REPORT OF THE AGENT GENERAL
FOR REPARATION PAYMENTS
BERLIN, June 10, 1927

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VI. German Credit Conditions and the Currency.

The German currency during the past six month has satisfied all the requirement of the gold standard. and so has continued to realize one of the primary objects of the Experts' Plan. The internal purchasing power of the reichsmark as measured by the general level of wholesale and ret ail prices, has remained fairly constant. Movements in the foreign exchanges have been more marked ; the premium on the reichsmark at the end of 1926 gave place early in 1927 to a discount, which with some variations has continued up to the present. During the same period an outward flow of funds has drawn largely upon the Reichsbank's stock of gold and other reserves interchangeable with gold. This decline in the reserves followed inevitably from the prevailing credit policy, a material element in which was the maintenance of a 5 per cent discount rate at the Reichsbank until June 10, 1927, when it was raised to 6 per cent.

At no time since the Experts' Plan went into effect have credit and financial developments been of such material importance as in the past six months. In the following chapter, credit conditions and the financial policy which influenced them are, discussed at length, and that discussion is followed by a brief section dealing with the currency.

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a. Credit Conditions, November, 1926, to May, 1927.

German credit conditions during the last six months have been under the influence of a financial policy which has aimed to reduce the inflow of foreign funds, and to restrict the German money markets as far as possible to domestic resources. This policy succeeded only temporarily with respect to short-term credits from abroad, but since the beginning of 1927 the inflow of long-term credits has been practically shut off. As the flow of credits toward Germany fell off, a counterflow of investment credit from Germany to foreign countries began. In part this outflow was a reaction from the heavy borrowing abroad during the preceding two years; but in part it marked a revival of the German capacity to invest in foreign countries., and as such introduced a new phase of German reconstruction.

It is natural that the outflow of credit for whatever purpose should have narrowed the basis of credit at home, particularly as represented in the gold and devisen reserves of the Reichsbank. The Reichsbank, however, has stood ready to provide the foreign exchange required, and its portfolio of domestic bills has expanded as its stock of devisen has declined. In consequence, the general volume of credit has continued to increase and money rates taken as a whole were easier, until toward the end of this period, than at any time since stabilization.

The relative ease of credit has had a marked bearing upon the activity of industry and commerce, and has been an important factor in the process of recovery from the crisis of eighteen months ago. At this time, according to the available figures, the volume of goods being produced and passing into consumption is in general higher than at any time since stabilization. Internal development has resulted in lower costs of production and in a somewhat increased purchasing power on the part of the people. But as the internal market has grown and the volume. of production has risen, German industry has required a largely increased supply of raw materials from abroad. For the past six months German imports as a whole have been far in excess of German exports, and past accumulations of credit, largely the result of last year's foreign loans, have been drawn upon in paying the deficit. In due course it is to be presumed that a sufficient portion of these imported raw materials will go out again in the form of finished exports to provide for further imports of raw commodities. But up to the present. though public financial policy has been directed against the inflow of foreign funds with which imports can be bought, no tangible increase has taken place in exports.

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1. Position of the Reichsbank.

During most of 1926 the Reichsbank was out of technical contact with the banks and the money market, and had to exercise its influence otherwise than by the rate or through its control of credit. The steps it took to reestablish contact with the market and to re-assume the direction of credit policy have been of primary importance in the development of credit conditions as a whole.

There have been. as will be recalled from the last Report, two main sources of credit available to the money market aside from the Reichsbank. One was the so-called public funds, and the other was foreign credits. Both were instrumental in making the Reichsbank rate ineffective. The measures designed to place the public funds under control, which thus far have had only partial success, are postponed for discussion to a later section of this chapter. The steps taken to limit foreign credits have had a profound effect upon German credit conditions in general and upon the Reichsbank in particular. Accordingly, it is most convenient to discuss these measures and their consequences from the general standpoint of the Reichsbank rather than as isolated developments of the past six months. In the following pages will be considered, first, the steps taken in limitation of foreign credits., including the maintenance of a low bank rate: second, the impetus given thereby to an outflow of funds from Germany; third, the effects of that outflow upon the foreign exchanges and the Reichsbank's reserves. and upon the volume of domestic credit granted by the Reichsbank; and fourth. the effort of the Reichsbank to correct by direct action the stimulation which cheap money gave to speculation.

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(a) Limitation of foreign credits.

Up to the end of December, 1926, the long-term foreign credits granted to Germany, since the Experts' Plan went into operation amounted to about 3,850 million reichsmarks. Of that sum, 960 millions represented the nominal amount of the German External Loan, 1924. which was issued in connection with the, Plan itself. The remainder was composed of a wide variety of borrowings for the account of the States and communes, the enterprises controlled by them, and private industry. In addition to the funds derived from long-term loans, the bulk of which was transferred for use within the country., there was the usual ebb and flow of short-term money. It is impossible to estimate the volume of the latter, since the successive movements in and out of Germany, determined largely by relative interest rates in Berlin and abroad, often cancelled one another. But the amount of foreign funds of both classes available for temporary use in the German market was at times very large.

The inflow of foreign funds had the double effect of rapidly expanding the Reichsbank's stock of gold and devisen and of reducing its portfolio of domestic bills. The influence of the Reichsbank was correspondingly diminished and in the autumn of 1926 its rate was almost without effect upon the German money market. At the same time it had possession of a very large supply of gold and foreign currencies convertible at will into gold. The President of the Reichsbank, appearing on October 21, 1926, before the Sub-committee on Money and Credit of the official Committee of Inquiry into German economic conditions, stated his views as to the possible bearing of this situation on the transfer of reparation, payments, as follows:

"These stocks of devisen which the foreign credits bring into the country at present accumulate at the Reichsbank to an extent which is far too great for the cover of our note circulation. We do not need this cover. Consequently if I were to be asked by the Agent General for Reparation Payments. 'Can you now produce devisen for transfer purposes?', I could only answer, 'Yes'. It would not be possible for me to say to hint, 'The German currency cannot stand it'. The German currency would remain intact even though a great part of the devisen of the Reichsbank were to be withdrawn to-day. The position therefore is that at the present moment we are making display of a capacity not only to pay but to transfer, which must in the natural course diminish and totally disappear at the moment when the position is reversed and we have the other side of the medal. The capacity to transfer which we at present display, will beyond a doubt have ceased to exist after a certain time. As however we shall then have also to make interest and redemption payments on our foreign borrowings, the position is that we are creating an advantage for a political creditor to-day at the cost of a private creditor in the future."

Since early in 1925 official agencies, including the Reichsbank and the Finance Ministry of the Reich, had been attempting to control foreign borrowing, but with limited success. Meanwhile, as the German domestic market strengthened, it became possible for German borrowers to obtain funds at home on terms which compared more and more favorably with terms offered by foreign bankers. By the end of November, 1926, the domestic and foreign markets were nearly in equilibrium, and as the opportunity for long-term borrowing at home increased borrowing abroad diminished. There remained, however, a tax preference operating nominally in favor of the foreign lender, and this the Finance Minister proceeded to remove. Under date of December 4, 1926, the exemption from income tax formerly accorded to German issues placed abroad was suspended, except for certain loans then awaiting consideration The nominal effect was to make the income from future German loans, whether placed in domestic or foreign markets, subject without distinction to a deduction of 10 per cent collected annually at the source. The actual effect, however, was to raise up a tax barrier against foreign loans, which continued until early in June, when the Finance Minister announced that he was again prepared in certain cases to recommend tax exemption for loans made abroad.

The gradual awakening of the German domestic market, and its increasing power to take care of the long-term credit needs of both industry and the various units of Government, was a development of great constructive importance, and has been commented on at length in previous Reports. The withdrawal of the tax exemption marked the point at which the domestic long-term market for the time being at least became self-sustaining; it did not supply the cause, which was to be found rather in the gradual filling-up of the reservoir of credit from foreign borrowings and domestic savings. With the beginning of 1927 long-term foreign loans became of relatively slight importance, and as will be seen elsewhere in this Report, the total German loans placed abroad during the first four months of the year amounted to about 94 million reichsmarks, whereas similar issues offered on the domestic market amounted to 712 millions.

The cheapening of credit and the broadening of the domestic market was fully in accord with Reichsbank policy. On January 11, 1927, the Reichsbank reduced its discount rate from 6 to 5 per cent. The 6 per cent rate had been in effect since July 6, 1926, and during most of that time had been of little or no consequence to the money markets. The bill rate, as well as the rates for Stock Exchange money, ranged far below the Reichsbank rate.

As will be seen from the foregoing diagram, which shows the rate for prime bills on the Berlin private discount market and the rate for day-to-day money in Berlin, the reduction of the bank rate at the beginning of 1927 was followed by a further decline in market rates for money. In part this was the result of the discount rate reduction itself, but it was also the consequence of seasonal forces which ordinarily bring cheaper money in the first weeks of a new year.

The discount rate remained at 5 per cent until June 10, 1927, when it was increased to 6 per cent.

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(b) The outflow of funds.

The immediate consequence of the easy money conditions at the beginning of 1927, which the reduction of the bank rate had explicitly defined, was a rapid outflow of funds from Germany. Thus the situation as it had existed for many months was reversed: the inflow of foreign funds was checked and an outflow in very substantial proportions began. Probably some part of this outflow would have taken place whether the Reichsbank had lowered its rate or not. but it is doubtful whether the outflow would have reached such magnitude or lasted for so long a time, if it had not been encouraged by the Reichsbank rate.

The outflow took a number of forms, some of which had been manifested tentatively during the previous year. The first, not perhaps in the amount of money involved but in its potential importance, was the growth of German investments abroad. As early as the spring of 1926 Germans had begun to repurchase bonds of their own issues sold in foreign countries. As the year advanced such purchases were reported to be more numerous. The first piece of direct foreign financing which attracted attention was a purchase in June, 1926, of a substantial amount of treasury bills offered by a foreign government. Later in the year the formal stabilization of the Belgian currency and the steadiness of the French franc began to attract German capital to Belgium and France. In part the German interest in those markets was speculative and temporary, but in the main it arose from the expectation of a rise in security values over a term of years. While it is manifestly impossible to estimate the gross amount of the German purchases of French and Belgian securities, competent banking opinion has placed them at a very substantial figure. There have also been substantial German investments in Italy and credits to Eastern and Southeastern Europe, including a long-term merchandise credit granted to Russia under the partial guaranty of the Reich and the States. This credit, though involving no export of funds as such to Russia, was extended by German banks and industry. It amounted in the beginning to 300 million reichsmarks, and was later increased to 366 millions, which was fully committed by the end by of March, 1927. In addition to the foregoing., there have been important participations by German bankers in various new issues of foreign industrial securities offered internationally. The portions of such issues allotted for German subscription have on the whole been well taken.

A second important class of funds moving into and out of Germany is made up of the various types of short-money. Under the conditions prevailing in the money marks of the world in recent years such funds have moved from market to market with great rapidity, the result no doubt of great concentrations in a few markets of liquid capital seeking investment in short term obligations payable in gold. The main factor determining the direction in which such funds flow is of course the relative rates of interest. Taking the year 1926 as a whole, for example, the movement of short-money was away from Germany, where interest rates were falling and where there was an ample supply of foreign funds derived from long-term loans. In substance a very large part of the short-term indebtedness of Germany was converted through this process into long-term debt. The sharp drop of interest rates at the beginning of 1927 accompanying the reduction of the Reichs bank discount rate caused a further outflow of short-term money, and in January it was reported from London that German funds were again seeking short investment in that market. This movement, however, soon came to an end; and by the end of February rising interest rates, notably on the Bourse, were again attracting foreign money to the Berlin market. For the most part, this inflow, which has lasted more or less persistently up to the present, has been of an especially undesirable nature. It introduced funds which were offered primarily for the purpose of financing active stock market speculation and which as short-dated debt were peculiarly susceptible of being withdrawn either on account of unfavorable developments in the German market or in that of the lender. It is of more than passing importance to observe that except for a very brief period at the beginning of 1927 the Reichsbank discount rate had very little to do with the inflow of foreign short-term money. Such funds have moved in accordance with money rates in the market, and whenever the Reichsbank rate was out of contact with the market it was without control over the flow of short foreign funds either in or out.

Foreign investment and speculation in the German stock market have also played an important part in the flow of funds. About year ago, rising prices on the Bourse began to attract foreign participation, which increased rapidly as the market continued to rise. It is impossible to estimate the amount of money brought to Germany for this purpose, but it is obvious that the withdraw of profits has made a large and unproductive drain upon the foreign exchange reserves.

Of all the factors entering into the outward flow of funds since the first of the year, without doubt the most important adverse foreign trade balance. In the last two months of 1926 German imports of merchandise exceeded exports by 388 reichsmarks, and in the first four months of 1927 the adverse balance amounted to an additional 1,175 millions. In these six months, in other words, the deficit in the foreign trade amounted nearly to the entire proceeds of the long-term foreign loans placed during the year 1926. Obviously, those loans provided a stimulus to imports. and in some sense the present heavy deficit in the trade balance is a delayed reflection of too extensive foreign borrowing. But it is clear that the deficit could not have reached such proportions if credit conditions in Germany during the time it was in process had not favored it. A powerful dominant factor in this direction was the Reichsbank's discount rate, which was decidedly encouraging to domestic credits the proceeds of which were directly or indirectly convertible into foreign exchange.

The remaining form of capital outflow which needs to be mentioned here is reparation payments. These have already been summarized, at the outset of this Report. Reparation transfers, by their very nature, necessarily reduce the inflow of funds, if the current is toward Germany, or increase the outflow if the current is away from Germany. In these effects it is not essential whether the payment of reparations takes the form of a transfer in foreign currencies or of deliveries in kind, except that deliveries in kind represent to some extent exports which Germany would not otherwise make.

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(c) Effects of the outflow of funds.

The reversal in the current of money resulting from the various movements outlined above was promptly reflected in the foreign exchange rates. Sterling at the end of December was at or about the point at which it was profitable to ship gold from London to Berlin, and some such shipments had in fact been made. Immediately after the first of the year, however, sterling began to rise, and by the middle of January the exchange on London stood at a marked premium. Simultaneously, the dollar which for a brief period had been below parity with the reichsmark rose nearly to the gold export point. This condition has in general continued up to the present, and such tendencies to recover as manifested themselves from time to time became more feeble as the period advanced. The course taken by sterling and the dollar in terms of reichsmarks since last August is shown in the diagrams below. Prior to August 23, 1926, when the reichsmark was released from its technical adherence to the dollar, the New York quotation stood consistently at 4.20 reichsmarks to the dollar, and the other exchanges moved with respect to the reichsmark in the same sense as they moved with respect to the dollar. It should be added here that the last remaining legal regulation governing foreign exchange transactions was removed by decree on February 22, 1927, when the rule restricting such transactions to legally authorized banking institutions was abolished.

The effect of the outflow of funds upon the Reichsbank's reserves was immediate. While the German commercial banks naturally maintain balances abroad, any unusual demand for foreign funds is bound to be passed on to the Reichsbank as the holder of the gold and foreign exchange reserves of the country. The Reichsbank has stood ready ever since June, 1924, to provide foreign exchange when the market itself was unable to supply it, but such calls heretofore had not made much visible impression upon the Reichsbank's reserves. On the contrary, as has been pointed out in former Reports, the Reichsbank on the whole had received far more foreign exchange than it was called upon to provide, and its reserves in consequence showed a large net gain. At the end of December, 1926, the Reichsbank reported 1,831 million reichsmarks of gold and 519 millions of devisen. The total, 2,350 millions, was the highest figure yet reported and represented an increase of about 1,500 millions since the bank was reconstituted in October, 1924. In addition to the devisen reported as reserves, the Reichsbank possessed a large stock of bills and other items payable in foreign currencies, which it did not report separately but merged with its other assets. This practice of carrying unreported devisen made it impossible during the time of accumulation to estimate the growth of the Reichsbank's stock of foreign exchange, and at the beginning of 1927 when funds began rapidly to flow away from Germany, made it equally impossible to tell the rate at which the stock was declining. On May 31, 1927, the reported gold and devisen reserves of the Reichsbank amounted to 1,894 million reichsmarks, a fall since December 31, 1926, of about 450 millions. The unreported devisen declined in the same period by somewhat more than the same amount, bringing the total decline to about one milliard.

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(d) Reichsbank credit policy.

The relative courses taken by the two lines in the foregoing diagram give a fair impression of the way in which the loss of gold and devisen has been met., without causing thus far any general contraction in the volume of credit. The line representing the reserves takes account only of the gold and devisen cover for the note issue as reported in the Reichsbank's quarter-monthly statements, and necessarily leaves out of account the unreported devisen. Except for a brief period in the spring of 1926, the reserves rose steadily, and, as for example in December, at times very sharply. The decline in the reported reserves took place mostly in January and February, 1927, with a further reduction in May. The five months of decline rather more than offset the five previous months of rise, and the reserves are now somewhat below, the level at the end of July, 1926. The second line, representing loans and discounts, takes account of the two items in the Reichs bank statement entitled "Bills and checks" and "Collateral loans." The Reichsbank has ordinarily carried an unstated amount of its unreported devisen in the item "Bills and checks," which during the autumn of 1926 were of sufficient volume to account for twenty to twenty-five per cent of the loans and discounts. After the beginning of 1927 the calls upon the Reichsbank for foreign exchange were such that these unreported devisen were gradually drawn off, but the general level of loans did not fall correspondingly. On the contrary, except for a seasonal decline after the Christmas holidays, the volume of Reichsbank credit has steadily risen, and the portfolio of bills and checks plus the collateral loans stood at a higher point on May 31, 1927, than at any time since the Reichsbank was reconstituted on October 11, 1924. In substance, it appears that the Reichsbank has replaced with domestic credit the full amount of gold and devisen which have been withdrawn from its reserves and from its unreported holdings of foreign currencies. Whereas the Reichsbank's stock of gold and devisen, reported and unreported, is about a thousand millions lower than at the end of last December, the volume of domestic credit granted by it is about a thousand millions higher than it was at that time.

The effect of the Reichsbank's credit policy upon the German economy as a whole has already been indicated. In general, the stimulation which the long inflow of foreign credits had given to business was retained even though a portion of the foreign funds flowed out again. It remains to speak of Reichsbank credit policy as it affected the stock market.

Share prices on the Berlin Bourse rose with very little interruption from the beginning of 1926 until May, 1927. In part, the rise was a reflection of progressively easier money conditions attribuable in considerable degree to the inflow of foreign funds either as loans or for the specific purpose of Stock Exchange speculation and investment. In part, also, particularly in the earlier stages, the rise reflected a recovery of confidence in the earning capacity of German industry. But as was said in the last Report, prices reached by a number of leading stocks even as long ago as last November were "less a reflection of probable dividend return than a discounting of possible speculative profits". In fact, the prices of many stocks which paid no dividends at all were continually rising. By the end of 1926 the average dividend return on shares listed on the Berlin Bourse at the prices then prevailing was barely 3 per cent. This compared with an average interest rate on bonds of 7 1/4 to 7 1/2 per cent. The relative movement of stock and bond prices on the Berlin Bourse, in their monthly averages, is shown in the following diagrams:

The rapid and long-continued rise of stock prices, far from being a proof of strength, was an element of weakness in the German economy as a whole. It was bound to bring undesirable credit to the market from abroad which after due time would be withdrawn along with the profits of speculation. These profits when transferred abroad were necessarily a sheer loss to the German credit system. The Reichsbank in determining its rate policy was fully conscious of these adverse aspects of stock market speculation. It refrained from lowering its discount rate during the second half of 1926 in order to avoid giving any further stimulus to speculation, and when it finally acted on January 11, 1927, it left unchanged at 7 per cent the so-called Lombard rate,---that is, the rate on collateral loans, a type of borrowing often employed for short accommodation over stock market settlement dates. The very reduction of the discount rate, however, was so definitely an indication of easier credit conditions, that it inevitably accelerated and sustained the rise in stock prices which began at that time and continued through January and February.

By the end of March the Reichsbank had fully achieved its purpose of regaining contact with the money market. It had a large and increasing portfolio, a good share of its devisen had already been exchanged for domestic bills, and its rate was in relation with other money rates. By the end of April it was in a fair way to lose the control thus acquired, not because its rate was above other money rates. as was the case during the previous autumn. but because its rate was below other important rates with the single exception of the open-market bill rate. That the Reichsbank rate was still slightly above the bill rate was not a matter of any significance, because the market for bills remains strongly under the influence of the Reichsbank itself and the bill rate is largely determined by the buying rate at the Reichsbank.

In these circumstances, if the Reichsbank was to avoid losing control of the market altogether, it had either to raise its rate, or alternatively, to attempt some form of direct action against excessive users of credit. It chose the latter expedient and set in motion through the Berlin banks measures against stock market speculation, which it deemed to be largely responsible for the money conditions then prevailing, and which, as has already been seen, was attracting short-term foreign funds to the market. It took this course in preference to raising the rate on the theory that a contraction of stock exchange credits would increase the liquidity of the banks without exerting credit pressure on commerce and industry or causing a general rise in the cost of credit. It appears to have been moved also by the thought that an increase in its discount rate might again attract foreign funds in large volume to Germany.

On May 12, the principal Berlin banks and banking houses, acting in general agreement with the Reichsbank's analysis of the situation , decided upon a radical curtailment of Stock Exchange credit, and published the following statement next morning:

"The members of the Berlin Bankers' Association (Stempelvereinigung) have agreed gradually but appreciably to reduce the funds loaned for report and lombard purposes and for other advances on securities. They will therefore begin by making a reduction of 25 per cent in the funds available for report and forward purposes on the Bourse by the date of settlement at the middle of June and will undertake further reductions, on subsequent dates of settlement. The same procedure will be adopted towards customers. It is expected that lenders of money not belonging to the said Association will take similar action."

The effect of this very direct statement of intention caused a decline in stock prices which for one day assumed the proportions of a panic. Subsequent movements were more restrained, and at times prices recovered somewhat; but at the end of May the general level of stock prices on the Berlin Bourse was not far from where it stood at the end of 1926. The extent of this decline is not reflected in the diagram printed above, because the figures there illustrated are monthly averages and the May figure represents in part the high prices at the beginning of the month.

It is still too soon to tell whether the general credit purpose of this effort has been achieved or not, because the immediate effects of the disturbance on the Bourse may possibly have led to an expansion of credit which is purely transitory. But at the end of May the same tendencies were visible in the Reichsbank statement that had been in progress since the end of December. There was a further decline in reserves, and a large further expansion in loans.

It is appropriate at this point, before passing on to a discussion of the public funds. to review briefly the purposes and consequences of the Reichsbank credit policy thus far in 1927. When the Reichsbank lowered its rate on January 11, 1927, it regained temporary contact with market rates. which had ranged considerably below the bank rate. Foreign credits had played a large part in making the rate ineffective, and in the view of the President of the Reichsbank had the further quality of "making display of a capacity not only to pay but to transfer" reparations, and of "creating an advantage for a political creditor to-day at the cost of a private creditor in the future." The reduction of the bank rate, together with the action of the Finance Minister in suspending the tax exemption on foreign loans, had the effect of practically shutting off long-term credits from abroad.

Simultaneously, however, the low return then obtainable on loans at home, and on the other hand, the facility with which money could be borrowed in the domestic markets, led to a large outflow of funds to foreign countries. This took the form not only of investments, credits and speculative operations on foreign markets, but also of larger imports of goods, which have proved the dominating factor in the adverse trade balance. The withdrawal of these funds from the local markets had a prompt and marked effect upon the Reichsbank's reserves and upon the foreign exchanges, and finally upon interest rates. The Reichsbank discount rate did not follow other rates upward., and the general volume of credit was not reduced because the outflow of reserves from the Reichsbank was offset by a corresponding increase in Reichsbank credit. Furthermore, the outflow of funds had no dampening effect on stock exchange speculation, partly because access to Reichsbank credit was limited only by the available amount of bills eligible for rediscount, and partly because foreign short-term money of a singularly transient nature began to be offered on the Bourse.

In taking direct action to contract the use of credit on the Bourse the Reichsbank adopted an unusual method in preference to the more customary method of raising the bank rate. Rate action was avoided temporarily largely on the ground that a higher bank rate would attract foreign funds with all of their implications. But at the same time the bank rate was permitted to remain the lowest representative rate in Germany. The outflow of reserves continued, and the volume of Reichsbank credit reached its highest point since stabilization. At the end of May, 1927, while the Reichsbank reserves remained amply sufficient to provide the legal proportion of 40 per cent against the Reichsbank's own note issue, they fell slightly below that proportion if the Rentebank notes which have no gold cover of their own and are an undeclared charge upon the Reichsbank reserve, are taken into account.

These changes introduced a new phase of credit conditions in Germany. The position of the Reichsbank has become substantially reversed from what it was six months before; whereas its reserves were then high, now they are low: and whereas its loans were then low, now they are high. The bank rate was ineffective then and it had become ineffective again, but with the difference that in November it was above. the market and in April and May it was below the market. The size of the Reichsbank's portfolio, however, gives it the undoubted power to regain control of the market at such time as it deems action to be necessary for the protection of its reserves; and it has now taken action in this direction by raising its discount rate to 6 per cent, effective June 10, 1927.

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2. The Administration of the Public Funds.

The relation of the public and quasi-public funds to the money market has been for many months a complicating and uncertain factor with which Reichsbank credit policy has had to reckon. At times the offering of these funds wherever they would earn the most satisfactory interest return has been sufficient to undermine Reichsbank policy and has had an important part in making the bank rate ineffective. At other times the rapid withdrawal of these funds from the market has worked in the opposite direction and has magnified difficulties already existing. In general, the public funds have tended to exaggerate money market tendencies, and so have worked exactly as a central supply of funds should not act.

The public funds have been discussed more or less at length in each one of the preceding four Reports. It will be recalled that last autumn the accumulated public funds of the Reich, the States and the communes had become less important both in size and in influence on the money market than during previous periods. The funds of the public agencies and services, however, were still being managed primarily for profit and without relation to the general credit situation. At the present time the situation is in a measure reversed: the question of Reich funds has been revived, whereas some progress has been made at least toward more consistent management of the quasi-public funds.

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(a) The Reich Loan, 1927.

The event which raised once more the question of public funds in the case of the Reich, was the issue in February, 1927, of a Reich loan in the nominal amount of 500 million reichsmarks. The Finance Minister had had authority for some time to borrow money to meet expenditures of the class chargeable to the extraordinary budget, but the highly favorable cash position of the Reich had permitted it to postpone borrowing up to that time. Even at the beginning of 1927, though its cash balances were much reduced, the Treasury was not faced with any pressing demands requiring a large loan; on the contrary, the proceeds of the loan were desired for future use, and its size corresponded with the requirements of the year 1927 as estimated by the Finance Minister. The decision to place a long-term loan at that time was based upon conditions as they then existed on the money market, which were referred to as follows in the semi-official announcement of the issue:

"The reduction of the discount rate of the Reichsbank to 5 per cent and the satisfactory condition of the money market have now induced the Reich Finance Minister to take advantage of what appears to be a particularly favorable opportunity and to float a Reich loan of 500 million reichsmarks bearing interest at 5 per cent."

Of the 500 millions nominal amount, 300 millions were underwritten by a syndicate of banks headed by the Reichsbank and were offered to the public at 92. The remainder was reserved for subscription by various public and semi-public institutions, including the Railway Company and the Post Office, on the understanding that for the time being such bonds would be withheld from the market. The terms of the issue provided that no drawings for sinking fund purposes would take place before 1934, and that the loan as a whole could not be called for redemption before 1937; amortization was to be completed by 1959.

The Reich loan was nominally a success. But while it was possible for the Reichsbank to announce an over-subscription of the 300 millions tranche when the books closed on February 11, this result was accomplished only through the assistance of public and semi-public institutions. The loan was officially admitted to trading on the Bourse on April 5. Steps had been taken to limit offerings during the first months of trading by making a certain portion of the bonds sold to the public non-transferable for six months. Nevertheless, enough were offered on the Bourse to cause the quotation to fall below the issue price on the next day after trading opened. For some weeks the issue was officially supported at 90, but during May in connection with the strained conditions on the Bourse there was a further small decline to 89.

The effective proceeds of the tranche issued to the public were about 270 million reichsmarks. The Reich had no immediate occasion for funds in such amount. and the Finance Ministry placed somewhat more than half at interest with the Gold Discount Bank and the remainder with the Reichs-Kredit-Gesellshaft and the Seehandlung.

The Reich loan thus recreated the problem of the public funds on a basis substantially identical with that of 1925 and 1926, except that now a portion of the inactive funds were placed with the Gold Discount Bank. not previously a depositary. The loan is responsible in this way for bringing about an artificial repetition of a phase of German public finance which had worked adversely to the money market, to the Reichsbank's effective relation with the money market, and in a broad sense to the welfare of German economy itself. This result is much to be regretted, all the more so as the Reich's need for funds, if met in other ways, might have restored the normal relation of the Treasury to the money market and made a beginning with the final solution of the public funds problem. According to accepted practice, the purpose to he served by the loan could have been served much better by a series of offerings of Treasury bills, issued as and when funds were required, and taken up later, if necessary, by issues of bonds. Such a contingency was foreseen over a year ago when the programme of tax reduction made it probable that the Treasury surplus would become reduced and finally disappear. In order that the Finance Minister could carry that programme through without danger to his cash position, an amendment to the Reichsbank Law was proposed and passed, becoming effective on July 14, 1926. Under that amendment short Treasury Bills of the Reich when brought to the Reichsbank from the market were made eligible for rediscount or purchase. Thus the Reich was assured of a market for its offerings of short obligations.

Conditions in the German money markets last February were singularly appropriate for an issue of Treasury bills. There was a surfeit of short money and the long-term market, on the other hand, was already showing signs of strain under the numerous issues offered in preceding months. The stock market was in a state of speculative activity, stimulated by the large supply of funds flowing there for short-term use. To this supply of funds the temporarily inactive money of the public or semi-public enterprises contributed. Assuming that it was necessary for the Reich to borrow at that time at all, an issue of Treasury bills would have served not only to withdraw excess money from the short-term market, but to provide a convenient and altogether liquid investment for those public enterprises, as for example the Railway Company, which had funds seeking employment. Moreover, the long-term market would have been left in a better position to take care of the needs of other borrowers.

In point of fact., however, the Reich loan removed from the long-term market an exceptionally large volume of funds., and then put the Reich under the necessity of seeking temporary investment for these funds in the short-term market, thus aggravating the oversupply of funds in that market. Furthermore., instead of simplifying the administration of the public funds., it revived one phase of that problem which had been in a fair way to disappear. In due course, no doubt, as the Reich disburses these funds, there will be a reversion to the position as it existed last January, and the opportunity will recur to work out a borrowing programme which will fit in with a comprehensive settlement of public funds administration.

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(b) Funds of public and quasi-public enterprises.

There has been little change since the last Report in the financial practices of the public and quasi-public enterprises. A trial arrangement has been entered into, however. which modifies somewhat the practices of the Verkehrs-Kreditbank, and accordingly deserves attention.

The Verkehrs-Kreditbank, as has been explained in previous Reports, is maintained by the German Railway Company, which owns three-quarters of the capital stock. The Railway Company is practically the bank's only depositor. On December 31, 1926, the deposits of the Verkehrs-Kreditbank amounted to 529 million reichsmarks, as against 352 millions at the end of the preceding June. Its funds were redeposited with other banks and banking houses of great variety, or were invested in discounts. In addition the bank carried on the function for which it was originally established, that of financing freights on credit.

The large concentration of funds in the hands of the Verkehrs-Kreditbank made it a very important factor in the money market, and since these funds were managed chiefly for the purpose of profit, their administration frequently ran counter to the policy of the Reichsbank. Negotiations have been carried on between the Railway Company and the Reichsbank looking toward the development of a workable plan agreeable to them both, but up to this time these have been only partially successful. The tentative arrangement, in general outline, leaves in the hands of the Verkehrs-Kreditbank the management of the Railway Company's active cash and the funds needed for financing freights on credit; the remainder., consisting of surplus funds not required on short notice, are to be deposited with the Gold Discount Bank at a rate slightly below that which the Verkehrs-Kreditbank has been in a position to earn.

The arrangement marks some advance toward consistent administration, since it tends to remove the Verkehrs-Kreditbank as a factor in the money market, but it introduces a new complication by bringing in the Gold Discount Bank and will be reviewed toward the end of the year in an effort to reach a broader arrangement that is generally more satisfactory.

No progress seems to have been made with the Reichs-Kredit-Gesellschaft. Its general position has already been summarized in previous Reports, but it still publishes no statement of condition other than an annual balance sheet, and accordingly many of its activities remain invisible. It is indirectly owned by the Reich itself., and apparently serves to some extent as a depositary for the funds of the Reich and as a medium for carrying on other banking business for the Reich. It also continues to conduct an ordinary banking business in competition with the private banks, and even in competition with the Reichsbank itself, to the extent that it serves as a bank of rediscount for private banks and bankers.

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(c) The Gold Discount Bank.

The Gold Discount Bank, which is owned in full by the Reichsbank, assumed a function which it had not previously exercised when it became a depositary for funds belonging to the Reich and the Railway Company. In undertaking this new business the Gold Discount Bank acted as the instrument of the Reichsbank, not permanently, but as an interim means for bringing a portion of the public funds into the field of the Reichsbank's control. The Reichsbank as long ago as July, 1924. expressed the intention of liquidating the Gold Discount Bank, and it still adheres to that intention. But in the meantime the Reichsbank desires to frame a workable plan for bringing the management of the public funds as a whole into harmony with its credit policy.

Since the Gold Discount Bank began operations on April 16. 1924, it has been exclusively under the direction of the officers of the Reichsbank, of which practically speaking it is a department. Whereas the Reichsbank Law carefully delimits the functions of the Reichsbank to business appropriate to a central bank, the separate corporate existence of the Gold Discount Bank has enabled the Reichsbank to act through it in performing functions which the Reichsbank could not exercise if it acted in its own name. These supplementary functions have resulted in extending the business of the Gold Discount Bank into directions not contemplated when the Bank was founded.

The Gold Discount Bank was organised as a bank of issue, but that function was never exercised. The associated function of granting credits in foreign currencies for the benefit of German foreign trade, however, was exercised largely and successfully.

After the reconstitution of the Reichsbank in October, 1924, this function became less important and the Gold Discount Bank passed into the stage of liquidation. which was suspended in March, 1925, on the ground that the bank was needed to stimulate German foreign trade, then heavily adverse.

During 1926, the export credit business of the Gold Discount Bank again diminished. but in the meantime it had undertaken new functions in other directions and its liquidation accordingly, remained in suspense. Early in January, 1926, the bank agreed to buy from the Rentenbank-Kredit-Anstalt, the central bank for .agriculture, farm mortgage bonds maturing in three to five years and carrying interest at 7 per cent, which was well below the then prevailing rate. By the end of 1926, its holdings of such bonds amounted to about 220 million reichsmarks. While the Gold Discount Bank had considerable assets of its own, most of which were rediscountable at the Reichsbank, these purchases placed some burden upon its resources. Accordingly in December, 1926, it offered in the market its own one-name bills known as Solawechsel, with a maturity of three months. The volume of bills sold at that time amounted to 72.6 million reichsmarks, of which 50 millions were sold to the Verkehrs-Kreditbank as an investment for railway funds. This operation achieved a second object in withdrawing a substantial volume of funds from the short-term market which at that time was over-supplied. In January a further 20.5 millions of Solawechsel were issued, maturing in April. All have now been repaid with the exception of those held by the Verkehrs-Kredit-Bank, which at the request of the latter were renewed and are due .on June 14, 1927.

The acceptance by the Gold Discount Bank of deposits from the Reich and the Railway Company naturally has relieved it from selling further amounts of its one-name bills in the market. At the same time, the Gold Discount Bank, in taking on the obligation to pay interest on these deposits, assumed an obligation to earn the money with which that interest could be paid. Consequently, its functions have become more and more like those of an ordinary bank, with agricultural bonds and discounted bills on the one side and interest-bearing deposits on the other. On May 31,1927, according to its published statement which is made up in terms of sterling it had among its assets about £7,900,000 of bills and checks and £14,000,000 of securities, mostly the bonds of the Rentenbank-Kredit-Anstalt, and among its liabilities about £4,900,000 of day-to-day obligations, mainly demand deposits, and £6,600,000 of obligations subject to notice, mainly time deposits.

The Reichsbank in agreeing that the Gold Discount Bank should accept these deposits at interest, used the Gold Discount Bank for a function which it could not exercise itself. The law authorizes the Reichsbank itself to receive only non-interest bearing deposits, in recognition of the fundamental rule of central banking that a bank of issue must be free to govern its discount policy according to the market and without regard for earnings. The Experts' Plan, in the various sections quoted in the Agent General's Report for May 30, 1925, had fully contemplated, however, that the public and quasi-public funds would be placed with the Reichsbank, in accordance with the general principle that a bank of issue cannot fulfil its functions with respect to credit and the currency unless it has control of the public funds.

The arrangement by which funds of the Reich and the Railway Company are placed at interest with the Gold Discount Bank give the Reichsbank only nominal control over their disposition. The Reichsbank, through its subsidiary, has had to give an indirect guaranty that these deposits will earn interest. A central bank in the long run cannot directly or indirectly guarantee interest on funds placed under its control, and at the same time be free to manage its discount policy with an eye single to credit and the currency. If a rate of interest is guaranteed, it presumably must be earned, which means that the funds must be employed irrespective of market conditions, and irrespective of whether the credit policy of the Reichsbank inherently favors their investment or not.

The Reichsbank regards the use of the Gold Discount Bank as only a partial and interim solution of the problem of public funds administration. The final solution cannot be based on the isolated advantage of separate parts of the public service by way of interest return or otherwise; it must take into account the common advantage of a unified credit policy to German economy as a whole. There is no reason in the law or in principle why firm administrative action cannot now bring the public funds problem to a definitive solution, on such a basis as will produce a reasonable return not necessarily month by month but probably year in and year out, and at the same time insure management consistent with the policy of the Reichsbank, which after all has the final responsibility toward credit and the currency.

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3. Volume of Credit.

The volume of credit, as measured by the capital issues placed in the domestic market and the loans and deposits of the banks, has risen further in the last six months. During this period, as distinguished from any other of equal length since the Experts' Plan went into effect, growth has taken place without the stimulation of inflowing foreign loans; on the contrary, the direction of the flow of funds has been outward. As the period progressed, particularly after the issue of the Reich loan in February, the power of the domestic market to absorb new long-term issues materially diminished and late in the spring steps were taken looking toward some renewal of foreign borrowing.

The forces governing the various money markets during the last. six months have already been described. It remains to give in summary form the figures relating to the principal developments.

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(a) Capital issues.

Thus far in 1927 foreign borrowing has been of slight importance. Whereas in 1926 Germany borrowed abroad in the nominal amount of nearly 1,700 million reichsmarks, during the first four months of 1927 foreign loans have amounted to less than 94 millions. A substantial fraction of this year's borrowing was the result of banking arrangements made last year, and on that account does not reflect credit conditions prevailing in Germany at the time the loans were placed.

The controlling influences which brought about the great reduction in foreign loans in 1927 have already been discussed, as well as those forces which late in the spring were already opening the way for some revival of borrowing abroad. On June 3, The Finance Ministry made the following announcement:

"Since money market conditions have changed considerably during the past few weeks as against the end of last year, the Reich Finance Minister has decided again to examine the individual requests for exemption of foreign loans from the tax on income received from capital and, in presenting these requests to the Reichsrat and the Tax Committee of the Reichstag, to advocate exemption if the loans are to be used for desirable economic purposes and if their conditions correspond to the conditions of the money market."

In contrast with the limited volume of foreign loans issued during the first four months of this year was the large amount of long-term loans issued at home. Up to the early part of 1926 there was practically no market in Germany for long-term loans, but in the course of that year formal domestic issues of bonds and notes of varying maturities aggregated about 960 million reichsmarks. In addition, less formal issues were reported up to a total of about 380 millions. making a total for the year of approximately 1,340 millions nominal amount. In the first four months of 1927 public offerings of bonds and notes were in the nominal amount of more than 700 million reichsmarks, or more than half the total for the whole year 1926,

The Reich loan offered in February in the nominal amount of 500 million reichsmarks, of which 300 millions were offered to the public, marked the turning point in the market for new issues. This loan, as has already been seen, was not well taken and shortly after being quoted on the Bourse fell below the issue price. It is noteworthy that, during the first two months of 1927, the loans offered to the public amounted to about 600 millions, but that in the next two months the offerings fell to about 100 millions. In May there were practically no long-term public issues at all. The loans of private enterprises, as appears from the table, amounted during the last sixteen months to only 20 per cent of the total; the rest were loans of the Reich, the States and their political subdivisions, and the enterprises owned or controlled by them.

In addition to the domestic loans included in the table given above there have been other important issues of varying character. These include the so-called Pfandbriefe, issued by mortgage banks and other real estate credit institutions, which are sold from time to time and at varying prices according to the market. During the first four months of 1927. the mortgage banks and other real estate credit institutions issued securities. aggregating 740 million reichsmarks. In the last quarter of 1926 these issues amounted to 563 millions, and in the whole of 1926 to 1,703 million reichsmarks. Issues of shares in the first four months of this year are estimated to have involved about 527 millions of new capital, compared with 374 millions in the last quarter of 1926 and 898 millions in the whole of 1926.

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(b) Private bank credit.

Except for a brief period of interruption in the early part of 1926, the volume of credit reported bi-monthly by the private banks has continued to expand ever since stabilization. Statements as of April 30, 1927, for the six largest reporting banks, which together represent about three-quarters of the non-public banking strength of Germany, indicated that credits had increased in the six months since October 31. 1926, by over a milliard of reichsmarks, or about 20 per cent. The published statements do not segregate credits so as to show what portion of the increase was due to Stock Exchange loans, though the expansion of such loans offered the occasion for the contraction of credit announced in May which precipitated the decline on the stock market.

The item Gläubiger, composed mainly of time and demand deposits, increased since last October by 19 per cent, almost the same rate of increase as in the case of the credits. The acceptance liabilities of the banks have risen about 125 millions since October, or nearly 50 per cent. But the total remains far below what was customary before the war.

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(c) Public bank credit.

The volume of loans of the principal State banks appears to move with less regularity than is shown by the loans of the large private banks whose statements have been summarized above. For several months prior to August 31, 1926, there was little change in the volume of public bank credit. Between that date and February 28, 1927, the loans of these banks increased substantially, but in the next two months the change was again negligible. By far the largest of the banks included in the following statement is the Prussian State Bank, known as the Seehandlung.

The loans of the Girozentralen. the central institutions through which the various savings offices and communal banks are interrelated, have continued to increase, whereas there have been only inconsiderable changes in the deposits. This apparent disproportion is owing to the practice of the Girozentralen of granting credits at fixed term out of the proceeds of long-term loans.

Neither the Verkehrs-Kreditbank nor the Reichs-Kredit-Gesellschaft make public statements of condition except in their annual reports. Consequently figures for those banks are omitted.

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(d) Savings.

During the six months ended April 30, 1927, the volume of savings deposits in Germany as reported by the Sparkassen or savings offices, increased over one milliard reichsmarks The increases reported each month were above the average month-to-month increase in 1926 and in the early months of 1927 the increments were higher than at any time since stabilization. Practically all the savings deposits now reported have been accumulated in a little over three years; but they are still only 20 per cent of the pre-war volume.

The accumulation of savings other than those reported by the savings offices can only be inferred, because figures are lacking. Current figures for life insurance are not reported in Germany, but insurance companies have apparently been showing some increased capacity to purchase bonds in the market. The volume of long-term loans issued in recent months is itself a reflection of the general accumulation of savings, including those of the savings offices, but it no doubt gives a considerably exaggerated implication.

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b. The German Currency.

The decline in the Reichsbank's stock of gold and devisen has had no effect thus far upon the volume of the currency. On the contrary, the circulation during the last six months has continued to rise, thereby maintaining the tendency which has prevailed since stabilization. The increase in the circulation has on the whole been remarkably steady, and periods of business inactivity, as for example in the winters of 1925 and 1926, have affected the circulation rather by retarding the rate of increase than by causing a reduction. In the main, as is illustrated in the diagram given below, the rise from month to month has been progressive., and the weekly and seasonal variations of one year have been repeated during the next but on a higher level. The maximum for 1926 was reached as usual at the end of December; the total of 5,830 millions has not yet been exceeded, and it was still somewhat below what was regarded as customary before the war, when the total German circulation fluctuated around 6,000 millions.

The notes of the Reichsbank have necessarily furnished the main fluctuating element in the circulation, both as regards weekly variations in the volume of currency and the year-to-year increase. During the last six months the Reichsbank circulation has ranged from 250 to 600 millions above the 1926 monthly average. In addition to this element of increase, the Reich has been issuing further amounts of coins, the amount of which in actual circulation at the end of April was about 60 millions higher than six months previously. Some demand for new coins was created during 1926 by the retirement of Rentenbank notes of the 1 and 2 rentenmark denominations, and when notes of the 5 rentenmark denomination pass into retirement, further issues of coins can probably be absorbed by the public. But the supply of unissued coins held by the Reichsbank stood at the end of May at about 98 million reichsmarks, a slight reduction from the stock of 115 millions on hand at the end of October, 1926. To some extent a supply of small coins is needed for till money at the Reichsbank and its branches, but in large measure the present stock must be regarded as redundant. In this sense, as was pointed out in the last Report, it represents an unauthorized credit without interest from the Reichsbank to the Reich. A large part of the stock consists, moreover, of 50 pfennig pieces which are admittedly unfit for circulation. These clearly have no place among the Reichsbank's assets and should long ago have been taken over by the Government of the Reich.

As appears from the preceding table, the notes of the Rentenbank have represented since the first of the year about 20 per cent of the total German circulation, whereas during 1926 they amounted to about 25 per cent and in 1925 to 34 per cent. This change is due not only to the larger volume of currency in general but to the decreasing circulation of Rentenbank notes, which have been in process of redemption since the Plan went into effect. Up to the end of April, 1927, the total redemptions amounted to 980 million rentenmarks, of equal value with reichsmarks. Of this amount 379 millions were redeemed during the last six months, chiefly through the repayment of 293 million rentenmarks on November 30, 1926, representing the year's maturity of agricultural bills. There remains one further instalment of agricultural bills in the same amount, due on November 30, 1927.

Rentenbank notes are an artificial element in the German currency and since they have no gold reserve of their own, are necessarily all undeclared charge against the gold reserves of the Reichsbank. Their retirement has led heretofore to a counter-expansion of other elements in the circulation, mainly of Reichsbank notes, and further retirements are likely to work in the same direction. But as long as they exist, they must be taken into account in testing the adequacy of the Reichsbank's reserves. At the end of May, 1927, a time of lowered reserves and of high circulation, the gold and devisen reserves of the Reichsbank were a fraction below 40 per cent of the joint note circulation of the Reichsbank and Rentenbank, thereby reflecting in vivid fashion the loss of reserves which has characterized the period.

Section VII, Germany's Foreign Trade

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