America's Great Depression (30 page)

Yet, even so, the vigorous open market sales of securities and drawing down of acceptances hobbled the inflation. Stock prices rose only about 10 percent from January to July.40 By mid-1928, the gold drain was reversed and a mild inflow resumed. If the Federal Reserve had merely done nothing in the last half of 1928, reserves would have moderately contracted, due to the normal seasonal increase in money in circulation.

At this point, true tragedy struck. On the point of conquering the boom, the FRS found itself hoisted by its own acceptance policy. Knowing that the Fed had pledged itself to buy all acceptances offered, the market increased its output of acceptances, and the Fed bought over $300 million of acceptances in the last half of 1928, thus feeding the boom once more. Reserves increased by 40Anderson (
Economics and the Public Welfare
) is surely wrong when he infers that the stock market had by this time run away, and that the authorities could do little further. More vigor would have ended the boom then and there.

The Development of the Inflation

161

$122 million, and the money supply increased by almost $1.9 billion to reach its virtual peak at the end of December 1928. At this time, total money supply had reached $73 billion, higher than at any time since the inflation had begun. Stock prices, which had actually declined by 5 percent from May to July, now really began to skyrocket, increasing by 20 percent from July to December. In the face of this appalling development, the Federal Reserve did nothing to neutralize its acceptance purchases. Whereas it had boldly raised rediscount rates from 32 percent at the beginning of 1928 to 5 percent in July, it stubbornly refused to raise the rediscount rate any further, and the rate remained constant until the end of the boom. As a result, discounts to banks increased slightly rather than declined. Furthermore, the Federal Reserve did not sell any of its more than $200 million stock of government securities; instead it bought a little on net balance in the latter half of 1928.

Why was Federal Reserve policy so supine in the latter part of 1928? One reason was that Europe, as we have noted, had found the benefits from the 1927 inflation dissipated, and European opinion now clamored against any tighter money in the U.S.41 The easing in late 1928 prevented gold inflows into the U.S. from getting very large. Great Britain was again losing gold and sterling was weak once more. The United States bowed once again to its overriding wish to see Europe avoid the inevitable consequences of its own inflationary policies. Governor Strong, ill since early 1928, had lost control of Federal Reserve policy. But while some disciples of Strong have maintained that he would have fought for tighter measures in the latter half of the year, recent researches indicate that he felt even the modest restrictive measures pursued in 1928 to be too severe. This finding, of course, is far more consistent with Strong’s previous record.42

41See Harris,
Twenty Years of Federal Reserve Policy,
vol. 2, pp. 436ff.; Charles Cortez Abbott,
The New York Bond Market, 1920–1930
(Cambridge, Mass.: Harvard University Press, 1937), pp. 117–30.

42See Strong to Walter W. Stewart, August 3, 1928. Chandler,
Benjamin
Strong, Central Banker,
pp. 459–65. For a contrary view, see Carl Snyder,
Capitalism, the Creator
(New York: Macmillan, 1940), pp. 227–28. Dr. Stewart, we
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America’s Great Depression

Another reason for the weak Federal Reserve policy was political pressure for easy money. Inflation is always politically more popular than recession, and this, let us not forget, was a presidential election year. Furthermore, the Federal Reserve had already begun to adopt the dangerously fallacious qualitativist view that stock credit could be curbed at the same time that acceptance credit was being stimulated.43

The inflation of the 1920s was actually over by the end of 1928.

The total money supply on December 31, 1928 was $73 billion.

On June 29, 1929, it was $73.26 billion, a rise of only 0.7 percent per annum. Thus, the monetary inflation was virtually completed by the end of 1928. From that time onward, the money supply remained level, rising only negligibly. And therefore, from that time onward, a depression to adjust the economy was inevitable.

Since few Americans were familiar with the “Austrian” theory of the trade cycle, few realized what was going to happen.

A great economy does not react instantaneously to change.

Time, therefore, had to elapse before the end of inflation could reveal the widespread malinvestments in the economy, before the capital goods industries showed themselves to be overextended, etc. The turning point occurred about July, and it was in July that the great depression began.

The stock market had been the most buoyant of all the markets—this in conformity with the theory that the boom generates particular overexpansion in the capital goods industries. For the stock market is the market in the prices of titles to capital.44 Riding on the wave of optimism generated by the boom and credit expansion, the stock market took several months after July to awaken to might note, had shifted easily from being head of the Division of Research of the Federal Reserve System to a post of Economic Advisor to the Bank of England a few years later, from which he had written to Strong warning of too tight restriction on American bank credit.

43See
Review of Economic Statistics,
p. 13.

44Real estate is the other large market in titles to capital. On the real estate boom of the 1920s, see Homer Hoyt, “The Effect of Cyclical Fluctuations upon Real Estate Finance,”
Journal of Finance
(April, 1947): 57.

The Development of the Inflation

163

the realities of the downturn in business activity. But the awakening was inevitable, and in October the stock market crash made everyone realize that depression had truly arrived.

The proper monetary policy, even after a depression is under-way, is to deflate or at the least to refrain from further inflation.

Since the stock market continued to boom until October, the proper moderating policy would have been positive deflation. But President Coolidge continued to perform his “capeadore” role until the very end. A few days before leaving office in March he called American prosperity “absolutely sound” and stocks “cheap at current prices.”45 The new President Hoover was unfortunately one of the staunch supporters of the sudden try at “moral suasion” in the first half of 1929, which failed inevitably and disastrously.

Both Hoover and Governor Roy Young of the Federal Reserve Board wanted to deny bank credit to the stock market while yet keeping it abundant to “legitimate” commerce and industry. As soon as Hoover assumed office, he began the methods of informal intimidation of private business which he had tried to pursue as Secretary of Commerce.46 He called a meeting of leading editors and publishers to warn them about high stock prices; he sent Henry M. Robinson, a Los Angeles banker, as emissary to try to restrain the stock loans of New York banks; he tried to induce Richard Whitney, President of the New York Stock Exchange, to curb speculation. Since these methods did not attack the root of the problem, they were bound to be ineffective.

Other prominent critics of the stock market during 1928 and 1929 were Dr. Adolph C. Miller, of the Federal Reserve Board, Senator Carter Glass (D., Va.), and several of the “progressive” Republican senators. Thus, in January, 1928, Senator LaFollette attacked evil Wall Street speculation and the increase in brokers’

loans. Senator Norbeck counseled a moral suasion policy a year 45Significantly, the leading “bull” speculator of the era, William C. Durant, who failed ignominiously in the crash, hailed Coolidge and Mellon as the leading spirits of the cheap money program.
Commercial and Financial Chronicle
(April 20, 1929): 2557ff.

46Hoover,
The Memoirs of Herbert Hoover,
vol. 2, pp. 16ff.

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America’s Great Depression

before it was adopted, and Federal Reserve Board member Charles S.

Hamlin persuaded Representative Dickinson of Iowa to introduce a bill to graduate bank reserve requirements in proportion to the speculative stock loans in the banks’ portfolios. Senator Glass proposed a 5 percent tax on sales of stock held less than 60 days—

which, contrary to Glass’s expectations, would have driven stock prices upward by discouraging stockholders from selling until two months had elapsed.47 As it was, the federal tax law, since 1921, had imposed a specially high tax rate on capital gains from those stocks and bonds held less than two years. This induced buyers to hold on to their stocks and not sell them after purchase since the tax was on
realized
, rather than accrued, capital gains. The tax was a factor in driving up stock prices further during the boom.48

Why did the Federal Reserve adopt the “moral suasion” policy when it had not been used for years preceding 1929? One of the principal reasons was the death of Governor Strong toward the end of 1928. Strong’s disciples at the New York Bank, recognizing the crucial importance of the quantity of money, fought for a higher discount rate during 1929. The Federal Reserve Board in Washington, and also President Hoover, on the other hand, considered credit rather in qualitative than in quantitative terms. But Professor Beckhart adds another possible point: that the “moral suasion” policy—which managed to stave off a tighter credit policy—was adopted under the influence of none other than Montagu Norman.49 Finally, by June, moral suasion was abandoned, but discount rates were not raised, and as a result the stock market boom continued to rage, even as the economy generally was quietly but inexorably turning downward. Secretary Mellon trumpeted once again about our “unbroken and unbreakable prosperity.” In 47See Joseph Stagg Lawrence,
Wall Street and Washington
(Princeton, N.J.: Princeton University Press, 1929), pp. 7ff., and
passim.

48See Irving Fisher,
The Stock Market Crash—And After
(New York: Macmillan, 1930), pp. 37ff.

49“The policy of ‘moral suasion’ was inaugurated following a visit to this country of Mr. Montagu Norman.” Beckhart, “Federal Reserve Policy and the Money Market,” p. 127.

The Development of the Inflation

165

August, the Federal Reserve Board finally consented to raise the rediscount rate to 6 percent, but any tightening effect was more than offset by a simultaneous lowering of the acceptance rate, thus stimulating the acceptance market yet once more. The Federal Reserve had previously ended the acceptance menace in March by raising its acceptance buying rate above its discount rate for the first time since 1920. The net effect of this unprecedented “strad-dle” was to stimulate the bull market to even greater heights. The lowering of the Federal Reserve buying rate for acceptances from 53 percent to 5c percent, the level of the open market, stimulated market sales of acceptances to the Federal Reserve. If not for the acceptance purchases, total reserves would have fallen from the end of June to October 23 (the day before the stock market crash) by $267 million. But the Federal Reserve purchased $297 million of acceptances during this period, raising total reserves by $21 million. Table 9 tells the story of this period.

What was the reason for this peculiarly inflationary policy favoring the acceptance market? It fitted the qualitative bias of the administration, and it was ostensibly advanced as a stup to help the American farmer. Yet, it appears that the aid-to-farmers argument was used again as a domestic smokescreen for inflationary policies.

In the first place, the increase in acceptance holdings, as compared with the same season the year before, was far more heavily concentrated in
purely foreign
acceptances and less in acceptances based on American exports. Second, the farmers had already concluded their seasonal borrowing before August, so that they did not benefit one iota from the lower acceptance rates. In fact, as Beckhart points out, the inflationary acceptance policy was reinstituted following “closely upon another visit of Governor Norman.”50 Thus, once again, the cloven hoof of Montagu Norman exerted its baleful influence upon the American scene, and for the last time Norman was able to give an added impetus to the boom of the 1920s.

Great Britain was also entering upon a depression, and yet its inflationary policies had resulted in a serious outflow of gold in June and July. Norman was then able to get a line of credit of $250 million 50Ibid., pp. 142ff.

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America’s Great Depression

TABLE 9

FACTORS DETERMINING BANK RESERVES

JULY–OCTOBER 1929

(in millions of dollars)

July 29

October 23

Net Change

Federal Reserve Credit

1400

1374

-26

Bills discounted

1037

796

-241

Bills bought

82

379

297

U.S. Govts.

216

136

-80

All Other

65

63

-2

Treasury Currency

2019

2016

-3

Treasury Cash

204

209

-5

Treasury Deposits

36

16

20

Unexpected Capital Funds

374

393

-19

Monetary Gold Stock

4037

4099

62

Money in Circulation

4459

4465

-6

Other Deposits

28

28

0

Controlled Reserves

206

Uncontrolled Reserves

-185

Member Bank Reserves

2356

2378

22

from a New York banking consortium, but the outflow continued through September, much of it to the United States. Continuing to help England, the New York Federal Reserve Bank bought heavily in sterling bills, from August through October. The new subsidization of the acceptance market, then, permitted further aid to Britain through purchase of sterling bills. Federal Reserve policy during the last half of 1928 and 1929 was, in brief, marked by a desire to keep credit abundant in favored markets, such as acceptances, and to tighten credit in other fields, such as the stock market (e.g., by “moral suasion”). We have seen that such a policy can only fail, and an excellent epitaph on these efforts has been penned by A. Wilfred May: