The Public Debt and the Private Citizen


By WINTHROP W. ALDRICH, Chairman Board of Directors, The Chase National Bank of the City of New York

Delivered at a Luncheon Meeting of the Boston Chamber of Commerce, Boston, Massachusetts, December 12, 1940

Vital Speeches of the Day, Vol. VII, pp. 185-189.


OVER the past six months, the United States has embarked upon a defense program of great magnitude. The invasion of the Low Countries and the collapse of the French defenses forced a quick reappraisal of our strategic relationships in the Atlantic and the Pacific. We became convinced that it was only through making ourselves strong that our way of life might be preserved in a world in which democratic idealism was being replaced by the policies of dictatorial powers. We abandoned the illusion that we could insulate ourselves from a Europe in which destructive forces were rampant. Historical experience should make us realize that we are a part of the whole complex of world forces, and that we must, in the future, try in a more active way, to shape those forces in the interests of world peace and in the preservation of man's freedom.

This afternoon I wish to discuss the defense program in its economic and financial aspects, to call attention to the costs that are involved, to indicate the ways and means of financing these costs, and to emphasize the relation of that program to the private citizen. The magnitude of the defense program is, at the present time, little appreciated. We are still in the initial stage of rearmament, and the economic effects have not yet made themselves apparent.

The sums already involved are far larger than is generally realized. The defense appropriations by the third session of the 76th Congress came to nearly nine billion dollars. Contract authorizations came to an additional eight and one-half billion dollars. Together, these total seventeen and a half billion dollars, a sum which exceeds the total ordinary expenditures of our federal government for the entire thirty year period prior to our entrance into the first world war. This sum is more than 24 per cent of estimated realized national income for 1940. To the appropriations and contract authorizations already voted by the present session of Congress, large additional amounts for defense will doubtless be added by the next Congress. These vast sums, of course, are in addition to the ordinary expenditures of the government for which Congress, at this same session, appropriated five billions, 300 millions. That amount did not include 154 millions representing permanent, special and indefinite appropriations, nor did it include interest on the public debt estimated at one billion, one hundred million dollars.

Prospective defense expenditures caused the Secretary of the Treasury to suggest, in a recent press interview, that the Congress would be requested to increase the federal debt limit to 60 or 65 billion dollars. He added that such an increase would suffice until June 30, 1942. On the assumption that the lower, rather than the higher, debt limit is required by deficit financing, total gross federal debt eighteen and a half months from now will amount to 60 billion dollars.

Our federal debt, direct and guaranteed, will be further increased if the federal government decides to extend direct financial aid to England. There will be much discussion in these coming weeks about the extent and nature of the financial aid we are prepared to give. Many ingenious proposals have already been made, some of which seem designed more to avoid raising the issue on the floor of Congress than to settle it on its merits. The impression seems to prevail that the Johnson Act and the Neutrality Act are somehow involved. The fact is, however, as I am reliably informed, neither act prohibits our government from giving direct financial aid to Great Britain, though both interpose barriers against private citizens or corporations giving credit to the British government or to any agency of that government. So it would appear there is nothing in the law to prevent the United States government from giving credit to Britain or from making an outright grant-in-aid to Britain. Whether it is desirable or not to amend the Johnson Act and the Neutrality Act so as to permit private grants of credit to Great Britain is a matter relatively of small importance.

Both political parties have declared it to be the American national purpose to give every aid to Great Britain short of war. If that pledge means anything it means that our full industrial and financial strength shall be thrown into the scales on the side of England. Let us meet the issue head-on without subterfuge or evasion, and put it directly up to Congress to provide Britain with the funds she will need urgently in the near future. These funds can be furnished by a federal guarantee of British credit, by a loan from the United States Treasury, or in the form of an outright grant. For the purpose of the present discussion it makes little difference which method of dealing with the situation is followed. The main point is that the funds be available when needed.

Our aid should be given promptly and generously, before England's financial sands have run dangerously low. It should be extended before she has utilized her last remaining dollar assets, before she has exhausted the last of her other foreign resources. England is valiantly defending the ramparts of the democratic world, including our own. We can no more afford to have England break down financially than we can contemplate her defeat in this war. In both cases our own interests are vitally involved.

Now, it goes without saying that our own defense program plus what we must do for Britain puts a great load on American productive capacity. It has been estimated that, over the next eighteen months, total direct purchases in this country by the American and British governments will absorb 25 per cent of the capacity of our steel plants, and that the indirect purchases of these governments will increase this figure to 50 or 60 per cent. A large part of the recent improvement in rate of operations in the textile industry is a direct result of our war orders. Our aircraft and machine tool industries are now almost entirely occupied in filling military requirements. The capacity of our shipyards must be greatly expanded to meet the need for warships, not to mention the enormous need which is sure to develop in the immediate future for merchant vessels for England and for ourselves. The influence of army and navy orders is being felt in various other industries, including heavy machinery, hardware, men's clothing, and lumber. I believe it is safe to say that two-thirds of the unfilled orders of the electrical equipment industry are government orders. Thousands of dwelling units must be constructed to house those now being employed in the defense industries, and the railroads will need additional freight cars because of the primary and secondary effects of the program.

The United States will emerge from the program, as it is presently conceived, with a two ocean navy composed of 645 combatant ships in addition to a vast number of auxiliary vessels, a naval personnel of about 550,000 officers and men, naval bases on the Atlantic seaways, with perhaps 25,000 airplanes, and a trained army of at least 1,500,000 men. Unless we can be assured of lasting peace, this armed establishment, once developed, must be maintained, and this in itself will involve continuously heavy charges on the budget.


A program of this magnitude must necessarily give rise to sober reflection on the ability of the economic system to produce the goods required, and to careful consideration of the accompanying fiscal policies.

In a broad way, the defense program simply involves channeling a smaller or larger part of our productive capacity into the procurement of armaments. It will probably be larger, rather than smaller, for the experience of all nations is that modern defense programs, and participation in actual warfare, take a very large share of the real national income. In England and Germany, well over 50 per cent of the national income is being absorbed by war expenditures.

To a certain extent, the goods required by the American defense program can be obtained through an increase in productive effort. How much can be obtained in this fashion depends upon the tempo of the program, the available supply of workers trained in the particular skills required, the possibility of training additional workers quickly, and the existence of idle plant capacity in the defense industries. As we know all too well, we have been suffering in this country from an excess of plant capacity and a long period of unemployment, representing together a very considerable slack in our industrial processes. In some departments, such as the airplane and the machine tool industries, this slack has already been taken up. As the process goes further, we shall be faced with the need to curtail non-military consumption.

We deceive ourselves if we think we can have the cannon, the tanks, the airplanes, and the ships that our military andnaval establishments require, and still fully meet civilian demands for durable goods. Already priorities of an informal character have been adopted and, with the lapse of time, additional priorities will probably be imposed. Priorities are in reality merely another name for rationing. But happily, in this fertile country, we do not have to choose between cannon and butter. We can have our cannon and butter too, even if we do not have to limit our demands for new model cars.


The financial problems of the defense program, the counterpart of the industrial problems, arise from the need to channel a larger share of the nations money income into the hands of the government. To obtain the funds required for governmental expenditures, should exclusive use be made of taxation? Should appeals be directed to investors? Should resort be had to the expansion of currency or credit? What consequences flow from the sale of the public debt to commercial banks as opposed to investors? Can we so finance the program that higher commodity prices will be avoided? Which of these financial and fiscal measures serve best the interests of the private citizen, in the short run and in the long run?

Categorical answers obviously cannot be given. The answers will depend upon the existing fiscal situation. We must build upon what we have. Unfortunately, the fiscal position of the federal government is not relatively as strong as it was at the beginning either of the Civil War or of the first World War. The national debt is large, and less elasticity remains in the federal tax system. In the past decade, the federal debt has risen by 28 billion dollars, and federal taxes have been increased sharply. We are inaugurating our defense program from a high plateau in public debt and taxation. In 1917, we entered war with government costs low, with a modest debt, and with a tax system that could readily be adjusted to the changed conditions. Our present situation is much less happy.

Conservatism in fiscal policy demands that the costs of the defense program should be financed, as far as possible, from taxation. Past experience has shown that this is the most desirable method of obtaining the funds required for military use. Armaments, however necessary, are economically non-productive and should not, unless this is unavoidable, form the basis of debt increases. Taxation has the advantage of reducing non-military consumption and, in consequence, of releasing productive facilities and materials for defense requirements. A reliance upon taxation minimizes also the danger of expansionist increases in bank credit and makes easier post-defense financial and economic readjustments.

To the principle that as large a share of the defense program as possible be financed through taxation, I hasten to add several necessary corollaries. In the first place, non-defense expenditures should be curtailed sharply. In the second place, the federal tax system should be revised and thoroughly integrated to make a harmonious whole. Taxation itself should not be pushed beyond the limits of productive return. The limits to taxable capacity, the incidence and economic effects of taxation, should receive most careful consideration. Tax rates should not be so high that productive effort is impaired, that incentive is reduced, or that corporations are unable to maintain plant equipment. The limits to taxable capacity are determined by factors partly psychological and partly economic. Involved in this most complicated problem are the willingness of individuals to reduce their living standards, and the ability of the nation to endure further taxation without impairment of its productive equipment.

Even though the tax system be reformed and tax increases be provided, the defense program will no doubt be financed to a great extent through public borrowings. There was a time when public debts were looked upon with disfavor. But in recent years, public debts have often been taken as the mark of a civilized nation, and the lavishness of governments has been defended as enhancing the well-being of private citizens.

Formerly, we adhered rigidly to a belief in a balanced budget. Debts accumulated in emergencies were reduced in succeeding periods. The Civil War debt could have been completely retired in the early years of this century, had not a public debt been required for the backing of the national bank notes. The World War debt was reduced from 26 billions to 16 billion dollars in the decade of the Twenties.

In recent years, a belief in the wealth-creating powers of federal deficits has had wide currency and has underlain the fiscal policies of this country. In consequence, the public debt has increased rapidly. The spending program of the government first rested on the belief that government expenditures, whether for purposes economically productive or not, should be used to offset business depression. To this initial belief, the doctrine has been added that government expenditures should be used to offset the alleged stagnant forces in our economy, or, in other words, that public investment should be substituted for private investment. Whatever the rationalization of the spending program, I submit that it has not only failed to realize its objective of full employment, but has left the country in a weakened financial condition to embark on the defense program.

To the extent that public borrowings are required by the defense program, every effort should be made to sell the issues floated directly to private individuals and to savings institutions. As far as possible, the sale of securities to commercial banks should be avoided. The sale of the Treasury's obligations to endowed institutions, savings banks, insurance companies, and individuals rather than to commercial banks, has a double advantage. The private demand for goods is reduced and commercial bank deposits do not rise. The dangers of credit excesses are rendered less.

The mistake made in the World War of encouraging individuals to borrow from their banks to buy Liberty Bonds should also be avoided. This practice proved a powerful stimulus to forces of expansion, and experience is convincing that individuals should be encouraged to purchase government obligations from their own accumulation of capital. The extent to which individuals will be able to buy government bonds from savings will depend, of course, upon how far those savings are depleted by taxation or increased by lessened consumption.

Through the first year of the war, England has followed many fiscal policies that might be emulated here. Every effort was made to sell obligations directly to investors. Relative to the magnitude of the costs of the war, reliance upon bank credit expansion was small. British fiscal policy safeguarded the interests of the private citizen. His interests suffer if defense or war requirements are met by inflationary credit expansion. Commodity prices are bound to rise. In consequence, those groups in the community powerless to obtain wage or income increases are the ones who bear the heaviest burden. This situation inevitably calls forth a demand for the imposition of totalitarian controls, for controls over prices, over wages, over individual choices as to spending and saving, in short, over every phase of economic activity. In the sense that they lead to totalitarian controls, inflationary methods strike at the very heart of our democratic institutions.

In putting forth the suggestion that government obligations be sold to endowed institutions, savings banks, insurance companies and individuals, I realize that the easier course administratively is to sell defense obligations directly to commercial banks. Little effort need be exerted. Greater effort would be required to sell obligations to investors. Loan drives would have to be instituted and higher rates of interest would have to be paid. A break would have to be made with the easy money policies of the past.

The easy money policies of the federal government are incompatible with the principle of thrift which is so necessary if private citizens are to subscribe for government obligations. These policies have such a direct relation to the financial problems of the defense program that consideration of them is germane to the present discussion. Recently they have been subjected to general discussion, and differences of opinion have risen between public officials and others as to their desirability. That the existing low level of interest rates reduces the borrowing costs of the federal government is generally recognized. However, in the determination of policies affecting interest rates, the narrow pecuniary interests of the Treasury should not dominate. The public welfare must be given primary consideration. It is not conducive to the public good that rates of interest remain artificially low for reasons which will presently appear.

By easy money policies, I mean the reduction, through monetary means, of rates of interest below where they would have ruled on the basis of the savings of the community. In this country, interest rates have been forced to extremely low levels. The unprecedentedly low interest rates have not been beneficial on the whole to the private citizen. They have not activated private enterprise, as was alleged would be the case. They have penalized thrift and discouraged savings. They have diminished the incomes of all who have savings accounts, and of all who hold life insurance policies. The extremely low interest rates have encouraged governmental extravagance. They have forced changes in the portfolios of commercial banks which are advantageous neither to commercial banks nor to the community at large. Commercial banks have been forced into long-term investments and long-term loans. Their assets have tended to become more immobile.

Since the beginning of 1934, our easy money policies have taken the form of marking up the price of gold, of the failure to sterilize gold imports,—that is, the failure to set gold aside so that it does not become the base for an expanding volume of credit—and of the purchase of silver. The spending program of the federal government has caused government authorities to exercise their influence in the direction of easy money. Federal deficits have reduced the demand for commercial loans, and commercial banks, to cover their modest operating costs, have purchased a large proportion of the increase in the public debt, though sold at abnormally low interest rates. The fact that commercial banks hold a substantial amount of long-term bonds, and the fact that higher rates of interest will increase the costs of our federal government, make a break with the extremely easy money policies of the past six years very difficult. Nevertheless, a break must be made. Present artificially low interest rates cannot be continued indefinitely. The sooner the change comes, the smaller will be the financial, economic, and social costs, and the less the danger of the imposition of totalitarian controls on our credit and capital markets.

The core of the easy money policies is to be found in the present large volume of member bank excess reserves; consequently, a reversal of these policies requires a reduction in excess reserves. The existing volume of excess member bankreserves, i.e., deposit balances with the Federal Reserve Banks over and above legal requirement, are of primary significance. They are responsible, on the one hand, for the present low level of interest rates and provide, on the other hand, the basis for a huge multiple expansion in credit. If the credit expansion takes place that is potentially possible, we will experience the sort of thing witnessed in the last war and again in the decade of the 'Twenties. Each was a period of rapid credit expansion, followed by a severe depression.

Member bank excess reserves have increased in the main as a result of the gold inflow and of the failure of the government to sterilize gold imports. Up to the outbreak of war in 1939, the gold inflow, itself, resulted from a capital influx of unprecedented proportions, due to the abnormal conditions then existing, and since that time has resulted from war purchases by the United Kingdom and her Allies.

The effect of the gold inflow upon the commercial banking system is not generally appreciated. It brings about an increase in total and excess reserves of the Federal Reserve Banks; an increase in total and excess reserves of member banks; and an increase in the deposit liabilities of the commercial banks themselves. The excess reserves of the Federal Reserve Banks now amount to about 12 billion dollars (1) and those of all member banks to about 7 billion dollars.

The total reserves of the Federal Reserve Banks and of member banks (2) would not have risen if the Treasury had sterilized gold imports. Had it done so, it would have paid for the gold from funds borrowed rather than through the issue of gold certificates. A gold sterilization program involves a rise in the gross public debt. But this is an increase that does not adversely affect the private citizen. It is a debt incurred by the gold purchased and the interest cost on that debt is small in comparison with the social gains of such a policy.

The treasury did follow a sterilization policy from December, 1936, to April, 1938. The policy of gold sterilization, coupled with three increases in member bank reserve requirements, reduced excess reserves to manageable size. Had the policy of gold sterilization been continued, member bank excess reserves would have remained in this condition (3) The credit system would have been divorced from a gold inflow of abnormal size and growing out of abnormal conditions.

As it was, the policy of gold sterilization was abandoned. Member bank required reserves were reduced slightly, and excess reserves, in consequence of the continued gold inflow, rose to their present huge totals. The very magnitude of the problem makes a change much more difficult now than in 1937. However, a change must be made if the private citizen is to be given safeguards against uneconomic expansions of credit.

I believe there is still time to take measures which do not have the totalitarian taint but which may keep credit expansion within reasonable bounds. I know that this suggestion runs counter to the belief that dangers of creditexcesses do not exist while there is a large body of unemployed. I know it is contrary to the doctrine that a rising internal debt is no source of danger irrespective of the purpose of that debt, irrespective of its distribution, and irrespective of the way in which it was financed. These doctrines, in my opinion, lack valid foundation and should not be used as a justification for the failure to terminate easy money policies, for the failure to exercise prudence over governmental expenditures, and for the complacency with which the increase in public debt is viewed.

It is in the interests of the private citizen that measures be taken to bring an end to extremely easy money policies and to check excesses in credit expansion. These constitute one part of a conservative financial program, of which the sale of the public debt directly to investors constitutes another important part. The measures that I would suggest to be taken follow:

1. that gold coinage and gold redemption be reintroduced;

2. that future additions to the gold stock be sterilized;

In connection with this suggestion, it should be provided by Congressional enactment that any increase in the debt by reason of gold sterilization be exempt from the debt limit and that the gold so sterilized should be de-sterilized only with the approval of the Open Market Committee of the Federal Reserve System. The approval of the Open Market Committee should also be required for the use of the unused portion of the profits of gold dollar devolution;

3. that the Exchange Stabilization Fund, resulting from gold dollar devaluation in 1934, be used to grant credits to foreign nations or to others only to the extent of the $200,000,000 in the active account. Credits extended above this amount should come from the general funds of the Treasury. Otherwise member bank excess reserves will rise;

4. that the monetary powers now vested in the President be withdrawn. Powers of credit control and of money market control should be returned to the Federal Reserve Banks. They were established to exercise such powers and only if they exercise them can they once again perform the traditional role of central banks as "keeper of the government's financial conscience";

5. that the Board of Governors of the Federal ReserveSystem raise member bank reserve requirements to the maximum now permitted by law. This will reduce excess reserves by over one billion dollars;

6. that the Board of Governors of the Federal Reserve System use the powers granted under Section 11e of the Federal Reserve Act to add to the number of cities classified as Reserve and Central Reserve Cities;

7. that the Board of Governors of the Federal Reserve System be granted, under adequate safeguards, additional powers to raise member bank reserve requirements. Doubtless, these powers should not be used until sufficient time has elapsed to note the effect of the measures already suggested. When administrative increases in member bank reserve requirements are made, the increases should be sufficiently large to bring total excess member bank reserves within the scope of control of the open-market portfolio of the Federal Reserve Banks;

This suggestion is frequently criticized on the ground that it immobilizes gold in the banking system, making its repatriation impossible. It must be remembered that there is no more complete way to freeze gold in the credit system than by credit expansion based on it. If an outflow of gold should develop in the future, it could be met by the use of the unused profits of gold dollar devaluation, by the use of gold held in the Treasury's inactive account, and, if necessary, through a reduction in member bank reserve requirements;

8. that expenditures for non-defense purposes be vigorously reduced.

The various measures suggested above have a direct bearing on the welfare of the private citizen. To safeguard his interests, the increase in public debt incident to the defense program should be lodged as far as possible with investors. Government securities should not be coined into commercial bank credit. Increases in fiat credit are quite as harmful in the long run to the body economic as are increases in the fiat currency. Dictates of prudence require that the public deficit not be so financed that the defense program will assume a feverish character to be followed by an equally severe slump. Only by following conservative fiscal policies will the private citizen be protected, and will our industrial machine operate most efficiently to bring the defense program to a successful conclusion.

(1) Assuming that the Board of Governors of the Federal Reserve System permits the Federal Reserve Banks, as it may under Section 16 of the Federal Reserve Act, to offer direct government obligations as collateral for Federal Reserve notes.

(2) If payments for gold imports had been made by selling Treasury obligations to member banks, their excess reserves would have declined by reason of the increase taking place in their deposit liabilities.

(3) To prevent excess reserves from disappearing completely, the Treasury would, from time to time, have had to de-sterilize an amount of gold sufficient to provide the additional reserves required by the increase occurring in member bank deposit liabilities and to offset the effect on member bank reserves of the increase occurring in the volume of money in circulation.