Gresham's Law.
Two major influences brought this gold to us. The first was the working of Gresham's Law. Under Gresham's Law gold leaves countries which have fluctuating, irredeemable paper money and goes to countries which are on the gold standard. If no country is on the full gold standard, gold will still go to countries where some semblance of a fixed rate is kept, in preference to countries where there is no fixed rate or where the fluctuations are expected to be greater. The de facto stabilization of the dollar in terms of gold at 59.06% of the old par strengthened the confidence of the American people in their own currency, a confidence which manifested itself in the revival of the bond market, and in a great increase in the purchase of annuities from life insurance companies. It also led to a resumption of gold movements to the United States from outside. Fear of Hitler.
The second great factor sending gold to us from Europe was a growing fear of Hitler. This fear was felt especially by the Jewish population of virtually all European countries throughout the period 1934 to 1941. But it became very acute for Europe as a whole as Hitler's strength, and the weakness of England and France, were so dramatically revealed at Munich in September of 1938. Our gold monetary stock stood at $13,136,000,000 at the end of August,1938. Thereafter it rose at a startling rate as nearly 10 billions more came in bet\veen Munich and October of 1941. The single month, June, 1940, shows gold imports of $I, 163,000,000, reflecting Hitler's actual invasion of the Netherlands, Belgium, and France. Effect on Member Bank- Reserves.
The effect of this great mark-up in our monetary gold stock upon member bank reserve balances was very impressive. The original mark-up of the gold stock under the President's proclamation made no difference in member bank balances. The so-called gold profit was not immediately put into play. Two billion dollars of it were put into a Stabilization Fund in the hands of the IJnited States Treasury, of which the Treasury transferred $200,000,000 to "Special Account No. I" in April, 1934. 1 The major part of the rest was used in retiring bonds which secured National Bank notes, and consequently in retiring the National Bank notes-transactions which neutralized one another so far as the volume of member bank reserves was concerned. But the new gold coming in from abroad went immediately into member bank reserves, creating $35 of member bank reserves for every ounce of gold imported. The imported gold would be sold to the Federal Reserve banks for Treasury account. The importer, whether a bank or a broker, would receive checks drawn on the Federal Reserve banks, which would speedily be deposited by a commercial hank in the Federal Reserve hanks, adding to member bank reserves. Member bank reserve balances stood at $2,851,000,000 on January 24, 1934, and rose to $14,4°0,000,000 in January of 1941. The Startling Growth of Excess Reserves. Excess reserves 2 of the member banks of the Federal Reserve System were never very great in the years prior to 1932. The banks worked their reserves closely in the periods when confidence was high, 19 I 4 to 1919 inclusive and 1922 to 1929 inclusive. And on the other hand, bank reserves were pulled low in 1921 and in 193 I. Even in 1924 and 1927, years in which the Federal Reserve banks were increasing reserves rapidly by purchases of Government securities, excess reserves for the dates available were not large because commercial bank expansion was tnoving so rapidly on the basis of increased reserves, and expanding deposits took up the slack.
The only available figures for excess reserves in excess of $ I 00,000,000 prior to 1932, are June 29, 1918, when the figure was $2 15,000,000, June 30, 19 19 ($133,000,000), and September 29, 1930 ($130,000,000). It is probable that the years 1924 and 1927 would both show certain dates when the figure again exceeded $ 100,000,000, but this does not appear in any of the four dates given for either of these years.
There were a good many times when reserve deficiency, instead of excess reserves, was shown in' the years 1914 to 1931 inclusive. But in 1932, with the very heavy purchases of Government securities made possible by the Glass-Steagall Act, excess reserves increased rapidly, rising from $27,000,000 on February 24, 1932, to $554,000,000 on December 28. With the passage of the Thomas Amendment in May, 1933, which authorized the Treasury to make a contract with the Federal Reserve banks to buy $3,000,000,000 of Government securities, the Federal Reserve System (though the contract was never formally made) once more began heavy purchases of Government securities; and by January of 1934, when the Gold Reserve Act was passed, it had increased its Government securities from $ 1,837, 000,000 to $2,432,000,000. Excess reserves stood at $938,000,000 on January 24, 1934, a figure already very difficult to manage. Peak of Excess Reserves Seven Billions, January, I94I. In the period from early 1934 to January 15, 194 1, excess reserves rose to approximately $7,000,000,000 (actually $6,896,000,000).
This was the peak, and under the influence of our Governmental war borrowings from the banks, later to be described, the excess reserves began to run down, and following March 12 of 1941 ran down rapidly.
The primary cause of this great growth in reserves and excess reserves was the incoming gold, every ounce of which now made $35.00 instead of $20.67. An additional important factor was the issue of silver certificates exceeding $1,25 0,- 000,000, which followed the'silver purchases of the Federal Government under the silver legislation of May, 1934 (of which an account is given in an earlier chapter).
Excess reserves would have risen to even higher levels, of course, had there not been (I) a 3-billion-dollar growth in money in circulation in the years 1934-I 940, (2) a great growth in demand deposits in· the banks, due chiefly to member bank purchases of Government securities, and (3) increases in the reserve requirements of the member banks by action of the Federal Reserve authorities in 1936 and 1937.
Excess Reserves Cause Fantastically Low Interest Rates. The effect of the increasing member bank reserves upon money rates and the yield on United States Government bonds was very striking. The following table tells the story. When the excess reserves reached $2,779,000,000 in August, 1935, interest rates had broken to fantastic levels. A very significant fact shown by this table is that practically all of this beating down of interest rates had been accomplished by July of 1934, at which time excess reserves stood at $1,873,000,000. On that date open market commercial paper had a range of r4 %to 1%, and prime bankers' acceptances were discounted at 78 % to ;4 %. Treasury bills, three to six months, were yielding only .08% and the yield on Government bonds was 2.85%. In other words, when excess reserves grew as large as $1,873,- 000,000, subsequent additions to excess reserves made very little difference.
The money market was completely flooded and money rates could go very little lower. Call loans to the stock market were pegged at 1%and would have gone much lower in the absence of the pegging. Prime customers' loans at the great city banks were pegged at 10 %, with occasional undercutting by banks in St. Louis and Chicago.
The immense increase in the excess reserves which followed the last date of the table, August, 1935-an increase from 2r4 billions to nearly 7 billions at the beginning of 194 I -made very little difference indeed in interest rates, except that the yield of long Government bonds moved down from 2.74% to 2.23% by August,S 1940. Board of Governors Raises Reserve Requirements, 1936-1937.
The growing volume of excess reserves was a matter of grave concern to most informed students of money and banking, and the Federal Reserve authorities were greatly troubled about it. The Federal Reserve banks could, of course, have cut into the excess reserves by selling Government securities, of which they had in 1935 and 1936 $2,43 1,- 000,000. But they had no desire to do this because it. would cut their earnings and it was, moreover, a procedure politically in bad odor.
Raising their discount rates would have made no difference, since total bills discounted in 1935 were only $7,000,000 and in 1936 only $6,000,000. But they had the device (authorized by the Congress under the 1~homas Amendment of 1933 and, under limitations, in the Banking Act of 1935) of raising reserve requirements, which would reduce excess reserves. This, being a New Deal device, was politically much easier. It had the further great merit that it would reduce the expansion potential of such excess reserves as remained.
The effect of raising reserve requirements as a restraining measure would be different from the effect of selling Government securities or even of· raising discount rates. Raising reserve requirements would immediately hit every member bank, whereas the selling of Government securities would have its immediate effect upon those banks which had excess reserves and were prepared to buy Government securities. There was always the possibility that, even though reserves in the aggregate were excessive, still a good many individual banks might not have excess reserves, and a move which struck at all the banks might catch a good many of them unprepared.
Of course, the Federal Reserve authorities were in a position to have exact information regarding the position .of individual member banks and could know to what extent individual banks might· be put under pressure by such a measure. The Board of Governors of the Federal Reserve System moved. On August 16, 1936, they raised reserve requirements by 5°%, and announced that there would be two more increases of 25 % each on March 1 and May I, 1937, so that the reserve requirements of the country would be doubled by May I, 1937. This programme was carried through. Reserves for demand deposits in New York and Chicago were raised to 26 ro, for the other reserve cities req'uirements were raised to 20%, and for country banks to 14%, while reserve requirements against time deposits were everywhere made 6%-all· these figures being double the requirements that had previously exi~ted.
These measures reduced excess reserves to something.like a billion dollars. But excess reserves continued to grow. In,April, 1938, the Federal Reserve authorities cancelled the last 25 %increase in reserve requirements, but 'in. November, 1941, restored it. Subsequently, in 1942, reserve requirements on de.. mand deposits for New York and Chicago banks were reduced to the 20% level of the other reserve cities.
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