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Back in 2012, we looked at what the Federal Reserve was up to in the
1920s.
December
...
23, 2012: The Federal Reserve in the 1920s 4: The Historical
Record
December
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16, 2012: The Federal Reserve in the 1920s 3: Balance Sheet and
Base Money target="_blank"
target="_blank"November
...
25, 2012: The Federal Reserve in the 1920s 2: Interest Rates
target="_blank" November
...
18, 2012: The Federal Reserve in the 1920s
I can't believe over a year has passed since then. But, I was
finishing my book. Finally, we can continue our story, taking it
into the 1930s.
We will extend our charts up until 1941, which provides a nice
perspective for the entire interwar period. The source of the data
is here target="_blank":
http://fraser.stlouisfed.org/publication/?pid=38
Virtually all the increase in Fed assets during the 1930s was in the
form of gold bullion. This was driven primarily by Europeans
protecting their capital from war and the distress of the Great
Depression. The United States also had difficulties during the Great
Depression of course, but it wasn't as bad as in Europe, where there
were many sovereign defaults, bank failures, currency devaluations,
and of course the rise of fascist governments throughout the
continent. Scary! But, why would one deposit their gold with the
Fed/Treasury, instead of just keeping it in a vault somewhere? A
number of reasons: no storage costs, relatively easy access
worldwide, liquidity, etc. The Fed/Treasury was seen as a place
where one could deposit gold and get banknotes, and then later
redeem banknotes and get your gold back.
The big jump in gold holdings in 1934 was related to the devaluation
of the dollar at that time. Although the U.S. devalued, it then
repegged to gold in 1934. Most countries, including Britain,
devalued but did not repeg to gold. Instead, they had a floating
fiat currency up until formally rejoining the world gold standard
system in 1944 with the Bretton Woods Agreement. Thus, the U.S. was
a relative safe haven. Plus, of course, there was no real risk of a
land war in the U.S. itself, and the political system probably
seemed a lot more stable than in other countries at that time.
We also see that the Fed was fairly active with its "open market
operations" in the 1920s (which we documented in 2012), in this way
mimicking the normal operating procedures of the Bank of England,
which was the example everyone imitated in those days. However,
after 1934, open-market operations basically cease, and the Fed
essentially operates as a simple bullion/base money currency board,
or what I call an Example #2 System in my book Gold: the
Monetary Polaris. This imitates the way the Bank of England
Issue Department operated.
The Liabilities side of the Fed balance sheet of course includes
base money, including banknotes and deposits at the Fed. Base Money
also makes a big jump in 1934, but this is apparently due to the
corresponding jump in Treasury Cash at the Fed, which is probably
related to the 1934 devaluation. Money in Circulation (banknotes and
coins) doesn't make any particular rise at this time. We also see a
big rise in Bank Reserves, beginning gradually in 1934. This is to
be expected; banks would want to hold more reserves due to the risky
environment of that time. If anything, I am a little surprised that
this did not start to rise earlier.
The rise in banknotes beginning around 1939 might be related to
increasing international usage of dollar banknotes, in light of
failing currencies worldwide and political turmoil, including
large-scale military invasions.
From this we can see that the Fed was not particularly expansionary
in the 1920s, nor particularly contractionary in the 1930s. This is
a bit of a myth, without any real historical evidence.
Here's a little breakdown of deposits at the
Fed, which consisted mostly of bank deposits ("bank reserves").
Plus, there is a little bit of Treasury deposits, and "nonmember
deposits" which are probably foreign central banks.
There's a little story behind the "excess reserves." Apparently
there was a change in the 1936-1937 period whereby the reserve
requirements were raised. However, since reserves were already
so high above the reserve requirement, this had little real
effect except perhaps driving banks to hold more reserves, so
that they would continue to have a large surplus above the
requirement. This is not particularly "contractionary" in the
context of a gold standard system, because the system itself
will create more base money in response to the demand for it.
Thus, if a higher reserve requirement created a higher demand
for base money in the form of bank reserves, the gold standard
system would accommodate this increased demand, which is of
course exactly what happened, and is why base money and bank
reserves rise so much in the latter 1930s. Because of this,
there is never a "shortage of money."
In general, people are far too eager to look for monetary
explanations for the difficulties of the 1930s, when actually it
was largely a fiscal (tariff/tax increase) event, combined with
credit defaults including sovereign default and bank insolvency.
Of course there were monetary problems too, including many
currency devaluations, most of which were followed by a period
of floating fiat currencies for most countries. The fact that
the currency was floating was bad enough; there was always the
possibility that the currency could be devalued again, or simply
depreciate in a chaotic fashion, which indeed was the case in
many examples.
I don't see anything in particular here that suggests the Fed
was particularly "contractionary" in the early 1930s, or in the
1936-37 period, as a result of an increase in reserve
requirements at banks.
We will look at more info from the 1930s soon.
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