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These warnings are typical of the state of mind of bankers in the early months of 1923. In February and March, 1923, the reserve banks of New York, Boston, and San Francisco raised their rediscount rates. Due in part to this action, interest rates of commercial banks rose in February and again in March, rates rates on call loans on 60 to 90 day paper and on 4 to 6 months paper being all higher in March than in any month of the previous year. Raising of money rates was followed promptly by curbing of the upward movement of prices and overproduction. Not so generally understood is the fact that the open-market operations of the Federal reserve banks in the first half of 1923 tended to curb the involuntary movement and in the second half of the year tended to sustain business on its new level. Early in January the Federal reserve banks held open-market acceptances and United States securities to the value of $734,These they reduced steadily throughout the period of incipient business boom. By July the total holdings were less than $300,000,000. Between October 17 and the end of the year, however, the holdings increased from about three hundred million to four hundred and seventy-three million dollars. Thus the open-market operations took money out of general circulation at a time when, according to our indices, money in circulation was increasing faster than the volumes of trade, and later in the year when these same guides began to point in the other direction the open-market operations put more money into circulation. We were cautious in 1923 because we had had a recent lesson.

We will be less cautious as time goes by, and in a very short time when credit begins to be demanded all over the country for developments of all sorts the Federal Reserve Board, without express legislative authority, will not be able to restrain a period of inflation greater, probably, than any we have ever known.

In 1920, with our gold reserve down to 43.4 per cent, the index number was 226, or two and one-fourth times higher than in 1914. In 1922, with a reserve percentage of 77.9, the index number fell to 149. With the present reserve percentage of 82 per cent, the index number of wholesale prices is about 160, so that a determined demand for credit based on our gold reserve could pull our reserve percentage down to 45, probably, before it could be stopped. The index number would rise to around 300, which would mean prices higher than this country has ever seen, and which would result in an economic collapse greater than that of 1921 and 1922. This problem, my friends, is on the very verge of being solved, but we can't wait too long. As I said before, human memory Is short. Unless our obligations as a world power and a leader of civilization are fulfilled shortly, the gradual abolition of war never can be achieved until

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side, while the march of civilization passes by and presses on to the promised land of the future, guided on its dark way by faith in the destiny of man as by a pillar of fire."


BANK OF ENGLAND, JANUARY 28, 1928 To-day I shall turn to ask you to consider the present position of gold as an international standard of value.

Nearly three years have elapsed since the pound sterling was reestablished on the gold basis, and most of the important currencies are now stabilized in relation to gold. This general reversion to gold gives the appearance of a return to pre-war conditions in matters of credit and currency, but if we look further into the question we shall find that there has been a remarkable change. The development of central-bank policy in the United States has shown that, while gold may be retained as a medium for making international payments, it can be deprived of its function as the ultimate standard of value. How this came about, the stages through which American policy has passed, and the meaning of the conclusion deserve our close attention.


Let me begin by reminding you of the conditions before the war. At that time the central banks adopted a purely passive attitude with regard to the control of credit, allowing the movement of gold into or out of a country to regulate the internal supply of money. If gold flowed in freely, credit and currency expanded; if more credit was created than was required to support the current growth of business, prices rose.

If gold flowed out, credit and currency contracted; the growth of business was checked and prices showed a tendency to fall. It followed from this that the current course of world prices was determined by the supply of monetary gold. This does not mean that other causes, such as improved methods of production and communication, do not affect the price level, but these only come into play over more extended periods of time.

This passivity of the central banks probably arose from the peculiar structure of the British central banking system. London was then the unchallenged financial center and free gold market of the world. In addition, Britain, as the world's principal creditor, was the main source of supply of new capital, and international trade was for the greater part financed by sterling bills.

These various factors taken together constituted London the point through which a surplus or scarcity of gold made its influence felt, and the British price level was the medium through which gold operated on the price levels of all other countries.


Under the British central banking system only a small part of the country's total gold holding was available to meet demand. So small, indeed, was the primary reserve in relation to the demands winch might possibly be made upon it, that the principal aim of our central bank policy was to protect it from withdrawals of gold, even when these were really of quite moderate dimensions in relation to the total stock in the country. The movement of gold became a matter of the utmost importance, and the means of counteracting its influence on the supply of money and the course of prices hardly existed. In these circumstances there was little scope for the formulation or exercise of conscious policy, and the principles of central bank credit control remained undeveloped, if not unknown.

The first authoritative suggestion that gold movements need not have predominant importance in the control of credit and currency appeared in the recommendations of the international economic conference held at Genoa in 1922.

The financial commission appointed at that conference, perhaps the most important of its kind that has been held, were deeply impressed by the danger of a gold shortage. As advised by most of the leading authorities, the commission took the view that a scarcity was to be looked for in the absence of any unforeseen developments in production.

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They were alarmed at the prospect of the supply of gold to the principal trading countries of the world becoming inadequate to provide for such an expansion of credit and currency as would be needed to meet the requirements of growing trade. Accordingly the commission's recommendations were aimed at economizing the use of gold, and one of their main suggestions was that instead of reverting to the pre-war system, under which each country held its own gold stock, gold exchange standards should be adopted by most countries, leaving only a few to hold the ultimate metallic reserves for the entire world.

The purpose of the conference in propounding measures to economize gold was undeniably sound, and it is a matter of regret that the suggestions for the adoption of gold-exchange standards have been widely departed from. The proposal, it is true, was at first incorporated in a modified form in schemes of reorganization in many parts of the world, particularly in central Europe and South America, but, Unfortunately, the system has come to be regarded as merely a step on the road to a full gold standard. Already many countries actually on a gold-exchange standard are unprofitably using their foreign assets in the purchase of gold reserves.

The eager desire to accumulate metallic reserves is no doubt prompted by the recollection of pre-war practice and ignores our more recent experience that, even in a gold-standard country, gold need no longer be the controlling factor in the supply of money. This brings me to the example of the United States, and I shall endeavor to outline the stages along which that country has moved in its progress from the pre-war to post-war conceptions of monetary policy. If, however, the successive proceedings of the' American central reserve banks are to be fully understood, we must continually bear in mind a general proposition which lies at the root of monetary theory and to which I have referred on several previous occasions.


Stated in the briefest terms, the proposition is that every central bank purchase and every loan by a central bank increases the cash resources of the other banks and provides the basis for an expansion in the volume of credit, or, in other words, of money; while every sale by a central bank or repayment of a central bank loan reduces bank cash and restricts the supply of money. This proposition holds true whatever the central bank may purchase or sell, whether it buys or disposes of gold, bills, securities, or any other asset. From this it follows that central banks possess the power to regulate the supply of money irrespective of gold movements. According to their view of trade requirements they may, if they choose, wholly or partially offset, a purchase of gold by a sale of other assets or a sale of gold by a purchase of assets.


Obviously this power has always been inherent in a central bank system, and, apart from its ordinary day-to-day business, the Bank of England used from time to time in pre-war days to make purchases and sales of assets other than gold. But such transactions were undertaken only as an auxiliary to bank-rate policy, which was itself determined by actual and potential movements of gold.

Purchases and sales of gold were alone regarded as the effective control of the volume of bank cash and consequently of the supply of money.

t come now to the story of the recent development of monetary policy in the United States. In consequence of the enormous accumulation of gold, coupled with movements into and out of the country on a scale which, if left uncontrolled, would have proved disastrous to the stability of the American price level, the attention of the reserve banks was forcibly directed to their controlling powers. Beginning with only a partial use, in the course of time they have learned to utilize these powers to the full. All the stages in the development of American practice can be seen in the 13 years since 1914, which I divide into five periods. Each of these is marked by distinctive gold movements, and t propose to show how the resulting problems have been successively dealt with.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis STABILIZATION 331 The first period runs from the outbreak of the war to the middle of 1919, covers the beginning of the great westward flow of gold to America. All the incoming gold, amounting on balance to over 1,000 million dollars, was purchased by the Federal reserve banks, and following pre-war practice was allowed to become the basis of additional credit.


As if this were not enough, the central institutions created a further basis of credit by discounting bills for member banks for very large sums, and thus the ground was laid for the vast expansion of credit which actually occurred. The demands for credit on this inflationary basis were insatiable. No sufficient measures for counteracting the effect of the incoming gold had yet been adopted and inflation ran a free course.

The second period runs from the middle of 1919, when the war-time embargo on gold export was removed, to the late summer of the following year. During this period dollar balances owned by South American and Far Eastern countries were withdrawn in gold, and America lost a net amount of nearly $400,000,000.

The export demand was met by the reserve banks, but it should be noted that the sale of this gold did not permanently deplete bank cash. Under the influence of the current inflation the reserve banks continued freely to discount bills and buy earning assets to such an extent that the supply of bank cash was considerably increased and an enlarged basis was provided for further credit inflation.


My third period covers more than four years and extends from the summer of 1920 to the last month of 1924. This period was marked by continuous imports of gold, and already in the early years we perceive a growing anxiety on the part of the central banking authorities with regard to the inflow. They realized that if the gold were allowed to function to the fullest extent it would lead to a further expansion of credit and a perpetuation of the evils of inflation. They determined, therefore, as far as possible, to deprive the incoming gold of its credit-creating capacity until the demands of trade should call for a larger credit basis.

The period I am now reviewing falls naturally into two parts: In the first the gold was neutralized; in the second it was allowed to form new bank cash.

In the first two years, which covered the liquidation following the postwar boom, $1,000,000,000 of gold were imported and bought by the reserve banks.

The immediate effect of the purchases was to increase bank cash, but the whole of this increase was used by the member banks to pay off maturing bills held by the central banks, and on balance the volume of bank cash was unchanged.

During this time policy was at work. The gold was absorbed by the reserve banks and held by them in place of discounted bills. This process of acquiring gold in lieu of interest-bearing assets was expensive and severely curtailed the income of the reserve banks. But their object had been achieved. The effect of the inflowing gold had been nullified in accordance with the dictates of policy, and pre-war practice was in process of abandonment as unsuitable to the novel conditions confronting the American authorities.


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