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his 1963 address at the IMF, the outflow of American gold 'did not come about by chance.'1
THE 'DISCOVERY' OF THE OPEN MARKET
It is commonly asserted by writers on this topic that the power of the open-market mechanism to manipulate the money supply was 'discovered' by the Fed in the early 1920s and that it came as a total surprise. Martin Mayer, for example, in his book, The Bankers, writes:
Now, through an accident as startling as those which produced the discovery of X-Rays or penicillin, the central bank learned that
'open market operations' could have a significant effect on the behavior of the banks.2
This makes the story interesting, but it is difficult to believe that Benjamin Strong, Paul Warburg, Montagu Norman, and the other monetary scientists who were pulling the levers at that time were taken by surprise. These men could not possibly have been ignorant of the effect of creating money out of nothing and pouring it into the economy. The open market was merely a different funnel.
If there was any element of surprise, it likely was only in the ease with which the mechanism could be activated. It is not important whether that part of the story is fact or fiction, except that it perpetuates the 'accidental' view of history, the myth that no one is responsible for political or economic chaos: Things just happen.
There was no master plan. No one is to blame. Everything is under control. Relax, pay your taxes, and go back to sleep!
In any event, by the end of the war, Congress had awakened to the fact that it could use the Federal Reserve System to obtain revenue without taxes. From that point forward, deficit spending became institutionalized. A gradually increasing issuance of Treasury bonds was encouraging to the Fed because it provided still one more source of debt to convert into money, a source that eventually would become far more reliable than either bank loans or banker's acceptances. Best of all, now that Congress was becoming dependent on the free corn, there was little chance it would find its wings and fly away. The more dependent it became, the more secure the System itself became.
1. See Chapter six.
2. Mayer, p. 401.
THE GREAT DUCK DINNER
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In 1921, the twelve regional Reserve banks were separately buying and selling in the open market. But motives varied. Some merely needed income to cover their operating overhead, while others—notably the New York branch under Benjamin Strong—
were more interested in sending American gold to England. Strong began immediately to gather control of all open-market operations into the hands of his own bank. In June of 1922, the 'Open-Market Committee' was formed to coordinate activities among the regional Governors. In April of the next year, however, the national board in Washington replaced the Governor's group with one of its own creation, the 'Open-Market Investments Committee.' Benjamin Strong was its chairman. The powers of that group were enhanced ten years later by legislation which made it mandatory for the regional branches to follow the Open-Market Committee's directives, but that was a mere formality, for the die had been cast much earlier. From 1923 forward, the Fed's open-market operations have been carried out by the New York Federal Reserve Bank.
The money trust has always been in control.
DROWNING IN CREDIT
Actions have consequences, and one of the consequences of purchasing Treasury bonds and other debt-related securities in the open market is that the money created to purchase them eventually ends up in the commercial banks where it is used for the expansion of bank credit. 'Credit' is another of those weasely words that have different meanings to different people. In banker language, the expansion of credit means the banks have 'excess reserves'
(bookkeeping entries) which can be multiplied by nine and earn interest for them—if only someone would be kind enough to borrow. It is money waiting to be created. The message is: 'Come on to the bank, folks. Don't be bashful. We've got plenty of money to lend. You have credit you didn't even know you had.'
In the 1920s, the greater share of bank credit was bestowed upon business firms, wealthy investors, and other high rollers, but the little man was not ignored. In 1910, consumer credit accounted for only 10% of the nation's retail sales. By 1929, credit transactions were responsible for half of the $60 billion retail market. In his book, Money and Man, Elgin Groseclose says: 'By 1929 the United States was overwhelmed by a flood of credit. It had covered the 488
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land. It was pouring into every nook and cranny of the national economy.'1
The impact of expanding credit was compounded by artificially low interest rates—the other side of the same coin—which were intended to help the governments of Europe. But they also stimulated borrowing here at home. Since borrowing is what causes money to be created under fractional-reserve banking, the money supply in America began to expand. From 1921 through June of 1929, the quantity of dollars increased by 61.8%, substantially more than the increase in national product. During that same time, the amount of currency in circulation remained virtually unchanged.
That means the expansion was comprised entirely of money
substitutes, such as bonds and loan contracts.
BOOMS AND BUSTS MADE WORSE
