Economics and the Public Welfare. Benjamin M. Anderson
of 3.5 percent, fully tax-free. The second liberty loan was at 4 percent, partially tax-free. The fourth liberty loan was at 4.5 percent, partially tax-free. There were, moreover, provisions that holders of one loan might convert into a later loan if the rate were higher. The government did not rely upon the rate alone to attract investors’ money. It counted also on patriotism, and on the wonderfully organized system of drives under which a good many men who were reluctant to buy bonds found themselves under such pressure from their neighbors that they bought them. Social pressures were used as well as rates. But the rates were well above the rates at which government bonds had been selling before the war began, and were rates which an investor could feel would give a good bond, selling at par if he carried it through the period of war pressure.
Rediscount Rates Below the Market, but Rising with the Market. The Federal Reserve banks, to facilitate the loan policy of the government, put their rediscount rate below the market. The New York Federal Reserve discount rate was placed at 3 percent in 1917, was raised to 3.5 percent at the end of the year, and to 4 percent in early 1918, remaining below the market, but following the market up. But our experience with the Federal Reserve System has shown that while a rate below the market is undesirable, it does not in itself create bank expansion, nor does it by itself create cheap money. Banks usually are prudent in rediscounting. They do not like to be in debt to the Federal Reserve banks.
In 1919 and early 1920 the banks did borrow to relend at a profit, but expansion of bank credit which took place in those years was in the face of rapidly rising rates of interest and was due to the inordinate demands of borrowers in a boom. The rates below the market permitted expansion to go further than it would have gone, but did not permit it at low rates of interest. Our experience with the Federal Reserve System, taking all the years since it has been in existence, would show that the decisive instrument for cheapening money is open market purchases rather than discount rate.
Wartime Reduction in Reserve Requirements. The legislation of 1917 reduced the reserve requirements to thirteen percent, ten percent, and seven percent for demand deposits in central reserve cities, reserve cities, and country banks, respectively, and to three percent on all time deposits.3
Bank Expansion Slows Down During War. The extremely low reserve requirements set by the legislation of 1917 did no harm in the period of the
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war. The fact that these low reserve ratios make possible a tremendous multiple expansion on the basis of excess reserves was not operative,4 because there were no excess reserves to work on.
The expansion of bank credit was slowed down sharply during the war as compared with the preceding years 1915, 1916, and the first part of 1917. For the period June 30, 1914, to June 30, 1918, bank deposits expanded year by year as follows:
TOTAL DEPOSITS OF ALL COMMERCIAL BANKS
(In millions of dollars)
| Call date | Total |
| 1914—June 30 | 17,390 |
| 1915—June 23 | 17,993 |
| 1916—June 30 | 22,079 |
| 1917—June 20 | 25,885 |
| 1918—June 29 | 28,011 |
For the period of our actual participation in the war, the expansion was as follows:5
DEPOSITS OF COMMERCIAL BANKS
| December 31, 1918 | $26,541,039,000 |
| April 6, 1917 | 20,705,588,000 |
| Increase | $ 5,835,451,000 |
LOANS, DISCOUNTS, AND INVESTMENTS OF COMMERCIAL BANKS
| December 31, 1918 | $29,354,214,000 |
| April 6, 1917 | 22,297,775,000 |
| Increase | $ 7,056,439,000 |
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This is a remarkable exhibition of restraint in the employment of bank credit in a great war. We had to finance the government with its four great liberty loans and its short-term borrowing as well. We had to transform our industries from a peace basis to a war basis. We had to raise an army of four million men and send half of them to France. We had to help finance our Allies in the war, and, above all, to finance the shipment of goods to them from the United States and from a good many neutral countries. We had an immense shipbuilding problem.
Private Financing of War Production—War Finance Corporation Unimportant. Commercial bankers and investment bankers, moreover, had to finance the industrial expansion that took place for war purposes. There were no great government loan organizations replacing private finance. There was, to be sure, the War Finance Corporation, a government corporation with a capital of $500,000,000, which was to extend new credits to essential industries and to savings banks and public utilities which had been suffering under the war pressure. But in practice the War Finance Corporation down to October 15, 1918, had extended credits of only $43,202,592. The most important extension of credits made by that date was $20,000,000 to the Bethlehem Steel Corporation, $17,320,000 to the Brooklyn Rapid Transit Company, $3,235,000 to the United Railways of St. Louis, and $1,000,000 to the Northwestern Electric Company. All the rest of the credit given to industry in the great war effort was made by the commercial banks and the investment market. Private finance was adequate, and private finance did an immensely efficacious job. To repeat the figures, in doing this job commercial bank credit expanded only $7,000,000,000 in loans, discounts, and investments, and only $5,835,000,000 in deposits. (The gap on the liability side of these bank figure is filled by rediscounts at the Federal Reserve banks and by an increase in banking capital funds.)
The Rationing of Credit. One important factor in holding down the expansion of bank credit was the rationing of credit, and the denial of credit to nonessential industries. The first organized step in this direction was taken on September 17, 1917, by a subcommittee on money rates of the New York Liberty Loan Committee, composed of the leading bankers of the city. It undertook to limit the funds available for the stock market, providing funds, on the other hand, when necessary for the protection of the stock market, and, above all, for the protection of the liberty loans. It pegged the call rate at six percent to the brokers, but it held down the supply. They could have what they had to have and what could be spared after giving precedence to the needs of the government and to the needs of the commercial borrowers. The committee also made a ruling that banks should require a margin of thirty percent on collateral loans made to stockbrokers where an average of twenty percent had previously been required. The stock market ceased to be a very effective competitor for
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loan funds, though it was not strangled, and continued to function effectively.
In addition, early in 1918 the Capital Issues Committee of the Federal Reserve Board, semiofficial in character, was organized, whose function it was to pass on proposed new issues of securities. Only essential industries were to be allowed access to the investment market. It lacked power to prohibit such issues, but it met such loyal and effective cooperation from bankers throughout the country that it was virtually able to boycott all issues of which it disapproved. Connected with it were local Capital Issues Committees in each of the twelve Federal Reserve districts. This committee surrendered its function upon the organization of the new War Finance Corporation in May 1918 to the Capital Issues Committee of the War Finance Corporation, though in part the personnel of the two committees remained the same.
There