THE BRITISH EMBASSY,
WASHINGTON, D, C
• #
December 5th, 1939.
Ho. 1364.
My Lord,
I transmit to Your Lordship
herewith a copy of a memorandum by the
Financial Adviser to this Embassy regard-
ing the financial situation in the United
States*
I have the honour to be,
with the highest respect.
My Lord,
Your Lordship*s most obedient,
humble servant,
(SG3» LOTHIAN
The Right Honourable
The Viscount Halifax, K.O
etc.,
etc.,
etc
FRHMrHK
FINANCIAL AND ECONOMIC SITUATION IN THE
UNITED STATES OP AMERICA, MOVSMBKK. 1939,
(of. memorandum of 23rd August, 1030,
accompanying Washington Despatch
No, 978 8 of 29th August, 1939.)
General Conditions.
1. In the debate In Congress on the
Neutrality Bill Representative Wadsworth of New
York said "This legislation is toeing proposed
largely because we are afraid of our own emotions"•
This same fear of his emotions, even of his
instincts^ characterises the attitude of the
American towards the prospects of business.
2. When war broke out, instinct at first
got the upper hand.   A rush out of fixed-interest-
bearing securities into equities in expectation of
war profits caused stocks to soar and bonds, es-
pecially Treasuries, to slump.   Although the Federal
Reserve Banks bought in over &400 million of Treasury
Bonds * acting rather at cross-purposes with the
Treasury which wanted to see the market settle down
by Itself - the index for long-term Treasury bonds
fell by 225? in September.   High grade utility and
other bonds were less affected.   The stock index rose
erratically from 84 to 96.
Prices of many commodities jumped sharply.
There was a rush of domestic orders to manufacturers,
and even a little household hoarding for a short
time.
3. In/
4-
8*   In October-November the Bond market,
including Treasuries, recovered practically all the
ground lost in September.   Shares weakened only
slightly and steadied down somewhat.   The market
was still disturbed by contradictory rumours about
Allied purchases, but has slowly approached ft better
measure of probabilities.
4«   When the dust had cleared somewhat it
was seen that the principal movement had been the
endeavour to increase depleted stocks in most branches
of the system towards a more normal level*   Steel pro-
duction (Iron and Steel Institute) rose from 63# at
the beginning of September to       in the fourth week
of November?   The demand for steel has been increased
by very good automobile prospects (somewhat damped
sore recently by strikes), and by the fact that the
railways have had to place substantial orders for new
rolling stock to cope with the anticipated increase in
traffic, their carrying capacity being lower now than
In 1937•   The "Now York Times" business index rose
from 91 at the beginning of August in a progressively
steep curve until it shocked slightly after reaching
107 in the second week of November. Unfulfilled
orders in many industries, especially steel, are suf-
ficient to maintain activity at a high level for
several months to come*
Up to date this is hardly a war boom at all,
but rather a revival of normal structure, the condi-
tions for which were already existing in latent form,
and the trigger of which was pulled by the war.
The/
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The Money and Capital Markets,
6*   The gold stock baa increased from
§16,227 Billion at the end of July to $17,287 million
on November 22nd, and excess reserves of Member
Banks have increased from $4,690 million on August
16th to $6,170 Billion on November 22nd,   The rate
of increase in excess reserves has been raised this
year by the fact that the Treasury has financed the
budget deficit in part by drawing on Its general fund*
Since the market steadied down in October the
Treasury has replenished the general fund to some ax-
tent by fresh Issues, and this, coupled with the
slowing down of gold shipments owing to the war, has
caused excess reserves to drop a little from the peak
of §5,530 million reached on October 25th* Money
rates have not altered to any appreciable extent.
6*   Reserve banks have now allowed their
Treasury Bills to run down to the low level of
§77 million, so that In spite of the large purchases
Of Treasury Bonds referred to in paragraph 2 above,
their total holding of Government securities has now
returned close to the level of the first half of 1969,
7.    Increased purchasing for stook has led
to a moderate rise In bank advances.   The commercial,
industrial, and agricultural loans of reporting member
banks rose from an average of §3,930 Billion In
August 1939 to $4,338 million on November 22nd*
8*   Capital issues fell off sharply In
August and September*   Only after the market steadied
w
In October did the Treasury cautiously enter the
market for new money (apart from the sale of "Baby
Bonds" which itself dropped from $89 million in
July to $47 million in September) *   ftl50 Million
was raised mostly in October toy Increasing the
issues of Treasury Bills.   The Reconstruction Finance
Corporation made an issue in October of 1% 2& year
notes, ths proceeds Of which were used to repay
3243 million previously borrowed from the Treasury •
a convenient scheme which replenished the Treasury's
coffers without inoreast ng the official Federal debt
which la subject to the £45 billion limit. Finally
on November 27th the Treasury made an offer for cash
of $500 million 2p 9*11 year Treasury Bonds - the
first offer of direct Federal obligations with a long
maturity since 1938, and the longest dated 2£'s ewer
issued*   These were taken up rapidly and went to a
premium of 2>5f and the market for Government bonds
improved at the same time.   The market has in faet
been starved for 3 months, during which there had been
no substantial corporate issues until the appearance
on November 27th of §52 million ef Public Service of
Colorado bonds*
Federal Finance.
9.   The deficit to 27th November on the 1940
Budget is §1,676 million, as compared with $1,967
million for the same period last year*   Though income
tax is yielding less than last year there has been a
slight recovery in customs and excise duties9 so that
the total revenue to date ($2,145 million) is only
$47 million/
7
$47 million below that of last year.   With the
increase In business si noe the outbreak of war a
further recovery In excise duties is expected, and
there may he acme savings on relief, m that un-
official prophets now estimate the deficit for the
year at about #3,500 million (with a wide margin of
error) instead of the $4,000 million or nearly that
estimated in my memorandum of 23rd August last.
10.   The war has brought the question of
defence again into prominence.   She President, who
is nor preparing his 1941 Budget, has told the Press
that he will propose an increase of about $500 million
in the War and Navy Department appropriations for
next year.   He la searching in other directions for
compensating economies, but a net increase in expendi-
ture seems inevitable and the President Is revolving
the question whether to cover this increase by more
borrowing or more taxation.
11*   New Dealers, while opposed to increased
taxation in general, are quite prepared to tax war
profits 100$ {so that some manufacturers are reported
to be pepared to make contracts with the Allied
Governments on a no-profit basis).   Another cross-
current here is the examination of the tax structure
which is being carried out by Under Secretary Hanes.
He is known to be in favour of the abolition of the
income tax exemption on Federal securities, coupled
with a revision of the tax rates which will put a
higher proportion of the burden on the middle and
lower Incomes - all oontroversial questions.
12. The/
i
12*   The statutory debt limit of #40
billion la looming unpleasantly near* After
certain adjustments to the present debt of
§41,797 million have been made there remains about
§3,800 million of unused borrowing power*   Some of
this must be set aside for the automatic growth in
the value of outstanding Baby Bonds and the re-
mainder of this year's deficit must bo financed.
It seems unlikely that next year's budget expendi-
tures can be met without increasing either taxation
or the dobt limit.   The Administration is reluctant
to take the initiative and will probably leave to
the Congress the responsibility for the necessary
decisions*
id*   A side issue of some importance has
been the continued agitation for increased old ago
pensions*   Special schemes were submitted to the
vote in California (the "Bam and Sggs" scheme) and
Ohio, and though they were both defeated by largo
majorities, the results of the elections woro unpre-
dictable, and the issue is by no moans closed* The
authors of various schemes are giving some of their
energy to abusing one another, but there may bo
enough popular pressure behind the whole movement to
foroo administrators to seek credit for putting for-
ward reforms themselves*
General Outlook.
14*   The facts that the recovery of the
last months has arisen in the main from the filling
up of domestlo inventories and that the volume of
v/ar/

I
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war purchases may not bo as great aa was at first
assumed, ha s   led many people to take the view
that there will he a halt in recovery, or even a
fresh reoeaaion, in a few months time*   This view
may, however, be partly the product either of the
politioal desire of the New Dealers not to see
their case vanish in to the thin air of a real
revival, or of the American business man's distrust
of his own instincts, awakened by the successive
blows of the crisis and the New Deal.
15. As every revival starts in precisely
this fashion, I think that the reasons, if any, for
doubting the prospect of a continued revival lie else-
where.   The pressure which has been applied by the
Administration to prevent a rise of industrial prices
may alow the pace of revival - though this may be
salutary rather than otherwise.   The most conspicuous
example is the investigation of steel prices by the
Temporary National Economic Committee (the "Monopolies
Committee") whereby the steel makers were forced to
eschew any material change in their prices for the
first quarter of 1940, notwithstanding an alleged rise
in costs.   Another important factor is the disposition
of labour to put forward fresh wage or other demands
On the least sign of returning prosperity*
16. If a price boom can be prevented, it
seems that war purchases can have only a limited
effect on the American economy, helping to give em-
ployment in oertain branches (while creating dlffloultl
for/
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for others) rather than stimulating activity all
round to any material extent.   On the other hand,
the Acta inlst rat ion fear that there may ho a sub-
stantial rise in the prices of Industrial raw ma-
terials which would ho a serious disturbing factor*
17«   Owing to the war Now Deal politics
seem likely to play a smaller part in the 1940 elec-
tions than would otherwise have been tho case. An
increase in defence expenditure will he approved by
all parties, and will to some extant replaee recovery
expenditure.   The Republicans have recently started
a campaign against Mr. Hull's Reciprocal Trade
Treaties Act and they may possibly choose this as
one of their campaigning grounds.   The war, with its
sudden turns, Is however still competing with Internal
politics for public interests and the character of
the 1940 campaign is still very obscure.
(SOD) G.R.3. FIN3J3OT
1st December, 1939