Ring-Around-a-Morgenthau

In trying to finance the war without bringing on inflation, Treasury Secretary .Morgenthau has been forced to do part of it with mirrors. These mirrors were being used again last week in the Fifth War Loan.

Maypole Dance. To avoid credit inflation, Mr. Morgenthau ruled that not a nickel of his $16-billion Fifth War Loan could be sold to commercial banks. This rule has, to a considerable extent, been circumvented. A good part of the Fifth, like 20% of the previous War Loan, which was similarly restricted, is being financed by bank credit. This is easily done to get the cash with which to buy the current loan, insurance companies, savings banks and other investors "dump" Government securities by selling them to commercial banks. With the proceeds they buy bonds of the new issue. Naturally, this has exactly the same inflationary effect as if the banks bought war bonds directly.

This ring-around-a-Morgenthau is generally danced with the highest patriotic motives--although it makes Mr. Morgenthau, as the unwilling Maypole, look a little sheepish. Sometimes the dancers are not even aware that they are circumventing the rule that he set up as a bar to inflation. For example, one person sells non-Government securities to buy war bonds,/- The securities are bought, in turn, by a second person, who sometimes sells Government securities to get the money with which to buy. The banks in their turn, buy these--just as they buy other Government securities in order to invest their idle funds. Thus this sort of "sale" of war bonds is a triangular bookkeeping transaction rather than any sponging up of inflationary cash; and it circumvents entirely Mr. Morgenthau's intention that the little man's spending money, along with business' excess funds, should be drained off into war bonds.

In addition, the commercial banks do a land-office business in making big loans to those who purchase war bonds: $7 billion during the First drive; $1.3 billion during the Second; $1.7 during the Third (Federal Reserve figures for 101 cities).

Free Ride. Some of these loans were to speculators, i.e., "free riders," who borrowed from the banks at an interest rate lower than that paid on the bonds. Subsequently they sold the bonds, profiting by the difference between the interest rates over the period they held the bonds. This practice was sharply curtailed during the Fourth Loan. Result: bank loans for the purchase of Government securities declined to $.9 billion. Most of these loans, of course, are paid off and the bonds held. But "dumping," combined with the "free riding," had boosted bank holdings of Government securities by about $13,000,000,000 since the First War Loan. Result: these factors, plus the bank purchases of new Government securities, have boosted total bank holdings of Government securities to $64,100,000,000, an all-time high, and constitute about one-third the national debt.

Between war-bond drives the banks often have to sell part of their holdings of Government securities in order to maintain their legally required reserves. The most practicable way to do this is to sell Government securities to the Reserve Banks. So large a volume of these sales has occurred that by last week Reserve Banks held $15,000,000,000 in Government securities ($9,100,000.000 in Treasury bills), an $8,400,000,000 increase in ore year, and an alltime peak. The enormous currency draw on the banks, a $5,100,000,000 increase in cash in circulation in the year, has been the main factor reducing reserves and forcing the commercial banks to resort to the Federal Reserve, who now hold about 8% of the national debt.

For Reserve Banks to buy & sell Government securities in the course of regular business is perfectly normal. But Reserve Banks in buying securities are creators of money--not only of bank deposits, which they can create by writing checks, but also of folding money (Federal Reserve notes), which they can print as needed. Thus a small portion of Henry Morgenthau's war financing has already been taken care of by a first cousin of the Government Printing Office.

Front Door to Inflation? This use of the commercial and the Reserve Banks measures the degree by which Mr. Morgenthau, even with mirrors, is failing to finance the war by noninflationary means.

Despite the success of the War Loans, which has seemed to come about by many small individual purchases, the banks have actually carried almost half the load. But the full extent of bank participation has been overlooked under the flood of bond posters, brass bands and mutual congratulations. And the bonds which banks have acquired indirectly, i.e., through loans, etc., measure the extent to which Secretary Morgenthau has failed to sop up increased public purchasing power, while taking credit for doing so.

As long as the public hangs on to this cash--as it is now doing--inflationary results will not be felt. But when the public begins to spend, i.e., to prefer goods to cash, the results will show. If this occurs while the war is still on and goods scarce, the U.S. will have much to worry about. But if it occurs during a possible reconversion slump and eases the U.S. into prosperous times, he can shake hands with himself.

/- Examples: Metropolitan Life Insurance Co. is selling $10,000,000 of municipal bonds for this purpose this week; John D. Rockefeller Jr. proposed last fall (but later changed his mind) to sell $25,000,000 worth of Standard Oil stock for the same purpose (TIME, Nov. 1).

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