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For, if the depression and fall of prices in Europe reduces the prices of American exports, they thereby, to that extent, further depress the already declining general price level in America. It is well known, and is shown in the chart on export, import, and average prices (Chart, Commons: Wholesale Prices, p. 278), that export and import prices, consisting largely of raw materials, have wider fluctuations than do manufactured goods and domestic prices. In times of prosperity and rising prices the prices of exports and imports rise sooner and more extremely than does the all-commodity index of prices (including exports and imports), and in times of depression and falling prices they fall sooner and more extremely.

This relation showed itself in the period from the peak in the

beginning of 1925 to the low point in April, 1927. (Chart, Commons:

Wholesale Prices, p. 278.) While the general level of prices fell 10 per cent, export prices declined 27 per cent. Hence, the reserve system, by reducing its own rates of discount and thus helping European countries to preserve the gold standard without raising their rates of discount, was acting consistently with the purposes of this bill relative to "relations and transactions with foreign banks."

Almost immediately gold began moving to Europe from our surplus stock, replenishing their deficient stock, the total net exports from September, 1927, to April, 1928, being $352,000,000. Of course, favorable nonmonetary causes were also operating, but the liberal Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 436 STABILIZATION policy of the system toward Europe, combined with the nonmonetary causes, was accompanied by a rise in American export prices in the latter half of 1927, thus lifting somewhat the general price level (chart previously referred to) which previously had been declining.

The testimony and also public information revealed a strong difference of opinion among the Federal reserve banks and within the board itself respecting these operations in 1927, resulting in a change in the membership of the board in opposition to the easy money policy. On this opposing side was the opinion that easy money would not affect commodity prices while business was in a state of depression and falling prices but would augment the existing overspeculation and extraordinary rise of stock exchange prices. With this in view the open market policy was reversed, and sales of securities were begun in January, 1928, amounting to $222,000,000 during three months, and rates of discount were raised from 3 ^ to 4 and 4% per cent just at the time when business was recovering and commodity prices rising. The purpose apparent now was to check stock speculation rather than assist the recovery of business and the stabilization of the purchasing power of money in terms of commodity prices. No method had as yet been discovered or applied by which stock speculation could be restrained without, at the same time, restricting the recovery of business and restoring the full employment of labor by rising commodity prices. Several such methods were suggested, such as a requirement that time deposits be invested in securities; or higher rates of discount be imposed on notes secured by Government collateral than on commercial paper, thus reversing the practice during the war and until 1921; or no discount less than seven days, following the practice of the Rank of England; or by refusing to lend to a member bank which is extending its stock exchange loans at such a period; or by the extension of branch banking. All of these proposals are objected to on the ground that they are either impracticable, or unpopular, or would require additional legislation, or require too much interference with member banks.

Whatever may be the fate of these proposals or of experimentation upon them, there are evidently several circumstances connected with the rise of stock prices over which the reserve system can not obtain control. One is the immense increase in savings, going on at a more rapid rate than ever before, which goes into securities and other investments, and which can not readily be distinguished from increased supply of money because they are themselves money savings. These have become especialy large in the case of corporate savings, which render corporations relatively independent of the banks. There is a vast difference between a large accumulation of savings seeking investment and a plethora of funds in the New York market, although the difference may not be capable of statistical measurement.

Another uncontrollable factor is the large investment by banks throughout the country in the call-loan market, which is the most secure and liquid of all markets, instead of investments arid loans in their local markets, where they might get higher rates of interest but less secure or liquid. Another is the mad speculation throughout the country regardless of real earning power oi the companies whose securities are purchased for a rise, a kind of speculation that usually accompanies the peak of stock prices. These circumstances have Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis STABILIZATION 437 made ineffectual the effort of the reserve system to restrict stock speculation.

Moreover, although the Federal reserve system, when established, was purposely planned to encourage legitimate commercial business and discourage stock speculation, it is a serious question whether its discount policy should not let stock prices alone. To attempt to control so volatile a matter cripples the power to control the purchasing power of the dollar. And while stock gambling is reprehensible, it would be a serious error to ascribe every rise in stocks to speculation. A large part certainly represents improved prospective earnings. The very prosperity accomplished, other than in agriculture, during the past few years of relative stabilization has had as one of its notable effects a cumulation of prosperity bound to be reflected promptly in higher prices of the securities in business.

The increased savings of the general public from the same causes, have similar effects, and the trend of modern investment from bonds toward stocks has a like effect.

Along with the uncontrollable factors is the illusion created by current statistical bureaus which show the rise of only a small part of all the securities dealt in on the stock exchange. These are 20 to 197 selected industrial stocks of especially large and profitable companies, while all of the listed companies are about 1,100. The weighted average of the prices of these 1,100 listed stocks, as shown by the stock-exchange reports, has risen only 22 per cent from January, 1925, to January, 1928 (25 per cent for April 1, not shown in chart]). But these selected stocks have risen, according to different statisticians, 70, 87, and 76 per cent to March, 1928. (Chart, Commons: Stock Prices, p. 438.) Other computations, not shown on the chart, show a rise to a similar extent. If, in addition to listed stocks, the stocks of all corporations throughout the country were included, many of which have suffered serious declines, it would perhaps become apparent that stock prices, as a whole, have not materially advanced beyond what lower rates of interest would justify, compared with the advance in the average of commodity prices; and that the rise of selected profitable stocks above the average rise of stock prices indicates rather a shifting of increased savings and speculation from unprofitable to profitable companies, from companies which do not show an increase of assets to those which do show an increase, resulting from great changes in the distribution of wealth and savings among the American people, all of them mainly nonmonetary factors not directly controllable by the monetary and credit policy of the reserve system.

From these considerations it appears, and is confirmed by the testimony of Gustav Cassel, that the control of inflation or deflation of stock prices should not be one of the purposes of monetary and credit policy, but the purpose should be the control of the rise arid fall of the average of commodity prices, which is stabilization of the purchasing power of money in trade, commerce, industry, and agriculture. Changes in prices of stocks and bonds, like changes in realestate values, are changes in the expectations of net earnings accompanied by changes in the supply of savings and changes in the speculative temper of the community. If Federal reserve credit " leaks " into the stock market, this is to be expected, since the stock market is Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 438 STABILIZATION the money market, and because prices of stocks reflect the expectations of future net earnings, and therefore ordinarily precede changes in commodity prices. If, however, there is an excessive " leakeage " into the stock market, it might be remedied, if sufficiently important, by some of the above-mentioned remedies or others less objectionable,

–  –  –

which would discriminate against loans for speculation and in favor of loans for commercial purposes. But while this " leakage" is relatively important from the point of view of the earning assets of the reserve banks, it is relatively unimportant from the point of view of the country's volume of credit, since even the excessive amount of brokers' loans are even yet scarcely 8 or 10 per cent of the overwhelmingly great volume of commercial and productive loans of all the banks in the country. These conclusions are evidently tentative, so far as statistical measurements are concerned; yet they are called for on account of testimony showing the diverse and changeable purposes in the administration of the reserve system which now obstruct a

•consistent use of their powers toward the stabilization of the commodity purchasing power of money.

Equally important with the prevention of so-called cycles of prices and industrial activity hitherto discussed, is the expected long trend of the purchasing power of money. In general the evidence of experts on the present and future supply of gold (Lehfeldt, Cassel, Kemmerer, referred to or incorporated in the testimony as exhibits), points to a world scarcity of gold and unless certain economies are effected, such as retirement of gold from actual circulation and using it in central banks as the basis of notes and member bank credit reserves; the extension of cooperative arrangements between central banks, which, it is deemed by Doctor Miller, will permit a reduction in gold reserve ratios neld by central banks; the increased use of checks, etc. All of these and other possible economies of gold ar'e provided for in this bill under the two directions of maintaining a " stable gold standard " and " relations and transactions with foreign banks shall not be inconsistent with the purposes of this amendment."

This long-time trend of scarcity or abundance of the world's supply of gold can not, however, be left to the future, or to the present experiments of the reserve system unguided by a policy of price stabilization, as proposed by witnesses, but is a matter' of immediate attention, because the proposed economies will not come automatically of themselves. Present policies are already proceeding which will determine whether the above-mentioned or other economies of gold shall be inaugurated and directed towards stabilization of the value of the world's gold standard at present levels, or toward an increase in the value of gold and a falling trend of prices. Since the matter, however, is one of detailed investigation and of prediction over a period of years, it can not be cared for by legislation except in the general terms of a stable gold standard and stable purchasing power of the dollar, as a purpose directed in this bill to be followed by the Federal Reserve system. I will therefore conclude by submitting as an exhibit the summary of a monograph on the future of gold, made by Prof. Lionel L. Edie, of the University of Chicago, based on extensive investigations and the previous studies of others. This exhibit should be preceded by a more recent investigation by Professor Edie, to be published in the Journal of Political Economy, but furnished to me in outline by him in advance

of publication. He makes these general inferences:

1. The usual estimates of our " excess " gold stock are about double the true figure.

2. If no further exports or imports of gold were to take place, we should, in the United States, grow up to our gold stock within about four years, instead of 10 to 15, the usual estimate.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 440 STABILIZATION

3. The usual claims about greatly reduced reserves under the Federal reserve act are absurd exaggerations, because the new method of note issue wastes about as much gold as the deposit reserve ratios economize.

4. The notion that 35 to 40 per cent is the minimum of potential reserve of Federal reserve banks is illusory because of the manner of putting gold in the Treasury and backing notes by commercial paper. The de facto minimum potential reserve ratio is nearer 60 to 70 per cent, roughly 65 per cent.

5. Although nine-tenths of our business is transacted by deposits and checking accounts, fully two-thirds of our gold slock is used up as backing for note issue, which transacts only one-tenth of our business. Note issue is absolutely defective when secular elasticity is concerned.

6. Using Cassel's method in modified form, I estimate that the 3 per cent rate of Cassel needs to be split between the United States and the outside world. The normal gold rate of increase in United States stocks turns out to be 4.3 per cent per annum, that of the outside world 2.4 per cent. This means that, by 1930, the United States alone requires about $180,000,000 increment in gold stock annually, an amount equal to the entire new gold produced annually and available as money. If this is even roughly correct, then all the vague hopes about gold economy from pooled reserves and gold exchange standard are futile. The United States alone will require all the new money gold turned out annually by the mines. This would have to be imported. I will not elaborate this further, but will merely emphasize that the official, optimistic view of gold economies seems to be completely rejected by the quantitative investigation of all phases of the problem.

The exhibit of the summary of Professor Edie's earlier study isas follows:

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