The forces of the free market are amazingly flexible. Like the black market, they manage to exert themselves in unexpected ways in spite of political decree. That had been the case throughout most of American history. Prior to the creation of the Federal Reserve, banking had been coddled and hobbled by government. Banks were chartered by government, protected by government, and regulated by government. They had been forced to serve the political agendas of those in power. Consequently, the landscape was strewn with the tombstones of dead banks which had taken to their graves the life savings of their hapless depositors. But these were mostly regional tragedies that were offset by growth and prosperity in other areas. Even within the communities most severely affected, recovery was swift.
Now that the cartel had firm control over the nation's money supply, the pattern began to change. The corrective forces of the free market were more firmly straight-jacketed than ever. All banks in the entire country were in lock step with each other. What happened in one region is what happened in all regions. Banks were not allowed to die, so there could be no adjustments after their demise. Their illness was sustained and carried like a deadly virus to the others.
The expansion of the money supply in the 1920s clearly shows that effect. It was not a steady advance but a series of convulsions.
1. Groseclose,
THE GREAT DUCK DINNER
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Each cycle was at a higher level than the previous one. That is because the busts that followed the booms were not allowed to play themselves out. The monetary scientists now had so many mechanisms at their command they were able to initiate new expansions to cancel out the downward adjustments. It was like prescribing increasing doses of narcotics to postpone the awareness of an advancing disease. It increased the prestige of the doctor, but it did not bode well for the patient.
THE ROLLER COASTER
Between 1920 and 1929, there were three distinct business cycles with several minor ones within them. For the average American, it was confusing and destructive. For the investor, it was a roller-coaster ride to oblivion:
UP! The Fed had inflated the money supply to pay for World War I. The resulting boom caused prices to rise.
DOWN! In 1920, the Fed raised interest rates to cool off the inflation. That caused a recession, and prices tumbled.
Farmers were hit the hardest, and hundreds of country
banks were closed.
UP! In 1921, the Fed lowered interest rates to stop the recession and to help the governments of Europe. Inflation and
expanding debt resulted.
DOWN! In 1923, the Fed tightened credit to put the brakes on inflation.
UP! But that was offset by its simultaneous policy of lowering the rate at the discount window, thus encouraging banks to borrow new reserves to expand the money supply.
UP! In 1924, the Fed suddenly created $500 million dollars in new money. Within one year, the commercial banks
parlayed that into more than $4 billion, an expansion of
eight-to-one. The boom that followed took on the character of speculation rather than investment. Prices in the stock market rose drastically.
DOWN! In 1926, the Florida land boom collapsed, and the
economy began to contract once again.
UP! In 1927, Montagu Norman of the Bank of England visited the United States to consult with Benjamin Strong. Shortly after his visit, the Fed pumped new money into the system, and the boom returned.
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THE CREATURE FROM JEKYLL ISLAND
d o w n ! In the spring of 1928, the Fed contracted credit to halt the boom.
up! But the banks shifted their reserves into time deposits (where customers agree to wait before withdrawing their
money). Since time deposits require a smaller reserve ratio than demand deposits, the banks were able to issue more
loans than before. That offset the Fed's contraction of credit.
up! By that time, the British government had consumed its previous subsidy which was used to maintain its welfare
state. In the spring of 1928, the pound sterling was again sagging on the international market, and gold began to flow back into the United States. Once again, the fledgling
Creature came to the aid of the Bank of England, its ailing parent. The Fed bought a huge volume of banker's
acceptances to depress interest rates and halt the flow of gold. The money supply suddenly increased by almost
$2 billion.
