47. In a memo to his files, Harrison reports Black’s statement more fully. “He said that there is persistent and insistent pressure in Washington for immediate inflation, not for inflation in two or three weeks, but for inflation at once” (Harrison Papers, file 2210.3, September 16, 1933, 2; emphasis in the original). Black named Senator Bryan P. (Pat) Harrison, the majority leader, and Senators Elmer Thomas, Ellison D.Smith, and Duncan Fletcher as proponents of inflation. He had talked to Senator Harrison, who wanted more done than the Federal Reserve was doing. Black also wrote to Jesse Jones at the RFC and urged him to purchase $600 million of preferred stock to reopen closed nonmember and member banks by January 1.
Opposition to the purchase program increased. Disturbed by the decline in rates and loss of revenues and by the volume of government securities, the executive committee of the Chicago bank unanimously approved a resolution on September 29 calling for reduction in its share of open market purchases. Chicago continued to adhere to the real bills doctrine, citing not only the $700 million of excess reserves but the need to be in position to rediscount paper for commercial, agricultural, and industrial borrowers. Further, the directors saw “no need for further purchases” (Letter C. R. McKay to Eugene Black, Board of Governors File, box 1449, October 4, 1933). Since Chicago took the largest share of new purchases, its decision threatened the purchase program.48
The background memo for the October 10 meeting showed that “basic commodity prices” reached a peak in July, then fell back. By early October, the index was above April but substantially below mid-July. Governors Roy A. Young (Boston) and George W. Norris (Philadelphia) argued that market rates were so low that they deterred lending. Banks incurred costs with very little return. All the governors agreed that the credit and banking position gave no reason for purchases. The committee voted to continue purchases, however, to avoid political confrontation.
The minutes of the meeting give the governors’ view of how open market operations work and why they had not worked on this occasion. Open market operations force funds into the short-term market and, as short-term rates decline, into the longer-term markets. The focus is on interest rates, not on the broader interplay of relative prices of assets and output. Some governors reported that banks were reluctant to lend because of their recent experience and concerns about some (inflationary) provisions of the Securities Act and the Banking Act. Borrowers were reluctant to take on debt. The governors believed that the inflationary program deterred lending and investment. They favored an administration program to strengthen confidence. The latter is probably a reference to the budget deficit and the uncertainty surrounding the administration’s policy of buying gold to raise the price level and devalue the dollar (FOMC Minutes, Board of Governors File, box 1449, October 10, 1933).
48. In April the FOMC changed allocations of government securities to give more securities to banks with larger gold reserves. The change shifted the allotment by reducing New York, Kansas City, and Dallas. Chicago went from 12 percent to 36 percent. New York’s percentage was 15.25 percent (McKay to Black, Board of Governors File, box 1449, September 12, 1933). Hitherto New York had always taken the largest share.
Harrison described the committee’s position when presenting the recommendation to the Board. The committee found “little or no reason for further purchases.” A reduction in purchases should be made if it could be carried out without harming the recovery program (Board Minutes, October 12, 1933, 3–4).
Chicago’s directors voted to participate in 12 percent of the purchases, based on the allocation formula in effect before May 1933, instead of 36 percent under the new formula. This was a modest concession to the Board, since the directors had voted to participate only on the written request of the Federal Reserve Board (Letter McKay to Black, Board of Governors File, box 1449, October 16, 1933). The main reason for the concession was that the Banking Act of 1933 required a month’s notice by reserve banks withdrawing from the purchase program (Letter Young to the Board, Board of Governors File, box 1449, November 6, 1933).
Chicago was not the only recalcitrant bank. After the FOMC voted to reduce the rate of purchase to $18 million on October 25, Boston voted on November 1 not to participate in the purchase. It cited the Chicago decision, the large amount ($581 million) remaining from the $1 billion commitment, and uncertainty about what its share would be. The formal rules required prior notification. The bank was willing to consider purchases weekly (ibid., 2).
In October and November the System purchased $55 million, then purchases stopped. The committee did not meet again until March 1934, when it voted to reduce the authorization to purchase from $1 billion to $100 million. Between November 1933 and April 1937, the open market portfolio remained at about $2.43 billion. Changes represent expiring maturities not immediately replaced.
The System’s discussion of interest rates and credit conditions ignored the sustained upward movement of stock prices. During the spring and early summer of 1933, the Standard and Poor’s index of stock prices nearly doubled, rising from 45 in March to 85 in July. Thereafter the index declined slightly to the end of the year. By July 1933 the index of industrial production reached the highest level in three years, more than 50 percent above its trough; the Board’s index, available at the time, shows a larger increase, 70 percent above its trough, back to the level last experienced in May 1930. The index declined in the fall. By December much of the increase had reversed.
Just as in 1932, open market purchases stopped as the economy began to expand. Although the circumstances differed, the reasoning was much the same. Harrison explained the prevailing view in a memo to his files on November 20. Acting Treasury Secretary Henry Morgenthau wanted the reserve banks to purchase $25 million a week in advance of the December Treasury financing.49 All the governors opposed. Harrison told Morgenthau that “it would not only do no good, but it might do some harm; it would be only another factor of uncertainty, tending toward inflation” (Harrison Papers, November 20, 1933). According to Harrison, Morgenthau agreed.50
Federal Reserve officials appear to have learned nothing from the experience of 1929–33. They continued to operate in established ways and to interpret events as they had in the past. The principal reason for large-scale purchases was fear—fear of legislation or of action by the new administration. Balancing this fear was fear of inflation, a concern more closely related to the real bills doctrine than to the fact that the price level was 25 percent below its 1929 level.
In 1920–21, gold movements and a falling price level raised real balances and ended the recession despite high real interest rates. The pattern was very different in 1933. The economy recovered strongly beginning in the second quarter, as banks reopened and the financial crisis ended. The deflator rose at an 11 percent average annual rate for the last three quarters of the year, mainly the effect of NRA codes approved in July. Growth of the monetary base remained negative throughout the spring and early summer, and real balances fell. The ex post real interest rate was negative. In the fourth quarter output fell, and the risk premium in interest rates rose by 0.75 percent from the low reached in May.51
Unlike Hoover, Roosevelt did not intend to be the victim of Federal Reserve inaction. He began buying gold and silver to raise their prices and the general price level. Although Federal Reserve credit declined slightly in 1934 as discounts and acceptances fell to insignificant levels, gold and silver purchases increased the monetary base. The base and the money stock resumed their increase, and recovery also resumed.
49. Woodin was ill and resigned. Morgenthau became secretary on January 1, 1934.
50. Harrison took a different attitude toward commercial bank bond purchases. In January he called on Winthrop Aldrich to discuss sales of governments by Chase National. He told Aldrich Washington believed that “New York banks were selling . . . as part of a conspiracy to depress government bonds and thus to defeat the government’s program.” Aldrich agreed to cooperate (Harrison Papers, file 2500.1
, January 9, 1934).
51. The risk premium is the difference between Baa and Aaa bonds. Output data are from Balke and Gordon 1986. Monthly data for industrial production, wholesale prices, and common stocks show similar patterns. Industrial production rose 57 percent between March and July, then faltered. By November, half the initial rise was gone. Wholesale prices rose 18 percent between March and August, then remained unchanged for the rest of the year. The stock market peaked in July, 80 percent above the March average. By November the average was 16 percent below its peak. The NRA was the proximate cause of the stock market decline from its peak. Announcement of the first codes raising costs of production in mid-July, precipitated the decline (see below).
GOLD AND SILVER POLICY, 1933–34
From the banking holiday to April 11, the gold price remained within 15 cents (0.7 percent) of its par value, $20.67 an ounce. There is no sign of anticipated devaluation in either the gold price or the forward market. The Treasury granted export licenses without hindrance. Gold returned to the Federal Reserve banks.52 These and other available data suggest that the markets regarded the suspension of convertibility as a temporary move. The relatively large United States gold holdings at the time gave no reason for permanent devaluation under “rules of the game.”
Sentiment began to change in April. Discussions leading to the Thomas amendment and pressure for inflation or reflation increased requests for licenses to export gold. In mid-April, gold outflows increased. The liberal gold export policy ended abruptly on April 18, when Secretary Woodin refused to issue new export licenses. The following day, the president prohibited gold exports except for gold previously earmarked, and hence owned, by foreign governments.53 The United States was no longer on the gold standard.54
Business and the public supported the decision. The stock market response was euphoric. The Dow Jones index of industrial stock prices rose 14 percent in the next two days and 55 percent in the next three months (Sumner 1995, 12). A daily index of the wholesale prices of seventeen commodities rose 76 percent, and the gold price rose to $30.18 in the next three months (Pearson, Myers, and Gans 1957, 5613).55 J. P. Morgan praised the decision as an end to the deflationary policy (quoted in Crabbe 1989,436). Proponents of devaluation within the administration were delighted, as was the Committee for the Nation, a group of prominent citizens who favored reflation as a cure for depression (Pearson, Myers, and Gans 1957, 5610).56
52. Between March 4 and March 22, $250 million in gold coin and $310 million in gold certificates returned to Federal Reserve banks (Draft Statement of Executive Order Forbidding the Hoarding of Gold Coin, Board of Governors File, box 2160, April 2, 1933). The statement was issued on April 5.
53. The shift in policy appears to have been a sudden change, supporting the view that the Thomas amendment played a major role. Two weeks earlier, Harrison and the New York directors had discussed possible resumption of gold payments and a fixed parity. Harrison acknowledged, however, that he did not know the administration’s plans (Minutes, New York Directors, April 3, 1933, 253–54).
54. April 19 is also the day Roosevelt agreed to accept the discretionary powers to print greenbacks granted by the Thomas amendment and talked about depreciating the dollar to raise the domestic price level.
55. The stock market boom ended on July 19. The Dow Jones average fell 4.8 percent that day and an additional 15.5 percent in the next two days, eliminating half the gain since April 18. On July 19 the NIRA announced an increase in wages and reductions in hours. Sumner (1995, 18–19) computes the increase in nominal and real wages as 20 percent in the two months from July to September 1933, using the wholesale price index as the deflator for average hourly earnings. Weinstein (1981, 267) estimates that the NIRA codes raised nominal wages 26 percent a year for the two years of NRA existence and raised prices by 14 percent a year.
Suspension of the gold standard was a decision to favor domestic over international considerations in the recovery. Most observers at the time presumed this was a temporary move, not a decision to float the dollar permanently. Roosevelt had not yet made a firm decision about either gold or the dollar.
Congress took a longer view. On June 5 the president signed legislation abrogating the gold clause in all contracts. The action redistributed wealth from creditors to debtors, including the government as a principal debtor. The clause applied to about $100 billion of public and private debt and to $1.6 billion of currency—gold certificates. Holders of mortgages, bonds, notes, and currency calling for payment in gold at 23.22 grains per dollar could not insist that their claims be enforced by the courts. Creditors challenged the action, but the Supreme Court upheld the government’s action five to four in February 1935 (Pearson, Myers, and Gans 1957, 5598).57
The London Monetary and Economic Conference
Events soon forced President Roosevelt to choose between stabilization and devaluation. An international conference at Lausanne, Switzerland, in July 1932 agreed to call another conference to consider international capital movements, currency stabilization, tariffs, and trade policy.58 London was chosen as the site and June 12 as the date. As the conference date approached, Roosevelt became active. Between April 22 and June 3, he met with ten prime ministers or presidents and cabled fifty-four others. His statements supported the aims of the London conference and an international solution, as pledged in the 1932 party platform (Pearson, Myers, and Gans 1957, 5617). In a fireside chat on May 7, he told the public that the conference “must succeed. The future of the world demands it” (quoted in Beckhart 1972, 306).
56. The group of three hundred included Henry Morgenthau Sr., father of one of Roosevelt’s closest advisers, soon to become secretary of the treasury. Other members included the heads of Sears, Roebuck, Remington Rand, and several banks. Earlier, on April 5, an executive order prohibited domestic gold holding of more than $100 (except for industry and the arts).
57. Gold clauses became common after the Civil War, especially after de facto stabilization in 1879 at the gold price of $20.67 per ounce. The clause specified payment “in gold coins of present standard weight and fineness,” that is, 23.22 grains of gold to the dollar (Pearson, Myers, and Gans 1957, 5598).
58. The Lausanne conference ended German reparations payments permanently.
Roosevelt’s advisers were divided. George Warren was the leading advocate of devaluation within the administration. Outside, Irving Fisher favored devaluation based on his proposal for a compensated dollar and his belief that the rise in the real value of debt was a main obstacle to recovery. Both wanted the price level restored to the 1926 level.59 Morgenthau supported Warren’s views and used his charts comparing weekly changes in agricultural prices to changes in the world price of gold to convince Roosevelt. The president “was impressed” (Blum 1959, 64).
Conservatives within the administration opposed devaluation. Dean Acheson, later secretary of state in the Truman administration, was undersecretary of the treasury under Woodin. Woodin appointed Oliver Sprague of Harvard as his adviser on international economic policy. Sprague held traditional views; he favored deflation to reduce the price level as required under gold standard rules. Government could help by reducing “sticky” prices—wages, freight rates, and telephone charges.60
Secretary of State Cordell Hull headed the delegation to the London Monetary and Economic Conference. Hull’s concern was multilateral tariff reduction, and he does not seem to have taken much interest in monetary or financial issues. Drafting the United States position on these issues was left to Sprague and James Warburg, who favored a return to a gold standard after a 15 to 25 percent devaluation of the dollar. This plan was unacceptable to the British and the French (Kindleberger 1986, 205–6).61
Harrison was the principal Federal Reserve official involved in the discussions. In May he talked to Montagu Norman about a French proposal to stabilize the dollar, franc, and pound. Norman suggested that the franc and the dollar could remain at their current values but said the pou
nd was likely to depreciate. He proposed that France and the United States accumulate sterling balances in London, to be paid in gold when the stabilization agreement ended. He doubted that the plan would work or would be helpful to Britain, but he promised to send a member of his staff to Paris to discuss the proposal (Harrison Papers, Memo, file 3115.4, May 18, 1933).
59. Warren was a professor of agricultural economics at Cornell, where Henry Morgenthau Jr. had been a student. Morgenthau introduced Warren to Roosevelt as an agricultural adviser in 1930. Warren kept a diary of his meetings with Roosevelt and others in 1933–34. The diary is the basis for large parts of the paper by Pearson, Myers, and Gans (1957) on which I draw heavily. Warren served as a consultant and did not hold any position in the administration. Fisher wrote to Roosevelt, sometimes by request, but he did not participate in the principal policy discussions within the administration, as Warren did, and he was not an adviser.
60. Sprague also favored increased government spending, especially on construction (Pearson, Myers, and Gans 1957, 5649). In the 1920s he testified in Congress against bills to make price stability a goal of the Federal Reserve. He was always skeptical of linkage between money and prices and opposed Fisher’s compensated dollar. Other prominent opponents of devaluation included James Warburg, son of Paul Warburg, a member of the original Federal Reserve Board, Herbert Feis, economic adviser to the secretary of state, and the budget director, Lewis Douglas.
A History of the Federal Reserve, Volume 1 Page 64
