Speech

PREPAREDNESS AGAINST BOTH WAR AND INFLATION* by Marriner S. Eccles Mr. Chairman and members of the Committee, or maintain ground forces at every strategic point I appreciate this opportunity to appear before your around the 20,000 mile periphery of the Commu­ Committee in its hearings on the problems of con­ nist empire. We cannot be prepared on the ground trolling inflation. to meet attacks at the time and place selected by Russia. Defense Preparedness Program There are, however, decisive things we can do Our defense preparedness program must be de­ with our superior technology and scientific know­ signed to prevent war and to prevent inflation, how, and within the limitations of a budget we can while at the same time preserving the essential pay for. We can, with the assistance of the British freedoms of our democratic institutions. It must Empire and such cooperation as other free nations also be sustainable for an indefinite period of time. are willing and able to give us, rapidly establish If we fail to make these aims our major goals, the overwhelming control of the air and the sea. From very system which we are trying to maintain will be strategic air and naval bases throughout the world, destroyed. This means we must adopt a realistic protected by adequate ground forces, we can foreign policy—one which recognizes the limita­ threaten swift retaliation with atomic and our other tions of our resources and manpower, and one destructive weapons if Russia undertakes aggres­ which we can pay for currently. sive action. How can we best, within this framework, protect We should recognize the facts that our unrivalled ourselves, maintain our essential economic and productive capacity is our strongest line of defense, democratic strength, and at the same time fulfill that our ability to produce is largely determined our commitments to help defend and protect the by our available manpower, and that our country other free countries of the world? I believe to do is the arsenal of the free nations of the world and this we must limit our aggregate expenditures on must not be weakened by a military program our defense and foreign aid program to a maximum which we cannot maintain indefinitely without of 50 billion dollars annually. This we can pay regimentation or inflation or which leads to war. for currently, given a total national product of some We should keep our ground forces as small as 300 billion dollars, the estimated amount for the possible so as to maintain our production at full next fiscal year. This money must be used in strength to meet our civilian and military needs such manner as to assure the maximum military and help the other free nations to arm their avail­ effectiveness of ourselves and our allies, which able manpower and build up their defenses. Our means a program most likely to prevent war. manpower can contribute far more to the defense We must recognize the fact that Russia occupies of the free world in our production lines, in our or controls the greater part of the tremendous land navy and air force than in the front lines of land mass of Europe and Asia. This land mass has a armies in Asia or Europe. population of nearly a billion people, and great We should quickly arrange a peace treaty with material resources, and is far removed from our Japan and Western Germany, bringing them into own shores. We can never expect to defeat Russia the United Nations and helping them and other on land. We would be bled white and destroyed, friendly countries, including Spain, to rearm as economically as well as militarily, by any attempt quickly as possible so as to be able to deter, or to do so. We cannot hope to be prepared to supply resist if necessary, aggression by China, Eastern Germany, or other Russian satellites. Our present *Statement of Marriner S. Eccles, Member. Board of Governors of the Federal Reserve System, before the Joint military forces' should be maintained in Germany Committee on the Economic Re|port on its hearings on and Japan until they have fully rearmed for de- the President's Economic Program. January 25, 1951. [1] Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PREPAREDNESS AGAINST BOTH WAR AND INFLATION fense. Neither they nor the other free countries the atomic bomb only if it is used against us Erst. can be expected to resist successfully direct attacks Such a commitment offers us no protection. We by Russia. The addition of such land forces as we must retain the initiative for use of all our weapons, could send, and at the same time maintain our including the atomic bomb. Any defense prepared­ supremacy on the production line, and in the air, ness program may mean an uneasy peace, but it and on the sea cannot be expected to provide the will be as uneasy for the Russians as for us. balance of power necessary to deter, contain, or de­ I should like now to discuss rather fully the in­ feat the Russians. flationary problems as related to fiscal, monetary, Russia should know that direct attack by her and direct controls. would mean war with the rest of the free world— Why Balance the Budget? war in the air, on the sea and on the land, involving atomic and all other weapons of destruction. This We shall lose the fight against totalitarianism threat of world-wide total war will, I believe, deter even though our military and foreign policies are the Soviet Union, because it would mean her de­ successful in maintaining peace if we permit in­ struction as well as that of her enemies. A world flation to sap the strength of our democratic insti­ war would be an atomic war or worse, a war that tutions. Inflation is an insidious thing. In its early could not be won by any nation or group of na­ stages it can have a certain exhilarating effect. But tions, a war that might mean the destruction of as it proceeds it will operate to destroy our free civilization. For that reason, we should not think economy. Inflation works a grave injustice on or talk of war as being inevitable. We can, I be­ great masses of people. It injures most the aged, lieve, by the plan I have outlined, make it so costly the pensioners, the widows, and the disabled, the for Russia to start war that she will not dare at­ most helpless members of our society. It diminishes tempt it. the desire to work, to save, and to plan for the Under the protection of American and British future. It causes unrest and dissension among peo­ air and sea power the free nations on the periphery ple and thereby weakens our productivity and of the Soviet empire can rapidly rearm with the hence our defense effort. It imperils the existence great help we can give them from our production of the very system that all of our efforts are de­ lines. signed to protect. We should not attempt to rebuild great military We must recognize that our problem of control­ strength in either Germany or Japan for possible ing inflation is more complicated now than in war with Russia. Russia may not be willing to World War II. There is no end in sight for the tolerate the reconstruction of great military forces necessity of maintaining very large government of Western powers on her borders, any more than expenditures even though nondefense expeditures we would if our positions were reversed. I do not are reduced to the very minimum, as they cer­ believe Germany or Japan will be parties to such a tainly should be. People hold an unparalleled program. It would seem that they do not propose amount of liquid assets in the form of bank deposits, to be the battleground for the defense of the West­ Government bonds, equity in insurance policies, ern world. I believe we must plan on Germany building and loan shares, and other forms. Poten­ and Japan developing as defensively armed neutral tialities for inflation are now tremendous. It would areas, between the Communistic and the Western be impossible to prevent inflation under these con­ world. ditions without at least balancing the Federal War can be avoided, I believe, if we do not at­ Budget. tempt to build up international competitive and Everyone will agree that our military and foreign threatening military forces in Japan or on the con­ aid program will divert large supplies of goods tinents of Europe or Asia. Any attempt to do so and services from private consumption and invest­ is likely to provoke aggression—great standing armies cannot be mobilized, facing each other for ment. This is a physical fact that will not be long periods of time, without war. In any case, changed whether or not we tax ourselves to pay what is the stopping point of expansion and how for it. The production of the goods and services do you ever demobilize them? for this program will provide money income to We should not make any commitment to use those who are engaged in it, but it will not provide [2] Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PREPAREDNESS AGAINST BOTH WAR AND INFLATION a corresponding volume of goods or services for Government’s need and their ability to pay. In which this income may be spent. this country income and financial resources are Without a pay-as-you-go tax program the Gov­ broadly distributed. Tax increases to raise 16 bil­ ernment will have to borrow to make up its deficit, lion dollars will likewise have to be broadly dis­ either from the banks or from the nonbank public. tributed. Although borrowing from the public is less infla­ An increase in individual income taxes should tionary than from banks, there is no assurance that produce about half of the additional revenue re­ such borrowing could succeed in soaking up the quired. Since the bulk of the taxable income is excess funds available for spending. In my judg­ in the first taxable bracket, the increase will have ment, it would be impossible to avoid distructive to begin there, starting say with a rate of 25 per inflation and further debasement of the dollar if cent instead of 20, and go all the way up the in­ the policy of an unbalanced budget, however fi­ come scale. There should be an increase in the nanced, were long continued. An over-all com­ regular corporation income tax with some credit al­ plete harness of controls would only postpone the lowance on that part of income which is dis­ disastrous consequences. bursed as dividends, these being subject to in­ Borrowing from banks creates new money. Bor­ dividual income taxes. We should also greatly rowing from nonbank sources does not increase the strengthen the new excess profits tax law. Excise money supply, but it adds to the total volume of taxes should be placed on all nonessential goods the public debt and to the liquid assets held by now exempt and increased on nonessentials now the public, thus storing up inflationary pressures subject to tax. for the future under present debt management pol­ With the proposed increased tax rates on individ­ icies. The money supply is already excessive, ual and corporate incomes, it is especially essential considering the fact that it is being used less actively that all loopholes in the tax laws be closed. This than it could be, compared with past experience. source alone might provide as much as 3 billion In addition, the tremendous amount of other liquid dollars in additional revenue. Exempt income of assets held by the public is like money in many insurance companies, savings and loan associations, respects because it can be turned into money under and farm, labor, educational and religious coopera­ the present Federal Reserve policy of supporting tives, as well as interest from new securities of the Government security market at fixed prices State and local governments, should be taxed. De­ and interest rates. pletion allowances should be greatly reduced in As inflation proceeds, the desire increases to accordance with Treasury recommendations, and convert liquid assets into money and then into unusual expenses and promotional and advertising goods and services. This is what is known as the outlays made nondeductible for tax purposes. And flight from the dollar. The need to hold money there are other loopholes that should be closed. The and other liquid assets is not as great today as it present capital gains tax is one of these loopholes has been in the past. This is because of improved for tax avoidance. It also promotes inflation, par­ insurance and pension provisions for old age. Also ticularly in commodities, real estate and stocks. the urge to provide for the contingency of depres­ To maintain the morale of the taxpayer who pays sion and unemployment is less compelling. Under his honest share of taxes, loopholes must be closed these circumstances the more liquid assets the and tax enforcement intensified. The Treasury public holds the more likely they are to cash them should have sufficient competent personnel to give and spend the proceeds. Thus you can have an in­ the same strict enforcement of tax collection to flation even if all Federal deficit financing is done farmers, professional people, and the small unin­ outside the banks. corporated businesses as is now applied to other types of taxpayers, notably those whose entire in­ How to Raise Tax Revenues come is subject to withholding taxes. There can be no escaping the fact that a pay-as- you-go tax program will increase the tax burden Credit Restraints Needed of all who receive more than a subsistence. We No tax program by itself is sufficient to prevent will have to get the money from those individuals inflation under the conditions we face. It must be and businesses who receive it in relationship to the backed up by restrictive credit and monetary meas- [3] Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PREPAREDNESS AGAINST BOTH WAR AND INFLATION ures. Many individuals and corporations, when the Government cannot prevent their being offered their expenditures are squeezed by higher taxes, for sale if the public is not willing to hold at those will try to supplement their incomes by borrowing. rates. If interest rates are not to be allowed to rise Other credit demands will continue as there is an in response to market forces, then the Government increasing effort to borrow to build up inventories, must create all the money it takes to keep rates particularly of scarce goods, to take advantage of down. This in effect makes interest bearing money investment opportunities, and to speculate on the out of all Government securities and adds to the inflationary rise. The harm to our economic sta­ liquidity of all private debt as well. It is hard to bility from such private deficit financing is at least conceive of a more inflationary monetary policy. as great as that from deficit financing by the Gov­ There is another aspect of an interest rate freeze ernment. In fact, the whole postwar inflation, and that under present conditions works to promote particularly since the Korean outbreak, has been expansion of our money supply. Interest rates on due to private rather than Government deficit short-term Government securities are about half spending. If we impose painful taxes to avoid one of what rates are on long-term issues. Corporations form of deficit financing we must surely seek out and other nonbank investors hold short-term securi­ a way to put a check on the other. ties, however, because they do not wish to take the To prevent inflation we must stop the over-all chance of a market loss on long-term issues should growth in credit and the money supply whether they need their funds. But if the policy as an­ for financing Government or private deficit spend­ nounced by the Secretary of the Treasury is to ing. The supply of money must be controlled at prevail, that the existing pattern of interest rates the source of its creation, which is the banking will not be allowed to rise, then long-term Govern­ system. Under our present powers, the only way ment bonds in effect become demand obligations. to do this is by denying banks access to Federal The lower yielding short-term securities held by Reserve funds which provide the basis for a six-fold nonbank investors will be shifted to the Federal expansion in our money supply. The only way to Reserve. This process generates demand for long­ stop access to Federal Reserve funds is by with­ term Government securities, helps to maintain a drawing Federal Reserve support from the Govern­ lower long-term rate than would otherwise prevail, ment securities market and penalizing borrowing and gives the appearance of tremendous success to by the member banks from the Federal Reserve each Government financing effort. It is, however, Banks. As long as the Federal Reserve is required a success bought by the creation of tremendous to buy Government securities at the will of the sums of money, at the cost of progressive decline in market for the purpose of defending a fixed pat­ the value of the dollar. tern of interest rates established by the Treasury, To allow interest rates on Government securities it must stand ready to create new bank reserves in to respond to the forces of the money and credit unlimited amount. This policy makes the entire market, I realize,'raises problems of debt manage­ banking system, through the action of the Federal ment because of the large volume of debt maturing Reserve System, an engine of inflation. each year and the demand liabilities in savings If access to Federal Reserve credit were strictly bonds. With large and frequent refundings, the limited or denied, and if there were more sellers process of permitting interest fluctuations involves than buyers of Government securities, then prices careful management. If a refunding offering is of outstanding Government securities would de­ not in line with market rates, Federal Reserve cline and interest rates would rise until the market support is necessary to insure its success. became self-sustaining. More sellers of Govern­ These are important problems which a frozen ment securities than buyers indicates that the public pattern of interest rates can avoid. But they are is not willing to hold at existing rates. The only not nearly as formidable as the problems that we way to restore the balance is to let interest rates go take on if we accept a frozen interest rate structure. higher to meet public demands. The Government We cannot prevent increases in the volume of our with the support of the Federal Reserve has the money if we are unwilling to deny Federal Reserve machinery and the power to decree what prevailing credit when inflation is taking place, and to allow interest rates are to be. But lacking the power to interest rates to rise if market forces operate in require the holding of its securities by the public, this direction. Inflation and debasement of the [4] Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PREPAREDNESS AGAINST BOTH WAR AND INFLATION value of the dollar is the price we pay for the luxury not be imposed upon the economy. Price controls of a booming Government securities market. Any cannot be successfully applied unless simultaneously tax program we are likely to adopt can hardly be accompanied by allocation and rationing. Price adequate to stop inflation in the long run as long controls alone merely lead to black markets and as the money and credit floodgates are left open. racketeering, profiteering, and tax evasion. We If the Federal Reserve is to be required to main­ know from past experience that even during war tain a fixed pattern of interest rates established by a comprehensive harness of direct controls unsup­ the Treasury, then the System should either be dis­ ported by adequate fiscal and monetary policies did charged of its responsibility for controlling the vol­ not prevent inflation, but only concealed and post­ ume of credit and money or be given new powers poned the inflationary results. They deal with the as partial substitutes for those that it is not per­ effects rather than the causes—they sugar-coat the mitted to use. The limited selective controls which inflation, so that the public’s will to accept the re­ the System now has over certain consumer, real quired taxes and credit restraints is weakened and estate, and stock market credit may be useful and destroyed. There is no substitute for adequate desirable, although their effectiveness is certainly fiscal and monetary measures; with them, the need much more limited than is generally believed. for direct controls is reduced to a minimum. Authority to increase reserve requirements of all One of the worst features of trying to enforce a commercial banks would be a partial substitute for comprehensive harness of direct controls is that it traditional credit control powers to enable the Sys­ so regiments the entire economy as to destroy our tem to immobilize new bank reserves arising from essential freedoms. It requires the establishment its purchases of Government securities in support of a huge bureaucracy for policy making, adminis­ of the market. Authority would also be needed to tration, and policing—a most uneconomic utiliza­ require all commercial banks to hold an adequate tion of an already short supply of manpower. This percentage of their deposits in a special reserve cannot be justified. Worst of all, such regulation in Government securities, or at their option a like and regimentation, undertaken for any extended pe­ amount in cash. It would likely be essential for riod of time, will prove so intolerable that public the Federal Reserve to have authority to require revulsion will lead to withdrawal of essential sup­ savings institutions such as life insurance com­ port for a program necessary to defend the free panies, savings banks, and savings and loan asso­ world, prevent war, and assure the preservation of ciations to hold a certain proportion of their assets the value of the dollar. in Government securities in order to prevent them Even though I have strongly opposed a general from selling in a market supported at pegged prices price freeze for the reasons stated, I still feel that by the Federal Reserve. it is essential that wage and salary ceilings be put All of these substitute powers would be neces­ into effect promptly, [allowing up to 10 per cent sary to compensate for the control over expansion in increase for those who have not had an increase our money supply that we give up when the interest by that amount since 1948]. On an over-all basis, pattern on Government securities is frozen. prices are made up largely of wages and salaries, Selective Price and Wage Controls and prices cannot be kept down with continuing increases in wages and salaries. Labor should not Fiscal and credit action will have to be buttressed object to wage and salary ceilings, so long as any for the present with some rationing and allocations. excess profits of corporations are drained off through They will be required to control the use of certain taxation. essential goods in short supply and of scarce or critical materials and finished products. To prevent Another reason for a wage freeze is that higher the bidding-up of prices on these items, price con­ personal income taxes required to balance the trols will be needed. Such controls should be se­ budget will reduce the hourly take-home pay of lective, however, and applied only in those limited labor, as they must do if they are to be effective. cases where materials or goods are both essential Union leaders are likely to press demands for and in short supply, and removed as soon as they higher wages to offset this reduction in take-home are no longer in short supply or deemed essential. pay and to maintain labor’s standard of living. To Over-all price controls are unnecessary and should grant such wage increases would entirely defeat one [5] Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PREPAREDNESS AGAINST BOTH WAR AND INFLATION of the major purposes of increased taxes, viz., the Labor should be willing to accept wage ceilings curtailment of purchasing power at a time when and a longer work week at a time when both are there is a scarcity of many civilian goods. Finally, so essential to the prevention of further inflation. due to the shortage of labor, employers, especially After all, the defense of the dollar is more vital to those subject to high excess profits taxes, will bid labor than to almost anyone else. employees away from each other. Conclusion Not only should wage and salary ceilings be im­ posed, but all fringe benefits, including bonuses In conclusion, let me repeat that a successful and pensions, should be rigidly curtailed. Escalator preparedness defense program must prevent war clauses should be excluded from all future wage and must not lead to destructive inflation. Total contracts—they are built-in inflationary devices. war, with atomic weapons, would mean victory for A 44-hour week, without overtime rates of pay, none and destruction for all. Regimentation or should, I believe, be generally adopted for the pur­ further inflation, even if war is avoided, will ulti­ pose of increasing total production and helping to mately lead to the destruction of our capitalistic maintain the standard of living without increasing democracy. Therefore, our foreign policy must be costs. Increased production is, in the end, the pri­ designed on the basis of what we can pay for cur­ mary solution to the inflation problem, provided it rently, and our fiscal program must be supported can be brought about without increasing costs and by restrictive monetary and credit policies, to­ purchasing power more rapidly than the supply gether with only such limited direct controls as of goods. the situation may require. [6] Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis

Marriner S. Eccles (1951, January 24). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_19510125_eccles

@misc{wtfs_speech_19510125_eccles,
  author = {Marriner S. Eccles},
  title = {Speech},
  year = {1951},
  month = {Jan},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_19510125_eccles},
  note = {Retrieved via When the Fed Speaks corpus}
}