1939: Banks And Banking

Three Phases of the Year.

During 1939 banking in the United States passed through three phases with crises abroad marking the dividing line between them. In the first phase, general business was in recession again, after an upturn which had begun in April 1938 and ended in December of that year. During this period, banking was stagnant with only minor changes in deposits, reserves and loans. Bond prices rose a little and stock prices declined. At the end of March the crisis attendant upon the consolidation of the remnants of Czecho-Slovakia into the German Reich outweighed all other factors. The security markets broke and gold poured into the United States in amounts even surpassing those which accompanied the crises of the previous September. In the second phase, business turned upward again. The movement was slow at first but gathered momentum during the summer months. Throughout this phase, gold continued to flow into this country at a rapid rate. Fed by these imports and in part by Treasury operations, bank deposits and excess reserves mounted. Bank loans began to expand by summer and money rates declined. Security prices recovered slowly. The outbreak of war abroad ended this second phase. The immediate effects of war were less serious for the financial markets of the United States than those of the war scares of the previous year. Stringent controls were immediately put into effect abroad which served indirectly to protect our markets, and the Federal Reserve Banks took steps to strengthen them further. Although the government bond market broke badly, rises in the prices of the securities of war industries dominated other markets. In the latter part of the year the pace of industrial activity increased rapidly. Accompanying this increase in general activity went increases in commercial bank loans, deposits, and reserves. Commodity prices rose spectacularly partly because of speculation movements, and partly because of demands for war materials. Security prices remained at the higher levels but did not continue to rise. New capital issues had not increased and interest rates for loans had not tightened according to the latest available figures. Throughout the year, Federal Government spending continued at the pace set during 1938 and the deficit mounted. An attempt by the administration to instigate even further increases in the lending program was defeated in Congress. The monetary powers of the President were extended for two years. Purchases of foreign silver were curtailed but the price for domestic silver was raised. Congress began an inquiry into the whole monetary and banking system of the United States following a complaint by the Board of Governors of the Federal Reserve System that our present system was badly organized and lacked coordination.

Federal Reserve and Member Banks.

The recession in the early months of 1939 was less violent than that which developed in 1937 and resulted only in minor changes in the banking system. Demand deposits at banks, members of the Federal Reserve System, which had been $22,293,000,000 on Dec. 31, 1938, were $22,364,000,000 at the end of March, a decline in individual deposits being counterbalanced by a rise in state deposits. The velocity of circulation of these deposits declined also. Time deposits rose from $10,846,000,000 to $10,940,000,000, while loans declined from $13,208,000,000 to $13,047,000,000. Reserve balances at the Federal Reserve Banks increased from $8,745,000,000 to $9,021,000,000. Gold imports into the United States in January amounted to $156,000,000 and in February to $223,000,000, a rate much lower than that prevailing during the last quarter of 1938. The effect on bank reserves was offset in part by an increase in the general fund balance of the Treasury of $410,000,000 in February. Open market money rates in the New York market remained unchanged. Corporate bond prices rose from 81.1 in December to 82.1 in February while those for United States Government bonds rose from 104.1 to 104.8. The Standard Statistics Company's index of common stock prices declined from 92 to 90. Offerings of securities to raise new capital were at a standstill with $200,000,000 in January, $398,000,000 in February, and $162,000,000 in March, most of which arose from Government financing, state and Federal. General commodity prices changed but little, the index of the Bureau of Labor Statistics for wholesale prices (1926 = 100) declining from 77.0 to 76.7.

The crises in Europe at the end of March and early April brought an abrupt end to these conditions of stagnation. The immediate effects of the crises showed themselves primarily in the security and the international capital markets. Stock and bond prices declined. Just before the crises, the index of stock prices (March 29) stood at 88; on April 12, it was 79. Corporate bond prices declined from 82.3 to 78.7 during the same period. United States Government bonds, however, declined hardly at all (106.6 to 106.2). The rate on Treasury notes declined slightly (.52 to .49 per cent) and that on Treasury bills rose from a negligible amount to .025 per cent. Thus although the stock market was affected more than in September, the market for Government bonds was better sustained than it had been in the earlier crisis. Recovery, too, for the stock market was much slower and the level of March was not regained until September. In the international capital market, the effect was an immediate increase in the imports of gold. These imports rose with the increasing tension in March to $365,000,000; in April they were $606,000,000, an amount greater even than in October 1938, a previous high point; in May they were still $429,000,000 and the amount did not drop below $250,000,000 a month until October after war had actually broken out.

Although the effects of the crisis aggravated by the bituminous coal strike did not disappear quickly, by June a real improvement in business was evident. Even before this, the business of the banks had improved. Fed by the imports of gold and by a Treasury policy which allowed the general fund balance at the Federal Reserve Banks to decline, reserves of member banks increased to $9,997,000,000 in May and $10,659,000,000 in August, just prior to the outbreak of the war. Excess reserves increased from $3,559,000,000 at the end of March to $4,758,000,000 at the end of August. Demand deposits of member banks stood at $23,587,000,000 at the end of June and time deposits at $11,063,000,000. For 'reporting member banks' for which later figures are available, demand deposits which had been $16,032,000,000 at the end of March, increased to $17,182,000,000 in June and $18,096,000,000 the end of August. The velocity of circulation of the deposits of New York City banks had begun to increase in May but for outside banks declines continued throughout the summer. In keeping with the expansion of business, loans, too, expanded, but not until the summer months. For reporting members banks loans amounted to $8,241,000,000 in March, were $8,094,000,000 in June and $8,209,000,000 at the end of August.

Effects of the European War.

The immediate effects of the outbreak of the war were surprising in the light of the experience in the earlier crises and at the outbreak of war in 1914. The stock market instead of breaking rose rapidly. The Standard Statistics index for the week before war broke out stood at 84; on Sept. 6 it was 92 and Sept. 27, 96. Certain stocks responded even more. Between Aug, 30 and Sept. 27 industrial stock prices rose from 98 to 113 and railroad stock prices from 24 to 34. Even prices for corporation bonds rose a little. Their average (Standard Statistics) for Aug. 30 was 80 and for Sept. 27, 83. The brunt of the desire for liquid funds fell on the Government bond market. Treasury bonds dropped in price from 107 on Aug, 30 to 101 on Sept. 27 and municipal issues from 113 to 107. The yield on Treasury notes rose from .53 per cent to 1.18 per cent at the maximum and those for Treasury bills from .08 per cent to .16 per cent. Meantime rates in the open market for commercial paper and stock exchange loans remained unchanged and rates for customers' loans at banks declined. The foreign exchanges broke rapidly with sterling declining from $4.68 just before the crisis to $3.73 on Sept. 15. Later it recovered to a point just above $4.00. Wholesale commodity prices which had been declining for more than a year jumped from 75 on Sept. 2 (Bureau of Labor Statistics index, 1926 = 100) to 80 on Sept. 30.

Government Controls.

The peculiar response of the market to the outbreak of war is partly traceable to the speed and efficiency with which government controls were applied, partly to the extremely liquid condition of our banks. In Europe, declines in prices of securities were cushioned by the establishment of official minima, and prohibition of the export of securities and the taking over of supplies of foreign exchange by the government were instituted. These measures prevented a throwing of securities on our markets such as occurred in 1914. Speculative accumulation of stocks of commodities caused prices to rise and the anticipation of war orders and profits tended to stimulate industrial activity which was already expanding. The excess reserves of commercial banks were so high that all conceivable demands could be easily met while the demands upon the open money market had been so low that the Federal Reserve Banks had been allowing their holdings of Treasury bills to decline to provide business for the market. To protect the Government bond market, the Reserve Banks bought bonds and announced that they would make loans secured by Government bonds to non-member banks on the same conditions as to member banks. This offer was not made use of. The Reserve Banks did buy some $400,000,000 of Government bonds in the open market. The pressure on the Government bond market was short-lived and the demands for liquid funds were not sufficient to cause any serious increase in Federal Reserve note issues. The break in the foreign exchange markets came as a result of the discontinuance of sales of gold by the equalization funds in Britain and France, in accordance with an agreement under the Tripartite monetary convention.

Banking Activities.

Such were the effects of the war crisis itself. In the remainder of the year, although the immediate speculative movements did not persist, all the accompaniments of a period of rapid industrial expansion were present, accelerated after the embargo on arms shipments was lifted. Bank deposits expanded. On Nov. 15 (latest available figure), demand deposits of reporting member banks were $10,348,000,000. Loans expanded to $5,606,000,000. Although investments in securities, especially United States Government securities, still bulked large ($8,550,000,000) the change was a healthy one for the banks. Reserves continued to increase primarily because of declines in the Treasury's general fund balance, for imports of gold became small after the embargo on exports from Europe ($70,000,000 in October and in November). Open money market rates remained unchanged while yields on Treasury bills and notes declined again to .018 per cent and .63 per cent respectively. Stock market prices declined a little from their September highs. On Nov. 15 (latest figure) the index for common stocks was 94 and average corporate bond prices were 83. New capital issues had not appeared in any volume by the end of October. The Government bond market recovered but not to its previous high points.

Government Policy.

Throughout the year the Government continued its policy of deficit spending. Expenditures in excess of revenues averaged nearly $400,000,000 a month. In July, the administration introduced a bill to provide expansion of loans by Federal Agencies which are not directly parts of the Government thus allowing an increased spending program without exceeding the debt limit. Congress did not approve this bill, but it did extend for two years the monetary powers of the President, with respect to the devaluation of gold as well as the power of the Treasury over the exchange equalization fund, and the right of the Federal Reserve Banks to use Government bonds as a cover for Federal Reserve notes. The lives of the Export-Import Bank, the Commodity Credit Corporation and the Reconstruction Finance Corporation were similarly continued. The price of domestically mined silver was raised to 71 cents an ounce but the policy of purchasing foreign silver was curtailed.

In the fall, the Senate Banking and Currency Committee, headed by Senator Wagner, began a consideration of the whole banking and currency structure. In its annual report for 1938, issued in April 1939, the Board of Governors of the Federal Reserve System had protested that the present system allows for conflicts of authority and gaps in authority among the various government organs such that prompt and effective action in a crisis is no longer assured. In particular, the Board no longer has sufficient power to cause a contraction of excess reserves should inflation threaten. The matter is aggravated by the fact that various divisions of the Government are following different monetary theories. The Senate Committee is to consider the whole problem of currency and banking regulation and, it is hoped, will introduce new legislation next year. See also BUSINESS; FINANCIAL REVIEW, UNITED STATES; WORLD ECONOMICS.