Our Inflationary Bond Standard

December 22, 1947

Any return to a system of government wage and price fixing would dislocate profit margins, dampen incentives, and disorganize production. And proposals for such a system, by centering public attention on false remedies and on symptoms instead of causes, tend to divert that attention from the real causes of inflation and the real remedies for it.

The basic cause of inflation, always and everywhere, lies in the field of money and credit. It is unfortunately assumed that money and credit inflation can safely be ignored today because the Federal budget, for the first time in sixteen years, is balanced. This is like assuming that a river reaches high-water mark the moment the rain has stopped. On the contrary, it keeps rising because it continues to be fed from a thousand swollen rivulets and flooded fields.

Chairman Eccles of the Federal Reserve Board has testified before a Congressional committee that “under present and prospective conditions, it is not only desirable but essential, in the opinion of the Treasury and of the Reserve System, that the established 2½ percent rate on long-term marketable government securities be maintained.” This means, as Mr. Eccles does not hesitate to make clear, that the Federal Reserve will continue to stand ready to buy all government securities offered to it at par or present prices. It is pegging the price. “Such sales have to be met [my italics] by Federal Reserve support of the prices of marketable government bonds so as to protect the 2½ percent rate on long-term issues.” And “the result of these support operations is to increase bank reserves and thus to support further inflation.”

How much inflation? Mr. Eccles is disarmingly frank about that, too, “Commercial banks currently hold about $70,000,000,000 of government securities. This sum is about 50 percent of their total deposits. If they should sell half of these securities and the Federal Reserve System, in providing the ultimate market, should buy them, the banks could acquire an equivalent volume of new reserves. On the basis of these reserves, the banks could expand credit by about six times, or by more than $200,000,000,000.” We have, in short, the testimony of our highest banking official that as long as the Federal Reserve Board continues its policy, the country faces a huge potential further inflation.

How do the Treasury and the Federal Reserve propose to deal with this danger? They refuse to take the one step that could bring it to a halt. That would be to stop providing an automatic market at current interest rates for government securities. What Mr. Eccles asks for, instead, is power to set up a “special reserve” of a maximum of 25 percent on demand deposits of all commercial banks. This “reserve” would be composed not primarily of cash but of “Treasury bills, certificates, and notes.” Of course, to call this a “reserve” is a misnomer. It could not be paid out to depositors demanding cash. It would be, in fact, a requirement that a minimum proportion of the commercial banks’ loans and investments be in short-term government securities. It is an attempt to establish another automatic market for such securities.

It is an attempt, in Mr. Eccles’s own words, to “divorce the market for private debt from the market for government securities.” In the long run such an attempt could not succeed. If the yield on other securities went up while that on government securities stayed down, such a plan would merely drive all government securities into the banking system, where they would become the basis for further credit. On Mr. Eccles’s own testimony his plan would allow a potential credit expansion two and a half times as great as the government securities held.

The United States today is not on a gold standard, except in a Pickwickian sense. It is, as the economist Melchior Palyi has put it, on an inflationary bond standard, the essential feature of which is the automatic monetization of the national debt. And attention is merely diverted by the Administration from this potentially explosive reality when it asks for power to dictate wages and prices.