CHAPTER 7

The Great Contraction, 1929-33

THECONTRACTION from'1929 to 1933 was by far the most severe busincss-
cycle contraction during the near-century of U.S. history we cover and it
may well have bccn thc most severe in the whole of U.S. history. Though
sharper and morc prolonged in the Unitcd States than in most other coun-
tries, it was worldwidc in scope and ranks as the most severe and widely
diffused international contraction of modern times. U.S. net national
product in current prices fell by more than one-half from 1929 to 1933;
net national product in constant prices, by more than onc-third; implicit
prices, by morc than one-quarter; and monthly wholcsalc prices, by morc
than one-third.
T h e nnteccdcnts of the contraction have no parallel in the more than
fifty years covered by our monthly data. As noted in the preceding
chap&, no other contraction bcforc or sirice has bccn preceded by such
a long period ovcr which the money stock failed to rise. Monetary
behavior during the contraction itself is even more striking. From the , . ,

cyclical pcnk in August 1929 to thc cyclical trough in March 1933, the *. \ . '
stock of money fell by over a third. This is more than triple the largest
preceding declines recorded in our series, the 9 per cent declines from
1875 to 1879 and from 1920 to 1921. More than one-fifth of the com-
mercial banks in the United States holding nearly one-tenth of the
volume of dcposits at the beginning of the contraction srlspendcd opera-
tions because of financial difficrlltics. Voluntary liquidations, mergers,
and consolidations added 'io the toll, so that the number of commercial
banks fell by well ovcr onc-third. T h e contraction was capped by banking
holidays in many states in early 1933 and by a nationwide banking
holiday that cxtendcd from Monclay, March 6, until Monday, March
'13, and closed not only all commercial banks but also the Federal Reserve
Ranks. There was no precedent in U.S. history of a concerted closing of
all banks for so extendcd a period ovcr the entire country.
T o find anything in our history remotely comparable to the monetary
collapse from 1929 to 1933, one must go back nearly a century to the con-
traction of 1839 to 1843. That contraction, too, occurred during a period
of worldwide crisis, which intensified the domestic monetary uncertainty
already unlcashcd by the political battle over the Second Bank of the
Unitcd States, the failure to renew its charter, and the speculative
299
 T H E CREAT CONTRACIlON
activities of the successor bank under state cha;ter. After the lapsing
of the Bank's federal charter, domestic monetary uncertainty was further
heightened by the successive measures acloptcd by the govcrnmcnt--
distribution of the surplus, the Specie Circular, and establishment of an
Independent Treasr~r).in 1840 and its dissolution the next year. In 1839-
43, as in 1929-33, a substantial fraction of thc banks went out of business
-about a quarter in the earlier and over a third in the later contraction
-and the stock of money fell by about one-third.'
T h e 1929-33 contraction had far-reaching effects in many directions,
not least on monctary institutions and acadcmic and popular thinking
about the role of monetary factors in the economy. A numbcr of special
monetary institutions wcre established in the course of thc contraction,
notably the Reconstruction Finance Corporation and the Fedcral Home
Loan Banks, and the powers of the Fedcral Reserve Systcm wcrc sub-
stantially modified. T h e contraction was shortly followed by tlic cnnct-
mcnt of federal insurance of bank dcposits and by furtllcr important
nlntlifications in tllc po\\.crs of tlic Pcclc~nlRcscn r S! Ftcrn. It wnr Tollo\\c.tl
also by a brief pcriod of si~spcnsion of golcl pa!nicnts ancl tl1c11 Oy n
clrnstic modification of the gold standard which reduced it to a pale
shadow of its formcr sclf (scc Chaptcr 8 ) .
T h e contraction sliattcred the long-held bclief, which l ~ a d bccn
strengthened during the 1920's, that monctary forces were important
elements in the cyclical process and that monetary policy was n potcnt
instrument for promoting cconomic stability. Ol~itiionsliiftccl allnost to
tlic opposite cstrcmc, t l ~ a t"rnonry cloes not m n ~ t c r " ;that it is n 1,nssivc
factor which chicfly rcflccts tlic cffccts of otlicr forccs; and tllat m o n c t a ~y
policy is of extremely limited value in promoting stability. T h c evidcncc
summarizcd in thc rest of this chapter suggcsts that these jud,mcnts arc
1 not valid inferences from experience. T h e monetary collapse was not tlic
inescapable consequence of other forces, but rather a largely independent
factor which exerted a powerful influence on the course of evcnts. T h e
I
failure of the Federal Rcsewe System to prevent tlic collapsc reflectcd not
the impotence of monetary policy but rather the particular policies fol-
lowed by the monetary authorities and, in smallcr dcgrec, the particular
monetary arrangements in existence.
T h e contraction is in fact a tragic testimonial to the importance of
monetary forces. True, as events unfolded, the decline in the stock of
money and the near-collapse of the banking system can be regarded as a
consequence of nonmonetary forces in the United States, and monetary
and nonnionctnry forccs in tllc rest of t l ~ cworlcl. Evcrytl~ingcl(-pcnds on
' For an interesting comparison of the two contractions, see Gcorge hfacesirh,
"hfonetary Disturbances in the Unitcd States, 1834-45," unpublished Ph.D. dis-
sertation, University of Chicago, June 1958.
300
T H E CREAT CONTRACTION
how much is taken as given. For it is true.also, as we shall see, that
diflcrcnt, and feasible actions by the monetary authorities could have
prc:vcntcd thc dcclinc in tllc stock of money-indeed, could have produced
almost any dcsircd increase in the moncy stock. T h c same actions
\vol~ld also have cased tlie banking clificl~l~ies appreciably. Prevention
or moderation of the clccline in the stock of moncy, let alone the substitu-
tion of monctary expansion, would hA\.e rcduccd the contraction's severity
and almost as certainly its duration. T h e contraction might still havc bccn
rclativcly scvcrc. But it is hardly conceivable that money income could
havc dcclincd by ovcr one-half and priccs by over one-third in the course
'
of four ycars if thcrc had been no decline in the stock of money.'
1. T h e Course of Money, Income, Prices, Velocity, a n d Interest R a t e i
Chart 16, which covers thc two decades from 1914 to 1933, shows the
magnitude of tlic contraction in tlic perspective of a longer pcriod.
I'
htionry income dcclincd by 15 per ccnt from 1929 to 1930, 20 pcr ccnt
t l ~ rnrst ycnr, and 27 pcr ccnt in tllc next, ancl t l ~ c nby a furtllcr 5 per
cent from 1932 to 1933, even tlio~lghthe cyclical trougll is dated in
h4arcIi 1933. T h e rapid dcclinc in priccs made the dcclines in rcal income
considerably smaller but, even so, rcal income fcll by 11 per ccnt, 9 pcr
ccnt, 18 pcr ccnt, and 3 pcr ccnt in thc four successive years. These arc
cxtraordinary dcclines for individual ycars, let alone for four years in
s~~cccssion. A11 told, moncy incomc fcll 53 per ccnt and rcal income 36
11vr ccnt, or at continuol~sannual rates of 19 per ccnt and 11 per ccnt,
rcspcctivcly, ovcr t l ~ cfol~r-yearpcriod.
Alrcncly by 1931, moncy incomc was lower than it had been in any year
sincc 1917 and, by 1933, rcal incomc was a trifle below the level it had
reacl~cdin 1916, though in the interim population had grown by 23 per
ccnt. Per capita real incomc in 1933 was almost the samc as in the dc-
prcssion year of 1908, a quarter of a century earlier. Four years of con-
traction had temporarily erased the gains of two decades, not, of course,
by erasing the advances of technology, but by idling men and machines.
At the trough of the depression one person was unemployed for every
three employed.
I n terms of annual averages--to render the figures comparable with
tlie annual income estimates-the money stock fell at a decidedly lower
'This view has been argued most cogently by Clark Warburton in a series of
important papers, including: "Monetary Expansion and the Inflationary Gap,"
Amcrican Economic R c v i c w , June 1944, pp. 320, 325-326; "Monetary Thcory,
Full Protluction, and the Great Dcprcssion," Bconometrica, Apr. 1945, pp. 124-
1211; "'The Volume of Money and the Price Lcvel Between the World Wars,"
Journnl of Political Economy, June 1945, pp. 155-163; "Quantity and Frcqucncy
of Use of hfoney in the United States, 1919-45," Journal of Political Economy,
Oct. 1946, pp. 442-450.
30 1
 T H E GREAT CONTRACTION

CHART 2 7 CHART 2 8
'
M o n e y Stock, Currency, a n d Commercial Bank Deposits, Prices, Personal Income, a n d industrial Production, Monthly,
Monthly, 1929-March 1933 1929-March 1933

I SIock Fgrst Second Eraloan F R. Final I

. -
mrhtl
crash
bonkmp
cr4.n)
tankmq
cra)t)
laawes
qold
bond
purchases
bonktng
crl)as I

u l n d u r t r ial production I 1

-wholesale or'ice index I I I

~ 7 ~0 - ~ 1 1 1 1 , 1 ~ 1 ~ 1 , , 1 1 1 , ~ 1 1 1 , 1 1 , , 1

-
60
- Rolio 8CaIC8

50
19'29 1930 1931 1932 1933

SOURCE:
Industrial production, some as for Chort 16. Wholesale price Index, same as for
Chort 62. Personal income, Business Cycle Indicators (Princeton for NBER, G. H. Moore, ed., 1961 1,
Vol. II, p. 139.

rntc than moncy income-l~y 2 pcr ccnt, 7 pcr ccnt,'l7 pcr ccnt, and 12
per ccnt in thc four years from 1929 to 1933, a total of 33 pcr ccnt, or at
a continuous annual rate of 10 pcr ccnt. As a result, vclocity fcll by
nearly one-third. As we ha\.c sccn, this is tlic usual qualitative relation:
i ~ l o c i t ytcnds to rise during tlic expansion phase of a cyclc and to fall
during thc contraction pliasc. I n general, thc magnitudc of thc movement
in vclocity varics directly with thc magnitudc of thc corrcsponding movc-
mcnt in incomc and in money. For cxnmplc, the sharp declinc in velocity
from 1929 to 1933 was ro~lglilymatclicd in tlic opposite direction by tlic
sharp risc during \\'orld War I, wl~iclinccoml~anictlthc rapicl risc in tlic
stock of moncy and in money incoinc; nncl, in tlic snmc direction, by the
302
sharp fall thcrcaftcr accompanying thc dcclinc in moncy incomc and in thc
stock of moncy after 1920. O n the other hand, in mild cycles, the mo\.c-
mcnt of vclocity is also mild.= I n 1929-33, the decline in velocity,
though dccidcdly larger than in most mild cycles, was not as much
largcr as might havc bccn cspcctcd from the scvcrity of the decline
in incomc. T h e rcason was that tlic accompanying bank failures greatly
rcduccd tlic attracti\,cncss of dcposirs as n forin of holding \\.calth and
so induced tlic pilblic to hold lcss money rclativc to income than it
othcrwisc would have hcld (scc sccrion 3, below). Evcn so, had a declinc
' S r c Milton Fricdman, T h c Dcmand for Moncy: Somc Thcorctical and Empiri-
cal Itcrults, Ncw York, National Burcau of Economic Rcscarch, Occasional Paper
68, 1959, p. 16.
303
 T H E GREAT CONTRACTION
CHART 29
Common S t o c k P r i c e s , I n t e r e s t Y i e l d s , and D i s c o u n t R a t e s of
Federal R e s e r v e B a n k of N e w Y o r k , M o n t h l y , 1929-March 1933
SOURCE: Common stock price index, Standard a n d Poor's, as published in Common-Sfock
Indexes, 1871-1937 (Cowles Commission for Research in Economics, Bloomington, Ind., Principia
Press, l938), p. 67. Discount rates, Banking and Monetary Stafisfics, p. 441. Other data, same as
for Chort 35.
T I I E GIIEAT C O N T R A C T I O N
in tllc stock of money bccn a\.oiclccl, ~,clocityalso nvo~rldprobably 11al.c dc-
(:lined less and thus woulcl liavc rcinforcccl moncy in moderating tlic dc-
clinc in incomc.
For a closer look a t the course of events during these traumatic years,
we sl~iftfrom annual to montlily figures. Chart 27 reproduces on an ex-
pandcd time scalc for 1929 tlirough March 1933 the stock of moncy, as
plottccl on C l ~ a r t16, and adds scrics on dcposits and currcncy. Chart 28
rcprocluccs the scrics on industrial production and wliolcsale prices, and
adds a sc,ric*s on personal income. Chart 23 plots a number of intc~.rst
rates-of sl)[*c.i;~l
irnportancc l)ccar~scof tlic crucial rolc playcd during
t l ~ cront~.;~c.lio~iby cliangcs in lirianc.ial ~n;~r.kcts--and also Stancl:rrd
and I'oor's index of comnion stock prircs a ~ ~ ttl l~ cd i s c o ~ ~ nrates
t of tllc
Fcdcral Reserve Bank of New York.
I t is clear that the coirrsc of the contraction was far from uniform.
T h e vertical lines mark off scgmcnts into which we have diviclccl tlic pc-
riod for further discussion. Altliough the dividing lines chosen designate
monetary events-the focus of our special interest-Charts 28 and 29
demonstrate that the resulting chronology serves about equally ~vell to
dcmarcate distinctive behavior of the other economic magnitudes.
'
T h c fi~.st date markcd is October 1929, tlir month in wliich the bull
mnrkct rrashcd. Though stoch prices had reachcd their peak on Scp- 1
tcmbcr 7, whcn Standard and Poor's composite price indcs of 90 common
stocks stood at 251, thc decline in the following four wccks was orderly i
and produced no panic. I n fact, aftcr.falling to 228 on Octobcr 4, the 1
irltlcx rose 'to 215 on Octobcr 10. T h c decline tt~crcaftcr dcgcncratcd 1
into a panic on Octobcr 23. T h e next clay, blocks of securitics wcre
tltrrnpcd on tlic mnrkct ancl nearly 13 million shares wcre tradcd. O n
I
0c.tol)cr 213, ~ v l ~ ct nl ~ cinclcx fcll to 162, ncnrly 16% million sl~arcswcrc
tradctl, compared to tlic daily avcragc cluring Scptcmbcr of little more
than 4 million sharcs.' T h c stock markct crash is reflectcd in thc sliarp
wigglc in the money series, cntircly a result of a corrcsponding ~vig,glc
\
,
1
in demand dcposits, which, in turn, rcflccts primarily an increase in
loans to brokers and dcalcrs in securitics by New York City banks in re-
I
sponsc to a drastic reduction of tliosc loans by o t l ~ c r sT. ~h e adjustment was
".AS in prc-Fcdcral Resen.e timcs, J. P. Morgan and Company assumcd Icader-
ship or an rlTort to rcstore an orclerly markct by organizing a pool of funds for
lentli~i!: on the call mnrkct and for purchase of srct~ritics. But the balikcrs' pool
clicl 1101 stcm the tide of sclling. By the second wcck nffcr the crash the phase of
orgarlizcd support of thc market was ovcr.
'During the two weeks before the panic on Oct. 23, loans to brokers for the
account of others by reporting member banks in New York City dcclincd by $120
million, largely as a recult of withdr?wals of funds by foreigners. From then to
the end of the year, those loans declir~cdI)y $2,300 million, or by n o less than 60
305
 T I l E GREAT CONTRACTION T I I E CREAT CONTRACTION
orderly, thanks largely to p r o m p t a n d eITectivc action by tlrc Ncw York
ciselY, that it decreased t h e a m o u n t they desired to spend o n goods a n d
Fcdcral Reserve Bank in providing additional reserves to the New York scrviccs a t any givcn lcvcls of intcrcst ratcs, a n d income, which has,
banks tlirough open market pirrchascs (sec section 2, below). I n partic-
as its counterpart, t h a t it increased the a m o u n t they wantcd t o a d d t o
ular, t h e c m s h left n o m a r k o n currency held by tllc public. Its direct
their rnoncy balances. S u c h cffccts on.dcsired flows were presumably ac-
financial cffect was confined to tlie stock markct a n d did not al.ousc any
companied by a corresponding cffcct o n dcsircd balance sheets, namely, a
distrust of banks by their depositors.
shift away f r o m stocks a n d toward bonds, away from securities of all
T h c stock market crash coincided wit11 a stcpping irp of thc rate of
kinds a n d toward rnoncy holdings.
economic declinc. During t l ~ ct\vp m o n t l ~ sfrom tlrc cyciical pcak in
T h e sharp decline in velocity-by 1 3 per ccxlt from 1929 to 1930-and
.\~rgust 1329 to thc crash, production, wl~olcsalc prices, a n d personal
thc turnaround in intcrcst ratcs a r c consistent with this i n t ~ r ~ r c t a t i o r l
incolilc f r l l a t a n n ~ r a lratcs of 20 per cent, 7!.5 per cent, ant1 5 per ccnt,
tliouglr b y n o means conclr~sivc, since both declines represent fairly
rrspccti\-cl!.. I n thc n c s t t\\.el\.e months, all tllrcc scrics fcll at nl~prccinbly
typical cyclical reactions. W c have seen t h a t yelocity usually dcclincs
liicllcr rntcs: 27 per ccnt, 13?..5 per cent, a n d 17 per cent. rcspcctively.
during contmction, a n d thc morc so, t h e sharpcr t h e contraction. F o r c s -
:Ill told, by October 1330, prodirction h a d fallcn 26 p c r ccnt, prices, 14
ample, velocity dcclincd by 10 per cent f r o m 1907 to 1908, by 1 3 p c r cent
per cent, a n d personal income, 16 pcr cent. T h e trencl of thc rnoncy
from 1913 to 1914, a n d by 15 p e r cent from 1920 t o 1921-thougll it
stock c l ~ a n g c d from hori701ltal to mildly tlo\~n\r,artl. Interest ratcs,
. s h o i ~ l dbc notcd that thc banking panic in 1907, t h e outbreak of w a r in
,qcner;lll!. rising ~ l n t i lO c t o b r r 1929. began to frill. Even if t l ~ ccontraction
1914, ant1 thc commodity price collapsc in 1920 may wcll havc h a d thc.
li:~(l corric to ;in (,ri(l in In[(* I q:;O o r c*ar.Iy I!):\ I , :IS i~ 111i~1rt I I ; I \ ~ : tIori(-
sarnr: kind of cITcct o n thc: tlemand for monry as thc stock markct craslr in
in tlie x b s c ~ ~ co cf tlie nlorictnry collapse tl13t w;ls lo cris~lc.,it \ v o ~ ~ lIt~l n \ , c
1929 Iiad. I n contraction ycars t h a t wcrc both milder a n d unmarked by
r.ankctI as o n e of t h e morc sc\.cre contractions on rrcortl.
s u c l ~cvcnts-191&ll, 1923-24, a n d 1926-27-\.clocity dcclincd by only
Partl!.: n o doubt, the stock market crash was n syrnptorn of t.11~~ t n d c r -
4 to 5 per cent. I t sccms likely t h a t a t Icast p a r t of tlrc m u c h sharper dc-
]!.in< forccs making for a sc\.cl.e contraction in rronomic :ic:ti\.ity. nrlt
clincs in vclority in t l ~ cother years was a conscqucmcc of the special
11:1rtIy also, its occurrence must Ilave Iicll~cdto tlccpcn tlic contrnctiori.
cvcnts listed, rather t h a n simply a reflection of unusually sharp dcclincs in
I t cl13ngcd t h e ntmosplicrc \\.itliin \\.hich b~lsincssliirn nntl otlrc>l.s \vcrc
rnoncy incomc produccd by othcr forccs. If so, thc stock markct crash
m:tkitlr; tlirir plans, a n d sprcntl ~rnccrtninty\vlirrc tlnzzlirlg Iioj~csof n n1.w
rnadc t11c dcclinc in incomc sharper than it otl~crwiscwould havc bccn.
1.r.n had prevailed. I t is commonly bclie\.etl tlint it rcducctl tllc \villinsmcss
Certainly, the coincidcncc in timing of tlic stock market crash a n d of tllc
o f I ~ o t l l consumers a n d business entcrpriscs to spend;O or, morc prc-
change in t h c scvcrity of thc contraction supports t h a t vicw.
\Vhatcver its maSgnit~ldc,t h e downward prcssurc o n income p r o d ~ l c c d
per ccnt. Loans o n account of out-of-town l n n k s fcll an atlclitional $1 1)illion. Xlore
cornl~rc~l~ec~si\.c. figurrs show a drclinc of r o ~ r ~ l i l$4.5 y I~illion i l l I)rokrrs' loans b y by thc cITccts of thc stock markct crash o n expectations a n d willingness t o
out-of-town I ~ n n k sand otlicrs fro111Oct. .t to Llcc. 31, ant1 n rrlorc t l ~ a t lIialvic~gol six-nd-cffccts that can all Ilc summarized in a n independent declinc in /
total brokers' loans. \relocity-was strongly rcinforccd hy tlre behavior o l thc stock of money. ,/ .,
For thc tlnta on Nrw I'ork City \r.rrkly rrllorticts ~ncnll)rrI)nrtk lonl).c to I~rokrrs
n n t l tlralcrs in s c ~ c ~ c r i t i t src
: ~ . I l n r l k i ~ l q rrrr11 ~ ~ f l ~ l l ~S/rr/i.r/ics.
~ / l l ~ j ~ Ihlnrcl nl Co\.c.rnors
C o m p a r e d to thc collapsc in tlic n c s t two ycars, tlrc dcclinc in t h e stock'
of tlic Fcdcral Krscr\,r Systrcl~. 13.1:1, 71':ll~lc111, 11. ,199, alttl. 1~11.cllcnrtt.rly csti- o l nioncy u p to O c t o l ~ c r1930 sccms mild. Vicwcd in a l o n ~ c pel-spcctivc,
r
rrincrs of the total of such loans by all Ictidrrc, src ibirl., Ta1)lc 133, 1). 43.t. it \vas sizable indeed. F r o m tlic cyclical pcnk in August 1929-to a\.oid
:\ltIioc~gl~botli tnblcs show s i r ~ ~ i l nrnptioris r for thr ]~ri~tcil)al ji:.oc~l)s ol Ivcttlcrs-
rnort of wl~osc flrnds \\,ere placed for tlircl~ I)y t l l c s New York banks-csc.c.l)t for the sharp wigglc in thc stock of rnoncy produccd by tlic immcdiatc cffccts
I,,nns 11y SIVV York City 1)anks for tlirir own at.t.culnts, tlic 1)rrnktlowris arc not of thc stock market crash-the moncy stock declined 2.6 pcr ccnt to
roti~l~nrnbic.I n the wcckly scrics, "out-of-town tlo~ncsticbatiks" inclutlc nicnilcr October 1930, a largcr dcclinc t h a n during thc wholc of all h u t four prc- ,,
and nonmrmbcr banks outside Xcw York City and, to an unknown a n i o u n t , rus-
torncrs of rliose bnriks. wllcrcas in the co~nprcl~cr~si\~c series that cntcsory is rc- ceding rcfcrcnce cyclc contractions-1873-79, 1893-91,' 1907-08, a n d '
<crictcd to nirriibcr I~nnkso~ctsidcNew I'ork City. Sir~rilarly,"otlicrs" i n the wcckly
;,.:il..: co\cr rcinitily c.or~)oralioris; I I I C ~ foreign I~nnkingagrlrcies, brrt in the con1l)rc-
!:,.;,<i\.rrrics iliclutlc nlco otlicr I)rnkrrs. intli\.itl~cnls,ant1 nonnicn~bt.rIrar~ks. nracc, 1332, pp. 1 11-1 12; J. A. Schurnpcter, n ~ l r i n e r sCycles, IlrGraw-Ilill, 1939,
Ftlr loans csrept to brokers and clealcrs by New I'ork City \vc.cklv rcporring Vol. 11, pp. 679-6130; It. A . Gordon, Durinerr I:l~~c~rrations, Ilarl~cr, 1352, qp.
my: i l y r h:tnks. \~!liclialso increased in the wcck alter ~ h ccrnsli. scc ibirl., 11. 171. 377-379, 31313; J. I;. Gall)raith, The Grenf Crnrh, 1929, Boston, IIougl~tonhlimrn,
.\!iu ;ce t h e c!irr~cr~io:t of !!:at cpisode i n sect. 2 , below. 1955, pp. 191-192. See also Fcdcral Rcscr\,c Board, A n n u a l Report for 1929,
Sci. . \ . I i . IIn:ijc:i. Eiunor~rirS~rrbiliznfionin 1111 Urrlnlnnrt-rl Il'orld, IIarcourr, p. ,I2.
Since only Junc cstirnatcs of the rnoncy stock are available for those ycars, the
3 (I(;
307
 T H E G R E A T CONTRACTION THE GREAT CONTRACTION

1920-21-and all thc exceptions are contractions that were extraordinarily

CHART 30
severe by otlicr indications as well. T h e detlinc was also Iarger than in all
Deposits of S u s p e n d e d Commercial Banks, Monthly,
st~ccecdingrcfcrrncc cycle contl.actions, tllor~glionly slightly L q c r tllan
1929-February 1 9 3 3
in 1937-38, the only later contraction cotnpnml~lc in sc\.crity to t l ~ c
earlier oncs listcd.
T h e decline in the stock of moncy is cspccinlly notable bccausc it
took place in n monetary and banking environment t!lat was in other rc-
spccts free of marked difficulties. There \\.as no sign of any distrust of
banks on the part of depositors, or of fcar of st~chd i s t r ~ ~on s t the part of
b ~ n k s .As Chart 27 shows, currency lirld by the pt111lic dcclincd by a
larger pcrccntngc than dcposits-8 pcr cr11t coml~nrrclwith 2 pcr cent-
though tlic reverse relation had bcen a11 i~ir.a~.inble accompaniment of
earlier banking crises. Similarly, the banks n ~ n d cno special cffort to
strengthen tlicir own l i q r ~ i d i tposition.
~ Esccss rrsel~vcs-for which no
estimatcs arc available bcfore 1929-rcniainrcl ncgligiblc. As wc shall
scc in morc dctail in thc ncst section, tllc clcclinc in thc stock of money
1113 to Octobrr 1930 rrflrctcd cnti~.c*ly a clcclinr in Frdc.l.al Rcscrvc crrdit
ot~tstanclingtvhicli morc tlian ofl'sct n rise in t l ~ rgolcl stock and n slight
shift by thc public from crlrrcncy to clcposits.

O N S E T OF F I R S T B A N K I N G CRISTS, OCTOBER 1930

I n October 1930, the monetary character of the contraction changed dra-
matically-a c h a n ~ crcflcctcd in Chart 30 by thc extraordinary rise in thc
dcposits of sr~sprndedbanks. ncforc Octobcr 1930, dcposits of srlspcndcd
banks had been somewhat higher tlian during most of 1929 but not out of
line \\.it11 experience during thc preceding decade. I n Novcmbcr 1930,
they Itrere more than double the highest value recorded since the start of
monthly data in 1921. A crop of bank failures, particularly in Missouri,
1 Indiana, Illinois, Iowa, Arkansas, and North Carolina, led to widc-
I variations b y the monthly mean method, opplied 1921-33.
spread attempts to convert demand and time deposits intn currency, and
also, to a much lesscr estcnt, into postal savings deposit^.^ A contagion
of fcar sprcad among depositors, starting from tlle agrict~lturalareas,
which hat1 rsl~crirnced thc hravirst impact of bank fniltlrcs in thc
t~vcntics.But such contagion kno~vsno gcogrnpliical limits. T h c failure
of 256 banks ~ v i t l i$180 million of dcposits in Novembcr 1930 was fol-
lo~vcd by the fnilt~reof 352 with over $370 million of dcposits in De-
dcclinc was m c a s ~ ~ r c cfrom l June 1832 to J ~ l n c 109.t rather than from Jan. I n 3 3
to J u n c lR3.1, thc n ~ o n t l ~ lrcfcrcncc
y tlntcs.
I n ric\\* of tllc 5.4 p r r ccnt clrclinc in t l ~ cnionry stock fro111 J a n , 1867 lo Jan.
1068-tllc carlicsl tlatc.5 for w l ~ i r hwc I ~ n \ . ccsti~~lalcs---
;rnoll~cr~>ossil)lcc s c c p l i c ) ~ ~
is thc r c f c ~ . c ~ l rcoi~traction
c frorn .\l>r. 1865 to Dcc. 1067.
' T h c growth of postal savings tlcl~ositsfrom 1329 to 1933 is onc rqirasllrc of 111c
spread of distrtut of banks. In No\,. 1914 postal savings dcposits wcrc $57 million.
By Aug. 1929 thcy had grown hy only $100 million. By O c t . 1930 they were $190
million; from then to Mar. 1933 thcy increased to $1.1 billion.
308
SOURCE: Data from Federal Reaenr Bulletin, Srpt. 1937, p. 909, were adjusted for seasonal
1
ccmber (all f i p r c s seasonally unadjristed), thc most dramatic being the
failure on December 11 of thc Bank of United States with over $200
million of deposits.* T h a t failure was of especial importance. T h e Bank of
I
' A n n u a l R e p o r t of. Superintendent
- of Banks, State of New York, Part I, Dec. I
31, 1930, p. 46.
For two a n d a half months before its closing, Joseph A. Broderick, Ncw York
State Supcrintcndent of Banks, had sponsored various merger plans-some vir-
tually to the point of consummation-which would have saved the bank. Goverilor
IIarriron dcviscd the final reorganization plan, the success of which seemed so
surc that, two days 1,cforc thc bank closed, t l ~ cFederal Reserve n a n k had issued
a s t a t c r l ~ c ~ lnaming
t proposccl directors lor thc mcrgcr. T h e plan would havc be-
cornc ol,erntive had not the Clcaring l i o i ~ s cI ~ a n k sa t the last moment w i t l ~ d r a w n
front thc arrangement whcrcby tllcy would h a w subscribed $30 million in ncw
capital funds to thc reorganized institution. U n d e r Harrison's plan, the Bank of
United States would havc mergcd with hlanufacturers Trust, Public National, and
Intcrnational Trust-r group of banks that had a majority of stockholders and
309
 T I I E C R E A T CONTRACTION
I/
I -
United Statcs was the largest cornmcrcial bank, as measured by volrimc
of deposits, cvcr to have failed up to tliat time in U.S. history. hforc-
ovcr, thougli an ordinary commercial bank, its name llncl Icd Inany at
tli~.cctorror t l ~ cS ~ I I I C c t h l ~ i corisill ant1 sorial aiid fii~a~wi.\l
~ I ; I C ~ ~ I ;IF
. ( I111ost
thc stockl~oldcrs a n d directors of the Bank of Unitcd Statcs-wit11 J. 1Icrl)crt
Casc, chairman of thc board a n d Fcdcral R r s c n e agcnt of thc Ncw York Bank,
as hcad. T h c decision or the Clcaring House banks not to c ~ v cthc Rank or Unitcd
Statcs was rcachcd a t a rnccting hcld a t thc Ncw l'ork Dank ant1 war not changed
d c ~ p i t cprrsonal appcals by Brodcrick a n d Ncw York Statc 1,icutcnant C o v c r l ~ o r
Iicrbert 11. Lchrnan. Brodcrick, aftcr waiting in a n antcroom for l ~ o l ~ rdcsl)irc
repcatcd requcsts to IIC allowcd to join thc bankcrs in thcir conlcrcncc roorn,
was finally admittcd through the intcrccssion of l'liomas W. L.a~~iont,of J. P.
Xlorgan a n d Company, a n d O w e n D. Young, a dircctor of tllc Ncw York Fcdcral
Rcscrve Bank. Brodrrick's account of his statement of thc bankcrs follows in p a r t :
I said it [thc Bank of Unitcd Statcs] had thousands of borrowers, that it
financcd small merchants, especially Jewish merchants, a n d that its closing might
a n d probably would rcsult in widcsprcad bankruptcy among those it s c n c d . I
warned that its closing would rcsult in the closing of a t least 10 othcr banks
in thc city a n d that it might cvcn allcct thc savings Ilanks. T h c influcncc of
rllc closing might cvcn cxtrntl o l ~ t s i d cthc r i ~ y ,1 told tlirtn.
I rclninclctl thcm that o t ~ l ytwo o r tllrrc wc.c.lis I)rforc thcy 11ad rrs(.11(~1two
of thc largcst priratc bankcrs of ttlc city a n d Ilatl willil~gly1,11t thc I I I O I I ~ ~
nccdcd. I recalled t h a t only seven o r eight ycars bcfore that they had cornc to
the aid of o n e of the biggcst trust companies in New York, putting u p m a n y
times thc s u m necded to save the Bank of Unitcd Statcs but only after some
of their heads h a d been knocked together.
I askcd them if their decision to d r o p the plan was still final. T h c y told m e
it was. T h e n I warned them that they wcrc making the most colossal mistakc
in the banking history of Ncw York.
Brodcrick's warning failed t o impress Jackson Reynolds, president of the First
h'ational Bank a n d of the Clearing EIouse Association, w h o i n f o m ~ c d Brodcrick
that thc cllcct of thc closing would be only "loral."
I t was not the actual collapsc of thc reorganization plan b u t runs on scvcral
of rhc bank's branches, which had started on Dcc. 9 a n d wllich h c I~clicvcdwould
I ~ c c o n ~itlrrrasingly
c scrio~rs, t h a t lctl nrotlcrirk to ortlrr t11r clnsi~lgof tllc bank
to coilscnc its asscts. At n nicctirl!: with the d i r c c ~ o r saftcr It.avil~g rllc rorlfcrcr~zc
with the bankers, Brodcrick rccallcd t h a t h c said: "I considcrcd thc I n n k solvcnt
as a going conccrn a n d ... I was a t a loss to trndcrstand t l ~ cattitudc of askance
which the Clearing I [ o \ ~ s chanks had acloptrtl toward the rral rstatc Iioltlin~sof
rhr Rnllk of Unitcd Starrs. I toltl t l ~ c ~I ntllo11~11t i t was I ~ r r a u s c11o11cnf tllc otllrr
I~nnks l ~ a dcvcr Ice11 intcrcstcrl in this ficltl a n d thcrcforc Ltww no111it)g of it."
Until that t i ~ n c ,he said he nevcr had propcr rcasorr to closc thc bank.
Ilrodcrick did sl~ccccd in pcrsl~adill!: thc confrrrncc of I)ankrrs to aplwn\pc
i ~ ~ i ~ l i c d i a ~the
c l y~ ) r ~ i t l a]q)lirntions
it~~ for I I I ( > I I I I I ( . ~ S ~ ~ ~i ~l lI ~ I I C C I c ; l r i ~ ~IgI ~ ( I SoCf
two of tllc banks in tllc proposcd nlrrgcr, so that they would havc thc ft111 rcsorlrccs
of the Clcaring House whcn thc ncxt day h c announccd the closing of thc Bank
of Unitcd Statcs. As a rcsult, thc two banks, wtiich likc the Bank of Unitcd Statcs
h a d bccn affected by runs, did not succumb.
T h c details of the cRort to savc the bank wcrc rcvcalcd in thc second of two
trials of Brodcrick upon his indictment by a Ncw York County grand jury for
allcgcd ncglcct of duty in failing t o closc the bank bcforc h c did. T h e first
~ x o c c c d i n g sendcd in a mistrial in Fcb. 1932. Brodcrick was acquitted on Xfay 20.
See C o m m e r c i a l a n d Financial Chronicle, hlay 21, 1932, pp. 3744-3745 for the
quotations; also J u n c 4, 1932, p. 4087, for Karrison's tcstimony.
3 10
T I I E CREAT CONTRACTION
liomc and al,road to rcgrartl i t somcliow as an official bank, hcncc its
failure constituted more of a blow to confidence than wo\lld have becn
administcrcd by tlic fall of a bank with a lcss distinctivc namc. In addi-
tion, i t was a mcrn\,cr of tllr Fcclrral Rcsrr\fc Systcm. T h e \vitl~drnwal
~ I I I(11
~~ of srrpport by tllc CI(.:~ring I I t i i ~ s t : hanks frorn t l ~ cconccrtcd mcnstrrcs
sponsored by the Fctlcral Rcscrvc Dank of Nc\v York to sa\.c the bank-
mcasul.cs of a kind tlic bnnking c o m m t ~ n i tl~~ a doftcn takcn in similar
circt~mstanccsin thc past-was a scl.iorrs blow to the Systrm's prestige
s (sc~ section 3, below) .
T h e change in tllc cl~aractcr of tlic contraction is rcflcctcd clcarly
in Chart 27. Cttrrcncy l ~ c l dby the ptthlic stopped cleclining and started
to rise, so tliat tlcposits and cltrrcncy began to move in opposite direc-
tions, as in earlier banking crisrs. Danks rcnctcd as thcy always had i~nclcr
such circumstancrs, cach seeking to strcngtiien its own liquidity position.
Dcspite the withclrawal of deposits, which worked to deplete rcservcs,
there was a small increase in seasonally adjusted reserves, so tlic ratio of
deposits to bank rcscrvcs clcclincd sl~arplyfrom Octobcr 1930 to,Janr~ary
133 1.
We liavc nlrrady cxl,rcssctl t l ~ cvitbw (pp. 167-168) that irndcr tlic prr-
Frclcral Reserve banking system, the final months of 1930 would
probably havc sccn a restriction, of the kind that occi~rredin 1907, of
convertibility of deposits into currency. By cutting the vicious circle
set in train by the search for liquidity, restriction would almost certainly
havc prevented the subseqi~entwaves of bank faili~resthat were dcstinccl
to come in 1931, 1932, and 1933, just as restriction in 1893 and 1307 had
quickly .ended bank st~spcnsionsarising primarily from lack of liquidity.
Indeed, under such circumstances, the Bank of Unitcd States itself might
have hccn able to rcopcn, as the Knickcrbockcr Trust Company did in
I3on. After all, tlic Dank of Unitccl Stntrs i ~ l t i m a t c lpaid ~ off 83.5 pcr
ct:nt of its a~ljl~strcl liabilities at its closilig on Dcccmbcr 11, 1330, dcspitc
its.havin,g to liquitlate so Iar,qc a fraction of its assets during the extraor-
tlinnrily tliffict~lt financial contlitions that prcvailcd during thc ncxt two
ycnrs.l"
As it was; the cxistcncc of thc Rcscrvc Systcm prc\,cntcd conccrtccl
rvstriction, both dircctly ant1 intlircctly: clircctly, by rctlucing tllc
cor1rc:l.n of stronger I)ar~ks,wlricli l ~ n din t l ~ cpast typically takcn tllc lcatl
. .
in s u c l ~a conccrtctl move, sincc thc Systcm provided tlicm with an cs-
cape mechanism in the form of discotlnting; and indirectly, by si~pporting
tlic general assi~mptionthat s u c l ~a nlovc was made ttnncccssary hy tlic
establishment of tlic Systcm. T l ~ cprivate moves takcn to shore u p tlic
" A n n u n l R e p o r t o/ S ~ l p e r i n t e n d r n t o f Onnks, Statc of Ncw York, Part 1, 1931-
1 5 , Schedule E in carh rcport. Four-firths of the total rccovercd by depositors a n d
othcr creditors was paid ollt, within two yrars of the bank's closing.
31 1
 T I I E GREAT CONTRACTION
banking system wcre thcreforc extremely limited." T h e result was that
the cpisodc, instcacl of being the climactic phase of the banking difficul-
tics, tvas only thc first of a scrics of liquidity criscs tliat was to cliaracterize
the rcst of tlic contraction and was not to terminate until thc banking
Iioliday of X,farcli 1933.
T l ~ ciliiti:~l c.t.i~ir;(lid riot lnst long. R;1ri1< failures tlcclinctl sl~nrply
in carl! 193 1 . and tlic banlis' scramble for liquiclity camc t,o a l~nlt.Tlicrc
was a marked risc in tlic ratio of dcposits to reserves from Jan:lnry 1931 to
3,farcIl 1931, thc tcrminal month of the segment we havc been discussing
and tlie month of tlic onset of the second banking crisis. I n January and
February, thc public slackcnrcl its dcmand for additional currency; de-
mand and tinic deposits, aftcr declining in January, rosc a trifle in Fcb-
ruary and Ilrld ncnrly constant in hiiarch.
Intcrcst rates sllo~v clcarly the effccts of the banking crisis. Until
Scptcmbcr 1930, thc month before the first Innking crisis, both long- .and
short-term interest ratcs had becn declining, and so had the yiclds on
corporate Ban bonds. Synchronous ~ v i t hthc first crisis, a widening differ-
cntial began to cmergc bct\\,c.cn yiclds on lo~vcr-gradecorporate bonds
and on govcrnmcnt bonds. T h e yields on corporate bonds rose sharply, the
yiclds on government bonds contini~cdto fall. T h e reason is clear. I n thcir
search for liquidity, banks ancl othcrs were inclined first to dispose of
their lower-gradc bonds; tlic \,cry desire for liquidity made govcrnmcnt
l ~ o n d s cvcl- morc dcsirablc ns srcondnry rcscrvcs; hcncc the yicld on
lowcr-gradc sccuritics rose, \vhich is to say, their priccs fcll, wl~ilctlic
yiclcls on governrncnt bonds fell. Ttic decline in bond priccs itsclf con-
tributed, as \vc shall see in morc clrtnil latcr. to thc subscqucnt hnriking
crises. I t maclc banks morc fcarful of liolcling Ijonds and so fostcrctl dc-
clincs in prices. ny reducing tlic m'arkrt vnl~!cof tllc bond portfnlios of
banks, dccli~irs iri boncl prices in t1tl.n r.rtltlcrtl tlic mnrgiri nf cnpi~nl
as evaluated by bank cxalnincrs, ancl in t l ~ i sway contributccl to s[ll,sc-
qucnt hank fail~ires.'~ T h e cnd of tlic first banking crisis was registered
l1 In some communities financial reconstruction was attempted by arrangements
for a strong bank to merge with a weakcncd bank or, i f sevcral weakencd banks
were involved, by establishing a new institution with additional capital to take over
tlic liabilities of the failing banks, t h e storkholdcrs of which took a loss (F. Cyril
Jamcs, The Groruth of Chicago Banks, New York, Harper, 1938, Vol. 11, pp.
991-995 ) .
"According to a memorandum, dated Dec. 19, 1930, prepared for the executive
committee of t h e Open hfarkct Policy Conference, banks "dumped securitics to
make their positions morc liquid," t h u s increasing the prcssure on the bond market.
\\'cak bond priccs in t u r n produccd "a substantial depreciation in the invcstrnent
portfolios of many banks, in some cases causing a n iqpairment of capital." In
addition. t h c bond niarkct was alnimt complctcly rlosrtl to new issucs ( G c o r ~ cI,.
I-larrison Paprrs on t h e Fcdcral Resrr\.c Systcln, Columbia Univcrsity Library,
IIarrison, Opcn hlarkct, Vol. I , Dcc. 19, 1930; for a full dcscription of the Papers,
scc Chap. 5, footnotc 41 and tlrc accompanying t c x t ) .
312
I T I I E GREAT CON'rIIACTION
in a sliarp improvc~ncntin the bond market aftcr the turn of the ycar;
the onsct of the next crisis, in renewed deterioration.
iI T h c onsct of the first liquidity crisis lcft no clear imlx.int on the
c ,
broad economic scrics, shown in Chart 28. I-Io\vcver, after thc turn of the
ycar, thcrc wcre s i * ~ of s improvcmrnt in tliose indicators of c.conomic
activity-rio cloul~tpartly cause and 1);irtly crrcct of the contc111l)or.nneous
minor irnprovcmcnt in thc monetary area. Industrial productiorl rosr from
January to April. Factory employment, scasonally adjusted, wliicl~ had
fallcn u n i n t c r r ~ p t c d lsincc
~ A u c ~ l s t1929, continued to fall but at a much
tcd~rccdrate: in all but one month from August 1929 to February 1931,
the clcclinc was equal to or greater than the total decline in t l ~ cthree
months from Fchruary to May 1931. Other indicators of physical activity
tcll a similar story. Personal income rose sliarply, hy 6 per ct-lit from
. Fcbl.unry to April 1931, but this is a misleading indcs since t l ~ rrise was
protlucccl largcly by govcrnmcnt distributions to \.ctcrans." All in all, the
figilrcs for the first four or five months of 1931, if esaminecl without
refrrcncc to what actually followed, have many of tlie carmarks of the
bottom of a cycle and the beginning of revival.
Perhaps if thosc tentative stirrings of revival had been rcinforccd
by a vigorous cspansion in the stock of money, they could have bccn con-
vertccl into sustained recovery. But that was not to be. T h e effects*of
returning confitlcnce on the part of the public and the banks, \\.hich
mntlc for rnonctnry cspansion by raising the ratios of dcposits to currcncy
and to rcscrvcs, ycrc- largcly ofrsct by a reduction in Fcderal Rescrve
crcclit outstancling (src srction 5, hclow). Consequently, the total stock
of moncy was less than I ' p r r ccnt h i ~ l i e rin hiarch than in January 1931,
and lowrr in Atarch than i t had hccn in Dccember 1930. In hfarch, a
sccnntl Innking crisis stnrtccl a rcnc~vrd(Icclinc in the stock of moncy
nntl : ~ trill ncctslc.r;~trclrat(,. A 111nritl1or twn Intcr, a rrnr\vccl clrclinr.
started in cco~iomic activity in gcncral, ancl the hope of revival that
scason was cndcd.
. O N S E T OF SECOND n A N K I N G CRISIS, MARCH 1931
As Chart 30 shows, dcposits of suspendrd banks began to rise in 3Iarcli!
reaching a high point in June. From March on, the public resumed con-
verting deposits into currency, and from April on, banks started strength-
ening their reserve position, liquidating available assets in order to meet
both the public's drmand for currcncy and thcir own desire for liquidity.
Exccss rcscrvcs, which in January 19.31 had for the first timc since 1929,
" U.S. advanrrs to \.ctcranr 01 World \Var I of u p to 50 per c c n t 01 the face
valuc 01 tllcir atljtlstcd s r n i r c ccrtificates were made possible by legislation 01
Fcb. 27; 1931. l ' l ~ c s e loans totalcd $796 million in t h e first four months after the
enactmcnt.
313

TEIE G R E A T CONTRA(7I'ION
j of the United States, central banks and privatc holders in a numbcr of
' countries-notably Francc, Bclgirtnl! S\\.itzrrlnncl, Swrdcn, ant1 thc
Nrthcrlnnds-converted st~l)~tnntinlnrnol~ntsof tlirir dollar nssrts in thc
Sv\v York moncy market to ;old I)c~t\\~c-c~n S(.l~trlnl)c.~, 16 aritl O(.tol~c'r38.
Ihy-nusc of tlic low Icvcl of tlionc~-~~i:l~.Iic~t ititc*l.c.st I.;II~-Sin tI1t: Ur~itcd
States, foreign ccntsal banks llacl for solnc tirnc I~ccnsclling dollar bankcrs'
acccptances previously purchascd for tl~cir accounts hy tiic Ncw York
Rrsrr\.c Rank, tlic procccds of wllicll \vrrc rrc*rlitcd to tlirir clollnr I n n k
dcposits. From tllc \\.cck of Scptc1111x-r16, t l ~ c11111oacling of t l ~ cI~illsonto
thc Fcdcrnl Rcscrtec assumcd panic proportions. Forcign ccntrnl banks
drcw down tlicir dcposits to incrensc cnt~markingsof golcl, n l ~ t c hor \\fllicli
was cxportcd during tllc following six \\,clc%ks.From Srptrrnl)c*r 16 to
Scptemhcr 30, tlic gold stock dcclincd 11y $275 niillion, ftnm tllcn to tllc
cnd of Octohcr by an additional $1.50 ~riillion.Thosc losscs a l ~ o t ~offsct t from August 1931 tl~rottghJanuary 1932, 1,860 banks with dcposits of
tlic net influx during thc preceding t\vo ycars and brought tlic gold stock
bnck roughly to its avcragc Icvcl during 1929.
Tllc onsct of tlic estcsnnl drain \\,as ~)rrccclcclant1 ac.co~npntiicdI)y an
intensification of tlic intcl.nnl clrnin on tlic banking systcm. 111 At~gust,
drposits of s~tspcnclrclb;lnlis sosc to ;I It:\.e*l t l ~ n tllatl b ( ~ ; c-xc.rc-tlc~cl
~i only
in tlie month of Dccember 1930, a n d in Scptcmbcr rosc Iiighcr yct. I n
those two months alone, banks with deposits of $414 million, or morc than
1 per ccnt of the by-then shrunken total of commcrcial bank dcposits,
closed their doors. Tlic outflow of gold in Scptcmhcr added to thc pres-
sure on bank rcscr\.cs. Currency was being \vitliclrnwn ititernally by dc-
positors justifiably fearful for thc safcty of Innks, and golcl was being
\\.ithdra\\,n cstcrnally by foscigncrs frat.fu1 for tlic mnintcnancc of thc gold
standard. T h e cornhination of an cstcrnal dsnin ancl an intcrnal drain,
a n d particularly their joint occurrence in tlic a u t ~ ~ n lwhcn n the dcmancl
for currcncy \\,as in any cvcnt a t its seasonnl prnk, \vas prccisrly thc srt of
circumstances that in prc-Fcdcral Rcscrvc days would Ilavc producctl
rcstriction of con\,rl.tibility of dcposits into cr~rrericy.If tlic pre-Fcdcral
Rescr\.c bankin: systcm Iiacl I ~ r r nin c f f c ~ t ,all other cvcnts had I~cen
as they \jrcrc? and rcstriction of payircnts by banks hat1 not talicn
place in Dcccmbcr 1930, rcstriction allnost ccrtninly w o ~ ~ l tllnvc l oc-
curred in Scptcml)cr 1931 ant1 \,cry lilic,ly wor~ldlinvc prcvrntccl a t lrast
thc subscqucnt bank failurcs."
" M e n w h o had experienccd thc 1907 panic were not unmindful of lessons to
be learned from it. Samuel Reyburn (president of Lord and Taylor, a New York
City department store, and a director of the h'cw York Fcderal Rescnrc Bank)
suggested a t a board meeting in Dec. 1931 "that if the banking difficulties c s -
tended much further, it w o t ~ l dbe possible lor tlrc h n ~ i k sto susl>rntl rash payn~c-nls
as they did in 1907, but still continue in busillcss." IIc Ii~licvctl~ h c r ewoultl bc a
difficulty, "which had not been present in 1907, that the Fetlcral reserve hanks
cannot suspend cash payments." I n Mar. 1933, this turned out not to I)e a
3 16
, < -
T I I E G R E A T CONTRACTION 8
T h c Fedcral Rescrvc System reactch vi~orousIya n d promptly to the
extcrnal drain, as it had not to the pre\lious intcrnal drain. O n 0ctol)cr
9, tllc R(:srrvc Bank of New York raiscd its rediscount ratc to 2 % pcr
cent nrlcl on Octobcr 16, to 3% pcr cent-tl~c sharpest rise within so
.I~t.ic-fn ~)c-riodin thc wliolc history of tllc Systctn, bcfore or sincc. T h c
Inow \\.ns followed by a ccssation of the esternal drain in the nest two
wcrks. Tllc gold stock rcaclicd its trough a t the end of October, and'
tlicscnrtcr rosc until a rcncwcd golcl drain bcian at tlic cnd of Deccmhcr.
Ilut tlic m o w also intcnsificd intcrnal financial diflic[tltics and \\.as
accompanied by a spcctncular incrcasc in bank failurcs and in rllns on
banks. In Octobcr alonc, 522 commcrcial banks with $471 million of dc-
posits closcd t l ~ c i rdoors, and in t l ~ cnest tlircc months, 875 addition:]
bnnlis witli $564 million of deposits. 1\11 told, in the six months
$1,449 million suspcndcd opcrations," and thc deposits of those banks
tlint manngccl to kecp afloat fell by a much largcr sum. Total deposits
fill ovrr t l ~ csix-month pcriod by nrnrly five tirncs the deposits in sus-
prntl(.tl banks or by no lrss than 17 pcr crnt of tlic initial Icvcl of dcposits
in operating I~anks.
Tlic risc in currcncy offsct somc of tlic cffect on the moncy stock of
thc dcclinc in dcposits. But tllc offsct was minor. T h e money stock fell
problcm; the Rescrvc Banks joined thc other banks in restricting payments. O n e
Rank oficbr commented that "there is thc further difference between 1907 a n d
the prcscnt time, that the difficulty of the banks in 1907 was not one of solvency.
I ~ u tinability to continuc t o pay out currency, whereas a t the present time the
hanks are able t o pay out currency in large amounts, if necessary, but there is
the dangcr that they may become insolvent in so doing" (Harrison, Notes, Vol.
11, Dcc. 7, 1931).
T h a t answcr was hardly t o the point, confusing the problem of thc individual
hank with thc problcm of thc banking system. T h e threat of insolvency arosc from
tlie inability of t l ~ cbanking system as a whole to pay out currency without a re-
d ~ l r r i o nin total clcposits, givcn thc failure of thc Fcdcral Reserve System to create
s u f i r i r n t aclclitional high-powcrcd moncy. l ' h e attcmptcd liquidation of assets to
a r q u i r r thc high-powered nloncy drovc down thcir priccs a n d rendercd insolvent
bar1k.c that would otherwise have becn cntircly solvent. By cutting short this proc-
css, the carly rcstriction of payments prcventcd thc translomation of a tcmporary
liquidity prol)lc~ninto a pro1)lcm of insolvency.
'"Rumors about thc condition of some of the largest and bcst-known Ncw York
City hanks sprcad alarm i n Europc (Ilarrison, Conversations, Vol. I, Oct. 2,
1931 ) . tIowcvcr, IIarrison considcrcd their position in October 1331 "stronger and
morc liquid than for a long tirnc." T h c 2 3 New York Clearing House banks were
not includccl in a m c m o r a n d ~ ~ md, a t e d Dcc. 8, 1931, listing the shrinkage in
capital funds of thc membcr banks in the second Federal Reservc District, which
Harrison scnt to Governor hlcycr ( h l i s c e l l a n r o ~ ~ sVol.
, I, Dcc. 8, 1931). T h e
shrinkage ranged from 56 per rcnt f o r thc higllcst quality group of banks to more
than douhlc the capital funds for thc lowest quality group. O n e of the reasons
Ncw York City hanks wrrc said to I)c reluctant to borrow from the Rescrve Dank
was the fcar that Euro!)cans \r.oulcl interpret Imrrowings as a n indication .of
weakness.
317
 T H E G R E A T CONTRACTION
by I2 per cent from August 1931 to January 1932, o r at tlic annual ratc of
31 per ccnt-a rate of decline largcr by far than for any othcr com-
parable span in the 53 years for which wc have monthly data,'' and in
the \vliolc 93-!car pcriod for which \vc liavc a continuous scrics on thr
moncy stock.
\Vhy slio~rldthe gold drain and the subsclucnt rise in discount ratcs
'
have intensified the domestic financial diffict~ltics so grcatly? Thcy
, would not havc donc so, if they had bccn accompanictl by cstcnsive opcn
market purchases designed to offsct thc cffect of tlic cstcrnal gold drain
on high-powered money, and of thc internal currency drain on bank
rcsenrcs. Unfortunately, purchases werc not made. Tlic Rcscrvc Systcm's
holdings of government securities were actually ~ c d u c c dby $15 million in
thc six-week period from mid-September to the cnd of October, and
then krpt unchanged until mid-December. Though the System raiscd
bill buying rates along with discount rates, it did b t ~ ysomc $500 million
additional bills in the crucial six-weck pcrind. IIowcvcr, that amount
was inadequate. to offsct cvcn tlic outflow of gold, Ict alonc tlic intcrnal
drain. T h e result was that the banks found tlicir rcscrves being drained
from two directions-by esport of gold and by intcrnal dcmands for
currcncy. Thcy had only two recourses: to borrow from thc Rcscrvc
Systcm and to dump thcir acsrts on tlic markct. They did both, tliot~gh
neither was a satisfactory solution.
Ditcounts rose to a Icvcl not rcachcd sincc 1929, dcspitc thc risc
in discount ratcs. T h c situation and its effects arc wcll described in
a mcmorandum ~ r c p a r c dfor a mccting of the Open Markct Policy Con-
ference in Fcbruary 1932. T h e conditions it described were still much thc
rnmc as those that had prcvailcd in Octobcr 1931.
. . . Tlic \\.cislit of thrsc disrounts is falling most hcavily o n banks outsitlr
1111: principal crnlcrs. I n fart, t h c d i s r o l ~ n t sof thrsc grollps of I)atiks arc con-
sidcrnhl!. Inrqrr tlian thry w r r c in 1329 w h c n t h r rrscrvc systrm \\,as cscrting
tlic masiliirlm of prcssurr for dcflntion. T h c prctrnt a m o u n t of m c n i l ~ r rbank
borro\\.inq Iin; nl\\.nys provrd drflntionary, rsrc-pt perhaps cluring thc war,
a n d \\.ith tlic. prrsc,rit scnsitivc psyrholo,q, a n intrrr~lption.to drIl;ttion sccms
~lnlikclyns l o l i ~nc tlic \\.riglit of discounts is a s hr.nvy ns nt prrscnt."
Tlic a\-ersion to bol-rowing by hanks, wl~iclitlic Rcscr\.c Systcm had trictl
to strengthen during tlic twcntics, was still grcatcrr a t a tirnc whcn dc-
positors were fearful for the safety of every bank and were scrutinizing
balance sheets with great carc to sce which banks wcre likely to be thc
*Excluding only the five 5-month intervals spanning the holiday, O c t . 1932-
h f a r . 1933-Feb.-July 1933, when the recorded d a t a show a dccline of the same
order of magnitude as the annual rate of dccline, Aug. 1931-Jan. 1932. As we
shall sce in C h a p . 8, sect. 1, thc banking holiday produccd a discontinuity in the
money figures, and tlie recordcd dcrline may be a statistical artifact.
*Harris011, O p c n hfarkct, Vol. I f , rncmoranduni, datcd Fcb. 23, 1932.
318
TIIE (:Ill:A'r CONTI<ACI'ION
ncst to go. This is thc contest of thc "sensitive psycliology" to which the
quotation refers.
T h e cffcct of tlic attempt to rcalizc on 'assets is vividly displayed . .
in C l ~ n r t29. For tlic first tirnc, yields on long-term government boncls
and on conlmcrcinl p a l m rosc sllarply along wit11 thc yiclds on Io\vcr-
grndc corporate sccuritics. Thosc riscs in yiclds clearly did not rcflcct
t l ~ ccfTcct of tlic dcprcssion on corporate earnings; thcy rcflcctcd tltc
licltiidity crisis and tlic unwillingness or inability of banks to borrow
c\-cn iiiorc licavily from thc Rcserve Systcm. Thcrc was sonic clisciission at
tlic tiinc, and cvcn morc latcr, attributing tlle decline in tlic pricc of
I
govcrnmcnt bonds to the fcdcral dcficit (undcr $0.5 billion in fiscal 1931;
$2.5 billion in fiscal 1932), and to the fcar of "irrcsponsiblc" legislation,
-
but it is hard to belicvc that thosc factors had much effcct in corn-
parison with thc e z r t r ~ m ~ l y ~ l ~ cpressure
avy on banks to liquidate tlicir as-
sets. Certainly, thc risc in tlic commercial-paper rate rcflectcd both in
timing and amollnt primarily tile movcmcnts in tlic discount ratc.
Again, wc may draw on a preliminary mcrnorandum for an Opcn
hfarkct Policy Confcrcncc, this time in January 1932.
\Vitliin .I pcriotl of a fcw months U n i t r d Stntcs Gor,rrnmcnt bonds havc
tlcc.linrtl I 0 p r r ccnt; high gmtlc corporation Lontls h ; ~ v cdcclincd 20 p c r ccnt;
nncl Io\vrr S I . ; I ~ ~ I : I)oritls linvc shn\vn vvrn 1:lrgc.r pricc tlcclincs. Di:clincs of such
p~.oportions incvit:~l>ly havc inc.rc.;~sc.tl grcntly thc dillicultics of m a n ) banks, ,.
a n d it has now b c c o ~ n capparctlt that t h c cfTorts of inclividunl instit~rtions to
strctigthcn thcir position h a v c seriously wcakcncd t h c banking position in
.is'
gcncrnl."
Some mcasures were attempted or proposed for the relief of banking
clifficultics, for example, mcasurcs sponsored by the New York Rcscrvc
Dank to encourage a more liberal evaluation of bank assets, to rcduce
tlic prcssilrc on railrontl boncl prices, and to accclcrate thc litluidation
of tlcl)osits in closed Thcsc wcrc pnllintives that \voilld liavc
:' I h i d . . rnrrnoran(lum, datctl Jan.0, 33.72.
" (1 ) l'llc.Bank sl~onsorctlan attempt to devclop a uniform method of \,sluing
I ~ a n k nswts, involving a Inore liberal procedure to be followcd by cxarnincrs in
cstirnnti~~gdrl~rcciation. l ' h e Comptroller ruled that national banks would bc
rcquircd to charge o r no dcprcciation on bonds of the four highest ratings, and
only 25 pcr cetlt or the depreciation on all other bonds, except defaulted issucs on
whir11 tllc f ~ r l ltlcprcciatiori was to be charged on. T h c rulc, howcvcr, was applied
.only to I ~ a n k swhose capital funds would not be wiped out if the entire deprccia-
tion of all the investments, togcther with any losses on other assets, wcre to be
written o n . I-Ience banks most in need of liberal treatment wcre not helped
f IIarrison, Notcs, Vol. I I, h u g . 6 , 13, a n d Dec. 7 , 1 9 3 1 ) . ( 2 ) I t tried to obtain
a rcvision of the rulcs governing the list of invcstmcnts legal for sa\,ings banks,
insurance companies, and trust fun& in Ncw l'ork State. T h e prospcct of the
elimination of railroad bonds from the lcgal list tlireatcned a further decline in
thcir pricc, as lioldcrs bound by thc list sold tlie I~onds.As a result, comrncrcial
bank I~oltlings of railroad I~ontls sufTcred loses (ibid., Aug. 13, 1931). ( 3 ) I t
prornotcd the formation of a railroad bond pool, to rcstore bond values, conditional
319
 T H E GREAT CONTRACTION
h a d little effect, even if they h a d bccn fully carried out. M o r e far-
reaching proposals c a m e f r o m outside tllc Rcscrvc System. A t the
urging of Prcsidcnt Hoovcr, a n d with only t h c reluctant cooperation of t h e
b a n k i n g community, a private National C r e d i t Corporation was created
in O c t o b r r 1931 to c s t e n d loans to indi\.idual banks, associated togrthcr
in cooperati\.cs in each Fcdcral Rcscr\.c district, against s c c ~ ~ r i tcol-
lateral n o t ordinarily acceptable a n d against the joint g u a r a n t e e of thc
membcrs o f tile cooperative. T h c Corporation's loans were, howcvcr,
limited. It1 I-Ioo\.rr's words, "Aftcr a fcw wcrks of imtrrprising cottrage
. . . [it] bccamc ttltrncon.zcrvnti\.r. 11lc.n fc*nt.ful. nlltl fillally tlirtl. I t 11:ltl
n o t cscrtcd nnythitlg likc its f t t l l 1~ossil)lcstrrngtll. I t s r~tc~~~~bc-t~s-.--nntl
bttsincss \vorlcl--tlt~.cw t ~ their p 11nncls atltl askcd for g o v c t ~ t ~ t ~ ~ cnctiotl."'"
nt;ll
T h e s e a r r a n g c m c n t s were explicitly pattcrncd after tllosc in t11e: tcntllornry
Aldrich-Vrccland Act, which h a d worked so wcll in 1914, the o n c occa-
sion w h e n thcy were uscd. O n H o o ~ , c r ' srccommcndation, the Reconstruc-
tion Finnncc Corporation w a s establislicd in l a n t l a r y 1332: wit11 attthority
to m a k e loans t o banks nnd otllrr fit1nnci;ll i t ~ s t i ~ t ~ t i oas n s .\\.c:II a s to rnil-
roads, m a n y of ~ v l l i c hwcrc in clangcr of clcfat~lto n tl~csirI ~ o ~ l c l itlclc.l,ti,d-
~~cl
ness.14 T h e epidemic of bank failures cllclctl a t a b o u t tllc samc tirnc as tllc
cstablishmcnt of tllc RFC, though tltc two cl~:vrlopnlcnts ]nay 11avc
l ~ c r nunrclatcd. I n a n y cvcnt, d ~ t r i n gtllc rest of 19.72, RFC loans to
on prior adjustment of railroad costs and income (ibid., Oct. 5, and Dcc. 7, 1931 ;
nlso, Conversations, Vol. I, Dcc. 5, 1931 ) . ( 4 ) i t sought thc assistance of a group
of member banks to accclcrate thc liq~~idation of tleposits in closcd banks. The
going banks \\*ere askcd to buy thc asscts of thc closcd hanks, ant1 to make an
immediate advance against the assets, so that an agrcctl pcrccntngc of tlcposits
could be paid out promptly to depositors (Harrkon, Oficc, Vol. 11, Scpt. 11,
1931).
" FIoovcr, hfernoir.r, p. 97. Scc thc copy of the prrparcd stntrmcnt-reqrcrsting
f o n ~ ~ a t i oofn thc Corporation-rcntl to a n ~ r c t i ~of~ gninctccn Ncw York bar~kers
held nt Sccrctnry hlcllon's npnrtlncnt. Suntlny, Oct. 4, I9:ll : IIoovcr's Irttrr, tl.ctrtl
Oct. 5, 1931, to Ilarrison: nntl 1Inrrison's ancwrr of Ort. 7 (all in hlitrcllanc~o~~s,
Val. I ) . llarrison strcssctl the nrctl for a railroad I)ontl pool, to rniw thc priers
of those bonds in bank assets, as an indispcnsnble mcns\lrc to hclp thc hanks in
atldition to thc formation of the Corporation. Also scc Notcs, Vol. 11. Oct. 5, 12,
15, 1931, for the tepid reception of the Corporation by most of the nank's
directors.
" The Emergency Relief and Construction Act of July 21, 1932, which incrcascd
the borrowing power of the RFC lrorn $l.qbillion to $3.3 billion in addition to
its subscribed capital of $500 million, author~zedit to atl\.ance up to $300 million
at 3 per cent int~restto statcs and territories for uncrnploymcnt rclirf; to makc
loans for self-liquidating public works (little was actually acl\.n~~ccd cithcr lor
relief or public works up to the end of the ycar) ; to finance marketing of agri-
cultural products in foreign markets and in the U.S.; and to create a rcgional
credit corporation with capital subscribed by the RFC in any land-hank district.
These nieasurcs did not prcvcnt thc continlccd fall in farrn incomc and farm land
vnlucs, the risc in farm forcclosurcs, and continued lorccd sales d ~ cto tax
dcliclquency.
3 20
T I I E GREAT CONTRACTION
banks totaled $0.9 billion, a n d deposits of bnnks t h a t suspended fluctuated
a h o u t the lcvel of mid-1930.
T h e Glass-Stcagall Act, passcd o n February 27, 1932, which h a d its
origins in t h e T r e a s u r y and t h e W h i t e Housc, was mainly designed t o
I r o n d e n t h e collatcral t h e Rcscrvc Systcm cottld hold against Fcdcral
y
Rcscr\.c notes, by permitting governmcnt I ~ o n d sas wcll a s eligiblc p a p e r
t o serve a s collateral.25 B u t it also inclildctl provisions designed t o h c l p
incli~.idual banks by widening t h e circumstances u n d e r which they could
I)ot.row f r o m tllc S y ~ t c m . ~ ~
111 M a y 1932, a I ~ i l lto proviclc fcdcral insurance of deposits in 1)nnks
tl~c
was passcd by tllc FIottsc of Rcprcscntativcs. I t was rcfcrrcd to a suh-
comt~littc.c of tllc S c n a t c I1;tnking a n d C t ~ r r c n c yComnlittcc, of w l t i c l ~
C a r t c r Glass was c h a i r m a n , b u t was ncvcr rcportcd H e h a d opposed
a similar provision a t tlte t i m e of t h e passage of the original Fcdcral
Rescrve Act.2a Glass bclicvcd t h a t t h e solution was reform of t h e
practices of commcrcial banks a n d i n t r o d ~ l c e dseveral bills t o t h a t e n d . l D
N o n c rcccivcd tllc s u p p o r t of t h c acl~ninistration o r of tllc Rescrvc Sys-
' tem, a n d n o n e was
I n July 1932, t h e Fedcral H o m e L o a n Bank A c t was passcd in a n o t h c r
attempt to cope with t h c problcm o f , f r o z e n assets-specifically of h o m e
" Thc provision was to expirc on Mar. 3. 1933, but was extendcd another
ycar on Fcb. 3, 1933, and thcrcaftcr pcriodically until made pcrmanent by
the act of Junc 12, 1945.
% T h e Clau-Stcagall Act pcrmittcd mrmher hanks to borrow from the Reserve !
Banks (at penalty ratcs) on ineligible assets under specified conditions. With thc
'conscnt of at lcast five mcrnbcrr of thc Federal Rcscne Board, notcs of groups of
five or more mcrnbcr banks with insufficient eligible assets could be discountrd.
A unit bank with a capital lrntlcr $5 million was also authorized, in exceptional
circumstanccr, to borrow on inc1igil)le assets with the consent ol at least f i \ ~
mernl)crs of the Fcdcral Rescnc Donrd. The rclcase of lunds by these tcrrns was
slight. The Emcrgcncy Relicl ant1 Construction Act of July 21, 1932, tlicrcfore
pcrmittcd thc Rcscrve nanks to disco~rn~ lor intlividuals, partncrships, and corpo-
rations, with no othcr sources of I~cntLs,notcs, drnlts, and l,ills ol cxchange cligihlc
for tliscoltnt lor mcmbcr banks. Tllosc powcrs werc uscd to a vcry lirnitcd cxtcnt.
lliscounts for individuals, partncrships, and corporations reac1)cd a maximurn'of
$1.4 million in hlar. 1933. Authorization to make those discounts cxpired July 31,
1936.
" I-iousc bill 11362 was refcrred to the Scnatc Banking and Currency Commit-
tee on May 28, 1932 (Congressional Record, 72d Cong., 1st sess., p. 11515).
Class had been chairman of the House Banking and Currency Committee in
1913. The bill passcd that year by the Senate included deposit guaranty; the bill
passed by thc House did not. In the conference, the House conferecs succecded
in eliminating that provision (Pal11 A4. Warburg, The Federal Rcscruc S)*stern,
Ncw York, hlacmillan, 1930, Vol. I, p. 128).
In 71st Cong., 2d scss., June 17, 1930, S. 4723, on national banking associa-
tions (Con,crcssio~~al Record, p. 10973); in 72d Cong., 1st sess., Jan. 21 and hlar.
17, 1992, S. 3215 and S. 41 15, on Fcdcral Rcscnc Banks (ibid., pp. 2403, 6329),
also Apr. In, 1932, S. 1112, on Fcdcral Rcscrvc Banks and national banking
associations.
10 Sec also footnote 134, bclow.
 T H E CREAT CONTRACTION
financing institutions (i.e., savings and loan associations, savings banks,
insurance companies). T h e act provided for thc organization of fcdcral
homc loan banks to make advances to those institutions on thc sccurity of
first mortgages they hcld.
Tlic broader cconolnic indicators in Chart 28 show little cfTcct of tlic
financial dc\.clol~nlcnts tllat follo\\ved nritain's dcpartirrc from gold.
Rather, thcy show a continuous dcclinc from t,hc onsct of thc sccond
bankinc crisis in AIarcIi 1931 rigllt on throlrgh niicl-1932. If anytlling,
there is somr stepping up of tlic of clcclinc, I)ut any accrlcl.ation is
Icss notnblc than the high ratc of clcclinc t l i r o ~ ~ ~ l l o an u t : annual ratc of
31 per ccnt for ~ ~ c ~ . s o incomr,
naI oi 1.1pcr ccnt for \vllolcsalc prices, and
of 32 pcr cent for prodr~ction.
T h e sc\,crity of tlic dcprcssion stimr~latcdmany rcmcclia1 cfTorts, gov-
ernmental and nongo\.crnmcntal, outsidc tlic monetary arca. A nation-
\\,icle dri\.c to aid pri\.atc relief agcncies \\.as organizccl in tllc fall of 1931
l1y a committcc o i se\.cnty. al>pointcd 1)y TToo\.rr ant1 named tllc Presi-
dent's Uncmploy~ncnt Rclicf 01.~nnizntiot1.Tllc r~nrniployccl i l l mnny
states fonncd self-liclp and -barter
. -. .- .organizations; with tlleir own systcms
of scrip. Hoovcr cspandcd fcdcral cspcndit\~icson public works, I ~ u twas
concerned about incurring dcficits for such a purpose. A committcc of
twelve, representing thc public, industry, and lal~or,appointed by him in
September 1931, opposed a constrrrction program financed by public
funds. In Congress, howcvcr, thcre was growing support for increasccl
go\.crnment cspcnditures and for monetary expansion, proposals widely
castigated by thc business and financial c o m m ~ ~ n i tas y "grccnbackism"
and "inflationary." O n its part, the br~sinessancl financial community, and
many outsidc it, regarded fedcral deficits as a major source of difficulty.
Pressure to balance tlic budgct finally rcs~~ltccl in tlic cnactmcnt of a sub-
stantial t a s risc in Junc 1982. Tllr strcngtl~of tllat scntinicnt, whicll, in
liglit of prcsc~it-day\.ics\vs. svcms Itnl.tl to c~.c*tlit,is tl(~~no~lst~.atc.tl
fact tliat in tllc Pl~csicl(~~iti;rl
c a ~ n l ~ : ~ iogin 1937, I ~ o t lcancli(l;rtcs
~ ran on
/ platforms of-financial ortlrotlosy, ~)~.otliisillq
lo I);~l;lncc:tllc fc:tlcral l ) ~ ~ c I ~ c t .
I n April 1932. under licavy Con~rcssionalI)rcssllrc (scc section 5, below),
the System embarked on large-scale open market purchases which raised
its sccurity holdings by roughly $1 billion by early August. Ninety-five pcr
ccnt of thc purchases werc macle before the end of June, and no nct pur-
cl~ascswere made after August 10. T h e Systcni's holclings tllcn rcmaincd
almost csactly constant until aftcr the turn of thc ycar when they wcrc
reduced in tlic usual seasonal pattern. Initially, tlic purcliascs servcd
mostly to offset a renewed gold outflow but, aftel- Jrrnc, thcy \zrcrc rcin-
322
T H E CREAT CONTRACTION
forced by a mild gold inflow. From the time the purchases ended until
tlic end of thc year, a continued and stronger gold inflow servcd in their
strad to kccp high-powcrcd moncy rising.
Tlic provision of additional reserves reinforced the effect of thc tapcr-
ing ofT of bank failures in January and Fcbruary 1932, referrcd to above,
. whicl~was accornpanicd by a return of currency from circulation from
Fcbruary to May. I n the absence of thc bond purchases, it is possiblc
that thc renewed flurry of bank failurcs in mid-1932, consisting partIy
of a wave of ovcr 40 failures in Chicago in J i ~ n c ,bcfore the R F C granted
a loan to a Ieading Chicago bank, would havc dcgencratcd into a major
crisis. As it was, bank failures again strbsiclcd, so that the risc in thc
1~1l)lic'scurrency holdings from hlay to Jtrly was again follo~z.ccl11y a ''
dcclinc.
T l ~ ccombination of t11c more favorable banking situation and of thc
boncl-purcllasc program is clearly rcflcctcd in t l ~ ebehavior of t11c stock
of 1nonc.y. As Chart 27 shows, thc clcclinc in both bank clcposits ancl tllc
stock o i lrlollcy ~nod(sratc:cl.I>c.~nantlcl(%positsrcachcd a trolrgh in Jc~ly,
totill clcposits and tlrc moncy stock, in Scptcmbcr; thc following risc \\,as
niilcl. In absolute terms, thc changes in thc stock of moncy were small; by
coniparison with the prior sharp declines, the shift was major.
T h c cfTcct of tllc purchase program is even clearer in Cllart 29, \vhich
shows intcrcst rates. 111 thc first qrlartcr of 1932 the ratcs Ilad fnllcn from
thc pcaks rcachcd in Deccmbcr 1901 or January 1932. In thc sccond
quarter, howcvcr, the corporate Baa bond yicld soared to a pcak ( 1 1.63
pcr cent in May)-unmatched in thc monthly record since 1919-and the
yicld on long-term government bonds rosc slightly. Commercial papcr
ratcs continued to clcclinc in the sccond quarter, tlic reduction in thc dis-
count ratc in Ncw York on Fcbruary 26 having Icd the commercial paper
ratc. After thc purchase program began, a sharp fall occurred in all the
ratcs. T h e reduction in tlic discount ratc in Ncw York on Junc 2.F again
I)y tllc
Iccl t l ~ ccomm(:rcial I);ll>cr ratc and, in Auqlst, thc commercial papcr rat(.
fcll below thc cliscorlnt ratc and rcmainrtl thcrc, a rclation without paral-
lel sincc thc beginning of t l ~ cRcscrve Systcm.
Tllc rcvcrsal in the rclation bctwcen thc commercial papcr rate and
tllc cliscol~nt ratc marked a major changc in thc rolc of discounting,
allout lvllich wc shall have morc to say in Chaptcr 9. Escept for a spurt
in connection with tlic 1933 banking panic, discounting was not again
to bc of major importance until long after the end of \,Vorld \Var 11. /
Banks werc henceforth to srck safety through "excess" reserves, and latcr,
through govcrnmcnt scctrritics whosc prices were pegged, not through
recourse to borrowing. T h a t changc was, of course, a major factor in
kccping rates from going cvcn lo\z,cr. Throughout 1932, for esaniple,
323
 TI-IE CREAT CONTRACTION
yields on long-term government bonds wcrc notably higher than a t any
time between May 1930 and September 1931.
T h e tapering off of thc dcclinc in thc stock of moncy and thc b c ~ i n n i n g
of thc purchasc program ivcrc ~ h o r t l yfoIIo\vccI by an cq~lnllynotnblc
clinngc in tile gcncrnl cconon~ici~~tlicators sl~o\vrii l l Cllart 2:1. \Vllol<.snlc
priccs started rising in July, production in August. Pcrsonal incolnc con-
tinucd to fall but a t a much rcduced rate. Factory rmploynicnt, railroad
ton-miles, and numcrous othcr inclicators of pl~ysicalactivity tc!l a similar
story. All in all, as in early 1931, thc data again have many of thc car-
marks of a cyclical rc\.ival. I~itlcctl, somc studcnts tlntc thc cyclical
trough in 1932. Burns and blitclicll, nlthougll dating thc trough in h l a r c l ~
1933, rcTcr to tlic period as an csnmplc of a "double b ~ t t o r n . ' ' ~ '
Tlicre is, of coursc, no way of knowing tllnt t l ~ ccconomic improvc-
nicnt rcflcctccl tllc monctary improvcnicnt. B11t it is cntircly clcar that t l ~ c
rcvcrse was not thc casc. Aside from the preccdcnce in tilnc of thc monc-
tar! improvemcnt, tlie program of largc-scalc opcn markct purchases was
n clt~lil)crnti\~c
action untlcr~nl.rc~~i
by t l ~ cRcscrvc Systcln. And it was thc
major factor accor~ntingfor thc ~iionctnryirnpro\.cli~cnt.
Tlic timing rclntions, prcvious cspcl.icncc., nlicl ~,.t.~lcrnl consitlcm[ions
all make it highly plausible that the economic improvcmcnt reflcctcd the
influence of thc monctary improvcmcnt, rather than the only other
alternative-that it occurred shortly thercaftcr entirely by coincidence.
LVe have observed that, in the past, an increase in the rate of monctary
growth-in the present case, frnm rapid decline to mild decline and then
mild rise-has invariably preceded a trough in general business. Aftcr
three years of economic contraction, there must have been many forces
in the economy making for revival, and it is reasonable that they could
morc readily come to fruition in a favorable monetary setting tlian in tlic
midst of continued financial uncertainty.
As it happencd, the recovery provcd only temporary and was followcd
by n rclnpse. Oncc again, b n n k i n ~tliflicultic~swcre a notnblc fcaturc of
t l ~ crclapsc. A rcnc\vcd scrics of bank fai1111.c~began in t l ~ clast qllnrtcr oT
1932, nlostly in tlic hlitl\vrst nlid Far \Vest, allcl t l ~ c r c.\\'as n s l ~ a r ps p ~ ~ r - t
in Jnnuary involving n \\sidcr nrcn. TIlc tlcposit-c~~rrc~icy ratio Tt:ll; t l ~ c
stock of moncy ccasctl growing atid bcgnn to fall prccipi[orlsly after
Jnnuary 1933. Statcwitlc bank holidays spread, increasing tllc dcninnd
Tor currency. Substitutes for currcncy wcrc introducccl as in carlicr panics,
offsetting to some cstent the dccline in the money stock shown in our
" A . F. Burns and \V. C . htitcl~cll, Measuring Busirrcss Cycles, Ncw York,
hrBER, 1946, pp. 82-83; i d e m , Prodrcction during the Anzerican Business C y c l e
01 1927-1933, New York, NBER, Bulletin 61, Nov. 1936, pp. 2 and 4.
3 24
T > I E CREAT CONTRACIYON
estimate^.^' T h e monetary dificultics wcre accompanicd by a reversal in
the movement of intcrcst rates and by a relapse' on the economic front.
Physical indcxcs ccascd rising and began to fall once again and so did
priccs nncl o t l ~ c rinclicators of business activity.
'Tllis tilnc thc a\,nil;tbility of R F C loans did not stcm tlic rising titlc of
bnnk failures, partly bccn~lsca provision of an act passed in July 1332
was intcrprctcd as requiring- publication
.
of tlie names of banks to which
the R F C liad maclc loans in the prcccding month, and such publication
bcgzzn in August. Tlic inclusion of a'bnnk's name on the list was corrcctly
intcrprctcd as a sign of weakness, ancl hence frcqucntly Icd to runs on tlic J
bnnk. I n conscqucncc, banks \vcrc fearful of borrowing from thc RFC.
Tile dnmagc was fu~.tlicrilicrcascd in Jnnuary 1933 wlicn, pursuant to a
FIo~lscresolution, tlic R F C madc pul~licall loans cxtcndcd bcforc August
1332.33Whcn runs on individual hanks in Nevada threatened to involvc
bnnlcs throi~ghoutthc state, a state banking holiday relieving tlicm of the
ncccssity of mccting thcir obligations to creditors was declarcd on
Octol~cr 31, 1332. Iowa followcd suit ttndcr similar circurnstanccs on
Tnlil~nry20, 1333; Louisiana clcclarcd a holiday on February 3 to aid thc
I)nlilis of tllc city of Ncw Orlcans; and Michigan, on Fcbruary 14.
Congrcss frccd national banks in Fcbruary from penalties for restricting
or dcfcrring withdrawals according to the terms of holidays in the statcs
where they were located. By ~ a r c l 3,, holidays had been declared in about
half the state^.^' Whilc thc holiday haltcd withdrawals in a given state, it
" I t has been estimated that probably as much as $1 billion in scrip was.in cir-
culation in the United States u p through the bank holiday (H. P. Willis and J. hi.
C h a p m a n , T h e Banking Situation, New I'ork, Columbia University Press, 1934,
,p. 15). See also Chap. 8, sect. 1.
" IIoover asserts in his memoirs that, hcfore signing t h e bill in question ( t h e
Emcrgcncy Rclicf a n d Construction Act of July 21, 1932), he was assured that
thc list of borrowers from the R F C would be treated as confidential and would not
t ~ cp ~ ~ b l i s h c dand
, that if it had not been for this assurance, he "would probably
have had to veto the bill" ( M e m o i r s , pp. 1 10-1 11 ) .
T h c law specified only t h a t the R F C make monthly reports to the President
of thc United States and the Congrcss on all loam grantcd the ~)rcviousmonth.
It was .lohn N. Garner, then Speaker of thc IIouse, w h o in August instructed the
Clcrk to n ~ a k cthe rcports p111)lic.l'hc L)crnocrats claimcd that publication of R F C
loans scrvccl ns a snfcguard against favoritism in the distribution of loans. T h c r c
was also some rcscnlnlrnt against Eugcnc Mcycr, chairman of thc R F C until ,111ly
1332, nut1 Sccrctary of the Trcnsury biills, a mcmhcr of the hoard of directors,
for not kcrl)ing I>rr~lorratictlircctors ir~forrncd a l ~ o u tR F C actions (Jcssc Jor~cs,
Filly nillion Dollnrs, h.lacrnillnn, 1951, pp. 72, 02-03, 51 7-520). For thc House
rcsol~rtiol~, scc Congresrional R e c o r d , Jan. G, 1933, p. 13G?.
"Bank holidays, by legislation or cxccutivc order, included the following main
typcs: ( 1 ) for a designated time loral banks undcr state jurisdiction wcre for-
1)iclden to pay out funds a t depositors' requcst; ( 2 ) individual banks wcrc author-
izcd, cithcr on thcir own initiativc or with the consent of the state banking dcpart-
mcnt, to notify their depositors of their determination to restrict withdrawals t o a
sperificd amount o r proportion of dcposits; ( 3 ) a pcrccntage of dcposits u p to
which depositors might d r a w was spccificd for all the banks in a state.
3 25
 T l I E CREAT CONTRACTION
increased prcssure clsewhcrc, because the banks that had been given
temporary relief withdrcw funds from their corrcspondcnts in other states
in order to strengthen thcir position. In addition, substitutes for bank
moncy brcame esscntial, as in past restrictions of convertibility of deposits,
nnd intcrnal cscliangcs wcrc tlisruptcd. Currcncy holdings of the public
rose $760 million, o r about 16 pcr ccnt, in thc two montlis from tlic cnd
of 1932 to Fcbruary 1933.
T h e main burden of the internal drain fell on New York City banks.
nct\\.crn F c b n ~ a r y1 and hlarch I , intcrior banks withdrew $760 million
in bnlnnccs they held with thosc banks. Ncw York City banks rcduccd
thcir holdings of govcrnmcnt securities by $260 million during Fcbrllary-
a measure thnt tightened thc moncy market-and turned to tlle Rcservc
Bank for borrowing funds. T h c situation produccd ncrvousncss among
NC\VYork banks with thcir much intensified aversion to borrowing. At
thc b c g i n n i n ~of March thcy still hcld $900 million in interbank balanccs.
Fcnr of a rcnc~\.rclforcign drain addcd to thc anxicty of b o t l ~thc com-
mcrcial bnnks nncl tlic Fcdcrnl Rcsrr\.c Systcin. Rumors that tlic incoming
administration ~ v o u l d devalue-rumors that were later confirmed by
the event-led to a speculative accumulation of foreign currcncics by
private banks and other holdcrs of dollars and to increased carmarkings
of gold. For thc first time, also, the internal drain partly .took the form
of a specific demand for gold coin and gold certificates in place of Fedcral ,
Rcserve notcs or other currency. Mounting panic a t Ncw York City banks
on these accounts was reinforced in the first few days of March by hcavy
\vithdrawals from savings banks and demands for currcncy by interior
banks.
T h e Fcdcral Reserve Systcm reacted to these events vcry much as it
had i n September 1931. I t raised discoilnt ratcs in Fcbruary 1933 in rc-
, suggested instead a banking holiday in the State of New York. Harrison refuscd
action to thc estcrnal drain, and it did not scck to counter either thc
csternal or intcrnal drain by any cstcnsivc opcn markct purchases.
Though it incrcascd its govcrnmcnt sccurity holdings in Fcbruary 1933,
after permitting thcm to dcclinc by ncarly $100 nill lion in January, tliry
wcrc only $30 million liiglirr at thr timc of thc Ilnnking holiday than
tliry \\,err nt tllc cncl of l)c.ct.~~il,rr19.73. Agnin i t rnisccl tlic Ix~yingratrs
c ~ ~ \ v i l l i I I I I , (I~SCOIITI[ I.:I~(,, :111cl :~,c:ii~~
011 n c c ( ~ p t n ~ inlo~ig l>ills I ~ I I ~ ~ I
incrcnsccl but by far lcss t l ~ a n t l ~ cconcu1.1.cnt clrain on banlc rcscrvcs.
Again, as in Scptcmbcr and Octobcr 1331, banks wcrc driven to discount
a t the higllcr ratcs and to clulnp sccilritics o n the markct, so that intcrcst
ratcs on all catcgorics of scci~riticsrose sharply (sce Chart 2 9 ) .
This time the situation was even more serious than in September 1331
bccausc of all that had gonc bcforc. In addition, the panic was f a r more
widespread. I n the first few days of March, heavy drains of gold, both
internal and esternal, reduced the New York Bank's reserve pcrcentagc
326
T H E GREAT CONTRACTION
bclow its legal limit. O n March 3, Govcrnor Harrison informed Go\.crnor
hlrycr of the Fcdcral Rcscmc Doard that "hc would not takc tlic rcsponsi-
Ilility of running this bank with dcficicnt rcscrvcs in the absence of lcgal
sanction providcd by tllc Fcdcral Rcscr1.c Act." With some rcluctancc,
(lie Rc~nrdslispcndcd rcscrvc rccl\iirrlnc.nts for tliirty
Tlic System itself shared in- thc panic that prc\.ailcd in Kc\\. York.
Harrison was cagcr for a bank holiday, regarding suspension of r c s c i . \ ~
rrcli~iremcntsas an i n a d e q i ~ ~ solution
tc and, o n thc morning of hfarcli 3,
rccom~ncndcd n nationwidc holiday to Sccrctary of thc Ti~casurv .\fills
and Govcrnor h4cycr. Dcspitc much discussion bctwccn Ncw ~ d r kand
Wasl~ington,by cvcning tlic declaration of a national holiday \\,as i.ulcd
out. I-Iarrison thcn joincd tllc Nc\v York Cltaring Housc banks and t11c
Statc Supcrintcndcnt of Banks in requesting Ncw York's Go\.c~.nor
Lcliman to dcclarc a stntc banking I ~ o l i c l a y~. ~c~l l i n a ndid so, cfTccti\.c
hlarcll 4. Similar action was takcn by tllc governors of Illinois, hias-
sachiisctts, New Jcrscy, and Pcnnsyl\.ania. O n March 4, thc Fcdcral Rc-
scr1.c nanks i.cmaincd closccl as did all tlic leacling- cschanscs. - T h c ccntlal
bankins systcm, sct up primarily to rcndcr impossible thc restriction of
paymcnts by commercial banks, itsclf joincd the commercial hanks in a
"Harrison, Notes, Vol. 111, Mar. 3, 1333.
'"~Iarrison regarded suspension of reserve reqi~ircmcnts as the least dcsiralrle
alternative, bccausc the Reserve Bank would still be obliged to pay out gold and
currcncy to hoarders. Anothcr alternative was susl)ension of specie payments, which
he also considered unattractive, because "hystcrin a n d panic might rcsult and there
~)rol>al)ly would be a run on thc banks of the c o ~ ~ n t r y .I-Ie " concluded that the best
course was to declare a nntionwitle holiclay "wliirh would permit the country
to calm down a n d which would allow timc for tllc passage of legislation to remedy
t l ~ csituation."
I n response to IIarrison's recommendation, Secretary Mills a n d Go\.ernor hfcycr
to riiakc such a rcq~testof Governor Lehman on thc initiative of thc Ncw York
I3ank, becacue he bclicvctl a state holiday woultl only result in greater confusion,
since the New York Bank would still havc to pay out gold to foreigners, and thc
rest of the country's banking systcm could not function if New York declared a
holiday. T h e directors of the New York I3ank adopted a resolution requesting the
Fcdcral Reserve Board to urge thc Prcsidcnt of thc United States to proclaim a
nntionwitlc holiday on Satc~rtlny, Mar. 4, and Montlay, Mar. 6. Ilarrison
t;clkctl lo President Iloovcr 11y t e l c l ~ l ~ o ~Iri~t ~ c ,111c President woc~ld not cornn~it
11i11i.rt.IT.1,ntcr tlint evr-riing, rrllorts wcrc rrr.(!ivc.tl frorn Washington that I , o ~ h the
I'rvsiclvnt o r ~ dI'rrritlcnt-clcct 11;itl g o ~ i cto 1)c.d a ~ ~ that
t l tlrcrc was n o charice that
* a national holiday would I>c declared.
Ilarrison left thc Bank immediately to join a confcrcnce a t Go\.crnor Lehman's
home in New York, a t which thc decision for a state holiday was finally reached.
Lchman had advised Harrison earlier in the day that he would declare the holi-
day if it seemed desirable, but h e , h a d been annoyed with the Clearing House
banks because they had induced him to makc a statement that he would not.
Later that day the Clearing FIousc banks had agreed to cooperate if Lehman
declared a holiday but would not request him to. T h e y feared it would hurt thcir
prestige if they wcrc rcprcscntcd as sccking a holiday; in that case, "the). would
. rather stay opcn a n d take thcir beating" ( i b i r l . ) .
327
 T H E G R E A T CONTRACTION
, more widespread, complete, and economically disturbing restriction of
I pa)ments than liad cvcr bccn cspcricnccd in the history of the country.
{ O n e can certainly sympa~l1i7rwith IIoovcr's r o m ~ n c n about
t that cpisoclc:
; "I concluded [thc R r s c ~ \ , cRoard] was indrrd n \vrnk rced for n nation to
lean on in ti111c of t ~ . o ~ ~ L l c . " ~ '
A nationwide banking holiday, which was finally proclai~ncd aftcr
Inidnight on hfarch 6 by P~.csiclcnt Rooscvclt, ciospd all banks until
March 9 and suspenclcd gold rcclcmption and gold shipments abroad. O n
.?larch 9, Congrcss at a spccial session enacted an Emergency Banking
Act confirmin? the powers assumed by the President in declaring the
holiday, pro\,idcd for a \\lay of dealing with unlicenscd banks and
authorized emergency issucs of Fcdcral Rescrve Bank notcs to fill currcncy
nccds. T h c President thereupon extended the holiday; it was not termi-
nntcd until Xlarch 13, 14, and 15, dcpcnding on the location of the banks,
\\,l~ich\\.crc authorizcd to opcn only if licrnscd to clo so by irclcral or state
banking authorities (for a fullcr discussion, scc Chapter 0, scction I ) .
-4s notcd in Chaptcr 4, scction 3, thc banking holiclay, while of the
samc spccics nz carlicr I-cstrictions of paymrnts in 1814, 1818, 1037, 1039,
1857, 1873, 1893, and 1907, was of a far more virulcnt gcnus. T o thc bcst
of our kno\vlcdge, in these earlicr restrictions, no substantial nurnbcr of
banks closcd do\vn entirely cvcn for a day, Ict alonc for a minimum of
sis busincss days.3BI n the earlier restrictions, banks had continuccl to ~ n a k c
loans, transfer deposits by check, and conduct all thcir usual b~~sincss
escept the unlimited conversion of 'deposits into currency on demand.
Indecd. thc restriction enablcd thcm to continue sl~chactivities and, in
some instances, to expand their loans by relieving thcm from thc im-
mediate p r c s s ~ ~ rto
e acquire currency to mcct the dcmands of thcir
dcpositors-a pressure that was doomed to be sclf-dcfcating for thc
banking system as a whole except throrlgh drastic reduction in tlic stock
of money. T n ~ e ,to prepare themselves for resumption, banks gcnerally
tcndcd to rcduce the ratio of thcir deposits to reserves, following rcstric-
" Afcmoirs, p. 212.
Clark \\'arburton notcs: "By the middlc It?BO's most of the statcs had adoptcd
o r \\.crc in the process of dcvcloping gcncrnl banking codes, with thc insertion of
provisions for severe penaltics for failure to pay notcs in spccie, o r h a d placcd
such provisions in bank charters whcn rcnewing thcm o r granting ncw oncs. U n d c r
such pro\.isions, suspcnsion of spccic paymcnts mcant forfciturc of chartcrs, o r a t
least curtailment of busincss until spccie payments wcre rcsumcd. I n some cascs,
the latter was permitted by spccial enactrncnts of state Icgislatt~rcs.U n d e r these
conditions, suspcnsion of spccie paymcnts providcd rclic! from a n immcdiate bank-
ing panic, but Icd to a proccss of contraction of the bank-s~tpplicd c i r c ~ ~ l a t i n g
mcdium" ("Variations in E c o n o n ~ i c Growth a n d Banking Dcvclop~ncntsin thc
United States from 1835 to 1885," Jottrnnl of Economic History, Sept. 3958, p.
2 9 2 ) . \\'c know of n o instance whcrc any legislature or bank supervisory a ~ ~ t h o r i t y
declared bank chartcrs t o be forfeited as a rcsult of a gcncral rcstriction of con-
vertibility. Instead, legislation was cnactcd postponing o r rclicving banks of the
penalties the law imposed for suspension of specie paymcnta.
328
T H E G R E A T CONTRACTTON
tion. But thc fall in thc deposit-reserve ratio and thc resulting downward
prcssurc on the moncy stock wcre moderate and gradual and could bc
largcly or wholly ofTsct by expansion in I~igli-powercd
. .
moncy tl~rougli
sprcic inflows.a0 As a result, contraction of thc stock of moncy, whcn i t
oc.c.rlrrcd a t all, was rclati\.c-ly mild ant1 1is11aIlylastcd pcrliaps a ycar, not
scvcral ycars as in 1929-33. Restriction was, as we rcmarked carlicr, a
thcrapcutic measure to prcvent a cumulation of bank failures arising
s ~ l c l yout of liquidity nccds tllat the systcm as a whole could not possibly
satisfy. And rcstriction succccdcd in tliis respect. I n none of the earlicr
cpisodcs, with the possiblc csccption of thc rcstriction that began - in 1839
and continued until 1842:O was there any cstensivc series of bank failurcs
aftcr rcstriction occurrcd. Banks failed hccausc they wcre "unsound," not '
because they werc for thc moment illiquid.
Restriction of payments was not, of course, a satisfactory solution to
tlie problcm of panics. If .tllc prccrding description makcs i t sound so,
it is only by comparison with the vastly lcss satisfactory rcsolution of
1930-33. Indccd, the prc-IVorld IVar I restrictions wcre rcgardcd - as
anytl~ingbut a satisfactory solution by tllosc who experienced them, wllich
is wily tlicy prod~rcccl s u c l ~strong prcssurc for monetary and banking
rcform. Those earlicr restrictions wcrc accompnnicd by a premium ;*I
currency, which in cfTcct created two scparatc mcdia of paymcnts; and 1)).
charges imposcd by banks in one locality on the remission of funds to
othcr banks at a distancc, sincc local substitutes for moncy would not
"Scc Bray Hammond, Banks and Politics in America, Princeton University
Prcss, 1957, p. 713. Rcfcrring to the restriction in 1857 which had occurred in
thc Unircd Statcs but not in C a n a d a , he states: "As usual, the immcdiate cffcct
of stopping specie payments in the States was case. T h e banks, rclicvcd of having
to pay their own dcbtr, ceased their harsh prcssurc on their borrowers. T h e gcncral
undcrstanding t h a t specie paymcnts must sooncr or later be rcsumcd impcllcd a
continuance of liquidation but of milder sort."
" I t is significant t h a t the cxtcnsivc bank failurcs o f 1839-42 wcrc associatcd
with a restriction of convertibility that was limited mainly to banks in thc \Vest
and the Sputh. T h c banks of New York and Kcw England maintaincd paymcnts.
W e arc doubtful t h a t the 1837 restriction is a n cxccption, although \Villard L.
Thorp's Burinerr Anna11 (Ncw York, NRER, 1926, p. 122) rcfcrs to "ovcr six
hundred bank failurcs" in that year-which may, of course, h a w occurrcd before
rcstriction came in May. T h c rclia1)ility. of this figure is qucstionablc. T h e only
d a t a available on number of banks f o r the period 1834-63 a r e thosc containcd in
thc rcports on the condition of the banks, madc annually to Congress in compli-
ance with a rcsolution of I832 ( t h e figures are rcprintcd in Annual Report of
the Comptrollcr of the Currency, 1876, Appendix, p. 9 4 ) . T h e nurnbcr of banks,
according to this source, rose from 713 in 1836 to 788 in 1837, 829 in 1838, a n d
840 in 1839. This serics shows a continued risc, whcrcas it almost surely would
show a dccline if the nurnbcr of failurcs had been the more than 600 noted by
Thorl). T h c nurnbcr of banks is doubtless a n tindcrcstimatc and may cntircly cs-
cludc unincorl)oratcd private banks, whereas failurcs may havc been conccntratcd
among thc latter. Evcn so, it seems unlikcly that new banks would havc hccn more
numerous than lailurcr in 1837 even among thc categories covcred, if so many
banks of all kinds h a d in fact failed.
329
 T H E CREAT CONTRACTION TlIE CREAT CONTRACTION

tlic tlicn esisting gold par it^.'^ After the clcction, nlmors spread that the
CHART 3 1
nctv administration planned to dcvalue, that Rooscvelt had been per-
T h e S t o c k o f M o n e y a n d Its P r o x i m a t e D e t e r m i n a n t s , M o n t h l y ,
sundcci by Grorgc \\.'arrcn to follow a policy of altering tlic gold contcnt
1929-March 1933
of thc dollnr as n mrans of "rrflnting" priccs. T h e rumors brcnmc par-
ticulnrl\. \vitlvsl~rrnd in cnrly 1933 nncl gni~iclclrrrtlcnrc: \vllc.n I<oosc-vclt
rcfrlsrd to clcny thcm. T h e crfcct of the rumors ancl tlic failttrc to deny
tlicm was that, for the first timc in tlie course of the contraction, the
internal drain in part took the form of a dcmand for gold coin and
certificates tlicreby reinforcing tlie estcrnal drain arising from speculative
accumulation of foreign exchange.
T h e rumors about gold were only one part of tlic gcncral uncertainty
during the intcrregnurn about future financial and economic policy. Undcr
ordinary circumstances, i t would have bcen doubtful that such rumors
and such uncertainty could be a major factor accounting for so dram,atic
and widespread a financial panic. But these were not ordinary circum-
stances. T h e uncertainty came after more than three ycars of scvere
cconomic contraction and after more than two years of banking difficulties I L I I I I I I I I I I I I I I 1 1 1 1 1 , I l , 1 1 1 1 , 1 1 I I I I I

in which one wave of bank failures had followcd another and had lcft the Ralio
14
banking system in a peculiarly vulnerable position. T h e Fedcral Reservc
itself participated in the general atmosphere of panic. Once the panic Deposit-reserve ratio -
ttarted, it fed on itself. 12 - -

2. Fnctors Accounting for Changes in the Stock of Money -

T h e factors accounting for changes in the stock of money during the four 10 - -
years from 1929 to 1933 are strikingly different from those in the other 9- -

pcriods we have esamined. Generally, the pattern for high-powered 8 - -

moncy lias iniprrssrd itsclf most strongly on thc total stock of rnoncy, the
.7- -
hcliavior of thc two dcposit ratios serving mainly to alter tlie tilt of the
moncy stock rclativc to the tilt of high-powered rnoncy. T h a t relation
holds in Chart 31 only for the pcriod up to October 1930, thc onsct of
bonhinq banhinq
Crisis Crlsis
lcorrs
.old 4 -
the first banking crisis. Thereafter, the two deposit ratios take command.
Higli-powercd moncy moves in a direction opposite to that of the total
stock of money, and not even most of its short-tcrm rnovemcnts lcavc an SOURCE: T a b l e s ~ - l : ( c a l . 81 a n d 8-3.

impress on the stock of money.

have produccd a decline of 37 per ccnt; the change in the deposit-reserve
From August 1929 to March 1933 as a whole, thc cliangc in high-
ratio a dccline of 20 _per ccnt; interaction bctwecn the two ratios, a rise
powered money alonc would have produccd a rise of 17% pcr cent in the J-

stock of money. he-change in the deposit-currency ratio alone would
" Frank B. Freidel, Frnnklin Delano Rooseuelt, Vol. 3, T h e Triumph, Boston,
I.ittle, Brown, 1956, p. 351 ; Rixey Smith and Norman Bcaslcy, Cnrter Glnss, Ncw
York, Longmans, Green, 1939, pp. 321-323. W h e n Rooscvelt was authorizcd to
rcdacc thc golcl content of the dollar under authority of the T h o m a s amcndmcnt
to the Agricultural Adjustment Act of M a y 12, 1933, Glass, who had m a d e a n
important speech on behalf of Roarevelt during the election campaign, m a d e a
vigorous attack on him in the Senate (Smith and Beasley, pp. 349-356).
332
of 10 pcr cent; thcse thrce convcrted the 17% PC'? cFn-t'rise that high-
powercd money would have produced into a 35 pcr cent dcclinc in the
stock of m ~ n e y . 'For
~ a morc detailed examination of these changes, wc
"The trough of thc moncy stock was reached in April 1933. Although the
percentage dcclinc from Aug. 1929 to Apr. 1933 is only slightly larger than from
Aug. 1929 to Mar. 1933 (35.7 rather than 35.2 pcr c e n t ) , the percentage changes
in the money stock each determinant wor~lrihave produccd if it alone had changed
over the longer period show larger diflcrences: 13, -35, -19, a n d 9 per cent, in
333
 T H E GREAT CONTRACTION T H E GREAT CONTRACTION

consider separately each of the pcriods distinguislicd in the prccccling transferred from one holder to another. T h c widespread attempts to
section and niarkcd olT on nllr cl1;il.t~. liquidatc simply rcduccd prices to a lc\.cl at \vIiich intcndcd purchases
matchrd intcndcd sales.
Loans on sccuritics, csprcially call loans, arc a sornc\vliat niorc con]-
Rcforc the stock markct crasl~,all thrcc dctcrlninants of tlic rnoncy stocli, plcx alrair. I n large mcasurc, w l ~ a t is invol\.cd is also a transfer of
and hence also tlie rnoncy stock itself, llacl bccn r o i ~ g l ~ lconstant.
y Tlic dcbts from onc lcndcr to anotlicr, r a t l ~ e rthan a c l ~ a n g cin total. But.
constancy in high-powered rnoncy rcflcctcd a rcugii constancy in cacll of in addition, the total can hc altcrcd much morc rapidly. Aside from dc-
thc categories into \\,liich \ve have divided tlie corresponding nsscts of fault, one way is by a transfer of other asscts, as most directly when a
thc monetary n~~tlioritics: tlic gold stock, Fcclcral Rcscrvc private claims, borrower transfers rnoncy to a creditor and reduces his own rnoncy bal-
and otlicr physic?l asscts and fiat of tllc nio11c:tal.y a ~ ~ t l ~ o r i t(src
irs Cl~art ancr, or Inorr indirectly w l ~ r na horrowrr acquires c a s l ~I)y selling thr sccu-
32B). I-Io\\,e\.er, tllc constnl1c.y of Fc.clt~~.;iI
I<c*sc*r\.c*
~,l.i\.;~tc
cl;ii~ns~.o~iccals rity serving as collateral to somconc clsc who draws down a moncy bal-
a not uninteresting detail, b~.ougl~t out by Cllart 3,\L'II~CII SIIO\VS tllc ance to acquire it. Anothcr way is by what is in cfTcct mutual cancellation
components of Fedcral Rcscrve crcdit orltstancling. Tlie total was rougl~ly of reciprocal dcbts. Tllc most ohvicus but clcarly insignificant examplc in-
constant bccausc a decline in bills discountcd was ofTsct by n risc in bills volvcs thc canccllation by two borrowcrs of loans thcy have madc to one
bought. T h c rcason for tlic divcrgcnt movcmcnts was thc simultaneous another. A lcss obvious but more important example involves a longer
rise in A L I ~ L 1929
I S ~ of the Nc\v York Rcservc Dank's cliscount ratc from chain, say, a corporation lending on call in the stock market and simul-
5 to 6 per cent and the decline of its b~lyingratc on bills (bankers' ac- tancously borrowing from a bank. If the bank takes over the call loan in a

ceptances) from 5% to 5% pcr cent. Wc analyzccl thc rcason for thcsc discharge of its loan to thc corporation, the total of the two kinds of debt
apparently inconsistent movcmcnts in the prcccding chapter (section 4 ) . outstancling is rcduccd. T h c total can also bc altered by creation of debts;
Thcir clTcct was to make it profitable for banks to gc:t f ~ ~ n c from ls tl~c for c>saml)lc, if a corporation Iclicling on call in thb niarkct is \villing to
Rescrvc System by creating acccptanccs and scllin,(r t l ~ c mto tllc Rescrvc accrpt a notc from a bank or-more rcalistically-a deposit in tliat bank
Banks rathc,r than by increasing their own inclcbtcdncss. in rctt~rnfor tlic corporation's claim. I n that casc, tlie total of thc tbvo
Whcn the crash came, thcrc were widrsprcad attclnpts by lioldcrs of kinds of c1cl)t is incrcascd.
sccuritics to liquidatc tlicm and by banks and o t l ~ c rIr~iclcrsoutsiclc Ncw Tllc rssrntial point for our pllrposc is that the dcmand for liquida-
York to reduce their loans. As in all such cascs, thc position of thc collcc- tion of sccltrity loans involvcs onc of thrcc arrangemcnts: ( 1 ) finding
tion of is dilTcrcnt from that of any onc participant. Long- somrnnc willing to takc ovcr thr loans wliicli, as for sccuritics, can be
tcrm sccuritics cannot, on nct, bc liqt~itlatcdin a s11ol.t interval but only done 1)y a cllangc of pricc, that is, a risc in intcrcst rates; ( 2 ) finding
- -.--. .. . ... ..... - . .. - --.- .. -- solnc*ollc \\*illing to acquire ass(-ts for moncy to I,c uscd hy the bnrrotver to
repay l ~ i slonn, w l ~ i c lcan ~ 1)c clnnr I)y lo\vc:rinx t l ~ cpricc of thc asscts; or
llre orclcr show~lin thc Icxt. 'I'llr rrnsotl is tllat \!I(! rctlll.11 Ilow c ~ t.llrrc-l,c.y
f :~(lc.r1111-
banking holitlav rctlt~ced high-powcrctl nlollry s t ~ l ~ s ~ : ~ ~ l t ai a~ltlt yl;~lsor:tiscil t11c: ( 3 ) : ~ ~ . r i t l q i nfor
g rnorc or lcss r o ~ ~ n d a b om
i ~tt ~ t ~ canccllation
~al or crca-
deposit-currcncv ratio from Mar. to Apr. 1933. tion of clt:l)ts, which involvcs changes in tlic rclativc pricrs of the various
The numerical valt~esof the contributions of the tlctcrminants tli~ri~lg the con- asscts. T h c prcssurc on intcrcst ratcs and on security priccs can bc
traction, datcd w ending in hlar. and in Apr. 1933, follow.
cascd hy any mcasurc that cnhanccs tlic supply of funds in one of these
Cllange in Money Stock T h a t LVoultl I-lave k e n Producctl 1))' forms to facilitate tlic liqt~idationof loans in onc of thcsc ways.
Indicated Determinant if I t Alone I-lad Changed Tlic situation was cascd greatly a t thc time of the stock markct crash
Rarr of Changr Prr Yrar
(pn cmf) Fraction of Total Changr by t l ~ cwillingness of Ncw York banks to takc ovcr the loans. I n thc first
Aug. 7929- Aug. 7929- Aug. 7929- /!fig. 7929- wcck aftcr thc crash, tliosc banks increased their loans to brokers and
Proxima/r Drlrrrninant M a r . 7433 Apr. 7933 M a r . 7933 Apr. 793.3 dcalcrs by $1 billion and tlic rrst of thcir loans by $300 million.'' I n
High-powered money 4.6 3.2 -0.37 -0.28
Deposit-reserve ratio -6.2 -5.9 0.52 0.49 large mcasurc, this involvc*d a creation of dchts. T h e formcr lenders,
Deposit-currency ratio -13.0 -11.8 1.07 0.98 thc "othcrs" for t l ~ caccounts of whom the New York banks had been
Interaction 2.6 2.3 -0.22 -0.19
making loans, accepted deposits in Ncw York banks as repaying their
All -12.1 -12.0 1 .oo 1 . 00 loans, and thc Ncw York banks in turn took over the claims on thc bor-
Detail may not add to total bccallsc of rounding. " For sources, see footnote 5, abovc.
334 335
 T H E GREAT CONTRACTION T I J E GREAT CONTRACTION

CHART 32 CHART 32 (Concluded)

H i g h - P o w e r e d M o n e y , b y A s s e t s a n d L i a b i l i t i e s of t h e T r e a s u r y 0. A s s c t s
B6lItons of dollars
a n d F e d e r a l Reserve Banks, M o n t h l y , 1 9 2 9 - M a r c h 1933

4
Federal Reserve noles

M o n e t a r I goid stock

3 ..
2-
Treasury currency
I - - -
-
3 -
Olher physicat assels and fiol o f Ihe mon
-
-

I - -
3
Gold coin and gold c e r l i l i c a l e s 0 . I ~ I I I I 1 I I t I I ~ l ~ ~ ~ I ~ I I I ~
I t ~
l . Il l I I ~
I I II II ~ I L I l I~ II I ~
I I ~I I I I I I .

I I ~ I ~ I I I I ~ ~ ~1 1I l II I I Il I II 1I 1 1I 1 I ~ ~ ~ ~ ~ ~ ~ ~
I
1 1 1 1 1 1 1 1
I Federal Reserve claims on Ihe public and banks
I I I I I I
Bonk deposits at Federal Reserve Banks I

l l 1929
l l l l l l ~ l I I930
1 ~ J 1 l l l l 1931
~ l l I ~ ~ l I~9 3l2 ~ l l ~ l l 1J9 3~3 l l l I
1 1 1 1 l 1 ~ 1 1 1 ~ ~ ~ 1 ~ ~ ~ ~ rowers without pressing for their immediate payment. T h a t is the reason
NOTE: Federal Reserve notes, Treasury currency, and gold coin and certificates are outside the monetary effect of the crash shows u p in our money stock serics as a
the Treasury and Federal Reserve Banks. sharp incrcase in demand deposits and the reason the increase was in New
SOURCE: Same as for Chart 19.
York City. Indccd, thc incrcase in our cstimatcs understates the magni-
tuclc of thc action of thc Ncw York hanlts. Some of the loans taken over
337
 T I I E GREAT CONTRACTION

rescrvcs. Jndccd, thc ratio of deposits to high-powered rcscrvcs was

CHART 33 lowcr in Ncw York than in thc rcst of the country because of thc higllcr
Federal Reserve Credit Outstanding, by Types, Monthly, lcgal rcscrvc rcquircmcnts imposcd on hanks in ccntral rcscrvc citics.
1929-March 1933 Tl~r~.c-forc: tllc incrcasc in clcl~ositsin Ncw York rclativc to d(*posits in
Blllnons 01 dollars
3.0
. I I I C t.c*st of tllc coltntty in O c t o l ~ c r1929 procl~~ccd a dcclinc in tllc a\.cl.agc
Federal Reserve credit outstandinq dt%l~osit-rrscrvc ratio for tllc country as a whole. Accordingly, tlic N e w
-
York hanks had to and did acqi~ircadditional reserves, as the bulgc in /
- h i ~ I ~ - p o \ \ * c rmoncy cd sl~ows.Thcy did so in the wcek of the crash partly !
- by l~orrowingfrom thc Fcdcral Rcscrvc Bank of Ncw York, w l ~ i c l ~in,
1.5
I-Ia~.rison's.w9_rdsi kcpt its ,"discount window wide opcn and Ict i t 1)c
-
1.0- known that mcmbcr banks might borrow frccly to establish the rcscrvcs
.5 -
Slock
rmrkel
Ftrsl Seconi
bankbng bonk~nq
Briloin
Ieores bond bonking - rcqitircd against thc Iargc incrcasc in.drposits resulting from thc taking
crosh i s r i gold plrchases crisis
I I I I I I I I I I I ovrr of loans cnllccl Ly otllcrs;"'' ant1 ~ ~ n r t I)y l ! virtue of tllc
- pilrchasc
.
by
2.5 tllc Nrw York Bank of nLo11t $160 million of go\.crnrncnt sccuri&s. T l ~ n t
U.S. government securities held - prrrcllasc was far in csccss of thc amount tllc Systcm's Opcn hlarkct I n -
2.0-
-
vcstmcnt Committcc had bccn ailthorizcd to purchasc for Systcm account.
1.5- I t \\Ins maclc by thc NCIV York Dank on its own initiative for its o\vn
account without consi~ltingcithcr thc Opcn Markct In\rcstmcnt Com-
mittcc or thc Roard. Thoiigh subscqurntly ratified, it was, as we shall scc
in more clctail in section 5, I~clow,thc occasion for anothcr bnttlc in the
struggle 1)ctwccn thc Rank and the Doard, wllich had important cffccts on
Bills discounted - F(,tlcral Rcsrrvc policy during thc rcst of thc contraction.
7'llr actions takrn 11y thc Ncw York Rcscrvc Bank wcrc timely ant1 cf-
.5 - P
-
fcctivc. Dcspitc tllc stock markct crash, thcrc wcrc no panic incrcascs in
I I I I I I I I I I I moncy markct ratcs such as thosc in past market criscs, and no indirect
t .o cffccts on confidence in banks which might have arisen if thcrc had bccn
Bills bought any sizal~lc defarllts on scci~rity loans. Harrison himself esprcssed thc
vicw that "it is not a t all unlikcly that had we not bought go\-ernments

--
so frccly, thus supplcmcnting thc rcscrvcs built u p by large additional
1.0
Other discounts, thc stock cxchangc might have had to yicld to the trcmcndor~s
.5 - pressurc brought to bcar up011 it to closc on some onc of thosc \.cry bad
0 days thc last part of O c t ~ b c r . " ' Harrison ~ may have overstated thc casc-
Ilc \+-as,aftcr all, writing in defense of thc actions the Ncw York Dank
-.5 l l , l l l l l l l l l ~ l l l l ~ l l l f l l l l l l L 1 l
1929 1930 1931 1932 193.5
l~ncltakcn-but tliat is by no mrnns crrtain.
SOURCE: Same a s for C h a r t 22, except t h a t all seasonal adjustments are by Shiskin-Eisenpress
method (reference given In worce for C h a r t 21).
In the month following thc crash, therc was a rc\*cl.sal. Drposits
clcclincd, as more lasting arrangcmcnts for thc transfer and ~.cductionof
wcrc for tllc accounts of o ~ ~ t - o f - t o wbanks
n ancl werc matchecl by an in- stock markct loans rrplacrd thc temporary shift of many of thosc loans
crease in interbank deposits of $510 lnillion in Ncw York City wcckly to N(.\\. J'ork I~anks.T h r r h n n ~ r sin dcposits produced a dcclinc in tllc
reporting mcmbcr banks. But our moncy stock rstimatcs cxcl~~clc intcr- tl(-lxfii~-c.t~r~.c.nc.! ratio, follo\vi~lyt l ~ rrise in Octobcr, and a dcclinc. in
bank deposits. " I l n r t . i . \ u ~ ~3li.;c.c.ll;111co11.i,
. \'IJ~. I . Ictccr, t l n ~ c t l Sov. 2 7 , 1923, Ilarrison lo all
T o bc ablc to espand dcposits, the Ncw York banks had to bc ablc co\,#.rllors.n~~riris t l ~ c .wrck r~ltlil~q01.1. 30. 1329, tlisrountr incrcascd $ 2 0 0 million
:I[ all Ilrscr\,c I h n k s . of which $130 niillion was thc incrcase in Ncw York City
either to raise the ratio of deposits to rescrves or to acquire additional ivrclily rvl)orting ~ l l c r n l ~ chank r I>orrowings from thc Ncw York Rcserve Dank.
rcservcs. T h e first was impossible bccarlsc NewlYork banks had no exccss " I b i d . , Ic~tcr.datcd Nov. 27. 1329, IIarri5on to all go\.ernors.
338
 T I i E GREAT CONTRACTION
the deposit-rcservc ratio mildcr than tlint in Octobcr. Higli-powcrcd
moncy also dcclincd as a result of a rccl~~ction in bills discotlntcd ancl in
tlic gold stock, gcncrally attributed to thc withdrawal by forcigncrs of
f ~ r ~ i from
d s tllc Nc\v York moncy niarkct." Tllc nrt rfrcct \vns to lcnvc the
stock of money aftcr thc crash at a lowcr lcvcl than bcforc. At t l ~ ccnd
of Ko\.c~nbcr 1929, tllc stock of moncy was ,$1.3 billion, or 3 pcr ccnt, less
than it had bccn a t tllc cnd of Scptcmbrr. I3y tlic cncl of Dccembcr, most
of t l ~ closs had bccn mndc u p ; the stock of money was about $0.5 billion,
or 1 p r r cent, lrss tllnn in ScptrmLcr.Thrse changrs were conccntratcd in
dcmnnd deposits. From Drcembcr 1929 to O c t o l ~ c r1930, 'tllc stock of
money f l ~ ~ c t i ~ a taround
ed n rottglily constant level tllot~gliwith a mild
do\vn\vard trcnd. I n Octobcr 1930, the stock of moncy was almost the
samc as it had been in November 1929 and nearly 2 per cent bclow its
Icvcl at the cnd of December 1929.
For tlic period from August 1929 to Octobcr 1930 as a wholc, tlte moncy
stock declinccl 11). 2.6 pcr crnt. Higli-po\vcred n1onc.y alonc dcclincd by 5
per ccnt. Ho\vc\,er, tlic clcposit-currency ratio rosc by about 7 pcr ccnt,
enougll to offset a minor dccline in thc deposit-rcscrve ratio as wcll as
half tllc decline in high-powered money. In Octobcr 1930, tlic deposit-
currency rntio stood at the highcst lcvcl rcncllcd a t any timc in the 93
years co\.crcd by our data, exccpt only for a fractionally higl~er peak
rcachcd in tlic nionth of the stock market crash (sce Charts 31 and 64,
ancl Tablr B-3). As \vc notcd carlicr, thc public was clcarly not greatly
concclmcd nt tlic timc about tlic safety of bank drposits. ntlt t l ~ chigh
rntio maclc the System pcci~liarly vi~lnerableto thc dcvelopmcnt of any
such conccrn, as the following ycars werc to demonstrate so tragically.
T h e dccline in high-powered money occurred despite an incrcasc of
$210 million in the gold stock and of $470 million in thc fiat of the
monctary a11tl1oritics.Tllc lattcr incrcnsc rcflcctcd nlostly a rise i l l go\rcl.n-
mcnt sccuritics 'hcld by the Systcm, i.e., thc substit~~tion of nonintcrcst-
bearing for intcrcst-bcaring government debt. Those c x p a n s i o n a ~ .factors
~
were more than offsct by a decline in Fcdcral Rcscrve private claims of
$1,020 million-$100 million in bills bought and $920 million in bills dis-
counted and othcr claims (see Chart 32B). Ultimately then, i t was the
failure of the Reserve System to replace thc decline in discounts by othcr
" T h e return flow of foreign funds gave temporary relief to the foreign cx-
changcs, which h a d becn under pressure during the period of speculation. Foreign
cl~rrencies h a d depreciated vk-8-vis the dollar, while foreigners wcrc remitting
f u n d s lo tlic security markets hcre. Bcforc the peak in stock priccs in 1929, the
prices of tliosc currcncics had dcclincd to thc Unitcd States' gold import poir~t.
; \ f ~ c r ~ l i ccrash, ~ l i crclurt) flow of funds raiscd illrir ~)riccsto tlic gnltl csport
point. For c x a m l ~ l c ,thc pound was as low as $4.045857 in Scpt. 1929 a u d in Dcc.
was as high as $4.08?010 ( t h c figures a r e noon b u y i ~ i g ratcs for cablc trnnsfrrs
to Ncw York, from Con~mcrcinla n d Financial Chronicle, Scpt. 21, 1929, p. 1969;
Dcc. 27, 1929, p. 4 0 1 7 ) .
340
T I i E GREAT CONTRACTION
crctlit outstanding that was responsible for the dccline in the stock of
Inow)..
Tllc tlcclinc in disco~lntstook place despite sharp rcductio~is in dis- '
co1111t~.:ttcs-nt t l ~ cNi-w Yo1.k Il;lrik, fr.o~n6 per cent to 2); per cent
i l l , ] I I I1950
~ ~ (C11:~r.t2 9 ) . 1 ' 1 t t : succc.ssi\.c drclincs in disco\lllt r a t c s - ~ -
tllc first of w l ~ i c lcnlnc
~ in No\*clnl~cr1929, t l ~ r c cmonths aftcr the datc
sct I)y thc National Durcar~as tlic rcfcrcncc cycle peak-though sharp and
rapid by caldirr stnnclards, took place d ~ ~ r i nag timc whcn thcrc was a
sliarp dcclinc in tllc dcmancl for loans and an increase in tllc dcrnand for
asscts rc,gnrded as snfc, not11 made for n sharp dcclinc in market intcrcst
rntcs. l'llot1:11 tlic discount ratc fell al)sol~ltcl~, i t probably rosc l.clati\.c to
tlrc rclcvant ~ n a r k c tintcrcst ratrs, namcly, thosc on short-term securities
with essentially zero risk of default. Hencc, discounting became less
attractive. I t is perhaps worth noting that this is not mcrels a retro-
spccti\,c ,judgment. T h c New York Reserve Bank favored more rapid re-
ductions in the rate than tllosc made. I-Iarrison said in May 1931 tllat "if
tlicrc I~aclbccn no Fcdcral Rcscrvc System in Octobcr, 1929, moncy ratcs
would probably liavc come down more rapidly than they had . . . ." I n
Scptcnibcr 1330, Adolph Millcr of the Federal Rcserve Board said a t a
mcctiug with all the govcrnors, "Moncy is not rcally chcap nor casy."
I n mid-1930, Harold L. Rccd, in tlic sccond of his two excellent books on
thc Fcdcral Rescrve Systcm said: "In the writer's opinion, however,
tlicre was much stronger ground for holding that the rate reductions had
bccn too gradual and long delayed" than that they had bccn too rapid.51
As the ncar-constancy of the deposit-reserve ratio indicates, tlicrc
was no tcndcncy of banks to accumulate excess reserves. I t has brcn con-
tended with respect to latcr years (particularly during the period aftcr
1934, whcn large cxccss rcservcs accumulated) that increases in Iii,qIi-
powcretl rnoncy, through expansion of Fcdcral Rcscrvc credit or otllcr
nicans, would simply have becn added to bank rcscrvcs and wot~ldnot
liavc bccn uscd to incrcasc the moncy stock. I n othcr words, a rise in
higli-powcred money would have bccn offsct by a dcclinc in the deposit-"
,
rcscrvc ratio. We shall arguc latcr that tllc contention is in\-alid c\.cn for
thc latcr pcriod. I t is clearly not relevant to the period from August 1929
to Octobcr 1930. During that pcriod, additional rescrves would almost
certainly have bcen put to use promptly. Hencc, the decline in tlie stock
" See scct. 5 hclow for the Ncw York Bank's position. T h e quotation from Harri-
son is from Harrison, Notcs, Vol. I, May 21, 1931 ; from hlillcr, Cliarlcs S.
Ilamlin, I-lamlin Pnpcrs, Manuscript Division, 1-ihrary of Congress, Diary. Vol. 18,
Srpt. 25, 1930, p. 0 6 ; from R r c d , Ferlera[ Rcrcruc Policy, 1921-1930, Ncw York,
h,l~.(':raw-llill, 1930, 11. 191. This may not have 11cc.n Millcr's vicw carlicr i l l thc
ycnr. I n hiay, llamlin r c l ) o r ~ c d ," h ~ i l l c rsaid thc 1:cdcral Rcscrvc Bank of Ncw
York was obscsscd with the idca that casy moncy would help the business reccs-
sion" ( I l a ~ n l i n Diary,
, Vol. 17, h l a y 9, 1930, p. 15 1 ).
34 1
 T H E GREAT CONTRACTION
)f nloney is not only arithmctically attributable to tlic declinc in Fcdcral
Zcscr\.c crcdit orttstanding; it is cconomically a direct result of that
Icclinc.
Tlic onsct of tlie banking crisis is clearly marked in all tlircc proximate
3cterniinants but particularly in the deposit ratios (Chart 3 ! ) . Froni a
peak of 11.5 i l l October 1930, tlic ratio of dcposits to currency dcclinctl
sharply-a declinc that was to carry the ratio, with only minor intc~.rul~-
tiotis nlorlg tlic way? to a low of 4.4 in hfarch I T % : \ . Tlic drl~osit-l.csc~.\~c
ratio likc\vise Ijcgan a dcclinc that was to carry it ft.o~tia 1cvc:l of 12.9 in
October 1950-the all-time IiiKh was 13.4 in April 1919-to a Ict~clof 8.4
in hlarch 1933. Tlicsc dcclincs brought thc deposit-currcncy ratio back to
its I c ~ c la t t l ~ cturn of tile century and tlic dcposit-rcscrvc ratio to its
Iv\.cl in 1912. Thcy thus wiped out the whole of the much heralded spread
i r i tlic usc of clrposits and "cco~lomy" in rcsclvcs acliicvcd itt~dcrtllc Re-
scrvc Systcm.
Tlic dcclinc in tlie stock of moncy as a result of thc Innking crisis-
a declinc of sliglitly morc than 3 pcr ccnt from Octol~cr1930 to January
1931, or morc than in the preceding fourtecn months-was clearly a rc-
si~ltof thc dcclincs in tlic t ~ v odcposit ratios, sincc high-powcl.rd money
rose by 5 per ccnt. As Charts 32B and 33 show, the risc of $340 million in
liish-powercd money, scasonally adjustcd, was produced par~lyby an in-
flow of $84 million of golds2-tlic source that had always bccn tlic
major rcliancc in pre-Federal Rcscrvc criscs-partly by an increase of
$117 million in Fcderal Reserve crcdit outstanding. T h e incrcasc in
Fcderal Resertte crcdit consisted partly of a risc of $41 million in govcrn-
mcnt sccuritics, tlie balallce of a risc in float. A rise in discounts just
about offset a drclinc in bills bought. Thcrc was a brief spurt of roughly
$200 million in bills discounted in the two wcelis after tl;e failurc of the
Bank of Unitcd States, but it docs not show up in thc scasonally adjustcd
rnd-of-month figures plottcd in Chart 33.
T h c rise in Fedcral Rescrve credit certainly helpcd to ofl'sct some
of tlie immcdiate effects of the banking crisis. But the movcmcnt was
minor in magnitude. Many an earlicr year-cnd sllows rises of co~nparablc
ma'pitude and, even a t its peak in December 1930, seasonally adjusted
Federal Reserve credit was only 84 per cent of its level in the summer
of 1929 when the System was seeking to curb speculation. T h e one other
mcasure taken by the Systcm in rcaction to thc banking crisis was a re-
" T h e gold inflows reflected partly the Hawlcy-Smoot Tariff Act passed in June
1930, which raised the tariff to the higllest lcvcl up to that time in U . S . history;
partly the reduction of U . S . lending abroad, and the continuance at a high lcvcl
of intcrcst and dividends on in\,cstmcnts abroad and o i war debt payments; partly
the consequencc o f U.S. deflation on in11)orls and cs],orts. Scc sect. 4, bclow.
342
T I l E C R E A T CONTRACTION
duction in late December 1930 in the New York Rescr\.e Bank's discot~nt
rate to 2 per ccnt-to reassure the public.63
T h e rise in Federal Rcscrve Bank crcdit was temporary. After Dcccm-
bcr 1930, discoi~ntsdeclined, bills bought wcrc allowed to run off without
rcplaccmrnt, wl~ilcgovcrnmcnt security holdings incrcatrtl by only a small
fraction of the combined rlcclinc in discou~tsand bills bought. I-Iigh-
powcrccl moncy rosc in January 1931, only because a contin~tedgold
inflow offset the decline in Federal Reserve crcdit. I t declined in Febritary
despite continucd gold inflow, and rosc slightly in March along with a
minor risc in Fctlcral Rcscr\~ccrcrlit and tl!c gold stock. T h c tlcclinc in
Fctlcral Rrscrvc crcdit from Dcccmbcr 1930 to March 1931 was ~ r c a t c r
than the gold inflow. I n cffcct, the System was not only sterilizin~the
gold inflow, but exerting a contractionary influence greater than thc
expansionary influence of thc gold inflow.
Despite. the reduction in high-powcrcd money in February 1931, thc
moncy stock rose a bit bccausc of a risc in both dcposit ratios, as the
wave of bank failurcs dicd down and confidence in banks was somcwhat
rcstorrd. As suggested carlit:r, i f the risrs in the dcposit ratios had bcrn
reinforced by a vigorous ~xpansion in high-powcrcd rnoncy, instead of
bcing offset by a reduction, tltc ground gaincd might have bccn con-
solitfated and extcndcd.
T h e onsct of the srcond banking crisis is clcarly markcd in Chart 31 by
the rencwcd dcclinc in thc dcposit ratios and the bcginning of a dcclinc
ir? the moncy stock at the fastest ratc so far in the contraction. In the
fivc months from March to August, to cxclude wholly thc crrccts of ',
Britain's dcparturc from gold in September, tlic stock of moncy fcll by 5 % ',
per cent, or by almost exactly the same percentage as in all thc prc- I
ceding ninctccn months of thc contraction. This was a t thc phenomenal
annual rate of 13 pcr ccnt, yet thc ratc was soon to rise still higher.
As aftcr thc first banking crisis, thc decline in the stock of moncy
was entirely a conscclucncc of the fall in the dcposit ratios. High-powered
money rosc, this time by 4 prr cent from March to A~tgust,and so offscr
nearly half thc contractionary cffcct of the declining deposit ratios.
There were, howevcr, two difl'crcnccs bctween thc second banking crisis
and thc first one some sis montl~searlier.
o Govcrnor Harrison wrote, "he hat1 bccn urged from many quarters to make a
remr~ringstatement which might aitl in quieting the banking situation. Such a
statement was practically imposrible because to be strong e n o u ~ hto d o any good
it wor~lclrun the risk of bcing con~ratlictedby any small bank failure which might
thereafter occur. The rate rcclurtion, apart from other reasons, served as a method
of stating to thc public that rnont-y was frrvly availnhlc" (IIarrison, Open Market,
Vol. 11, Jan. 21, 1 9 7 1 ) .
 T H E CREAT CONTRACTION
( 1 ) This time, the rise in high-powercd rnoncy was produccd almost
entirely by thc continued gold inflow, whereas earlicr there had bccn at
lcnst a temporary incrcase in Fcderal Rcscr\.c crcdit, wliich hclprd to ab-
sorb some of the initial effccts of tlic crisis. Fcclrml Rcscrvc crcdit
rcmaincd almost pcrfcctly stnblc, rising sliglrtly only in July and Arrg~st
I
, 1 1931. Dcspitc thc unprcccdcntcd licluidation of thc cominercial banking
! ! system, tllc books of tlrc "lcndcr of last rcsort" show a clccline in bills
tliscountcd from thc cnd of Fcbruary,to thc encl of April-a 1,criotl when
tlic usual scasonal movcmcnt is up~varcl-and a risc from April to tllc cncl
of August that made thc \vllolc incrcase from F(~11rtraryto Arigtrst lcss tllan
111 rlsrrnl srnsonnl incrcnsc; tllcy sllo~vi r r c y ~ l n rincrc-nsrs nntl tl(~crcnscsin
bills bot~ght,\\.it11 the total a t tllc cncl of A~rgrrst$75 million Iiigllrr tllnn
at tlic cnd of Fcbrunry, but still bclo\v its Ic\.cl at tllc turn of tllc ycar;
nncl thcy show an incrcasc of $130 million in sovcrnmcnt sccuritics pirr-
chnsccl. the wholc of the incrrasc beginning latc in Jirnc. Of this incrcasc,
$50 million was a purcly tcchnicnl movc rathcr than n rcaction to clo~ncstic
fiiinncinl tlificultics: it siml~lyolTset otl~c*rrrtlrrctions in cr.c.(lit or~tstnntl-
i n s Tllc rcmnininy $80 million reprcscntcd a delibcratc, if timid,
move to contributc case.84
( 2 ) T h c second crisis lasted longer. I n late 1930, thrre wcre signs
of improvement after two or thrcc months. O n this occasion, as Chart 31
sl~otr.s, thc deposit-currcncy ratio-the most scnsitive indicator of thc
~)ublic's attitude toward banks-not only contin~tcdto fall, but fcll at
an increasing rate. Thcrc was no sizn that thc crisis was drawing to an
end wllcn Britain's departure from gold intensified it.
Asidc from the modest open market purcliascs in July and August, thc
only other domestic action of the Systcm relevant to thc rnoncy stock was
n further reduction in the discount rate of the Ncw York R c s c r v ~Rank to
I!.< per ccnt in hlay-bcforc tlrc slrnrp Jrrnc incrrasc: in bn~tkCnil~lrcs.
As \\.c have secn, the rcdtrction did not stimulate borimwing. O n a dif-
fcrcnt front, potentially of grcat consequence for the domcstic rnoncy
stock, the Systcm participated in loans to forcign banks as part of an intcr-
national effort to avcrt financial catastrophe abroad.ss
" Frdcral R r s c m e Board, A n n u a l Report for 193 1, pp. 7-8. Thcse figrrrcs arc all
of \\'edncsda!.s. Of the $130 million o i government scc~iriricspurchased, $80
million was for System account and $50 million for thc Ncw York Bank's own
account (Harrison, O p e n Market, Vol. 11, minutes of J u n e 22 and Aug. 1 1, 193 1,
O p e n hfarket Policy Conference meetings; Miscellaneous. Vol. I, Icttcr, datcd
July 9, 1931, Harrison to Seay; Notes, Vol. I , July 16, 1931, and Vol. 11,
:\ug. 4. 1 9 3 1 ) . T h e latter purchase was m a d e to offsct r l ~ ecffcct of the transfer of
lorciqn-hclcl balances from the acccprance market to Fcclcrnl Rcsrrvc nanks.
' J D i ~ r i n g the second and third quartrrs of 39.71, thc F~.clrral Rcsrrvc n a n k of
Ncw York in association with orhcr Fcdcral Rrscr\.c llariks ~ ~ ~ ~ l - c l ~1)rirnc as~,tl
commcrcial bills with guaranteed rcpaylncnt in gold from thc A!tsrri:ln Nariotial
Bank, the National Bank ol Hungary, thc Rcichsbank, and thc Bank of Ellgland.
T h c crcdit agreements with the Feclcral R c s c n c Banks a t thcir separate maximums
344
T H E CREAT CONTRACTlON
In thc few months aftcr thc departure of Britain from the gold standar?,'!
tllc prosirnntc dctcrminants of the moncy stock plottcd in Chart 31 con- 1
tinuccl thc pattern of thc preceding five months, but the pattern was evcn
more emphatic. T h e stock of money fell still faster: in the five months
from August 1931 to January 1932, it fcll by 12 per cent-compared with
5 pcr ccnt in tlrc prcccding fivc months--or a t thc annual ratc of 31
pcr ccnt-compared with 13 per cent. I-Iigh-powered money again rosc,
t l ~ i s timc by about 4% pcr ccnt, and again omsct only part, and this
timc a smnllcr part, of thc clTcct of thc declincs in the dcposit ratios, par- ,
tict~lnrly tllc dcposit-ctrrrcncy ratio. T h e banks tvcre so hard prcsscd 1
to mcct tlic tlcmnnds of their depositors that, try though they ditl: they i
wcrc aLlc to d o littlc to lotvcr thc ratio of thcir deposit liabilities to tlicir \
rescrvcs. T h a t had to wait for a more propitious time, which is wily thc
most rapid tlcclinc in tlic dcposit-rcscrvc ratio camc latcr whcn thc clc-
clinc in tllc clcposit-ciirrcncy ratio liad tapcrcd off, and the slowest dc-
clinc camc carlicr whcn thc dcposit-currency ratio was declining fastcst.
As tvc sliall see in latcr chapters, much of the adjustment on the part of
thc banks dicl not come until aftcr the end of the business contraction
and the beginning of recovery. T h e timing relations between changes in
thc two deposit ratios during the 1931-32 segment of the contrac-
tion repcated the tcndencics we have observed in each earlier banking
crisis.
T h e major diffcrcnce, asidc from scale, bctwecn the five-month pcriod,
Atrgust 1931-January 1332, and the preceding five months is the sourcc of
thc risc in high-powered money, which docs not show up in Chart 31 but
docs in Cliarts 320 ancl 33. U p to Augist 1331, high-powercd money
11x1riscn cllic.fly as a rrsrrlt of goltl inflows. As notccl in section 1 above,
tllc pcriod after Britain's clcpartirre from gold saw a sharp outflow,
particularly in Scptcmbcr and Octobcr 1331, large enough to offsct
agqrcgatccl allout $156 million and were rencwcd several times. R c s c n c Bank
holtlings of bills payable in foreign currencies increased from $ I million a t the end
of hlarch lo $145 million in August (Federal Rcscrve Board, Annual Report f o i
1931, pp. 17-13).
Sce also Harrison, Miscellancous, Vol. I, letter, d a t r d July 9, 193 1, Harrison to
h:fcDougal; O p c n Market, Vol. 11, minutes of meeting, ,Aug. I I, 1931 ; and Notes,
Vol. I, J u n e 1, 15, 2 2 ; July 13, 16, 1931 ; VoI. 11, July 28, 3 0 ; Aug. 4; Sept. 24,
28, 1931, for discussion of thc forcign crcdits. O n e of the directors of the New '
York Rcserve Bank, Charlcs E. Mitclrcll, was quotcd as saying, "In all of these
caws, hc was conccrnccl al)out thc soc~ndncssof the operation to be undertaken by
I I I C Fctlcral rcscrvc b a n k wliich, in their domcstic business, take ax fcw chances
as l~ossil)lr,"and "thc rhirig which bothcrcd him with rcgard to these forcign crcdits
was the risk involvecl whcn, a t Iromc, the Fedcral resenre banks take no risks"
( I Iarrison, Noles, Vol. I , June 22; 193 1 ).
345

the gold inflows during the earlier segments of the contraction. High-
powered money rose because Fcdcral Reserve credit outstanding rose.
Federal Reserve credit rose primarily because of the sharp risc in dis-
counts as banks, having no other recourse open to them, were driven
to borrowing from the Reserve System, despite the unprcccdcntcdly sharp
rises in discount rates in October 1931. Bills bought increasccl substan-
tially in September and October, but then were a!lowcd to run off so
that, by Janllary 1932, thcy liad fallen below thcir level at the end of
A I I ~ I I 1931.
S ~ A11 told, from August 1931 to January 1932, the risc of
$330 million in high-powercd moncy was :iccor~ntrd for l>y n risc of
f.560 nill lion in discol~nts. $110 nill lion in govrrnr~lrnt sc-c~~~.itirs. $370
million in other assets of the monctary al~thoritirs,omset by a clcclinc of
$580 million in the gold stock.
During those five months when high-powered moncy rosc by $330
million, currrncy hcld by the p ~ ~ b l iincreasedc by $720 million. T h e cxtra
$390 million had to come from bank rrscrvcs. Since banks were unwilling
and unable to draw down reserves relative to thcir the $390
million, amounting to 12 per cent of their total reserves in August 1931,
cor~ldbe freed for currency use only by a multiple contraction of deposits.
T h e multiple worked out to ro~ighly14, so deposits fcll by $5,727 million
or by 15 per cent of thcir level in A t ~ y s t1931. I t was the necessity of
reducing deposits by $14 in order to make $1 available for the public to
hold as currency that made the loss of confidence in banks so cumulative
and so disastrous. Here was the famolls multiple expansion process of the
banking system in vicious reverse. T h a t phenomenon, too, explains how
seemingly minor measures had such major effects. T h e provision of $400
million of additional high-powered money to meet the currency drain
without a dcclinc in bank reserves col~lcl ha\^ prevented a clccline of
nearly $6 billion in deposits.
I n discussing the 1907 crisis, we showed how the risc in drposit
ratios had made the banking system morc vl~lncrablcto an attcmptrcl con-
\.rrsion of dvposits to currency. T h e s i t ~ ~ a t i oinn 1931 was cvrn more (:x-
trcme. At no time in 1907 clid the p r ~ l ~ l i11olcl c morc than $6 in tlc:pnsits
for every $1 i t hcld in currency; in Marc11 193 1, wllrn tlle scconcl I~anking
crisis began! i t liclcl o\.cr $10 in clrposits lor c : \ ~ r y$1 of ctlrrvncy, an
amount it succeeded in reducing to under $7 by January 1932. I n 1907,
the banks owetl less than $9 in tleposits t'or every $1 of high-poweretl
moncy thcy hcld as reserves; in March 1931, they owed morc tllan $12.
T h e morc extensi\fe use of deposits-widely regarded during the twenties
as a sign of the great progress and refinement of the American financial
structure-and the higher ratio of deposits to reserves-wiclcly regarded
as a sign of the effectiveness of the new Reserve System in promoting
" .\t the end of Jan. 1932, t h e i r excess reserves totaled $40 million.
346
T I I E GREAT CONTRACTION
"economy" in the use of rescrvcs-made the monctary systcm much more
vulnerable to a widespread loss of confidence in banks. Tlic defenses dc-
libcratcly constructed against such an eventuality turned out in practice
to be far less effective than those that liad grown u p in the earlier era.
When bank failures tapered off in February a n d March 1932, the
deposit-currency r a t i ~temporarily stopped falling. However, high-powered
moncy declined by $160 million in those two months, dcspitc a dwin-
dling of gold outflows, mainly as a result of changes in Reserve Bank
crcdit: a decline of $280 million in discounts, and a continucd decline
of, $50 million in bilk bougl~t,while government security Iloldings rosc
I)y ;~l)nut$1.80 million. Discounts dcclincd I~ccauscbanks took advantage
of the pause in t11c demands on t l ~ c mto repay some of thcir I)orro\vings.
They follo\\.cd that'coursc despite a rcdl~ctionin the New York Bank's
discount ratc to 3 per ccnt in February. T h e banks took advantage of the
pause also to strcngtllcn ttleir rcscrt-c position somewhat, so t l ~ cdeposit-
reserve ratio fcll slightly from January to March 1932. Tlic result was
that t11c stock of moncy continucd to clccline though a t a slower pace.
In these two months it fcll by another 2 per cent, an annual rate of 13
per ccnt, which can be described as moderate only by comparison \\.ith
the preceding 31 per ccnt annual ratc of decline.
nP:ClNNING O F LARGE-SCALE O P E N MARKET P U R C H A S E S , APRIL 1932
T l ~ cbeginning of the purchase of government securities on a large scale
by tllc Federal Reserve System in April 1932, involving purchase of $350
million during that month (see C h a r t 33 for seasonally adjusted end-
of,-the-month figures), had no immediate effect on the behavior of the
stock of moncy. I t declined another 454 per ccnt for another four months,
or a t an annual ratc of 14 pcr ccnt. T h c dccline then slowed up sharply,
the moncy stock falling one-half of 1 per cent in the two months from
July to September 1932, or at the annual ratc of 3 per cent. From Scp-
tcml~cron, i t rosc mildly ~ ~ n tJanuary il 1933, whcn the moncy stock was
one-11alf of 1 per ccnt higl~er tllan in Scptcrnl~cr 1932, implying 3n
; I \ J ( * ~ ; I ~ It.;ttc
- of S r o w ~ hof a1)out 1 per ccnt per year.
?'he reason the bond purcl~ascshad no grcatcr cfTect to bcgin with is
that tllcy were omset in part by a rcncwctl outflow of gold and the rest was
more than ofTsct by continucd declines in the deposit ratios. From April
to July 1932, whcn Reserve System holdings of government securities went
u p by roughly $1 billion, the gold stock fell by about half that amount,
most of the olitflo\v going to France. .4t the same time, a renewed flurry
of bank failures in June produced a further,appreciablc decline in the
deposit-currency ratio, and the continucd efforts of the banks to strengthen
tlicir position produced a f l ~ r t h c rclcclinc in the deposit-reserve ratio.
T h e gold drain ceased in mid-June and was replaced by an inflow.
347
 T H E GIZEAT CONTRACTION
Ovcr the rest of the year, the gold stock rosc by $600 million, bringing
the gold stock in January 1933 above its level a year earlier. Rcscrvc Sys-
tcm bond purchases ccascd in August 1932. Discounts and bills bought fell
from July on, so that total Federal Reserve credit outstanding rcachcd a
pcak in that month and fell by $500 million from then to January 1933.
Nonetheless, high-powered money continued to rise a t roughly a constant
rate from April 1932 to January 1933 because of ~ h rcvel.sal
n of thc gold
flow, plus an increase of $140 million in national bank notes. T h c latter
increase was due to a n amendment attached to t l ~ cI-Iomc Loan Bank Act
of July 1932, which broadened thc range of go\-crnmcnt I~ondscligiblc as
security for national bank n o t c ~ . ~Oncc
' thc dcposit-c~~rrcncy
ratio rcachcd
its trough in Jilly 1932, tlie risc in high-powered moncy pli~sthc risc in
thc deposit-currency ratio wcrc enougl~to offset tlic continued fall in the
deposit-rcservc ratio and prodt~cctlie pattern of clinngc in tllc lnoncy
stock already described.
T h e form tnlicn by thc impro\wncnt in thc banking position, rccordcd
in thc dcbposit-rcscnlc ratio, is worth noting bccnusc it ~~rcsngctl n clc-
\.cloprnent that was to bc important in tlie nest few ycars. nanks began to
accumulate substantial reserves in escess of legal rcqi~iremcnts. Since
tlic Rescrx~eSystem regarded the so-called "cxcess reserves" as a sign of
monctary case, thcir accumulation contributed to adoption of tlic policy
of kccping total government securities a t thc lcvcl rcnchccl in cnrly
August. Excess reserves wcrc intcrprctcd by many as a sign of lack of
demand for bank funds, as meaning that monctary autl~oritiescoultl makc
"credit" available but could not guarantee its use, a position most suc-
cinctly conveyed by the saying, "monctary policy is likc a string; you
can pull on it but you can't push on it." I n our view, this intcrprcta-
tion is wrong. T h c reserves were esccss only in a strictly lcgal scnsc.
T h e banks had discovered in thc course of two traumatic ycars that
neither lcgal rcscrves nor the prcsllmed availability of a "lcndcr of last rc-
sort" was of much avail in time of trouble, and this Icsson was shortly to
bc dri\.en homc yct again. Little wonder that tllc reserves they found it
prudent to hold cscccded substantially thc rcscrvcs tlicy wcrc Icgally rc-
qnircd to I ~ o l d .AS~ ~notcd abo\rc, their rcaction was the same as in
" T h e amendment pcrniittcd usc for a pcriod of tlirce ycars of all ~ovcrnnlcnt
bolids bcaring interest at 3% pcr cent or less, incltlditig future I)o~iclissucs during
the pcriod. From August 1929 up to July 1932 thcre was a slight incrcasc-$60
million-in national bank notes in circulation, as national banks exercised somc-
what more fully thcir right to issuc on tlic srcurity of three govcrnmcnt bond
issucs bcaring illtcrcst at 2 pcr ccnt, which had the circulation privilege.
'"ee Chap. 8, sect. 1 , for cvidcncc on this view. In, Dcc. 1932, Governor
Afcyer said that "if thc banks knew that therc was going to be a constant amount
of excess resenees ovcr a long pcriod, that amount could be rclativcly small and
.
still be more effective than a much larger but uncertain amount . . . We havc
not obtained the full effect of rcccnt large cxccss rcscr\?cs b c c a ~ u cof uncertainty
as to our future policy" (Harrison, Notcs, Vol. 111, Dcc. 22, 1 9 3 2 ) .
348
T I I E CREAT CONTRACTION
earlier criscs, only grcatcr in magnitude in response to the greater
severity of the crisis.
T h e final banking crisis, which terminated in tlie banking holiday early
in hlarch 1933, was in most csscntial respects a duplicate of the two prc-
ccding ones but still more drastic. T h e money stock fell 12 per cent in
thc two months from Janu;lry to March 1933, or a t an annual rate of dc-
clinc of 78 pcr cent. For reasons we discuss in detail in thc nest cliapt&,
our cstimntcs ovcrstatc thc clcclinc in thc stock of money, but hardly any
rcasonnblc allowance for crror could cut thc rate ~f decline to less than the
31 pcr ccnt ratc of dcclinc from August 1931 to January 1932. As in the
cnrlicr criscs, high-powcrcd rnoncy rosc, primarily as a rcsult of a rise
in tliscounts ancl a lcsscr rise in bills bought. Chart 33 shows an apprc-
cinl>lc risc in go\,(-rnmcnt sccuritics. T l ~ i s rise is produccd Ily the
scnsonnl ndjustlncnt. Tllrrc is no risc in tllc original figures. T h c early
~ n o n t l ~ofs thc ycars bcforc 1933 wcrc gcncrally charactcrizcd by a dcclinc
in tlic Rcscrvc portfolio of govcrnmcnt securities in response to the rc-
turn flow of cilrrency from circulation usual a t that season. I n 1933,
thcrc was, of coursc, a drain of currency rather than a return flow:
govcrnmcnt sccilritics wcrc ncvcrthelcss reduced in January by $90 mil-
lion, but then raiscd in Fcbruary by $70 million, to a levcl a t which they
also stood a t thc cnd of March. Seasonal adjustment of the figures con-
vcrtcd thc dcclinc in January and thc modcst rise in Fcbruary to apprc-
ciablc incrcascs, and raiscd thc original March figllrc only slightly Icss.
Tllc Innking I~oliday in hlnrch rcndcrs all the money figures non-
compnrablc with carlicr oncs, so wc considcr the change from January to
February alone, as a n approximation of thc dccline u p to the bank holi-
day. I n that one month t l ~ crnoncy stock fell 4 5 pcr ccnt, or at an annual
rate of 56 pcr ccnt. Currency licld by the public rose by over $600 mil-
lion, Iiigh-powcrcd rnoncy by $535 million-almost the samc. But even thc
remaining $65 million which had to Ilc supplied from bank rcscrvcs, plus
thc scrnmblc by banks for rcscrvcs, produccd a dccline in deposits of
ovcr $2 billion in t l ~ a tonc month, or nearly 7 % pcr cent of tlie already
shrunkcn total. This time tllc m~lltiplicrwas not 14 but 29.
T h c major monctary diffcrcncc bctwccn the final banking crisis and
tlic carlicr ones was that for thc first time the internal drain in part
clcnrly took tlic form of a drain of gold coin and certificates. As Chart
32A shows, the volumc of gold coin and certificates had risen mildly in
1930 but then had bccn constant or declining until thc onsct of thc final
crisis. I n January 1933, thc amount of gold coin and gold certificates
outside thc Treasury and Fcdcrnl Rcscrvc Banks was $120 million lcss
than :t its pcak in Dccembcr 1930, $340 million Icss than at its prcvious
349
 THE GREAT CONTRACTION
J a n u a r y pcak in 1931. T h c decline was apparently in somc measure t h e
resrrlt of a dclibcratc policy o n tlic p a r t o f t h c Fcdcral Rescrvc System o f
a d d i n g t o its gold rcscr\.rs by paying o u t Fcdcral Rcscrvc notcs instcad
of gold ccrtificatcs \\*Iierc fcnsiI,Ir. n rc\.crsnl o l tlic policy adopted
d r ~ r i tlic
~ i ~t\rcntics to k ( . c l ~do\\.tl tlic n p p a r c n t t.c3sc.1.\.c ratio (scc C l ~ n p t r r
6, scction 4 ) . s 8 Tliottgll tllc total of gold coin a n d gold ccrtificntcs
declined, t h c a m o u n t of gold coin alonc i n c r c a s c j by nearly $120 million,
f r o m $65 million in April 1931 t o $181 million in Dcccmbcr 1932. T h a t
increase may ha\.e rcflectcd a prcfcl.c,..:e f o r gold coin in t h e earlier
period. tlior~gli t o somc c s t c n t it Inust iivrt tlic growth of all forms of
rrlrrcncy a s opposed t o deposits. Ilut il i t clors r ~ l l r r tn p~.cfcl.cnccfor
gold, t h a t prcfcrcncc \\,as not srtficic~itl!. \riclrsl,rcad o r clrntnntic t o nt-
tract m u c h attention. I n F c l ~ r u a r ya n d Alarcli 1933, t l ~ cs i t ~ ~ a t i owas n cn-
tircly different, as shown by t h c s h a r p spl!rt in golel coin a n d crl.tificatcs in
carly 1933 in C h a r t 32A. Fears of dc\.al~tationwcrc widcsl)rcad a n d t l ~ r
~)rtl~lic~ ' sx e l ' e r e n c cfor golcl as unmistaknl)lc. O n FcI)t.~tal-y2 5 , 19YY,
Harrison told tlie directors o f tlic New York Rcscrve Dank, "thcrc
is little tliat forcigncrs c a n d o to h ~ ~ rnllr t gold posiiinn, . . . thc
r r a l d n n g c r conics f r o m domestic s o ~ ~ r c c s . " ~ ~
"Gold ccrtificatcs in circulation dcclincd in all 1)ut thrcc months in 1931 and
1931-when thc ccrtificatcs may have bccn paid out partly 1)ccause of a shortagc
of other forms of currcncy, as in Fch. and Afar. 1933 before tllc bank holiday-
for a net changc of $460 million. Although thcrc is no acknowlcclgn~cnt in the
Anntlal Report for I931 and 1932 that .ruth a rrtircmcnt policy was in clfect, it
is significant tlin~ tltr Frdrrnl I?r~rrr,rnt,llrlit~ (No\.. 1331, 1). 60.1.) contains thc
following commrnt :
1n considrring thr goltl position of t l ~ crollntry, i~ sho~~ltl Ilc notccl also that
thcrc arc $1,000.000.000 of goltl rcrtificntrs i l l rirc.ulntion, a l a r ~ cpart of wtlicli
can bc rctircd 1)s thc Fcdcral rcscmc banks I)y s111)stitutingan cquivalcnt arnollnt
of Fctlcrnl [rrsrt-\.r] ~iotcs.Thc rctirrlncnt of goltl ccrtifirntcs woltltl incrcasc. tltr
gold holdings of thc rcscl-\c banks, and of this incrcasc 40 pcr cent wo~llclbr
rcquircd as rcscnPcsagainst the aclditional Fcdcral rescrvc notcs and 60 pcr ccnt
wollld be added to the systcm's cxccss rcscrvcs.
m H e wcnt on to say, "During thc last ten days out-payments of gold coin at
this bank, and, probably, at all of thc Fedcral rcscrvc banks have hccn heavier
than in any rcccnt similar period. This movcmcnt rcprcscnts something morc that1
thc hoarding of currency, whirl1 rcflccts a distrust of banks; i t rcprcscnts in acldi-
tion a distrust of the currency itsclf and i t is inspircd by talk of clcvaluatiori of t l ~ c
dollar and inflation of the currency" (?-Iarrison,Notes. \'ol. 111).
Harrison madc elforts to gct banks to discourage hoarding. Hc sr~ggcstcd that
thcy refuse to facilities for storage of gold and to grant loans against thc
collateral of an equivalent amount of gold. With ropcct to the first, hc suggested
that hanks imposc no obstacles to the acquisition of gold but makc no ofTcr of safc-
kccpinS facilities; with rcspcct to tlrc sccond, hc adviscd banks to dcclinc a loan
to buy gold on thc ground that i t was a loan for a capitnl purl)osc. 1 . 1 ~ said, "I
saw no occasion for a mcmbcr bank, in tlicse tirnrs particularly wllcn so many
I)col:lc who nccclcd crcdit for businccs purposes roultl not oljtnin tltc crrtlit, to
makc loans to thcir customers for tlrc purl)osc of buyins sold to Iloard. It wac
nothing but a spcculativc loan gambling on our soilis off the golcl stantlard"
(Con\.crsations, Vol. 11, Fcb. 9, 1933). Dircct prrssttrc had comc full cir~lc.
350
TIIE CREAT CONTRACTION
T h e prcccding accortnt givcs a protnincnt placc in tlic secluencc of cvcnts
c l ~ ~ r i ntllf
g contraction to t h c succcssivc wavcs of bank failurcs. T h r c c
tluc.stions allout t l ~ o s cfailurcs dcsc.rvc f u r t h e r attention: \Vhy wcrc t11c
bank failurcs i m p o r t a n t ? W h a t was t11c origin of t h e b a n k failurcs? LVIlat
was t l ~ ca t t i t u d e o f t h e Fcdcral Rcservc Systcm toward t h c bank failurcs?
ROLE O F D A N K F A I L U R E S
T h e bank failurcs h a d two clilfcrcnt aspects. First, thcy involvcd capital
losst-s to I)oth thcir owncrs ant1 illcir depositors, just as t h c failure o f
. a n y o t l ~ c rg r o u p o f business c.ntrrpr.isc-s involvcd losscs to thcir owncrs
a n d crcditors. Sccond, given t l ~ cpolicy follo\\.cd by t h e Reser\.c System,
t h c faill~rcs were t11c m c c l ~ n n i s m t l ~ r o u g l i\).liicli a drastic dcclinc was
proclrlccd in t l ~ cstock of money. Whic11 aspcct was the more i m p o r t a n t
for thc collrsc of br~sincss?
F o r t11c U n i t c d Statcs, thc two aspccts were so closcly rclatcd t h a t
it rnay sccm impossihlc to distinguish t h e m a n d to judgc their s e p a r t t c
clfccts. But evcn for tlic Unitccl Statcs alone, a few figurcs serve to
show t h a t t h e sccond was vastly Inorc i m p o r t a n t t h a n t h e first. R c g a r d r d
solcly in t l ~ c i rfirst aspcct, tllc failurcs imposed losses totaling a b o u t $2.5
billion o n stockholdcrs, depositors a n d o t h e r creditors of t h e m o r c t h a n
9,000 Ilanks t h a t suspcndcd operations d u r i n g the f o u r years from 1930
tIlro11g11 1933. Slightly m o r c t h a n h a l l the loss fcll o n depositors, thc rcst
o n ot11c:r crcditors ant1 s t o c k l ~ o l t l c r s .A~ loss of $2.5 billion is certainly
sizal)lc, yct by itsclf it woultl not cntitlc bank f a i l r ~ r c sto t l ~ ca m o u n t of
attention wc a n d o t h c r strrdcnts of t11c pcriocl h a v e devoted to them.
By comparison, over t h e s a m c f o ~ ~ years,
r tlic value of all preferred
a n d c o m m o n stock i n all chterprises in t h c U n i t e d States is estimated t o
ha\.c dcclined by $85 billion. O r , t o m a k e a different comparison, t h c dc-
cline in i h e total value of all shares listed o n t h e N e w York Stock Es-
c h a n g c i n O c t o b e r 1929 is estimated t o h a v e been nearly $151/2 billion.82
As a fraction of total wealth, t h c losscs producccl by b a n k failures werc
minor a n d would deserve n o m o r e attcntion t h a n losses of a comparable
a m o u n t in, say, rcal estate.
" Loss to depositors, estimated at $1.3 billion (unpublished FDIC estimates; see
sourcc notcs to Table 16, part 1 ) ; loss to other creditors is a rough guess: loss
, to stockholdcrs, cstimated at $0.9 billion (Federal Reserve Bulletin, Sept. 1937,
p. 037). A sizable fraction of the losses was not realized until after the end of the
banking holitlay. Of thc morc than 9,000 hanks that suspended in the years from
'1300 through 1333, morc than 3,500 suspcndcd after Mar. 15, 1933.
Ilistoricnl Statistics of the United Stntes, Colonial Times to 1957, Bureau of
the Ccnstts, 1960, Scrics F-175, p. 150; Business Slalislics, 1932 Supplement, p.
104.
 T H E C R E A T CONTRACTION
I n the second aspect, the situation is cntircly different. T h e total
stock of money fell by over one-third from 1929 to 1933; commcrcial bank
deposits fcll by o\.er 42 per cent; in absolute amount, tlicy fcll $18 bil-
lion. Total deposits in strspcndcd banks alonc were much largcr tlla~ilosses,
c 1 1 >to~ $7 billion in tlrc snmc f o ~ ycn1.s.
~r I f 111cInnk failrt~,c*s
tlc~sc*r\.c
sl~ccialattention, it is clcn1.1~bccatisc tlicy were tlic mc,clianis~n tlir.ol~gh
\vlrich tlic clrnstic dccline in tlie stock of moncy \vns protluccrl, ant1 bc-
cause thc stock of moncy plays an important rolc in rcono~nicclcvclop-
nlcnts. Tllc Lank failurcs were important not primarily in tlicir own right,
but hccausc of thcir indirect effect. If thcy hatl occurrccl to prcciscly the
snmc cstcnt without producing a drastic clcclinc in tlic stock of moncy,
tlicy \voi~ldhave becn notable but not crucial. I f thcy had not occurred,
but a correspondingly sharp dccline had bccn produccd in the stock of
moncy. by. some othcr means, the contraction would have bccn at Icast
cqunlly scvcre nnd probably evcn morc so.
Pcrsuasivc evidcncc for this final statcmcnt is proviclcd by Canadian
cspcricnce. Cnnadn had no bank fnilurcs at all d t ~ r i n gtlic depression; its
10 banks with 3,000-odd branchcs througliout tlic country did not cvcn cs-
pcricncc any runs, although, presumably as a pfeventive measure, an
eleventh chartercd bank with a small number of branchcs was merged
\sit11 a largcr bank in May 1931. But because Canada kept its cscllange
rate with the Unitcd States fixed until Britain left the golcl standarcl in
Scptcmbcr 1931 and then maintained its eschange rate at a ncw level in-
volving a smallcr dcpreciation than that undcrgonc by the pound sterling,
its internal level of income and its stock of money had to adjust to main-
tain estcrnal equilibrium. Though the requircd fall in both prices ancl in-
come was sharp, the depreciation of the Canadian eschange rate per-
mittcd thc percentage fall to be somewhat smallcr than that in tlie Unitcd
Statcs. T h e stock of moncy fcll sharply also, but by a much smaller pcr-
ccntngc than in thc Unitcd Statcs. Even thc smnllcr fall was, however,
nearly one and a half times as large as the fall in any contraction in U.S.
history since the Civil War escept only the 1929-33 contraction. So it
can hardly be regarded as minor. T h e rclcvant figures are as follow^:^'
Pncrn!a~cDcclinr,
79-3-33 Unitrd S(atcr Cnnndn
Stock of money 33 13
Net national product 53 49
Velocity 29 41
Exccpt for the Canadian currency cornponcnt, which is an ~ r n e c n t c r r da n n ~ ~ a l
average of monthly data, moncy stork figures are annual a\.cragcs of montllly
data. ccntcrcd on Junc 30. Canadian data arc s u m s of demand, noticc, and pro-
vincial Sovcrnment dcposits i n chartercd banks, minrrs d~rplications (Caltndn
G n z c r t t . Dominion of Canada. Jan. 1929-Jan. 1934), pllrs r t r r r r n r y hcld I)y thc
public (Cnnndn l'enr Book, 1947. Do~ni~iion h ~ r c a uof Staiislics, 11. 10'23). Nct
national incomc a t factor cost,' for Cannda. f1.on1 Cnnnditrn Stnli.rlicnl Reuicru,
1953 Supplement, Dominion Burcau of Statistics, p. 15.
352
T I I E CREAT CONTRACnON
Why was the decline in the stock of money so much sharper in the
United States relative to the dccline in income than it was in Canada? Or,
alternatively, why did not the stock of money in Canada have to fall much
more sharply than it did to be consistent with so sharp a decline in
inc.otiic? 'I'llc. rcqnson for tlrc diffcrcncc is, \vc bclirvc, primarily the effect
of tlrr: U.S. Innk failurcs tl~cnlsclvcs.Tlic bank failurcs made dcposits a
rnrlch less satisfactory form in which to hold assets than thcy had bccn
before in tlic Unitcd Statcs or than they remained in Canada. That, of
course, is the reason tlicy produccd such a shift in the deposit-currency
ratio in the Unitcd Statcs, \Vl~ilccurrency was a n alternative, it was not
a fully satisfactory altcmativc, otherwise deposits would never havc
constituted so large a fraction of the total stock of moncy. Hcnce the
dcmand for thc sum of dcposits and currency was rcduccd by the
diminished attractiveness of deposits-an effect of tllc bank failurcs not
hcrctoforc consiclcrcd. Of course, that effect was not strong enough to
offset complctcly the incrcascd dcmand for moncy relative to income
as a result of thc othcr factors associated with the contraction, such as
the grcat incrcasc in uncertainty, the dcclinc in attractiveness of equities
and real goods, and so on (see Chapter 1 2 ) . If it had bcen, the amount
of moncy would havc fallen by a larger percentage than income fcll, i.e.,
vclocity would have risen rather than have fallen as it did. But the effect
was strong enough to make the dccline in velocity decidedly smaller in
the Unitcd States than in Canada, where thc same cfTcct was not present.
I n Canada, deposits rcmaincd as attractive as they had ever bccn, and
tlrcre \\,as accordingly no reduction in the dcmand for money from this
source. T h e othcr factors increasing the dcmand for money had full
scopc.
I'nraclosically, therefore, thc bank failurcs, by thcir effect on the
dcmancl for money, offset some of the harm thcy did by their cffcct on the
supply of moncy. T h a t is why wc say that, if the same reduction in the
stock of money had bccn produccd in some other way, it would probably
have involved an evcn larger fall in incomc than the catastrophic fall
that did occur.
ORIGIN O F D A N K FAILURES
Tlrc isztrc that has perhaps rcccived the most attcntion centers on the
rrnsons for the bank failurcs. Did they arise primarily from the financial
practices of the prcccding years? O r were thcy produced by the develop-
mcnts of the carly thirties? Even if the first vicw wcre correct, the
indirect monetary consequences of the failures are separable from the
failures as such and nccd not have bcen also the ncar-inevitable con-
sc~lrtrnccsof the clcvclopmcnts of thc twenties. As we have just sccn, it was
tlie indirect consequences that wcre the most important effect of the
bank failures.
353
 T H E GREAT CONTRACTION
New York Rcscrve Bank, told the Bank's board of dircctors in February
1931, the chief problem confrontilig many banks was thc scvcre dcpre-
ciation in their bond accounts; "given a bctter bond markct and rising
bond prices, .. . the condition of banks now jcopardizcd by depreciation
in thcir bond accounts would, in many cases, improve automatically be-
yond the point of immediate Becausc there was an active
market for bonds and continuous quotation of thcir prices, a bank's capital
was more likcly to be impaired, in tlie judgment of bank exarniners, whcn
it held bonds that were expected to be and werc honored in full whcn
due than when it held bonds for which there was no good market and
few quotations. So long as the latter did not comc due, thcy were likcly
to be carried o n the books a t face value; only actual dcfaults or post-
ponements of payment would rcduce the csamincrs' evaluation. Para-
dosically, therefore, assets regarded by the banks as particularly liquid
and as providing them with a secondary rcscrve turned out to offcr the
most scrious threat to their solvency.
T h e most extreme example of thc process we havc bccn describing is
the experience after Britain lcft thc gold standard.' T h e dcclinc of 10
per cent in the price of government bonds and of 20 pcr ccnt in thc price
of high-grade corporate bonds (notcd in thc preliminary mcmorand~rm
for the January 11, 1932, meeting of the Opcn Market Policy Confcrcncc,
cited earlier) clearly did not reflect any deterioration in thc quality of
credit in the twenties or "bad" banking in any mcaningful scnsc of t l ~ c
term. I t reflected the inevitable effect of the enforced dumping of
bonds by banks to reduce the volume of their asscts by a largc multiple
of the amount of additional currency supplicd to depositors.
If deterioration of crcdit quality or bad banking was thc trigger,
\\.l~icl~it may to somc cstcnt havc bccn, the clamaging bullct it cliscI~argcd
was thc inability of the banking systcm to acquire additional hig11-powc~.cd
rnoncy to mcct the resulting demands of dcpositors for currcncy, witllout
a multiple contraction of deposits. T h a t inability was rcsponsiblc alike
for the extcnt and importance of bank failures and for the indirect cffcct
bank failures had on the stock of money. I n the absence of the provision
of additional high-powered moncy, banks that suffcrcd runs as a result
of American Banking, London, Routledge, 1933, p. 1 0 6 ) . We are inclcbtcd to
Manuel Gottlieb for this reference.
Commenting on bank suspensions in 1932, Bray Hammond wrote: "The situa-
tion had worked to the point where the stronger banks were being dragged down
by the weaker banks, partly because the latter drew on the former for reserves and
partly because the forced liquidation of portfolios by banks in difficulties impaired
the value of portfolios of all other banks" ("Histori~al Introduction," Banking
Studies, Board of Governors of the Federal Reserve System, 1941, p. 2 9 ) .
*Harrison, Notes, Vol. I, Feb. 26, 1931. See also footnote 12, above.
356
T H E GREAT CONTRACTION
of thc initial failure of "bad" banks would not have been helped by
holcling solcly U.S. government securities in addition to required reserves.
If tllc composition of their assets did not stop the runs simply by its effcct
oh depositors' confidence, the banks would still have had to dump thcir
govcrnmcnt securitics on the market to acquire needed h i g l i - p o ~ c r c d
rnoncy, and many would havc failed.07Alternatively, the composition of
asscts held by banks would hardly have mattered if additional high-
powcrcd rnoncy had bccn made available from whatcvcr source t o mcct
thc demands of dcpositors for currcncy without requiring a multiplc con-
traction of deposits and asscts. T h e trigger would havc discharged only a
blank cartridge. T h e banks would havc bcen under n o necessity to d u m p
thcir asscts. There wotlld havc bcen no major decline in the markct
priccs of thc asscts and no impairmcnt in thc capital accounts of banks.
T h c faill~rcof a fcw bad banks would not have caused the insolvency
'of many othcr banks any morc than during thc twenties whcn a largc
ntlml~erof banks failed. And cvcn if an abnormally largc nr~mhcrof
banks had failcd bccausc .they wcre bad, imposing losses on depositors,
othcr crcditors, and stockholdcrs, comparable to those actually imposcd,
that would havc becn only a regrettable occurrcnce and not a catastrophe
if i t had not bccn accompanied by a major dcclinc in the stock of money.
Tlic failure of the Bank of Unitcd States provokcd much soul searchinz
by tllc clircctors of thc Ncw York Rcscrvc Bank. They devoted meeting
aftcr niccting from mid-Dcccmbcr 1930 to April 1931 to discussions of thc
responsibilities of thc Rcserve Bank with respect to member bank sus-
pensions and of thc actions it cotrld takc to prcvcnt thcm. Thcy wcrc well
awarc of tlic scrio~rssl~ockthc failurcs llad atlministcrcd to confidencc not
'nnly in commercial banks but also in thc Fcdcral Rcscrve System. Owcn
D. Young, thcn dcputy chairman of thc board of directors of the Ncw
York nank, repeated to his fcllow dircctors thc rcmark of an upstate Ncw
York bankcr that thc failurc of the Bank of United States "had shakrn
confidence in the Federal Rescrve System more than any other occurrcncc
in rcccnt y c a r ~ . " ~ Q t thc first joint meeting of the Fcderal Rcservc Board
and thc Opcn Markct Policy Confcrcncc aftcr thc banking dificultics had
tlcvclopccl, Adolph Miller, a mcmbcr of thc Board, commcntcd that
"thc banking situation was now more important than thc credit situa-
" O f course, had banks held only U.S. government securities in addition to thcir
required reserves, the Reserve System would have been under much greater pres-
sure than it was to intervene by providing additional high-powered money to sup-
port the prices of those securities. But that is an aspect of the problem wholly
different from the effect of the possible deterioration oi credit quality.
Harrison, Notes, Vol. 11, Aug. 13, 1931.
357
 TIIT: CRF,AT CONTRACTION
tion, and askcd what thc governors wcrc planning to d o in diffrrcnt dis-
tricts if further banking trouble s t a r t e d . " " T h e minutes of directors'
meetings of the New York Bank and memoranda prepared for mcctings of
thc Opcn Markct Policy Conference reveal that thc technical pcrsonncl
of the Bank and the Board were fully aware of the intcrconncction bctwccn
the banking and the credit situations, and of thc effects of thc liquidation
of sccr~riticsto mcct the dcmands of depo~itors.'~ R c p c a t c d l ~clr~ringthe
next two years, the problem of bank failurcs and bank s i ~ ~ ~ c r v i s iwas on
discussed at meetings within the Systcm.
Despite thc attention to the problem after 1310, the drily Systrm
actions directed specifically at the problem of bank failurcs wcrc thc
proposals notcd above for mcnsurcs tllat otlicrs might tnkr, lvith pnrticu-
lar emphasis on proposals dcsigncd to permit assets to bc valnccl more
liberally in bank csaminations. T h c gcncral tcnor of Systcrn commcnts,
both inside and out, was dcfensi\,c, strcssin~tliat bank fnilurcs wcrc a
~ ~ r o b l c nofl bank manngcl-ncnt \\liic.l~wns not the Systrm's rc.sponsil~ility.
Tllc major rcason thc Systcrn was so bclntcd in s l i n w i ~ ~coricc1.n
g nl)o(~t
bank failures and so inactive in responding to them was undoubtedly
limited understanding of the connection bctwccn bank failurcs, runs on
banks, contraction of deposits, and wcakncss of the bond markets-
connections we have tricd to spell out earlier in this chapter. T h c tech-
nical personnel of thc Ncw York Bank understood thcsc connections, as
~ ~ n d o u b t c d lmany
y othcr individuals in thc Systcm did nlso; but most of
thc governors of the Banks, mcmbeis of thc Board, and othcr administra-
tivc officials of the Systcm did not. They tcndrtl to rcgrrd bank failr~rcs
as regrettable consequences of bad managcmcnt and bad banking prac-
tices, or as inevitable reactions to prior spccr~lntivccxccsscs, or as n con-
srqucncc hut hardly a carlFc of thc finnncinl and rconomic collal~scin
process. As implied in Millcr's cornmcnt qr~otrtlabovc, thcy r c ~ : ~ ~ . t ltllc ctl
banking situation as something diffcrcnt from thc crctlit situation.
Four additional circumstances may help to esplain tlic Systc~n'sfailr~rc
both to develop conccrn ovcr bank closings a t an cnrlicr (late and to
undertake more positive mcasurcs when conccrn did dcvelop. ( 1 ) Frdrral
Rescrve officials had no fecling of responsibility for nonmcmbcr bnnks. In
1921-29 and the first ten months of 1330, most failed bnnks were non-
mcmbcrs, and nonmcmbcrs held a high pcrccntagc of thc dcposits in-
volved. ( 2 ) T h e failures for that period were concentrated among smallcr
banks and, since the most influential f i p r e s in the System were big-city
bankcrs who dcplorcd thc existcncc of smallcr banks, their disappearance
may have been viewed with complacency. ( 3 ) Evcn in Novcmbcr and
December 1930, whcn the number of failurcs incrcascd sharply, ovrr 80
"'Jlnrrison.Opcn h4arkct, Vol. 11, minutcs of meeting, Jan. 21, 1331, 11. 7 .
Scc, lor rxamplc, quotationc in footnotc 12, abovc.
358
T I 1 E G R E A T CONTRACTION
pcr ccnt wcrc nonmcrnbcr.~. ( 4 ) Tllc rclativcly fcw targc nicmber banks
that failctl at tlic cnd of 1930 wcrc rcgardcd by many Rescr\.c officials
as u n f o r t ~ ~ n a tcascs
c of Ilnd ~nanagclnrnt and t l l c r c f o ~ .not
~ mbjcct 10
correction Ily ccntlal bank actio~r."
I n Scptcml~cr193 1, ~ , l i c nGovernor Harlison convcncd a meeting of
commercial bankcrs to discuss mcans of making dcposits in closcd banks
availablc, Iic rccallcd that "at onc time it was thc fccling of many of us
down town tllat tlic cffccts of tlic failure of . . . small banks in the com-
rnuriity could be isolated," but "it was clcar that tlic continucd closing
of institutions in tllc city is now .having serious rcpcrcussions. . . .""
4. International Character of the Contraction
In 1929, most countrics of thc Wcstcrn world liad rcturncd to a monctary
standard involving fixcd cxchangc ratcs bcticccn diffcrcnt national cur-
rcncics. T h c standard was widcly known as tlic gold-exchange standard bc-
carlsc many countrics kcpt tlicir monctary rrschrvc:s in tlic form of balnnc'cs
ol otl~c:rcurrcncics convcrtiblc into goltl at fiscd prices, notably sterling
and dollars, rather than in tlic form of gold itsclr. OfTicial agcncics in
srlcli countries, usually tlic central banks, oftin fiscd cschangc ratcs
dirc:ctly Ily standing rcady to brly or scll thc national currcncy at fiscd
ratcs in tcrms of otllcr ct~rrcncics,rathcr t l ~ a ninclircctly by standing rcady
to buy or scll gold at fiscd priccs in tcrms of thc national currency.
Sincc thc gold-excliangc standard, likc tlic gold standard, invol\,cd
fixed cxchangc ratcs, it also mcant tliat, so long as the standard was
rnnintainctl, priccs and incomes in diffcrcnt countrics wcrc intimately
conncctcd. Thcy had to bchavc so as to preserve a rough equilibrium in
tlic balance of payments among tlic countrics. T h c use of thc gold-cs-
cllange standard did mean, howcvcr, that thcrc was less Iecway in tllc
atljr~stmcntsarnong cor~ntrics-tl~c rotrgli cclr~ilil~rium could not bc quite
so rough as undcr t l ~ c11111gold stanclard. T h c gold-exchange standard
rcndcrcd the international financial systcm morc vulnerable to disturb-
anccs for the samc rcason that the rise in the deposit-rcscrve ratio
rcndcrcd tlle domcstic monctary system more vulnerable: because it
raised the ratio of claims on the relevant high:powcred money-in this
casc, ultimately, gold-to tlic amount of high-powered moncy availablc
to mcct thosc claims.
Tlic links forgcd by the fixed rates of exchangc ensured a worldwide dc-
clinc in income and priccs aftcr 1929, just as the links forgcd by the
lcss rigidly fixcd cxchangc rates in 1920 cnsurcd a worldwide dcclinc
tlicn. No major contraction involving a substantial fall in priccs could
dcvclol) in any onc country witliout thosc links enforcing its trans-
" Wc arc i~idcbtcdto Clark Wxrl~c~rton for this paragraph.
" I-Iarrison, Oficc, Vol. 1 I, Scpt. 1 1 , 133 1 .
359
 T H E GREAT CONTRACTION
mission and spread to othcr countries. Thcrc was sufficicnt play in the
links to ~ c r m i tnlinor uncoo~.dinatedmo~.emcntsbut not to pcrmit major
oncs.
As in 1930, tlie world~vidcscopc of tlic contraction oncc it got undcr
way docs not mean that i t did not origil~atcin t11c Unitrd Statcs. Evcr
sincc \\'orld \Var I at tlic latest, tlic Unitrd Statcs lias bccn n suficicntly
important participant in ~vorldtrade and in world capital and financial
markcts and lias hcld a s~~fficicntlylargc fraction o i t l ~ c wo~ld's
gold stock to be capable of initiating worldwide movements and not
merely of rcacting to them. Of course, if it did initiatc a worldwidc dis-
turbnncc, it would inc\.itably bc aflrctcd in turn by 1.c-flcs influcnccs
from tlic rcst of tlic world.
\Ve saw in Clinpter 5 that tlicre is good rcason to regard tlic 1920-21
contraction as having bccn initintcd p ~ i m a r i lin~ the Unitcd Statcs. T h e
initiaI step-thc sharp rise in discount ratcs in January 1920-was indccd
a consequcncc of the prior gold o ~ t f l o w ,but that in t w n rcflcctcd tlic
Unitcd Stntcs inflation in 1919. T h c risc in discount rates prodi~ceda
rc\.crsal of thc gold movclncnt in Mny. T h c sccond stcp-thc risc in
cliscount ratcs in June 1920 to tllc higlicst level in Fcdcral Rcscrvc history
before or sincc-was a dclibcratc act of policy involving a reaction
stronger than was needed, sincc a gold inflow had already begun. It was
succeeded by a hcavy gold inflow, proof positivc that tlie othcr countrics
were being forced to adapt to Unitcd Statcs action in order to check their
loss of gold, rather than the revcrse.
T h e situation in 1929 was not dissimilar. Again, thc initial cli-
mactic c\.cnt-the stock markct crash--occurred in thc Unitcd Statcs.
Tlie scrics of dcvclopmcnts wliich started thc stock of moncy on its ac-
celcratcd downward COLII.SC in Intc 1330 was again p r ~ c l o m i n n n t ldo-
~ scvcrcd, such assistance rvas at bcst a tcmporary palliative. In countty
mcstic in origin. I t would bc dificult indcecl to nttributc tlic scqucncc of
bnnk failurcs to any major current influcrlcc froin nbrond. And ag;lin, thc
clinching e\fidcncc that thc Unitcd Statcs was in thc van of t l ~ cmovcmcnt
and not a followcr is thc flolv of gold. If dcclincs clscwlicre wcre hcing
transmitted to the United Statcs, the transmission mcclianism would l ~ c
a balance of p n p c n t s deficit in tlic Unitcd Statcs as n rcsr~ltof n di,clinc
7 in prices and incomcs ~ l s c ~ v l i ~rclativc
rc to priccs and incomcs in tlic
United Statcs. T h a t dcclinc wo~ild lcad to n gold o ~ ~ t f l o w from tllc
United Statcs ~vhicli,in turn. would tend-if tlic Unitcd Statcs followed
gold-standard rules-to lower the stock of moncy and thcrcby income and
prices in the United Statcs. Howevcr, the U.S. gold stock rose during
the first two years of tlie contraction and did not dcclinc, demonstrating
as in 1920 that othcr countrics were being lorccd to nclnpt to our monc-
tary policics rathcr than thc rcvcrse.
Tlic international cflccts wcrc s r ~ c r c and tlic t~niismission
360
T l I E GREAT CONTRACTfON
not only bccause tlie gold-exchangc standard had rcndered the inter- i
national financial systcm morc v~tlncrableto disturhanccs, but also bccausc ,
thc Unitccl Statcs cliil not follow gold-standard rules. \Yc did not pcrmit
thc inflow of gold to cxpancl t l ~ cU.S. moncy stock. CVc not olily stcrilizcd
it, \\*c \vrnt much furtlicr. O u r moncy stock moved pcr\,ersely, going
down as tlie gold stock wcnt up. I n August 1029, our moncy stock was
10.6 timcs our gold stock; by August 1931, it was 8.3 timcs tlie gold
stock. Tllc rcsult was t l ~ a tothcr c o ~ 1 n t 1 not
. i ~ ~only l ~ a dto bcar tlic \vl~olc
burden of adjustment but also wcrc faced with continued additional dis-
turbances in tlic same direction, to wllich they had to adjust. As Harrison
notcd in early 1931, forcign commcntntors wcrc particularly critical. of the
monctary policy of thc Unitcd Stntcs I~ccausc
thc gold as i t camc into thc country has I~ccnuscd by mcmbcr banks to rcpav
Fcdcral rcscrve crcdit in onc form or another, with the rcsult that in this period
tl~ctotal volumc of Fcdcral rcscrvc crcdit hat1 dccliiicd by an amount cqunl
to tlic gold imports. Thus i t may be said that thc Unitcd Statcs has prcvcriic~cl
tlic usual or normal cffcct of gold which has comc to i t . . . . Tlic clrils to rh~:
\vorld of continued gold stcrilization . . . arc so grcat as to niakc dcsinblc
a carcful scrutiny of Fcdcral rcscrvc open markct policy."
T h e effccts first became severe in those countries that had returned
to gold with the smallest actual gold rcservcs, and whose financial struc-
tures had bcen most scriously weakcncd by World M'ar I-Austria,
Gcrmany, Hungary, and Rumania. T o shore u p the financial systcms of
thosc countries, intcrnationnl loans, in wl~ichthe Rcserve System partici-
pated, wcre arranged. But so long as cithcr the basic prcssure on those
.'countries dcriving from deflation in tlic United Statcs was not relievcd, or
tlic fixed cxcllangc-ratc link which hound thcm to tllc U.S. dollar was not
nrtcr coiintry, that is what it provcd to 'hc. As thcy expcricnccd financial
diflicultics, thc Unitcd Statcs, as wc havc sccn, was in turn affected by
thc rcflcx influcncc of the cvcnts it h,ad sct in train.
Tlie kcy rolc of fiscd cxchangc ratcs in thc international transmission
mcclianism is cogcntly illustrated by the case of China. China was on a
silvcr rather than a gold standard. As a rcsult, it had the equivalcnt
of a floating cxchangc rate with rcspcct to gold-standard countries. A
dcclinc in the gold price of silvcr had thc same cffcct as a dcprcciation
in the forcign exchangc valuc of tlic Chinese yuan. T h e cffect was to in-
sulntc Chinese intcrnal economic conditions from the worldwidc dcpres-
sion. As world priccs fcll in tcrms of gold, so did thc gold pricc of siI\.cr.
Hencc thc prices of goods in tcrms of silvcr could remain approximately
the samc. China cotrld continue to maintain cxtcrnal balance without
undcrgoing an intcrnal dcflation. And that is what happcncd. From 1939
'' IIarrison, Opcn Market, Vol. 11, Apr. 1 7 , 1931.
36 1
 T I I E CREAT CONTRACTION
to 1931, China was hardly affected internally by thc ilolocaust that was
swccl>ing the gold-standard \r.orIti." jt~st as i t , i920-2 1 , Grrmany hat1
bcen insulated by her I~yl>crinflation and associated floatills c!scl~a~lgc
Tllc first major country to cut t l ~ clink was Britain, wllcn sllc left the
gold standarci in 1931. T h e trough of the dcprcssion in Britain anti in
othcr countries that accompanied Britain in Imving gold was rcaclted
in thc third quarter of 1932. In the countrics that remained on t l ~ cgold
standard or, likc Canada, t i n t \vent only part way with Brimin, t l ~ c
dcprcssion dragl=cd on. I n China, wl~osc'currency ,al,l~rcciatcdrelative to
the pound as a result of tllr sllnrp drl,rcciation of t l ~ cpound ~ r l a t i v cto
gold,, thc dcprcssion set in for the first timc in 1931.
Of course, the country in tllc vanguard of such an international movc-
mcnt need not stay thcre. Francc, which had accumulatcd a largc stock of
gold as a rcsult of returning to t l ~ cgold standard in 1928 at a n cxcllangc
rntc that undcrvalucd the franc, and therefore had much Iccway, at somc
point passed the United Statcs and not only hcgan to add to its gold stock
but also, after late 1931, to drain gold from the Unitcd Statcs. T h e link
bctwcen the franc and the dollar was cut whcn the Unitcd Statcs sus-
p n d c d gold payments in March 1933, whicll proved to I x the I,r~siness
cycle trough for the United Statcs and countrics closely linked to it. In
France, \vhich stayed on gold for a further interval, the contraction
clt-aggcd on still longer. Although there was an upturn from July I932 to
July 1933, thc low point of thc interwar ycars was not reacllcd until April
1935.
5 . Dcvclo/)mcnt of A!onrtnry Polic~l
corlt.sc of monctnry ~>olicyit1 t l ~ cclificr~ltant1 critical ycn1.s of t l ~ c
contraction \\as y.(-;ltly i ~ l f l ~ ~ ( ' t l c r ~I lll ( : s11.11ggIc:fol. I)o\v('I. \ v i t l i i ~ l t11(*
Fcdcral Rescr\.c System, tllc bcgirltlings or \\,lticl~were tlt:scl.il)cd i t ) tlic
prcccding chapter. At the timc of the stork markct crash, t l ~ cNcw York
Reserve Bank actcd in the tradition of its earlier dorninancc, moving
rapidly, decisively, and on its own. T h e adverse reaction of tlie Hoard
greatly inhibited further' indcpcndent mcasurcs by Ncw York.
I n 1930, New York strongly favored expansionary opcn markct opcra-
tions, but after thc middle of the year was i ~ n a l ~ to l c persuade cither the
otllcr Bank govcrnors-all of whom by this time had bccomc n~cmbcrsof
the Open Market Policy Confercnce, which replaced the
earlier Opcn Markct Invcstment Committee-or the Board in Wash-
inston. T h e same was true in 1931, except that New York was lcss
"Arthur Salter, C h i n a a n d Silver, N e w York, Economic Forum, 1934, pp. 3-6,
15-17.
"Frank D. Graham, Exchange, Prices, a n d Production in Ilyperinflafion:
Gertnnn)', 1920-23, Princcton Univcrsi~yPress, 1931, pp. 287-200.
362
T H E CREAT CONTRACTION
vigorous in prcssing for cxpansionary action, though it was now supported
by the ncw govcrnor (Eugcnc Meyer) of the Federal Rcscrvc Board.
'I'l~crcaction to Britain's tlrpartt~rcfrom gold tlicl not provoke a flare-up
of thosc conflicts. Tltc measures adoptcd at that timc were favored by
almost all afiliatcd with tllc System. T h c asrccmcnt rcflccted the
dominant importance then attachccl to the preservation of the goltl
standard and the grcatcr significance attached to external than to
intcrnal stability, by both the Systcm a n d 'the commrtnity at largc. Not
long aftrr, the diffcrcnccs within the Systcm that had bccn submcrgcd
in the fall of 1931 re-emerged, New York generally pressing for ex-
pansionary opcn markct operations, supported by the govcrnor and
somc otllcr mcmbcrs of the Board and by a fcw Bank governors, and
opposcd by most of the Bank govcrnors.
T h c opcn markct operation of 1932 wa5 acceded to largely under Con-
grrssional prcssurc and wit11 the ncw Glass-Steagall Act ostcnsihly
permitting rclcase of the Systcrn's cxpansionary powers. T h e operation
was tcrminatctl in Arigtst, shortly after Congress adjourned, because so
many Bank govcrnors remained uncnthusiutic abortt the policy and
reluctant or unwilling to ptlrsuc it. T h c deadlock persisted throltgh thc
rest of thc contraction.
At the timc of the stock market crash, the Open Markct Invcstmcnt
Committcc consisted of fivc Bank govcrnors with the New York govcrnor
as chairman. I t was operating under its recommendation to the Board,
Scptembcr 4, which had bccn approvcd by the Board on Octobcr 1 , to
p~trcl~asc "not to c~xcccd$25,000,000 a wcrk" or sllort-term government
sccr~ritirs i f ncst!tlt.tl to s~~pj)l(.rnc~r~t~)urcliasc*sof acceptances, "for thc
plIrpos(: 01 avo it lit^!: ;my incrc.:tsc: and, i f possil)lc, facilitating somc furt11c:r
n tllc: total vol~tmeof rncmbcr bank discounts . . . ." U p to
r e d ~ ~ c t i oin
tllc week ending Octobcr 23, the Committcc had not made any govcrn-
ment security purchascs bcca~iscbills had bccn available. T h c System's
holdings had declined by $16 million, while its bill holdings had increased
by $1 15 m i ~ f i o n . ~ '
Wltcn the crashcame, the New York Bank had no doubt about what
steps shol~ldbe taken and proceeded to take them. I t purchased $160
million of Sovcrnmcnt, securities in addition to e n c o u r a g i n ~New York
banks to discount freely. T h e amount purchased was far in escess of the
amount that the Opcn Market Invcstment Committee was authorized
to purchasc, but the Ncw York Bank did not claim to be operating for the
Committcc. It contcndcd it had tltc right to purchase government secu-
"Iiarrison, Opcn Market, Vol. I, minutes, Sept. 24, 1929, and letter, dated
Oct. 1 , 1929, Young to I-iarrison.
3 63
 TIIT, G R E A T C O N T R A m O N
rities for its own account, as a matter of general credit policy, without the
h a r d- ' s. a n~ n r o v a l . ~Harrison
' informed Governor Young of the Federal
8
Rmerve Board that his dircctors had authorizcd him to purchase govern-
m r n t securitirs witliout limitation as to amount, and that bn October 29,
before the call loan rate was anno\~nccd,a ptrrcl~ascllad bcrn arranged.
Members of the Board regarded the NPW York Bank's failure to -seek . no objection to a purchasc operation being undertaken, with the under-
the authorization of the Board before taking action as smacking 01 In-
subordination, though some regarded the action itself as desirable. As
a Ircal mattrr. thr New York Dank srrmrd clcarly within its rights. Under
tllc I933 aql.crrncllt s r t t i ~ rtip ~ tlw O p r n hfarkvt In~.rstmclltCorn~nittcc,
racll Rrsrr\.c Bank rrtainrcl tllc risht to pt~r-cllascancl holcl govcrnlncnt
sccuritics for its own account. Young ancl most Doarcl ~ncml,crsacknowl-
cdSed the legal right yet Iclt that the cl~ellcngcto tllc Board's a r ~ t l ~ o r i t y
\rnc
.. insrlnnortable. After much discurrion, the Board finally authorizcd
.
I L
Y o u n ~to tell Harrison that, if New York sllor~ldreqllcst approval of a
rccluction of its rate to 5. per cent, thc Donrtl ~vorrldconscnt on condition ..
that no f\~l.tllcrpurchasrs of government sccuritics be mnclc csccpt w ~ t h
annroval of the Board.'8 O n November 1, the discount ratc a t the New
-1.1-
York Bank was so rcduccd. T o the Nc\v York clircctors it was clear that
the System o u g l ~ t to proccrd immediately with further pnrcl~ases for
"unless this is done, aftcr the cvcnts of the past weeks, thcrc may be
greater danger of a recession in bl~sincsswith conseqtlent depression and
~ ~ n c m p l o y m e nwhich
t, we should do all in our power to prevent," as they
declared in a resolution they adopted on Novcmber 7.'D Under the
Iradership of Harrison, the O p r n Market Investment Committee, meeting
November 12, recommendrd that "the present limit of $25,000,000 per'
wcek on the purchase of government securities be rcmovrd and that the
Committee be authorized in lieu thereof to purchase not to exceed
$2OO,OOO,OOO of ~ o v c r n m r n tsccuritics for accot~ntof such banks as care
to participate . . . ," having in mind $.w the fact "that present condi-
tions may possibly develop to the point where, as an emergency measure,
in the interest of maintaining banking and business stability, it may be
nrcenary quickly to purchase large amounts of G o v e r n m a t securities in
order to avoid any undue stringency in
" O f the $160 million government securities purchasrd by New York in the wcek
ending Oct. 30, $75 million was transferred to System account. During the follow-
ing two weeks, the New York Bank bought an additional $25 million directly lor
System account.
" Hamlin, Diary, Vol. 16, Oct. 29, 30, 1929, pp. 187-196. Miller did not con-
sider the purchase desirable. He suggested a resolution to thc cRcct that the Board
would not havc approved the purchase, had i t been consulted; that New York
was morc conccrncd about thc stock markct than tltc gcncral crcdit situation; that
forcing the banks to come to thc discount wintiow woultl havc been the proper
response.
" For the resoliltion, see Harrison, Misccllancous, Vol. I.
Open Market, Vol. I, minutes of meeting, Nov. 12, 1929.
364
T H E G R E A T CONTRACTION.
T h e next day, t h e Board notified the Committee that "the general
situation was not sufficiently clarified for the System to formulate and
adopt a permanent open market policy a t that time," but conceded that if
"an emcrgcncy shortld arise with stlch suddenness and be so acute that i t
is not practicable to confer with the Governor, thc Board will interpose
standing, however, that prompt advice of such purchasc be furnished the
Board."81
O n Novcmbcr 15, Governor Young of thc Federal Reserve b a r d was i r l
Nrw Yolk, and EInrrison 11atl a n cxcllnngc of vicws with him: "I told
Ili~n," Ilnrrison wrotc in recording t11c interview, "tllat I wanted a very
frank and complete conversation with 11im regarding our present dif-
fcrcnccs in the matter of the purchase of government sccuritics . . . that
it had bccome obviol~sthat tile Federal Rcsct.\.c Board and the dircctors
of the Fcdcral Reserve Bank of New York were rcaching a point in their
views regarding thcir respective powers whcrc'it might liavc very scriot~s
conseqtlcnces unlcss we could come to some sort of a workable under-
standing or agrccmcnt . . . I told him that morc and more tlie noard
hacl taken to itself not supervisory powcrs but the cqui\lalcnt of operatins
.
functions and the responsibility for the detailed transactions of the V-I ~ 'I O ~ I S
.
Fcdcral reserve banks. . ." Harrison then reviewed the Board's veto,
earlier in 1929 for a period of four months, of the increase in the discount
rate the directors of the New York Bank had repeatedly voted; the Board's
decision that year to fix the spread above thc minimum buying rate for
acceptances within which the Bank might operate, although it had never
done so earlier, and, during the fall of the year, its actual determination
of tllc minimum ratc, which had always hccn the Bank's prerogative; and
finally, its stand
thnt we should go to tlrc Fcdcml Rrscrvc Board in advancc for a prior
approval of any tmnsa.ctions in govcrnmcrlt sccuritics . . . I told him that thc
logical conscquence of his point of vicw, which was that the Fcdcral Rescrvc
Donrd shoultl approve of all thcsc t h i n s in advancc, was that thc Fcdcr;ll
Rcscrve Board would become a ccntral bank opcrating in IYashington . . .
[II]is only comment was that the Fcdcral Rcscrvc Board had becn given most
cxtr:~ortlinarily widc pourers, that as long as the Board had thosc powcn, thcy
\vol~lclfccl frce to cxcrcisc. them and Congress could dctcrminc whcther thcy
objccted to having a ccntral bank opcrating in IVashington."
Ncithcr side was prepared to make any concessions until Governor
Young had a meeting with Owen D. Young, deputy chairman of the
board of directors of the New York Bank,.in the office of Secretary of the
Treasury Mellon, the ex-officio chairman of the Reserve Board, on
Novcmbcr 22 to discuss the Board's power over transactions in govern-
" Ibid.,letter, dated Nov. 13, 1329, Young to Harrison.
" Harrison, Conversations, Vol. I, Nov. 15, 1929.
3 65
 T H E GREAT CONTRACTION
tnent scct~rities.Secretary Mellon said h e was willing to give the N e w York
directors tllc widest discretion, b u t h e rcalizcd that the Board had rights
a n d dutics in thc mattcr. Otvcn D. Young said h c saw n o reason-apart
ll.onl s ~ ~ t l d ccritical
tl c n l c r ~ r n c i c . ~; ~. l , o ~wllicl~
~t t h r r c was no clisputc-his
l o b t a i t ~tilt. c.otlsc.tlt o l t11t. Ilo;~rtl to ;\I1 rll;ljor tr:111~-
cIil.cctors c o ~ ~ l cnot
actions. Got r r n o r Yoling rrl~lircltl1:lt w ; ~ sj~lstwllat tllc Ilo;~rtl\ ~ a n t c c l . ' ~
T h e next day, Novctnber 23, Governor Young ailcl Sccrctary Mcllon
tllct \\.it11 Harrison, w h o statcd that "tvc in New York wcrc willing a n d
prcparcd to operate any policy agrccd upon cithcr for o u r own account
o r for the System account." Young ans\\,erc.d t l ~ q th e was prcparcd to
appr0t.c without reservation the O p c n M a r k e t Invcstmcnt Colnmittcc's
rrcolnmendation of Novcmbcr 12, but first wantccl to know
where this would leave the dcbatcd question of thc Ncw York bntlk's
oprrating for its own account. I [I-Iarrison] told him that I fclt that this il~volvctl
a mattcr of procedure and jurisdiction which I woultl likc to lcavc for dc-
rrrtnination sornctime latcr on when we wcrc through this critical pcriotl ant1
\\hrtl \vc could work out some mutually satisfactory proccdurc when contli-
tions and pcoples' cmotions wcre in a quictcr and morc normal stntc. I then
maclc this proposition: That if the Fcdcral Rcscrvc Bonrd woctltl appmvc
thc Opcn Markct Investmcnt Committce's rcport \vithout q~~alification, leaving
i t to the cornnlittce to execute, I would rccommcnd to our dircctors on next
\Vcdnesday [Novcmbcr 271 that the Pedcral Rcscrvc Dank of Ncw York rc-
fmitl, until such timc as it and the Fcderal Rcscrvc Doard might forml~latc
sornt. nlr~tually satisfactory procccl~trc, from purchasing gotrrrrlnIcnt scr~tritirs
for its o\\m account as a nlattcr of gcncral crrdit policy without thc Doartl's
nl~proval.
As a rcsult o f this understanding, the Board reconsidered, Novcmber 25,
a n d \.otcd to approtVet h e Committee's recommendation a n d thc policy
olltlinrd in the resolution o f the directors of the N e w York Dank.x1 Al-
tllo~lgli nutllori-lc~clto p~trchasr.$200 million, tllc Committee purcllasccl
only $155 million between Novcmbcr 27, 1929, a n d Janlrary 1, 1930.
I n response to inquiries from othcr Danks about the N e w York
purchases d u r i n g the week of t h e stock market crash, Harrison wrote a
long letter to all governors o n Novcmber 27, describing the situation in
N e w York a t the time, esplaining t h e reasons for the measures thc Bank
took. a n d defending them. S o m c governors supported the action ant1 cx-
" Hamlin, Diary, Vol. 17, Nov. I?, 13, 22, 1929, pp. 13, 17, 20-22, 3 1-32.
" Thc motion to approvc was passcd 5 to 3, the Sccrctary of the Treasury and
thc Comptroller voting with Govcrnor Young, Vice-Govcrnor Platt, and Hamlin.
hliller objectcd on the ground that "rnoncy was now cheap and would be made
cheaper by thc purchase of Governmcnt securities" and that i t would bc bad
Fedcral Rcscrvc policy--"abdication in favor of the Fedcral Rcserve Bank of New
York." Thc two othcr ncgativc votcs wrrc cast by Boarcl mcmbers Etlwartl Cun-
ningham, an Iowa farmer, and Ccorgc Jnmcc, a hfcml~hisrncrct~ant (scc scction
7, below). Harrison, h.lisccllancot~s,Vol. I, letter, datcd Nov. 25, 1323, Y o u n ~to
Harrison; Officc, Vol. 11, mcmorandum of Nov. 25, 1929; Iiamlin, Diary, Vol.
17, Nov. 24, ?5, 1929, pp. 35-36, 38-40.
366
T H E GREAT CONTRACTION
prcsscd willin,qrss to participate in the purchases. O t h e r s criticized the
action o n t h c ground t h a t it mcrcly delayed "natural liquidation" and
hence r e c o v ~ r y . ~ ~
I'hc situation wllicli confrontcd the Ncw York Dank during the first
few wccks after tltc craslt was to rccllr during thc succeeding years of
tllc contraction: it ltad a policy, wllicli t11c Board o r t h c otllcr Ijanks
w o ~ i l dnot approvc, o r would approvc only reluctantly after protracted
discussion. A t the tirnc of tllc crash, New York wcnt a h c a d o n its own.
T l l o u g l ~the Dank thcn yiclclcd to thc Board in N o ~ , c m b c r1929, later on
it again considcrcd Illit, as we sllall scc, did not adopt, the altcrnativc of
ignoring tllc Systcm account and purchasing for its own account, as i t
had in October 1929.
F r o m the timc of the crash on, t h c Ncw York Dank favored the rcditction
of disco~lntratcs a n d purchase of bills a n d sccttritics in sufficiently large
amounts to onset reductions in discounts. T h e directors of the Ncw York
Bank apparently votcd to rcducc the discount r a t c from 5 p e r ccnt to
4 % pcr ccnt for thc first timc o n Novcmbcr 14, 1929, a n d the Board gave
its approval. O n January 30, 1930, t h e dircctors votcd to reduce the rate
to 4 per c c n t ; t h c Board disapprovcd by a tic vote. O n February 7, the.
rcd~lctionwas again votcd by t h c dircctors a n d o n t h c first vote by t h c
Doard again lost o n a tic votc. O n e m c r n l ~ c rthcn changed his votc to
afirmativc, not bccausc h c approved tile rate redilction, b u t because h e
disapprovcd dcfcat of a motion on a tic votc; so t h e rcduction was a p -
proved. T l l c reduction of tllc ratc to 3% per ccnt o n M a r c h 14 was a p -
parrntly al)])rnvc~tlIly t / ~ ( *I3oartl tllc first t i m r tllc clircctors votrcl it. 0 1 1
April 24, tllc c1ircctot.s votcd to rc<l~tcctllc cliscount rate to 3 pcr c c n t ; tltc
rcduction was disapprovcd by t h c Doard. I t was votcd again o n M a y 1,
wit11 tllc dircctors this time even considering but deciding against a pul>lic
statcmcnt if t h c Board should again disappro\v. Howcvcr, the Doard a p -
proved it. Similar repeated delays wcrc encountered in getting Board
approval of rcd~tctionsin bltying rates o n bills.nc
rIarrison, Miscellanco~~s, Vol. I, Nov. 27, 1929; for criticism, sce Notes, Vol.
I, rnccting of cxcr~~tivc co~~~rnittcc,
June 9, 1930.
"For thc tirnc I,erore Apr. 17, 1930, the first date of minutes of dircctors' meet-
ings of thc Ncw York Rrscmc Bank in thc lIarriso11 Papcrs, wc haw rclicd mairlly
on 'Iarnlin's Diary for stalctncnts allout delays in Board allproval of Ncw I'ork's
rcqursts for recluctions in cliscount ratcs. IIarnlin simply notcs tllc Board's appro\,al
on Nov. 14, 1329, witholtt inclirating whctl~crthc motion to rcducc was hclorc thc
Iloard for ~ l r rfirst tinlc. IIc doc-s not rcfrr to thc reduction in tllc ratc, clrcctivc
hlar. 14, 1330. (Sce IIatnlin, Diary, Vol. 17, Nov. 14, 1929; Jan. 30, Fcb. G,
Apr. 24, May 1 , 1330, pp. 23, 07, 97, 133-141, 145-146; also Ilarrison, hlisccl-
lancous, Vol. I, lettcr, dated Fcb. 5, 1930, Ifarrison to all govcrnors; another letter,
367
 THE GREAT CONTRACTION

Nc\v York had cvcn less succcss in winning approval of its rccom- 1 , bankers'. a c c ~ p t a n c e s As
. ~ ~in 1929, New York hoped to be able to accoln-
plish through tllc purchase of bills what i t might not be able to pcrs~latlc
mcndations for opcn market purcliascs. Aftcr the purchascs in tlic final
I months of 1929, \\.hich \\.ere in accord with tlme unial seasonal pattcrn of the rcst of thc System to do through transactions in go\.crnmcnt sccuritics.
Unfortunately, Ncw York was not srlcccssf~~l with its altcrnativc.
incrcasc in Fcdcral Reserve credit outstancling, the Opcn Markct In\.cst-
At its first mccting in May 1930, tlic Opcn Mnrkct Policy Confcrcncc
mcnt Committce \\.as most reluctant to cngagc in further purcl~ascs.
made no recommcndation but left limited authority in ttlc llands of tllc
Somc mcml~crs\\.crc in fa\,or of selling government sccuritics in thc usrlnl
cxccutivc comniittce. Early in June, I-inrrison rccommcndcd t l ~ a t thc '
pattern of tllr post-Christmas season. T h e final ~ c c o ~ n ~ n c n d a t iofo ntllc
System undertake thc purchase of $25 million a \\,cck for a t w o - ~ c c k
Tn~munlynmccting of thc Committcc \vns that "no open markct oprrations
in Go\.crnnlrnt scc~lritics[\\.crc] ncccssary at t l ~ i sti111r c.itlicr to lialt or l o
trial pcriocl, arguing that "small pl~rchascsof Covcrnlncr~tsccuritics at
this time could d o no liarm . . . and might bc dcsir~al~lc,"and, as i l l
cspcditc tllc prrccnt trcncl of crrdit."!"
carlicr years, suggesting tliat sccurity porcl~ascsbc resorted to only if
I n early Afarcll, concerned about tllc \\eorscning of t l ~ ccconomic situa-
basing through the acceptance market failed. T h e recommcndation to
tion and the inability of the New York Rank to maintain its bill portfolio,
purchase was much mildcr than the statements at the meetings of the
the directors of thc Bank votcd to authorize purchase of $50 million of
New York directors, and the amount rcconlmcnded was much smallcr
g-o\.ernment sccnrities. T h e purchases were carried out after approval by
than tlmcy thought desirable. Indeed, "there was some rcluctancc" on t l ~ c
the Boarcl and a circular lettcr to all Bank governors asking \vhcthcr thcy
, part of the New York directors "to acccpt this program on tlme grounds
wanted to participate. When the Opcn Market Committee mct formally
that our difficulties of crcdit administration have grown 1ar.geIy out of our
!at the end of March, it concluded that "at present there is no occasion
clisposition to postpone action and to administer remedies in homeopathic
for further purchascs of Government s e c ~ r i t i e s . " ~ ~
doses." Apparently, however, Harrison felt that a bold program was ccr-
: T h a t was the final meeting of the Open Market Investment Committee.
tain to be rejected and preferred agreement on a small program to rejcc-
I t was replaced by the Open Market Policy Conference of all twclve Bank
tion of a large one. A majority of the executive committee and of gov-
governors, with a n esccutive committee consisting initially of the same
crnors agreed (after being consulted by teleplione or tclcgram), thc Board
fi\.e go\.ernor~\~lmo had constituted the Committce (Ncw York, Boston,
approved, and the purchase was made. A decline in the System's bill
Chicago! Clcvclnnd, Pl~ilaclclpliin).n u t tllc csrcutivc committcc was in a
Imoldings during the two weeks largely offset the effect of the p u r c h a a of
different position from thc fommcr Committcc. I t was cntrustcd with
,government securities, so, on Junc 23, Harrison suggested that pur-
csccuting policy decisions of thc Confcrcncc; it did not, likc thc carlicr
chases contirnlc in the amount of about $25 million a week. This time, tlic
Con~mittce.both initiate and csrctltc policy. T l ~ cConfcrcncc itself rc-
cxccutivc committcc rcjcctcd the rccommcndation by a vote of 4 to
mnincd a \.ol\~ntaryorganization of rqrlnls. E n c l ~Ilnnk \\.as f r c ~to clrcitlc
Faced with a clear rcjcction of its Icadcrship, the Ncw York Bank
\vlictlicr i t \\,otllcl or \\,orlld not ~nr.ticil>ntrin a lxll~cl~nsc~or snlc rccom-
considcrcd thrrc altcmativcs: ( 1 ) simply to accede withor~tfurtlmcr action
mcndcd by tlic Confcrcncc, tho11~11 disscn~c~.s \vc*rc rc-q~~i~.rtl
to accltlnint .
in the hopc that its views would eventually prevail; ( 2 ) to "withdraw
~

tlme Fcdcral Reserve Board and the chairman of tlic csccuti\se committrc
\\.it11 thc reasons for not participating. Each Dank also rcscrvrd thc
option to \\.ithdr.n\\*fro111tile Confcl.ence. XCIVI'ork \\.as not at all Iiapp!t
about the change and consented to it reluctantly and only \\it11 tlic cs-
plicit proviso that the Conference had no authority over transactions in
dated hlar. 17, 1930, Case to Go\pernor Young; and a lcttcr, datcd Apr. 29, 1930,
Harrison to Platt: Notes, Val. I. .4pr. 24, hfay 1, 1930.)
At the Opcn 3farkct Policy Confercnce meeting on Afay 21-22, 1930, Govcrnor
Harrison reportcd t h a t "in a n u m b e r of rcccnt \vecks t h e Fcderal Reserve Board
hnd failed to appro\.e without dclay al,l~lications of tllc Fcdcral Rcscr\.c Dank of
Kciv York for a lower n i i ~ i i m ~ ~buying
m rntc on bills, and that for consideral)lc
periods thc New Irork b a n k liad thercforc bccn without a n y downward flexibility
in its bill buying rate as was the casc a t that vcry tin~e"(O)>cnhlnrkct, Vol. I ) .
'' Ibid., minutes of meeting, Jan. 20-29, 1930.
Misccllnt~eorts,Vol. I! Icttcr, datcd hlnr. 7, 1930,' Case to all governors; Opcn
Markct, Vol. I , m i n u t a of mccting, h l a r . 24-25, 1930.
368
from the . . . Conference and, assuming that thc approval of thc Federal
Reserve h a r d either can be or necd not be sccured, purchase Govern-
ment securities for the account of this bank"; ( 3 ) to conduct a c a m p a i , ~
of persuasion. T h e Bank adopted the third alternative, perhaps partly
because Harrison had lingering doubts about the validity of New York's
mCommenting the following year on t h e change, Hamson was recorded by
Hamlin as saying that "he had always felt i t was a mistake to put all thc Co\.ernon
on the Opcn Market Policy Conference; that the Governors came instructed by
their directors; that u n d e r the formcr System the Exccuti\~cCommittee werc ne\.cr
so instructed" (Hamlin, Diary, Val. 19, h u g . 1931, p. 123). Sce also Harrison,
Opcn Markct, Vol. I, minutes of meeting, Mar. 24-25, 1930; Notcs, Vol. I, hlay 1,
1930; Opcn Market, Vol. 1, letter, dated May 15, 1930, Care to Young.
"Harrison, Opcn Markct, Vol. I, minutes of meeting, May 21-22, 1930;
Misccllancous, Vol. I, telegram, datcd Junc 3, 1930, Harrison to Young; Notes,
Vol. 1, June 5, 1930; Open Market, Vol. I, Junc 23, 1930.
369
 T H E GREAT CONTRACTION
position. As thc rcport on the rclcvant dil.cctors' mccting has it, thc clcci-
sion to adopt the third altcrnativc was influenced by thc csistcncc of a
"rcal differcncc of opinion among those dccmcd capable of forming a
j ~ ~ d g n ~ cas
n t to
, the power of chrap and abundant crcdit, alone, to bring
about improvement in busincss and in commodity p r i c c ~ . " ~ l
I n July 1930, Harrison accorclingly wrotc :I lonz lcttcr to all governors,
telling tliem his directors "felt so earnestly the nccd of c6:ltinuing pur-
chases of govcrnmcnt securities that thcy have suggcstrd that I writc to
you or~tliningsomc of thc reasons why thc Fcdcral Rcscrvc Bank of Ncw
York lins for so many m o ~ l t l ~fn\:orrtl
s Ilnving thc Frtlrrnl Rrsc,rvc: Systrm
tlo cvcrYtlling possible ancl w i ~ l ~ iits
n powc.r to facilitate ;I rocovr1.y of
b~isincss." Tlicrc followed n clost.ly rrasonrtl, infor~nrtl,2nd wcll tlocll-
mcntcd analysis of the economic situation ancl thc problcm of monctary
policy. Harrison strcsscd thc scriousncss of the rcccssion, indicated that
\vhilc thcre werc many othcr causcs of thc rccession, tight rnoncy of thc
preceding two years had contributcd to it, and placed grcatcst iinportancc
on thc depressed state of the bond markct and the limited availability of
[~tntlsfor long-term financing. "In previous br~sincss dcprcssions," hc
wrotc, "rccovery has never taken place until thcre has bcen a strong boncl
markct." Harrison acknowledged that there was little demand for short-
tcrm funcls, and that "when the Systcm buys securities, short-timc rnoncy
bccomcs more plcntiful and chcapcr." Howcvcr, "it has bccn dcmonstratcd
it, the past that in stlch circ~unstanccs,thro~lgha lurthcr incrcasc in t l ~ e
rescrvcs of member banks rnoncy will bc madc available lor the bond
market or shifted to the bond market from thc short time markct or from
otllrr invcstmrnts lcss profitable than bonds." I-lc pointrtl out that Fcclcral
Rcscrvc crcclit hacl dcclincd 2nd tllnt Lanks wcrc scnsitivc to borrowing.
'.[:\In rvcn small nlnount of borrowing ~lntlcr prcsct~t contlitions is as
cflecti\.c a restraint as substantially n grcatcr a m o ~ l n twas a year ago." FIc
concluded that "whilc thcrc may bc no dcfinitc assurance that oprn
markct operations in govcrnmcnt sccrlritics will of themsclvcs promotc
any immediate recovery, we cannot foresee any appreciable harm that can
rrs~litfrom such a policy and bclievc that thc scriousness of thc present
tlt.pression is so great as to justify taking cvery possiblc step to facilitate
in~provcmen t.''92
O n c notable omission from Harrison's letter was rcfercnce to the stock
of rnoncy, as such. Like almost every other document on monetary policy
" Harrison, Notes, Vol. I, June 26, 1930. O n several occasions, IIarrison
revealed doubts (Notes, Vol. I, July 17, Sept. 17, 1 9 3 0 ) . I t is clear from internal
documents of the Bank that the technical personnel, notably W. R. Burgess a n d
Carl Snyder, were the most consistent supporters of expansionary measures on a
large scale. Perhaps because of these doubts, perhaps bccausc of his overriding
desire to secure consensus, Harrison continued to prcscnt to the rest of thc System
purchase proposals scaled down wcll below the level that some of the directors
a n d technical personnel of the Bank regarded as desirable.
'' hliscellaneous, Vol. I, letter, dated July 3, 1930, Harrison to all governors.
370
T H E GREAT CONTRACTION
within thc Systcm until tllc 19501s, thc rmpflasis was c s c l ~ ~ s i ~ on~ c l ~
crcdit conditions rathcr than tlic stock of money, However, the omission
did not affect the policy conclusion; it only altered the line of argilmcnt
tllrough which it was rcachcd. Considcration of the behavior of thc stock
of money would havc Icd to prcciscly the same conclusion: that tlic Sys-
tem should act so as to prcvcnt a rcduction in the amount of high-
powered money availablc and indecd so as to increase it. Morcovcr: as
we saw in section 3, thcrc was a p a r t i c ~ ~ l aclosc r l ~ connection at thc titnc
between thc bond market and tllc rnoncy stock. Improvcmcnt in thc bond
markct would llavc done m~lcli to avcrt the w~bscqumthank faili~rrs.
Ancl tllougl~tl~isconncction was not explicit in the Icttcr, it was implicit.13
I-Iarrison's Icttcr and tllc rcplics to it provide an cxtraorclinarily illuminat-
ing ant1 comprclicnsivc pictcirc of attitudes toward rnonctary matters
within thc Systcm. Only two governors-Eugene Black of Atlanta and
Gcorgc Scay of Richmond+lcarly and ilnambiguously agreed wit11
Harrison's analysis and supportcd his policy rccommcndations. T h c rcst
disagreed, most of thcm sharply.
James McDougal of Chicago wrote that it secrned to him thcre \\*as
"an abr~ndanccof funds in t11c markct, and under thcse circurnstanccs, as
.
a matter of prudence . . it should bc the policy of the Fedcral Rescr1.c
Systcm to maintain a position of strength, in readiness to meet futrlrc
demands, as and whcn they arisc, rather than to p11t rcscrvc funds into
rllc markct whcn not ncctlcd." H e went on to strcss tlic dangcr tlint
"speculation might easily arisc in somc othcr dircction" than in thc stock
markct. McDo~lgalhad all along brrn the most or~tspokcnopponent of thc
New Yorli policy and was to rcmain f o r tllc rcst of thc contraction n con-
sisl~bnt1)roponvnt of srllinq xo\.rrnmrnt srcuritirs on almost any occasiorl.
'1'111: cl~.lnnn(lsfor wllicli tllc S y s t c ~ lslio~lld
~ hl~shnndits rcsourccs ronninrtl
i r ~ t11c fut~lrc.Mcl>ougal's outlook \\.as p a r t i c l ~ l a r l inflt~cntial
~ bcca~~sc
Cllicago was ncxt only to Nciv York in importance as a financial ccntcr,
and I~ccauschc had bccn with thc Systcm so long. McDougal had bccn
appointed governor of thc Chicago nank at its founding in 1914, at thc
samc timc Strong was appointccl governor in New York. H c had had
disagrccmcnts with Ncw York on earlicr o c ~ a s i o n s . ~ '
" O n c important advantage of cxplicit attention to the stock of money, both on
that occasion a n d later, would have bccn provision of a clearly dcfincd indicator
by which to judge in quantitativc tcrms thc nccds a n d efTccts of policy. T h c out-
sidcr is struck, in reading the rcports of discussions within thc Systcm, by ttlc
vagueness a n d imprecision of the criteria r~scd. For cxamplc, with the "needs of
busincss" undcfincd, onc participant rcgardcd "crcdit," also undefined, as "re-
dundant," another as "tight." Lack of a common univcrsc of discourse a n d in-
ability to rcducc diffcrenccs of opinion to quantitativc tcrms wcrc
important factors enabling dificrcnccs to persist f o r so long with n o approach to a
mccting of minds.
" Harrison, Misrcllancous, Vol. I , letter, datcd July 10, 1930, McDougal to
FIarrison; I.cstcr V. C l ~ a n d l c r ,Benjamin Strong, Central Banker, Brookings, 1958,
pp. 7 9 , 4 4 5
37 1
 T I I E CREAT CONTRACTION
I John U. Calkins of S a n Francisco w a s n o lcss explicit t h a n M c D o u g a l
\I Lrrs. I n a n earlier letter t o G o v e r n o r Y o i ~ n gexplaining why S a n Francisco
h a d not participated in t h c J u n e o p c n m a r k c t p ~ ~ r c h a s c sh,e h a d statcd
: t h a t "with crcdit c h e a p a n d r e d u n d a n t we d o not believe t h a t business
reco\.cry will bc accelerated by m a k i n g crcdit c h e a p e r a n d m o r e rc-
d u n d a n t . " I n his reply to Harrison's Icttcr, h e repeated t h c sentiment,
esprcssed t h e view t h a t "tlie creation, promotion, or encouragement of a
bond markct" is n o t "\\ritliin t h e province of t h e Fcderal Reserve System,"
a n d t h a t "no encouragement of tlie market for foreign bonds c a n counter-
bnlnnce t h c d e s t r ~ ~ r t i vcffcct
e ~ l p o n.otlr foreign t r a d e of t h e tariff bill
rcccntly approvcd." H c \\.cnt o n to say, "\Z1c bclicvc t h a t thc v o l ~ ~ mof c:
credit forcibly fcd to tlie m a r k e t LIP t o this time has h a d n o considerable
good cffect, certainly n o disccrniblc cffcct in tlic last fcw months. W e also
bclic1.e t h a t cvcry time wc inject further c r r d i t \vithout apprcciablc effort,
wc diminish t h c probable ad\.alltaqc of fcccling niorc to tllc ninrkct a t a n
opportune m o m e n t which m a y r ~ m e . " " ~
L y n n P. Tallcy o f Dallas wrote t h a t his directors were not "inclinr(1 to
c o ~ ~ n t e n a n cme u c h intcrferrncc with economic trends through artificial
mctliods t o composc s i t ~ ~ a t i o ntllat s in thcmselvcs grow o u t of events
reco_pized a t t h e time as being fallacious"-a reference t o the stock
m a r k c t speculation of 1928-29, Tallcy's Icttcr, like some others, rcveals
rcscntmcnt a t N e w York's fni111re t o carry t h e d a y in 1929 a n d t l ~ efeeling
t h a t existing difficulties were t h c proper p ~ ~ n i s h m e nfor t t h e Systcm's
past misdeeds in not checking the bull market. "If a physician," wrote
T a l k y , "either neglects a patient, o r even t h o u g h he docs all h c c a n for
t h e patient within t h e limits of his professional skill according to his bcst
judgrncnt, a n d t h e patient dies, it is conceded to he q u i t e impossible t o
bring t h e patient back t o life through t h e use of artificial respiration o r
injections of adrenalin."D6
\ W. B. Geery of Minneapolis wrote t h a t "there is d a n g e r of stimulating
1 financing which will lead t o still m o r e overproduction whilc attempting.
,'
to m a k e it easy t o d o financing which will increase c o n s ~ m p t i o n . " ' ~
George LV. Norris of Philadelphia replied t h a t discussions with a n
insurance c o m p a n y executive a n d with a private banker in Philadelphia
h a d confil.med h i m in his o w n vicw "of t l ~ cfl.uitIcssncss a n d tlnwisdoln of
a t t e m p t i n g t o depress still furtllcr t h e abnormally low intcrcst rates now
prcvailing." L a t c r in t h c year, a t a meeting of tlic O p c n M a r k c t Policy
Confcrence in September, Norris, in strong disagreement with w h a t he
regarded a s t h e c u r r e n t policy of tlic Systcrn, read a lengthy m c m o r a n d u m
summarizing t h e Philadelphia view. T h e Philadelphia Bank objected t o
hiiscellaneous, Vol. I, lettcr, dated June 16, 1930, Calkins to Young; lettcr,
dated July 10, 1930, Calkins to Harrison.
" hiisccllancous, Val. I, letter, datcd July 15, 1930, Talley to Harrison.
" Ibid., letter, dated July 7 , 1930, Gee? to Harrison.
372
T H E CREAT CONTRACTION
"the present abnormally low rates for money" as a n interference "with
the operation of the n a t u r a l l a w of supply a n d d e m a n d in t h e money
markct . . ." a n d concluded, "this is a complete a n d literal reversal of
...
t h e policy stated in the Board's T e n t h A n n u a l R e ~ o r t W e h a v e been
p u t t i n g o u t credit in a period of deprcssion, whcn it w a s not w a n t e d a n d
could not be used, a n d will h a v e to witlidraw credit w h e n it is wanted
a n d c a n be u s ~ d . " ~ ~
T h e s e views, which seem t o us confused a n d misguided, were by n o
means restricted to t h e Rescrve Systcm. T h e Fedcral Advisory Council,
whose members wcrc leading bankers t h r o u g h o u t t h e country, consistently
acloptcd rccommcndations cxprcssing t h e s a m c point of \.icw, usillg
plirascs s ~ ~ cas,h "the present situation will be bcst s e n f e d i f t h e natural '
flow of crcdit is t ~ n l l a m p c r c dby open-markct opcrations."" INo\\*c\rcr,e\,cn
in t h e financial community, t h c Ncw York Rcscrve Dank was not alone
in its vicw of t h e situation. T l l c July 1930 monthly lcttcr of the Royal
"IIarriron, Misccllancorls, Vol. I, lcttcr, datcd July 8, Norris to IIarrison;
Open hfarkct, Vol. 1, mcmorandum rcad by Norris at Sept. 25, 1930, mccting.
'I'lic ~ricnioratitl~lrnis such a rcmarkably clcar statcmcnt of the real bills doctrine
that was so widcly acceptcd at thc time and earlier that i t is worth quoting at
Srcater Icngth. The policy which had
created artificially low interest rates, and artificially high prices for governmcnt
..
sccuritics . is an injustice to our member hanks. It had resulted in making
open markct operations usurp thc discount function, and tcnds to fostcr thc
regrettable impression that there is some clcmcnt of impropriety in borrowills
by member banks ... [A], the result of injecting a large amount of unaskcd
and unneeded Fedcral Reserve crcdit into an already glutted money markct, we
find ourselves with over 600 millions of governments on hand, the bulk of which
must ultimately be disposed of . .. We do not undertake to say how much
Fedcral Rcscrve credit lhould be in use today, but we do hold to the belief that
a substantial part of it should be the rcsult of a demand exprcssed in borrowing
by n~rmberbanks, and used in cooperation with those banks. 1.ess than one-
sixth of i t is of this character today.
In addition to the letters quoted, and the two from Black and Seay, a bricf
fetter was sent to Harrison by 0. hi. Attcbcry, deputy governor at St. Louis, on
behalf of Governor Martin, on vacation, expressing doubts and stating that condi-
tions in the Eighth District providcd no justification for further opcn market pur-
cliases (Miscellaneous, Vol. I, lcttcr, datcd July 9, 1930). Frcdcric H. Curtiss,
chairman of the Boston Bank, sent a lengthy lcttcr datcd July 9 (the Boston Bank
at the time had no governor, Harding having died in April, and Young, still
govcrnor of the Board, not yet having becn appointed to fill thc Boston Bank
vacancy). Curtiss' lcttcr cxprcsscd strong opposition to furthcr p~lrchaseson thc
ground that they wcrc likcly to fccd the stock markct rather than the bond markct.
Only the Fcdcral Rcscrve Bank of Cleveland did not rcply, but its govcrnor
acknowledged the letter by telephone. In a letter to Governor Young, Harrison
summarized the views exprcsscd by Governor Fancher of Cleveland on his own
behalf and as spokesman for a majority of his directors, "that continued purchases
.
of government sccuritics would not contribute substantially to . . reco\?ery and
that, therefore, they would. not . . . favor further purchases" (hfiscellaneous, Vol.
I, Icttcr, dated July 23, 1930, IJarrison to Young).
" Quoted from recommendation, dated Nov. 18, 1930 (Federal Reserve Board,
A n n u a l Report for 1930, p. 2 ? 0 ) .
373

T l I E CREAT C O N T R A a I O N
Dank of Canada concluded that "imrncrlintc and dccisivc action on tllc
~ n r of
t thc Frdrral R r s c n ~ cBanks in putting new funrls into t l ~ cnlnrkct
in large volrrmc is \+ellat is ncccssn1.y to nrrcst tllc I)rc.scr~tsc.rio~rsn r l t l
protrnctcd price decline and to changc the prcscnt ~ ~ s y c h o l oofq I)~~sincss."
O n c cannot rcad tllc corrcspondcncc witll Harrison just rcvicwcrl, tllc
t copen
~ n i n ~ ~of s markct mcctings, and sinlilar Rcsrrvc Systcm documcnts
\vithout /Icing imprcsscd with thc extraordinar). d i f f ~ r c n c cbctwccn
s NCW
York and most of thc othcr I\anks in tllc Icvcl of sopllistlcation ant1
understanding a l ~ o u t monetary mattcrs. Years of primary and direct
rcsi~onsil)ility for tllc concluct of monetary policy in the central moncy
market of thc country and of cooperation with men similarly placcd i l l
the other leading money markets of thc world had dcvclopcd in t l ~ c
technical personnel, officers, and directors of thc Ncw York Dank a
~)rofoundawareness of monctary relations and a sensitive recognition of
tile effects of monetary policy actions. Those q~lalitieswcrc clcarly abscnt
nt 111ost otllrr Rcscrve Ranks, which had of necessity Ixcn conccmcd
~)riln:lI-il~ \vitll local and I-cgional mattrrs, or at tllc Fcdcrnl Rcsvrvc
I30nr.d~\).hicll had playcd only a minor rolc in the gcncral conduct of
policy and had had no important operating functions.
T h c largely n e ~ a t i v eresponse evoked by Harrison's lcttcr induccd Ncw
York on sc\.ernl occasions during July to consider again engaging in
open lnarkct purchases on its own but with the approval of the Roard, and
Harrison s o ~ ~ n d cout
d the scntimcnt of the Board about such action. T h e
rcsults wcre sufficicntly unfavorable to detcr any attempt.loO
By Scptcmbcr, 1930, some of the Banks wcre even opposed to scasonal
casing. As Harrison told his directors,
Somc of thc othcr Fcdcral Rcscrvc Ranks, including pcrhaps a majority of thc
bnnks whose governors form the exccutivc committce of thc Systrm Open
hfarket Policy Confercnce, advocate a policy of corrcction rarhcr tllal) of an-
ticipation. They would allow tightening of thc moncy markct and hardening
of ratcs of intcrcst to dcvclop, and thrn wo~lldmovc to corrcct thc situation
tl~rouglrtlrc purchasc of Govcrnmcnt sccuritics.
A few days latcr, \\,hen Carl Snyder, at a meeting of the oficcrs' council
of thc Ncw York Bank, suggcstcd that "this deflation should now bc
aq~scssi\,clycombatted by additional purchascs of Govcrnmcnt sccuritics
. . . ," Harrison replied that "from a System standpoint it is a practical
i~npossibilit~to cmbark on such a p r o p a m at the present time-to do so
\vould mcan an actixpe division of System policy."lO'
Dcspitc tllc dcclinc in Fcderal Rcscrvc cr.cdit outstanding, thc noard
dcscribcd its policy for tllc year 1930 as one of "monctary case . . . ex-
pressed through the pcircllase a t intervals of additional. Unitcd Statcs
Irn Harrison, Norcs, Vol. I, July 10, 24, 1930; a n d Office, Vol. TI, June 5, 1930.
lo' Notes, Vol. I, Sept. 11, 17, 1930.
374
I
T H E CREAT CONTRACTYON
Govcrnmcnt sccuritics and in rcductions of rcscrve bank dis-
I count nncl acccptancc r a t c ~ . "This ~ ~ ~ is a striking illustration of thc
ar~ll,i,ql~i~y of tlrc tcrms "monctnry C;LSC" ant1 "tigt~tncss" and o f thc nc&l
strcssrcl ahovc ( p . 272) to interpret Frdcral Rcscrve actions in the light
I of all tllc forces affecting t11c stock of monry and crcclit conclitions. It
I
srvms pnracioxical to dcscribe ns "monctary casc" a policy which prrmittrcl
thc stock of moncy to dcclinc in folrrtccn months by a pcrccntagc rs-
c r t ~ l r t lonly four timcs in tlrc prcccding fifty-four yrnrs nncl thrn only
c l ~ ~ r i nrxtrcmcly
g srvcrc business-cyclc contractions. And thosc \vortls
srrm csprcially paracloxical whrn othrr factors wcrc trncling to rxpnncl
thc monry stock, so that a potential cxpansion was convrrtccl into an
actrral contraction entirely by thc dcclinc in Fcdcral Rcscrvc crcclit out-
standing. -
I n thc contcxt of the chanycs thrn occurring in the economy and in the
moncy markets, thc policy followccl shor~ldhe regarded as one of monctary I ,'
"ti,qhtness" not "casc." Dlrring a pcriocl of scvcrc economic contraction
cxtcntling ovcr morc than a yrnr, thc Systrm w.u content to Ict its dis-
colrnts clcclinc by ncarly twicc its net purchascs of govcrnmcnt sccuritics,
ancl to lct its total crcclit outstanding dcclinc by almost three times the
incrcasc in thc gold stock. Through carly 1932, the most striking feature
of thc Systcm's portfolio of govcrnmcnt scc~rriticsand bills bought is the
usual srasonal pnttcrn of contraction during thc first half of thc ycar and
cxpansion clr~ring the sccond. From Au.grst 1929 to October 1930, thc
wliolc incrcasc in govcrnmcnt sccuritics plus bills bolrght camc in thc
second half of 1929. T h c Systcm's holdings of government sccuritics plus
bills bought wcrc nearly $200 million lo\vrr at thc end of J11ly 1930 than
thvy wcrc at thc rncl of Dcccmbrr 1929. E\.rn a mcchanical contin~lntion
of the Systrm's cnrlicr gold stcrilizntion program, by which it had qrritc
explicitly rccognizcd thc ncrcl to cletcrminc its actions in light of othcr
factors outsiclc its control, \\~o~rlcl hnvc calircl for more vigorous cxpan-
sionary action from August 1929 to Octohcr 1930. Such action ~vould
hnvc limilrcl thc dcclinc in Fcclcral Rcscr\gc crcdit outstanding to $210
nill lion, the magnitude of the risc in thc gold stock, insteacl of allowing
the actrrnl sc.asonally acljtrstcct clcclinc of $590 million. As wc rcad thb
cnrlicr policy statrmcnts of thc Board, they callcd for soing beyond
mcchanical gold stcrilizntion in vicw of contcrnporary cconomic condi-
tions. Sincc thc b~rllmnrkct in stocks had collapsccl ancl thcrc wcrc no
signs of anythin: approaching spcculation in commoditirs, any cxpansion
in crctlit w o ~ ~ l bc c l likrly to be, in the words of the T e n l h Annunl Rrporl
(for 1323), "rcstricted to productive t ~ s c s . " ~ ~ ~ J
'"Fcdcrnl Reserve Board, A n n u n l R e p o r t lor 1930, p. I .
'OfI t should be noted, howcver, that thc possibility that easy money conditions
might stimulate speculative cxccsses in thc stock markct was a recurrent theme in
375
 T H E GREAT CONTRACTION
T h c stalemate within t h c System c o n t i n ~ ~ c cwl ,i t h only minor variations,
t h r o u g h o u t t h e n e s t year. Harrison was prcsscd o n thc o n e sidc by his
officcrs a n d directors-though less consistently by thc directors t h a n in
t h e prcccding ycnr-to \vork for grcatcr easing a n d largcr purcl~ases.O n
the o t h c r sidc, he fclt strongly his responsibilitics, as chairman of t h c O p e n
hfnrkct Policy Confcrcncc, t o carry o11t loyally t h e policy acloptrd by t h e
Conference. T h c o n e m a j o r diflerencc in t h e situation ;vas t h c replace-
m e n t of R o y Y o u n g by E u g e n c Mcyer a s govcrnor of the Fcdcral Rcserve
Donrcl. Y o u n g became go\.crnor of thc, Doston Rank in Septcmbcr 1930
a n d , a s such, was a m e m b e r of t h e esccutivc committee of t h c Confcrcnce,
whcrc h e joined M c D o ~ ~ g in a l consistently'opposing purchascs a n d favor-
ing sales.104 M e y e r w a s generally favorable toward purchascs a n d , not
having g o n e t h r o u g h Harrison's frustrating experience of 1930, inclined
t o press strongly for them.
T h e J a n u a r y 1931 mccting of t h c O p e n M a r k e t Policy Conference
brought o u t clearly t h e changes in t h e situation. F r o m O c t o b c r t o m i d T
Deccmbcr 1930, there h a d been virtually n o changc in t h e Systcm's
holdings of governmcnt securitics. T h e banking difficu!ties in N c w York
following t h c failure of t h e Bank of U n i t e d States in t h e second week of
Dcccmbcr nccessitatcd purchase of $45 million of govcrnrnent securitics
by t h c N e w York Reservc Dank for its o w n account. T h c y were bought
from t w o banks undergoing heavy withdrawals of currency in o r d e r to
enablc t h c ~ nt o a\.oid borrowing. I n addition, $80 million of govcrnmcnt
securities w e r e purchascd for System account, as Harrison esplaincd, "in
o r d e r t o avoid too grcat tightening of credit d u e t o a n unusual a m o u n t o f
'window drcszing'." T h e ptlrchnsrs wcrc mncle in accorclance with t h c
authorization by tllc Confcrcncc mcctinq o n S c p t c m b c r 25, 19.70, as a
cnrnpromizc I~c,t~\.ccn tlic, n t l ~ m c n t r sof "nntic.ipntion" ant1 "cnrrrction," of
p11rcl1nscs 1111 to $100 lnilliot~ for srn\on:~l ( ~ : i \ r . " ' A t its J : i t ~ ~ ~ : i r1931
y s~antling tlrat the New York I>atik worrld keep in close cornm~rnirntinn wit11 t l ~ r
the deliberations of the period, e.g., Harrison, hliscellaneous, Vol. I, letter, dated
hfar. 17, 1930, J. H. Case (chairman of the New York Bank) to Governor Young;
Notes, Vol. I, Apr. 24, 1930; ~liscellaneous,Vol. I, letter, dated Apr. 29, Harrison
to Platt; ibid., letter, dated July 10, 1930, J. B. hlcDouga1 to Harrison.
'"According to Hamlin, Young was eased out of his position on the Board be-
calrse of the administration's disappointment with his leadership. If so, the result
could hardly have been the one intended. As governor of the Boston Bank and a
member of the executi\.e committee of the Conference, he may well have been in a
Dosition to exercise a stroncer influence on open market operations, the key area in
which policy had been a<d continued to be utisatisfactory, than he could have
exercised as governor of the Federal Reseme Board (see Hamlin, Diary, Vol. 18,
Sept. 4, 6, 24; Oct. 3, 10; Nov. 24, 1930, pp. 67, 70, 84, 89, 91-93, 118-119).
" See Harrison, Open Market, Vol. I, minutes of meeting, Jan. 21, 1931, in
which Harrison reviewed changes in the money market since the Sept. 25, 1930,
meeting. See also a memorandum, prepared for Harrison by W. R. Burgess, dated
Dec. 19, 1930, referring to the absence of change in the System account between
Sept. 25, 1930, and the date of the memorandum. The purchases by New York up
376
T I I E GREAT CONTRACTION
mccting, t h c O p c n M a r k c t Policy Conference recommcndcd t h a t "it
woulcl be desirable to dispose of some of t h e System holdings of govern-
m c n t sccurities as a n d whcn opportunity affords itself t o d o this \vithout
disturbance o r a n y tightening of t h e money position,"lw W h e n t h e m e m -
bcrs of thc Rescrve Board m c t subsequently with the governors, both
Adolph Miller a n d Eugene Mcyer objected. Harrison, in his capacity as
c h a i r m a n of t l ~ cConfcrcnce, clcfcnded t h c recommendation o n t h c g r o u n d
t h a t it "represented a compromise since some of those present werc in
favor of considrrablc salcs of securitics, while others were only in fn\.or
of such m o d c r a t c salcs as might bc necessary to take u p t h e slack." hCcycr,
xnsitive t o political repercussions, stated t h a t
a rccluction of bills and discounts of the System did not involve t l ~ r
launching of any major policy, whereas the sale of governments is commonly
intcrprcted as a major move in Federal reserve policy. T h e Reserve Systrn~
has bccn accusccl in n ntrmbcr of quarters of pursuing a deflationary policy in
thc past ycar, and a sale of govcrnmcnt securities at this time is likely to draw
firc. In this situation it would appcar most desirable to avoid a move which ap-
pears to prcscnt a major change in policy when there is no ncccssity for
doing it.
Dcspitc Mcyer's rcservations, t h e Board a p p r o v e d t h e Confercncc's recom-
mendation a n d , by February 1931, security holdings h a d fallen by $130
million,. although there was concern a b o u t t h e associated tightening of
t l ~ cbond market.Io7
to that date were only $40 million from one large bank. The purchases for System
account after Dcc. 20 wrre matle by Ncw York at its own tliscretion, thr exccu~ive
committee at a mccting on that (lay in Washington with Go\,ernor Xfeyer ant1
sevcral Board mernhcrs ha\'ing afircetl "to Ica\.e i t to the judgmrnt of lhc Frtlrrnl
Rcservc Bank of New York whether some additional amount of xo\,crnrr~ent
srruritirs rtroultl be purchaactl wi~liin thc $l~0,000,000n~rthoritywith r t i r . 1rnt1r.r-
rncrnhers of the committee" (ibid., minutes of executive committee rneeting, Dec. 20,
1930).
'-The original resolution as passed had the word "undue" (Inter deleted) be-
fore "tightening."
IW Harrison, Open hlarket, Vol. 11, minutes of meeting, Jan. 21, 1931, and
letter, dated Jan. 23, 1331, hlcClelland (for Board) to I-Iarrison, approving the
recommendation; Notes, Vol. I, Jan. 15, 13, 22, 1931.
A memorandum on the Open Market Policy Conference meeting of Jan. 2 1 ,
1931, written by E. A. Goldenweiser, the Federal Reserve System's director of
research, stated:
Meycr strongly opposes sales of securities beyond the amount bought in Decem-
. .
ber for seasonal ant1 special purposes . . The rest of the governors tlid not
change their minds, but 'were impressed by Mcyer's sincerity and force. It ap-
pears to have been his first bout with the intrenched hard-money crowd of the
Federal reserve system.
The memorandum is part of the Goldenweiser Papers in the Manuscript Division
of the Library of Congress (Container 1, folder of Confidential Memoranda,
377
 T H E GREAT CONTRACTION
I n April 1931, Harrison, as chairman of thc O p c n M a r k c t Policy
Confcrencc, prcscntcd a rcport to tllc Governors Confercncc. H c ex-
pressed great concern about the gold inflow a n d tlic dangers to thc world
of continued gold stcrilization by tlic Unitcd S t a t c ~ . As
' ~ ~to tlic domcstic
situation, lic noted:
\Irhilc it is commonly statcd that moncy conditions h a w bcen cxcccdingly
easy in rcccnt months, and \vhilc indccd moncy ratcs i~nvcbee-n at very low
Icvcls thcrc 113s not bcen ovcr a period of months nny consistcmt s~lrplrlsof
Frdcral rcscrt2r funtls prcssing for 11sr rlpon tllr markrt . . . . 17~lrthrrrnorr,
n p x t fro111 tlir r(.lativrly c:~sy posi~io~l
of t l ~ cI~anksi l l t l ~ c1;lrgc.r c.itic.s, crc-(lit
cannot IN- snit1 to bc \.cry chrap or vrry l~lcnlif~llgc-ncr:~lly thro~lgl~o~lt
coulltry.Io
I-Tnrrison's rcport was discusscd a t thc O p c n M a r k e t Policy Confcrcncc,
t\.hich approved, a t his urging, a thrcc-part program to makc gold imports
morc cffcctivc a n d crcclit more active: maintenance of thc bill portfolio,
i f posciblc; reduction of buying ratcs on bills a n d , lcss dcfinitcly, of dis-
count rates; and-as a last resort, if bills pl~rchasccldid not c n n l ~ l ccarn-
in: asscts to bc maintaincd-authority for thc csccutivc comrnittcc to
p~rrchascu p to $100 million of govcrnrncnt s c c ~ ~ r i t i eTs .h c resolution in-
cluding thc final part of this mild program-thc only part within thc
Confcrcncc's esclr~sivc jurisdiction-was adoptcq with four rrluctant
supporters, threc of t h e four, mcmbcrs of thc cxccutivc c o m m i t t ~ r . " ~
N o purchnsrs \crcrc m a d c ~lnclcrthat rccommrnclntion ~ ~ n tnftrr i l n J~lnc
23 m c c t i n ~of tlic c s c c ~ ~ t i \ lcomrnittcc,
c a t which I-Inrrisnn r ~ r g r t lpllr-
chnscs of $50 million. Mcycr, who was prcscnt a t thc mrcting, strnnqly
s 1 1 ~ ~ o r t cI-Tnrrison,
.d saying that "thc Fcclcral Rcscrvc Boarcl \vn~lltl . . .
have somc prcfcrcncc for a Iargcr program of p ~ ~ r c h n s r. s . '. ." Tllc
n ~ ~ t h n r i z n t i o\\Ins
n qrantccl wit11 only n n r nrgativc vntr (Yntlnl: of l%nstnn).
bccnusc Norsis of Philadclphin nl,stninrrl a n d ~ c l 3 o l r ~ : lofl C l l i c n ~ n
votcd against his convictions out of dcfercnce to Prcsiclent IIno~.rr's
proposal, announced two days enrlicr, of n moratorium on intcrgnvern-
mcntnl dcbts ("purchascs of govcrnmcnts would be received by tlic p l ~ b l i c
as supporting the President's announcement"). O n J ~ i l y9, the cxecuti\.c
1322-33). Of the seven cardboard letter files (describcd as containers in the Divi-
sion's records), only six are open to readers; the seventh may he opened bcfore
1965 only upon writtcn from Mrs. Goldcnwciser. Only a small frac~ion
of the opcn collection contains currcnt analyses of Federal Rcscrve policy in
1919-45, the period of Goldenwciser's service with the Board. The Goldenweiscr
Papers are meager in coverage compared to thc Harrison Paprrs and provitle a far
lcss comprchcnsi\~eview from within the Federal Reserve System than the EInmlin
Diary docs. Consequently, we havc made only minor use of them. ,
103
See quotation from his rcport in sect. 4; above.
Open Market, Vol. 11, Apr. 27, 1931.
'lo Norris of Philadelphia, Young of Boston, and McDougal of C h i r a ~ o .The
fourth was Calkins of San Francisco (ibid., minutes of meeting, Apr. 29, 1331).
378
T l I E GREAT CONTRACT ION
I
I cornrnittcc agreed t o a further purchase of $50 million to complete the
$100 million authorizcd in April, but buying was stoppcd on July 16 2t
only $30 million bccausc of IIarrison's conccrn ovcr forcign devclopmcnts
a n d dcspitc thc rcmonstranccs of hlcycr."'
Dy carly August, Harrison a n d Mcycr again prcsscd for purchascs. I n
discussing tllc situation with tllc cxccutive c o ~ n n i i t t c cof directors of thc
Ncw York Dank, Mcyer prcscntcd figurcs sllowing that between No\rcm-
bcr 1, 1930, a n d August 5, 1931, t h r r c hacl bccn "a total incrcasc of
$421,000,000 in t l ~ cgold stock of tltc Unit(-d Stntc:~;that currcncy circu-
lation Ilad incrcascd $350,000,000 instcsad of sllowing a normal seasonal
t11~
dcclinc of a t lcast $100,000,000; and that t l ~ cDank of France had with-
,drawn a b o u t $125,000,000 from thc market" (presumably the acccptancc
m a r k e t ) . H c then pointed o u t that "whilc tlicrc h a d bccn n o intentional
contracticin of thc basc o n wllicll crcdit could 11c cstcnded, thc stcriliza-
tion of an a m o u n t l a r ~ c rthan tllc p i n of goltl Ilad bccn passively pcr-
mittcd." EIc said that, "if wc had I ~ r c nasked last Novcmbcs \vllctllcr \vc
would favor, or cvcn permit, thc stcrilizatinn of $400,000,000 of gold,
unt1oul)trdly wc would havc answcrcd in tllc n c p t i ~ c . " ~ ~
\Vl~cna ~ n a j o r i t yof tlic cxccutivc comrnittcc of thc O p c n hlarkct Policy
Cor~fci.cnceproved to bc unwilling to support furthcr purcl~ascs,a mcct-
ing of thc full Confcrcncc was called for August 11. Harrison proposcd a
program, to bc p u t into cfTcct when desirable, authorizing thc executive
comrnittcc to buy u p to $300 million of govcrnmcnt sccuritics. Otllcr
governors, csccpt nlack of Atlanta who joined Harrison in favor of it,
wcrc cntircly negative in thcir rcaction, a n d thc Conference votcd instcad
a n ai~tliorizationfor thc cxccutivc committcc to huy or scll $120 million.n3
S o f a r as w e can discover, t h a t was thc first Confcrencc m c c t i n ~a t
which t l ~ c ~was c explicit rcfcrcncc to a ~ ~ r o l ) l c m
later to I)c cited ns a
major reason for the Rcscrve Systcm's failurc to m a k c any cxtcnsivc
x c u r i t y purchases-thc problcm of frcc gold. Howevcr, the frec gold
problcm, to bc discusscd in thc n c s t scction, played n o role in the
outcome.
W h c n t h e Confcrcncc mct t h c same d a y with members of the Board,
Harrison was again in thc position of having to present a n d defend a
recornmcndation hc did not favor. H e explained that the Conference
opposcd immcdiatc purchascs of large amounts of govcrnrnent securities,
bccausc banks would not cm11loy cxccss rcscrvcs. T h c banks' reason:
"'Harrison, Open Market, Vol. 11, minutes of executive meeting, June 22, 1931 ;
Miscellaneous, Vol. I, letter, dated July 9, 1931, Harrison to Seay; Notes, Vol. I,
July 16, 23, 1931.
"'Notes, Vol. 11, Aug. 10, 1931.
"'Opcn Market, Vo!. 11, minutes of executive committee meeting, Aug. 4, 1931 ;
minutes of mecting, Aug. 11, 1931. The $120 million included the usual $100
million plus the $20 million authorized in April but not used.
379
 T H E GREAT CONTR.4CTION
"most prime investments are selling on a very low ~ i e l dbasis, wl~ilesec-
ondary bonds consist largely of railroad issucs, of which a considcrable
proportion may in a short time become ineligible for in\.cstncnt I)y sav-
ings banks, insurance companies, and trust funds, d u c to tlic provisions
of \.arious statc In\vs. I n addition tlic bond markct has bci,n u~icertain
bccause of prcssure on tlic markct, duc to forced licl~~idation of bolid
portfolios of closcd banks.'! Go\.crnor Meycr n ~ i d~)tllcrI I I C I ~ ~ Cof~ St11c
Board esprcsscd disappointment at the action takcn by thc Confcrcncc,
"in that it limitcd possible purchascs to an incffccti\:c amount." Ho\vever,
tlic only consequence of thcir disappointment was a change in thc timing
of tlic Board's scssion with the Confcrcnce. Thereafter, the two bodies
discussed policy actions before rathcr than aftcr the Confcrcncc adoptcd
its recommendation. Later, when the Board formally considcrcd the
rccommcndation, it did not approve it outright but dclegatcd to Go\.crnor
h4eyer the authority to approve purchases but not sales."' In tlic cvcnt,
not cven thc $120 million authorization was carricd out. .
Britain's departure from gold and the resulting gold outflow from tlie
Unitcd States changed tlie focus of policy-making from thc Open Market
Policy Conference back to the New York Bank. New York had always
had, and continued to have, primaly responsibility for intcrnational
monetary relations. T h c Bank of England, tllc Bank of Francc, and othcr
ccntral banks had always trcatcd the New York naqk as thcir counterpart
and had conductcd negotiations and consultations with it. Tllc Board had
becn kept informed, consulted in the process, and its approval obtain&
"' Harrison, O p e n Market, Vol. 11, minutes of meetings, Aug. 11, Nov. 30, 193 1 ;
and letter, dated Aug. 18, 1931, Mcyer to I-Iarrison.
T h o u g h Harrison was in agreement with Meyer on the substance of the policy
issue, he was disturbed by the Board's response to the Confcrcnce rccon~~ncntlation,
anc! complained to hleyer that it was contrary to the rules adopted when the
Conference was established. T o his own board of directors, H a r r h o n stated:
..
. the whole situation emphasized the inherent difficulties of existing open
market procedure. Direction of system policies by a conference of twelve men
who must also consult the Federal Rcserve Board means .. .
. that . . we run
a real risk of having n o policy a t all. Some of the Federal rescrve bank governors
.
. . attended the Conference with preconceived ideas which would not admit
of argument, and others in spite of, o r perhaps because of, the fact that thcir
banks would not be able to participate in further purchases of go\,ernment
sccuritics, looked a t the whole question from the narrow standpoint of thcir
individual position (Notes, Vol. 11, A u g 20, 1 9 3 1 ) .
Commenting on the results of that meeting of the Confcrcncc, Governor h4cycr
said, according to Hamlin, that "Governor Harrison could present a matter very
gracefully, but could not scll i t ; that if the Board had takcn part in the conference,
he believed the Governors would have followed the Board and the New York
bank" (Ilarnlin, Diary, Vol. 19, Aug. 11, 1931, p. 1 2 9 ) . I-Ic may t ~ a v ch e n rig111
on this occasion, but later experience suggests that 11e was unduly sanguine.
380
T H E GREAT CONTRACTION
before final action, but it had never had a major voice in forming policy.
T h c othcr Reserve Banks had for the most part simply bccn kept in-
formed. T h a t had becn the practice while Strong was alive and had re-
mained thc practice. T h e most recent instance during the contraction
had bccn the nc~otiations
- in the summer of 1931 in conncction with
loans to foreign banks.
Ncw York had littlc doubt about wliat action to takc. At its Octobcr
8 mecting, the board of directors votcd to raise the discount ratc from
1% to 2% prr ccnt. T ~ Cargumrnts givcn a t thc mecting were, first, the
gold outflow itsclf, and sccond, "aclviccs from France, where foreign
fcars conccrning thc dollar appear to llavc concentrated, which indicated
that an incrcase in the ratc would be interpreted there more favorably
than otherwise." Some fear was esprcsscd that the risc in ratcs m i ~ h t
have advcrsc domcstic cffccts, particularly hy intcrfcring with I-Ioo\.cr's
efforts to organize a National Credit Corporation, but that fcar was
belittled. Harrison notcd that any unfavorable effect on tlic bond markct
could bc offset by security purchascs, sincc t l ~ ccxccutivc comrnittcc of
the Open Market Policy Confcrcncc still had authority, undcr thc rccom-
mendation of the August 11 rnccting, to buy up to $120 million of go\.-
crnment securities.l18 T h e only discordant note was a cablegram from
Burgess, who was in Europc on a mission for the Bank, recommending
no action that would bring about higher money rates in the Unitcd
S t a t c ~ . "T~ h c cablrgram was read at the meeting, thcn disregardcd. T h c
Rcscrve Board promptly approved the rise in discount rates, scveral of
its mcmbcrs having bccn strongly in favor of a rise cvcr sincc thc bc-
ginning of the gold drain.ln
A wcek later, Eugrnc Mcyer attcndcd the directors' meeting at the
Nc\v York Bank. Harrison proposcd a further increasc in the discount
rntc to 3 % pcr ccnt, giving as thc tcchnirnl rcason the continurd qold
or~tflow.One director, Cllarles E. Mitchell, cxpressed seriot~sdoubts about
tlic tlomcstic cffccts. Mrycr replicd that "an advance in thc ratc was called
111
However, three days earlier, a t a meeting of the executive committee of the
board of directors, Harrison said that "hc considered the gold position of the
System paramount at this time and on that account would not be inclined to
purchase Government securiticc" (Harrison. Notes, Vol. 11, Oct. 5, 1931).
' Burgess had arrived in Europe on Oct. 9 to attend a regular monthly meeting
U
a t Basle of the Bank for Intcrnational Settlements. I t was the first time a Federal
Reserve olficial had formally participated in discussions of European central
bankers a t the worltl bank. T h e New York nank was not a member, b e c a ~ ~ qi tc had
bccn f o r l ~ i d d e nby the State Department to subscribe to shares of the BIS wllcn
the lattcr was formed in 1930. Ilowcvcr, there were unofficial ties between the two
institutions, strengthened by t5e fact that Gates W. M c C a r r a h , president of the
BIS, had formerly bccn chairman of the New York Bank.
I" IIamlin and Miller, a t least, strongly favored an increase in discount ratcs
a n d co~lxidcrcd a possil~lccfTcct on the bond market as no valid rcason for delay
(IIamlin, Diary, Vol. 19, O c t . I , 1931, p. 148).
38 1
 TIf E C R E A T CONTRACTION
for by cvcry kno\\,n rulc, and that . . . forcigncrs wotlld rcgard it as a
lack of courage if thc ratc \\.crc not advancrd." 1Ic rsprcsscd tllc opinion
that "thc bond markct \\Ins already adjustccl to a l ~ i ~ l l cIc\*cl r of inttwst
rates, and thercforc it \\.auld br- but littlc a l f c ~ t r c l . " " ~A montll Iatcr,
O\ven D. Young prcssed tllc desirability of purcl~asinggo\)c~.nmcntsrcuri-
tics to offset unfa\~orablc domestic cffccts. Harrison was cxcccclingly
hesitant to acccde."O
T h c sharp riscs in discount ratcs \\rcrc widcly supported not only within
the System but also o ~ t s i d c . T
' ~h~c maintcnancc of thc gold standard w a s .
accepted as an objective in support of which men of a broad rangc of
vie\vs \<ere rcady to rally. T h e drain of gold \\,as a dramatic evcnt
for which therc wcrc many p r c c c d c n t ~ . 'Thus
~ ~ both thc problem and its
solution secmed clcar and straightforward. Indced, onc gcts thc imprcs-
sion that after grappling with unfamiliar, clrisivc, and subtlc prol~lcms,
the System greeted with almost a sense of rclicf thc cmcrgcncc of a
problcln that could bc put in black-and-white terms.
Less than two weeks aftcr the second risc in discount ratcs, tllc csccu-
tive committce of the Open Market Policy Confcrcncc rnct. T h c prclimi-
nary memorandum for thc mceting outlined thc drastic change that had
occurred in currcncy in circulation, pointed out that internal dcvrlop-
mcnts had brcn more important than thc gold outflows in tlirir clfects
on domrstic business, and notrd tllat thc dcclinc in clcposits "constitr~tc~s
by far tllc most rapid sl~rinkagcin mcmbcr bank clcposits cluring thc lifc
of the System." Ncvcrthclcss, M c D o u ~ a lcontinucd to rccomlncnd that
the System should reduce its security holdings, although-in addition to
the unprecedented prcssure on commercial banks at the timc-it was tlxc
beginning of thc season when the System typically expanded its sccurity
lloldings. T h e final outcome was a vote against sales but in favor of rc-
questing thc Fcderal Rescrvc Board to givc thc committcc t l ~ csamc
lccway for sales that the Board had givcn it for p~lrchascs undcr the
Conferencc rccommcndation of Ali,qlst 1 1.lZ2
'IS Harrison. h'otcs, Vol. 11, Oct. 15, 1931.
" ' I b i d . , S o \ . . 9 5 , 1931.
In "\\'c think the really constructive cvcnt of the wcek has been . . . thc action
of the X c w I'ork Fcdcral Rcsenvc Bank in raising its rediscount ratc . . . . This
stcp sllould have I>rrn taken long ago, and. indccd, i t was a sad crror of jutlsmc.nt
to put such a fantastically low ratc as that at Ncw York in force. . ." (Com-
.
mercial and Financial Chronicle, Oct. 10, 1931, p. 2 3 0 5 ) . ". . [Tlhe Fcdcral
Reseme Bank of New York has bcen driven into making another advancc of a
full 170 in its rediscount ratc . . . , a dccidcdly wisc nlo\,c. . . " ( i b i d . , Ort. 17,
1931, 1,. 3 4 6 0 ) . T h c New I'ork Titnes reported that thc risc was "wclcon~cdI)y
almost all bankcrs" ( O c t . 1 1 , 1931 ) ; that the risc was "hailcd with enthusiasm
in banking circles" ( O c t . 16, 1 9 3 1 ) .
I" See, however, further discussion in sect. 6, below.
l3 Harrison, Opcn h4arkct. Vol. 11, memorandum and minutes of cxecutivc com-
mittce meeting, Oct. 26, 1931. In thc coursc of the mccting, Harrison noted that
.
"the frre gold position . . was not a considcration at this timc. . ." . ( i b i d . , mcmorandurn and minutes of mccting, Nov. 30, 1 9 3 1 ) .
382
T I I E GREAT CONTRACTION
T h c preliminary mcmorandurn for a mccting of the full Confcrcncc at
tlic cnd of Novcmbcr notccl with satisfaction that thc "forcign and do-
mcstic clrains upon bank rcscrvcs wcrc rnct in thc classic way by incrcascs
in cliscount ratcs cotnl)int*cl with a policy of frce Icnding." I t rccorclcd
that "onc rcsult" of tllc risc in discount ratcs and the associated. risc in
othcr markct rates "was certainly to make bankcrs and others morc timid
and rcl~ictant in contemplating ncw uscs of funds or new cntcrpriscs."
It strcsscd tllc sharp clcclinc in bond prices and thc resulting \vorscning
of tlic position of thc I~anks.It discussed the car-cnd seasonal prol~lcm,
suggesting tllat purchascs "similar to tl~oscmade last !.car" should bc
provided for, and proposcd dcfcrring thc longer-term policy decisions
until aftcr the first of tlic year. T h c Confcrcnce adoptcd a rcsoliition gi\.-
ing tllc cxccutivc committee authority to purchase up to $200 million of
govcrnmcnts for seasonal nccds.lZ3Only part of that authority tvas in fact
excrciscd.' Government sccurity holdings wcrc raiscd by 575 million to thc
cnd of Dcccmbcr 1931 and thcn lowcrcd by $50 million in January 1932.
Dtlring thosc montlis, it is not clcar that Harrison was as unhappy with
tile policy followed as hc had bccn bcforc and was to bc again. His con-
cern about gold inhibited his dcsirc to cxpand Fedcral Rcscrvc credit.
Ncw York still had control over thc buying ratc on bills, subjcct only to
thc approval of thc Board. As wc llavc sccn, Ncw York had rcpcatcdly
trictl to tlsc bill purchascs to cnablc it to accomplish on its own what it
cor~lclnot acco~nplisl~ tl~roughthc System opcn market account. Yct the
bill buying ratc, which hacl bccn raiscd from 1 % per ccnt to 3% pcr
cent in Octobcr along with thc discqunt rate, was reduced only slo\~ly
a n d moderatcly, to 3 pcr ccnt on Novcmbcr 20, and to 2?4 pcr cent on
January 12, 1932. Both reductions lcft the ratc abovc thc market ratc
and thcrcforc did not lead to an incrcasc in hill holdings.
Early in January 1932, partly i~nclcrprcssure from 11isstalf and directors,
,Harrison rcsumcd his advocacy of a program of further substantial piir-
chascs as part of a broader national program which he outiincd to ttic
mccting of thc Opcn Markct Policy Confcrcnce that month. T h c main
fcaturcs of thc program wcrc: passage of an act establishing thc Rccon-
struction Finance Corporation, thcn under considcration by Congress;
o r ~ a n i z c dsupport of thc boncl markct, prcdicated on an azrccmcnt bc-
twccn tllc railroacls ant] tllc unions to cut \vagc ratcs; coopcration pf
Fcclcral Rcscrvc Banks ant1 mcmbcr banks with thc Trcasury in its financ-
ing program; purcl~ascof bills by the Rescrvc Systcm tvhcn possible; rc-
cluctions in discount ratcs; and, as a final stcp, "buying of Govcrnmcnts,
if ncccssary, facilitated by an alleviation of thc frec gold position," the
la Governor McDougal asked assurance at the mecting that no purchases would
be made immediately. Governors Norris and Fanchcr said "they were not disposed
.to approve of thc purchase of government securities solely for t h ~purpose of en-
abling the New York and Chicago banks to keep out of debt at the cnd of the year"
383
 T H E GREAT CONTRACTION,
final phrase being a reference to proposals then under consideration which
were finally cmbodied in thc Glass-Steagall Act. T h e Conference author-
i7cd the esecutive conlmittec to p~trchascup to $200 million, "if ncccs-
sary," over thrce negative votes.'14 T h a t autliorization was not cscrciscd
at all. Bct\\~cciithc January 11 and February 21, 1332, mcctings of t l ~ c
Conference, government security holdings declined by $1 1 million, bill
t~oldingsby $80 million, while discounts rose $20 tnillion. Fvderal Reserve
credit outstanding fell by $100 million ovcr the six-wcck period.
T h e February meeting of the Open Market Policy Confercncc was
Inrgcly a repetition of thc January mecting, although tltc pending passage
of the Glass-Steagall Act removed tlie problem of free gold. At thc joint
meeting with the Board preceding the formal busincss session, Mcyer, who
continued as governor of the Board though hc had by then been named
chairman of the R F C as well, asserted that "it secmcd unnecessary for
the banking position to be subjected to severe strain because of the funds
\\.itlidm\vn for lioarding." Miller statcd tliat "he brlicvrd tllrrc was ncvcr
n safcr tinic to opcrntc boldly tlian at prcsctit." IIc intlicntc-tl tlint "ltc
would alIprovc purcliasrs on an cvcn largcr scnlc tlian t l ~ canlounts Lcing
discussed." hfcnougal con tinucd to argue that "on gcncral princil~lcslie
prcfcrrcd to sec tlic banks borrowing to sccurc f~rncls." T h c upshot was
n mild cspnnsion in thc authority of the esccutivc conimittcc. I t was au-
ttiorizcd to buy up to $250 million at the approsimatc rate of $25 nill lion
n wcek, hicnougal and Young voting in tltc negative. Immcdiatcly
aftcl tlic gcncrnl mccting, tlic cscc~lti\.cconimittcc votctl 3 to 2 to start tltc
program.12s
T h a t modest program would very likely never have been expanded into a
major one, or perhaps even carried out, if it had not been for dircct and
indirect pressure from Congress. Harrison told thc cxccutive committee
of his directors on April 4 that apparently "the only way to forestall
some sort of radical financial legislation by Congress, is to go further
and faster with our own program." When Harrison reported to a full
mceting of his directors on April 7 t l ~ a tthe csccutivc committee of thc
Open Market Policy Conference was deeply divided about the wisdom
of accelerating the purchase program, and' had voted to continue the
existin: program, one of the directors asked "if a more vigorous program
'" Ilnrrisoli. Open Market, Vol. 11, minutcs of mccting, Jan. 11, 1932. McDou,qal
of Cliiraco. Scay of Richmond, and Deputy Govcrnor Day, rcprctcnting Govcrnor
Calkins of S;in Francisco, wcrc thc thrcc who votctl in tlic ncgative. Ncithrr
Governor Y o t ~ n g nor any othcr rcprescntative of the Boston Bank attcndcd thc
meeting. Thc Kansas City Bank was represented by a dircctor who was not prcscnt
at the session when the resolution was adopted.
'x Ibid., minutes of meeting. Fcb. 24, 1932.
T H E GREAT CONTRACTlON
on tlie part of the Federal Rescrve System \vould not be helpful in dc-
fcating 'the Thomas bonus bill and otlrcr similar Icgislation.
- Govcrnor
Harrison saicl tliat Senator Thomas had indicated to him that lie might
IIC satisfied not to press for Congressional action if tllc Systcm would pro-
cccd more vigorously." T h e Bank directors accortlingly votcd to have the
Bank, subject to the approval of the noard, br~yfor its own account up to
$50 million of government securities, outside the System account and
bcforc tlic mccting of tlic Conference, ~vliich was set for April 12.12'
In opcning thc joint mceting of thc Conference and thc Rcscrvc
Board, prrccding the busincss mecting of tlie Confcrcncc, Govcrnor hlryrr
"callcd attention, merely as a matter of information, to the fact that ,a
rcsolution had bccn ofTcrcd in the Srnatc asking the Fcdcral Rcscr\.c
Board to state its program . . . . Considcra:ion of this resolution had
becn postponed. He statcd tliat tlie Rcscrvc Systcm could now undrrtakc
to do more toward aiding in the recovery than it had yct done, and tlint
lie bclicvcd tlic time had comc wlic.n tlic Systcm might be cspectccl to usc
its powers more fully in an cflort to stop t l ~ ecl.cdit dcclinc." Othcr 1ncm-
brrs of the Board supported Mcycr. Ogdcn L. Mills, since Fcl~runl-y13,
1932, Sccrctnry of the T r c a s ~ ~ r who
y , had all along bccn in favor of more
estcnsive action, statcd: "For n grcat ccntral Innking system to stand 11y
wit11 a 70% gold rcscrvc without taking active stcps in such a situation
was almost inconcci\,al~leand almost unforgivable. T h e rcsourccs of thc
Systcm s l i o ~ ~ lbc
d put to work on n scalr: commcnsuratc with thc rsisting
ctncrgrncy."
hft& tlic Board left, thc Conlrrrncc votcd 10 to 1 to approve a rrso-
Iution offcrcd by Harrison authorizing t l ~ ecxccutive committee to purchase
up to $500 million of government sccuritics in addition to the uncspircd
arltliority grnntccl at tlic Fcl~ruary24 mccting. T h e purchascs wcrc to be
made as rapidly as practical~lcand, if possible, to bc no less than $100
million in the current statement \\leek encling ncst day, April 13.'?' Tlic
"Notes, Vol. 11, Apr. 4, 7, 1932.
ln T h e lone dissenter was Govcrnor Young of the Boston Bank, who had said
at the joint session with the Board that he
qucstioncd whcthcr purchascs of govcrnmcnts which piled up reserves in the
centers wottld result in thc distribution of these funds to othcr parts of the
country. H c was skeptical of gctting thc cooperation of the banks without which
succcss appcared difficult, and was apprehcnsive that a program of this sort
would dcvclop the animosity of many bankcrs, and was apprehcnsive also that an
extcnsivc program of purchascs of government sccuritics would impair the con-
fidcncc of thc public in thc Rcscrvc banks. I-Ic cited the c x ~ ~ c r i c n cof
c 1931 as
;In indication of tlic futility of go\,crrimcnt purcliascs.
Govcrnor h.lcDougal of Chicago s k c d whcthcr thc Rcscrve Systcm "could retain
thc confidcncc of the public aftcr inaugurating a policy of this sort, which was in
some mcasurc inflationary, particularly since it involvcd the use of government
sccurities as col1atcr;ll for Federal reserve notes" (Harrison, Open Markct, Vol. 11,
minutes of meeting, Apr. 12, 1 9 3 2 ) .
 T H E GREAT CONTRACTION
final proviso was inscrtcd aftcr Harrison h a d informed tlic Confcrcncc hc
was sclicduled to testify t h c ncxt d a y bcforc a subcommittee of t h c Nousc
o n a bill t h a t in cffcct would havc dircctcd t h e Rescrve System to purchase
in t h c o p c n lnnrkct r~ntilwl~olcsalcpriccs I ~ a driscn to tllcir 1326 Icvcl. I-Ic
said that "it \vorrltl ~ ~ ~ , o l ) n Oc.
l ) l ync-cc,ssnly for 11in1to makc s o ~ ~ l rc-ft-rcncc
c:
to thc proyram a t that
Aftcr tlic initial Ilrograln was votcd o n April 12, tlic Systcm I ~ o r ~ g l l t
$100 million of government sccr~l.iticspcr weck for five wccks. A t tllc
M a y 17 mccting, t h c Confercncc again votcd anothcr $500 million opcn
markct purchase, McDor~giiljoining Young in dissenting. A t t h c suggestion
of Mcycr, t h c weckly ratc of pr~rchascsaftcr t h a t mccting was rcdrlccd.
Harrison deplored t h e reduction: " T h c tcmpcr of Congrcss is not im-
pro\,ing, a n d t h e d a n g e r of unsound crcdit proposals is still great. I t
n ~ i q h t ,thcrc-forc, bc r~nwiscto sivc unnecessary substance to thc a r g i ~ m r n t
no\v being r ~ s c d ,tliat thc Fcdcral Rcscrvc Systcm intends soon to ahan-
d o n its open markct program." Yct in J r ~ n e ,partly no doubt in tlic hope
of conciliating hlcnorrgal a n d l'orlng, IIC suggcstcd to tllc csccutivc coin-
mittcc of t h c Confcrcncc that tlic pi~rchascscach wcck b c gcarcd to tlic
maintcnancc o f mcmbcr hank csccss rcscrvcs a t a figure s o ~ n c \ v l ~ c rbc- c was reluctant to participate. I-Iis own fccling, I-Iarrison said, "is that
t\\-cr.n $250 a n d $700 million, tllc prrrcl~nscsto Ilc as sni;~llas possil>le to
prcscn7c t h c dcsired I c \ ~ l but, witli some incrcasc f r o ~ nwcck to wcck in tllc
System's holdings. "to a\.oicl tile crrntion of n frcling t l ~ a tlic t 1)olicy of t11c
system l~aclb r r n chan~rcl."""
By tlic r n d of J r ~ n c ,as nrrrgrss s r ~ m ~ ~ i a r i ztllc
c d rcsrllts of thc program
for tlic N c w York directors, total pr~rchascs of $1 hillion h a d offset a
loss of $500 million in golcl a n d a redr~ctionof $400 million in discounts
ancl bills l,orlglit, Icaving a nct incrrast: of $100 million in Fcdcral Re-
scr\.c crrdit otrtstanding. T o O\vcn I). Young, this m c a n t tint "most o f
ollr efforts h a d , in reality, served to check a contraction of crcdit rathrr
tlian to stimulate a n expansion of crcdit. W c havc becn clearing t h c way
f o r action, rather than taking action. . . .'I A weck later, in discussing tllc
prcssrlrc from Cliicago ancl Ijoston to stop t h e prowram, P IIC saicl,
As i t is, \tPcarc asked to stop \\.hen \vc arc just half way t l ~ r o u ~our
h program,
\\.hen \\.c arc just at tlic point \vlicrc further pr~rchnscsof Covcrnmcnt srcuritics
"Thc hearin~s,which threatcncd to dcvclop into a lull-scale investigation ol
the System, wcrc held by thc Housc Subcommittec on Banking and Currcncy on
1T.R. 10517 ( a bill to stabilize commodity priccs, introduced by Rcp. T. Alan
Goldsb~rorl~ll). Go\.ernor Harrison tcstificd that thc Fcdcral Rescrvc "l~rgan to
rcally utilize rhc" Glass-Stcagall Act only two days hclore he appcarcd Ixlorc rhr
cornrnittcc (Congres.riona1 Record, Housc, June 8, 1932, p. 12351, rcmnrks ol
hlr. Goldsborou~h).Scc also Stnbiliznlion 01 Cortltnodity Prices, Mcarings 1)clorc
rhc I-Ioi~scSul~com~nirtce on Banking and Currrncy, 72d Cons., 1 s t scss.. pnrr 2 ,
pp. 477-470, 500-501. Jullc 160
1-3 HaI.risorl, Ope11 $farkc[, \'ol. 11, ~ninilrcsof nlccrings, \ f a y 17
1932: Notes. \'ol. 11, h l n v 26, 1332.
T H E GREAT C O ~ ~ T R A C T I O N
will bring actual and aflirmativc pressure to bcnr upon thc mcmbcr bnnks ....
TOstop just when you havc rcachcd the placc \\*hcrcyou arc ablc to put on thc
prcssurc thc program wns dcsignrd to producc, \c-ould bc a riclicrrlous t h i ~ ~rog
do. IVc shall havc no policy left i f wc tlo this.lm
C l ~ i c a g oant1 noston took t11osc sarnc facts ii.9 cvidcncc in fa\.or of
tlicir opposition to tllc: program, as c\,itl(mcc: t l ~ a tit h a d oiily srtl)stitr~tcd
a n r~ndcsirablcform of crcclit for a clcsirablc form. h ~ I c D o u g ~ ri-portccl
l,
Harrison, "does not src what thc purchases have donc any\vay, a n d is in
favor of stopping." Govcsnor Young fclt "that therc a r c going to bc a
lot morc bnnks closccl, that tllcrc will bc a la'rgc increase in borrowing a t
t h c Fcdcral rcservc banks ancl tliat, therefore, wc a r c wasting o u r rc-
sources buying Govcrnmcnt s c c r ~ r i t i e s . " ~ ~ ~
Somc officcrs of thc Ncw York nank, notably Burgcss, a n d somc tli-
rectors favorcd continuing thc program, with thc approval of tllc Board,
c\.cn if that mcant New York w o r ~ l dh a w to procccd \vithout Chicago a n d
Boston. Sincc tllc Rcscrvc J%oartlwas in favor of continuing tlic program,
it clor10tlcss worrlcl 11avc apl~rovccl.nrrt Harrison was un\villing to follo\v
that course. T l i c golcl rcscrvc ratio of tllc Ncw York Bank was only 5 0
pcr ccnt, of thc Systeln 5 8 pcr ccnt, of Chicago 75 pcr ccnt. Yct Chicago
wc should continue with our opcn markct program, a n d perhaps step it irp
a bit, b u t o n o n c condition-that t h c program b c m a d c a rcal Systcm pro-
g r a m ant1 that thc Frclrral Rcscrvc n a n k s of noston a n d Chicago, in par-
tici~l:rr, givc it thcir affirmitivc support." When t h c comment was m a d c
that thc Board had tile legal powcr to reqr~ireo t h e r Banks to rediscount
for N c w 'York, if its ratio fcll bclow 5 0 pcr cent, Harrison replied "that
it would bc most undcsirablc for rls to g o a h e a d in defiance of the wishes
of thc othcr Fcdcral rcscrvc banks a n d thcn to havc thosc hanks balc us
o u t under compulsion. Systcm policy ancl thc system O p c n M a r k c t Policy
Confcrcncc might just as wcll bc thrown orlt the window undcr such cir-
cumstance~."~~~
At that j r ~ n c t r ~ r Harrison
e, m a d e a final effort to secure thc cooperation
of Boston a n d Chicago. I-Ic plcarlcd t h c casc not only with the governors
a n d directors of t h e two Banks but also with commercial bankers a n d busi-
nessmen in thc two cities. O w c n D. Young m a d e a trip to C l ~ i c a g oto
'"Notes, Vol. 11. Junc 30, July 5, 1932.
'I' Office, Vol. 111, July 5, 1932; Notcs, Vol. 11, June 30, 1932.
'"Notcs, Vol. 11, Junc 30, July 5, 1932. Harrison was at first.attracted by the
proposal that the Reserve Board bring pressure on the other Banks to participate
in the purchase program. The Board's authority to compel one Reserve Bank to
rediscount paper lor another Rcscrvc Bank, i t war suggested, would apply also to
purchases of government sccuritics, whcn the rcscrvc position of several Banks was
involved (ibid., Junc 30, 1932). On rcconsidcration, he decided that thc Board
had no powcr to bring such prcssurc, and that, "lr~rthermorc,this bank would bc
the first to object to such action by thc Doard, in other circumstances" (ibid.,
July 5, 1932; see also July 11, 1932).
387
 T H E CREAT CONTRACTION
attempt to persuade the directors of tllc Chicago Bank. D t ~ tall to no
a~ail.'~'
In an attcmpt to deciclc tllc issue, the full Opcn hfa~,kctPolicy Con-
fcrcmcc mct on Jul), 14. At thc joint mrcting \ v i t l ~ thc Board, Govcrnor
hlcycr su~gcstcdt l ~ a t"in tlcrcmmining ftrt~rt.cpolicy i t \\.as i ~ ~ i l ) o r i : ~ton t
considcr that thc public cffcct of any discontint~nnccof thc policy wl~ich
l ~ a dbccn pursued would be unfortunate, a~lrlaisn that in futurc policy
cvcry effort should bc made to sccltrc an cflcctivc unitcd sysicm policy."
Hc pointcd out that "there existed a trcnd in Congrcss toward giving tllc
Systcrn more centralization, and that the open m a ~ k c tprogram offcrcd a
test of the capacity of the Systcm to function eflectivcly in its pscscnt
f ~ r r n . " ' ~T
' h e Conferencc voted that excess rcscrvrs should bc maintained
'*Notes, Vol. 11, July 7, 14, 193'2; Office, Vol. 111, letter, tlatcd July 8, 1932,
Harrison to O w e n D. Young.
'" IIarrison, O p c n hfarkct. \'ol. 11. hfcyer was rclcrring to the scrics of bills
introduced by Scnator Glass (see footnote 29, above), the most recent M a r . 17,
1332. predecessors of the Banking Act of 1933. T h e latest bill was the occasion
for a hittrr cxchange of letters between Glass a n d IIarrison. With the approval of
~ h cNew \'ork Bank's directors, Harrison wrote to Scnator Peter Norbeck, chair-
m a n of the Senate Banking and Currency Committee, enclosing a letter h e had
scnt Glass, Feb. 6, about an earlier draft of the bill, which read in part as follows:
hfany provisions of this bill are designed further to limit the autonomy of the
individual Federal r e s e n e banks and to concentrate more a n d more power in
the Federal Reserve Board . . . . [Tllle provisions of your bill relating to the
open market committee which is given jurisdiction over operations in bills ar
well a government securities are so cumbersome as to be inimical to the best
interest of Federal reserve operation ....
T h e bill requires approval not only
of the Federal Reserve Board but of a committee of 12 representatives of the
several Federal reserve banks . . ..
U n d e r the proposed bill no operations in
securities o r bankers bills, even the clay to day transactions, can be emected,
even in cascs ol rmcrgcncy, without approval of thc committee . . . .
T o the extent that your bill further shifts power and authority from the Fccleral
reserve banks to the Federal Reserve noard, t o that extent, I believe it aims
towards centralized operation and control through a politically constituted body
in Washington.
O n .4pr. 9 , Glass answered Harrison's letter to Norbeck, writing:
I n my considercd view it constitutes a challenge to statutory authority and an
unyielding antagonism to any restraining influence wl~atsoe\.er.
.
. . yo11 and your board have thus statrd in trnrqui\,ocal tcrrns thc rnisconccl)-
tion o f the Frtlrral Reserve hankins a r t which so l o t ~1 1~s I)ec.11 rcllecretl in t l ~ c
extraordinary policies pursued by the New \'ork bank with rcspect to both
domestic and foreign transactions.
T h e "extraordinary policies" referred to by Glass, who was an undeviating follower
of the real bills doctrine, included the use of open market operations in govern-
m r n t src~rriticsand the failure to rcstrict loans to real bills only. In his cyc.c, the
failure was responsible for both the boom and the bust.
Harrison's rrply of Apr. 18 conclrrdcd the exchange:
T h e officers and directors of this bank have been just as desirous to d o their
part in checking the use of bank crcdit for excerrivc speculation ar you or anyone
388
T H E CREAT CONTRACTION
a t approximately $200 million by purchases limited in total to the amount
previously autllorizcd by the Confcrcncc but not executed-$207 million.
For the p i d a n c e of the executive committce, the Conference rccom-
mcnclrd purchases not to cxcccd $15 million a wcck-csccpt in unusual
or trnforcsccn circtlmstanccs-but not lcss than $5 million a weck for thc
ncxt f n t ~ rwccks. McDor~gal,Young, and Seay of Richmond ~ ' o t c dagainst
cvcn tl~isrc~olution.'~"
Frccd from Congressional pressurc-Congrcss acljourncd on Jr~ly 1 6
thc Confcrcncc Iapscd into its cnrlicr p a t t ~ r n . 'T~h~c program adopted
was a minimum face-saving program, and was carried out a t ncarly the
minimum lcvcl consistcnt with the lcttcr of the recommendation. hlc-
Dougal and Young rcfuscd to participate in further purchases. Harrison
was unwilling to procccd on his own. As a consequence, in the four wccks
d t r r tlic Confescncc met, total purcl~ascsamountcd to $30 million ($15
million thc first wcck, then $5 million a week). From August 10 until thc
close of thc ycar, thc Systcm's holdings rcmaincd almost prcciscly constant.
T l I E B A N K I N G P A N I C OF 1933
T h c prcliminary rncmorandum for the January 4, 1933, meeting of the
O p r n Markct Policy Confcrcncc said of thc csisting situation, "that a
good start was madc toward recovery, that this movement has bccn intcr-
d , is now hcsitant and uncertain." At the meeting, both Govcr:
r ~ ~ p t c ancl
nnr Mcycr and Sccrctary of thc Trcasury Mills stresscd that any slack-
cning in Federal Rcscrve open market policy might provide an excuse for
the adoption of inflationary measures by ~ o n g r c s s .Governor Harrison
listcd the Congrcssional situation as one of three reasons for holding the
Systcrn portfolio of govcrnmcnt securities intact; the sccond was that a
rccluction "might operate as a chcck to the bond markct thur retarding
business rccovcry and furthcr injt~ringbond portfolios of banks;" the third
else. From their practical experience in operating a bank in this money center,
thry feel that in the long run there is only one really eflecti\,e method of bring-
ing ahout this result, and that is the traditional method of the vigorous use of
c l i w o ~ ~ nrate
t . .
and open market operation, . . T h e tragedy of the experiencr
of 19-38 ancl 1929 lay, in o u r opinion, in the failure of the R e s e n e Systcrn
promptly and vigorously to usc the instruments for credit control which decaclrs
of experience ha\,e proved t o be powerful and effecti\,e (hliscellaneous, Vol. 11).
"'Open Market, Vol. 11, minutes of mceting, July 14, 1932.
'"To the executive committee of the New York Bank's board of directors
IIarrison reported on July 11, 1932, a discussion he had had with blcyer in which
"Governor hleycr agrectl as to clesirahility of going ahead with the System open
markct program sayins that, if for n o other reason, it is politically impossible for
11s to stop at this partictilar time. T h e program was brgun at about the time the
Goldsl)orough Rill was introdtrcrd in Congress a n d i f it were terminated just as
Congrcss adjourned we would he crucified ncxt winter" (Notes, Vol. 11, July 11,
1932).
 T H E G R E A T CONTRACTION
was that larger cxcess reserves might lead to thr~climinationof interest
on deposits in principal centers, thus clistribt~ting "the prcssurc Tor
putting moncy to work more widely." Against tliosc three reasons, I-Iar-
rison listed three othcrs in favor of some reduction of the portfolio: first,
the "System open market policy had not bcen one to accumulate any
definite amount of securities but rather to check cleflation through the re-
d ~ ~ c t i oof
n bank debt and the creation of substantial cxcess rcscrves,
which had bccn accomplished;" sccond, any further substal~tialincrease
in csccss rcscrvcs might not increase pressure on the banks to lent1 ant!
i n \ w but would serve only to minimize control when nccc-ssary; tl~ircl,
tlic open m n r l r t pr~rcl~nscs lincl c-n:iblcd tlic T~.casr~ry
to Ilorrow chc*nply
and "so in some mcasure lias encouraged the continuance of an unbal-
anced budget."
T h e sentiment of most governors was clearly in favor of reducing the
portfolio, and the final motion reflected that sentiment. I t gave the
executive committee authority to reduce the System's holdings of Treasury
bills, the rcduction in January not to exceed $125 million and not to
bring cxcess rcscrves below $500 million. T h e committee was authorized
to purchase securities if necessary to prevent exccss rcscrves from falling
bclow the existing level, but not if such purchases would do more than
make up for declines in holdings. ~ e f d r any e increase in security holdings
abor~ethe existing level was maclc, a new meeting of the Conference was
to be c o n \ ~ ~ n c d . ' ~ '
T h e policy rccommcndation was followed, and security holdings re-
duccd by $90 million in January, tlcspitc the concern of I'mrgcss and
Trrnsury officials about tlic wcakncss of tlic bond markct, nncl dcspitc re-
newed banking difficulties. 13y Fobruary I , 1933, exccss rcscrvcr had
I.illcn below $500 million, nntl tlic pt~rcli;~ws lnaclc wcrc not cno~lglito
rcstorc t l ~ a tl c \ ~ I From
. tlic l x t wcck in Jnnrlnry to Fcl)r~~nl.y 15, tlic Sys-
tcm incrcascd its security lioldings by $45 million, ant1 ~x,rmittccl tot:iI
Rescr\.c credit to rise by $70 million. Yet, in those tl~rccweeks alone,
member bank reserve balances a t Federal Reserve Banks declined by
$280 million.
T h e state to which open market operation-the most potent monc-
tar). tool of the System-had fallen was graphically revealed when, as the
banking difficulties mounted in February, Harrison ruled out a mceting of
the Confercnce on grounds that it would be "difficult, if not impossible,
to hold a mceting of the system Open Market Policy Confercnce a t this
time." Instead, New York turned to bills as an alternative. O n Fcbnlary
16, New York requested, and the Board approved, a reduction in its mini-
m u m buying rates on bills t o % of 1 per cent. I t acquired $350 million in
~n Harrison, Open Market, Vol. 11, preliminary memorandum, dated Dec. 31,
1932, and m i n u t a of meeting, Jan. 4-5, 1933.
390
T I f E G R E A T CONTRACTION
, Oills the following two wccks, tliough at tlic end of tlic sccond tlic Dank
raisctl tlw I ~ i l l ratc twice, lo 1 prl. ccrit on Fcl~runry 27, and to 1!,5
per ccrit on March 1, in consonance with rises in tlie discount ratc.
I t also acquired $25 million of go\*crnmcntsccrlritics in tllc first of tllc t\vo
wccks and $2 million in tlic sccond, primarily to enable banks to liqi~i-
date by selling go\fcrnmcnt securities instead of borro\ving on t l l ~ m . ' ~ ~
In the filial two montlis prior to the ballking Iioliday, tlicrc was nothing
that could 11c called a Systc~iipolicy. T h e Systcni was dclnoralizcd. Eacli
Bank was operating on its own. 1\11 participated in t11c general atlnos-
1111erc of panic that war sl~~.cacling in tlic financial community and tllc
c o r ~ ~ ~ r i ~at~ nInrxc.
i t y Tllc Ic:~cl[:~.sl~ii)
w l ~ i c lan
~ inclcl~cnclcntcentral Ijank-
ing systcrn was sr~l,poscd to givc the markct and the ability to withstan!
tlic ~~rcssurcs of politics and of profit alike and to act counter to the mar-
ket as a wliolc, dicsc-tlic justification for establishing a quasi-govern-
mental institution with broad powcrs-wcrc conspicuous by their absence.
6. Alternative Policies
I t is clear that the monetary policies lollowcd from 1929 to 1933 wcrc
not the inevitable result of external pressure. At ail times, altonnti\.c
policics wcrc available and wcrc being seriously proposed for adoption
11y leading figures in the System. At all times, tlic System was tech-
nically in a position to adopt the alternative policics.
T o givc a clearer idea of tlic consequences of tlie policics actually
followed, we consider csplicitly t l ~ calternatives available at tlircc critical
pc~.iods and what their cfrccts miglit have bccn. Tlic periods arc:
( 1 ) tllc first ten rnontl~sof 1930; ( 2 ) tile first cight nlontlis o l 1331 ;
( 3 ) tlic four niontlis following Ihitain's tlcpart~rrcfrom gold in Scptc~m1,cr
193 1. 'J'l~is is followccl I)y a n cvcllrtation of tlw cl~ic-fjllstification t i n t lias
I)cc.t~o f T ~ . ~ . c . t lI)y writc:rs on I:c.dcrnl Rcscrvc I~istor-ylor t l ~ c1)nlicy actrlaIIy
~ ) ~ w s ~ ~inc clate ' l 1931 ant1 c,nrly 1932, namely, t l ~ a ta s l l o r t a ~ cof "frcc
sold" gl.catly inliil~itcduse of tllc policy altcrnati\,cs availal~lcto tllc S!.stcm
until the passage of tlic Glass-Steagall Act at the end of Fkbruary 1932.
Tlic succcssivc banking crises which followed the first period and
occurrcd during the other two were, as we saw in section 2, each morc
severe than the preceding. Measures that might havc bcen adequate to
cope with the earlier oncs would have been inadequate for the later oncs.
O n the other hand, as we sliall see, the bond purchases actually made in
the spring and summer of 1932, wliicll did halt tlic decline in tlie stock of
moncy but wcrc inadequate to prevent a subseq~lcntrelapse some months
arter, would havc bccn morc than adequate to cope with the earlier
crises. As so often in human affairs, a stitch in time saves nine.
"Notes, Vol. 111, Jan. 16; Feb. 2, 6, 16, 27, 1933; Conversations, Vol. 11,
Jbn. 18, 1933. Quotation from Notes, Vol. 111, Feb. 16, 1933.
39 1
 T H E GREAT CONTRACTION
None of the arguments latcr advanced in support of thc view that c s -
pansionary monetary mcasurcs by t l ~ cI.'[-clcral Rcscrvc Systcm might
I ~ a v ebecn incflectit.~or undcsiral~le a11l)lies to t l ~ i s pcriod, as noted
a))o\.c. Tlierc \+.as no sign of lack of confitlrncc in I~anksby t l ~ cpuI)lic,
or of unusual concern by banks about their ow11 safety. Banks wcrc using
rcscr\~esto the full. Any incrcasc in rcservcs prol~al~ly would havc bccn
put to 'use in cspanding tlie asscts of banks. Espansionary measurcs
ofTt-rcd no threat to tlic gold standard. O n the contrary, the gold rcscrvc
!\.as lli.ql~ and golcl inflows pcrsistcd. l ' l ~ r o ~ ~ ~ l l111c o r ~twer~tirs,
t tl~c
S>.srcvn l ~ a d bccn conccrnctl t l ~ a t it 11c.lcl too lnrgc a fraction of IIIC
world's gold stock; the only problcm a b o t ~ tgold t l ~ a tc\~oIictldisci1ssion
in 1930 within the System was how to rcpcl tlic flow. Finally, no scrious
monetary difficultics had yet arisen abroad.
T o e\.nluatc the possiblc quantitative cffcct of an altcrnntivc policy,
let us consider what the effect \vould have been if the purcllase prograln
actually carried out in 1932 had been carried out in 1930 instcad; that is,
if the System had cmharked on a program to raisc its security holdings by
$1 billion during t l ~ efirst tcn months of 1930. From Deccmbcr 1929 to
Octobcr 1930, if \ve adjust for scasonal rffc.crs, govcrnmcnt srcltrity
holdings acttlally rose hy $150 million. If somc $050 million additional
govcrnmcnt securities had bccn purcliascd. I~iyli-powcrcdmoncy, instcad
of declining by $160 nill lion, \vould Iin\.c siscn by $690 nill lion, all of
which would have incrcascd rescrvcs, sincc d t ~ r i n gthc first tcn months of
1330 the public rcdr~cedits currmcy I~oldings.I-lowcvcr, cl~angcsin other
forms of Rcscrvc nank crrdit migllt havc rccl~~cctl t l ~ cimpact of t l ~ chypo-
tllctical additional purchase. Frotn Dcccml~cr1329 to Octol~cr1930, bills
l ~ o [ t ~fcll
l ~ tby $1 10 n~illion-from $21.0 n~illionto $130 million-and bills
discounted fcll by $390 million-from $530 million to $200 nlillion. T l ~ c
purchase of $850 million additional gnvcrn~ncntsccuritics wo~ilddoubtless
have produced an even larger decline in bil-Is discounted and less
certainly in bills bought, since banks wot~ldl ~ a v cuscd some of thc funds
to rcpay borro\vings and there might havc I ~ c r na larger dcmand for bank-
ers' acceptances. T o make rather estrernc allowance for s ~ ~ can l i cKect,
let us suppose that discounts and bills bought had cach becn rcduccd to
$50 n ~ i l l i ~ Even
n. then, the effect of the purchases would havc bcen a risc
in Fedcra] Reserve credit outstanding by $130 million instcad of tlic
actual decline of $490 million, and a rise in high-powered moncy by
$460 million.
I f the deposit ratios had behaved as in fact they did, the changc
from a decline in high-powered moncy of 2 % per cent to a rise of 6 %
per cent would have converted the actual 2 per cent decline in the stock
392
TI1 E GREAT CONTRACTION
of moncy into a risc of 7 pcr cent. Undcr thosc circumstances, t l ~ cde-
posit ratios might Ilavc altcrcd in a d i r k t i o n to onset sonlc of tlic hy-
potl~cticnl 1.j.s~in his])-powered moncy. But cvcn w r y targc allo\vnnccs
on this score would hardly change thc gcncral conclusion: a rise in the
Systrm's security holdings by $1 billion instrad of $150 million in t l ~ c
first ten months of 1930 would have changed the monetary situation
drastically, so drastically that such an operation was almost surely dc-
cidcdly larger than was required to conLrert the decline in the stock of
money into an appreciable rise.
T h c change in the monetary situation might have affected the gold
movrmcnt, rcdr~cingt l ~ cgold inflow or cvcn converting i t into a gold out-
flow. 1h1t i t wolrld Iiavc clonc tllat only Ily its clTccts on thc trcntl of
cconornic activity and on thc statc of t l ~ ccapital markcts. Only if thc*
change in the monetary climate had lessened thc sc\*crity of the economic
contraction and madc the capital markets easier, would i t havc aflcctcd
gold flows. But it is prcciscly the achievement of such results that \vould
have bccn the aim of the alternative policies. I-Icnce, a reduction in tlie
gold inflow would have becn a sign of the success of the altcrnative policy,
not an offset to it.
T h e hypothetical purchase of government seruritics would have rcduccd
in two ways the likelihood of a banking crisis like the one in tile fall of
1930: indirectly, through its elTcct on thc scvcrity of the contraction;
and directly, through its emect on the balance shccts of Lanks. T l ~ cin-
direct cffcct would l ~ a v cimprovcd thc al~ilityof I~orrowcrsto rrpay loans;
the dircct effect would have meant that bank rescrvcs were rising sllarply
instead of staying roughly stablc. I t is impossible to say with any as-
surancc that thcsc elTccts would havc prc\,cntcd a banking crisis from
occurring-tliough t l ~ c ymight Ita\~c-but it is crrtain they would ]lave re-
duccd the magnitude of any crisis that did occur and hcncc thc magni-
rutle ol' irs al'tcrcfl'ccts.
Tlic cffccts on thc capital markcts and tlie rcduction in the drain of
gold from thc rest of the world would havc l ~ a ddesirable effects abroad.
'
Again, these might not have prcventcd thc latcr financial difficulties
entirely, but thcy certainly would have eased them.
T h c early months of 1931 wcrc the next crucial time for monetary policy.
T h c banking crisis had died down, therc were signs of returning confi-
dcncc in banks and of improving conditions in business. We I ~ a v ea!-
ready suggcstcd (section 2 ) that a vigorous monetary push at that time
might have converted thc faint signs of rccovcr). into sustained revival.
Lct us suppose that actual policy to the cnd of 1930, including
the first banking crisis, had bccn what it was, but that in the first eight
393

months of 1931 t l ~ cSystcm had raised its security holdings by $1 billion
instead of $80 million, aftcr allowing for scnsonal cl~angcs. Dtrril~g
thosc right inontl~s,curl.cncy held Ily thc public rose by $370 million as a
rrsult of tlic ir~teriialdrain on the banking s).stcm; bank rcscrves fell by
$120 millioli. Tlic diffcrcncc bet~\.cc~i the risc in currcncy and thc decline
in bank rcscrves, or $250 n~illion,is the amount by wliicll I~igh-powered
moncy rosc. T h e purchase of $920 miilion additional govcrnmcnt sc-
curitics, with no changc in bills cliscountcd or bills bought: would havc
raised high-powcrcd money by $1,170 million instcad, enough to meet
tlic drain of currcncy that actually occurred and at the samc time to in-
cr.cnsc bnnk rcsrrvcs by $300 million. \Vitl~s r ~ c nl ~siznblc iric~.cnscin tllc-ir
rcscr\.cs, iristcntl of a dccrcasc of $120 n~illion,banks \vortld Iln\.c I~ccn
frccd from thc nrccssity of liqr~itlntingsccr~sitics,ancl corrlcl 11n1.c rctlrrccd
tlicir borrowing from tllc Rcscrve Systcln, instcad of increasing i t by $10
million. T h e bond markct would accordingly h a w Ixcn far stronger, bank
failurcs would have becn notably fcwcr, and I~cncetlic runs on banks
milder if at all appreciable. I n consequencc, the drain of currency into
circulation would have been smallcr than it was and thc increase in bank
rcservcs would have bcen even larger than these figurcs suggest.
T o put thc matter as before, in terms of the elTcct on Fcdcral Rc-
scrvc credit-again assuming that bills discountcd and bills bought
~ v o r ~ lcach
d lia\.e becn scduccd to $50 million-had thc Systcm bought
an additional $920 million of government securities during tlic first eight
~iiontlisof 195 1 , Fcdcsal Rescrvc credit o ~ ~ t s t a n d i nwould
g llavc riscn by
$470 million instcad of $40 million. High-powcrcd money, undcr these
circumstanccs, would liavc riscn by $680 million or by 10 per cent instcad
of by 3% pcr ccnt. Evcn if both t l ~ cclcposit ratios llad fallen by as lnrrcl~
as tllcy dicl, t l ~ c~.csrrltw o ~ ~ lIlavc
d bccn no cllangc in tllc st0c.k of morlcy,
instead of a dccrcnsc of 5% pcr ccl~t.
O n this occasion, I~owcvcr, clTccts of thc cllnngc in tllc monctary
climate on tlic dcposit ratios would clearly llavc cnl~anccdrather than
offset tlic espansionary effect of the l~ypotlicticalopcn markct purchases.
Depositors worrld havc bccn far lcss eager to convcrt dcposits into crlrrcncy
and Ilanks, to strcngthcn still frlrtlicr thcir reserve position. 130th dcposit
ratios \\.orrld tlicrcfosc ha\^ fallcn lcss than tl~c).clid. Tllc sccolld Ilank-
ing crisis might indecd nc\.cr lia\.c occurrcd at all in such a cl~angcdmonc-
tary environment. Once again a $1 billion purchase program would have
bcen much greater than needed to change drastically the monctary situa-
tion. But even if thc second bankins crisis had occrirred, and evcn if it liad
been as severe as it was, the hypothctical open market operation would
ha\.c completely eliminated its effect on the stock of money.
Again, the change would have produced a reduction in the inflow of
gold and might have converted it into an outflow with a resulting casing
394
T I I E GREAT CONTRACTION
of the financial difficulties in Europe. And again, this must be counted
a n achicvcmcnt of the hypothctical purchase program and not an offsct.
SEPTEMBER 1931 TO E N D O F J A N U A R Y 1932
We citcd earlier the statement in a Systcm rncmorandum written in No-
vember 1931 that the " f o r e i p and domestic drain upon bank reserves
[after Britain's departure from gold] were met in the classic way by in-
creases in discount rates combined with a policy of frec lending." T h e
rncmorandum included. a quotation from the locus classicus of central
bnnk policy, Bagchot's Lombard Street. I n fact, howcvcr, the System fol-
lo\vctl nagchot's policy only with rcspcct to tlic cstcrnnl clrain, not t l ~ cin-
tcrnnl drain. T o mcct an external drain, nagchot prcscribcd a high Hank
rntr, tlic part of his prescription thc Systcm followed. T o mcrt an in-
'tcrnal drain, he prcscribcd lending frccly. "A panic," hc wrote, "in a
word, is a species of neuralgia, and according to the rules of scicncc yo11
must not starve it. T h e holders of the cash reserve must be re a d.v not
only to kecp it for their own liabilities, but to advance it most frccly for
the liabilities of others."lJ9 Dcspite the assertion to the contrary in the
memoranclum, the System gavc little more than lip service to this part of
nagchot's prescription, either before the external drain or aftcr it endccl.
Truc, dr~ringthc height of the internal and external drain in October, it
pcrmittcd its discounts ancl its bills bought to rise sharply. Brrt this \\!as
at thc initiative of the mcmbcr banks, in spi,te of sharp rises in the ratcs
on both, and was a result of the desperate situation of member banks bc-
cause of the double drain. As wc have seen, evcn after thc hcight of the
crisis, the New York Bank rcduced bill buying rates only gradually ancl
kept thcm abovc markct ratcs, so bills bought dcclinrd rapidly. T h c Sys-
tcm took no activc mcasurcs to casc the intcrnal drain, as i t could havc
done throrigh opcn markct purchascs. Contrast its behavior with that rc-
~ o r t c dapprovingly by Bagchot:
Thc way in which the panic of 1825 was stoppcd by advancing moncy
has bccn clcscribcd in so broad and graphic a way that the passngr has bc-
comc classical. "Wc lcnt it," said Mr. I-Iarman on bchalf of thc Bnnk of Ens-
lancl, "by cvcry possiblc mcans and in modcs we havc ncvcr adoptrcl bcfore;
\vc took in stock on srcurity, wc pr~rchascdExchcqucr bills, wc madc sdvanccs
on Exclicqucr bills, we not only discountcd outright, but we madc advanccs on
thc dcposit of bills of exchange to an immense amount, in short, by every
possible means consistent with the safety of the Bank, and we were not on
somc occasions ovcr-nice.'"M
Though the response of the System to the external drain was "classic,"
it was sharply at variance with the alternative policy the System had de-
'"Walter Bagchot, Lombard Strcct, London, Henry S . King, 1873, p. 51
'"Lombard Strcct, pp. 51-52.
395
 T H E GREAT CONTRACTION
velopcd during the 1920's, the gold sterilization policy. T h a t policy
called not for tightness but for ease to counter the gold drain and, even
more clearly, for case in the before and after the gold drain to
counter the internal drain."'
T h e Svstcm had sterilized inflows and outflo\vs of gold ciuring thc
t\c.cntics. .1t llad more than sterilized inflows from August 1 9 2 9 to August
1 9 3 1 . Consistent policy callcd for sterilizing the outflo~vafter Septcmbcr
1 9 3 1 as \c.ell. And the System was in an cstraordinarily strong tcclinical
position to follow such a policy. Just bcforc Britain's departure from
the gold standard, the U.S. gold stork was nt its Iliglicst I c \ ~ in l history,
o\.cr $ 4 . 7 billion, and anio~rntcd to about 10 per ccnt of thc \vorltl's
monetary gold stock. T h e Systcm's rescrve pcrccntage-tlie ratio of its gold
Iloldinps to its notc nnd deposit linbilitics-cscccdrcl 80 pcr ccnt in Jt~ly,
averaged 74.7 in September, and ne\.er fell below 56.6 in Octobcr. At the
l o \ c ~ s tpoilit. to\vnrcl the end of Octobcr, its golcl rcscrvrs cscccdctl legal
rcqnirr~ncntsfor co\.cr by more than $1 billion.142And this sum could
lin\.c bccn cspandcd undcr prcssurc by $80 million to $200 million by
simple bookkeepin: a d j u s t m c n t ~ . " ~Further, the Reserve Doard had the
legal po\e.cr to suspend gold reserve rcqtiiremcnts with ncgligiblc sanctions,
a po\crcr it (lid in fact invokc in carly 1 9 3 3 .
T h e major short-term balances subject to withdrawal wcre held by
Francc. French short-term balances, which had bcen declining since
1 9 2 9 , amountrd to $780 million in January 1 9 3 1 (out of a total of $1.8
"'For csamplc, src the mcmorandum by Benjamin Strong, listing t l ~ crcasons
for the Fcderal Rrscr\.e easy-money policy of 1924, one of which was, "To check
t l ~ cpressurc on thc banking situation in the Wrst a n d Northwest ancl tllc resulting
failures a r ~ d disasters. . ." (Stobilizotion, Ilearings 1)cfore the l l o r ~ s c nanking
and Currency Committee, 69th Cong., 1st scss., Afar:-Junc 1926; I.'cl~. 1927, pp.
335-336). O n e of the tests of Fcdcral Reserve policy, 192?-26, that Strong pro-
posrd was the n ~ ~ n ~ of b r bank
r faill~rcs ( p . 4 7 6 ) . S r c also Atlolpl~ h4illrr of thr
Fctlrrnl Rrscr\*c Iloartl or] t l ~ crolc of t l ~ rSystcln in Icl~tlillgto "l~acllis that arc i l l
s " supplying cn~crgcncyrurrcncy nccds (1111. O G I , 890.-
distrcssed c o ~ ~ ~ r n u n i t i cand
099) a n d 1%'.R . Burgess, thcn assistant Federal Rescwc agent of thc Ncw York
Rank, on thc powcrs of the Systcm for stabilization, including "clcspcratc rcmcdirs
for a dcspcrntc cmcrgcncy" ( p . 1 0 1 9 ) .
111
In contrast, thc Systcm's gold rrser\.c ratio was only 5 3 per ccnt at its maxi.
m u m in 1919 when it permitted inflation to procccd ~ ~ n c h c c k r c and l, it did not
takr contractionary action in 1920 until thc ratio had fallen to less than 43 p r r
cent.
"'Fcdcral Rescr\.c notcs in \,aults of issuing Fcdcral Rcsenpc Banks wcre suhjcrt
to the same collateral and rescrvc requirements as notcs in circulation. O n O c t . Dl.
1931, thcrc wcrc about $330 million of such notcs in vaults of issuing Banks.
According to a n internal Systcm mcmorandum, about $120 million in vault would
have been a d r q u a t c (Harrison, hfisccllaneou.s, Vol. I , enclosure, datcd Aug. 20,
1931, in lettcr, datcd Aus. 21, Harrison to M c D o u g a l ) . A rcduction of $200
million would have relcascd $00 million in rcquircd gold reserves held against the
notes. If, instead of 6 0 pcr ccnt cligil~lcpaper, gold wcre hcld as collateral against
thc notcs, a n additional $120 million in old wottld have been relcascd from lcgal
requirements.
396
T H E GREAT CONTRACTION
billion hcld by European countries) and by Septcmbcr wcre around $ 7 0 0
million.'" France was strongly committed to staying on gold, and the
Frcnch financial community, the Dank of France incl~rdcd,csprcssed the
greatest conccrn about thc Unitcd States' ability and intcntion to stay on
the gold standard. T h a t accounted for the special \,olatility of the French
balanccs. As it happened, tllough thc Frcnch balanccs \evere not with-
drawn in Octobcr 1931,'" they were almost entirely \,-itlidrawn in the
"'Banking a n d Monetary Statistics, p. 574. These a r c estimates of short-term
balances hcld by France a n d all of Europe in rcporting New York banks on
Jan. 31, 1931. T h c peak figures a year carlirr wcrc $890 rnillion and $2.0 billion,
rcsl~cctivcly.
I Y IIarrison informed the Bank of France in Oct. that, if it did not want to
invcst its funds in the U.S. money market, he prcfcrrcd not to hold Frrnch clcl)osits
in cxccss of $200 million. H e suggcstcd that it buy gold which would bc cithcr
earmarked for the Bank of France or cxported to France. T h e Frcnch rcprescnta-
tivcs cxl~rcsscdsurprise at Ilarrison's willingness to part with gold, but wcre not
caacr to witlrdraw it at tlrc t i ~ n cI,eca~~seor thcir fcars of possil)le inflationary
errccts of gold imports on the French cconomy a n d bccause of the loss of earnings
to the Bank of France. I t was agrced, howcvcr, that the Rank of Francc would
eflcct a gradual repatriation of a substantial fraction of its balancer in New York
(Ijarrison, Notes, Vol. 11, Oct. 15 a n d 26, 1 9 3 1 ) .
Rumors about Ilarrison's conversations with the French misrepresented thrir
substance: hc was said to have requestcd them not to take more gold from this
country a n d they had not agrced; a n d he was said to have committed hirnsclf to
maintain a firm money policy. H e denied these r u m o n in a lettcr to Co\fernor
hlcyer:
I have reviewed these matters in somc detail only because of the continued and
rcpeatcd rcports of an asrccmcnt in the nature of a "bargain" whcreby the
Fcderal Rcserve Bank of New York surrendered its frecdom of action regarding
crcdit o r discount rate policies in exchange for' a promise from the Bank of
France that it would not withdraw its funds from the market. T h e r e was not
any surh agrcemcnt, nor any such bargain. T h e Bank of France is pcrfectly free
at any tirnc it chooses to withdraw its dollar funds. T h e Federal Rescrve Bank
of Ncw York is cqually free in its crrclit and discount policies. In fact, there has
nevrr I ~ c c na tirnc in any of nly conversations with any central bank when there
was any rcqucst o r even any suggestion that they o r we should in any way make
a commitment as to any future policy that would in any way destroy o r limit
our completc freedom o f action in our own sclf-intcrcst.
These statcmcnts by Harrison are not ncressarily inconsistent with the artertion
by E. A. Coldenwcisrr, who was director of the noard's Division of Rcscarct~ a r ~ d
Statistics at the time: "The Bank of France at that time had large dcpmits in the
United States and it was undcrstood by the authorities that, if bill rates in this
country did not advance, these dcposits would be withdrawn in gold."
Without France's asking for a commitment and without Harrison's cntcring
into one, the French representativer could still have made it clear that they would
rcgard failure of the United Statcs to raise discount ratcs ac a sign that the
United Statcs was not serious about its announced intention to take whatever
meacurcs wcrc neccrsary to stay on the gold standard (Harrison, Miscellaneous,
Vol. I, letter, dated Dec. 18, 1931, Harrison to hleyer; ibid., letter, dated Dec. 22,
1931, Harrison to Calkins, who cvidcntly had acccptcd the rumors as t r u t h ;
E. A. Goldenweiser, American Monetary Policy, New York, McCraw-Hill, 1951,
pp. 158-159).
397
 T l I E GREAT CON'TRACTION
spring of 1932.140T l ~ e i rwithtlrawal in October would liave madc no
ultimntc diffcrcncc in thc goltl position. I t would, howcvcr, ha\.c rctlucccl
thc Systcm's rcscr\.c pcrccntngc to about 49 pcr ccnt and l ~ c n c crni~llt
l ~ a \ , chacl psycl~ologicalcffccts solnc:\vl~atdiffrrcnt from tl~osccxpcricnccd
\vllcn thc balanccs \\,ere actually witliclra\vn, sincc thc Systcm's rcscrvc
pcrccntagc did not. thcn fall bclow 58 per ccnt. T h e lowcst tlie reserve
perccntagc c\.cr rcachcd during tlie 1932 open markci operation was 56
pcr cent (monthly avcragcs of daily figures). Consequer~tly, it sccms
highly likely that, if a gold sterilization policy Iiad been adopted, gold
outflows \\.auld havc ccascd long bcforc tlic lcgal reserve ratio was
reaclicd, let alone bcfore the gold stock was drastically dcplctcd.14'
Suppose the Systcm hat1 raised discount ratcs w l ~ e nit dic!, adopting
the "classic" remedy for an esternal drain, but had accompanied tlie
mcasurc by purchase of govcrnmcnt sccuritics as callcd for by the "classic"
rcmed!. for an intcrnal drain and by its carlicr sterilization policy. Again,
to bc concrctc, Ict $1 billion bc tlic anioullt of tllc l~ypotl~ctical incrcnsc in
its s c c ~ ~ r i lioldi~igs.
ty 1Ylint would liavc bccn t11(: conscclucncc?
Bctwccn August 1931 and January 1932, currcncy hcld by thc public
rosc by $720 million and bank rescrves fell by $330 n ~ i ~ ~ i which d n , means
that, as a result of the increase in discounts a n d other minor changes,
high-powered money had risen by $330 million dcspitc the gold drain.
Other items being the same, Reser\.c purchases of $1 billion of govcrn-
ment securities \vould have mcant an increase of $1,330 million in high-
'@ Frcnch short-tcrm balanccs with reporting Ncw York banks wcrc, on selcctrtl
dates, in millions: Scpt. 16, 1931, $605; Dec. 30, 1931, $549; May 11, 1932,
$304: J u n e 15, 1932, $ 1 0 2 ; J u n e 29, 1932, $49 (Banking a n d hfonetary Stnti.rtic.r,
pp. 5 7 4 - 5 7 5 ) . T h e statistics include all dcposits and short-tcrm securities held by
the F r r n r h a t reporting domestic banks ant1 bankcrs, l111t thcy may not inclutlc
othcr American short-term liabilities to Frcnch citizens, such ar bills ant1 short-tcnn
securities hcld for them by agents othcr than thc reporting I~anks. I-Icncc thcse
f i g ~ r r smay c~ndcrcstimatcFrcnch withclrawals.
Go\*rrnor Harrison denicd that the ultimate withclrawal of Frenrh short-tcrm
halnnrcs reflected Frcnch clissatisfnction with thc c h a n ~ rin Fctlcral Rrscr\.c policy
in ttlc spring of 1932, though that was widcly rcportccl. I I c saicl, "[S]omc ~1co11lc
might arguc that o u r policy had been rcsponsiblc for thc rcccnt heavy outflow of
gold. b u t wc know that it was largely the repatriation of ccntral bank balanccs
which would have been withdrawn in any care" (Nutcs, Vol. 11, Junc 30, 1 9 3 2 ) .
"' Goldenweiser asserts t h e contrary, writing that "a full-fledged easing policy
[by which he clearly means, from the context, low discount ratcs, rather than opcn
market operations] .. . would have involved a suspension of reserve requircmcnts
against Federal Reserve deposits" (American Monetary Policy, p. 1 5 9 ) . Howcver,
Goldenweiser eives no et~idence to support .. his assertion. I t may have been the
opinion of thc authorities a t the time, thoush we have hecn able to find no
internal document in the Goldenwciscr Papcrs or in the 'Iarrison Papers and
no reference in the Hamlin Diary indicating that s ~ l c ha policy was cver seriously
contemplated or its consequcnces for the r e s e n e ratio explicitly considered. Thcsc
documents make the rise in discount rates appear to be more nearly a conditioncd
reflex than a policy decision reachcd after full consideration of a range of
feasible alternatives.
T r I E GREAT CONTRACTfON
powcrcd moncy. T h a t sum wor~ldhavc provided the \vhole $720 million
in currcncy witlidra\vn by the prlblic and a t the same timc liave cnnhlcd
bank rcscrvcs to incrcasc by $610 million instcad of decreasing by $330
million, or onc-ciglith of thcir initial levcl. T h e increase in bank rcscr\.cs
\vould have permitted a multiple expansion in dcposits instead of thc
multiple contraction that actually took place.
Of course, undcr thcsc circumstances, banks \vould h a w bccn untlcr
far lcss licavy pressure than they were and w o ~ ~ havc l d borro\ved lcss from
thc Rcscrvc Systcrn, thereby offsetting some of thc hypothetical incrcasr:
in high-powered moncy. Howevcr, this offsct would have rcflcctcd fewer
hank f a i l ~ ~ r cand
s a reduction in tlic public's dcsirc to con\.crt dcposits
into currency. Hcncc, thc currcncy hcld by tlie public \\,auld ha\.c riscn
lcss than it did. T h e nct cfrcct of thcse offsetting factors on bank rcrcrvcs
might liavc hecn eithcr cspansionary or contractionary.
Again, to suggcst ordcrs of magnitude, suppose that from August 1931
to Jnn11al.y 1932, cliscounts ant1 bills Louglit had both remained un-
cllnngrcl instcad of t l ~ cfirst rising from $280 nil lion to $840 million, and
thc sccond falling from $310 million to $100 million. Even undcr tliesc
assu~nl~tions: a p ~ ~ r c l i a sofe $1 billion of governrncnt securitics \\.auld lia\.c
meant a rise in high-powered money by $650 million more tlian tlie
actual risc. Evcn if wc couplc these assumptions witli tlic fr~rthcrestrcmc
assumption that, undcr such greatly improved monctary conditions, the
dcposit ratios \vould liavc fallcn as much as they ditl-and for the dcposit-
currcncy ratio, tlic fall in so short a timc was thc largcst on rccorcl-thc
rcsult tvould havc Iwcn to cttt the dcclinc in the stock of nionry to lrss
tlian half the actual clrclinc from August 1931 to January 1332. Onl!. n
motlrratc ilnl~rovrrnrvnt in tllc deposit-currency ratio--a dcclinr f r o ~ n
8.95 ro 7.10 instcatl of to 6.47-wor~ld, undcr thcsc I~ypothrtical cir-
cumstnncrs, liavc rnal~lcd tlic stock of monry to I)c stal)lc instencl of
falli~lq11)' 12 pcr ccnt.
T l ~ c(.rises wcrc 1)ccominn succrssivcly nlorr sc\fcrc, so t l ~ i stimc thr
$ 1 I~illion we 11avc bccn using as our standartl is not, as in t l ~ ccarlicr
pcriods, clcarly a mr~ltiplcof tlic amount r c q ~ ~ i r ctod turn t11c monrtary
tidc. n u t tllcse calculations s ~ ~ g q c stliat t an opcn markct purchase of
that sizc* \\,ot~ldhavc bccn adcquatc. And witli so great a changc in thc
monctary tidc, the cconomic situation co~lldhardly have detcl.ioratcd so
rapidly and sharply as it did.
.It1 t11(. I~ook11c pul~lisllcdaftcr retiring from the System, from which wc
quotccl abovc, Goldcnwciscr analyzed briefly thc System's rcaction to
Britain's departure from gold. Aftcr discussing the risc in discount rates
in rcaction to tlic external drain, which he terms a "brief return to
 T H E GREAT CONTRACTION
o r t h o d o ~ y " ~ which
'~ "had only passing a n d tcmporary cfTccts on the
b a n k i n s system o r o n t h e course of the depression," h e wcnt o n to say,
with rcspcct to the intcrnal d r a i n :
hforc scrious \\.as the fact that thc Systcm (lid not cxtcnd suficicnt aitl to
nlcrllbcr bnrlks through discounting their paper nrld tlint i t failctl to purquc a
vigorous policy of 'purchascs in the opcn markct. For this Inilt~rcof thc Systctn
to g i \ ~rnorc help it1 an clncrgcncy thc rnajor Llnrlic in on tlrr law wliirh prc-
scril)cd rigid rirlcs for thc eligibility of pnpcr for tliscount anc! also 1)nrrcd
gnvcrntllc.nt scr~~ritit*rfvotn collatcrnl arrcpt;~l)lvfor FCclrrnl Rrqrrvt. n n t c ~ . " ~
T l ~ rprnl)lrm to \\.ilich Goltlcn\\~eisrrrcfcr~.cd is t h r so-cnllctl frre-gold
~woI)Ic~rn. 1'11~ intrlmnl dr.:lin lind incrrnsrd t l ~ c . \.c)lt~rncof I:c.tlc.rnl Rrsrr.\.c
notes outstanding. T h e law spccificd that t h c System hold against notcs
a rcscrve of 4 0 per ccnt in gold a n d additional collateral of 6 0 pcr cent
in either gold o r cliSil>lc papcr (which consisted of commercial, agri-
cultural, o r illdustrial loans, o r loans s r c r ~ r r dby U . S . govcrnmcnt sccuritics
rrdiscountcd by m e m b c r banks; loans to mcmbcr banks sccurcd by pnpcr
cligiblc for rediscount o r by govcrnmcnt securities; a n d bankers' ac-
ceptances, i.e., "bills bought" in thc terminology of Fcclcral ~ c ' s c n . c
accounts). Becausc the System did not hnvc enough cligiblc paper to
furnish 6 0 per cent of the collatcral for Fcderal Rcscrvc notcs, part of the
gold in csccss of m i n i m u m rcquircmcnts had to bc plcdgcd f o r this pur-
pose. T h e a m o u n t o f frcc gold not n c r d r d to m c r t cithcr n ~ i n i ~ ngold ~~m
r c q ~ ~ i r c ~ n conrt collatcral
s r c q u i r c ~ n c n t swns thercforc lcss than t l ~ camount
of csccss gold rcscrvcs. T h c Fcdcral Rcscrvc Systc~n,in its Atttrtrnl Rrjlnrt
for 1932, a n d Goldcnwciscr, in thc passage quoted above a n d elscwherc
in his book, asscrt that thc shortagc of free gold was a n important factor
~ x e \ . c n t i n gtllc Systcm from engaging in larger open m n r k r t purchases,
such as t h c hypothctical purchases discussed in t h c preceding subscction.
Such p~rrchnscs,they asscrt, wottld havc rrdtlcccl cligiblc p n p r r holdings
still ftwthcr by reducing scdiscounts a n d thcsrlorc could have bccn con-
ducted only to a very l i n ~ i t c dextent w i t l ~ o u teliminating frcc gold cn-
tircly. T h c Glass-Steagall A c t of Fcbruary 27, 1932, disposed of t h a t
problem by permitting government bonds in the Rcserve Banks' portfolios
as well as eligible paper to serve as collateral against Fcdcral Rcserve
notes in addition to t h e 4 0 pcr ccnt m i n i m u m gold r c ~ c r v c . ~ ~ O
O u r o w n examination of t h e evidence lcads us to a different conclu-
llSHowevcr, while discount rates wcre raised at all Reserve Banks in Oct. or
No\.. 1931, they wcrc reduced a fcw months latcr only in Dallas and Richmond
and New York. Thc reduction in Ncw York was made more than [our months
aftcr the sccond risc in Oct. 1931, and brought the discount ratc only one-quarter
of the way back to thc Icvcl I,cforc thc gold drain. Four months Intcr, a tccond
reduction was madc in Ncw l'ork to 2'4 pcr cent-only halfway back to thc lcvcl
before the gold drain-wl~cre the rate rcmaincd u n t i l raised again in hiarch 1933.
'"American Monetary Policy, pp. 159-160.
'" Sce footnote 26, abovc, for other provisions of the 6 l a s s - ~ t c a ~ aAct. ll
400
T H E GREAT CONTRACTION
sion. Dcspitc thc attention it has sincc received, w c d o not bclievc a
shortagc of frce gold cscrtcd any m a j o r influence o n Fcdcral Rcscn.c
policy, for fivc reasons.
(1 ) T l l c carlirst pul~lishcd full-drcss tliscussion of frcc gold during
t h e 1929-33 contraction wc 11avc f o ( ~ n t lis a n article by Benjamin
Andcrson in thc Cltn.re Ecorzornic Bulletin of Scptcmbcr 29, 1930.
Anrlcrson, a firln belicvcr in tllc rcal l~illscloctrine a n d a n cqually firm
o p p o n c r ~ tof opcn markct opcrations, war.ncd, "Tllcrc is not enough frcc
gold to jtrstify artificially c l ~ c a prnoncy.'lr" IVc ha1.e found no cvidcncc
that tllc articlc cscrtcd any infl~lcnccwitllin thc Rcscrvc Sl.stc:~n.I n any
cvcnt, by t l ~ ctime it appcarcrl, N e w York hacl already lost its battlc for
expansionary opcn mnrkct pr~rcl~ascs, a n d thc general lincs \vhicll werc
to dominate policy until t h c spring of 1932 hncl already becn sct.
( 2 ) T h c carlicst ~ l n p u l ~ l i s h cSystrln
d documcnt o n frcc golcl \\,c havc
fotrncl is a m c n ~ o r a n d u mby Goldcnwciscr, written on J a n ~ l n r y 3, 1930.
H c rcfcrs to a n o a r d discussion of a statement by Anderson "that frcc
sold was down to $600,000,000 . . . " (in a n acldress to tllc American
Economic Association a n d Alncrican Statistical Association on Dcccmbcr
30, 1929) ; Anderson conclt~dccl,"Thc Fcdcral Rcscrve System is nearing
thc timc when it must look to its o w n reserve . . . ." T h e m c m o r a n d u m
mnkcs clcar t h a t thc Rescrve System regularly kept track of frcc gold,
ancl t l ~ n tits lcvcl was not a t tllc time a source of concern to t l ~ cBoard.
T l l c lirnitcd attention paid t o frce gold by tllc Systcm is suggcstcci
tlrc fact that thc carlicst mention of frcc gold wc havc found in thc Hamlin
:Diary is a n cntry of July 30, 1931, a n d in the Harrison Papcrs, a prc-
lirninary mcmorandum, August 3, 1931, for thc mceting of the O p c n
hfarkct Policy Confcrcncc o n August 11. Both noted that frcc gold on
J u l y 29 totaled $748 million a n d t h a t intcrnal bookkeeping adjustments,
involving reduction of Fcdcral Rcscrvc notcs in the tills of most Rescrvc
Banks to a "reasonable minimum," would have raised the free gold on
that date to $1,086 million.15z A later m e m o r a n d u m of August 21, 1931,
prcparcd a t the N c w York Bank considered the likely effect o n free gold
of a variety of alternative hypothctical de\~clopmcntsincluding large-scale
open markct purchases, internal drain of notes a n d gold, a n d a n esternal
drain and, concludcd that, even u n d e r rather extreme assumptions, free
"' Antlerson had referred to the significance of free gold in a Mar. 14, 1930,
articlc (1'. 1 3 ) , indicating his intention to discuss the subject fully later, as
hc did in tlic Scpt. 1930 Bulletin article, "The Free Gold of the Federal Reserve
Systcm and thc Cheap Money Policy" (p. 8 ) . W. R. Burgess told the Board
that a suhscqr~cntarticlc by Andcrson on gold (Chase Econonlic Bulletin, Mar. 16,
1931) did much damagc abroad to tljc Fcdcral Rcserve System (Hamlin, Diary,
Vol. 19,Oct.30, 1931,p. 173).
'" Sce Goldcnweiscr Papers, Container 1, foldcr of Confidential Liemoranda,
1322-33; Ncw York T i m e s . Dcc. 31, 1929, which rcfcrs to Andcrsoli's addrcss;
IIamlin, Diary, Vol. 19, p. 132; Ilarrison, Open hiarkct, Vol. 11.
401
 T H E C R E A T CONTRACTION
gold dicl not constitute an important limitation on the alternatives avail-
able to the S y s t ~ m T. h~e~ ~ memorandum for the October 26
meeting of the Open Market Policy Conference noted there had bccn
little change in frec golcl as a result of the gold outflow. Excess gold rc-
scrves had declined from $1.9 billion on September 16, 1931, to $1.1
billion on October 21, but free gold reserves had becn roughly constant
at oLper $0.8 billion because of a rise in eligible paper holdings. T h e pre-
liminary memorandum for the November 30, 1931, meeting did not even
refcr to free gold, though it did note, "there is skill plenty of gold left."
Aftcr tlic first of tht* year, frec gold may l ~ n v cfallcn as low as $i00 million
during January and February 1932, wl~ich could llavc bccn raisccl to
perhaps $525 million by bookkecping a d j ~ s t r n c n t s . ~Hence
~' the actual
amount of frce gold - throughout the whole period was sufficient to have
permitted extensive open market operations.
(. 3 .) IVhile frce -old was alluded to from time to time at mcctings of
the Conference or of its executive cornmittce or of thc Fcdcral Rcscrvc
Board or of the New York Bank directors, it was alinost always mentioned
as a problem by persons who had opposed open rnarkct operations all
along on other grounds; it was never given as the principal argument
against purchases, and the objections raiscd on this score almost always
\\.ere iinmediately countered by f i ~ i r e ssliowing that a shortage of frec
gold offcrcd no scrious limitation to policy.'" It is impossible to rcacl
' = I n his letter transmitting the memorandum to all governors, Harrison con-
cluded, "apart from the position of indivitlual Rcscrvc banks thc systcm as a wholc
has ample funds to deal with a n y situation within rcason which may arisc, ancl that
in matters of policy wc arc probably in a position to d o whatcvcr sccrns wisc for
the country's economy."
T h e memorandum stated the immcdiatc effect of thc purchase of $300 million
of g o v e r n n ~ e n t bonds would be a rcduction of about $137 mirlion in frce goltl,
Ica\.ing the System about $600 million, which could be incrc,zted to more than
$900 million by reducing Fcdcral Rescrve notes in vaults of tllc R c s c n c Ihnks. A
large increase in the demand for Fedcral Rescrve notcs or for gold, accortling to
the statement, woc~ldnot affcct the frcc gold position because that incrcasc would
bc accompanied by a n incrcasc in Fcdcral R c s c n c discounts and I ~ i l l holtlings,
which would supply eligiblc papcr collntcral for Fctlcral Rcscnrc notcs a~lclrclcasc
goltl uscd for that purposc. Goltl thcn in usc as collntcral, c s r l ~ ~ s i of\ ~ rfrrc goltl*
\\.as sufficient to provide a 1 0 p r r cent rrsrr\.c for ~ ~ l o rthan
c $ 3 I~illiorl of atltli-
tionnl note circulatioll, or to pro\.idc $ I % billion of gold for csport (hIisrrllnnroc~s,
Vol. I ) .
'"Opcn hlarket, Vol. 11. N o continuous figures on free goltl during thc critical
period, Sept. 1931-Feh. 1932, were shown either in the Atlnfrnl Rrport o r Federnl
Re.rerve Bulletin f o r 1931 and 1932, and w e havc hccn nlilc to f i ~ ~ tnonr l irl any
System puhliration since. 0 \ 1 r cctirnatcs for J a n . and F r h . 1932 arr Insrd on a
chart in Fetlcral Rcservc Boartl, Annlrnl I?eport for 1932, 1,. 17, pl11.c arnotlnts of
their own notes held by issuing Ranks, p. 91.
'"At the .4ug. 11, 1931, mecting of the O p c n hlarket Policy Confcrcnce,
Governors Calkins a n d Seay said, in response to I[arrisonls rccornrncntl:~tion of
substantial pnrchases of government sccc~rities, their 1l;111ks clitl not lloltl cnol~all
free to permit thcm to participate in further purchascs. Governor Harrison
402
T H E C R E A T CONTRACTION
in f t ~ l lthe record of proceedings of the Opcn Market Policy Confcrcnrc
and of meetings of tlic Ne'eiv York Dank diirctors during tllc period from
September 1931 through February 1932 and assign great significance to
frcc gold as a factor determining policy. T h e closest approach ..
to scrious
concern was expressed in January and Fcbruary 1932, when the Glass-
Stcagnll Act was in process of cnactmcnt and thc problem was on its way
to s ~ l t i t i o n . ' ~ T o n c c rover
n the gold problein during the period ccntcrecl
. citcd thc figures on frcc gold in thc rncrnorandurn of Aug. 0 , 1931, rcfcrrrd lo
al~o\.c,and pointed 0111 that "tllc q ~ ~ c s t i oto n tlcc:itlc was not whcther intlivitlual
h a t ~ k s corrltl, o r coultl riot, ~ ~ a r t i c i l > a tIc~, u tto try to agrcc on a Systcrn policy
w l ~ i c lwor~ltl
~ I>c Iicll>ful." IYhcn the Confi.rcncc 111ct with tlic Board later that clay,
C.o\*rrnor klcycr askcd i f "thcrc whc nny dangcr to thc Systcrn" in authorizing thr
c x c c ~ ~ t i \ . cornmittce
c to purcllase $200 nlillion o r $300 nlillion of go\.crnrncnt
I)onds. "hfr. Coldcnwciscr statcd that thcrc was n o dangcr in that dircction as wr
1lat.e $750,000,000 frcc gold which can be irlcrcascd t o $1,000,000,00C) I>y \\.itll-
drawals from tlic agrnts" (Ilarrison, O p e n hfarkct, Vol. 1 1 ) .
.At a rllccting of thc cxecutive committee of the directors of thc Ncw l'ork
Bank on Oct. 5, Owcn D. Young askcd how the purchase of govcrnnlcnt securities
I>y thc Rcccrve Banks "would fit into the proposed plan" for a corporation,
c\.rntunlly dcsignatcd thc National Crcdit Corporation. Harrison answcrcd, "that
Ilc considcrcd the gold position of the Systcrn paramount at this time, a n d on that
account would not bc inclincd to purchase Govcrnrncnt sccuritics." T h r c e days
latcr, however, a t a board mceting of the New York Bank, Harrison said "that t h e
amount of frce gold hcld by thc Systcrn h a d not bccn materially affected by the
rcccnt loss of gold, s o that thcrc was still considcrahle lecway for purchases of
Go\rcmmcnt securities" (Notcs, Vol. 11, Oct. 5 , 8, 1 9 3 1 ) .
At the Oct. 26, 1931, meeting of thc Conference, Harrison said that "the frec
gold position of thc Systcm was not a considcration at this tirnc" ( O p c n Market,
Vol. IT). O n Oct. 27, Goldcnwciscr reported to the Board that frec gold had bccn
n~nintainrtl tlrspitc thc gold exports of the precrding fivc wccks (1-Iamlin, Diary.
Vol. 19, p11. 169-170). N o reference w a m a d e to frce gold at the Not*. 30, 193 1 ,
mcrting of thc Confcrcncc, which authorized thc exccutive committce to buy u p to
$200 million of government sccuritics hcfore the end of the ycar ( O p c n hfarkct,
Vol. I f ) .
7'hc carlicst mention of the free gold problem we havc found in publications of
thc Fcdcral Rcscrve Board is in thc Bulletin, Sept. 1931, pp. 495-496. T h e term is
defined a n d a chart is presented showing free gold a n d excess rcscmes of the
Rcscrvc Banks from 1925 on. I t is rcfcrrcd to again in the Bulletin, No\.. I 9 3 1 , p.
604. N o mention of frcc gold is made in the Annual Report for 1931. I n ncither
that rcport nor any rarlirr onc is thrrc a su,q~cstionof Icgislation to rncct such a
prol>lrm, tho11gI1it was standard p r o c r t f ~ l r efor the Rcscrve System to list legislative
rccornrncndations in its rcports. 7.11~ Ann1101 Report for 1932, in cornmcnting on
thc passagc of thc Glass-Stcagall Act, contains the first discussion of frcc gold in
thc annual rcports.
'"On J a n . 4, 1932, IIarrison told the cxecutive cornrnittcc of the New York
Bank that "his only hesitancy in rccommcnding" substantial purchases of go\.cm-
rncnt I,ondc was o n account of the rclativcly small amount of frce gold "we now
havr at our clisposal," a n d for that rcason thc Rcscrvc Banks should havc autlloriry
to p l ~ d g call thcir asscts as rollatcral for Fcdcrnl Rcscr\,e notes (Notes, Vol. 11,
J a n . 4, 1 9 3 2 ) .
Ilis hesitancy did not prcvcnt his urging open rnarkct purchases a t thc Jan. I I,
1932, mccting of thc Confcrcncc (scc scct. 5 , above). At the Feb. 24 rnccting just
before the cnactrncnt of the Glass-Steagall bill, the System's failure to pursue
403
 T I I E GREAT CONTRACTION
not in the Fcdcral Rcserve Systcm but in thc Wliitc I-Iousc and Treasury.
At a confercnce with Congressional leaders on October 6, 1931, President
Hoo\.cr prcscnted thc proposals eventually cmbodicd in thc Glass-Stcagall
Act.lS7
( 4 ) If free gold had been a scrious handicap to a dcsircd policy, fcaciblc
mcasurcs f i t l l y consistent with past policir< of tlic Systcm wcre available,
cvcn clurinq the hcight of the gold drain, to rclicve thc frcc qold problcm.
( a ) T h e bookkeeping adjustmcnts rcfcrrcd to ahovc wcre apparently
csploitcd to sonic cstcnt, b t ~ tby no mcans fttlly. ( b ) Bills coi~ldhavc bccn
pr~rchascd instcad of go\.crnmcnt securities, sincc thcy wcrc cligiblc as
collateral for Fcdcral Rcscrvc notcs. Aftcr rising sharply during tlic Iicight
of thc crisis (Septemhcr-Octobcr, 1931), holdings declined continuously
from Octohcr 1931 to February 1932, because buying rates wcre kept
ahovc markct ratcs.lS8 ( c ) h.lcmhcr banks could have bccn encortragcd
activrly bill purchases, discoltnt ratc rcduction, a n d "l~ctying of Govcrnmcnt
sccurities, i f necessary, facilitated by alleviation of frcc gold position," recom-
mcndcd on Jan. 11, was explained as follows:
Continued uncertainties in the domestic situation, as wcll as a larsc drain of
gold to Europe and particularly to France, stimulated by fcar of inflation in
this coltntry, have becn important factors in making it secm undcsirablc to carry
through a n aggressive program of rcduction in discount ratcs a n d purchascs of
Go\.ernment sccurities. T h e rclativcly small amount of frcc sold hcld by the
r c s c n e systcm was a fttrthcr major factor in limititig the possibilities of purchascs
of Govcrnmcnt securities ( O p c n Markct, Vol. 11, minutes of meetings, Jan. 11,
a n d Fcb. 24, 1932).
"' FIoorer, hfemoirs, pp. 115-1 1 8 ; see also Bcnjamin Anderson, "Our Gold
Standard H a s Not Bccn in Danger for Thirty-Six Years," Chase Econotttic Bul-
letin, Nov. 10, 1932, p. 10.
In O n I,chalf of the System it could be claimed that the dccline was not its own
choicc. that its buying rate on acccptances was bclow the rcdiscount ratc, hut Ncw
York City hanks, which alonc h a d bills, wcre sul)stantially octt of clcl~t to thc
Fcdcral Rcsewc Bank of Ncw York by Nov. 1931 and hcncc had n o incrntivc to
sell ( H . 11. Villard, " T h c Fcderal Rcsen*c Systrm's hfonctary Policy in 1931 and
1932," Journal 01 Political Economy, Dec. 1937, p. 7 2 7 ) . T h c crucial point, how-
e\*er, is the rclation of thc buying ratc, not to thc recliscount ratc, but to thc
markct ratr. As Villard has pointcd otlt, from AUK. 1931 through O c t . 1931, whilc
the Systcm's bill holdings wcrc expanding, its I ~ u y i n grate was a t o r I)clow thc
markct r a t e ; thereafter its buying rate was /'19 to 'A pcrccntage point above the
markct rate (ibid., pp. 7211-732). If the Rcscnrc Bank hat1 lowcrcd thc buying ratr.
thc New York hanks would havc sold their acccptanccs to it. T h c Ncw York
Rank was fully awarc that thc relevant considcration was thc rclation of the
buying ratc to the markct ratc ancl trot to the r e d i s c o ~ ~ nratc,
t as its actions
in Aug. 1929 show. O n Jan. 21, 1932, IIarrison tolcl his boartl of dirrctors,
"[\V]c should probably have lowcrcd o u r bill ratcs hccausc thcy [arc] wcll al)ovc
the effective market rates and o u r portfolio of bills [is] rapidly diminishing"
(Harrison, Notes, Vol. 11).
Benjamin Anderson, w h o argued that thc a\.ailal~ility of frcc gold was a
constraint on Federal Rcscwe expansionary policics \(which, as we have notcd,
he opposed), nevertheless denied that the Glass-Steagall Act was esscntial to
404
T H E GREAT COS'I'I<ACTION
to incrcasc thcir cliscounts. At all timcs tllcrc tvas ample cligible papcr in
t l ~ cportfolios of 1ncm1,cr I,ank~.'~O
Golclcn\vciscr and otlicrs rccognizc this
but say that thc only way to incrcasc the amount in the hands of tlic
Fcdcral Rcscrvc Banks wottld have bccn to scll bonds and thcrcl)y forcc
mcmbcr banks to disco~tnt.'" Thcy add, quite correctly, that such a stcp
would have bccn dcfiationary. Howcvcr, that \\.as not the only way.
Failurc of banks to discount was partly a conscquence of thc long-stand-
ing Fcdcral Rcscr\.c prcssurc against continuous borrowing. I n 1929, thc
Systcm went beyond that and rcsortcd .to "dircct pressure" to dissuadc
mcmbcr banks from discounting for particular purposes. I t tvould ha1.c
bccn casicr to usc dircct prcssttrc to pcrsuadc mcmbcr banks in 1931 or
relieve the constraint. He listctl alternatives available for increasing t h e s u p l ~ l y
of frcc goltl similar to those listctl in o u r item 4 . Concerning 4 (h) he wrote:
bforco\*cr, it woultl havc I ~ c c nvcry casy to inrrcasc thc volume of opcn-market
a r ~ , c l ~ t a t ~ cavail;tl)lc
cs for ~ ) u r c h a s cI)y the Fedcral R c s e n c Banks, by concerted
policy irlvolvitlg the c & ~ ) c r a ~ i o nof batiks a n d great business corporations-a
proposal of this sort was actually made by important industrial lcadcrs ("Our
Cold Standard H a s Not Uecn in Danger," p. 9 ) .
101 Scc the figures on country and rcseme city member banks' holdings of cligil~le
assets, including cligible paper a n d U.S. govcrnmcnt securities not plcdgcd against
national bank note circulation, o n J m c 30 or a t call dates, J u n e 192G through Dec.
1932, Fcdcral Rcscnre Board, A n n u a l Report for 1932, p. 126.
IIoldings o f cligil~lcpaper, including papcr under rediscount, were four timcs,as
largc as rncmbcr bank borrowings, when this ratio wac a t a low point in Dcc.
1931. Of course, mcmbcr bank borrowings were sccured by U.S. government
sccurities as well as by eligiblc papcr, so thc possibility of increased borrowing on
thc Insis of eligible papcr holdings in Dec. 1931 is understated.
O n M a r . 24, 1932, in Hcarings beforc the Senatc Committee on nanking a n d
Currency on S. 41 15 (National a n d Federal R e s e r ~ ~Banking,
c S ~ r t e r n ,i 2 d Cong.,
1st scss., p. l o g ) , Scnator Glass rcmarkcd, "Lct mc say that in a n interview I
had with him as latc as last Saturday evening, the chief of hankins o ~ ~ c r a t i o nit,s
thc Fcdcral rcscwc system statcd to me that the hanks had amplc eligit)lc papcr."
I.Ioldings of cligiblc paper wcrc also wiclcly .tlistributed, according to figures
Glass prcscntcd during the Scnatc dcbatc on the Glass-Stcagall bill. I l e said hc
supported the section of the I)ill that permitted banks without eligible paper to
rcdiscottnt other sccurity satisfartory to thc Reserve Isanks, not bccausc tmnks no
longer hcld adequate amounts .ofcligiblc paper, but bccat~seof the psychological
ellcct of the mcasure in frccitig tllc fear-riddcn banks from their inhibition to
rcdiscount the cligiblc papcr thcy owned (Congrtrrional Record, Senatc, Fcb. 17,
1932, p. 4'1 3 7 ; sce also H. P. Willis and J. M . Chapman, T h e Banking Siltration,
Ncw York, Columbia University Press, 1934, pp. 678-679).
la C.oldcnwciscr, American bfonetary Policy, p. 1 6 0 ; and Fcdcral Rcscrvc Board,
Anntral Report for 1932, p. 10. Benjamin Anderson believed force would not '
havc bccn necessary:
Thcy [ t l ~ c Fcderal Rcscrve Uanks] could have done this [sold government
securities] without force, by arrangement with the great banks of the country in
such a way as to tighten money markets little, if a t all, if it wcre done in
concert a n d as a matter of gcncral policy ("Our Gold Standard Has Not Bcen
in Dangcr," p. 9 ) .
405
. ' \
T H E C R E A T CONTRACTION
1932 to increase their discounts, since that could have becn made psofit-
ablc for memlcl- banks.161
(5) Finally, enactment of the Glass-Steagall Act on F r l ~ r t ~ 27,
a s ~1932,
cntirclg ren~ovcd the prollcm of free yoltl. Yrt, as we Iia\.c srcn, its
enactment did not lead to a cllallge in Fcdcsal Rrscr\-e.poticy. T h e large-
scalc opcn market operation of 1932 was hegun sis wccks latcr primarily
bccause of Congressional prcssurc and was allowcd io lapse not long after
Conyscss adjourncd.
T h e 'concltision scems incscapablc that a shortagr ol frcc gold did not
in fact wriously limit thc alternatives open to tlic Systcm. T h c amount
was at all times ample to support large open markct pi~rchascs.A sllortage
was an additional reason, at most, for measuscs acloptcd primarily on
otlicr grounds. T h c removal of tllc prol,lcm did not of itsclf lcnd to changc
of policy. Tile problem of frcc gold was largely an c s post justification
Tot policics followed, not an e s ante reason for thcm.
'" T h c Systcm need only have ofTcrcd to discount mcrnbcr bank papcr barkcd
by govcrnmrnt sccuritics (\\*hicll ronstitl~tcd acccptal)lr collateral for Fcdrral Rc-
rcr\.c notrs) nt a rntc bclo\v tllr n ~ a r l t r t vicld or] Co\,rl.llrllcnt scv-rrritic. Ilntlrr
Sccrctary of tllc l'rcasur). hiills al)lnl.crlrly nradc that rrcorrlrnc.ndation to t l ~ cO p r n
hlarkct Policy Confrrcncc nlceting on Jan. 1 1 and I?, 1932. l'hc 'Treasury, which
had t o raise $1% billion by June 30, wanted t o encourage bank subsrriptions
in the face of a severe depreciation in govcrnnlcnt securitirs sincc Scpt. 1931.
"l'l~c inrlinatiorl o f banks to sul)sc~.il)cwot~ltlI)e irlc.rcnscd I)y r c t l ~ ~ r t i o of
rl Fr~lrral
r c s c n c discount rntcs to gi\,c some t l i f T ~ * ~ . r ~ I,r-~wc~rrr
~tial thosc rntrs all11 t h r yit.ltls
on government securities. I f banks can I)e inducctl to borrow arld I I I I ~ tlrc net
efTcct must l)c a n cspansion of crcdit" (I-Iarrhot~,O p c n hfarkct, Vol. 1 1 ) . NO
action was takcn on the rccolnn~cndation.
Suggrstion of a "variation of thc 'dircrt prcssurc' mctllod, tricd unstrcccssfully
in 1919." namely, "borrowirlg ..
. would not be frowned upon l>y the Fcdcral
R c s c n c Banks," was made in 1930 I)y a Ncw York Bank director, Inlt it was not
ronsidcred to bc a I)ractical ralutior~of the 1)rol)lcm (Notes, Vol. I , hlny 26, 1930).
Individual R m c n e Banks must have difTercd a t any gi\.cn timc in thc r1)couragc-
nlent to discount they gave their m r m b e r banks. See. for example, Charles T:.
hfitchell's comnlcnts on thc San Francisco Dank, which rtlgscst that it was not
liberal in its intcrpretation of cligil)ility requirements (Notcs, Vol. 11, Oct. 15,
1931). Even Harrison, who in Oct. 1931 rccommendcd that Ncw York City banks
borrow freely from the System "what was necusary to nlcct thc tlccds of the
situation," hesitated to call bankers in to see him in this connection, I~ccausc"we
must bc prepared to have o u r action corlstrued as a n invitation to conlc in and
borrow from this bank a n d to d o sometl~ingwith the funds thus obtained. This
procedure would, therefore, have its rcsponsil)ilities." Owen D. Young said he
wanted "to stop, look, and listen," before proceeding "by calling group rnectings
of bankers a n d b y issuing what will be, in effect, a n invitation to the rnembcr
banks t o come in a n d borrow at this bank" (Notcs, Vol. 11, Oct. 26, 1931; Mar.
?4, 1 9 3 2 ) .
Clark LVarburton maintains that, far from encouraging discounting as a nlcans
of getting more eligible paper, "as bank failures became frequent, the Fcderal
Rcscrve banks de\,elol)cd a n extremely hard-boilcd attitudc toward n~cnll)rr1,arlks
which needed to borrow to meet deposit withdrawals" ("Has Bank Supervision
Bccn in Conflict with hforletary Policy?", R ~ u i e c u of Economics a n d Stnfirtic.r,
Feb. 1952, pp. 70-71 ) .
406
T H E CREAT CONTRACTlON
7. W h y W a s Monetary Policy S o Inept?
We trust that, in light of the preceding sections of this chapter, thc
acljcctivc itscd in thc licading of this one to characterize monetary policy
during tlic critical period from 1929 to 1933 strikes our readers, as it
docs [IS, as R plain description of fact. T h c monetary system collapsed,
but i t clcarly need not havc done so.
T h e actions required to prevent monetary collapse did not call for a
Irvrl of knowlcdgc of thc operation of thc banking system or of the work-
inxs of mnnctnry forces or of economic fluct~tationswhich was de\fclopc'd
only lntcr a n d was not available to the Rcsrnje System. O n thc contrary,
as we havc pointed o i ~ tearlier, pursuit of thc ,policies ot~tlincdby tllc
Systrrn itsrlf in thc 1920's, or for that niattcr by l3agchot in 1873. wottld
hnvc prcvcntcd thc catastrophe. T h c mrn who established the Fedrrnl
Rcsrrvc Systcm had many misconceptions about monetary theory and
.banking oprrations. It may wcll bc that a policy in accorclancc with thcir
~tndrrstanclingof monctary matters wot~ldnot l ~ a v cprcvcntctl thc dcclinc
in thc stock of money from 1929 to thc cntl o l 1930.'" 211tlthry trntlcr-
111 For example, M. Parker LVillis, who played a major rolc in the c\,olution of
thc Frtlrral R c s c n c Act, was regularly reported in the coltrn~nsof thc Corrrr~~prcinl
nnd Firrnncinl Chronicle in 1931 and 1932-hc had rcsigncd from ihc editorship
of thr Jotrrnnl of Cotnmerce in May 1931-as inveighing against o p r n market
o l ~ c r n ~ i o ~a t~s~ arguing
cl that thc only task of t h c Rcscrvc Systcm was to tliscocrnt
t.li.qilll(.' I'apcr. A cal)lcd articlc by Willis in a Frcnch publication (Agence Eco-
rromiqrir el Finnnci2re) in Jan. 1932, announcing that thc Fcdcral Rescwe Systcm
hntl atloptcd inflationary policics, creatctl a sensation in Europcan financial circlcs.
Govcrnor hforet of the Rank of France cabled the article to Harrison for comnlcnt.
It rratl in part:
.
Inflation is the order of thc day . . . T h e discol~ntrate will prohably he low-
crctl at the next mccting of tllc Roard of Ilircctors of the Fcdcral Rescrvr nank
of New York. [ T h e rate was not lowrrrtl until. F r h . 26, possibly because of
Willis' articlc.] l'hc rctl~~c:tionof the hrrving rate for acccptanccs in thc opcn
market which took place on Trrrstlay [Jan. I ? ] is a preparatory mrasurc to
which the Federal R c s c n c Bank always has recourse in such rnscs. Financial
circles considcr it a n intlication of a change in monctnry policy and csprct heavy
purchases of govcrnmcnt scruritics, acccptanccs, a n d pcrhaps of other bills
.
. . . T h c r c is rcason to expcct that all attempts to crrrh inflation a n d hampcr
crrdit rspansion hascd on long term paper will meet with general opposition.
Inflationary ideas havc s c r i o ~ ~ c ltakcn
y hold of many minds in financial circlcs
.
. . . . Wall Strcct . . hails inflation as assuring an upward movemc'nt of
sccuritics . . . . T h e greatcst d a n s c r inheres in the risks to which the Fedcral
Rcscr\.c Banks arc cxposcd in conncction with the various proposals for thc
11roatlenin.q of thcir discount a n d loan operations . . . . I n view of thesc dc-
\.clopmrnts rrrtain obsrrvcrs rrmark that the gold export which ccascd some timc
ago may casily begin again, the markets which permit the free export of gold
having cvrrywhrrc hecomc \,cry narrow (Harrison, Miscellaneous, Vol. 11,
LVillis article, tlatctl Jan. 13. 193?, quoted in full in cablc, dated Jan. 15, 1932,
Bank of France to Harrison).
Trlrl)honc calls ant1 cablc rncssages wcrc exchanged by the New York Bank and
thc nank of Francc t)cforc the cxcitrment over Willis' article subsided (Conver-
407
 T H E GREAT CONTRACTION
stood ver)' wcll the problcm raiscd by a panic attempt to convert dcposits
into currency, and tiicy provided ample powcrs in the act to dcnl with
such a panic. Tlierc is little doubt that a policy bnscd solely on a thor-
ough pcrusal of tlic hcarings pl.ccctliny tllr cnnctmcnt of the Fcdcral
Rcscrvc .4ct and n niodcrntcly infnl.mc.d t~ntlc~~stnntling o l t h r ~ n\ \ ~ ~ t r l t l
Iin\.c cut sliort tltc liq11itlity crisis bcforc it ltnd gonc vc.1.y far, ~)cl.llal)s
bcforc tlic cnd of 1930.lG3
Contemporary economic comment \\,as hardly distinguisllctl by thc
corrcctncss or profundity of t~nclcrstandingof the economic forccs at work
in the contraction, though of coursc tlicrc were notable csccptions. hrlany
sations, Val. 11, Jan. 14, 1932, dictated Jan. ?O; hliscellnnco~ls, Vol. 11, cal>lc.
dated Jan. 15, 1932). New York City banks also received cablcs from thcir Paris
agcncies inquiring about the artirlc. On Jan. 16, I-Iarrison askccl Scnator Glass
to use his i n f l ~ ~ c n ctoc stop "l\'illis' rather steady flow of clisturbing and alarming
articles about the Amcrican position" ( h l i s c c l l a n c o ~ Vol.
~ ~ , 11).
l\'illis followcd his former teacher J. Laurence Laughlin in his espousal of thc
"real-bills" doctrine (see C h a p . 5, footnotc 7 ) . H c applied those criteria to the
operations of Fedcral Reserve Banks when he helped draft thc Fcdcral Rescrvc
.Act whilc s c n i n g in 1912-13 as a n expcrt on the Housc Banking and Currcncy
Sul~committccof wllich Carter Glars was chairman. Aftcr Glass bccamc a Senator,
\Villis continucd to be closcly associated with him.
la'Scc Banking a n d Crtrrency R e f o r m , Ilearings before a subcommittee (Cartcr
Glass, C h a i r m a n ) of the Hotrse nanking and Currcncy Committee, 62d Cong., 3d
scss., Jan. i-Fcb. 28, 1913; and A Bill t o Provide for the E ~ t a b l i s h m e n fo f Federal
R e r ~ r ~ .Banks,
e Hearings before thc Senate Banking a n d Currcncy Committcc
( R . L. O w e n , C h a i r m a n ) , 63d Cong., 1st scss., Sept. 2-Oct. 27, 1913, 3 vols. I n
the I-Iouse hearings especially, many witnesses showcd clear understanding of the
rcmcdy for a liquidity crisis: cf. the testimony of Lcslic hf. Shaw, former Sccrctary
of the Trcasury, pp. 99-101; F. J. lVadc, St. Louis banker, pp. 219-221; W. A.
S a s h , former chairman o f the Ncw York City C1carin.q Iiousc Association, pp.
338-339; A. J. Frame, M'isconsin banker, pp. 415-4?1. Frame did not favor estab-
lishing a r c s c n c system; he urged cxtcnsion of the Aldrich-Vrcclancl Act to state
banks so they could "obtain cxtra rash in timc of troul)lc." If that wcrc donc.
"wc would nc\.cr have a suspension of cash paymcnts in the United Statcs again"
( p . 4 2 1 ) . I n thc Senate hcarillgs, cf. the tcsti~nony of G. hf. Reynolds, Chicago
banker, Vol. I, p. 2 2 8 ; a n d Nathaniel Frcnch, Iowa businessman, who testified,
"lVe can prevent a panic such as occurred in 1907 ... by provisions for a n
elastic notc issue, the mobilization of reserves, and thcir usc in timc of nccd"
(Vol. 111, p. 2 0 7 5 ) .
Note also Clark \Varburton's comment:
I t is apparent that the Fcdcral Rcscr\lc System could opcratc as intended-i.e.,
to providc a n clastic currency without contracting mcmber bank rcscrves-if
a n d only if the Federal Reser\:e Banks acquired additional assets . . . to the
full c s t c n t of increased clrrrcncy issucs in thc form o f Fcdcral Rcscrvc notcs
... . T h c necessity of kccpillg this principle in mind in the operations of tllc
Fcdcral Rcscrvc System is so ol)viol~s-in vicw of its discussion in the litcraturc
preccding establishment of the Fcdcral K c s c n c Systcm and thc provisions of tllc
Fcdcral Rcscr\,c Act-that thc fni1i11.cof Fcdcral Rescr1.c oficials to hantllc thc
System in conformity with i t in thc 19.70's warrants a cllargc of lack of adhcr-
cncc to the intent of thc law ("hlonctary Diffictrltics a n d thc Structure of t l ~ c
Monetary System," ]ournal of Finance, Dcc. 1952, p. 5 3 5 ) .
408
T H E GREAT CONTRACTION
professional cconomists as well as others viewcd the depression as a
desirable and necessary cconomic devclopmcnt required to eliminate in-
eficicncy and wcakncss, took for granted that thc appropriate cure was
bclt tiglitcning by both private individuals and the govcrnmcnt, and
intcrprctcd monctary changcs as an incidental rcsult rather than a con-
tributing c a t ~ s e . l ~ '
T h c banking and liqt~iditycrisis must, ho\vcvcr, be distinguislicd from
tlic contraction in gcncral. It was a much morc spccific phcnomcnnn?
'with far morc clcarly ctclicd prcdcccssors \\,llich had been studicd nntl
clnssificd at Icngth. One might thcrcforc ha\,c cspcctcd a milch bcttcr
untlcrstanding of tlic banking and liquidity crisis and of thc mrnstlres
rrquircd to rcsol\rc it satisfactorily than of thc contraction in gcncml. To
. some cstcnt, this cspcctation was fulfilled. For csamplc, Conyrcssmnn
A. J. Snl)nth of Illinois wrote to Eugcnc Xfcycr in January 1931. altcr
Mcycr Ilad turncd clown his strggcstion that thc propcr rcsponsc to tlic
incrcasc in bank failttrcs \+,asrelaxation of cligi1)ility rcquiremcnts in ordcr
to encotrragc rediscounting: "Docs thc board maintain tlicrc is no
emcrgcncy existing a t this time? T o my mind if evcr thcrc \\,as an
cmcrgcncy, it is now, and this, I fccl, no onc can s~icccssfullydcny. For
while 439 banks closcd thcir doors in 1929, during the ycar 1930, 3.7-1
banks wcrc forced to suspcnd business." O n the floor of thc Hotrsc,
Sal~nthsaid, "I insist it is within the power of the Fedcral Rcscrvc nnarcl
to rclicvc thc financial and commercial distress."ls8 Some academic pcoplc,
"'Scc, for cxamplc, Al\.in , H . Hanscn, Economic Stabilization in nn Unbnlnnced
IVorld, New York, Harcourt, Brarc, 1932, pp. 377-378. T h e repeated attempts to
curb fcdcral cxpcnditurcs and thc sharp t a s ritc in 1932 tcstify to thc efTcctivrncss
of thcsc vicws. Writing in 1382, A. B. Adams ( T r e n d s of Brtsiness, 1922-1.9.72,
Ncw York, FIarpcr, 1932, p. 61)) statctl:
It w o ~ ~ l cbel qttitc 11ndcsiral1lc to havc an additional inflation of hank crctlit in
this coilntry a t ~ h cprcscnt timc. l'hcrc is too much of thc old inflation to I)c
gottcn ritl of hcforc I)usinmt can I)c put on a sound basis. Temporary inflation
woultl rcsi~ltonly in a postponement of thc incvital~lcdeflation and rradjustnicnt
ant1 th,crcl)y result only in prolonging the prcscnt dcprcssion.
I la R e c o n z f r ~ t c t i o nFinance C o r p o r a t i o n , IIcarings hcforc the I-Iousc Banking and
Currcncy Committee, 72d Cong., 1st scss., Jan. 6, 1932, pp. 78, lo?-104. Scc also
thc tcstirnony in h4nrch 19.32 of formcr Scnator R . L. Owcn of Oklahoma, a hankcr
ant1 Iawyrr bcforc his clcction to thc Senate in 1307, and chairman of thc Senate
Banking a n d Currcncy C o m m i ~ t c cwhcn thc Fcdcral Rcserve Act was passed:
T h e powers of the Fcdcral Rcservc Board a n d of thc Fedcral rcservc hanks wcrc
abundantly great to havc checked the collapsc of valucs if thcy had had thc
vision to cmploy thc authority given by law.
Instcad of cspanding thcir crcdit whcn crcdit was bcing contracted and cor-
recting thc dangcro~ts cvil thcy rontractctl tlreir own crcdits from Dcccmhcr,
1323, to Junc, 13.70, ahout $700,000,000 and only cxpandcd i t hy Fcdcral rc-
s c n c notcs whcn thc tlcpotitors in 1)nnks wcrc tlri\.cn hy fcar to wholcsalc hoard-
ing in August, 1330. Sincc January, 1932, thcy arc again contracting crcdit.
Clcarly what the authorities of thc Fcdcral Rcscrvc System should have donc
was to buy United Statcs bonds and bills in the opcn market and emit Fcderal
409
 , c
T H E C R E A T CONTRACTION
such as I-Iarolcl R c c d , Irving Fisher, J . W . Angcll, a n d K a r l n o p p es-
pressed similar views.1BB
Despite these important esceptions, t h e literature, a n d particularly t h e
academic litcrattire, o n t h c banking a n d liqiticlity crisis is almost as d e -
pressing a s 111at o n t h e contraction in grnc-ml. Alost st~rprisingly,some of
tllosc whose \\.ark h a d d o n e most t o lay t h e grounclwosk for tllc Feclcrnl
rescne notes to thc extent necessary to stop the depression as far as it was due
to thc contraction of crcdit and rurrcnry. They werc so advised Ily thc experts
of thc Royal Bank of Canntla ant1 hy others. 'I'hcy shollld havc nrrtlctl no atlvirc
for a rrn~ctlyso srlf-rvidrrlt (Slnbilizntion 01 Cot~rr~~oclily
Pricr.r. Itcnrings I>rforc
t l ~ c1Io11scS~~brolnmittrcon Bnnking ant1 Cl~rrcnry,72tl Cong., 1st srss., part 1 ,
p. 136).
Sce also testimony of D. H. Fishcr, a director of the largest national farm loan
association in the U.S.,and of an Indiana county bankers' association (ibid., pp.
289-293).
The monthly lettcr of thc Royal Bank of Canada notcd in July 1332:
. . . [I]t is ob\.ious that the attitude of the Rmervc Systrm tltrring I330 and
1931 to crctlit contraction was passivc . . . When l>oartlingset in [datetl Orto-
I ~ r r1930 by the Icttcr]. this ft~rthcrrontrnrtion of crctlit w.u only partly omset
by thc purrhasc of sccuritics . . . [I]t is ncccssary for largc surpluc rcscrvcs to
accumulate in ordcr that the banks should feel that i t is safe for thcm to pursue
a more liberal policy with thcir clients. It is notcworthy that in relation to the
violence 01 the great depression, thcrc hm bcen much lcss of an accumulation of
surplus rescncs than in prcviol~spcriods.
'" Scc lootnote 51 abovc; also H. L. Reed, "Rcscrve Bank Policy and Economic
Planning." Anlrrirnn Economic Reviezc~, Afar. 1933 Supplement, pp. 114, 117
, I I C s u l ) s e q ~ ~ c q~~alifictl
~ ~ t l ~ his al.gunlcnr, on the grotlntl t h a t cj~~an~ifative con-
trols r~cctl lo be supplemcntetl 1)s cl~~alitativccontrols, in "Thc Stal)iliza.
tion Doctrines 01 Carl Snydcr," Q~tnrterly Journal o/ Economics, Aug. 1935,
pp. 618-6201 : Tning Fisher. Rooms nnd Depre.irion.r, Nrw York, Aclrlphi,
1982, pp. 96, 10G, 126-134, 148-152: and J . 1.1. Rogcrs, who wrote, "For thc fail-
.
llrc to create . . a basis for much-ncctlcd crcdit nncl price cxpansion, thc
Frdcral Rcser\,e Systcm is by many capable students of its policy being hcld
dirrrtty responsihlr. It is rontcntlctl with murh forrc that in pcriotls likc tllc
j)rrsr~itonr, 111rsc rcntral i ~ ) s ~ i t ~ ~ t irnllqt
o i i s ritlirr llsr their Krrxt '01)rn-inarkrf'
powrrs to arrrst damaging prirc dcclinrs, or rlsr mtrst fnrc highly tlcsrrvctl rrit-
irism" (..I111erirn IIJei,qhs I l r r Cold, Salc University Prcss, 1931, pi>. 206-309) ;
\V. I. King, who wrotc, "Supposc . . . that in 1930. whcn prircs I~cgnn to
plunge downward precipitously, the propcr Fcderal authorities had begun vigorously
to pump new monry into circulation. \Voultl not this 1)rorcss hnvc startctl priccs up-
ward, rcstorcd confidenre, or optimism, ant1 b r o ~ ~ g hbt~sir~css t Inrk to normal hy the
middle of 1931? The most probable answer . . . sccrns to hc 'Ycs!"' ("Thc
Immcdiatc Cause of the Business Cyclc," Iournal o{ the American Statistical
Associntion, AIar. 1932 Supplcmcnt, p. ? 2 9 ) ; J. W. Angell, "Monetary Prc-
rcquisitcs for Employment Stabilization," in Stabilization o{ Employment, C. F.
Roos, ed., Bloon~ington, Principia, 1933, pp. 207-214, 222-226; Karl Bopp,
who wrotc, ". . . AIr. -4. C. AIiller, who seems to be the dominant figure in
the Board, has stated that hc is opposcd to open-markct opcrations-thc only
effcctivc method of stimulating re\.ival from a severe depression-esccpt as a
'surgical operation.' Even through 1932 he was not of the opinion that such a
'surgical operation' was necessary" ("Two Notes on the Fedcral Reserve Systcm,"
Journal o{ Politicnl Econo~ny,June 1932, p. 390).
410
T l I E C R E A T CONTRACTION
Rescrvc A r t o r w h o liad I ~ c e nmost intimately associatcci with its formula-
tion-for c s a m p l c , 0. A{. W . Spraguc, E. IY. Kcnlmcrcr, arid 13. Parkcr
IYillis-wcrc lcast pcrccptivc, pcrliaps bccausc tlicy h a d so strong a n
i n t r l l c c t t ~ a lcommitment to t h c vicw t h a t t h c Fcdcral Rcscrvc System h a d
once a n d f o r all sol.vcd of liquidity. O n e c a n rcad t h r o u g h the
annual Procccdiugs of t h e American Economic Association o r of t h e
Acadcrny of Political Science a n d find only a n occasional sign t h a t t h e
academic world even kncw a b o u t t h c unprcccdcntcd banking collapsc in
proccss, let alone t h a t it understood t h c causc a n d thc rcmcdy.
T l l a t cliinatc of intcllcctual opinion 11c:ll)s to c s p l a i n w l ~ ytllc h c l ~ a v i o r
bf tile Fcdcral Rcscrvc System from 1929 t o 1933 \\.as n o t c l ~ c c k c do r
rcvcrscd by vigorous a n d informed outsidc criticism. But ncithcr t h e
climate of opinion n o r external financial pressures n o r lack of power e s -
plains why t h e Federal Rcscrve Systcm acted as it did. N o n e of t h c m c a n
csplain why a n active, vigorous, self-confident policy in t h e 1920's was
followc,d hy a passivc, dcfcnsivc, l ~ c s i t a n tpolicy from 1929 t o 1333, lrast
of all tvliy tlic Systcln failed t o m c c t a n internal drain in t h e way in-
tcndcd by its for~ndcrs.Ecorlomic contrdction f r o m 1923 to the fall of
1930, bcfore t h e onsct of t h e liquidity crisis, was m o r e scverc t h a n it was
from 1923 to 1924 o r from 1926 to 1927. Yet, in reaction to those earlier
rcccssions, t h e RcscrGc Systcm raiscd its'holdings of government securities
by over $500 million f r o m Dccembcr 1923 t o Scptcmbcr 1924 a n d by
over $400 million from November 1926 t o November 1927 (all figures as
of t h c last Wednesday of t h c m o n t h ) . By contrast, its security holdings in
September 1930 wcrc less t h a n $500 million above t h e lowest level a t a n y
time in 1929 a n d m o r e t h a n four-fifths of t h e increase h a d occurred
bcforc tlic c n d of 1929 in. response t o t h e stock m a r k e t crash. I n t h e
financially t i ~ r b u l c n tycars, 1930 a n d 1331, t h e System's holdings of gov-
e r n m e n t sccuritics varicd ovcr a narrower range t h a n in all b u t two of
t h c rc1ativc:ly tranquil ycars from 1922 througli 1928-1925 a n d 1926.
l'llc c x l ~ l a n a t i o n for tllc contrast I)ctwccr> Fcdcral Rcserve policy bc-
forc 1329 a n d aftcr, a n d hcncc for t h c incpt policy after 1929, tha't
cmcrgcs from the account in t h e carlicr scctions of this c h a p t e r is t h e
shift of powcr within t h c System a n d the lack of understanding a n d
c x l ~ c r i c n c co f t h e individuals t o wliom t h c po\Ircr shifted. U n t i l 1928, t h e
Ncw York Bank was t h e p r i m e mover in Fcdcrnl Rcservc policy both a t
hornc a n d a b r o a d , a n d Bcnjamin Strong, its governor f r o m its inception,
was t h c d o m i n a n t f i , p r e in t h e Federal Resenre Systcm. S t r o n g reprc-
scntcd t h c Systcm in its dealings with central banks a b r o a d in a period
whcn each o f t h c great central hanks sccmed to be pcrsonificd by a single
outstanding individual-the Bank of England by M o n t a g u N o r m a n , t h e
Bank of F r a n c e by Bmile M o r c a u , t h c G e r m a n Reichsbank by H j a l m a r
Schacht. I n t h e early ycars of t h c System, S t r o n g was c h a i r m a n a n d t h e
41 1
 T H E GREAT CONTRACTION
dominant figure of the Govcrnors Conicrcncc, a group composcd of the
cllicf csec~rtivcofficcrs o i tllc twclvc Rcscr\lc B;tnks. Latcr, in 1322, wllcn
tllc Confcrrncc cstablishcd a Govcrnors Committee on opcn rnarkct
operations, out o i which developed the Open Markct.Invcstment Com-
mittcc, he was namcd pcrmancnt cl~airrnan.'~'
Strong began his carccr as a commercial banker. H e had bccn dccply
involvcd in the 1907 banking crisis, as sccrctary of the Bankers Trust
Company, something of a "bankers' bank," and as head of a committee
sct up by thc Ncw York financial Icndcrs "to drtcrminc wl~ichinstitu-
tions could be savcd and to appraise the coll;~tcrnlofTcrcd for loans."1G8
T h a t cspcricncc had grcatly imprcsscd I~iln,as it did thc banking com-
munity in gencral, and had givcn him a strong intcrcst in the rcform of
banking and currency. I t had mucli to d o with his becoming thc first
go\.crnor o i tllc Ncw York Bank.
S t r o n ~ morc
, tllan a n y othcr individual, Ilad the confidcncc and back-
inq of otllrr financial lcadcrs inside and outside thc Systcm, thc pcrsonal
forcc to mnkc his own vicws prevail; and also thc courage to act upon
them. I n one of his last letters on System policy, to Walter Stcwart on
August 3, 1928, lie spokc of thc necessity of an casy moncy policy to
anticipate the approach of the "breaking point" Stewart fcarcd, and
commcntcd :
I I r r c is w h c r c I fcar t h c consrqucnccs of hcsitntion o r dilTcrc*nccs of opinion
.
\ \ . i t l ~ i r t~h c Systcm . . . If t h c Systcm is unwilling t o d o i t , thcn I prcsunic
tlir. N c \ \ J'ot.k Bank must d o it alonc, dcspitc t h r tradition \\.l~icIi \\.c: hnvc
hclpcd to crcatc a n d maintain, that n o cstc~nsivc olwll-mnrkut opcrations
should bc conductcd by individual banks. A n cnlcrgcncy prcscnts t h c pos-
siblc nccd for cn~crgcnc);~mcnstrrcs."
Orlc of tllc directors of tllc Nrw York Bank rccnllrd in April 1952, wllcn
tllc Systc~nfinally bcgan largc-scalc opcu rnnl.krt pt~rcllasrs,t i l n t l~nd I 1 c 9
once asked Strons, "wlly thc authority for Fcdclal reserve banks to pur-
cliasc Government sccuritics had bccn inscrtcd in thc Fcdcral Rcscrve
Act and that Governor Strong llad replicd that it was in thcrc to usc.
Governor Strong had said further that if this po\rpcr wcre tlscd in a big
way, it would stop any panic which might confront 1 1 s . " ~If~Strong
~ had
still brcn ali\.c and head of thc Ncw York Bank in the fall of 1930, he
"'See Chandlcr, Benjanlin Strong, pp. 41-53, 69-70, 214-215, and Chaps.
VII-XI.
' O Chandler, Benjamin Strong, pp. 27-28.
'" Chandlcr, Benjamin Strong, p. 460.
"'Harrison, Notes, Vol. 11, Apr. 4, 1932. T h e director, Clarence A. Woolley,
then asked why the open market purchases "could not have been done sooner." H e
said, "the national nervous system has now been subject to strain for 29 months
whereas, in former periods of business depression, 5 or 6 months have sufficed to
clear u p the worst of the wreckage. Is the Federal Reserve System responsible
for cutting off the dog's tail by inches?" Burgeu pointed out that "the presence
412
T l l E GREAT CONTRACTION
wo11lt1 \.cry likcly havc rccognizcd thc oncoming liquidity crisis for
wliat i t was, would ha\.c I~ccnprcparcd by espcricnce and conviction to
takc strenuous and appropriate measures to hcad it off, and would hat.e
had thc standing to carry thc System with him. Strong, knowing that
monetary measures could not be expected to produce immediate effects,
woultl not hat.c bcen put ofT the expansionary course by a temporary per-
sistence of thc dccline in busincss activity.lT1
Strong bccamc inactive in A u g ~ s t1928 and died in October of that
yrar. Once lic \\,as rrmovcd from the sccnc, neither thc Board nor thc
otllrr Rrscr\.c nanks! as wc ha\vc sccn, wcrc prcparcd to accept thc Icad-
crsllip of t l ~ cNcw York 13ank.lT2Chandlcr says in his biography,
of the Federal Reserve System tended to extend both the period of stimulation
ant1 of rlrpression of h ~ ~ a i n e activity"
ss ({bid.).
" ' S r e the copy of a letter, dated a t Colorado Springs, Aug. 26, 1923, from
Strong to Adolph Miller, in the Goldenweiscr Papers (Container 3, folder of
Open h4arket Committee, 1923-52). Strong wrote in p a r t :
T h c ptlcnomcna of credit somewhat resemble some of the phenomena of
t ~ ~ l ~ e r c u l o sconcerning
is, which I can speak with some certainty. Any imprudence
or rxcrss by a T. 5, s~~lTerer will not show ill results often for weeks o r months.
Some unusual mental or physical elTort starts a slight inflammation which
gradually develops, causes a lesion, then later comes the temperature, pulsr,
c , r ~ ~ g hc ,~ c .In our operations, suppose the imprudence consists in selling 50
or 100 millions of our Section 14 investments in the New York markct . . . .
j\V]e can if we are ignorant or careless l)u11 down the credit structure a t a rapid
nr~tl dnngcroua rate, by a sale of in\.estments, which shortly causes pressure
lo liquidate a much grrater volume of hank loans. T h a t process is at maximum-
(with rapid pulse and high temperature)-at some indefinite period following
ollr sale, a n d we may fail to detect the cause on account of the lag I mention.
Ir\.ing Fisher said, "Governor Strong died in 1928. I thoroughly believe that
i f he hatl lived and his policies h a d been continued, we might have had the stock
mark^,^ rrash in a miltlcr form, l ~ u tafter the crash there would not have bccn the
s r c n l i n d ~ ~ s t r i adepressior~"
l (Annals of the American Academy of Political a n d
. \ o t . ~ t ~.lV r i r ~ ~ r cI'hiladclpl1ia.
~, 1934, p. 151). See also Carl Snyder, Cap'tnlisrr~
r l ~ rCrrntor. New S o r k , hlacmillan, 1940, p. 203.
"'An episode in the struggle between the Board a n d the Banks, still earlier than
thr d k p ~ ~ about tc how to deal with the stock market boom, occurred in thc fall of
19'27, whcn the Chicago Reserve Bank was unwilling to reduce its discount rate in
line with the easy-money policy originated by Strong a n d adopted by the Board.
T h c Board finally ordered the Chicago Dank ( b y a 4 to 3 vote) to reduce iis rate-
a n unprcrcdrntcd action. T h e "action aroused bitter controversy both within a n d
.
without the System . . . Most of the critics questioned the legality of the action;
all denied the wisdom of this assertion of power in the absence of a n emergency."
T h o u g h Strong himself wanted a reduction in the Chicago rate, he "was quite
unhappy about the Board's action a n d sought to prevent, or a t lcast to delay it"
(Chandler, Benjntnin Strong, pp. 447-440). Presumably, he saw the preservation
of the Banks' independence and indeed dominance in the System as morc important
than the specific substantive action of the moment.
Governor Crissinger's resignation may have been related to that incident. T h e
Board met on Sept. 9 to impose the rate without being informed by Crissinger that
Streng had telephoned him earlier in the day asking him to delay the meeting
until Secretary of thc Trcasury Mellon, who had conferred with Strong in New
413
 T H E GREAT CONTRACTION
Strong's dcath lcft the Systcm with no centrr of cntcrprising and acceptahlc
Icadcrsl~ip. Thc Fcdcral Rcscrvc Board was dctcrmincd that the Ncw York
Bank should na longer play that role. But the Board itself could not play the
rolc in an enterprising way. It \\.as still \c.*cakand dividcd dcspitc the sul)stitution
of Young for Crissingcr irl 1927. hforco\.cr, most of tllc o[hrr Rvsrrvc Ihnks,
as ~\.cll as that in NCIVYork, Iverc reluctant to follo\r tllr Iraclrrship of tlir
Donrd, partly because of tlic Board's prrsonncl, partly bccausc thcy still
thought of i t as primarily a supervisory and review hody. Thus i f was cnsy for
thc System to slide into indecision ancl deadlock."'
T l l c Ranks outside New York, scrking a larger share in tllc dctermina-
tion of opcn market policy, obtained t l ~ rd i f f ~ ~ s i oofn po\\'rr tllrou~11t 1 1 ~
brondrning o f thc mrnil)rrsllip o f thc 0 p c 1 1 h,l;ll.l;c*t 1 1 1 \ ~ c ~ s t r ~ 1 1C
. 1o
~ 1~ n -
mittrc ill h l a r c h 1930 to incliidc tllc go\.crnors of all tllc nnllks. Open
markct operations now depended Lipon a majority of twclvc r a t h r r tllan
of five governors a n d thc twe1X.e "came i n s t r \ ~ c t c dily tllcir dircctors"
ratlicr t h a n m a d y to follow the lcadcrship of hTr\\,J7or.k as tllc fivc had
bcrn \\,hen Strong \\!as govcriior.
T h c shift in tlic locus of po\vcr. wllich almost s ~ ~ r c lwotrltl
y not Ilavc
occurred \\.llcn it did if Strong h a d lived, had important a n d far-rcaclling
consequences. I-Iarrison, Strong's successor a t Nctv York, was a lawycr
w h o had a c t r d as counscl to tlie Fedcral Rcsrrvc Board frorn 1911 to 1920
b r f o r c coming to t h c Ncw York Bank as o n c of Strong's tlrputirs. I n 1929
a n d 1930, lie operated in thc a u r a of Strong's Icgacy a n d sot~glitto cxcr-
cisc comparable lcadcrship. As timc wcnt on, ho~vcvcr,h c revcrtcd to his
natural character, t h a t of a n extremely competent lawycr a n d ctccllcnt
administrator, w h o wanted t o see all sides of a n issuc a n d placed grcat
\-aluc on conciliating opposing points of view a n d achieving harmony. H e
was persiiasivr yet too reasonable to b e truly singlc minded a n d dominant.
Ncvcrtlicless, if t h c composition of the O p c n M a r k r t Committee had not
bccn changed, his policies might havc prevailed in Junc 1930-though
t h a t change probably was partly a reaction to N e w York's indeprndcnt
actions to meet t h e stock market crash. As it was, h e h a d ncithcr t h e
standing in t h c System nor t h e prcstigc o ~ i t s i d c the Systcm nor t h c
prrsonal forcc t o gct his policy vicws acccptcd in t h c face of activc o p -
position o r even plain inertia. Hi.? pr.oposals wcrc rcpcatcdly votcd down
by tlic othcr Dank governors. W h e n tllcy finally agrccd to a largc o p r n
market operation in the spring of 1932, they wcrc halfhearted a n d only
Yo&, upon his return from a trip abroad,,would arrive in Washington the next
day. Presumably Mellon would have tried to dissuade the Board from taking action,
and in any case would have tied the vote (Hamlin, Diary, Vol. 14, Sept. 15, 1927,
p. 38). Crissingcr resigned Sept. 15.
"'Bcnjomin Strong, p. 465. Hamlin, who resentcd the dominance of thc Nrw
York Bank (see his Diary, Vol. 19, Aug. 10, 1931, p. 126), nevertheless wrotc of
Strong, "He was a genius-a Hamilton among bankers. His place will be almost
impossible to fill" (Diary, Vol. 16, Oct. 18, 1928, p. 60).
414
T H E CREAT CONTRACTION
too eager to discontiniic it. O n Janlinry 20, 1933, Harrison told H a r n l i l ~
that n majority of thc governors really fnvorcd n coinplctc rcvcrsal 01
opcn mnrkct policy by letting govcrnmcnt s c c ~ ~ r i t i crun
s off."'
W c conimentcd carlicr on thc diffcrcncc in tlic lcvcl 01 undcrstaiitling
a n d sophistication about monetary matters displayed by Ncw York a n d
' thc other Rcscrvc Banks. T h c diffcrcncc is undcrstandablc in view of tlic
circumstances in which the scveral Banks opcratcd a n d of their responsi-
bilities. New York was t h e active financial center of the country. T h e
scciiritics markct in general a n d the government securities markct in
particular wcrc conccntratctl thcrc. So also wcrc intcrnationnl financial
tr:~ns:lctio~ls.Ncw York was t l ~ conly U.S. moiicy markct tliat was also a
worlcl markct. Dcspitc thc attempt of tlic Fcdcral Rcscrvc Act to rcducc
tlie dominance of New York in the banking structure, thc demancls of
banks in the rest of thc country for funds continued to bc cliannelcd
through thc othcr Rescrve Bank cities into hTcw York, a n d banks in thc
rcst of t h c country contintrrcl to maintain corrcsponclcnt relations with
Ncw York banks, cspccially aftcr thc stock niarkct boom got undcr \Yay.
TIE Ncw York Fcdcral Rcscrvc Rank was tlicrcforc ac~rtclyscnsitivc to
thc statc of thc financial markets a n d to tbc liquidity prcssurc not only o n
banks tllcrc b u t also on their corrcspondcnt banks tllrotrghout thc country.
Among Rcscrve nanks, the Ncw York Bank alonc was cffcctivcly national
in .scope a n d acc~rstomccl to regard itself as sllaping, not rncrcly rcacting
to, conditions in t h e credit markct. T h c othcr Banks wcrc miicll morc
parochial in both situation a n d outlook, m o r c in the position of rcacting
to financial currents originating elsewhere, m o r c concerned with their
immrdiate rcgional problems, a n d hcnce morc likcly to bclicve that the
Rcscrve Systcm must adjust to other forces than t h a t it could a n d should
takc thc Icad. T h e y had n o backgroiind of leadership a n d of national
responsibility. Moreover, they tended to bc jealous of New York a n d prc-
disposcd to question w h a t Ncw York proposed.
T l i c form which the shift of powcr took-from New York as dominant
h r n d of a fivc-man committee to New York as t h e head of a n exccutivc
c o m n ~ i t t c cadministcring policies adopted by t h c twelve governors--aIsq
l ~ n t la n important effect. A cornmittcc of twelve men, each regarding
himsclf as nil equal of all thc others a n d each the chief administrator of
a n institution established to strengthen regional independence, could
much morc easily agree on a policy of drift a n d inaction t h a n o n a
coordinntcd policy iri\~olving t h e public assumption of responsibility
for dccisivc a n d large-scale action.175 T h c r c is morc than a little element
of tr11tIi in t h c jocular description of a cornmittcc as a group of people,
no onc of w l ~ o mknows what should be done, w h o jointly decide that
"'Diary, Vol. 22, p. 61.
"'Cornpare statcrncnts by FIarrison i n f{lo!nolrs 89 and 114 above.
415

n o t l l i n g c a n b c d o n c . Ancl this is cspccially likcly t o b c trtlc of a g r o u p
like t h e O p e n M a r k e t Policy C o n f c r c n c c , consisting of i n d c l ) t ~ n t l c n t
p c r s o n s from widely s e p a r a t e d cities, w l ~ os h a r e n o n e of t h a t common
o u t l o o k o n d c t a i l c d p r o b l e m s or rcsponsihilitics wllich cvolvcs in tile
c o u r s e of l o n g - t i m c d a i l y c o l l a b o r a t i o n . S ~ r c l ia committee is likrly t o bc
a b l c t o t a k c decisi1.e a c t i o n o n l y if it l t a p p c n s t o it~cltrclcn m a n \\.llo is
d c f c r r e d t o by all tllc rest n n d is acc11stonl~:cl t o clolnitlatc. S t r o n g nligltt
11a1.cp l a y e d sttch a rolc. H a r r i s o n c o u l d n o t .
T h c s h i f t of p o w e r f r o m N c w Yosk t o t h e o t h e r B a n k s m i g h t n o t h a v e
b c e n decisive, if t h e r e h a d b c e n sttfficicntly v i g o r o u s a n d info~.mccl in-
tcllcctttnl I c a d r r s l i i p in tlic nonrcl t o hn1.c join(-cl w i t h I-Int.~.isonin over-
c o m i n g tltc rcsistnncc of s o m c or tlic o t l l c r Ilnnks. H o \ v c v c r , n o tratlition
of leadership c s i s t c d 1vitlti11 t h e Bon~.cl. I t llad n o t plnyctl a kcy rolc i n
d e t e r m i n i n g t h e policy of t h c S ) . s t c ~ n tlirottgliout tllc t\vcntics. I ~ i s t c a d ,it
had b c c n p r i m a r i l y a s u p e r v i s o r y a n d r c v i c w body.176 I t I~nc! its Ivny in
e a r l y 1 9 2 9 a b o u t t h e ~ s of c "direct pressure" i n s t r a d of q u a n t i t a t i v e
m e a s u r c s i n d e n l i n g ' w i t h s p c c u l n t i o n , b c c n ~ ~ sitc I ~ n r la \!c%to p o w c r o v c r
d i s c o u n t r a t e c h a n g c s , n o t b c c a u s e it w a s a b l c t o w i n tllc I h n k s t o its
views. i
There w a s no i n d i v i d u a l B o a r d mcmbcr w i t h S t r o n g ' s s t a t u r c in t h e
f i n a n c i a l c o m m u n i t y o r in t h e R e s e r v e S y s t e m , or w i t h comparable cx-
p c r i c n c e , p c r s o n a l force, o r d e m o n s t r n t c d c o u r a g c . R o y Y o u n g , go\.c:rnot.
of t h e R e s c r ~ v eB o a r d u n t i l S c p t c m b c r 1, 1930, was apparently an a b l c
a d m i n i s t r a t o r , a n d S t r o n g supported his a p p o i n t m e n t . H o w e v e r , h e
t o o k a lcading r o l c i n t h e conflict b c t w e c n t h e B a n k a n d t h e Bbard a n d
s t r o n g l y o p p o s e d opcn m a r k e t o p e r a t i o n s i n government sccuritirs. I-Ic lcft
t h c B o a r d t o b c c o m c g o v c r n o r of t h e R e s c r v e B a n k of Boston, a p o s i t i o n
svhicll e n a b l e d him t o c o n t i n u e t o c x c r t his i n f l ~ t c n c ea g a i n s t t h c policy
falvored b y N c ~ vYolk-and p e r h a p s n o t lcss cffcctivcly t h a n b c f o r c . Yot~ng
\\.as s u c c e c d c d by E t r g c n e M e y c r , who had lcft his Wall S t r c c t b r o k c r a g c
f i r m i n 1 9 1 7 t o s e r v e w i t h a w a r a g e n c y , b e c a m e h e a d of t h e W a r F i n a n c e
C o r p o r a t i o n , a n d t h e n ser\.ecl w i t h a n u ~ n b e of r g o v e r n m e n t a g e n c i e s , in-
c l t ~ t l i n gt h e F e t l c r ; ~ l F a r m L o a n B o n r t l , b e f o r e coming t o t h e R e s c r v e
B o a r d i n 1930. i\Ie!.cr w a s a p l ~ o i n t e c jl u s t a f t e r H a r r i s o n hncl f;tilctl in Ilis
"'Tlic salary structure in tlic Systc~n nt that tinlc is sorl~c i~itlic.a[ior~
of thc
re1atit.c position of thc Banks and thc Board and of thcir ability to nttrnct al>lc
p c q ~ l c .Board mcmbcrs rcccivcd $1?,000 a ycar until 1935. Though equal to t11c
salary of cabinet mcrnbcrs, those salaries wcrc drastically lower than {host of Bank
go\.crnors (latcr prcsidcnts). Strong a t New \'ork rcccived $50,000 a ycar from
1919 until his dcath, and Harrison the same. T h e salarics of othcr Bank Sovcrnors
ranged from a low of $10,000 (six southern and wcstcrn Banks) to $35,000
(Chicago) during the twcntics. T h e relative dillcrcntials werc only slightly nar-
rower in 1960: Board mcmbcrs, $20.000 ( ~ h cchairman $500 rnorc) ; thc
highcst paid Bank prcsidcnt, $60,000 (New York) ; thc lowcst, $35,000 (all
o t l ~ c rBanks exccpt Chicago and San Francisco).
416
TI1E G R E A T CONTRACTION
; t t t e l i i p t t o pcrsttnclc t h e o t h e r g o v e r n o r s t o e n g a g e i n o p c n m a r k e t 11ttr.
c h a s c s a n d j u s t bcforc t h e o n s e t of t h e first l i q u i d i t y crisis--on b o t h
g r o u n d s a difficult t i m e t o g e t t h e S y s t e m t o c h a n g e c o u r s e s h a r p l y . P c r -
h a p s , if he h a d had m o r e t i m c t o d e v e l o p his l e a d c r s h i p o f t t ~ cS y s t c m , h e
m i g h t l i a v e b e e n able t o l e a d t h e S y s t e m a l o n g a d i f f e r e n t r o ~ t c . ' ~I' n t h e
initial m o n t h s a t h i s post, h c w a s in f a v o r of c s p a n s i o n a r y m e a s u r e s a n d ,
t l l r o u g h m o s t of 1 9 3 1 , h e t r i c d u n s t ~ c c c s s f u l lt~o p e r s u a d e t h c C o n f e r e n c e
t o a p p r o v e l a r g e r o p c n m a r k c t purchases. D u r i n g his six m o n t h s a s chair-
m a n of t h c RFC, F c b r u a ~ y - J t ~ l y 1 9 3 2 , m e m b c r s of t h e B o a r d felt h c
sliglitrd h i s d r l t i r s as governor. N o n c of t h c o t h c r ftrll-time m c m i ~ c r sof
t h c Iloarcl or staff llad t h e p c r s o n a l qualities a n d t h e s t a n d i n g w i t h i n t h e
S y s t c m t o cxercisc t h e r e q u i r c d I c a d ~ r s h i p . ~ ' ~
"'During Meycr's tcrm of oficc, two committccs of the Rcscn.c Systcm (in-
cluding oficials of sevcral Rcservc nanks), appointcd to study problems of branch,
chain, and group banking, and of reserves, suhrnittcd rcpork but n o action was
takcn on thcir rccornrncndntions (scc Rrport of tlic Fcdrral Rcscrvc Committcc on
Brancli, Group, and Chain Banking, mimrographcd, 1932; and "hlcmhcr Bank
Rcscrvcs-Rcport of thc Comrnittec on Rank Rcscrvcs o l the Fedcral Rcsemc
System," Fcdcral Rcscnre Board, Annual Report for 1932, pp. 260-285). hfcycr
rccommendcd to thc Scnatc Cornmittce on Banking and Currcncy a unificd com-
mcrcial banking system for the United States to bc imp'lcmcntcd by limiting bank-
ing privileges to institutions with national charters. I-Ic obtained thc opinion of the
Board's gcncral counscl in su1)port of the constitutionality of such legislation
( ; b i d . , pp. 229-259), but no furtlicr stcns wcrc takcn.
"'I-Iarrison opposed hlcycr's a c c c p t a ~ c cof thc chairmanship of the RFC (Notes,
Vol. 11, Jan. 21, 1932).
T h c rcrnaining members of thc Board lrom 1919 to 1933 consisted of Edmund
Platt (who scrvcd as vice-govcrnor until hc lcft thc Board on Scpt. 15, 1930),
Adolph Miller, Cliarlcs S. I-Iarnlin, Gcorge R. James, Edward Cunningham (until
Nov. 28, 1930), and Wayland 14. Magce (after hlay 5, 1931). Platt had studicd
law, had bccn a newspaper editor, thcn a mcmber of Congress (where he served
on the Banking and Currcncy Comrnittec) hcforc hc was appointed to the Board
in 1920. Millcr and Iiamlin wcrc members of the orisinal Board appointcd in
1914. hlillcr, an economist of considcrahlc scholarly ability, had written some good'
articles on monetary matters. But he, and FIarnlin as well, had already dcmon-
stratcd just aftcr World War I an incapacity to exert leadership and to takc an
indcpendcnt course. I n Chandler's words, Miller, "undoubtedly the most ablc of
thc appointed rnernbcrs of thc Board, was thc ctcrnal consultant and critic, nevcr
thc imaginative and bold cntcrpriscr" (Benjnnrin Stronp, p. 257, and also pp. 44-
4 5 ) . If any crcdcncc cnn I>c put in Ilarnlin's rcpratcd commcnts on hlillcr, this
is n gcncrous evalua~ion.I-Ianilin's Diary makcs Millcr out to be a self-ccntcrcct
pcrsorl, with little licsitancy in \)sing his pul)lic position for pcrsonal advantagc,
nritl cnl~al)lcof shifting posirion on important issucs for tri\.ial rcasotu (see Vol. 4,
Aug. 6, 1918, pp. 180-181; Vol. 6 , hlay 6 , 1921, p. 9 0 ; Vol. 14, Jan. 6 , June 9,
1928, pp. 105, 106, 100; Vol. 16, Oct. 30, 19?9, p. 1 9 4 ) .
Hanilin was a lawycr, dcscrihcd by Chandler as "intclligcnt, . . . but . as ..
onc of his associ3tcs put it, 'an amanncnsis sort ol fcllow unlikcly to undcrtakc any-
thing on his own' " (Btnjnmin Strong, pp. 256-257). I-Iis Diary confirms this
view. H e was shrewd, particularly about political issucs and details of administra-
tion, public spiritcd in a sclf-righ~cousway, depcndablc and honest, if inclined to
bc partisan, and, fortunately for o u r purposes, an inveterate and, so far as
we can judge, an accurate gossip. But the Diary shows exceedingly limited under-
417
 L 8
T H E G R E A T CONTRACTION
T h e detailed story of cvcry banking crisis in our Iristory sllows llow
much depends on the presence of one or more outstanding individuals
willing to assirme responsibility and l e a d ~ r s h i p . ~I 't~was a defect of the
financial systcm that it was susccptiblc to crises resolvable only with such
leadership. T h e cxistcnce of such a financial systcm is, of coirrsc, thc
itltimate explanation for the financial collapse, rathcr than tllc shift of
power from NCWYork to the othcr Fedcral licsrrvr: Banks and thc wcak-
ness of the Reserve Board, sincc it permitted those circirmstar~ccsto have
such far-reaching consequences. Nonetheless, given the financial systcm
that esistcd, the shift of power and the \vcakncss of the Board grcatly rc-
clirccd thc likelihood that the immediate dccisivc action \vo\rld hc takcn,
which \\.as rcquired to nip the liquidity crisis in thc bud.
I n the al~scnccof vigorous intcllc.ct\~alIcadcrsl~ipby thc Donrd or of
a consensus on the corrcct policy in thc community at large or of Rcscrve
nnnk g ~ \ ~ c r n o r\villing
s and a l ~ l eto asslrmc rcsponsi1)ility fnr nn iilcle-
pendent collrsc, tile tcndcncics of drift and inclccision hacl r \ ~ l lscopc.
hforcot.cr, as tirnc went on, their. forcc cum~rlatcd.Encll f a i l ~ ~ rtoc act
made another sucll failurc morc likcly. Mcn arc far rcadicr to 11lcac1-to
thcmscl\~csas to others-lack of powcr than lack of judgment as an cx-
planation for failurc. \Ye have alrcacly sccn this tcndcncy esprcssccl in thc
standing o f rhc broadcr issucs of monetary policy a n d no sign of vcnturcsomcncss
in tliought or action. James was a s~naII mrrcliant and ~ n a n u f a c t u r c r from
Trnncssce a n d , for a few years, had bccn prcsidcnt of a commercial b a n k ;
Cunningham, a l a m e r ; hlagee, also a farmcr and ranchcr, who had I ~ c c n
a m c m l x r of thc board of the O m a h a branch of the Rcscnlc Dank of
Iiatisas Ciry and then a director of thc Bank of Kansas City (see Chandler's com-
ments, Benjnrnin Stron.g, pp. 256-257).
Of the staff, E . A. Goldcnwciscr, director of research and statistics from 1926
lo 19.15, was pc1.1iaps the most infl~lcntial,b u t lie was primarily a techllicinn. Jlis
predccrssor, \\'alter \V. Stewart, had bccn close to Strong, had influcnccd him
grcatly, and continued their rclationsl~ipafter leaving thc Board in 1326. C;oltlc11-
wciser was a gentlc person w h o could not ~ n a t c l iStewart's infltrcncc 011 policy.
T h e ex officio members of thc Rcscrvc Doard were the Comptrollcr of tlic
Currency, a n d the Secretary of the Treasury, who served as chairman-from 1971
to February 1932, Andrew W . Mcllon, a wcll-known financier a n d industrialist at
thc time of his nppoinmcnt; thercaftcr, until M a r c h 1933,Ogdcn L. Mills. hfills,
a Inwycr, tax cspcrt, and Congrcssnian, bcforc becoming U n d e r Srcrcrnry
of t)le Treasury in 1977, was an able and forccf~llm a n . As mentioned above, Iic
gavc active st1l;port to the Class-Stcagall bill bccausc he saw lack of frcc sold
limiting Fedcral Rescnpc action. Mills apparently contributcd tllc chief iclcns
cml,odied in thc Emergency Banking Act of M a r . 9, 1933 (sce Chaptcr 8 ) .
J. \V. Pole, formerly chief U.S. national bank examiner, and Coml)trollcr of thc
Currency from 1928 to September 1932, advocated as a bank reform measure
branch banking limited to "trade areas" or regions around important cities. n u t
he had n o influcncc of record on bank legislation or Fedcral Rcscrvc policy during
that period (see Comptroller of the Currency, Annual Report, 1929, p. 5 ; 1930,
p. 5 ; 1931, p . 1 ). Hamlin referred to him as "on the whole, a good b u t not very
strong man" (Diary, Vol. 21, Scpt. 1, 1932, pp. 105-106).
I71
See Sprague, History of Crises, passim.
418
T I l E GREAT CONTRACTION
Fcderal Rcscrvc Systcm's rcaction to thc criticism of its policies during
. 1919-21. It was cspresscd again in 1930-33 as the Board csplaincd ccn-
nomic dcclinc and then banking failures as occurring despite its own
actions and as thc product of forces over which it had no control.
And no doubt the Board persuaded itself as wcll as others that its
reasoning was true. Hencc, as evcnts procecded, it was increasingly
inclined to look clsewhcrc for thc solution, a t first to hopc that matters
woulcl rigllt themsclvcs, then increasingly to accept the licw that crisis
and doom wcre thc inescapable product of forces in thc private busincss
community that wcre developing beyond the System's control. Having
failed to act vigorously to stcm the first liquidity crisis in thc fall of 1930,
thc Systcm was evcn less likely to act the nest time. It was onlb. great
:prcssurc from Con~rcssional critics that i n d ~ ~ c cthcd System to rcIscrsc
itsclf temporarily in cnrly 1932 by unclcrtaking thc largc-scalc scc~lritics
purcltascs i t slrotrlcl Ilavc maclc m~rclirarlicr. W11cn tlrc opcr;~tionfailcd
to bring immcdiatc dramatic improvcmerit, thc Systcm promptly rclapscd
into its rarlicr passivity.
Tlrc foregoing cxplanation of tlrc financial collapsc as resulting so
Iaigcly from the shift of powcr from d c w York to the othcr Fcdcral Rc-
scrvc nanks and from pcrsonal backgro~rndsand characteristics of thc men
nominally in powcr may sccm farfctchcd. I t is a sound general principle
that great evcnts havc great origins, and hcnce that something morc than
the cllaractcristics of thc spccific pcrsons or official agencies that hap-
pened to be in powcr is required to explain such a major evcnt as the
financial catastrophe in the United Statcs from 1929 to 1933.
Yct it is also true that small cvcnts at times havc largc consequcnccs,
that there are such things as chain reactions and cumulative forccs. I t
happens that a liquidity crisis in a unit fractional reserve banking
system is prcciscly the kind of evcnt that can trigger-and oftcn has
trisjicrcd-n chain reaction. Ancl cconomic collapse often has the charat-
tcr of a c~lmulativcproccss. Let it go beyond a certain point, and it will
tcnd for a tirnc to gain strength from its own dcvelopmcnt as its effects
spread and rcturn to intensify the proccss of collapsc. Dccausc no
grcnt strength wo~rld be required to hold back thc rock that starts a
landslide, it docs not follow that thc landslide will not be of major
proportions.