FOUNDATION FOR ECONOMIC EDUCATION
Money in the 1920s and 1930s - Nowhere is monetary ignorance more apparent than in an analysis of these decades.
Richard H. Timberlake
Thursday, April 1, 1999
One of the most enduring and troublesome mysteries in economics is money: how it is created, what sorts of institutions initiate the process, what kinds of mystique and priestcraft central bankers use in managing monetary systems, and what rules, laws, or customs limit their actions.
Perhaps the common ignorance about money is harmless.
After all, the millions of people who use this money drive sophisticated automobiles and manipulate complex computers without knowing much about the technical properties of either.
As long as cars, computers, and money behave themselves, can we perhaps ignore them?
The answer is that we can for cars and computers, but we should not for money.
For one thing, ignorance about money has side effects that are not comparable to ignorance about technical equipment.
Competitive markets drive the production and sale of all household durables, but the production of money in every country in the world today (and yesterday, too) is the province of governments.
Through the offices of their associated central banks, states monopolize the machinery of money.
Each central bank determines within very close tolerances just how much money an economy has and the rate at which the current stock of money will change.
Unquestionably and inevitably, political pressures that are rarely visible even to experienced observers influence these operations.
Because they have the power to create money without license, governments also have the complementary incentive to claim that depressions and inflations resulting from the mismanagement of money occur because of unusual and unexpected economic developments — “shocks,” as they are labeled.
The term implies a sense of impending and inevitable drama.
No such social catastrophes result from the public’s incomplete knowledge of computers and automobiles, nor of “shocks” that might affect their production and distribution.
However, neither do governments monopolize that production and distribution, and therein lies the difference.
Fateful Decades
Nowhere is monetary ignorance more apparent than in bystander evaluations of the economic and monetary events of the 1920s and 1930s.
Although several decades have passed, the various popular accounts continue to misinterpret the causes of the disequilibrium that occurred and also the federal government’s aggravation of the problem.
Government apologists of many persuasions not only argue that the massive interventions of the 1930s were necessary; they also contend that the lack of response in the private sector to the multitudinous government programs put into place proved that the economic system was moribund.
Nothing, they argue, could have prevented the debacle.
They encourage the popular belief that the market economy zealously overextended itself in the 1920s.
The boom, they contend, led to the stock market crash in 1929, and to the several banking crises of the early 1930s.
These financial failures, the legend continues, provoked exhausting industrial liquidations, and the other devastations of the 1930s.
The role that the central bank — the Federal Reserve System — and its managers played in the catastrophe of the 1920s and 1930s is largely unknown and therefore unappreciated.
Other observers, for example, many Austrian economists, believe that all the trouble started with a central bank “inflation” in the 1920s.
This “inflation” had to be invented because it is a necessary element in the Austrian theory of the business cycle, which seems to describe most Austrian economic disequilibria.
Austrian “inflation” is not limited to price level increases, no matter how “prices” are estimated.
Rather, it is any unnatural increase in the stock of money “not consisting in, i.e., not covered by, an increase in gold.”[1]
Once the Austrian “inflation” is going, it provokes over-investment and maladjustment in various sectors of the economy.
To correct the inflation-generated disequilibrium requires a wringing-out of the miscalculated investments.
This purging became the enduring business calamity of the 1930s.
The late Murray Rothbard was the chief proponent of this argument.
Rothbard’s problem is manifest in his book America’s Great Depression.
After endowing the useful word “inflation” with a new and unacceptable meaning, Rothbard “discovered” that the Federal Reserve had indeed provoked an inflation in the 1921–1929 period.
The money supply he examined for the period included not only hand-to-hand currency and all deposits in commercial banks adjusted for inter-bank holdings — the conventional M2 money stock — but also savings and loan share capital and life insurance net policy reserves.
Consequently, where the M2 money stock increased 46 percent over the period, or at an annual rate of about 4 percent, the Rothbard-expanded “money stock” increased by 62 percent, or about 7 percent per year. [2]
Here, Rothbard mistakes some elements of financial wealth with money.
The latter two items he specifies as money are not money.
They cannot be spent on ordinary goods and services.
To spend them, one needs to cash them in for other money — currency or bank drafts.
Increases in their quantity do not pervasively spill over into all other markets causing serious macroeconomic disequilibrium.
Their appearance as financial assets in people’s possession is just as likely to be deflationary as not because their purchase and sale require money that would otherwise be used for transactions of conventional goods and services.
Apologists for central banking, by way of contrast, see stock market “speculation” instead of over-investment as the culprit.
They argue that the System did all it could to counteract the “inevitable” contraction that followed the 1929 stock market boom, but that its best effort could not be good enough.
Since earnest and sophisticated men operated the federal government and the Federal Reserve System, something had to be wrong with the economic system itself.
Markets just could not be trusted to provide full employment and steady real growth.
TO BE CONTINUED ...
MONEY IN THE 1920s
Re: MONEY IN THE 1920s
FOUNDATION FOR ECONOMIC EDUCATION
Money in the 1920s and 1930s - Nowhere is monetary ignorance more apparent than in an analysis of these decades., continued ...
Richard H. Timberlake
Thursday, April 1, 1999
The Mismeasure of Money
Careful scrutiny of the monetary system and its associated monetary data reveals that neither of these views is analytically correct.
Their defects result from ignorance of the flawed institutional framework within which the gold standard and the central bank generated money.
Both also suffer from mismeasurement of the central bank’s monetary data.
Four definable institutions created the money in use during the 1920s: the gold standard, the U.S. Treasury, the Federal Reserve System of 12 regional banks and the Federal Reserve Board in Washington, and the commercial banking system of 20,000-odd banks.
These institutions were not created equal, however.
Only the gold standard and the Fed, with a notable assist from the Treasury, were important in initiating either monetary policy or the monetary happenings of the period.
The commercial banks could only take what came their way from the central bank and the gold standard.
They, too, created money.
But their money-creating activities were all unintentional and strictly a byproduct of their lending operations.
The gold standard after World War I was anything but the autonomous, self-regulating institution that the Founding Fathers had prescribed — quite the contrary.
The Federal Reserve Bank officers, particularly presidents, and the governors on the Federal Reserve Board, based then in the Treasury Building in Washington, exercised a monetary policy that often finessed the gold standard.
When gold came into the U.S. economy from a foreign country, importers deposited it in a commercial bank.
The commercial bank, in turn, sent the gold to the regional Federal Reserve Bank to which the commercial bank belonged.
The Fed Bank would credit the reserve account of this member bank, credit its own gold asset account by the same amount, and deposit the physical gold in the Treasury.
If the member bank needed currency instead of an additional balance in its reserve account, the regional Fed Bank would issue its own Federal Reserve notes, dollar for dollar, based on the gold it had received.
In either case, the Fed Bank was simply a monetizer of the gold.
It converted the gold into dollars just as an ordinary commercial bank would have done in the absence of a central bank.
The monetary system thereafter had more dollars of bank reserves and deposits, or dollars of currency, because gold had come into the country.
All other legal tender items, such as silver currency and greenbacks, were accounted in the Fed Banks in the same way as the gold.
Fed Banks, therefore, were the custodians of a large fraction of the economy’s basic money stock — the currency and bank reserves behind the checking accounts that households and businesses used for everyday transactions.
TO BE CONTINUED ...
Money in the 1920s and 1930s - Nowhere is monetary ignorance more apparent than in an analysis of these decades., continued ...
Richard H. Timberlake
Thursday, April 1, 1999
The Mismeasure of Money
Careful scrutiny of the monetary system and its associated monetary data reveals that neither of these views is analytically correct.
Their defects result from ignorance of the flawed institutional framework within which the gold standard and the central bank generated money.
Both also suffer from mismeasurement of the central bank’s monetary data.
Four definable institutions created the money in use during the 1920s: the gold standard, the U.S. Treasury, the Federal Reserve System of 12 regional banks and the Federal Reserve Board in Washington, and the commercial banking system of 20,000-odd banks.
These institutions were not created equal, however.
Only the gold standard and the Fed, with a notable assist from the Treasury, were important in initiating either monetary policy or the monetary happenings of the period.
The commercial banks could only take what came their way from the central bank and the gold standard.
They, too, created money.
But their money-creating activities were all unintentional and strictly a byproduct of their lending operations.
The gold standard after World War I was anything but the autonomous, self-regulating institution that the Founding Fathers had prescribed — quite the contrary.
The Federal Reserve Bank officers, particularly presidents, and the governors on the Federal Reserve Board, based then in the Treasury Building in Washington, exercised a monetary policy that often finessed the gold standard.
When gold came into the U.S. economy from a foreign country, importers deposited it in a commercial bank.
The commercial bank, in turn, sent the gold to the regional Federal Reserve Bank to which the commercial bank belonged.
The Fed Bank would credit the reserve account of this member bank, credit its own gold asset account by the same amount, and deposit the physical gold in the Treasury.
If the member bank needed currency instead of an additional balance in its reserve account, the regional Fed Bank would issue its own Federal Reserve notes, dollar for dollar, based on the gold it had received.
In either case, the Fed Bank was simply a monetizer of the gold.
It converted the gold into dollars just as an ordinary commercial bank would have done in the absence of a central bank.
The monetary system thereafter had more dollars of bank reserves and deposits, or dollars of currency, because gold had come into the country.
All other legal tender items, such as silver currency and greenbacks, were accounted in the Fed Banks in the same way as the gold.
Fed Banks, therefore, were the custodians of a large fraction of the economy’s basic money stock — the currency and bank reserves behind the checking accounts that households and businesses used for everyday transactions.
TO BE CONTINUED ...
Re: MONEY IN THE 1920s
FOUNDATION FOR ECONOMIC EDUCATION
Money in the 1920s and 1930s - Nowhere is monetary ignorance more apparent than in an analysis of these decades., continued ...
Richard H. Timberlake
Thursday, April 1, 1999
Blocking the Effects of Gold
Of course, the Federal Reserve System did not come into existence to be a custodian of the economy’s base money and nothing else.
The Fed Banks also had the legal power to create bank reserves and currency.
Using the gold and other legal tender they held as their reserves, the Fed Banks could themselves become fractional reserve institutions.
They could expand the reserves of their member commercial banks, or issue additional currency to them, by buying certain interest-earning “eligible” assets from the banks.
If Fed Banks wished to block the effects of gold deposited with them to prevent the creation of common money based on the new gold, they could restrict their own lending to the commercial banks or sell off some of their interest-earning assets.
Within limits, the Fed’s money managers could deliberately and purposely supplement or counteract what the gold standard machinery did as a result of market forces.
It was this particular machination to which Rothbard properly objected.
The Fed Banks’ institutional authority derived from the Federal Reserve Act of 1913.
The Act gave the Fed Banks the role of sequestering most of the banking system’s gold, and the power, explained above, either to enhance or hinder the monetary effects of any incoming gold.
At the same time, the congressional founders of the Fed saw the new institution only as a supplement to the official gold standard.
In the Federal Reserve Act itself, they inserted a provision stating: “Nothing in this act ... shall be considered to repeal the parity provisions [between gold and the dollar] contained in an act approved March 14, 1900.”
That referred to the Gold Standard Act, which made gold the sole legal tender monetary metal in the U.S. system.
The new Federal Reserve System was supposed to act only within this official gold framework.
To show how the Fed’s hands-on controls worked during the 1920s, I have constructed a table that summarizes the major monetary elements in the combined Fed Banks’ balance sheet for the 1921–1933 period.
It also includes the level of prices as measured by the Consumer Price Index (CPI).
The column labeled M1 measures the stock of common money — currency and checking account balances.
From 1921 to 1929 this stock of everyday money increased on average 2.5 percent per year (compounded). [3]
The column labeled “Total Fed” shows the Federal Reserve base on which this common money rested.
Although this base increased slightly from 1924 to 1928, it declined over the whole eight-year span at an annual rate of 1.6 percent.
Fed-held gold and other reserve assets increased nominally at 1.1 percent per year primarily because of gold inflows.
Federal Reserve policy prevented some of this gold from becoming a basis for new money by “sterilizing” it.
That is, as the gold came into their tills, the Fed Banks allowed their holdings of other assets, which were primarily debts of the member banks, to decline: The member banks paid off some of their debts by reducing their reserve account balances at the Fed Banks.
Changes in “net monetary obligations” of the Fed Banks (the column labeled “Net Fed”) accurately reflects this deflationary policy.
“Net monetary obligations” are total monetary assets minus gold and other legal tender reserves.
This datum, which faithfully indicates the intent of Fed policy, declined at an annual rate of 8.0 percent over the eight-year period.
Fed policy successfully offset the gold inflows so that prices rose only slightly — 0.5 percent per year for the eight-year period.
This much of a change can hardly be labeled an “increase” because it is less than the statistical construction error of the index.
One thing is certain: it was not any kind of an inflation.
All the economic chronicles for the period, besides the monetary data, confirm that Fed policy was braking against possible gold-inspired price increases in the United States.
The Fed’s primary purpose was to further international monetary policies, particularly to help the Bank of England achieve and maintain gold payments for the pound sterling — but that is another story.
In their Monetary History of the United States, Milton Friedman and Anna Schwartz conclude their summary of the monetary events of the 1920s with this paragraph:
“Gold movements were not permitted to affect the total of high-powered money [bank reserves and currency]."
"They were ... sterilized, inflows being offset by open market sales, outflows by open market purchases.” [4]
They observe further:
“The widespread belief that what goes up must come down, ... plus the dramatic stock market boom, have led many to suppose that the United States experienced severe inflation before 1929 and [that] the [Federal] Reserve System served as an engine of it."
"Nothing could be further from the truth."
"By 1923, wholesale prices had recovered only a sixth of their 1920–21 decline."
"From then until 1929, they fell on the average of 1 percent per year."
"... Far from being an inflationary decade, the twenties were the reverse."
"And the Reserve System, far from being an engine of inflation, very likely kept the money stock from rising as much as it would have if gold movements had been allowed to exert their full influence.” [5]
Ironically, the Federal Reserve System that has provided itself in recent decades with the well-deserved label “engine of inflation” was in the 1920s an “engine” preventing gold inflation.
Any gold inflation would have been very mild; so the question of whether Fed policy was proper is arguable — until we look at what happened afterward.
Given that its intervention prevented a minor gold inflation, did the Fed then reverse itself as bank failures occurred and economic contraction threatened?
Following approved central bank doctrine, did it lend freely during the ensuing contraction at stiff interest rates until its remaining gold reserves would not have been enough to plate a teaspoon? [6]
Let’s see what happened.
Disaster Hits
As everyone knows, the following four years, 1929–1933, were a deflationary disaster.
Not quite so clear is what the Federal Reserve did, or, more important, did not do during that time.
Fed spokesmen have often alleged that the Fed tried “everything in its power” to turn around the contraction and that it used its gold reserves to their utmost.
Again, nothing could be further from the truth.
By 1929, the Fed’s monetary liabilities — commercial banks’ reserve-deposit accounts in Fed Banks, and the public’s holdings of Federal Reserve currency — were $4.25 billion.
These monetary items exceeded the Fed’s gold asset holdings by only $1.39 billion.
Put another way, the gold that came into the Fed Banks, which the commercial banks would have held in the absence of a central bank, was $2.86 billion.
Federal Reserve policy actions had created the remaining $1.39 billion.
By August 1929, the Fed’s gold and other reserves had grown to $3.12 billion (not shown in the table).
The Federal Reserve Act required half these gold reserves to back outstanding Fed liabilities, but the other half of them, $1.56 billion, were “excess” and available for whatever monetary purposes the Fed managers thought appropriate.
During the following three-and-a-half years, the Fed Banks’ managers continued to build up the Fed Banks’ gold holdings — even as the financial system spiraled downward as a result of three serious banking crises.
By February 1933, owing to the Fed’s tight money policy, the economy was in shambles and constricted to the point of monetary suffocation.
The Fed Banks’ gold stock had increased to $3.36 billion, and “excess” gold reserves were still $1.35 billion!
(The higher figure in the table is for June 1933.)
This damning statistic is seen in the column labeled “Fed Gold.”
While the Fed had enjoyed an increase of $700 million in its gold and other reserve holdings, its monetary output had increased by only $680 million: Commercial banks had $20 million less in reserves than they would have had with no Federal Reserve System.
This statistic, however, is not the end of the story.
Since total commercial bank reserves were $2.29 billion in February 1933, the $1.35 billion of excess gold reserves Fed Banks held could have enhanced the banking system’s reserves by another 60 percent — to $3.64 billion.
TO BE CONTINUED ...
Money in the 1920s and 1930s - Nowhere is monetary ignorance more apparent than in an analysis of these decades., continued ...
Richard H. Timberlake
Thursday, April 1, 1999
Blocking the Effects of Gold
Of course, the Federal Reserve System did not come into existence to be a custodian of the economy’s base money and nothing else.
The Fed Banks also had the legal power to create bank reserves and currency.
Using the gold and other legal tender they held as their reserves, the Fed Banks could themselves become fractional reserve institutions.
They could expand the reserves of their member commercial banks, or issue additional currency to them, by buying certain interest-earning “eligible” assets from the banks.
If Fed Banks wished to block the effects of gold deposited with them to prevent the creation of common money based on the new gold, they could restrict their own lending to the commercial banks or sell off some of their interest-earning assets.
Within limits, the Fed’s money managers could deliberately and purposely supplement or counteract what the gold standard machinery did as a result of market forces.
It was this particular machination to which Rothbard properly objected.
The Fed Banks’ institutional authority derived from the Federal Reserve Act of 1913.
The Act gave the Fed Banks the role of sequestering most of the banking system’s gold, and the power, explained above, either to enhance or hinder the monetary effects of any incoming gold.
At the same time, the congressional founders of the Fed saw the new institution only as a supplement to the official gold standard.
In the Federal Reserve Act itself, they inserted a provision stating: “Nothing in this act ... shall be considered to repeal the parity provisions [between gold and the dollar] contained in an act approved March 14, 1900.”
That referred to the Gold Standard Act, which made gold the sole legal tender monetary metal in the U.S. system.
The new Federal Reserve System was supposed to act only within this official gold framework.
To show how the Fed’s hands-on controls worked during the 1920s, I have constructed a table that summarizes the major monetary elements in the combined Fed Banks’ balance sheet for the 1921–1933 period.
It also includes the level of prices as measured by the Consumer Price Index (CPI).
The column labeled M1 measures the stock of common money — currency and checking account balances.
From 1921 to 1929 this stock of everyday money increased on average 2.5 percent per year (compounded). [3]
The column labeled “Total Fed” shows the Federal Reserve base on which this common money rested.
Although this base increased slightly from 1924 to 1928, it declined over the whole eight-year span at an annual rate of 1.6 percent.
Fed-held gold and other reserve assets increased nominally at 1.1 percent per year primarily because of gold inflows.
Federal Reserve policy prevented some of this gold from becoming a basis for new money by “sterilizing” it.
That is, as the gold came into their tills, the Fed Banks allowed their holdings of other assets, which were primarily debts of the member banks, to decline: The member banks paid off some of their debts by reducing their reserve account balances at the Fed Banks.
Changes in “net monetary obligations” of the Fed Banks (the column labeled “Net Fed”) accurately reflects this deflationary policy.
“Net monetary obligations” are total monetary assets minus gold and other legal tender reserves.
This datum, which faithfully indicates the intent of Fed policy, declined at an annual rate of 8.0 percent over the eight-year period.
Fed policy successfully offset the gold inflows so that prices rose only slightly — 0.5 percent per year for the eight-year period.
This much of a change can hardly be labeled an “increase” because it is less than the statistical construction error of the index.
One thing is certain: it was not any kind of an inflation.
All the economic chronicles for the period, besides the monetary data, confirm that Fed policy was braking against possible gold-inspired price increases in the United States.
The Fed’s primary purpose was to further international monetary policies, particularly to help the Bank of England achieve and maintain gold payments for the pound sterling — but that is another story.
In their Monetary History of the United States, Milton Friedman and Anna Schwartz conclude their summary of the monetary events of the 1920s with this paragraph:
“Gold movements were not permitted to affect the total of high-powered money [bank reserves and currency]."
"They were ... sterilized, inflows being offset by open market sales, outflows by open market purchases.” [4]
They observe further:
“The widespread belief that what goes up must come down, ... plus the dramatic stock market boom, have led many to suppose that the United States experienced severe inflation before 1929 and [that] the [Federal] Reserve System served as an engine of it."
"Nothing could be further from the truth."
"By 1923, wholesale prices had recovered only a sixth of their 1920–21 decline."
"From then until 1929, they fell on the average of 1 percent per year."
"... Far from being an inflationary decade, the twenties were the reverse."
"And the Reserve System, far from being an engine of inflation, very likely kept the money stock from rising as much as it would have if gold movements had been allowed to exert their full influence.” [5]
Ironically, the Federal Reserve System that has provided itself in recent decades with the well-deserved label “engine of inflation” was in the 1920s an “engine” preventing gold inflation.
Any gold inflation would have been very mild; so the question of whether Fed policy was proper is arguable — until we look at what happened afterward.
Given that its intervention prevented a minor gold inflation, did the Fed then reverse itself as bank failures occurred and economic contraction threatened?
Following approved central bank doctrine, did it lend freely during the ensuing contraction at stiff interest rates until its remaining gold reserves would not have been enough to plate a teaspoon? [6]
Let’s see what happened.
Disaster Hits
As everyone knows, the following four years, 1929–1933, were a deflationary disaster.
Not quite so clear is what the Federal Reserve did, or, more important, did not do during that time.
Fed spokesmen have often alleged that the Fed tried “everything in its power” to turn around the contraction and that it used its gold reserves to their utmost.
Again, nothing could be further from the truth.
By 1929, the Fed’s monetary liabilities — commercial banks’ reserve-deposit accounts in Fed Banks, and the public’s holdings of Federal Reserve currency — were $4.25 billion.
These monetary items exceeded the Fed’s gold asset holdings by only $1.39 billion.
Put another way, the gold that came into the Fed Banks, which the commercial banks would have held in the absence of a central bank, was $2.86 billion.
Federal Reserve policy actions had created the remaining $1.39 billion.
By August 1929, the Fed’s gold and other reserves had grown to $3.12 billion (not shown in the table).
The Federal Reserve Act required half these gold reserves to back outstanding Fed liabilities, but the other half of them, $1.56 billion, were “excess” and available for whatever monetary purposes the Fed managers thought appropriate.
During the following three-and-a-half years, the Fed Banks’ managers continued to build up the Fed Banks’ gold holdings — even as the financial system spiraled downward as a result of three serious banking crises.
By February 1933, owing to the Fed’s tight money policy, the economy was in shambles and constricted to the point of monetary suffocation.
The Fed Banks’ gold stock had increased to $3.36 billion, and “excess” gold reserves were still $1.35 billion!
(The higher figure in the table is for June 1933.)
This damning statistic is seen in the column labeled “Fed Gold.”
While the Fed had enjoyed an increase of $700 million in its gold and other reserve holdings, its monetary output had increased by only $680 million: Commercial banks had $20 million less in reserves than they would have had with no Federal Reserve System.
This statistic, however, is not the end of the story.
Since total commercial bank reserves were $2.29 billion in February 1933, the $1.35 billion of excess gold reserves Fed Banks held could have enhanced the banking system’s reserves by another 60 percent — to $3.64 billion.
TO BE CONTINUED ...
Re: MONEY IN THE 1920s
FOUNDATION FOR ECONOMIC EDUCATION
Money in the 1920s and 1930s - Nowhere is monetary ignorance more apparent than in an analysis of these decades., concluded ...
Richard H. Timberlake
Thursday, April 1, 1999
“Real Bills Doctrine”
The Fed Banks were truly absorbers of gold.
They simply extended and intensified the tight money policy they had begun in the 1920s, but for a different reason.
Instead of helping the Bank of England return to a gold standard, the Fed managers had become enthralled with the idea that production of goods and services initiates and promotes the production of money.
Economists sometimes refer to this as the “real bills doctrine.”
While it has a grain of truth in it when a true gold standard is in place, it has no validity at all in a system dominated by a central bank.
With this flawed doctrine governing their thinking, the Fed Banks’ managers marked time waiting for new production to appear so that they could in good conscience expand their monetary obligations in support of the private economy.
It never happened.
The U.S. banking system went through three serious contractions and the money stock continued to shrink.
By 1933, the M1 and M2 money stocks were 27 percent and 25 percent below their 1929 levels.
Meanwhile, the Fed Banks sat on their huge hoard of gold — the gold reserves legally required for their current monetary output and the “excess” gold reserves that could have provided significant monetary increases — and did ... nothing!
Truly, when such a crisis appears, all the central bank’s gold is excess.
A proper central bank can never be faulted for “running out of gold.”
If the Fed Banks had followed the established (Bagehot) doctrine of the time, they would sensibly have expanded their loans, discounts, and accommodations to their “member” banks until their gold stock was a cipher.
Of course, they would not have had to run their gold reserve ratio down to zero.
Long before they had expanded or used up their gold reserves, the crisis of central-bank mismanagement would have ended (or, more probably, would never have begun).
The economy would have been back to normal, and none of the ugly governmental machinations of the later 1930s would have occurred.
No Supreme Court conflicts would have appeared; no New Deal bureaucracies would have emerged to plague the economy; the Leviathan would have been kept in its constitutional cage.
Most importantly, many of the freedoms we are now trying to restore would still be commonplace.
One would think that with this experience behind them, the “monetary authorities” and the congressional wheelers and dealers would have learned some lessons about U.S. monetary machinery and its relationship to the economy.
They did not.
Next month I will treat the reserve requirement debacle of the mid-1930s, which added additional travail to the monetary mistakes made in the early part of the decade.
Notes
Murray N. Rothbard, America’s Great Depression (Kansas City: Sheed and Ward, 1963, 1972), p. 87. Emphasis in the original.
Ibid., p. 88.
The M2 money stock, which includes all of M1 plus time deposits at commercial banks, increased 5 percent per year from 1921 to 1929, and then fell at 13 percent per year from 1929 to 1933. No basis exists for a more inclusive money stock than M2.
Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton: National Bureau of Economic Research and Princeton University Press, 1963), p. 297.
Ibid., p. 298. Emphasis added.
This well-understood doctrine for central bank procedure was proposed by Walter Bagehot in his classic work, Lombard Street, rev. ed. (London: Kegan, Paul, Trench, Toubner & Co., 1906 [1873]).
Richard H. Timberlake, Jr. (born June 24, 1922) is an American economist who was Professor of Economics at the University of Georgia for much of his career. He also has become a leading advocate of free banking, the belief that money should be issued by private companies, not by a government monopoly.
Further Reading
Austrian Inflation, Austrian Money, and Federal Reserve Policy
Staff - 9/1/2000
Money and Gold in the 1920s and 1930s: An Austrian View
Joseph T. Salerno - 10/1/1999
Monetary-Policy Disasters of the Twentieth Century
Kirby R. Cundiff - 1/1/2007
Gold Policy in the 1930s
Richard H. Timberlake - 5/1/1999
https://fee.org/articles/money-in-the-1920s-and-1930s/
Money in the 1920s and 1930s - Nowhere is monetary ignorance more apparent than in an analysis of these decades., concluded ...
Richard H. Timberlake
Thursday, April 1, 1999
“Real Bills Doctrine”
The Fed Banks were truly absorbers of gold.
They simply extended and intensified the tight money policy they had begun in the 1920s, but for a different reason.
Instead of helping the Bank of England return to a gold standard, the Fed managers had become enthralled with the idea that production of goods and services initiates and promotes the production of money.
Economists sometimes refer to this as the “real bills doctrine.”
While it has a grain of truth in it when a true gold standard is in place, it has no validity at all in a system dominated by a central bank.
With this flawed doctrine governing their thinking, the Fed Banks’ managers marked time waiting for new production to appear so that they could in good conscience expand their monetary obligations in support of the private economy.
It never happened.
The U.S. banking system went through three serious contractions and the money stock continued to shrink.
By 1933, the M1 and M2 money stocks were 27 percent and 25 percent below their 1929 levels.
Meanwhile, the Fed Banks sat on their huge hoard of gold — the gold reserves legally required for their current monetary output and the “excess” gold reserves that could have provided significant monetary increases — and did ... nothing!
Truly, when such a crisis appears, all the central bank’s gold is excess.
A proper central bank can never be faulted for “running out of gold.”
If the Fed Banks had followed the established (Bagehot) doctrine of the time, they would sensibly have expanded their loans, discounts, and accommodations to their “member” banks until their gold stock was a cipher.
Of course, they would not have had to run their gold reserve ratio down to zero.
Long before they had expanded or used up their gold reserves, the crisis of central-bank mismanagement would have ended (or, more probably, would never have begun).
The economy would have been back to normal, and none of the ugly governmental machinations of the later 1930s would have occurred.
No Supreme Court conflicts would have appeared; no New Deal bureaucracies would have emerged to plague the economy; the Leviathan would have been kept in its constitutional cage.
Most importantly, many of the freedoms we are now trying to restore would still be commonplace.
One would think that with this experience behind them, the “monetary authorities” and the congressional wheelers and dealers would have learned some lessons about U.S. monetary machinery and its relationship to the economy.
They did not.
Next month I will treat the reserve requirement debacle of the mid-1930s, which added additional travail to the monetary mistakes made in the early part of the decade.
Notes
Murray N. Rothbard, America’s Great Depression (Kansas City: Sheed and Ward, 1963, 1972), p. 87. Emphasis in the original.
Ibid., p. 88.
The M2 money stock, which includes all of M1 plus time deposits at commercial banks, increased 5 percent per year from 1921 to 1929, and then fell at 13 percent per year from 1929 to 1933. No basis exists for a more inclusive money stock than M2.
Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton: National Bureau of Economic Research and Princeton University Press, 1963), p. 297.
Ibid., p. 298. Emphasis added.
This well-understood doctrine for central bank procedure was proposed by Walter Bagehot in his classic work, Lombard Street, rev. ed. (London: Kegan, Paul, Trench, Toubner & Co., 1906 [1873]).
Richard H. Timberlake, Jr. (born June 24, 1922) is an American economist who was Professor of Economics at the University of Georgia for much of his career. He also has become a leading advocate of free banking, the belief that money should be issued by private companies, not by a government monopoly.
Further Reading
Austrian Inflation, Austrian Money, and Federal Reserve Policy
Staff - 9/1/2000
Money and Gold in the 1920s and 1930s: An Austrian View
Joseph T. Salerno - 10/1/1999
Monetary-Policy Disasters of the Twentieth Century
Kirby R. Cundiff - 1/1/2007
Gold Policy in the 1930s
Richard H. Timberlake - 5/1/1999
https://fee.org/articles/money-in-the-1920s-and-1930s/
Re: MONEY IN THE 1920s
FOUNDATION FOR ECONOMIC EDUCATION
Gold Policy in the 1930s - How the fed monetarily starved the country into the great contraction.
Richard H. Timberlake
Saturday, May 1, 1999
Between 1929 and 1933, the Federal Reserve System, which is the central bank of the United States, monetarily starved the country into the worst economic crisis it has ever experienced.
Markets, and the market system generally, did not fail, and nothing was inevitable about the collapse that occurred.
Rather, the monetary system was so mismanaged that even a healthy and vigorous market system could not correct the disequilibrium that resulted.
The popular application of “market failure” to describe the economy during the years of the Great Contraction, 1929–1933, is wrong.
Market actions in that era made the politically inspired crisis less severe than it otherwise would have been.
Furthermore, “market failure” is a term people often apply to events when they cannot understand the complexities of economic processes that result from ill-conceived government policies.
The operations of just about any monetary system, and especially one with a central bank, are always puzzling to the layman.
Consequently, when things go wrong owing to monetary mismanagement by central bankers or some other political intervention, the instigators can ring in “market failure” as an excuse for their personal failures to make the right decisions.
Failure in other aspects of human endeavor often generates learning that subsequently leads to correction and eventual success. [1]
Federal Reserve policy failure in 1929–1933, however, led only to federal legislation that increased the number and power of federal government agencies.
The Republican Hoover administration, for example, initiated the expensive Reconstruction Finance Corporation in 1932 to carry out lending policies that the elaborately structured Federal Reserve System had failed to undertake.
The Roosevelt administration then took control of the political machinery in 1933 and began a program of federal intervention and bureaucratic propagation that is mind-boggling even today.
Two items of Roosevelt-era legislation markedly affected the U.S. banking and monetary system.
The first was the so-called Gold Reserve Act of 1934.
This legislation gave the president the unconstitutional power to call in all privately owned gold for deposit in the U.S. Treasury.
It also gave him the unconstitutional power by his fiat to revalue the price of gold (devalue the dollar) by as much as 60 percent.
Congress’s constitutional power to “regulate the value of money” was a power that could not be delegated to the executive.
Furthermore, “regulate” did not mean a massive change in the monetary values of either gold or silver.
Its sole purpose was to provide a means for congressional housekeeping control over the coinage system.
Properly used, it allowed Congress to make incremental changes in the legal tender value of either gold or silver so that both metals would stay in circulation.
It was put into the Constitution to counteract Gresham’s Law.
Otherwise, changes in the market value of one or the other metal would result in what had now become the cheaper metal going to the mint and the other, dearer, metal going into the markets as a commodity. [2]
A New Central Banking Measure
The other piece of legislation, the Banking Act of 1935, was more momentous than the original Federal Reserve Act passed in 1913.
In fact, the Act of 1935 might better have been labeled “The Central Banking Act of 1935,” because it virtually rewrote the earlier Act.
A central bank, like a gold standard, can assume many institutional forms that differ markedly from one another.
The 1913 Fed Banks, for example, were regionally autonomous; the Board in Washington was relatively powerless.
Board members were treated and paid on a scale similar to government employees in the U.S. Treasury, while the presidents of the regional Fed Banks commanded salaries comparable to those of executives heading major corporations.
The Fed Banks’ gold reserves severely restricted their lending policies, as was proper under an operational gold standard.
Finally, the real bills doctrine was supposed to furnish the grounds for Fed Banks’ accommodation of credit to their client member banks.
The Banking Act of 1935 changed the whole paraphernalia of monetary control.
It vested the Federal Open Market Committee (FOMC) with complete discretionary control to determine the stock of money in the United States.
Regional Fed Bank presidents still had five of the 12 seats on the FOMC, but the Board was now a seven-man majority.
From that time on, the FOMC has fashioned monetary policy by authorizing the purchase (or sale) of U.S. government securities in the open market, an operation that the Fed Bank of New York conducts week by week.
When the FOMC buys the U.S. securities that the Treasury has previously sold to pay the government’s bills, it does so by creating money.
This new money is either commercial bank reserves or Federal Reserve note currency.
Clearly, if a 12-person board is determining the quantity of money that exists, the quantity of gold in the system has little or nothing to do with the money.
Either a gold standard specifies the quantity of money in the economy, or a central bank does.
A marriage of the two never lasts longer than an unhappy weekend.
The Gold Reserve Act of 1934 was the final divorce decree between gold and the monetary system.
After January 31, 1934, no private household, bank, or business was allowed to own or hold more than a trivial amount of gold.
Gold coin was forbidden for monetary purposes.
This Act also authorized the president, Franklin Roosevelt, to raise the price of gold by 60 percent.
Roosevelt, however, did not use all the power given him — only 98 percent of it.
In early 1934, he increased the official mint price of gold, which had been $20.67 per ounce for 100 years, to $35 per ounce.
The Treasury gold stock, valued at $4,033 million in January 1934, became $7,348 million in February 1934, an increase of $3,405 million by the decree of one man. [3]
The federal government had also, unconstitutionally, repudiated all gold clauses in its contracts and debts, so it did not have to share any of its newfound wealth with the private sector.
In one month Congress and Roosevelt, by their legislative and administrative fiats, created seigniorage revenue from gold equal to one year’s ordinary tax revenues.
In contrast, the federal government of 1834–1837, when it realized one year’s extraordinary revenue from land sales, returned that surplus to the state governments to be used or distributed as those sovereign governments saw fit.[4]
President Roosevelt rationalized this usurpation of private property rights in gold in one of his notorious fireside chats.
“Since there was not enough gold to pay all holders of gold obligations,” he claimed, “the Government should in the interest of justice allow none to be paid in gold.”[5]
This rationalization of government confiscation was fatuous pretension.
Gold in banks was then and had always been a fractional reserve against outstanding obligations.
When the banks were on their own, they had adequate means to protect their reserves — gold, silver, or other legal tender.
The Fed Banks and the U.S. Treasury — government institutions — also held only fractional reserves against their outstanding currencies.
Use of gold as a recognized fractional reserve always precluded immediate liquidation of all monetary obligations into gold.
So in effect, Roosevelt was saying, “Since there was not enough gold to pay all holders of gold obligations, ... the federal government should expropriate and keep all of the gold.”
The increase in the dollar price of gold, though other countries had gone off the gold standard or had also raised the price of gold in their own currencies, started a massive inflow of gold to the United States.
Political apprehension in Europe and elsewhere also contributed to the U.S. accumulation.
By 1940, the U.S. gold stock totaled $20 billion, or almost 20,000 tons!
The contrast was notable between a government awash in gold and a depressed economy denuded of money and functioning with a shell-shocked banking system.
Fed Banks and the Treasury still accounted new gold coming into the U.S. system as though the gold were a monetary asset.
The Treasury issued “Gold Certificates” — currency notes in $100,000 denominations — accounted at the new gold price of $35 per ounce, which it “deposited” in Federal Reserve Banks.
Fed Banks then debited their “Treasury deposit” liability account, and credited their “Gold Certificates.”
Whoever had received a check for the gold from the Treasury, however, had by now deposited that check in a commercial bank that, in turn, sent it to the Fed Bank for clearance.
The Fed Bank cleared the check against the “Treasury deposit” account and debited the deposit-reserve account of the client bank by the same amount.
No one could get the gold out of the Treasury, or touch it, or see it, or use it.
(It was now a criminal act to use gold for monetary purposes!)
Nonetheless, the gold provided an accounting medium for increasing the basic money stock of bank reserves and Federal Reserve note currency.
TO BE CONTINUED ...
Gold Policy in the 1930s - How the fed monetarily starved the country into the great contraction.
Richard H. Timberlake
Saturday, May 1, 1999
Between 1929 and 1933, the Federal Reserve System, which is the central bank of the United States, monetarily starved the country into the worst economic crisis it has ever experienced.
Markets, and the market system generally, did not fail, and nothing was inevitable about the collapse that occurred.
Rather, the monetary system was so mismanaged that even a healthy and vigorous market system could not correct the disequilibrium that resulted.
The popular application of “market failure” to describe the economy during the years of the Great Contraction, 1929–1933, is wrong.
Market actions in that era made the politically inspired crisis less severe than it otherwise would have been.
Furthermore, “market failure” is a term people often apply to events when they cannot understand the complexities of economic processes that result from ill-conceived government policies.
The operations of just about any monetary system, and especially one with a central bank, are always puzzling to the layman.
Consequently, when things go wrong owing to monetary mismanagement by central bankers or some other political intervention, the instigators can ring in “market failure” as an excuse for their personal failures to make the right decisions.
Failure in other aspects of human endeavor often generates learning that subsequently leads to correction and eventual success. [1]
Federal Reserve policy failure in 1929–1933, however, led only to federal legislation that increased the number and power of federal government agencies.
The Republican Hoover administration, for example, initiated the expensive Reconstruction Finance Corporation in 1932 to carry out lending policies that the elaborately structured Federal Reserve System had failed to undertake.
The Roosevelt administration then took control of the political machinery in 1933 and began a program of federal intervention and bureaucratic propagation that is mind-boggling even today.
Two items of Roosevelt-era legislation markedly affected the U.S. banking and monetary system.
The first was the so-called Gold Reserve Act of 1934.
This legislation gave the president the unconstitutional power to call in all privately owned gold for deposit in the U.S. Treasury.
It also gave him the unconstitutional power by his fiat to revalue the price of gold (devalue the dollar) by as much as 60 percent.
Congress’s constitutional power to “regulate the value of money” was a power that could not be delegated to the executive.
Furthermore, “regulate” did not mean a massive change in the monetary values of either gold or silver.
Its sole purpose was to provide a means for congressional housekeeping control over the coinage system.
Properly used, it allowed Congress to make incremental changes in the legal tender value of either gold or silver so that both metals would stay in circulation.
It was put into the Constitution to counteract Gresham’s Law.
Otherwise, changes in the market value of one or the other metal would result in what had now become the cheaper metal going to the mint and the other, dearer, metal going into the markets as a commodity. [2]
A New Central Banking Measure
The other piece of legislation, the Banking Act of 1935, was more momentous than the original Federal Reserve Act passed in 1913.
In fact, the Act of 1935 might better have been labeled “The Central Banking Act of 1935,” because it virtually rewrote the earlier Act.
A central bank, like a gold standard, can assume many institutional forms that differ markedly from one another.
The 1913 Fed Banks, for example, were regionally autonomous; the Board in Washington was relatively powerless.
Board members were treated and paid on a scale similar to government employees in the U.S. Treasury, while the presidents of the regional Fed Banks commanded salaries comparable to those of executives heading major corporations.
The Fed Banks’ gold reserves severely restricted their lending policies, as was proper under an operational gold standard.
Finally, the real bills doctrine was supposed to furnish the grounds for Fed Banks’ accommodation of credit to their client member banks.
The Banking Act of 1935 changed the whole paraphernalia of monetary control.
It vested the Federal Open Market Committee (FOMC) with complete discretionary control to determine the stock of money in the United States.
Regional Fed Bank presidents still had five of the 12 seats on the FOMC, but the Board was now a seven-man majority.
From that time on, the FOMC has fashioned monetary policy by authorizing the purchase (or sale) of U.S. government securities in the open market, an operation that the Fed Bank of New York conducts week by week.
When the FOMC buys the U.S. securities that the Treasury has previously sold to pay the government’s bills, it does so by creating money.
This new money is either commercial bank reserves or Federal Reserve note currency.
Clearly, if a 12-person board is determining the quantity of money that exists, the quantity of gold in the system has little or nothing to do with the money.
Either a gold standard specifies the quantity of money in the economy, or a central bank does.
A marriage of the two never lasts longer than an unhappy weekend.
The Gold Reserve Act of 1934 was the final divorce decree between gold and the monetary system.
After January 31, 1934, no private household, bank, or business was allowed to own or hold more than a trivial amount of gold.
Gold coin was forbidden for monetary purposes.
This Act also authorized the president, Franklin Roosevelt, to raise the price of gold by 60 percent.
Roosevelt, however, did not use all the power given him — only 98 percent of it.
In early 1934, he increased the official mint price of gold, which had been $20.67 per ounce for 100 years, to $35 per ounce.
The Treasury gold stock, valued at $4,033 million in January 1934, became $7,348 million in February 1934, an increase of $3,405 million by the decree of one man. [3]
The federal government had also, unconstitutionally, repudiated all gold clauses in its contracts and debts, so it did not have to share any of its newfound wealth with the private sector.
In one month Congress and Roosevelt, by their legislative and administrative fiats, created seigniorage revenue from gold equal to one year’s ordinary tax revenues.
In contrast, the federal government of 1834–1837, when it realized one year’s extraordinary revenue from land sales, returned that surplus to the state governments to be used or distributed as those sovereign governments saw fit.[4]
President Roosevelt rationalized this usurpation of private property rights in gold in one of his notorious fireside chats.
“Since there was not enough gold to pay all holders of gold obligations,” he claimed, “the Government should in the interest of justice allow none to be paid in gold.”[5]
This rationalization of government confiscation was fatuous pretension.
Gold in banks was then and had always been a fractional reserve against outstanding obligations.
When the banks were on their own, they had adequate means to protect their reserves — gold, silver, or other legal tender.
The Fed Banks and the U.S. Treasury — government institutions — also held only fractional reserves against their outstanding currencies.
Use of gold as a recognized fractional reserve always precluded immediate liquidation of all monetary obligations into gold.
So in effect, Roosevelt was saying, “Since there was not enough gold to pay all holders of gold obligations, ... the federal government should expropriate and keep all of the gold.”
The increase in the dollar price of gold, though other countries had gone off the gold standard or had also raised the price of gold in their own currencies, started a massive inflow of gold to the United States.
Political apprehension in Europe and elsewhere also contributed to the U.S. accumulation.
By 1940, the U.S. gold stock totaled $20 billion, or almost 20,000 tons!
The contrast was notable between a government awash in gold and a depressed economy denuded of money and functioning with a shell-shocked banking system.
Fed Banks and the Treasury still accounted new gold coming into the U.S. system as though the gold were a monetary asset.
The Treasury issued “Gold Certificates” — currency notes in $100,000 denominations — accounted at the new gold price of $35 per ounce, which it “deposited” in Federal Reserve Banks.
Fed Banks then debited their “Treasury deposit” liability account, and credited their “Gold Certificates.”
Whoever had received a check for the gold from the Treasury, however, had by now deposited that check in a commercial bank that, in turn, sent it to the Fed Bank for clearance.
The Fed Bank cleared the check against the “Treasury deposit” account and debited the deposit-reserve account of the client bank by the same amount.
No one could get the gold out of the Treasury, or touch it, or see it, or use it.
(It was now a criminal act to use gold for monetary purposes!)
Nonetheless, the gold provided an accounting medium for increasing the basic money stock of bank reserves and Federal Reserve note currency.
TO BE CONTINUED ...
Re: MONEY IN THE 1920s
FOUNDATION FOR ECONOMIC EDUCATION
Gold Policy in the 1930s - How the fed monetarily starved the country into the great contraction., continued ...
Richard H. Timberlake
Saturday, May 1, 1999
The Treasury in Control—The Fed Plays Ball
With all of the new gold coming into the system, the FOMC did not need to use its newly legislated powers.
From 1933 to 1936, the M2 money stock grew at annual rates of 9.5, 14.0, and 13.0 percent. [6]
In fact, so much gold was coming into the Fed-Treasury’s coffers that sentiment in both the Fed and Treasury leaned toward monetary restriction.
The Fed had active hands-on control of monetary policy.
Not only did it have the power to initiate open-market operations in government securities through the FOMC, but the Banking Act of 1935 also gave the Fed Board extensive control over member bank reserve requirements.
Prior to the Banking Act, reserve requirements were statutory at 7, 10, and 13 percent—not based on the size of the bank, but on the size of the city in which the bank was located.
The larger the city, the higher the legal reserve requirement. [7]
The Banking Act of 1935 used the existing set of reserve requirements as the lower end of a new range of requirements: 7–14, 10–20, and 13–26 percent.
Board of Governors’ decisions in Washington were to specify the precise set of requirements in force at any time.
Thus Fed policy could be restrictive by mandating an increase in requirements. [8]
Banking Act or not, the Treasury was still very much in the monetary picture.
Treasury Secretary Henry Morgenthau, Jr., had recommended to President Roosevelt the appointment of Marriner Eccles to be chairman of the Federal Reserve Board.
Eccles outspokenly favored lots of federal spending and fiscal budget deficits.
By his stance, he effectively signed over monetary policy to the Treasury.
(Morgenthau had recommended Eccles for this reason.)
The upshot of the arrangement was that Morgenthau ran the show.
Both men favored a dominant fiscal policy that had Federal Reserve support.
Although the new Banking Act took the secretary of the Treasury off the Fed’s Board of Governors (he had been the ex officio chairman), he now had a surrogate as chairman.
He was more than satisfied to see his purposes served from behind the throne.
Even a surrogate position was not enough for Morgenthau.
The realized seigniorage from the gold devaluation had given the Treasury a $2 billion windfall, accounted in an Exchange Stabilization Fund, that the Treasury was supposed to use to “stabilize” the dollar price of foreign currencies.
The Treasury thus had a gold “position” and license for conducting gold policy.
Federal Reserve policy directed the first increase (50 percent) in reserve requirements in August 1936—from 7, 10, and 13 percent to 101¼2, 15, and 191¼2 percent.
A few months later the Treasury initiated its own gold sterilization policy — the same policy the Fed had fostered in the 1920s.
Its purpose was “to halt the inflationary potentialities [sic]” of all incoming gold.
Beginning December 22, 1936, the Treasury placed its gold purchases in an “inactive” account.
Instead of issuing gold certificates and depositing them in Fed Banks to raise the necessary credit balance to pay for the gold, the Treasury paid for the gold by selling government securities in financial markets.
By this means, it carried out its own open market operations — sales in this case — with its own “FOMC.”
This way the gold remained stockpiled but unmonetized in the Treasury.
Besides neutralizing the gold inflows, the policy was further deflationary because it brought more government securities into markets to compete with consumers’ and investors’ dollars.
It thereby tended to raise interest rates as it inhibited general spending.
In March and May of 1937, the Fed complemented this generally deflationary policy by increasing reserve requirements to the maximum allowable percentages: 14, 20, and 26 percent.
Fed-Treasury policymakers had acted deliberately and purposely.
They believed in human management of the monetary system.
Just before he was appointed Fed chairman, Eccles had boldly stated that the Fed should “support expansionary fiscal policy through discretionary monetary policy.” [9]
Unfortunately, the discretionary monetary policy now being practiced was anything but expansionary.
It was, in fact, extremely repressive.
Unprecedented Depression
However, the rest of the economy, unlike politically prosperous Washington, was moving at an unprecedentedly slow rate.
Never before had a recession-depression been so tenured or so intense.
By late 1936, business was picking up, but the price level was still 18 percent below its 1929 value, and unemployment was still 16 percent of the labor force.
Nonetheless, the great concern in the Treasury and Federal Reserve was the danger of inflation!
Fed and Treasury officials looked at the overhang of excess legal reserves in the banking system and imagined what would happen if the commercial banks expanded all those reserves into an avalanche of checkbook money.
Monetary mismanagement had just provoked the most disastrous hyper-deflation in history.
Yet, before all the foreclosures had been properly settled, the government’s monetary managers were contriving to counteract the inflationary potential that they had systematically built into the monetary machinery.
Secretary Morgenthau announced in a press release, dated December 20, 1936, that Treasury gold policy was coordinated with the Fed’s reserve requirement increases. [10]
By mid-1937 “inactive” gold in the Treasury was $1,087 million, or about 9 percent of total Treasury gold.
TO BE CONTINUED ...
Gold Policy in the 1930s - How the fed monetarily starved the country into the great contraction., continued ...
Richard H. Timberlake
Saturday, May 1, 1999
The Treasury in Control—The Fed Plays Ball
With all of the new gold coming into the system, the FOMC did not need to use its newly legislated powers.
From 1933 to 1936, the M2 money stock grew at annual rates of 9.5, 14.0, and 13.0 percent. [6]
In fact, so much gold was coming into the Fed-Treasury’s coffers that sentiment in both the Fed and Treasury leaned toward monetary restriction.
The Fed had active hands-on control of monetary policy.
Not only did it have the power to initiate open-market operations in government securities through the FOMC, but the Banking Act of 1935 also gave the Fed Board extensive control over member bank reserve requirements.
Prior to the Banking Act, reserve requirements were statutory at 7, 10, and 13 percent—not based on the size of the bank, but on the size of the city in which the bank was located.
The larger the city, the higher the legal reserve requirement. [7]
The Banking Act of 1935 used the existing set of reserve requirements as the lower end of a new range of requirements: 7–14, 10–20, and 13–26 percent.
Board of Governors’ decisions in Washington were to specify the precise set of requirements in force at any time.
Thus Fed policy could be restrictive by mandating an increase in requirements. [8]
Banking Act or not, the Treasury was still very much in the monetary picture.
Treasury Secretary Henry Morgenthau, Jr., had recommended to President Roosevelt the appointment of Marriner Eccles to be chairman of the Federal Reserve Board.
Eccles outspokenly favored lots of federal spending and fiscal budget deficits.
By his stance, he effectively signed over monetary policy to the Treasury.
(Morgenthau had recommended Eccles for this reason.)
The upshot of the arrangement was that Morgenthau ran the show.
Both men favored a dominant fiscal policy that had Federal Reserve support.
Although the new Banking Act took the secretary of the Treasury off the Fed’s Board of Governors (he had been the ex officio chairman), he now had a surrogate as chairman.
He was more than satisfied to see his purposes served from behind the throne.
Even a surrogate position was not enough for Morgenthau.
The realized seigniorage from the gold devaluation had given the Treasury a $2 billion windfall, accounted in an Exchange Stabilization Fund, that the Treasury was supposed to use to “stabilize” the dollar price of foreign currencies.
The Treasury thus had a gold “position” and license for conducting gold policy.
Federal Reserve policy directed the first increase (50 percent) in reserve requirements in August 1936—from 7, 10, and 13 percent to 101¼2, 15, and 191¼2 percent.
A few months later the Treasury initiated its own gold sterilization policy — the same policy the Fed had fostered in the 1920s.
Its purpose was “to halt the inflationary potentialities [sic]” of all incoming gold.
Beginning December 22, 1936, the Treasury placed its gold purchases in an “inactive” account.
Instead of issuing gold certificates and depositing them in Fed Banks to raise the necessary credit balance to pay for the gold, the Treasury paid for the gold by selling government securities in financial markets.
By this means, it carried out its own open market operations — sales in this case — with its own “FOMC.”
This way the gold remained stockpiled but unmonetized in the Treasury.
Besides neutralizing the gold inflows, the policy was further deflationary because it brought more government securities into markets to compete with consumers’ and investors’ dollars.
It thereby tended to raise interest rates as it inhibited general spending.
In March and May of 1937, the Fed complemented this generally deflationary policy by increasing reserve requirements to the maximum allowable percentages: 14, 20, and 26 percent.
Fed-Treasury policymakers had acted deliberately and purposely.
They believed in human management of the monetary system.
Just before he was appointed Fed chairman, Eccles had boldly stated that the Fed should “support expansionary fiscal policy through discretionary monetary policy.” [9]
Unfortunately, the discretionary monetary policy now being practiced was anything but expansionary.
It was, in fact, extremely repressive.
Unprecedented Depression
However, the rest of the economy, unlike politically prosperous Washington, was moving at an unprecedentedly slow rate.
Never before had a recession-depression been so tenured or so intense.
By late 1936, business was picking up, but the price level was still 18 percent below its 1929 value, and unemployment was still 16 percent of the labor force.
Nonetheless, the great concern in the Treasury and Federal Reserve was the danger of inflation!
Fed and Treasury officials looked at the overhang of excess legal reserves in the banking system and imagined what would happen if the commercial banks expanded all those reserves into an avalanche of checkbook money.
Monetary mismanagement had just provoked the most disastrous hyper-deflation in history.
Yet, before all the foreclosures had been properly settled, the government’s monetary managers were contriving to counteract the inflationary potential that they had systematically built into the monetary machinery.
Secretary Morgenthau announced in a press release, dated December 20, 1936, that Treasury gold policy was coordinated with the Fed’s reserve requirement increases. [10]
By mid-1937 “inactive” gold in the Treasury was $1,087 million, or about 9 percent of total Treasury gold.
TO BE CONTINUED ...
Re: MONEY IN THE 1920s
FOUNDATION FOR ECONOMIC EDUCATION
Gold Policy in the 1930s - How the fed monetarily starved the country into the great contraction., concluded ...
Richard H. Timberlake
Saturday, May 1, 1999
Meanwhile, the banking system and the private economy foundered in a new recession.
If one were to write a script that chronicled the end of free-enterprise capitalism, the events of 1929–1938 would logically serve the purpose.
Since few people understood the nuances of Fed-Treasury monetary policies, the common perception was that the Recession of 1937–1938 posed yet another failure of the market system.
Dozens of tracts, novels, plays, and newspaper editorials reflected this notion.
The appearance of the depression-recession evidently convinced Morgenthau that the “danger of inflation” was passed.
In September 1937, he released $300 million of gold from the inactive account thereby restarting the machinery of gold monetization.
Gold certificate accounts at Fed Banks responded and gave rise as usual to increases in monetary base items in Fed Banks’ balance sheets.
Finally, on April 19, 1938, Morgenthau announced the discontinuance of the inactive gold account altogether.
The time span of the Treasury’s gold policy was 16 months — December 1936 to April 1938, while the Fed’s reserve requirement increases occurred in August 1936 and March-May 1937, and continued in force with little change until after World War II.
Treasury policy cut off new gold at the initial point of monetization; Fed policy effectively smothered the money-creating potential that old gold had already provided.
For the next three years, the economy stagnated.
By 1941, the price level was still 14 percent below its 1929 value, and unemployment was still 10 percent of the labor force.
Treatises appeared analyzing “the stagnant industrial economy.”
The Keynesian notion of less-than-full-employment equilibrium seemed documented beyond reasonable doubt.
Fed-Treasury methods in the mid-1930s reflected the prevailing notion of the times — that someone had to run the show, that operations without the rule of men were destined to be “chaotic.”
Economists and financial gurus were just as convinced of this argument as politicians and political scientists.
One economist, Gove Griffith Johnson, commented in his contemporary book on Treasury policy:
“One may be skeptical of the wisdom with which monetary instruments will be used, but the possibility of abuse extends throughout the whole sphere of governmental activity and is a risk which must be assumed under a democratic or any other form of government.”
The Treasury’s gold policy, Johnson continued, “was an essential instrument for producing desired political aims.”
Congress had given over the Fed’s powers of monetary regulation to the Treasury because the central bank had proven ineffectual.
These powers had become more democratic because “they were now exercised by politically responsible officials ... [and] would eventually be subject to review by the electorate."
"... In large part,” he concluded, “the [Federal Reserve] System has served merely as a technical instrument for effecting the Treasury’s policies.” [11]
Clearly, the awesome monetary powers the Fed-Treasury had wielded were not the product of either “wisdom” or scientific analysis.
They were simply discretionary, seat-of-the-pants responses, sometimes politically motivated, by political authorities who faced no responsibility for their decisions.
Furthermore, the “risk of abuse” did not need to be “assumed” under a democratic government suitably restrained by the rule of law.
Finally, the electorate knew less about these policies than it knew about Sanskrit, and it had no power at all either to pass judgment on them or to change them.
Under a true rule-of-law gold standard, the Treasury would not have had a “gold policy.”
The gold standard itself would have been the gold policy and would have been self-regulating through the concerted actions of thousands of households and businesses that bought and sold goods and services in hundreds of markets.
The gold, more important, would not have been stockpiled in Treasury vaults unavailable and illegal for human use, like some dangerous drug or weapon.
It would have been in commercial banks primarily, serving its conventional function of securing bank-issued money.
The monetary mismanagement chronicled here should serve as the all-time example of the failure of discretionary monetary policy.
Although a gold standard was still on the books, it was nothing more than a façade for Fed-Treasury manipulations.
First the Fed by itself in the 1920s, then the Treasury ten years later, simply fit this “gold standard” into their other hands-on policies.
Both agencies saw to it that the gold was safely tucked away where it could do no one any good.
Approximately seven thousand banks failed in the early 1930s for want of reserves while the stockpiling went on.
Congress then gave the executive the power to enact an unprecedented increase in the price of gold and added as well significant new powers to the Federal Reserve’s authority.
By 1936, the Fed-Treasury managers, fearing they had over-done monetary expansion, decided to put on the brakes by again sterilizing gold and doubling bank reserve requirements.
The result was a virtual paralysis of the monetary system and the economy.
Had the banks held their own reserves or had them available in their own clearinghouses, as they did before the coming of the Fed, bank and clearinghouse executives (who were often the same people) would have parlayed the gold into strategic trouble spots where it would have prevented failures of healthy banks and general monetary destruction.
Gold to be effective cannot be declared illegal and buried in the ground where no one can get it.
If that is the best that civilization can do, we might as well have left the gold in California, the Klondike, Australia, and South Africa.
Notes
See, Dwight R. Lee and Richard McKenzie, Failure and Progress: The Bright Side of the Dismal Science (Washington, D.C.: Cato Institute, 1993).
For further discussion of this issue, see Richard H. Timberlake, Gold, Greenbacks, and the Constitution (Berryville, Va.: The George Edward Durell Foundation, 1991), pp. 8–9.
Board of Governors of the Federal Reserve System, Banking and Monetary Statistics (Washington, D.C.: Government Printing Office,1943), p. 537.
See my Monetary Policy in the United States: An Intellectual and Institutional History (Chicago: University of Chicago Press, 1993), chapter 5.
James D. Paris, Monetary Policies of the United States (New York: Columbia University Press, 1938), p. 18.
Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton: National Bureau of Economic Research and Princeton University Press, 1963), p. 544.
This pattern of law reflected the flawed notion that banks in larger cities were more subject to “speculative” influences and were more likely to make risky loans than banks in the “country.”
Donald F. Kettl, Leadership at the Fed (New Haven: Yale University Press, 1986), pp. 48–53.
U.S. Treasury, Press Releases, nos. 9–20, December 20, 1936.
Gove Griffith Johnson, The Treasury and Monetary Policies, 1933–1938 (Cambridge, Mass.: Harvard University Press, 1939), pp. 205–11, 223; emphasis added.
https://fee.org/articles/gold-policy-in ... arsely-api
Gold Policy in the 1930s - How the fed monetarily starved the country into the great contraction., concluded ...
Richard H. Timberlake
Saturday, May 1, 1999
Meanwhile, the banking system and the private economy foundered in a new recession.
If one were to write a script that chronicled the end of free-enterprise capitalism, the events of 1929–1938 would logically serve the purpose.
Since few people understood the nuances of Fed-Treasury monetary policies, the common perception was that the Recession of 1937–1938 posed yet another failure of the market system.
Dozens of tracts, novels, plays, and newspaper editorials reflected this notion.
The appearance of the depression-recession evidently convinced Morgenthau that the “danger of inflation” was passed.
In September 1937, he released $300 million of gold from the inactive account thereby restarting the machinery of gold monetization.
Gold certificate accounts at Fed Banks responded and gave rise as usual to increases in monetary base items in Fed Banks’ balance sheets.
Finally, on April 19, 1938, Morgenthau announced the discontinuance of the inactive gold account altogether.
The time span of the Treasury’s gold policy was 16 months — December 1936 to April 1938, while the Fed’s reserve requirement increases occurred in August 1936 and March-May 1937, and continued in force with little change until after World War II.
Treasury policy cut off new gold at the initial point of monetization; Fed policy effectively smothered the money-creating potential that old gold had already provided.
For the next three years, the economy stagnated.
By 1941, the price level was still 14 percent below its 1929 value, and unemployment was still 10 percent of the labor force.
Treatises appeared analyzing “the stagnant industrial economy.”
The Keynesian notion of less-than-full-employment equilibrium seemed documented beyond reasonable doubt.
Fed-Treasury methods in the mid-1930s reflected the prevailing notion of the times — that someone had to run the show, that operations without the rule of men were destined to be “chaotic.”
Economists and financial gurus were just as convinced of this argument as politicians and political scientists.
One economist, Gove Griffith Johnson, commented in his contemporary book on Treasury policy:
“One may be skeptical of the wisdom with which monetary instruments will be used, but the possibility of abuse extends throughout the whole sphere of governmental activity and is a risk which must be assumed under a democratic or any other form of government.”
The Treasury’s gold policy, Johnson continued, “was an essential instrument for producing desired political aims.”
Congress had given over the Fed’s powers of monetary regulation to the Treasury because the central bank had proven ineffectual.
These powers had become more democratic because “they were now exercised by politically responsible officials ... [and] would eventually be subject to review by the electorate."
"... In large part,” he concluded, “the [Federal Reserve] System has served merely as a technical instrument for effecting the Treasury’s policies.” [11]
Clearly, the awesome monetary powers the Fed-Treasury had wielded were not the product of either “wisdom” or scientific analysis.
They were simply discretionary, seat-of-the-pants responses, sometimes politically motivated, by political authorities who faced no responsibility for their decisions.
Furthermore, the “risk of abuse” did not need to be “assumed” under a democratic government suitably restrained by the rule of law.
Finally, the electorate knew less about these policies than it knew about Sanskrit, and it had no power at all either to pass judgment on them or to change them.
Under a true rule-of-law gold standard, the Treasury would not have had a “gold policy.”
The gold standard itself would have been the gold policy and would have been self-regulating through the concerted actions of thousands of households and businesses that bought and sold goods and services in hundreds of markets.
The gold, more important, would not have been stockpiled in Treasury vaults unavailable and illegal for human use, like some dangerous drug or weapon.
It would have been in commercial banks primarily, serving its conventional function of securing bank-issued money.
The monetary mismanagement chronicled here should serve as the all-time example of the failure of discretionary monetary policy.
Although a gold standard was still on the books, it was nothing more than a façade for Fed-Treasury manipulations.
First the Fed by itself in the 1920s, then the Treasury ten years later, simply fit this “gold standard” into their other hands-on policies.
Both agencies saw to it that the gold was safely tucked away where it could do no one any good.
Approximately seven thousand banks failed in the early 1930s for want of reserves while the stockpiling went on.
Congress then gave the executive the power to enact an unprecedented increase in the price of gold and added as well significant new powers to the Federal Reserve’s authority.
By 1936, the Fed-Treasury managers, fearing they had over-done monetary expansion, decided to put on the brakes by again sterilizing gold and doubling bank reserve requirements.
The result was a virtual paralysis of the monetary system and the economy.
Had the banks held their own reserves or had them available in their own clearinghouses, as they did before the coming of the Fed, bank and clearinghouse executives (who were often the same people) would have parlayed the gold into strategic trouble spots where it would have prevented failures of healthy banks and general monetary destruction.
Gold to be effective cannot be declared illegal and buried in the ground where no one can get it.
If that is the best that civilization can do, we might as well have left the gold in California, the Klondike, Australia, and South Africa.
Notes
See, Dwight R. Lee and Richard McKenzie, Failure and Progress: The Bright Side of the Dismal Science (Washington, D.C.: Cato Institute, 1993).
For further discussion of this issue, see Richard H. Timberlake, Gold, Greenbacks, and the Constitution (Berryville, Va.: The George Edward Durell Foundation, 1991), pp. 8–9.
Board of Governors of the Federal Reserve System, Banking and Monetary Statistics (Washington, D.C.: Government Printing Office,1943), p. 537.
See my Monetary Policy in the United States: An Intellectual and Institutional History (Chicago: University of Chicago Press, 1993), chapter 5.
James D. Paris, Monetary Policies of the United States (New York: Columbia University Press, 1938), p. 18.
Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton: National Bureau of Economic Research and Princeton University Press, 1963), p. 544.
This pattern of law reflected the flawed notion that banks in larger cities were more subject to “speculative” influences and were more likely to make risky loans than banks in the “country.”
Donald F. Kettl, Leadership at the Fed (New Haven: Yale University Press, 1986), pp. 48–53.
U.S. Treasury, Press Releases, nos. 9–20, December 20, 1936.
Gove Griffith Johnson, The Treasury and Monetary Policies, 1933–1938 (Cambridge, Mass.: Harvard University Press, 1939), pp. 205–11, 223; emphasis added.
https://fee.org/articles/gold-policy-in ... arsely-api