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its policy in the spring of 1928, and tried to halt the boom. From the end of December 1927, to the end of July 1928, the Reserve reduced total reserves by $261 million. Through the end of June, total demand deposits of all banks fell by $471 million. However, the banks managed to shift to time deposits and even to overcom-pensate, raising time deposits by $1.15 billion. As a result, the money supply still rose by $1.51 billion in the first half of 1928, but this was a relatively moderate rise. (This was a rise of 4.4 percent per annum, compared to an increase of 8.1 percent per annum in the last half of 1927, when the money supply rose by $2.70 billion.) A more stringent contraction by the Federal Reserve—one enforced, for example, by a “penalty” discount rate on Reserve loans to banks—would have ended the boom and led to a far milder depression than the one we finally attained. In fact, only in May did the contraction of reserves take hold, for until then the reduction in Federal Reserve credit was only barely sufficient to overcome the seasonal return of money from circulation. Thus, Federal Reserve restrictions only curtailed the boom from May through July.
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 Fed-eral Reserve had merely done nothing in the last half of 1928, reserves would have moderately contracted, due to the normal sea-sonal 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 pol-icy. 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.
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$122 million, and the money supply increased by almost $1.9 bil-lion 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 redis-count 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.1 The easing in late 1928 prevented gold inflows into the U.S. from get-ting 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 disci-ples 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 con-sistent 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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Another reason for the weak Federal Reserve policy was politi-cal pressure for easy money. Inflation is always politically more popular than recession, and this, let us not forget, was a presiden-tial 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 mar-kets—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 expan-sion, 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 restric-tion 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.
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the realities of the downturn in business activity. But the awaken-ing 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. 6 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. Commercialand Financial Chronicle (April 20, 1929): 2557ff.
46Hoover, The Memoirs of Herbert Hoover, vol. 2, pp. 16ff.
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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 pro-posed 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, con-sidered 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 pol-icy—was adopted under the influence of none other than Montagu Norman.49 Finally, by June, moral suasion was abandoned, but dis-count 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.
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