Economics and The Public Welfare

Chapter 11

The Money Market, 1920-1923—Renewed Bank Expansion

A very important factor in the revival, as in all revivals, was an easing of the money market and an expansion of bank credit. There was a very substantial liquidation of bank credit from the high figures of 1920 to the low figures of 1921, very impressive in dollar volume, though less impressive in percentage. The tide of bank credit turned, however, in the latter part of 1921 and a renewed expansion began. National Bank figures are better than figures for member banks in the Federal Reserve System in the period 1914-1923, because the number of National Banks changed very little, while the number of member banks changed a good deal. The following tables make use of National Bank figures, Federal Reserve Bank figures, and Reporting Member Bank figures.

Gold, Money in Circulation and Rediscount Rates. The bank credit expansion, 1922-1923, which reversed the process of liquidation, was due first to incoming gold, which amounted to about a billion dollars in the years 1921 and 1922; second, to an $800,000,000 decline in money in circulation; and third, to Federal Reserve policy. The Federal Reserve banks reduced their rediscount rates in 1921. Beginning in the first half of the year by successive stages of 1/2% each, the New York Federal Reserve Bank reduced its rate from 7% to 4% in the summer of 1922. During this same period rediscounts were steadily declining, though the steady reduction in the rate, which brought the Federal Reserve rate well below the market, undoubtedly retarded the decline in the volume of rediscounts. But member banks continued to get out of debt to the Federal Reserve banks, and rediscounts fell from the peak figure in the autumn of 1920 of $2,750,000,000 to $1,000,000,000 at the beginning of 1922.

The First Large Open Market Operation of the Federal Reserve Banks, 1922. A second contributing factor in Federal Reserve policy was open market purchases of United States Government securities by the Federal Reserve banks. Beginning early in 1922 there was a sharp increase in the holdings of Government securities by the Federal Reserve banks, the total rising from roughly $250,000,000 to approximately $650,000,000.

Operations of National Banks * (In millions of dollars)
	Total resources	U. S. securities owned	Other securities owned	Total investments in securities	Loans and discounts	Total Loans, discounts and investments	Demand, time, and U. S. deposits
June 4, 1913	11,037	789	1,089	1,878	6,143	8,021	6,022
June 30, 1914	11,482	790	1,116	1,906	6,430	8,336	6,358
May 1, 1917	16,144	768	1,950	2,719	8,713	11,470	9,696
High point, 1919-1920	22,711	4,028	1,985	5,877	12,416	16,612	13,914
	Dec. 31, 1919	May 12, 1919	Dec. 31, 1919	May 12, 1919	Sept. 8, 1920	May 4, 1920	Dec. 31, 1919
Intermediate low point	19,014	1,862	1,917	3,835	10,978	14,813	12,143
	Sept. 6, 1921	Sept. 6, 1921	June 30, 1920	Sept. 6, 1921	Sept. 6, 1921	Sept. 6, 1921	Sept. 6, 1921
Condition, Dec. 29, 1922	21,975	2,656	2,348	5,004	11,600	16,604	14,159

* Chase Economic Bulletin, Vol. III, No. I, Mar. 27, 1923, p. 15.

Operations of Federal Reserve Banks and Reporting Member Banks (In millions of dollars)
Federal Reserve Banks			All Reporting Member Banks
	Discounts	Total earning assets	Demand, time, and U. S. deposits	Total loans discounts and investments †	Total loans and discounts †	“All other” loans and discounts ‡	Total investments in securities	Investments in U. S. securities	Rediscounts and bills payable at Federal Reserve banks
March 30, 1917	20	168
Approximate High Point in 1919-1920	2,827	3,422	14,465	17,284	*	*	*	3,267	2,278
	Nov. 5, 1920	Oct. 15, 1920	June 18, 1920	Oct. 15, 1920				May 2, 1919	Nov. 5, 1920
Approximate Intermediate Low Point	380	1,021	13,002	14,526	10,739	7,002	3,229	1,190	98
	July 26, 1922	Aug. 9, 1922	July 27, 1921	Mar. 8, 1922	July 26, 1922	July 5, 1922	July 27, 1921	July 27, 1921	July 26, 1922
Condition, March 7, 1923	571	1,135	15,341	16,338	11,635	7,645	4,704	2,518	372

* Separate figures not available.

† Including rediscounts at Federal Reserve banks.

‡ “All other” loans and discounts are those not secured by United States obligations or by other bonds and stocks and are sometimes called “commercial” loans. These figures include rediscounts at Federal Reserve banks.

The policy that lay behind these purchases initially was not a desire to make the money market easy, or a desire to facilitate bank expansion. These were unintended and unanticipated consequences. The motive, as explained privately by a member of the Federal Reserve Board early in 1922, was a much simpler one. The Federal Reserve System had grown enormously during the war and postwar boom. With its growth there had come a great volume of expense. The System needed 45 million dollars a year to meet its expenses and to pay dividends on its stock. This meant a billion dollars of earning assets at 4 1/2%. When, in early 1922, rediscounts fell below a billion, the Federal Reserve banks began to buy Government securities to uphold total earning assets. The authority for this statement, who was one of the very able men in the Federal Reserve System, was chuckling over the failure of some of his associates to realize that increased purchases of Government securities by the Federal Reserve System would accelerate the process of paying off rediscounts. In buying Government securities the Federal Reserve banks increased the reserve balances of the member banks, and the member banks promptly used these increased reserves in reducing their debt to the Federal Reserve banks. Rediscounts dropped to around 400 million dollars in the summer of 1922. But they did not thus use the whole of the increase in reserves, and the result of these Government security purchases, taken in conjunction with the other factors mentioned above, was a relaxation in the money market, a lowering of interest rates generally, and a renewal of the expansion of bank credit.

At no time, however, did interest rates in the period, 1920-1923, go really low, as shown by the following table on open market commercial paper rates in New York City.

Open Market Commercial Paper Rates in New York City *
	High	Low
1920	8	6
1921	7 3/4	5
1922	5	4
1923	5 1/2	4 1/2

* Annual Report of Federal Reserve Board, 1927, p. 96.

The lowest rate in the whole period for open market commercial paper was 4%, and this prevailed for only one month in the whole four years, 1920-1923 inclusive. The Federal Reserve System gave the economic situation a dose of strychnine, but it was a relatively mild dose.

The Chase Economic Bulletin, Vol. I, No. 5, July 20, 1921, contained an article called “The Gold and Rediscount Policy of the Federal Reserve Banks,” 1 which maintained that rediscount rates should always be held above the market, meaning by the “market” the rate which great city banks make to those prime borrowing customers who have accounts with several banks. The Chase Economic Bulletin of March 27, 1923, protested against the artificially generated expansion of bank credit as masking the underlying shortage of real capital which four years of war and four more years of disorganization after the war had brought about, and urged that higher interest rates were called for, both to increase the volume of savings and to make sure that the capital that was created would be used for the most important purposes. The tendency to substitute bank credit for real capital was looked upon as a very ominous tendency. The years 1924-1929, as we shall later see, abundantly justified these apprehensions. The Federal Reserve System itself took alarm in late 1922, and reversed its policy in early 1923, the New York Federal Reserve Bank raising its rediscount rate from 4% to 4 1/2%, and the System selling substantial blocks of Government securities.

In retrospect one may hold that this first dose of strychnine did little harm and some good, and may recognize it as one of the factors, although not the dominating factor, in the strong business revival of 1921 to 1923. Great harm came from the strychnine administered in 1924, and above all, from the renewal of the dose in 1927. There is no racetrack which has a code of ethics which permits doping the same horse three times.

• 1This point will be discussed at length in Chap. 34.