America's Money Machine

The Reversals of War 2 13
the world's stock. During 1939 total reserves ofmember banks had risen
by $2.7 billion. This had followed a rise of $1.9 billion in 1938; during
the two year period the amount ofexcess reserves of the banking system
had increased from $1 billion to $5 billion, the highest on record. At the
end of 1939, nearly halfofthe $12 billion banking reserves were in excess
of the statutory requirements. This gave the commercial banks a credit
power and an independence from restraint that would naturally cause
Federal Reserve authorities uneasy nights.
It was, however, the commercial banks themselves, through their representatives
on the Federal Reserve Advisory Council, that showed the
greater concern. On October 8, 1940, the Council made a recommendation
to the Board ofGovernors regarding the financing ofthe war defense
program that was roundly critical offiscal and monetary policies and that
urged the Board to use its influence to the end that future issues of
government securities be placed with individuals and corporate investors
rather than with banks ofdeposit, where they would add to the potential
credit power of the banking system. 2
Following this recommendation, the Board, the presidents of the
twelve Reserve banks, and the Federal Advisory Council joined in an
unprecedented statement in the form ofa special report to Congress on
monetary and fiscal policy. The report appeared on December 31, 1940.
"While inflation cannot be cured by monetary measures alone," the
Report declared,
the present extraordinary situation demands that adequate means be provided
to combat the dangers of overexpansion of bank credit due to monetary
causes.
The volume of demand deposits and currency is 50 per cent greater than
in any other period ofour history. Excess reserves are huge and are increasing.
They provide the base for more than doubling the existing supply of
bank credit. Since the early part of 1934, $14 billion of gold, the principal
cause of excess reserves, has flowed into the country. The necessarily large
defense program of the government will have still further expansion effects.
. . . Interest rates have fallen to unprecedentedly low levels. Some of these
are well below the reasonable requirements of an easy money policy. . . .
Specifically, the report recommended that Congress: (a) increase the
statutory reserve requirements for demand deposits to 26 per cent for
central reserve city banks, 20 per cent for reserve city banks, 14 per cent
for country banks, and 6 per cent for time deposits; (b) empower the
Open Market Committee to make further increases of reserve require-