A History of the Federal Reserve, Volume 1

by Allan H. Meltzer

  His views help to explain his decisions and his passivity as head of the Federal Reserve. Eccles did not blame the Federal Reserve for the depression or urge credit expansion. The Reconstruction Finance Corporation and the Federal Reserve banks had expanded credit without result.99 The “extension of credit alone is not the solution” (ibid., 709). Nor was the solution a continued or deeper deflation, as many bankers and businessmen insisted.

  Eccles opposed devaluation, silver purchases, or increases in money unless they increased consumers’ purchasing power. He believed the money stock, though 22 percent below 1929, was adequate to support higher spending; the problem was low velocity of circulation resulting from hoarding currency. His program, calling for $2.5 billion of government spending on public works (more than 4 percent of depressed GNP), financed by debt, and cancellation of Allied war debts, did not appeal to most senators (ibid., 712).100 He also favored “a more equitable distribution of wealth” (730) to increase purchasing power, unification of the banking system under Federal Reserve supervision, high income and inheritance taxes, a minimum wage, unemployment insurance, old age pensions, government supervision of security issues, transport, and communications, and a national planning board to coordinate public and private activities (730–31).101

  Eccles’s views on budgets and deficits differed from Roosevelt’s or Morgenthau’s. Roosevelt advocated a balanced budget and reduced expenditure as “the most direct and effective contribution that Government can make to business” (Eccles 1951, 97, quoting Roosevelt’s campaign speech of October 19, 1932).102 Morgenthau was a strong advocate of a balanced budget, and the difference became a source of friction between the two men.103

  99. Eccles in 1935 accepted the much-used phrase “pushing on a string” to describe his belief about expanding credit and money in deep recessions.

  100. Gross investment had fallen $26 billion from the 1929 peak.

  101. Although Eccles advocated a national planning board, he opposed the NRA price and wage-raising schemes. He was glad when the Supreme Court declared the NRA unconstitutional (Hyman 1976, 153).

  102. As noted earlier, Roosevelt categorically rejected deficits but then added that he would tolerate a deficit to relieve “starvation and dire need.” Eccles (1951, 98) claims that Samuel Rosenman, who edited Roosevelt’s papers, tried to reconcile Roosevelt’s deficits with his 1932 speech by claiming that Roosevelt meant only the administrative costs. Eccles viewed Roosevelt as a “budget-balancer” who regarded a balanced budget as “a self-contained good” (98).

  103. Eccles was highly critical of wartime deficits. He favored deficits only to make up for a shortfall of private investment. Although his proposals for deficit finance are similar to Keynes’s views after 1928, Eccles claimed never to have read Keynes’s main work.

  Eccles’s first job in the Roosevelt administration was as an assistant to Morgenthau for banking and monetary problems. He came to Washington early in February 1934 with the stated intention of staying sixteen months. He remained for seventeen years, most of the time as head of the Federal Reserve System.104

  His initial meetings with Morgenthau were a prelude to their later relationship. The two men were very different in background, personality, and beliefs. Eccles described himself as blunt, and his biographer adds that his relationship with Morgenthau was “deeply troubled” (Eccles 1951, vii; Hyman 1976, 207). Morgenthau saw Eccles as talented and energetic but also as confident, assertive, and ambitious, with “an insatiable drive to gain personal power” (Hyman 1976, 207; Blum 1959, 279). Morgenthau was a country gentleman who had been drawn into government by the longstanding family friendship of the Roosevelt and Morgenthau families. His biography shows him to be cautious, rarely willing to make a decision without the president’s approval. He distrusted bankers and opposed “bigness” and government deficits. Eccles attributed many of his disputes to the “quirks of Morgenthau’s personality” (Hyman 1976, 207).105 Both men tended to see substantive issues as personal, a fact that Eccles realized after Morgenthau resigned and his disputes and differences continued, and intensified, with Secretaries Fred M. Vinson and John W. Snyder, who followed.

  Eccles’s self-image was that he defended principles against expediency (Eccles 1951, 394). The role of government was to run deficits in depression to finance investment and to run surpluses during prosperity, even in wartime, to reduce debt. This view of government spending and deficits clashed with Morgenthau’s belief that spending financed by deficits during depressions was a cause for alarm and hesitancy by business, leading to lower investment. Wartime deficits were, for Morgenthau and many others, a very different matter—a necessity. Eccles saw the inconsistency in this position and attributed it to the self-interest of those who benefited most from the spending.106

  104. His service as head of the Federal Reserve ran from November 15, 1934, to January 31, 1948, when President Truman replaced him as chairman. He remained as a member of the Board until July 14, 1951. Eccles believed that his pursuit of antitrust charges against Transamerica Corporation angered powerful political and banking interests in California during the 1948 election year. This, combined with his antagonistic relationship with Treasury Secretary John W. Snyder, a friend of the owners of Transamerica, may have led to his dismissal (Eccles 1951, 450–53). The dismissal was the subject of a congressional hearing, but the reason was not firmly established.

  105. A contemporary describes Morgenthau as “suspicious” and irritable, Eccles as a person of “contradictory enthusiasms.” “He loved the freedom . . . which allowed him to get very rich, and at the same time, a born centralizer” (CHFRS, interview with Casimir Sienkiewicz, March 18, 1954, 3). Sienkiewicz worked in the Federal Reserve System from 1920 to 1947. Jacob Viner describes Eccles as a “voluble talker” who “talked for hours at a time.” Morgenthau “had no patience with Eccles. The two men grated on each other.” Viner, like Sienkiewicz, described Morgenthau as a “suspicious man” but also as decisive in the early days (CHFRS, interview with Jacob Viner, March 17, 1954, 3–5). Currie (1971, 2) adds that “Morgenthau disliked Eccles intensely.”

  Appointment to the Federal Reserve

  Despite their early differences, Morgenthau proposed Eccles to replace Eugene Black as governor of the Board. In September, when President Roosevelt interviewed him, Eccles told him that he would accept appointment only if the president agreed to change the System. He wanted a commitment to end President Wilson’s compromise by centralizing power and authority in the Board and its chairman. The regional banks, particularly New York, representing “private interests,” controlled the System. Their power had to be broken, or the job was not worth having (Hyman 1976, 155).

  Eccles agreed to prepare a memo describing the changes he regarded as necessary. He presented it to Roosevelt shortly after the 1934 congressional election. The memo, prepared with the assistance of Lauchlin Currie, combined Eccles’s and Currie’s ideas of what went wrong at the Federal Reserve. Currie claimed to have drafted the memo (Sandilands 1990, 63); his views were well represented.107 It seems highly likely that it was how Eccles learned about the role of the real bills doctrine as a cause of the depression. Currie had written extensively on that issue; Eccles never mentioned it in his testimony and speeches, before meeting Currie or after. The memo to Roosevelt, however, began with an explicit statement of the need to eliminate procyclicality of the money supply. Money supply should be used as “an instrument for the promotion of business stability” (Eccles 1957, 173). The notion of eligible paper, a keystone of real bills, would be replaced by “sound assets.”

  106. Clashes were not limited to spending and budgets. Eccles was often involved in government policy. One of the principal clashes with lasting effect arose in 1936 over the undistributed profits tax. Eccles proposed his own version and actively worked against the Treasury’s proposals.

  107. Currie (1968, 39) concluded that “there is no valid theoretical justification for the Commercial Loan Theory
of Banking” (real bills). He found that the Federal Reserve had never defined “productive credit” or distinguished productive from nonproductive credit except by casual inference (39). Currie also favored 100 percent reserve requirements against demand deposits and zero against time and savings deposits (151). He favored control by a three- or four-person board, in Washington, with reserve banks reduced to branches of the central bank and with all banks required to be members of the System. He recognized that expanding the Board’s control was useless (or worse) unless it gave up quality of credit (real bills) as a guiding principle. Its goal should be control of spending by controlling money— currency and demand deposits (157). He repeated some of these points in different form in a long memo to Secretary Morgenthau written in September 1934 (197–226). The memo contains many of the same points but differs from his book, notably by calling for government ownership of the reserve banks. Morgenthau’s diary does not mention the memo.

  The memo departed from the more extreme position on nationalization of the reserve banks that Currie took in his September memo to Morgenthau (Currie 1968). But he proposed to vest control of open market operations in the Board, with “banker interest” removed. Bank directors would no longer have power to refuse to participate in open market operations. Also, the Board would have the power to approve or disapprove appointment of governors of the reserve banks.108 The memo met the usual complaint head-on. The Federal Reserve would become a central bank, centrally controlled: “Private ownership and local autonomy are preserved, but on really important questions of policy, authority and responsibility are concentrated in the Board” (quoted in Hyman 1976, 158).

  In the two-hour meeting at which Eccles presented and discussed the memo, Eccles records that Roosevelt paid close attention, recognized the serious political obstacles, rejected the idea of national branch banking, and accepted the proposal as a blueprint for reform. Six days later, on November 10, Roosevelt nominated Eccles as governor of the Board.109 The announcement emphasized Eccles’s business and banking background and reported the capital value of each Eccles enterprise, its volume of business, and the fact that all his enterprises had survived the depression. In this way the administration hoped to defuse criticism of Eccles’s radical ideas about budgets and show that not all the new appointees lacked business experience.

  Perhaps because Carter Glass had not been notified of his appointment, Eccles served in a recess appointment for five months. He was not confirmed until the following April, by a four to three vote in Glass’s banking subcommittee with Glass opposed, and by a unanimous vote in the full banking committee with Glass absent.

  Much of the opposition to Eccles focused on the banking bill prepared by Eccles and Currie. Many bankers opposed the legislation, particularly the sections that shifted power from the New York bank to the Board. Harrison was among them, firmly opposed to the legislation. Always ready to put an issue in personal terms, Eccles viewed this opposition as acting “on behalf of the private banking interests of New York” or out of personal pique (Eccles 1951, 178–79). He never mentions, and seems unaware, that the proposed move toward a central bank and the weakening of the System’s regional structure was seen as a substantive issue of great importance in many sections of the country and by many groups.110 Even bankers who favored a central bank did not want the bank controlled from Washington.

  108. Until 1936, each bank’s directors appointed the bank’s governor without approval by the Board. The Board approved salaries, however.

  109. Roosevelt failed to clear the appointment with Carter Glass, increasing the animosity that Glass held toward Eccles. Up to this time Eccles had not had to resign from any of his business activities. After the appointment, Eccles resigned as president of First Security Corporation and First Security Bank and sold his stock. But he was legally permitted to retain positions as chairman on leave of the Utah Construction Company, vice president and treasurer of the Amalgamated Sugar Company, and president of the Eccles Investment Company. He attended directors’ meetings of the latter companies throughout his Washington career (Hyman 1976, 160).

  Further, Eccles irritated Glass by his brash manner, failing to pay a courtesy call until two months after the president announced his appointment and failing to keep his promise to give Glass an advance copy of the legislative proposal that became the Banking Act of 1935. Eccles, uncharacteristically, recognized the second failure as a mistake (ibid., 196).

  Eccles’s recess appointment did not deter him from taking charge. Three days after taking office, he met with the Federal Advisory Council, a group of twelve bankers legally constituted under the Federal Reserve Act to confer and advise the Board. The council had adopted the practice of issuing statements without submitting them to the Board.111 Eccles threatened to ignore the council and deny them access to the staff unless they agreed to submit their statements to the Board before their release. This would allow the Board to reject the statements privately and, if it chose, publicly. The council reluctantly accepted the new arrangement.

  Even before he was sworn in, Eccles clashed with Harrison. The immediate issue was the System Committee for Legislative Suggestions, established in spring 1934 at the request of the Federal Reserve bank chairmen. The Board approved the committee in June (Board Minutes, June 23, 1934, 4–5). Harrison was elected chairman. All but one of the members came from the reserve banks; Vice Governor J. J. Thomas represented the Board. To Eccles, control by the reserve banks was control by private interests, especially the reserve bank directors. Eccles determined to shift control to himself, representing the public interest.

  When Harrison came to congratulate Eccles on his appointment and invite him to replace Thomas on the committee, Eccles replied: “I don’t intend to be a member of your committee. And, moreover, one of my first acts after I’m sworn in as Governor will be to move the abolition of your committee. . . . I have accepted the post of Governor primarily for the purpose of carrying out an important legislative program, which you in all probability are going to oppose” (Eccles 1951, 192). Thus Eccles began his tenure at the Board.112

  110. Eccles several times charged Glass with changing sides, from fighting the “interests” in 1913 to defending them in 1936 (Eccles 1951, 179, and elsewhere).

  111. The statement that irritated Eccles was issued in September just before the 1934 congressional elections. The statement demanded a balanced budget. Eccles regarded the statement as a political document issued to embarrass the administration.

  THE BANKING ACT OF 1935

  Planning for changes to the Federal Reserve Act started before Eccles became governor. A Treasury committee headed by Jacob Viner began work on banking and currency legislation early in 1934. The Board’s research director, Emanuel A. Goldenweiser, and the Federal Reserve agents (chairmen), recommended that a System committee work with the Treasury. On June 25 the Board approved the recommendation and established the legislative committee, chaired by Harrison, that Eccles abolished on taking office. Also, Eccles and Currie had prepared recommendations for Eccles’s November meeting with Roosevelt.113

  Eccles did not want the modest reforms and compromises expected from a System committee. With Currie, he challenged two of the main tenets underlying the Federal Reserve Act. First was the almost ritual restatement that the Federal Reserve was not a central bank. Eccles wanted a central bank with authority concentrated in Washington, specifically in his hands. Second, although he did not seem to share Currie’s strong beliefs about the need to abandon the real bills doctrine, he did not defend it. Eccles disliked rules such as the real bills doctrine. He preferred to rely on judgment and wanted a large measure of authority to do what he believed was in the public interest.

  Glass held exactly the opposite view from Eccles on both main issues. Financial collapse reinforced his commitment to the real bills doctrine. In his view the collapse was the inevitable consequence of violating the doctrine, and he continued to favor a decentralized system. The fault was
that New York had acquired too much power. Centralization had gone far beyond original intent.

  112. Relations were rarely good. In September, before Eccles’s appointment, Harrison discussed relations with the Board “and the possibility of their improvement” (Minutes, New York Directors, September 17, 1934, 171).

  113. There were many other proposals for change. One bill by Senator Elmer Thomas (Oklahoma) established a government-controlled system by purchasing all stock of the reserve banks. The System’s objective would be to “control the price of commodities through control of the purchasing power of money” (Board of Governors File, box 141, S. 433, undated). A bill offered by Senator Gerald P. Nye (North Dakota) created a central bank with representatives elected from each state for twelve-year terms. The bill also imposed 100 percent reserves against demand deposits and 5 percent against time deposits (ibid., S. 2162, March 4, 1935).

  Even if Eccles and Glass had had good personal relations, they would have clashed over substance. In the event, substance and personal feeling set up a clash between two strong-willed men.

  Harrison and the System Committee

  The work of Harrison’s committee shows the internal view of what went wrong and the desirable changes.114 There were, of course, differences of opinion and pressures to avoid contentious issues.115

  The committee began to consider an ambitious agenda of reform of the banking system and Federal Reserve controls. A comparison of failure rates in the United States, Canada, and Britain led to a proposal for branch banking. The background paper for the meeting recognized that “England, with a central bank, and Canada, without a central bank, entirely escaped bank failures” and that United States banking failures explain “both the greater severity of the depression in this country, particularly from 1931 on, and the greater difficulty experienced in achieving recovery” (Memo on Banking Reform, Goldenweiser to Committee, Board of Governors File, box 142, September 6 and 7, 1934, 2). But the memo shifted away from this promising start by blaming the “soundness of bank assets” for the higher failure rate (3). Thus it missed the opportunity to rid the banking system of its greatest weakness—restricted portfolios and limited diversification.