The rate cut today is a good reminder that the Fed can’t always get its way. It is usually assumed that the trouble with the Fed in 1930 was that it failed to attempt to expand money and credit. In fact, Bernanke himself has made this argument and sworn it will never happen again. Rothbard, in America’s Great Depression, makes the opposite case: the Fed tried to flood the market with money but could not:
The Federal Reserve was prepared to let the money market find its own level, without providing artificial stimuli that could only prolong the crisis. But early in 1930, the government instituted a massive easy money program. Rediscount rates of the New York Fed fell from 42 percent in February to 2 percent by the end of the year. Buying rates on acceptances, and the call loan rate, fell similarly.
At the end of August, Governor Roy Young of the Federal Reserve Board resigned, and was replaced by a more thoroughgoing inflationist, Eugene Meyer, Jr., who had been so active in government lending to farmers. During the entire year, 1930, total member bank reserves increased by $116 million. Controlled reserves rose by $209 million; $218 million consisted of an increase in government securities held. Gold stock increased by $309 million, and there was a net increase in member bank reserves of $116 million.
Despite this increase in reserves, the total money supply (including all money-substitutes) remained almost constant during the year, falling very slightly from $73.52 billion at the end of 1929 to $73.27 billion at the end of 1930. There would have been a substantial rise were it not for the shaky banks which were forced to contract their operations in view of the general depression. Security issues increased, and for a while stock prices rose again, but the latter soon fell back sharply, and production and employment kept falling steadily.
A leader in the easy money policy of late 1929 and 1930 was once more the New York Federal Reserve, headed by Governor George Harrison. The Federal Reserve, in fact, began the inflationist policy on its own. Inflation would have been greater in 1930 had not the stock market boom collapsed in the spring, and if not for the wave of bank failures in late 1930. The inflationists were not satisfied with events, and by late October, Business Week thundered denunciation of the alleged “deflationists in the saddle,” supposedly inspired by the largest commercial and investment banks...
Moving on to 1931:
The Federal Government had tried hard to inflate, raising controlled reserves by $195 million—largely in bills bought and bills discounted, but uncontrolled reserves declined by $302 million, largely due to a huge $356 million increase of money in circulation. Normally, money in circulation declines in the first part of the year, and then increases around Christmas time. The increase in the first part of this year reflected a growing loss of confidence by Americans in their banking system—caused by the bank failures abroad and the growing number of failures at home. Americans should have lost confidence ages before, for the banking institutions were hardly worthy of their trust. The inflationary attempts of the government from January to October were thus offset by the people’s attempts to convert their bank deposits into legal tender. From the end of September to the end of the year, bank reserves fell at an unprecedented rate, from $2.36 billion to $1.96 billion, a drop of $400 million in three months. The Federal Reserve tried its best to continue its favorite nostrum of inflation—pumping $268 million of new controlled reserves into the banking system (the main item: an increase of $305 million in bills discounted). But the public, at home and abroad, was now calling the turn at last. From the beginning of the depression until September, 1931, the monetary gold stock of the country had increased from $4 billion to $4.7 billion, as European monetary troubles induced people to send their gold to the United States. But the British crisis made men doubt the credit of the dollar for the first time, and hence by the end of December, America’s monetary gold stock had fallen to $4.2 billion. The gold drain that began in September, 1931, and was to continue until July, 1932, reduced U.S. monetary gold stock from $4.7 billion to $3.6 billion. This was a testament to the gold-exchange standard that Great Britain had induced Europe to adopt in the 1920s. Money in circulation also continued to increase sharply, in response to public fears about the banking structure as well as to regular seasonal demands. Money in circulation therefore rose by $400 million in these three months. Hence, the will of the public caused bank reserves to decline by $400 million in the latter half of 1931, and the money supply, as a consequence, fell by over four billion dollars in the same period.
During 1930, the Federal Reserve had steadily lowered its rediscount rates: from 4 percent at the beginning of the year, to 2 percent at the end, and finally down to 1 percent in mid-1931. When the monetary crisis came at the end of the year, the Federal Reserve raised the rediscount rate to 3 percent. Acceptance buying rates were similarly raised after a steady decline. The Federal Reserve System (FRS) has been sharply criticized by economists for its “tight money” policy in the last quarter of 1931. Actually, its policy was still inflationary on balance, since it still increased controlled reserves. And any greater degree of inflation would have endangered the gold standard itself. Actually, the Federal Reserve should have deflated instead of inflated, to bolster confidence in gold, and also to speed up the adjustments needed to end the depression.
And then 1932:
The monetary history of the year is best broken up into two parts: end of February—end of July, and end of July—end of December. In the first period, total reserves rose by $213 million. The entire securities-buying program of the Federal Reserve took place during this first period, security holdings rising from $740 million at the end of February to $1,841 million at the end of July, an enormous $1,101 million rise in five months. Total controlled reserves rose by $1,000 million. This was offset by a $290 million reduction in bank indebtedness to the Fed, a sharp $380 million fall in the total gold stock, and a $122 million rise in money in circulation, in short, a $788 million reduction in uncontrolled reserves. For open-market purchases to be pursued precisely when the gold stock was falling was pure folly, and endangered public confidence in the government’s ability to maintain the dollar on the gold standard. One reason for the inflationary policy was the huge Federal deficit of $3 billion during fiscal 1932. Since the Treasury was unwilling to borrow on long-term bonds from the public, it borrowed on short-term from the member banks, and the Federal Reserve was obliged to supply the banks with sufficient reserves.
Despite this great inflationary push, it was during this half year that the nation’s bank deposits fell by $3.1 billion; from then on, they remained almost constant until the end of the year. Why this fall in money supply just when one would have expected it to rise? The answer is the emergence of the phenomenon of “excess reserves.” Until the second quarter of 1932, the nation’s banks had always remained loaned up, with only negligible excess reserves. Now the banks accumulated excess reserves, and Currie estimates that the proportion of excess to total bank reserves rose from 2.4 percent in the first quarter of 1932, to 10.7 percent in the second quarter.[24]
Why the emergence of excess reserves? In the first place, Fed purchase of government securities was a purely artificial attempt to dope the inflation horse. The drop in gold demanded a reduction in the money supply to maintain public confidence in the dollar and in the banking system; the increase of money in circulation out of season was an ominous sign that the public was losing confidence in the banks, and a severe bank contraction was the only way to regain that confidence. In the face of this requirement for deflation, the Fed embarked on its gigantic securities-buying program. Naturally, the banks, deeply worried by the bank failures that had been and were still taking place, were reluctant to expand their deposits further, and failed to do so. A common explanation is that the demand for loans by business fell off during the depression, because business could not see many profitable opportunities ahead. But this argument overlooks the fact that banks never have to be passive, that if they really wanted to, they could buy existing securities, and increase deposits that way. They do not have to depend upon business firms to request commercial loans, or to float new bond issues. The reason for excess reserves must be found, therefore, in the banks.
In a time of depression and financial crisis, banks will be reluctant to lend or invest, (a) to avoid endangering the confidence of their customers; and (b) to avoid the risk of lending to or investing in ventures that might default. The artificial cheap money policy in 1932 greatly lowered interest rates all-around, and therefore further discouraged the banks from making loans or investments. just when risk was increasing, the incentive to bear risk—the prospective interest-return—was being lowered by governmental manipulation. And, as we noted above, we must not overlook the frightening effect of the wave of bank failures on bank policies. During the 1920s, a typical year might find 700 banks failing, with deposits totaling $170 million. In 1930, 1350 banks failed, with deposits of $837 million; in 1931, 2,293 banks collapsed, with deposits of $1,690 million; and in 1932, 1,453 banks failed, having $706 million in deposits. This enormous increase in bank failures was enough to give any bank pause—particularly when the bankers knew in their hearts that no bank (outside of the nonexisting ideal 100 percent bank) can ever withstand a determined run. Consequently, the banks permitted their commercial loans to run down without increasing their investments.
Thus, the Hoover administration pursued a giant inflationary policy from March through July 1932, raising controlled reserves by $1 billion through Fed purchase of government securities. If all other factors had remained constant, and banks fully loaned up, the money supply would have risen abruptly and wildly by over $10 billion during that period. Instead, and fortunately, the inflationary policy was reversed and turned into a rout. What defeated it? Foreigners who lost confidence in the dollar, partly as a result of the program, and drew out gold; American citizens who lost confidence in the banks and changed their deposits into Federal Reserve notes; and finally, bankers who refused to endanger themselves any further, and either used the increased resources to repay debt to the Federal Reserve or allowed them to pile up in the vaults. And so, fortunately, inflation by the government was turned into deflation by the policies of the public and the banks, and the money supply dropped by $3.5 billion. As we shall see further below, the American economy reached the depths of depression during 1932 and 1933, and yet it had begun to turn upward by mid-1932. It is not far-fetched to believe that the considerable deflation of July 1931—July 1932, totaling $7.5 billion of currency and deposits, or 14 percent, was partly responsible for the mid-summer upturn.[25]
The major increase in bank reserves came in the latter half of 1932, when reserves rose from $2.05 to $2.51 billion, or by $457 million. Yet this rise was not caused by FRB security-buying, for the Hoover administration had by then ceased purchasing, apparently realizing that little or nothing was being accomplished. With the end of Hoover’s inflation, the gold stock reversed itself, and money in circulation even declined, violating its normal seasonal pattern. In this second period, controlled reserves increased by $165 million; and uncontrolled reserves rose by $293 million: chiefly gold stock, which increased by $539 million. The money supply, however, remained practically constant, currency and bank deposits totaling $45.36 billion at the end of the year. In short, in the second half of 1932, gold swarmed into the United States, and money in circulation also fell.
