The Myth of The Federal Reserve Contracting the Money Supply during The Great Depression
The Myth of The Federal Reserve Contracting the Money Supply during The Great Depression
The last time broad based deflation was seen in America was during the depression. During this period President Hoover convinced US businesses to keep wage rates at pre-depression levels instead of reducing wages as had been done during other depressions. As a result of Presidents Hoovers action American companies tried very hard to keep wage rates from falling. As a result real earning power was increased for those who remained employed.
A popular myth of this time period is that The Federal Reserve allowed the money supply to contract after 1931, taking money out of circulation and producing broad based deflation whereas prices in almost all goods, services, and assets declined, increasing the buying power of money.
The key to understanding the Fed’s actions is in understanding the Glass-Steagall Act. This act changed the collateral requirements of the Federal Reserve to use US sovereign debt (US government securities) as well as gold (the historic bank collateral) to back Federal Reserve Notes (paper currency) in 1932.
Federal Reserve notes were redeemable in gold, thus pyramid was formed as US securities, backed by Federal Reserve Notes were used as collateral for Federal Reserve Notes, which in turn was redeemable in gold.
The Federal Reserve creates bank reserves by purchasing government securities, thereby linking public debt with the money supply. Bank reserves are then used as the basis for lending credit through fractional reserve banking whereas for every dollar in gold or US securities held by the bank as collateral can be used to create nine dollars of credit. Credit increased the total supply of money as money loaned out is actually currency which is created.
The Fed must purchase all US securities offered by the government. If the Fed sells US securities acquired, then national deficit increases, however, if the Fed just assumes the debt and does not sell it, this action increases the money supply without adding to the national deficit. This is equivalent to just “printing money” or creating new money, debasing the currency by expanding the money supply.
Therefore we must look at three important elements of the monetary system under Glass-Steagall, the national deficit, bank reserves, money supply, and the supply of gold held as collateral by US banks.
The National Deficit
As recorded by the Treasury the National Debt grew by $2.7 billion in 1932.
Bank Reserves
By February 1932 bank reserves had fallen to $1.85 billion, the Fed acted and purchased 660 million in government securities by the end of the year increasing their reserves by 35% in less than one year to a total of $2.51 billion at the end of the year. From February to July total reserves rose by $213 million. From July to December reserves increased by $457 million.
Securities holdings in the Fed increased from $740 million to $1.85 billion for a gain of $1.1 billion. After July President Hoover’s administration determined this was having no affect and stopped the securities buying program at the Fed.
Therefore in the first half of 1932 controlled reserves increased by $1.1 billion while uncontrolled reserves fell by $788 million due to $290 million reduction in bank indebtedness to the Fed, and loss of $380 million in the gold supply, and a rise of $122 million of money in circulation.
In the second half of 1932 controlled reserves rose by $165 million and uncontrolled reserves rose by 293 million due to the gold supply increasing by $539 million.
Bank deposits fell by $3.1 billion and remained constant until the end of the year.
Money Supply
The money supply changed in 1932 form $68.24 billion to $64.72 billion for a decrease of $3.52 billion for the year.
As the Fed purchased $1.1 billion dollars of US securities, and these securities could have been used as a base of creating money through lending of approximately $10 billion of additional money to the money supply in a very short amount of time. Due to positive feedback, the monetary mechanic of loaned money coming back into the banking system and being used again to create money through credit this number could have jumped much higher in a very short amount of time, but the money supply actually fell.
Gold Used As Bank Collateral
In the first half of 1932 the gold stock fell by $380 million while in the second half gold increased by $539 million for a positive increase of $159 million in gold stock.
Examining the data is very clearly shows an inflationary policy at The Federal Reserve embarked upon during the depths of the depression in 1932. The Fed tried in vain to hyper inflate the currency, however as faith was lost in the banking system as banks closed.
In the 1920’s approximately 700 banks closed each year losing $170 million in deposits. In 1930 1,350 banks failed with deposits of $837 million.
In 1931 2,293 banks failed with deposits of $1,690 million.
In 1932 1,453 banks failed with deposits of $706 million.
Therefore foreigners and US citizens observed an enormous increase in not only the exponential amount of banks failures, but the exponential magnitude of the failures. As a result US citizens withdrew their money from the banks in the first part of 1932 leading to a fall of bank deposits of $3.1 billion. Foreigners redeemed their US currency for gold leading to the fall of the gold stock in the first half of 1932 by $380 million.
The banks, afraid of taking on additional risk in a low interest rate environment build up excess reserves and did not increase the money supply through lending as they would have when they made loans to the maximum capacity in the 1920’s. Bank reserves were maxed out at 10% and then by the end of 1932 increased to 20%.
This activity driven by a loss of faith countered the normal positive feedback in the banking system as money fled out of the banking system leading to a $3.5 billion dollar reduction in the supply of money. When the Fed stopped its security buying program by the middle of 1932 gold came back into the country increasing the gold stock by $539 million.
Therefore the Federal Reserve did not in fact provide a policy of contraction of the money supply. The facts support that the Federal Reserve in fact tried to hyper inflate the currency by holding US sovereign debt and using this as the basis for creating money through lending. This tactic backfired when people and governments lost faith in the US banking system and pulled their money and gold out of the system.
Angered by the inability of the Federal Reserve to inflate the money supply and inflate prices back up to pre depression era prices President Hoover then began is war on Hording.
Appendix of Data
The national deficit as recorded by the Treasury department is the following
July 1st, 1920 is approximately $26 billion
July 1st, 1925 is approximately $21 billion
July 1st, 1928 is approximately $17.6 billion
July 1st, 1929 is approximately $16.9 billion
July 1st, 1930 is approximately $16.2 billion
July 1st, 1931 is approximately $16.8 billion
July 1st, 1932 is approximately $19.5 billion
July 1st, 1933 is approximately $23.5 billion
July 1st, 1934 is approximately $27.0 billion
July 1st, 1935 is approximately $28.7 billion
The US gold stock held as collateral by US banks is as follows
1920 is approximately $3.1 billion
1921 is approximately $3.7 billion
1922 is approximately $4.0 billion
1923 is approximately $4.2 billion
1924 is approximately $4.35 billion
1925 is approximately $4.3 billion
1926 is approximately $4.4 billion
1927 is approximately $4.35 billion
1928 is approximately $4.2 billion
1929 is approximately $4.3 billion
Source Material
Richard Duncan’s The Dollar Crisis
Milton Friedman and Anna Schwartz A Monetary History of the United States
Murrey Rothbard A History of Money and Banking in the United States
Murrey Rothbard America’s Great Depression
Chromatic Dispersion
Banking, Derivatives, and Systemic Risk
http://bankdersysrisk.blogspot.com/
http://bankdersysrisk.blogspot.com/atom.xml
The last time broad based deflation was seen in America was during the depression. During this period President Hoover convinced US businesses to keep wage rates at pre-depression levels instead of reducing wages as had been done during other depressions. As a result of Presidents Hoovers action American companies tried very hard to keep wage rates from falling. As a result real earning power was increased for those who remained employed.
A popular myth of this time period is that The Federal Reserve allowed the money supply to contract after 1931, taking money out of circulation and producing broad based deflation whereas prices in almost all goods, services, and assets declined, increasing the buying power of money.
The key to understanding the Fed’s actions is in understanding the Glass-Steagall Act. This act changed the collateral requirements of the Federal Reserve to use US sovereign debt (US government securities) as well as gold (the historic bank collateral) to back Federal Reserve Notes (paper currency) in 1932.
Federal Reserve notes were redeemable in gold, thus pyramid was formed as US securities, backed by Federal Reserve Notes were used as collateral for Federal Reserve Notes, which in turn was redeemable in gold.
The Federal Reserve creates bank reserves by purchasing government securities, thereby linking public debt with the money supply. Bank reserves are then used as the basis for lending credit through fractional reserve banking whereas for every dollar in gold or US securities held by the bank as collateral can be used to create nine dollars of credit. Credit increased the total supply of money as money loaned out is actually currency which is created.
The Fed must purchase all US securities offered by the government. If the Fed sells US securities acquired, then national deficit increases, however, if the Fed just assumes the debt and does not sell it, this action increases the money supply without adding to the national deficit. This is equivalent to just “printing money” or creating new money, debasing the currency by expanding the money supply.
Therefore we must look at three important elements of the monetary system under Glass-Steagall, the national deficit, bank reserves, money supply, and the supply of gold held as collateral by US banks.
The National Deficit
As recorded by the Treasury the National Debt grew by $2.7 billion in 1932.
Bank Reserves
By February 1932 bank reserves had fallen to $1.85 billion, the Fed acted and purchased 660 million in government securities by the end of the year increasing their reserves by 35% in less than one year to a total of $2.51 billion at the end of the year. From February to July total reserves rose by $213 million. From July to December reserves increased by $457 million.
Securities holdings in the Fed increased from $740 million to $1.85 billion for a gain of $1.1 billion. After July President Hoover’s administration determined this was having no affect and stopped the securities buying program at the Fed.
Therefore in the first half of 1932 controlled reserves increased by $1.1 billion while uncontrolled reserves fell by $788 million due to $290 million reduction in bank indebtedness to the Fed, and loss of $380 million in the gold supply, and a rise of $122 million of money in circulation.
In the second half of 1932 controlled reserves rose by $165 million and uncontrolled reserves rose by 293 million due to the gold supply increasing by $539 million.
Bank deposits fell by $3.1 billion and remained constant until the end of the year.
Money Supply
The money supply changed in 1932 form $68.24 billion to $64.72 billion for a decrease of $3.52 billion for the year.
As the Fed purchased $1.1 billion dollars of US securities, and these securities could have been used as a base of creating money through lending of approximately $10 billion of additional money to the money supply in a very short amount of time. Due to positive feedback, the monetary mechanic of loaned money coming back into the banking system and being used again to create money through credit this number could have jumped much higher in a very short amount of time, but the money supply actually fell.
Gold Used As Bank Collateral
In the first half of 1932 the gold stock fell by $380 million while in the second half gold increased by $539 million for a positive increase of $159 million in gold stock.
Examining the data is very clearly shows an inflationary policy at The Federal Reserve embarked upon during the depths of the depression in 1932. The Fed tried in vain to hyper inflate the currency, however as faith was lost in the banking system as banks closed.
In the 1920’s approximately 700 banks closed each year losing $170 million in deposits. In 1930 1,350 banks failed with deposits of $837 million.
In 1931 2,293 banks failed with deposits of $1,690 million.
In 1932 1,453 banks failed with deposits of $706 million.
Therefore foreigners and US citizens observed an enormous increase in not only the exponential amount of banks failures, but the exponential magnitude of the failures. As a result US citizens withdrew their money from the banks in the first part of 1932 leading to a fall of bank deposits of $3.1 billion. Foreigners redeemed their US currency for gold leading to the fall of the gold stock in the first half of 1932 by $380 million.
The banks, afraid of taking on additional risk in a low interest rate environment build up excess reserves and did not increase the money supply through lending as they would have when they made loans to the maximum capacity in the 1920’s. Bank reserves were maxed out at 10% and then by the end of 1932 increased to 20%.
This activity driven by a loss of faith countered the normal positive feedback in the banking system as money fled out of the banking system leading to a $3.5 billion dollar reduction in the supply of money. When the Fed stopped its security buying program by the middle of 1932 gold came back into the country increasing the gold stock by $539 million.
Therefore the Federal Reserve did not in fact provide a policy of contraction of the money supply. The facts support that the Federal Reserve in fact tried to hyper inflate the currency by holding US sovereign debt and using this as the basis for creating money through lending. This tactic backfired when people and governments lost faith in the US banking system and pulled their money and gold out of the system.
Angered by the inability of the Federal Reserve to inflate the money supply and inflate prices back up to pre depression era prices President Hoover then began is war on Hording.
Appendix of Data
The national deficit as recorded by the Treasury department is the following
July 1st, 1920 is approximately $26 billion
July 1st, 1925 is approximately $21 billion
July 1st, 1928 is approximately $17.6 billion
July 1st, 1929 is approximately $16.9 billion
July 1st, 1930 is approximately $16.2 billion
July 1st, 1931 is approximately $16.8 billion
July 1st, 1932 is approximately $19.5 billion
July 1st, 1933 is approximately $23.5 billion
July 1st, 1934 is approximately $27.0 billion
July 1st, 1935 is approximately $28.7 billion
The US gold stock held as collateral by US banks is as follows
1920 is approximately $3.1 billion
1921 is approximately $3.7 billion
1922 is approximately $4.0 billion
1923 is approximately $4.2 billion
1924 is approximately $4.35 billion
1925 is approximately $4.3 billion
1926 is approximately $4.4 billion
1927 is approximately $4.35 billion
1928 is approximately $4.2 billion
1929 is approximately $4.3 billion
Source Material
Richard Duncan’s The Dollar Crisis
Milton Friedman and Anna Schwartz A Monetary History of the United States
Murrey Rothbard A History of Money and Banking in the United States
Murrey Rothbard America’s Great Depression
Chromatic Dispersion
Banking, Derivatives, and Systemic Risk
http://bankdersysrisk.blogspot.com/
http://bankdersysrisk.blogspot.com/atom.xml
posted by Chromatic Dispersion at 10/02/2005 02:34:00 PM
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