^Lx,  714*. Cla
BRITISH SfflBASSY,
WASHINGTON, B. C.!
May 8th» 1939
No* 498 E
Uy Lord,
In continuation of my despatch No* 1993 of
February 16th I hare the honour to transmit herewith
copies of a memorandum "by Mr. T. K. Bewley, Financial
Adviser to this anbassy, on the financial position of
the United States.   X should like to draw the especial
attention of Your Lordship *s department to Section 5
of this report in which Mr. Bewley, while writing
from the economic and financial point of view, depicts
the extraordinary inefficiency of the American
governmental machine, and its inability so far to
adapt itself to new conditions.
2. I regret that this is the last of the
periodic reports from Mr. Bewley that I shall have the
pleasure of forwarding to Your Lordship, as he is due to
leave in the course of a few days and return to duty in
the Treasury.   His reports have always "been accurate,
clear and penetrating, and all his work may he
similarly characterised.    T© myself his advice has been
invaluable, and I have often stood in grave need of it.
By his technical competence combined with the integrity
of his character he has commanded the implicit
confidence of the United States Treasury and State
Departments and 1 think it a high tribute to him to he
able/
The Right Honourable
The Viscount Halifax, K.G.,
etc., etc,, etc.
JBSX:VALM:FRHM:RCL:DH , Jfl SfJl^
able to say that his departure will he regretted
baldly less by Mr. Henry Horgeathau than hy myself.
I hope that what I now write may be home in mind
when in the future questions may arise as to the
nature of Mi*. Bewley's farther employments.
3. Copies of the report are being sent
direct to His Majesty's Treasury, the Department of
Overseas Trade, the High Commissioner for the United
Kingdom in Canada, and to Mr. P. K. Debenham, 2,
Whitehall Gardens, London, S.W.I.
I have the honour to be,
with the highest respect,
Hy Lord,
Your Lordship's most obedient,
humble servant,
(S03>)   S. C. LIHDSAY
H1 WfMM
FINANCIAL SITUATION IN THB
UNITED STATES
tl
1».  Present Position.
There lias not been any very great change in
the general economic situation in the United States since
the date of my last report (February 14th)#   The Federal
Reserve Board Adjusted Index of Industrial Production,
which was 101 in January, stood at 98 in February and
March, and a further moderate fall is expected for April
largely on account of the eoal strike*   The "New York
Times11 Weekly Business Index fell from 92.3 for the
end of January to 86 for the middle of April.   On the
other hand neither of these indexes fully reflect the
conditions in the building trade, which has continued
to expend a little.-  Thus broadly speaking the general
level of activity has remained fairly steady through
the first quarter of the year.
Owing to the continued influx of gold and
silver and to the Government's borrowing from the banks,
bank deposits have continued te grow, the figures of
adjusted demand deposits of member banks being $16,619
millions for April 19th against $16,077 millions for
February 8th.   Reporting member bank loans shew a very
slight fall at $8,124 millions for April 19th, against
$8,179 on February 8th, while investments in Government
and other securities continue to rise, being $15,684
millions on April 19th against $13,280 millions on
February 8th.   Bank reserves have, as expected, risen
further, and excess reserves of member banks are
estimated at *4,120,000,000 on April 26th.   In these
circumstances/
1
-8-
up-
circumstances money has of course remained exceedingly
easy and Government bonds have risen to new high record
levels.
The Stock Exchange on the other hand broke
severely in March, partly tinder the influence of war
fears, the Dow Jones Index falling to a lower figure in
the first week of April than any reached since the upturn
in June last*   There has since "been a partial recovery*
New corporate capital market issues, excluding
refunding issues, in the first quarter of 1939, amounted
to only §53 millions, compared with $180 millions in the
fourth, and §316 millions in the third quarter of 1938,
There was a fairly sharp upturn in April*   Final figures
for this month are not published at the moment of
writing, but the figure is expected to be in the
neighbourhood of §850 millions.    Owing to the growing
habit of placing small and moderate sized issues
privately in order to avoid the formalities laid down by
the Securities and Exchange Commission, the published
figures are becoming less and less satisfactory as a
measure of the real volume of capital issues;   but it is
clear at least that taking the first four months of the
year as a whole, the volume of new corporate issues has
been rather small.
Commodity prices have on the whole remained
very steady, and wheat and cotton prices remain severely
depressed.   There have in the last few days been some
signs of improvement in some raw material prices.
2./
2;   War fears and other obstacles to recovery.
There is widespread dlsappoiatment that there
has been bo upturn In the "business situation since the
new year, as some farther improvement had been generally
expected.   In consequence, since no other new factor Is
a&parent to explain the lack of residence In the business
situation, there is a tendency to place the blame upon
the uncertainties of the European political situation*
That these have some direct effect upon the
Stock Exchange seems impossible to deny, since security
prices have been fluctuating in direct response to the
news from Europe*   That a fall in stock exchange prices
has some effect in slowing down the whole economy, and
probably more effect in this country than in any other,
is also hard to deny*   And It may be that some
manufacturers or merchants have even refrained from
placing long term orders owing to the uncertainties
created by the fear of war, though I find it hard to
believe that this can be a factor of any very great
importance.   But granted all this, I still do not think
that the influence of war fears in holding back business
can be as important as is sometimes maintained* A
glance at the Federal Reserve Index of Production figures
for the second half of 1938 will show that the upward
trend was unaffected by the Munich crisis*
The direct cause of the Stock Exchange
weakness has not been foreign but domestic selling* A
member of the Treasury told me in March that foreign
purchases of securities were running ahead of foreign
sales* and the volume of foreign dealings is in any
case comparatively small*   There are a number of reasons
why/
why war fears might give rise to domestic selling of
stocks.   In the first place, it is widely anticipated
that foreign Governments involved in war will confiscate
their nationals* holdings, and endeavour to realise them
on the market*   This weight of possible sales over*
hanging the market certainly has a depressing effect, and
reassuring "but vague hints given out by the authorities
that plans have "been made to meet the situation, have
probably not given very much confidence to the nervous
investor.   There is also the fear of the short term
operator that the stock exchange might be closed for a
quite lengthy period, as was done in 1914, and that he
might be in difficulties if he could not get his money out*
And in addition speculators — I know of at least one
large investment trust which falls in this category -
are counting on a panic at the outset of war in which they
could pick up shares cheaply*
These are all short term motives, bat the
short term operator is still fairly dominant in the
United States*   For the longer term, a European war
would seem as likely to lead to higher as to lower
quotations on the American stock exchanges*   There may be
some investors who are afraid that if war broke out in
Europe the United States might be drawn in, and that
this would load to drastically increased taxation on
war profits and a wide extension of Government control*
I cannot say how much weight to attach to this*
But when all this is said, It still remains
hard to explain why, if war fears are the major influence,
the fall in security prices during the last couple of
months should, if 1 am not mistaken, have been more
severe here than in London or Paris.   I think one must
conclude/
-5-
conc.lude that the underlying weakness of the Stock
Exchange is largely due to disappointment vita the
progress of domestie recovery and that the spark was
merely touched off by recurring European alarms* Of
course the two things react upon one another, and it
is impossible to assign the exact importance of either
by itself.
Apart from this internal unsettling factor
and the resurgence of some labour unrest, especially
the current coal strike, the situation remains much
as it was at the turn of the year.   I do not think that
the analysis of the position in my February report and
in particular of the causes of the sluggishness of
private capital investment, needs any material revision*
The failure of any improvement to make itself felt
during the past quarter is disappointing, but not very
unexpected, and the Federal Reserve authorities appear
to be still expecting some moderate improvement during
the rest of the year*   The residential building
situation still remains mildly favourable* but rather
high costs and a certain shortage of skilled labour in
certain districts work against any spectacular expansion
5*   Monetary position*
It is perhaps worth giving details of the
remarkable monetary position that has now been reached
in this country.
In the first place the gold stock is now
well on its way to the §16,000 million dollar mark,
and amounts to about 60 per cent of the total aggregate
gold reserves of the world, and gold is still flowing
in rapidly.   In addition the Treasury holds some
I
-6-
#2,500 million ounces of uncoined silver against which it
issuea silver certificates at §1.29 an ounce*   As regards
money, the amount of currency in circulation, excluding
cash held by "banks, is now about $5#700 millions^
compared to about #8.600 millions in 1929.
(The reasons for this expansion of the currency
are not very clear.   Various reasons have "been given, in
particular (i) the substantial reduction in the number of
"banks in the country, necessitating greater holdings of
cash in places where no bank is now handy, (ii) relief
payments, and (ili) hoarding of United States money by
foreigners.   $25 millions of United States currency is
reported to have been shipped abroad from New York in
March, and a much larger amount in April, in addition
to which foreigners are said to be holding large
denomination United States currency notes in safe deposit
boxes, etc* in this country.   But these developments
do not seem quite sufficient to explain so large an
expansion, and it may possibly be that there is in
addition a certain amount of domestic hoarding, though
it is hard to see why this should be so, if it is*)
Bank deposits are now higher than at any
previous time in the country's history;   the aggregate
amount of bank deposits against which checjaes can be
drawn (all banks) being now about $26,000 millions, as
compared with about $23,000 millions at the peak of the
1929 boom.
The bank reserve situation is even mere
striking.   The excess reserves in the banking system now
amount to some $4,120 millions, whereas prior to the
slump which started in 1929 the system never had as
much as $500 millions in excess reserves.   Moreover the
reserves/
-T-
reserves are almost "bound to rise very much higher even
than their present level.   Not all the gold imported to
date has yet been added to the credit "base (I.e. had g> Id
certificates issued against it)» while as regards
continued imports, at the present rate an addition of
from $1,000 to $2,000 millions a year seems quite a
conservative estimate.   In addition, if silver purchases
continue and silver certificates are issued against them
at $1*29 an ounce, this might increase the reserves "by
$500 millions a year or so.   In addition the Treasury
holds something like $1,000 millions as balances in the
Federal Reserve Banks:   as this amount is spent or
transferred to the member banks, it will increase the
reserves to a corresponding amount.   There is also
£1,800 millions of gold sterilised in the stabilisation
fund which might some day be spent.
No doubt the practical effect on the country^s
economy of 6 or 8 thousand million dollars of excess
reserves might not be very different from that of 4
thousand million dollars, since in either case it is
plenty to provide an explosive Inflation.   The essential
point Is that there is now a supply of money of all sorts
in the country in excess of the supply at any previous
point in the nation's history, that the volume of exeess
reserves is already so large as to be well beyond the
existing technical powers of the Federal Reserve
authorities to control and is rising rapidly, that
strenuous efforts to induce credit expansion are being
made by the Administration Including "pump priming11
expenditure on the grand scale, and that despite all
this there is no present sign of an Inflation "taking"
and the only visible result is that Government obligations
are
-8-
are standing lagher than they over- have before, 90-day
Mils are selling on practically a no-yield oasis, and In
general the return on money is lower than it has ere* he*
la saying that the reserves are already
"beyond the technical powers of the   Federal Reserve
authorities to control, I do not of course mean to imply
that the Administration necessarily could not control an
inflation by otter means, should one get started, hut
simply that control of credit through the reserves, the
classical weapon of the Reserve authorities, is now out of
their power*   The Board has suggested that Congress should
give them additional powers, hut I think there is
enough force behind the belief that the mildly
restrictive action taken by the Board in the spring of
1957 was an important contributory cause to the slump of
1937-38, to make it unlikely that additional powers will
in fact be given by Congress this session.
It may be of Interest that I know that the
Federal Reserve Board has actually considered open
market selling operations in order to keep down the
price of Government obligations, and that Mr. Horgenthau
was in favour of this, apparently on the simple theory
that he would rather have a steady price for Government
bonds and that what goes up will one day come down again.
The Board decided against such action on the ground that
"a.
open market operations should be directed towards the
general economic situation, which certainly does not call
for selling operations now, and should not be determined
by the price of Government bonds.
4.   Governmental action.
Since expansion of the volume of money and of
the credit base have not resulted in very fall recovery it
wou!
hp
would be expected that the Government would take further
steps.    So far however very little has In fact been done
either by the Administration or by the Congress except
for the voting of large appropriations.   The current
budget is running about as expected, the net deficit for
the tea months up to the end of April being $2,856
millions (or, after deduction ef payments to trust
funds, etc. $2,275 Billions)*   There has been a much
publicized fight about the appropriation for relief far
the balance of the current fiscal year, and Congress
eventually cut $50 millions off the amount requested by
the President, but this was an easy and not unpopular
gesture In the direction of economy, since it is
generally believed that the administration of the Works
Progress Administration is thoroughly wasteful, and in
any case $50 millions is not much compared to the total
relief appropriations actually voted for the year of over
$2,160 millions*   In other directions, apart from some
speechifying, no serious signs of economy have been
visible*   Indeed the farm bloc have been pressing for,
and may yet succeed in putting t hrough, substantially
increased subsidies for cotton and other farm products,
social security benefits are likely to be raised, and
other additional expenditures are not impossible*
A useful bill has been passed increasing the
maximum up to which the Federal Housing Administration
may guarantee mortgages from #5000 millions to $4000
millions*   This should at least ensure that the incipient
improvement in residential building will not be brought
to an end for lack of reasonably cheap mortgage
facilities, and I understand that the losses on these
guarantees are not expected to be very heavy*
There/
There has been a lot of talk of cooperation
with "business, bat nothing much of a practical nature has
come of it as yet*   The Secretary of the Treasury
agreed to have a review made of the tax system with the
object of amending it In such particulars as might be
harmful to business, bat no specific proposals have yet
been made* and remarks dropped by the President at press
conferences and also by the Democratic Senate leader
on the floor have been very cool to the prospect of any
major revision such as is really required* One
specific recommendation which has been made is that the
Social Security payroll taxes for old age benefits
should be frozen at their present level instead of rising
by 1<£ in 1340, and the States should similarly be
encouraged to freeze their unemployment insurance taxes
at the present level.   The prospective rises in these
taxes would of course increase labour costs* and the
proposal to leave the taxes for the present at their
existing level is naturally welcomed by industry. The
proposal seems likely to go through, but it will of
course be expensive, and the actuarial soundness of the
whole Social Security scheme is open to question* A
complete overhaul of Social Security finance is really
needed* and while there is a new Social Security Bill
promised, it is doubtful if this will really place the
finances of it on a sound foundation.
The prospects of satisfactory railroad
legislation are similarly still very obscure owing to
the elash of the different interests - labour, capital,
other forms of transport, and the users of the railraods.
The same is true of any amendment of the National Labour
Relations Act*   Nor has any success so far attended the
at*
attempts/
-11*
attempts to patch up the qaarrel between the Awe#J*an
Federation of Labor and the Congress of Indujsfcrial
Organisations, and the labour situation, while apparently
not particularly menacing, remains confused.
The negotiations between the Securities and
Exchange Commission and the public utility companies
under the Public Utility Act continue to drag along
without, so far as I have discovered, any striking progresf
having recently been made, and the nomination of Mr. Leon
Henderson, generally regarded as a long way to the left,
as a member of the Commission, and the apparent
likelihood of Mr. Jerome Frank being elected chairman,
have caused some dismay*
Various proposals have been put forward both
by the Administration and by interested Senators, for
dealing with the very uncomfortable cotton situation, but
no general agreement has been reached and no solution of
the problem is in sight.
The Administration in fact, \#iile seriously
disturbed about the failure of any full recovery to
manifest itself, has so far been prevented, either by
political considerations or by the conflicting pull of
various interests in Congress, from taking any effective
action other than by the flow of deficit spending and
the lowering 'of interest rates.
5.   More general considerations.
The main financial and economic problems
which strike the eye as confronting the American
Government are the budgetary problem, the unemployment
situation, and the plight of certain branches of
agriculture, in particular cotton.   Fundamentally all
these/
r
¦
these are aspects of the single general problem of
creating conditions under which the full productive
capacity of the country will "be put to work.    If this
could be done the budgetary and unemployment situations
would clear up of themselves, sad even the agricultural
situation would be enormously improved by the enlarged
market*   This is the general angle from which the
economic problems of the nation are mainly being studied
in Washington* and the division of opinion naturally
is between those who think that the productive
capacity of the country will function satisfactorily
if it is only left alone by Government, and those who
think that a greater degree of Government assistance
and control is required to make it function properly*
This division of opinion outs across the division between
the political parties, but broadly speaking the
Republicans are mere the party of industry who want the
minimum of Government interference (except of course
for high tariffs), while the New Deal wing of the
Democratic Party stands for increased Government
direction and control of business.   At present owing
to the comparative failure of the New Deal to restore
prosperity and to uneasiness at some of its policies
the trend of popular feeling seems to be away from
further extension of Government control, and this is
behind the Administration statements that the period of
reforms was over and that the emphasis was now to be on
consolidation and recovery.   At the same time the
strength of the trend is not easy to decide, both
because it cuts across the organised political
alignments, and because of other complicating issues*
in particular foreign affairs.   In any case it is
probably/
-IS-
¦
probably a temporary reactions   in the long ran it
would seem that because of the anarchy of private
business or decentralised State control, the trend
must he towards greater centralised control by the
Federal Government*   For the moment however it seems
that the President would he prevented by the feeling in
Congress from embarking at the present juncture upon
new measures of control or reform* hut that it is
at the same time difficult for him, both perhaps from
personal conviction and because of the attitude of his
supporters in the Democratic Party and of his advisers in
the Administration, materially to modify the reform
measures already introduced (e.g. in the very important
realms of taxes and labour).   This seems to be the main
reason why it has not been possible for the Government
so far to take any effective action to stimulate
recovery other than by the high rate of spending* Of
course if recovery continues absent the pressure for
new measures will become stronger* and it is possible
for instance that Congress might push a tax revision bil
through either against the wish or with the very half-
hearted assent of the President.
Behind this comparative impotence to take
effective economic measures lies the inefficiency of
the system of Government itself.   I do not mean
inefficiency of the Givil Service* which can be very
greatly exaggerated.   I mean rather the division of
powers between the Congress and the Executive, and the
method of election of Congressmen and Senators, which
makes of them little more than delegates appointed to
represent the interest of their particular constituency,
while the President* more or less alone, represents
the/
-14-
the country as a whol:e.    (I need not mention the position
of the Supremo Court which at the moment seems inclined to
"go along"•)   The division of power made Mr# Hoover
practically impotent in the early stages of the slump
"because Congress was politically opposed to hims but
even under a Democratic President who has had a
Democratic majority in both houses since his election,
the inevitable lack of party discipline and the play of
regional and sectional interests have resulted in
striking divagations of policy.   It has, for instance,
been clear- since 1933, if not before, that railroad
legislation was needed, but after six years, owing to the
conflict of Interests, an Act has still to be written
(something may be done this Session, but it is quite
doubtful);   the Silver Purchase Act had few genuine
supporters in Congress and was opposed by the Treasury,
but was pushed through by a handful of interested
Senators;   I presume that not more than a small minority
of Congress really believed that the Veterans Bonus Aet
Of 1936 was justifiable;   regional log-rolling in Congress
has greatly complicated the Administration1 s dealings
with the agricultural problem;   even in 1933, immediately
after the banking crisis, the President was unable or
unwilling to insist on the establishment of a unified
banking system, because of the fear of opposition from
the supporters in Congress of the State banks*   I need
not multiply instances:   the only point I want to
make is that the damaging Incapacity to declare a definite
policy on many important matters, and then to stick to it,
arises in many cases out of the constitution of the
Government iseir,   (Of course this is abundantly clear
in the matter of the neutrality legislation), Ofois
absence/
J       -1
-15-
absence of a clear policy on many points, and the
uncertainty created thereby, are a serious factor in
holding hack business.    The lack of an efficient system
of Government was comparatively unimportant while the
country was expanding rapidly and abundant supplies of
cheap labour vere coming in.   It is a more serious matter
in a country which has ceased to expand geographically,
where large scale immigration has ceased, where labour
is aetlve and to a large extent organised, where unified
central Government control of business has increased and
probably must continue, in the long run, to increase, and
which has acquired a substantial national debt*
Whether even moderately full utilisation of
the country1 s productive resources can be obtained under
the present system of Government, or whether alternatively
the country will eventually be forced into some drastic
constitutional change, are matters for the future* At
the moment the prospects of a rise in commodity prices
and in the rate of business activity sufficient to
balance the budget seem rather slight, and since the
authorities do not regard the budgetary position as
particularly dangerous* the present situation of unbalanced
budgets and a substantial number of persons on relief seems
likely te run along.
Of course a credit inflation might get
started, and it is for instance not impossible that the
election or even the expectation of a Republican
President in 1940 might touch off a stock exchange and
capital issue boom on the theory that the Republicans
would leave business alone*   This would entirely alter
the immediate economic picture, but not the more
fundamental question suggested above, whether the
existing/
^1
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existing form of Government 1b capable, without
considerable change, of coping satisfactorily with the
over increasing complexity of the financial and economic
problems of the country*   From this point of Tiew the
question from having been whether the Government could
lift the country out of a depression* would only change
to whether It could control boom conditions without
precipitating a slump.
In the event of war in Europe* I suppose that,
assuming the united States not to join in, there would at
first be considerable stimulation of economic activity,
arising out of preparedness orders on the part of the
United States Government and of war purchases by Great
Britain and France.    Should the resources of the latter
countries run low, this war boom would probably be
followed by a severe slump* and the pressure on this
country to extend farther help to the United Kingdom and
France* whether by loan or otherwise, would then become
very severe*   It is fruitless to pursue the
speculation further*
6. Various*
(i)   The legislation to extend the life of the
stabilisation fund and to prolong the President's powers
to devalue, within limits* has passed the House of
Representatives by 225 to 158 but has not yet reached
the floor of the Senate*   The division was on straight
party lines In the House, whereas some Democratic
Senators are opposed to the extension of the devaluation
powers, but the chances seem on the whole to be that the
Bill will pass*
(il)   The prospects of the continuation of
purchases/
n
-17-
purehsMS of foreign silver are still quite obscure.
Mr* Secies has come out strongly against the policy;
but Mr. Morgenthau has rather half heartedly said that,
while he is merely carrying out the mandate of Congress*
it may be better to get silver than paper promises ia
return for American exports.   The fight has not reached
the floor of either House.   A member of the Treasury
told me he thought la the end very likely nothing
would be done this year because the Republicans would
like to keep the issue as a telling one at the 1940
elections*
(ill)   Taxation by the States of Federal salaries
and vice versa lias now been legalised, but nothing has
been dene aa yet about tax free bonds, and the
prospects for legislation on this issue are still
quite doubtful*
(SOD) T. k. Bsmsr
May 4th, 1939