Memorandum on the Depression
Lauchlin B. Currie, P.T. Ellsworth
and Harry Dexter White
[Harvard University, January, 1932]
The depression has been in progress more than two years. During this
period the index of business activity has declined over a third;
unemployment has assumed very grave proportions; partial employment
has seriously reduced the weekly earnings of a large proportion of
those listed as gainfully employed. In terms of real income the
depression has already cost the American people more than the Great
War. Nor can the loss be measured in terms of real income alone. The
widespread and long drawn out period of unemployment and greatly
reduced incomes has been accompanied by increasing physical suffering
and anxiety. It has, further, engendered a loss of confidence in
American leadership and American institutions which is becoming more
marked as the depression lengthens.
The end is not yet in sight, nor can any precedent be used as a
forecast of duration; the significant factors of the present crisis
have no parallel in modern economic history. The situation has passed
the bounds of a business depression and has assumed the aspect of an
international calamity. With the reparations problem involved,
economic distress throughout Europe on the increase, with the
progressive maldistribution of gold reserves, the growing loss of
confidence in banks, the mounting trade barriers, disorders in Spain,
India, and China, the outlook for recovery in the near future is not
encouraging.
In view of the manifest uncertainty as to the duration of the
depression, the likelihood of its continuance for another year or
longer and the failure on the part of the government to adopt other
than palliative measures, there devolves upon the economist the
responsibility of recommending a course of action which will hasten
the approach of recovery. There are some economists who believe that
the course of the depression cannot be checked, that political and
economic changes are beyond human control, that to attempt to
influence their direction is an attempt to interfere with the "natural"
operation of economic principles; there are others who believe that
the factors involved are so complex that economists can safely
recommend no way out, and that the only policy to follow is one of
patient submission to the as yet little understood operations of
economic maladjustments; there are even a few who believe that the
depression should be permitted to run its course because they regard
it as a vehicle for the wholesome purging of inefficiency from our
industrial system. A great number of economists, however, are not in
sympathy with such views; they believe with Dr. Persons that "the
depression will not cure itself and requires prompt, intelligent, and
vigorous action"; they believe that recovery can and should be
hastened thru the adoption of proper measures.
The recommendations recently made by Dr. Persons and signed by a
number of eminent economists are a first step towards a vigorous
grappling with the situation. We feel, however, that the proposals are
stated in terms too vague, and the program offered is not sufficiently
comprehensive to insure the desired goal of business recovery. We
therefore venture to submit the following specific program together
with a brief discussion of the economic principles involved.
BANKING POLICY
Production and prices have been and are falling, not because of a
decline in the need for goods, but because of a decrease in monetary
demand. This decrease, in turn, is due both to decreased monetary
incomes and to the decreased spending of those incomes. Monetary
incomes, broadly speaking, are determined by the volume and the rate
of spending of the community's means of payment, which consist of
money and demand deposits. The banking system can influence the rate
of spending only indirectly. It can, however, thru its control of
demand deposits, control within wide limits the volume of the means of
payment, and it can offset, to a large degree, changing rates of
spending by changing the volume of the means of payment.
Our banking policy has not exerted any effective influence to check
the decline in the means of payment. Instead of offsetting the decline
in the demand for goods caused by the decreased rate of spending, our
policy has intensified it by permitting a contraction of the volume of
the means of payment. The contraction has resulted chiefly from the
extremely high level of indebtedness of member banks to the reserve
banks. This indebtedness arose from the necessity placed upon the
member banks of meeting customers' demands for notes and gold, and it
has been maintained at that high level by the action of the reserve
banks, which, from October to the end of January, decreased their
holdings of acceptances by some $600,000,000. A decrease in the
holdings of acceptances reduces correspondingly the reserve accounts
of member banks and so forces them to increase their borrowings from
the Federal Reserve Banks. To reduce this indebtedness, the member
banks resort to a policy of credit contraction.
Why, it may be asked should banks wish to reduce their indebtedness
to the reserve banks? There are various reasons. In the first place,
there is the understanding -- virtually an unwritten law -- that
recourse to the reserve banks should be for temporary and emergency
purposes only. Continuous indebtedness to the reserve banks has, in
the past, been frowned upon by the authorities. In addition there is
the urgent desire of conservative bankers to be in a liquid condition,
and it is considered that borrowings impair liquidity. For these and
other reasons, member banks have been selling bonds in unprecedented
amounts and have not been renewing old loans nor making new ones. As a
consequence we have been experiencing an enormous contraction of
demand deposits.
The results of this contraction have been uniformly unfortunate. It
has unquestionably contributed to the demoralization of the bond
market, and so to bank failures and the postponement of bond issues
for construction purposes. In addition it has deepened the depression
in less obvious ways. When an individual having a deposit buys a bond
from or pays off a loan to the banking system and the system cancels
the deposit, precisely the same effect is brought about as if the
government were to issue bonds for banknotes and then destroy the
banknotes. Individuals acquire means of payment from current
production; they save, that is refrain from exercising a demand for
the goods they have contributed in producing, and with their savings
pay off a loan or buy a bond. If the bond is issued by a borrower who
uses the proceeds to finance construction, no net decrease in spending
or demand for goods has taken place. If, on the other hand, it is
bought from a bank, as has recently been the case, the deposit is
wiped out and a net decrease in the demand for goods is the result. In
other words, a deposit which is not spent by the original owner on
goods cannot, since it has been wiped out, be spent by anybody.
Obviously, continued liquidation of this nature will hinder any plan
to overcome the depression. It is of the utmost importance, therefore,
that liquidation be terminated as soon as possible. We do not believe
that it will be terminated as long as member banks are so heavily in
debt, and we believe, therefore, that it is absolutely essential for
the indebtedness to be reduced. How can this be done?
Broadly speaking, indebtedness to the reserve banks can be reduced in
four ways: (1) by an inflow of gold; (2) by an inflow of money from
circulation; (3) by purchases of bills and securities by reserve
banks; (4) by a contraction of member bank loans and investments and
hence of deposits. A contraction of deposits sets free a proportion of
the member banks' reserves which can be used to pay off rediscounts
with the reserve banks. It is, however, important to note that a
reduction of a billion dollars in deposits reduces reserve
requirements, and hence rediscounts with the reserve banks, by only
one hundred millions (assuming a 10 per cent reserve ratio). In
default of the first three ways member banks have been forced to have
recourse to this last method of reducing rediscounts. After four
months of contraction, however, they found themselves more heavily
indebted than ever, owing to the diminution in the holdings of
acceptances by the reserve banks.
Since we dare not wait for an inflow of gold or of cash, and it is
obviously undesirable that banks should continue to reduce
indebtedness by contracting deposits, the only alternative is for the
reserve banks to enter upon a vigorous open market purchasing policy.
At the moment of writing the indebtedness amounts to over
$800,000,000. We strongly recommend, therefore, that the reserve banks
purchase upwards of a billion dollars of bills and securities. This
action would satisfy member banks= desire for liquidity and in
addition give them large surplus reserves. Member banks, out of debt
and in possession of surplus reserves, could be relied upon to
increase their holdings of short term government bonds and in this way
bring about an expansion of deposits in place of the present
contraction.
The reserve and member banks' purchases of bonds would aid in the
recovery of the bond market and this, in turn, would enhance the
solvency of bond holding institutions and would enable borrowers to
secure loans at better rates. Further, this policy would
unquestionably result in an increase in consumers' incomes, demand for
goods, and production. What is needed at the present time is a net
increase in the effective demand for goods. If the government borrows
from the reserve banks and other banks, it receives deposits which
have been newly created and which have not been taken from
individuals. In this way a net increase in spending can be achieved.
If, however, as is pointed out elsewhere in this plan, the government
attempts to finance its deficit solely by taxation, or even by bonds
sold to individuals, there is a probability that most of the increased
government spending will be offset by the decreased spending of
taxpayers and bond buyers.
An objection to our proposal that the reserve banks buy bonds, which
probably carries some weight with the reserve administration, is that
it would decrease the "free gold" of the system. There is a
provision in the Federal Reserve Act that federal reserve notes must
be backed 40 per cent by gold plus 60 per cent by eligible paper or
gold. Member bank rediscounts secured by government securities bought
in the open market are not. If, therefore, a policy were adopted which
would result in the displacement of bills discounted by government
bonds in the reserve banks' earning assets, the amount of gold that
would have to be held against notes would be increased. We believe
that this provision in the act has no valid justification and
recommend, therefore, that government bonds be declared eligible as
collateral against federal reserve notes. The reserve banks need not,
however, wait for a change in the law. Their reserves are ample, and
in any case they could purchase at least $600,000,000 of acceptances
if they raised their buying price sufficiently. Acceptances are
eligible paper.
Some people feel that an increase in means of payment would have no
perceptible effect since, they say, there is plenty of money now; the
real difficulty is in getting it spent. We can dispose of this
objection very briefly by pointing out that we have provided for the
spending of the increased means of payment by linking the plan for
deposit expansion to one providing for public works with no immediate
rise in taxes. If there is one point on which everyone is agreed, it
is that any money borrowed by public bodies will be spent.
A criticism of an entirely different character is that our proposal
is "inflationary". It should be noted that the people who
make this criticism concede fully the efficacy of a policy of
expansion on the part of the central bank. Their fear is, apparently,
than an upturn started in this way would get out of control and
eventually involve us in a situation similar to that of war time. We
do not believe that there is the slightest justification for this
fear. We concede and, indeed, think it desirable that some recovery in
prices should take place. In this connection, it is important to
distinguish between an increase in monetary incomes when the factors
of production are fully utilized and when they are only partially
utilized. In the former case the output of goods can rise but slowly.
In the latter, which corresponds to the present situation, an increase
in monetary demand for goods could very shortly be met by increased
output. It is only after much of the present enormous slack in our
economic system has been taken up that the danger of inflation becomes
real. Before that point is reached, the production of goods and
services will have greatly increased. This additional production in
answer to an increased demand is just what is wanted; it is the very
goal of our economic system. As Keynes has so aptly said, "To
bring up the bogy of Inflation as an objection to capital expenditures
at the present is like warning a patient who is wasting away from
emaciation of the dangers of excessive corpulation." It is true
that an approach to prosperity -- i.e., the upswing in the movement of
business activity -- brings with it danger of inflation; the very
nature of expanding business activity contains the impetus to
expanding bank deposits and rising prices. But the danger can be
avoided, as it has been in the past. The reserve banks will be in an
excellent position to apply brakes on the upswing by virtue of their
very large holdings of bills and securities which they can sell and so
place member banks heavily in debt. We find it difficult to understand
why the spending of newly created means of payment should be any more
inflationary than an increased rate of spending of the existing means
of payment, which is universally advocated today.
It may be objected that a banking policy designed to check deflation
would result in such an outflow of gold as to endanger the maintenance
of the gold standard here. Our present gold stock is, however,
approximately four and a half billions. French balances in this
country were variously estimated in January to amount to between
$400,000,000 and $450,000,000 and were being steadily reduced. Other
foreign balances are much smaller. We could, therefore, well stand, if
need be, the loss in gold of all foreign balances. It has been
intimated that foreigners would also sell their holdings of our
securities for gold. This is, of course, a matter of opinion and is,
by its nature, incapable of definite refutation. We can only state it
as our belief that such a reaction is unlikely. It seems more probable
that a continued fall in our stock and bond prices would cause more
foreign selling than would arise in those brought about by the
anticipation of business recovery.
It must be remembered that only a few countries remain on the gold
standard, and that they have received enormous quantities of gold in
the past two years. It appears doubtful that they could absorb the
upwards of two billions that we could spare, without any effect on
their internal price structures. As long as the United States
continues, by its policy, to raise the value of gold, central banks in
countries off the gold standard feel constrained to adopt restrictive
measures in order to prevent continued depreciation of their
exchanges. Should we succeed in starting a business recovery
independently, it is probable that foreign exchanges would move
initially against us. This would enable central banks in countries off
the gold standard to relax their present drastic restrictive policies
and pave the way for a world upturn. It need hardly be pointed out
that a policy which leads to an increase in our aggregate money income
to be spent on both home and foreign goods would do much to lighten
the pressure on Germany and other debtor countries without causing any
diminution in demand for home goods.
In conclusion, we believe that the most serious danger to the
maintenance of the gold standard would be an internal drain of money
into "circulation", which would result from a policy of
continued liquidation. Such a policy, involving a steady decline in
all values, would result in increased bank failures, which, in turn,
would lead to increased hoarding. Suspensions of specie payments in
the past have occurred as a consequence of internal rather than
external runs on our banking system.
PUBLIC EXPENDITURES
While it is true both that an easing of credit conditions will tend
to encourage private investment, and that any increase in credit,
resulting in greater expenditure, will create additional employment,
it is doubtful - in the present situation - whether the desired
increase in private borrowing will take place. With confidence as
badly shaken as it is at present, and with prices continuing to fall,
there is little in the current outlook to make it attractive to
business men to borrow in amounts sufficient to stimulate recovery.
And while presumably the fall in prices will some day stop and
confidence revive, the policy of waiting for this day to come involves
us in a continuation of the present unemployment and business losses
for an indeterminate period. Such measures as the National Credit
Corporation and the Reconstruction Finance Corporation are in the main
designed to prevent the liquidation from becoming more serious, not to
give business an impetus which would start it on the upward path.
Since the initiation of a voluntary program of expansion by
independent, scattered producers must wait upon the appearance of the
prospect of profits, and since the Federal Government is the sole
agency in a central position and strong enough to undertake drastic
remedial action, it is strongly recommended that the Government
immediately commence a program of public construction on a nationwide
scale. Such a program would stimulate directly the building and
construction industry and those industries engaged in the production
of raw materials and tools, and indirectly a large number of other
lines of enterprise, thru the expenditure of the earnings of the
re-employed. The revival of these industries would involve a further,
secondary increase in employment, which in turn would stimulate
recovery in other lines in ever widening circles. As employment in
industry at large increased, a gradual reduction in government
expenditure on construction would be called for, and would permit the
return of men engaged on such work to their ordinary occupations.
This program should be financed, not by taxation, which serves
principally merely to divert expenditure from one channel to another,
but by an issue of bonds, under conditions specified below. It is
recommended that United States bonds be issued in amounts sufficient
to the purpose. The bonds should be sold, not in one block, but after
an initial issue of $500,000,000, at such a rate as the progress of
construction makes necessary. It is expected that it will not be
necessary to issue more than one to two billions to achieve the
desired results. These bonds should be made eligible for rediscount at
the Federal Reserve Banks, and also as collateral for the issue of
Federal Reserve notes. Partial retirement should be provided out of a
surtax on incomes, the remainder out of generally higher taxation to
be imposed as soon as recovery has been attained, the retirement to
take place as rapidly as is consistent with the state of business
activity, preferably at a rate of 15 per cent a year. Public utterance
of prominent individuals to the contrary notwithstanding, it is deemed
obvious that a period of national poverty is the worst time to
increase federal taxes, and a period of prosperity the worst time to
reduce them.
Increased taxes result normally in a transfer of purchasing power
from the individual to the government; it is only when taxes come from
hoarded or idle funds that an increase rather than a transfer of
purchasing power results. If the government employs this purchasing
power (i.e., collected taxes) instead of borrowing "created"
or idle funds, the result is a drop in the effective demand for bonds
at a time when the government should be doing everything in its power
to build up the effective demand. When at the same time the government
adopts a policy of retrenchment, of ruthless cutting of expenditures,
the effect is doubly bad. In times of intense depression a paring down
of productive expenditures that can be financed thru the borrowing of
"created" or idle funds is inexcusable. A course of action
which may be proper for a private corporation, for a municipality, for
a state, or for some other country is no criterion of the proper
policy for the United States Government. The City of New York may find
it expedient to reduce its deficit, notwithstanding the resulting
intensification of the depression, because it may not be able to
borrow unless it reduces its budgetary deficit. If the important
bankers refuse to support a municipal loan, New York has no
alternative; it must reduce its deficit by increased taxes and
decreased expenditures. But the United States Government is never in
such a predicament; it always has a choice: it can make possible such
credit conditions as will facilitate the flotation of its bonds, and
can, if necessary, even supply the funds with which its own bonds may
be purchased.
It cannot be emphasized too strongly that financing public works
through domestic bond flotations by the federal government does not
saddle future generations with a burden. Even the 25 billion dollar
loan raised to finance the war did not pass on to later years any
portion of the burden of conducting the war. It doubtless caused in
later years some redistribution of the national income (to what extent
and in what direction involves an analysis of the incidence of the
taxes raised to liquidate the loan and of the factors connected with
the rapidity of liquidation, changed rates of interest, effect of loan
and redemptions on prices, etc -- matters extremely complex for the
economist and wholly beyond the layman -- but it did not decrease the
aggregate real income. The economic burden of the war on future
generations consisted of the loss of benefits that would have been
derived from the use of such capital, actual and potential, as was
destroyed. The loss of future generations would have been neither more
nor less had the war been financed wholly out of current taxes. Those
who reiterate that domestic borrowing by the Federal Government
saddles future generations with a burden should familiarize themselves
with the A B C of economics. It is the failure of the Federal
Government to increase its outstanding indebtedness during a period of
depression that in a sense saddles the future with a burden; the
capital goods that could be and are not produced deprive the future of
the continuous stream of utilities that would have been derived from
those capital goods. Every month's delay in setting idle equipment and
idle men to work not only denies to us currently an enormous amount of
consumer's goods and service, but also deprives future generations of
the utility to be derived from the additional factories, schools,
parks, roads, machinery, and so forth that could be produced if the
Government now embarked on the program here outlined.
It is claimed that any large issue of bonds would destroy confidence
in the United States Government and cause the value of its outstanding
bonds to decline seriously. Such objection is wholly unwarranted. From
1921 to 1929 the Government reduced its indebtedness from 26 to 16
billions. Had the Government deemed it expedient, it could without
difficulty have maintained the higher tax rates and by 1929 wiped off
another ten billions of the debt. But it chose rather to lower taxes
and to reduce the debt less rapidly. In 1930 the debt was 16.8 billion
dollars, or about $134 per capita, a sum less than one-third the per
capita indebtedness of France and less than one-fifth that of Great
Britain. The tax burden in the United States, on the other hand, is
considerably less than in either of these two countries. The United
States, in short, has (in per capita terms) a much greater income, a
smaller debt, and considerably lower taxes than any of the great
nations. In the light of these facts there are those who continue to
affirm that if in this emergency -- an emergency certainly as great as
the war if privation and national loss be the measure -- the
outstanding domestic debt is to be increased by a few billion dollars,
confidence in the United States Government will be destroyed. Those
who make the claim point to the decline in the price of United States
Government bonds during the fall of 1931 as evidence of a loss of
confidence, but there is no sound basis for such a view. A loss of
confidence in the financial stability of a government is quite
different from a loss of confidence in the financial stability of a
corporation or municipality. In the case of the federal government it
does not and cannot mean that the government is in any danger of
suspending payment on its domestic debt. It can mean only that the
government may cease to pay its debt in money redeemable in gold; in
other words, that the government is in danger of being forced off the
gold standard. If such fears were entertained in the fall of 1931, the
first sign would have been a hoarding of gold, and we know that this
did not occur. Hoarding took place, but it was the hoarding of paper
money, not gold, and indicated a loss of confidence in the banks, not
in the Government. The decline in government bond values was caused
definitely not by loss of confidence, but by the suddenly increased
supply of bonds coming from those banks which were liquidating their
investments in order to reduce their indebtedness to the reserve
banks.
It is to be expected that a great increase in the demand for funds
would probably depress the bond market unless the Federal Reserve
Banks or member banks come to its support, as they did during the war,
by purchasing a large portion of the government issues. Indeed, such
action by the Federal Reserve Banks will be essential to the success
of the plan herein outlined; otherwise a large bond flotation will
heighten the long term borrowing rate and discourage new undertakings
on the part of private corporations and municipalities. A result to be
sedulously avoided. The Federal Reserve Banks need support the market
with large purchases only at the start of the program. Once the upturn
in business activity begins, there will be a return of business
optimism, confidence in the banks will be revived, and the 1.3
billions of hoarded funds, which the Government is trying to "coax"
and "reason" back, will flow of its own accord (either by
direct deposits or by the purchase of securities) into the banks. The
demand for securities brought about by the inflow of hoarded funds
will alone prevent the interest on long term borrowing from rising.
It has also been claimed that such a large government loan would
merely have the effect of causing an equal decline in private
investment. In view of the fact that new corporate issues of
securities during the last six months of 1931 averaged well under
$100,000,000 per month, the lowest figure since 1918, this is hardly a
serious objection at the present. The proposed rate of issue of new
government securities would far offset even a complete abandonment of
private investment. Furthermore, as the effects of the increased
expenditure on employment, prices, and profits began to be felt, the
prices of industrial securities could scarcely fail to rise, and as
business revived, new industrial issues would be needed and would
appear. Better security prices would be the inevitable result of
rising monetary incomes of corporations. Again, more profitable
business would mean both higher taxable capacity and higher tax
returns, and this, together with the diminished burden of
unemployment, would raise the value of the securities of states and
municipalities, many of which have recently been forced to abandon
their own public works programs because of low revenue and high cost
of borrowing.
The program should begin with the letting of contracts to private
contractors to an initial sum of $1,000,000,000, the work to be pushed
as rapidly as possible; where feasible, by the employment of two or
three separate shifts a day. In the awarding of the first group of
contracts, preference should be given to those works that can be
completed within the shortest possible time. It is essential that
enough contracts be completed each month to make possible a decrease
in total expenditures as business conditions improve. The emergency
nature of the expenditure should be kept uppermost in planning the
details. A high rate of expenditure at the outset should be aimed at,
and bonds sold as rapidly as need be to meet the payments coming due.
In view of the large number of public projects that have been
postponed thruout the country by states and municipalities, it should
be possible in a short time to achieve a rate of expenditure of
$300,000,000 per month. As the stimulus of this expenditure spreads to
other lines of activity, the rate of expenditure should be reduced.
The value of contracts let after the first billion is spent should be
scaled down as the index of production of the Federal Reserve Board
rises. When the index reaches 90 (in 1928-29 it averaged 114), only
those projects as yet incomplete should be finished and no new
contracts should be let in.
The expenditure of the emergency funds should be governed by the
following considerations: (1) facility with which projects may be
initiated at the earliest possible date and completed within a short
time; (2) amount of labor that will be employed, directly or
indirectly; (3) number and diversity of the industries which will be
affected, directly or indirectly, by the projects; (4) value of the
projects to the economic and social welfare of the country; (5)
economical administration of the work. While waste and duplication
should be avoided so far as is humanly possible, the object of the
expenditure is to put men to work at useful tasks immediately instead
of waiting until we are forced to relieve them in idleness -- hence
the emphasis on speed and on the numbers employed.
As to the objects upon which the funds should be spent it is clear
that there is a wide variety of useful public works which need to be
undertaken, and which, if done, will leave the country definitely
ahead in a tangible way. Specifically, it is recommended that the
proceeds of the loan be used in the construction of roads, the
elimination of grade crossings, the erection of bridges and public
buildings for which there is a clear need and for which plans are
ready, the elimination of unsightly areas in municipalities, and in
carrying out a program of flood prevention and reforestation, both
directly by the Federal Government and thru loans to states and thru
them to municipalities. In order to ensure a coordinated policy in the
execution of the program of construction, it is recommended that there
be created an Administration of Public Works, along the lines laid
down in the bill (S. 2419), presented to the Senate by Senator La
Follette.
It will doubtless be argued that such public work will be costly,
that some things will be done which do not seriously need doing, and,
in general, that such vast expenditure by the Government is unwise.
Admittedly the work done will probably involve a larger outlay than
ordinary public works, but it is the object of the program to meet a
specific emergency B men are to be given employment because they are
unemployed. The alternative is direct unemployment relief, which, to
be adequate, would require a large outlay, would leave nothing behind
to show for the expenditure, and would prove demoralizing to the
recipients.
Innumerable difficulties lie in the path of a rapid and successful
execution of so large a program. Yet those difficulties are not
insurmountable. In 1917 the United States demonstrated its ability to
execute a far more difficult program. The seriousness of the present
emergency warrants the straining of every effort to achieve quickly an
adequate rate of public expenditure which will do so much to bring
about business recovery.
TARIFF POLICY
One of the factors that has in no small way contributed to the
present world wide depression and is an additional obstacle in the way
of recovery is the determination on the part of the nations to keep
out goods of other countries. Since 1925 the tariff schedule of every
important country has been revised upward at least once. Not content
with mere increases in duty, many countries have set up import quotas,
licensing restrictions, and embargoes. Germany in a desperate attempt
to prevent an outflow of gold has instituted a system of licensed
imports and control over foreign exchanges, designed effectively to
cut her imports to the bone. Austria, Czechoslovakia, Turkey, Greece,
Jugoslavia, and Roumania exercise close control over exchange, and
Spain, incensed by the restrictions imposed on her exports, has
recently retaliated with import quotas. Even France, whose gold
reserves are in no way threatened, is adding import quotas to her
already high tariff schedule. This concerted rush to place more and
more obstacles in the path of international trade has operated to
increase not only the real costs of production of innumerable
international commodities, but also the maladjustments which are now
playing economic havoc. The relationship between the world supply and
demand of many important world commodities has been seriously
disturbed: the present ruinous prices of wheat, sugar, textiles, and a
host of other manufactured articles are in part traceable to the
policy of expanding home industries and domestic crops by means of
subsidies provided by protective duties, regardless of the fact that
in the exporting countries crop areas and plant capacities are not
reduced until long after prices have become ruinous.
Heightened tariff barriers, by rendering more difficult the
adjustments of international accounts, have magnified the problem of
debt settlements, both private and public, and have contributed
materially to the maldistribution of gold reserves. The higher the
import duties in the creditor countries, the harder the task of
developing export surpluses in the debtor countries. Forced to adopt
extreme measures to develop the export surplus necessary to meet
payments abroad, the debtor countries have cut imports to a minimum,
and have maintained high discount rates. The difficulty of developing
a sufficient export surplus has in some cases led to virtual
abandonment of the gold standard. The concentration of gold in the
United States and France, where it is not needed, at the expense of
gold reserves in countries where its loss proved disastrous, has been
encouraged by their high tariff policies. In an attempt to stem the
outward flow of gold or encourage an inflow, tariff barriers in other
countries have been increased, and have in turn incited retaliatory
increases. And so the mad march toward declining trade, increasing
costs, and economic maladjustment goes on.
The United States has been in the forefront in the building up of
tariff walls; it is only fitting that she take the lead in the
downward revision so necessary to a return to economic sanity. A step
by her in that direction may well initiate a general reduction in the
tariff schedules of all important countries, but whether or not other
countries follow America's lead, the reduction of import duties in the
United States would be an important step towards economic recovery and
a means of increasing the real aggregate national income. We therefore
recommend a reduction in all duties protective in design or in effect.
We indorse also that portion of the tariff bill (now before Congress)
calling for the creation of a commission to confer with European
governments with the express intent of securing the scaling down of
tariff schedules. International conferences, however, are certain to
be long drawn out, and the present situation calls for immediate
action. Let the United States by a reduction in her import duties
demonstrate to the world that she no longer will contribute to the
dangerous spirit of unenlightened nationalism and international
bitterness which high protective policies foster.
It is important to recognize, however, that a sharp reduction of
duties would involve injustice to vested interests in the protected
industries, and would result in additional short-time maladjustments.
The diversion of capital and of workers from protected industries to
others should be so gradual as to cause minimum losses to the owners
of protected industries and a minimum of additional temporary
unemployment. It is therefore recommended that all import duties in
excess of twenty per cent ad valorem be reduced by one fifth of the
existing duty. Such a reduction would avoid serious maladjustments and
losses: many of the duties in the present schedule, being much in
excess of the differences in the domestic and the foreign costs of
production, would continue to keep out the foreign commodities;
others, being completely ineffective, would merely continue so; while
commodities taxed twenty per cent ad valorem or less (the ad valorem
equivalent of specific duties to be based on the average import price
of 1930) would not be touched by the revision. The employment of a
flat rate of reduction applying to all commodities (except those taxed
twenty per cent or under) would have a double advantage: it would
obviate the delay and the uncertainty of lengthy consideration of the
separate items, and it would immediately make clear to the world that
an important downward revision of the tariff schedule had been made.
The proposed reduction would have, we believe, a beneficial economic
effect out of all proportion to the actual changes involved.
REPARATIONS AND INTERALLIED DEBTS
We feel confident that the adoption of the foregoing recommendations
in regard to banking policies, public works, and the tariff will bring
about business recovery in the United States; but we cannot overlook
the fact that extreme distress in Europe must tend to retard our
progress. Europe consumes normally one-fourth of our exports, and the
sharp decline in her demand for our products will continue to be a
depressing factor in many of the export industries, particularly in
agriculture. Americans have invested, moreover, five billion dollars
in European countries, and the income from these investments has been
curtailed by the depression abroad. We believe, therefore, that
business recovery in the United States will be more easily attained,
and will reach a higher level, if accompanied by recovery in Europe.
Reparations are the chief obstacle to European prosperity. They hang
like a storm cloud over Europe, presaging possible chaos, shutting out
the influences essential to a resumption of normal international
relations, and inducing a state of mind wholly inimical to business
recovery. In Germany -- the crucial country, whose situation so
largely affects conditions in the rest of Europe -- the very high
interest rates, the budgetary difficulties, the interference with the
normal course of trade, the precarious banking situation, are all in a
large measure a consequence of the reparations tangle. Unemployment is
now approaching six millions, and political strife is assuming more
and more a threatening aspect, while the growing determination among
all parties in Germany that reparations be cancelled, or at least
greatly reduced, is keeping France in a state of great uneasiness that
is reflected in increased hoarding, a cautious banking policy, and a
growing pessimism.
The Young Plan has not provided a solution to the reparations
problem; payments are not being made, and there is little likelihood
that they ever will be made on the scale fixed by the plan. Germany
balks at the prospect of saddling the next two generations with
burdens she holds them to have in no way merited, and is becoming less
and less inclined to submit to terms she believes to be unreasonable.
Any attempt to force from Germany larger payments than she is willing
to make can result, as France discovered in 1923, only in disaster to
all concerned. It is evident, therefore, that German reparations must
be revised, and in a manner that will receive the co-operation of the
German people.
Interallied debts are, as every economist recognizes, inextricably
bound up with reparations. It may be political wisdom for United
States government officials to continue to deny that such is the case,
but the fact remains that France will not make her annual payments to
the United States and England if she does not receive annuities from
Germany, and that England will not pay the United States if Germany
and France default in their payments to her. An extension of the
moratorium will not be a settlement of the tangle; it will serve
merely to perpetuate the uncertainty. If, on the other hand, a
definite and permanent arrangement be made on a basis satisfactory to
the principal nations concerned, Europe will be rid of the great
impediment that bars the road toward her economic recovery. With
intergovernmental debts permanently out of the way, the next decade
may well see a great stride towards a higher standard of living and
better international relations.
We believe that the quickest, most equitable, and most effective way
to settle the problem of reparations is thru a complete cancellation
of interallied debts and reparations. The principal justification for
cancellation rests upon other than economic grounds, but our economic
interests alone, we believe, warrant the step. The greatest monetary
loss of such a settlement would fall upon the United States, yet if by
a cancellation of all intergovernmental debts we can achieve a ten per
cent higher level of business activity, even for a single year, the
United States will have lost nothing, while Europe will have gained
much. Those who oppose cancellation on the ground that the American
people would lose $300,000,000 a year, base their attitude on the
questionable assumptions that the Allies are going to meet their
obligations, and that intergovernmental debts in no way retard
economic recovery or prevent a higher level of prosperity. As we have
pointed out, whether or not the United States receives $300,000,000 a
year depends upon whether or not Germany pays her reparations in
accordance with the Young Plan. Germany, we repeat, will not make
those payments, and cancellation, therefore, does not mean a loss of
$300,000,000, for in no case would the United States receive this sum.
Cancellation would mean an end to the bickerings, moratoriums,
uncertainties, political and economic disturbances, and international
frictions which are contributing so much to the downward movement of
business activity in Europe, and which cannot but affect the situation
in the United States. But public sentiment, however unjustified,
remains strongly opposed to cancellation. We recommend, therefore, as
an alternative the following plan, which while gaining the support of
those who resent cancellation, will achieve a measure of its benefits.
The United States loaned the Allied Governments about ten billion
dollars. This sum, compounded at 4 ¼ per cent annually would
amount to 15 billions. Of this sum 2.5 billions have already been
paid, leaving the current indebtedness, on the foregoing basis, at
12.5 billions. (For purposes of brevity only approximate figures are
used.) At the time these funds were loaned the purchasing power of the
dollar was about one-half what it is today. Since it is palpably
unfair to expect our allies to pay back double the amount of goods and
services they borrowed for the conduct of a joint war, the sum owing
to the United States ought to be adjusted to its present purchasing
power. In terms of 1932 dollars the debt to the United States would be
only 6.25 billions. This sum of 6.25 billions, it must be emphasized,
represents no real reduction from the amount borrowed by the Allies
plus the interest which would have accrued from the date the loan was
made until the present time. However, in its arrangements with the
various debtor countries, the United States has already demonstrated
its willingness to scale down the real burden of the debt. In its
agreement with Italy the effective reduction, in view of the low
interest rate and dates of payment, amounted to 74 per cent; with
Belgium, 46 per cent; with France, 50 per cent; with England, 18 per
cent. If these reductions were applied to the deflated value of the
loan (namely, 6.25 billions), the remainder due the United States
would be 3.75 billions. The reduction of 2.5 billions, or 40 per cent
of the debt, would then be the contribution of the United States
toward a permanent settlement of the debt problem, the reduction being
contingent upon a similar treatment of German reparations. The annual
loss of revenue to the United States from the 2.5 billion dollar
reduction would be a negligible portion of our annual income, and
would be much more than offset by the good results of a permanent
solution of the inter-allied debts and reparations problem.
We recommend that this 3.75 billion dollar debt be paid in the
following manner:
Each country will give to the United States, in place of bonds
already given, its bonds, bearing an interest rate of 7 per cent per
annum, payable in gold, to an amount equal to the sum due the United
States after correction is made for the changes in the purchasing
power of gold, and after the reductions listed above for each country
are made. The bonds will be equally divided into three classes -- A,
B, and C, -- the only difference in the classes being the date and the
callable price. Class A bonds will be dated August 1, 1932, and will
be callable (by lot) for the first two years at 103, and thereafter at
par; Class B bonds will be dated August 1, 1933, and will be callable
for the first three years at 110, during the second three years at
105, and thereafter at par; Class C bonds will be dated August 1,
1934, and will be callable during the first three years at 115, during
the next three years at 110, during the following three years at 105,
and thereafter at par. All bonds will be payable in 20 years, with
redemption required at the rate of 2 per cent, beginning in the
seventh year and increasing at the rate of 2 per cent every second
year. This splitting of the bonds into different classes would delay
maximum interest payment until 1935.
The United States Government will offer these bonds to the public at
not less than par. Because of the attractive rate of interest, the
bonds will be rapidly absorbed by individuals and banks in the United
States. The sale of these bonds will not depress the bond market,
because the proceeds will be used to liquidate its own bonds; in fact,
it might be easily arranged to permit the holders of United States
government bonds to exchange them for the 7 per cent foreign
government bonds. The debts to the United States Government would thus
be liquidated and removed from the field of governmental
consideration. To prevent exchange difficulties arising in the issuing
countries from a possible extensive purchase of these bonds by the
residents of the issuing countries, a tax could, if necessary, be
imposed by those countries on their purchase or interest payment.
Improvement in the credit of the debtor governments is certain to
follow a satisfactory solution of the reparations problem and the
return of prosperity. The issuing governments could then refund
one-third of the loans at a lower rate of interest, followed by
another third three years later, and so forth. Before ten years had
passed, the interest payments would in all probability have been
reduced one-fourth by virtue of the lower rates, made possible by
improved credit conditions. A portion of these bonds would doubtless
replace some of the foreign securities now held in the issuing
countries, and the transfer problem would thereby be further reduced.
A settlement of the debts in this manner is conditional, of course,
upon a similar settlement to be made by the Allied Governments with
regard to reparations. The Young Plan fixed the remainder of
reparations due from Germany at 9 billions. Since the payments already
made under this plan have amounted to no more than the interest on
that amount, the reparations due remain at 9 billions. In terms of
1932 dollars this sum would equal about 6 billions. From this sum is
to be deducted an amount equal to the reduction made by the United
States to the Allies B namely, 40 per cent. This will leave about 3.6
billions due from Germany to the Allies. In settlement of this debt
Germany will give to each of the Allies, in such proportion as shall
be agreed upon among themselves, German Government 7 per cent bonds,
payable in gold. The service on those bonds shall have priority over
any other government loan except the $300,000,000 loan of 1925. The
bonds, like those given to the United States by the Allies, are to be
divided into three classes with the same provisions. The first payment
to be made by Germany would be $84,000,000 in 1934, followed by
$168,000,000 in 1935, and by $252,000,000 in 1936. Under the Young
Plan the annuities were to [be] $450,000,000 in 1934, $465,000,000 in
1935 and $475,000,000 in 1936. The new plan thus considerably reduces
the transfer problem. As soon as Germany's credit improves, she can
refund the 7 per cent bonds for others bearing a lower rate of
interest, and, if advisable, reduce the rate of redemption. The
transfer problem may thus be reduced still further.
Under the favorable conditions following the virtual elimination of
the transfer problem and the reduction of Germany's debt, the 7 per
cent bonds will pass into the hands of private holders. Once this
occurs, the reparations problem will lose all political importance and
will cease to be a disturbing factor in international affairs. Long
before this final absorption of the bonds takes place, however, Europe
will have been relieved of the demoralizing burden of uncertainty and
fear, and will have taken forward steps toward prosperity.
Introduction
by Roger Sandilands and David Laidler
|