America’s Money Machine

THE BANKING ACT OF 1935 practically turned the Federal Reserve System over to Franklin D. Roosevelt and New Deal influences. It did so by abolishing the old Federal Reserve Board and creating a new Board of Governors, to be appointed by the President. Fortunately for those who believed in an independent banking system, Roosevelt was inclined to temporize when it came to political appointments, and Marriner S. Eccles, to whom he had promised the chairmanship, was a man to arouse antagonism rather than to conciliate antagonists. His Mormon father had taken two wives, and Eccles disputed the inheritance with his half-brothers; his own marriage was unsuccessful and resulted in divorce; no sooner had he been appointed head of the Federal Reserve System than he alienated the influential Governor George Harrison of the New York Reserve bank; his confirmation to the post lay in jeopardy by reason of his inability to gain the confidence of the powerful Carter Glass, who not only suspected Eccles’ monetary conservatism but even the means by which Eccles had risen to wealth and position. Eccles never quite succeeded in placating the Virginian or gaining his support; in fact, as time passed he rather exacerbated the old man’s animosity, as he also awakened the resentment of his patron Morgenthau.

In 1935 banking opinion became alarmed over the prospects of a new stock market boom. There was abundant cash and liquid assets in the banking system, as a result of the government spending program, but a slackness of commercial demand for credit, and funds were being absorbed either by the government or by the stock market, which had been steadily rising since March.

A few statistics will illustrate the condition that was causing concern. The revaluation of gold, along with gold receipts from abroad, had more than doubled the dollar and gold reserves (from $4,036 million at the end of 1933 to $10,072 million at the end of 1935). Much of this gold increment had flowed into the Federal Reserve in the form of gold certificates, where they provided additional banking reserves.1 In addition, the Federal Reserve banks had acquired $2,432 million of government bonds by the end of 1934; and although no more were being purchased, these purchases (since they were paid for by checks on the Federal Reserve banks) provided the commercial banks with additional reserves. Rediscounts by the banking system had practically ceased by 1934, falling from the peak of $1,096 million in the middle of 1929 to around $6 million at the end of 1935, while other bill holdings of the Reserve banks also continued to drop. (In 1939 the Reserve banks ceased altogether to buy bills.)

Excess reserves of member banks—that is, commercial bank deposits at Federal Reserve banks, in excess of their required reserves—had been a nominal figure until after the stock market crash and the beginning of the Depression. In June, 1929, total member bank reserves amounted to $2,314 million, of which $42 million were excess. Just before the revaluation of the dollar, in January, 1934, total reserves were $2,764 million of which $ 1,898 million were required and $866 million were excess. By the end of 1935, however, total reserves had reached $5,716 million, of which $2,733 million were required and $2,983 million were excess.

It was this nearly $3 billion excess reserves that troubled the thinking bankers, since it represented a potential inflation of $18 billion in bank credit.

It is necessary in looking at the meaning of these items to have also at hand the figures for total banking assets. In June, 1929, for instance, the commercial banking system had outstanding total loans and investments of around $49.5 billion, of which $35.7 billion were in the form of loans, and $13.7 billion in investments in securities; but of this $13.7 billion only $4.9 billion were invested in U. S. government securities. By June 1935, however, total loans and investments had fallen off to $34.5 billion, due to the lack of commercial demand. Loans had dropped to $14.9 billion. In order to earn on the deposits held, the banks invested the difference, totalling $19.7 billion, in securities, of which $12.7 billion were government securities. During approximately the same interval, also, the Federal Reserve banks had increased their holdings of government securities by some $1.9 billion.2 In short, government was replacing business as the great user of credit, and the banks had become the principal suppliers of that credit. Of the increase of federal interest bearing debt from the time Roosevelt took office in 1933 until June 1936, totalling $12.4 billion, some $11 billion had been lent by the banks. The banking system was becoming primarily an agency for financing the federal deficit.

At the November 14 meeting of the American Bankers Association, the issue of the government’s spending program and its inflationary consequences came to a head. Both Eccles and Glass had been asked to address the convention. Eccles agreed on condition that he be the final speaker, and thus be given the last word. When Glass learned this he sent his regrets. Eccles was still on hold-over appointment, and in fact Roosevelt had not yet announced his appointments to the new Board of Governors. Nevertheless, Eccles boldly defended his policies.

Orval W. Adams, the incoming president of the Association, had called upon the bankers to boycott government bonds as a form of pressure to reduce deficit financing. Eccles answered by recalling how the government had bailed out the banks following the Crash, and declared that orderly economic progress required a degree of government intervention.

Meantime, the Federal Reserve Advisory Council on November 21 adopted resolutions recommending Federal Reserve action to reduce excess credit in the economy. The Council, of course, since it was chosen by banks of the several Reserve districts, did not see eye to eye with the Eccles expansionist program. It pointed out two alternatives, either to reduce Federal Reserve credit outstanding by selling off System holdings of securities, or to raise bank reserve requirements. Under the 1935 Act, it will be recalled, the Board had authority to raise reserve requirements by as much as 100 per cent of the minimums set by the 1917 amendments to the basic act.

The recommendations, supposedly private, did not remain so, and immediately became a subject of public debate—not so much as to the desirability of the action as to the choice of means.

It was not the commercial bankers in general, but the powers now in control of the Federal Reserve System, who stood in opposition to tighter credit. Among the bankers who supported new credit controls was Winthrop W. Aldrich, Chairman of the Chase National Bank, New York City’s largest bank. S. Parker Gilbert of J. P. Morgan & Co., however, took an opposite view, in support of Eccles. The Board of Governors and the Federal Open Market Committee now issued statements to the effect that business recovery—which was the principal object of Reserve policy—had not advanced far enough to warrant such action, and that there was no evidence of credit overexpansion.

Throughout this controversy, Eccles was still in the position of an interim appointee, with his status under the new banking act still obscure. Roosevelt continued to procrastinate in appointing the new Board of Governors, but to quiet rumors and to forestall opposition he did announce in September his intention to nominate Eccles to the new Board of Governors and to designate him as chairman. There remained, however, the question of a board membership that would support Eccles’ policies. On this issue, the opposition of Glass was to be expected.

Time was running out. The new Board had to be appointed by February 1, 1936, when the act became effective. Eccles was not above using what he admits were Machiavellian tactics to hoodwink Glass and to hamstring his future opposition. He proposed to Roosevelt that Glass be given the privilege of naming three of the seven members of the new Board, but only from a list which Roosevelt would pick beforehand (all of whom would of course be New Dealers). It Was like playing with marked cards, but Glass, Whether wittingly or no, accepted, probably realizing that the Roosevelt tide was running too strong to resist. The new nominees went to the Senate, and were confirmed without a hearing and without a record vote.

The conservative opposition to Eccles’ management and policies did not fade, however, and a running battle continued over Federal Reserve objective and policies down to the outbreak of World War II.

Eccles seems at last to have recognized that some tightening of credit was indicated. On July 14 the Board responded by raising member bank reserve requirements by 50 per cent, to be effective August 15.

On January 30, 1937, a further raise in reserve requirements was imposed, to bring them to the maximum allowable. The raise was to take effect in two steps, on March 1 and on May 1. The new reserve requirements, when effective, would be for demand deposits, respectively 14 per cent for country banks, 20 per cent for reserve city banks, and 26 per cent for central reserve city banks; on time deposits the reserves required would be 6 per cent in all classes of banks.

The significance of the incident lies in the evidence it offers of the extent to which the once independent Federal Reserve System had become the instrument of federal fiscal policy.

Whether because of Federal Reserve intervention, or, as Eccles argued, from other causes, signs of a new business depression now began to show. Stock prices, which had recovered to a level of 60 per cent of the 1928 index, now tumbled again, falling from an average of 15.47 (1941 –43= 100) in 1936 to 11.49 by 1938. (The stock market, barometer of business, was to continue downward until war influences again began to course through the economy in 1942.)

Again, the nostrum for recovery, for which Eccles was the physician and the Federal Reserve the apothecary, was increased federal spending—what Eccles called “compensatory spending.” Morgenthau, as the chief fiscal officer, in an address before the American Political Science Academy on November 10, 1937, had come out publicly for a balanced budget. This had been with Roosevelt’s approval, for Morgenthau was always careful in clearing his positions with the President. Eccles, by his championship of spending, was able to win over the vacillatory Roosevelt, and thus become practically the fiscal as well as monetary policy framer for the New Deal. In this he had the stout support of Harry Hopkins, reputed author of the saying, “We will spend, spend, spend, and elect, elect, elect.”

Following a conference in Warm Springs with the President, in the following April, in which Eccles was joined by three other Roosevelt advisers, Leon Henderson, Aubrey W. Williams, and Beardsley Ruml, Roosevelt was won over, and in his message to Congress on the fourteenth he asked for resumption of large-scale spending.

Eccles’ rise to dominant influence in both fiscal and monetary policy was not without bruises. He was, as he states, “rapidly losing the few friends I had and influencing fewer people.” Among those now in opposition to him was the powerful junior senator from Virginia, Harry F. Byrd, with whom he engaged in acrimonious debate, first by letters, and later by radio; Senator James F. Byrnes, later to become a Supreme Court justice (1941) and still later (1944) head of the Office of War Mobilization; and not least, Eccles’ former chief and patron Henry Morgenthau.

Among the non-political figures in the arena was the Reverend Charles E. Coughlin, a parish priest of Royal Oak, Michigan, who found a nation listening to his radio program when he turned from the salvation of souls to saving the country from the bankers.

What probably saved the country from more radical monetary legislation was the continuing abundance of money, and an enormous receipt of gold from abroad, fleeing from a Europe in fear of Hitler. During the six calendar years, 1934-1939, inclusive, the country gained $10 ½ billion of gold in addition to $3/4 billion of silver.

Meantime, the policy of spend and spend undoubtedly made many of the electorate happy with the Democratic Administration, and by August, 1939, the face of the world had changed with the German invasion of Poland, and the Federal Reserve System faced a new set of conditions and policies.

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3The gold itself is held by the Treasury, which issued its certificates of deposit. Custody of the gold is with the Mint, except for the amounts held in the Treasury Stabilization Fund. The Mint keeps the gold at the various mints, the New York assay office, but mainly (since 1937) at a large depository at Fort Knox, Kentucky. The gold in the Stabilization Fund is in the custody of the New York Federal Reserve Bank.

4Figures for year end holdings of government securities by all commercial banks were not compiled prior to 1936.

• 1Mrs. Fish’s social invasion of Washington may have been the result of the intimacy that existed between her husband and Roosevelt. It is important to recall this camaraderie in any attempt to understand the tangle of subsequent events. Both were New York aristocrats; both were Republicans; they had a common fondness for rural estate life; they had gone together on hunting trips to the South. It is reported that during the Fish residence in Washington, Roosevelt, who was accustomed to early morning canters in Rock Creek, would ride over to the house and shout up, “Stuy!” and when the railroad president came to the window would joke with him for a while before continuing his ride.
• 2Nevertheless, not all railroads were prosperous, and much of Harriman’s success lay in his careful husbandry of his properties and his superb railroading management. He was like a good householder. If he milked his cow, he also fed it well. No sooner had he acquired control of the Union Pacific than he began a large scale rebuilding of tracks and stations, and modernizing equipment. He continually travelled inspecting his properties. He paid particular attention to public relations. He cultivated new customers by offering inducements to industries to establish themselves on his routes. In the only magazine article he is known to have written, he gave his creed of railway management: “The railroad that does not seek to build up the territory through which it passes by offering good service, pursues a policy that will only bring it grief in the long run.” When the Colorado River left its banks and flooded the Imperial Valley of California in 1907, Harriman sent Southern Pacific engineers to the area and he personally directed the work of relief and rehabilitation. Before the control of the river was achieved, the Southern Pacific had invested $3 million in the effort.
• 3Theodore Roosevelt returned from a year of big game hunting in Africa and a triumphal tour in Europe to find again an opprtunity and a demand for his political talents. Drawn by an appeal to public service, and perhaps to a considerable degree by ambition,* he began to angle for the leadership of the insurgent wing. In a speech at Osawatomie, Kansas, on August 31, 1910, on “The New Nationalism” he backed the Supreme Court’s attitude toward social legislation and announced the political doctrine “that every man holds his property subject to the general right of the community to regulate its use to whatever degree the public welfare may require it.”
• 4Wilson came into office under considerable popular momentum toward centralization of government. Ten days before his inauguration the Sixteenth Amendment to the Constitution, which had been proposed only three years before, was finally ratified and declared in effect. This revolutionary fiscal measure, authorizing a tax on incomes, vested in the Federal government almost unlimited taxing power and gave it the financial means by which it could dominate and eventually overwhelm the state governments. On February 28, 1913, the Pujo Committee investigation into the “money trust,” which had been authorized the February before,* reported an unwholesome concentration of money and credit through bank consolidations, company mergers, interlocking directorates, security syndicates, and increased banker representation on the boards of insurance companies, railroads, public utilities and industrial corporations.