Economics and the Public Welfare. Benjamin M. Anderson
War. The Federal Reserve System performed great and distinguished services for the government and the country in World War I. It is difficult, indeed, to see how we could have handled the financial problems of the war without it. It made possible a smoothness and simplicity in handling huge financial transactions that would have been incredible under the old system. In the summer of 1918, for example, the federal government collected around $4 billion in taxes in a few weeks. In connection with the first liberty loan in 1917, $2 billion were paid into the federal Treasury in a short time. Financial transactions of this magnitude would have led, under the old system, to drains, falling primarily on the New York banks, which would have forced the banks almost instantly to suspend cash payments. Had the old subtreasury system remained in full
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vigor, under which all payments to the federal government were placed in cash in the vaults of the government itself, the mechanism would have broken down with the first liberty loan. Under the Federal Reserve System, however, these huge financial transactions were largely accomplished by bookkeeping entries. The Federal Reserve banks and the Federal Reserve Board at Washington, moreover, developed an extraordinary finesse in balancing debits and credits. They studied in advance the probable demands to be made on banks in various localities, and made an effort to route collection items through them in such a way as to give them funds which would break the shock of the heavy withdrawals. They provided in advance for rediscounting paper for these banks, and suggested to the Treasury the best places where government deposits might be made to offset heavy drafts. The policy was also developed of having each Federal Reserve bank rediscount with the others in such a way as to keep the gold reserve ratios of the twelve Federal Reserve banks approximately equal.
Gold Settlement Fund. Shortly after the inauguration of the Federal Reserve System, the Federal Reserve Board required the Federal Reserve banks to create a gold settlement fund in Washington, designed to lessen the physical transfer of gold from one Federal Reserve district to another in connection with interregional settlements. On July 1, 1918, daily settlements among the Federal Reserve banks were inaugurated, reducing in general the amount of gold that had to be transferred from one to another at any given date, and making it possible for the Federal Reserve Board at Washington to keep in constant touch with the reserve situation of each bank and to keep reserve percentages equalized by rediscounting. Daily settlements did not mean daily shipments of gold to and from Washington. “Suspense accounts” kept by the various Federal Reserve banks with the gold settlement fund obviated this. We went far during World War I in the direction of making one central bank out of our twelve Federal Reserve banks.
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THE POSTWAR BOOM, CRISIS, AND REVIVAL, 1919-23
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The Armistice, November 11, 1918, was followed by a sharp reaction in business and in commodity prices at wholesale. The general average of commodity prices fell from 204 in September 1918 to 193 in February 1919. The first symptoms of this reaction came to the bankers’ attention in New York about the middle of November, when currency—$1 bills, $5 bills, $10 bills, as well as subsidiary coins—was pouring into the New York banks from correspondent banks in many parts of the country, especially from the Pittsburgh region. There were not enough clerks in the currency departments of the banks to count this money, despite overtime work, and the cashiers were going around from department to department to find additional clerks who could be spared to help.
The Brief Postwar Reaction. With the Armistice there was immediately a cessation or sharp reduction of a great deal of production for war purposes. Payrolls were falling off, retail trade in manufacturing centers was falling off, cash was piling up in the interior banks, and they were sending it to their New York correspondents to build up their balances or to reduce their loans. A very substantial liquidation of bank credit took place as businesses, no longer needing large loans for current purposes, proceeded to reduce them or to pay them off. The money market eased. The rate to prime borrowing customers in the great New York banks dropped to 4 percent in the early part of 1919, though customers’ loans in general remained well above this, and though bankers’ acceptances stood at about 4.25 percent. The Federal Reserve rediscount rate meanwhile held at 4 percent.
Commodity Price Reaction. Certain commodities broke sharply in price. There had been during the war a suspension of the antitrust law, accompanied by price fixing, rationing, and allocation. The government controls promptly relaxed, but in a good many cases prices remained fixed by informal agreement among producers. In one such case the fixed price was
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held to despite a drastic reduction in demand.1 One great smelting company had a contract to take and refine all the lead that a number of important mines could produce. It was being overwhelmed by the lead which they were producing and which it was unable to dispose of at the fixed price. The company thereupon notified the other interested firms that the next morning, beginning at nine o’clock, it was going to sell lead, and was going to make a price that would move the lead. What that price would be it did not know. The other companies felt that the great smelting company was very decent to give them advance notice and stood aside and watched the procedure. The next morning lead was down ¼¢, down another ¼¢, down another ¼¢, the reduction finally amounting to 4½¢, with no increase in buying. Another ¼¢ reduction met some speculative buying. The selling company promptly raised its price ¼¢ and then encountered trade buying. It raised its price another ¼¢ and the trade buying fell off. It dropped its price ¼¢ and the trade buying was resumed. Then the other companies got into the game and began to sell lead, and a free and open competitive market was established at which lead moved within a range of ½¢ at about 4½¢ below the previously prevailing fixed price. The reduced price discouraged lead production. Supply and demand were equated. Right prices are prices that move goods. Right prices cannot be foreseen in advance. They must be found out experimentally in the open market.
Business and Prices Turn Upward in Late March 1919. There was a drop in employment and there was a great deal of apprehension as to what would happen to employment as the soldiers in the army on our side of the water were released. The apprehension was short-lived. The tide turned in late March and early April. The average of commodity prices at wholesale stiffened and began to advance again. Businessmen began to report a great increase in orders.
Heavy Exports. The export and import figures for the early months of 1919 showed a continuance and even a growth in the volume of exports and in the size of the export balance. The month of January showed an export surplus exceeding $400 million. Foreign orders for goods, first of all European orders, came in increasing volume.
The expectation had been that with the end of the war, Europe would resume her manufacturing activities, and that, while she would need a great deal of food and raw materials from the United States, she would reduce very sharply her buying of manufactured goods. But orders from her for manufactured goods continued on a great scale. The export trade went on and business revived rapidly in the United States on the basis of this export trade.
Continued Government Loans to Allies. An explanation of the financial
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basis of this export trade was readily at hand. The United States government had been authorized by Congress to lend $10 billion to our Allies in Europe during the war. The war was not yet technically over and the loans continued to be made. Something like $7 billion had been loaned down to the time of the Armistice. In the post-Armistice period, down to the end of June, nearly $3 billion more was loaned. The burden put upon the foreign exchanges by the