America’s Money Machine

With this background we may now examine the effects of the policy of foreign aid and military alliances upon the ability of the Federal Reserve System to maintain the gold value of the dollar and its own integrity as a monetary institution. In 1949, which may be taken as the year in which foreign aid became a continuing foreign policy, the gold stock available to support the monetary and credit structure was in excess of $24 1/2 billion, or some 70 percent of the free world visible gold supply. The position of the dollar was unimpeachable.

Beginning in 1949, however, the United States experienced a deficit in its international transactions.1 The manifestation of this deficit was an outflow of gold and an increase in foreign holdings of dollar exchange (bank deposits in U. S. banks, Treasury bills, and other credits.) It was, however, not until 1958, when a hemorrhage of $2.3 billion occurred, that the gold outflow began to cause alarm. By the end of 1963 the gold reserve of the country had been reduced to $15 1/2 billion and the soundness of the dollar was everywhere in question.

Meantime a complacent Federal Reserve System had accepted the political philosophy of the Truman Fair Deal, the Eisenhower Crusade, and the Kennedy New Frontier, that tolerated fiscal deficits and demanded easy money. The return of peace, therefore, had not meant balanced budgets and a reduction in the public debt. Between the end of 1945 and the end of 1963 the federal debt held by the banks and public2 rose from $227.4 billion to $261.5 billion. At the same time the commercial banks were reducing their holdings of governments to provide funds for expanding commercial demand. To supply the credit for all these needs the Federal Reserve banks added to their holdings of governments. Thus, as we have noted, between 1947 and the end of 1963 Federal Reserve banks increased their portfolios by a good third, that is, from $22.6 billion to $30.6 billion.

In addition, the Federal Reserve Board authorized a series of reductions of the reserve requirements of member banks, bringing down the rates for central reserve cities from 26 per cent in 1948 to 16 1/2 per cent, for reserve city banks from 22 per cent to 16 1/2 per cent, for country banks from 16 per cent to 12 per cent (with a temporary reduction to 11 per cent from 1958 to 1960), and for time deposits from 7 1/2 per cent to 4 per cent.

The effect upon total bank credit is seen in the increase in money supply, or what is now known as M1, that is, bank deposits and currency in circulation, from $180 billion at the end of 1945 to $300 billion at the end of 1963. By this time the gold available to meet these obligations was only 4.7 per cent of total liabilities, compared with 7.4 per cent during the period just preceding the Great Crash in 1929.

Since 1934, however, no bank depositor or note holder has been able to demand gold for his note or deposit slip. Thus, the threat to gold did not arise from domestic demand, but from abroad. By its undertakings with the International Monetary Fund, the Treasury was committed to deliver gold to foreign central banks of government members of the Fund, at the rate of $35 per ounce. Under this assurance, foreign central banks and international institutions had accumulated some $12 billion of dollar deposits or short term Treasury bills, which they treated as the same as gold in their statements of reserve.

In addition other foreign holders had accumulated dollar quick assets (bank deposits or Treasury bills) to an additional amount of $14 billion all of which could, through sale to their respective central banks, be converted into claims for U. S. gold.

Here was the dilemma faced by the Federal Reserve System in the final days of its fifth decade, its jubilee year. As during the 1920’s, foreign central banks had erected a tottering structure of bank money upon a feeble foundation of gold and dollar exchange. Again, they found themselves caught in an inflationary spiral of rising note volume for which increasing quantities of coin or metal were required if the parity of the paper with its stated metal equivalent were to be maintained.3 World gold production was not enough to provide these reserves. Except for South African production, gold production had been static or declining, because of the rising costs of mining. Moreover, despite widespread restrictions on the possession of, or trade in gold, increasing amounts were going into private hands. Of estimated free world4 gold production in 1963 of 39.2 million ounces ($1.37 billion) some 28 1/2 million ounces ($1 billion) went into private hands. Only the circumstances of short crops and other misfortunes in Soviet Russia, that forced it to sell an estimated 600 tons of gold in the world’s markets, together with the corresponding balance of payments difficulties of the U. S. that required a transfer of some $465 million to foreigners, enabled the central banks of Europe to increase their gold reserves as they did. Even so they were compelled increasingly to rely upon dollar exchange to provide reserves for their expanding monetary liabilities.

The increment of dollar exchange which they needed had been pro-vided largely from the U. S. foreign aid program, by creating a net debit in the U. S. balance of payments. But these increments increased the strain upon the dollar, and created apprehension in the U. S. and led to popular agitation for curtailment of the foreign aid program. The practical effect of this would be deflationary. Foreign central banks would find it necessary to curtail the credit they had been extending so freely. The prospect of another depression, triggered by a stoppage of the flow of U. S. credit abroad, generated widespread consternation.

The frailty of the situation was cloaked under the sophistry of the “international liquidity problem.” Various schemes were advanced—the Bernstein, the Triffin, the Maudling plans—which space does not warrant our detailing here. All of them evaded the issue of the inadequacy of the gold stock to support such an inflated money supply, and offered palliatives.

Meanwhile, such was the decay of confidence in the dollar that the Treasury, for the first time in its history, was compelled to borrow abroad in monetary units other than the dollar. That is, foreign governments, or their central banks, increasingly doubtful of the ability of the Treasury to redeem its obligations in gold, quietly but insistently pressed for obligations payable in currencies in which they had more confidence. Thus it happened that the government, which during the darkest days of the Civil War never borrowed in any terms but dollars, was compelled in 1961 to go “hat in hand” to the governments of European powers seeking their assistance to maintain the integrity of the U. S. dollar. By the end of 1963, the Treasury had incurred debts totaling the equivalent of $760 million payable in various foreign currencies (Swiss francs, German marks, Austrian schillings, Belgian francs, Italian lire). No bonds, however, were issued payable in French francs—a circumstance we shall comment on further on. In addition, the Federal Reserve, through a devious device known as “swap arrangements,” entered into arrangements with various foreign central banks to obtain foreign currencies in order to strengthen the dollar abroad.

In short, the Federal Reserve System ended its fifth decade with a paradox of the so-called gold exchange standard. Its dollar obligations represented prime reserves of foreign central banks whose currencies, supported by these dollar obligations, were in turn the support for the dollar obligations. If this seems a bit confusing, one can think of the little island where supposedly everyone lived by taking in each other’s wash.

_______________

5 The balance of international payments is generally defined as the difference between the payments to foreigners for goods and services and the receipts from foreigners for goods and services, which may be settled by shipments of gold or the increase or decrease of liabilities. The analysis of the balance of payments is complicated by the fact that investments made abroad create a form of balance sheet liability which must be offset by actual shipments or services, or by per contra liabilities.

6 Excludes government obligations held by government agencies and trust funds, including the Federal Reserve banks. Gross public debt rose from $257 billion to $309.5 billion.

7 An over-all statistic for the expansion of money supply is not available, but figures for a few representative countries are illustrative. Using 1953 as a base of 100, the International Monetary Fund reported that between 1948 and 1961 (at which date the index base changed) money supply rose as follows: France, from 47 to 238; Germany, from 49 to 232; Italy, from 53 to 231; United Kingdom, from 92 to 110; Netherlands, from 85 to 147. For the U. S. the index of money supply rose from 85 to 113.

8 Free world, i.e., countries not under Communist government.

• 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.
• 5Theodore 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.”
• 6Wilson 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.
• 7Following 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.
• 8Nine 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.*