions of the other Reserve Banks. The individual Banks would remain free to follow or not the recommendations of the Committee, but they were likely in the circumstances to endow a recommendation with the force of an order. What, then, would happen to the "Ibid., pp. 218-219. M

Ibid., ρ, 222.

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regional concept upon which the Reserve Banks were constructed and to the supervisory and regulatory power of the Federal Reserve Board ? Assertion

of Authority

by the

Board

The Board, however, was not to be left out of the policymaking process. In March, 1923, it decided to show its jurisdiction over the open-market transactions of the Federal Reserve Banks by dissolving the Governors Committee and then reappointing the same Committee to carry on its work under principles and regulations decided upon by the Board. This action was far from pleasing to the Governors. W. P. G. Harding, who had been the second Governor of the Board and who was now Governor of the Reserve Bank in Boston, suspected that the Treasury was the instigator of this action. He denied that the Treasury had any legal power over the open-market transactions of the Reserve Banks. If the Board enforced its action it would be promoting the domination of the Treasury Department over the Reserve Banks. Second, he stated that "there is no authority given the Board at all [in the Federal Reserve Act J, unless you take refuge in the broad supervisory power, to limit the amount of Government bonds and notes that the directors of the Federal Reserve Banks in their discretion may purchase." 31 His argument was admittedly a legal one. He did not contemplate the Board's stepping out of the picture, but he maintained that it should rely upon its supervisory powers and not upon an assertion of definite power over the amount and direction of open-market operations. Board member A. C. Miller, who defended the Board's " Chandler, op. cit., p. 225.

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action at the Governors Conference, admitted that some Board members had doubts about their authority. He, however, had no such doubts. At the time, Miller made the surprising statement : " I think we have got the power; to me it is almost as clear as though it were there."32 Three years later, he was not so certain. His testimony before a Congressional committee about this action of the Board included these statements : The theory underlying this whole thing was to put the openmarket operations substantially on the same basis as prescribed for discount operations by the Federal reserve act itself.83 It is not clear that the Federal Reserve Board has the same power with respect to open-market operations of Federal Reserve Banks as it has with respect to discount operations. I think that ought to be cleared up.34 Miller also testified that some of the Reserve Bank Governors did more than state their doubts about the legal authority of the Board to limit purchases of Government securities by the Banks : There have been one or two informal indications that if the board declined to approve, the board of directors of the reserve bank would go ahead on their own account and operate in the market.35 Benjamin Strong was on sick leave when the Board exercised jurisdiction over the Committee. In a letter to the New York Deputy Governor who substituted for him on the Committee he wrote a strong objection to the Board's action : Ibid., p. 226. U.S., Congress, House, Committee on Banking and Currency, Hearings on H.R. 7895, Stabilization, 69th Cong., 1st Sess., 1926, p. 865. 3< Ibid., p. 863. 35 Ibid., p. 866. 32

33

110

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

T h e Federal Reserve Board had no right to discharge the committee and wouldn't have done so had I had a crack at them. . . . I'd see them damned before I'd be dismissed by that timid bunch."

As Governor Strong viewed the situation, in place of the unwarranted assumption of power, the proper form of participation by the Board was by way of suggestion to the Governors. Failure to oppose this encroachment by the Board meant that the Reserve Banks "approach nearer to actual management (instead of supervision) by a political body."*1 What Strong feared was that this action tended to make the Reserve Banks rubber stamps. What he proposed could be expressed perhaps in words used by the first Governor of the Federal Reserve Board (Charles S. Hamlin, a member of the Board until 1936) to criticize a later change in the authority lines of the openmarket transactions Committee : "a sovereign body [the Board]" entering "into treaties with twelve other sovereign bodies [the Federal Reserve Banks]."" Subsequent action of the Committee in the Twenties did indicate that there was a kind of twofold sovereignty. When the Governor of the Board (in 1923) attempted to force the Committee to have the Reserve Banks sell all their holdings of government securities, the Committee resisted on principle but in action acquiesced to the extent that they sold more of the Banks' holdings than they originally had planned to sell. "Chandler, op. cit., p. 228. " ¡bid. " Rudolph L. Weissman, The New Federal Reserve System (New York: Harper & Brothers, 1936), p. 167. Hamlin upheld the power of the Board. Testifying in 1928 about the authority of the Board over open-market operations, he stated : "There may be some question as to the legality of our complete power over open-market operations, but, in fact, there is no question that we are exercising the power." (U.S., Congress, House, Committee on Banking and Currency, Hearings on H.R. 11806, Stabilization, 70th Cong., 1st Sess., 1928, p. 403.)

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Compromise Between Board and Banks None of the Federal Reserve Banks were obliged to follow the recommendations of the Committee named by the Board in most cases, however, each Bank participated in the transactions which were carried out as recommended by the Committee. Even though the Banks participated, they did not always approve of the action and at times resisted the power and leadership shown by the New York Bank's Governor.40 This disapproval was strongest after the purchase transactions recommended and carried out in 1927. T h e results were an increase in the power of the Federal Reserve Board and a decrease in the power of the New York Bank. The adjustment which brought about these power shifts was initiated in 1930 when a new open-market committee, the Open-Market Policy Conference, was established. This Committee included a representative from each Federal Reserve Bank; furthermore, the new Committee submitted all decisions to the Federal Reserve Board for approval, and without that approval it could not act. The reallocation of power was ratified and somewhat amplified in the Banking Law of 1933. Further development of the shift was made in the Banking Law of 1935, which combined five representatives of the Reserve Banks and the full Washington Board (newly christened the Board of Governors of the Federal Reserve System) on one Federal OpenMarket Committee. ιβ The designated Reserve Banks were not obligated to appoint their Governors as their representatives on the Committee. They could have chosen their Chairmen or other officials. " A t least in 1923, the Committee held meetings in New York, Cleveland, and Boston, and at these meetings a Board member was usually present. While this was probably inconvenient for the Board member, the change of the place of meeting was an offset to the appearance of domination by New York.

112

THF, INDEPENDENCE OF THE FEDERAL RESERVE

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Internal Struggle over Authority—Discount Rate Determination An internal struggle also manifested itself in attempts by both the Board and the Reserve Banks to exercise authority over discount rates. An early 1913 version of the Federal Reserve Act, sponsored by Carter Glass, provided that

the

Federal Reserve Board should "establish a rate of discount which shall be mandatory upon each Federal Reserve B a n k . " " T h i s authority arrangement later was changed so that the Banks had the power to "establish" discount rates "subject to review and determination" by the Board." T h e change was a compromise; unfortunately it was also a source of misunderstanding and conflict." Early Control Action by Board Before the Reserve Banks began operations in November, 1914, they asked the Federal Reserve Board " t o make suggestions to them with regard to their discount policy."" This request was based upon the assumption that " a uniform and consistent policy to be pursued by all the banks" would help the System to make a smooth start. Accordingly, the Board asked each Bank what rate it considered advisable for its district. For ninety-day paper, the answers ranged from 5 to " Willis, op. cit., p. 1541. r : One commentator called these words of Section 14 " a masterpiece of indefinite phraseology." (William O. Weyforth, The Federal Reserve Board [Baltimore : T h e Johns Hopkins Press, 1933], p. 72.) " B e n j a m i n Strong stated that the difference of opinion and the dispute within the System over the authority to initiate changes in the discount rate arose "from inept language . . . chosen as the result of compromise of opinion. . . . " (Chandler, op. cit., p. 449.) " First Annual Report of the Federal Reserve Board, 1914 (Washington, 19151, p. 10.

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7 per cent. The Federal Reserve Board then decided that prudence and conservatism demanded a narrower range. "It was consequently voted [by the Board] to fix the rates of discount at from to 6 ^ % . " This action was clearly initiative on the part of the Federal Reserve Board; it fixed the range for all the Banks. Then the Board took another step in the direction of solidifying its power over the discount rate. It required the Banks to file with it each week the rate they proposed for the following week. This requirement gave the Board a continuing veto power. The Board's reasoning was somewhat as follows. The Federal Reserve System should be administered as " a genuine central banking system." One necessary condition for effective achievement of this coherence was the harmonizing of the "autonomous" regional Banks. The combining of harmony and autonomy would be helped by a common discount policy." The Act nowhere gave the Board the specific authority to require the Banks to file with it a weekly schedule of rates. Even H. Parker Willis admitted that this action by the Board was "beyond the Act." He also stated that the procedure was accepted by the Reserve Banks. If so, it was not accepted completely and willingly. In January, 1915, the Governors Conference complained that the rights of the Reserve Banks to initiate changes in the discount rate were being violated by the practice of the Federal Reserve Board in suggesting changes. The Board reacted strongly to this complaint : The Governors of the banks assumed powers which they do not possess under the law when they undertook collectively to direct or to suggest to the Federal Reserve Board the manner of its exercise of the powers conferred upon it in its dealings with individual banks." 45

177. 48

Willis, op. cit., pp. 8 9 1 - 8 9 3 ; and Paul M. Warburg, op. cit., pp. 176Chandler, op. cit., p. 73.

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T H E INDEPENDENCE O F T H E FEDERAL R E S E R V E

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Subsequent restrictions placed on the powers of the Governors Conference and the advent of the participation of the United States in World War I shelved for the time this question of authority. During the postwar period and the Twenties, three main instances of dispute on this question arose between the Federal Reserve Board and the Federal Reserve Banks. These conflicts indicated further the lack of a unified System and the vulnerability of its parts to attack from the outside. Intervention

erf

Treasury

In 1919, the war was over, but not officially so, for the United States. Hence the Overman Act, still part of the law of the nation, applied to the Federal Reserve System in so far as the Treasury had not completed all its financing of the war debt. When the Reserve Banks wanted to raise the discount rates in 1919, the Treasury opposed the change because of its possible effects on the borrowing plans of the government and on the market value of outstanding securities. The Treasury used its authority on the Federal Reserve Board to make its opposition effective. Interestingly enough, the Secretary of the Treasury who was the promoter of the primacy of the Treasury's plans was Carter Glass, the early promoter of the independence of the Federal Reserve System. The 1919 dispute started in early November when the New York Reserve Bank voted to raise its discount rate on commercial paper, but not on paper secured by Treasury obligations. The Federal Reserve Board approved this policy decision, and the other Reserve Banks took similar action. The Treasury was not pleased and insisted that the Board and the Banks use "direct action," rather than rate increases, to curb the inflation and speculation which then were spreading

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through the economy. Later in November, however, the New York Reserve Bank (as well as the Boston Reserve Bank) again voted rate increases. On this occasion the Federal Reserve Board sided with the Treasury and refused to approve the changes. In December, the Board modified its stand and allowed an increase in the rates applicable to government securities so that there would be no preferential rate for them. During this episode Governor Benjamin Strong and Secretary Carter Glass seriously disagreed with each other's position. Strong asserted that Glass's opposition was promoting easy money to the harm of the nation. Glass countered with a strong flank attack. He judged that Strong really was aiming at domination not only of the Federal Reserve System but even of the Treasury Department. His judgment seemed to be confirmed when Strong stated his doubt about the authority of the Federal Reserve Board over the discount rate and threatened to have the New York Bank raise the rates without getting the approval of the Board. In reaction to this assertion of independence, Glass replied that he would have President Wilson remove Strong from his Governorship. Furthermore, Glass argued that the Board had the power to initiate changes in rates and to impose them on the Reserve Banks, despite any decisions of the boards of directors at the Banks." To prove his point, Glass obtained a ruling from the Attorney General on this power. The Attorney General, aided by a briefing from Glass, decided in favor of the Secretary's position : I think it is quite clear that the Federal Reserve Board is the ultimate authority in regard to rediscount rates to be charged by the several Federal Reserve banks and may prescribe such rates." " Ibid., p. 163. " Opinions of the Attorney

General, X X X I I , 1919, pp. 81-84.

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THF. I N D E P E N D E N C E O F T H E

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Later on, Glass rejected this opinion and blamed it on incorrect arguments he had used to persuade the Attorney General to make ruling in his favor in the dispute with Strong." In January, 1920, the dispute was renewed. The New York Bank wanted to raise its discount rate higher and voted to do so. the Treasury suggested that the Bank raise its rate on commercial paper but not on paper backed by Treasury obligations. When the New York Bank refused to do this, the Federal Reserve Board informed the Bank that the Board had "determined" that the rate on commercial paper should be 6 per cent (up from per cent) and that the rate on the Treasury paper should not be changed.5" The directors of the New York Reserve Bank replied that if the rate was to be effective it would have to be initiated by the Board. One of the members of the Board later remarked about this : "and initiate it we d i d . " " The New York Reserve Bank submitted to this ruling. Later in the year (when a new Secretary had replaced Glass) the Board allowed increases in the rates on paper based on Treasury obligations as well as on commercial paper. The final changes were made in June, 1920, and rates were not modified until the spring of 1921.

Support

from Congress

for

Independence

In May, 1920, the economy changed from exuberance to collapse ; and the decline in business activity, employment, and prices continued until mid-1921. The Federal Reserve System came in for a large share of the blame : a conspiracy of high interest rates aimed at deflation and depression. Congress " C h a n d l e r , op. cit., pp. 1 6 3 - 1 6 5 ; Glass, op. cit., p p . 2 2 7 , 279; Weyforth, op. cit., pp. 75-80. 50 T h e vote of the Federal Reserve Board was tie until the Chairman (Secretary Glass) was asked to cast his vote. "' Chal les S. Hamlin, quoted in Bopp, op. cit., p. 54.

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appointed a committee to investigate the causes of the collapse as well as to check the integrity, honesty, and competency of Federal Reserve officials. Although one of the principal accusers was a former Comptroller of the Currency who had served as a member of the Federal Reserve Board for seven years,Sï the Federal Reserve officials closed ranks and worked together for their own defense. They were aided now by their guardian and one-time Chairman, Senator Carter Glass. When members of the Board were accused of speculating in cotton and loaning money to themselves for this purpose,53 the Chairman of the Federal Reserve Board asked the investigating committee to call as witnesses the Congressmen who had made the charges; but his request was not granted. When Senator Glass made a speech in defense of the System and the Board had the speech printed and distributed through the Reserve Banks, the Board's spending money for its defense was challenged as being improper. Thus it was not altogether easy for the System to get a hearing. The result of the investigation, however, was a Congressional report that supported the independence of the Federal Reserve System.54 The Congressmen criticized the Federal Reserve for not breaking away sooner from the Treasury; in 1919, said the report, the Reserve Banks should have increased their rates as they wanted to do, even though the Treasury was opposed to this action. There was no dishonesty, no connivance on the part of bankers, no head-in-the-sand attitude. Moreover, the investigating committee did not criticize the Federal Reserve for failing to reverse the tight money policy in late J o h n S k c l l o n W i l l i a m s , ex o f f i c i o m e m b e r , 1914—1921. " Willis, op. cit., pp. 2 2 3 - 2 2 4 . 54 U . S . , C o n g r e s s , J o i n t C o m m i s s i o n of Agriculture Inquiry, The Agricultural Crisis and Its Causes, R e p o r t N o . 4 0 8 , 6 7 t h G o n g . , 1st Scss., 1921.

1 18

T H E I N D E P E N D E N C E O F T H E FEDERAL R E S E R V E

SYSTEM

1920 or early 1921 when the evidence was that the slide in business was rather precipitous, not gradual or short." The inquiry, while producing a Congressional judgment on the desirability of independence for the Federal Reserve, also served to promote unity within the System. It provided concrete evidence of the likelihood of political retaliation when the Federal Reserve officials took actions which rightly cm- wrongly restricted the flow of credit; if they were divided among themselves, the likelihood of damaging or crippling legislation was even greater. Federal Reserve officials recognized that it was hard enough to explain and justify their action at all times; they were asking for a heavy hand to be laid upon them if they disagreed among themselves at a moment of crisis and this disagreement became a matter of public record.

Public

Disagreement

and Political

Pressures

The lesson apparently learned in the early Twenties seemed to be forgotten later. In 1927 and again in 1929, the Federal Reserve Board and the Reserve Banks disagreed on what the discount rate should be; and in both cases they attempted to ignore each other. The Reserve Banks were not united in their views on what the discount rate should be, but they were united in opposition to unilateral action by the Board. In 1927, the case concerned directly the Chicago Bank and the Federal Reserve Board. Both the New York Bank and the Board judged that the prevailing 4 percent rates should be lowered to per cent; 55 It is i n t e r e s t i n g t o n o t e t h a t t h o u g h t h e f a i l u r e of t h e R e s e r v e B a n k s t o raise rates w a s b l a m e d o n t h e T r e a s u r y , t h e 1 9 2 1 c h a n g e i n rates w a s n o t c r e d i t e d t o t h e T r e a s u r y ; y e t the S e c r e t a r y , A n d r e w M e l l o n , w a s t h e first strong a d v o c a t e of a r e d u c t i o n in A p r i l , 1 9 2 1 . E v e n B e n j a m i n S t r o n g w a s n o t c o n v i n c e d of the s o u n d n e s s of this proposal. ( C h a n d l e r , op. cit., p. 174.)

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all but four of the Reserve Banks took such action by the middle of August, 1927. The obstinacy of the Chicago Bank directors aroused the zeal of Governor Crissinger and other members of the Federal Reserve Board to demonstrate the Board's authority.5" At a meeting early in September, the Board by 4 - 3 vote (the Chairman was absent) took the following decisive action : Be it resolved that the Federal Reserve Board in the exercise of its power of review and determination fixes a rediscount rate for the Federal Reserve Bank of Chicago of per cent on all classes of paper of all maturities, effective at the close of business today.1'

Other Reserve Banks which had not reduced their rates to this point took the hint and agreed to fall in line. Criticism of Federal Reserve Actions. Governors of the Federal Reserve Banks, the Secretary of the Treasury, three other members of the Board, and Senator Glass, to name a few, vigorously denounced the action of the Board. They questioned its legality, and they denied its prudence. Glass called it "utterly capricious" and predicted that it would "subject the Board and the Federal Reserve System to injurious criticism, if not unwise attempts to radically alter the Act itself.'"18 The Governor of the New York Bank expressed similar fears of political repercussions which would find the Federal Reserve System disunited and vulnerable. He wrote in a personal letter as follows : If Congress inquires into this matter in connection with attempts to amend the Act it will involve the appearance of various members of our own institution who hold contrary opinion on this subject, and the country will be concerned lest internal war lead to a situation in which the whole country might suffer. . . . M

Bopp, op. cit., pp'. 55-56. "Chandler, op. cit., p. 447. "Ibid., p. 165.

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THE INDEPENDENCE OF THE FEDERAL RESERVE

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I t is so d i s c o u r a g i n g a f t e r these t h i r t e e n y e a r s to feel that

we

m a y all be v i c t i m i z e d by this silly a n d wholly u n n e c e s s a r y a n d , o n e m i g h t e v e n s a y , q u i t e g r a t u i t o u s a d v e r t i s i n g of d i f f e r e n c e s of o p i n i o n b e t w e e n m e n of m a t u r e e x p e r i e n c e w h o s h o u l d be c a p a b l e of m o r e f o r e s i g h t . . .

In the 1927 episode there was an added factor which had apparently "sinister" overtones. At the time, the Governor of the New York Reserve Bank was in constant touch with the heads of European central banks. Annually the Governor of the Bank of England would visit the New York Bank. " H e traveled incognito and when asked about the purpose of his visits declared he was taking an American vacation." 60 Actually he was concerned over the reserve position of the Bank of England and undoubtedly influenced the setting of the low discount rate by the New York Reserve Bank. In the English press, the Federal Reserve Bank of New York came to be regarded as the "central bank of the Reserve System, with the other eleven banks merely branches."" Reference to the "central bank" of the United States stirred up old fears and suspicions. As an example, one Congressman in a speech in the House of Representatives described the Federal Reserve Board and the Reserve Banks as "one of the most corrupt institutions the world has ever known" because they had been "international bankers from the beginning, with the United States Government as their enforced banker and supplier of currency."" 2 The Congressman was not entirely accurate in Ibid., p. 449. Weissman, op. cit., p. 93. " G l a s s , quoted by Chandler, op. cit., p. 450. (Cf. also: Lawrence E. Clark, Central Banking under the Federal Reserve System [New York : T h e Macmillan Company, 1935], p. 171.) It is rather ironic that about the same time as Glass was complaining about the action of the New York Bank he was hearing from Strong about the "dangers of centralizing power in the B o a r d " which appeared evident in the Chicago discount case. (Chandler, op. cit., p. 449.) K Louis T . McFadden, quoted by Weissman, loc. cit. S9

M

T H E OPERATIONAL P R O B L E M S O F INDEPENDENCE

— 1914-1930

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linking together the Board and the Reserve Banks, since the Board did not wholeheartedly approve of the actions of the New York Bank in attempting to handle by itself the international situation. For the Board to answer by publicizing the lack of harmony in this area would only heighten the bad feelings already made public in the disagreement on the discount rate. Change in Leadership. The hopeful, but somewhat uncertain, times in 1927 stirred doubts in the Executive Department of the government. When they reached the President, he reacted by relying on the hands-off policy that had characterized the Administration of his predecessors : The doubts sometimes broke·through to the President [Coolidge]. Secretary [of Commerce] Hoover, for example, objected periodically [though not publicly] to the buoyant Federal Reserve policy. But Coolidge's stock reply was to insist that the Board was independent of the Treasury and beyond the scope of the Executive, while Mellon seemed to dismiss his colleague's intermittent concern as so much ado about nothing."3 Although no serious political pressures openly applied to the operations and the organization of the Federal Reserve System, changes were made on the Federal Reserve Board. The Governor of the Board who had instigated the ordering of the change of the discount rate at Chicago resigned. Official sources denied that there was any connection between this resignation and the preceding disputed action. (The ordering occurred on September 6; the resignation on September 15.) The next two holders of the position of Governor of the Board denied (at Congressional hearings in 1931) that the Federal Reserve Board would initiate or fix the discount rate, even though it had a veto power."4 The situation was altered in 83 Arthur M. Schlesinger, Jr., The Age of Roosevelt, Vol. I : The Crisis of the Old Order, 1919-1933 (Boston : Houghton Mifflin Co., 1957),p. 70. M Bopp, op. cit., p. 56. Governor D. R. Crissinger was replaced by Roy

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THE INDEPENDENCE OF THE

FEDERAL

RESERVE

SYSTEM

another way. T h e New York Bank lost its dynamic leader. Benjamin Strong resigned early in August, 1928, and died in October. New leadership at the Board and at the New York Bank did not bring a new unity to the System. T h e new men did not heal the old lesions. T h e Board itself remained divided, except on the determination that the New York Bank should not be the leader in setting System policy. O n the other hand, the Reserve Banks remained somewhat unwilling to follow the leadership of the Board, partly because they still thought of it as primarily a supervisory and review body and a means of political control. These results set the stage for the indecision and the lack of forceful leadership in 1928 and 1929 which harmed the unity and prestige of the Federal Reserve System and tended to reduce the importance of its independence.

Further

Weakening

of

Responsibility

In 1928 the Reserve Banks raised their discount rates and sold in the open market. J u s t before resigning in August, 1928, Benjamin Strong had advocated the necessity of being ready to reverse the policy by discount rate reductions and openmarket purchases. H e further stated that if hesitation or differences of opinion within the System prevented such action the New York Bank "must d o it [open-market purchases] alone, despite the tradition which we have helped to create and maintain, that no extensive open-market operations should be conducted by individual b a n k s . " " A. Y o u n ; ; o n O c t o b e r 4, 1927. At the time of his a p p o i n t m e n t , Y o u n g was G o v e r n o r of the F e d e r a l R e s e r v e B a n k of M i n n e a p o l i s . T h e Minneapolis B a n k w a s the last of the R e s e r v e B a n k s to lower their discount rates, d o i n g so almost a week a f t e r C h i c a g o took action. " C h a n d l e r , op. cit., p. 4 6 0 . D u r i n g the stock m a r k e t crash in O c t o b e r , 1929, the N e w Y o r k B a n k d i d " d o it a l o n e . " T h e G o v e r n o r of the B a n k ,

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In August, 1928, the Open Market Committee, however, followed the advice left by Strong. It recommended the purchase of government securities if needed to reduce an expected credit stringency. The Federal Reserve Board, however, limited the amount of securities which might be purchased and recommended lowering the discount rate on bills concerned with the seasonal movement of crops. The Committee cooperated : few government securities were purchased but holdings of bills were increased. In early 1929, the Committee changed its policy. It reduced holdings of both government securities and commercial bills, but it could not obtain the Board's approval for increases in the discount rate. Ten times between February 14, 1929, and the following May 23, the New York Bank applied for an increase in its discount rate. It finally won approval when it agreed to reduce its buying rate on acceptances at the same time as it raised its discount rate. The position of the Board was that the speculation in the stock market should be curbed by direct action. It wrote a persuasive memorandum on this matter; the New York Bank, being so much in disagreement with the method proposed and so frustrated in its own plans for action, refused to pass along the memorandum to its member banks. During the first half of 1929, other Federal Reserve Banks also applied in vain for an increase in their discount rates. After agreement was reached between the Board and the New York Reserve Bank in late May, 1929, the Bank applied for no more rate increases until early August; it was worried about the effects of tight money on domestic business and on the international situation. By the middle of June, the Board after consulting only a few of his directors and without prior approval of the Federal Reserve Board, bought over $100,000,000 of securities within a two-day period. T h e Washington Board objected to this procedure. (Bopp, op. cit., p. 61.)

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THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

tempered its insistence on direct action and indicated its readiness to approve open-market purchases if the situation demanded such. In August, the New York Bank alone received approval from the Board again to reduce its buying rate on bills and to raise its discount rate. The events later in 1929 proved that the Federal Reserve System had not found a unified policy which could avoid a calamitous break in stock-market prices, a money panic, and a set-back in business—all of which broke forth in 1929 and all of which the System wanted to avoid. The depression of the Thirties was a serious blow to the System's arguments for independence. At a minimum, the System was suspected of incompetence; at a maximum, it was subjected to all sorts of serious charges ranging from gross negligence to damnable conspiracy. As a result the System was relegated to a kind of back seat in the management of the government's program for recovery. Given the continued existence of the System, this relegation did not automatically solve the problem of internal authority and independence. It gave the problem, however, a new perspective which emphasized the importance of the "sovereignty" of the System as contrasted with the cooperation of a "sovereign" Board and twelve "sovereign" Reserve Banks.

ν Federal Reserve Relations with the Government in the Thirties

DURING T H E FIRST H A L F OF T H E T H I R T I E S T H E GOVERNMENT,

acting apart from the Federal Reserve System, promoted various monetary and banking measures to increase prices, national income, and employment. Later in the decade it relied more on fiscal measures, though monetary policy always remained important. In such circumstances it became clearer and more widely accepted that the policies of the Federal Reserve System were direct concerns of the government; they had to be part of the total policy by which the government sought to produce and maintain prosperity for the nation. Through new laws, regulations, and actions, the Congress and the President advocated this active participation and unity of operation. In turn, the Federal Reserve System in its own announcements and actions showed a remarkable elasticity of adjustment in adapting itself to the new environment. This resiliency enabled the System not only to cooperate actively with the government but also to retain and broaden basic powers from which its independence could draw meaning in more propitious times. The more active acceptance by the Federal Reserve of the 125

126

THF. I N D E P E N D E N C E O F T H E

FEDERAL R E S E R V E

SYSTEM

role of a participant in the determination and implementation of national policy was a forceful factor for unification and centralization of authority within the System. The Federal Reserve Bank of New York remained the principal operating arm of the System and continued to exercise individual power as the fiscal agent and close cooperator of the Treasury Department. The Board of Governors, however, became the fountainhead of new and broader powers both within the System and in coordinating those operations which involved the System and the Executive Department of the government. This change was due in part to new personnel on the Board and in part to the urgency of the problems faced. The result was that the greater the Board's cooperation, the greater its authority became within the System and in the monetary-fiscal operations of the government. The cooperation of the System was probably the principal reason that the government did not use some of the direct powers over monetary affairs given it by law and continued to operate through the Federal Reserve. The existence of cooperation probably also explained why Congress put five of the Presidents of the Federal Reserve Banks on the Federal Open Market Committee and charged the full Committee to share government responsibility. By creating this new authority, Congress denied total control of open-market policies and operations to the government-appointed Board of Governors. Though it could have done so, and though the times seemed to be calling for such action, the government did not transfer complete control of the money supply directly to the Executive Department. This rearrangement, both within the System and between the System and the government, did not settle for all occasions the problems of how to provide the most unbiased, most reasoned judgment about the proper monetary policy for the

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country. Nor did it decide how to establish the role of the government in the formation and execution of that policy so as to fulfill its responsibilities in times that were normal as well as those which were highlighted or dominated by crisis. The problems were solved one way under normal conditions, in another in times of crisis. But there was no doubt about the fulfillment of the wishes erf the government once these were clearly set forth. Extension of Federal Reserve Powers The Banking Act of 1935 was the principal source of the extension of Federal Reserve powers. In the Congressional hearings on this Act many divergent viewpoints were expressed. The Secretary of the Treasury (whose position as ex officio Chairman of the Federal Reserve Board was put in jeopardy in the discussions which preceded the banking laws enacted in 1932 and 1933) proposed that the Federal Reserve System be changed into a system of government banks by having the government buy all the stock of the Federal Reserve Banks. He stated that this change in ownership would reduce the influence of private bankers and would enable the government to control open-market operations of the Reserve Banks.1 1 U.S., Congress, Senate, Subcommittee of the Committee on Banking and Currency, Hearings on the Banking Act of 1935 (S. 1715), 74th Cong., 1st Sess., 1935, p. 507. Henry Morgenthau, Jr., the Secretary of the Treasury in 1935, argued strongly for the centralization of all credit control authority in a government agency. His argument was rather picturesque : I think that the engineer and the fireman should be working together and that there should not be a possibility, if a crisis should arise, that one might want to go full steam ahead and the other might not want to put coal under the boiler. {Ibid., p. 505.) When Morgenthau talked about a "Government agency" as a centralizing authority, he did not mean the Treasury (even though the credit control power of the Treasury was included in his proposal). "I would like to see it [the credit control authority] concentrated in an independent

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On the same occasion, the Governor of the Federal Reserve Board, Marriner S. Eccles, in opposition to the proposals of the Secretary of the Treasury, advocated a concentration of authority in the Federal Reserve Board so that it could control policy-making decisions and their execution. T o make the Reserve Banks more responsive to the Board each Bank's chief executive officer should be one of the Class C directors appointed by the Board. (Later the Governor modified this proposal by subjecting the selection of the executive heads of the Banks to the veto of the Washington Board.) Along with this concentration of control, the executive officer of the Federal Reserve Board should serve at the pleasure of the President of the United States. In addition, Eccles wanted the objectives of the Federal Reserve System to be broadened. Specifically, he urged that the Board be given the definite responsibility to use the powers of monetary and credit administration to promote stable business conditions and to mitigate unstabilizing fluctuations in production, trade, prices, and employment. The actual Banking Act of 1935 did not provide all the control elements proposed by Mergenthau and Eccles, one of the reasons being the organized opposition led by Senator Glass. It did result, however, in changes which evoked sharp criticism from such a defender of the Federal Reserve System as H. Parker Willis. He described (in 1936) the altered System as "the most highly centralized and irresponsible financial and banking machine of which the modern world holds record," "despotically controlled central banking," and giving the "real authority" to "a body politically chosen and entirely outside of the banking circle.'" G o v e r n m e n t agency. . . . [independent] of all outside influences— just as i n d e p e n d e n t as you can m a k e it." (Ibid., pp. 5 0 5 - 5 0 6 . ) : H. Parker Willis, The Theory and Practice of Central Banking (New York : H a r p e r & Brothers, 1936), pp. 106-108.

FEDERAL R E S E R V E

Increased.

Authority

for

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Board

In arguing for a change in the authority arrangement and the purposes of the Federal Reserve System,1 Governor Eccles stated that while the Federal Reserve System had provided for the expression of private and public interests in the banking and currency system it had become unbalanced with preferential weight to private interests. The private interests, and especially those in the New York financial district, acting through their connections with the Reserve Banks, exercised an improper influence on the nation's economy. They could so use the Federal Reserve Banks because (1) the Banks were owned by private interests, (2) the Governor erf each Reserve Bank was the representative of private interests, and (3) the Banks, therefore, were privately managed for the interests of the owners.' The logic for the remedy proposed by Eccles was simple enough. What was needed to achieve a proper balance was the restoration of control to the Board in Washington. In this way the public interest would be protected, and the government would receive the needed cooperation erf the Federal Reserve in carrying out its fiscal program, even if private bankers were opposed to the program. Eccles maintained that the Federal Reserve System should provide a deliberate management of the monetary system for the promotion of business stability 3 Marriner S. Eccles, Beckoning Frontiers (New York : Alfred A. Knopf, 1951), pp. 166-174; 215-216. * T h e Secretary of the Treasury agreed with Eccles on these points. He judged that private bankers controlled the Federal Reserve Banks and that their interests were protected by the Governors of the Reserve Banks. He went further than Eccles when he stated : " T h e large New York private banks and insurance companies dominated the Federal Reserve Board and the Open Market Committee." (John Morton Blum, From the Mergenthau Diaries [Boston : Houghton Mifflin Company, 1959], pp. 343-344.)

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through monetary and credit policies. The determination and execution of such policies could not safely or wisely be turned over to private organizations. Hence private interests might participate in, but should not control, the System. On the other hand, it was the duty of the government to control monetary and credit policy for public purposes through a reconstituted Federal Reserve System, one which would recognize the public character of that control and would be strong enough to resist political pressures for the use of its authority for purposes not consistent with its public objectives. Thus, to Eccles, public control did not mean control by the Treasury or by partisan politics; likewise it did not mean control by private banks or private interests. The Federal Reserve Board rather than the Reserve Banks should be given this authority because only in this way could its exercise result in what had to be "public" control. As mentioned, the proposals of Governor Eccles for centralizing control were not all adopted by Congress. They were influential, however, in unifying the System and having it more definitely understood as operating within the framework of the government. Undoubtedly they helped persuade Congress to strengthen the Federal Reserve Board in relation to the Reserve Banks. Through laws passed in 1934 and 1935, the Federal Reserve Board (renamed the "Board of Governors of the Federal Reserve System" with a "Chairman" at its head) received new powers over member banks as well as over the Federal Reserve Banks, all of which increased its control over the monetary and banking system. Four of these new powers were (1) authority to change the percentage reserves required to be maintained by member banks at the Federal Reserve Banks, (2) authority to approve, or not, the chief executive officer (renamed the "President") and his first assistant chosen by the

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boards of directors at the respective Reserve Banks, (3) authority to regulate all actions taken by the Reserve Banks in conjunction with foreign banks, and (4) authority to determine the loan value of securities when credit was used to purchase securities on the stock exchanges. These new areas of choice and decision for the Board increased its control power within the System. Management centralization, however, found a greater fulfillment in a new organization within the System : the Federal Open Market Committee.

New Open Market

Committee

Since 1930 the open-market operations of the Reserve Banks had been directed by a committee of twelve representatives of the Reserve Banks somewhat independently of the Washington Board. Marriner Eccles wanted the arrangement turned around so that the Board would make the open-market policy decisions and the Presidents of the Reserve Banks would be only advisers on the matter. Congress compromised disparate views on the question by forming a new organization composed of the whole Board and five of the Reserve officers (the latter serving on a rotational basis).5 The members of the new Federal Open Market Committee served not as representatives of the other organizations to which they belonged but as participants chosen to fulfill a Congressionally designated purpose. Public Character. The new public responsibility had a special meaning for the representatives of the Reserve Banks. "Until 1942, the Federal Reserve Bank of New York served on the Committee in rotation· with the Federal Reserve Bank of Boston. In July of that year, an amendment to the Federal Reserve Act authorized the continuous representation of the New York Bank on the Committee and the rotation of the Boston Bank with those in Philadelphia and Richmond. (Twenty-Ninth Annual Report of the Board of Governors of the Federal Reserve System, 1942 [Washington, 1943], p. 56.)

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Although they were either Presidents or First Vice Presidents of the Reserve Banks, they were not accountable, as in the ordinary corporation, to the boards of directors which elected them. T h i s unusual relationship was later spelled out by the Presidents of the Reserve Banks : T h e presidents as members of the Open Market Committee do not go to meetings of the Committee with specific instructions from the boards of directors of the Federal Reserve banks, for in that capacity the presidents act as individual members of the committee. They do not reveal to their boards of directors policy actions that are to be considered at forthcoming meetings of the committee, and they do not report to the directors concerning the decisions made by the Committee until those decisions are public information. Thus, although the informed judgments of the directors are obtained concerning the broad characteristics of economic developments and the desirable direction of open market policy, and although the directors are in a position to help broaden the public understanding of policy decisions taken, the directors are not given access to confidential information concerning the open market policy. 0 T h e distinction in responsibilities of the Reserve Bank Presidents as Presidents and as members of the Federal

Open

Market Committee was rooted in the specific public character of the new Committee. It was signalized in the public oath of office which the Presidents took as members of the Committee, the same oath as that of other officers of the government. T h i s distinction, however, was not always recognized, much less understood, and its feasibility was questioned by critics within and outside of the System. In addition to giving added status to the Presidents of the Reserve Banks, the new structural arrangement increased the authority and responsibility of the Federal Reserve Board, but ' Patman

Compilation,

Part

2,

1952,

p. 6 6 7 .

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in a qualified way. Thus, although the Federal Reserve Board ac quired power to initiate open-market policy decisions, it had to share that power with other Federal Reserve officials who were chosen by the Reserve Banks. The Board was given major representation on the Committee, not the sole authority. It had, however, some control over the men who shared with it the powers and responsibilities of the Federal Open Market Committee. The chief executive officer and his first assistant at the respective Reserve Banks, the only eligibles for membership on the Committee, were elected to their Bank positions by their boards of directors, subject to the approval of the Board of Governors. Group Authority. By bringing the Board of Governors and the Reserve Banks together in one authoritative organization, the Federal Open Market Committee was a major attempt to provide both a new source of unity for the System and a way to increase its efficiency and public responsibility. It did not abolish the idea of decentralized control or make one official all-powerful. Thus it was different from other government bureaus and agencies established during the same period. In the new alignment of control in the Federal Reserve System, the decisions were group decisions decided by majority vote with each member of the Committee having one vote. Moreover, one man, whether Chairman of the Board of Governors or President of the New York Bank, legally was not able to bind the Committee to a course of action he alone espoused. His ideas had to be submitted to group vote to become effective. A strong personality, such as Marriner S. Eccles, could overcome these committee impedimenta by the force of his personality and persuasion. But not necessarily so; and when it was not so, the situation could be frustrating to the Treasury Secretary or even to the President of the United States, both of

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SYSTEM

whom usually conferred only with the Chairman or the New York Bank President.' Since the open-market authority was a committee authority, it precluded holding one man publicly responsible for the Committee's decisions. Congress had to face this obstacle when it attempted to exert pressure on the Chairman (who acted as the Committee's and the System's spokesman) for greater deference to the wishes of Congress. Since the committee decisions remained a group function and a group responsibility, the Chairman, when pressured, could fall back on this arrangement which Congress itself had established. Committee control and committee responsibility were not indispensable. But given their existence, they provided protection against easy domination by the Board of Governors and against easy and complete Executive or Congressional control of the System. 8 Agency of Government. Nonetheless the new statutory Federal Open Market Committee was an agency of the government. This was shown in several ways. The Committee used government-directed powers for the achievement of public goals; its members were clothed with the garment of 1 At times it was exasperating also to C h a i r m a n Ecoles. (Cf. Blum, op. cit., p. 375.) O n one occasion, he thought of personally joining the Treasury in a public statement in opposition to a policy stand of the Committee. At this time, there were only six members on the Board, and the President of the New York Reserve Bank had a strong voice in Committee decisions. (Ibid., p. 378.) 8 In the new Committee arrangements there was a n o t h e r f a c t o r which provided a kind of check and balance. Decisions of the Federal O p e n Market Committee were executed by the Federal Reserve Bank of New York. This arrangement resulted in the New York Bank's exercising some discretion as to the actual dollar a m o u n t , the area, and the timing of the particular transactions. Moreover, t h e separation of the institutions which made the decision and which executed it was complicated by the fact that the executor was also the fiscal agent for t h e T r e a s u r y D e p a r t ment. T h e New York Bank could be obliged to carry o u t decisions for two' different organizations at the same time, and it, r a t h e r than the Board or the Committee as a whole, exercised the immediate power to resolve any conflicts which might a p p e a r .

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public responsibility and participated in decisions of national importance; it was obliged to make (through the Board of Governors) a public report of its decisions to Congress. The purposes assigned by Congress to the Federal Open Market Committee obligated it to promote the public interest. An amendment in the Banking Act of 1933° to the Federal Reserve Act provided the following directive for the Committee : The time, character, and volume . . . of open-market operations shall be governed with a view to accommodating commerce and business and with regard to their bearing upon the general credit situation of the country.10 Another indication that the Committee was to operate within a governmental framework was found in the requirements of membership. Some of the members were chosen by the President of the United States when he appointed them to the Board of Governors; the others were chosen by the boards of directors to the Reserve Banks when they were made executive officers of the Reserve Banks. As mentioned previously, all the Committee members took the formal oath of office of a Federal Government official. Though this oath was customarily taken by members of the Board of Governors, it was not taken by the Presidents of the Federal Reserve Banks in their capacity as officers of the Reserve Banks." Obligation for Public Report

The greater definition of public control and public purposes for the Federal Reserve System provided by new laws and new 8 The Banking Act of 1933 gave statutory recognition to a Federal Open Market Committee composed of twelve members, each elected by the board of directors at each' Federal Reserve Bank.

10

Section 12A.

" At each Bank, the Federal Reserve Agent, who was also the Chairman of the Board of Directors, took the formal oath.

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structures had as a corollary an increase in the System's direct accountability to Congress. The original Federal Reserve Act directed the Federal Reserve Board to "make a full report of its operations to the Speaker of the House of Representatives, who shall cause the same to be printed for the information of the Congress.'" The content of this directive was amplified in the Banking Act of 1935. The Board was ordered to keep "a complete record of actions taken by the Board and by the Federal Open Market Committee upon all questions of policy relating to open-market operations." The record was to include the votes taken "and the reasons underlying the action of the Board and the Committee in each instance." A similar record was to be kept "with respect to all questions of policy determined by the Board." The disclosure principle of the report requirement was a public recognition of the dependence of the Board and the Committee on Congress. Such recognition, in itself, was honest and proper; however, Marriner S. Eccles saw in the report requirement the danger that the Committee's operations would be exposed in a direct and regular way to political influences.'' For this reason Eccles opposed the enactment into law of such a requirement. His objection was in the tradition of the early ideas of the independence of the System. There was, however, no accepted proof that such influences would seriously hamper the effective operation of the Committee or the Board. Moreover, the Treasury, which was urging the enactment of the new banking law, could not be expected to support Eccles in this opinion. On the contrary, the "political influences" could be helpful in promoting the Treasury's view on the monetary policies to be adopted by the Board and the Federal Open Market Committee. In addition, other larger S e c t i o n 10. " B l u m , op. cit., 11

p. 3 5 1 .

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features of the proposed law (such as the provisions for permanent regulations for deposit insurance) were politically very desirable, and they carried along the report requirement (and other features initially opposed by Eccles) to enactment. The objection of Eccles, however, did make a point. The operation of the report requirement could produce questionable results as well as benefits for the Federal Reserve. Since it was not to be expected that all would be sweetness and light at Committee or Board meetings, the necessity of a public report could affect the Board and the Federal Open Market Committee in a way inimical to frank discussion of policy and operational procedures. For example, if the report were sufficiently detailed, the manifestation of repeated divisions among the members of the Board and the Committee could open the way to accusations of disunity and delays harmful to the achievement of the public interest. A likely result would be that criticism and analysis of government policies as they impinged on the monetary and banking field would be played down in the report. Moreover, some possible decisions might not even be proposed for consideration lest the System appeared divided and /or in opposition to the government. On the other hand, there could be favorable results. Obligatory detailed reports were a means for the System to justify its operating outside the day-to-day control of the Congress or the Treasury. They were a way the System could explain its objectives in the light of overall government policy and of the powers available to it. Such explanation and justification, although susceptible to flow-back effects on the actual decisions and operations of the System, were all the more necessary as the government's policies and objectives broadened in the Thirties and designedly overlapped the policies and objectives of the Federal Reserve System. Taken together with other control arrangements which not

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only tended to unify the System but to place it more clearly within a governmental framework, the public accountability requirement made the idea of independence of the System from domination by the Executive branch of the government more acceptable to Congress and the Executive branch at a time when the pressure for outright government control was growing strong.

Formal

Separation

from

Treasury

In the Thirties, Congress strengthened the independence of the Federal Reserve System in its relations with the Executive branch of the government by eliminating the formal participation of the Treasury in the operations of the Federal Reserve Board. The Secretary of the Treasury and the Comptroller of the Currency were removed from membership on the Board, and the Board was given full control over its own operating funds. The removal of the Treasury officials from the Board was proposed early in 1933. Senator Carter Glass explained to the Senate why his committee recommended the removal of the Secretary of the Treasury from the Federal Reserve Board : The view of nearly every recognized publicist and political economist [was] that the Secretary of the Treasury should not be upon the Board. That has been the view of the Board itself, for the reason that the Secretary of the Treasury has an undue influence upon the activities of the Board, and constrains it to adapt its policies to the requirements of the Treasury rather than to the requirements of the business of the country. . . . My own experience as Secretary of the Treasury and my observation since convince me that the Federal Reserve System is used in an unwise way by the Treasury and under the dominance of the Secretary of the Treasury." " U.S., Congressional

Record,

L X X V I , 2264.

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Senator Huey Long was one of the few Senators who opposed this change. He argued that the removal of the Treasury Secretary would hinder the effective responsibility of the Board : It is said that it is desired to take him off because he dominates the board. That is all the more reason why he ought to be kept on the board. The responsibility ought to be charged to the administration in power. . . . When the Secretary of the Treasury is dissociated from the Federal Reserve Board, then the Federal Reserve Board will constantly "pass the buck" and say, "it is the Treasury Department that is responsible," and the Treasury Department will "pass the buck" back and say that it is the Federal Reserve Board that is responsible.15 Although the proposal of Senator Glass passed the Senate in January, 1933, it was not acted upon by the House of Representatives. In June, 1933, when a new banking law was enacted by Congress, there was no change in the status of the Secretary of the Treasury. Glass explained that the status quo was kept because "the Secretary of the Treasury seemed to regard [the proposed change] as a personal affront to him and as a curtailment of his power which ought not to be made at this particular time."" Two years later, in 1935, the opposition of the new Secretary of the Treasury to his own removal from the Board was not as deciding and, furthermore, at his own insistence his loss of membership was coupled with the removal of the Comptroller of the Currency. One other change in the connection between the Federal Reserve Board and the Treasury Department, concerned the operating funds used by the Board. These funds, derived from assessments on the Federal Reserve Banks, were considered by the Attorney General (at the very beginning of the Federal "Ibid., 2276. ,β U.S., Congressional Record, LXXVII, 3725.

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Reserve System) to be "public" funds and thus they came to be deposited in the Treasury and subject to audit control by the Treasury Department. This was changed in 1933, when the Board was allowed to deposit its assessed funds in the Federal Reserve Banks and to control their use. T h e Banking Act of 1933, in amending the fourth paragraph of Section 10 of the Federal Reserve Act, stated that "funds [of the Board] derived from such assessments [on the Reserve Banks] shall not be construed to be Government funds or appropriated moneys." These two changes, the unseating of Treasury officials and the right to audit control of its funds, gave to the Board a note of formal independence from the Treasury Department. In the mind of the Governor of the Federal Reserve Board these changes did not seal off the Federal Reserve System from the government's economic policies or from the Treasury Department's need to finance the government's execution of its policies. In the Congressional hearings on the Banking Act of 1935, Eccles testified : Since central banking institutions derive their power from the Government—are in fact creatures of the Government—they do not, and in the nature of things, cannot work at cross purposes with the Government. . . . Hence, in one form or another there must be cooperation between the Government, which determines economic policies, and the bank of issue which determines monetary policies.11 17 U . S . , Congress, Senate, Subcommittee o f the C o m m i t t e e on Banking and Currency, Hearings on the Banking Act of 1935 (S. 1715), 74th Cong., 1st Sess., 1935, p. 284. At the House hearings on a similar bill, Eccles argued that the Governor of the Federal Reserve Board should be appointed by the President to serve at his pleasure. T h i s dependence was "in the interest of the Federal Reserve S y s t e m " which should provide for " a very close relationship between the banking system and the administration in power." Eccles was asked about the results if possibly "political exigencies might be in direct conflict with wise banking and wise credit policy." His reply w a s : " I f you have such exigencies —war is a case in

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This was a realistic statement of the ultimate dependence of the Federal Reserve System, a creature of the government and its policies. It was realistic not only because of the demands of the sovereign government but also because of other actions the government had taken and would take in the future with respect to the formation of monetary policies.

Extension of Treasury Powers During the Thirties various laws and executive orders organized and/or directed executive agencies which operated in the banking and credit field. They made clear that what was done or should be done in the realm of monetary policy was clearly to be guided by the national interest as interpreted by the government. In carrying out this scheme the government did not locate all national authority over money and banking in either the Federal Reserve System or the Treasury Department. Separate agencies such as the Federal Deposit Insurance Corporation and a revitalized Reconstruction Finance Corporation were given large powers over banking and credit financing of business, and they were not directly part of either the Treasury Department or the Federal Reserve System." The Treasury and the Federal Reserve, however, were not neglected. As just mentioned, provision was made for strengthening the Federal Reserve. Likewise, increased point and depression is a case in point —then I think it would be very unfortunate if the administration was unable to carry out its program." (U.S., Congress, House, Committee on Banking and Currency, Hearings, on H.R. 5357, 74th Cong., 1st Sess., 1935, p. 363.) 18 The RFC was not totally unrelated to the Federal Reserve : "The Governor of the Federal Reserve Board sponsored the establishment of the Reconstruction Finance Corporation and agreed to serve as its first chairman." (E. A. Goldenweiser, American Monetary Policy [New York : McGraw-Hill Book Company, Inc., 1951], p. 162.)

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monetary and banking powers were given to the Treasury. The two most important of the new laws affecting the Treasury and its relations with the Federal Reserve were the Thomas Amendment and the Emergency Banking Act, both enacted in early 1933. Thomas

Amendment

In the monetary history of the United States the perennial advocates of easy money and greenbacks were always found among and supported by the farming population. It was in keeping with this tradition that the Thomas Amendment"' was an addition to the Agricultural Adjustment Act of 1933.w This amendment gave the Secretary of the Treasury powers over credit policy which were comparable to those of the Overman Act during World War I. "The prospect or suggestion that these powers might be exercised would probably be as effective as a knowledge that the Overman Act might have been used against a recalcitrant Board during [World War I]." 7 ' The purpose of the Thomas Amendment was to use monetary policy to inflate the price level and thus solve the nation's economic problems. Attention was focused on agriculture : through monetary measures farm prices would be raised and the burden of debt on farmers would be eased. Specific monetary and banking powers given to the President and the Secretary of the Treasury referred to (1) open-market operations and direct purchases of government securities by the Federal Reserve System, (2) reserve requirements for member banks, (3) issuance of United States notes (greenbacks) by the Treasury, and (4) valuation and coinage of gold and silver by the President. 10 w

31 U . S . C . 821. T i t l e I I I , Sec. 43. B o p p , op. cit., p. 2 1 .

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The Thomas Amendment authorized the President, when he judged it proper, to delegate to the Secretary of the Treasury the authority to confer with the Federal Reserve Board and the Federal Reserve Banks and to have them agree to enter into open-market operations in government securities or to purchase such securities directly from the Treasury to the amount of $3 billion. If the Federal Reserve System refused to undertake these investments, or if the purchase did not raise the general price level, or if the President decided that additional action should be taken, the President had the authority to direct the Secretary of the Treasury to issue $3 billion of United States notes (greenbacks) for the purpose of purchasing outstanding government securities. These notes would be full legal tender; but they would not be a permanent addition to the nation's supply of currency, since they were to be retired at the rate of 4 per cent annually. On the other hand, the Amendment gave the Federal Reserve Board coercive power over open-market and other operations of the Federal Reserve Banks to check inflation." This power was conditioned, however, on two suppositions: (1) the need to prevent undue credit expansion, and (2) the approval of the Secretary of the Treasury or the President. The Amendment stated : The Federal Reserve Board, with the approval of the Secretary of Treasury, may require the Federal Reserve banks to take such action as may be necessary, in the judgment of the Board and the Secretary of the Treasury, to prevent undue credit expansion. [Emphasis added.] This power of the Board was further specified when the new 12 This was prior to the passage of the Banking Act of 1935, which set up the Federal Open Market Committee and which gave the Board of Governors the authority to change reserve requirements. It remained in force, however, after the passage of that law.

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THE INDEPENDENCE

O F THF. F E D E R A L R E S E R V E

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law gave the Board the authority to change reserve requirements of the member banks in times of emergency, but only with the approval of the President. In addition to their participation in the enlarged powers of the Federal Reserve Board, the President and the Treasury were given by the Thomas Amendment monetary powers apart from any action which the Federal Reserve might take. T h e President was authorized to reduce the weight of the gold and the silver dollar up to 5 0 per cent, to have the Treasury coin gold and silver at a fixed ratio, and to accept silver (valued for this purpose at fifty cents an ounce) from foreign countries in payment of their debts to the United States. (Another law, the Silver Purchase Act of June, 1934, authorized and directed the Treasury Secretary to purchase silver at prices and times he considered advantageous.) T h e Thomas Amendment was not a designed part of the New Deal in the early Thirties; rather it was something that was accepted and adopted by the President once the authority it carried was made discretionary rather than mandatory. Even at that, when it was supported by the President, the Director of the Budget Lewis Douglas predicted, "Well, this is the end of Western civilization.'" 3 At any rate, the Administration made use of the powers relating to the valuation and coinage of gold and silver. The other wide grant of authority which the Treasury received, though it was not activated, remained at hand to make the wishes of the Treasury forceful in the councils of the Federal Reserve System. Emergency

Banking

Act

In a sense, the cooperation of the Federal Reserve System with the Treasury became subject to an ultimatum. T h e Sys" Raymond Moley, After 1939), p. 160.

Seven

Years

(New York : Harper & Brothers,

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tem if it did not cooperate actively could be overridden or superseded, at the best, and abolished, at the worst. The abolishment would have to be done directly by Congress; the overriding or superseding could be done by other government agencies. Already mentioned was the power given the Treasury by the Thomas Amendment. Authority over the Federal Reserve also came from another law, the Emergency Banking Act of March 9, 1933. Section 4 of this Act24 was designed (1) "to provide for the safer and more effective operation" of national banks and the Federal Reserve System, (2) "to preserve for the people the full benefits of the currency provided for by the Congress" through national banks and the Federal Reserve System, and (3) "to relieve interstate commerce of the hurdens and obstructions" resulting from bank checking accounts which were established on an unsound basis. For the accomplishment of these purposes, at a time decided upon by the President, the Secretary of the Treasury was given almost complete powers of control over banking : During such emergency period as the President of the United States by proclamation may prescribe, no member bank of the Federal Reserve System shall transact any banking business except to such extent and subject to such regulations as may be prescribed by the Secretary of the Treasury, with the approval of the President.25 In view of such an all-embracing law there was no denying the supremacy of the government's power. The monetary and banking powers of the Treasury made it clear that the Federal Reserve System could not maintain a wall of separation between itself and the Treasury. The M

12 U.S.C. 95. Similar broad powers had been given to the President by Section 5b of the Trading with the Enemy Act of 1917, as amended (12 U.S.C. 95a). (This was the law Franklin D. Roosevelt invoked when, on March 6, 1933, he issued his Executive Order closing all banks.) 25

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THF. I N D E P E N D E N C E O F T H E F E D E R A L R E S E R V E

SYSTEM

Federal Reserve could not go about its business and ignore the wishes of the Treasury which, in accordance with Congressional directives, had to finance the government through the collection of taxes a n d / o r the creation of debt. L a t e in the Thirties, when there was renewed pressure in Congress for greater government control of the System, the Chairman of the Board of Governors stated this viewpoint : T h e primary function of the Treasury is to collect taxes, borrow money, and provide funds for the various agencies of the Government in accordance with congressional appropriations. T h e primary function of the Federal Reserve System is to influence the flow of money and to contribute to the soundness of the banking system. In a broad sense the objectives of both agencies are the same, namely, to serve the public interest, but their points of view and experience, and their approach to current problems may at times be different. T h e maintenance of an organization for the regulation of credit separate from the fiscal arm of the Government has been found advantageous in most countries of the world, and its abandonment [would] be a backward step.^ T h u s , while stating the impracticality of aloofness and the need for cooperation, Eccles also insisted on the separateness of the two organizations. T h e public concern for the respective powers of the Treasury and the Federal Reserve did not produce an atmosphere of complete harmony at all times. O n occasion feelings were ragged and emotional insistence on prerogatives influenced the relationships. In general, however, the shifts in power resulted in an increase in understanding of each other's role. Closer cooperation, even though at times secured through the force of threats, tended to become more normal and accepted. ?e U . S . , Congress, House, Committee on Banking and Currency, Hearings on Government Ownership of the Twelve Federal Reserve Banks, 75th Cong., 3rd Sess., 1938, p. 4 4 8 . (Testimony of Marriner S. Eccles.)

F E D E R A L R E S E R V E R E L A T I O N S IN T H E

THIRTIES

147

Cooperation of Federal Reserve with Government In the Thirties it was difficult for Federili Reserve officials to develop and promote the role of monetary policy through the usual System operations. Confidence in the System and esteem for its power had been weakened by the persistent depression which unexpectedly spanned the decade. Moreover, the importance of monetary policy tended to be overshadowed by the burgeoning fiscal policy of the government. One economist judged the eifect in this way in 1941 : One of the most striking facts about the development of fiscal policy in the past decade [i.e., in the Thirties] is that, while it grew out of monetary policy and was designed to supplement and strengthen it, fiscal policy has ended up by threatening to supplant monetary policy altogether/" The reaction of the Federal Reserve System to this development was not continually a discontented head-in-the-sand attitude. Initially, perhaps, it manifested aloofness and indifference and even opposition. Later as the government expanded its own objectives in the economic life of the nation and set about broadening the powers and objectives of the Federal Reserve System as well as those of other government agencies, the Federal Reserve showed a new life and found a new place within the government. Its new vocation was particularized in the phrases of President Roosevelt at the dedication of the headquarters building of the Board of Governors in 1937 : " I dedicate this building to progress toward the ideal of an America in which every worker will be able to provide his family at all times with an ever-increasing standard of comfort." 27 John H. Williams, "The Implications of Fiscal Policy for Monetary Policy and the Banking System," The American Economic Review, X X X I I , No. 1, Supplement, Part 2 (March, 1942), p. 234.

148

T H E INDEPENDENCE O F T H E FEDERAL R E S E R V E

Increased

Public

SYSTEM

Responsibility

President Roosevelt certainly expected that

the

Federal

Reserve System would use its monetary and banking powers for the promotion of the ideal which he had proposed. T h i s objective was implicitly added to the Federal Reserve Act or was enacted in related laws in the Thirties. T h e Board was given the power to change reserve requirements for the purpose of preventing "injurious credit expansion or contraction" ; :s in its regulation of stock market credit, the Board was to have "due regard for the general credit situation of the country."" T h e boards of directors of the Reserve Banks were enjoined to make sure their loan operations were consistent "with the maintenance of sound credit conditions." 1 0 T h e Federal Open Market Committee's mandate required that the Committee carry out its operations "with regard to their bearing upon the general credit situation of the count r y . " " T h e new directions were not as specific as some members in Congress desired, as, for example, the attempts to have the Federal Reserve System base its policy upon changes in wholesale prices or to make the achievement and maintenance of a specified price level a primary objective of monetary policy.' 2 T h e y were, however, specific enough in tying in the operation and policies of the System with those of the government and in clarifying the concept that the

government's

promotion

policies

of certain monetary

and banking

ipso

facto were not improper and did not constitute "undue inter12 15 30 12 31 12 35 Cf. Federal M

w

U.S.C. 462b. U.S.C. 78g. U.S.C. 301. U.S.C. 263. Twenty-Fourth Annual Report of the Board of Governors of Reserve System, 1937 (Washington, 1938), pp. 221-222.

the

FEDERAL R E S E R V E RELATIONS IN T H E T H I R T I E S

149

ference." The new specification of public responsibility undoubtedly would provide new occasions for testing the elasticity of adjustment of the System. Two conclusions seemed evident : (1) ultimately the wishes of the government would dominate, and (2) the influence of the Federal Reserve on the specification of those wishes would depend upon its sense of participation and its achievement. In endeavoring to fulfill its responsibilities, the Federal Reserve System came to acknowledge that the objectives it had been given by Congress and which it used as guides for its policy and operational decisions were unachievable by monetary policy alone. In its Annual Report for 1937, the Board stated that Federal Reserve policy objectives are but one phase of "the general objective of public policy, to maintain economic stability." Then the Board went on to recognize further that it should work together with other government agencies : It should be the recognized duty of the Board of Governors of the Federal Reserve System to use all its powers to contribute to a concerted effort by all agencies of the Government toward the attainment of this objective [i.e., "to maintain economic stability"].33 The increase in the public responsibility of the Federal Reserve System was related directly to the action of the government in broadening its own responsibility. The expansion of public objectives, powers, and operations met with many obstacles, partly because of the absence of a kind of master plan which might have prevented duplication and provided unity. As the government strengthened the powers and extended the objectives of existing organizations and formed new ones which influenced the monetary and banking 33

Ibid.,

p. 2 2 3 .

150

T H E I N D E P E N D E N C E OK T H E F E D E R A L R E S E R V E

SYSTEM

system, it did not avoid setting up overlapping authorities.34 Any resulting conflicts in policies and objectives had to be avoided; or if that was not feasible, they had to be resolved harmoniously. Since no separate arrangements were made for such harmonization,

the parties involved were

practically

forced to negotiate among themselves and to strive to work together. Conflicts of authority, however, were not without their benefits. These benefits were principally in the form of checks and balances which operated at a time when the government was rapidly expanding its role in the economic life of the nation. T h e powers and responsibilities of the Federal Reserve System were also subject to such checks and balances as conflict or cooperation produced. T h e monetary and banking powers given to the Treasury Department and agencies of the government restricted the ability of the System to manage its own household. It had to take into account the whole picture. O n e of the items in the picture which attracted increasing attention in the Thirties was the growth in the government debt and the continual demands for its financing. Influence

of Treasury

Policy

As the decade of the Thirties marched along, the Federal Reserve authorities had to recognize more and more one in34 E. A. Goldenweiser, technical adviser to the Board at the time, judged that in the early Thirties the attitude of Federal Reserve officials tended to foster the somewhat scattered approach to the problem : In 1933 the Federal Reserve System was not in sympathy with much that was being done by the government and opposed many of its measures. T h e consequence was that a whole series of institutions was established, with functions that could have been Federal Reserve functions and should have been closely coordinated with the Federal Reserve System. O n e difficulty was that the Federal Reserve System in 1933 was largely guided by the conceptions of 1913. A central bank must not remain on its Olympian heights. [E. A. Goldenweiser, " T h e Federal Reserve System T o d a y , " A Forum on Finance, ed. Joseph B. Roberts (New York : Columbia University Press, 1940), pp. 7 6 - 7 7 . ]

FEDERAL RESERVE RELATIONS IN THE THIRTIES

151

escapable fact : the expansion in the uses of the government's fiscal power and the concomitant increase in the government's debt. Between 1930 and 1939 (June 30 dates), the government's debt increased $24.2 billion (from $16.2 to $40.4 billion). Financing this debt involved not only its initial creation but also its re-creation as it passed its many maturity dates. The work of debt management, of course, was the Treasury's, and it was not new work for the Treasury Department. It was an operation begun at the very founding of the Republic and continued on through all the succeeding years. What was new and of enormous importance to the Treasury and to the Federal Reserve was the sudden growth in that debt. In the Thirties, the debt increased to an amount considerably larger than ever before, even during the First World War. The growth of the government's debt affected the openmarket operations, the determination of reserve requirements of member banks, and the setting of discount rates by the Federal Reserve System. There were two main reasons. First, the Treasury strongly desired to do its financing at relatively low rates of interest. Second, the tradition of the propriety of government bonds selling at par was heightened by the recent history of the failure of many bond-issuing institutions. Private-business bonds selling at a discount frequently were a sign of poor credit standing. Popular opinion (and also that of some government officiais) seemed to apply a similar test to government securities. Accordingly, since the increase in government debt was widely denounced as irresponsible, there was strong pressure on the government not to allow its security prices to fall below par and thereby compound the accusation of irresponsibility. The consequent Treasury policy of low rates and strong prices limited the freedom of the Federal Reserve in the money market, especially in its open-market operations. This limitation on Federal Reserve action and its

152

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

effect on the System's relations with the Treasury were illustrated in the ramifications of monetary policy decisions in 1936 and 1937. Problem of Support for Bond Prices. During all of 1935 and most of 1936, member bank excess reserves were about equal to required reserves. This unusual situation made a difficult problem for the Federal Reserve : how to offset the implied inflationary potential." Selling sufficient government securities from its portfolio might cause an immediate weakening of bond prices. The alternative proposal, raising reserve requirements, did not seem to have as direct or as necessary a connection with a weakening of bond prices. The Treasury, however, disagreed with this judgment.3* The Board of Governors decided a choice had to be made; accordingly, on July 15, 1936, the Board announced a 50 percent increase in reserve requirements to be effective on August 16. This decision had been approved a week earlier by President Roosevelt, who stated that the action would be agreeable to the Treasury. The Treasury was agreeable but only because it had hopes that the System would support bond prices if disturbing selling pressure developed. The Secretary, however, became angry about the decision because he had not been informed prior to the public announcement and had to learn about it from the morning newspaper. His complaint had merit. Subsequent protection for bond prices came mainly from the Treasury's willingness to make any needed purchases." " Not all informed opinion was agreed that there was a danger of inflation and a need for action : the excess reserves would disappear if business recovery became stronger and investment increased. M T h e Secretary of the Treasury was influenced in part by the opinion that the proposal for increased reserve requirements was main'.y a scheme devised by commercial bankers, through their influence on the Presidents of the Federal Reserve Banks, for raising interest rates and bank profits. (Blum, op. cit., p. 355.) " Ibid., p. 357.

FEDERAL R E S E R V E RELATIONS IN T H E T H I R T I E S

153

In supporting bond prices, the Treasury used funds from its trust accounts. Since these funds were not inexhaustible and since the Federal Reserve could not be persuaded to initiate support operations, the Treasury offered the Federal Open Market Committee an option to take up each day onehalf of the trust funds purchases. When this offer was accepted, Secretary Morgenthau remarked to Chairman Eccles, "Well, nòw that's fine, Marriner, now we're partners."38 The partnership, however, had to face the fact that excess reserves in the banking system continued to increase. Segregation of New Gold. The Treasury was concerned about the persistent growth of excess reserves, though it disagreed with the Federal Reserve about the emphasis placed on the inflationary danger. In the opinion of both parties, the problem was rooted in the large increases in the gold stock of the nation.39 Accordingly, the Treasury proposed a way to prevent net gold imports from affecting domestic monetary management and, consequently, bond prices.40 The Stabilization Fund, which was managed by the Treasury, would purchase and transfer to the Treasury the net increases in gold. The Fund would pay for these purchases with dollars acquired by the Treasury through the sale of ninety-day bills in the market. The Treasury, in turn, would issue no gold certificates for the additions to the gold supply. Officials of the Federal Reserve objected to this plan on two main counts. First, a further increase in reserve requireIbid., p. 358. Between early 1934 (after revaluation) and the middle of 1936, the gold stock of the nation increased from about $7.4 billion to more than $10.6 billion. By the end of 1936, it amounted to almost $11.3 billion. During the following year it increased $1.5 billion. " T w o changes were made in the final form of the plan: (1) newly mined domestic gold was included and (2) responsibility was given to the Treasury operating through its General Fund rather than the Stabilization Fund. 18

55

154

T H E INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

ments would accomplish the same result without causing additional national debt and interest burden. Second, the proposal of the Treasury was an invasion of traditional central banking areas : the use of monetary techniques for adjusting to international imbalance. Having made these objections, the Federal Reserve was willing to withdraw its opposition on condition that the plan would operate automatically (unless the Board of Governors requested a change) and the transactions by the Treasury in the ninety-day bills would always equal the amount of gold involved. Similar to the Federal Reserve's concern for its prerogatives was the Treasury's emphasis on its own role. T h e Secretary was disturbed by the "impertinent" and "peremptory" manner in which the Chairman of the Board presented his position. The lack of harmony became more manifest in December, 1936. The Fedeial Open Market Committee withdrew its agreement to take an option on one-half of the security purchases made by the Treasury with its trust funds, and the Board of Governors repeated its criticism of the Treasury's gold segregation plan. Although the Chairman of the Board of Governors reiterated his desire to preserve a spirit of cooperation, Secretary Morgenthau interpreted the actions as a manifestation of a larger problem : Whether the Government through the Treasury should control . . . monetary policy . . . or whether the control should be exercised through the Federal Reserve Banks which are privately owned and dominated by individuals who are banker minded." This larger problem was not settled, but the gold question was. Since the Treasury needed authorization for its gold operations, the dispute was taken to the President. At the meeting with the President, Chairman Eccles admitted there were adBlum, op. cit., p. 363. (These were the words of an adviser of Morgenthau's with whom the Secretary agreed : Herman Oliphant.)

FEDERAL R E S E R V E RELATIONS IN THE THIRTIES

155

vantages in the Treasury's proposal and he agreed with the Secretary to work for greater cooperation. Accordingly, the Treasury's segregation of new gold began in December, 1936. Pressure

for

Support

Operations.

T h e operation of

the

Treasury's gold segregation plan did not solve the problem of excess bank reserves. Disagreement between the Federal Reserve and the Treasury reappeared when, in January, 1937, the Board of Governors proposed additional increases in reserve requirements. The opposition of the Treasury was directed at both the increase and its size : a one-third increase, to be achieved in two steps, on March 1 and May 1. After the Treasury failed to secure any adjustment in the proposal, the Secretary withdrew his opposition. When the March 1 increase in reserve requirements was followed by a decline in bonds prices, the Treasury used its trust funds to support prices and urged the Federal Reserve to make purchases. In response, the Federal Open Market Committee authorized the New York Bank to add up to $250,000,000 to the System's portfolio. The New York Bank did not immediately use this authority; instead it operated on both sides of the market. (Purchases of $104,000,000 of bonds were matched by sales of notes and bills.) Coupled with the Federal Reserve's failure to make any net purchases of government securities was the Treasury's inability to do so; its trust funds were almost exhausted. The Treasury, however, considered another source of funds : the segregated gold. Accordingly, the Treasury proposed to release $500,000,000 of segregated gold by issuing gold certificates and using the dollar credits to purchase government securities. At the same time the Treasury continued to urge the Federal Reserve to use its open-market operations to strengthen the market. Chairman Eccles, in reply, asked the Secretary of the Treas-

156

THE INDEPENDENCE OF THE FEDERAL RESERVE S Y S T E M

ury to delay the operation of the plan to release gold. H e told the Secretary that the fall in government security prices should be blamed on the failure of the New York Reserve Bank to follow the instructions of the Federal Open Market Committee. True, there was disagreement within the Committee over the wisdom of vigorous action on the purchase side when the System wanted to reduce excess reserves. Nonetheless the Committee had decided to keep the government securities market steady and to make purchases accordingly. Hence, new and more explicit instructions would be given to the New York Bank. In a sense, Eccles was not the master of his own household, as the Secretary seemed to think he should be. He told Secretary Morgenthau that "he could not use a club on twelve bankers, and further discussion would take time."" For Morgenthau, however, "time" was not a negotiable item. Therefore, both sides appealed to the President. Intervention of President Roosevelt. At the meeting with the President, the Secretary insisted that the trouble in the bond market was the result of the increase in reserve requirements. H e considered it necessary to release segregated gold unless the Federal Reserve postponed the May increase in reserve requirements. Eccles did not accept the Treasury's premises or its proposed remedies : I expressed the view that what Morgenthau proposed would indicate that the Administration was incapable of pursuing a steady course of action. Second, it would indicate that the Secretary of the Treasury had taken over control of monetary and credit policy. Third, it would inform the nation that the Banking act of 1935 was a failure, in that the Open Market Committee for whose organization we had fought so hard, failed to do the work we expected of it. Nonetheless, I assured the President that if in a week's time we Blum, op. cit.,

p. 373.

FEDERAL R E S E R V E RELATIONS IN THE THIRTIES

157

did not stabilize the price of government securities through open market operations, I would be the first to favor what Morgenthau wanted done.43 The Secretary agreed that the Federal Reserve should be given "one more chance,"" and on that note the meeting came to an end. T o make his position clear, Morgenthau attended the next meeting of the Federal Open Market Committee and, at President Roosevelt's suggestion, made a forceful statement of what he expected : We hope and earnestly request that you use the machinery which you have and give us an orderly market. Now, if within reasonable time you don't or refuse to, then I'm very sorry to say—I have to say that the Government will, and that's the whole story. I'm not threatening, I'm just making a statement.4' The next day, when President Roosevelt heard from the Secretary about opposition from the New York Bank President at the meeting, he asked : "Did you tell him that once the United States Government stepped in we're there for life ? " " Morgenthau had not so stated the case, but he felt such a result was sensed by the Committee. As a result of the intervention of the President, the Committee announced its readiness to add to its portfolio. No large purchases were necessary : between April 4 (the day after Morgenthau visited the Committee) and April 28, the System added $96,000,000 in bonds to its portfolio (without any matching sales of other securities). The final increase in reserve requirements went into effect as scheduled on May 1. This was not the end, however, of the episode. 4:1 Eccles, op. cit., p. 292. " Blum, op. cit., p. 373. According to Morgenthau, week's grace was Roosevelt's. "Ibid., p. 374. "Ibid., p. 375.

the idea of

a

158

THF. I N D E P E N D E N C E O F T H E FEDERAL R E S E R V E

SYSTEM

In the last half of 1937, the Federal Reserve completely reversed itself, and it became clear that the timing of the System's stand for its independence was unfortunate. The fear of inflation gave way to the reality of depression. As business fell off, stock margins and the discount rate were reduced. By September, the discount rate at the New York Bank was 1 per cent, "the lowest central bank rate in history."" In the same month, the Board of Governors asked the Treasury to release $300,000,000 of gold and announced its readiness to buy government securities "to meet seasonal demands for credit and to maintain monetary ease."" (In November, the System increased its holdings of government securities by $38,000,000.)" Excess reserves amounted to $1 billion in September and remained at that level for the rest of the year. During the last four months of the year, however, the index of industrial production fell as much as it had gained during the previous two years. T h e episode of 1936-1937 meant a loss of prestige for the Federal Reserve and made clearer the odds involved in an insistence on independence. T h e episode, however, had plus factors for the Federal Reserve. When disagreements arose between the Treasury and the System, the President could play a conciliatory role. It was reassuring to the Federal Reserve that the Secretary of the Treasury could not always count on the President to give quick support to the Treasury's viewpoint. Consequently, there was strong hope that the President, given cooperation, would not bluntly interfere in monetary policy decisions of the Federal Reserve. One of the 4 ' Twenty-Fourth Annual Report of the Board of Governors of the Federal Reserve System, 1937 (Washington, 1938), p. 9. Ibid. " T h e s e net purchases, together with those of April, constituted the first serious modification of the System's "constant portfolio" policy. Since October, 1933, holdings of government securities had been maintained at about $2.4 billion.

FEDERAL RESERVE RELATIONS IN THE THIRTIES

159

ways of specifying that cooperation was through the personal contacts of the Chairman with the Administration. The willingness of the President to listen to the Chairman of the Board of Governors as well as to the Secretary of the Treasury gave added weight to the Chairman's views in disagreements with the Treasury. Cooperation became more particularized and more feasible when both parties had a hearing, with each other and with any conciliatory third party. The enhanced position of the Chairman with the Administration, however, did not mean the coercion by the Treasury was no longer possible. The conflict with the Treasury in 1936-1937 illustrated that coercion could have subtle meanings. The same conflict also showed that the personal approach could be used to offset coercion. This means was used frequently by the Board Chairman not only to win support for Federal Reserve policies but also to influence government policies which impinged upon the Federal Reserve. Liaison Activities

of Board

Chairman

Though the influence of the Treasury in monetary-policy formation and execution became increasingly manifest in the Thirties, the Federal Reserve did not cease trying to maintain a place for a monetary and banking authority apart from the Treasury Department. The System officials searched for ways to cooperate and yet have a significant voice in the bi-located monetary and credit power which was being used in the achievement of government policies. One of the ways used was personal liaison with the Administration through the Chairman of the Board of Governors. Eccles became a frequent visitor to the White House and often spoke in public in support of the Administration's program for taxes, for balancing the budget, for agricultural

160

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

relief, for housing, and for other social improvement projects. In 1938, he became a member of a Presidential advisory board which considered fiscal and monetary policies related to production and national income. The other three members were the Secretary of the Treasury, the Director of the Budget, and the Chairman of the Advisory Committee on Natural Resources. They were concerned with drawing up the government budget as well as with related factors of taxes, public works, government debt structure, and an armament program. This broad spectrum of economic factors provided a wide range of decision areas. The effectiveness of the Federal Reserve representative in presenting an independent viewpoint undoubtedly was colored by his own promotion of the fiscal policies of the Administration. With the advent of war in Europe the advisory board ceased functioning. The free choice of monetary and fiscal policy became practically overwhelmed by the necessities of war production and war finance : each advisory board member had to bring his own agency into tune with those necessities. Nonetheless the Presidential advisory board of 1938 set a precedent which could be significant for the independence of the Federal Reserve System. The participation of the Chairman of the Board of Governors on the interagency board as well as his other personal liaison activities with the Chief Executive and with the heads of important executive agencies affected the independence of the System in several ways. First, it enabled the Federal Reserve to participate in government decisions which were interrelated with monetary and credit policy. The participation might be looked upon as a way of self-preservation for the Federal Reserve, lest it be absorbed by some other more closely directed executive agency. At the same time it offered an opportunity for the System to show the value and help of its own particular contribution. Second, the liaison activities

FEDERAL RESERVE RELATIONS IN THE THIRTIES

161

established the basis for a possible political influence on the Federal Reserve System, an influence which could be apart from the broad objectives of government policy as interpreted by the Federal Reserve. In other words, the workings of friendship could force, or at least color, the cooperation of the System. One qualification on this matter of liaison and cooperation had to be made. The contact was mainly through the Chairman of the Board of Governors; it was not directly through the other members of the Board or the top officiais of the Reserve Banks. It remained in doubt how influential the Chairman could be in bringing the other decision makers in the System to accept his point of view or his proposals. It was clear, however, that the tightening of the internal organization of the System in the first half of the Thirties tended to allow this solus idoneus type of spokesman. Other Attempts

to Strengthen

Authority

The liaison and cooperative activities of the Federal Reserve did not always produce the specific results desired. T h e System's activities which overlapped those of the Federal Deposit Insurance Corporation and the Comptroller of the Currency provided an example. When the Federal Reserve's influence was being weakened by the monetary and credit policies and operations of other government agencies, the System sought to strengthen its influence in another area of banking. It desired to have control of the examination policies of all bank examiners and authority over reserve requirements for all commercial banks. This proposal was not acceptable to the other agencies involved. Moreover, little support, if any, came from the Administration for this attempt to widen the System's power.50 50 S i m i l a r recommendations had b e e n made earlier. F o r example, in D e c e m b e r , 1 9 3 1 , President H e r b e r t Hoover had proposed them, and

162

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

A new approach to unification of policy making was taken when the Chairman of the Board of Governors sought the support of the Administration for a resolution, introduced in the Senate in 1939, by the Chairman of the Banking and Currency Committee, Senator Robert Wagner. This resolution proposed that the Senate committee make a study in order to determine : . . . a national monetary and banking policy by which the monetary and banking authorities of the Federal Government shall be guided and governed, and to determine the character of governmental machinery best calculated to carry out such policy.'1 The resolution passed the Senate and the committee took up the assigned work. The European war, however, at this time spread further into Europe and killed off interest on the part of the committee in the proposed study. What the result would otherwise have been for Treasury-Federal Reserve relations in the Forties will never be known. It should be noted nonetheless that in view of debt-management problems the interest of the Federal Reserve for the long term needed to be broader than a desire to increase its control over bank examination policies and the reserve requirements of non-member banks. Most likely the Federal Reserve would have been just that percipient if the proposed study had been completed. Girded with stronger powers and ennobled by a wider vision, the System would have been better prepared for its operations in conjunction with the Treasury Department during the Forties and Fifties.

they h a d been included in a follow-up bill for banking reform introduced by Senator Glass. (Studenski and Krooss, op. cit., p. 373.) " Eccles, op. cit., p. 284.

VI Federal Reserve Relations with the Government during World War II

IN

THE

FORTIES

NEW

LIMITS

WERE

PLACED

ON

THE

independence of the Federal Reserve System by further changes in the economic and political environment in which the System operated. The Federal Reserve actively participated in the government's successful and relatively facile financing of the Second World War. As the wartime financing grew, the System began to manifest greater concern over the inflationary consequences of its actions. After the war, the Federal Reserve continued its cooperation with the Treasury and intensified a search for ways to reconcile the monetary effects of the war financing with the promotion of a prosperous national economy. Although in both war and early postwar periods the cooperation of the System was neither begrudging nor servile, it was necessarily responsive to the urgent political and economic demands of the times. This was not uncomplicated. The political and economic demands and their resulting complications in monetary terms were manifested, first, in the tremendous growth of the government's debt during the war years and, second, in the increasing importance of government 163

164

THE INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

securities in the asset structure of banks and other public and private institutions. During the five-and-a-half-year period, from June 30, 1940, to the end of 1945, the total gross debt of the government increased almost $236 billion.1 Individuals added about $55 billion to their holdings of interest-bearing government securities; the remainder of the increase was accounted for by various institutions, among which the commercial banks bought an additional $75 billion and the Federal Reserve Banks, $22 billion. This relatively sudden increase in the government's debt and the addition of government securities to banking and institutional assets provided new problems for both the Treasury Department and the Federal Reserve System about the coexistence of credit control and the maintenance of the Government's credit. There was no doubt about the primacy of support for the Government's credit and the necessity for skillful and continuing management of the public debt. The question was how to do it and who should do it. The second part of this question was relatively easy to answer. It was the first part, the "how," which impinged upon the independence of the Federal Reserve System because debt management came to be intimately and rigidly connected with monetary and credit policy.

Preparations for War Finance Program At the outset of the Second World War there was no haggling between the Treasury and the Federal Reserve System over who had the primary responsibility for the management of the public debt. It was clearly the Treasury's. ' In each of two fiscal years, 1943 and 1944, the debt jumped more than $64 billion. T h e magnitude of these changes can be seen in comparison with the figure for the end of fiscal 1940, when the total debt was $43 billion. The addition made to the debt during the Thirties, from the end of fiscal 1930 to the end of fiscal 1940, was about $27 billion.

F E D E R A L R E S E R V E R E L A T I O N S DURING W O R L D W A R II

165

That answer, however, did not put the Federal Reserve out of the picture. The securities which represented the debt were floated mainly through the banking system and became prime liquid assets for various institutions, especially banks, as well as prime money-market instruments. Thus they were a direct concern of the Federal Reserve. The amount, timing, and price involved in the flotation of such securities, as well as their continuing existence, raised the question of how the debt should be managed. This question had no easy nor simple answer. Complications derived from two facts. First, the management operation overlapped the traditional areas of responsibility of the Treasury Department and of the Federal Reserve System. Second, these two agencies did not always agree on how debt management should be handled. One source of their disagreement was the failure to foresee (1) the extent of the growth of the debt, (2) the importance of government-debt securities as part of the nation's banking assets, and (3) the desirableness of not committing themselves to an irreversible position. The result for the Federal Reserve was a loss of control over interest rates and the availability of credit. The System's open-market operations, which had been a source of initiative for it, were transformed into a new form of passivity; that is, the Federal Reserve Banks created reserves, not at the direction of private banks through the discount of their commercial paper (the old form of passivity), but at the direction of the Treasury Department through its fiscal and debt-management policies and operations. During the war this procedure was rationalized by appealing to the necessity of expeditiously financing the military operations of the government; in the early postwar period, the appeal was based on a don't-rock-the-boat attitude arising out of a fear of depression before industry could reconvert and expand to meet the enlarged needs of the economy.

166

THE INDEPENDENCE OF THE FEDERAL RESERVE S Y S T E M

Early Market

Support

Operations

As the possibility of war in Europe became more apparent, the Federal Reserve System was not deficient nor unwilling in its cooperation with the Treasury in working for the "maintenance of the credit of the United States." In April, 1939, the Federal Open Market Committee authorized large purchases of securities so that the System would be ready to prevent disorderly conditions and to promote orderly conditions in the market." This authorization did not mean the maintenance of current prices. During the first half of 1939, government-bond prices rose sharply; on June 6, the long-term bonds sold at their record high. Thereafter, their prices fell. Apart from small purchases of securities during the last days of August, the Federal Open Market Committee did not intervene in the market to check the decline.

This policy, however,

was

changed when war broke out in Europe. Strong intervention for market support purposes began on the day Hitler invaded Poland, September 1, 1939. W h e n government-security prices broke sharply on that day, the System account added about $100,000,000 to its holdings. Market support by the System continued through most of September; by September 25, purchases had amounted to $473,000,000.' Promotion

of Orderly

Market.

T h e Federal Reserve also

attempted to limit, for the duration of the crisis, the selling of government bonds by large market participants. O n

Sep-

tember 1, before the market opened, the System bought (as : Twenty-Sixth Annual Report of the Board of Governors of the Federal Reserve System, 1939 ( W a s h i n g t o n , 1940), p. 69. 1 As prices s t r e n g t h e n e d l a t e r in t h e y e a r , t h e System sold a b o u t $ 7 7 , 0 0 0 , 0 0 0 of securities. T h e s e sales, t o g e t h e r w i t h t h e c o m p l e t e l i q u i d a tion of t h e F e d e r a l R e s e r v e ' s p o r t f o l i o of g o v e r n m e n t bills, resulted in a decline of a b o u t $ 8 0 , 0 0 0 , 0 0 0 for t o t a l h o l d i n g s d u r i n g 1939.

F E D E R A L R E S E R V E R E L A T I O N S DURING W O R L D W A R II

167

part of the $100,000,000 previously mentioned) the $61,000,000 inventory of the government-bond dealers. This action was intended not only to mitigate current market pressures but also to promote orderly future conditions. If the bond dealers were to liquidate their position (financed mostly with borrowed funds) in the market, this heavy selling would likely "demoralize the market.'" Moreover, the dealers might suffer such losses that they would not be able to help future government financings.5 Similar reasoning applied to other action taken by the System to limit pressure from the selling side of the market. New York banks agreed to refrain from selling during the crisis period and to advise their correspondent banks to follow the same policy. This agreement was strengthened when large institutional investors, such as insurance companies, temporarily restrained their selling in the government-bond market. T o make banks more willing to hold their government securities, even in the face of a sharp market decline, the Federal Reserve initiated a new discount policy. On the afternoon of September 1, the Board of Governors announced that "all the Federal Reserve Banks stood ready to make advances on Government securities to member and nonmember banks at par and at the discount rate.'" The support feature of this new discount policy was evident not only in its terms but also in the fact that it was announced when member banks had about $4.5 billion of excess reserves. These support 4 Twenty-Sixth Annual Report of the Board of Governors of Federal Reserve System, 1939 (Washington, 1940), p. 6. 5 Henry C. Murphy, The National Debt in War and Transition (New York: McGraw-Hill Book Company, Inc., 1950), pp. 20-21. " Twenty-Sixth Annual Report of the Board of Governors of the Federal Reserve System, 1939 (Washington, 1940), pp. 6, 65. T h e discount rate at the time was 1¿ per cent at all Reserve Banks except the New York Bank, where the rate was one per cent. (The differential between advances to member and to nonmember banks was as much as 2 i per cent at five of the Federal Reserve Banks.) Later in the month, six of the Reserve Banks reduced their rates to the level of the New York Bank.

168

T H E I N D E P E N D E N C E OF T H E F E D E R A L R E S E R V E

SYSTEM

actions did not immediately stop the fall in governmentsecurity prices; the decline in the long-term market continued until September 25, when the longest-term bonds were off six points since the beginning of the month and were selling slightly below par. From that low point prices rose during the rest of the year. Doubts About Pegging the Market. In reviewing the September market in their annual report the Board of Governors made clear that the maintenance of orderly conditions in the government-securities market did not mean pegging prices. The Federal Reserve had in mind a somewhat qualified market support policy : While the System has neither the obligation nor the power to assure any given level of prices or yields for Government securities, it has been its policy in so far as its powers permit to protect the market for these securities from violent fluctuations of a speculative, or panicky nature. . . . Consequently, an orderly rise or fall in United States bond prices in response to changes in underlying credit conditions . . . does not call for action by the System. Violent temporary movements, however, caused by such circumstances as the shock of European hostilities, make it in the public interest for the System to use its influence toward preventing a disorganized condition in the market. [Emphasis added.]' This surprisingly candid statement echoed one of the recommendations of the Federal Advisory Council which were included in the Board's annual report. On October 9, 1939, the Council expanded a previous argument (made on June 6) for the gradual correction of the "long continued 'easy money' policy." The October recommendation took into account the behavior of the bond market in September : While the Council fully recognizes the need in a grave emergency, such as that recently experienced, of taking steps designed to 7

Ibid., p. 5.

FEDERAL RESERVE RELATIONS DURING WORLD WAR II

169

preserve an orderly market in Government securities, it also believes that the market price of Government bonds should be allowed to find its natural level, free of official intervention, as rapidly as possible, consistent with an orderly market. T h e operations of the Open Market Committee, acting for the Federal Reserve banks, in maintaining an orderly market (as distinguished from a pegged market) should not be influenced by its judgment as to what the proper price level should be, but that level should be the result of general operations of willing normal buyers and sellers. Neither should it be influenced by any considerations of maintaining or extending the former policy of extremely easy money. T h e Council believes that any policy of maintaining an orderly market in Government securities makes advisable the sale of the bonds and notes bought in the process of maintaining an orderly market as and when the free market will absorb them, and that these bonds and notes should not be withheld with a view to forcing the price of bonds back toward pre-September prices." Even the Treasury D e p a r t m e n t seemed to accept to some extent a similar line of reasoning. O n e Treasury official who attended top-level meetings between the T r e a s u r y D e p a r t m e n t a n d the Federal Reserve d u r i n g the September crisis stated that both agencies h a d doubts about pegging the market : A study of the records of the period [August 30 to September 27, 1939] shows a general lack of faith in both the Treasury and the Federal Reserve in the ability of the monetary authorities to "peg" the market. The Treasury in particular was anxious to let the market find its "natural" level, and this view was shared by the Reserve Bank president members of the Executive Committee [of the Federal Open Market Committee]. T h e Board of Governors members of the Committee were more in favor of market support, but they likewise had very limited objectives in mind. ' Ibid.,

p. 80.

170

THE INDEPENDENCE OF THF

FEDERAL R E S E R V E

SYSTEM

. . . T h e members of the Board of Governors and the Reserve Bank presidents, like Saturday's [sic] child, had " f a r to g o " to the days of the wartime pattern of rates. But the distance

which

they had to traverse was as nothing c o m p a r e d with that stretching before the T r e a s u r y — w h i c h was to reverse its position completely and b e c o m e the most active exponent of a policy of low interest rates,

implemented

by

a

tightly

managed

money

market.

[Emphasis added.]'

More than two years were to pass before the fixed wartime pattern of rates was set, and at higher levels than were prevailing at the beginning of 1940. It took that long for the Treasury and the Federal Reserve to acquire the needed confidence and to make the decision concerning natural and pegged rates in the market. Meanwhile, although an avowed novice in stabilizing the market for government securities, the Federal Reserve seemed to merit an "experienced" rating for its September, 1939, operations. It was a fortunate rating to have at the start of the Forties.

Proposals for Increased

Authority

As the national defense program began to expand after June, 1940, the Federal Reserve once again emphasized the danger of inflation. In December, 1940, with the unanimous approval of the Federal Advisory Council and the Presidents of the Reserve Banks, the Board of Governors sent a special report to Congress stressing the increase in inflationary pressures.10 T h e manifestations of these pressures were not found in the wholesale and consumer price indexes, which were fairly stable. Rather, certain monetary phenomena caused the con* M u r p h y , op. cit., p. 23. 10 Twenty-Seventh Annual Report of the Board of Governors Federal Reserve System, 1940 (Washington, 1941), pp. 68-70.

of

the

F E D E R A L R E S E R V E R E L A T I O N S DURING W O R L D W A R II

171

cern : increasing gold stock, yields on long-term government bonds falling close to 2 per cent, excess reserves in member banks approaching $7 billion, and discount rates of 1 per cent. These phenomena were related to the deficit financing used by the government in its expanding defense program. The purpose of the Federal Reserve's report to Congress was to highlight the seriousness of the financing task which the Treasury faced. The Federal Reserve wanted the formation of a preparedness program in which it would be the coordinating agent for the nation's monetary system. The principal proposals of the report called for an increase in the powers of the Federal Reserve and a decrease in those of the Treasury. The Board of Governors asked for authority to raise reserve requirements up to double the current maximum amounts (that is, to 52, 40, and 28 per cent for the three classes of member banks)" and to impose these requirements upon all banks, not only member banks. In addition, the Board proposed that the President give up his powers (exercised through the Treasury Department) to devalue gold and silver and to issue $3 billion of United States notes. Other discretionary powers of the Treasury should also cease. The Treasury should be obliged to segregate net gold imports and to refrain from using its silver seignorage values as the basis for additional currency. Stepping into the fiscal field, the Federal Reserve recommended that the government obtain through taxes a larger proportion of its expenditures and keep deficits at a minimum when full employment was reached. The proposals of the Board of Governors did not receive a favorable reception. They were opposed by the Secretary of " The Board wanted this authority to be given to the Federal Open Market Committee : "The power to change reserve requirements, now vested in the Board of Governors, and the control of open market operations, now vested in the Federal Open Market Committee, should be vested in the same body." (Ibid., p. 69.)

172

T H E INDEPENDENCE OF T H E F E D E R A L R E S E R V E

SYSTEM

the Treasury and, among others, by the operating heads of two important government agencies concerned with banking and credit—the Federal Deposit Insurance Corporation and the Department of Commerce. Jesse Jones, Secretary of Commerce and head of the Federal Loan Administration, referred to this new monetary program as an obstacle to his current policy : " I am trying to get the banks to lend more. I want to see as much bank credit available as possible."" The Chairman of the Board of Governors appealed to President Roosevelt for his support, but to no avail. Congress did not act upon the recommendations of the Federal Reserve.13 Failure here, however, was compensated for in another way. Although the Treasury opposed a change in the law, it did not use the powers to which the Board of Governors had objected. This self-imposed restriction most likely was related to the cooperation the Treasury received from the Federal Reserve in other more urgent matters. T h e cooperation

was full

and

whole-hearted,

but

nonetheless

necessitous. One might speculate on how the Federal Reserve System would have reacted to the Treasury's war-financing plans if the Thomas Amendment were not a continuing authorization

for

Treasury

separatist

action

and

if

the

previously mentioned Wagner resolution had resulted in a more specific mandate for the System. There is, however, no convincing evidence that the Federal Reserve System would have followed a course different from actual cooperation, with all its overtones of a strategic withdrawal from exercising control over interest rates and the availability of credit. Eccles, op. cit., p. 354. " L a t e r , in 1945, Congress enacted part of the recommendations — those concerned with the powers of the President and the Treasury to devalue gold and silver and to issue currency in the form of United States notes. 11

F E D E R A L R E S E R V E R E L A T I O N S DURING W O R L D W A R II

173

Establishment of Rate Structure Although the Federal Reserve failed in its 1940 attempt to strengthen its authority, it did not seek to offset the failure by changing its open-market policy. That policy continued, and the longer it continued the less likely it was to be reversed. The readiness of the Federal Reserve to use its power for the promotion of orderly market conditions practically eliminated uncertainty in the market and in this form gradually molded market expectations. The effects on expectations of the 1939 market support operations were strengthened enough by subsequent actions and statements to last through the war years and beyond. During 1940 and 1941, government-bond prices continued strong, even with an increase in the government debt in 1941 of more than $13 billion. The Federal Reserve did not increase its holdings until after the United States entered the war and then added only $70,000,000 to its portfolio in early December. If there were any signs of weakness in the government-securities market, they were overcome by an announcement of policy from the Board of Governors shortly after the declaration of war : 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 conditions in the United States Government security market that are satisfactory from the standpoint of the Government's requirements. Continuing the policy which was announced following the outbreak of war in Europe, Federal Reserve Banks stand ready to advance funds on United States Government securities at par to all banks." 14 Twenty-Eighth Annual Report of the Board of Governors Federal Reserve System, 1941 (Washington, 1942), p. 1.

of the

174

THE INDEPENDENCE OF THE FEDERAL RESERVE

Purpose of Rate

SYSTEM

Structure

This policy statement which was meant to reassure private participants in the market was also indicative of the cooperation which existed and would continue to exist between the Federal Reserve and the Treasury Department. By the end of March, 1942, the Treasury and the Federal Reserve worked out the essentials of an agreement to maintain a definite structure of interest rates on government securities. This agreement was reached through a series of ad hoc decisions which for the time settled the question of natural versus pegged rates. It was not intended to be a commitment for all times and all occasions. Nonetheless, because of the amount and manner of the Treasury's financing operations, the agreement took on the characteristics of a binding commitment. T h e terms of the agreement were rationalized by the "public interests" they promoted—(1) keeping down the cost of the government's borrowings, (2) removing any hesitancy on the part of prospective purchasers who otherwise would wait for higher yields, (3) encouraging investors to hold securities without fear of loss from price fluctuations and thus reducing disorderly movements in the market, (4) limiting the increase in bank profits from securities purchased.' 5 T h e range of the rate structure as finally established was from f per cent on Treasury bills and | per cent on certificates of indebtedness to 2 per cent on tenyear bonds and per cent on the longest bonds. T o achieve the purpose of the rate structure, the Treasury and the Federal Reserve judged it expedient to give special treatment to commercial banks. These institutions were not allowed to purchase the 2£ percent bonds until ten years after ls Thirty-Second Annual Report of the Board of Governors Federal Reserve System, 1945 (Washington, 1946), p. 11.

of

the

F E D E R A L R E S E R V E R E L A T I O N S DURING W O R L D W A R II

175

1

the date of issuance. " As an offset the Federal Reserve initiated several measures encouraging bank participation. First, in April, 1942, it offered to selling banks repurchase options for the I percent bills at the given rate. Second, in October, the Federal Reserve announced its willingness to lend to banks at the preferential rate of £ per cent on advances collateraled by government securities maturing or callable in one year or less. Third, the Board of Governors reduced reserve requirements (from 26 to 20 per cent) at central reserve city banks. Fourth, in April, 1943, a special Act of Congress exempted war-loan deposit accounts from reserve requirements until six months after the cessation of hostilities. Long-Term

Rate

The crucial rate in the pattern was the rate set for the longest-term b o n d s — p e r cent. In general, Treasury and Federal Reserve officials accepted this rate from the current market as proper and fortunate, though the Presidents of some of the Federal Reserve Banks wished that a higher rate, such as 3 per cent, had been worked out before the war began." The " Through this restriction bank purchases were effectively limited to bonds selling on a yield basis of 2 per cent or less. T h e terms of ineligibility were later changed. In the Fourth War Loan (January-February, 1944), 2 i percent bonds were bank restricted until ten years before the earliest call date; in the Seventh War Loan (May-June, 1945), both 2 i and 2 i percent bonds were bank restricted until ten years before maturity. " Murphy, op. cit., pp. 92-94. T h e fixing of the maturity of the 2 i percent issues, however, was a source of disagreement. One group of Federal Reserve officials, headed by Chairman Eccles and President Sproul, wanted the maturity to be fixed within the range of 1955 and 1960. They argued that the war should not be financed "at the lowest rates of all time." Other members of the Board of Governors (and several of the Board's staff, among them E. A. Goldenweiser and Leroy Piser) sided with the Treasury in proposing that the maturity be based on the existing 2J's of 1967-1972. Since at the time of this disagreement (March, 1942), the outstanding 2i's rose to a market price of 101, the matter was decided in favor of the position held by the Treasury. (Ibid., pp. 94-96.)

176

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

discussions which led to the setting of the percent rate produced these reasons for its adoption : (1) it was the current market rate "established by the 'natural' forces of the market . . . just prior to the entrance of the United States into the war," (2) the percent rate was one-half per cent lower and therefore better than the rate used by England, (3) it was "in line with the interest rates being paid on long-term liabilities of financial institutions," (4) any higher rate would have allowed interest receivers to "profit" from the war, something which was politically unwise." Most Federal Reserve and Treasury officials wanted to issue a public statement that the 2£ percent rate would be the long-term rate for the duration of the war (that is, it would be the top rate offered by the Treasury and would be supported by Federal Reserve action). This proposal, however, was vetoed by Secretary Morgenthau of the Treasury.

Short-Term

Rate

Certain details—the short-term rate and the amount of excess bank reserves—connected with the 2\ percent rate were settled by compromise but remained subjects of disagreement during the war period and later. Between November, 1941, and April, 1942, the government bill rate fluctuated around ¿ per cent, a significant increase from the practically zero level which had prevailed during the Thirties. This increase was not pleasing to Treasury officials. They maintained that the earlier very low short-term rates had produced " ¡bid., pp. 93-94. These reasons did not establish any compatibility of the rate with desired economic relationships (such as, full employment and price stability) when the war would be finished. " I t seemed better to assume that 2 i per cent was the rate and hope for the best. This was probably the wisest policy. Nevertheless, . . . the decision . . . made any future change in the rate extremely difficult." (Ibid., p. 94.)

FEDERAL RESERVE RELATIONS DURING WORLD WAR II

177

the percent rate fpr the longest-term bonds and were necessary for its stability. Furthermore, the same officials reasoned that the continuation of large excess reserves was required to keep the short-term rates at a low level. Since the decline in excess reserves which began in 1941 continued m 1942, they were reluctant to increase the volume of short-term securities. Federal Reserve officials, on the other hand, emphasized the inflation potential and the necessity for a "sounder" structure of interest rates. They were now convinced that through open-market and discount operations they could maintain the 1\ percent rate in a pattern which was bottomed on a I or 1 percent rate. To reduce the relative amount of long-term securities purchased by banks, the Federal Reserve urged the Treasury to increase the amount of short-term securities. When Secretary Morgenthau refused to agree to an increase in the short-term rate in March, 1942, Chairman Eccles and President Sproul attempted to place full responsibility on him for the consequences. They told him : . . . that they held their views very strongly but that they would accept a directive from the Secretary as the person primarily responsible for financing the war provided that he took the responsibility for the decision. Secretary Morgenthau said that he would take this responsibility and asked them to maintain the then existing pattern of rates except as he agreed to its subsequent modification." This talk about "a directive" and "responsibility" was probably born of the urgency of the problems the Treasury and the Federal Reserve faced. The overtones of precedent and subordination did not develop any further. No directive was issued. Rather, something of a compromise resulted. When the " Ibid.,

p. 97.

178

T H E I N D E P E N D E N C E OK T H E F E D E R A L R E S E R V E

SYSTEM

Federal Reserve decided to establish a posted buying-rate for Treasury bills (a procedure previously used for purchases of bankers' acceptances), the Treasury wanted a £ percent posted rate. Agreement, however, was reached on the § percent rate proposed by the Federal Reserve. The posting procedure, together with repurchase agreements, tended to create excess reserves as the Federal Reserve acquired Treasury bills not wanted by the market. As a result the Treasury became willing to increase its financings through short-term securities. By the end of 1943, the Federal Reserve's holdings of Treasury bills amounted to $6.8 billion out of total holdings of $11.5 billion in government securities. In order to strengthen the market, the Federal Reserve urged the Treasury to increase the bill rate and to establish an exchange arrangement for maturing bills (and thus bypass the cash bidding procedure). The Treasury refused to make any change in the short-term rate; furthermore, it opposed the exchange procedure because it involved direct transactions between the Treasury and the Federal Reserve Banks. Such transactions, the Treasury believed, would needlessly arouse the critics "who were quick to condemn any direct dealings between the Treasury and the 'central bank.'" w Encouragement

of Bank

Participation

On the one essential point there was always agreement between the Federal Reserve and the Treasury : that the M Ibid., p. 213. The Federal Reserve had already faced these critics. In the Second War Powers Act (1942), Congress, at the urging of the Federal Reserve and with little or no encouragement from the Treasury, gave the Federal Reserve authority to malte direct purchases from the Treasury up to the amount of $5 billion. The initial grant of authority lasted only until the end of 1944, after which it had to be renewed. (The unlimited authority for such purchases, which had been in the original Federal Reserve Act, was abrogated by the Banking Act of 1935.)

F E D E R A L R E S E R V E R E L A T I O N S DURING W O R L D W A R II

179

government should b e successful in its financings. T o achieve this, both agencies were ready to compromise their ideals. Evidence of this unity can b e f o u n d in their relations with commercial banks. F r o m the very start of t h e support program both the Treasury a n d the Federal Reserve m a d e known their preference for non-bank investors. T h e actual gigantic offerings of securities, however, frequently enough relied upon t h e active participation of the commercial banks. This participation was promoted at times by the Federal Reserve's open encouragement of banks to buy government securities so t h a t the war-loan drives of the Treasury would be successful. O n e Reserve official later spoke about the early necessity of promoting bank purchases : In reviewing Federal Reserve policy during the period of United States participation [in the war], it is helpful to recall that until about the time of the Second War Loan Drive in April, 1943, it was necessary to encourage banks to take even the "residual" amount of securities not taken by others. It is easy to forget that banks were called upon at the last minute virtually to underwrite two new issues of securities in October, 1942. To those who recall those days, however, it will not be necessary to demonstrate that the initial problem was to encourage bank participation. Commitments made and programs adopted in this early period became increasingly serious obstacles when the problem, after the middle of 1943, became that of discouraging unnecessary bank acquisition of Government securities. [Emphasis added.] 21 T h e encouragement of b a n k purchases relied on several factors favorable to the banks. First of all, the maintenance of the pattern of rates enabled the banks to "play the pattern of rates" since all the securities were equally liquid regardless of maturities. This m e a n t , of course, that the longer-term Karl R. Bopp, et al., Federal Reserve Policy ("Post-war Economic Studies," No. 8 ; Washington : Board of Governors of the Federal Reserve System, 1947), p. 18.

180

T H E INDEPENDENCE O F T H E F E D E R A L R E S E R V E

SYSTEM

securities appreciated as they approached maturity. Banks sold their short-dated securities to the Federal Reserve, purchased long-dated securities, and rode the market up. Second, the market, as long as it held large volumes of short-dated securities, had control over the volume of money. It could increase reserves as it wished. Third, the elimination of reserve requirements for war-loan accounts maintained for the Treasury encouraged banks to purchase government securities for their own accounts or for the accounts of their customers. Lastly, the preferential discount rate of £ per cent, by reducing risk, made it relatively easier for banks to invest in short-term securities. Attitude Toward Cooperation The establishment of a fixed pattern of rates and the encouragement given to participation by banks were the products of a continuing cooperation between the Federal Reserve and the Treasury. This cooperation secured the maintenance of conditions in the government-securities market which were "satisfactory from the standpoint of the Government's requirements." It resulted, however, in the surrender of control of that market to other participants on terms which could not be freely altered by the System; thus it appeared to take away the substance of independence and leave only its form. On the other hand, the attitude and actions of the Federal Reserve indicated that the System did not accept the idea that all its responsibility and initiative had been obliterated. It considered that the substance of independence, though confined, was very much alive. Acceptance

of Restrictions

The active implementation of the support program did not mean that the Federal Reserve ceased to be concerned about

FEDERAL RESERVE RELATIONS DURING WORLD WAR II

181

both actual and potential inflation. This familiar fear, common to central bankers, was never wiped out; rather, it was root stock from which grew disagreements and compromises between the Federal Reserve and the Treasury. How far the Federal Reserve had gone in agreeing with the Treasury on the handling of this problem during the war (and after) was shown in the position taken by the Board of Governors early in 1944. At that time the evidence of inflation was very striking. Between the beginning of the war and the end of 1943, wholesale prices advanced 37 per cent and the cost of living rose 25 per cent. To hold down this increase in prices, the Board of Governors (in April, 1944) advocated : . . . adequate further increase in taxation, . . . firmness in holding the line against price and wage advances, . . . resistance all along the domestic front to pressures exerted by groups representing special interests rather than the public welfare.22 In answer to those who wanted the Federal Reserve to use its monetary powers more fully for the prevention of inflation and deflation, the Board of Governors stated that such proponents exaggerated the influence of monetary action : In the past quarter century it has been demonstrated that policies regulating the quantity and cost of money can not by themselves produce economic stability, or even exert a powerful influence in that direction. . . . In order to be effective in bringing about stability the regulation of the availability and cost of money must be integrated with a flexible fiscal policy and at critical times reinforced by direct controls over prices, wages, and supplies.23 Addressing itself specifically to the fixed pattern of rates, the Board had one exception to make : the short-term rate was "low compared with past periods" and could advance in 22 Thirtieth Annual Report of the Board of Governors of the Federal Reserve System, 1943 (Washington, 1944), p. 3.

182

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

response to market conditions without affecting the rate on long-term m o n e y . " W i t h regard to the other end of the pattern of rates, " t h e bond rate largely reflected conditions in the investment m a r k e t . " " Moreover, the Board predicted that it would be necessary to continue low long-term interest rates after the war, when the time came for reconversion of industry to peaceful purposes. " A d e q u a t e financial machinery . . . , and the m a i n t e n ance of stable and relatively low long-term interest rates to encourage industry, should form a vital part of a postwar p r o g r a m . " 3 T h e Board also included the satisfaction of the needs of the government as a benefit which would result if its predictions about " t h e continuance of low long-term interest rates" were borne out : " O v e r the years a low cost of m o n e y . . . would facilitate the task of refunding t h e public debt and safeguard the value of Government security holdings of the millions [of investors]."" I n this prognosis the B o a r d was echoing, at least in part, the opinion of the T r e a s u r y . I n a speech in D e c e m b e r ,

1 9 4 3 , the U n d e r Secretary, D a n i e l W .

Bell,

pointed out that the average rate paid on the government debt in World W a r I I was 1 J per cent, as c o m p a r e d with 4 J per cent in World W a r I. He continued : Interest rates have remained stable during the war-time period and confidence of this stability has been and is widespread and well justified. . . . I think it can be fairly said of the United States, as the late Chancellor of the Exchequer, Sir Kingsley Wood, recently said Ibid., p. 10. The importance of this integration of policies was expressed by the Board in another way which seemed to make a case for a flexible monetary policy : unless effective direct controls were applied, inflationary pressures would cause a rise in market rates of interest. '-'Ibid., pp. 18-19. :s Ibid., p. 3. "Ibid., p. 19.

FEDERAL R E S E R V E RELATIONS DURING W O R L D WAR II

183

of Great Britain, that ". . . we have revolutionized public opinion as to what are fair rates for Government war borrowing." I believe that this revolution in opinion has a sound basis in underlying economic realities, and is applicable to the coming times of peace also. I hope that the policies of the Government will be directed to this end.*1 Criticism of Details When the war was finished, the Federal Reserve had three complaints about the terms of its cooperation with the Treasury's wartime financing operations. One was that the spread in the pattern of rates was too large, especially because the short-term rate was set too low. The profit advantages of "playing the pattern" increased the incentive of banks to purchase securities. Thus there was not as great a necessity to win non-bank investors. The second complaint followed from the first. Too much of the financing was done through banks, and not enough effort was made to tap the savings of large investors such as business corporations and insurance companies. The third complaint was that, with easy bank financing, taxes did not have to produce more funds for the government's wartime expenses. Though these complaints had significance in the postwar period, it was not clear that when the war demands resulted in the need for an avalanche of funds the complaints could have been avoided. For example, when a war-loan drive was launched, it was considered of the essence that the drive succeed. The Federal Reserve Banks, accordingly, were ready to supply the reserves so that the drive was a success in obtaining the desired funds, even though that meant placing government securities in the vaults of " Annual Report of the Secretary of the Treasury Finances for the Fiscal Year Ended June 30, 1944 Government Printing Office, 1944), p. 500.

on the State of the (Washington : U.S.

184

THE INDEPENDENCE O F THE FEDERAL R E S E R V E

SYSTEM

commercial banks. The insistence on success was greater than the insistence on non-bank purchases. Whether without such priority of emphasis the government's credit would have properly been maintained remained a moot question. The alternative of long-term non-marketable securities placed in non-bank hands was hardly seen as realistic at the time. The war had followed a period of depression and deflation which colored business finance plans and gave support to an emphasis on liquidity and cash funds. No one knew how short or how long the war would be. If it were very short, the cashing-in of these securities at its conclusion would force the Treasury into marketable securities anyway. If the war were to last a long time, the cashing-in would be delayed ; but the funds for investment would tend to diminish relative to the need. Thus the Treasury would be forced eventually to a fast money-creating type of financing. In addition, in the midst of air-raid alerts and passing trainloads of soldiers, the long-term view had few strong supporters in any disagreement. Given the actual results of the financing program of the Treasury, the Federal Reserve's criticism was valid. Yet the System could hardly have expected action on such proposals if at the same time it had stressed its public-interest character. In wartimes the immediate public interest seemed clear—the active participation of the Federal Reserve in the expeditious financing of the government.

Willingness

to

Cooperate

Although the complaints about the wartime financing program tended to place the responsibility on the Treasury Department, there were indications that this was not the full story. The question of the willingness of the Federal Reserve in its support operations was also moot. In 1954, Allan Sproul,

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185

President of the Federal Reserve Bank of New York and a member of the Federal Open Market Committee at the time of the initiation of the support program, denied that the Federal Reserve System at the outbreak of the war became : . . . the supine servant of the Treasury. . . . [We] lost our "independence" [during the war period], but we lost it to the inexorable demands of war. It was not meekly handed over to the Treasury in abdication of our responsibilities.™ Another member of the Federal Open Market Committee, Governor M . S. Szymczak, was even more specific in testimony before a Congressional subcommittee in 1954 : [When the war began with Pearl Harbor] we pegged the Government security market at that time to help the Treasury through the financing of the war, and that was all to the good. Nobody could complain about winning the war. We needed money to win the war. That pegging was done on our own initiative. [Emphasis added.]" Marriner S. Eccles, who was Chairman of the Federal Open Market Committee during the war period, while expressing his dissatisfaction with the Federal Reserve's loss of control, also stated his satisfaction with the job performed by the System. H e noted with pride that the Federal Reserve System acted in a unified manner and apparently with great ease increased the reserves of the banking system to provide for the needs of the government. He judged that the unity and power of the System to supply bank reserves in this fashion assured the survival of the Federal Reserve System as an independent organization. In 1951, he wrote: M Address at the Mid-Winter Meeting, New York State Bankers Association, January 25, 1954. w U.S., Congress, Subcommittee of the Joint Committee on the Economic Report, Hearings on United States Monetary Policy: Recent Thinking and Experience, 83d Cong., 2d Sess., 1954, p. 247. Cited hereafter as the Flanders Hearings, 1954.

186

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

The real test of the Open Market Committee's effectiveness to do the pivotal work assigned to it arose, of course, during the war years proper. We were fortunate to enter those years with the Banking Act of 1935 on the statute books; the Open Market Committee as it existed prior to this act could not have carried out its war-financing job. With the Reserve System committed both to support the bond market according to a pattern of rates set by the Treasury and to get such money as was needed at these rates, the System had to operate as a central bank without limitation on its ability or authority to purchase Government securities in the open market. Acts of obstruction that were possible in the open-market arrangement before the Banking Act of 1935 could not be tolerated. . . . More than likely, the pressure of war needs would have led the government to take over the Federal Reserve System, or at least would have forced the needed changes brought by the Banking Act of 1935.a0 In 1949, a new C h a i r m a n of the Federal O p e n Market Committee, T h o m a s B. M c C a b e , "in a judicial spirit," and "not as an a d v o c a t e , " reviewed for Congress the System's wartime policies. H e frequently used phrases such as : "Both the Treasury and the Federal Reserve were in full agreement that . . . . " H e stressed that disagreements over policies were settled only after both sides were heard and that the two organizations were of one mind in their objectives, including the lowcost financing of the war : Looking backward, it still seems that the decision not to let interest rates rise during the war was right in that the war was financed at an exceptionally low interest cost, the Treasury had no difficulty in obtaining all the funds it needed, and there was no lack of confidence in Government securities. The most important lesson of the war-financing experience is that it was desirable to have a stabilized level of rates during the war, but not necessarily the 10

E c c l e s , op.

cit.,

p. 3 5 1 .

F E D E R A L R E S E R V E R E L A T I O N S DURING W O R L D W A R II

187

particular highly abnormal structure of rates which happened to exist at the beginning of the war.3' The "highly abnormal structure of rates" was not necessarily the lowest possible, nor was it proof of a lack of concern for inflation. T h e discussions between the Treasury and the Federal Reserve had produced concessions on both sides : It was recognized that the policies being followed were necessary in view of the exigencies of war finance and that inevitable inflationary developments would have to be restrained largely by use of other measures of control such as rationing and price fixing. It was acknowledged that, although the war might be financed at even lower rates of interest through the Federal Reserve and the banks, such policies would make more difficult the control of inflation through other measures and would intensify postwar difficulties.32 These statements of various Federal Reserve officials indicate at least some degree of willingness on the part of the Federal Reserve at the time of decision on the support program. There were reservations, but there was no abrogation of responsibility, no obstruction to effective cooperation. This did not mean all was peace and harmony. As already mentioned, the unity of objective and policies did not eliminate all discussions of possible changes in what had been the object of agreement. Moreover, the cooperation and coordination depended upon individuals. The day-to-day confrontation of heads of cooperating agencies who did not always have the same understanding of the common problems and their respective responsibilities produced conflicts over what might be called "nonessentials." Such conflicts, however, could seriously disrupt the sometimes tense relations between the Federal Reserve and the Treasury. " U.S., Congress, Joint Committee on the Economic Report, Statements Submitted to the Subcommittee on Monetary, Credit, and Fiscal Policies, 81st Cong., 1st Sess., 1949, p. 36. Hereafter cited as Statements to Douglas Subcommittee, 1949. 32 Ibid., pp. 33-34.

188

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

Operational Relationships with Treasury After the agreement of the Treasury and the Federal Reserve on the support program, the work of the Reserve Banks and the Board settled down largely to routine operations. T h e Reserve Banks engaged also in a plethora of agency activities for the Treasury Department. Foremost among the agency functions was the heavy load of work connected with the selling and handling of government securities. For example, in 1943, about 12,000 employees (half of the System's total personnel) were required for the fiscal agency operations performed for the Treasury, and a majority of these employees were hired to handle the war-savings-bond program, making it the largest single operation (in terms of employees) performed by the Reserve Banks. Other important fiscal agency work included doing much of the work connected with the withholding tax arrangement (begun in 1943), processing ration checks for the office of Price Administration, and acting as agents of the Treasurer of the United States in paying government checks. Also time-consuming were such activities as maintaining inventory records of machinery and equipment owned by the Defense Plant Corporation and used in warproduction plants, and handling the flow of funds to and from the Commodity Credit Corporation and the Reconstruction Finance Corporation. Although these various agency functions as well as the routine operations of the Reserve Banks did not involve decisions on national monetary policy, they were very useful and important to the Treasury and other government agencies and required expert management time. Board Chairman

as Critic

The same preoccupation with operating details did not bind the Board members to their positions. For them, the routine

F E D E R A L R E S E R V E R E L A T I O N S DURING W O R L D W A R II

189

work was not as demanding or as satisfying.*3 The Chairman of the Board of Governors, however, did not remain silent in his office. He openly criticized the government's program in various fields, such as taxes and labor. In large part his criticism was aimed not at the Chief Executive and his departments but at Congress and its preference for apparently easy financial devices. In 1943, the Board of Governors in their annual report explained the context of the critic function of the Federal Reserve : Federal Reserve authorities have no direct responsibility for taxation, but in view of the importance of taxes in the monetary picture they feel free to give such suggestions and advice to the Treasury as seem appropriate. The Board's interest in taxation and other aspects of anti-inflation policy is recognized by the fact that the Board is represented on the Economic Stabilization Board created by Executive Order on October 3, 1942." Chairman Eccles also turned his attention to the unification of authority for the supervision of banks. This authority was shared by three organizations : the Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency. Since the latter two organizations were either directly or indirectly under the Secretary of the Treasury, the Chairman, in so far as he appeared to want the Federal Reserve to have full control of bank examination and supervision, was asking the Treasury to surrender its power in this area to the Federal Reserve. Eccles appealed to the Chief Executive and to Congress for their support." Al33

During the war years there was one vacancy on the Board ; also, one Board member found time (in 1944) to be Minister to a foreign government in. exile. (G. L. Bach, Federal Reserve Policy-Making [New York : Alfred A. Knopf, 1950], p. 280. 14 Twenty-Ninth Annual Report of the Board of Governors of the Federal Reserve System, 1942 (Washington, 1943), p. 26. 35 H e suggested that the President use his wartime powers and by an

190

THF. I N D E P E N D E N C E O F T H E F E D E R A L R E S E R V E

SYSTEM

t h o u g h n o action w a s t a k e n to b r i n g a b o u t this unification, the a t t e m p t p r o b a b l y increased the c u r r e n t tension between t h e F e d e r a l Reserve a n d the T r e a s u r y a n d t e n d e d to m a k e the p o s t w a r c o o p e r a t i o n of the t w o o r g a n i z a t i o n s m o r e fragile. I n s p e a k i n g a b o u t the w a r period in g e n e r a l , Eccles w r o t e as follows : I regret to say that each of us who served in Washington during 1940-5 fought a civil war within an international war. Apart f r o m encounters with other agencies of government and congressional committees, my principal disagreements were with Henry M o r g e n t h a u , the Secretary of the Treasury. . . . In general we agreed on the objectives that were being sought during the war period. . . . We disagreed on the methods by which these objectives should be reached. U n f o r t u n a t e l y , as our tempers were rubbed raw by the pressures of events, the character of our disagreements was often distorted into disagreements over objectives. And this, in turn, in the tense and nervous war atmosphere, invited charges and countercharges of a sort I, and, I a m certain, M o r g e n t h a u , regret to this day. . . . I n the shadows t h a t conceal the boundaries of the Treasury D e p a r t m e n t and the Federal Reserve System, spite-fence cases are bound to arise, with each party claiming that the other fellow it a poacher on territory that doesn't belong to him. And then the shadowland becomes a battleground for some rough infighting."

Conflict

over Bond-Sales

Organization

As a n e x a m p l e of the " s h a d o w s t h a t conceal the b o u n d aries" a n d t h e resulting "spite f e n c e s , " C h a i r m a n Eccles described a n i n c i d e n t w h i c h took p l a c e in M a y , 1943, a n d conExecutive o r d e r achieve this result without being h a m p e r e d by a slowmoving Congress. (Op. cit., p. 385.) " Ibid., pp. 3 3 7 - 3 3 8 .

F E D E R A L R E S E R V E R E L A T I O N S DURING W O R L D WAR II

191

cerned the sales organization for government securities. At the time of the First War Loan (December, 1942), the sale of government securities was promoted by two separate organizations. One was organized on state lines and was under the sole control of the Treasury. It was called the War Savings Staff and handled programs for the sale of savings bonds, principally Series E. The other organization was composed of Victory Fund Committees which were joint TreasuryFederal Reserve operations. They were established on the basis of the twelve Federal Reserve districts and had as ex officio chairmen the Presidents of the twelve Reserve Banks. General direction of these committees was had by an official of the Treasury Department. In addition, the Secretary of the Treasury was chairman of a committee of the Reserve Bank Presidents acting as chairman of the various committees. The Secretary, however, felt that he could exercise little control over them since they were not his appointees." Hence, the Chairman of the Board of Governors acted as an intermediary between the Treasury and the Reserve Banks because the Bank Presidents tended to look to him rather than to the Secretary for instructions. Moreover, since the Federal Reserve Presidents could afford little time for the work of the district committees, they appointed full-time executive managers. These appointments became the "boundaries" over which contention arose. At the time of the Second War Loan (April, 1943), the sales organization was made more complex. War Finance Committees were set up at each of the Reserve Banks and coordinated through a national Treasury War Finance Committee. The district War Finance Committees were made up of members of the War Savings Staff and the Victory Fund Committees which remained in existence as before. Reserve 31

Murphy, op. cit., p. 137.

192

THE INDEPENDENCE OF THE FEDERAI. R E S E R V E

SYSTEM

Bank Presidents were chairmen of the various district War Finance Committees and were supposed to report to the director of the national Treasury War Finance Committee and to the Secretary of the Treasury. One Treasury official stated that the resulting "organization chart was so complex that one looked closely in the lower right-hand corner for the signature of Rube Goldberg."" Although the Second War Loan was a financial success, it disrupted the harmony between the Treasury and the Federal Reserve. The authority arrangements set up to safeguard respective boundaries of operation overlapped and were too complex : [The Second W a r Loan] left a bad taste in the mouths of the rival sales organizations

and ended in a free-for-all

orgy

of

wrangling—by far the most bitter in the entire course of the war borrowing program. T h e merits of organization along state lines vs. organization by Federal Reserve Districts were learnedly debated.

Accusations

and counteraccusations were hurled freely. T h e W a r

Savings

Staff was accused of being "political," largely because of the continuance of some collectors of internal revenue and collectors of customs as state administrators. The Victory Fund Committees were accused of being narrow cliques of bankers seeking to move the capital of the United States back to Wall Street. None of these accusations had much substance."

Meanwhile the Chairman of the Board did not help matters when he testified before a Congressional committee that the success of the recent war loan was not all glorious. T o o large an amount of securities had been purchased by banks and had become, thereby, a source of inflation.10 'Ibid., p. 139. "Ibid., pp. 1 4 0 - 1 4 1 . ,0 Ecclcs, op. cit., pp. 3 7 8 - 3 8 0 .

FEDERAL R E S E R V E RELATIONS DURING W O R L D W A R II

193

The issue around which the disagreement revolved was the relationship of authority to responsibility. To the Federal Reserve, the time and effort it gave, and the cost it incurred in selling government securities indicated its great responsibility for the success of' the government's borrowing operations. Its authority should be commensurate with its responsibility. The Secretary of the Treasury, however, would not agree to any diminution of his authority or responsibility. In particular, the Reserve Bank Presidents wanted to initiate the appointment of sales managers and other executive personnel who would serve under them. Before making any appointments they proposed to consult with the Secretary of the Treasury and obtain his approval. The Secretary, on the other hand, insisted that he should have the right to select the main executive personnel; he would consult with the Reserve Bank Presidents before he made the appointments. In his mind, to follow the appointment procedure proposed by the Federal Reserve would amount to his turning over the financing of the government to the Federal Reserve. Secretary Morgenthau stated that before he would accept the appointment procedure proposed by the Federal Reserve he would resign. He then went on to say, according to Eccles, in his address to the Board and the Reserve Bank Presidents : You don't think I know anything. I can do this job. If you want to accept me on my own terms, I would like to have you. But I am not going to bargain with you. I don't have to. You need me, but I don't need you. I am not going to turn this job over to you and have nothing to do but sit back and do what you say. Before that I would resign. . . . You can take it or leave it.41 To the Federal Reserve officials this was an unfounded attack. They did not want the responsibilities of the Treasury Department. They expected that some consideration should be given 41

Ibid.,

p. 341.

194

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

to the all-out effort they made in past successful war-bond drives. They thought that a workable organization in each district would presuppose that the person who had responsibility for it should have control of its top officiais. Without this control power, some of the Bank Presidents were inclined to give up and to resign from their Banks. Results of Conflict T h e differences of opinion on this organizational matter were resolved so that neither the Secretary nor the Federal Reserve officers resigned. According to Eccles, after an appeal to President Roosevelt by the Chairman of the Board, the Secretary yielded and "made amends" for his statement and treatment of the Reserve Bank Presidents. Later the Secretary of the Treasury eliminated one of the sources of the disagreements—the existence of two rival sales organizations. In his announcement about the Third W a r Loan drive he stated that : . . . while substantial progress in selling securities to individuals had been made in the Second W a r Loan, it had been decided that the local Victory Fund Committees and War Savings Staffs would be more effective if combined permanently into unified W a r Finance Committees established on State lines under the direction of a chairman in each state reporting to the W a r Finance Division of the Treasury."

T h e unified sales organization became entirely responsible to the Secretary of the Treasury. A new division was established in the Treasury Department, a new promoter became the head of the unified sales organization, and he appointed the " Annual Report of the Secretary of the Treasury Finances for the Fiscal Year Ended June 30, 1943 Government Printing Office, 1943), p. 41.

on the State of the (Washington : U . S .

F E D E R A L R E S E R V E R E L A T I O N S DURING W O R L D W A R II

195

various State chairmen. The new setup eliminated the "spite fences" and produced very little, if any, friction during the succeeding six loan drives. The disagreements between the Federal Reserve and the Treasury over the proper form of the sales organization caused chagrin for both parties. The importance of the conflicts, however, in the minds of the officials involved was stretched almost to the point of self-destruction. It might be conjectured how all this would have been settled if the Chairman of the Board of Governors in 1943 had not been a close friend of the President and had stayed aloof from contacts with the Chief Executive while the Secretary of the Treasury was a member of the President's close advisers. Possibly the Treasury would have reduced the System to permanent impotence. Such a takeover of the banking and monetary authority by the government would likely have been comparable to the government's take-over of the railroads in the first World War when the Secretary of the Treasury was given command of the operation of the railroads. The railroads at that time fought for their independent existence and lost. Most important, the return to independence would not have been as easily made in the case of the Federal Reserve System, either politically or practically. The absorption in relatively routine matters which flowed over into arguments about operating procedures tended to turn the Board members and the Bank Presidents away from the broader issues of monetary policy at a time when a forceful viewpoint was most necessary. In the immediate postwar period monetary policy should be part of the total government program. The war period was the time when such a policy and program might be prepared. As mentioned, the main effort in this direction, the bank unification proposal, however, was a proposal that required great political skill as well

196

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

as monetary acumen. It was not adopted; nor did its discussion pave the way for further planning and the establishment of a constructive monetary program for the Federal Reserve System. Unfortunately, the proposal tended to alienate rather than to unite, the banks among themselves and the banks together with the government authorities in their relation to the Federal Reserve.

VII Federal Reserve Relations with the Government in the Early Postwar Period

IN

THE

EARLY

POSTWAR

PERIOD

THE

FEDERAL

RESERVE

moved slowly to establish a more independent position vis-à-vis the Treasury. Slow as the movement was, it was not readily acceptable to the Treasury. Caution was urged : not to move too fast nor too far lest the problems of debt-management and reconversion of industry be made unduly difficult. The Federal Reserve recognized the prudence of the advice, but it did not agree with the forebodings of the Treasury that any small steps taken to reactivate monetary control power would necessarily develop into giant strides. At the same time, the System did not have strong conviction and determination to act contrary to the Treasury's wishes. There were, however, signs that disagreements were not always resolved by acquiescence on the part of the Federal Reserve. One of the early indications was a decision by the Federal Reserve to modify slightly its discount policy. In July, 1945, Federal Reserve officials negotiated with the Secretary of the Treasury on a lifting of the preferential discount rate on bank borrowings collateraled by government securities due or callable within one year. This attempt was 197

198

THF. I N D E P E N D E N C E O F T H E F E D E R A L R E S E R V E

SYSTEM

not successful with Secretary Morgenthau who considered it inappropriate for him to give such concurrence just before he left office on July 23,1945. Nor did the new Secretary, Fred Vinson, immediately approve the change. He feared that the elimination of the preferential rate might be interpreted by the market as an indication of higher interest rates generally. During the next nine months, the suggested change continued to be discussed by the Federal Reserve and the Treasury. In April, 1946, all twelve Federal Reserve Banks decided to make the change in policy. The Board of Governors approved the decision even though it had at hand a strong letter from the Treasury arguing against the action. When the Board announced the elimination of the preferential rate, the Treasury issued a press release which said that "the Treasury was fully informed of the proposal.'" Although this initiatory action was a definite step toward a more independent position for the Federal Reserve, it did not mean that the full control of monetary policy would soon be restored to the System. Federal Reserve officials themselves continued to maintain that their policy was not designed to increase interest rates and, therefore, the cost of carrying the government debt. Such a result appeared to be unthinkable in the current circumstances. There was a straw in the wind, however, when shortly before V - J Day, Congress considered various proposals to meet what many considered would be the chief economic problem when the war was won and finished—deflation, depression, and mass unemployment. The proposal it decided upon, which came to be known as the Employment Act of 1946 (enacted February 20, 1946), set up a new planning arrangement within the Executive Branch of the government and directed that the Federal Budget be used as a device to balance and regulate the economy. T h e Employment Act im1

Murphy,

op.

cit.,

p. 220.

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199

plicitly recognized that neither central bank policies, as in the Twenties, nor Treasury fiscal operations, as in the Thirties, were sufficient of themselves to assure that continuing prosperity which the government desired. It specifically stated that the Federal Government had a responsibility to use in a coordinated way all the tools at its disposal : The Congress hereby declares that it is the continuing policy and responsibility of the Federal Government to use all practicable means consistent with its needs and obligations and other essential considerations of national policy, with the assistance and cooperation of industry, agriculture, labor, and State and local governments, to coordinate and utilize all its plans, functions, and resources for the purpose of creating and maintaining, in a manner calculated to foster and promote free competitive enterprise and the general welfare, conditions under which there will be afforded useful employment opportunities, including selfemployment, for those able, willing, and seeking work, and to promote maximum employment, production, and purchasing power.2 This declaration remained but a straw in the wind for the time, as far as the Federal Reserve was concerned. The harmonious and effective use of fiscal, debt-management, and monetary policy which this mandate seemed to emphasize did not immediately demand that monetary policy formulation and execution be under the complete control of the Federal Reserve System. At the time of the enactment of the Employment Act of 1946, the discretionary powers of the Federal Reserve were largely inoperative, except to ease monetary conditions. Nor did it appear likely that they soon would be operative. Moreover, Federal Reserve officials apparently were in favor of a continuance of the support program, with some modifications. !

15 U.S.C. 1021.

200

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

Modification and Continuation of Support Program In their annual report for 1945 (sent to Congress on June 14, 1946), the Board of Governors explained why the Federal Reserve continued its cooperation with the Treasury in the support program and did not advocate the use of its full monetary powers as a counter-inflationary measure. T h e powers of the System were inadequate, and their full use would produce harmful results : There has been a widespread assumption that, with the coming of peace, such statutory powers as the Reserve System possesses should be exerted in the traditional way against the heavy inflationary forces at present confronting the country. The Board believes that such an assumption does not take sufficiently into account either the inherent limitations of the System's existing statutory powers, under present-day conditions, or the inevitable repercussions on the economy generally and on the Government's financing operations in particular of an exercise of such existing powers to the degree necessary to be an effective anti-inflationary influence." As an alternative to the full use of flexible rates, the Board asked Congress for new powers of control over the investments and reserves of commercial banks. The exercise of these powers by the Federal Reserve was expected to produce two immediate anti-inflationary results: (1) commercial banks would become firmer holders of government securities, and (2) market prices of short-term government securities would be strengthened. These interrelated results would be favorable to a continuation of the support program. 3 Thirty-Second Annual Report of the Board of Governors Federal Reserve System, 1945 (Washington, 1946), p. 1.

of

the

FEDERAL R E S E R V E RELATIONS IN EARLY P O S T W A R PERIOD 2 0 1

Attitude

Toward

Continuation

At the time the Board of Governors made public their report, Federal Reserve officials were discussing with the Treasury a modification in the way of handling Treasury bills which would lead to an increase in bill and certificate rates. In the report, however, the Board did not argue for an exception to the existing support policy. Most likely the Board was influenced by a desire to avoid public controversy with the Treasury and to concentrate on winning approval from Congress for the new control powers over bank investments and reserves. Moreover, in the report the Board specifically ruled out any change in the fixed rate carried by certificates : There can be no assurance that the process of shifting from the shorter- to the longer-term Government securities will be discontinued unless the shorter-term rates should rise to the point where the shifting would no longer be profitable—and this would be undesirable because it would increase the cost to the Government of carrying the public debt. . . . It is contended that an increase in the short-term rate from J [the existing rate on Treasury certificates] to as high as 1J per cent would increase the cost of carrying the public debt by an estimated 200 million dollars and that this would be a small price to pay in combating inflationary dangers. However, there is no assurance that this much of an increase in the short-term rate would stop further debt monetization and even less reason to suppose that it would be of value in combating inflationary dangers which have arisen from two primary causes, neither of which would be corrected by higher rates. One cause is the volume of money already created, which can not be rapidly reduced. The other, and by far the most important basic cause, is the insufficiency of production as yet in relation to the existing money supply. [Emphasis added.]4 4 Ibid.,

pp. 6-7.

202

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

Although the Federal Reserve was united in opposing the full use of flexible interest rates in 1946, there was a division of opinion about the value of the new powers sought by the Board of Governors. In a speech to bankers late in 1946, the President of the Federal Reserve Bank of New York expressed his agreement with the Board in approving the support program : Substantial changes in interest rates, affecting ali maturities, such as were formerly employed for purposes of monetary control, are now impractical. I deem them impractical because of their effect on the prices of public debt obligations, and their effect on the cost of public debt service. At the same time control over the availability of credit has been substantially relinquished, for the time being, by obligations or responsibilities which have been assumed in support of the Government security market.5 President Sproul, however, judged that the proposals of the Board for new powers had "little relevance as far as meeting present problems." He admitted that money management had "only a very secondary role in meeting the major problems" of the day—imbalance between the supply of goods and services and the supply of money, the danger of a continuation of the cost-price spiral, the avoidance of depression and unemployment, and the international economic and political implications of the success or failure of the United States to achieve a lasting prosperity. Nonetheless a secondary role did not make credit control a matter of no significance : It is important, however, that [credit control] be free to work in the right direction. That is the significance of what might be called the next step in the modest approach to restoring credit control—breaking out of the strait-jacket of the pattern of rates, 5 Address at the Eighteenth Mid-Year T r u s t a n d Banking Conference, New Jersey State Bankers Association, December 6, 1946. (Reprinted in Monthly Review, Federal Reserve Bank of New York, X X I X , No. 1, Supplement [January, 1947], p. 6.)

FEDERAL R E S E R V E RELATIONS IN EARLY P O S T W A R PERIOD 2 0 3

in which we voluntarily allowed ourselves to be tied and fastened during the war. By that I mean, specifically, the defrosting of the presently frozen short-term rates on Government securities. I do not suggest this as an urgent matter of the moment; other actions and other factors have given us and are giving us time to consider the problem. And I recognize that the benefits of such a move are not certain; there are few certainties in credit administration. . . . I do not mean, of course, that so long as anything like the present situation exists, we should abandon the short-term market to its own devices. And I do not mean that we should relax our controls so far as to breach the 2| per cent rate on long-term Government securities. The former is not necessary and the latter is not desirable." Modification

of Short-Term

Rates

While these statements of approval of support for the pattern of rates were being made, the Federal Reserve, as mentioned, was negotiating with the Treasury over an increase in short-term rates. The discussions started at least in early 1946 and were not resolved until July, 1947. The first change in the pattern of rates was the termination, on July 10, 1947, of the posted § percent rate on Treasury bills. The change was not announced until the Treasury agreed to it. At the time, the Federal Reserve Banks held all but $1.5 billion of the $16 billion of outstanding Treasury bills. The Federal Reserve pointed out that this almost exclusive holding eliminated the Treasury-bill rate as a factor in the money market. On the other hand, the discontinuance of the posted rate and the expected rise in the market rate would increase the attractiveness of the Treasury bill.' The Treasury thus would acquire Ibid., p. 7. Thirty-Fourth Federal Reserve 0 7

Annual Report of the Board of Governors System, 1947 (Washington, 1948), p. 89.

of

the

204

THE INDEPENDENCE OF THE FEDERAL R E S E R V E S Y S T E M

greater flexibility in its debt-management operations. As an additional inducement, the Federal Reserve decided to turn over to the Treasury 90 per cent of its earnings which otherwise would be added to the Reserve Banks' surplus accounts. This arrangement would give the Treasury most of the increased Federal Reserve earnings resulting from the upward adjustment of the bill rate. The Treasury not only agreed to this change in the wartime pattern of rates but also, later in July, initiated action which led to an increase in the rate it offered on certificates.

Acceptance

of Modified

Program

These modifications in short-term rates did not mean that the Federal Reserve was trying to move away from support of a fixed pattern of rates and especially the long-term 2\ percent rate. The Federal Open Market Committee continued its adherence to a policy of promoting stable and orderly conditions in the government securities market. It did so willingly. In 1948, the President of the New York Bank reaffirmed his belief that the Federal Reserve should not break away from its definite support of the market. In testimony before a Congressional committee he raised the question and gave his answer : Why should we support the Government security market, and to that extent circumscribe our powers and our actions to control the volume of credit? . . . I justify the policy we have followed, not on the basis of cheap money or low interest rates so far as the Government debt is concerned, although that has its important aspects, but because I question what good could have been accomplished by a vigorous aggressive policy of over-all credit contraction—such sales of Government securities from our port-

F E D E R A L R E S E R V E R E L A T I O N S IN E A R L Y P O S T W A R P E R I O D

205

folio as might have broken the market. . . . A general monetary control, if used drastically enough, works through a restriction of production. The steps in the process are restriction of money supply, rise of interest rates, contraction of employment and production, contraction of income. . . . I think it is an illusion to think that some painless way of avoiding the consequences of making credit really tight, can be found. To use our existing powers without regard to interest rates and the Government security market, in order to get the eßect our critics suggest, would mean that our action would have to be drastic enough to lower the money income of a large segment of the consuming public. To accomplish this by over-all monetary or credit action would mean a serious decline in production and employment. Such action could only be justified if we were faced with a runaway inflation due solely or primarily to monetary causes. That is not our present situation and that cannot be the right policy now. [Emphasis added.]' Thus Sproul did not think that the Federal Reserve should move away from its support program,' that 1948 was the time for the Federal Reserve to return to a policy whereby openmarket operations would inject or withdraw funds regardless of what happened to the prices of government securities and interest rates. Early Thomas Reserve he told

in 1949, the Chairman of the Board of Governors, B. McCabe, confirmed the willingness of the Federal to support the adjusted pattern of rates. In February, a Congressional committee:

* Statement before Joint Committee on the Economic Report, May 12, 1948, pp. 10-12. (Mimeographed.) * In the following year he confirmed this : "I was strongly in favor of the support program which was given to the long-term Government security market at the time we gave it, at the time we gave that support following the war." (U.S., Congress, Subcommittee of the Joint Committee on the Economic Report, Hearings on Monetary, Credit, and Fiscal Policies, 81st Cong., 1st Sess., 1949, p. 439. Cited hereafter as the Douglas Hearings, 1949.)

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T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

We are . . . still confronted with the necessity of balancing our several objectives, one of the most important of which is maintenance of stability in the Government securities market. T o accomplish this the Federal Open Market Committee stands ready to buy such securities when there are no other buyers at established prices, and also to sell securities when demand is heavy. I think the System's support of the Government securities market has been wise and necessary. It is one of the outstanding accomplishments of the postwar period. [Emphasis added.]' 0 L a t e r in 1949, C h a i r m a n M c C a b e denied specifically that the Federal Reserve was forced by the T r e a s u r y to m a i n t a i n the support policy in the postwar period. H e a d m i t t e d that there were differences of j u d g m e n t within the System about the p r o p e r course of action for the Federal Reserve; he denied that the Federal O p e n M a r k e t C o m m i t t e e acted unwillingly : It has been said that the Open Market Committee of the Federal Reserve System, which is charged by Congress with responsibility in these matters, did not wish to continue to support the 2b per cent level on long-term Treasury bonds but was induced to continue this policy by pressure from the Treasury. This is not true." C h a i r m a n M c C a b e then gave his reasons for the continuance of the support program. T h e Federal Reserve was obligated to m a i n t a i n an orderly market f o r g o v e r n m e n t securities not primarily to help the Treasury in its r e f u n d i n g operations b u t to avoid the widespread

h a r m f u l effects on

the

nation's

economy. Such effects would be sure to follow if market participants were to judge that their holdings of government securities lacked stable values.

U.S., Congress, Joint C o m m i t t e e on the Economic Report, Hearings, January 1949 Economic Report of the President, 81st Cong., 1st Sess., 1949, p. 351. " Douglas Hearings, 1949, p. 465.

F E D E R A L R E S E R V E R E L A T I O N S IN EARLY P O S T W A R P E R I O D

Concurrence

of

207

Treasury

The Treasury Department accepted the modifications which had been made and pressed for continuance of the support program. Its reasons were similar to those of the Federal Reserve. Speaking, in 1948, about the changes in the bill and certificate rates, Secretary John Snyder was ready to share the responsibility for the modification : As part of the Treasury program to reduce inflationary pressures, credit has been tightened by a gradual increase in interest rates on short-term Treasury securities, and by a sharp reduction in premiums on long-term issues.12 In the same year, but on another occasion, the Secretary emphasized the importance of a significant decline in bond prices on the cost of carrying the government debt and the consequent burden on the taxpayers. He gave greater emphasis, however, to the necessity of stability in the governmentbond market, first, for the continuation of confidence in the credit of the government and, second, for a strong financial system in the nation : "Therefore, during my tenure of office, the Treasury, in cooperation with the Federal Reserve Board, has directed its efforts toward maintaining this confidence in the stability of the government bond market.'" 3 Continuation of this policy was and would remain a major contributing factor to "business confidence" and the attainment of "the fullest economic activity in our peacetime history." His interest was not just that of a spectator : he included an account of how the Treasury bought and sold in the open market for 12 Annual Report of the Secretary of the Treasury on the State of the Finances for the Fiscal Year Ended June 30, 1949 (Washington: U.S. Government Printing Office, 1949), p. 315. "Ibid., p. 318.

208

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

its investment accounts in order to promote stability and thus complement the actions of the Federal Open Market Committee. A recurring phrase used by the Secretary in describing debt management and monetary management in the early postwar years was : stability in the government bond market through the cooperative efforts of the Federal Reserve System and the Treasury Department. Reduction in Influence of Board Chairman Although the Federal Reserve continued its support program with certain modifications, Chairman Eccles did not keep his influential position with the Administration. In the late Forties his influence changed noticeably from what it was in the Thirties and the war years. Once a close adviser, friend, and advocate of the Chief Executive, he later tended to become a lone crusader. T h e Secretary of the Treasury and the Comptroller of the Currency were not always in sympathy with his views, nor at times were the President, the Congress, Reserve Bank Presidents, and the Federal Advisory Council. It was not surprising that this wall of separation lost him his influence and his Chairmanship. Rejection

of Proposals

for New

Authority

An illustration of the loss of influence of the Chairman of the Board of Governors occurred in 1947. At a special session of the Eightieth Congress called to consider measures for aiding Europe and for meeting inflationary pressures in the United States, he testified in behalf of most of the new monetary powers proposed by the Board of Governors in their 1945 and 1946 annual reports—increased statutory reserve requirements, permanent establishment of the direct control of con-

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209

sumer credit, and temporary authority for the Federal Open Market Committee to impose on banks a special reserve requirement which could be met by holding either cash or shortdated government securities." At the same time he criticized the Administration's record in removing credit controls, reducing taxes, and not producing budgetary surpluses. He stated that restrictive monetary and credit policies would be less urgent if "needed action [were] taken on the far more important front of fiscal policy."16 This testimony was counterbalanced by that of the Secretary of the Treasùry and the President of the Federal Reserve Bank of New York, both of whom opposed the special bank reserve plan. Congress did not enact the proposals of Chairman Eccles. What hurt him especially was the opposition of the Treasury and the New York Reserve Bank President. He claimed that the Secretary of the Treasury was responsible for the lack of support for his proposals by the President. Moreover, the Secretary, prior to Eccles's testimony in Congress, "correctly insisted that the field of money and credit was the primary responsibility of the Reserve Board and I should speak for the Board and not for the Administration when the President's inflation-control program was considered by Congress."" With regard to the opposition of the New York Bank President, Chairman Eccles complained : "Sproul legitimately reflected the opposition of the bankers in his district to the specialreserve plan."" The qualifying word "legitimately" was in " The Chairman included these ideas in a memorandum prepared for President Truman prior to the presentation of the Administration's antiinflationary program to Congress. The President, however, did not espouse the proposals of Eccles in his message to Congress. " E c c l e s , Beckoning Frontiers, p. 431. "Ibid., p. 430. " Ibid., p. 433. Eccles also stated about the New York President : Despite the fact that he had been elected to his post at the New York Reserve Bank by the action of its board of directors, six of whom were

210

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

keeping with the Chairman's general belief that the Board of Governors presented the public point of view and promoted primarily the public interest which counterbalanced the point of view and the interest of private bankers frequently promoted by the Reserve Bank officials. Loss of Position as

Chairman

That the influence of the Chairman was on the wane was made clearer early in the following year (1948) when President Harry Truman informed Eccles that somebody else was going to be made Chairman. Since there was a vacancy on the Board at the time, Eccles was not losing his position as a Governor. President Truman, however, did not inform Eccles why he was not being redesignated Chairman." This loss of the Chairmanship was another indication that a kind of wall had been erected between the President and the Chairman of the Board of Governors. While President Truman did not reappoint Eccles for a four-year term as Chairman, he did not immediately appoint somebody else. Two and a half months went by (February 1, 1948, to April 15, 1948) before the new Chairman was appointed. Meanwhile, Eccles continued to serve as Chairman pro (em. Two days prior to the new Chairman's taking office, Eccles, before a Congressional committee, testified again in e l e c t e d b y i h e b a n k s o f t h e d i s t r i c t , S p r o u l w a s a n d is first a n d f o r e m o s t a representative o f the public interest. H e has sometimes argued the case o f t h e b a n k s , b u t h e h a s j u s t as o f t e n a r g u e d a g a i n s t t h e m . (Ibid., pp. 363-364.) " E c c l e s b e l i e v e d t h a t h e w a s n o t r e a p p o i n t e d C h a i r m a n , n o t so m u c h b e c a u s e o f his o p p o s i t i o n t o t h e A d m i n i s t r a t i o n ' s fiscal p r o g r a m , b u t because of political pressure against him resulting from a n o t h e r action. D e s p i t e the lack of interest by the J u s t i c e D e p a r t m e n t and the opposition of the Comptroller of the Currency, he had instituted anti-trust proceedi n g s a g a i n s t t h e T r a n s a m e r i c a C o r p o r a t i o n . ( E c c l e s , op. cit., pp. 4 3 4 4 5 6 . ) T h e B o a r d o f G o v e r n o r s w a s u n s u c c e s s f u l in this c a s e a n d finally stopped the proceedings in 1 9 5 3 .

FEDERAL R E S E R V E RELATIONS IN EARLY P O S T W A R PERIOD 2 1 1

favor of his proposals to strengthen the Federal Reserve's powers and in criticism of the Administration's fiscal program. Later in the year, when the new Chairman was in office, Eccles continued his criticism before Congress : The program [proposed by the Administration] taken as a whole seems to me to be more of a political program than an economic one. . . . I do believe that we should—and I may sound naive in this regard—adjourn political considerations . . . and consider honestly and openly the economic facts of life." What Eccles was trying to fight was the build-up of inflationary pressures which had been increasing since the end of the war. He was opposed to budget deficits, easy credit terms for new housing, and support programs for farm prices. He was actually asking that the government's fiscal program be adapted to the needs of the economy as he judged them in the light of monetary policies and goals. To him it was not an "economic fact" that veterans needed and wanted easy credit terms for new housing, even in the face of a relative shortage of labor and materials available for its construction; it was not an "economic fact" that farmers hurt by farm prices demanded financial aid from the government; it was not an "economic fact" that foreign aid and national defense expenditures were part of the foreign policy of the government. Eccles could see the implications of such actions by the government for the monetary health of the nation. He argued that such implications should persuade the government to adjust its political, military, and international policy-making to conform with sound monetary policy as he saw it. Certain policies of the government were monetary dynamite; yet their failure or non-adoption was dynamite for the partisans of government action in those areas. This was not an easy lesson to learn or to live with. " Ibid., pp. 458-459.

212

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

Adoption of More Flexible Policy T h e appointment of the new Chairman of the Board of Governors, Thomas B. McCabe, became effective on April 15, 1948. In August of the same year, Congress granted temporary authority for an increase in reserve requirements and a restoration of direct control over consumer credit. In May, 1949, Chairman McCabe asked Congress to extend its authorization of these powers and to apply the reserve requirements to all insured banks. He stated that the Federal Reserve needed "elbow room" for its central banking functions. The authority requested would offset to some extent the limitation resulting from the support program : " S o long as we have the huge Federal debt to support we cannot count on use of either the discount rate or operations in the open market to exert the same degree of influence that they did before the war."*" Although he had the backing of President Truman (and presumably, the Secretary of the Treasury), he was not succcssful in his request. T h e danger of inflation was not pressing at the time, and Congress allowed the special authority over reserve requirements and consumer credit to lapse on June 30. In keeping with the changed economic conditions, the Federal Open Market Committee, with the approval of the Treasury, announced, on June 28, a new policy to increase the supply of funds in the market : It will be the policy of the Committee to direct purchases, sales, and exchanges of Government securities . . . with primary regard to the general business and credit situation. The policy of maintaining orderly conditions in the Government security market, and the confidence of investors in Government bonds will be continued. Under present conditions the maintenance of a M "Statement before the S e n a t e B a n k i n g and C u r r e n c y Federal Reserve Bulletin, X X X V (May, 1949), 476.

Committee,"

F E D E R A L R E S E R V E R E L A T I O N S IN EARLY P O S T W A R P E R I O D

213

relatively fixed pattern of rates has the undesirable effect of absorbing reserves from the market at a time when the availability of credit should be increased.21 Later in the year, the Chairman stated how important he considered this announcement : "I regard June 28, 1949, as a most important date. It signified the removal of the strait jacket in which monetary policy had been operating for nearly a decade; that is, since the beginning of the war.'" 2 He reaffirmed the need for coordination between debt-management and open-market policies, but he did not explain how the abandonment of a stable pattern of rates would affect the meaning of "orderly conditions" and "confidence of investors."

Meaning

of New

Flexibility

The reaction of the government securities market to the new policy of the Federal Open Market Committee was to expect an easier money policy. The abandonment of stable rates was interpreted to mean that the rates on government securities would be allowed to fall. This downward flexibility was in keeping with the economic influence of "recession" or "inventory adjustment" which became dominant in the second half of 1949. It was not clear to the market, however, that the June 28 announcement also meant greater flexibility upward in rates if the economy should turn around and become very bullish. Senator Paul Douglas expressed this doubt about the establishment of a new two-way flexibility. His dialogue with Chairman McCabe on the significance of the announcement contained the following attempt at clarification : 11

Federal Reserve Bulletin, XXXV (July, 1949), 776. " Douglas Hearings, 1949, p. 471.

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T H E INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

DOUGLAS : . . . T h e instance of cooperation which you chose was one which was very happy from the Treasury point of view, when there was no conflict between the purposes in a period of depression. But would this cooperation

necessarily

continue

in

a

period

of

inflation ? MCCABF. :

T h e acid test of relationships and even of partnerships, Senator,

comes when you have

to

meet

a

critical situation in the future. I am going on the assumption that this was an agreement made by men of understanding and goodwill and that it means what it says. T o the Federal

Reserve

it means . . . that open-

market operations will be flexible . . . and that we will conform to the economic situation with which we are confronted. DOUGLAS :

Y o u will have flexibility both ways?

MCCABE :

Both ways.

DOUGLAS :

D o you think the Treasury so understands i t ?

MCCABE :

T h a t is my understanding. T h e Treasury understands this : T h a t they have the final decision on fixing the rate on any refunding of Treasury obligations. W e so recognize that they have this final decision and that when they announce a maturity—the refunding of a m a t u r i t y — t h e y determine the rate.

DOUGLAS : [Suppose a deficit in 1950 and rising prices.] If the Treasury should then insist upon low interest rates in order to prevent cash outlays by the Government for interest charges rising, but the Federal

Reserve

believed that interest rates should be increased in order to check expansion in the private sector, you would be in conflict; would you n o t ?

FEDERAL R E S E R V E RELATIONS IN EARLY P O S T W A R PERIOD 2 1 5 MCCABE

: Yes, and I would say that we would go to extraordinary lengths to convince the Treasury of the point of view of the Open Market Committee.23

Reliance on Persuasion-Appeal

Approach

"Flexibility both ways" evidently was a desirable principle; whether it could be actuated remained for future verification. Chairman McCabe based his hopes on what might be called the persuasion-appeal procedure. If the two agencies disagreed over policy and the Federal Reserve failed to persuade the Treasury, the System would then appeal to the President and, finally, to the Congress/ 4 That such persuasion and appeal might be necessary was evident from statements by the Secretary of the Treasury and members of the Council of Economic Advisers. The Secretary of the Treasury was clear about his intention to preserve the 2J percent rate. In speaking about the means to "create and maintain conditions by which the people of the country may expect [government] bonds to be paid" and thereby maintain the government credit, Secretary Snyder declared : "We have felt very definitely that it was important to maintain our present two-and-a-half percent rate in the markets for government bonds. That has been our endeavor." 25 He expected to continue that endeavor. In this hope he was supported by John D. Clark, of the Council of Economic Advisers : We are certain that confidence by the public . . . is important to maintain a Government credit position that will make it possible to roll over this $50,000,000,000 of debt that is maturing every 12 months, and that everything else must be subordinated 23

Ibid., pp. 494-495. Ibid., pp. 489, 492-493. Hearings on the 1949 Economic p. 171. 54 25

Report

of the President,

op. cit.,

216

T H E I N D E P E N D E N C E OF THF. F E D E R A L R E S E R V E

SYSTEM

to that. . . . [Successful d e b t - m a n a g e m e n t policy requires that the] p u b l i c have absolute confidence that the G o v e r n m e n t bonds a r e g o i n g to be s u p p o r t e d at a point which they c a n know a b o u t a n d u n d e r s t a n d , a n d the only point that we think you can use is p a r . *

Clearly, if the June 28 announcement meant the removal of the "strait jacket," it was also evident that only the removal of one side of the jacket was readily agreeable to all the parties involved. A future inflationary situation would provide an opportunity to put into operation the persuasion-appeal procedure. Meanwhile, the Treasury seemed to resent the reference to a strait jacket; it also believed in flexibility. Economic conditions outside its control, it kept saying, prevented the unrestricted testing of that flexibility. Renewed Concern for Independence As the early postwar period merged into the Fifties, the Federal Reserve increasingly emphasized one desire—the reformation of its power to act as a two-way stabilizer and an energizing force in the economy. The Federal Reserve became less satisfied with subordinating everything else to the debtmanagement problems of the Treasury, as it had largely done during the defense, war, and early postwar period ; it began to grow more restless and dissatisfied over its inability to initiate changes in monetary policy. Attempts to substitute special authority over reserve requirements, moral suasion, or direct controls over certain types of credit for ordinary monetarymanagement powers came to be considered as measures of only partial or temporary value. In the long run and for effective monetary management, such special powers were judged inadequate substitutes for the full revitalization of the Douglas

Hearings,

1949,

p. 5 3 5 .

F E D E R A L R E S E R V E R E L A T I O N S IN EARLY P O S T W A R P E R I O D

217

System's dormant powers to control the cost and availability of credit through open-market operations. This judgment did not mean that the Federal Reserve regretted its cooperation with the Treasury during World War II or that, given more time for its decision at the start af the war, it would have insisted on a radically different debtmanagement policy. Nor did the Federal Reserve's dissatisfaction in the late Forties mean an impending open revolt from the circumscribing power of the Treasury Department. From the viewpoint of both political and economic realities, cooperation remained necessary, but new attempts at persuasion and new definitions of cooperation became more desirable to the Federal Reserve. Secretary Snyder of the Treasury and Chairman McCabe of the Board remained optimistic that needed adjustments could be made through responsible cooperation. In addition, the Federal Reserve became increasingly restless in its own backyard. Internal disagreements over System policies and authority arrangements tended to make the Federal Reserve weak and vulnerable to attack from those who wanted the government to take it over completely. This was a serious consideration, for if the Federal Reserve System expected the government to trust it with the management of the nation's monetary and credit policy, a management whose essential characteristic would be responsible flexibility and not rigidity, it needed to have to have its own household in order. Neither the Treasury nor the Congress could be expected to allow the determination of significant aspects of debt management to depend on a complex organization like the Federal Reserve System when that organization was not unified and well-ordered. Both the Board and the Reserve Banks agreed with some Congressmen who wanted to establish a new National Monetary Commission which would investigate the framework and

218

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

functioning of the nation's financial system a n d would position central banking and the government in that system. With regard to the Federal Reserve, perhaps the correct procedure was to have Congress first unify and reorder the control of credit powers within the System; then set u p firm procedures for cooperation with, or absorption of, other agencies in the field;

a n d give the System a clearer m a n d a t e with greater

authority to chart its course in spite of winds from either Washington or Wall Street. President Sproul of the N e w York B a n k a n d C h a i r m a n M c C a b e of the B o a r d of Governors were ready

with

ideas

about

the

internal

and

the

external

strengthening of the System. Proposals of Sproul O n frequent occasions the President of the N e w York B a n k , Allan Sproul, discussed certain organizational aspects of the independence of the Federal Reserve System. F o r example, in a speech in 1946 he treated the proposal that the System would be fully relied upon by the government and even be given greater powers in the monetary and credit field if it were reorganized so that there would be no private participation in the functioning of the System. His answer was twofold. First, the System had a d e q u a t e powers to d o its work. N o reorganization was needed. Second, the private participation w a s not without a public responsibility. Moreover, it was a n effective and meaningful arrangement which might provide a precedent for solving the problem of the cooperation of government and business in the economy : It has been said, in the past, that the only way to insure the proper participation of the Federal Reserve System in any re-ordering of our financial affairs, is to deprive the System of all taint of private participation. T h e Government, so the argument runs,

FEDERAL R E S E R V E RELATIONS IN EARLY P O S T W A R PERIOD 2 1 9

would be willing to place full reliance in the System's existing powers, or to grant it new powers, only if every vestige of private participation in its management were removed. . . . Rather than seek powers by trying to make the Federal Reserve System just another Government agency, we should be able to claim powers because2' we are a successful working example of Government functioning in the economic field, with the aid and support of private business. Our experience in Government-business cooperation—Government having the dominant voice as it should have in the field of monetary and credit policy—may be a signpost along the way to solution of one of the major economic problems of the postwar years : the relation between Government and business in our whole economy Concentration of Power in Open Market Committee. Over the next few years Sproul amplified his ideas about reorganization. He urged Congress to strengthen the position of the Federal Reserve in the formulation of monetary policy for the nation. First, in agreement with the Board of Governors, he proposed that Congress make a general review of "our whole monetary and credit organization and its workings" in order to acquire a long-range view of credit powers and credit policy. " I t is time," he affirmed, "to review all of our legislative authorities in the light of our experience and our existing economic environment."2" Second, this review should consider the unification of authority and responsibility in the monetary and credit field which was now shared by the Federal Reserve System with other agencies of the government. Third, he 21 When Sproul repeated the rest of this quote in 1949 at the Douglas Hearings, he slightly changed his position about the appropriateness of the government's role. T h e phrase, "Government having the dominant voice as it should have in the field of monetary and credit policy" (emphasis added), was modified to read, "with the Government having the dominant and deciding voice." (Douglas Hearings, 1949, p. 446.) "Address of Sproul (December 6, 1946), op. cit., p. 4. M Statement before Joint Committee on the Economic Report, May 12, 1948, p. 18. (Mimeographed.)

220

T H E INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

wanted a reconsideration of the internal organization

and

functions of the Federal Reserve System. Here he proposed a reaffirmation of the importance of private participation in the monetary control machinery, a reduction in influence of the Board of Governors, and an increase in the powers of the Federal Open Market Committee : We have in the Federal Reserve System a wise blend of national authority and regional responsibility, of Government control and private participation. But it is some time since the Congress gave us its mandate and various interpretations of its intent have gained currency. More and more it seems to have become the habit to think of the System as a head office in Washington with 12 branches or subsidiaries in the 12 Federal Reserve Districts, and even to forget that the Board of Governors is a Board and not a chairman with deputies, great though the powers of the Chairman be. More and more it has become the habit to minimize the value or deny the propriety of any private participation in the affairs of the System. I oppose these tendencies.5" At the same time he advocated that the regional characteristics of the Federal Reserve System which were manifested in the decentralized operations of the System should be expressed more adequately in the policy-making of the System. Not only should the minority representation of Reserve B a n k officials on the Federal Open Market Committee be maintained, but the power and authority of the Committee should be increased by transferring to it the related credit powers exercised solely by the Board of G o v e r n o r s : " "the power over reserve and margin requirements, and the review and determination of discount rates initiated by the Reserve B a n k s . " " Sproul spoke of the members of the Federal Open Market Committee as all endowed with statutory powers and responsibilities, " m e n who Ibid., p. 16. " Ibid., p. 17. E Douglas Hearings,

30

1949, p. 444.

FEDERAL R E S E R V E RELATIONS IN EARLY P O S T W A R PERIOD

221

are devoting their full time to the problems of the Federal Reserve System and who are in touch with governmental policies and private views and opinions, in Washington and throughout the country." 33 In his judgment, to give them as a group the principal control powers of the System might well be "a foiward and constructive step." It was generally assumed with regard to the members of the Federal Open Market Committee that the Board of Governors were devoted to the public interest. The same assumption, Sproul insisted, should apply to those members who were Presidents of Reserve Banks : There is an argument that the Presidents on the Federal Open Market Committee exercise authority without having responsibility. In the first place, as I have stated, membership OR the Federal Open Market Committee, and the duties and responsibilities of the Committee are now fixed by statute. Every man who accepts a place on that Committee derives his authority from the Congress and assumes a responsibility to the Congress, and, through it, to the public. These Presidents are mostly men who have devoted their lives to the Federal Reserve System—they are career men in the public service. It comes with ill grace for anyone who has ever served on the Committee to hint that they are swayed by private interests to compromise public duty. You do not plant honor and integrity in a man by bringing him to Washington and giving him an official position in the Government.34 Adjustment of Relations with Treasury. With regard to the relationship between the Federal Reserve System and the Treasury Department, Sproul first pointed out that "an inherent conflict" might develop between an effective monetary management which relied on fluctuating rates and an effective debt management which insisted above all on 33 Ibid., p. 445 ; also, Statement before Joint Committee on the Economic Report, May 12, 1948, pp. 16-17. (Mimeographed.) 34 Douglas Hearings, 1949, p. 445.

222

THE INDEPENDENCE OF

ΓΗΕ FEDERAL R E S E R V E

SYSTEM

minimizing expenditures for debt service. For this difficulty he suggested several remedies. One would be a Congressional directive that the Treasury in its debt-management operations "should work within the structure of interest rates appropriate to the economic situation."* Such a directive would provide, however, no hard and fast rules as to who was to be the judge of "appropriate" interest rates; but it would prevent the Treasury, "as a matter of right or superior position,"" from forcing the Federal Reserve System to maintain rates which the System did not consider in conformity with the degree of credit restraint necessary at a given time. This last point seemed to contain the substance of the suggestion : the Treasury Department would not have the right to demand immediate and unalterable acquiescence by the Federal Reserve in the Treasury Department's debt-management policies. T h e suggestion of a Congressional directive, however, did not provide for the "conflict" situation in which neither party agreed with the other and one party initiated action to force its position on the other. It was not prudent to expect that such a directive would confer on the favored party the mark of infallibility. Other suggestions which Sproul made could be considered as directed toward the solution of the problem of non-agreement. He toyed with two ideas, both concerned with the principle that there be regular and/or formal consultation between the Treasury Department and the Federal Reserve System : One suggestion along these lines . . . is that there be created a national advisory council on domestic financial policy, a consultative body which would bring together the heads of the four or five principal agencies whose activities affect, directly or "Ibid., 36

Ibid.

p. 4 3 1 .

F E D E R A L R E S E R V E R E L A T I O N S IN E A R L Y P O S T W A R PERIOD 2 2 3

indirectly, the areas of prime responsibility of the Treasury and the Federal Reserve System. Such a council might also extend its scope to include within its purview, on a purely consultative basis, the lending and loan guarantee activities of all other Federal financial agencies—in the interest of frequent consideration of overlapping mutual problems. . . . Another suggestion is that the Secretary of the Treasury be made a member of the Board of Governors of the Federal Reserve System.3' Although Sproul did not place much hope in the help that might come from either of these two suggestions if they resulted in actual changes in the authority of the System, yet he thought they should be considered by Congress as it sought a solution to the "inherent conflict." It was possible that the suggestions about the advisory council and the Board membership of the Secretary of the Treasury would improve the required negotiations over the uses of monetary power. It was unrealistic, however, for Congress or anyone else to expect the blossoming of a golden age once the mode of communication was improved. Consultation and exchange of viewpoints between the Federal Reserve and the Treasury, such as Sproul and others advocated, would be helpful if they enabled policy makers to arrive at "wiser" decisions; but such procedures of themselves did not provide any norm for what was wise. The most that could be hoped for was that they would help the consultants to understand better the viewpoints of each other. This result was worthwhile, for such understanding, arising out of regular liaison and discussion work, could pave the way for ready and full cooperation at all times. Proposals of McCabe The new (1948) Chairman of the Board of Governors also proposed organizational changes as well as cooperative 31

Ibid.,

p. 4 3 2 .

224

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

arrangements for the Federal Reserve System. About a year after he became Chairman, Thomas B. McCabe in testimony before Congress stressed the area of agreement and cooperation between the Federal Reserve, on the one hand, and the Treasury Department and the Administration, on the other. He spoke of the "truly splendid achievement in financing the most devastating and costly war of all time and in restoring the country to full peacetime production and employment."" He was pleased with his relations with the Treasury : " I have found the Treasury anxious and always willing to listen, to consult, and to get our point of view. I have gone to great lengths to get their point of view.'" 9 But the problem of coordination remained—coordination of authority within the System and with other agencies within the framework of government policy, including policy not strictly monetary. If this broad coordination were attained, the Federal Reserve System would be a government agency rightfully possessing as great an independence as possible in the determination of credit policies. Feasibility of Cooperative Procedures. T h e Chairman was asked to list the more important times "when the powers and policies of the System have been inadequate or inappropriate to accomplish the purposes of the System." In his answer he distinguished between policies and powers : It is well recognized that the policies pursued by the Federal Reserve System, over the 35 years of its existence, have not always been adequate or appropriate to accomplish fully the purposes which such an agency is designed to serve. How far this has been a result of inadequate or inappropriate legal powers, however, is a matter on which competent students of the subject do not seem to have come into general agreement." M

Statements to Douglas Subcommittee, 1949, p. 36. Douglas Hearings, 1949, p. 491. " Statements to the Douglas Subcommittee, 1949, p. 26. M

F E D E R A L R E S E R V E R E L A T I O N S IN EARLY P O S T W A R P E R I O D

225

He did not think that a change in powers should be made by bringing the System closer to the government by such means as putting the Secretary of the Treasury back on the Board of Governors, eliminating the stock ownership feature of the Federal Reserve Banks, or having Congress specify policy goals or guides in greater detail for the System. While there was a continuing need for coordination of debtmanagement and money-market policies, Chairman McCabe did not believe that "formalized procedures" were necessary to assure the achievement of that coordination. He told Congress : Our problems arise out of the different character of the very serious responsibilities that are borne by the Treasury on the one hand and the Federal Reserve System on the other. The record of history is clear, that institutions charged with these responsibilities should be mutually independent of each other, for the subordination of each might lead to unfortunate results. This seems to me to imply that we must rely on the men who carry these respective responsibilities, on their good will, constructive vision, and spirit of cooperation/ 1 He stressed the accomplishments made through cooperation between the Treasury and the Federal Reserve, a cooperation which though voluntary was demanded by the problems they faced together. His satisfaction over past performance spread into optimism for the future. No special directives were needed : To be absolutely realistic about it, I feel that for the immediate future the best solution I can see is for Congress to have sufficient confidence in the Treasury and in the Federal Reserve—confidence that they can coordinate . . . their activities to attain the desired objectives of the Congress and the public." 41

Douglas Hearings, "Ibid., p. 491.

1949, p. 472.

226

T H E I N D E P E N D E N C E O F THF. F E D E R A L R E S E R V E

SYSTEM

Somewhat similar views were expressed by the Secretary of the Treasury. His repeated theme was that responsible authorities, informed of cach other's viewpoints, would find workable solutions to common problems. Secretary Snyder was not opposed to the establishment of a national advisory council (such as the Hoover Commission proposed for coordinating monetary and fiscal policies), but he did not think it would of itself "solve any fundamental problem."" Likewise he could not sec any particular advantage in making the Secretary of the Treasury a member of the Board of Governors : The Secretary of the Treasury did serve as a member of the Federal Reserve Board from its inception until February 1, 1936. There is no evidence that the coordination of Federal Reserve and Treasury policies was carried out more effectively during that period than it has been subsequently." In addition, there was one possible disadvantage. His membership on the Board of Governors for the purpose of bringing about a better coordination of Treasury and Federal Reserve operations "would appear to subordinate the responsibility of the Treasury Department in fiscal-monetary matters."" He was very serious about this and he expressed his opinion strongly : " I n the final analysis, the principal responsibility in the fiscal-monetary area must rest with the President and his fiscal officers, who are accountable to the electorate for their actions."" Although coordination built upon this nonformalized basis might give rise to certain definitional problems, the Secretary and the Chairman of the Board had high hopes for the future accomplishments of the established cooperative arrangements. "Statements to Douglas Sumcommittee, " Ibid., p. 11. " Ibid. " /bid.

1949, p. 14.

F E D E R A L R E S E R V E R E L A T I O N S IN EARLY P O S T W A R P E R I O D

227

Changes for Improved Cooperation. Chairman McCabe did not limit himself to praise of the past; he also had suggestions for changes to increase the effectiveness of the Federal Reserve. Some of his proposals were directed toward realignment of the powers of the System, both internally and in relation to other government agencies besides the Treasury. He wanted Congress to make it clear that all government agencies whose actions affected monetary management were bound by the objectives of the Employment Act of 1946. The formation of a national council which brought the heads of various government agencies together for consultation and advice was approved, though not urged. Furthermore, he suggested the reconstitution of the Board of Governors—three members appointed by the President as at present and two members from among the Presidents of the Federal Reserve Banks. This new board would have all the powers of the existing Federal Open Market Committee as well as all the powers of the existing Board of Governors. In his opinion, the reconstituted Federal Reserve Board : . . . would be in harmony with the regional character of the Federal Reserve System which contemplates that the coordination, supervision, and final determination of national credit and other major policies would be in the hands of a supervisory governmental body located in Washington.·" He further suggested that the President of the Federal Reserve Bank of New York, because of the importance of the New York money market, participate in the matter of open-market policies and operations. In order to restore some of the essential contact between the System and the President of the United States he advocated that the law be changed so that a newly elected President of the United States would be able to appoint the Chairman of the Board of Governors. " Ibid.,

p. 6 9 .

228

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

All this testimony was far from being stubbornly critical of the Administration or the Treasury, in the past or at the time it was given. Rather, by denying infallibility to the Federal Reserve and by admitting that some organizational changes might be helpful, it promoted a more willing cooperation. McCabe seemed to have set the Federal Reserve household in order and ready to get on with the business of helping the economy out of the doldrums of the late Forties and into the excitement caused by war threats and war itself at the start of the Fifties. Hence the sudden publicity given to a major disagreement between the Federal Reserve System and the Treasury in 1950-1951 was a shock to many, so contrary was it to the sweetness and light spread by the Chairman in the 1949 Congressional hearings.

Vili The Renascence of the Independence Issue — The 1951 Accord

AT

THE

START

OF

THE

FIFTIES,

THE

FEDERAL

RESERVE

System and the Treasury Department publicly disagreed about appropriate debt-management and monetary policies for the nation. At stake was not only an increase in independence for the Federal Reserve but also the preservation of any independence.The problem was to find a way to combine independence with an increasingly important finance program of the Treasury. While the Federal Reserve affirmed that it intended to maintain an orderly market for government securities, at the same time it asserted that this policy did not mean the System would or should support a fixed pattern of rates. By August, 1950, public disagreement between the Federal Reserve and the Treasury had become open and serious. It continued to gain momentum during the next seven months. The President of the United States sided with the Treasury in opposing the Federal Reserve's change of policy, especially if the change were made rapidly and extensively. The System, in turn, was encouraged by large support from Congress for its position. Finally, discussions between the two organizations resulted in the issuance and publication on March 4, 1951, of 229

230

THE INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

the following statement by the Secretary of the Treasury, the Chairman of the Board of Governors, and the Federal Open Market Committee : The Treasury and the Federal Reserve System have readied full accord with respect to debt-management and monetary policies to be pursued in furthering their common purpose to assure the successful financing of the Government's requirements and at the same time, to minimize monetization of the public debt. 1

Events Leading to the 1951 Accord The background of the disagreement included events occurring in the latter part of 1950 and the early months of 1951. These months embraced the beginning and rapid expansion of military action by the United States in Korea. The serious possibility of a Third World W a r added both urgency and uncertainty to the planning by the Federal Reserve and by the Treasury for financing the Government. T h e Federal Reserve was most concerned about the continuance of the support program which dated from the beginning of the Second World War. T h e System could not easily free itself from the restrictions involved in this program. Governor M . S. Szymczak spoke for other officials of the Federal Reserve when he conceded that attempts to modify the pegged-price policy created new problems : It was very difficult to unpeg once we had pegged and continued the pegs too long after the war. Many people who had securities and valued them at the pegged price, banks, individuals, insurance companies, and many others, in addition to the Treasury, did not want to see a drop in the price of the securities they held. That would make the refunding by the Treasury more difficult.2 1

Thirty-Eighth Annual Report of the Board of Governors Federal Reserve System, 1951 (Washington, 1952), pp. 4, 98. •Flanders Hearings, 1954, p. 248.

of

the

RENASCENCE OF INDEPENDENCE ISSUE

THF. 1 9 5 1 ACCORD

231

The Treasury agreed with this analysis, added other problems (such as, more difficulties when acquiring new money and increased cost of the debt), and stressed intermittently all of them in opposing changes in the support program. In short, the Treasury argued against shifts in policy that made its own responsibilities more onerous and that it considered unnecessary. When continued consultations between the two agencies did not produce agreement on a greater initiative for the Federal Reserve, both agencies used other methods to gain dominance. Attitudes

Toward

Continued

Consultations

The Federal Reserve in 1950 was immensely more powerful than it had been at the outbreak of World War II when cooperation came so easily. Of this both the Treasury and the Federal Reserve were aware. The growth in the Federal Reserve's market power was comforting to the Treasury when the two agencies were in agreement on overlapping policies; it was cause for concern when the Federal Reserve wanted to act contrary to the Treasury's wishes. In the given setup of the monetary authority of the nation the Treasury did not have offsetting market power of equal strength. Accordingly, it wanted more time for negotiation and conferences; above all it wanted to avoid conflicts in the market between debtmanagement and monetary operations. Federal Reserve officials, however, judged that the cooperative procedures of wartimes were becoming like a Gordian knot which tied the System's operations to the debt-management operations of the Treasury. This restriction would become more frustrating if new inflationary pressures resulted from large-scale deficit financing. What was needed at the time of the Korean military action, they seemed to say, was an

232

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

Alexander the Great to cut the knot with one swift stroke of his sword. Special reasons for speed and decisiveness were to be found in the economic conditions of the country as it prepared for possible war on a world-wide basis. In contrast to 193Ö a n d 1940, when the resources of the nation were available for quick development into wartime uses, the spring of 1950 found relatively full employment of the nation's resources as the given situation to be a d a p t e d to wartime uses. T h e dangers of monetary inflation would become more imminent if the current easy money policy were to be combined with wartime production. Hence it was argued that all monetary measures, including open-market operations, should be available to c o m b a t inflation a s well a s help finance the-government. In particular, the Federal Reserve did not want future uses of its powers to be h a m p e r e d by past procedures which allowed adjustments only slowly, perhaps too slowly.

The

emphasis by the Federal Reserve on the need for drastic action tended to dominate the need for continuing consultation a n d conferences with the T r e a s u r y and to m a k e a public confrontation almost inevitable.

Conflict

over Policy

in

1950

T h e outbreak of military action in K o r e a (June, 1950) was followed by a widening spiral of inflation in the United States. T w o months passed, and in August, 1950, the Federal Reserve took the initiative in opposing publicly the Treasury and thus asserted its significant, though modest, independence of the Treasury. It happened in this way. O n J u l y 21, 1950, the Federal Reserve Bank of N e w York voted to increase its discount rate. T h e Board of Governors in Washington refused to approve this action. T h e N e w York Bank repeated its proposal on J u l y 27 a n d again on August 3. Both times the B o a r d of

RENASCENCE OF INDEPENDENCE I S S U E

THF. 1 9 5 1

ACCORD

233

Governors refused approval, "pending further discussions of System monetary and credit policy and Treasury

financing

policies."' The Board had at hand, and undoubtedly took caution from, a letter of the Secretary of the Treasury asking the Federal Reserve to maintain the current confidence in a stable market for government securities : This involves, first of all, avoiding any course which would give rise to a belief that significant changes in the pattern of rates were under consideration. . . . The maintenance of stability should take priority over all other market considerations. . . . In short, every circumstance at the present time calls for steadiness and manifest strength in the Federal security market as a primary measure of economic preparedness.' Unilateral Action on Discount Rate. The Secretary knew he was writing his cautionary words in the face of strong opinion within the System's councils that the Federal Reserve should not commit itself to a stable market at the expense of increasing bank credit. Either this opinion won out against the Secretary or a change in discount rates was not considered a harbinger of "significant changes in the pattern of rates," because on Friday, August 18, the Board announced its approval of an increase in the discount rate of the New York Reserve Bank from 1 £ to I f per cent, effective on the following Monday, August 21. At the same time the Federal Open Market Committee decided to adapt its purchases of government securities to make reserves less readily available to commercial banks. The announcement stated : The Board of Governors of the Federal Reserve System and the Federal Open Market Committee are prepared to use all the means at their command to restrain further expansion of bank ' Thirty-Seventh Annual Report of the Board of Governors Federal Reserve System, 1950 (Washington, 1951), p. 87. 1 Ρ at man Compilation, Part 1, 1952, p. 67.

of

the

234

T H E I N D E P E N D E N C E : O F THF, F E D E R A L R E S E R V E

SYSTEM

credit consistent with the policy of m a i n t a i n i n g orderly conditions in the G o v e r n m e n t securities market. . . . [Prompt] restraint in the area of m o n e t a r y a n d credit policv is essential. 5 Federal

Reserve

officials k n e w ,

when

they

made

these

a n n o u n c e m e n t s , t h a t t h e T r e a s u r y w a s a b o u t to a n n o u n c e t h e r a t e s f o r a $ 1 3 . 6 billion S e p t e m b e r - O c t o b e r r e f u n d i n g o p e r a tion.

For almost

a

year

the

Treasury

had

been

making

a d v a n c e - t i m e a n n o u n c e m e n t s of r e f u n d i n g s w h i c h effectively secured p r i o r c o m m i t m e n t s f r o m t h e F e d e r a l Reserve.

The

A u g u s t a n n o u n c e m e n t of t h e F e d e r a l Reserve a m o u n t e d t o a n a t t e m p t t o d e p r i v e t h e T r e a s u r y of its initiative in this a d v a n c e t i m i n g p r o c e d u r e . It w a s e v i d e n t t h a t consistency

between

policies of t h e T r e a s u r y a n d t h e F e d e r a l R e s e r v e r e q u i r e d t h a t t h e rates set by t h e T r e a s u r y on t h e r e f u n d i n g issue w o u l d h a v e t o b e h i g h e r t h a n those on t h e m a t u r i n g securities. T h e r e f u n d ing rates, h o w e v e r , w e r e not i n c r e a s e d . T h e w a y t h e d i s a g r e e ment

became

public

knowledge

was

described

by

Allan

Sproul : Advice of the action of the Board a n d the committee was conveyed to the T r e a s u r y on F r i d a y a f t e r n o o n , August 18. T h e Secretary was told that the action h a d been taken, a n d t h a t a public statement concerning it was being p r e p a r e d for issuance t h a t a f t e r n o o n ; t h a t his blessing had not been specifically sought in advance because it had been decided that this would be asking too much of him in the field of our primary responsibility. The immediate response was t h a t an accomplished fact required no c o m m e n t . T h e delayed response was advice to us, that same afternoon, that the T r e a s u r y h a d decided to a n n o u n c e its S e p t e m b e r October 1950 r e f u n d i n g — a $ 1 3 billion o p e r a t i o n — i m m e d i a t e l y , m a i n t a i n i n g the existing rate of per cent for 1-year obligations—the actual offering was a 13-month note. T h e inconsistency of this decision with our action was clear to all concerned. 5

Loc.

cit.,

p. 8 8 .

RENASCENCE OF INDEPENDENCE I S S U E

THE

1951

ACCORD

235

W e could not reverse our earlier action, in the light of

our

responsibilities to the Congress and to the public as we saw them. W e took the only course open to us. W e purchased the larger p a r t — $ 8 billion—of the securities maturing September 15 and O c t o b e r 1, 1950, in order to assure that there would not be an overwhelming

rejection

of

the

Treasury

offering.

[Emphasis

added.]"

As offsets to these purchases the Federal Reserve sold from its portfolio comparable securities at higher yields, closer to what it thought the offering rate on the new issue should have been. This head-on collision of the Federal Reserve and the Treasury dimmed the Secretary's hopes that such disagreement should not show in the market where the importance of success for government financing operations should always come first and that "[differences] of opinion between the Treasury and the Federal Reserve should be resolved by discussion, mutual understanding, and, when necessary, by compromise.'" On the other hand, the initiation of the change in rates by the Federal Reserve was a sign that the System decided to risk the scandal of an open dispute in the expectation of winning public support for its viewpoint and thus strengthening its bargaining power in its continuing consultations with the Treasury. Continuation of Restrictive Policy. The Federal Reserve considered that it was strong enough in the face of a public dispute to assure orderly conditions in the government securities market. This attitude was manifested at the first meeting (September 28) of the Open Market Committee after the September-October refunding operation. The Committee " U . S . , Congress, Subcommittee of the Joint Committee on the Economic Report, Hearings on Monetary Policy and the Management of Public Debt, 82d Cong., 2d Sess., 1952, p. 520. Cited hereafter as the Patman Hearings, 1952. 7 Patman Compilation, Part 1, 1952, p. 66.

236

THF. I N D E P E N D E N C E OK T H E F E D E R A L R E S E R V E

SYSTEM

reaffirmed its new policy of restraint, including a rise in shortterm rates, but with provisoes : It was agreed that any rise in short-term interest rates should not be permitted to go to a point where market selling of long-term bonds would be encouraged, that an orderly market would be maintained, and that the timing and amount of any changes would be made with consideration to Treasury financing operations. . . In a letter dated O c t o b e r 16,° the C h a i r m a n of the Federal Open

Market

Committee

informed

the

Secretary

of

the

Treasury about the decision of the Committee " t o follow a more restrictive open-market policy, even though the action results

in

a

moderate

increase

in

short-term

rates."

He

appealed to the President's announced anti-inflationary policy as given in the mid-year economic report which urged such use of general fiscal and credit measures as to reduce the need for comprehensive direct controls. In an attempt to reassure the Secretary, the C h a i r m a n

stated that this restrictive

would not affect the maintenance of the

policy

percent rate on

the longest-term government bonds. H e was confident that the new anti-inflationary policy would maintain confidence in the credit of the government because it would promote confidence in the purchasing power of the dollar. In conclusion,

the

Chairman politely acknowledged the continuance of the disagreement between their agencies : Although in this instance we have not been able to bring about a complete meeting of minds in our discussions with respect to System policy and debt management, we have both thoroughly considered in all of the aspects of the difficult problems confronting us and we have earnestly sought to achieve that accord which * Thirty-Seventh Annual Report of the Board of Governors Federal Reserve System, 1950 (Washington, 1951), p. 91. ' Patman Hearings, 1952, p. 9 5 1 .

of

the

R E N A S C E N C E OF I N D E P E N D E N C E I S S U E

T H E 1 9 5 1 ACCORD 2 3 7

I know you desire as m u c h as we d o in m e e t i n g o u r respective responsibilities. At your c o n v e n i e n c e we w o u l d like to sit down with you to e x p l o r e f u r t h e r the p r o b l e m s for which we both seek solutions that are in the best interests of this c o u n t r y .

The Secretary was willing enough for further discussions, even though the public disagreement and the Chairman's reaffirmation of the Federal Reserve's separatism seemed to demand from him as a basis for further constructive cooperation the compromise about which he had spoken. He had to face the evidence of the market power which supported the Federal Reserve's desire for greater independence. Accordingly, consultations continued between the Treasury and the Federal Reserve. The results, however, were not indicative of greater unanimity of policy. Dissatisfaction over November Refunding. The next Treasury refunding—$2.6 billion of bonds and $5.3 billion of certificates—was announced in late November, 1950. The rate was I f per cent for a five-year note and was recommended by the Federal Reserve. In addition, the Chairman of the Board of Governors pledged the "full cooperation of the System."" This pledge was in keeping with the consensus reached at the October 30 meeting of the Federal Open Market Committee. At that meeting the Committee agreed that short-term rates should not be permitted to rise further; otherwise, the percent rate might be endangered. The refunding ran into trouble, however, and required a large amount of support by the Open Market Committee which was not happily given. In addition, the Committee allowed yields on other government securities to rise at the same time as it supported the refunding. Concerning this financing operation which the Treasury labeled " f a r from satisfactory," Sproul stated : " W e may have made mistakes in recommending it and in our 10

Patman

Compilation,

Part

I, 1952,

p . 72.

238

THF. INDEPENDENCE OF THE FEDERAL R E S E R V E S Y S T E M

technical handling of the market, but lack of cooperation of the Federal Reserve was not the trouble."" He also insisted that although the Committee desired to reduce the premium on long-term bonds at that time, it was not advocating that the 2\ percent bonds be allowed to sell below par. In the opinion of the Treasury, the assurances of Federal Reserve officials did not offset the market performance. The fall-off in prices of government securities was disturbing, even though the 2\ percent bonds were kept at a premium. The Secretary apparently wanted a commitment on the pegging of the long-term bonds and appealed to the President to use the influence of his office to formalize the promise of the Federal Reserve. On December 4, 1950, President Truman addressed to the Chairman a letter which presumably contained such a request, for Chairman McCabe replied to the President in the following manner : Since the end of November . . . we have maintained a fixed buying price for the long-term restricted bonds. I would prefer not to take up with the Open Market Committee the question of notifying the New York bankers of a fixed peg until I have an opportunity fully to discuss with you the adverse consequences of such an action. I expect to be [away] until December 15 . . . I can assure you that in the meantime our operations will be directed toward maintaining stability in the market." Climax

of Disagreement

in 1951

Prior to the proposed discussion with President Truman, the Chairman and the Vice Chairman of the Federal Open Market Committee conferred with the Secretary of the " Patman Hearings, 1952, p. 522.

" Ibid., p. 958. (Letter dated December 9, 1950.)

R E N A S C E N C E OF INDEPENDENCK I S S U E

THF. 1 9 5 1 ACCORD

239

Treasury. In this conference Vice Chairman Sproul took the lead in proposing a program which covered both debt-management and monetary policy. The written copy of his proposal contained the following : Admittedly, credit controls, by themselves, cannot wholly check inflationary pressures when other strong forces are working to increase costs and prices, but we must do all we can to hold down the money supply, and that means we should use general or quantitative controls which affect interest rates, as well as selective controls. The next 6 months, while the Treasury will be largely out of the market, offer the best chance to get our house in order, through general credit measures. After that the requirements of credit policy and Government financing needs— refunding and new money—may be in conflict and financing needs will take precedence. The lesson to be learned from the financing of the last war is that long-term financing at rates which won't hold up in the market, without Federal Reserve support, is to be avoided. This suggests a slightly higher rate than percent for long-term financing." Such forthright advice, even though it came directly from only one member of the Federal Open Market Committee, increased the concern of Secretary Snyder and made more urgent his appeal to the President. Chairman McCabe agreed that the matter should be taken to President Truman." Public Announcement by Secretary Snyder. At the early January meeting with the President, the Secretary of the Ibid., pp. 959, 960. (The memorandum was dated J a n u a r y 2, 1951.) " Patman Compilation, Part 1, 1952, p. 73. Concerning this conference and the proposals made, Secretary Snyder said : In view of the importance of these matters to the whole defense program and the widespread rumors and confusion in the market, the Chairman of the Board of Governors and I felt that the matter should be discussed with the President. 1:1

240

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

Treasury and the Chairman of the Board agreed that it was desirable to have a stable market. According to the Secretary, "the Chairman again assured the President that he need not be concerned about the percent long-term rate on Government securities.'"5 This interpretation conflicted with later evidence which indicated that the Open Market Committee had not authorized its Chairman "to commit it to support future long-term financing on a 2\ percent basis"" even though the Committee was not proposing at the time that the current 2\ percent bonds should drop below par. Secretary Snyder, like all the Secretaries during the previous thirty-five years, was aware that the Chairman's authority was qualified by limitations arising out of the System's organizational structure. One way to attempt to make the agreement binding would be to make it public. On January 18, 1951, the Secretary announced in a speech that the percent rate would be held in future financing. Addressing the New York Board of Trade he stated : In the firm belief, after long consideration, that the percent long-term rate is fair and equitable to the investor, and that market stability is essential, the Treasury Department has concluded, after a joint conference with President Truman and Chairman McCabe of the Federal Reserve Board, that the refunding and new money issues will be financed within the pattern of that rate." Reaction to Announcement. Four days after this announcement, the President of the Federal Reserve Bank of New York addressed the Mid-Winter Meeting of the New York State Ibid. Ρ at man Hearings, 1952, p. 5 2 2 . Cf. Eccles, Beckoning Frontiers, pp. 4 8 4 - 4 8 5 . " Annual Report of the Secretary of the Treasury on the State of the Finances for the Fiscal Year Ended June 30, 1951 ( W a s h i n g t o n : U . S . Government Printing Office, 1952), p. 6 1 6 . 11

1β

RENASCENCE OF INDEPENDENCE I S S U E

Bankers Association

in N e w

York

THE

1951

ACCORD

241

City and expressed

his

doubts about the Secretary's proposed policy : There have been two clear public statements, in the past few days, from those in high authority; the first about the need for direct controls in our economy, and the second about fiscal policy and debt management. . . . I am afraid that the announced debt management policy would lead us directly or indirectly into too much financing by the banks, if we had to do any substantial amount of deficit financing. . . . If all-out war comes, we should face a different set of circumstances and a different order of magnitudes. We would then face a federal deficit requiring Treasury market borrowing, probably in substantial amounts. . . . I should hope that, at that time, we might review our policies, so that we would be sure of tapping all available sources of nonbank funds in a way which would prevent the unnecessary expansion of bank credit, either during the war, or following the war when channels of investment other than in Government securities are again opened." A few days later ( J a n u a r y 2 5 , 1 9 5 1 ) G o v e r n o r E c c l e s a p p e a r e d before the J o i n t C o m m i t t e e on the E c o n o m i c R e p o r t .

His

testimony openly opposed t h e T r e a s u r y : t o prevent inflation, the F e d e r a l Reserve should stop supporting the g o v e r n m e n t securities m a r k e t on the basis of a fixed pattern established b y the T r e a s u r y . The

financial

press was mostly on the side of t h e F e d e r a l

Reserve. Its p r o n o u n c e m e n t s , w h i c h initially sounded like a kind of crusade against the T r e a s u r y ' s policy a n d the S e c r e t a r y in particular,

mobilized

public

opinion

support for the F e d e r a l Reserve. The

New

and

Congressional

York

Times

editor-

ialized that S e c r e t a r y S n y d e r , in his J a n u a r y 18 speech, " w a s invading the d o m a i n of the F e d e r a l R e s e r v e System when he undertook to state what the rates on G o v e r n m e n t securities * January 22, 1951, pp. 1-3. (Mimeographed.)

242

T H E INDEPENDENCE OF T H E FEDERAI. R E S E R V E

SYSTEM

were going to be in the years immediately ahead."" O n e of the paper's financial writers suggested that the Secretary was publicly rebuking "certain members of the Open Market Committee, the body responsible for making a market failure of the Treasury's . . . offering of 1£ percent note last fall" and was challenging them "to dare attempt" to increase yields in the long-term market as they had done the previous fall in the short-term market." Other writers became very vituperative and attacked Secretary Snyder personally, referring to him, in their more polite moments, as inept and impertinent in his speech. These harsh judgments tended to foment a kind of personal feud between Secretary Snyder, on the one hand, and Committee members Eccles and Sproul, on the other.

Meeting

of Open

Market

Committee

with

President

T h e highly charged atmosphere hindered attempts of the Treasury and the Federal Reserve to follow the ordinary procedures of consultation and cooperation with hope of reaching a mutually agreeable solution. The need for agreement, however, was serious. T h e government's budget for fiscal 1952 predicted expenditures of $71.5 billion and a deficit of $16.5 billion. A partially off-setting increase in taxes was not receiving quick support in Congress. If the government had to finance the total projected deficit by borrowing, it would want assurance that conditions in the government securities market would be conducive to success. T h i s consideration became all the more important when account was taken of the Treasury's $50 billion of refunding operations scheduled for the last half of 1951. Although the Federal Reserve did not deny the seriousness "'January 24, 1951, p. 26. © 1951 by The New York "January 21, 1951, p. IF. © 1951 by The New York

Times. Times.

R E N A S C E N C E OF INDEPENDENCE I S S U E — T H E

of the

financing

1 9 5 1 ACCORD

243

problem facing the Treasury, it refused to

agree with the Treasury's judgment about the degree of certainty needed in the market for the success of w h a t e v e r

financ-

ing had to be done. Clearly, there was no meeting of minds, and publicity tended to compound the disagreement. Such a situation

seemed

to demand

further intervention

by

the

President if both organizations were to keep their authority and responsibility. This intervention took place in several ways. T h e most dramatic intervention was the President's face-toface meeting with the Federal O p e n Market Committee at the W h i t e House on J a n u a r y 3 1 , 1 9 5 1 . n In his memoirs, President T r u m a n explained the context and the content of the agreement reached at this meeting : It did not seem appropriate to me that we should enter into a period of deficit financing on a rising money-rate pattern. I also felt strongly that in the moment of impending crisis we should not take deliberate steps that could possibly disturb public confidence in the nation's financing. . . . I invited the members of the Federal Reserve Board [j¿c] to visit with me. A t this conference I asked them to give the Treasury their full support for its financing program, just as they had done during World W a r II. I was given assurance at this meeting that the Federal Reserve Board [ite] would support the Treasury's plans for the financing of the action in Korea. This assurance was given entirely voluntarily. A t no time during the conference did I attempt to dictate to the Board or to tell them what specific steps they ought to take. I explained to them the problems that faced me as Chief 21 All seven members of the Board but only four Presidents of the Reserve Banks attended. At this time, five members of the Board were appointees (including one re-appointee, M. S. Szymczak) of President Truman. Of these, two (Edward L. Norton and Oliver S. Powell) had been appointed as recently as September 1, 1950.

244

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

Executive, and when they left I firmly believed that I had their agreement to co-operate in our financing program. I was taken by surprise when subsequently they failed to support the program." T h e press release from the White House after the meeting made public this interpretation of the President : " T h e Federal Reserve Board

[jic]

has pledged its support to

President

T r u m a n to maintain the stability of Government securities as long as the emergency lasts." 23 T h e Treasury added its confirmation

by stating that

according to the

White

House

announcement "the market for Government securities will be stablized at present levels and these levels will be maintained during

the

present

emergency." M

The

President

repeated

similar ideas in a letter addressed to the Chairman of the Board of Governors and released to the press on February 2. These

public

announcements

as well

as their

possible

political overtones deeply disturbed members of the Open Market Committee. O n e of them, Marriner S. Eccles, made it his private crusade to let the public know the Federal Reserve's side. He gave to the press a confidential memorandum prepared and approved by the Committee

which

differed from the President's interpretation of the agreement made at the J a n u a r y 31 meeting. Another member of the Board of Governors, J a m e s K . Vardaman, J r . , declared, however, that the memorandum had not been approved by all the Committee members. He pointed out that prior to the meeting with the President the Committee had voted down a proposal to support the Treasury's program and that the 33 Harry S. Truman, Memoirs, Vol. II : Years of Trial and Hope (Garden City, New York : Doubleday & Company, Inc., 1956), pp. 4 4 - 4 5 . © 1956 Time Inc. 73 Patman Hearings, 1952, p. 963. Ibid.

RENASCENCE OF INDEPENDENCE I S S U E

Committee

knowingly

left

the

THE

President

1951

ACCORD

with a

245

false

impression. During the next two weeks President T r u m a n reiterated his interpretation, although he qualified it by saying that

"a

majority of its members [the Federal Open Market Committee] had agreed . . . ."'' In the meantime the Committee sent to him a letter stating that the assurance they gave him concerned cooperation with the Treasury in a way which would maintain public confidence in the values of government securities and would protect the purchasing power of the dollar. T h e letter made no mention of agreeing to the rate pattern announced by the Secretary in his J a n u a r y speech. T h e President did not release this letter. Further

Attempts

to Settle

Dispute

During February, the press continued to publicize the dispute, referring to it in terms of "public degradation" for the Federal Reserve, "destructive of the System's independence," "interference from political administrators," and "captive of the exchequer." Secretary Snyder spoke of his critics as being promoters of bigger profits for banks at a time when other segments of the economy were asked to forego part of their profits from the defense effort." As emotions quieted down, one newspaper commented on the dispute as follows : "Would•sThe New York Times, February 6, 1951, p. 19. •'The New York Times, February 9, 1951, p. 33 ; February 16, 1951, p. 17. © 1 9 5 1 by The New York Times. The New York Times, February 1, 1951, p. 35. President Truman expressed a somewhat similar judgment in his Memoirs. At the conclusion of his treatment of the dispute with the Federal Reserve he wrote : " M y approach to all these financial questions always was that it was my duty to keep the financial capital of the United States in Washington. This is where it belongs —but to keep it there is not always an easy task." (Op. cit., p. 45.)

246

THF. I N D E P E N D E N C E O F T H E F E D E R A L R E S E R V E

SYSTEM

be explanations in terms of rival groups making a power grab, or of evil bankers trying to fill their coffers, are simple—and simply

inaccurate.""'

Nonetheless

public

accusations

and

innuendos made it both more difficult and more important to settle the dispute. Inter-Agency

Conferences.

Some officials of the

Federal

Reserve believed strongly that the only way out of what was becoming an impasse was to seek the intervention of Congress on behalf of the independence of the System. At first this support was sought in a rather oblique way which did not seem to help matters much. In early February, 1 9 5 1 , a series of conferences were held by the C h a i r m a n of the two banking committees in Congress, the Chairmen of the J o i n t E c o n o m i c Committee,

Treasury

officials,

and

representatives

of

the

Federal Open Market Committee. Again the participants did not agree on what took place. Commenting later on these conferences, the Secretary of the Treasury stated : It was generally agreed between the parties involved that there would be no change in the existing situation in the Government security market, and no Congressional hearings held on the differences between the Treasury and the Federal Reserve, for a short period while I was in the hospital recuperating from an eye operation." W h e n the Congressional hearings referred to were held a year later, in the spring of 1952, the V i c e C h a i r m a n of the Federal O p e n Market Committee, Allan Sproul, denied that there was an agreement about " n o c h a n g e " : This suggestion was offered but it was never accepted by the Federal Open Market Committee, and at the conferences which I attended it was made clear that it could not be accepted, "The Washington Post, February 11, 1951. (Quoted in Record, X C V I I , 1487.) M Ρ at man Compilation, Part 1, 1952, p. 73.

Congressional

R E N A S C E N C E OF INDEPENDENCE I S S U E

desirous

as w e

•τ•

30

i reasury.

were

of

reaching

some

THE 1 9 5 1 ACCORD

agreement

with

247

the

At one of the conferences (February 8, 1951) the Chairman of the Federal Open Market Committee left with the Secretary of the Treasury an outline for further discussions about the coordination of monetary and debt-management policy. In the memorandum the Chairman promised that the Committee would prevent the government's long-term securities from falling below par, but he attached a significant condition to the agreement. If support proved to be substantial, the Treasury should issue a new bond with a rate conforming to the market and thus remove or reduce the need for Federal Reserve support in the future." Vice Chairman Sproul later expressed what he considered to be the viewpoint of Federal Reserve officials. It sounded more like an ultimatum than a proposal for discussion : We were disturbed, of course, by the illness of the Secretary, but we did not think that our business and the Treasury's business, which means the public's business, could be held in suspense for the indefinite period of his recuperation. The pressures were too great. We were being forced to put large amounts of reserve funds into the market each day in support of the longest term Government bonds at premium prices, a policy which we considered to be profoundly wrong. Inflationary pressures were again strong. We said, therefore, that unless there was someone at the Treasury who would work out a prompt and definitive agreement with us as to a mutually satisfactory course of action, we would have to take unilateral action." "Unilateral action" was taken on February 19, when Chairman McCabe told the Treasury that the Federal Reserve "was "'Patman

Hearings,

1952, p. 522.

" L e t t e r of C h a i r m a n M c C a b e to S e c r e t a r y Snyder, F e b r u a r y 7, 1 9 5 1 .

(Quoted in Patman Hearings, Patman Hearings, 1952,

1952, p. 965.) p. 522.

248

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

no longer willing to maintain the existing situation in the Government security market." 3 ' This assertion of independence was doubly significant because it came when the m a j o r finance worries of the Treasury were turning into realities. Government expenditures were exceeding receipts, and the Treasury had to borrow new money as well as make more immediate preparations for its approaching refundings. U n d e r pressure of the circumstances, designated representatives of the Treasury and the Federal Reserve met to work out a way to settle or compromise the differences between the two organizations. These discussions apparently were more willingly entered upon because of further action taken in Congress and by the President. Discussion on the Senate Floor. O n February 22, 1951, Senator Paul Douglas in a long, and sometimes sardonic, speech on the floor of the Senate argued that current openmarket operations of the Federal Reserve were "the prime cause of inflation" and were dictated by the Treasury : " I n the words of the Book of Genesis, ' T h e voice is Jacob's voice, but the hands are the hands of Esau.' " " He exonerated the Federal Reserve because it was intimidated with threats of nationalization and loss of all independence if it failed to carry out the wishes of the Treasury. T o offset these threats and to counteract the influence of the White House, he proposed the intervention of Congress. H e threatened that if his discussion of the dispute on the floor of Congress did not suffice to change the position of the Treasury, he would introduce a resolution to subordinate the Treasury's financing operations to the monetary policy of the Federal Reserve. Douglas's speech tended to strengthen the bargaining position of the Federal Reserve, yet because it was perhaps over13

Patman Compilation, Part 1, 1952, p. 73. " Congressional Record, X C V I I , 1473.

RENASCENCE OF INDEPENDENCE I S S U E

THE

1 9 5 1 ACCORD

249

generous in help it raised doubts in the minds of many supporters of the Federal Reserve. The proposal that the Treasury should have only a subordinate role in the coordination of debt-management and monetary policy did not seem feasible or adequate." Moreover, intervention by Congress which dictated the terms of cooperation might be as detrimental to free cooperation as that of the Chief Executive. Such help might make the Federal Reserve and the Treasury less amenable to mutual persuasion, a procedure which both agencies hoped would not be eliminated. Furthermore, if coexistence meant a serious weakening of the authority of either organization at that time, the momentarily stronger one likely would face later reversal. There were powerful forces, governmental and private, on both sides. This tentative conclusion seemed more realistic when the Administration proposed a new form of intervention. Here again was a proposal which might be not a help to constructive cooperation, but an unnecessary substitute procedure. It might prove to be also an undesirable precedent for the settlement of future disagreements. Formation of Special Committee. On February 26, 1951, President Truman called a meeting of ten top officials in agencies concerned with the formation and execution of the nation's economic policies. These officials were the three members of the Council of Economic Advisers, the Chairman and Vice Chairman of the Federal Open Market Committee, the Under Secretary of the Treasury, an Assistant Secretary of the Treasury (William McChesney Martin, Jr., later to be " Although The New York Times editorially supported the argument and proposal of Douglas, one of its financial writers had some serious reservations. He stated that it was "unthinkable" that the Federal Reserve would refuse to support Treasury refundings. " I f 'victory' in the dispute between the authorities is to hinge on the outcome of refundings, the Treasury must come out on top." (February 25, 1951, p. 4F. © 1951 by The New York Times.)

250

THF. INDF.PF.NDENCE OI· T H E F E D E R A L R E S E R V E

SYSTEM

made Chairman of the Board of Governors), the Chairman of the Securities and Exchange Commission, the Director of the Office of Defense Mobilization, and a special counsel to the President. T h e President told them that he was forming a committee consisting of the Secretary of the Treasury, the Chairman of the Board of Governors, the Director of Defense Mobilization, and the Chairman of the Council of E c o n o m i c Advisers. T h e President outlined the agenda for the committee concerning the dispute between the Federal Reserve and the Treasury : One outstanding problem which has thus far not been solved to our complete satisfaction is that of reconciling the policies concerning public-debt management and private credit control. T h e maintenance of stability in the Government securities market necessarily limits substantially the extent to which changes in the interest rate can be used in an attempt to curb private credit expansion. Because of this fact, much of the discussion of this problem has centered around the question of which is to be sacrificed—stability in the Government securities market or control of private credit expansion. I am firmly convinced that this is an erroneous statement of the problem. We need not sacrifice either. Changing the interest rate is only one of several methods to be considered for curbing credit expansion. Through careful consideration of a much wider range of methods, I believe we can achieve a sound reconciliation in the national interest between maintaining stability and confidence in public credit. . . . Consequently, I am requesting the Secretary of the Treasury, the Chairman of the Federal Reserve Board, the Director of Defense Mobilization, and the Chairman of the Council of Economic Advisers to study ways and means to provide the necessary restraint on private credit expansion and at the same time make it possible to maintain stability in the market for

RENASCENCE OF INDEPENDENCE I S S U E — T H E

1 9 5 1 ACCORD

251

G o v e r n m e n t securities. W h i l e this study is u n d e r w a y , I hope t h a t n o a t t e m p t will be m a d e to c h a n g e the interest rate p a t t e r n , so t h a t stability in the G o v e r n m e n t security m a r k e t will be m a i n tained."

The official addition to the discussion of new parties who were known proponents of the Treasury's position seemed to increase the weight of pressure against the Federal Reserve. There was, however, a sign of hope. T h e President temporarily shortened the time limit for a rigid market : "While this study is under way, I hope no attempt will be made to change the interest rate pattern." This limitation was a concession as compared with the insistence of the Treasury on continuation of the status quo for the duration of the national emergency and the insistence of others on no change at any time. The committee of four was put under the direction of Charles Wilson, Director of Defense Mobilization. At the time of his assignment Wilson expressed hope that the committee would have a report ready in ten days or two weeks. T h e committee, however, did not report until almost three months later—May 11, 1951. Part of the urgency for an earlier report was removed when on March 2, four days after the committee was appointed, the Treasury and the Federal Reserve reached the full accord which was publicly announced on March 4. Most likely it was true, as some have suggested, that both M Patman Hearings, 1952, pp. 126-127. Among the possible remedies suggested by the President was the use of emergency powers granted by the Emergency Banking Act of 1933 and the Trading with the Enemy Act of 1917. According to the provisions of these acts, the President oould by executive order have the Treasury regulate and limit the issuance of credit by banks. (The Treasury, in turn, could delegate the administration of such a program to the Federal Reserve Banks.) This was perhaps a pressure tactic aimed as much at Congress and private banks as at the Federal Reserve System. The President had previously asked serious consideration for a voluntary credit restraint program as well as higher and changed reserve requirements for commercial banks.

252

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

the Treasury and the Federal Reserve were pressured into arriving at a mutually satisfactory agreement on their own, because they did not want other members of the committee (Leon Keyserling and Charles Wilson) to enter into the negotiations.1 Those members of the committee were kept informed about progress toward the accord, but they did not actively participate in the determination of its terms.** Neither the Treasury nor the Federal Reserve officials liked the implication that another agency was needed to help them, perhaps permanently, to manage their own affairs. In addition, as far as Federal Reserve officials were concerned, there already was sufficient participation by the Executive Department in the dispute and the search for a solution. The special committee not only was not needed but also might be a cause for concern. Perhaps the President's charge to the committee was in the direction of more centralized government control rather than increased independence for the Federal Reserve. Agreement on Cooperation—the Accord Although the Treasury and the Federal Reserve jointly announced that they were in "full accord" as to their procedure in the government-securities market, the particulars of this agreement were not immediately made known to the public. Gradually these details became manifest from subsequent actions and statements by the two organizations.19 In general, the Federal Open Market Committee initially operated in the long-term and short-term market, making purchases as needed at refunding times and for maintaining an 37

" M a n a g e r s of the Dollar," Fortune,

X L V , No. 2 (February,

1952),

217. Patman Hearings, 1952, p. 125. Thirty-Eighth Annual Report of the Board of Governors Reserve System, 1951 (Washington, 1952), p p . 8 4 , 100. 38

M

of the

Federal

RENASCENCE OF INDEPENDENCE I S S U E

THE

1951

ACCORD

253

orderly market, and later largely offsetting such purchases by sales or redemptions. Long-term bonds fell below par without bringing about serious trouble in the market. Most important, the System seemed to have acquired a significant degree of "flexibility" which it considered desirable for the maintenance of its status as an independent monetary authority. All this was very interesting to Congress, and both agencies had to try to explain what was meant by the accord and the cooperation it implied.

Proposal of Joint Resolution by Congress T h e announcement of the accord did not set at rest the disturbed minds of some of the ardent supporters of the Federal Reserve. O n March 6, 1951, before the details of the accord were publicly known or even decided upon by the parties involved, Senator Paul Douglas introduced the joint resolution which he had threatened some two weeks previously. A joint resolution, as the Senator pointed out, had special significance. When passed and signed by the President, it had the force of law. It differed from a concurrent resolution, which merely indicated the "sense of Congress." T h e Senator wanted to clarify the meaning of the accord and to do so in this serious manner. T h e joint resolution was sponsored by six Senators, including members of both political parties. It called upon Congress to resolve : . . . that (1) notwithstanding any other provision of law, including any provision of law granting emergency powers to the President of the United States, the primary power and responsibility for regulating the supply, availability, and cost of credit in general shall remain vested in the duly constituted authorities of the Federal Reserve System; and (2) the policies and actions of the Secretary of the Treasury relative to money, credit, and trans-

254

THE INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

actions affecting the Federal debt shall be made consistent with the policies of such Federal Reserve authorities."' Senator Douglas explained the timing of the introduction of the joint resolution : There is no information available as to what the Federal Reserve System has agreed to do so far as purchasing Government securities in the open market in the future is concerned. . . . [But] it is this very point which is vital to the problem at hand." His resolution had two purposes. First, its introduction and passage would indicate to the Federal Reserve that it had friends in Congress who were

interested

in

the

System's

powers remaining intact. Second, the resolution would specify, as a matter of law, that in a conflict of policy with the Treasury the Federal Reserve would have precedence. If these two purposes were accomplished, the System would be enough

to resist the "pressures and blandishments

strong of

the

Treasury." T h e joint resolution never came out of the Committee on Banking and Currency to which it was referred. T h e r e was not adequate support for it at the time in Congress or in the 40 Congressional Record, X C V I I , 1981-1982. This resolution related back to the joint resolution recommended by the Douglas Subcommittee in 1950. (U.S., Congress, Subcommittee of the Joint Committee on the Economic Report, Report on Monetary, Credit, and Fiscal Policies, 81st Cong., 2d Sess., 1950, p. 2) Marriner Eccles most likely would have agreed with Senator Douglas as to the modus operandi at a time of disagreement. Just prior to the accord, Eccles stated his viewpoint at a meeting of the Federal Open Market Committee :

We know what we should do in this inflationary situation. We should publicly inform the President, the Treasury, and the Congress of what we propose to do, and then do it. Otherwise the public will get the impression that we capitulated and lack the courage to discharge our responsibilities. If Congress objects to our actions it can change the law; but until it does that, we have a clear responsibility to check inflation —in so far as we can do this within the framework of our authority —by preventing a further growth in the supply of money and credit at this time. (Eccles, Beckoning Frontiers, pp. 4 9 7 - 4 9 8 . ) 41 Congressional Record, X C V I I , 1982.

RENASCENCE OF INDEPENDENCE I S S U E — T H E

1 9 5 1 ACCORD

255

Administration. (Later the resolution was shunted aside even by its proponents when the Joint Committee on the Economic Report—of which Senator Douglas was a member—began a broad analysis of the problem the resolution proposed to solve.) Since the accord had been agreed upon, the Federal Reserve itself was not inclined to push for further changes in the legal framework under which the System operated. Federal Reserve officials were even less likely to advocate a change which was a kind of reprimand to the Treasury and consequently would tend to disturb the new basis for coordination. Nonetheless, the introduction and discussion of the resolution added moral strength to the Federal Reserve officials who were to cooperate with the Treasury in working out details of the accord. Principle

of the

Accord

O n e year later Senator Douglas, and other Congressmen, were still not satisfied that the accord was adequate or feasible. At the special Congressional investigation of the relations between the Treasury and the Federal Reserve, various officials of the two organizations, as well as other experts, were called upon to answer voluminous questions. At one of the hearings, Allan Sproul, President of the Federal Reserve Bank of New York, explained what he meant by the principle of the accord : when credit policy and debt-management policy overlap, the Treasury and the Federal Reserve have equal rights in the determination of a unified policy. He maintained that this equality would provide a feasible and adequate basis for the development of a coordinated program. In replying to questions put by Senator Douglas, Sproul spoke as follows : SPROUL

:

T h e principle of the accord is that the Treasury, through the person of the Secretary and his policymaking officials, and the Board and the Open Market

256

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

Committee through its policy-making officials, will consult freely and frequently in an attempt to work out a joint program, neither one being the superior authority telling the other what it is to do and why it should do it, and that that consultation and conference at the policy-making level will be and is being supported by consultation and conference at the staff level. DOUGLAS

: Was this accord reached after the Federal Reserve decided that it would no longer support the Government bond market at fixed prices?

SPROUL

:

T h e accord was reached after the Federal

Reserve

had decided it could no longer support the longest term restricted bonds at premium prices, and part of the accord was, as it was finally worked out, that we would no longer support the whole market or any part of it at pegged prices. DOUGLAS

: At fixed prices. In other words, that you would have a fluid market; in effect, therefore, you reached an accord on the Federal Reserve's terms.

SPROUL

:

As I say, I do not like the implication which one of your witnesses left that this was a battle that

the

Federal Reserve won, and while it may have won a battle, that the Government always wins the wars. I say there is no battle between the Government and the central bank. It was a conflict, a difference of opinion,

between

the

Reserve

System,

both

Treasury of

them

and

the

Federal

representing

the

Government, and you can call it a triumph of reason, if you want to, but not the winning of a battle. DOUGLAS : . . .

I am not interested as to whether the Secretary

of the Treasury appears as the vanquished . . .

or

not. But I am interested in the principles involved, because what you are saying is that merely coequality is sufficient.

RENASCENCE OF INDEPENDENCE ISSUE

THE

1951

ACCORD

257

I am trying to point out that the accord was not really possible until after the primacy of the Federal Reserve System in the matters of credit policy was not only asserted, but consented to by the Secretary of the Treasury. Was it not part of the accord that you would cease to support the Government bond market at fixed prices? SPROUL

:

It was part of the accord that we would cease to support the Government security market at fixed or pegged prices. But I would put it the other way, that the accord was reached after it became clear that the Federal Reserve had a considerable support in the Congress and among the public for requesting and demanding equal powers and equal consideration in the determination of these questions of credit policy and debt management where they overlapped."

This explanation of the principle of the accord indicated that the two organizations would try in the future not to display in public their disagreements; it did not, however, delineate the concrete policy and operations which the cooperation hoped to achieve. T o this extent it was only moderately reassuring to the government-securities market but at the same time was quite unsatisfactory to Senator Douglas and others. Treasury's Emphasis on Cooperation The Secretary of the Treasury, John W. Snyder, also had his day before Congress. T h e Treasury's interpretation was that the accord was a reassurance that both agencies would bring a cooperative spirit to bear on their mutual problems and policies. It would provide a new opportunity with sufficient time to correct mistakes or to make needed concessions κ

Ρ at man

Hearings,

1952,

pp. 5 3 4 - 5 3 5 .

258

T H E I N D E P E N D E N C E O F THF. F E D E R A L R E S E R V E

SYSTEM

on policy. Secretary Snyder insisted that the new arrangements did not, and could not, mean the one-sided determination of monetary and credit policy. He stated that what was involved in the accord was "cooperation." Senator Paul Douglas tried to lecture him and to force him to specify the meaning of that word. T o the Senator "cooperation" did not express a clear principle which would guide accurately the Treasury and the Federal Reserve at times when they disagreed on policy. O n this point, the following exchange took place : DOUGLAS

: There is a fundamental issue involved here, namely, whether you will provide so-called natural markets for Government securities or the degree to which you will provide artificial markets for Government securities. Perhaps, I am using question-begging words in referring to the purchase of the Federal Reserve as an artificial device, but the question is the degree to which the Government will maintain its own bond market or the degree to which it will allow the bond market to be settled by the natural forces in the private field.

:

Well, it boils down to the meeting of a practical situation, I think, Senator, as long as

DOUGLAS

: When you face a practical situation without any general philosophy you are apt to come to great difficulties; and what we are trying to do here, if this inquiry has any merit—and if it does not have merit we should close it out immediately, Mr. Chairman

SNYDER

SNYDER

:

: Is to see if we can try to work out general principles for meeting these concrete situations which lie ahead. : The question then arises as to whether or not we should have an open-market operation.

DOUGLAS

SNYDER

Well, the question is

RENASCENCE OF INDEPENDENCE ISSUE DOUOI.AS SNYDER

:

DOUGLAS

THE

1951

ACCORD

259

: No, that is not the question. It is the degree I think so. : (continuing) T o which the Federal Reserve System should be committed to enable a Treasury issue to be successful or the degree to which a Treasury

issue

should be allowed to take its own chances in the public bond market or the private bond market. SNYDER :

think

I

we

have

to

consider

the

public

interest

involved. W i t h the large financings that we have to conduct in these days, with the debt the size it is, there must be some assurance mutually agreed upon between the Federal Reserve and the Treasury that these operations will be carried out with assurance as to the stability

of the Federal Government

bond

market. DOUGLAS

: In other words, the Federal Reserve System should be willing and agree to purchase a sufficient number of securities so that the issue can be sold?

SNYDER

:

I think that is a matter that will have to be carefully weighed.

DOUGLAS SNYDER

:

: W h o is to determine the interest rate? Well, that matter is always discussed very carefully, sir.

DOUGLAS SNYDER

:

: W h o is to make the final decision on i t ? T h e r e is only one place that it can finally be made by law, and that is in the Treasury Department.

DOUGLAS

: W h e n the T r e a s u r y makes the decision, therefore, is the Federal Reserve Board supposed to purchase a sufficient number of bonds so that the issue can be a success

at

the

interest

rates

determined

by

the

Treasury ? SNYDER : DOUGLAS

I

think we can work out cooperation.

: Cooperation is a beautiful word, but it is like an overcoat, it covers quite a range of reality.

260

T H E INDEPENDENCE OF T H E F E D E R A L R E S E R V E

SNYDER :

SYSTEM

I t has to d o that, sir. I n these days w e have to f a c e realities as well as theories."

The Senator came back several times to the preceding type of questioning and attempted to have the Secretary tell what the Treasury Department expected the Federal Reserve to do if unlimited support were required to make a particular issue of government securities successful. As the answers of the Secretary did not become more specific, they aroused an increasing dislike of the Senator for the word "cooperation." He called it " a mystic phrase" and a "very vague word" which might mean "dictation."" Evidently Senator Douglas was not fully pleased with the way the new arrangement between the Federal Reserve and the Treasury was working out. At one point he stated : "Some of us are a little fearful that this accord may be discontinued or if cooperation is obtained that it may be the Federal Reserve agreeing to the policies of the Treasury."" Although the Secretary of the Treasury attempted to reassure the Senator on this point, he would not say exactly what the accord meant concerning the degree to which the Federal Reserve was expected to support a Treasury financing operation under terms set by the Treasury but contrary to the judgment of the Federal Reserve. This was, however, a key question in the search for a meaningful independence for the monetary authority with responsibility and accountability distinct from that of the Treasury. Co-equality

as

Requisite

When Allan Sproul, in his statement on the principle of the accord, affirmed that under the new arrangements neither " Ibid., pp. 16-17. 41 Ibid., pp. 36, 40. "Ibid., p. 23.

RENASCENCE OF INDEPENDENCE I S S U E

the Treasury

THE

1 9 5 1 ACCORD

nor the Federal Reserve was an

261

authority

"superior" to the other, he was expressing the mind of other Federal Reserve officials. T h e Chairman of the Board (William McChesney Martin) was asked by Senator Douglas what he would do when there was a "conflict of wills" and time pressed for a decision. He replied : All I can say at the moment is we would sit around the table and hammer it out. . . . I think there has to be some give and take in it, and I don't think that an entirely one-way decision would resolve the problem. I think that you have got to adjust a conflict between the two. For the Federal to take the law into its ovVn hands and just automatically let a financing fail would, I think, be a mistake. It would be an irresponsible action." Senator Douglas replied that a complete failure of a Treasury refunding was not "in the sphere of controversy." He remained unsatisfied with the answers he received on what the Federal Reserve would do if a time came when the Treasury insisted on rigid support as distinguished from an orderly market. Both Martin and Sproul understood and appreciated that the support which the Federal Reserve received from Congress helped it to reach an accord with the Treasury and thereby to assert its independence. They were not ready, however, to embrace the full extent of the help Senator Douglas wanted to give. They judged that the ability of the Federal Reserve to reach decisions in conflicting situations with the Treasury would be better activated under conditions of "co-equality of authority" and "common responsibility." T h e leaders of the Federal Reserve did not agree with Senator Douglas when he stated : " Ibid., pp. 96-97.

262

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

It seems clear to me that we will have a better end result and that the Treasury and the System will be better neighbors in the long run, the less they invite themselves in to play in each other's backyards. The proper principle is, "Good fences make good neighbors ! " " Rather, they accepted the judgment of the majority of the Subcommittee which held hearings on "monetary policy and management of the public debt" in 1952. In the Subcommittee Report, the majority affirmed its acceptance of the mon responsibility" and " t e a m "

"com-

relationship between

the

Federal Reserve and the Treasury. Said the Subcommittee majority : the Board of Governors should have " a considerable degree of independence" in order to increase its "bargaining power" in the process of determining over-all government policy. The report, with a dissent by Senator Douglas, continued : But, the Board of Governors, like all other parts of the Government. must play as part of a team, not as an outside umpire, and must ultimately abide by the decisions of Congress." Neither the Treasury nor the Board of Governors should be subordinated to the other. It is vitally necessary, however, that monetary policy, fiscal policy, and all the other economic policies of the Government should be coordinated so that they will make a meaningful whole, working in the direction of price stability, high-level employment, and a dynamic, free-enterprise economy. It is not merely the right, but the duty of the President to seek " U . S . , Congress, Subcommittee of the J o i n t Committee on the Economic Report, Report on Monetary Policy and the Management of the Public Debt, 82d Cong., 2d Sess., 1952, p. 76. Cited hereafter as the Patman Subcommittee Report, 1952. O n a later occasion, Senator Douglas acknowledged that he took this aphorism from a poem by Robert Frost ("Mending Wall"). T h e poet's point, however, is that the aphorism does not have unqualified application. A wall may be meaningless, said Frost, for making good neighbors; in fact, it might give offense and thus be a hindrance rather than a help. " Ibid., p. 53.

RENASCENCE OF INDEPENDENCE ISSUE

T H E 1 9 5 1 ACCORD

263

to effect this coordination—by direction with respect to agencies under his control and by persuasion with respect to the agencies which are not."

Admittedly the dominance of the Executive and the Treasury (or of the Federal Reserve) could result from their power of persuasion." That danger, however, was not so much to be feared as the isolation and lack of coordination which could result if the "good fences" prove to be an obstacle to meaningful intercommunication. Hence Martin qualified the "good fences" principle by stating that there be a "revolving door in the fence so that both of us can go through it, because adjustments have to be made from time to time.""

Limitations on Independence It was not surprising that the Federal Reserve showed little enthusiasm for being placed on a pedestal as a superior authority and preferred to stress the feasibility of active cooperation with the Treasury. The politically mature leaders of the System were well aware that there were built-in limitations on the Federal Reserve's independence. The limitations came from the characteristics of the government securities market in which the Federal Reserve operated. They derived also from the political fact that the System had to work along with Administration programs and policies. In this common effort directed toward common goals, it seemed proper for the Federal Reserve to want a strong and clear voice; but it was not the part of prudence to insist always on a dominant voice. "Ibid., p. 56. 50 William McChesney Martin, Jr., interview in the U.S. News and World Report, February 11, 1955, p. 130. © 1955 by U.S. News avd World Report. "Ibid., p. 129.

264

T H E INDEPENDENCE OF THE FEDERAL R E S E R V E

Responsibility

for Government

Securities

SYSTEM

Market

In the 1952 Congressional hearings, the Secretary of the Treasury spoke forthrightly about both independence and its limitations for the Federal Reserve. His attitude was cautious; the full meaning of the accord was yet to be established, especially in f u t u r e difficult situations. At one time he acknowledged : " T h e r e is n o one outside of the Federal Reserve Board that can force them to take any action. T h e Federal Reserve Board was set up by Congress and they make their final d e t e r m i n a t i o n . A t another point in his discussion, he placed limits on what the Federal Reserve could d o : I think many times, of necessity, to carry out the functions as given to them, and the responsibilities as given to them—by Congress—that the Federal Reserve certainly must measure carefully the conditions and the times and the problems facing the Nation at the time they make decisions. Now, if that is an influence that somewhat tempers their absolute independence of action, then I think it must be tempered to that extent. But so far as not having any dictation or direction, that is the type of independence that I said I would like to see preserved." This viewpoint of the Secretary was in keeping with his general hope that cooperation would be the normal procedure for the two agencies. Its wisdom was derived f r o m his analysis of the type of operations carried out by the Federal Reserve System. T h e Federal Reserve executed its open-market policy in the government-securities market. T h e Secretary reasoned that this fact placed limitations on the freedom of the System. His thinking was based on the following statements. First, there M

Palman Hearings, Ibid., pp. 55-56.

1952,

p. 39.

R E N A S C E N C E OF I N D E P E N D E N C E I S S U E

T H E 1 9 5 1 ACCORD

265

were general principles. (1) Section 12A of the Federal Reserve Act stated that "the time, character, and volume" of openmarket operations "shall be governed with a view to accommodating commerce and business and with regard to their bearing upen the general credit situation of the country." (2) Since the Federal Reserve System used open-market operations in government securities for credit control purposes, such operations should be carried out in conformity with the purposes of the power granted by law. Second, there were particular judgments which affected the Treasury's functions. (1) "As long as open-market operations involve billions of dollars of transactions a year, we cannot consider that the market for Government securities is an entirely free one." Accordingly, the magnitude of its participation in the market gave the Federal Reserve control. (2) Since it had control, it was also responsible for the stability and orderliness of that market. "The Open Market Committee has realized that with a tremendous debt and with the financing that has to be done [by the Treasury], you could not allow a small segment of that financing to upset the whole market."14 The conclusion of this line of reasoning seemed to be that since the Federal Reserve engaged in large purchases and sales of government securities for credit-control purposes, it must help the Treasury financings to whatever extent required for their success. The continued success of these financings was necessary for the "accommodation of commerce and business" and for meeting the needs of "the general credit situation of the country." Such a conclusion seemed to subordinate open-market operations to debt-management operations. On the other hand, the reasoning perhaps led to a further conclusion : the same authority should have charge of open-market operations and debt management operations. At M

Ibid.,

pp. 6 3 - 6 4 .

266

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

a minimum, the Secretary stated that the freedom given the Federal Reserve by the accord was limited and conditioned by the legal necessities and the practical consequences of the System's operations in the government-securities market. He felt that attention had to be called to this qualification since the statement of the accord and its recent implementation did not clarify the limits or explain how it would work under various possible conditions. Surely there were such limits and conditions. Secretary Snyder attempted to make it clear that the accord was not a Declaration of Independence which would inaugurate a radically new authority arrangement. O n the other hand, he wanted to deny, what others had claimed, that he alone was in the driver's seat. Now for sure there was going to be a try for two drivers.

Pressures from

Executive

Another limitation on independence, which might be called "Executive pressures," was effective no matter how cooperation was defined. T h e pressures referred not only to those from the Secretary of the Treasury backed by the Executive but also to those from the power of appointment had by the Executive. T h e wide publicity given to the Treasury-Federal Reserve disagreement and its accompanying sharp words made it very likely that there would be a change in the personnel of the agencies involved. By the beginning of 1951, Governor Eccles had decided to resign, though his appointment extended for seven more years. He changed his mind after he took the initiative in making public his strong view that the President misinterpreted the policy of the Federal Open Market Committee and attempted to force the Committee to follow a course of action which it did not like. Accordingly, he with-

R E N A S C E N C E OF INDEPENDENCE I S S U E

THF. 1 9 5 1 ACCORD

267

held his resignation. Meanwhile the accord was announced in the press on March 4, 1951. It did not result in any changes in the actions of the Federal Open Market Committee until the following month. At the end of March, however, Chairman M c C a b e resigned; Governor Eccles resigned later in July. T h e two new members of the Board came directly from the Treasury Department. The new Chairman, William McChesney Martin, had been Assistant Secretary of the Treasury for more than two years prior to his appointment and was one of the Treasury's representatives in the negotiations which led to the accord. T h e other new Governor, J a m e s L . Robertson, who took office on February 18, 1952, had been First Deputy Comptroller of the Currency. T o Senator Douglas there was " a suspicious concatenation of events" in this sequence : (1) accord; (2) resignations; (3) appointments of Treasury officials to the Board of Governors. With regard to these appointments Senator Douglas stated : While I thought highly of both . . . and did not wish to vote against them [i.e., their appointment], I felt sufficiently suspicious so that I did not feel it proper to vote for them, so in both cases I passed my vote in the Banking and Currency Committee which passes on their confirmation." He carried his fears and suspicions further by attempting to connect the resignation of the Chairman of the Board of Governors with the possible ultimate victory and supremacy of the Treasury. 58 He pressed Sproul on the question whether or not the resignation of Chairman M c C a b e was an essential feature of the accord. Sproul admitted that there was a con* Ibid., p. 543. M Ibid., p. 542. Senator Douglas was disturbed perhaps by an opinion that the nomination of Martin "may have represented a mischievous thrust at those Congressional leaders who had thrown their support behind the Reserve Board, but hardly a malicious one." ( T h e New York Times, March 17, 1961, p. 14. © 1961 by The New York Times.)

268

THE INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

ncction but denied that Chairman McCabe's resignation was one cf the terms of the accord, not even in the sense of an implied agreement or understanding. Furthermore, he emphatically did not believe that the new Chairman would turn out to be an instrument for the Treasury in the running of the Federal Reserve System. "Anyone who thinks Mr. Martin was put in as Chairman of the Board as a stalking horse for the Treasury or a Trojan Horse is greatly mistaken."" Nonetheless, nobody argued that Chairman Martin had been appointed by President Truman without the willing endorsement (or even at the suggestion) of Secretary Snyder. The Secretary's work for and with the Administration had achieved too much for his advice to be neglected by the President. Reaction of Federal Reserve Officials. Allan Sproul had already demonstrated that he himself was no Greek bearing gifts ; his position vis à vis the Treasury was open and clear. He further exemplified his attitude when he commented upon the proposal that the Secretary of the Treasury be made a member of the Board of Governors and of the Federal Open Market Committee : There is considerable distrust of such a relationship for fear the Secretary of the Treasury would then become not only a member and Chairman, but the dominating influence on the Open Market Committee. I am not so much afraid of that. I think if the Federal Open Market Committee could not stand up to a Secretary of the Treasury and express itself and make its opinions felt, and have them considered, that it would not be the appropriate Open Market Committee. 118

Likewise, William McChesney Martin's position was indicated when he expressed his reaction to the same suggestion concerning the Secretary of the Treasury. In conciliatory fashion 5! 51

Patman Hearings, Ibid., p. 530.

1952, p. 542.

R E N A S C E N C E OF I N D E P E N D E N C E I S S U E

T H E 1 9 5 1 ACCORD

269

he admitted there would be communication values in the arrangement. H e denied, however, that the Secretary in such a position would dominate everybody else : Now, I realize the dangers of that. Senator Glass said that, with a strong man in the office of the Secretary of the Treasury, he would exert influence and therefore would distort the judicial process of an independent Federal Reserve System. I don't get excited about that argument. . . . I have explored this idea with a great many people. Particularly under the present atmosphere [i.e., Congressional hearings following and concerned with the accord] you get the reaction that this is just a device to put the Secretary of the Treasury in control of the Federal Reserve Board. Now, I think that public servants at some point have to stand up and be counted. If I am not strong enough to hold my own with the Secretary of the Treasury, then I am not entitled to the job I occupy. And if the legal position is such that the open-market committee has control, there is a very real question whether it would not be wise to have the Secretary of the Treasury a part of the deliberations." In 1956, when he was nominated for a full fourteen-year term as Governor, Chairman Martin expanded on his, and the System's, ability to be independent. H e considered the hypothetical case in which the Treasury and the Federal Reserve disputed over policy in an area where debt-management a n d monetary policy virtually merged, and pressure was applied by the Executive Department. Since in Martin's view the Federal Reserve had the authority to act as it believed necessary, it might part ways with the Treasury. If, then, the two authorities attempted to carry out incompatible policies, the Federal Reserve "would stand at the bar of public opinion," and would run the risk of having its authority changed by Congress. Moreover, Martin readily recognized that holding 59

Ibid., pp. 94-95.

270

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

the offices of Governor and Chairman placed him in positions of honor and trust. As an honest man, he assured the Committee considering his appointment : " I am perfectly willing to say here that I would promptly resign if in my judgment I was not able to exercise my independent judgment of what is the best interest."" Chairman as Object of Pressures. Though neither Chairman Martin nor President Sproul mentioned it, perhaps some unwarranted Executive pressure could be lessened by learning from the experience of the disagreement which preceded the accord. At that time, Governor Eccles firmly believed that on occasion Chairman McCabe was forced into committing the Federal Open Market Committee to take action which was not previously authorized by the Committee. According to Eccles, the Committee, except for one member "who had close White House connections,"" was united in opposing the "off-hand" way in which the Committee and the Board were being treated by the President in his contacts with the Chairman and in his press releases about these meetings, and united in their decision to show strong opposition, as a matter of principle, to the pressure of the Treasury Department. Perhaps most of the explanation for the somewhat peremptory treatment of the Committee and the Board by the President was to be found in a failure to realize that the Chair60 U.S., Congress, Senate, Committee on Banking and Currency, Hearings on the Nomination of William McChesney Martin, Jr., 84th Cong., 2d Sess., 1956, p. 67. Cited hereafter as the Martin Nomination Hearings, 1956. (See also U.S. News and World Report, February 11, 1955, pp. 129-130.) " Eccles was referring to James K. Vardaman, Jr. (Beckoning Frontiers, pp. 492, 498). At the height of the controversy, Vardaman was quoted in the press as saying : " F o r myself, I unhesitatingly waive any theoretical statutory authority and prerogatives in order to support the Government and the President at this time." And again : " W e believe the duty of this board to be to make its ideas available and known in council, but not to make such ideas prevail." (The New York Times, February 6, 1951, p. 19. © 1951 by The New York Times.)

RENASCENCE OF INDEPENDENCE ISSUE

THE

1 9 5 1 ACCORD

271

man's relationship to the Committee and the Board was different from that of the executive head of a government department or bureau who wielded the final authority in that department or agency. T h e Chairman had no authority to decide by himself what Federal Reserve action should be, not even if the President supposed or urged that he could do so. Allan Sproul expressed these ideas, far from new, to a Congressional Subcommittee in 1 9 5 2 : The Chairman of the Board of Governors is the natural means of liaison between the Federal Reserve and the Executive, and it is quite appropriate that he should keep open the channels of communication and information between the Federal Reserve and the Executive. But both the Executive and the Chairman must remember that the Chairman is only first among equals on the Board of Governors and in the Federal Open Market Committee ; he cannot make commitments not previously sanctioned by the Board or the Committee, and he cannot give assurance of action which has not been considered and approved by the Board or the Committee." Sproul very likely directed his admonition not only to the President but also to the Chairman of the Board of Governors. He seemed to indicate that the previous Chairman may have attempted to exceed the limits of his authority in his dealings with the President as well as the Treasury. Thus he insisted that the Chairman could not be expected to force the Board or the Committee to agree with his own decisions or suggestions." Nonetheless, the limitations on independence remained " Palman Hearings, 1952, p. 518. Sproul was overstating the primus inter pares situation. One need only recall the dominating position of such men as Benjamin Strong and Marriner Eccles, and even some of the Secretaries of tha Treasury when they served on the Board. Furthermore, Sproul himself was a strong leader. " Sproul did not mention how a vigorous Chairman would work to achieve a consensus at committee or board meetings, probably because in the presence of other equally vigorous members such work could sometimes be futile.

272

THE INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

—the power of the Executive to appoint, his influence to force resignations, and the pressures which came from his personal contact with the Chairman. The accord did not change these facts. The accord likewise did not mean that Federal Reserve officials wanted to isolate themselves in a sound-proof room which would keep out all word of what the government was doing or of what it wanted in the way of a monetary policy. Rather, the accord meant that the Federal Reserve would have a voice and expect to be heard in matters where the debtmanagement policies and operations of the Treasury as well as the other financial policies of the government impinged on the powers and responsibilities of the Federal Reserve System. With the Treasury's acceptance of this positioning of the monetary powers of the Federal Reserve, the System saw for itself a proper role in the achievement of the economic objectives of the government. Pressures would remain. But Federal Reserve officials believed that they were strong enough to assert the authority of their new position and even to extend their independence.

IX The Consolidation of Independence after the Accord

AFTER

T H E ACCORD

WITH

THE

TREASURY

DEPARTMENT

IN

1951, the Federal Reserve System proceeded to consolidate its newly acquired independence. The accord meant that the Federal Reserve was recognized as having a voice in the management of monetary affairs; it did not signify, however, that the government-securities market and the Treasury Department were no longer a concern of the Federal Reserve. On the contrary, the accord included the understanding that the Federal Reserve would continue to maintain an orderly market and to support Treasury financings, though the meaning of "orderly" and of "support" was broadened. "Maintenance of orderly conditions in the Goverment security market" no longer was equated with "maintenance of fixed prices for Government securities." Both the Treasury and the Federal Reserve looked upon this change as a necessary step in the right direction, but they did not consider it the end of the journey. Although dictation by the one to the other was to be avoided, intercommunication and contact between the two agencies were to be promoted. In the post-accord period, the Treasury and the Federal Reserve worked to achieve a 273

274

T H E I N D E P E N D E N C E OF T H E F E D E R A L R E S E R V E

SYSTEM

mutually acceptable rapprochement. This objective apparently was not endangered, but encouraged, by a step in 1953 which the Federal Reserve took to consolidate its independence. Proposals for Changes in Operating Procedures At the second meeting of the Federal Open Market Committee after the accord (and the first after the appointment of the Committee's new chairman), that is, on M a y 17, 1 9 5 1 , the Committee authorized the formation of an A d Hoc Subcommittee to study the operations of the Federal Open M a r ket Committee in the government-securities market. 1 The appropriateness of such a study arose from the fact that the technical operating procedures and practices of the Open Market committee "were conceived in the atmosphere of war finance and developed to maintain a fixed pattern of prices and yields in the Government securities market.'" The Subcommittee was concerned with two important topics which referred to the independence of the Federal Reserve System— 1 Some of the controversial statements in the report of this Ad Hoc Subcommittee were included in the 1953 annual report of the Board of Governors, published in M a r c h , 1954. The entire report of the Ad Hoc Subcommittee, along with the comments of the President of the Federal Reserve Bank of New York, were made part of the public record in December, 1954, as an appendix to the printed hearings of the Subcommittee on Economic Stabilization of the Joint Committee on the Economic Report. This publication of the report was insisted upon by Senator Douglas and resisted by President Sproul. (Senator Douglas, at the time of the Patman Hearings in 1952, was the one who insisted on the publication of documents concerning the communication between the Treasury and the Federal Reserve at the time of the accord. Cf. Patman Hearings, 1952, pp. 9 0 - 9 2 , 125-133, 9 4 2 - 9 6 6 . ) Putting these Federal Reserve papers in the public record was significant for the independence issue because it helped to clarify what was meant by the "public responsibility" of the System. That responsibility included some measure of detailed accountability. (The report of the Ad Hoc Subcommittee, along with the comments of Sproul, will be cited hereafter as Flanders Hearings, 1954, Ad Hoc Report.) - Flanders Hearings, 1954, Ad Hoc Report, p. 259.

T H E C O N S O L I D A T I O N OK I N D E P E N D E N C E A F T E R T H E A C C O R D

275

first, the extent of its freedom from the Treasury Department and the proper way to achieve this freedom in actual openmarket operations, and second, the enlarged responsibility which came with this freedom and the consequent increased accountability. T h e latter topic raised the problem of internal control of Committee operations and, specifically, the powerful position of the Federal Reserve Bank of New York on the Committee. Although the Ad Hoc Subcommittee was authorized in May, 1951, it was not organized until the following April and May, 1952. T w o reasons were given by the Federal Reserve for this delay—(1) the System's preoccupation with a Congressional inquiry into monetary policy and debt management, and (2) the desirability of acquiring further experience in the somewhat flexible market which operated after the accord. T h e Subcommittee as finally organized had three members—the Chairman of the Board of Governors; a newly appointed* member of the Board, Abbot L. Mills, J r . ; and the President of the Federal Reserve Bank of Atlanta, Malcolm Bryan. They had as a full-time technical consultant an officer of a large New York commercial bank, Robert H. Craft, vice president of the Guaranty Trust Company. This Subcommittee submitted its report to the Federal Open Market Committee on November 12, 1952. New Rules for Open-Market

Operations

In general, the Ad Hoc Subcommittee recommended that the Federal Open Market Committee engage in open-market operations only to make effective monetary and credit policies and that it conduct its sales and purchases in the very short sector of the market. Hence it should not intervene to make 'February 18, 1952.

276

THE INDEPENDENCE OF T H E F E D E R A L R E S E R V E

SYSTEM

any Treasury financing succeed, nor should it operate to maintain a predetermined pattern of yields. The general purpose of these recommendations was to work toward the establishment of a "free" government-securities market which reflected basic economic forces and which would be a more appropriate, even necessary, arena for the execution of monetary policy decisions. It was not the belief of the Ad Hoc Subcommittee that monetary policy was all-powerful or allimportant in achieving the government's economic goals as declared in the Employment Act of 1946. Rather, the recommendations of the Subcommittee supposed that monetary policy had some power and some importance, that it was the responsibility of the Federal Reserve, and that the System had authority to decide how this policy could be best achieved. The report of the Ad Hoc Subcommittee discussed two different views on relations between the Federal Reserve and the Treasury. The first view proposed a separation, in theory and in practice, between the System's responsibilities and the debtmanagement responsibilities of the Treasury. The two agencies should be considered like neighbors, not living next door to each other, but across the street from each other. The Federal Reserve's responsibilities were "strictly limited to the formulation and execution of credit and monetary policy."' On the other hand, the Treasury, in its debt-management function, was responsible for naming such terms and coupons on new securities as to secure the success of its financing operations. The conclusion was that the Federal Reserve should exercise only a kind of police function in the government-securities market and that the Treasury should receive no special treatment : ' Ibid.,

p. 270.

T H E C O N S O L I D A T I O N OK I N D E P E N D E N C E A F T E R T H E A C C O R D 2 7 7

There would be no occasion, therefore, for intervention or support by the Federal Open Market Committee. The Committee might, of course, engage simultaneously in open-market operations to relieve an unexpected stringency in the money market, but it would not be expected to do so, and if it did it would operate only because of its responsibility for the general credit situation. This view rests on the doctrine that the governmental structure must provide that responsibility for public decision be clearly fixed and that public officials be held strictly accountable for their decisions. . . . Since decisions with regard to debt management are unquestionably a prerogative of the Treasury, the Treasury would be expected to accept the consequences of an erroneous decision. . . . All attrition would fall on the Treasury if the issue were not attractively priced. [Emphasis added.]' The second view on relations between the Federal Reserve and the Treasury was more conciliatory. It maintained that complete separation of debt-management and reserve-banking operations was practically impossible. The Federal Reserve and the Treasury were more than just neighbors; they were like Siamese twins. Each was charged with the primary responsibility for its respective monetary and debt-management policies, but each shared the other's responsibilities : The problems of debt management and monetary management are inextricably intermingled, partly in concept and inescapably so in execution. The two responsible agencies are thus considered to be like Siamese twins, each completely independent in arriving at its decisions, and each independent to a considerable degree in its actions, yet each at some point subject to a veto by the other if its actions depart too far from a goal that must be sought as a team." 5

Ibid.

6

Ibid.

278

T H E I N D E P E N D E N C E OF T H E F E D E R A L R E S E R V E

SYSTEM

The Subcommittee did not consider that either view was the correct one, nor did it think either view should be pushed to its "full logical extreme." Evidently, then, there was a third view, but the Subcommittee did not formulate it. Rather it selected ideas from the two views and suggested that they form the framework for open-market operations of the Federal Reserve System. The Treasury should work out new procedures for its financing operations and should not expect to be shielded by the Federal Reserve from an attrition which was only "moderate." Second, during Treasury financings, the Federal Reserve should not operate in those areas in which the financings were taking place. If the Federal Reserve did help out the Treasury, the open-market operations should be concerned with "very short maturities, principally bills." Moreover, the Federal Open Market Committee should use open-market transactions for the purposes of monetary policy which would not include the maintenance of an orderly market. Intervention would be proper only if needed to prevent a disorderly market which had definite signs of climaxing in a panic. Finally, the Committee should not initiate advice on terms of new Treasury offerings, but it should give its advice when asked. These restrictions would increase the Treasury's responsibility for its own decisions and allow greater independence to the Federal Reserve. The Subcommittee seemed to limit the objectives of debt management and to enhance the objectives of monetary policy. Debt management should be handled efficiently and independently in a market free from special supporting action by the monetary authority. Broader economic goals, such as those enumerated in the Employment Act of 1946, were in the purview of the Federal Reserve System and its policies; they were not direct objectives of debt-management as such.

T H E CONSOLIDATION O F INDEPENDENCE A F T E R T H E ACCORD

Reduction

in Authority

of New York Reserve

279

Bank

The Ad Hoc Subcommittee also considered the internal organization of the Federal Open Market Committee, in particular, the relationship between the Federal Reserve Bank of New York and the full Open Market Committee. The direct recipient of the general directives of the Federal Open Market Committee was an Executive Committee made up of the Chairman and two other members of the Board of Governors, the President of the New York Reserve Bank, and the President of one other Reserve Bank. The Executive Committee particularized the general directives and authorized the New York Bank to execute them through transactions in the open market. A vice president of the New York Bank was the manager of the System account and carried out the actual transactions, under the supervision of the Bank President. T h e Ad Hoc Subcommittee was concerned about the prestige, power, and responsibility which this arrangement gave the New York Bank and especially its President. Accordingly, the Subcommittee proposed that careful study be given to changing this allocation of internal responsibility. The most important topic suggested for study was to make the manager of open-market operations directly responsible only to the whole Open Market Committee. Related to this change were certain corollaries : the Open Market Committee would have its own budget and its own staff; and the agency functions which the New York Bank performed for the Treasury and for foreign accounts would be performed by a group of officiais different from those who executed System openmarket operations. In proposing to rearrange and strengthen the authority of the Open Market Committee in relation to the Reserve Bank

280

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

of New York, the Subcommittee did so in the light of its view of the statutory independence of the Federal O p e n

Market

Committee within the Federal Reserve System and of the necessity of the Committee's being free from political pressures and

banker-domination.

T h u s its argument

was built

on

considerations similar to those used when the Federal Reserve Act was being considered some forty years earlier : [The Federal Open Market Committee's] composition is designed to insure, to the full extent that legislation can insure, that its members will not only be fully competent, but will also be immune to outside pressure. It is neither an appendage of the Federal Reserve Board nor a creature of the Federal Reserve banks, but a completely independent body, each member of which, as an individual, whether he be a Governor from the Board or a president from a Federal Reserve bank, reports to no one. His actions are a matter of public record but each member sits as an individual, bound only by his oath to execute the law. . . . This unique structure of the Federal Open Market Committee was hammered out after long experience and intense political debate. Like other components of the Federal Reserve System, it exemplifies the unceasing search of the American democracy for forms of organization that combine centralized direction with decentralized control, that provide ample opportunity for hearing to the private interest but that function in the public interest, that are government and yet are screened from certain governmental and political pressures since even these may be against the longrun public interest.7 T h e Subcommittee then proceeded to analyze the influence and authority of the New York B a n k . First it mentioned the unique position of the Bank : T h e Federál open market account is not managed by the Federal ' Flanders

Hearings,

1954,

Ad Hoc

Report,

pp. 280-281.

T H E CONSOLIDATION O F I N D E P E N D E N C E A F T E R T H E ACCORD

281

Open Market Committee. This function has been delegated to the Federal Reserve Bank of New York, subject to policy directives that provide discretionary leeway within which the management operates. The manager of the account is selected by the directors of the Federal Reserve Bank of New York and approved by the full Federal Open Markpt Committee each year. In his day-to-day operations, he is subject to the authority of the Federal Reserve Bank of New York, and not to that of the Federal Open Market Committee." Second, there were advantages and disadvantages for this position. The Subcommittee readily recognized that the New York Bank had "superb facilities" for the mechanical operations connected

with

the open-market

account,

that

its

President had "immediate access to financial information not so readily available to anyone else" and could "supervise on the spot the execution of general policy directives" of the Committee. These advantages, however, did not ipso facto make for smooth Committee operations. The New York President sat in Committee meetings "necessarily as a protagonist for the actual day-to-day operations of the account" because these operations were his responsibility. Other members of the Committee, "reluctant to seem critical of a colleague,

[might]

hesitate

to

scrutinize

adequately

the

technical operations of the account.'" The Subcommittee related the position and authority of the New York Bank to outside pressures which affected the position of trust which the Open Market Committee occupied. From one point of view, this fiduciary role might be strengthened by the current arrangement through a reduction in the danger of improper political pressures. Effective operations, the Subcommittee stated, required that the financial com8 0

Ibid., ρ, 281. Ibid., p. 282.

282

THF. I N D E P E N D E N C E O F T H E F E D E R A L R E S E R V E

munity have confidence

that open-market

SYSTEM

operations

were

"'immune from political pressures" : This confidence is undeniably strengthened by the fact the Federal Reserve Bank of New York actually conducts open market operations for the Committee. Under the present management arrangement, the actual contacts of the market are contacts with personnel of the Federal Reserve Bank of New York, subject to the discipline of its directors. 1 " O n the other hand, there was " e q u a l necessity" that the C o m mittee's operations be " i m m u n e from b a n k e r d o m i n a t i o n . " T o achieve this immunity in a p p e a r a n c e as well as in fact, the S u b c o m m i t t e e suggested that each m e m b e r of the C o m m i t t e e maintain close contact with all important aspects of openmarket operations. T h u s each m e m b e r would be able

"to

carry out more effectively his individual statutory responsibility as a committee m e m b e r . " " T h i s procedure would reduce the apparent or suspected dominance, as well as the actual role, of the New York B a n k . As was to be expected, such judgments did not remain unchallenged by the New York officials.

Responses

of President

Sproul

T h e strongest objections within the System to the proposals of the Ad H o c S u b c o m m i t t e e c a m e from the President of the N e w Y o r k B a n k , Allan Sproul. C o n c e r n i n g the proposed area for operations, the short-term sector of the market, he questioned the wisdom

of the " c o m m i t m e n t "

involved in

the

proposals. Although Sproul stated that " i n most circumstances transactions in short-term securities will probably be found the most appropriate form of System open market 10

Ibid.

" Ibid., p. 283.

opera-

THE CONSOLIDATION OF INDEPENDENCE AFTER THE ACCORD

283

tions,"12 he seriously questioned whether "a central bank, which [depended] for its effectiveness upon psychological as well as direct influences," should so commit itself that it formalized "for all time the principles and procedures which have grown out of current experience."1* In response to the Subcommittee's opinions about the influence of the New York Bank on the Open Market Committee, Sproul argued that the Subcommittee's reasoning involved two false premises. The first was the supposition that the Committee should be an operating organization and not just a policymaking body. There was nothing in the Federal Reserve Act to justify this supposition. Moreover, to place the function of conducting open-market operations in a separate entity distinct from the Reserve Banks "would seem to depart from the intent of the statute and also from the 'Federal' structure of the Federal Reserve System."14 The second false premise concerned the purpose assigned by the Subcommittee to the Open Market Committee : using its powers "to provide an elastic currency for the accommodation of agriculture, commerce, and business, i.e., to promote financial equilibrium and economic stability at high levels of activity."15 To Sproul this statement of purpose described not the responsibilities of the Committee but those of the Federal Reserve System as a whole, and even that by inference rather than by direct statement . To accept this premise and the suggestions based upon it would be making a major change in the structure of the System which might tend to reduce the participation of the Banks in the work of the Committee. In addition to his opinions about possible harm to the " Ibid., 13 Ibid., " Ibid., 15 Ibid.

p. 3 2 7 . p. 3 2 8 . p. 3 2 4 .

284

THE INDEPENDENCE OF THE FEDERAL R E S E R V E S Y S T E M

"Federal" character of the System, Sproul pointed out that if there were anomalies in the established authority and responsibility arrangements, there would be comparable anomalies in other possible arrangements. If the New York Bank President were suspected of coming with a biased viewpoint to meetings of the Committee, so also would anyone else on the Committee who was assigned the work of execution and supervision of open-market operations. The manager for the System's account would have to be responsible to some one—either the whole Committee, or its Executive Committee, or the Chairman of these Committees. If the person with authority over the manager's actions were the Chairman, then similar doubts could be cast on his being unbiased. If the whole Committee or the Executive Committee assumed this authority, the manager might end up in confusion as to what his actions should be in a given situation. Instructions might be conflicting because they came from several different individuals. Moreover, if the supervisor of the manager were located in Washington and not in New York, he would not be able to have that continuous and intimate knowledge of the money market which would be required for effective supervision. In such an arrangement the manager might become independent and autonomous to a degree inimical to effective control." Decision for New Operating Procedures Although the Ad Hoc Subcommittee submitted its report on November 12, 1952, the Federal Open Market Committee took no formal action at its meeting on the following December 8. In its operations, however, the Committee initiated the implementation of one of the recommendations of the report. It gave no direct support to a Treasury financing " Ibid.,

pp. 3 2 5 - 3 2 7 .

T H E C O N S O L I D A T I O N O F I N D E P E N D E N C E A F T E R T H E ACCORD 2 8 5

operation later in December, 1952; and it continued that policy in 1953. At its first meeting in 1953 (March 4 and 5) the Federal Open Market Committee unanimously adopted several of the recommendations made by the Ad Hoc Subcommittee.

Content

of the Decision of March,

1953

The March, 1953, decision of the Open Market Committee, in keeping with the Ad Hoc Subcommittee report, was concerned with the development of a more self-reliant market in government securities. Under present conditions open-market operations would be confined to the short-end of the market and would be engaged in solely to effectuate the objectives of monetary and credit policy. The objectives of monetary and credit policy would include the correction of disorderly markets but not the maintenance of any pattern of prices and yields. Furthermore, during a period of Treasury financing, the System would not support the Treasury by purchasing maturing securities about to be exchanged, when-issued securities, or securities with a maturity comparable to those being offered for exchange. The procedure of confining operation to the short-end of the market was without a contractual assurance to the market as to the framework of its operations;" the nonsupport of Treasury financings was made experimental (pending further study and action by the Committee). N o qualifications were put on the decision not to support a pattern of prices and yields or on the decision to intervene to correct disorderly markets. This new policy, which Chairman Martin said was part of " Fortieth Annual Report of the Board of Governors Reserve System, 1953 (Washington, 1954), p. 89.

of the

Federal

286

T H E INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

the "transition to free markets,"" indicated that the Federal Reserve was separating itself further from possible domination by the Treasury. It meant an increase in freedom for the System in determining the immediate purpose as well as the amount, timing, and market area of its operations. T h e March, 1953, decision did not include any of the recommendations of the Ad Hoc Subcommittee about the System's internal authority arrangements. These recommendations, however, were not forgotten. In 1956 the Chairman of the Board of Governors was questioned about what he and the Board or the O p e n Market Committee were doing to bring the Account M a n a g e r immediately under the hiring control of the Committee. In reply he stated that he was "not sure" whether the Committee had the power to make this change. He further mentioned that a subcommittee met with the board of directors of the New York Bank and endeavored to work out a satisfactory solution in view of the "institutional position" of the Bank to hold on to the functions and powers it already had. He made the distinction that the point at issue was one of "mechanics" and not of "control." He stated, " I believe we have control today."" Two years later, in April, 1958, Chairman Martin showed a greater confidence that the New York operation was controlled by the Committee and the Board : The manager of the account is subject to the direction of the Open Market Committee, of which the president of the New York bank is only one member. He has one vote in 12, and that is settled. Now there has been a lot of discussion about this over the last few " William McChesney M a r t i n , Jr., " T h e T r a n s i t i o n to Free M a r k e t s . " Federal Reserve Bulletin, X X X I X (April, 1953), 330. " Martin Nomination Hearings, 1956, pp. 40-^41.

T H E C O N S O L I D A T I O N O F I N D E P E N D E N C E A F T E R T H E ACCORD

287

years as to whether there shouldn't be some way of taking the manager of the account away from the New York bank . . . and have him paid by the open market committee. We have come to the conclusion . . . that the important thing is the power of control over the manager of the account. . . . Now some of us in the System have been working on this, and feel that it might be better to have the open market committee appoint the manager of the account, and then refer it to the board of directors of the New York bank as to whether they have any particular objections, since he is going to reside in their premises. . . . But that is a fine distinction, and I think that it works satisfactorily as it is at present. . . . T h e r e is no question about the control, as we have to approve the president and the first vice president of the New York—that is to say, their selection is subject to the approval of the Board of Governors."

Disagreement

on Open Market

Committee

The Federal Open Market Committee did not remain unanimous in approving the operating techniques adopted at the March, 1953, meeting. Internal disagreement expressed itself at the next meeting, June 11. On this occasion two of the members of the Board of Governors (whose total membership at the time was six) were absent. TTius the Bank Presidents outnumbered the members of the Board five to four. There was discussion about rescinding some of the action taken at the last meeting. The prevention of disorderly markets was not challenged; but the other parts of the decision were. Finally, the Committee voted to rescind the disputed action, but with the understanding that the Executive Committee (three Governors and two Bank Presidents) would be free to deterM U.S., Congress, Senate, Committee on Finance, Hearings on the Financial Condition of the United States, 85th Cong., 1st Sess., 1957, pp. 1945-1946. Cited hereafter as the Byrd Hearings, 1957.

288

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

mine how the operation should be carried out in order to execute the credit policy of the full Committee. The vote showed the five Bank Presidents as opposed to the four Governors. Reasons for Split Vote. Those who favored the rescinding action did not deny that they were qualifying to some extent the market freedom which had been the objective of the previous decision. They asserted, rather, that the Executive Committee should have the discretion, especially at times of Treasury financings, to make purchases in any areas of the market which needed support. Thus the market could be kept free from undue pressures and more conformable to the general policy of the Open Market Committee. Moreover, they wanted the Executive Committee to have discretion not only to adjust reserves but also to affect investment conditions, since both effects were part and parcel of monetary policy/1 The four Governors placed a different emphasis on freedom for the market and for the Committee in its operations. They wanted "some general rule for the guidance of the Manager of the System Account" so that the Committee would have a "minimum burden" of "determining what the market should be.""2 Furthermore, they maintained that this was the type of freedom toward which the Committee had been working ever since the accord and that the new procedures should be given a further opportunity to validate their soundness as means toward this freedom. These were the official reasons for the split vote. Unofficial reasons for the vote of the Governors emphasized political factors and internal organization of the Committee. If the Committee directly influenced or determined long-term rates by operating outside the short-term market, it would become -'Fortieth Annual Ibid., p. 96.

Report

of the Board,

1953, pp. 9 5 - 9 6 .

T H E CONSOLIDATION OF INDEPENDENCE A F T E R T H E ACCORD 2 8 9

more susceptible to political pressure to peg interest rates. Furthermore, the Committee could not be expected to give sufficiently detailed policy directives to guide completely the manager of the account as to the correct purchases and sales. If the general rule were not operative, policy would really be made in New York, at the open-market trading desk. This was described authoritatively as an "oft-heard argument. Reaffirmation of March, 1953, Decision. Though the five Bank Presidents were able to qualify the March, 1953, change in operating techniques and to allow the Executive Committee to use its discretion in their use, the action was soon reversed. After the June 11 meeting of the Open Market Committee, the Executive Committee decided by a majority vote to exercise its discretion by confining operations "exclusively to Treasury bills."'2* At the next meeting of the Open Market Committee, on September 24, 1953, all six Governors were present. By a nine-to-two vote the Committee rescinded the action taken at the previous meeting. Only one other Bank President voted with the New York President. Thus discretion was taken away from the Executive Committee. Every March when different Reserve Bank Presidents became members through the rotational process, the Committee reconsidered the March, 1953, decision and reaffirmed it. The New York Bank President cast the sole negative vote each year until he resigned in the spring of 1956." In June, 1955, the authority of the Executive Committee ceased to be a matter for discussion. At that time it was abolished by the full Committee. U.S., Congress, Joint Economic Committee, Hearings on Employment, Growth, and Price Levels, 86th Cong., 1st Sess., 1959, p. 1249. Cited hereafter as the Douglas Growth Hearings, 1959. "Fortieth Annual Report of the Board, 1953, p. 99. "'5 His successor did not assume this opposition role at the first meeting in 1957. At subsequent meetings during the Fifties, however, he cast the sole negative vote.

290

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

Changes

in Control

SYSTEM

Arrangement

After the Open Market Committee abolished its Executive Committee, it issued its regular policy directive to the New York Reserve Bank. Moreover, it decided to meet regularly every three weeks instead of every three months. The probable purpose of this change was to give the full Committee more direct control over open-market operations. It could be looked upon as a remedy for the complaint mentioned by the Ad Hoc Subcommittee that the Reserve Bank members, other than the one from New York, were "out of intimate touch with one another as well as with the market." This new procedure would be a way of giving effect to the recommendation "that the individual members of the Federal Open Market Committee maintain close contact with all important aspects of its operations."" If this were done, the Subcommittee reasoned, the full Committee would be providing for "the necessity of maintaining the confidence of the public generally that the Committee's operations are immune from banker domination." 37 Accordingly, the abolition of the Executive Committee could be looked upon as a step toward placating, not those who were worried about the independence of the System in relation to the government, but those who were concerned about the influence of private banks on the System. One further event directly affected the Federal Reserve Bank of New York. In May, 1956, Allan Sproul resigned as President. Strangely enough, his resignation was announced only four months after he had been elected by his board of directors to another five-year term and five years before he •"Flanders Ibid.

37

Hearings,

1954, Ad Hoc Report,

p. 282.

THE CONSOLIDATION OF INDEPENDENCE AFTER THE ACCORD 2 9 1

would have been retired on account of age. The man finally chosen to replace him was vice president of a relatively small commercial bank with no previous Federal Reserve experience. One account of this change in officers mentioned unfavorable reactions : "The most frequent comment [on the appointment and the resignation] is that Washington wants someone in charge who will do its bidding, that Mr. Hayes [the newly appointed New York President] knows how to compromise."™ The same commentator stated that the question whether the President of the New York Bank played too dominant a role in the open-market operations of the System underlay the examination of the techniques and methods made by the Ad Hoc Subcommittee in 1952 and that the question was answered in the affirmative. The change in Presidents was taken as a sign that those who wanted "more power centralized in Washington" succeeded "in cutting the wings and humbling the pride of the New York Bank."" Further Action on Consolidation—Centralization of Control Authority within the Federal Reserve System was divided among three organizations : the Federal Reserve Banks, the Board of Governors, and the Federal Open Market Committee. The division made it possible, though not necessarily likely, that a decision by one organization to take a certain action or to resist outside pressures—-from the Treasury, Congress, or private interests—might be unsupported or hindered by another organization. Achievement of unified authority was always a concern of the Federal Reserve System. In the postaccord period, when greater independence made restrictive and "unpopular" actions more possible, the problem tended to become more urgent. 3

*

The Economist Ibid.

(London), CLXXIX (June 2, 1956), p. 897.

292

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

One solution proposed more frequent conferences within the System and greater authority for the Federal Open Market Committee. This Committee was considered the proper locus for new authority arrangements because it encompassed the authority elements of the Board and the Banks. Thus it was a centralizing organization and was more acceptable since it provided for regional representation, group meetings, and majority vote. Conferences within the System which aimed at unity of authority stressed such topics as the Reserve Banks' agency functions and their operations in bills of exchange, bankers acceptances, and repurchase agreements. Out of the conferences came changes which increased the authority of the Federal Open Market Committee at the expense of the separate Reserve Banks and to the advantage of the Board. In this sense the solution provided unity through a weakening of the federal structure of the System. Control of Operations- -Bills and Repurchase

Agreements

In October, 1951, the Open Market Committee formally noted that "the use of repurchase agreements was becoming increasingly important as one of the mechanisms available to the System in executing open market policy.'" 0 Accordingly, the Committee formulated regulations to be followed by the Reserve Banks when they used repurchase agreements. The regulations concerned the type duration, rate, participants, and purpose of such agreements. In July, 1952, March, 1953, and March, 1955, the Committee made further spécifications about the Reserve Banks' use of these agreements. Finally, in August, 1955, the Federal Open Market Committee decided to authorize only the Federal Reserve Bank of New York to M Thirty-Eighth Annual Report of the Board of Governors Federal Reserve System, 1951 (Washington, 1952), p. 108.

of

the

THE CONSOLIDATION OF INDEPENDENCE AFTER THE ACCORD 2 9 3

enter into repurchase agreements, under the regulations and rules cf the Committee. The New York Bank was told to make a weekly report on these transactions and, in case the securities were not repurchased, to sell them or to add them to the System account. Evidently some question was raised about the authority of the Open Market Committee to exercise this control over repurchase agreements. In reporting to Congress on a proposed new banking law in 1957, one of the Governors stated : "The law does not specifically refer to such transactions nor make them specifically subject to the direction of the Federal Open Market Committee."" According to the Chairman of the Board of Governors, such agreements "admittedly have some of the attributes of a loan.'"1 If repurchase agreements were actually "loans," then jurisdiction over them belonged to the Reserve Banks and not to the Open Market Committee. In any case, the Board of Governors recommended that the Federal Reserve Act be amended to give to the Committee specific authority over repurchase agreements. Such action was aimed at limiting the authority of the New York Reserve Bank and centralizing control in the Committee. Similar to its action on repurchase agreements, the Committee took over control of the operations of the Reserve Banks in bills of exchange and bankers acceptances. From the very beginning of the System, the Banks purchased such instruments in the open market. Prior to June, 1952, rates governing purchases were established by the Reserve Banks, subject to review and determination by the Board of Governors. This 31 U.S., Congress, Senate, Committee on Banking and Currency, Hearings on Study of Banking Laws, Part 1, 84th Cong., 2d Sess., 1956, p. 167. Cited hereafter as Hearings on Study of Banking Laws, 1956. U.S., Congress, House, Committee on Banking and Currency, Hearings on Financial Institutions Act of 1957, 85th Cong., 1st Sess., 1957, p. 25.

294

T H E I N D E P E N D E N C E OF T H E FEDERAL R E S E R V E

SYSTEM

was the same procedure followed by the Reserve Banks in setting discount rates for loans conforming to the requirements of Section 14 of the Federal Reserve Act. In June, 1952, however, the Open Market Committee decided to control the open-market rates. It set a minimum buying rate and authorized'the manager of the System account to specify the effective buying rate in the light of market conditions and under the directions prescribed by the Committee or its Executive Committee. In March, 1955, the Committee modified its authorization with respect to rates by allowing Reserve Banks to buy bankers acceptances "at market rates of discount." It also insisted that such purchases be "consistent with the general credit policies" of the Committee and "within limits to be determined-by the executive committee."" Later in the month the Executive Committee spelled out a specific authorization to indicate to the New York Reserve Bank the intent of the full Committee. In the following year (on March 6, 1956), the full Committee made it clear that its authorization was restricted to the New York Reserve Bank. It did not intend to authorize the other Reserve Banks to engage in these operations. These directions and restrictions on operations in bills of exchange and bankers acceptances manifested the desire of the Open Market Committee and the Board of Governors to strengthen the centralized authority and responsibility of the System. By means of these changes the Federal Reserve was expected to operate in a more unified and consistent way for the public interest. This desire for centralization of control was further manifested in the concern of the Board over the independent exercise of authority by the Reserve Banks in their agency functions. 11 Forty-Second Reserve System,

Report of the Board of Governors 1955 ( W a s h i n g t o n , 1956), p p . 9 1 - 9 2 .

of

the

Federal

T H E C O N S O L I D A T I O N OF INDEPENDENCE A F T E R T H E ACCORD

Control

of Operations—Agency

295

Functions

The principal agency functions of the Reserve Banks were concentrated in the New York Bank and concerned transactions in, and safekeeping of, government securities and the management of demand deposit accounts of the Treasury Department and of foreign central banks and foreign governments. The 1952 Ad Hoc Subcommittee pointed out the importance in the government-security market of the transactions of the New York Bank for accounts other than the System account. It noted that in the twelve-month period ending June 30, 1952, such business amounted to about $2.4 billion, of which $ 1.5 billion was in bills, $600 million in certificates and notes, and $900 million in bonds : "These transactions amounted to about one-third the volume of total trades for open market account; they were almost as large as open market transactions other than in periods of Treasury refunding."34 Nor did the Subcommittee overlook the fact that transactions for other accounts, particularly as fiscal agent for the Treasury, might involve "special operations designed to support the market."3" Clearly its concern was directed toward reducing the independence of the New York Bank in its agency operations. In his comments on the Ad Hoc Subcommittee report, the President of the New York Bank seemed to assume that the Flanders Hearings, 1954, Ad Hoc Report, p. 263. "Ibid., p. 262. In May, 1957, the Federal Reserve Bank of New York, as agent for the Treasury, made at least a total of $482 million of purchases and sales. (Purchases and sales of each security were tabulated on a net basis.) This was one-twelfth of thé total outright transactions, including cash redemptions, during all of 1957 for the System account. These agency transactions included purchases totaling $363 million of a Treasury note involved in a $4 billion Treasury refunding and was admittedly a support operation. (Byrd Hearings, 1957, p. 195.) M

296

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

Bank's agency operations were not under the control of the O p e n Market Committee or even the B o a r d . " Yet there was n o doubt that these agency transactions impinged on transactions for the System account through their effects on bank reserves and market prices for government securities. Accordingly, the officials of the New York Bank exercised discretion in meshing the two actions so that both the desires of the principals of the agency functions and the directives of the Open M a r ket Committee were satisfied. Robert Roosa, Vice President of the New York Bank, explained the discretionary element as follows : There are times when foreign orders may arrive which can make a helpful contribution in furthering the reserve effects intended by Federal Reserve action. For example, if purchase orders should come in on a day when the System Account is itself contemplating purchases, the release of funds by the foreign accounts might make Federal Reserve action at that moment unnecessary, although the Account Manager would, of course, remain alert to provide funds through offsetting purchases if there were to be a subsequent absorption of funds by the foreign accounts. . . . In executing Treasury orders, there is seldom conflict with the reserve effects implied, since the officials at the Treasury and at the Federal Reserve Bank of New York who are involved in these orders are the same officials who normally consult each day concerning the management of the Treasury's cash balance, with a view to minimizing any disturbing effects resulting from the combination of all receipts and disbursements flowing through the Federal Reserve Banks. T h e other possible zone of conflict with the general objectives of credit policy, or the area in which results may perhaps be integrated with the ends of credit policy, lies in the market impact of the actual execution of outright purchases or sales, if they should be in any significant volume, so far as price movements and the psychology of the market are concerned. 36

Flanders

Hearings,

1954, Ad Hoc Report,

p. 316.

T H E CONSOLIDATION OF INDEPENDENCE A F T E R T H E ACCORD 2 9 7

. . . The Account Management always feels free, when any consequences are envisaged that might be in conflict with the Federal Reserve System's current efforts, to request wide discretion from the Treasury officials with respect to the timing or the place of fulfillment of orders. [Emphasis added.]" The Federal Reserve Act did not make the Reserve Banks subject to the Board of Governors when they acted as fiscal agents of the Treasury or the departments and agencies of the government. According to Section 15 of the Act, the Federal Reserve Banks were ordered to act as fiscal agents of the United States when required to do so by the Secretary of the Treasury ; according to Sections 11 (a) and 11 (j), the Board of Governors was authorized to exercise general supervision of the Reserve Banks and was empowered to examine the books and affairs of the Banks as might be necessary. The Federal Reserve Act, however, did not make the Board's authority more specific. In 1956, the Board of Governors proposed that the Federal Reserve Act be amended to provide that : The operations of a Federal Reserve bank pursuant to authority of law as fiscal agents, depositary, or custodian of the United States or any instrumentality thereof or of any other organization shall be subject to the supervision and regulation of the Board of Governors of the Federal Reserve System.1" In making its recommendation, the Board mentioned several persuasive arguments, three of which pertained to centralization. First, coordination of such agency activities with the over-all purposes of the Federal Reserve Banks was required. Second, because of their "extensive monetary and credit conRobert V. Roosa, Federal Reserve Operations in the Money and Government Securities Market (New York : Federal Reserve Bank of New York, 1956), pp. 9 1 - 9 3 . M U.S., Congress, Senate, Committee on Banking and Currency, Study of Banking Laws, 84th Cong., 2d. Sess., 1956, p. 93.

THF. I N D E P E N D E N C E O F T H E F E D E R A L R E S E R V E

298

SYSTEM

sequences,"* the fiscal agency operations should be coordinated with System monetary and credit policies. Third, doubts had been raised about the authority of the Board in this matter. Admittedly, the Federal Reserve Act gave no clear, direct grant of authority to the Board. Yet the Board needed such authority in order to carry out its responsibility for supervising and regulating the operations of the Reserve Banks. A way to remove the doubts would be to amend the Act. Effect

on Federal

Character

of System

Bound up in the movement toward centralization of control and responsibility were the perduring discussions about the specification and importance of federal elements in the authority arrangements of the Federal Reserve System. These elements were designed to make the System efficient and at the same time to protect the sovereign monetary power against monopoly control by other organizations—private banks or partisan government agencies. T h e y served this purpose well; however, they made more difficult that unity of authority which was necessary for not only a powerful but also a responsible monetary authority. Accountability to Congress and the Executive became increasingly important as the powers and responsibilities of the System expanded. Yet the federal elements, if they were not sufficiently united, compounded the problem of accountability. T h e original Federal Reserve Act intended that the individual Reserve Banks should be important agencies as well as operating

units.*0

policy-making

As the Federal Reserve

System developed, the trend was toward a diminished autonomy for the individual Reserve Banks. T h i s trend was emphaM

Ibid. Patman

Subcommittee

Report,

1952, p. 53.

T H E C O N S O L I D A T I O N OK I N D E P E N D E N C E A F T E R T H E A C C O R D

299

sized in the statutory formation of the Federal Open Market Committee. The emphasis was continued in the post-accord period as (he Board and the Committee moved to tighten internal control arrangements. The resulting restriction on the autonomy of the Reserve Banks did not necessarily imply that officials of those Banks were without the required broad point of view for the public interest or that they should not have a voice in the formulation of the System's monetary policy. Rather, their influence, and that of their respective Reserve Banks, changed because of the growth in importance of monetary policy. This policy had to be determined on a national basis and not by regional Banks acting in an autonomous manner." While centralization of control modified the System's federal character, it seemed necessary for the freedom of the System as a whole. The argument now ran that with greater centralization, the System would be more efficient and more likely trusted by the government—the Congress as well as the Administration. There remained, however, a counter argument. Repeating the views of the early proponents of the Federal Reserve System, those who opposed changes in the federal character equated centralization in a Washington-centered organization with the ever-feared government domination. Centralization, viewed in this way, would harm not only the federal character but also the basic independence of the Federal Reserve System. And there the argument remained. Meanwhile the System put its independence into practice in its relations with the Treasury and then tried to explain its actions to Congress.

"

Ibid.

χ Treasury-Federal Reserve Relations after the Accord—Theory and Practice

T H E E L E C T I O N O F A N E W A D M I N I S T R A T I O N IN 1 9 5 2

PROVIDED

fresh encouragement for the Federal Reserve System to move toward greater freedom in using monetary policy as an active instrument in the promotion of its public goals. Without such help the System would not, and probably could not, have acted so forthrightly in restricting its market operations and in tightening its internal control arrangements. The change in political officers seemed to herald a new era of coordination of objectives and policies between the Treasury and the Federal Reserve. Principles of coordination were developed in greater detail and their meaning was tested in action. The resulting increase in prestige and independence for the Federal Reserve did not signify that the System was separating itself completely from the Treasury or demanding always a superior position when monetary policy was at issue. The importance of Treasury operations was not diminished and solutions for its problems were still the concern of the Federal Reserve. At the same time, however, contacts and cooperation between the two agencies did not abolish the customary threats to independence. What seemed to be dif300

treasury--federal reserve relations a f t e r accord 301 ferent was that the dangers to independence remained dangers; they were not necessarily signs of an impending loss of independence. In the changed atmosphere the Federal Reserve and the Treasury seemed more ready to accept and trust each other's viewpoints on common problems and goals. They apparently were more prone to believe that they could confer together and work together and yet not be weakened or subdued, the one by the other. Treasury's Promotion of Federal Reserve's Independence The encouraging attitude of the new Administration toward the Federal Reserve's independence was foreshadowed in the platform of President Dwight D. Eisenhower when he advocated in the 1952 campaign that there be "a Federal Reserve System exercising its functions in the money and credit system without pressure for political purposes from the Treasury or the White House.'" What these words meant in the concrete was indicated when announcement was made about the choice of the Under Secretary of the Treasuiy who would be in charge of the debt-management program. The choice was W. Randolph Burgess who had been connected with the Federal Reserve Bank of New York from 1920 to 1938, and who had been the first manager of the System's account under the newly formed Federal Open Market Committee in 1936. From 1938 until his appointment to the Treasury, he had been an official of the National City Bank of New York. More significant than this background was the fact that in the poetWorld War I I period Burgess had been a prominent member of public committees which propagandized for the restoration of flexible interest rates and for greater independence of the Federal Reserve from the Executive and the Treasury.' ' Q u o t e d , in Byrd Hearings, ; Ibid., p. 805.

1957, p. 16.

302

T H E INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

These expectations were not illusory. Not only the U n d e r Secretary but also his superior, the new Secretary of the Treasury, George M . Humphrey, provided at the start of their administration a new approach to Treasury-Federal Reserve relations : they considered that the accord had not brought about adequate freedom for the Federal Reserve's operations. Burgess stated that the accord required the Federal Reserve to give "somewhat excessive" support of Treasury

financings.3

H e further asserted that the Treasury considered it proper to help the Federal Reserve attain greater independence. His interpretation of what the accord should mean was very encouraging to the Federal Reserve : In the spring of 1951, the Treasury and the Federal Reserve got together and agreed that they would discontinue that practice of pegging the prices of Government securities. Now the agreement had a lot of codicils and strings and things to it that made it far from perfect, but it was a great forward step. It did not go all the way. It did not completely free the market from Federal Reserve support. The Treasury continued, I think, to try to put out its securities at artificially low rates. But it was a great step forward. When we came in at the end of 1952 and the beginning of 1953, we recognized those principles. We felt we carried them to their logical conclusion in giving the Federal Reserve System the freedom it needed to fulfill its lawful function in influencing the credit situation in the public interest.4 This new approach was quickly put to the test, and its sincerity and practicality became evident. T h e " n e w f r e e d o m " for the Federal Reserve soon resulted in increased interest 'Ibid., p. 811. ' Ibid., p. 819. T h e expression about "giving the Federal Reserve the f r e e d o m " was hardly the view of the Federal Reserve. T h e latter maintained that this " f r e e d o m " already belonged to the System. What needed to be given was the recognition of this right by the Treasury.

TREASURY-FEDERAL

RESERVE

RELATIONS

A F T E R ACCORD

303

rates and below-par prices for government securities. This change, in turn, produced strong public objections. In particular, a group of nineteen Senators and Congressmen united in a statement of protest. They "demanded that the Government [sic] bring interest rates down by supporting the prices of Government securities at par." ! Burgess, however, publicly answered that the Treasury had "no intention of yielding to this pressure" and that it was "committed to a policy of letting market forces determine the prices of Government securities and interest rates.'" Cooperation Between the Treasury and the Federal Reserve— Theory The public support given by Treasury officials to the new freedom for the Federal Reserve was a consequence of their approval of the March, 1953, decision of the Federal Open Market Committee. According to this decision the System, though remaining ready to prevent disorderly markets, operated in the short-term sector of the market and did not directly underwrite any issues offered by the Treasury. It gave the Treasury full information about the current monetary policy objectives of the Federal Reserve. Concerning new issues, the System did not initiate advice to the Treasury but gave its opinions about terms for such issues when requested to do so. These new procedures did not mean that the Federal Reserve would allow Treasury financings to be failures; however, the meaning of "failure" remained yet to be defined. Agreement on Free Markets The acceptance by the Treasury Department of the change in open-market procedures was indicated not only in the testi5 6

Ibid., Ibid.

p. 8 0 7 .

304

T H E INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

mony of the Under Secretary about the "new freedom," but also in other statements of the Treasury. In 1954, the Secretary of the Treasury told a Congressional committee that two principles were followed in the management of the government debt. The first principle was that both monetary and debt-management policies should be flexible, ready to counteract inflation as well as deflation. T h e second principle was one of subordination : Treasury debt-management operations should be consistent with the current monetary policy of the Federal Reserve.' The Secretary acknowledged that the government-securities market was not an entirely "free market," since the Treasury was in and out of the market frequently and since the Federal Reserve was a constant factor in the market. The crucial question was : how much freedom should be given to the "natural" forces of supply and demand in the money market? This question implied that there was some point where intervention by the Treasury or the Federal Reserve was required. The Treasury expressed its position on the necessity for accepting the judgment of the market place in this qualified way : We believe that things will be healthier if the natural forces of supply and demand have a good deal of leeway to operate, and that they tend to be self-corrective of difficulties in the market— I say tend to be. When we are such large factors, the Federal Reserve and ourselves, we always have to be alert to the market, and ready at some point to see that at least we do not upset it, and at times to act as a stabilizing factor, but whatever freedom you can give it we believe is very useful." ' Flanders Hearings, 1954, p. 161. It might be noted t h a t this principle of subordination achieved t h e purpose of the 1950-1951 Douglas resolution without forcing on the Federal Reserve any entangling alliance with Congress. * Ibid., p. 178.

TREASURY-FEDERAL

RESERVE

RELATIONS

A F T E R ACCORD

305

The Federal Reserve concurred in this viewpoint of the Treasury. The flexibility it desired for its monetary policy was not intended to give it freedom in any absolute sense, or in any sense which utterly ignored all other affected parties. The Federal Reserve in its trick at the helm wanted the Treasury to cooperate by pricing its offerings "in line with market conditions and expected credit policies of the System" and by making them "sufficiently attractive to assure ready market acceptance.'" The Federal Reserve recognized that the Treasury might have to face very difficult situations and might make mistakes. At such times the System would be ready to modify its course, change the terms of cooperation, and assure the basic success of the financing of the government.

Change

in Treasury's

Emphasis

on Free

Markets

In 1957, Congress asked the Treasury about the use of free markets and the lack of support operations by the Federal Reserve. The key question was : "Is it not a fact that for some time you [the Treasury Department] have been indicating to the Federal Reserve that you felt they should be supporting Treasury issues during the flotation period?"10 In his answer Under Secretary Burgess changed his emphasis on free markets by pointing out the responsibility of the Federal Reserve for the successful financing of the government : We [the Treasury Department] have discussed with them [the Federal Reserve officials] the money market conditions and their operations during the period of flotation of securities. We have felt perfectly free to express our opinion about it, and they have expressed their opinion to us. We recognized at all times that the ' Flanders Hearings, 1954, Ad Hoc Report, 10 Byrd Hearings, 1957, p. 821.

p. 304.

306

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

final decision was theirs. . . . We have suggested to them that they should see that there was not any marked additional tightening of money while we were selling our issues; that the market should have enough money so it was not particularly squeezed at those times. . . . I have, and Mr. Humphrey [the Secretary] has, talked with the Federal Reserve before every issue with respect to the condition of the money market. We have suggested that they have very clearly in mind the job we have to do. . . . They have always recognized in every public statement that the floating of a successful flotation of Treasury issues was one of the things they had to pay attention to in their credit policy . . . and do something about. . . . We have always recognized that the Federal Reserve had an underlying and major responsibility to make its decisions with respect to the general credit situation. When we discussed these things with them, they have always said, " W e will do what we can to help, within the range of our general credit policy," and we recognized that that was right. Now, of course, . . . the Federal Reserve System . . . cannot just go on ignoring the fact that the Government has a huge job of financing . . . and it has to pay some attention to it. . . . [Financing the government] is a major factor in the operation of the Federal Reserve System. [Emphasis added.]" This appeared to be a somewhat different attitude about freedom and free markets from that expressed by the Under Secretary when he began his term of office. After some experience in his debt-management responsibilities, he made more specific allowances for the complexities of free markets. The independence of the Federal Reserve System was not denied, but its meaning was clarified through a practical recognition of limitations for reasons of the public interest. "Ibid.,

pp. 821-823.

TREASURY—FEDERAL

Opposition

to Federal

RESERVE

Reserve

RELATIONS

Control

AFTER

of Debt

ACCORD

307

Management

The Treasury and the Federal Reserve agreed that there was a place within the government for both agencies and that the problem was how to cooperate with each other in their respective operations. They both rejected the proposal that their authorities—debt management and monetary policy formation—be united in one organization. This rejection was manifested in their replies to the question asked by Congress : "What are the arguments for and against assigning the entire task of debt management to the Federal Reserve System, completely separating budgetary policy and debt-management policy?" Viewpoint of Treasury. In opposing the transfer of its debtmanagement authority to the Federal Reserve, the Treasury argued that such a transfer would be contrary to the purposes Congress had in mind when it established a Treasury Department in 1789. The Treasury was given the responsibilities of handling public moneys and of supporting the public credit. Successful management of the public debt, argued the Treasury, was a vital phase of the support of the public credit. Moreover, this management should not be given to an independent agency which was not part of the Administration. Otherwise the powers and the responsibilities of the Treasury would not be proportionate. The second argument of the Treasury was taken from the 1950 report of the Subcommittee on Monetary, Credit, and Fiscal Policies of the Joint Economic Committee. The Subcommittee opposed concentrating debt-management and monetary powers in the Federal Reserve for two reasons. (1) There were doubts about the wisdom of making one government agency perform two functions which involved a conflict

308

T H E INDEPENDENCE O F T H E FEDERAL R E S E R V E

SYSTEM

of interest : (a) borrowing for the government and (b) determining the monetary and credit conditions under which the borrowing would be done. (2) The report judged that it would be inappropriate to assign to an independent agency the responsibility for handling the technical details of managing the government's debt. Such responsibility should belong to an agency, such as the Treasury, directly controlled by the Administration which had to do the borrowing.1' Viewpoint of Federal Reserve. The answer of the Chairman of the Board of Governors to the question about the advisability of assigning the debt-management authority to the Federal Reserve considered first the arguments favorable to such a rearrangement. He began by making a point about the desirability of a consistent approach to economic stabilization policies. The close relation of the financial and economic impacts of debt-management and monetary policy demanded that the two operations be handled so that they reinforced and did not counteract each other. His second favorable argument also stressed the need for harmony. What was done in the area of debt management affected the environment in which monetary policy operated, and vice versa. Hence each operation to some extent predetermined what would be appropriate policy in the other area. A third possible reason for assigning debt management to the monetary authority was drawn from a consideration of the day-to-day implementation of the debtmanagement policies. The resulting interaction with monetary policies limited the freedom of the monetary authority, just as action in the monetary field conditioned the operating decisions of the debt-management authority. In presenting arguments against assigning debt management to the Federal Reserve, the Chairman of the Board based his reasoning on the desirability of having checks and balances Douglas

Growth

Hearings,

1959, pp. 1728-1729.

TREASURY-FEDERAL

R E S E R V E R E L A T I O N S A F T E R ACCORD

309

for various functions of government. First, the money-creating function should be completely separated from the borrowing function. If the Federal Reserve performed both functions, there would be a greater danger that it would be subject to pressures to finance the government directly or to facilitate the financing of the government in other highly inflationary ways. Such results would conflict with the economic stabilization objectives assigned to monetary policy. The second argument overlapped the first. Debt management and monetary policy could have conflicting objectives : the appropriate supply of money and bank credit for economic growth and stability might not enable the government's debt to be carried at the lowest possible cost. Although the debt manager could be presumed to have a broad interest in economic stabilization objectives, he also had, like any debtor, a strong desire to borrow at the lowest possible cost. Emphasis on reducing cost might become so influential as to destroy flexibility in the level of interest rates." In summary, the Chairman expressed the opinion that the favorable arguments based on interactions and consistency "more properly" emphasized the need for close coordination rather than actual unification. Likewise, the unfavorable arguments pointed up the need for, first, mutual understanding by the Treasury and the Federal Reserve of each other's objectives and, second, coordination by them of their respective techniques of implementation. In other words, neither authority should or could ignore the other. Each in its own actions necessarily had to take into account its relations to the other and the interactions of their respective policies. Otherwise a single authority which was rejected in theory would result from actual practice. Moreover, the required coordination should not be forced but should result from constant inter13

Ibidpp.

1794-1796.

310

THF. I N D E P E N D E N C E O F T H E F E D E R A L R E S E R V E

SYSTEM

communication directed at the common objectives and at the coordinated use of the particular means available to each. Such teamwork would not only strengthen internally the two agencies but would also enable them to withstand the attacks on their independence made by outsiders. Necessity

for

Intercommunication

Both the Treasury and the Federal Reserve believed that their continued cooperation with each other required constant and sincere intercommunication. They needed to share their interpretations of market phenomena, their plans, and their problems. Accordingly, they set up regular meetings on staff and top authority levels. On occasion there were informal meetings between the Chairman of the Board and the President, along with the Secretary of the Treasury, the Chairman of the Council of Economic Advisers, and the economic assistant to the President. These various meetings provided a forum for the exchange of views on current economic questions. They also gave the Federal Reserve the opportunity for attempting the persuasion which it considered an essential part of the practical meaning of its independence. This persuasion was aimed at getting the Administration to understand and accept Federal Reserve policy as correct policy and to make its actions consistent with the Federal Reserve's. In turn, the Federal Reserve was open to persuasion by the Administration to conform to the Administration's policy." The Federal Reserve did not consider that the discussion of policy differences which affected government objectives would nullify the respective rights and duties of the parties involved. Rather, it agreed with the Treasury that the "essence of independence" demanded " Byrd Hearings,

1957, p. 1362.

TREASURY-FEDERAL

RESERVE

R E L A T I O N S A F T E R ACCORD

311

that both parties, freely and without any threat of dictation, discuss policy and operational difficulties.15 In 1959, Secretary Anderson of the Treasury made one qualification on this procedure of interdepartmental conferences. He was asked by a Congressional committee whether he thought it was in the public interest for the Treasury to express in public its disagreement with the Federal Reserve's monetary policy. The Secretary replied that such public expression of disagreement was in the public interest if the Federal Reserve's monetary policy "was irresponsible and at odds with the financial and economic policies of the rest of the Government—a situation which is almost inconceivable."1' Apart from this case, public statements of disagreement on monetary policy between the Treasury and the Federal Reserve, said the Secretary, presumably would be made to force a change in policy. As such they would be harmful to "a highly desirable characteristic" of the nation's financial system —the independence of the Federal Reserve from the Executive Branch of the government. The Secretary readily admitted that it was not to be expected that there would always be clear sailing weather ahead. The makings of problems were ever present—two independent agencies with closely related or overlapping responsibilities, sincere men giving different weights to factors influencing economic and financial trends, and no absolute norms for timing, strength, or degree of action. In answer to a related question, Secretary Anderson also gave approval to the policies and methods of operations used by the Federal Reserve in the post-accord and post-1953 " This emphasis on discussion and negotiation was a repeat of Secretary Snyder's viewpoint. Cf. Patman Compilation, Part 1, 1952, p. 30. "Douglas Growth Hearings, 1959, p. 3333.

312

T H E I N D E P E N D E N C E O F T H E FEDERAL R E S E R V E

SYSTEM

period. He suggested no way to ease the Treasury's debtmanagement problems without at the same time causing even more difficult problems which in the long run would harm the Treasury's interests and those of the nation as a whole. The Secretary sounded like a spokesman for the Federal Reserve. For monetary policy to make its primary contribution to the promotion of the economic objectives relating to employment, growth, and price stability, it should be flexible in its administration. "Major consideration [should] be given to the attainment of these vital national objectives rather than to some apparent easing [of] the problems erf debt management."" With a Secretary of the Treasury who publicly expressed such congenial views, the Federal Reserve officials would have little or no fear about coercion when they sat down and discussed their programs and policies which differed from those of the Administration.

Cooperation Between Treasury and Federal Reserve— Practice The theory about cooperation between the Treasury and the Federal Reserve was put to the test on different occasions. Testing the theory proved that intercommunication involved more than conferences about past or future plans and problems. It helped to clarify the meaning of independence for the Federal Reserve System when confronted with the unpredictable realities of the market place. On occasion, the importance of assisting the Treasury became the dominating concern of the Federal Reserve; at other times, the System showed strength enough to maintain its position in opposition to the viewpoint of the Administration. " Ibid., p. 3334. See also p. 1743.

TREASURY-FEDERAL

Assistance

RESERVE

RELATIONS

to the Treasury—November,

AFTER

ACCORD

313

¡955

Between August 4 and November 18, 1955, the Board approved increases in the discount rates effective at Reserve Banks from 1 f per cent to 2 \ per cent. These restrictive changes were made at a time when the Open Market Committee was facing two other problems which involved nonrestrictive actions. First, the regular seasonal growth in the demand for money and credit indicated a need for increased purchases of government securities, which by the 1953 policy would be Treasury bills. Second, the Treasury was about to announce the terms of a $12.2 billion refunding of certificates and notes. Somewhat later the Treasury was expected to seek about $1 billion of new money. The November refunding of the Treasury was initiated after the Federal Reserve had agreed that the terms to be set on the refunding securities were appropriate in the light of current market conditions. As it turned out, however, the refunding offer was not accepted by the market as well as had been expected. The Treasury, in a somewhat panicky manner, judged that the lack of acceptance was serious enough to have repercussions on the whole government-securities market. Accordingly, it appealed to the Open Market Committee to intervene by purchasing some of the new issue, even though this was contrary to the Committee's announced policy. In response, the Committee set up a telephone conference arrangement to hold a meeting. By a nine-to-three vote it agreed to purchase, on a when-issued basis, up to $400,000,000 of the new certificates. To justify this exception the majority stated that the Committee could not ignore the Secretary's request, nor could it fail to take account of a possible psychological deterioration of the whole securities

314

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

market if the Treasury's offering came to be regarded as a failure. The exception seemed reasonable since the Treasury had consulted with the Committee about pricing its offering correctly in relation to the market situation at the time. Further rationalization was provided by the prior action of increasing the discount rate and by the seasonal need for $400,000,000 of increased bank reserves." Answer of Federal Reserve to Congressional Criticism. This intervention of the Open Market Committee did not escape the notice of the press or of Congress. "Independence" was labeled in the press a "flexible word" when "reality" rather than "theory" was considered. Both the Chairman of the Board and the Secretary of the Treasury were questioned by Congressional committees about possible pressure which the Treasury might have used in the situation." Chairman Martin admitted that the Treasury asked him to persuade the Committee to give direct support to the financing operation; but he denied that this meant a loss of independence for the Committee or that he personally was being coerced because his term on the Board of Governors was soon to expire (January 31, 1956) and he was expecting to be appointed to a full fourteen-year term. He admitted that a minority on the Committee judged that the Treasury's trouble was due to its failure to judge the market correctly and that it could and should bear the burden of its mistake. The Committee, however, was not the victim of coercion and its action did not manifest the inadvisability of the 1953 decision against supporting operations. While Chairman Martin did not think that this incident 1!Forty-Second Annual Report of the Board of Governors of the Federal Reserve System, 1955 (Washington, 1956), pp. 109-110. 19 Martin Nomination Hearings, 1956, pp. 6 - 3 2 ; U.S., Congress, Joint Economic Committee, Hearings on the January 1956 Economic Report of the President, 84th Cong., 2d Sess., 1956, pp. 1 9 2 - 1 9 4 ; 3 0 1 - 3 0 5 .

TREASURY-FEDERAL

RESERVE

RELATIONS

AFTER ACCORD

315

showed the loss of independence for the Federal Reserve, he did admit, at least indirectly, that it showed independence to be qualified by the needs of the Treasury. The qualification came from two facts. First, the Federal Reserve had been consulted by the Treasury and had approved the terms of the issue. Second, the difficulty of the Treasury was caused by psychological forces for which the Federal Reserve in some measure was responsible : O u r desk people in New York participated in discussions and they were inclined to think that the rate was an appropriate one and we had perhaps miscalculated the course of the market. It was not a fault of pricing but more a fault of psychological forces in the market.™

The "psychological forces" were manifested in a delayed response by the market to the rather recent rise in discount rates. The possible market reactions to the concurrent sudden and serious illness of President Eisenhower had caused the Reserve Banks and the Board to postpone the last rise in discount rates until after the middle of November. This delay, in turn, brought about a greater tightness in the market at the time of the Treasury financing than the Federal Reserve had expected. In such circumstances, the majority of the Open Market Committee took upon themselves the responsibility for qualifying the independence of the System. This ratiocination and "breast-beating" was not considered satisfying or proper by several Congressmen, notably Senator Paul Douglas : This is a type of coercion of the Federal Reserve System by the Executive which I regard as improper. T h e Treasury should determine the terms of its issues, and if they misjudge the market they should be punished accordingly. . . . They should not call M

Martin

Nomination

Hearings,

1956,

p . 19.

316

T H E INDEPENDENCE OF T H E F E D E R A L R E S E R V E

SYSTEM

on the Reserve to bail them out and inflate the money supply in order to cover up a mistake in terms of yield." Chairman Martin objected strongly to the use of the word "coercion" to describe the pressure exerted by the Treasury or the reaction of the Federal Reserve. He maintained that the incident manifested the necessity of a practical cooperation : I think you have to recognize that the Treasury and the Federal Reserve are partners, each with a 50 percent interest, if you want to put it that way. Neither of us is subservient, one to the other. It is our endeavor to see that the Treasury is successfully financed and neither the Treasury nor the Federal Reserve should ignore the dictates of the market; and neither the Treasury nor the Federal Reserve benefit by having the Treasury fail at any time." Problems of Cooperation. How to reconcile a practical cooperation with a meaningful independence was not easy, especially when mistakes were made by either the Treasury or the Federal Reserve, or both. It was difficult to determine in such circumstances the motivating force behind the Federal Reserve's actions : its own principles, adequately considered, or pressures from the Treasury, overt or otherwise—or both. T o some Congressmen, there was no such problem; to treat it as a problem was to involve oneself in a labyrinth of semantics. Senator J . W. Fulbright, Chairman of the Senate Banking and Currency Committee, told the Chairman of the Board of Governors that it was a "joke" to speak of the "independence" of the System. For the Senator independence was a synonym for isolation and, therefore, nonviable : [We should] avoid kidding ourselves and kidding the public that we do actually have an independent agency independent of the influence of the Treasury. I do not quite think we have, and I do not quite think we are ever going to have. After all, the Presic i id., p. 21. ~ Ibid., p. 22.

TREASURY-FEDERAL RESERVE RELATIONS AFTER ACCORD 3 1 7

dent does appoint the members and nominate them, and the Executive is going to have that very basic influence. Whenever the Treasury gets in bad enough shape, you [the Federal Reserve] are going to come to the rescue if it is really serious. . . . I do not like for us to practice self-deception and say, "Well, now we have got agreement, and no longer is the Federal Reserve going to come to the rescue of the Treasury," when that is not the case. . . . I do not believe there is any real independence . . . except in the sense that you can quit. You do not have the power to continue your own way in the face of the pressure the White House is able to exert through the Treasury.3* Rather than reply directly to Senator Fulbright, Chairman Martin questioned whether it was meaningful to push the matter to the show-down positiort on which the Senator based his judgment. Martin's counter argument started with the presumptions that the basic power over money—its creation and its management—resided in Congress and that this power was assigned by Congress to the Federal Reserve System under trust. Although Congress in this assignment was limiting its own power as well as that of the Executive, it was not doing so irrevocably. T h e indenture of the trusteeship could be altered by Congress at any time. Furthermore, this assignment of power in trust was made for practical reasons as well as in the public interest : The reason for having an indenture was that the Federal Reserve System, which stands at the bar of public opinion just the same as anyone else, ought to have in this field a reasonable opportunity to make its decisions, insulated from direct political pressures or private pressures." T h e "reasonable opportunity" did not mean isolation from 33 M

Ibid., Ibid.,

pp. 66-67. p. 24.

318

T H E INDEPENDENCE OF T H E F E D E R A L R E S E R V E

SYSTEM

the Treasury any more than it meant compulsion or coercion by the Treasury or the Executive, regardless of the wishes of the Federal Reserve. O n the other hand, the decisions of the Federal Reserve had to take into account its responsibilities which included the achievement of the successful financing of the government. T h e System could not sit incommunicado in an ivory tower; it had to be in constant contact with Treasury plans and problems. T h e independence of judgment given to the Federal Reserve had to be something earned—constantly tested and reaffirmed. Independence was worthwhile only if it helped the System to promote the best interests of the nation.

Opposition

to Treasury—April,

1956

If independence appeared at times to be a flexible concept, it was also a concept that at other times meant strength. T h e charge that it was impossible for the Federal Reserve to act in a way disagreeable to the Administration was put to public test in April, 1956. At that time, despite the open opposition of the Secretary of the Treasury, the Secretary of Commerce, and the Chairman of the President's Council of Economic Advisers, the Board of Governors approved increases in the discount rate as voted for by the Reserve Banks. T h e disagreement between Federal Reserve authorities and officials of the Administration focused on the significance of inflationary pressures in the economy. T h e Chairman of the Board of Governors later described how the System's independence expressed itself with vigor : Pursuing our method of cooperation, I began discussions with Secretary Humphrey [of the Treasury]. In February [1956] Governor Balderston and I had a meeting with Secretary Humphrey and there was a disagreement as to the nature that the economy was developing. We were so convinced; we discussed it

TREASURY-FEDERAL RESERVE RELATIONS AFTER ACCORD

319

with various people, and in a series of meetings from about the middle of February until the last week in March. By the last week in March the position in the Federal Reserve . . . was that it would be wise for us to go up in the discount rate. . . . We finally reached a point where there was no meeting &f the minds that could be had, and there was nothing for the Federal Reserve to do except to go and act. And we acted. . . . There was no pressure put on us not to do what we did. Everything was very friendly and amicable, but I am inclined to believe, to be honest, that if it had been handled by the Administration it would have been handled differently. . . . They would have been less rapid [in advancing the discount rate], although I want to be very fair in this and say at one point, early in 1955, I think, the Administration probably would, if they had had the authority, or might have gone up and at that time we were opposed to going up. It has not been a one-way street. [Emphasis added.]3' Meaning of "Independence Within the Government." Chairman Martin referred to this episode as an illustration of the Federal Reserve's being "independent within the Government." This independence did not allow the System to pursue a course contrary to national economic policies. Rather, by the intent of law as expressed in the Federal Reserve Act and in subsequent Congressional determinations of that Act, Martin explained, this independence signified that : within its technical field, in deciding upon and carrying out monetary and credit policy, [the Federal Reserve System] shall be free to exercise its best collective judgment independently.2* We feel ourselves bound by the Employment Act and by the Federal Reserve Act. And in the field of money and credit we consider ourselves to be, regardless of what the decisions of the administration may be—we consult with them but we feel that •'Byrd "Ibid.,

Hearings, p. 1258.

1957, pp. 1362-1363.

320

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

we have the authority, if we think that in our field, money and credit policies, that we should act differently than they, we feel perfectly at liberty to do so." The disagreement in April, 1956, became public knowledge shortly after the event. Happy were the Federal Reserve officials when President Eisenhower backed the System, not necessarily in the wisdom of the particular action of raising the discount rate, but in their authority to take a position opposed to the Administration. "He [stated] unequivocally that he thought it best for the country that the Reserve System should not be subject to his command."" As one foreign account explained this support : "In the stately marble building on Constitution Avenue that houses the Board of Governors of the Federal Reserve there was, needless to say, much rubbing of hands."1* Quick Reversal of Policy by Federal Reserve. If there was "much rubbing of hands" on Constitution Avenue, there was no weeping in the corridors on Pennsylvania Avenue. The Secretary of the Treasury did not feel isolated and ignored. He could be confident that the disagreement in April, 1956, did not mean that the Federal Reserve would utterly disregard the wishes of the Treasury. Confirmation of this judgment was evident in the summer of 1958 when disorderly conditions briefly dominated the government-securities market. Again the Open Market Committee set up a telephone conference arrangement (twice on the same day, July 18, 1958) and moved quickly to check the disorder. It authorized the Manager of the System Account to purchase unlimited amounts and in all ranges of maturity, and to purchase rights and when-issued securities since the Treasury was financing at "Ibid., p. 1361. The Economist (London), Supplement : A Survey Banking, C L X X X , No. 5908 (November 17, 1956), 9. " Ibid., pp. 9-10. M

of

International

TREASURY-FEDERAL

RESERVE

R E L A T I O N S A F T E R ACCORD

321

the time. The Committee went even further and announced publicly what it was doing." Moreover, this all-out reversal of its policy came after the Federal Reserve had already purchased large amounts (in the six previous weeks, $1.4 billion) of government securities and had reduced the discount rate and reserve requirements. Such quick and strong cooperative action showed that there was indeed a "revolving door" in the "fence" between the independent agencies, the Treasury and the Federal Reserve. Perhaps it could be said that really the fence was invisible and that the neighbors cultivated a common garden, but each with his own tools.

30 Forty-Fifth Annual Report of the Board of Governors of the Federal Reserve System, 1958 (Washington, 1959), p. 55.

XI The Congressional Case for Control of the Federal Reserve System

FROM

THE

BEGINNING

OF

THE

FEDERAL

RESERVE

SYSTEM

there were two contrasting fears about its organization: (1) the Executive Branch of the government might use the monetary authority as a kind of political football, and (2) private interests might be influential enough to achieve purely private goals at the expense of the public good. Not everybody agreed that such fears were realistic ; nonetheless they were the basis for the governmental and private elements in the System's structure. This mixture of countervailing authorities, by providing built-in checks and balances, alleviated but did not eliminate the problems of possible abuse and of conflict of interest. Side by side with these enduring fears there were optimistic hopes. The Federal Reserve was expected to work for the good of the nation, and it was given independence as a means to this achievement. Clearly much was hoped for. It was not equally evident to all interested parties, however, that much was achieved. Because of the continuing presence of fears and hopes, Congress made frequent investigations of the Federal Reserve 322

C O N G R E S S I O N A L C A S E FOR C O N T R O L O F R E S E R V E S Y S T E M

323

System to check on performance and to reconsider the feasibility of independence. In doing so, Congress discussed ways and means of increasing its own control over the Federal Reserve and at the same time improving the performance of the System in the light of its assigned goals. This checking and rechecking provided urgent motives for the Federal Reserve to make continual self-examinations and to keep its organization in good working condition. With a brighter internal shine it could better reflect, the image the Federal Reserve Act intended. Survival then became more likely. Congressional Interest in Monetary Affairs Congressional interest in the control of monetary affairs was an enduring phenomenon in the history of the Federal Reserve System. When the original Federal Reserve Act was considered and enacted by Congress, it was a lively political issue and aroused strong emotion among its proponents and its antagonists. Carter Glass, the leading advocate of the Act in the House of Representatives, illustrated this reaction among the legislators. Reminiscing about the enthusiasm of the Speaker of the House in 1913, Glass stated: Champ Clark had no great familiarity with the details of the currency measure, nor had he any special knowledge of banking technique; but he took the in tensest interest in the polemics of the occasion, not only in the caucus, but in the House also. He seemed as an old war horse sniffing the battle and enjoying every moment of it. And there was battle to enjoy ! Always excitement was at a high pitch and frequently the hall resounded with cheers. Once or twice the enthusiasm became a riot, men standing in their chairs and tossing hats to the skylights.1 The passage of the Federal Reserve Act did not end the 1

Glass, An Adventure

in Constructive

Finance,

p. 143.

324

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

interest of Congress. Although members of Congress never again showed the enthusiasm described by Carter Glass, they kept propounding problems and considering answers to old and ever new questions about the Federal Reserve. They never felt completely confident that they had done the right thing in setting up the Federal Reserve System or that they could not do better in some other arrangement. Through the years members of Congress expressed their doubts about the System's powers, structure, and responsibilities. They considered proposals for changing the System so that they could exercise greater direct control. Constantly they seemed to fear the possible tyranny of the giant they had created. Delegation

of Monetary

Power

This continuing concern of Congress was in keeping with the historical position of Congress relative to the finances of the government and the operation of the nation's monetary system. Prior to the adoption of the Constitution, Congress had control of the Treasury either through a committee of its own or through its appointees. After receiving the constitutional grant of authority over the government's finances and the monetary system, Congress discussed various ways of exercising control. Some members wanted the Secretary of Treasury to be attached to Congress and to be their agent. The prevailing argument against this arrangement was the fear that it would allow the Secretary to influence the judgments and proceedings of Congress, even to dominate Congress. Although the Secretary finally was made an appointee of the President and responsible to him, Congress gradually took some of the initiative away from him. It did this by establishing a standing Committee on Ways and Means in the House to make

CONGRESSIONAL CASE FOR CONTROL OF RESERVE SYSTEM 3 2 5

inquiries into the finances of the government and to initiate revenue and appropriation measures. The establishment of the Treasury in 1789 was followed two years later by several related organizations. An Act of Congress established a mint and coinage system, thus making specific use of power given Congress by Article I, Section 8 of the Constitution : "To coin money, regulate the value thereof . . . ." Also in 1791, and at the suggestion of the Secretary of the Treasury, Congress chartered a national bank, the Bank of the United States." The bank was allowed to issue paper money, a kind of national currency. This arrangement did not set Congress at ease. The Treasury and the mint were clearly government establishments. The new national bank, though a creature of Congressional power, was not in the same category. Congress tended to distrust, almost from the start, the Bank of the United States in its independent exercise of banking and monetary powers. After the demise of the Bank in 1836, Congress decided to have the Treasury act as the depositary of government funds. While through the years Congress broadened the monetary and debt-management powers of the Treasury, it kept close watch on the actions of the Treasury. When the Federal Reserve System was organized, the constant interest and concern of Congress for monetary affairs was extended to the new agency. Although Congress never lost sight of the great good or the great evil which could result from the use or misuse of the monetary and banking power which it had given to other organizations, it never again seriously considered exercising 2 The United States Government contributed one-fifth of the capital of the bank, not by a cash transfer but by means of a loan from the bank. (Cf. Bray Hammond, Banks and Politics in America (Princeton : Princeton University Press, 1957, pp. 207-208.) T h e second charter of the bank, in 1816, gave the government a minority representation on the bank's board of directors.

326

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

that power itself. At times it debated about rearranging the loci of immediate use of that power. And always Congress questioned whether its control of the banking and monetary authorities was adequate. Frequent

Consideration

of Control

Questions about control led to Congressional demands for explanations and for adequate accountability from the Federal Reserve System. The questions and the demands became more frequent, more insistent, and more sophisticated as the government's role in the economic life of the nation increased. T h e Federal Reserve did not, and could not, ignore this increase in the watchfulness of Congress. Its structure, powers, and responsibilities came from statutory law. They were the expression of the will of Congress. They could be maintained and nurtured by Congress; or they could be taken away in another law. In this sense, Federal Reserve officials recognized Congress as always in command even though they did not agree with every legislator who proposed to change the specifications of that command. Purposes of Investigations. In the post-World War II period, and especially in the Fifties, probably no organization or agency within the government was subjected to as much probing by Congress as was the Federal Reserve System. M a j o r investigations looking for possible legislation were held in 1949, 1951, 1954, 1957, and 1959. There were almost continual hearings on proposed legislation and on government reports, such as the President's Economic Report, which concerned the Federal Reserve. The questions asked were numerous, often repetitious, and usually requiring detailed and complex answers. Some of this Congressional probing was based upon a fear that in the heart of the central banking authority

CONGRESSIONAL CASE FOR CONTROL O F R E S E R V E S Y S T E M

327

there was a mysterious and false beat. As a consequence, the questions, at times, were leading, set traps, and provided the questioner with the opportunity to propound his own personal feelings. T h e responding Federal Reserve officials needed wisdom, political acumen, and, above all, endurance. For the most part, however, fear or mistrust was not the most important force motivating Congress. Rather the hearings and the investigations arose out of sincere desires for education, albeit an education aimed perhaps at greater control over the Federal Reserve System. In the first place, the hearings and investigations could be considered an attempt by Congress to provide the Federal Reserve, its friends, and its critics with an open forum for explanations and judgments about the System's organization, powers, responsibilities, and actions. Education did not come easy, either for the teacher or for the listener. T h e subject matter was technical and complex; frequently it was obscured by past judgments and recondite rationalizations. Yet it was admittedly important and a proper object of the attention of Congress. Second, Congressmen wanted to know how and why the trusteeship arrangement was a feasible and responsible way of organizing the monetary authority of the nation. T h a t is, if Congress was to place trust in its agent, it needed to confirm the terms of that trust from time to time. This constant reappraisal quite normally led to suggestions for changing the control arrangements and for making the Federal Reserve more responsive to Congress. Importance of Investigations for Independence. N o matter what their motivations, however, the Congressional hearings and investigations were important for the independence of the Federal Reserve System. Looked at from a positive point of view, they gave the Federal Reserve the opportunity to defend and even expand its authority. I n response to questions and

328

THE INDEPENDENCE OF THE FEDERAL RESERVE

SYSTEM

complaints from members of Congress, Federal Reserve officials could put the matter in proper focus by delineating the legal and historical origins and the scope of their powers. By acknowledging their responsibilities, they were forced to make them more definite, perhaps more limited, and in any case subject to less misunderstanding and challenge. By trying to explain the adequacy of their accountability to the government, they had to make clearer the wisdom of their insistence on being independent within the government. By asserting their willingness to carry out the wishes of Congress as manifested in formal law, they were acknowledging their duty to keep Congress better informed. Frequent and adequate communication ruled out any ivory-tower concept about their operations. Becoming more sophisticated about their trusteeship under Congress, Federal Reserve officials made available more detailed information about their policies and operations and, to some extent, about their internal politics. This reaction of the Federal Reserve undoubtedly opened new avenues of attack for some members of Congress. But it was also reassuring to others that the trusteeship was feasible and praiseworthy. Through it all, Congress developed strong reasons for its exercising more detailed control. How to respond to the criticisms as well as to the proposals of Congress became the continuing problem of an independent Federal Reserve System. Reasons for Congressional Control The delegated powers of the Federal Reserve were public powers in a twofold way: (1) they were to be used in the public interest; and (2) they were directed toward cooperation with the government program for the national welfare. Coordination with the Executive, yes; but not a coordination

CONGRESSIONAL CASE FOR CONTROL O F R E S E R V E S Y S T E M

329

which meant absorption by, or subordination to, the Executive. All parties involved—the Congress, the President, and the Federal Reserve—openly agreed that the public powers of the Federal Reserve remained the powers of an agency of Congress. The importance of this arrangement for the welfare of the nation was increased by an awareness on all sides that granting these powers to an independent agency involved the risk of mistakes and even abuse. The public character of these monetary powers, the need for their cooperative use within the government, and the risk of their abuse—all these factors provided reasons for Congressional control of the Federal Reserve System.

Concern for Public Interest Various members of Congress often considered the adequacy of the arrangements which had been made for securing the primacy of the public interest in the operations of the Federal Reserve. They judged that their responsibility to the electorate for the performance of the nation's monetary system required them to obtain a full accounting of the success and failures of their agent. They admitted that the public tended to link the President, not Congress, to the operations of the Federal Reserve. Hence through investigations and public statements they tried to make it clear that Congress wore the mantle of responsibility and was not going to cast it aside. Opposition to Control by President. In the opinion of some Congressmen there were two main hindrances to the achievement of the public interest and especially the proper public interest. The first was the likelihood that because of the power of the Treasury and the influence of the Executive, the Federal Reserve would become a servant of the Executive and ignore Congress. In a somewhat facetious manner, but in one

330

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

which nonetheless made its point, Senator Douglas questioned Chairman Martin about this orientation of the agency arrangement : : . . . Do you regard the Federal Reserve Board as the agent of the Executive or the agent of Congress ? MARTIN : I regard it as an independent agency of the Government. D O U G L A S : To whom is it responsible ? T o the Executive or the Congress ? MARTIN : It is responsible to Congress. . . .* Later on Senator Douglas came back to this point : D O U G L A S : Mr. Martin, I have had typed out this little sentence which is a quotation from you : The Federal Reserve Board is an agency of Congress. I will furnish you with scotch tape and ask you to place it on your mirror where you can see it as you shave each morning, so that it may remind you.4 DOUGLAS

This insistence that Congress and not the Executive was the principal in this agency relationship perhaps helps to explain the reaction of Congress to suggestions made by successive Chairmen of the Board of Governors (Eccles, in 1935; McCabe, in 1949; Martin, in 1957) that the Chairman should serve at the pleasure of the President and that the President, at the beginning of his term of office, should have the authority to appoint the Chairman, just as he appointed his Secretary of the Treasury and other Administrative officials. Congress listened to these requests, but it never acted upon them. Restraint

on Private

Influence.

In the mind of Congress a

second hindrance to the Federal Reserve's achievement of the proper public interest was the participation of private financial parties in the organization and management of the System. 'Martin 4 Ibid.,

Nomination p. 25.

Hearings,

1956,

pp. 2 3 - 2 4 .

CONGRESSIONAL CASE FOR CONTROL OF RESERVE SYSTEM 3 3 1

T h e supposition was that representatives of private

financial

organizations would neglect the public interest and work for their own individual or group benefit. Originally they were given a place in the System to provide a remedy for the possibility of the government's abuse of its own power. Later they came to occupy an anomalous position as the public-interest aspect of Federal Reserve power was emphasized and came into situations of conflict with the government, both the E x ecutive and Legislative branches. T h e possibility of control by private interests was almost a perennial matter for discussion in Congress. It was perhaps most forcefully expressed in 1938 when Congress considered a proposal providing for government ownership of the Federal Reserve Banks. 5 At this time there was evidence that even past patrons and current officials of the Federal Reserve shared the concern of Congress. Congressman Wright Patman, who introduced this proposal, judged that private control of the Federal Reserve System was clear, dominant, and wrong : I think the big banks have largely dominated and controlled the Federal Reserve System. Take today the Open Market Committee. . . . T h e banks have five representatives on it. . . . are sitting there

to control,

of this entire nation, people's

interest.

you might say, the economic

but they are not charged

They affairs

in doing it in the

They are doing it, those five, in the interest of

their own banks, of their own depositors and stockholders. . . . They are carrying out their duty and their obligation to the people that they owe a duty and obligation to. . . . [Emphasis added.]" Congress has the duly elected representatives of the people, whereas the bankers are selfishly interested, and I think it is in the 5 U.S., Congress, House, Committee on Banking and Currency, Hearings on Government Ownership of the Twelve Federal Reserve Banks, 75th Cong., 3d Sess., 1938. Cited hereafter as the Patman Stock Hearings,

1938. 6

Ibid.,

p. 56.

332

THE INDEPENDENCE OF THE FEDERAL R E S E R V E S Y S T E M

interest of the general welfare for the representatives of the people to be trustees, rather than the bankers who are selfishly interested. [Emphasis added.]' Congressman Patman's viewpoint was confirmed by both former Senator Robert Owen and Chairman Eccles of the Board of Governors. Said Owen : The Federal Reserve banks should be engaged in the monetary business, in regulating the flow of credit, so as to protect the welfare of all of the people of the United States. . . . Under the management of our banking system that has heretofore prevailed, by the nature of their business they expand to excess against the public interest, and they contract to excess against the public interest, and they are incapable of helping that. They follow the law of human nature, the law of profit and of s a f e t y . You cannot expect them to cooperate. They are not charged with any political responsibility. [Emphasis added.]* And Eccles : The bank representatives on the Open Market Committee are not the appointees of the President, nor are they the representatives of Congress at all. They are selected in the first instance by private bankers and business people, and they therefore represent less of a public interest, possibly, than the Board. . . . I have felt very strongly that the function of the Open Market Committee should be confined exclusively to the representatives of Congress. . . [The viewpoint of the Presidents of the Reserve Banks] necessarily is likely to reflect that of member banks. . . . A committee which is entrusted with monetary policies as important as those given to this committee should consist entirely of persons representing the public interest. [Emphasis added.]10 Ibid., * Ibid., ' Ibid., " Ibid., 1

p. 169. p. 80. pp. 474-475. p. 478.

CONGRESSIONAL CASE FOR CONTROL OF R E S E R V E S Y S T E M

333

Judgments such as these were not easily forgotten by Congress. By frequently coming to the fore in public discussions such judgments, weighted with respected authority, kept revitalizing the interest of legislators in giving assurance to the public that the monetary powers of the Federal Reserve System were exercised for the achievement of the proper public interest. Coordination

of Governmental

Policies

In the Thirties, President Franklin D. Roosevelt made it clear that the Federal Reserve was obliged to coordinate its policies and operations with the economic program of the government. At the same time he acknowledged that the System was accountable to Congress for the way it exercised its powers. In his dedication speech at the official opening in 1937 of the new headquarters building for the Board of Governors he stated : T o this public body [the Board of Governors] Congress has entrusted broad powers which enable it to affect the volume and cost of money, thus exerting a powerful influence upon the expansion and contraction in the flow of money through the channels of agriculture, trade, and industry. . . . Much as they may contribute to the country's progress, monetary powers possess no peculiar magic. They are not omnipotent. T o be effective in performing their function, they must be closely coordinated with the other major powers and policies of government which influence the country's economic life." Since Congress had delegated the powers to the Federal Reserve, it was concerned with the necessity of coordinating these powers with other powers exercised by the government in executing its economic policies and fulfilling its other obligations. T h e report of a 1952 Congressional subcommittee which " Federal Reserve Bulletin, X X I I I (November, 1937), 1062.

334

T H E I N D E P E N D E N C E OF T H E F E D E R A L R E S E R V E

SYSTEM

investigated the problem of coordination reasoned as follows : It is vitally necessary . . . that monetary policy, fiscal policy, and all of the other economic policies of the Government should be coordinated so that they will make a meaningful whole, working in the direction of price stability, high-level employment, and' a dynamic, free-enterprise economy. As President Roosevelt pointed out, monetary powers were only part of the power picture, and economic stability did not encompass all the objectives of the government. Resourcedevelopment, housing, or defense programs needed the ready and willing cooperation of the monetary authority to bring about a meaningful combination of monetary policies with those of other government agencies involved in such programs. Cooperation, therefore, meant the Federal Reserve's policy would not necessarily dominate all government policy which impinged upon it. As Congress viewed the question, the President had a duty and a right to effect this needed unity of policy "by direction with respect to the agencies under his control and by persuasion with respect to the agencies which are n o t . " " Congress also judged that it had a duty and a right to promote this coordination : The problems of fiscal and monetary policy are not entirely those of the executive agencies and the Federal Reserve. They are also the problems of Congress. The Employment Act of 1946 set up a coordinating agency on the Congressional side in the Joint Committee on the Economic Report. . . . [This Committee] should maintain more active liaison at the top level [and continue its existing liaison at the staff level] with the Federal Reserve and the executive agencies." '·' Ρ at man Subcommittee 13 Ibid. " Ibid.

Report,

1952, p. 56.

CONGRESSIONAL CASE FOR CONTROL O F R E S E R V E S Y S T E M

335

As a corollary to this procedure Congress maintained that for effective coordination it needed the power of direction and persuasion over the Federal Reserve. Hence the attempts of Congress to specify activities and to demand a detailed accountability continued through the years. Prevention

of Abuse of Monetary

Power

The third reason for Congressional control of the Federal Reserve was based upon the responsibility of Congress to prevent a misuse of the monetary power. Legislators reasoned that if this power were not used to promote the public interest and if it were not coordinated with the total government program, then the monetary authority would be insubordinate and unjustified in its action. It also would expose the nation to the risk of serious harm. Public reactions to such results might lead to monetary chaos and the destruction of the System. Accordingly, the Federal Reserve, to be a meaningful and acceptable organization in the national picture, needed clearly defined powers, goals, and responsibilities. Congress, in its investigations, hearings, and enactments attempted to provide these definitions and in so doing to exercise its duty and right of control. Risks of Abuse. At times Congress expressed dissatisfaction with the existing goals or objectives assigned to the Federal Reserve : they were somewhat vague and consequently too discretionary. Moreover, Congress exerted no strong and immediate compulsion on the Federal Reserve to settle conflicts with other parts of the government over methods and goals. Such disagreements could produce serious harm to the government's program. The discussion-persuasion-cooperation procedure was not enough. What Congress wanted to provide was some principle to be used as a guide to keep monetary

336

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

policy from getting out of focus and assuming too much of the burden and of the decision-making process of the government. The burdens could be heavy and the risks serious, as Congress heard in the testimony of Marriner S. Eccles. The former Board Chairman judged that the Federal Reserve, prior to the recession of 1957-1958, "deliberately took the risk" of allowing its actions to lead to a recession. He denied that the Federal Reserve "deliberately produced" the recession. The point was that the Federal Reserve took the risk because of its obligation and responsibility for a certain type of action at the time. Eccles maintained that the Federal Reserve's obligation to counteract spiraling inflation was clear. Since in the opinion of the Federal Reserve such an inflation was imminent, it had to be opposed. The System used its powers even though it knew that its judgment might be wrong and that its powers were likely to be inadequate by themselves. The former Chairman approved of the action taken and even stated he would have acted in the same way.11 The idea that the Federal Reserve could take the risk which allegedly at times resulted in undesirable effects on the nation's economy was disturbing and confirmed the concern of Congress about ways to control the System. Retention of Basic Monetary Power. Even though the danger of abuse might be great, the problem of how to control the monetary authority so as to minimize that danger had no easy answer. The monetary powers at issue, the delegated powers, were complicated in their meaning and in their use. The past or likely future performance of the monetary authority could not be easily understood even by experts. Congress, however, tried to have the whole matter put in very simple language. For example, Congressman Jesse P. Wolcott 15

Byrd

Hearings,

1957,

pp. 1700, 1702-1704, 1711.

CONGRESSIONAL CASE FOR CONTROL OF R E S E R V E S Y S T E M

337

addressed a member of the Council of Economic Advisers on this problem of explanation : I found myself . . . at a loss . . . [in] a semantic wilderness. I am just a plain unadulterated Member of Congress here without too much knowledge of economics, and most of the people's representatives are not educated in economics and financial matters. I would hesitate to go back to my people and try to explain to them the recommendations of the Council of Economics Advisers as to just what we can do to stop inflation. Now can somebody . . . in very brief language give the recommendations of the Council . . . as to what must be done to prevent further inflation. . . Equivalent, but usually less forthright, demands were made on Federal Reserve officials. The difficulty of understanding tended to increase the concern of Congress about the extent of its control of the Federal Reserve. The real or contrived element of obscurity did not diminish but rather heightened Congressional estimation of the importance of the monetary authority. Because Congress knew or feared that the authority could act in a misguided or domineering way, it stressed the agency idea and the need for an accounting of the agent's performance. Very definitely Congress did not believe that the problem of explanation would be solved by turning over the monetary authority to the Executive Department. This reallocation of responsibility would not necessarily reduce the danger of the monetary authority's being tampered with for an ad hoc purpose or gain. On the contrary, it would diminish the effectiveness of the built-in checks and balances : operation under the mantle of the Executive would make the Federal Reserve more immune to Congressional wishes and challenges. Hope seemed to spring eternal in Congress that with a more sophisticated control " Patman

Hearings,

1952,

p. 2 6 0 .

338

THF. I N D E P E N D E N C E O F T H E F E D E R A L R E S E R V E

SYSTEM

procedure it would learn more and be better able to communicate its wishes to the Federal Reserve. At the same time Congress would nurture in a useful way its own basic monetary power.

Response of the Federal Reserve In

response to the concern

of Congress about

control,

Federal Reserve officials took unto their own the statements of their most voluble protagonist, Congressman P a t m a n . W h e n , after persistent persuasion on his part," the full Federal O p e n Market Committee appeared before an investigatory Congressional

subcommittee,

Patman

explained

his view

of

the

problem of Congressional control in terms perhaps agreeable to the Committee : Certainly, the Congress itself cannot carry out the constitutional requirement relating to the money and credit supply. We have done the right thing by delegating the power." T h e fact that Congress has seen fit, as a practical matter, to entrust or delegate the day-to-day exercise of this power to the Federal Reserve System does not lessen the ultimate power or responsibility of the Congress in this respect, nor does it make the functions which [the Open Market Committee] and the Reserve System perform any less public governmental functions. Congress, recognizing that restrictive monetary policies must sometimes be strongly stated to control inflation, has chosen to endow the System with a considerable degree of independence. But under the Constitution this independence can never rise about the relationships of a faithful and trustworthy servant and a responsible, watchful master, in this case the Congress." " Cf. Flanders Hearings, •'Ibid., p. 231. "Ibid., p. 217.

1954, pp. 3 9 - 4 3 .

C O N G R E S S I O N A L C A S E FOR C O N T R O L O F R E S E R V E S Y S T E M

339

The members of the Open Market Committee while pleased to hear this analysis from Congressman Patman would probably make one qualification. At various times in Congressional hearings both System officials and Congressmen called the Federal Reserve the servant, the creature, the agent of Congress. Preference on both sides, however, was for the agency relationship. This characterization would allow for a more meaningful independence. Existing Limitations on Authority Admittedly, the power which the Federal Reserve exercised was given by Congress. It was a power directed not only toward the smooth functioning of the economy but also toward the active promotion of the economic objectives of the government. Federal Reserve officials were frequently on the defensive in explaining their position in the government's program. They had to prove not only that monetary policy had an important contribution to make but also that it could and would be coordinated with other government policy measures. On the other hand, they pointed out that too much of a burden should not be laid on monetary policy. Nor should it be used to force the proper coordination of other government agencies. Such a pressure operation could cause misunderstandings and accusations of power-grabbing which would make independence for the System unpalatable to Congress and to the public alike. Involvement of Other Agencies. Thus Federal Reserve officials tried to make it clear that they did not desire, nor was it their responsibility, to manage the total government program. Coordination was just as important to them as to anybody else. They claimed they had a meaningful point of

340

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

view, and they wanted to be heard. If they were accepted as a knowledgeable and experienced participant, they would build a workable cooperation and coordination. In this building process the interest of Congress was by no means a necessary obstacle; it could be, and at times was, a decided help. While the Federal Reserve officials communicated on a regular basis with the Executive Department and used the opportunity to persuade others to their viewpoint, at the same time they left the way open for themselves to be persuaded. In their contacts with the Executive Department they were not obsequious but held on to their customary rights to the extent which they believed would be supported by Congress. Sometimes this procedure worked the other way : Federal Reserve officials opposed pressure from Congress to the extent which they were backed up by the Executive. In the shadow of big, complicated government, the authority of the Federal Reserve needed the support of the President or Congress in any seriously controversial area. The freedom which the Federal Reserve acquired through the accord of 1951 was due in large measure to the backing it received from Congress; the further advance of that freedom in 1953 relied heavily on support from the President. Basic Control by Congress. The core of the discussion about the independence of the Federal Reserve as it faced the challenges of Congress concerned ways and means to make the System effective, responsible, and accountable without destroying its unique organization and without absorbing it into the total government operation to the point of anonymity. In responding to the charge about improper private influence the monetary authority spoke about "Federal" and "System" while Congress was emphasizing the implications of private enterprise contained in the words "reserve" and "bank." "Federal"

C O N G R E S S I O N A L C A S E FOR C O N T R O L O F R E S E R V E S Y S T E M

341

meant that the monetary authority had worthwhile regional aspects; "System" was noteworthy because it indicated it was not a "one-man" operation. The problems faced in the monetary field were too complicated in their causes and the solutions proposed were too ramified in their results to be handled by a one-man, centralized authority. Since this answer supposed a unique organization for the Federal Reserve System, it was often proposed as conditional. It worked well, but Congress could change it if Congress so desired. In all discussions about modification of the monetary system, Federal Reserve officials stressed the importance of not making any fundamental change hastily. Rather such action called for careful and thorough investigation. On some occasions this caution was a stalling tactic to let the gusty winds of snap judgment blow themselves out. On other occasions, the stress on calm judgment was based on the principle that the established arrangement should be accepted as honest and competent unless the evidence was clearly against such judgments. For example, at the time of his appointment to a fourteen-year term on the Board of Governors, Chairman Martin understood and strongly resented the implications in suggestions made by Senator Douglas that : (1) the policy of the Federal Reserve was prejudiced in favor of profits for private banks; and (2) he had submitted to coercion from the Treasury to change the System's policy because he was about to receive his appointment.20 This type of accountability, though not very educational, was not an unusual part of the demands of political viability. The only response it could evoke was denial, not explanation. M Martin Nomination Hearings, 1956, p. 3. Also, U.S., Congress, Joint Economic Committee, Hearings on January 1956 Economic Report of the President, 84th Cong., 2d Sess., pp. 301-305.

342

T H E INDEPENDENCE O F T H E F E D E R A L R E S E R V E

Importance

of

SYSTEM

Trusteeship

At times the Federal Reserve in presenting an account of its performance gave technical explanations for monetary operations which had aroused the criticism of Congress. When such explanations did not satisfy, they were amplified by a referral to the history of the System and the problems and solutions put forth by its founders and early officials. The historical argument limped at times because of the changes which had taken place in the Federal Reserve System and in the environment in which it operated. Most important of the environmental changes was the expansion of the government's responsibilities and control. Logically this might mean a formal absorption of Federal Reserve functions directly into the ordinary government processes; the historical argument for independence, in such a case, had little force. Moreover, at times it was exasperating to Congress when the Federal Reserve took refuge in its legal and operational structure to oppose pressure for changes in accountability. If Congress wanted closer control over earnings, the Federal Reserve emphasized its private characteristics and claimed that such control was not proper nor needed. When Congress raised questions about private bank pressure or privilege, System officials insisted that the Federal Reserve structurally was within the government and at all times promoted the public interest. After one such occurrence, Senator Douglas told Chairman Martin : When you want public protection you are a public institution. When you want special privilege you are a private institution. Now you must be consistent in this matter. You cannot blow hot and cold in alternate sentences.21 :i

Potman

Hearings,

1952,

p. 9 8 .

C O N G R E S S I O N A L C A S E FOR C O N T R O L O F R E S E R V E S Y S T E M

343

T h e Federal Reserve Chairman proposed no ready solution to the dilemma. O n e of his answers, given on another occasion, presented the same matter in declarative, but far from definitive, form : [The Federal Reserve Act] provided for a merger of public and private interest. . . . The Federal Reserve Board in Washington is clearly Government. The Federal Reserve banks are quasigovernment, or quasi-private, depending on where you want the emphasis.22 No matter how the organization was explained, Federal Reserve officials relied mainly on the implications of the trust involved in it to explain their independence. Speaking about the power had by the Federal Reserve System, Chairman Martin made its independent exercise a corollary of the trust arrangement : I am certain that Congress realized it was a great power. So they set that power up in the form of a trusteeship. The indenture of this trusteeship was written by the Congress in the Federal Reserve Act, and can be altered at any time by the Congress. But the reason for having an indenture was that the Federal Reserve System, which stands at the bar of public opinion just the same as anyone else, ought to have in this field a reasonable opportunity to make its decisions, insulated from direct political pressures or private pressures.2" The insistence of Federal Reserve officials on the acceptance by Congress of the System as a form of trusteeship was based mainly upon the desire for stability and flexibility. They wanted stability so that they could approach problems and carry out solutions which had long-term and broad require32 U.S., Congress, Joint Economic Committee, Hearings on January 1960 Economic Report of the President, 86th Cong., 2d Sess., 1960, p. 196. Cited hereafter as the Joint Economic Committee Hearings, 1960. "Martin Nomination Hearings, 1956, p. 24.

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T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

ments. They could not have stability if they had to accept day-to-day orders from Congress. The control of monetary power was too important to be subjected to the shifting sands of public opinion concerned with ad hoc situations and remedies. Unless they were trusted enough to have a "reasonable opportunity" to make their decisions in an independent way, they would be pushed along and finally overwhelmed by the shifting sands. Federal officials wanted flexibility, as distinguished from rigidity born of detailed instructions from outside their own organization, so that they could take quick action to encourage or discourage economic forces which came within their purview. Without supporting confidence by Congress in their competency and honesty they could not expect to have the necessary flexibility. This line of reasoning—trust in an organization made strong enough and endowed with stability and flexibility—did not always satisfy all members of Congress to the extent that they left their "trustee" alone to carry on his business. At times legislators expressed their dislike for the end results as well as for the way the business was conducted. Accordingly, they kept searching for ways to increase their own control and to specify the terms of the trusteeship.

XII The Congressional Means for Control of the Federal Reserve System

WITH

THE

MORE

FREQUENT

CONGRESSIONAL

HEARINGS

AND

investigations in the Fifties, the Federal Reserve officials mellowed somewhat in their relations with Congress. Perhaps they showed a greater willingness to explain and to listen because they felt secure in the support they received from the Executive Department. Yet there was another partial explanation. The Federal Reserve accepted in more realistic fashion its agency status and the accompanying responsibility to account for its operations. Since it wanted to be treated as a competent trustee, perhaps it in turn could trust the trustor. Many of the matters proposed and discussed by Congress were more like annoyances which might be expected to hinder candidness on the part of the Federal Reserve. There were proposals which misunderstood and would radically alter the structure, powers, or responsibilities of the System. Even these annoyances, however, argued in favor of greater cooperation with Congress simply because they tended to make cooperation more necessary for survival. An obdurate attitude by Federal Reserve officials would not close off discussion about radical alterations. On the other hand, a willingness to listen and to 345

346

T H E I N D E P E N D E N C E Ol- T H E P E D E R A L R E S E R V E

SYSTEM

attempt an explanation might be enough in itself. O r at least such cooperation might remove the urgency, which always seemed to be present, and allow more careful consideration of the proposals. T h e record then could speak for itself. Cooperation

with

Congress—listening,

answering,

and

explaining—was something which had to be nurtured and festered. It was bound to be time-consuming. On occasion such cooperation might be of crucial importance, and then it might not be possible to manifest suddenly the cooperative attitude and expect ready acceptance. In this spirit, it seemed, the Federal Reserve showed an increasing awareness of the necessity for building a reputation Congress.

Show-downs

could

be

for cooperating

embarrassing

and

with even

alienate old friends. T h e Federal Reserve knew full well that some members of Congress had continually in the background something

more

than

requests

for

information

and

for

explanation. Throughout the life of the Federal Reserve System Congress frequently considered specific ways in which it might gain greater control over the System and be better assured that its own ideas about monetary policy would be put into operation. One of these ways was to give the Federal Reserve specific directions in law about policy and to enforce the directions with the power of removal of Federal Reserve officials. Another was to control the operating funds of the System through audit by the regular government auditing agency and through budget control procedures such as were applicable to other government agencies. A third method of control was the purchase by the government of all the stock of the Reserve Banks. 1 Allied to the stock-ownership issue would be the appointment by the government of all directors of the Reserve Banks and 1

T h i s method of control will be considered in the following chapter.

C O N G R E S S I O N A L M E A N S FOR C O N T R O L O F S Y S T E M

347

the necessity of the Reserve Banks to receive their operating funds through the appropriation procedures of Congress. Greater Specification of Methods and Goals One version of the Federal Reserve Act which was introduced into both Houses of Congress in 1913 contained a provision that the powers of the new Federal Reserve System should be used to promote a stable price level. Such a purpose was in keeping with the 1912 campaign issues and with the general program of the Wilson Administration—to work against inflation. The provision was not retained because the strongest proponents of the Federal Reserve were against the idea of a managed money.2 The inclusion of such a provision would have been a means of control by Congress over the Federal Reserve, because by dictating a particular policy it would have limited the area of discretion of the Federal Reserve.

The 1938 Mandate

Proposal

This question of specific directives was repeated on later occasions, and especially in 1938, when the problem was one of avoiding deflation. At this time the proponents in Congress wanted an inflation of prices. They were very specific about what the Federal Reserve should do : It shall be the duty of the Federal Reserve Board to raise the . . . so-called price level, until full employment . . . shall have been achieved, and until the price level shall at least reach the allcommodity index of 100 as established by the Department of Labor for the year 1926. . . . Thenceforth such price level shall • Patman Stock Hearings, 1938, pp. 77 and 95.

348

THE INDEPENDENCE OF THE FEDERAL RESERVE S Y S T E M

be standardized and maintained at a variation not to exceed 2 per cent above or below the standard reached.' T h e 1938 proponents were also determined that, given this directive, the Board of Governors would conform.' Congress was to have authority to remove members of the Board at will: The Board of Governors of the Federal Reserve System is hereby declared to be the agency of the Congress . . . and the individual members of such Board shall hold office subject to the will of Congress of the United States; and either the Senate or the House by resolution may authorize and request the President of the United States to nominate a successor . . . whereupon, the office of such member shall be vacated." Even former Senator Robert Owen testified in favor of this procedure : " I do so believing that our experience with the Federal Reserve

Board since

the passage of the

Federal

Reserve Act makes this safeguard necessary.'" In other words, the Federal Reserve should follow this directive; and if it did not, then Congress could dismiss the Board and build up a membership which would carry out its will.'

Mandate

Proposals in the Fifties

T h e question was never put so forcefully again, but it was not altogether forgotten. Congress kept up its interest in a mandate to the Federal Reserve. Sometimes Congress wanted to limit the area of discretion of its agent; at other times •Ibid., p. 168. The Board of Governors was to be increased to twelve members and was to be given all the functions and powers of the Federal Open Market Committee. 'Patman Stock Hearings, 1938, p. 168. • Ibid., p. 83. ' These proposals never came to a vote in Congress (Cf., infra, p. 375). 4

C O N G R E S S I O N A L M E A N S FOR C O N T R O L O F S Y S T E M

349

Congress was interested in strengthening the authority of its agent. Promotion of Monetary Policy. In 1950, the Douglas Subcommittee of the Joint Economic Committee recommended that Congress give general directions to both the Federal Reserve and the Treasury "regarding the objectives of monetary and debt-management policies and the division of authority over those policies.'" The objectives should be those of the Employment Act of 1946; the division of authority should be such that (1) the Federal Reserve had a primary power and responsibility for regulating the supply, availability, and cost of credit, and (2) Treasury actions relative to money, credit, and transactions in government debt were to be made consistent with the policies of the Federal Reserve. The Subcommittee considered that this statement of directives was necessary if the Federal Reserve was to have the strength and courage necessary for the effective use of monetary policy, especially when restrictive and unpopular action was called for. Such a proposal, as mentioned previously, was unsuccessfully introduced by Senator Paul Douglas at the time of the accord of 1951. In a minority report of the 1952 Patman Subcommittee, Senator Douglas repeated in slightly different form the two principles which the 1950 report emphasized—definite subordination and objectives. The "subordination" of the Treasury to the Federal Reserve became the "differentiation" of the responsibilities of the two agencies. The purposes of the Federal Reserve should be to use monetary policy "as a counterweight to economic fluctuations"—increasing the money supply in depression times and restricting its expansion in times of boom." At the same time he insisted on some such " Douglas Subcommittee " Patman Subcommittee

Report, 1950, p. 2. Report, 1952, p. 76.

350

T H E INDEPENDENCE OF T H E F E D E R A L R E S E R V E

SYSTEM

directive so that Congress could exercise its control over the Federal Reserve. He went further and seemed to overstate his case by arguing that without the Congressional directive only haphazard and irresponsible action could be expected : The most urgent and paramount business in the field of monetary policy is that of a clear Congressional directive to the Federal Reserve System, to wit, a mandate as we have come to call it. Without such a clear mandate, setting forth responsibilities and the general terms of policy, there can be no such thing as accountability or evaluation of performance. I would concede the difficulty of writing a mandate. But if it is alleged that the difficulties are so great that they cannot be surmounted, then that contention is tantamount to saying that we do not know what kind of general monetary policy we desire ; and, if we do not know what kind of monetary policy we want, then we had better simply abolish the instruments of monetary policy, for they are entirely too dangerous to be used for illconsidered purposes.10 Senator Douglas's own statements illustrated the seriousness of the complaint about the difficulty of writing an acceptable and specific mandate. First of all, there was the already mentioned difference, small though it was, between his expressions in 1950 and 1952. Second, in 1952 he argued almost blindly with the Chairman of the Council of Economic Advisers that improper monetary expansion was the cause of inflation." In 1959, however, the Senator took into account the force of administered prices in the inflation process. He said to the Chairman of the Board of Governors : "You are whistling in the wind, when you try to control those [i.e., administered prices] perfectly by credit controls." To the Chairman's response that the Federal Reserve recognized the limitations of 10 Ibid.,

" Patman

p. 74. Hearings,

1952, pp. 163-182; 194-200.

CONGRESSIONAL MEANS FOR CONTROL OF S Y S T E M

351

credit controls, he added : "That is fine. Now we are getting somewhere. This means that we should seek supplementary sources of price controls and not confine ourselves purely to credit controls."" What Senator Douglas objected to was the Federal Reserve's using its flexible policy "primarily to raise interest rates."" In his report on this matter, he repeated a statement he made in 1950 about the desirability of "an appropriate, flexible, and vigorous monetary policy, employed in coordination with fiscal and other policies" as "one of the principal methods [to be] used to achieve the purposes of the Employment Act."14 However, he no longer insisted on the primacy of the Federal Reserve in the monetary policy area and its freedom to use restrictive measures; rather, he complained that it was overreaching its power. Thus, his own experience argued against the advisability of making Congressional control easier by giving more specific directives to the Federal Reserve. Such directives might not be better than no directives. Mandatory Open-Market Operations. This experience, however, did not deter other Congressmen from proposing detailed operations to be followed and goals to be achieved. One of these was a so-called sense-of-Congress amendment1" which concerned the operations of the Federal Reserve when it expanded the money supply. The proposal started with the obvious : the basic mission of the System was to conduct a sound monetary policy. Then it specified one of the ways to fulfill this mission. When the Federal Reserve decided to Douglas Growth Hearings, 1959, p. 1311. " U.S., Congress, Joint Economic Committee, Report on Employment, Growth, and Price Levels, 86th Cong., 2d Sess., 1960, p. 29. 14 Ibid. 15 It amended a proposed bill for permitting an increase in the Ή percent rate on government securities with a maturity at time of issuance of five years or more. 12

352

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

increase the supply of money, it should purchase government securities of varying maturities rather than decrease reserve requirements." The enactment of this directive, its supporters argued, would settle

the internal

dispute

about

varying

maturities, offset the complaint about the profits of private banks, and provide support for the government-bond market which to some members of Congress was politically necessary. It would also enable Congress to demand from the Federal Reserve an

accountability

measurable.

Federal

which

was more

Reserve officials objected

precise

and

that

these

reasons were open to dispute, that the directive was an unwarranted limitation on their discretion, and that it was likely to shake confidence, both at home and abroad, in the stability of the monetary system and the capabilities of its authorities. The response of the interested Congressmen was to remind the Federal Reserve officials again and again about their agency position. One Congressman said to the Chairman of the Board of Governors : N o w justify your existence. H e r e you are serving the Congress. I assume you still recognize that. . . . Y o u are subservient to the Congress, and you should c a r r y out its will, and yet you

are

against this "sense of Congress" resolution."

T o this complaint, as to all similar ones, the Chairman had no answer but to state his judgment that the enactment of this directive would prevent the Federal Reserve System from being that effective and responsible agent which the Congress desired and had legislated for in the already existing laws. " Cf. U.S., Congress, House, Committee on Ways and Means, Hearings on Public Debt Ceiling and Interest Rate Ceiling on Bonds, 86th Cong., 1st Sess., 1959, p. 253. " Statement of Congressman Patman. Douglas Growth Hearings, 1959, p. 1318.

CONGRESSIONAL MEANS FOR CONTROL OF S Y S T E M

353

Control Through General Accounting Office Members of Congress and officials of the Federal Reserve had many serious discussions about the proper control of funds used by the System for operating purposes. In the Fifties these discussions usually ended in disagreement about the value of subjecting the Federal Reserve to the General Accounting Office, an established agency of Congress. Undoubtedly some Congressmen were mainly concerned with increasing the amount of information about the Federal Reserve's general operations and about its application of funds. In this way efficiency would be promoted, conflicts of interest would be avoided, and Congress would be better able to evaluate the performance of the System. Other Congressmen, however, advocated the use of the General Accounting Office as a means for Congress to control the operating funds of the Federal Reserve and thereby to control the System's monetary policies. Both groups judged that through subjection to the General Accounting Office the Federal Reserve would be more likely to provide the accountability required of an agent of Congress. On the other hand, Federal Reserve officials maintained that a government audit was a limitation on its independence and that, when analyzed, it was a serious limitation.

Audit

Procedure

of Federal

Reserve

The procedure followed by the Federal Reserve in controlling its operating funds was outlined in its response to questions asked by a Congresional subcommittee in 1951. The question read :

354

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

Are the expenses and other accounts of the Board of Governors or the Federal Reserve Banks subject to any budgetary or audit control of any other agency of either Congress or the Executive Branch of the United States Government? . . . Describe budgetary and auditing procedures now in effect."

The answer of the Board Chairman outlined the budgetary procedures, expenditures control systems, and audits applicable to the Board and the Banks. The Board provided its own budgetary and expenditure control arrangements; it also supervised and to some extent determined the budgetary and expenditure control systems of the Banks. With respect to audit control, both the Board and the Banks set up their own internal audit systems. Although the Banks submitted copies of their audit reports to the Board for review, they were examined each year by the field staff of the Board. This examination included a review of the Bank's audit procedure. The accounts of the Board were audited by one of the Reserve Banks chosen by the Board. These arrangements did not appear sufficiently objective and impartial to some Congressmen, especially Representative Patman and Senator Douglas. For this and other reasons, the Federal Reserve brought in outside (public but not governmental) experts to pass judgment on procedures and data involved in the budgets and audits.Then the Board made arrangements so that, starting in 1952, its accounts would be audited by qualified outside auditors. In 1954, the Board announced a new procedure for its examination of the Reserve Banks. Representatives of a public accounting firm accompanied the Board's field staff when it examined one of the Banks, and they reviewed and reported on the examination made by the Board's staff.'9 The Chairman considered that " Patman Compilation, Part 1, 1952, p. 307. 19 Cf. Martin Nomination Hearings, 1956, p. 54.

C O N G R E S S I O N A L M E A N S FOR C O N T R O L O F S Y S T E M

355

these procedures of careful internal control and external supervision made the System "the best audited institution in America."1" As this explanation indicated, the budget and expenses of the Board and the Banks were not controlled by any agency outside the System.21 The Reserve Banks had never been audited by a government agency outside the System. The Board of Governors, however, at one time had been subject to the audit procedure of the government. U p until 1921, the Treasury Department did the auditing; from 1921 on, the Comptroller General's office did it. In 1933, the authority of the Comptroller General was eliminated when the Federal Reserve Act was amended to provide that the funds of the Board "shall not be construed to be Government funds or appropriated moneys."" The 1933 amendment also gave the Board full discretion over its own expenses. The purpose of this change in procedure, as stated in the Senate and House reports on the 1933 Act, was to give "to the Board the determination of its own management policies."23 M

Ibid., p. 44. " T h e r e were three exceptions. U p until 1933, the law required the Reserve Banks to pay most of their net earnings, after dividends, to the Treasury, the amount being 90 per cent starting in 1917. Also, Congress controlled the salaries received by members of the Board of Governors and the building expenses of the Reserve Banks for their own branch banks. 23 T h e original Federal Reserve Act did not state that the Board's funds, which were derived from assessments on the Reserve Banks, were "Government funds"; that determination, however, came from a ruling by the Attorney General. 23 Quoted in Potman Compilation, Part 1, 1952, p. 308. This new arrangement was a kind of reward to the Federal Reserve for its participation in a government program for the insurance of bank deposits. Congress gave full control to the Federal Reserve over operating funds and surplus accounts at the time it established the Federal Deposit Insurance Corporation. T o provide funds for insurance purposes Congress assessed the Federal Reserve Banks for an amount equal to one-half of their surplus. In the following year, 1934, Congress also authorized the

356

THE INDEPENDENCE OF THE FEDERAL R E S E R V E S Y S T E M

In 1955, the Chairman of the Board of Governors added a confirmatory argument about the adequacy of the auditing procedures of the Federal Reserve. When the Government Corporation Control Act was being considered by Congress in 1945, a representative of the Comptroller General testified against including the Reserve Banks in the provisions of the bill under consideration. He stated : "They are examined frequently and thoroughly by Federal Reserve examiners, under the direction of the Board of Governors of the Federal Reserve System."" Through this supervisory procedure he considered that the government had a "very strong control" over the Federal Reserve Banks. On the basis of this expert opinion as well as that of others, Congress did not put the Reserve Banks under the government audit procedure of the new act." Congressional

Proposals for Audit by Government

Agency

The issue of a government audit was not resolved by the Government Corporation Control Act of 1945. Senator Douglas and Representative Patman were the principal proFederal Reserve Banks to use funds equal to their surplus at the time to participate in a program of commercial loan assistance to private business. (Cf. Monthly Review, Federal Reserve Bank of St. Louis, March, 1959, pp. 30-32.) 24 U.S., Congress, Senate, Banking and Currency Committee, Hearings on Providing for Financial Control of Government Corporations, 79th Cong., 1st Sess., 1945, p. 32. Chairman Martin did not repeat one of the main arguments used in 1945. The staff representative of the Generai Comptroller's office based his reasoning on the status of ownership of the Reserve Banks. It was his "understanding" that the Reserve Banks "are owned exclusively by member banks; that is, the stock is held by member banks." (Ibid., p. 31.) He testified: "The banks do own all the stock, and for that reason the Federal Reserve Banks are not included in this bill." (Ibid., p. 32. Emphasis added.) M Cf. letter of Martin to the Comptroller General, dated June 26, 1955. Quoted in Martin Nomination Hearings, 1956, p. 63.

C O N G R E S S I O N A L M E A N S FOR C O N T R O L O F S Y S T E M

357

ponents in the Fifties of an audit by the Comptroller General of the accounts of the Federal Reserve System—the Board, the Federal Open Market Committee, and the Reserve Banks. Their arguments were based principally on the agency status of the System. The System was within the government, an agent of Congress; it used the credit of the government as its basis for operations; it used the monetary power of the government to carry out government objectives. In his testimony in 1952, the Chairman of the Board agreed with this analysis and affirmed the System's readiness to keep Congress well-informed about Federal Reserve affairs. But he did not extend this readiness to an audit by the General Accounting Office : The Federal Reserve System is a servant of Congress and, through you, of the people of the United States. . . . Our task is to carry out your will and it is our duty to lay before you all the facts at our command for which you ask and to give you our best judgment on these important matters.2* Source of Information About Federal Reserve. In urging acceptance of the audit procedures of the government's General Accounting Office, Senator Douglas reminded the Chairman about the information-providing duty of the Federal Reserve : Since you are a public agency, the American public is entitled to know how you spend your money, and it is entitled to know it from a government source rather than from a group of auditors whom you choose yourself." Every other governmental agency is audited by the General Accounting Office. You are the only agency so far as I know which audits itself.2" " Palman Hearings, 1952, p. 74. 27 Martin Nomination Hearings, 1956, pp. 64-65. M Patman Hearings, 1952, p. 97.

358

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

I do not see how you get any immunity from the act governing the activities and functions of the Comptroller General and the General Accounting Office.Λ Senator Douglas expanded his point of view by arguing that audit by the government would provide useful education for Congress and the public. This, in turn, would lead to a better understanding of the work of the Federal Reserve and to confidence in its operations. The whole central banking function would benefit by being able to reach "sounder" decisions : Part of the trouble in this whole thing is that you make the process of banking excessively complicated. The more of this that can be known to the general public, the higher the level of financial knowledge and the sounder the decisions which are made. As long as the facts are in question or can be questioned, then an element of obscurity is introduced.30 " T h e facts" were "in question," argued Senator Douglas, as long as the Federal Reserve exercised the authority to set up its own audit procedure and, further, did not make the audit results readily available to members of Congress. Use of Information for Control by Congress. Representative Patman frequently indicated that his interest in the government audit was not only for information and education. He wanted Congress to exercise control over income and expenditures by the Board and the Reserve Banks so that it could influence the policies of the System. This method of Congressional influence was in keeping with Representative Patman's position that it was very cumbersome for Congress to control the actions of the Federal Reserve through the process of passing a law or an amendment to the Federal Reserve Act. It would be much easier if Congress had control over the 18 M

Martin Nomination Ibid., p. 47.

Hearings,

1956,

pp. 4 7 - 4 8 .

CONGRESSIONAL MEANS FOR CONTROL O F S Y S T E M

359

operating funds of the System. In 1952, he told the Chairman of the Board of Governors : It is easy to say that you are under the scrutiny of Congress, but you are not inconvenienced by it if they have no power to control the purse strings of your agency. It is a rather cumbersome procedure to pass specific laws controlling an agency, so you are not under much restraint or inconvenience at all. Of course, I do not mean inconvenience just to inconvenience you, but I mean quickly to pass upon policies, and even major policies.31 Since the Federal Reserve was not restrained by the government budget-apparatus, the next best thing seemed to be audit by the government's General Accounting Office with detailed reports to Congress. After continued pressure from various Congressmen, the Federal Reserve attempted a compromise by submitting its own audit reports for the inspection of certain Congressional committees. Shortly thereafter Representative Patman issued a newspaper release32 which headlined the words : " T h e Federal Reserve System is spending millions of dollars of taxpayers' money without restraint and without audit." He called the internal audit procedure " a contradiction in terms" and complained that the reports submitted by the Federal Reserve did not include information "dealing with the conduct of the officers and directors of the banks, their financial interest, and, if any, their speculations in the bond and securities market." Although Representative Patman was concerned with the "variety of deficiencies and mismanagements" which he illustrated from the details in the audit reports, his purpose went deeper than a rectification of these improprieties. He was concerned with a more basic type of control : the monetary policy pursued by the System. In the House, on May 25, Patman Hearings, 1952, p. 123. * June 22, 1959, p. 1. (Mimeographed.)

31

360

THE INDEPENDENCE OF T H E FEDERAL RESERVE

SYSTEM

1959, Representative Patman argued strongly in favor of a government audit for the Federal Reserve. He mentioned two policies which he would like Congress to control—(1) the independent use by the Federal Reserve of the interest received from holdings of government securities and (2) the promotion by the System of high interest rates : I am not against our banking system, including the Federal Reserve. My opposition to the way they are being managed now is due to the enormous, unjustified, unneeded subsidies and unearned interest they are receiving at the expense of the taxpayers and for forcing extortionate interest rates upon the Government and the people. . . . Our banking systems have served our country well both in time of peace and war. Many changes should be made in the public interest. We should not consider abolishing a good system because some of the operatore-are bad and greedy any more than we should consider destroying a fine automobile because the driver operates the car in a reckless manner. [Emphasis added.]" Response

of Federal

Reserve

In arguing against subjecting the System to the General Acounting Office, Federal Reserve officials asserted that it was necessary for them to provide their own audit procedures and to keep their audit results out of the public domain. Otherwise they would not retain control of their own decisions. T h e same argument was applicable to the System's control of its budget procedures. This reasoning, they maintained, was the traditional reasoning of Congress. T o change the existing audit and budget arrangements would be an indirect way of changing the careful control structure set u p by the Federal Reserve Act. In the past Congress did not subject the expenses and accounts of the Board and the Banks to outside audit and 31

U.S., Congressional

Record,

CV, 8137.

CONGRESSIONAL MEANS FOR CONTROL OF SYSTEM

361

budget control because it wanted the functions and responsibilities of the System to be carried out with the necessary maximum of independent discretion and judgment. The Chairman explained this point : If through some measure of control over its finances another agency of the Government were empowered to restrict operations which the reserve banking system deemed essential for the discharge of its statutory duties, there obviously would result a substitution of judgment of such other agency of Government for that of the reserve banking system, with a consequent and growing loss of effectiveness on the part of that instrumentality." Even without the confirmatory statements and actions of Representative Patman, Federal Reserve officials judged that changing the audit and budget procedures would lead to a significant loss of their traditional independence. Control over expenses meant control over the purposes for which the funds of the Board and the Banks were spent. The self-controlled arrangement under which the System operated allowed the Board and the Banks to make their own determinations concerning the uses of their funds in the light of current business and government practices. Thus they could select and maintain their staffs "on the basis of training and experience and without regard to other considerations."" More important, the broad policy decisions of the System were free from being "influenced in any way by the possibility that the budget of the Board or the Banks would be reduced or otherwise restricted because of decisions which, while sound from a credit and monetary standpoint, might be unpopular."" In thus expressing the opposition of the Federal Reserve— the need for full freedom to do the "sound" but "unpopular" —the Chairman made his basic argument. He judged that 34 35

Patman Ibid. Ibid.

Compilation,

Part 1, 1952, p. 307.

362

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

the System's audit and budget procedures were essential elements in its unique organizational structure. This arrangement enabled it to be a buffer between the electorate and the government, and thereby to exercise discretion within the government to do what from a political viewpoint was unpopular. Chairman Martin did not develop, however, an important and necessary proviso which his argument included— that the "unpopular" should also be "sound." T h a t proviso returned the question to the extent and manner of the control of the government, responsible to the electorate, for determining what was "sound." Likewise the Chairman did not answer the objections of officials of other agencies of the government that the Federal Reserve had unfair advantages in having ample funds for research activities and for influencing public opinion. When compared with funds available to some agencies, those of the Federal Reserve were referred to as "slush funds." Chairman Martin connected "control" not only with the budget process but also with the audit process. T h e two customarily went together. Even if they did not, there were inescapable control elements in audit alone. An audit report laid baie the various expenses and internal control measures used, as well as income and allocation. It did not necessarily explain all actions; approval or disapproval could stand unsupported by reasons beyond those derived from conformity to "accepted practice." As already indicated, the audits submitted to Congress were the source of criticism by members of Congress concerning different expense items. T h e criticism was actually a means of control because it implied that the item being criticized, unless satisfactorily explained, should not appear in a subsequent report. Furthermore, to require the Federal Reserve to explain continually a large number of even minor criticisms could prove disruptive to what should be a smooth

CONGRESSIONAL MEANS FOR CONTROL OF S Y S T E M

363

and careful operation. Hence the annoyance factor could also be a means of control. Since a thorough audit involved the interpretation of law and the allowance or disallowance of expenses, its control aspect seemed clear. According to Malcolm Bryan, President of the Federal Reserve Bank of Atlanta, authority to audit the System would give the General Accounting Office : . . . a very substantial discretionary and quasi-judicial power over the Board of Governors and the banks : the power to harass, if nothing else. . . . If there be doubt [about this] . . . then it will be of help to examine the imposing array of legal-looking books containing the decisions of the Comptroller General. There will then be no doubt in anybody's mind that the activities of the Comptroller typically extend (as they are intended to extend) far beyond any conception of asset and liability verification and into an extraordinarily broad field of quasi-judicial interpretation and discretion.3' President Bryan summarized his ideas in a simple statement : " T h e power to harass is the power to destroy."™ T o offset the arguments of the opposition, he stressed that "confidence must ultimately be reposed at some place as the only possible alternative to the impossible alternative of not reposing confidence at any place."™ If Congress did not trust its agent, the Federal Reserve System, why would or should it trust its agent, the General Accounting Office? O r as one of the Governors, James L. Robertson, asked : "Well, who's going to audit the auditor?" 40 Patman Hearings, 1952, p. 434. One very pertinent example of this result was the reporting of the General Accounting Office on the Federal Deposit Insurance Corporation. These reports strongly urged what was later done : the change in the location of the headquarters and in the ownership arrangement of that corporation. "Ibid., p.435. 38 Ibid., p. 440. 40 Hearings on Study of Banking Laws, 1956, p. 230.

364

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

Results

of Congressional

SYSTEM

Pressure

Reluctantly the Board made various audits and examination reports available on a confidential basis to authorized members of Congress, first, at the Board's offices and, later, at the offices of a Congressional committee. When

Representative

Patman asked that these documents be reviewed by the Comptroller General for the purpose of judging their quality and completeness, he was refused. Refusal

by Federal

Reserve.

The disagreement was climaxed

when the Committee on Government Operations directed the Comptroller General to make an audit of the Board, the Open Market Committee, and the Reserve Banks. T h e order was large : You are hereby requested . . . to include in the scope of the audit such operations and activities of the Federal Reserve System, so-called, as will enable Congress better to evaluate and appraise the operation of said System and to form judgments upon which may be premised possible legislative action. . . . ft is requested that your report include such comments and recommendations as you may deem advisable." When the Comptroller General attempted to make mutually convenient arrangements with the Board of Governors for carrying out this directive, he received an initial refusal. Chairman Martin stated that he would consult on the matter with the Open Market Committee and the chairmen, directors, and presidents of all the Reserve Banks. In other words, to agree to the audit by the Comptroller General required a decision by all the top officials in the System. The Chairman, or the " Letter of Chairman of House Committee on Government Operations to the Comptroller Generai, dated April 13, 1955. Quoted in Martin Nomination Hearings, 1956, p. 61.

C O N G R E S S I O N A L M E A N S FOR C O N T R O L O F S Y S T E M

365

Board of Governors, alone could not, or would not, make this decision. After consultation, Chairman Martin gave a final refusal to the Comptroller General. He affirmed that the System was ready to carry out the will of Congress, but he denied that a Congressional committee resolution was sufficient evidence of such a will. Furthermore, he judged that to carry out the proposal for the audit by the Comptroller General was "a fundamental determination" of the Federal Reserve Act. Such a determination ought to come from "a change in the Act," from Congress acting "as Congress."" The System had no intention of defying Congress or not doing what Congress wanted; the question was whether or not Congress, "as Congress," had changed its mind about the way the Federal Reserve should handle its expense accounts and administrative procedures. Changes Proposed by Federal Reserve. The refusal of the Federal Reserve in 1955 to agree to an audit by the Comptroller General did not end the pressures brought by Congressional committees on the audit problem. In November, 1956, the Board of Governors made a further concession. It recommended that Congress amend the Federal Reserve Act on the audit-procedure question. The recommendation was not to authorize the Comptroller General to handle the matter. Rather the Board took up the suggestion made in 1952 by its Chairman and urged earlier by members of Congress. In testifying before the Senate Committee on Banking and Currency in late 1956, Governor Robertson of the Board stated : We have reached the point now where we think, in view of all the talk that goes on about auditing in the Federal Reserve System, that Congress should take upon itself to make mandatory the use of a firm of certified public accountants to audit the " Ibid.,

pp. 48, 64.

366

T H E INDEPENDENCE O F T H E FEDERAL R E S E R V E

SYSTEM

F e d e r a l Reserve Board, and that we should be required to submit these audits to the committees of Congress and that the auditors should be obliged to come before the committees of Congress and explain any defects, and that we, the Board, ought to be obliged to submit reports with respect to every criticized item in that r e p o r t . "

The Board also approved an amendment to the Federal Reserve Act which would confirm the Board's modified practice with respect to the examination and the examination reports which it made of the Reserve Banks. By this amendment the Board would be obliged to tum over to the Committees on Banking and Currency in the Senate and the House these examination reports. Moreover, the amended law would oblige the Board to assure that such reports satisfied the highest standards of commercial audit by arranging for one or more firms of certified public accountants to observe and review the adequacy of the procedures, techniques, and practices used in the examination process. These recommendations for a more detailed and formal process still did not satisfy all Congressmen. The effort continued to be made for a government audit. Representative Patman referred to the Federal Reserve's position as "claiming a 'sacred cow' status." He tried innuendo : " I f they do not have something to hide, why do they oppose an investigation [by the Comptroller General] ?"" Implications

of Government

Audit

An adequate explanation of the reasons that the Federal Reserve defended so persistently and so firmly its audit procedures and was so slow to modify its position included many " Hearings on Study of Banking Laws, 1956, p. 229. 44 U.S., Congressional Record, CV, 9352.

C O N G R E S S I O N A L M E A N S FOR C O N T R O L O F S Y S T E M

367

considerations. First of all, Federal Reserve officials considered their procedures adequate and satisfactory from the audit point of view. Second, there was the negative principle— resistance to change unless there were evident abuses to be remedied or greater benefits to be gained. Such gains and needs for remedy were not established. The history of the Federal Reserve System contained no example of what could be called a scandal, such as private gain for System officials. Third, there was fear that concession here might lead to greater harm; that is, the demand for government audit would be followed by government budget-control. This fear was perhaps the most important reason. Thus government audit, both in itself and in its consequent control elements, would limit the freedom of judgment on policy matters. It probably would be like a small breach in the wall of separation between the government and the Federal Reserve. There was one particular part of the "wall of separation" that seemed to be the special object of attack. In the discussions about audit, some members of Congress had their aim on the "private" element in the Federal Reserve System. The participation of private banks in the ownership and the decisionmaking process of the System led to the suspicion that the System was operated for the profit of private banks. Audit reports, if unbiased and properly detailed, were expected to substantiate such suspicion. This result seemed more likely since the System frequently used its unique structural arrangement to hold Congress at arm's length. Moreover, some Congressmen claimed that this particular arrangement opened the door to a conflict of interest situation : the decision makers had access to inside information about actions of the Federal Reserve which affected companies in which they had ownership or positions of control. The suspicions engendered by

368

THE INDEPENDENCE O F T H E FEDERAL R E S E R V E

SYSTEM

such logic had no end except in distrust for all System officials, whether they were connected with private banks or not. If the hopes of Congressmen to cast such suspicions were realized through information gathered in government auditreports, Congress certainly would have a stepping-stone toward making the Federal Reserve System an all-public institution or even abolishing it. Since the most fervent proponents of government audit, however, also affirmed their acceptance of a Federal Reserve System, the audit question was restricted to a challenge of the private participation feature. For this reason it was connected with another Congressional proposal which affected the independence of the Federal Reserve— government ownership of all the stock of the Federal Reserve Banks.

XIII The Ownership of Federal Reserve Bank Stock as an Issue of Independence

T H E REPORT OF THE SUBCOMMITTEE OF THE JOINT ECONOMIC

Committee in 1952 devoted one of its sections to the "finances" of the Federal Reserve System. Under this title it considered four topics—(1) private ownership of the stock of the Reserve Banks; (2) disposition of the earnings of the Banks; (3) tax exemption of dividends on Reserve Bank stock issued prior to 1942; and (4) budgetary and auditing procedures. The report stated that the significance of these "finances" was that they gave the Federal Reserve System "a substantial degree of independence from Congress," and that "this independence has an impact on the formulation of monetary policy.'" The "substantial degree of independence" and the consequent "impact on monetary policy," the Subcommittee reasoned, came from three concomitants of the private ownership of the Reserve Bank stock. First, private ownership of the stock helped to establish the propriety of the System's being outside the procedures of the Federal Budget. Second, it gave the System grounds for not submitting "to the ordinary 1

Patman Subcommittee

Report, 1952, p. 59.

369

370

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

techniques of Congressional control," such as budget approval and appropriations, because it served "as a memo from Congress to itself that [Congress had] chosen to leave to the System a great deal of autonomy in its day-to-day and year-by-year operations.'" Third, the private ownership of the stock provided a meaningful link between the Federal Reserve and the private business community. After setting forth these reasons, the report quoted a prominent banker's testimony which it said was "so ably" spoken : I have been able to find no sound reason for the Government to acquire the stock in the Federal Reserve banks unless the ultimate objective is to destroy the independence of the System and make it merely a Government bureau.' In discussing the private ownership question, the subcommittee report noted that the capital provided by the stock was not a substantial factor in helping the Federal Reserve Banks in their operations or their ultimate solvency, since it amounted to less than one-half of one per cent of the total resources of the Reserve Banks (March, 1952). Moreover, while this stock arrangement gave a measure of participation in the System to private business representatives, it did not alter the control possessed almost entirely by the government through the Board of Governors. Since there was the sanction of tradition and the valuable link with the private business community, the report concluded that it saw no reason "why this memo and link should be disturbed as long as it [continued] to serve a useful purpose.'" When the Federal Reserve used monetary policy with greater flexibility, especially in a restrictive way, in the post-accord and post-1953 years, it again faced Congressional questions about the private owner5

Ibid., p. 60. Ibid., p. 61. Testimony of A. L. M. Wiggins. ' Ibid.

3

O W N E R S H I P OF F E D E R A L R E S E R V E BANK S T O C K

371

ship of stock in the Reserve Banks. Doubts arose about the "useful purpose" of such an arrangement, about the importance of the independence it implied, and about the bad results to follow if it were altered. Historical Background of Ownership Issue The stock which formed the contributed part of the capital structure of the Federal Reserve Banks was a unique type of stock. Its certificate did not tell what the rights of the stockholding bank were, except to deny one aspect of proprietary control : the shares of stock could not be transferred or hypothecated. The stock certificate simply stated that the evidenced stock was issued in pursuance of the provisions of the Federal Reserve Act as amended and was paid up to the extent of 50 per cent of par value.* Reference to the Federal Reserve Act revealed four other characteristics: (1) the amount of the stock to which a member bank subscribed was an obligatory 6 per cent of its own capital and surplus; (2) the member bank was responsible for the obligations of the Reserve Bank to the amount of the subscription in addition to the amount subscribed (3) the dividend was cumulative and fixed at 6 per cent on par value of $100; (4) on liquidation of the Reserve Bank and the payment of its liabilities, the stockholder would receive par value and unpaid dividends, and the Treasury would acquire title to any surplus which remained after those payments. Technically, the Federal Reserve Act was not clear as to whether other rights of the member banks came directly from the stock which they owned or 5 C o n g r e s s m a n W r i g h t P a t m a n p u t t h e w o r d i n g of such a c e r t i f i c a t e in the Congressional Record of J u n e 9, 1 9 5 9 . U . S . , Congressional Record, C V , 9352. ' B a s e d o n a 5 0 p e r c e n t p a i d - i n v a l u e , this a m o u n t e d t o a f o u r f o l d liability.

372

T H E INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

from the fact of their membership. Each member bank had the right to vote for two of the nine directors of its Reserve Bank. And there were other rights not ordinarily connected with a stock certificate, such as rights to the services of the Reserve Bank and to participation in the Federal Advisory Council.

View

of Founders

on Stock

Ownership

The founders of the Federal Reserve System discussed various ways to make certain that the Reserve Banks would have sufficient funds to begin operations. They foresaw three sources of these funds—(1) paid-in stock subscriptions (in gold or gold certificates) ; (2) deposits of member bank reserves (not necessarily in gold or gold certificates, though that was the preferred way from the viewpoints of the founders); (3) deposits of government moneys. They were not fully confident that an adequate number of banks would become members; so they provided that if additional funds were needed, nonvoting stock should be sold, first, to the public and, finally, to the government.' Such stock was called public stock and was transferable. Since Section 2 of the Federal Reserve Act explicitly stated that "stock not held by member banks shall not be entitled to voting," it could be inferred that the voting right was part of the rights evidenced by the stock certificate held by member banks. Though the particular characteristics of Federal Reserve Bank stock were somewhat complicated, they did not obscure ' They obtained membership by signifying in writing their acceptance of the terms and provisions of the Federal Reserve Act and by subscribing to the stock. " The government was expected to sell later any holdings it might acquire.

O W N E R S H I P O F F E D E R A L R E S E R V E BANK S T O C K

373

the intention of the founders of the Federal Reserve System to have the Reserve Banks owned and even controlled by the stockholding member banks. This ownership and control arrangement was considered to be a means of independence for the Reserve Banks from both private and government domination. In his report to the Senate on November 22, 1913, Senator Robert Owen pointed out this relationship between stock ownership and control. Among several reasons for requiring the member banks to subscribe to this stock with a double liability, Senator Owen mentioned that private ownership of the stock would : . . . justify the Government in putting on the [member] banks the prime responsibility of administering these [Reserve] banks and safeguarding their own reserves and their own capital stock, and making them responsible to the country for safeguarding the welfare of the national banking system, protecting the national gold supply under the safeguard of governmental supervision." Likewise, Carter Glass revealed his judgment in statements which he made at the time of the consideration by Congress of the Federal Reserve Act and later when Congress challenged the stock requirement and proposed changes in the law. In a report to the House of Representatives in September, 1913, Glass referred to the Reserve Banks as "privately owned institutions'"" which acted "primarily in the public interest."" He took for granted they would be organized like other business corporations, banks in particular. For example, he stated that their organization was like that of national banks : Unless it be true that the reserve banks are granted some special privilege or relationship to the Government there will be no reason why they should not be organized upon the same basis 9

Owen Report, 1913, p. 9. Glass Reports, 1913, p. 19. " Ibid., p. 20. 10

374

THE INDEPENDENCE OF THF. FEDERAL R E S E R V E

SYSTEM

and for the same general purposes as existing banks. Indeed, with one or two minor modifications of existing law they could be so organized under the present national bank act."

And again : "There is no reason why any important distinction as to type of organization should be drawn or exist between the typical reserve bank and the typical

national

bank."" T o Carter Glass the compulsory and pro rata capital contribution by the member banks and the restricted voting arrangement were not veiled denials of private ownership. Rather they were means to the achievement of a "democratic organization"" constituted by "the democratic representation of the several institutions which are members and stockholders of a reserve bank.'" 5 The emphasis on "democratic" rested on the principle that voting power was not proportional to the number of shares of stock owned : no matter how many shares it owned, each stockholding bank could cast only one vote for each of two types of directors. This businesslike and democratic organization of the proposed Reserve Banks, Glass explained, was considered necessary for the establishment of corporate entities which would act "primarily in the public interest" and which would have "motives and conduct . . . so absolutely well known and above suspicion as to inspire unquestioning confidence on the part of the community."" The right of the Federal Reserve Board, a government organization, to appoint one-third of each Reserve Bank's board of directors did not change the reasoning of Glass about the private aspects of the organization being established. Ibid., Ibid., "Ibid., 15 Ibid., " Ibid., 13

p. p. p. p. p.

32. 36. 37. 36. 20.

O W N E R S H I P O F F E D E R A L R E S E R V E BANK S T O C K

Later

Congressional

Challenges

of Ownership

375

Feature

In the middle Thirties when the question of strengthening the control of the Board of Governors was seriously considered by Congress, the allied question of the ownership of the Federal Reserve Banks was discussed. Popularly, the Reserve Banks were judged to be owned by the member banks. An unofficial steering committee of 160 members of the House of Representatives sponsored a law providing for changing the ownership arrangement so that it would unmistakably be governmental." Although extensive hearings were held in 1938, the proposal never came to a vote in the House. Part of the reason for its failure was the suspicion that the proposal was part of a vast inflationary scheme and had initially won support because of an expectation by some Congressmen that its passage would make other favored schemes more likely to succeed." Another part of the reason for its failure was the contention of some that it would give Congress no new power of control over the System, although this point was strongly disputed. The stock ownership feature was said to be different from ordinary common-stock ownership and more "like an investment in a Government bond."10 Chairman Eccles of the Federal Reserve Board also testified that the private control connotation of stock ownership was being over emphasized : "Ownership of stock by member banks does not enable the bankers to control the Federal Reserve System. It is more nearly in the nature of a compulsory capital contribution than a stock ownership."20 In the Fifties, the question of ownership reappeared, princi" Patman Stock Hearings, 1938, pp. 1-2. *' Ibid., p. 19. Ibid., p. 50. (Testimony of Committee Chairman Henry B. Steagall.) 20 Ibid., p. 446. 18

376

THF. I N D E P E N D E N C E O F T H E F E D E R A L R E S E R V E

SYSTEM

pally because the Federal Reserve resisted pressure from Congress for a more detailed accountability by appealing, in part, to its private-government institutional character."' As was mentioned before, this pressure from Congress increased when the Federal Reserve, acting on its independence enunciated in 1951 and 1953, used its powers to act in a restrictive and unpopular manner." T h e question of ownership became very explicit when Representative Wright Patman publicly challenged the propriety and legality of certain expenditures of the Federal Reserve Bank of Chicago. The Chicago Tribune of February 12, 1958, printed the following caustic comment by an official of the Chicago Reserve Bank on Representative Patman's public criticism : Fred Wilson, assistant vice president of the Federal Reserve Bank of Chicago, said . . . that Representative Wright Patman . . . "probably has the facts about Federal Reserve bank expenses, but obviously is misinterpreting them. A Federal Reserve bank is owned, lock, stock, and barrel by its member banks. . . . There is no taxpayer money involved, and we are not subject to the Federal Government's accounting. We try to be a part of our community just like any private institution, business, or industry."13 ' I n 1942, the problem was treated in a rather oblique way. From the beginning, dividends on Tederai Reserve Bank stock were exempt from income taxes. This exemption was eliminated by the Public Debt Act of M a r c h 28, 1942. This Act stated that d i v i d e n d s : . . . from shares, certificates, stock, or other evidences of ownership . . . issued on or after the effective date of the Public Debt Act of 1942 by the U n i t r d States or any agency or instrumentality thereof shall not have any exemption as such. . . . (56 Stat. 190. Cf. The Federal Reserve Act, as Amended through December 31, 1956, p. 16.) ~ This action was initially approved by Congress partly because it showed the System's independence of the Treasury. ":l U.S., Congress, House, Subcommittee No. 3 of the C o m m i t t e e on Banking and Currency, Hearings on Retirement of Federal Reserve Rank Stock, Part 1, 86th Cong., 2d Sess., 1960, p. 18. C i t e d - h e r e a f t e r as Patman Stock Hearings, 1960.

O W N E R S H I P O F F E D E R A L R E S E R V E BANK S T O C K

377

Later at a Congressional hearing, the President of the Chicago Bank stated that he had informed the assistant vice president that he did not approve of the opinion given to the newspaper. Although the official involved resigned the following year, his statement acted as a catalyst for Congressman Patman. With the support of other Congressmen, Patman introduced in 1960 a bill to provide for the abolition of the private ownership of the stock of the Reserve Banks. Congressional Arguments Against Private Ownership of Stock The arguments of members of Congress against private ownership of the stock of the Federal Reserve Banks were repeated and redeveloped in various Congressional hearings during the Fifties. In general, the arguments were that (1) such an ownership arrangement was not necessary, and (2) it produced undesirable results. Private ownership was not necessary for several reasons. It did not serve the usual capital function of providing necessary funds for operations; the money value of the stock was relatively too small for that purpose. It was not required for the essential money-creating power of the System, nor was it needed as a cushion for the protection of the liabilities of the Reserve Banks. Means other than stock ownership, such as a certificate of membership issued for a fee or compulsory deposits on which interest would be paid, could be used to keep the present voting rights and the "sense of belonging" for the member banks. Obstacle

to Congressional

Control of Federal

Reserve

Various undesirable results of private ownership of the stock were mentioned. The two most important concerned the con-

378

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

trol of Congress and its responsibility to the electorate. The private ownership characteristic was considered by some Congressmen to be a means used by the Federal Reserve to make itself immune to control by Congress. Thus it was a protection for independence and, in the view of these Congressmen, too great an independence. For example, when the Chairman of the Board of Governors was asked by members of Congress to give his approval to proposed changes in Federal Reserve procedures or even to give information about the System's decision-making process, he requested that he be allowed to consult other officials in the Federal Reserve, including Reserve Bank officials. A prime example of this occurred when Senator Douglas, almost to the point of exasperation, tried to get information about the vote of the Open Market Committee taken when it decided to come to the aid of the Treasury in November, 1955* This wall of secrecy was likewise resented when it hindered Congress from placing responsibility for decisions taken by the Federal Reserve.'5 Members of Congress chafed at this type of response; they did not like to be put off and to be subjected to arm's-length treatment by their agent. Such action was especially irritating when it was felt to be the result of the authority exercised by the Reserve Banks' directors whose majority was elected by the stockholding member banks. Of course, the stockholding arrangement was made the scapegoat; the committee form of authority for the Open Market Committee was the more basic source of irritation, as in a sense it was meant to be.

21 Martin Nomination Hearings, 1956, pp. 6—11. (At the time, the annual report of the Board, which gave an accounting of the vote, had not been published.) M Cf. Byrd Hearings, 1957, pp. 761-766; 1495-1504. Also, Martin Nomination Hearings, 1956, pp. 6—11.

O W N E R S H I P OF FEDERAL R E S E R V E BANK STOCK

Public Misinterpretation

of Stock

379

Ownership

The second undesirable result of the private ownership of all the stock of the Reserve Banks came from the popular interpretation that private ownership of the stock meant private ownership of the Federal Reserve Banks. That interpretation made it difficult, said members of Congress, to justify to the public a restrictive monetary policy : that it was carried out by the Federal Reserve in keeping with government policy and not necessarily to satisfy the wishes of private banks who "discriminated against small borrowers" and at the same time increased their own profits. Moreover, private ownership seemed to imply that private banks controlled the investment of assets worth billions of dollars and thereby, independent of the government, controlled to a large extent the destiny of the national economy. If they abolished the private ownership of Federal Reserve stock, members of Congress judged that they would be better able to exercise their own responsibility for control and direction and to satisfy their constituents that the monetary authority was under the full control of Congress. The popular explanation of necessarily restrictive actions would not be cluttered with irrelevant considerations. Federal Reserve Defense of Status Quo When Congressional subcommittees took up the question of the private ownership of Federal Reserve stock, they took testimony from both the Presidents of Reserve Banks and the Board. This testimony in general emphasized three ideas on the private ownership question : (1) the meaning of the private holding of Reserve Bank stock often was not understood properly and was even misinterpreted, (2) there were no strong

380

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

arguments for a change because of abuses resulting from the arrangement or from a misunderstanding of the arrangement, and (3) the private stock arrangement was important for the independence of the Federal Reserve. Ownership

of Stock as Distinct from

Control

The lack of proper understanding and the actual misinterpretation of the significance of private ownership of Reserve Bank stock was based on a tendency to give a univocal meaning to all common stock. This tendency became more pronounced when the stock was the only evidence of a contribution in a corporation's capital structure. T o counteract this interpretation, Federal Reserve officials attempted to explain why this stock was different from other common stock. Pressed on the point by Congress, they admitted that funds obtained through the issuance of stock were not necessary for the mechanical operation of the central banking function of the Banks. Moreover, the owners of such stock as a group did not acquire full ownership, and its accompanying characteristic of full control, of either the System or even the Reserve Banks. Chairman Martin maintained that the ultimate control within the System was held by the Board, not by the Banks : I think we have control and that we have a well-balanced, wellknit system. The final authority is in the Board of Governors. . . . I don't think there is anything they could do [if the Board disapproved of Reserve Bank action]. We could disapprove the salaries of any employee, right down to a guard. That would be pretty effective.1* Hence the ownership which was being discussed did not imply the control ordinarily involved in proprietorship. Equally im-6 Patman

Stock

Hearings,

1960,

p. 254.

O W N E R S H I P O F FEDERAL R E S E R V E BANK STOCK

381

portant for a proper understanding was the fact that the private-stock arrangement did not controvert the public character of the Reserve Banks. In the opinion of the Chairman : "The stockownership of the private banks in the Federal Reserve bank in no way detracts from the public character of the Federal Reserve System or gives the member banks any real control over that system."" Separation from Proprietorship. These ideas expressed by the Federal Reserve were not new; but since directly or indirectly they were challenged by Congress, they merited repetition. The Presidents of the Reserve Banks, in 1952, were asked about the implications of private ownership of stock and about the technical relations of the Reserve Banks to the government. Their answers made clear that they interpreted the ownership of stock as giving not proprietary control but rather a right of membership in the Federal Reserve Banks : Federal Reserve banks are "instrumentalities" of the Federal Government. As such, they act as agents of the Government in performing Government functions. . . . [They] are partially part of the private economy and are part of the functioning part of the Government (although not technically a part of the Government). . . . Ownership of stock does not imply proprietary interest in or the control over policies and operations of the Reserve banks. . . . Member bank ownership of the stock of the Reserve banks was not intended to place control of the System's policies in the hands of the member banks, and has not, in fact, done so. . . . It implies, rather, private provision of capital for, and membership in, one of a federated system of regional banks which administer and help to formulate monetary and credit policies which will contribute to a sound and stable economy. [Emphasis added.]" " Ibid., p. 227. *Patman Compilation,

Part 2, 1952, pp.649; 646-647.

382

T H E INDEPENDENCE O F T H E F E D E R A L R E S E R V E

SYSTEM

Even earlier, in 1938, when Congress considered abolishing the private ownership of the stock, the public aspects of the Reserve Banks were expressed in a more direct fashion by a member of the staff of the Board of Governors (and later its long-time Secretary) : Except perhaps in certain technical respects, [the Reserve Banks] are wholly outside the field of private proprietorship and of private enterprise. They are rather in the field of government. In structure, in function, and in respect to their powers, which are great in degree but narrowly limited as to purpose, they are public institutions.1" Complexity of Ownership Issue. Perhaps the Presidents of the Reserve Banks in 1952 were not as direct as was this Board staff member in their answers because they felt more uneasy, even fearful, about where their logic would lead them. Hence they seemed to want to make clear that qualifications on the meaning of private ownership were unique in the analysis of stock ownership and did not constitute an affirmation of government ownership. Thus the denial of the usual implications of private ownership did not lead to a ready acceptance of all the logical impedimenta to independence which were likely to be set up under the assumption of government ownership. This lack of a clear-cut disjunction between private and government ownership was manifested in the following dialogue which took place between Alfred Hayes, President of the New York Reserve Bank, and Congressman Oliver at a Congressional hearing in 1960 : OLIVER

: Your statement would lead me to believe there is a contention that there is no proprietary interest in this

59 "Federal Reserve Functions," an address given by Bray Hammond before the Ohio Valley Chapter, American Institute of Banking, Marietta, Ohio, May 21, 1938, p. 14. (Mimeographed.)

O W N E R S H I P OF FEDERAL R E S E R V E BANK STOCK

HAYF.S

: :

OLIVER

HAYES :

:

OLIVER

HAYES

:

383

so-called stock which the member banks have subscribed to. No proprietary sense in which that phrase is usually used; that is correct. And one could draw the assumption from that, then, that the Federal Reserve Banking System is a publicly owned system. I think it is essentially a system identified with the public interest. You would not say categorically it is a publicly owned institution? T h a t is a complex point. I certainly wouldn't say it is privately owned. I would say the stock is owned by private interests. What that makes the ownership of the System is very difficult to define; but I certainly would agree in spirit with what you say, that it is a public entity. 10

Congress itself had tried to put this "complex point" in proper perspective. The 1952 Subcommittee of the Joint Economic Committee which specifically considered this ownership question admitted the analogical meaning of stock ownership and left the matter there : T h e Subcommittee sees no objection to this hard-to-define position of the Federal Reserve banks. The Federal Reserve System has been a helpful institutional development. Its roots are sunk deeply in the American economy and it has borne good fruit. This is more important than that each portion of it be subject to classification by species and genus according to the rules of a textbook on public administration. But, one fact with respect to the legal status of the Federal Reserve banks stands out, and it is the only fact of importance. 30 Patman Stock Hearings, i960, p. 175. M r . Hayes had earlier s a i d : " I think this is an entirely different breed of cat from the stock of an average privately owned corporation, and it should certainly n o t be treated in the same m a n n e r . " (Ibid., p. 174.)

384

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

Congress created the Federal Reserve banks and Congress can dissolve them or can change their constitution at will. . . . Ultimately they are creatures of Congress." Further Attempts at Clarification. Congress did not remain satisfied, however, with its own judgment. Because Federal Reserve officials did not define the Reserve Banks as govemment-owned, the question apparently could always be reopened and the propriety of the stock arrangement challenged. T h e affirmation of a public character, public purposes, and ultimate control by the Board of Governors, a government body, was not enough to bury the matter. For one thing, the word "public," which was frequently used, did not necessarily mean "government." Nor did great help come from the recurring expression of the Chairman of the Board : " T h e Federal Reserve banks are quasi-public institutions."*2 At a later time he changed his definition : " T h e Federal Reserve banks are quasi-government, or quasi-private, depending on where you want the emphasis."*" This was a kind of definition of ignotum per ignotum. T h e qualifier "quasi" was also applied to private commercial banks by Governor James L. Robertson of the Board when he talked about the public interest which was their guiding purpose. In testifying against a proposed change in the National Bank Act to authorize national banks to grant stock options to their employees, he argued that unlike ordinary corporations national banks, were "quasi-public" institutions : Some banks might be encouraged by this authority [to grant stock options to employees] to develop unduly profit-minded managements. Even though employees' stock option authorizations may be appropriate for other types of corporations, the Board 31 37 M

Patman Subcommittee Report, 1952, Patman Hearings, 1952, p. 122. Joint Economic Committee Hearings,

p. 51. 1960,

p. 19b.

O W N E R S H I P O F F E D E R A L R E S E R V E BANK S T O C K

385

questions whether they are appropriate in the case of commercial banks which are quasi-public institutions entrusted with other peoples' money."

This statement might be used to show that Reserve Banks when described as "quasi-private," "quasi-public," or "quasigovernment" were similar to commercial banks which were admittedly private in ownership and control. Despite the effort, the lack of preciseness in definition kept the door open to misunderstandings about the location and the meaning of the ownership of the Reserve Banks and to suspicions about their zeal for the public good.

No Necessary

Reason

for

Change

Even with the failure to define strictly the ownership of the Reserve Banks, Federal Reserve officials still maintained that the Banks carried out public purposes and were ultimately under the control of a government agency, the Board of Governors. On the basis of this premise, they argued that there was no necessary reason to change the private-stock-type organization; the matter of misunderstandings should be the object of an educational program by Congress as well as by the banking community. Basically this solution meant an education in the details of both commercial banking and central banking. It also involved making well known the public purposes of the Reserve Banks and the unique and competent organization established for the achievement of these public purposes. In this education, one item required repetition : ownership as applied to the Reserve Banks was an analogous concept. Stock ownership did not necessarily connote full proprietorship. 31

U.S., Congress, Senate, Committee on Banking and Currency, Hearings on Study of Banking Laws, Part 2, 84th Cong., 2d Sess., 1957, p. 863.

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T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

As a reason for change, it could not be argued that there were glaring abuses based on private stock ownership. One of the glories of the Federal Reserve Banks, according to Allan Sproul, was that with all the investigations there was no established evidence of scandals, influence peddling, or favors given and received in connection with the operations of the Reserve Banks.33 Even when Congressman Patman picked out and complained about items from the examination reports of Reserve Banks, he did not claim that the actions of the Reserve Banks were strictly in violation of the law. He questioned their judgment. He challenged their right to do what they did, but only on the supposition that these Banks were entirely government-owned and were using only government funds. The "glory" was not without an explanation. The checks and balances built into the organization of the Reserve Banks and the System as a whole were safeguards against any abuse of the private ownership of the stock. In all Federal Reserve defenses of the status quo there was an emphasis on the word "system." Thus, it was said the organization's structure minimized the chance that its power would be controlled by an individual ; its decisions were made by a deliberative process in which representatives of private business and of the government and the public had a voice. In addition, the exercise of power had to take into account national goals and public reactions, thus removing the likelihood of any despotic power being exercised or even of any experimentation with power for experimentation's sake.3" Cf. Patman Compilation, Part 2, 1952, p. 649. Allan Sproul developed this idea that the power of the Federal Reserve could not be used "arbitrarily or capriciously" : 33 x

In the first place, it is a power exercised by a group of individuals of differing backgrounds and talents, and with differing approaches to the policy actions upon which they must finally agree. There are checks and

O W N E R S H I P OF FEDERAL R E S E R V E BANK STOCK

387

Finally, to supplement and to challenge the public disclosures of actions taken, Congressional committees and subcommittees were ever ready to put the Federal Reserve officials on the witness stand. Since the public interest was at stake, public criticism was pari of the life of the System. The criticism may not have always been welcomed, but at least it was always possible. Most of the discussion about the role of private banks in the power-control process of the Federal Reserve System was connected with the whole rationale of the organization of the System and not essentially with the stock ownership held by the member banks. However, traditionally, and partly structurally, this participation was connected with the stock arrangement; so defense of the private ownership of the stock came to bear the burden of the challenge to the role of the private banks.

Instrument

for Cooperation

Between

Business and

Government

The tenacity of Federal Reserve officials in defending the private ownership of Federal Reserve stock did not mean that they considered this arrangement absolutely necessary for efficiciency or even for independence. The founders of the Federal Reserve System seriously considered other ways of balances such as «ire characteristic of our whole concept of Government, which give assurance that decisions will be reached by a deliberative process, and that power will not be wielded by an individual who might acquire the habits of a despot. In the second place, it is power exercised in the white light of full disclosure: weekly, monthly, and annually our actions are publicly reported for all to examine and to judge. Finally, it is power exercised within the limits of national objectives and public tolerance, which would not permit the Committee to indulge a sense of power or to experiment rashly with it, even if it were so inclined. ["Reflections of a Central Banker," The Journal of Finance, XI, No. 1 (March, 1956), p. 8.]

388

T H E INDEPENDENCE OF T H E FEDERAL R E S E R V E

SYSTEM

acquiring funds and bringing in private banks as participants." The stock arrangement was important because it was the initial arrangement and the form under which the Federal Reserve System became successful and grew to its present stature. Consequently, in the opinion of Federal

Reserve

officials many of the favorable features and good results of the Federal Reserve System were connected with the arrangement providing for the private ownership of the stock of the Reserve Banks; the abolition of this arrangement, moreover, might cause disruptive interpretations and might lead to the loss of needed cooperation and confidence on the part of private business people both at home and abroad. The original decision to establish the corporate and privatestock type of organization was not completely arbitrary. The choice was based on the reasoning that the stock arrangement would assure participating banks that the Federal Reserve System would not become a monolithic government giant. With this assurance, private banks and other private business interests were more likely to have confidence in the new System and to cooperate in working for the success of the Federal Reserve. The stock-issuing corporate form of business was well-known

and well-tried, and thus it became

an

advantageous tool for the purpose at hand. The corporate form had to be qualified, however, to handle the objections of those who insisted on strict government control. T h e compromise arrangement restricted the rights of member banks holding the stock of the corporation so that the government had a significantly controlling position in the total venture. Even so, the opportunity offered to private business for participating in the establishment and operation of efficient " C f . H. Parker Willis, The Federal Reserve System: Legislation, Organization and Operation (New York : The Ronald Press Company, 1923), pp. 119-120.

OWNERSHIP OF FEDERAL R E S E R V E BANK STOCK

389

and effective Reserve Banks was important in winning the needed support of private commercial banks for the start of the Reserve Banks. It seemed clear that in the minds of commercial bankers this opportunity for participation was connected with their ownership of the stock of the Reserve Banks. Over the years the authority of the boards of directors of the Reserve Banks in the making of System policy gradually diminished in fact and in theory. The change was accepted as part of the evolving centralization within the System and of the formulation of national economic policy directly by the government. The speed and extent of the change, however, was resisted by member banks, partly through the voice they had as stock-holding member banks. Though the trend was to unity of control within the System, it did not cast aside the regional idea or private participation. The Federal Reserve System still remained a system. The report of the 1952 Congressional Subcommittee recognized these dual and interrelated organizational elements : central and regional, private and governmental. Moreover, it recognized the position of the Federal Reserve that the private participation in the System could be effective in promoting the public interest : The directors of the individual Federal Reserve banks have a large degree of responsibility with respect to the business management of their institutions but relatively little authority in the determination of monetary policy. They are, for the most part, men with a large amount of business experience and a broad point of view with respect to the public interest. They are an invaluable link between the Government and the business community. Because of them, the Government is better able to understand the point of view of business and business is better able to understand the point of view of Government. The Subcommittee believes that it is important that their responsibility, not merely in the business management of their banks but also in the formu-

390

THE INDEPENDENCE OF THE FEDERAL RESERVE

SYSTEM

lation of monetary policy, should be kept sufficiently great to attract men of high caliber."

Risks Involved

in

Change

Federal Reserve officials connected the private-stock arrangement with the attracting of men of high caliber to participate in the management and staff functions of policy making and supervision of operations. Such participants had to have a sign of responsibility if they were to make their contribution in the public interest. Traditionally the private ownership of stock was accepted as a symbol of responsibility. T o change this arrangement without evidence of its producing unsatisfactory results might lead, both at home and abroad, to a loss of confidence in the Federal Reserve System's ability to safeguard the currency. The loss of confidence might come from interpreting the abolition of private stock ownership as a step in the direction of completely centralizing the System and eventually of transforming the Federai Reserve into another bureau of the government. Such a change might be seen as the prelude to the nationalization of all commercial banks. Thus new life would be given to old fears of the government's abuse of its monetary power. Although this reasoning was based on conjecture and traditional belief, nevertheless it showed how confidence might be damaged. The risk here, Federal Reserve officials argued, was too great. Hence the private ownership of Reserve Bank stock should be kept intact. It was significant in maintaining confidence in a meaningful independence for the nation's monetary authority. There was another, less subtle, way in which the abolition of private ownership of Federal Reserve stock might change the traditional independence of the System. The elimination of "Potman

Subcommittee

Report,

1952, p. 53.

O W N E R S H I P O F F E D E R A L R E S E R V E BANK S T O C K

391

the stock might well result in the dependence of the System upon Congress for appropriated moneys for operating purposes. Using the common business capital arrangement of stock and surplus, the Reserve Banks were able to retain some earnings as a provision against unexpected losses and for expected operating and expansion purposes. Without stock in the capital structure, it might be more difficult, in a political sense, to use the argument from customary business procedure to build and maintain a surplus or even to provide for operating expenses. There was no doubt that without this capital arrangement Congress would appropriate the necessary funds; but then the judgment as to what was "necessary" would be more directly in the hands of Congress, and policy decisions of the System would be directly subject to various lobbying and partisan influences. The long-range point of view might be lost in the scurrying in the halls.

XIV The Independence of the Federal Reserve System—Retrospect and Prospect

AT

THE

FOUNDING O F T H E

FEDERAL

RESERVE

SYSTEM

THE

question of its independence was a vital issue. A stable and efficient monetary and banking system was the need of the hour. Past and current history read by the founders of the Federal Reserve seemed to teach the necessity for establishing a monetary authority which had freedom to develop and to express a technical viewpoint on orderly monetary affairs, to explain and urge unfailingly that viewpoint, and to take the action it required. T h e powers required for the operation of the Federal Reserve were considered too potent for good or evil to be placed in jeopardy from partisan influences, government or private. As a consequence, the Federal Reserve System was founded and endowed with an independence of judgment and action. Although this independence was a vital issue at the time and remained so, its meaning and emphasis changed through the years. Independence—Retrospect Nobody doubted that the sovereignty of the government— the freedom of the government to do what it wanted—was 392

INDEPENDENCE OF T H E FEDERAL R E S E R V E S Y S T E M

393

part of the independence issue. If the Federal Reserve System was to be effective, it had to have this sovereignty interwoven into its fabric. This enhancement was, of course, part of the grandeur of the new System. It was also a limitation on the ordinary concept of the sovereignty of the government, but a limitation accepted by the government and promoted by private interests and by the builders of the new structure. By design or otherwise, the unique arrangement implied that the government as such was not to be trusted. As the Federal Reserve developed, this implication became evidently false. Experience led to a more reasoned view that the new System was not a rival empire to the government. Rather it was seen as an organization of the government, the government's tool— an efficient means for accomplishing the government's purposes. In a very real sense, it was not something aloof from the government; it was the government in action. The Federal Reserve System required power and strength to express and to act according to its expert and independent viewpoint. The power and the strength were designed not to make the government's freedom less, not to make the government's program for national monetary and banking action impossible ; the power and the strength were meant to provide an obstacle to unsound and unwise financial procedures and to promote the sound and the wise. Such action required that the sound and the wise be made evidently so. Hence, as in all cases, responsibility went with freedom and power. Freedom could be exercised in this case only if the monetary authority proved to be the expert and the independent power it was intended to be. Proof was expected in action and results; and these had to be clearly and adequately explained. Without this proof and this explanation, the independence of the Federal Reserve was not only meaningless; it was politically impossible. The political feasibility of an independent Federal Reserve

394

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

SYSTEM

concerned both the Congress and the Executive. The power to keep or to change the System—its structure, powers, and responsibilities—remained constitutionally with Congress. As long as Congress gave monetary power and responsibility to an agent, that agent needed the confidence of Congress to keep its status. The Federal Reserve System grew up to a ready recognition of this dependency and showed its growth by an increasing willingness to acknowledge publicly its agency status. Not only acknowledgment was given ; there was also an increasing readiness to explain : what the System was, what it did, and how it was necessary for the promotion of government objectives and for the welfare of the citizens. Explanation was meant to be reassuring to Congress; undoubtedly, at times it was. The need for cooperation likewise bound the Federal Reserve to the Executive. His was the duty to carry out the laws of the land, to promote national goals. In the fulfillment of that duty he could try to ignore the Federal Reserve and through various means bypass the monetary authority. T o offset this kind of domination, the Federal Reserve could object, even "nag," to the point of resignation of its own officials. On the other hand, it could, and did, win respect and a hearing by establishing the worthwhileness of its own expert and independent viewpoint and by giving a knowledgeable cooperation in the Executive councils and actions. The agency relationship, or "servant" relationship, as Congressmen and Federal Reserve officials also called it, and the willing cooperation within the government were not easily reconciled with a meaningful independence. They could descend into a discussion on words and words alone. In an attempt to avoid this pitfall, Federal Reserve officials developed the concept of a trust. An agency, performing a government function and endowed with a measure of inde-

INDEPENDENCE OF T H E FEDERAL R E S E R V E S Y S T E M

395

pendence for its performance, at some point had to be trusted. This concept perhaps was no more definite than that of agent or servant. It was, however, a concept that was implied in the government's own exercise of sovereignty—trust by the people ; it was also a concept that helped to draw a line on where government control as to details stopped : at the point of trust. The development of the concept of trust and trusteeship was an attempt to put the independence of the monetary authority in proper perspective. Yet in itself it needed explanation; and the ever-present problem of the Federal Reserve was how to make meaningful this concept of trusteeship. It was a difficult task to be and to remain a trustee with power and discretion. By its actions, the Federal Reserve could not always and immediately please all interested parties—the Executive Department, the Congress, private banks, the public. It was a difficult task because it meant to some significant degree a hands-off policy on the part of not only the Executive and the Treasury but also the Congress. The hands of all these were strong. Hence a tolerable trusteeship demanded adequate safeguards built into its structure. Since the exercise of a sovereign power of the government—the monetary power— was at issue, the trusteeship had to include assurance that it existed and operated for the public good as established by the government. Providing this assurance had its positive and negative elements. The negative elements concerned resistance to, and containment of, various interfering pressures from partisan and government groups as well as from private banking and business interests. The negative, however, did not overshadow the positive elements. These involved ultimate control by the government and active cooperation with other government units. They also included participation and subordinated

396

T H E INDEPENDENCE OF T H E F E D E R A L R E S E R V E

SYSTEM

control in the trusteeship by private interests in a meaningful way, but only for the public good. Some proposals, such as a mandate, an audit, and a change in stock ownership, were concerned immediately with the adequacy of the control of Congress over its trustee. Other questions, such as relations with the Treasury and the Executive agencies, touched the problem of control by Congress less directly. Here the suggestions were for new legal arrangements to enable the monetary authority to carry on its work in keeping, of course, with the mind of Congress. T h e monetary authority could be made a bureau of the Treasury or a participant in some higher economic council in the Administration ; but no matter what the arrangement, it did not wipe out the fundamental trust which Congress gave and for which Congress demanded accountability. The Federal Reserve resisted changes in the trusteeship when such changes, either individually or in consequential groups, were judged to be restrictions on the independence of the trustee to act within the framework of the already given trust. Such reaction did not solve, but rather made clearer, the dilemma : how to increase acountability, how to give clear and sufficient explanations, and not to harm a proper independence. T h e increasing scope and responsibility of the government made more important^ and yet more difficult, the coexistence of "accountability" and "proper independence" of the monetary authority. T o the Federal Reserve, however, one point was clear : the issues at stake were too important and the power involved was too potent to allow facile change or reorientation of the monetary authority. Built on tradition and reason, a wall of separation stood between the government and its monetary authority. Almost by instinct the Federal Reserve tended to resist a break, or even a crack, in that wall. Initially at least, it reacted as though every break or crack were a

INDEPENDENCE OF T H E FEDERAL R E S E R V E S Y S T E M

397

portent of catastrophe; each seemed logically to lead on to other changes and finally perhaps to the destruction of the wall. Then the usefulness of an independent monetary authority would be buried in the rubble. This was not always all in the imagination; sometimes it was based on solid reasons. But imaginary or real, the fear of greater losses hindered necessary and useful cooperation of the Federal Reserve with other parts of the government, deprived it of the strength needed to exercise its rights, and obscured the two-way look of every trustee relation. The Federal Reserve relied on arguments from tradition, performance, and unfavorable expectations to oppose or, at least, to be coldly unenthusiastic about proposals to change the content and meaning of its independence. It did not maintain that the terms and the expressions of its independence were immutably fixed ; being an agent it could not do that. Rather, Federal Reserve officials wanted to be relied upon to provide the flexibility and the responsibility required for a meaningful monetary authority in the evolving economic environment. Rigidity in operation was forever anathema, and rigidity in operation was what the changes seemed to portend. Hence Federal Reserve officials reacted unfavorably to proposals that remotely or immediately restricted their judgment powers already given by law. Their basic position was that such proposals were fraught with dangers and troubles which would be as large as, and most likely larger than, the hazards of the existing Federal Reserve System. At the same time, they were often reluctant to recognize that larger decision areas required more extensive accounting for performance. There was, of course, a limit. Somewhere along in the expansion process, greater and greater accountability had to be tempered by a measure of trust ; otherwise it would become an end in itself. Where the limit lay was a question of judgment. To make

398

THE INDEPENDENCE OF THE FEDERAL RESERVE

SYSTEM

effective its own judgment, the Federal Reserve needed the confidence of Congress, the Executive, and the public in the usefulness and competency of the trusteeship of the Federal Reserve System. Independence—Prospect The history and implications of the independence of the Federal Reserve System indicate the practical difficulties of defining that independence : freedom of judgment and action in monetary matters, freedom from partisan political and private interests—both combined with a place within the government for the promotion of public goals. The analysis makes it clear, however, that neither government nor Federal Reserve officiais consider independence for the System as an absolute necessity. Nonetheless such independence can be desirable and useful ; in the monetary field it can be of decisive importance for arriving at careful judgments and taking prudent actions on national problems and hopes. Briefly put, several provisions seem to be required for making an independent Federal Reserve System a useful and desirable tool for the accomplishment of the government's business. 1. The Federal Reserve System has to be ready at all times to explain itself : what it is, what it does, and where it is headed. Although, in general, these terms are included in its papers of organization, they are wrapped in the complexities of banking and constitutional processes. Hence they have to be unwrapped continually and laid open. Admittedly, this explanation is not easy. It is further complicated because the listeners are frequently those who do not like to be bothered by the complexities. Failure at explanation, however, makes

INDEPENDENCE OF THE FEDERAL RESERVE SYSTEM

399

the continuance of independence more difficult and perhaps politically impossible. The ivory-tower concept is not only out of style; it is unacceptable and doomed to destruction. 2. Explanation is necessary, but not enough. The Federal Reserve System, as an organization with independent viewpoints, powers, and responsibilities, must be accepted by the government—Executive and Congress. It must be accepted as competent. This requires foresight, careful thinking, broad reaching proposals, firm convictions, and strong action—all in the light of government-assigned and government-recognized powers and goals. Such requirements pertain to activities in the monetary field and should be so restricted. Even so, sometimes the activities of the System might need an increase in power and responsibilitiy; at other times, a decrease. What the independent Federal Reserve System can and will do within the government depends upon its powers, its convictions, its activities, and its acceptance as competent. 3. The System must also be accepted as well-ordered, both internally and externally. Internal harmony merits respect and responsibility; its serious disruption breeds drastic changes and perhaps self-destruction. Likewise, if the Federal Reserve is to fit into the national purpose, it cannot be independent at the expense of cooperation with other organizations having identical or related powers and goals. There has to be a working relationship, desired and fostered, with other affected parties. Conflicts of authority are injurious to independence and difficult to solve. Unless they can be avoided by previous cooperation and coordination, the independence of the System becomes subject to sacrifice. Ultimately the independence of the Federal Reserve System will be as safe in such a situation, and as useful in all situations, as the System is adequate in its explanations, cooperative in its actions, and accepted in its status.

Bibliography Government Documents Great Britain. Committee on Finance and Industry (Macmillan Committee). Minutes of Evidence Taken before the Committee on Finance and Industry. London : H.M.S. Office, 1931. Great Britain. Committee on Finance and Industry. Report of the Committee on Finance and Industry. London : H.M.S. Office, 1931. Great Britain. Committee on the Working of the Monetary System. Minutes of Evidence. London : H.M.S. Office, 1960. Great Britain. Committee on the Working of the Monetary System. Principal Memoranda of Evidence. Vol. I. London : H.M.S. Office, 1960. Great Britain. Committee on the Working of the Monetary System (Radcliffe Committee). Report of the Committee. London : H.M.S. Office, 1959. Great Britain. Tribunal Appointed to Inquire into Allegations of Improper Disclosure of Information Relating to the Raising of the Bank Rate (Parker Tribunal). Report of the Tribunal. London : H.M.S. Office, 1959. U.S. Congress, House of Representatives. Committee on Banking and Currency. Report, Concentration of Control of Money and Credit. 62d Cong., 3d Sess., 1913. U.S. Congress, House of Representatives. Committee on Banking and Currency. Report, Changes in the Banking and Currency System of the United States. 63d Con., 1st Sess., 400

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1913. (This report [and other reports on major banking acts] was republished, February 10, 1958, by House Committee on Banking and Currency, 85th Congress.) U.S. Congress, House of Representatives. Committee on Banking and Currency. Hearings on H.R. 7895 (Stabilization). 69th Cong., 1st Sess., 1926. U.S. Congress, House of Representatives. Committee on Banking and Currency. Hearings on H.R. 11806 (Stabilization). 70th Cong., 1st Sess., 1928. U.S. Congress, House of Representatives. Committee on Banking and Currency. Hearings on H.R. 5357 (Banking Act of 1935). 74th Cong., 1st Sess., 1935. U.S. Congress, House of Representatives. Committee on Banking and Currency. Hearings on Government Ownership of the Twelve Federal Reserve Banks. 75th Cong., 3d Sess., 1938. U.S. Congress, House of Representatives. Committee on Banking and Currency. Hearings on Financial Institutions Act of 1957. 85th Cong., 1st Sess., 1957. U.S. Congress, House of Representatives. Committee on Ways and Means. Hearings on Public Debt Ceiling and Interest Rate Ceiling on Bonds. 86th Cong., 1st Sess., 1959. U.S. Congress, House of Representatives. Subcommittee No. 3 of the Committee on Banking and Currency. Hearings on Retirement of Federal Reserve Bank Stock. 86th Cong., 2d Sess., 1960. U.S. Congress, Joint Commission of Agricultural Inquiry. Report, The Agricultural Crisis and Its Causes. Report No. 408. 67th Cong., 1st Sess., 1921. U.S. Congress, Joint Committee on the Economic Report. Statements Submitted to the Subcommittee on Monetary, Credit, and Fiscal Policies. 81st Cong., 1st Sess., 1949. U.S. Congress, Joint Economic Committee. Hearings on Employment, Growth, and Price Levels. 86th Cong., 1st Sess., 1959. U.S. Congress, Joint Economic Committee. Report on Employment, Growth, and Price Levels. 86th Cong., 2d Sess., January 26, 1960.

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U.S. Congress, Joint Economic Committee. Index to Hearings on Employment, Growth, and Price Levels. 86th Cong., 2d Sess., December 30, 1960. U.S. Congress, Joint Economic Committee. Hearings on Review of Annual Report of the Federal Reserve System for the Year 1960. 87th Cong., 1st Sess., 1961. U.S. Congress, Senate. Committee on Banking and Currency. Report, Banking and Currency. 63d Cong., 1st Sess., November 22, 1913. U.S. Congress, Senate. Banking and Currency Committee. Hearings on Providing for Financial Control of Government Corporations. 79th Cong., 1st Sess., 1945. U.S. Congress, Senate. Committee on Banking and Currency. Hearings on the Nomination of William McChesney Martin, Jr. 84th Cong., 2d Sess., 1956. U.S. Congress, Senate. Committee on Banking and Currency. Hearings on Study of Banking Laws. 84th Cong., 2d Sess., 1956-1957. U.S. Congress, Senate. Committee on Banking and Currency. Staff Report: Study of Banking Laws—Federal Statutes Governing Financial Institutions and Credit. 84-th Cong., 2d Sess., September 27, 1956. U.S. Congress, Senate. Committee on Banking and Currency. Staff Report: Legislative Recommendations of the Federal Supervisory Agencies. 84th Cong., 2d Sess., October 12, 1956. U.S. Congress, Senate. Committee on Finance. Hearings on the Financial Condition of the United States. 85th Cong., 1st Sess., 1957. U.S. Congress, Senate. Committee on Finance. Index to Hearings on Financial Condition of the United States. 85th Cong., 1st Sess., 1958. U.S. Congress, Senate. Subcommittee of the Committee on Banking and Currency. Hearings on S. 1715 (Banking Act of 1935). 74th Cong., 1st Sess., 1935.

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U.S. Congress. Subcommittee of the Joint Committee on the Economic Report. Hearings on Monetary, Credit, and Fiscal Policies. 81st Cong., 1st Sess., 1949. U.S. Congress. Subcommittee of the Joint Committee on the Economic Report. Report on Monetary, Credit, and Fiscal Policies.'81st Cong., 2d Sess., 1950. U.S. Congress. Subcommittee of the Joint Committee on the Economic Report. Replies to Questions and Other Material for the Use of the Subcommittee on General Credit Control and Debt Management. Parts I and II. 82d Cong., 2d Sess., 1952. U.S. Congress. Subcommittee of the Joint Committee on the Economic Report. Hearings on Monetary Policy and the Management of the Public Debt. 82d Cong., 2d Sess., 1952. U.S. Congress. Subcommittee of the Joint Committee on the Economic Report. Report on Monetary Policy and the Management of the Public Debt. 82d Cong., 2d Sess., July 3, 1952. U.S. Congress. Subcommittee of the Joint Committee on the Economic Report. Hearings on United States Monetary Policy: Recent Thinking and Experience. 83d Cong., 2d Sess., 1954. U.S. President (Franklin D. Roosevelt). Address at Official Opening of New Headquarters Building of the Board of Governors. (Reprinted in Federal Reserve Bulletin, XXIII [November, 1937], 1061-1062.) U.S. Treasury Department. Annual Report of the Secretary of the Treasury on the State of the Finances. 1912, 1943, 1944, 1946, 1947, 1949, 1951 (fiscal years). Federal Reserve Publications and Papers Anderson, Clay J. Monetary Policy—Decision-Making, Tools, and Objectives. Philadelphia : Federal Reserve Bank of Philadelphia, 1961.

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Annual Report of the Board of Governors of the Federal Reserve System. Years : 1935-1960. Annual Report of the Federal Reserve Board. Years : 1914-1934. Balderston, C. Canby. "Monetary Policy Decision-Making." Address before the Western Assembly on United States Monetary Policy, Lake Arrowhead Conference Center, California, M a y 29, 1959. (Mimeographed.) Board of Governors of the Federal Reserve System. Banking and Monetary Statistics. Washington : Board of Governors of the Federal Reserve System, 1943. . Banking Studies. Washington : Board of Governors of the Federal Reserve System, 1941. . Federal Open Market Committee, Report of Ad Hoc Subcommittee on the Government Securities Market, November 12, 1952. Published by the Subcommittee of the Joint Committee on the Economic Report in its Hearings on United States Monetary Policy: Recent Thinking and Experience. 83d Cong., 2d Sess., 1954. . The Federal Reserve Act, as amended through December 31, 1956. Washington : Board of Governors of the Federal Reserve System, 1957. — . "The History of Reserve Requirements for Banks in the United States," Federal Reserve Bulletin, X X I V (November, 1938), 953-972. Bopp, Karl R., et al. Federal Reserve Policy. "Postwar Economic Studies, No. 8." Washington : Board of Governors of the Federal Reserve System, 1947. Bopp, Karl R. "The Rediscovery of Monetary Policy—Some Problems of Application." Address before the Conference of Pennsylvania Economists, The Pennsylvania State University, University Park, Pennsylvania, June 16, 1955. (Mimeographed.) Bryan, Malcolm. "The Sovereign, the Central Bank, and the Monetary Standard." Address before the Regional Cor.ference on United States Monetary Policy, cosponsored by

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Duke University and the American Assembly of Columbia University, March 19, 1959. (Mimeographed.) Carr, H. C., et al. The Treasury and the Money Market. York : Federal Reserve Bank of New York, 1954.

New

Federal Reserve Bank of New York. The Federal Reserve System Today. New York : Federal Reserve Bank of New York, 1936. . Federal Trust Fund Investments. New York : Federal Reserve Bank of New York, 1946. Federal Reserve Bank of Philadelphia. Forty-five Years of the Federal Reserve Act. Philadelphia : Federal Reserve Bank of Philadelphia, 1959. . "Federal Reserve Bank Directors," Business Review, (Philadelphia : Federal Reserve Bank of Philadelphia) January, 1961, 8—14·. Fousek, Peter G. Foreign Central Banking: The Instruments of Monetary Policy. New York : Federal Reserve Bank of New York, 1957. H a m m o n d , Bray. "Federal Reserve Functions." An address given before the Ohio Valley Chapter, American Institute of Banking, Marietta, Ohio, May 21, 1938. (Mimeographed.) Hayes, Alfred. "Cooperation of Monetary Policy in a Growing Economy." Address before the Thirty-First Annual Midwinter Meeting of the New York State Bankers Association, New York, January 26, 1959. (Reprinted in the Monthly Review of the Federal Reserve Bank of New York, X L I [February, 1959], 28-31.) Hersey, Arthur. "Historical Review of Objectives of Federal Reserve Policy," Federal Reserve Bulletin, X X V I (April, 1940), 279-289. King, G. H., Jr. " W h a t Purpose for O u r Country?" Address before the 21st Annual Pacific Northwest Conference on Banking, State College of Washington, Pullman, Washington, April 7, 1960. (Mimeographed.) McCabe, Thomas B. "Statement before the Senate Banking and

406

THE INDEPENDENCE OF THE FEDERAL R E S E R V E S Y S T E M

Currency Committee," Federal Reserve Bulletin, XXXV (May, 1949), 4 7 4 ^ 7 9 . Martin, William McChesney, Jr. "Banking Independence." Address before the 18th Annual Convention of the Independent Bankers Association, Minneapolis, Minnesota, M a y 19, 1952. (Mimeographed.) . "Federal Reserve Bank Responsibilities." Address on the Occasion of the Opening of the New Building of the Federal Reserve Bank of Boston, Boston, M a y 6, 1953. (Mimeographed.) . "Our American Economy." An address before the Executives' Club of Chicago, Chicago, December 12, 1958. (Mimeographed.) . "Our American Economy : Strength of the Republic." Address before the Economic Club of New York, March 12, 1957. (Mimeographed.) . "Prosperity for Free Men." Address before the Annual Meeting of the Association of Reserve City Bankers, Boca Raton, Florida, April 11, 1961. (Mimeographed.) . "The Transition to Free Markets." Address before the Economic Club of Detroit, Detroit, April 13, 1953. (Mimeographed.) . Untitled address before the 62d Annual Convention of the Pennsylvania Bankers Association, Atlantic City, New Jersey, M a y 4, 1956. (Mimeographed.) . Untitled address at the University of Pennsylvania Council Marking the 75th Anniversary of the Founding of the Wharton School of Finance and Commerce, Philadelphia, April 26, 1957. (Mimeographed.) . Untitled address at the 91st Annual Meeting of the Richmond Chamber of Commerce, Richmond, Virginia, January 9, 1958. (Mimeographed.) Mills, A. L., Jr. "The Meaning of Membership in the Federal Reserve System." Address at the Pacific Coast Banking School, Seattle, Washington, August 28, 1957. (Mimeographed.)

BIBLIOGRAPHY

407

Robertson, James L. " I n Defense of Monetary Policy." Address before the Bankers Club of Detroit, Detroit, Michigan. November 15, 1956. (Mimeographed.) . "Monetary Policy in a Dynamic Economy." Address before the 72d Annual Convention of the Iowa Bankers Association, Des Moines, Iowa, October 21, 1958. (Mimeographed.) . "Progress and Economic Stability." Address before the Annual Convention of the Ohio Bankers Association, Cleveland, Ohio, April 28, 1959. (Mimeographed.) . "Sputnik and Monetary Policy." Address before the 19th Annual Pacific Northwest Conference on Banking, State College of Washington, Pullman, Washington, April 10, 1958. (Mimeographed.) Riefler, Winfield W. " T h e Price of Stability." Address before the Rochester Chamber of Commerce, Rochester, New York, January 14, 1957. (Mimeographed.) Roelse, Harold V., et al. Money Market Essays. Federal Reserve Bank of New York, 1952.

New York :

Roosa, Robert V. Federal Reserve Operations in the Money and Government Securities Markets. New York : Federal Reserve Bank of New York, 1956. Sproul, Allan. "Central Banking and the Private Economy." Address before the 45th Annual Meeting of the Life Insurance Association of America, New York, December 12, 1951. (Mimeographed.) . "Independence of the Federal Reserve System." Address at the Mid-winter Meeting of New York State Bankers Association, New York, January 25, 1954. (Mimeographed.) . "Monetary Policy in Periods of Transition." Address at the 16th Annual Pacific Northwest Conference on Banking, Pullman, Washington, April 7, 1955. (Mimeographed.) . "Monetary Reconstruction." Address before the 35th National Foreign Trade Convention, New York, November 8, 1948. (Mimeographed.)

408

THE INDEPENDENCE OF THE FEDERAL RESERVE SYSTEM

. Statement before the Joint Committee on the Economic Report, May 12, 1948. (Mimeographed.) . Untitled address at the 18th Mid-year Trust and Banking Conference, New Jersey State Bankers Association, December 6, 1946. (Reprinted in Monthly Review, Federal Reserve Bank of New York, X X I X [Supplement, January, 1947].) . Untitled address at the Mid-winter meeting of the New York State Bankers Association, New York, January 22, 1951. (Mimeographed.) . Untitled address before the Fifty-Third Annual Convention of the New Jersey Bankers Association, Atlantic City, New Jersey, M a y 24, 1956. (Mimeographed.) Szymczak, M. S. " T h e Federal Reserve System—An American Precedent?" Address before the Fourteenth Annual Meeting of the Catholic Economic Association, New York, December 29, 1955. (Mimeographed.) . "A Review of Monetary Policy." Address before the National Credit Conference of the American Bankers Association, Chicago, J a n u a r y 14, 1957. (Mimeographed.) . " T h e Role of Monetary Policy in an Expanding Economy." Address before the 1959 Seminar, Fraternal Investment Association, French Lick, Indiana, June 3, 1959. (Mimeographed.) Books Abbott, Charles C. Federal Debt, Structure and Impact. New York : Twentieth Century Fund, 1953. Bach, G. L. Federal Reserve Policy-Making, New York : Alfred A. Knopf, 1950. Barron, C. W. The Federal Reserve Act. A Discussion of the Principles and Operations of the New Banking Act. Boston : Boston News Bureau Co., 1914. Beckhart, Benjamin H. (ed.). Banking Systems. New York : Columbia University Press, 1954.

BIBLIOGRAPHY

409

Blum, John Morton. From the Morgenthau Diaries. Boston : Houghton Mifflin Company, 1959. Bopp, Karl R. The Agencies of Federal Reserve Policy. Columbia, Missouri : University of Missouri, 1935. Boehmler, Erwin W. Financial Institutions. Homewood, 111. : R. D. Irwin, Inc., 1960. Burgess, W. Randolph. The Reserve Banks and the Money Market. New York : Harper & Brothers, 1946. Chandler, Lester V. Benjamin Strong, Central Banker. Washington : The Brookings Institution, 1958. Clark, Lawrence E. Central Banking under the Federal Reserve System. New York : Macmillan Co., 1935. Clay, Sir Henry. Lord Norman. London : Macmillan & Co., 1957. Commission on Money and Credit. Money and Credit—Their Influence on Jobs, Prices, and Growth. Englewood Cliffs, N . J . : Prentice-Hall, Inc., 1961. Conway, Thomas, and Patterson, Ernest M. The Operation of the New Bank Act. Philadelphia : J. B. Lippincott Company, 1914. Crick, W. F. Monetary and Banking Policies. University of London. Extra-Mural Studies. London : Institute of Bankers, 1955. Currie, Lauchlin. The Supply and Control of Money in the United States. Cambridge, Mass. : Harvard University Press, 1934. Cushman, R. E. The Independent Regulatory Commissions. New York : Oxford University Press, 1941. De Kock, M. H. Central Banking. London : Staples Press Limited, 1954. Dupriez, Leon H., et al. Money, Trade and Economic Growth. Essays in honor of John Henry Williams. New York : Macmillan Co., 1951. Eccles, Marriner S. Beckoning Frontiers. New York : Alfred A. Knopf, 1951.

410

THE INDEPENDENCE OF THE FEDERAL R E S E R V E S Y S T E M

Faulkner, Harold U. American Economic History. New York : Harper & Brothers, 1949. Friedman, Milton. A Program for Monetary Stability. New York : Fordham University Press, 1959. Glass, Carter. An Adventure in Constructive Finance. New York : Doubleday, Page and Company, 1927. Goldenweiser, E. A. American Monetary Policy. New York : McGraw-Hill Book Co., Inc., 1951. . Federal Reserve System in Operation. New York : McGraw-Hill Book Co., Inc., 1925. Hammond, Bray. Banks and Politics in America. Princeton : Princeton University Press, 1957. Harding, W. P. G. The Formative Period of the Federal Reserve System. Boston and New York : Houghton Mifflin Company, 1925. Hardy, Charles O. Credit Policies of the Federal Reserve System. Washington : The Brookings Institution, 1932. Harris, Seymour E. Twenty Years of Federal Reserve Policy, Including an Extended Discussion of the Monetary Crisis, 1927-1933. Cambridge, Mass. : Harvard University Press, 1933. Hawtrey, R. G. The Art of Central Banking. London : Longmans, Green and Co., 1932. Jacoby, Neil H. (ed.). United States Monetary Policy. Background papers prepared for use of participants, and the Final Report of the Fourteenth Assembly, Arden House, Harriman Campus of Columbia University. Harriman, New York : The American Assembly, Columbia University, 1958. Johnson, G. Griffith. The Treasury and Monetary Policy 19331938. Cambridge, Mass. : Harvard University Press, 1939. Kemmerer, E. W. The ABC of the Federal Reserve System. Princeton : Princeton University Press, 1938. Kisch, C. H., and Elkin, W. A. Central Banks. London : Macmillan and Co., Ltd., 1932. Latham, Earl (ed.). The Philosophy and Policies of Woodrow Wilson. Chicago : University of Chicago Press, 1958.

BIBLIOGRAPHY

411

Laughlin, J. Laurence. The Federal Reserve Act, Its Origins and Problems. New York : Macmillan Company, 1933. McAdoo, William G. Crowded Years, the Reminiscences of William G. McAdoo. Boston : Houghton Mifflin Company, 1931. Mints, Lloyd W. A History of Banking Theory. Chicago : University of Chicago Press, 1945. Murphy, Henry C. The National Debt in War and Transition. New York : McGraw-Hill Book Co., Inc., 1950. Musolf, Lloyd D. Public Ownership and Accountability. Cambridge, Mass. : Harvard University Press, 1959. Nadler, Marcus, and Bogen, Jules I. The Banking Crisis: The End of an Epoch. New York : Mead & Company, Inc., 1933. Neufeld, E. P. Bank of Canada Operations and Policy. Toronto : University of Toronto Press, 1958. New York Clearing House Association. Federal Reserve ReExamined. New York : New York Clearing House Association, 1953. Prochnow, Herbert V. (ed.). American Financial Institutions. New York : Prentice-Hall, 1951. . The Federal Reserve System. New York : Harper & Brothers, 1960. Riefler, Winfield W. Money Rates and Money Markets in the United States. New York : Harper & Brothers, 1930. Roberts, George B. (ed.). A Forum on Finance. New York : Columbia University Press, 1940. Rostow, Eugene W. Planning for Freedom: The Public Law of American Capitalism. New Haven : Yale University Press, 1960. Sayers, R. S. Central Banking after Bagehot. Oxford : Clarendon Press, 1957. Schlesinger, Arthur M., Jr. The Age of Roosevelt, Vol. I : The Crisis of the Old Order, 1919-1933. Boston : Houghton Mifflin Co., 1957. Seldon, Arthur (ed.). Not Unanimous—A Rival Verdict to Rad-

412

THE INDEPENDENCE OF THE FEDERAL R E S E R V E S Y S T E M

c l i f f e ' s on Money. London : Institute of Economic Affairs, 1960. Seiko, Daniel T. The Federal Financial System. Washington : The Brookings Institution, 1940. Shaw, Edward S. Money, Income, and Monetary Policy. Chicago : Richard D. Irwin, Inc., 1950. Shultz, William J., and Caine, M. R. Financial Development of the United States. New York : Prentice-Hall, Inc., 1937. Smith, Vera C. The Rationale of Central Banking. London : P. S. King and Sons, 1936. Studenski, Paul, and Krooss, Herman E. Financial History of the United States. New York : McGraw-Hill Book Company, Inc., 1952. Taus, Esther R. Central Banking Functions of the United States Treasury, 1789-1941. New York : Columbia University Press, 1943. Thornton, Henry. An Enquiry into the Nature and E f f e c t s of the Paper Credit of Great Britain. New York : Rinehart and Company, Inc., 1939. (Originally published in London, 1802.)

Truman, Harry S. Memoirs, Vol. II : Years of Trial and Hope. Garden City, New York : Doubleday & Company, Inc., 1956. Warburg, Paul M. The Federal Reserve System. New York : The Macmillan Co., 1930. Weintraub, Sidney. Classical Keynesianism, Monetary Theory, and the Price Level. Philadelphia and New York : Chilton Company, 1961. Weissman, Rudolph L. The New Federal Reserve System. New York : Harper & Brothers, 1936. Weyforth, William O. The Federal Reserve Board. Baltimore : The Johns Hopkins Press, 1933. Whittlesey, Charles R. Lectures on Monetary Management. University of Bombay, Series in Monetary and International Economics, No. 1. Bombay : Bombay University Press, 1960.

BIBLIOGRAPHY

413

Willis, H. Parker. The Federal Reserve System. New York : Doubleday, Page and Co., 1915. . The Federal Reserve System: Legislation, Organization and Operation. New York : The Ronald Press Company, 1923. . The Theory and Practice of Central Banking. New York : Harper & Brothers, 1936. Yeager, Leland B. (ed.). In Search of a Monetary Constitution. Cambridge, Mass. : Harvard University Press, 1962. Articles and Periodicals A F L - C I O Economic Policy Committee. " T h e Federal Reserve— A Public System," Economic Trends and Outlook, IV (March, 1959), 1-3. Bach, George Leland. " T h e Economics and Politics of Money," Harvard Business Review, X X X I (March-April, 1953), 84-96. . " T h e Federal Reserve and the Treasury," Harvard Business Review, X X I X (November, 1951), 29-39. Bell, Elliott V. "Who Should Manage Our Managed Money?," The Commercial and Financial Chronicle, CLXXXIV (November 1, 1956), 1870, 1882. Bopp, Karl. "Central Banking at the Crossroads," The American Economic Review, X X X I V (March, 1944), 260-277. Chandler, Lester V. "Federal Reserve Policy and the Federal Debt," American Economic Review, X X X I X (March, 1949), 405-429. Fergusson, Donald A. "A Suggested Reorganization of Monetary Policy Formation," Journal of Business of the University of Chicago, X X I V (January, 1951), 2 5 ^ 2 . Friedman, Milton. "A Monetary and Fiscal Framework for Economic Stability," American Economic Review, X X X V I I I (June, 1948), 245-264. Gregory, Sir Theodore. " T h e 'Norman Conquest' Reconsidered," Lloyds Bank Review, October, 1957, 1-20.

414

T H E I N D E P E N D E N C E OF T H E F E D E R A L R E S E R V E

SYSTEM

Harris, Seymour, et al. "How to Manage the National Debt,"' Review of Economics and Statistics, X X X I (February, 1949), 15-32. . " T h e Controversy over Monetary Policy," The Review of Economics and Statistics, X X X I I I (August, 1951), 179200. Kriz, M. A. "Central Banks and the State Today,'' American Economic Review, X X X V I I I (September, 1948), 5Ó5-580. Low, A. R. " T h e Varied Role of Central Banks," Record, X X X I V (December, 1958), 317-330.

Economic

Miller, A. C. "Federal Reserve Policy," American Review, X I (June, 1921), 177-206.

Economic

Mueller, W., Jr. " T h e Treasury-Federal Reserve Accord," Journal of Finance, V I I (December, 1952), 580-599. Murphy, Henry C., et al. "Round 'Textbooks'," Journal of Finance, 211.

Tables on the Patman V I I I (May, 1953), 152-

Reagan, Michael D. " T h e Political Structure of the Federal Reserve System," The American Political Science Review, L V (March, 1961), 6 4 - 7 6 . Riefler, Winfield W. " T h e Dilemma of Central Banking as Illustrated in Recent Literature," Quarterly Journal of Economics, L. (August, 1936), 706-718. Sayers, R. S. "Central Banking in the Light of Recent British and American Experience," Quarterly Journal of Economics, L X I I I (May, 1949), 198-211. Simons, Henry C. "Rules versus Authorities in Monetary Policy," Journal of Political Economy, X L I V (February, 1936), 1-30. Smith, Warren L. " O n the Effectiveness of Monetary Policy," American Economic Review, X L V I (September, 1956), 5 8 8 -

606. Sproul, Allan. "Reflections of a Central Banker," The Journal of Finance, X I (March, 1956), 1-14. Tobin, James. " T h e Future of the Fed," Challenge, I X (January, 1961), 24—28.

BIBLIOGRAPHY

415

. "Monetary Policy and the Management of the Public Debt : The Patman Inquiry,'" Review of Economics and Statistics, X X X V (May, 1953), 118-127. Warburton, Clark. "Monetary Control under the Federal Reserve Act," Political Science Quarterly, XLI (December, 1946), 505-534. . "Monetary Difficulties and the Structure of the Monetary System," Journal of Finance, VII (December, 1952), 523-545. Weintraub, Sidney. " 'Monetary Policy' : A Comment," Review of Economics and Statistics, X X X V I I (August, 1955), 292296. . "The New Monetary Policy," Social Research, XX (Winter, 1953), 399-417. Weston, N. A. "The Studies of the National Monetary Commission," The Annals, X C I X (January, 1922), 17-26. Whittlesey, Charles R. "Congressional Hearings and the Federal Reserve," Journal of Political Economy, L X V I I (April, 1959), 187-193. . "Relation of Money to Economic Growth," American Economic Review, X L V I (May, 1956), 188-201. Williams, John H. "The Implications of Fiscal Policy for Monetary Policy and the Banking System," American Economic Review, X X X I I , Supplement Part 2 (March, 1942), 4-26. Other Sources AFL-CIO Executive Council. "Monetary Policy." Statement of the AFL-CIO Council, San Juan, Puerto Rico, February 24, 1959. (Mimeographed.) First National City Bank. "The Radcliffe Report in an American Perspective," Monthly Letter, Business and Economic Conditions, New York, October, 1959, 113-117. Gregory, Sir Theodore. "The Present Position of Central Banks." The Stamp Memorial Lecture, delivered before the Univer-

416

THE INDEPENDENCE OF THE FEDERAL R E S E R V E S Y S T E M

sity of London, October 31, 1955. London: University of London, The Athlone Press, 1955. Silverman, Corinne. The President's Economic Advisers. The Inter-University Case Program, No. 48. University, Alabama : University of Alabama Press, 1959. Vardaman, James K., Jr. Untitled address before the 67th Annual Convention of the Georgia State Bankers Association, Augusta, Georgia, April 16, 1959. (Mimeographed.)

Index

Accord between Treasury and Federal Reserve (March 1951) action taken after, 252-253 announcement, 229, 251 appeal to President, 238-240 appointment of special committee, 249-252 background, 230-232 Congressional reaction, 246, 248-249, 253-255 consultation involved in, 2 3 1 235, 237-243, 248 disagreement prior to, 232, 2 3 6 237, 239-240, 246-248 meaning, 252-263, 273 statement, 229 Accountability of Federal Reserve Ad H o c Subcommittee (1952), 277 audit, 353, 367 checks and balances, 37 coercion, 341 Congressional control, 35, 37, 326-338, 342, 350, 375-376 Congressional hearings, 326-327 federal characteristics of System, 298 independence, 35, 298, 327-328, 342 reason for, 35, 37-38, 274 n., 326, 329 responsibilities of System, 35, 274 n., 298, 326, 337

"sense of Congress" resolution (1959), 352 sovereignty of government, 37, 326, 342 stock ownership of Reserve Banks, 375-376 trusteeship, 327-328, 371 unity of System, 298 Ad H o c ' S u b c o m m i t t e e (1952) action on report, 284-288 centralization of System responsibility, 281-284 formation, 274-275 freedom for O p e n Market Committee, 280-282, 288 internal authority of System, 279-282, 291 m a n a g e r of System account, 279, 281, 284, 286-288 membership of Subcommittee, 275 N e w York Reserve Bank, 279281, 291, 295-296 reasons for, 273-275 report, 275-282 Sproul, criticism of report, 2 8 2 284 Treasury and Federal Reserve relations, 276-278 Agency status of Federal Reserve accepted by Federal Reserve, 24, 340-341 adequacy, 26, 29, 343-344

418

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

audit control, 353, 3 5 7 - 3 5 9 concern of Congress, 24, 328, 330, 337, 384 meaning, 24, 26, 328 private banks, 19, 26, 28 Agriculture Adjustment

33,

Act

(1933), 142 Agriculture Department, 19, 58 Agriculture Inquiry (1921), Joint (Dommission of, 118-119 Aldrich, Nelson W., 45, 47 Aldrich Plan accepted by National Monetary Commission, 45—47 Aldrich, Nelson W., 45 central bank, 47 D e m o c r a t i c Party, 5 6 - 5 7 m a i n features, 46 opposition to, 44 48, 5 6 - 5 8 private control, 46—48 Progressive Party, 56 Anderson, R o b e r t o p p o s e d to public expression of disagreement, 311, subordination of debt management, 312 Attorney General's rulings changing number of Reserve Banks, 92 determination of discount rate, 115-116 independence of Board, 80 operating funds of B o a r d , 78, 139, 355 n. Audit of Federal Reserve, see General Accounting Office agency status, 353, 357 B o a r d audited by Treasury, 78, 355 budget control, 3 6 0 - 3 6 3 , 367 changes in procedures, 354, 364-365 Committee on Government Operations, 364

SYSTEM

conflict of interest, 367 control of Federal Reserve policy, 358-363 Corporation Control Act (1945), 356 Douglas, 3 5 4 - 3 5 8 Federal Reserve officials, 353, 355, 3 6 0 - 3 6 3 , 3 6 6 - 3 6 8 independence, 353, 358, 3 6 1 363, 3 6 7 - 3 6 9 operating funds of System, 140, 355, 367 P a t m a n , 354-359, 364, 366 procedure followed, 3 5 3 - 3 5 5 Autonomy of Reserve Banks action apart from B o a r d , 88-97 agency status, 24, 26 authority of Board, 61, 64-70, 113, 2 9 8 - 2 9 9 Eccles, 128-129 decentralized authority, 291 environmental changes, 29-31 Glass, 58 H a r d i n g , W. P. G., 6 9 - 7 0 independence, 23-24, 68-71, 299 interrelations of Reserve Banks, 70, 107, 111 M c A d o o , 102 open-market operations, 70, 107, 111, 294 operating head for Reserve Banks^ 7 1 - 7 2 Strong, 96 T h o m a s Amendment, 143-144 Willis, 69, 96

Bank of England, 22, 120 Bankers acceptances, 94, 292-294 Banking Act of 1933, 127, 140

104, 135,

INDEX

Banking Act of 1935 condemned by Willis, 128 direct sales by Treasury to Reserve Banks, 178 n. Eccles, 140, 186 proposals prior to, 127-130 provisions, 130-131 source of new Federal Reserve powers, 111, 127 report by Board, 136 T h o m a s Amendment, 143 n. Treasury officials, removal from Board, 138-139 Banks of the United States, 81, 325, 325 n. Bell, Daniel W., 182 "Bills only," 278, 282-283, 2 8 5 289 Board of Governors, see also Chairman of Board of Governors authority, 26, 2 9 - 3 0 , 3 5 - 3 6 , 61, 65, 6 7 - 6 8 , 80, 101-102, 130, 132-133, 145-146, 181, 2 0 0 201 background for establishment, 19-20, 5 9 - 6 1 changes proposed, 128, 170-171, 294, 297-298, 348, 3 6 5 - 3 6 6 coordinator, 28, 61, 65, 8 7 - 8 8 , 2 9 7 - 2 9 8 , 310 Eccles, 128-130 educator, 6 4 - 6 5 Federal Advisory Council, 5 9 63 first members, 19-20 location of headquarters, 7 9 - 8 0 operating funds, 73, 78, 83-84, 139-140 Overman Act, 100-101, 142 pegging market rates, 181-184, 189 political pressures, 8 3 - 8 4

419 reporting obligation, 136-138 Reserve Banks, 28, 6 1 - 6 5 , 6 7 73, 8 9 - 9 7 , 114-116, 118-119, 123, 128, 232, 2 9 4 - 2 9 9 Treasury Department, 26, 35, 61, 135, 138-139, 181-184, 189

unification of debt management and monetary policy, 3 0 8 - 3 1 0 Wilson, Woodrow, 59 Bopp, Karl R., 103 n., 142, 179 Bryan, Malcolm, 263, 275 Bryan, William Jennings, 21, 55, 75 Budget of Federal Reserve importance of control, 3 6 0 - 3 6 2 independence, 369 procedures, 354—355 stock ownership, 391 Burgess, W. Randolph, 3 0 1 - 3 0 6

Central bank, 4 6 - 4 8 , 5 6 - 5 8 , 128. See also Organization of Federal Reserve System Chairman of Board of Governors liaison with Administration, 159-162, 188, 195, 2 0 8 - 2 1 1 , 195, 263, 266, 270-272, 310 relationship to O p e n Market Committee, 133-134, 2 6 9 - 2 7 2 serving at pleasure of President, 128, 227, 330 unification of debt management and monetary policy, 3 0 8 - 3 1 0 Checks and balances, 37, 150, 3 0 8 - 3 0 9 , 337, 386 n. See also Organization of Federal Reserve System Chicago Federal Reserve Bank, see Federal Reserve Bank of Chicago Clark, Champ, 323

420

T H E INDEPENDENCE OF THE FEDERAL R E S E R V E

Clark, John D., 215-216 Comptroller General, 363-365 Comptroller of the Currency Aldrich Plan, 46 Board member, 19, 58, 75, 98 clarification of power, 77 coordinator in early Glass plan, 58 opposition to Board, 77-78, 117, 208, 211 organization of Federal Reserve, 19 removal from Board, 138-139 supervision of national banks, 77-78, 98, 161, 189 Congressional concern for Federal Reserve Accord (1951), 246-249, 253263 Agricultural Inquiry (1921), 118-119 audit control, 353 ff. changes proposed, 347-348 control by President, 329-330 criticism of November 1955 decision, 314-318 difficulty of explanation, 33, 327, 336-337 Douglas's Joint Resolution (1951), 253-255 early history, 323-324 h e l p to Federal Reserve, 340 investigations, 326-327, 387 methods of control, 322 ff. P a t m a n Subcommittee (1952), 262-263 protection against abuse, 34—35, 322-323, 328-337, 386 n. reasons for, 23-24, 322, 328-338 removal of Board members, 348 response of Federal Reserve, 338 ff.

SYSTEM

"sense of Congress" resolution, 351-352 stock ownership of Reserve Banks, 377 ff. Coolidge, Calvin, 121 Cooperation of Federal Reserve, see also Cooperation of Federal Reserve with Treasury Department assumptions at start of Federal Reserve, 22, 24 contrast with order-taking, 24 government, 22, 24-25, 30-31, 34, 125-126 necessity, 31, 34, 146, 149 private banks, 22, 26 vacillation, 32 Cooperation of Federal Reserve with Treasury D e p a r t m e n t Accord (1951), 229 ff. Ad Hoc Subcommittee (1952), 276-278 Burgess, 304 changes, 142-146, 231, 304306 criticism by Congress (1921), 117 Douglas, 214-215, 248, 253-263 Douglas Subcommittee (1949), 349 Eccles, 31, 140-141, 146 flexibility, 30, 38, 86, 125-126, 145-146, 149, 231, 333 Fulbright, 316-317 Glass, 138-139 Goldenweiser, 150 η. government policy, 30-31, 34. 85, 99, 125-126, 146. 149, 151, 333 independence, 30, 86, 125-126, 248, 300 ff., 345-346 intercommunication, 310-312 Long, 139

INDEX

McCabe, 186-187, 213-215 Martin, 261-263, 270 meaning in action, 34, 86, 99, 300 ff. overlapping authority, 30, 75, 78, 99-101, 106, 142-146, 149-154, 165, 188, 257, 263266, 295-296 Patman Subcommittee (1952), 262-263, 334 public disagreement, 311 reasons for, 85, 99, 126 sales organization (World War II), 190-196 segregation of new gold (1936— 1937), 152-157 Snyder, 207-208 Sproul, 184-185 Statement of Board (1946), 200 Strong, 106 Szymczak, 185, 230 Treasury control, 73, 78-79, 88, 248 unification of debt management and monetary policy, 307-310 World War I, 99-103 World War II, 163 ff. Corporation Control Act (1945), 356 Cortelyou, George B., 50, 73 Council of Economic Advisers, 215-216, 249-250, 337 Craft, Robert H , 275 Crissinger, D. R., 119, 121 Currency backing for, 55 currency bill, Federal Reserve Act as, 54 Emergency Banking Act (1933), 145 issuance, 22, 61-62, 70, 77 need for new arrangement, 2021

421 objective of Federal Reserve Act, 54, 66 Progressive Party platform (1912), 56 Thomas Amendment, 142-144

Debt management, see Accord between Treasury and Federal Reserve (March 1951) amount of government debt, 151, 164, 173 bank investors encouraged (1942), 179 concern of Federal Reserve, 30, 114-116, 150-158, 213-215, 263-266 Employment Act of 1946, 199 growth, 29-30, 150-158, 221222 monetary policy, 150-151, 164, 213-215, 221-222, 269, 304310 responsibility for, 151, 164 unification with monetary policy, 307-310 World War 1, 97-102 World War II, 163 ff. Decision of March 1953, 284-289 Democratic Party platform (1912), 41-42, 56-57 Discount rate determination bills and acceptances, 293-294 early action of Board, 94-95, 103, 112-113 early version, 70, 112 internal conflict, 109, 112-124, 293-294 Governors Conference, 106 political pressures, 82 ruling of Attorney General (1919), 115-116 veto power of Board, 113, 121

422

THE INDEPENDENCE OF THE

Douglas, Lewis, 144 Douglas, Paul Accord (1951), 255-262 action of Open Market Committee (1955), 315-316 agency status of Federal Reserve, 330, 357 audit control of Federal Reserve, 354, 356-358 Congressional resolution for primacy of Federal Reserve, 248-249, 253-262 cooperation, 214-215, 255-263 criticism of Treasury Department (1951), 248-249 independence, 262, 315-316 inflation, 248, 349-351 influences on Board Chairman, 314, 341 mandate, 248, 253-262, 349-350 Martin as Chairman, 267-268 monetary policy, 214-215, 248249, 253-262, 349, 351 public and private elements of Federal Reserve, 342 public disclosure, 274 n., 378 Subcommittee report (1950), 349

Eccles, Marriner S. bank supervision, 161, 189 Banking Act of 1935, 140, 186 changes proposed for Federal Reserve, 128-130, 208-209, 140 n., 330 conflict with Administration, 157, 289, 208-211, 241, 244, 254 n. cooperation with Administration, 31, 129, 140, 146, 158161, 185-186, 195, 208, 290

FEDERAL RESERVE

SYSTEM

Federal Open Market Committee, 185-186, 332 Federal Reserve Bank of New York, 156 functions of government, 31, 129-130, 209 influence as Chairman, 133-134, 208-209 loss of Chairmanship, 210 monetary policy, 128-129. 131, 146, 162, 201, 336 Morgenthau, 128, 153-157, 177, 190-196 participation of private banks, 129, 209, 332 Presidential advisory board (1938), 160 public disclosure, 136-137 resignation from Board, 266-267 Sproul, 209-210 stock ownership of Reserve Banks, 129, 375 Treasury Department, 31, 130, 146, 209 World W a r II financing, 175 n., 177, 185-186 Economic Stabilization Board (1942), 189 Eisenhower, Dwight D., 301, 315, 320 Emergency Banking Act (March 1933), 142, 144-146, 251 n. Employment Act of 1946, 198— 199, 227, 276, 278, 319, 334, 349 Federal Advisory Council, 59, 63, 168-169, 208 Federal Deposit Insurance Corporation, 137, 141, 161, 172, 189, 355 n., 363 n.

423

INDEX

Federal Open Market Committee, sec also O p e n - m a r k e t operations Accord ( M a r c h 1951), 229 ff. Ad H o c S u b c o m m i t t e e , 279 ff. agency of g o v e r n m e n t , 134-135, 221 agency functions of N e w York Reserve Bank, 2 9 4 - 2 9 9 centralization of authority, 2 2 0 -

public oath of office, 132, 135,

280 purposes, 134-135, 280, 283 rates on bills and acceptances, 293-294 repurchase 292-293 responsibility 290

agreements, increased

175, (1955),

221, 2 9 4 - 2 9 9 C h a i r m a n ' s a u t h o r i t y , 133-134, 269-272 changes proposed, 171, 220-221, 227, 279 executive c o m m i t t e e , 279, 287—

Sproul, 2 7 1 - 2 7 2 , 2 8 3 - 2 8 4 T r e a s u r y D e p a r t m e n t , see C o o p e r a t i o n of F e d e r a l R e s e r v e with T r e a s u r y D e p a r t m e n t unifying force, 130, 133, 280, 292

290, 294 g o v e r n m e n t d e b t , 151, see also G o v e r n m e n t securities m a r k e t g r o u p a u t h o r i t y , 133-134, 280,

F e d e r a l Reserve Act agency functions of R e s e r v e Banks, 24, 297 Aldrich P l a n , 4 4 - 4 5 b u d g e t control, 140, 355, 369, 372

290, 292 independence

within

System,

130, 133, 280, 292 influence of p r i v a t e banks, 3 3 1 332, see also P a r t i c i p a t i o n of private banks in Federal Reserve m a n a g e r of System a c c o u n t , 279, 281, 2 8 6 - 2 8 9 , 296 m e e t i n g s increased (1953), 290 meetings w i t h P r e s i d e n t T r u man," 2 4 3 - 2 4 4 m e m b e r s h i p , 131-135 N e w York Reserve Bank, 134 n., 179-282, 2 8 6 - 2 8 7 organization, 126, 131-132, 292 policy c h a n g e s : (1949) 2 1 2 - 2 1 3 ; (1951) 229 ff.; (1952) 302; (1953) 285-290, 302-303; (1955) 3 1 3 - 3 1 8 p u b l i c aspects, 131-135, 2 2 0 221 public disclosure, 1 3 6 - 1 3 8

changes proposed, 128, 148, 297, 345 ff., 369 ff. characteristic features, 19, 24— 26, 3 3 - 3 4 , 41, 54, 6 4 - 6 6 , 7 0 72 Democratic Party platform (1912), 5 6 - 5 7 discount f u n c t i o n , 294 early version, 112, 347 F e d e r a l Advisory Council, 59, 63 Federal Open Market C o m m i t tee, 148, 265 F e d e r a l Reserve Banks, 19, 24, 72, 297, 298 f u n d s of B o a r d , 140, 355 g o v e r n m e n t a l aspects, 2 3 - 2 5 , 30, 43, 6 4 - 6 5 location of Board's h e a d q u a r ters, 7 9 - 8 0 m e r g e r of public a n d p r i v a t e

424

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

interests, 23-28, 30, 43, 6 4 65 "money trust," 43-44 officials of Federal Reserve, 25, 27-28, 72 open-market operations, 104, 148 passage, 19, 40, 323 public disclosure, 136 purpose, 25, 41^*2, 64-65, 148. See also Purposes of Federal Reserve Republican Party platform (1912), 57 Reserve Organization Committee, 19 stock of Reserve Banks, 371-372 Treasury Department, 75-77, 79-80, 178 n., 297 trusteeship, 25 Federal Reserve Agent, 71-72 Federal Reserve Bank of Chicago, 118-119, 376-377 Federal Reserve Bank of New York Ad Hoc Subcommittee (1952), 273 ff. agency functions, 126, 134, 294— 299 authority, 107, 111, 122 criticism by Eccles, 129 discount rate, 114-116, 118-119, 123, 232 Federal Open Market Committee, 131 n„ 134, 155, 282284, 288-290 foreign central banks, 120, 131 Governors Conference, 106 open-market operations, 122, 294 repurchase agreements, 292-293 support from Secretary of the Treasury, 103

SYSTEM

World War I, 101-102 Federal Reserve Banks, see also Autonomy of Reserve Banks background for establishment, 20, 58-59 Banking Act of 1935, 130-131 board of directors, 26-28 Board of Governors, 28, 61-68, 88, 107, 128-130, 380 charter, 19, 62 creatures of Congress, 24, 384 currency issue, 61-62, 77 discount rate, see Discount rate determination earnings, 105-106, 204, 355 n., 376 Eccles, 128-130 Federal Advisory Council, 63 fiscal agents of government, 73, 126 Glass, 40, 55, 58-64, 80, 373374 Harding, W. P. G., 69-70 Morgenthau, 127-128, 154 offset to monopoly, 26, 28 open-market operations, 104105. See also Governors Conference operating head, 26, 71-72 organization, 19, 26, 60-61, 89, 373-374. See also Organi7ation of Federal Reserve System Overman Act, 100-101 Owen, 57, 332, 348, 373 political pressures, 81-85 policy-making institutions, 106, 290, 298 private aspects, 19, 26-28, 128129. See also Participation of private banks in Federal Reserve public aspects, 64-65, 381-385

INDEX

purposes, 61, 64-65, 148 reduction in number, 89-93 regionalism, 59-60, 69-71. See also Regionalism of Federal Reserve stock ownership, 105, 127, 356 n., 369 ff. Strong, 96 T h o m a s Amendment, 142-144 trustees, 64 unity, 62-65, 106 Willis, 69 Federal Reserve Board, see Board of Governors Fiscal policy authority separate from monetary authority, 146 coordination with monetary policy, 125, 146, 209 Eccles, 129, 146, 209 Employment Act of 1946, 198199 increased importance, 29-30, 147 Fulbright, J. William, 316-317

General Acounting Office audit of Federal Reserve, 353 ff. control exercised, 363 correspondence with Board Chairman, 356 Glass, Carter Aldrich Plan, 4 6 ^ 7 Attorney General's rulings on discount rate, 115-116 hankers' banks, 61 bi-partisan Board, 59 Board of Governors, 59, 63-64, 114, 119, 138-139, 269 central authority, 47, 57-60 central bank, 57-58

425

Comptroller of the Currency, 58 currency issue, 55 defense of Federal Reserve (1921;, 117 discount rate, 112, 115-116 Eccles, 128 Federal Reserve Act, 40, 59, 80, 323 Federal Reserve Banks, 60-61, 63-64, 91-92, 114, 373-374 intervention of the President, 93 member of Board, 114-115 ownership of Reserve Banks, 373 regionalism, 58, 60, 63-64 report prior to passage of Act, 59-62 Treasury Department, 74, 114115, 138-139, 269 stock of Reserve Banks, 373-374 Strong, 115-116 Gold, 25, 142, 144, 153-158 Goldenweiser, Ε. Α., 150 η., 175 η. Government securities market Accord (March 1951), 252-263, 273 Ad Hoc Subcommittee report, 273 ff. agency operations of New York Reserve Bank, 295 credit standing of government, 30, 178-180, 186 "free markets," 302-304 importance, 29-30 limitation on Federal Reserve, 30, 263-266 pegging of rates, 168 support by Federal Reserve, 9 9 101, 152-154, 168, 205-208, 212-216, 259, 295 n. rate structure (World War II), 173 ff.

426

THF. I N D E P E N D E N C E O F T H E FF.DF.R.M. R E S E R V E

Governors Conference a u t o n o m y of Reserve Banks, 107, 113 control by Board, 95, 108 effect on internal organization of System, 6 2 - 6 3 , 107 encouragement from Treasury D e p a r t m e n t , 95 n., 108 f o r m a t i o n , 63, 9 3 - 9 4 Governors Committee (1922), 106-107 O p e n - M a r k e t Policy C o n f e r e n c e (1930), 111 o p e r a t i n g office, 106 opposition to B o a r d , 9 4 - 9 5 , 105, 113

H a m m o n d , Bray, 382 H a r d i n g , W . P. G., 6 9 - 7 0 , 73, 95, 108 Harrison, George, 122 n. Hayes, A l f r e d , 289 n., 2 9 1 , 3 8 2 - 3 8 3 Hoover, H e r b e r t , 121 n., 161 n. H o o v e r Commission, 226 H u m p h r e y , G e o r g e M., 302, 3 0 6 308, 3 1 8 - 3 2 1

Inflation, see Price level

Jones, Jesse, 172

Keyserling, I.eon, 252

Long, H u e y , 139

M c A d o o , W i l l i a m A. actions as Secretary, 4 9 - 5 1

actions of 48-49

SYSTEM

previous

Secretary,

centralization of money 48-49

power,

m o n e t a r y powers of T r e a s u r y D e p a r t m e n t , 49. 5 2 - 5 3 , 7 5 - 7 6 s u p p o r t of Reserve Bank Governors, 95 n. t r a n s f e r of g o v e r n m e n t f u n d s to Reserve Banks, 7 5 - 7 6 threat to take over f u n d s of Reserve Banks, 100 M c C a b e , T h o m a s B. Accord ( M a r c h 1951), 229 ff. a d e q u a c y of F e d e r a l Reserve powers, 2 2 4 - 2 2 5 a p p o i n t m e n t as C h a i r m a n , 212 conferences w i t h P r e s i d e n t T r u m a n (1950-1951), 2 4 3 - 2 4 5 cooperation with T r e a s u r y D e p a r t m e n t , 186-187, 2 0 5 - 2 0 6 , 214-216, 224-225, 236-238 directions f r o m Congress, 225 disagreement with Treasury D e p a r t m e n t , 232, 237-240, 247-248 E m p l o y m e n t Act of 1946, 227 i n d e p e n d e n c e , 225 l o n g - t e r m r a t e (1949-1950), 206, 236, 238 national advisory council, 227 persuasion-appeal approach, 215-216 policy s t a t e m e n t (1949!. 2 1 3 215 President's power to a p p o i n t new C h a i r m a n , 227. 230 regional characteristics of System, 227 reorganization of B o a r d , 227 reserve r e q u i r e m e n t s , 212 resignation, 2 6 7 - 2 6 8

INDEX

Secretary of the Treasury as member of Board, 225 stock ownership of Reserve Banks, 225 World War II, 186-187 McFadden, Louis T., 120 MacVeagh, Franklin, 54 Mandate for Federal Reserve Congressional control, 346, 348, 351-352 difficulty of formulation, 350351 open-market operations, 222, 351-352 price level, 142, 347-348 primacy of monetary policy, 349-351 Thomas Amendment, 142-144 Martin, Jr., William McChesney Accord (March 1951), 249 Ad Hoc Subcommittee (1952), 275 agency status of System, 329330 appointment as Chairman, 267268 audit control question, 356-357, 360-362 Board of Governors, 268-269, 330, 380 control of Reserve Banks, 380 cooperation, 261, 263, 316-321 Corporation Control Act (1945), 356 disagreement with Treasury Department, 261, 263, 270, 318-320 Federal Reserve Banks, 343, 381 free enterprise system, 23, 286 General Accounting Office, 356, 364-365 independence, 23, 261, 263, 270, 315-316, 318-320, 343, 381

427

March 1953 decision, 285 manager of System account, 286-287 market support, November 1955, 313-318 Presidential power to appoint Chairman, 330 public character of Reserve Banks, 343, 381 reasons for resignation, 267-270 Secretary of Treasury as member of Board, 268-269 servant of Congress, 357 support from Congress, 261 Treasury Department, 261, 263, 268-269, 314-321 trusteeship, 36, 317-318, 343344 unification of debt management and monetary policy, SOSSIO Mellon, Andrew, 118 n., 121 Member banks, see Participation of private banks in Federal Reserve; also Stock ownership of Reserve Banks Miller, A. C., 107-109 Mills, Jr., Abbot L., 275 Monetary policy, see also Ad H o c Subcommittee (1952) Accord (March 1951), 229 ff. coordination with other government policy, 23, 31-32, 140, 211 Douglas, 350-351 finances of Federal Reserve, 369-370 growth in importance, 20, 29, 299 inadequacy, 200-201 prevention of abuse, 34, 3 3 5 336, 369 primacy, 214-215, 349

428

THF. I N D E P E N D E N C E O F THF. F E D E R A I . R E S E R V E

private interests, 3 3 0 - 3 3 3 , 3 6 9 370 purposes, see Purposes of Federal Reserve "sense of C o n g r e s s " resolution (1959), 3 5 1 - 3 5 2 Sproul, 204-205, 2 1 9 - 2 2 2 unification with debt m a n a g e ment, 3 0 7 - 3 1 0 " M o n e y trust," 20-21, 4 3 - 4 4 , 48, 56-57, 87 Morgenthau, J r . , Henry coordination of credit control authorities, 127 direct dealing with Reserve Banks, 178 disagreements

with

Federal

Reserve, 190-198 Eccles, 153-157 government ownership of Reserve Bank stock, 127-128 independence of centralized credit control authority, 127 n. rates in World War I I , 176-178 removal from membership on Board, 139 reserve requirements (1936), 152 segregation of new gold ( 1936— 1937), 153-159 support of government bonds (1936-1937), 152-159 Murphy, Henry C., 169-170, 176 n., 192 National advisory council (1949), 223, 226 National Monetary Commission, 44-45 National Reserve Association (Aldrich Plan), 46-47

SYSTEM

New York Reserve Bank, see Federal Reserve Bank of New York

Oliphant, H e r m a n , 153 n. Open-market operations, see also Federal O p e n Market C o m m i t t e e action taken by Treasury ( 1936— 1937), 152-155 Ad Hoc S u b c o m m i t t e e (1952), 273 ff. authority for, 9 4 - 9 5 ,

report

103-105,

108-110, 126-127, 148 autonomy of Reserve Banks, 94 early discussion and action, 94, 104-105 internal struggle over authority for, 94, 103" ff. limitations from government security market, 151-154, 165, 263-266 November 1955, 3 ) 3 - 3 1 8 Open-Market Policy Conference, 111 policy in 1928, 122-123 public report on, 136-137 "sense of C o n g r e s s " resolution (1959), 3 5 1 - 3 5 2 T h o m a s A m e n d m e n t , 142-144 World War I I , 165 ff. Organization of Federal Reserve System agcncy function, 24, 26, 29, 34, 37 allocation of functions, 23-24, 60, 68, 70, 3 8 8 - 3 8 9 approval by Congress, 60, 62, 323 approval by Wilson, 41—43 bankers' banks, 61 buffer against government d o m -

INDEX

¡nation, 21-22, 31, 34, 40, 298, 3 8 8 - 3 8 9 c h a r a c t e r i s t i c features, 22-24, 41, 61-62, 70, 3 7 3 - 3 7 4 checks and balances, 37, 322. See also C h e c k s a n d balances c o m p r o m i s e a r r a n g e m e n t , 60, 62 d a n g e r of private m o n o p o l y , 2 0 - 2 1 , 28, 41, 298 F e d e r a l Advisory C o u n c i l , 59, 63 flexibility, 66-67 Glass, 55, 5 8 - 6 2 governmental aspects, 21-24, 3 0 - 3 1 , 3 3 - 3 4 , 3 6 - 3 7 , 40, 81, 386 n , 3 8 8 - 3 8 9 i n d e p e n d e n c e , 23, 6 0 - 6 2 , 68 location of h e a d q u a r t e r s , 7 9 - 8 0 political pressures, 8 1 - 8 5 p r i v a t e interests, 19-22, 2 7 - 2 8 , 387-389 regionalism, 5 7 - 6 0 , 6 8 - 7 2 , 389. See also R e g i o n a l i s m of F e d eral Reserve s e p a r a t i o n f r o m Congress a n d President, 24 s t r u c t u r a l elements, 23-24, 41, 60-62, 298-299 T h o r n t o n , 22 unity of System, 6 2 - 6 5 , 68, 73, 299 weaknesses, 6 6 - 6 8 , 73, 9 3 Willis, 69 O v e r m a n Act, 100, 114, 142 Owen, Robert Aldrich P l a n , 47, 57 centralization of power, 57 control of Congress, 348 p a r t i c i p a t i o n of p r i v a t e banks, 332 stock o w n e r s h i p , 373 Treasury Department, 73-74

429

P a r t i c i p a t i o n of private banks in F e d e r a l Reserve audit a n d budget control of System, 3 6 7 - 3 6 8 currency issue, 61 d a n g e r s involved, 20-21, 27, 330-333 Eccles, 129-130, 332 F e d e r a l Advisory Council, 63 Federal Open Market Committee, 282, 290 m e a n i n g , 2 6 - 2 7 , 96, 282, 3 3 0 333 M o r g e n t h a u , 127, 129 n., 154 need for, 2 2 - 2 4 , 2 6 - 2 7 public good, 26 O w e n , 332, 373 Patman, 331-332 stock o w n e r s h i p , 3 8 7 - 3 9 0 Strong, 96 Willis, 9 6 - 9 7 Wilson, 41, 59 Patman, Wright agency status, 338, 352, 357 a u d i t , 3 5 4 - 3 6 1 , 364, 386 Congressional control, 3 3 1 - 3 3 2 , 3 3 8 - 3 3 9 , 348, 352, 359, 366 e x p e n d i t u r e s of F e d e r a l Reserve, 359, 386 F e d e r a l Reserve Bank of C h i c a go, 3 7 6 - 3 7 7 o w n e r s h i p of Reserve Banks, 3 3 1 - 3 3 2 , 376, 386 price level proposals (1938), 347-348 Subcommittee report (1952), 3 6 9 - 3 7 0 , 383 s u p p o r t of b a n k i n g system, 3 6 0 Piser, Leroy, 175 η. P r e s i d e n t of t h e U n i t e d States A l d r i c h P l a n , 46 a p p o i n t m e n t of B o a r d , 19, 26, 330

430

THE INDEPENDENCE OF THE FEDERAL RESERVE

conciliatory role, 158-159, 194 E m e r g e n c y Banking Act ( M a r c h 1933), 145-146 h e l p f r o m , 340 n o n - i n t e r v e n t i o n policy of W i l son, 9 2 - 9 3 . opposition f r o m Congress, 3 2 9 330 O v e r m a n Act, 100-101 pressures f r o m , 24, 264, 2 6 6 - 2 7 2 T h o m a s A m e n d m e n t , 142-144 P r i c e level A l d r i c h P l a n , 46 a v o i d a n c e of inflation (1936), 152-153 Congressional promotion of inflation (1938), 142, 3 4 7 - 3 4 8 , 375 Douglas, 3 5 0 - 3 5 1 early version of F e d e r a l R e s e r v e Act, 347 Eccles, 2 0 9 - 2 1 1 , 254, 336 i n a d e q u a c y of F e d e r a l R e s e r v e powers (1946), 200-201, 239 K o r e a n w a r , 231 ff. p o s t - W o r l d W a r I, 106, 116 stock o w n e r s h i p of Reserve Banks, 375 T h o m a s A m e n d m e n t , 142 W o r l d W a r I I , 170, 180 ff., 200 P r i v a t e banks, see P a r t i c i p a t i o n of private banks in Federal R e s e r v e ; also Stock o w n e r s h i p of R e s e r v e Banks Progressive P a r t y p l a t f o r m (1912), 56 P u b l i c D e b t Act of 1942, 376 n. Public disclosure by Federal Reserve B a n k i n g Act of 1935, 136 difficulty of, 33, 3 6 - 3 7 , 3 2 6 - 3 2 7 , 339 F e d e r a l Reserve Act, 135-136

SYSTEM

n e e d for, 33, 3 5 - 3 6 , 137-138, 327, 3 4 5 - 3 4 6 o b j e c t i o n of Eccles, 136-137 o p p o r t u n i t y to increase a u t h o r ity, 3 2 7 - 3 2 8 p u b l i c responsibility, 35, 37, 1 3 7 - 1 3 8 , 357, 386 n. sovereignty of the g o v e r n m e n t , 3 6 - 3 7 , 3 2 6 - 3 2 7 , 342 trusteeship, 3 6 - 3 7 , 3 2 7 - 3 2 8 P u j o C o m m i t t e e (1913), 4 3 - 4 4 P u r p o s e s of F e d e r a l R e s e r v e achievement through private banks, 26 b a n k e r s ' banks, 61 D o u g l a s S u b c o m m i t t e e (1950), 349 early a c h i e v e m e n t , 86 e m p h a s i s on s t r u c t u r a l a r r a n g e ments, 24-25 E m p l o y m e n t Act of 1946, 199, 227, 276, 278, 319, 334, 349 e n v i r o n m e n t a l effects on, 25, 28-29 e x p a n s i o n in the thirties, 29, 148-150 Federal Open Market Committee, 134-135, 280, 283 first F e d e r a l R e s e r v e B o a r d , 6 4 65 intent of f o u n d e r s , 23, 25, 72 lack of early s t a t e m e n t , 67, 86 g o v e r n m e n t policy, 2 5 - 2 6 , 3 6 37, 73, 146, 149 P a t m a n S u b c o m m i t t e e (1952), 2 6 2 - 2 6 3 , 333, 3 4 9 - 3 5 0 price level, see Price level p r o p o s e d changes (1938), 3 4 7 348 p u b l i c good, 23, 25, 28, 3 0 - 3 1 , 37, 60, 6 4 - 6 5 , 1 4 7 - 1 4 8 p u r p o s e s of T r e a s u r y , 30, 2 6 2 263

431

INDEX

Roosevelt, 147-148, 333 unity of System, 62, 73 Wilson, 43 World W a r II, 174

increased requirements: ( 1936— 1937) 152-159; (1948) 212 Thomas Amendment, 142-144 World War II, 177-178, 180, 200-201

Reconstruction Finance Corporation, 141, 188 Regionalism of Federal Reserve, see also Autonomy of Reserve Banks bankers' banks, 61 Glass, 58, 60-61 Harding, 6 9 - 7 0 importance for independence, 68-71, 299 lack of leadership, 87-88 McCabe, 227 operating head of Reserve Banks, 71-72 Owen, 57 reduction in n u m b e r of Reserve Banks, 8 9 - 9 3 result of compromise, 5 9 - 6 0 Sproul, 220, 283 viewpoint of first Board (1915), 64-65 Willis, 69 Republican Party platform (1912), 57 Repurchase agreements, 175, 2 9 2 293 Reserve Bank Organization C o m mittee, 19, 72, 80-90 Reserves Banking Act of 1935, 143 n. complaint of Treasury Department about excess (1914), 53 currency backing, 55 decline in excess (1941-1942), 177 increase at start of Reserve Banks, 29

Robertson, James L., 267, 363, 365-366, 384-385 Rososa, Robert, 296 Roosevelt, Franklin D. approval of increase in reserve requirements (1936), 152 dedication of Board headquarters (1937), 147, 333 relation of Federal Reserve to government, 125, 333 threat of takeover of Federal Open Market Committee, 156-157 use of Trading with the Enemy Act of 1917, 145 n. Roosevelt, Theodore, 56

Second W a r Powers Act (1942), 178 n. Secretary of the Treasury, see Treasury Department Security market, see Government securities market Shaw, Leslie, 47, 50, 73 Silver Purchase Act of 1934, 144 Snyder, John W. Accord (March 1951), 229 ff. appeal to President T r u m a n (1950-1951), 238-240 conferences with Federal Reserve (1951), 246-247 critici/ed, 241-242, 245-246 Eccles, 209 emphasis on cooperation, 226, 233, 235, 257-260 importance of environmental changes, 29-30

432

T H E INDEPENDENCE O F T H E F E D E R A I . R E S E R V E

independence of Federal R e serve, 2 6 4 - 2 6 6 letter to Board of Governors (1950), 233 meaning of Accord, 257 national advisory council, 226 proposed membership on Board, 226 responsibilities of T r e a s u r y Department, 226 speech at New York ( J a n u a r y 1951), 240 support for program of Federal Reserve, 207-208, 215 Socialism, 20-21, 26 Sproul, Allan absence of scandals, 386 abuse of power, 32, 386 n. Ad Hoc Subcommittee report (1952), 274 n., 282-284 agency functions of New York ' Reserve Bank, 2 9 5 - 2 9 6 authority of Chairman of Board, 267-268, 2 7 1 - 2 7 2 changes proposed, 209, 2 1 8 - 2 2 3 Congress, 222, 261 cooperation with Treasury Department, 32, 185-186, 202, 219, 222, 2 3 8 - 2 3 9 decision of M a r c h 1953, 2 8 4 289 disagreement with T r e a s u r y Department, 177, 202, 234-235, 246-247 Ecclcs's criticism, 209 n. Federal Open Market CornCommittee, 220-221, 283 federal structure of System, 220-221, 271, 283, 386 n. flexible policy (1946, 1948), 202 governmental power, 219, 239 independence, 32, 202-203, 222 monetary power, 239

SYSTEM

national advisory council, 2 2 2 223 participation of private banks, 218-221, 284, 386 n. resignation, 290-291 Secretary of the Treasury as member of Board, 223, 268 support program, 175 n., 177, 202-205 Stabilization Fund, 153 Stock ownership of Reserve Banks changes proposed, 105, 375, 377 ff. Comptroller General's opinion, 356 n. Congressional approval, 370 Congressional a r g u m e n t s against, 370-371, 377 ff. cooperation of private banks, 370-372, 375, 379, 381, 383, 386-390 defended by Federal Reserve, 379 ff. early history, 3 7 1 - 3 7 4 Eccles, 129, 375 failure of 1938 proposal, 375 finances of System, 369-370, 372, 376-377, 391 Glass, 373-374 importance at beginning of Federal Reserve, 388 independence, 129. 369-370, 373, 378-379, 382, 386 n., 389-391 meaning, 129. 3 6 9 - 3 9 1 membership in System, 19, 370-372. 386 misinterpreted, 3 7 9 - 3 8 2 , 385 Owen, 373 participation by private banks in System, 370-372, 375, 379, 381, 383, 3 8 6 - 3 9 0

INDEX

P a t m a n Subcommittee (1952), 369-370, 383, 389-390 proprietorship, 371-373, 376— 377, 381-385 taxation of dividends, 376 n. Strong, Benjamin, see also Governors Conference authority of Board over openmarket operations, 109-110 cooperation with Treasury Department (World W a r I), 100-102 disagreement with Glass (1919), 115 open-market policy (1928), 122 opposition to Board (1927), 119-120 Overman Act, 100-101 private aspects of Reserve Banks, 96 promotion of Governors Conference, 94—96 reduction in discount rate (1921), 118 n. resignation, 121-122 unity of system, 96, 106 Szymczak, M. S., 185, 230

Tennessee loan incident, 51-53 Thomas Amendment, 142-144, 171 Thornton, Henry, 22 Trading with the Enemy Act (1917), 145 n., 251 n. Transamerica Corporation, 210 n. Treasury D e p a r t m e n t Accord (March 1951), 229 ff. Ad Hoc Subcommittee (1952), 273 ff. agency operations of Reserve Banks, 295-299 audit of Board's funds, 78

433 authority, related to Federal Reserve, 75-76, 80, 99, 106 Board of Governors, 19, 58, 62, 75, 78-80, 97-98, 102-103, 138-140, 159, 268-269 Comptroller of Currency, 7778 cooperation with Federal Reserve, see Cooperation of Federal Reserve with Treasury Department, currency issue, 55, 61-62, 143 debt-management principles, 30, 99, 106, 302-308 discount rates, 114, 119, 318320 early history, 307, 324-325 Emergency Banking Act (March 1933), 145-146 Federal Reserve Bank of New York (World W a r I), 98-99, 101-102 funds of Board, 73, 78, 140 headquarters for Board, 79-80 long-term rates (post-World War II), 182-183 independence of Federal Reserve, 30, 68, 75, 97-102, 138-139, 300-306 membership on Board, 19, 58, 75, 97-98, 138-139, 268-269 monetary power, 30, 49-55, 68, 73-76, 82-83, 85, 97-102, 106, 108, 142-144, 307-308, 324-325 operations affected by Federal Reserve, 30-31, 106, 114-115 organization of Federal Reserve, 19 pegging rates (1939), 169-170 public expression of disagreement, 311

434

THE INDEPENDENCE OF THE FEDERAL R E S E R V E

rate structure (World War 173-178

II),

reserve requirements ( 1936— 1937), 152-159 Thomas Amendment, 142-144 unification of debt management and monetary policy, 99, 307-308 unity of Federal Reserve, 62, 102 T r u m a n , Harry S. appointments made to Board, 243 n. increase in reserve requirements (1949), 212 intervention sought, 2 3 8 - 2 4 0 letter to Chairman McCabe (1950), 238 meeting with Open Market Committee (1951), 2 4 3 - 2 4 5 removal of Eccles as Chairman, 210 special committee prior to Accord (1951), 2 4 9 - 2 5 1 Trust funds of government, 1 5 2 158 Trusteeship of Federal Reserve System audit control arrangement, 363 centralization of authority, 2 8 1 282, 299 concern of Congress, 33, 217, 327-328 explanation of relationship to government, 25, 37, 328, 342344 need for trust, 225, 281, 3 4 3 344 operational meaning, 37, 345 reasons for, 36, 225 safeguards for, 37, 280, 327 two-way relationship, 217, 345

SYSTEM

view of first Federal Board, 6 4 - 6 5

Reserve

Underwood, O. W., 4 2 - 4 3 Unification of debt management and monetary policy, 3 0 7 - 3 1 0

Vardaman, James 270 Vinson, Fred, 198

K.,

244-245,

Wagner, Robert, 162 Warburg, Paul M., 8 9 - 9 2 Ways and Means Committee, 324-325 Williams, John H , 147 Williams, John Skelton, see Comptroller of the Currency (1914-1921) Willis, H. Parker audit control by Treasury, 78 authority over discount rates, 113 autonomy of Reserve Banks, 96-97 Banking Act of 1935, 128 Governors Conference, 95 n. headquarters of Board, 7 9 - 8 0 political influences on Federal Reserve, 8 2 - 8 4 regional authority in System, 68-71 Wilson, Charles, 2 5 1 - 2 5 2 Wilson, Woodrow achievements of 63d Congress (1914), 43 appointment of Board members, 19 approval of Federal Reserve Act, 4 0 - Î 3 , 49

435

INDEX

attitude toward Board, 43, 5 8 59, 83, 92-93 central control, 43, 49, 58 compromise in legislation, 55, 67 issuance of currency, 55 letter to McAdoo, 49 "money trust," 43-44

participation of private banks on Board, 92 purpose of Federal Reserve, 4 1 42 Wolcott, Jesse P., 336

Young, Roy Α., 122 η.