Reading Between the Lines: A Memo from Fed Chairman Marriner Eccles

By Marriner Eccles (translation by Stephanie Kelton) 

After I shared a few thoughts on the impending decision to replace Ben Bernanke as Chairman of the Federal Reserve, I couldn’t help revisiting the writings of Marriner Eccles.  Eccles was a Republican and a businessman who, by the age of 22, had become a millionaire with an impressive record of restructuring and consolidating balance sheets (including those of financial institutions) to withstand the turmoil of the Great Depression.  In 1934, Franklin D. Roosevelt tapped Eccles to head the Federal Reserve, a position he held until 1948.

The following memo – written May 19, 1938 – gives you a flavor of the way Eccles thought about important issues related to financial stability and macroeconomic policy. What he doesn’t say is at least as important as what he does. For those who struggle with econo-speak, my own plain-speak is interspersed throughout.

As a general principle, deficit-spending by the government should only be undertaken in depressed times as a means of offsetting in part or compensating for the lack of private activity. Conversely, when private debt is rapidly expanding, there should be a contraction of public debt as a counterbalancing and stabilizing influence.

KELTON: The government is a partner in the economy.  When the private sector tightens its belt (i.e. borrows and spends less money), it is fiscally responsible for the government to compensate by loosening its belt.  (This, by the way, is exactly what ended the Great Depression and, more recently, what halted the Great Recession.)

However, there may be times when national income is at a high and rapidly advancing rate when it would be desirable from every standpoint to increase taxation—for example, by broadening the tax base— in order to maintain a flow of funds to impoverished elements of the population, to the aged and unemployables, whose purchasing power is necessary to sustain production and thus help to preserve existing capital and make possible further profitable expansion of facilities. This, in turn, would provide an outlet for accumulations for savings in the field of private investment. Otherwise, as happened in the late twenties, there may be excessive accumulations of investment capital which, unable to find out­let in productive domestic enterprise, are diverted to unproductive channels and to speculative bidding up of stocks and other equities or put into uncollectable foreign loans.

KELTON: It might make sense to raise taxes on the rich and increase spending on seniors and the unemployed, because the rich plow too much of their income into speculative endeavors, creating bubbles, whereas seniors and the unemployed will spend their income buying the products of industry, which helps this thing called capitalism work.

The problem to which I refer seems to me to be basic in our economy.  I think it has been well outlined by the Brookings Institution in their studies. Thus, in their volume entitled “Income and Economic Progress“, they point out that we have always had, even in boom times, a sufficient supply of manpower, of fuel, of money and credit and of material resources to produce far more than was actually produced. They point out (p. 37) that ‘the consumptive requirements or wants of the people were far from satisfied during the period of our highest economic achievement’; and (p. 36} that ‘the great problem of American business men is not how to produce more, but how to sell what they have already produced.’

KELTON: We have more money, people, and natural resources than we know what to do with.  What we lack — in a world where the profit motive rules — are enough lucrative ways to put them all to use.  So we end up with an economy that almost always undershoots its potential.

Having called attention to the maldistribution of income, they then raise what seems to me to be a most fundamental problem, namely, the maintenance of a balance between the three factors of savings, consumption, and capital formation. They state (p. 41 et seq.)* ‘According to traditional views the way in which income is divided as between spending and saving in no way affects the degree to which our productive resources will be utilized. If more money is saved, the greater, it is contended, will be the construction of capital goods; if more is spent, the greater will be the output of consumption goods. An increase in savings thus merely shifts labor and materials from employment in the consumption goods industries to employment in the capital goods industries; and the total disbursements for wages, interest, etc., remain unaffected. Society would, however, have the benefit of an increasing supply of capital goods.

This traditional analysis, it should be carefully noted, is based on the primary assumption that all money savings automatically become new capital equipment. Such an assumption ‘implies that business men will always expand plant and equipment to the full extent of the funds available. Stating the matter another way, it is assumed that the formation of new productive capital in no wise [sic] depends upon consumptive demand—that business men will increase the supply of capital goods even though the demand for consumptive goods is declining. In other words, it is assumed that consumptive demand and the construction of capital equipment ere independent variables.

KELTON: A lot of people will tell you that our system is naturally configured to make sure our economic ship never sails too far off course. They think of the economy as machine that comes equipped with its own mechanism to churn one person’s saving into someone else’s spending.

Now if this is true we should always have— barring other mal­adjustments— full employment either in the production of capital goods or consumer goods. But if it is not true— if the expansion of capital goods depends upon a concurrent expansion in the demand  for consumption goods— then an increase in savings might have very different results. How have we been able to clarify the basic issue thus raised?

KELTON: But what if our view of the way the economy works is wrong?  What kind of evidence is there to support the claim that businesses buy more equipment or build more factories when their customers are spending less?

First, we sought to show, on the basis of general reasoning and observation, that an increase in savings at the expense of consumptive demand would reduce the construction of new capital goods as well as of consumption goods. Since business men are concerned with making profits, and since profits from the use of new capital depend upon the manufacture and sale of consumer goods by such productive establishments, we contended that an expansion of plant and equipment will not take place in any large way when consumptive demand is declining and the general business situation as a whole is accordingly unpropitious.

KELTON: Common sense suggests that a businessman would not ordinarily borrow to expand his business when he’s experiencing a decline in sales.

Second, we surveyed the facts of our industrial history as a check on the validity of this general reasoning. The available evidence showed conclusively that new capital is constructed on any significant scale only during periods when consumption is also expanding. In periods of declining consumption the construction of new capital also decreases sharply.

KELTON: But we don’t have to rely on imagined behaviors.  The evidence shows that businesses spend more when they’re swamped with customers, not when their customers are closing up their wallets and saving more.

We concluded from this analysis that if new capital is to be constructed there must of necessity be an increasing flow of funds not only through investment channels but also through the channels of retail and wholesale trade. This led inevitably to the question: How is it possible to finance simultaneously an increase in the output of consumption goods and of capital goods? We showed that a concurrent increase in the flow of funds through consumption and investment channels is made possible by the expansive quality of our commercial banking system, which is a manufactory of credit. In a period of expansion, credit is in fact extended both for working capital purposes— to facilitate the production of consumptive goods— and for fixed capital purposes— to finance the construction of new plant and equipment.

In either case the funds are in due course disbursed in payment for wages, materials, and other production costs, and thus the aggregate money income received by the people is enlarged. This “makes it possible to spend more as well as to save more, and thus the flow of funds through consumptive and trade channels is increased concurrently. The facts with reference to investments and consumptive expenditures prove that this is the case.

KELTON: Credit — not savings — makes the world go round.  The idea that we have to sacrifice current consumption (i.e. save more today) for future consumption (i.e. more business investment today) is wrong.  Bank credit allows income, consumption, saving and investment to grow together.

Third, we found from the study of our industrial history that the growth of capital is closely adjusted to and dependent upon an expanding demand for consumption goods. The evidence bearing on this question is of two types.

We found in the first place that expansion or contraction in the construction of new capital closely parallels expansion or contraction in the consumption goods industries. Moreover, fluctuations in the construction of capital goods have usually followed rather than preceded fluctuations in the output of consumption goods.

KELTON: Businesses wait to invest in new capital until after they see strong demand for their products.  Consumer demand for the stuff they produce is the all-important guide.

The controlling importance of consumption was, however, more conclusively revealed by the discovery that the rate of growth of new plant and equipment in a period of industrial expansion is adjusted to the rate of increase of consumptive demand rather than to the volume of savings available for investment purposes. Savings are made in the first instance in the form of money. This money is directed into investment channels; but it does not follow that it will always be used in constructing new capital goods. We found that between 1922 and 1929 the volume of funds rendered available for investment purposes was in­ creasing rapidly, but that the volume of securities floated for purposes of constructing new plant and equipment remained practically unchanged in amount from year to year.  In 1929 the volume of new securities issued for the purpose of actual capital construction plus mortgages was less than 5 billions, while the volume of funds seeking investment was in the neighborhood of 16 billions.

The evidence thus shows conclusively that the construction of capital does not vary directly with the amount of investment money available. It is apparent that the decisions of business enterprisers with reference to the construction of additional plant and equipment are determined primarily by reference to the state of the markets for the products which such new capital equipment could turn out.

KELTON: Higher saving does not automatically get churned into new investment. The reality is, business won’t borrow money for investment purposes unless they experience strong demand for their products.

When the volume of money savings is in excess of the requirements for new capital construction, what becomes of the excess? The answer is that funds seek employment in one way or another— just how, depending upon varying economic conditions or situations. They may be loaned abroad, as large amounts were in the period from 1925 to 1929. They may be used in purchasing securities already outstanding in the markets, and be absorbed in bidding up the prices of such securities. Or, as during the depression, when new security issues for purposes of private capital expansion have virtually disappeared, they may remain stagnant in bank deposits, be used in financing government deficits, or, again, in bidding up the prices of outstanding corporate issues.

KELTON: Savers might just want to hold onto their cash.  They might part with some it in order to buy government bonds or foreign securities.  Or they might plow it into the stock market, driving up share prices.

A flow of money savings into investment channels in excess of the requirements of the capital markets is a comparatively new phenomenon in the United States. Throughout our earlier history, indeed until approximately the World War period, the requirements of business enterprises for funds with which to develop new capital were characteristically in excess of the supply emanating from the savings of the people. The deficiency was made good by borrowing abroad and by the expansion of commercial banking credit. In the last twenty years, however, the situation has been profoundly altered. As a result of a higher average level of income, and particularly because of the concentration of income, the volume of money savings flowing to investment channels has so greatly increased that the balance has been shifted. Instead of having a deficiency of investment money, we have a surplus.

KELTON: This wasn’t always such a big problem.  Income used to be more equally distributed, and people spent most of what they earned, leaving little extra to satisfy the investment appetite of the business community.  We have a vastly richer economy today, but it is also more unequal.  This makes it harder to keep investment high enough to keep the economy on track.

This diagnosis or analysis of the economic mechanism may then be summarized as follows. Our study of the productive process led us to a negative conclusion— no limiting factor or serious impediment to a full utilization of our productive capacity could there be discovered. Our investigation of the distribution of income, on the other hand, revealed a maladjust­ment of basic significance. Our capacity to produce consumer goods has been chronically in excess of the amount which consumers are able, or willing, to take off the markets; and this situation is attributable to the increasing proportion of the total income which is diverted to savings channels. The result is a chronic inability— despite such devices as high pressure salesmanship, installment credits, and loans to facilitate foreign purchases— to find market outlets adequate to absorb our full productive capacity.

KELTON: We have an economy that chronically undershoots its potential. Income inequality is a big part of the reason way. The very wealthy save too much, and try as we might, we can’t seem to get the poor to pick up the all of the slack by taking on debt to finance higher consumption.

In another volume entitled “The Formation of Capital”, the same authorities state (p. 146): ‘We had funds available for investment ranging from around 8 or 9 billions in 1923-24 to as much as 15 or 16 billions in 1928-29. On the other hand, the volume of new corporate issues for productive purposes, including mortgages, remained practically stationary at about 5 billions. The amount of the savings that passed into the hands of business enterprisers for use in buying materials and hiring labor for the construction of new plant and equipment was thus about 5 billion dollars annually. The question is what became of the balance.’

KELTON: A lack of saving is not our problem.  Too much saving is.

Answering this question (p. 151), they state: ‘The answer is that, aside from that portion which went into foreign issues, the excess savings were absorbed, dissi­pated, in bidding up the prices of outstanding securities. Money savings were thus transferred increasingly into specu­lative profits rather than into productive plant and equipment. The inflation of security values resulted in a vulnerable fi­nancial structure, the collapse of which was an important contributing factor to the depression.’ 

They state also (p. 152): ‘When the amount of the national money income that is saved increases faster than the amount that is disbursed through consumption channels, there are various possible outlets for the excess savings. Funds not demanded for the construction of new plant and equipment may be invested abroad, as during the World War and again in 1925-29. They may be absorbed in bidding up the prices of existing securities, as in the recent boom years.

They may stagnate in bank deposits— or go to finance government deficits— as has been the case during the depression. ”  This phenomenon of an excess of savings relative to productive out­lets, they discuss in the conclusions to this volume (p. 159 et seq.): ‘The rapid growth of savings as compared with consumption in the decade of the twenties resulted in a supply of investment money quite out of proportion to the volume of securities being floated for purposes of expanding plant and equipment, while at the same time the flow of funds through consumptive channels was inadequate to absorb— at the prices at which goods were offered for sale— the potential output of our existing productive capacity. The excess savings which entered the investment market served to inflate the prices of securities and to produce financial instability. A larger relative flow of funds through consumptive channels would have led not only to a larger utilization of existing productive capacity, but also to a more rapid growth of plant and equipment.

KELTON: In the period leading up to the Great Depression, savings were not churned into new factories and new machines but into speculative endeavors that turned our economy into a casino.

The phenomenon of an excessive supply of funds in the investment markets had never been anticipated. Not only had it been assumed that all savings would automatically be trans­formed into capital equipment, but it seemed impossible to con­ceive of a situation in which savings might become redundant.

KELTON: The dominant economic theory — which taught that you can never have too much saving — had it wrong.   Malthus was right.  We ended up with an economy that was capable of producing a lot more than we were collectively prepared to buy.   Those who believed in a self-correcting mechanism to turn unspent income (i.e. savings) into productive investment were wrong.

Such a point of view is natural enough in the light of our historical evolution. In the early history of this country the volume of funds available for the purposes of capitalistic enterprise was per­sistently inadequate. Business men often found it difficult to obtain the liquid capital, at any price, with which to expand the size of their business undertakings or to exploit new fields of enterprise. In colonial days, for example, the shortage of funds was a continual source of difficulty and a primary cause of irritation with the mother country, which opposed the issuance of bills of credit by colonial governments. Until well into the nineteenth century the volume of savings rendered avail­able through investment channels for the needs of business enter­prisers was negligible in amount. The philosophy which empha­sized the fundamental importance of increased savings was a realistic one for that age.

KELTON: There was a time when it made sense to assume that the business community would eagerly absorb any and all savings and put it to productive use. In fact, the appetite for surplus funds used to vastly exceed the supply.

In the period since the Civil War, however, two factors have combined to produce a profound change in this situation.  The first has been the growth of a well-to-do middle class, with funds available for investment. The second has been the develop­ment of the commercial banking system, making possible an ex­pansion of credit to business enterprise for both fixed and work­ing capital purposes. It is these developments which account for the emergence of the United States as a great financial power.

KELTON: It became a lot easier to secure funding after we built a strong middle class and a banking system that could easily provide credit when businesses wanted to expand operations.

Not only do we now have an abundance of funds with which to fi­nance American enterprise, but we are also able to extend credits to the world at large. In this development we have followed the road which England travelled at an earlier date.  At the present stage in the economic evolution of the United States, the problem of balance between consumption and saving is thus essentially different from what it was in earlier times. Instead of a scarcity of funds for the needs of business enterprise, there tends to be an excessive supply of available investment money, which is productive not of new capital goods but of financial maladjustments. The primary need at this stage in our economic history is a larger flow of funds through consumptive channels rather than more abundant savings.

KELTON: We solved one problem but created another.  Now we have too much much saving and not enough investment.

It is, of course, essential that the economy have at all times an ample supply of private capital for investment in productive enterprise. I am speaking of conditions not as they have been, or as we would like them to be, but as we are forced to deal with them as we find them today. These conditions include the slow rate of increase in the population, restricted immigration, the disappearance of the frontier in the west and south, and restricted world trade due to tariffs and quotas, exchange controls and fluctuating currencies.

These factors force upon the government the necessity for dealing with social and economic problems on a nationalistic basis to a degree that has never before prevailed.

KELTON: The world has changed, and there is a new role for government in our economy.

I agree that as a general rule of the past we had a scarcity rather than a superabundance of investment capital relative to productive outlets, and that, therefore, recovery from depressions before the last war was almost invariably led by new investment. I seriously question whether this rule, and the economic philosophy based upon it, is valid under present and prospective conditions.

KELTON: We cannot sit around and wait for the business community — which is driven by the profit motive — to lead us out of the doldrums.

The point I wish to make is that it would be to the interest of capital under such conditions to advocate such taxation on a broad income tax base as would, in effect, sustain buying power and thus make for a sustained and expanding production which, in turn, serves not only to protect existing capital investment but also to provide a productive and profitable outlet for accumulated private savings.

The idea is by no means new or untried, for we have an example of its application in England and some of the other capitalistic democracies, where the level of taxation is extremely high— and bear in mind that I am just as unenthusiastic about paying taxes as you are— but where by various public expenditures a reasonably even flow of purchasing power has been maintained and production has been kept at continuously high levels. It seems to me that this is very much in the interest of the capitalist because he is better off in the end, since the products of the mill and factory continue to find a market and the return in profits to the owner of capital, after paying the higher taxes, is far greater than would be the case if the economy bogged down, the plants had to be closed and the value of all investment sharply depreciated.

KELTON: Capitalism runs on sales.  If there aren’t enough customers to buy what our businesses are capable of producing, capitalists will suffer.  It is the government’s responsibility to do what it can to maintain a proper balance between saving and investment on the one hand and consumption on the other. Rebalancing the economy might involve raising taxes.

I recognize, of course, that the execution of such a policy would have to be very skillfully managed and well timed, and that, as I have said, there must be at the same time every encouragement for the employment of capital in new production— that there must be always an ample supply of funds for that purpose.

Accordingly, when the supply of savings is insufficient to meet the expanding needs of the country for new capital on a profitable basis, income taxes should be reduced. A condition such as this may develop in the future, for I realize that technical progress opens up indefinite possibilities for production, and education, by causing needs to become more refined and diversified, can increase the requirements of our people indefinitely. But in times when savings are too large relative to productive outlet, government should increase taxes and should apply the proceeds to depressed areas, to public health and educational purposes, to public improvements, conservation and protection of natural resources— to preservation of the resources, human and material, of prosperity and not to competition with private initiative.

Higher taxation could well be applied, in these circumstances, to the income groups of, say, between $2,500 and $50,000, and to corporations, always, of course, on an ability-to-pay basis. It seems to me that some of the other capitalistic democracies, such as Great Britain and Sweden, have managed this general policy fairly well in net effect upon their economies, and I am inclined to think that it is their greatest economic safeguard in the preservation of democracy.

KELTON: Redistribution of income can put idle money to work, supporting businesses that would otherwise fail.

As I said in the introduction, this piece is interesting  not just for what it says but for what it doesn’t say.  What is says is that the US economy has reached a stage in its evolution where chronic unemployment — due to insufficient demand — is the normal state of affairs.  What it doesn’t say is that the monetary authority (Fed) can do anything to fix it.  It was then, as it is today, primarily up to the fiscal authorities (Congress) to compensate for the demand deficiencies.  


57 responses to “Reading Between the Lines: A Memo from Fed Chairman Marriner Eccles

  1. So Eccles was a demand-sider ?

    He was way ahead of his time.

    Odd how during times of crisis, people like Eccles seem to appear out of nowhere.

  2. “What he doesn’t say is at least as important as what he does. For those who struggle with econo-speak, my own plain-speak is interspersed throughout.’

    Sounds like a great idea for a book.

  3. Stephanie,

    I think I have an explanation for this part:

    “A flow of money savings into investment channels in excess of the requirements of the capital markets is a comparatively new phenomenon in the United States. Throughout our earlier history, indeed until approximately the World War period, the requirements of business enterprises for funds with which to develop new capital were characteristically in excess of the supply emanating from the savings of the people. The deficiency was made good by borrowing abroad and by the expansion of commercial banking credit”.

    I was just reading a 1994 NBER paper by Robert E. Lipsey, which says the following:

    “the United States began its existence as a net debtor and all through the 19th century and up to World War I it paid out more in interest on its debts than it earned on its foreign assets. The obverse of this excess of current account payments was the import of capital into the United States. Until an abrupt turn to capital exporting at the end of the century, the United States was a net borrower from foreign countries throughout the 19th century (Table 5)”

    “These figures on net U.S. liabilities say that foreigners had some net claim on part of the wealth of the United States throughout the 19th Century. That is, foreigners’ claims on U.S. wealth were larger than U.S. claims on foreign wealth. One comparison of foreign claims with reproducible wealth suggests that the net foreign claims amounted to almost 14 percent of wealth at the beginning of the century. That share fell to about 7 percent by 1850, 4 percent by 1900, and only two percent on the eve of World War I (Davis. 1972, Table 8.12)”


    This is despite the fact that the U.S. had trade surpluses from 1870 onwards:

    “For most of the period from the inauguration of George Washington to the end of the 19th Century, the United States imported more merchandise than it exported. Only in the last three decades of the century did exports exceed imports, and that export surplus continued into the 20th Century (Table 4)”.


    “U.S. Foreign Trade and the Balance of Payments,1800-1913”

  4. It is all good but the claim that fiscal deficits ended the Great Depression cannot be defended and makes for an easy attack point for opponents of fiscal policy. The GDP rebounded in 1934-1936 although deficits were negligible. It was mostly private credit, pretty mysteriously turning around at the depths of the depression. Christina Romer and many others looked at deficits in 1934-1936 and they were simply too small to be effective.

    Monetarists claim it was the 1934 inflation (driven by dollar devaluation?) that helped end the depression. I am not really buying it because to me inflation is contractionary if anything (people try to replace lost savings and save up even more), but MMT seems unable to kill this myth.

    • The US federal government did run quite substantial budget deficits during the great depression, which would have offset some of the contraction elsewhere.

      Dollar devaluation and other factors from 1933 onwards meant that short term interest rates fell from around 5% to near zero. This is a very large drop, which explains in part the increase in private credit.

      In the late 1930s the US current account surplus also increased, suggesting an increase in demand from abroad.

      The inflation rate from 1934-37 was quite low (1934: 2.3%, 1935: 3%, 1936: 1.5%, 1937: 2.2%). This was far better than the massive deflation that had occurred prior to 1934, and far too low to have any of the potential negative effects associated with high inflation that you mention.

    • I think the depression really didn’t end until the war started, which resulted in a doubling of the US economy over six years.

      • The Glass-Steagal Act was also enacted in 1933, which presumably had a huge positive impact on confidence in the banking system, which can only have had a positive effect on private credit creation, saving and investment. But as you say Dan, it was massive government deficit spending as the result of WWII which really brought the economy back to its full productive potential. Unfortunately WWII also resulted in the mass destruction of real resources.

    • It is all good but the claim that fiscal deficits ended the Great Depression cannot be defended. No, in essence the nonsensical, revisionist claims that they did NOT cannot be defended. It took many years for people to fuddle their minds with enough nonsense to fool themselves with such whoppers. People in the 30s and 40s knew better. That’s why they elected FDR 4 times. His first term had the best peacetime growth in US history – a completely unmysterious effect of the New Deal. And they remembered for decades after. Romer just symbolizes how much economic understanding and common sense has regressed since the 30s and 40s. The New Deal deficits / fiscal policy, while relatively small, were good deficits, bottom up deficits that improved the economy directly and indirectly in many ways, rather than bad deficits of military waste production or even worse, from collapsing revenue from austerity. So smaller ultimate deficit spending went a long ways, had a much better multiplier effect. Because the New Deal spending was so effective, the deficits only had to have been somewhat, not enormously, bigger, to have completely eradicated the Depression.

      Alain Parguez’s In defense of the New Deal: Yes we can, therefore I must act, a comparative history revisioning the revisionist economic historians and Perry & Vernengo’s What Ended the Great Depression? Reevaluating the Role of Fiscal Policy counter the conventional “wisdom”. Parguez’s comparison with 1930s France is enlightening:

      If those who confuse the size of the deficits with its positive impact were true, France should not have suffered from increasing unemployment, which was in 1936 certainly higher than in the USA in 1932-33. …Targeting austerity, France got relatively much higher deficits than the USA in 1932-1933.

      The recovery was not complete, and was interrupted by the Roosevelt recession. But it was completed before the war, with increased spending to recover from the 37-38 recession, and the arms buildup before it. For more links on these issues, like Lauchlin Currie’s 1938 memorandum, see my comment here

      • Thanks for this, Calgacus.

      • The Alain Parguez link doesn’t work. In addition, I get a message when I try to go to his site at that is reserved for Warez sites. [If anything knows Parguez, warn him.]

        Calgacus, do you have a name for the doc, so I can search, or another html?

        • If anyONE knows…

        • Yeah, I omitted the initial http in the link, and the software here then prepends neweconomicperspectives to the url and makes it garbage. Either delete that, everything between http and wwwneties in the link I gave above, or follow the link at the end to my previous comment, where there is a good link to Parguez. When I redownloaded the paper a few days ago, I got such warnings too. But that particular Word doc there was still good. I checked the number of bytes against my earlier copy of a few months ago, and as they were equal, it looks like it is the same as it was and safe.

          He has or suggests very interesting comparisons – both to the contemporaneous success of the New Deal and the repetition of history with the Euro. While the Euro forced “sound finance” on the Eurozone, a game which only one can win, FDR’s “functional finance” was shown to be sounder than France’s/ Europe’s “sound finance” and of course accomplished rational public purposes far better. But that very fact makes the New Deal deficits, good deficits, look smaller than they were in effect, measured by comparsion, experience with not so good deficits of WWII, austerity, Reagan, Bush etc.

  5. The US government appears to have run a lot of budget surpluses in the 19th century following the Civil War. These were (I assume) used to pay down foreign debt, and would have drained domestic private savings. As such the domestic private sector would have had to borrow from abroad, given that the country as a whole was a net debtor. Hence Eccles’ statement that: “until approximately the World War period, the requirements of business enterprises for funds with which to develop new capital were characteristically in excess of the supply emanating from the savings of the people. The deficiency was made good by borrowing abroad”

    However as the US paid down its foreign debt whilst continuously running trade surpluses from 1870 onwards, the drain on US private savings gradually came to an end. (The US government also ran budget deficits in the 1890s). As such, what had been inadequate domestic private savings turned into a net surplus of savings, as the US achieved current account surpluses around the time of WWI. During WWI the government also ran a massive budget deficit, further adding to private domestic savings.

  6. Sorry, savings at the middle class level are too low but savings amongst the rich are too high. Too much money at the top and no demand at the bottom. Bailouts should go to the people, and speculation should be stopped, hoarding by the TBTF banks stopped, and prices have to come down.

  7. Money created as Liabilities increases the ability to produce but not to consume the new production. Why? Because government-backed credit creation steals purchasing power from consumers to lend to producers. But that’s stupid since now the consumers can’t afford the new production! And so the producers go bankrupt, the consumers lose their jobs, etc.

    However, money issued as shares in Equity increases both the ability to produce AND the ability to consume the new production.

    So why do we have government subsidies* for money created as debt (credit) over money issued as shares in Equity (common stock)?

    • People usually issue debt instead of equity because debt is usually cheaper to issue. This would be the case even if interest rates were higher and government subsidies of banks didn’t exist.

      To a lender/investor, buying debt is usually less risky than buying equity. This means that equity is usually more expensive to issue than debt. This also means that debt is usually more liquid than equity.

      Short term debt is usually less risky to a lender/investor than long term debt, making short-term debt less expensive to issue and more liquid than long-term debt. This means that short-term debt serves more readily as ‘money’ than either long-term debt or equity.

      • Thanks for the short and I think generally accurate description of the differences between debt and equity financing but what’s your point? I’m not arguing for a ban on credit creation or usury but for the abolition of all government privileges for them. The resulting higher real interest rates would also improve the balance between production and consumption because borrowing for consumption is silly anyway. So the best bet for consumers is to lend to the producers – at the best real interest rates they can get. And if the producers can’t abide those higher interest rates then let them issue shares and accept those shares back for the goods and services they produce.

        Also, monetary reform should include restitution* with new fiat distributed to the entire population so the abolition of government privileges for the banks need not necessarily cause real interest rates to rise. But even if they do, so what? Equity financing is always an option since fiat is only really needed for taxes while those with real capital, including their own skills and labor, can consolidate it for economies of scale by forming a common stock company and, in effect, issuing their own private money.

        *For theft by purchasing power dilution.

        • “but what’s your point?”

          My point is that short-term debt is always more likely to be a form of ‘money’ than equity because short-term debt is cheaper and more liquid. This will always be the case even if real or nominal interest rates are much higher than they are at present, and even if all government subsidies to the banks are abolished.

          The superiority of short-term debt over equity as a form of private ‘money’ is not based on the privileges that banks receive from the government. It is simply a result of basic market dynamics.

          Short-term debt is in most cases cheaper and more liquid than equity, end of story.

          • Short-term debt is in most cases cheaper and more liquid than equity, end of story.

            Then short-term debt should have no problem competing fairly. Or is fairness not the goal?

            • if you got rid of all government subsidies to the banks and, let’s say, interest rates rose in general, i.e. the cost of borrowing went up, then the cost of issuing equity would also go up in general. The difference in cost and liquidity between debt and equity is not based on the subsidies or privileges banks get from the government, it’s simply based on the different characteristics of debt and equity. Equity is more expensive to issue and less liquid simply by its nature.

              Yes banks should have to compete fairly if they are private businesses, but making them compete fairly wouldn’t change the fact that debt is cheaper and more liquid than equity (in most cases) and as such more suited to serve as ‘money’. This is why in the real world we see that people use either government fiat or private debt as money, and only very rarely use equity as a form of ‘money’.

              • Equity is more expensive to issue philippe

                Of course sharing is more expensive than legalized theft! So what? Is that what we want? Especially since the problem now is not production but the just distribution of that production?

                and less liquid simply by its nature. philippe

                Modern communications and computers should make common stock liquid enough for everyday commerce. But if you insist on a government enforced monopoly money supply for the sake of efficiency, well so did the Communists. And they may have learned a thing or two and are willing to try again just as the MMT folks think they can finally make the banking cartel work properly.

                • I don’t think you have understood my comments. The liquidity of debt vs equity has nothing to do with communication or computer technology.

                  Debt is less risky from the lender/investor perspective than equity. From the perspective of the person seeking finance, equity is more expensive to issue than debt. This makes debt more liquid. It has nothing to do with bank privileges or technology.

                  Debt is not ‘legalized theft’. Again, you are confusing things. What you consider to be legalized theft is the bank’s government privileges, not debt itself.

                  As I said, even if you removed all those bank privileges and subsidies debt would still serve as ‘money’ over equity, for the reasons outlined above.

                  You are trying to argue that if all privileges and subsidies for banks were removed people would use equity instead of debt as money. This is incorrect. Your idea is based on a misunderstanding of equity and debt. You are confusing the inherent difference between equity and debt, with government privileges for the banks.

                  As I said before, I agree with you that banks should compete fairly if they are private businesses, and shouldn’t have special privileges or subsidies which allow them to profit unfairly. So please don’t get more confused by thinking that I am ‘the enemy’.

                  Also none of this has anything to do with Communism.

                  • Debt is not ‘legalized theft’. Again, you are confusing things. philippe

                    I’ve never said debt was ‘legalized theft.’ But what we have is essentially a government-backed counterfeiting cartel that steals the population’s purchasing power for business investment and which drives the population into debt for essential consumption like housing.

                    And no, I don’t think equity financing will replace all debt financing or even limited, purely private credit creation. But shares in Equity is an ETHICAL form of endogenous money creation for those who insist (and I agree) that endogenous money creation is good.

                    Y’all best wise up and learn that ethical money creation is rock-bottom essential for a sound, sustainable economy. Gross injustice won’t stand indefinitely.

                  • The fact that you think equity is an ethical form of ‘money’ won’t change reality. The reality is that debt serves the purposes of ‘money’ better and so people use it as a form of ‘money’. Equity is almost never used as ‘money’ in any way. Again, this isn’t because of the “counterfeiting cartel”, it is because of the inherent characteristics of debt and equity. If we got rid of the “counterfeiting cartel” debt would still serve as money and equity not.

  8. John Hemington

    I read the speech directly and am delighted they you have made your translation. However, it might have been useful to the cause had you made some mention that Eccles was giving his speech in the light of a gold-standard world (I’m not certain whether we were still on the gold-standard in 1938, but even if we weren’t that’s the way people were thinking about money — and still are.) Eccles may well have been the finest Fed Chairman of them all; in fact, strike the might, I’m sure he was.

    I’ve read his 1947 testimony on how the Fed and money work and it is nothing short of inspiring — convoluted, but inspired. It was in this testimony in which he identified the real basis for the U.S. having a “national debt”, the Banking Act of 1935, the controlling section which reads:

    Sec. 206. (a) Subsection (b) of section 14 of the Federal Reserve Act, as amended, is amended by inserting before the semicolon at the end thereof a colon and the following: Provided, That any bonds, notes, or other obligations which are direct obligations of the United States or which are fully guaranteed by the United States as to principal and interest may be bought and sold without regard to maturities but only in the open market.

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  10. “but only in the open market.” the Banking Act of 1935

    In other words, any money creation by the US must include paying a toll to rentiers. But that’s fascism, the use of government power to promote private interests and not the general welfare.

    • F. Beard,

      You need to read Frank Newman’s recent book, “Freedom from National Debt” because your understanding of “but only in the open market” is wildly off the mark.

      • Gerry Spaulding

        Everyone should read two books on this – one being Newmans – “Freedom from National Debt”, ostensibly written by a former Treasury official who might know how to achieve such a thing.
        But as a career global Mega-banker CEO and high executive, who served his public two years at Treasury helping get deregulation done, the title of Newman’s book should be “Freedom From Fear of the National Debt”.
        It’s a painstakingly banker-centric view of the obvious benefits of the national debt to the creators, issuers and marketeers of capital and monetary assets, being principally based on the asinine observation that nobody has to pay back the national debt. Ever.
        Totally, “Not to Worry”.

        The other would be Bill Still’s – “No More National Debt”, a ramble through monetary history that includes a chapter on the 1939 Program for Monetary Reform,

        which reform proposal would eventually end the national debt through direct fiat money creation and public issuance, as would the reform proposal of the American Monetary Institute, manifested in the Kucinich Bill HR 2990. Still’s book takes the opposite tack to that of Newman, looking at the public burdens created from private issuance of debt-based money, notably those created by issuing and lending our national currency to our national government.

        Why is it that MMT sells the banker view of our money system in the name of progressive socio-economic reform?

  11. Gerry Spaulding

    Both Eccles and Stephanie are spot on the majors of government initiative and the role of consumption as superior to capital markets and finance as the driving force in real economy.
    Financing consumption through government initiatives in times of potential-GDP deficits will undoubtedly have positive effects on the economy. But the manner of financing those initiatives, whether through public debt or public equity, will also have effects on other important economic trends as well.
    These would include the distribution of wealth away from its producers to the issuers and marketers of debt-finance. Does it make sense, or not, to finance these public initiatives through the creation of new private monetary ‘assets’?
    Does it matter whether the financing of the government’s economic initiative in support of increasing demand in the economy should be done with private debt, or with public equity, as money, so that we all only pay for it only once.
    The Overt Money Finance (OMF) proposal of Lord Adair Turner, former chairman of the UK’s Financial Services Authority and member of the government’s Financial Policy Committee, proposed just such equity-money financing in several recent forums. A report of his proposal has recently been issued by Paul Volcker’s Group of Thirty.
    We are now well served by a discussion of the monetary options for funding government economic initiatives. Should the bankers or the government do the money? And why?

  12. Conversely, when private debt is rapidly expanding, there should be a contraction of public debt as a counterbalancing and stabilizing influence. Eccles

    Then where will the aggregate interest come from? So the population is to be driven into debt they can’t possibly pay in aggregate?

    A rather sadistic game of musical chairs, no?

  13. When aggregate demand is low, non-currency-issuing governments should engage in expansionary fiscal policy by raising taxes on the rich and redistributing the revenue to the poor. Currency-issuing governments, however, should just spend.

    • if there are significant distribution issues within the population the deficit could just accumulate as profits and savings for the rich, couldn’t it? This is apparently what has happened in the US. Because workers have such a weak position and small claim on overall wealth, the govt’s budget deficit seems to result in a massive increase in corporate profits and savings, and only adds to working/middle class savings in the form of paying down debt.

  14. Bank credit allows income, consumption, saving and investment to grow together. Kelton translation of Eccles

    Until it can’t because debt must be repaid, and worse, with interest.

    But there’s no need for a government-backed credit cartel anyway since private money can be issued as shares in Equity, without debt, much less usury.

  15. Gerry Spaulding

    (Stephanie) KELTON: Credit — not savings — makes the world go round. ….. . Bank credit allows income, consumption, saving and investment to grow together.(my emphasis)

    That which makes the world go round – i.e., that which enables the simultaneous expansion of income and consumption, and of savings and investment – can be the more popular ‘bank’ credit, alias, its less popular counterparty, private debt – or it might be money, in whatever form, issued without debt. More relevant in real economic terms would be an understanding of that which actually increases in the economy, regardless of the financing media used.
    That which increases is actually economic ‘purchasing power’. A broad advance of purchasing power in times of economic distress, such as we have today, is ‘that which’ actually enables a sustainable expansion of economic commerce – what is actually needed to keep the world going round.

    As we agree to expand national purchasing power, we should also ask ourselves, by private bank debt-issuance, or by public, debt-free money issuance.

    • Gerry,

      “debt free” government money is basically reserves that earn zero interest. This is what MMT advocates – a zero Fed Funds rate.

      • But what about the stealth inflation tax the government-subsidized banks impose on everyone for the benefit of themselves and the so-called “creditworthy?”

        Do the MMT folks advocate the abolition of those privileges? Not yet they don’t.

        • My understanding is that the MMT folks advocate control of asset-price inflation through other ‘tools’ than changes in the base interest rate (central bank rate/fed funds rate).

          See Mosler’s ‘proposals for the banking system’ and Wray’s ‘what should banks do?’, for example.

          • My understanding is that Mosler wishes to use credit rationing to control price inflation. I don’t see how this can possibly be ethical. Since credit is new purchasing power created via government or government privilege then everyone is entitled to exactly the same amount or else equal protection under the law is violated. Wiki “redlining” for more info.

      • Gerry Spaulding

        Thanks .
        First, please recall that the matter of issuing debt-free money has been similarly proposed by former chair of the UK’s Financial Services Authority Lord Adair Turner in a Group of Thirty paper which I linked to elsewhere, and it has nothing to do with being the same thing as reserve accounting effects. Nobody really cares whether these are required or what their cost structure may be. That is a matter yet to be resolved by the central bank in meeting the need of its payments system to properly function, which is what reserves do.
        That public money be issued at the cost of the federal funds rate, or any rate, raises the question of why there should be a tax on the people for issuing the money needed by the economy.
        There isn’t.
        It’s the people’s money system.
        And neither is there a need for any federal funds rate setting, as the adequate money supply puts the banks in competition for deposits, rather than consumers in competition for loans.
        What we want is for the overnight value to naturally be zero, because the supply of money is sufficiently in excess of the demand to provide cost neutrality.

        I think that arguments advanced as ‘functional equivalents’ in terms of reserve accounting, as a guide to public policy and decision-making, leaves a lot unsaid about the choices that are being made.

        Government issuing money debt-free is an economic policy that is aimed directly at the reduction of both government and private debt, while at the same time that government is achieving its broad macroeconomic policy objectives by providing an adequate money supply.

        At that point – having managed the supply of money – there is no need to manage the cost of money. We will have leveled the playing field for competition among financial(money) intermediaries with sharp pencils.

        • the fed funds rate is the overnight rate. You say you want the overnight rate to be zero, and that it would be zero in your ‘ debt free money’ system. Well MMT also advocates a zero overnight rate. If all government spending results in an increase in bank reserves by an equivalent amount then the overnight rate goes to zero. This is what MMT usually recommends, so the only difference between it and your ‘debt free money’ in practical terms is that the words used are a bit different.

          Just to clarify, you’re not proposing a full-reserve banking system are you?

          • Gerry Spaulding

            Philippe, thanks.
            Yes, totally agree that what MMT wants and what reformers propose – that is, conditions of surplus which result in a natural zero money-lending rate – are on the same street.
            MMT advances the position that excess reserves make that goal achievable. Reformers advance that a surplus of ‘money’ will do so, freeing the authorities from managing the money supply via interest rate targeting using either IOR or OM operations as policy.

            And, yes, in one sense, full-reserve banking can accomplish the economic goal of financially stable, anti-cyclical real (permanent) money creation. So, many reformers, including the proposal of the UK’s Positive Money, as well as the proposals of those who studied the post-’29 Crash during and after the gold standard, such as Simons, Fisher and Friedman, all advocated for a full-reserve system as the basis for reform. It’s almost uncanny that MMT ignores this progressive history.
            What I would propose as the money-management mechanism would be as contained in the Kucinich HR 2990 proposal, which is a complete abandonment of the gold-standard, reserve-based system of money creation and issuance.

            When banks can only lend real money that real people and businesses knowingly lend to the banks for on-lending purposes, what is there to ‘reserve’ against?
            But either full-reserve or non-reserve banking can accomplish the stability-inducing quality that should be the goal of monetary policy.
            Even Minsky picked up on this truism and advocated for consideration of 100 Percent Money later in his career as this Levy Institute research paper shows –

            Pushing the interest-rate string, again either with IOR or OM operations, in order to control the supply of money that is, in reality, issued completely independently as debt by private bankers, as a means to control inflation(or deflation) of the general price level, should have run its course a long time ago.

            If money is issued debt-free by the governmental monopoly issuer of the currency – in REALITY – then there is no need for reserves n order to have a well-functioning payments-settlement system.

      • Gerry Spaulding

        philippe, thanks.
        Except that reserves are not money, and debt-free money is money.
        MMT has two pictures that flash back and forth and need to become conjoined in order to advance the discussion around modern money.
        In its advocating for PK deficit spending to support GDP-potential – MMT advances a ‘real money’ economic issue. This goal can only be accomplished through what both Friedman and Turner call ‘the income stream’. That’s the ONLY way to increase GDP, or the economic utilization of idle real resources.

        However, whenever MMT kicks the ‘what is money’ hackey-sack around the cadre, we end up discussing reserves as a twisted, stylized form of its ‘money-ness’.
        No matter how you stylize it, reserves do not enter the income stream and can NEVER make any contribution to economic prosperity through fiscal-monetary policy mechanisms.
        philippe, I know the shtick on functional equivalence that goes around the barn at MMT. It is nigh onto parochial in the sense of monetary science, and leaves way too much unsaid.
        What I am looking for is not “accounting” equivalence, but political-economy equivalence. Who issues the money, and how, is a political-economic construct not advanced at all by the MMT ‘unit-of-accounting’ school.
        Thus, we never get to discuss real economic democracy, as we become increasingly ‘fogged-out’ by accounting and ‘keystroking’ logic.
        But I’m extremely grateful for the opportunity to say so.

  16. Perhaps someone could explain how these trillions now stored away as undistributed corporate profits are to find their way into the economy? Are those private equity in the traditional sense of partial disbursement in dividends, or do they reach a point where the accumulation becomes “too big to disburse?” The options would seem to be tax them back into circulation or debase them – given the current political intransigence to actually govern, I wonder what Eccles would advise – perhaps jacking up the capital gains tax to above the income tax rate for a time?

  17. Gerry Spaulding

    (Stephanie)KELTON: We solved one problem but created another. Now we have too much saving and not enough investment.

    Definitely agree that banks and corporations are hoarding rather than expanding production and employment, but is that lack of investment and production the ‘real’‘problem, or another symptom of the problem? Isn’t the real problem the existence of too much private debt and not enough spendable money for servicing that debt– the reduction of which (debt) will actually create demand, causing an economic expansion of production?
    If the problem IS really too much debt, given the public’s income stream, then any penchant for solving that problem by additional debt ‘issuance’ could be perhaps counter-productive.

  18. Pingback: Stephanie Kelton: Reading Between the Lines – A Memo from Fed Chairman Marriner Eccles « naked capitalism

  19. Dr Skelton –
    Thank you for disclosing this document in the economics blogosphere. It contains information I’ve been looking for, but wouldn’t have found otherwise, so I’m more interested in what Eccles does say.
    I independently inferred the persistent excess capital issue, but found little discussion in the economics blogosphere to support that. You show that it has been known for a lifetime.

    “The inflation of security values resulted in a vulnerable financial structure, the collapse of which was an important contributing factor to the depression.”
    – is a credible establishment characterisation of the GFC also. We seem not to have learned.

    “Instead of a scarcity of funds for the needs of business enterprise, there tends to be an excessive supply of available investment money, which is productive not of new capital goods but of financial maladjustments.”
    If true now, this implies that any economic theory that assumes capital to be limiting is invalid, and should not be used pending modification.
    ” I seriously question whether this rule, and the economic philosophy based upon it, is valid under present and prospective conditions.” Do you?
    Also, unless addressed, this type of problem will recur.

    May I suggest this as a new topic:
    > Is persistent excess capital a key destabiliser of the macroeconomy?
    > If so, how can a “balanced” capital:spending ratio be maintained?

    Note that a capital-gains tax may prevent the problem, but can’t resolve it once present. I only see alternatives of confiscation, large-scale philanthropy, or inflation higher than capital-accumulation. The last is the do-nothing option, so most likely.

  20. If we got rid of the “counterfeiting cartel” debt would still serve as money philippe

    Actually, some debt-free fiat is possible since if the monetary sovereign* never runs budget surpluses and sometimes runs budget deficits then fiat will accumulate in the economy to the sum of those deficits since that fiat can never be extinguished by taxation. So the population would have fiat in excess of their tax liabilities. And Assets in excess of Liabilities are called Equity, not debt, no?

    So some fiat can be Equity too.

    and equity not. philippe

    Since honest lending of existing fiat or purely private credit creation would cause real interest rates to rise**, you can’t really know that with certainty. Of course business might try to issue its own script instead but workers should have none of that since the abuses of the company store are well known.

    But in any case, government-backing for the banks has to go for philosophical reasons alone since it is welfare for rich. But welfare should be limited to those who need it.

    * Ignoring the central bank since such an abomination should not exist in the first place.

    **All other things being equal. However, a one-time distribution of new fiat, ala Steve Keen, would tend to drive interest rates down.

  21. I was referring to private forms of ‘money’. Government fiat money can be accounted for either debt or equity, but neither of those terms mean the same thing in the context of the government. They’re slightly arbitrary terms.

    “Since honest lending of existing fiat or purely private credit creation would cause real interest rates to rise”

    If real or nominal interest rates rise then the relative cost in general of issuing equity would also rise.

    • If real or nominal interest rates rise then the relative cost in general of issuing equity would also rise. philippe

      Because the share price would fall because the company would be less profitable? But if a company did not ever borrow in the first place then rising interest rates would not affect its profits but they would affect the profits of its competitors if they were borrowers. So the non-borrowing company should see its share price increase, at least relative to its borrowing-competition, if interest rates rise.

      • An investor has a choice between investing in debt instruments (lending) and investing in equity. If interest rates rise this means investors can get more for their money from debt. i.e. if interest rates go from 1% to 10% it obviously becomes far more attractive to buy debt. As such an investor would require an equivalent increase in value offered by equity – they would require more for their money from equity.

        Think about it, if the base interest rate is 10% you can get around that much just by putting your money in a bank. To tempt you into buying equity instead, the equity issuer would have to offer a higher rate of return overall, given that equity is generally more risky than short term debt. So as interest rates rise, the cost of issuing equity also rises, in general.

        Of course each case is slightly different, but this is a general rule of thumb.

        • If interest rates rise this means investors can get more for their money from debt. i.e. if interest rates go from 1% to 10% it obviously becomes far more attractive to buy debt. philippe

          But who cares? The share price of a company is ultimately determined by the demand for the company’s goods and services. And if the company insists on its own shares to pay for those goods and services, that will drive the value of its shares up and the value of debt down as people sell their debt instruments to buy those shares.

          • you’re getting things back to front. If you have a company and you want to buy equipment or materials from my company, you can offer to pay for them with cash, your own stock, or credit. Either you can borrow the credit from me or you can borrow from a bank. Accepting your stock in payment is the most risky option for me, so I would charge you a relatively higher price for payment with stock. This means that paying with your own stock is the most costly option for you. And if interest rates rise, the relative cost of paying with stock will also rise, in general.

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  23. to solve the u.s economy you need 2 do 1 of 2 things

    tax the federal reserve or tax the church

    simple & easy