Economics and The Public Welfare

Chapter 18

The Extent of Bank Expansion, 1922-1928

Between June 30, 1922, and April 11, 1928, the deposits of the commercial banks of the United States increased by approximately $13,500,000,000, while the loans and investments of the same banks increased by $14,500,000,000. April 11, 1928, represents the culmination of this great expansion of bank credit, though it is far from representing the culmination of the consequences of this great expansion, as we shall see.1

Deposits of Commercial Banks *
April 11, 1928	$44,234,000,000
June 30, 1922	30,690,000,000
Increase	$13,544,000,000

Loans, Discounts, and Investments of Commercial Banks
April 11, 1928	$47,607,000,000
June 30, 1922	33,095,000,000
Increase	$14,512,000,000

* See Chase Economic Bulletin, June 4, 1928, p. 22, and Appendix A.

Expansion in 1922-1928 Compared with Expansion Required to Win the War. This is obviously a great expansion. But great figures taken by themselves are not necessarily significant. Some sort of comparison is needed. How big is $13,500,000,000 as an increase in deposits? How big is $14,500,000,000 as an increase in loans and investments? A significant comparison is to be found in the expansion of credit by the same banks, needed during our participation in World War I. That expansion amounted to $5,835,000,000 in deposits and to $7,056,000,000 in loans and investments, as shown by the following table:2

Deposits of Commercial Banks
December 31, 1918	$26,541,039,000
April 6, 1917	20,705,588,000
Increase	$5,835,451,000

Loans, Discounts and Investments of Commercial Banks
December 31, 1918	$29,354,214,000
April 6, 1917	22,297,775,000
Increase	$7,056,439,000

There was real need for bank expansion in winning the great war. We had to raise an army of four million men and send half of them to France. We had to transform our industries from a peacetime basis to a wartime basis. We had to finance the United States Government, which had borrowed some 17 billion dollars in the four Liberty Loans and some billions more on short maturities. We had to finance the shipments of munitions and supplies to our Allies in Europe, and to finance a great many shipments to them from other parts of the world. We had to do business on a price level high above the price level in the period between 1922 and 1928. There was need for the expansion of bank credit.

We watched bank credit with fear and trembling as it expanded during World War I, because we knew then what we seem since to have forgotten, the dangers of overexpanded bank credit. We held it down all we could. But a great expansion was needed and we made it. It was enough. An expansion of $5,800,000,000 in deposits, with $7,000,000,000 in loans and investments, was enough.

Between the middle of 1922 and April of 1928, without need, without justification, lightheartedly, irresponsibly, we expanded bank credit by more than twice as much, and in the years which followed we paid a terrible price for this.

Protests Against the 1922-1928 Expansion. The process did not go on without criticism. The Chase Economic Bulletin challenged it again and again as it went on.3 Again and again throughout the period the Commercial & Financial Chronicle of New York, in powerful editorials, attacked the Federal Reserve policy responsible for this great bank expansion, and gave warnings. And again and again as the process went on the late H. Parker Willis, Professor of Banking at Columbia University and formerly Secretary of the Federal Reserve Board, sounded warnings. Inside the Federal Reserve System itself there was opposition and resistance. The Chicago Federal Reserve Bank held back, especially in 1927, and was compelled to lower its rediscount rate by a vote of the Federal Reserve Board. Governor Seay, of the Federal Reserve Bank of Richmond, protested. The influence of W. P. G. Harding who, after leaving the Federal Reserve Board became Governor of the Boston Federal Reserve Bank, was strongly on the side of sound policy. Inside the New York Federal Reserve Bank Dr. W. Randolph Burgess, author of the excellent book The Reserve Banks and the Money Market, was definitely on the conservative side, although his influence in the bank was reduced by his comparative youth, and although he was doubtless inhibited by a great personal loyalty and affection for his chief, Benjamin Strong.

But the system was adrift. It was hard to center responsibility, particularly after the Federal Reserve Board lost heart and courage when W. P. G. Harding was forced off the Board by President Harding, and Crissinger took his place.

Federal Reserve Banks Used to Finance Stock Market Boom. The Federal Reserve Act would have worked well had traditional central bank policies been followed, namely: the holding of the rediscount rates above the market rates, and the use of open market operations primarily as an instrumentality for tightening the money market, not for relaxing it.

The Federal Reserve System was created to finance a crisis and to finance seasonal needs for pocket cash. It was not created for the purpose of financing a boom, least of all for financing a stock market boom. But from early 1924 down to the spring of 1928 it was used to finance a boom and used to finance a stock market boom.

The Heart of the Money Market. The figures given above for the total of the deposits in the commercial banks of the country—over 44 billions on April 11, 1928—or for the loans and investments for the commercial banks, which stood above 47 billions on the same date, did not constitute the supply of loanable funds in the money market. The loans and investments represent money already supplied, money already loaned and invested. The deposits of the commercial banks do not constitute loanable funds for the banks. A depositor of the bank may loan his deposit balance to some other individual, but the bank cannot do so. A bank’s deposits are its liabilities, not its assets. The bank’s depoaits are what the bank owes, not what the bank has. A bank can increase its loans or investments only when it is in a position to pay out cash or to create a new deposit liability. And its ability to do either of these things depends upon its cash reserves, in relation to its existing deposit liabilities.

The reserves of the member banks of the Federal Reserve System on this same date, April 11, 1928, stood at4 $2,432,000,000, a figure very much smaller than the $44,000,000,000 of deposits or the $47,000,000,000 of loans and investments.

But not even in this smaller figure of the reserves of the member banks have we reached the heart of the money market. Not nearly all of this $2,432,000,000 was available as a basis for bank expansion. Most of it was required to maintain the existing volume of bank credit. Most of it was legally required reserves. Sometimes all of the reserves are required, and sometimes all of the reserves are less than the requirements. It is only when reserves are excessive that bank expansion can move easily.

The real heart of the money market is in the marginal reserves, plus or minus, above or below the required reserves. During the 1920’s this heart of the money market was contained within a maximum figure of $150,000,000: $100,000,000 above the required reserves and $50,000,000 below the required reserves. With excess reserves of $75,000,000 to $100,000,000 bank credit expanded rapidly. With a reserve deficiency of as much as $50,000,000 the member banks would be under pressure, would hold back on expansion, would sell investments, would call loans at the stock market, and would rediscount at the Federal Reserve banks.

In the New York money market alone, it was the experience of the middle 1920’s that an increase or decrease of $20,000,000 to $30,000,000 in the reserve balances of the New York banks with the Federal Reserve Bank of New York could make a difference of 0.5% in the call loan rate.5 The forces immediately involved in the short run adjustments of supply and demand in the money market, at a time when the banks are using their funds pretty fully, are concerned with marginal quantities—marginal quantities of Federal Reserve deposits, as distinguished from commercial bank deposits.

Federal Reserve Deposits “High-Powered Dollars.” Deposits with the Federal Reserve banks are “high-powered” dollars. To the ordinary individual a check drawn on the Federal Reserve bank looks like any other check. He deposits it with his own bank as he would deposit any other check. But to a member bank of the Federal Reserve System, a check on a Federal Reserve bank is a very different thing from a check on another bank in the clearing house. The great banks learned early to segregate checks on the Federal bank from other checks, so that they might be deposited at once with the Federal Reserve bank, instead of going to the Federal Reserve bank through the clearing house the next day. The point was simple—they got immediate credit in their reserve accounts by so doing, and immediately had additional loanable funds.

The reserve requirements of the commercial banks of the United States have long been fixed by law. This has not been generally true in other countries. In other countries the bankers have used their judgment and their experience in deciding how much reserve they would keep. A bank with a few large depositors, any of whom might withdraw large sums on short notice, would carry larger cash reserves than a bank with a large number of deposits of moderate size. A banker subject to heavy withdrawals at certain seasons of the year would build up his reserves in anticipation of these withdrawals. A banker, forseeing a crisis, would try to increase his reserves before the crisis came. In general, reserve policy would be related: (a) to the variability of deposits and other demand liabilities, and (b) to the liquidity of assets other than reserves. Short-dated paper, spaced so that maturities come daily, and Government bonds, instantly salable for cash, justify smaller cash reserves in a bank than would be the case if the bank’s chief assets other than reserves were less liquid.

American bankers were, of course, not unaware of considerations of this sort. But accustomed for two generations to having their minimum reserves percentages fixed by law, they had no such grasp of the theory of bank reserves as the best foreign bankers had.

The American country banker, remote from a city correspondent or a Federal Reserve bank, would, indeed, carry a great deal of vault cash in addition to his reserve balances in a city bank or with the Federal Reserve bank—cash reserves over and above his legal requirements. The abler city banks, seeing trouble in the future, in pre-Federal Reserve days did build up cash reserves above the legal requirements, in the form of cash in their own vaults. With the coming of the Federal Reserve System, however, the tendency was to carry only such reserves as the law required in the form of deposit balances with the Federal Reserve banks, and to look for the rest to “secondary reserves,” and particularly to those assets other than cash which could be taken to the Federal Reserve banks for rediscount. The tendency was for the banker to use his cash to the full, maintaining the cash reserve required by law but no more.

When the reserve requirements were lowered by the wartime legislation of 1917, a dangerous situation was thus created, unless the Federal Reserve System watched closely to prevent the accumulation of even small excess reserves. On the basis of excess reserves in the form of credit balances with the Federal Reserve banks, member bank credit could expand in a multiple ratio, and with the very low reserve requirements the multiple was very high.

Decline in Reserve Ratios, 1921-1928. When, moreover, the proportion of time deposits to demand deposits grew—and the preceding chapter has shown that this was the natural consequence of excessive bank expansion—then the reserve ratios went still lower, and the multiple still higher.

The following tables show how the increasing proportion of time deposits pulled down reserve percentages and pulled down required reserve percentages.

Reporting Member Banks (In millions of dollars)
Date	Net demand deposits	Time deposits	Actual reserve percentage
April 1, 1921	10,271	2,925	9.57
April 5, 1922	10,456	3,121	........
April 4, 1923	11,212	3,959	........
April 2, 1924	11,246	4,230	........
April 1, 1925	12,756	5,053	........
April 7, 1926	12,761	5,516	........
April 6, 1927	13,042	6,012	........
April 25, 1928	13,742	6,878	8.75

From April 1, 1921, to April 25, 1928, seven years, the increase in net demand deposits of the reporting member banks was $3,471,000,000, or roughly 33.8%, while the increase in their time deposits was $3,853,000,000, or 135.1%.

Reporting Member Banks—New York City (In millions of dollars)
Date	Net demand deposits	Time deposits	Required reserve percentage
April 15, 1921	4,118	290	12.34
April 12, 1922	4,308	353	12.24
April 11, 1923 ,	4,230	627	11.71
April 16, 1924	4,369	650	11.70
April 15, 1925	4,980	816	11.59
April 14, 1926	5,001	814	11.60
April 13, 1927	5,036	960	11.40
April 18, 1928	5,626	1,117	11.34

It is difficult to estimate the legal reserve requirements for all the commercial banks of the country. The table on the next page gives the actual, rather than the required, reserve percentages. The member banks of the Federal Reserve System, though less than half in number of all the commercial banks of the country, held in the 1920’s over 73% of the total deposits of all the commercial banks of the country. The nonmember commercial banks are linked closely with the Federal Reserve System through the fact that they carry the greater part of their reserves in the form of deposit balances with the member banks. Part of their reserves they carry in cash in their own vaults also. The following table, therefore, comparing the deposits of all the commercial banks with the reserve balances of the member banks, though misleading if it were interpreted as stating the total reserves of all the commercial banks, or the complete reserve percentage of all the commercial banks, still has real significance.

All State and National Banks and Trust Companies (In millions of dollars)
Date	Total deposits	Member Bank reserve balances with the Federal Reserve banks	Actual percentage member bank reserve balances to all commercial bank deposits
June 30, 1922	30,690	1,865	6.08
June 30, 1923	32,726	1,868	5.71
June 30, 1924	35,326	2,016	5.71
June 30, 1925	38,539	2,199	5.71
June 30, 1926	40,126	2,229	5.56
June 30, 1927	41,587	2,342	5.63
April 11, 1928	44,234	2,432	5.50

The figures for all member banks, which come only four times a year, do not enable us to fix a precise date for the culmination of the move, but the following midyear figures will show that the expansion ceased for all member banks soon after it had ceased for the reporting member banks:

Total Deposits
June 30, 1924	$29,566,000,000
June 30, 1925	32,457,000,000
June 30, 1926	33,762,000,000
June 30, 1927	35,393,000,000
June 30, 1928	36,050,000,000
June 29, 1929	35,866,000,000

The total loans and investments of all member banks also ceased to grow rapidly. They had increased from $32,756,000,000 on June 30, 1927, to $35,061,000,000 on June 30, 1928, but had then risen only to $35,711,000,000 by June 29, 1929. The figures for all commercial banks likewise ceased to expand on the June-to-June basis in 1928. The total deposits of all commercial banks rose from $47,781,000,000 on June 30, 1927, to $49,215,000,000 on June 30, 1928, but then dropped slightly to $49,036,000,000 on June 29, 1929.

Vol. 3, No. 1, Mar. 27, 1923,

Vol. 4, No. 3, Aug. 4, 1924,

Vol. 5, No. 3, Aug. 24, 1925,

Vol. 6, No. 3, Nov. 8, 1926,

Vol. 7, No. 4, Oct. 29, 1927,

Vol. 8, No. 1, June 4, 1928,

Vol. 8, No. 2, June 25, 1928,

Vol. 9, No. 1, Feb. 11, 1929,

Vol. 9, No. 3, May 8, 1929,

Vol. 10, No. 3, Sept. 29, 1930,

Vol. 11, No. 1, Mar. 16, 1931.

• 1This point will be discussed at length in Chap. 34.
• 2I have not been able to find that this article was ever published. However, the reader will find much of it in two books by Veblen: Imperial Germany and the Industrial Revolution, New York, 1915; and The Nature of Peace and the Terms of Its Perpetuation, New York, 1917.
• 3See my book The Effects of the War on Money, Credit and Banking in France and the United States, published by the Carnegie Endowment for International Peace, Oxford University Press, New York, 1919. For London, see the interesting articles by Mr. J. M. Keynes in the British Economic Journal in late 1914.
• 4O. M. W. Sprague: “Crisis of 1914 in the United States,” American Economic Review, September, 1915; H. G. S. Noble: “The New York Stock Exchange in the Crisis of 1914,” Garden City, N. Y., Country Life Press, 1915. These two papers are classics of permanent value.
• 5The figures of all the State and National banks and trust companies appear only once a year in the Comptroller’s report as of approximately June 30. For dates other than June 30, it is necessary to make estimates. During the war period these estimates are made on the basis of variation in the National Bank figures.