Blowing the Bubble! There Is One Way Out


THE need for balancing the Federal budget, and the methods by which that could be accomplished, have been fully discussed in previous articles. But — the mere balancing of the budget is not enough. Such action must be followed by the exercise of control mechanisms intended to prevent any repetition of inflation in the future. Otherwise business recovery and reemployment cannot be permanent in character. It would be tragic if the next business recovery were followed by another collapse. What we must seek is sound recovery, and reemployment of a permanent character.

No one has to be told that one of the principal causes of our present economic difficulties and widespread unemployment was the credit inflation of the 1920’s, which had as its basis the wartime Government deficits. With the suffering and wreckage caused by inflation still evident on every hand, it would seem reasonable to suppose that every effort would now be made to prevent any similar inflation in the future.

Instead we find that the Government, by its fiscal policies, has deliberately laid the base for another inflation on a scale so gigantic that the bubble of the 1920’s may finally seem small by comparison. We are now evidently going to have bigger and more painful inflation under Government sponsorship and induced by direct Government action. The New Deal is only the former ‘New Era’ dressed up in different clothes. When the next bubble bursts, let it not be forgotten that the responsibility lies directly at the door of the present Administration.

In discussing the country’s future prospects, many people to-day preface their remarks with this statement: ‘If we have inflation . . .’ There is no ‘if’ about it. We have inflation now. But this fact is not generally realized because the full effects of it have not yet become apparent. It nevertheless exists, and has been brought about primarily by two actions of the Government itself: the accumulation of enormous Government deficits, and the devaluation of the dollar, making possible the creation of the Government’s $2,000,000,000 stabilization fund.

Our accumulated Federal deficit of more than $14,000,000,000 has been financed by the issuance of Government bonds. Since 1930, the Federal debt has increased 85 per cent, and of this increase, all but 15 per cent has been accounted for by increases in the holdings of Government bonds by the banking system. The nation’s banks to-day hold approximately 53 per cent of the entire Federal debt — an unhealthy situation brought about primarily by the coercion of the banks by the Government.

Banks, when they buy Government bonds, rarely pay for them with cash that someone has deposited in the bank. Instead, they create a bookkeeping credit, against which the Government is entitled to draw. When the Government draws against one bank and spends the money, such money finds its way into some other bank in the form of a deposit. Thus the purchase by banks of large quantities of Government bonds has led to an inflation of bank deposits.

The other definitely inflationary act of the Administration was the devaluation of the American dollar. By devaluing the dollar, we artificially wrote up our gold supply by approximately 66 per cent. Another inflationary effect of such a step has its source in the settlement. of international balances.

If a citizen of France has francs equivalent to $100,000 in American money, the devaluation of our dollar from 100 to 60 cents automatically increases his worth to the equivalent of $166,666 in American money. Expressed another way, it permits him to purchase American goods or property at a discount of 40 per cent. This compelled a tremendous influx of gold to this country, which forms the greatest base for potential inflation that any country has ever had. To this must be added the gold which has recently come here because of fears of war and currency disturbances abroad. As a result, our present stock is more than twice as great as it was in the peak of the 1929 boom.

The so-called profit, on gold, incident to the devaluation, also permitted the creation of the Government’s $2,000,000,000 stabilization fund. The use of this fund adds to the supply of credit in the same way as does the purchase of Government bonds by the Federal Reserve Banks.

In a country in which more than 90 per cent of all business is done by the use of checks, there is no essential difference between the creation of bank deposits by fiat and the creation of printing-press money. Bank deposits — not currency— constitute our chief circulating medium. By devaluing the dollar and financing the Federal deficit through the sale of bonds to banks, the Government is responsible for the fact that deposits of reporting member banks now total $3,000,000,000 more than at the peak of 1929.

As a result of this gain in bank deposits, and the gold policy, the combined excess reserves of the Federal Reserve member banks have increased more than $2,000,000,000 since early 1934, and now stand at an all-time high of more than $3,000,000,000. The significance of excess reserves is that they constitute the base for the expansion of bank credit. The greater the reserves, the greater the amount of credit the banking system can advance.

An increase of only $600,000,000 in bank reserves from 1922 to 1929 was sufficient to support the enormous bank credit expansion of that period. The increase in the last two years has been nearly three and one-half times as great. This comparison may give some idea of the inflationary possibilities of the present situation.

Because of the low volume of current private borrowings, the dangers of this situation are not yet fully appreciated. But already the Government’s spending programme has put into circulation billions of this artificially created credit. As confidence develops and business men grow more venturesome or speculative and are again of a mind to borrow, can anyone doubt that this enormous supply of artificially created credit, coupled with artificially low interest rates, will induce tremendous borrowing? But it is not wholly necessary that this happen, because the Government is doing precisely this very thing and it makes little difference who does it.


Record gold stocks, swollen bank reserves, artificially low interest rates, and devaluation of the dollar — all deliberately engineered by the Government — have laid the basis for the greatest inflation the country has ever known. Our present gold and bank reserves are sufficient to support a credit expansion infinitely greater than that of 1929.

In a previous article it was pointed out that the deliberate inflationary acts of the Government might temporarily give all the appearances of a recovery. There are already many evidences that this is now taking place. Commodity prices, as measured by the Index of the Bureau of Labor Statistics, rose over 33 per cent in the thirtyone-month period from April 1933 to October 1935. The Dow-Jones average of thirty industrial stocks, which stood at 50 early in 1933, touched a recent high of 148, a gain of almost 200 per cent. This percentage gain is greater than was registered in the entire period from 1926 to the peak of 1929.

The average yield on the ninety stocks that make up the Standard Statistics composite average of industrials, rails, and utilities has declined from 5.58 per cent in April 1933 to 3.50 per cent in October 1935. This present average yield is only slightly more than the average yield of 3.16 per cent in July 1929. Bank debits, too, — that is, checks drawn against bank deposits, — are increasing at approximately the same rate as during the 1927-1929 period.

No one of these various factors taken alone is conclusive proof that we are now experiencing inflation; for any one of them a plausible explanation may be found. When, however, all are put together they make an unmistakable inflationary design.

Our current situation, if examined closely, is found to be strikingly similar in many respects to the situation in 1928 and 1929. We had a rapidly rising stock market then. We have a rapidly rising stock market now. In 1929, stocks sold at abnormal levels in relation to earnings. So do they now. During the last boom, there was no substantial rise in the commodity price level, but rather a tendency to fall. In the present situation, a rising commodity price level is another expression of inflation. In 1928 and 1929, there was reluctance on the part of authorities to undo the harm of cheap money. To-day, we have a flat refusal on the part of authorities to undo the harm of cheap money.

In 1929, we had a moderate creation of fiat money or its equivalent. To-day, such fiat money or its equivalent is being created in staggering amounts by the Government. When people expressed fears of inflation in the recent boom, they were reassured by public statements that everything was healthy. We are now being reassured by similar statements from those in positions of high authority.

Once inflationary forces become dominant, they cannot be controlled. They cannot be stopped at a given point and be held on a horizontal plane. They either run their course until they collapse of their own weight or are reversed by deliberate acts. This is amply proved by all experience. Moreover, until everyone recognizes the existence of inflation, there are always large groups which undertake to prove its absence. Knowing all this and realizing the inflationary possibilities of our present situation and the inflationary trend of events, are we going to wait again until the horse is gone before locking the stable door?

The insidious thing about our current position is that, as the present course of our inflation continues, we shall temporarily show apparent signs of recovery. As prices rise, speculative profits will be spent. Business will probably improve and private employment may increase somewhat. But the collapse that will follow this inflationary phase will again bring us the same destruction of savings, unemployment , and suffering brought by the 1929 collapse. Temporary improvement, bought at such a price, is paid for too dearly.


The Administration’s inflationary acts have already been committed. The important question now is what can be done to prevent their evil effects. Theoretically, there are at least six existing mechanisms for the control of inflation.

The first is the raising of the Federal Reserve rediscount rates. This increases open-market money rates and is supposed to curb new borrowing by increasing interest costs.

The second available mechanism for control of inflation is the sale by the Federal Reserve Banks of their holdings of Government securities in the open market. This is intended to reduce the supply of money and thereby harden money rates, which discourages borrowing.

The third mechanism is a new one, created in the Banking Act of 1935, which specifically empowers the Federal Reserve Board to raise the reserve requirements of member banks to any figure up to twice the present requirements. Exercise of this power would operate to reduce excess banking reserves and thus reduce the available supply of bank credit.

The fourth mechanism for control of inflation is the upward revaluation of the dollar. The fifth and sixth mechanisms — namely, the adjustment of the capital gains tax and the raising of margin requirements — may be dismissed as being unimportant at this juncture.

In theory, these control mechanisms provide adequate protection against the dangers of inflation. But, as a practical matter, can they be exercised under present conditions?

If the Federal Reserve rediscount rates were raised —assuming the existence of paper seeking rediscount — the resulting increase in money rates would severely depress the prices of Government bonds. Such a drop in Government bond prices would jeopardize the Government’s financial operations. For current and prospective deficits must be financed by the issuance of additional bonds. In addition, the Government still has to convert into long-term form an enormous total of short-term debt.

Almost 80 per cent of the increase in our Federal debt since 1931 has been accounted for by short-term securities, which must finally be funded. No such operations would be possible in a falling bond market for a Government whose budget was still unbalanced. Moreover, the decline in the level of Government long-term bond prices might easily impair the capital of many of the country’s banks. In any event, it would cause enormous losses to banks generally.

The same factors operate to prevent the application of control through the sale of Government bonds in the open market by the Federal Reserve Banks, for such a move might likewise severely depress the Government bond market.

Any attempt to increase substantially the present reserve requirements of the Federal Reserve member banks might also seriously jeopardize the Administration’s necessary new financing and refunding. This is because such a move, again, would tend to harden money rates. The higher rates, combined with continuing Government deficits, and losses by present holders of Government bonds, would provide a situation that would wreck the Government’s chances to continue financing its deficit, except by creating fiat money in a more obvious way than the one it has been using.

Upward revaluation of the dollar — the fourth control mechanism — would, at this late date, involve too great a shock through rapid deflation of agricultural prices, and would also involve serious international consequences.

A balanced Federal budget is obviously the condition necessary for effective use of the various available mechanisms for the control of inflation. A balanced budget is the heart of the entire system of control. As long as the budget remains unbalanced, the use of inflation controls is prevented by the primary need to protect the prices of Government bonds and thus assure the continued financing of the deficit.

The statement made on November 22 by Mr. Marriner Eccles, Governor of the Federal Reserve Board, shows plainly the position that the Administration must maintain. Mr. Eccles’s statement made it abundantly clear that the Federal Reserve Board planned to do nothing at the present time to put the brakes on a rapidly rising stock market.


Even assuming that the Federal budget is balanced, the use of control mechanisms — which would then be effective — would require considerable fortitude on the part of the American people. It would necessarily involve a short period of deflation. For a brief time, the prices of commodities and securities might decline. Some downward adjustment of costs might be necessary.

None of this would be pleasant. But it represents the price that must be paid to correct our inflationary actions of the past three years. The longer it is delayed, the more difficult it will be to accomplish and the more painful and far-reaching will be the consequences. This is why the budget must be immediately balanced and the controls immediately applied. The basis would then be laid for a sound recovery without the recurring weaknesses of inflation. Henceforth a rigid and effective control of inflationary tendencies could be exercised through the various mechanisms now existing, and through new devices designed to prevent the diversion of bank credit to speculative and capital uses of any sort, either by the Government or by individuals.

If the American people decide that they do not want these correctives, which will permit the exercise of a control to prevent a repetition of the speculative excesses of the past, and if the present powerful inflationary forces continue in the ascendancy, then under our existing policies we are headed eventually for a repetition of the 1928 — 1929 frenzy and collapse. The only difference is that this time, under Government auspices, deliberately induced by Government policies, it may be on an even greater scale.

When the bubble bursts again, we shall be in a much poorer position to withstand the shock than we were last time. We shall find in the next deflation that our Federal credit, on which new demands will be made, has already been extended almost to its limit. We shall find that our banking system is already loaded to the gunwales with Government bonds and cannot be used to absorb billions of new Government bonds issued to finance new deficits. We shall be fortunate, in fact, if we do not find that a large portion of our banking system is insolvent as a result of declines in the prices of Government bonds forced upon the banks in the deflation of the early 1930’s.

Under such circumstances, there will be no other way to meet the Government deficits except by continued issuance of worthless paper money. And we know well where that road leads.

If the American people fully appreciate the significance of the Government’s fiscal policies, it seems unlikely that they will countenance the new inflation and collapse for which we are now heading, especially when it is still possible, with small penalty, to establish conditions that will prevent inflation and pave the way for a sound and lasting recovery.

After the budget has been balanced, after the present inflation has been reversed, and after the basis for inflation deliberately created by the Government has been removed, then the entire banking system should be revised in order to prevent the future abuse of credit either by the Government or by individuals.

The original Federal Reserve Act of 1913 was designed to provide a credit and money supply to meet the shortterm requirements of commerce, agriculture, and industry. One of its major purposes was to prevent the creation of fiat credit, either by Government or by individuals. Unfortunately, that purpose was perverted by the Government under the necessity of financing the war, and during the period of the postwar managed currency. Even more unfortunately, it has been completely perverted during the past few years.

The ghastly results of these abuses of our credit system make it incumbent upon us to return to the original purposes of the Federal Reserve Act, for it is only by exercising inflation preventives and by keeping our budget continuously in balance, or, should there be a deficit, by selling government bonds to investors for cash only, that we can prevent a recurrence of the tragedies of the past. Only in this way can we bring about relatively permanent employment and social security. As long as Government fiscal policies and the operation of our banking system encourage booms and their inevitable aftermaths of human suffering, there can be no permanent employment, and notwithstanding the pious language of unemployment insurance legislation, there can be no social security.

Space does not permit of a discussion of the evils of monopolistic practices. It should be obvious, however, that they tend to prevent reemployment and the production of more goods at lower prices. In addition, under monopolistically fixed prices there may exist an excess of savings and a distribution of poverty, while under a competitive price structure savings in great amounts are always required for investment to produce more goods at lower prices and thus to distribute wealth.

Moreover, as was stated in a previous article, the exchange of goods between nations must be increased if there is to be full employment. There is no other answer to the agricultural problem. There is no other answer to the ‘economy of scarcity.’ There is no other answer to regimentation. There is no other way to assure a permanently stable currency.

To the predicament in which we find ourselves there is only one solution. It is to be found in a balanced budget, encouragement of the use of savings to create employment, a banking system and Government fiscal policies which prevent the manufacture of fiat credit money that leads to alternate booms and depressions, the avoidance of monopolistic practices, and an increase in the volume of goods exchanged between countries. These are the things upon which employment and economic security rest.

This is the one way out.