America’s Money Machine

NO HEAD of the Federal Reserve System provided more dynamic leadership, more clear-cut policy conceptions, or more fervent championship of Federal Reserve independence of function than did Marriner S. Eccles during his seventeen years in official capacity, of which fourteen were as the chief executive officer (governor or chairman) and three as a member of the Board of Governors. It was Eccles’ boldness, stubbornness, and presumptuousness that finally brought the issue of Federal Reserve-Treasury relations into open feud and what seemed ultimate victory for the Federal Reserve. Nevertheless, the extent of this victory remains doubtful.

Following the close of hostilities, in 1945, as we have noted, Eccles, no longer the champion of spending, became the advocate of fiscal solvency, together with credit controls to prevent what he foresaw as a runaway inflation. Specifically, he urged that the war-time controls of the economy be retained until peace-time production had been restored and that reduction be made in the money supply in the hands of the public. Some success was achieved in the latter. The Treasury managed to obtain budget surpluses from mid-1946 to mid-1948 which resulted in some reduction of government debt held by the banks, but the precipitate removal of war-time controls led prices to move upward in response to the tremendous consumer demand.

A factor in the defeat of the advocates of credit control was the general fear that the country would plunge into a depression as soon as war-time orders and employment eased off; in early 1946 (February 20) Congress enacted the Employment Act of 1946, which declared “the continuing policy and responsibility of the Federal Government to use all practical means . . . to coordinate and utilize all its plans, functions, and resources for the purpose of creating and maintaining . . . conditions under which there will be afforded useful employment opportunities . . . for all able, willing and seeking to work. . . .”

The pressure, which the Federal Reserve could not resist, was on to continue to maintain low interest rates that would encourage private business investment and expansion.

Following Roosevelt’s death on April 12, 1945, and the succession of Harry S. Truman to the Presidency, Eccles’ influence at the White House began to decline, despite the fact that Truman maintained Eccles in the chairmanship until the end of his term in February, 1948. By the end of the war prices had already moved substantially above pre-war levels, particularly real estate and securities, into which investment, blocked off by price controls of commodities, had moved. Farm land was up some 44 per cent over the 1935–39 level,1 urban real estate up from one-third to one-half above prewar,2 and stock prices some 75 per cent above the 1942 average.3

As Eccles and the Federal Reserve Board attempted to exercise influence in the direction of tighter credit, the difference between the Treasury and the Federal Reserve became more acute. The fact that Fred Vinson supplanted Henry Morgenthau as Secretary of the Treasury in July, 1945, made little difference, nor the fact that Vinson was later supplanted by John Snyder. The differences were deeper than personalities; they lay in two fundamental philosophies of the role of money and credit.

In July, 1945, Eccles had proposed that the preferential discount rate of 1/2 per cent on loans secured by Treasury bills and certificates, which had been established at all Federal Reserve banks in October, 1942, be discontinued. The Treasury indicated its opposition and the rate was retained. In April, 1946, the Board of Governors acceded to the recommendation of the twelve Reserve banks and approved the discontinuance of the preferential rate despite Treasury opposition; early in 1947 it was successful in persuading the Treasury to accept a free market rate on Treasury bills, and the 3/8 per cent buying rate was terminated. The rate on Treasury certificates was allowed to rise from 7/8 per cent to 1 1/4 per cent. These were modest achievements.

As banking assets continued to rise, however, further measures were advanced, but with less success. As early as 1945, the Board had proposed that the banks be required to hold a special reserve of obligations of the United States or cash as the Open Market Committee might determine in the light of credit conditions. The effect of the special reserve would be the immobilization of government securities held by banks; that is, it would prevent them being sold to the Reserve banks in order to increase the member banks’ reserves and hence banking power; at the same time the special reserve would not deprive the banks of the earning power which would be lost if the regular reserve requirements were raised (since the banks do not receive interest on reserves maintained with the Reserve banks). The proposal met strong banking opposition, as expected, but Eccles hoped to carry the plan by reason of the fact that President Truman, growing concerned over the mounting inflation, had called Congress into special session to enact a ten-point inflation control program, of which the restraint of consumer credit and the special bank reserve plan were supposedly principal items. However, political considerations prevailed and the President’s message omitted any reference to these measures.

Despite this rebuff, the Federal Reserve Board returned to its proposal in its Report for 1947. It pointed out that the commercial banks then held nearly $70 billion of Government securities and that there were another $70 billion floating supply in the market, not to mention $60 billion of non-marketable securities that were practically redeemable on demand. All these bonds were quasi-money or what might be called multiple money, since any member bank that was short of lending power could always sell them or discount them at its Reserve bank and thereby obtain additional reserves. The Board therefore renewed its recommendation that banks be required to hold special reserves of cash assets or government bonds that could not then be used as banking reserves for the purpose of multiplying the banks’ deposit power.

The most that the Federal Reserve was able to obtain was a Joint Resolution of August 8, 1947, which continued the authority to control consumer credit under Executive Order 8843 until not later than November 1. This authority soon lapsed but again in 1948 (August 16) a Joint Resolution restored the authority over consumer credit to June 30, 1949.

A Joint Resolution of the same date also amended Section 19 of the Federal Reserve Act to give the Board additional authority to increase reserves for a period ending June 30, 1949, within limits of 30 per cent for central reserve city banks, 24 per cent for reserve city banks, 18 per cent for other banks, and 7 1/2 per cent for time deposits. This authority was not renewed when it expired.

At this juncture, Eccles’ wings were unexpectedly, and somewhat mysteriously, clipped by Truman’s failure to redesignate him as Chairman of the Board at the end of his term on February 1, 1948. Truman did not notify Eccles of his decision until nine days before his term expired and the reason for this sudden act, so embarrassing to Eccles, has never been explained.4

Truman professed no lack of confidence in Eccles and promised to nominate him for Vice Chairman, but this appointment was never made. At the same time there was delay in naming a new Chairman of the Board and Eccles continued to act as interim Chairman until the appointment of Thomas A. McCabe April 15, 1948.

Eccles’ reduction in rank combined with the outbreak of war in Korea in July, 1950, to bring the issue between Treasury and Federal Reserve to a pyrotechnic climax.

Apparently with the object of tightening the rein on the Federal Reserve, on January 18, 1951, Secretary of the Treasury John Snyder issued a statement without consulting the Board, to the effect that the rate on long-term bonds would be held at 2 1/2 per cent. The announcement declared that the determination had been made at a joint conference with the President and Chairman McCabe.

The announcement created consternation not only in the Federal Reserve but in the banking community, and the New York Times commented:

On January 25, Senator Taft questioned Eccles in a hearing of the Joint Committee on the Economic Report.5 Eccles restated the Federal Reserve view.

“To prevent inflation,” he declared,

we must stop the overall growth in credit and the money supply whether for financing government or private deficit spending. The supply of money must be controlled at the source of its creation, which is the banking system.

Under our present powers, the only way to do this is by denying banks access to Federal Reserve funds which provide the basis for a six-fold expansion in our money supply. The only way to stop access to Federal Reserve funds is by withdrawing Federal Reserve support from the government securities market and penalizing borrowing by the member banks from the Federal Reserve System.

He went on to say:

As long as the Federal Reserve System is required to buy government securities at the will of the market for the purpose of defending a fixed pattern of interest rates established by the Treasury, it must stand ready to create new bank reserves in unlimited amount.

To box the Federal Reserve in, the President wrote a letter to McCabe and released the letter to the public, stating:

The Federal Reserve-Treasury differences were now a national issue, no longer to be ignored. Eccles was no longer in control of the Federal Reserve, but just a month later, on March 4, the Treasury and the Federal Reserve issued a joint announcement that read:

As a result, the Treasury undertook to exchange for outstanding long term bonds new long term bonds not directly marketable, an operation that paved the way for the discontinuance of Federal Reserve support of government bond prices by purchases in the market. The new bond issue bore 2 3/4 per cent (as against the 2 1/2 per cent rate at which the Federal Reserve had held the market), with a maturity of twenty-nine years, but were redeemable by the holder by conversion into five-year marketable Treasury notes. Following the agreement also, the Federal Reserve withdrew its support of the general structure of federal credit and allowed the market to seek its own level.

The new Chairman, William McChesney Martin, had distinguished himself as a compromiser, and this quality of disposition, despite a conservative tendency, kept him in office and in favor through both Republican and Democratic administrations for the following fourteen years, and permitted him to lead the Federal Reserve System to its jubilee year intact but shaken as to its independence.6

The bold action of Marriner S. Eccles seemed to have restored to the Federal Reserve System its statutory independence, and indeed this may have continued to be the case, but for a new set of circumstances, arising out of post-war foreign policy, that gradually drew the Federal Reserve System into a new entanglement and subserviency—now not to Treasury as much as to State Department.

This was the embarkation of a new foreign policy of world-wide military alliances and a cultivation of world opinion and support through a massive expenditure under a program of assistance to other countries.

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7From $33 per acre average for U. S. to $47 (Historical Statistics of the U. S., Washington, G. P. O. 1960).

8 Median asking price for existing houses, Washington, D. C. rose from $6,416 in 1939 to $10,131 in 1945. (Ibid.)

9Index for common stocks (1941–43=10) moved from 8.67 in 1942 to 15.16 in 1945. (Ibid.)

10 Eccles attributes it to the influence of the Giannini interests of California whose hostility Eccles incurred by his opposition to the expansion of the branch banking system of the Giannini-controlled Bank of America National Trust and Savings Association, the largest banking chain in the U. S. and today the largest banking institution in terms of total assets. (Op. cit. Part 7, ch. 3, pp. 434–FF.)

11 According to Eccles, Chairman McCabe begged off from testifying, finding himself in the dilemma of either defending the Treasury’s position or opposing it and resigning.

12 Martin had been made president of the New York Stock Exchange in 1938, when he was only thirty-one years old, as a compromise candidate between two contending factions. After the war he had been made president of the Export-Import Bank and later, as Assistant Secretary of the Treasury, had helped negotiate the “accord” that compromised the differences between Eccles and the Treasury. Republican Eisenhower found his views on credit restriction and currency discipline congenial, but when Kennedy was elected Martin went along with the new Administration’s desire for easy credit and a monetary policy of stimulation. In 1965, however, through some slip, he made a speech pointing out the parallels between the conditions preceding the Great Depression and the prosperity which President Johnson’s Great Society was enjoying—a speech that catalyzed a stock market break and that threw the Administration into consternation.

• 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.
• 3About the same time rumors drifted in another region of Manhattan of a falling out between Harriman and his long-time associate Stuyvesant Fish. Tongues wagged that Marian Fish had declined to sponsor the debut of Harriman’s daughter Mary, known more for her fondness for fox hunting in Virginia than for the Virginia reel in the ballrooms of New York.
• 4*New York Times, Oct. 24-26, 1913. There may have been an element of pique in Wilson’s reluctance to see Vanderlip. As a trustee of the Carnegie Foundation, Vanderlip had been one of a committee that had rejected Wilson’s application for a pension, and though Vanderlip had been in favor of the grant, he was accused of having gossiped about the matter to Wilson’s discredit.
• 5*The Comptroller of the Currency was also a member, but he kept to a passive role.
• 6†Head of the Mellon National Bank, and later to become “the greatest Secretary of the Treasury since Alexander Hamilton.”
• 7Theodore 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.”
• 8Wilson 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.
• 9Following the passage of power to the Democratic Administration, the principal protagonists of currency legislation the Congress were Carter Glass, chairman of the House Banking and Currency Committee, and Robert L. Owen, chairman of the corresponding Senate committee, along with academic figures like H. Parker Willis (who served as an assistant to Glass) and A. Piatt Andrew, who had served as special assistant to the National Monetary Commission.* William Gibbs McAdoo, a New York lawyer, had been named Secretary of the Treasury and the spokesman of the Administration on monetary matters.
• 10Nine of the twelve Committee members indicated their approval of the Vanderlip plan, but as the House was effectively under Presidential domination, enthusiasm cooled when Wilson issued a statement reiterating his warm endorsement of the pending bill. At the same time he declined to receive Vanderlip and Henry P. Davison at the White House, on the ground that banking was a subject with which he was not familiar.*
• 11HISTORY ALLOWED THE ADMINISTRATION Seven months to construct its new financial ark before the deluge of the First World War. The immediate task was purely political—where to locate the regional reserve banks provided by the Act. The Reserve Bank Organization Committee, which meant, in short, Secretary of the Treasury William Gibbs McAdoo and Secretary of Agriculture David F. Houston,* was provided with $100,000 for its investigations.
• 12The two officials fitted out a special car, organized a corps of secretaries, and right after the New Year began a country wide tour to study the advantages and disadvantages of each proposed reserve center. Hearings were held in eighteen cities and concluded on February 18. Over two hundred cities requested that their claims be heard. Certain decisions were foreordained. The influence of New York City would be cut down by lopping off New England and creating a reserve bank in Boston and another in Philadelphia. Pittsburghers, led by Andrew Mellon, † protested loudly at being neglected, urging the importance of their city as the center of the steel industry. Baltimore was disappointed to lose out to Richmond, Va., but this was inevitable considering Carter Glass’s origins.