disclosed to the public—they met on the 18th of May 1920; it was a secret meeting—and they spent all day; the minutes made 60 printed pages, and it appears in Senate Document 310 of February 10,1923. ..
Under action taken by the Reserve Board on May 18, 1920, there resulted a violent contraction of credit.... This contraction of credit and currency had the effect, the next year, of diminishing the national 1. Charles A. Lindbergh, Sr.
THE GREAT DUCK DINNER
477
production $15,000,000,000; it had the effect of throwing millions of people out of employment; it had the effect of reducing the value of lands and ranches $20,000,000,000.1
The contraction of credit had a disastrous effect on the nation as a whole, not just farmers. But the farmers were more deeply involved, because the recently created Federal Farm Loan Board had lured them with easy credit—like ducks at the pond—into extreme debt ratios. Furthermore, the large-city banks which were members of the System were given support by the Fed during the summer of 1920 to enable them to extend credit to manufacturers and merchants. That allowed many of them to ride out the slump.
There was no such support for the farmers or the country banks which, by 1921, were falling like dominoes. History books refer to this event as the Agricultural Depression of 1920-21. A better name would have been
BUILDING THE MANDRAKE MECHANISM
In Chapter Ten, we examined the three methods by which the Federal Reserve is able to create or extinguish money. Of the three, the purchase and sale of debt-related securities in the open market is the one that provides the greatest effect on the money supply.
The purchase of securities by the Fed (with checks that have no money to back them)
That is the way the monetary scientists discharge the commitment to create money for their partners, the political scientists. Without that service, the partnership would dissolve, and Congress would abolish the Fed.
When the System was created in 1913, it was anticipated that the primary way to manipulate the money supply would be to control the 'reserve ratios' and the 'discount window.' That is banker language for setting the level of mandatory bank reserves (as a percentage of deposits) and also setting the interest rate on loans made by the Fed to the banks themselves. The reserve ratio under the old National Bank Act had been 25%. Under the Federal Reserve Act of 1913, it was reduced to 18% for the large New York 1. U.S. Cong., Senate, Special Committee on the Investigation of Silver,
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THE CREATURE FROM JEKYLL ISLAND
banks, a drop of 28%. In 1917, just four years later, the reserve requirements for Central Reserve-City Banks were further dropped from 18% to 13% (with slightly lesser reductions for smaller banks).
That was an additional 28% cut.1
It quickly became apparent that setting reserve ratios was an inefficient tool. The latitude of control was too small, and the amount of public attention too great. The second method, influencing the interest rate on commercial loans, was more useful. Here i,s how that works:
Under a fractional-reserve banking system, a bank can create new money merely by issuing a loan. The amount of new money it creates is limited by the reserve ratio or 'fraction' it is required to maintain to cover its cash-flow needs. If the reserve ratio is 10%, then each $10 it lends includes $9 that never existed before. A commercial bank, therefore, can create a sizable amount of money merely by making loans. But, once the bank is 'loaned up,' that is to say, once the bank has already loaned $9 for every $1 it holds in reserve, it must stop and wait for some of the old loans to be paid back before it can issue new ones. The only way to expand that process is to make the reserves larger. That can be accomplished in one of three ways: (1) use some of the bank's profits, (2) sell additional stock to investors, or (3) borrow money from the Fed.
WHEN BANKS BORROW FROM THE FED
The third option is the most popular and is called going to the
'discount window.' When banks go to the Fed's discount window to obtain a loan, they are expected to put up collateral. This can be almost any debt contract held by the bank, including government bonds, but it commonly consists of commercial loans. The Fed then
