America's Great Depression (21 page)

TABLE 5

TIME DEPOSITS

(in billions of dollars)

All

Central

Savings Commercial Member

Reserve

Reserve

Country

Date

Banks

Banks

Banks City Banks City Banks Banks

June 30, 1921

5.5

10.9

6.3

.4

2.1

3.8

June 29, 1929

8.9

19.6

13.1

2.2

4.8

6.8

During the 1920s, time deposits increased most in precisely those areas where they were most active and least likely to be misconstrued as idle “savings.” Table 5 presents the record of the various categories of time deposits. The least active time accounts are in savings banks, the most active in the large city commercial banks. Bearing this in mind, below are the increases over the period in the various categories:

The Inflationary Factors

101

Savings Banks

61.8%

Commercial Banks

79.8

Member Banks

107.9

Country Banks

78.9

Reserve City Banks

128.6

Central Reserve City Banks

450.0

Thus, we see that, unerringly, the most active categories of time deposits were precisely the ones that increased the most in the 1920s, and that this correlation holds for each category. The most active—

the Central Reserve City accounts—increased by 450 percent.14

GENERATING THE INFLATION, II: TOTAL RESERVES

Two influences may generate bank inflation—a change in effective reserve requirements and a change in total bank reserves at the Federal Reserve Bank. The relative strength of these two factors in the 1920s may be gauged by Table 6.

Clearly, the first four years of this period was a time of greater monetary expansion than the second four. The member bank contribution to the money supply increased by $6.9 billion, or 37.1

percent, in the first half of our period, but only by $3.9 billion or 15.3 percent in the second half. Evidently, the expansion in the first four years was financed exclusively out of total reserves, since the reserve ratio remained roughly stable at about 11.5 : 1. Total reserves expanded by 35.6 percent from 1921 to 1925, and member bank deposits rose by 37.1 percent. In the later four years, reserves expanded by only 8.7 percent, while deposits rose by 15.3 percent.

This discrepancy was made up by an increase in the reserve ratio 14On time deposits in the 1920s, see Benjamin M. Anderson,
Economics and the
Public Welfare
(New York: D. Van Nostrand, 1949), pp. 128–31; also C.A. Phillips, T.F. McManus, and R.W. Nelson,
Banking and the Business Cycle
(New York: Macmillan, 1937), pp. 98–101.

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TABLE 6

MEMBER BANK RESERVES AND DEPOSITS*

Reserves

Member Bank

Date

Member Bank

Deposits

Reserve Ratio

June 30, 1921

1.60

18.6

11.6 : 1

June 30, 1925

2.17

25.5

11.7 : 1

June 29, 1929

2.36

29.4

12.5 : 1

*Column 1 is the total legal member bank reserves at the Fed, excluding vault cash (which remained steady at about $500 million throughout). Column 2 is member bank deposits, demand and time. Column 3 is the ratio of deposits to reserves.

from 11.7 : 1 to 12.5 : 1, so that each dollar of reserve carried more dollars in deposits. We may judge how important shifts in reserve requirements were over the period by multiplying the final reserve figure, $2.36 billion, by 11.6, the original ratio of deposits to reserves. The result is $27.4 billion. Thus, of the $29.4 billion in member bank deposits in June, 1929, $27.4 billion may be accounted for by total reserves, while the remaining $2 billion may be explained by the shift in reserves. In short, a shift in reserves accounts for $2 billion out of the $10.8 billion increase, or 18.5

percent. The remaining 81.5 percent of the inflation was due to the increase in total reserves.

Thus, the prime factor in generating the inflation of the 1920s was the increase in total bank reserves: this generated the expansion of the member banks and of the non-member banks, which keep their reserves as deposits with the member banks. It was the 47.5 percent increase in total reserves (from $1.6 billion to $2.36

billion) that primarily accounted for the 62 percent increase in the total money supply (from $45.3 to $73.3 billion). A mere $760 million increase in reserves was so powerful because of the nature of our governmentally controlled banking system. It could roughly generate a $28 billion increase in the money supply.

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103

What then caused the increase in total reserves? The answer to this question must be the chief object of our quest for factors responsible for the inflationary boom. We may list the well-known

“factors of increase and decrease” of total reserves, but with special attention to whether or not they can be
controlled
or must be
uncontrolled
by the Federal Reserve or Treasury authorities. The uncontrolled forces emanate from the public at large, the controlled stem from the government.

There are ten factors of increase and decrease of bank reserves.

1.
Monetary Gold Stock.
This is, actually, the only
uncontrolled
factor of increase
—an increase in this factor increases total reserves to the same extent. When someone deposits gold in a commercial bank (as he could freely do in the 1920s), the bank deposits it at the Federal Reserve Bank and adds to its reserves there by that amount. While some gold inflows and outflows were domestic, the vast bulk were foreign transactions. A decrease in monetary gold stock causes an equivalent decrease in bank reserves. Its behavior is uncontrolled—decided by the public—although in the long run, Federal policies influence its movement.

2.
Federal Reserve Assets Purchased.
This is the preeminent
controlled factor of increase
and is wholly under the control of the Federal Reserve authorities. Whenever the Federal Reserve purchases an asset, whatever that asset may be, it can purchase either from the banks or from the public. If it purchases the asset from a (member) bank, it buys the asset and, in exchange, grants the bank an increase in its reserve. Reserves have clearly increased to the same extent as Federal Reserve assets. If, on the other hand, the Federal Reserve buys the asset from a member of the public, it gives a check on itself to the individual seller. The individual takes the check and deposits it with his bank, thus giving his bank an increase in reserves equivalent to the increase in Reserve assets. (If the seller decides to take currency instead of deposits, then this factor is exactly offset by an increase in money in circulation outside the banks—
a factor of decrease
.) Gold is not included among these assets; it was listed in the first category (Monetary Gold Stock) and is generally deposited in,
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America’s Great Depression

rather than purchased by, the Federal Reserve Banks. The major assets purchased are “Bills Bought” and
“
U.S. Government Securities
.”
U.S. Government Securities are perhaps the most publi-cized field of “open-market operations”; Federal Reserve purchases add to bank reserves and sales diminish them. Bills Bought were
acceptance paper
which the Federal Reserve bought outright in a policy of subsidy that practically created this type of paper
de novo
in the United States. Some writers treat Bills Bought as an uncontrolled factor, because the Federal Reserve announced a rate at which it would buy all acceptances presented to it. No law, however, compelled it to adopt this policy of unlimited purchase; it therefore must be counted as a pure creation of Federal Reserve policy and under its control.

3.
Bills Discounted by the Federal Reserve
. These bills are not purchased, but represent loans to the member banks. They are rediscounted bills, and advances to banks on their IOUs. Clearly a factor of increase, they are not as welcome to banks as are other ways of increasing reserves, because they must be repaid to the System; yet, while they remain outstanding, they provide reserves as effectively as any other type of asset. Bills Discounted, in fact, can be loaned precisely and rapidly to those banks that are in distress, and are therefore a powerful and effective means of shoring up banks in trouble. Writers generally classify Bills Discounted as uncontrolled, because the Federal Reserve always stands ready to lend to banks on their eligible assets as collateral, and will lend almost unlimited amounts at a given rate. It is true, of course, that the Federal Reserve fixes this
rediscount rate
, and at a lower rate when stimulating bank borrowing, but this is often held to be the only way that the System can control this factor. But the Federal Reserve Act does not compel, it only authorizes, the Federal Reserve to lend to member banks. If the authorities want to exercise an inflationary role as “lender of last resort” to banks in trouble, it chooses to do so by itself. If it wanted, it could simply refuse to lend to banks at any time. Any expansion of Bills Discounted, then, must be attributed to the will of the Federal Reserve authorities.

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105

On the other hand, member banks themselves have largely controlled the speed of
repayment
of Reserve loans. When the banks are more prosperous, they generally reduce their indebtedness to the Federal Reserve. The authorities could compel more rapid repayment, but they have decided to lend freely to banks and to influence banks by changing its rediscount charges.

To separate controlled from uncontrolled factors as best we can, therefore, we are taking the rather drastic step of considering any
expansion
of Bills Discounted as
controlled
by the government, and any
reduction
as being
uncontrolled
, and determined by the banks. Of course, repayments will be partly governed by the amount of previous debt, but this seems to be the most reasonable division. We must take this step, therefore, even though it complicates the historical record. Thus, if Bills Discounted increase by $200 million over some three-year period, we may call this a controlled increase of $200 million, if we consider only this overall record. On the other hand, if we break down the record from year to year, it may be that Bills Discounted first increased by $500 million, then were reduced by $400 million, and then increased again by $100 million the final year. When we consider a year-to-year basis, then, controlled increase of reserves for the three years was $600 million and uncontrolled decrease was $400 million. The finer we break down the record, therefore, the greater the extent both of controlled increases by the government, and of uncontrolled declines prompted by the banks. Perhaps the best way of resolving this problem is to break down the record to the most significant periods. It would be far simpler to lump all Bills Discounted as controlled and let it go at that, but this would distort the historical record intolerably; thus, in the early 1920s it would give the Federal Reserve an undeserved accolade for reducing member bank debts when this reduction was largely accomplished by the banks themselves.

We may therefore divide Bills Discounted into: New Bills Discounted (controlled factor of increase) and Bills Repaid (uncontrolled factor of decrease).

4.
Other Federal Reserve Credit
. This is largely “float,” or checks on banks remaining temporarily uncollected by the Federal
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America’s Great Depression

Reserve. This is an interest-free form of lending to banks and is therefore a factor of increase wholly controlled by the Federal Reserve. Its importance was negligible in the 1920s.

5.
Money in Circulation Outside the Banks
. This is the main factor of decrease—an increase in this item decreases total reserves to the same extent. This is the total currency in the hands of the public and is determined wholly by the relative place people wish to accord paper money as against bank deposits. It is therefore an uncontrolled factor, decided by the public.

6.
Treasury Currency Outstanding
. Any increase in Treasury currency outstanding is deposited with the Federal Reserve in the Treasury’s deposit account. As it is spent on government expenditures, the money tends to flow back into commercial bank reserves. Treasury currency is therefore a factor of increase, and is controlled by the Treasury (or by Federal statute). Its most important element is silver certificates backed 100 percent by silver bullion and silver dollars.

7.
Treasury Cash Holdings
. Any increase in Treasury cash holdings represents a shift from bank reserves, while a decline in Treasury cash is spent in the economy and tends to increase reserves. It is therefore a factor of decrease and is controlled by the Treasury.

8.
Treasury Deposits at the Federal Reserve
. This factor is very similar to Treasury cash holdings; an increase in deposits at the Reserve represents a shift from bank reserves, while a decrease means that more money is added to the economy and swells bank reserves.

This is, therefore, a factor of decrease controlled by the Treasury.

9.
Non-member Bank Deposits at the Federal Reserve.
This factor acts very similarly to Treasury deposits at the Federal Reserve. An increase in non-member bank deposits lowers member bank reserves, for they represent shifts from member banks to these other accounts. A decline will increase member bank reserves.

These deposits are mainly made by non-member banks, and by foreign governments and banks. They are a factor of decrease, but uncontrolled by the government.

10.
Unexpended Capital Funds of the Federal Reserve.
They are capital funds of the Federal Reserve not yet expended in assets
The Inflationary Factors