America's Great Depression (51 page)

launched a gigantic program of purchasing U.S. government securities. By the end of 1932, total reserves had been raised to $2.51

billion. This enormous increase of $660 million in reserves in less than a year is unprecedented in the previous history of the System.

If the banks had kept loaned-up, the money supply of the nation would have increased by approximately $8 billion. Instead, the money supply fell by $3.5 billion during 1932, from $68.25 to $64.72 billion at the end of the year, and with the bank deposit component falling by $3.2 billion.

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
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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 24Lauchlin Currie, The Supply and Control
of Money in the United States
(2nd ed., Cambridge Mass.: Harvard University Press, 1935), p. 116.

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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
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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.

The public was therefore no longer a help in fighting inflation.

In the face of the huge and rapid increase in gold stock, the administration did nothing, whereas it should have sterilized the increase by tightening money and selling some of its swollen hoard of securities. In the face of the great increase in reserves, therefore, the bankers once again came to the nation’s monetary rescue by piling up ever greater excess reserves, and also by reducing some indebtedness at the Fed. Currie estimates that by the fourth quarter of 1932, excess reserves had doubled, to equal 20.3 percent of total bank reserves.

Professor Seymour Harris, writing at the depth of the depression at a time when he was a cautious moderate, conceded that the failure of the inflationist policy of the Federal Reserve might have been due to the fact “that liquidation has not proceeded far enough.” Furthermore, he added, the sound-money critics of the 25To keep our perspective on the monetary contraction of the 1929–1932

period, which has often been pointed at with alarm, we should remember that the total money supply fell from $73.3 billion in June 1929, to $64.7 billion at the end of 1932, a fall of only 11.6 percent, or 3.3 percent per annum. Compare this rate to the inflationary rise of 7.7 percent per annum during the boom of the 1920s.

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Administration might be right, and it may be that the heavy open-market purchases of securities from 1930 to 1932 “have retarded the process of liquidation and reduction of costs, and therefore have accentuated the depression.”26 Precisely.

If Hoover’s inflationist plans were thwarted variously by foreigners, the public, and the banks, the President did not permit himself to remain idle in the face of these obstacles. About foreigners he could do little, except to induce Congress to pass the Glass–Steagall Act to permit more leeway for domestic expansion.

Hoover was only a moderate inflationist relative to many others, and he did not wish to go off the gold standard. About the public, however, Hoover could do a great deal. Seeing money-in-circulation increase by $800 million in 1931, Hoover engineered a coordinated hue-and-cry against “traitorous hoarding.” “Hoarding,” of course, meant that individuals were choosing to redeem their own property, to ask banks to transform their deposits into the cash which the banks had promised to have on hand for redemption.

It is characteristic of depressions that, because of the inherently fraudulent nature of the commercial banking system, any real attempt by the public to redeem its own property from the banks must cause panic among banks and government alike. And so, on February 3, Hoover organized an anti-hoarding drive, headed by a Citizens’ Reconstruction Organization (CRO) under Colonel Frank Knox of Chicago. The hoarder is unpatriotic, ran the hue and cry; he restricts and destroys credit (i.e., he is exposing the unsound nature of the credit which was granted against his interests and in destruction of his property). A group of top-level Anti-Hoarding patriots met on February 6 to organize the drive: present were General Dawes, Eugene Meyer, Secretaries Lamont and Mills, A.F. Whitney, Alvanley Johnston, and industrialist Magnus Alexander. The CRO urged hoarders to invest in short-term Treasury securities, i.e., in unproductive rather than productive investments. On March 6, Hoover delivered a public address on the evils 26Seymour E. Harris,
Twenty Years of Federal Reserve Policy
(Cambridge, Mass.: Harvard University Press, 1933), vol. 2, p. 700. Dorfman,
The Economic Mind in
American Civilization,
vol. 5
,
pp. 720–21.

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of hoarding: “the battle front today is against the hoarding of currency.” Hoarding has lowered prices and incomes, and restricted credit; it strangles our daily life. “No one will deny that if the vast sums of money hoarded in the country today could be brought into active circulation there would be a great lift to the whole of our economic progress.” Hoover then commended Colonel Knox for his “great battle against . . . the American people, and called on everyone to serve in protection of the American home.” Perhaps Hoover is correct when he now gives credit to the Knox drive for the fact that “hoarding” never increased much during 1932: it reached a peak of $5.44 billion in July, and never rose above that until the bank crises in February, 1933. But if Hoover is correct, praise is not his appropriate reward. For it means that bank liquidation was postponed for another year and the final banking crisis intensified, and it also means that the public was not at last permitted to find out for itself the great truth of the nature of its banking system.

The banks also received their share of Hoover’s ire for their unwillingness to expand in those troubled times.
The New York
Times
reported on May 20 that Hoover was “disturbed at the apparent lack of cooperation of the commercial banks of the country in the credit expansion drive.” In short, the “banks have not passed the benefits of these relief measures on to their customers.” The anger of the inflationist authorities at the caution of the banks was typified by the arrogant statement of RFC chairman, Atlee Pomerene: “Now . . . and I measure my words, the bank that is 75

percent liquid or more and refuses to make loans when proper security is offered, under present circumstances, is a parasite on the community.” And Hoover had certainly done his very best to spark the bank credit expansion. It was he who induced Congress to pass the Glass–Steagall Act, and he and Meyer who conducted the open-market purchases of $1 billion. After the Glass–Steagall and RFC Acts were passed, Hoover proclaimed that they would

“so strengthen our whole credit structure and open the channels of credit as now to permit our banks more adequately to serve the needs” of the public. On May 19, Hoover tried to prod the banks by asking Secretary Mills to organize bankers and businessmen to
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use the surplus credit made available by the Federal Reserve purchases. A Committee was established in New York City for this purpose; on it were such men as Owen D. Young, chairman, Walter S. Gifford of AT&T, Charles E. Mitchell of the National City Bank, Alfred P. Sloan, Jr., of General Motors, and Walter C. Teagle of Standard Oil. The next day, May 20, Hoover issued a press release supporting this committee, and hoping for similar action throughout the nation. The Young Committee tried to organize a cartel to support bond prices, but the committee accomplished little, and the idea died.

THE INFLATION AGITATION

It is thus with considerable justification that Herbert Hoover was to declare in later years: “after coming to the Presidency, almost the whole of Roosevelt’s credit supports were built upon our measures.” Despite his intervention and inflationism, however, Hoover considered himself sound next to some of the wildly inflationist schemes that were filling the air during 1932. The silver bloc, for one, stepped up its campaign for an international conference to raise and stabilize the price of silver. They now added proposals for bimetallic systems. Backing these efforts were Senators King, Smoot, and Borah from the Mountain states, the International Chamber of Commerce, and the American Federation of Labor. Senator Burton K. Wheeler (D., Mont.) introduced a bimetallism bill with the old battle-cry of 16:1, fittingly enough in collaboration with William Jennings Bryan, Jr. The Bimetallic Association was formed to back such a bill in February, and it was also defended by the left-wing National Farmers’ Union. One of the articulate leaders of the silver-subsidy bloc was René Leon, who became adviser to the House Ways and Means Committee, and induced the Committee to suggest the international conference. Neither of these proposals passed a house of Congress.