1940: Banks And Banking

Increased Reserves.

During the first year of the war the banking system of the United States continued its rapid growth in resources and in liquidity. Imports of gold from abroad surpassed even the high figures of recent years and provided an expansion of deposits. In the first ten months of the year idle reserve balances rose, and debits to individual deposit accounts failed to keep pace with the growth of deposits themselves so that the turnover of deposits declined to a new low figure. At the end of the year the early stages of financial expansion occurred. The explanation for these facts lay in the general course of business. In the early months of the year business receded sharply from the high points induced by war speculation at the end of 1939. In the fall the defense program was accelerated and by December even businesses remote from immediate defense needs began to feel the stimulus. Even the expanding demands for funds for defense failed to produce any strain in the money or capital markets. Interest rates declined during the year both for short term and for long term loans. New issues of bonds were absorbed easily. The stock market, which broke considerably when France was conquered and did not recover again completely, nevertheless was very steady during the whole fall. The field in which the new demand made itself felt most was in commodity prices. The prices of some products rose very rapidly and the general average even rose substantially before the end of the year. Because of this threat of inflation and the extreme liquidity of the banking system, the Board of Governors of the Federal Reserve System again asked Congress for the powers necessary to an effective control of credit.

Imports of Gold.

The growth in resources of the banking system arose primarily from imports of gold. Imports in 1939 had been very high but this year the amounts were even greater. In the peak month last year (April) $606,000,000 were imported; this year in the single month of June, $1,163,000,000 entered this country. In the first ten months of this year imports averaged approximately $430,000,000 a month compared to $300,000,000 last year. As a result at the end of November the gold stock reached $21,755,000,000, compared with $17,644,000,000 last year. Most of the gold reached the United States from Canada and the United Kingdom. However, in June, $241,000,000 came directly from France and there were relatively large shipments from Sweden, Switzerland and South Africa in the early months of the year. Japan sent little gold to this country from February to August, but in September and October the level of last year (some $12,000,000) was resumed.

As a result of the imports of gold reserve balances of member banks of the Federal Reserve System increased also. The average for October was $14,000,000,000 compared with $11,900,000,000 a year before. Of these $6,800,000,000 were excess reserves. Increases in reserves were disproportionately heavy in city banks: Central Reserve city banks' excess reserves rose from $3,200,000,000 to $4,100,000,000, Reserve city banks' from $1,200,000,000 to $1,900,000,000 and county banks' from $7,000,000,000 to $9,000,000,000.

Growth of Deposits.

As the growth of excess reserves indicates, deposits failed to grow in proportion to the increase in the basis for credit. Demand deposits for all banks in the United States in June were $61,000,000,000 compared with $58,000,000,000 at the end of last year. For reporting member banks, for which later figures were available, demand deposits which were $18,300,000,000 in October last year rose to $21,000,000,000 in October, and time deposits were $5,200,000,000 compared with $5,000,000,000 a year ago. In New York City the growth of deposits paused in the summer but in outside banks it was continuous throughout the year.

The rate of turnover of demand deposits nearly matched the increase in deposits in banks outside New York City, but in New York itself it continued to decline. The turnover rate for the third quarter of the year for 100 leading cities outside New York was 19.9 compared to 18.7 last year. For New York City the rate was 17.2 compared with 19.4. This is the first year since 1917, when the figures were first compiled, that the rate for New York City was below that for the county as a whole. In October, however, debits increased sharply — by 16 per cent in outside cities and 10 per cent in New York City.

Expansion of Business.

The explanation of the lack of activity of deposits lies in the condition of business during the year. In the early months of the year production declined from an index of 122 (1935-39 = 100, adjusted) to 111 in April and payrolls (1923-25 = 100, unadjusted) declined similarly. Thereafter, however, production increased rapidly to 121 in June, July and August, 125 in September and 128 in October. Payrolls rose to 98 in June, 104 in August and 114 in October. Both in the recession in the spring and in the recovery at the end of the year the durable goods industries led. National Defense spending which was accelerated immensely in the autumn provides the key to these movements. By the late autumn the non-durable goods industries were expanding rapidly also and again reached the peak of the end of last year. Defense orders for textiles were heavy but civilian orders were increasing also.

Loans of banks followed somewhat the same course as business. In January, loans of reporting member banks were $8,600,000,000; by June they were $8,400,000,000; in September, they expanded to $8,700,000,000 and were $9,100,000,000 at the end of November. The decline was almost entirely due to changes in New York City banks while a slow rise in outside banks continued throughout the year. The increases of loans in the fall were in New York City predominantly. Many of these loans were connected with the defense program. The loans were for somewhat longer maturities than are usual and were for large sums to a relatively small number of borrowers. Industrial borrowing was facilitated by the new laws intended to simplify borrowing for the National Defense Program. Producers of goods for defense were given two contracts. One of these, under the 'plant option' plan, provided means for borrowing to expand plants, the other covered the process of producing the goods themselves. (See also BUSINESS.)

Increased Purchases of Securities.

Besides increasing loans the banks continued their purchases of securities. In January the reporting member banks of the Federal Reserve System held $14,600,000,000 in securities of which $8,800,000,000 were direct government obligations and $2,400,000,000 were fully guaranteed. These holdings mounted almost continuously throughout the year. At the end of November they had $15,800,000,000 of securities. Direct obligations of the government amounted to $9,500,000,000 and fully guaranteed obligations to $2,700,000,000. Banks both in New York City and in the rest of the country shared in the increase in holdings.

Although the increase in demand deposits was not great and bank debits were low, demands for currency increased throughout the year. The total amount of currency in circulation was $7,376,000,000 in January and $8,300,000,000 in October. The increase came in silver certificates which rose from $1,469,000,000 to $1,620,000,000 and in Federal Reserve Notes which rose from $4,796,000,000 to $5,541,000,000. Although expanding payrolls accounted for some of the increase in demand for currency the amount of increase was too large to arise from this cause alone and must have been caused in part by hoarding.

The Reserve Banks were amply able to supply all demands for currency. At the end of November these banks had on hand and due from the Treasury $19,492,000,000 of gold certificates and total reserves of $19,807,000,000. Since total Reserve Notes outstanding were only $5,670,000,000 and total deposits $16,185,000,000, the reserve ratio was nearly 90 per cent. Demands upon the Reserve Banks were slight. In addition to their large cash holdings, these banks had $4,100,000 of bills discounted, $7,900,000 of industrial advances, and $2,231,000,000 of government securities. They thus had a basis for either a great expansion of loans or for increased holdings of government securities. This year, however, the amount of bills discounted was no greater than a year ago, and the amount of government securities held has declined to the lowest point since 1933.

Effect of Banking and Business Policies on Prices.

The effect of the policies of banking and business combined on prices was little in the first three quarters of 1940. The wholesale price index (1926 = 100) was 79.4 in January and declined steadily to 77.4 in August. The declines were fairly general throughout the whole list of commodities. In the autumn, however, with the increased demands for defense, prices began to rise sharply. The general index number increased to 79.5 at the end of November. Those products most closely related to defense needs increased in price most rapidly. Prices of building materials responded very sharply, rising by 20 per cent between July and November. Federal requirements for lumber for the year 1940-41 were estimated at 8 per cent of the entire year's production and most of this supply was ordered in September and October. Prices of many minerals advanced; that for lead especially. Import duties of some 20 per cent protect these products from foreign competition. Prices of woolen goods increased so much that in November the government announced that further orders could be filled from foreign sources though the duty is 75 per cent. Prices for silks, on the other hand, fell in November after an increase in October common to all Far Eastern commodities. Farm products rose in price also. Livestock prices increased as payrolls advanced. Prices of grain and of cotton were increased by the government loan program which encouraged withholding of supplies from the market. Loan rates were below market prices. The loan rate for corn was advanced and the government made loans for three, instead of one, years. The Federal Government itself increased its stocks of essential materials but these were not available to the market. Stocks of some products, notably cotton, were large. The export of cotton was the lowest since Civil War days.

Effect on Interest Rates.

The effect of large reservoirs of credit and small demand continued to effect interest rates. In the open market the rate on prime commercial paper (4-6 months, prime names) was .56 per cent throughout the year; that on ninety day prime bankers acceptances was .44 per cent; stock exchange time loans were 1.25 per cent and call loans 1.00 per cent. New offerings of United States Treasury bills varied from .001 per cent in January to .072 per cent in June and were .004 per cent at the end of November. United States Treasury Notes were .47 per cent in January, .76 per cent in June and .32 per cent in November. Customer rates rose from 1.96 per cent at the end of December, 1939, to 2.14 per cent in September, 1940 in New York City. In other centers they declined in the first two quarters of the year but were firmer in the fall.

Rates on long term loans were also low. United States Government bonds yielded 2.30 per cent in January and 2.25 per cent in April, rose to 2.39 per cent in June and were 1.94 per cent at the end of November. Corporate bond yields averaged 3.63 per cent in January, rose to 3.72 per cent in June and declined to 3.39 per cent in November.

Effect on Common Stocks.

The prices of common stocks were adversely affected by the unfavorable turn of events abroad and probably also by sales by foreign governments for foreign exchange purposes. All groups of stocks dropped in price in the first half year and recovered again in the late summer to a level which was maintained throughout the remainder of the year. This level, however, was substantially lower than that of the beginning of the year. The general index of the Standard Statistics Company (1926 = 100) declined from 93 in January to 73 in June and rose to 85 in November. The index for industrials declined from 109 to 85 then rose to 99, that for rails dropped from 30 to 23 then rose to 29, while the index for public utilities fell from 88 to 75, and advanced to 80.

New Capital Issues.

New capital issues were small in volume in the early part of the year. In 1939, the issues for new capital had averaged $186,000,000 a month of which borrowings of the Federal Government accounted for $80,000,000, municipal borrowings for $80,000,000 and corporated borrowings for $30,000,000 approximately. Throughout most of 1940, corporate borrowings were a little higher, with $89,000,000 in the peak month (May) and municipal issues were substantially less. The Federal Government offered two large issues, one of $289,000,000 in July and one of $112,000,000 in October. Refunding issues were maintained at the 1939 levels. In the last month of the year, however, the new issue market became very active. In the first week of December, $248,000,000 of securities were offered of which $105,000,000 were for new capital. Although many of these issues were from State and municipal governments which wished to borrow before defense borrowing became heavy, there were several large corporate issues.

The ease with which the market absorbed new issues and the lowness of interest rates made it evident that the financing of the defense program would not be difficult at least in its early stages. This very abundance of credit coupled with the fact that prices of many commodities did rise rapidly when demand became heavy gave evidence of the danger of inflation. In 1939 the Board of Governors of the Federal Reserve System had warned Congress that it had not sufficient power to control credit should the necessity arise. Congress failed to act upon this suggestion. At the end of 1940, the Board of Governors again addressed a warning to Congress asking for specific powers to control the volume of credit and its use. See also INTERNATIONAL BANKING AND FINANCE; PAN-AMERICAN COOPERATION; and BUSINESS.