The Federal Reserve Board bade fair last week to bring upon itself direct government control, and will get just that before long, if it continues to withhold its support from the government bond market. It has excluded Morganthau, the President's chief fiscal officer, from its meetings, apparently with the intention of following an independent "we-know-better" policy of deposit contraction (credit deflation) to offset whatever attempts the President may make to finance the Recovery Act with government bonds. Happy the fate of these self-appointed Watchers Over the President if through obstinate resistance to the administration they bring about direct government control of the Federal Reserve System as the first step towards nationalization of the entire banking system.

In order to finance relief and recovery projects during the coming winter and long thereafter, the government will have to issue bonds, the proceeds of which will be directly or indirectly spent by the government and put into active circulation through public works, relief, or the R. F. C. And the process of issuing bonds is more than a gathering together of idle deposits in the hands of timid investors. It is the creation of new bank deposits backed by the bonds themselves; bank-deposits which are exactly as effective for government expenditure as an issue of flat money.

But the Federal Reserve Banks can make or break this process of deposit creation by buying or selling government bonds themselves in the open market. For if they sell bonds, the cash positions of member banks are weakened, and these member banks become correspondingly less willing to lend money, to create deposits against government bonds or anything else. And the depression in the bond market, which results is what people mean by a destruction of government credit.

It is because the Federal Reserve System thus holds in the palm of its hand the whole program of government deposit creation that official or unofficial Administration control is imminent. For the banking system, by virtue of the innumerable camouflages which it affords for direct "flat" purchasing power expansion, has been chosen by the government as its printing press, and it is unlikely that the government will idly watch Nine Men throw monkey wrenches into the equipment.

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The Budget Director is whooping it up again about the Burden of Government Extravagance falling upon the Middle Class Taxpayer. Perhaps Mr. Douglas will one day understand that the government's budget is not like the budget of an individual or a corporation; that the government controls the printing office and can therefore use it if it sees fit, whether under the camouflage of an unbalanced budget or under no camouflage at all.

There is no limit to the quantity of bonds which the government can float, simply by virtue of the control which it can exercise over the Federal Reserve System through the enactment of some simple legislation. If it became necessary, for example, a slight change in the existing laws relating to the Federal Reserve System would make possible the direct sale of large quantities of government bonds to the Federal Reserve banks against the creation of deposits in the account of the government.

As for Mr. Douglas' Middle Class, there is only one justification for retiring government bonds with taxpayers' money; for destroying their, the taxpayers' purchasing power in order to cancel government obligations; and that is the maintenance of a reasonably stable price level. Any other excuse for canceling bank deposits in order to balance the government's budget is insupportable. The fact remains, as always, that the danger, the only danger, which can attend a manipulation of the quantity of purchasing power is a violent change in the price level. And insofar as such a change in the price level will not attend an expansion of purchasing power, let the government go ahead and issue bonds and fail to balance its budget as far as is necessary to the successful execution of its recovery and unemployment relief program. The specific result of such an expenditure of government flat would be a stimulation of physical production which would, as soon as it reached the markets, exert a downward influence on prices sufficient to offset the initial upward influence of the new purchasing power. And the elastic limit of physical production in this country is still a long way off.

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So it is not unreasoning to suppose that the President knows what he is doing in the matter of gold buying. For he knows that the cry of terror about the government's credit is meaningless in view of the ever present possibility of forcing the sale of an unlimited quantity of bonds to the Federal Reserve Banks at par. And perhaps he only pretends that he expects to raise prices by buying gold, that he even expects or wants to raise prices at all. A good way of convincing foreign countries that the gold buying policy is not intended "artificially" to stimulate American exports would, after all, be to make them think that the whole business is nothing more than an ill-conceived device for raising the domestic price level. And perhaps the President has been doing just that. Whatever may have been his announced intentions so far, what he has actually done is to increase the quantity of purchasing power in circulation through gold purchases and through bond issues, and what he has not done is to precipitate anything which could be called a drastic rise in the price level. If, now, the Politician can be as good at politics as he is at economics, he may succeed in discrediting the politics of the Economist.