Book Ten - The Inflationary Age

Book Ten. THE INFLATIONARY AGE No more trenchant commentary on the monetary problem in modern times can be offered than the coincident increase in the supply of monetary metal and the insatiable demand for money. In these latter years nature has burgeoned gold, but a money famine has become chronic, and the more bountiful the supplies of metal, the greater the want. /. The Open Sesame In the fifth decade of the nineteenth century world production of gold suddenly leaped to new and unprecedented levels. From an average annual production of 650,000 ounces, for the decade 1831-1840, production was lifted to over 1,760,000 annually for the decade 1841-1850, and then to over 6,000,000 ounces annually during the succeeding decades. Such a wealth of precious metal had not bedazzled the eyes of men since the days of the Spanish treasure ships. In the twenty-five years from 1850 to 1875, the markets of the world were flooded with the extraordinary amount of over 150,000,000 ounces of gold, or more, according to the estimates of Dr. Adolph Soetbeer, than had been won from the mines since the discovery of America.1 Production was to be held at very nearly these high levels down to 1900, when—following the discovery of the Rand gold fields of South Africa—it was to mount still higher. Since 1900 annual world gold production has increased from around 15 million ounces annually to 41 million by 1970. Silver production reached 300 million ounces annually by 1970 compared with 150 million at the turn of the century.

What is significant is the amount of these metals that remains in use. Of the estimated 2.6 billion ounces of gold produced since the discovery of America, in 1970 some 45 per cent was 203 204 MONEY AND MAN known to be in existence in the vaults of central banks throughout the world. At the outbreak of World War II, some 12.7 billion ounces of silver, of an estimated 16.8 billion ounces produced since 1492, were visible in monetary and nonmonetary stocks: however, due to subsequent demonetizations and rising industrial consumption, visible stocks have been reduced to around 700 million ounces (1975) .2 Despite the fact that by 1873 over a billion dollars of gold had been drawn out of the California mines alone since their opening in 1849, and in the same period an additional quarter billion from other American mines, the cry for cheaper money was reverberating throughout the nation. In 1874 the echo resounded in the halls of Congress in the passage of the inflation act of that year, vetoed by President Grant, and from that time on American monetary history has been an intensified struggle between the advocates of "sound" money and "cheap" money.

The Civil War had been financed by both the Union and Confederate governments by bonds and paper issues rather than by taxes; business was buoyed by this increase in government purchasing power unaccompanied by any reduction of private purchasing power which would have resulted from corresponding taxation, and prices were forced to inflationary levels. The release of the national energies on the conclusion of peace, combined with the leverage of a fiat money mechanism, had induced a febrile internal expansion in commerce, industry and agriculture. The country went heavily into debt, borrowing in both the domestic and foreign markets, and began to overbuild. From 1860 to 1867 the railway mileage of the country had been increased at the rate of 1,311 miles a year. Nearly 5,000 miles of track were laid in 1864 and in the three years, 1870 through 1872, over 19,500 miles. Other activity was on similar though less grandiloquent scale: farmers, particularly, were going into debt. Abroad, a similar boom was in progress, financed largely by the inflationary and speculative stimulus of the AustroItalian War of 1866 and the FrancoPrussian War of 1870.

Meantime, the money system had begun to creak under the THE INFLATIONARY AGE 205 strain, and prices had been falling. The restriction upon state note issues, imposed by the National Bank Act amendment of 1864, the redemption of the public debt which served as the basis for the national bank notes, the crystallized structure of the federal note issue (greenbacks), which had of course ceased to expand after the close of the war, and the gradual demonetization of silver by legislation and by market action of the ratio, all tended to offset the influences of larger gold supplies and to produce an actual as well as relative contraction of the circulation.* Abroad, similar influences, particularly that of the demonetization of silver, which we have traced, were at work. And in 1873 the effects cumulated in a concussion that was worldwide. The crisis of 1873 was but one of a series that have occurred at startlingly regular intervals since the rise of commercial banking, and which have grown with the increasing penetration of money economy into every pore of productive activity. Others occurred in 1879, and 1890 and 1893, in 1907 and 1929. At each crisis, the principal remedy advocated was a further expansion of the money system, a stronger dose of the tonic of cheap money and cheap credit. The only difference was one of method.

Not since the days when the world was intoxicated with the elixir of John Law's system had there risen from industrialist and agriculturist, banker and merchant, from political forum and pulpit, such a paean to cheap and still cheaper money. **% £&> The decline in prices following the end of the Civil War had been met by a series of quasi-inflationary measures. Despite an earlier pledge to the contrary, Congress in 1868 forbade further redemption of the greenbacks. At that time $356,000,000 were still outstanding. An act of July 12, 1870, authorized an increase in the bank note issue from a maximum of $300,000,000 to $354,000,000. An inflation act passed in 1874 provided for * Money in circulation dropped from $1,083,541,000 in 1865 to $774,966,000 in 1870. (Annual Reports of the Secretary of the Treasury.) 206 MONEY AND MAN an increase in the greenbacks until the outstanding total reached $400,000,000, but this act was vetoed by President Grant. The pressure for cheaper money became the opportunity of the silver interests, to whom the drop in the price of the metal after 1873 was proving disastrous, and in 1876 a crop of silver bills came up in Congress. On February 28, 1878, the Bland-Allison Silver Purchase Act was passed over presidential veto, directing the Secretary of the Treasury to purchase silver to the amount not less than $2,000,000 and not more than $4,000,000 monthly, and to cause it to be coined into money as fast as purchased.

This measure failed to satisfy, and by the Act of July 14, 1890, the monthly silver purchases were raised to 4,500,000 ounces. When it finally became clear that the effect of forcing silver into circulation was only to drive gold into hoarding, and the policy of silver purchases was abandoned in 1893, the monetary stock of silver had been increased from $82,000,000 to $624,000,000. Between 1870 and 1892, as a result of these various measures, the total money in circulation had increased from $774,966,000 to $1,601,347,000. Meantime, while the representatives of the people were attempting to quiet the cry for cheap money by the various sedatives we have outlined, the commercial and banking community itself was devising its own remedy. This was the use of the bank check and deposit credit. In deposit credit was the answer to the insistent demand from agriculture and industry for cheaper money which the coinage of metal or the issuance of bank notes within the rigid limits of the National Bank Act failed to provide. In deposit credit was an instrument for the creation of purchasing power almost unlimited. Under the cloak of the commercial banker, King Midas again appeared. John Law had attempted to convert the commercial wealth of France into money, but the commercial banker, eclipsing Law, began, on a magnificent scale, to turn debt into money, and very poverty into wealth.

THE INFLATIONARY AGE 207 In spite of its importance in every phase of modern commercial civilization, the true nature of deposit credit is not generally understood beyond the circle of bankers and professional economists. A deposit credit may be defined as an obligation of a bank to pay a certain sum on demand, the obligation being indicated by an entry on the books of the bank rather than in the form of a transferable document. It is usually thought of as the bank's receipt, set up on its books, for money actually deposited in the bank. While deposits were originally created in this fashion, the larger part of commercial bank deposits arise from loans made in favor of customers by the bank, and indicated by the deposit entry. As long as the proceeds of the loan are left on deposit, or merely transferred to another customer of the bank by means of a check, no money or very little money is involved.

It is a fictitious loan, in the money or goods sense, and made possible by the universal use of the bank check in effecting payments. So long as customers do not draw down the resulting deposits in actual cash, but transfer them from one to another by check, it appears to be something real and tangible, so real that many people are dumfounded when they are informed that there may be over 750 billion dollars of commercial bank deposits in all the banks, yet the total sum of money in circulation may be less than 70 billion dollars (1975). Although the check came into fairly wide use in making larger business payments in the cities after the Revolutionary War, the great expansion in its use for ordinary payments dates, in this country, from the establishment of the national banking system in 1863-1864. Prior to that time credit expansion had been by means of the bank note. A borrower at a bank commonly received the proceeds of a loan in cash or bank notes, and except for larger sums, which might be transferred by check, made his payments in cash. The system is common throughout Europe, where the use of the bank check is still limited.

With the privilege of note issue cut off for state banks, and drastically limited in the case of national banks, bankers began to turn to deposit credit and the check as a means of expanding 208 MONEY AND MAN their credit operations. They discovered that they could do just as well by inducing their customers to take down their loans in the form of deposit credit at the bank, and by urging their depositors to use the bank check for local payments instead of filling up their pockets with silver cart wheels and paper money. There was tremendous convenience in the bank check. As paper money had been a vast improvement, physically speaking, over the use of coin, so the bank check was a great advance over the use of paper money. The individual could execute with a single piece of paper a payment for any amount within his capacity. He was not compelled to carry about a bundle of notes of different denomination, and small change in his pocket as well. It was a form of money not subject to theft, for it was not valid without the depositor's signature on its face. Every man, in fact, became his own mint, issuing money in amounts limited only by his ability to command credit at his bank.

The bank check quickly exercised its fascinating possibilities, and within fifty years approximately 85 per cent of the payments of the country were being made by check rather than by cash.3 There was tremendous leverage in this. In deposit credit and the bank check lay the machinery for the creation of a vast inflation, the actual measure of which we shall now detail. //. The Progress of Inflation THE progress of bank credit inflation from the Civil War to the Great Crash of 1933 may be traced as follows: In 1865, the year after the amendment to the National Bank Act had definitely restricted the note-issue privilege to national banks, commercial bank credit outstanding amounted to $747,400,000, consisting of $289,000,000 in national and residual state bank notes, and $457,400,000 deposit liabilities. The year 1865 was one of postwar inflation, when specie payments were suspended and government issues were at a distressing discount, and the gold stock amounted to only $189,000,000. Yet this gold stock constituted a reserve of over 25 per cent of bank THE INFLATIONARY AGE 209 liabilities—a figure to be borne in mind in considering the course of this ratio.* In 1880, the year after the resumption of specie payments, bank notes outstanding amounted to $344,000,000 but deposit liabilities had grown to $1,132,000,000. The gold stock at this time was $351,841,000 or 23.9 per cent of commercial bank liabilities outstanding. Following the resumption of specie payments, gold was attracted to this country and by 1890 the gold stock amounted to $695,563,000. During the ten-year period, there had occurred a gradual reduction of bank notes outstanding. Due to debt redemption by the Federal Government and consequent higher prices for government bonds, which were required as reserve against bank notes, bankers were finding it more profitable to extend their operations via the deposit route rather than by issuing notes. In 1890 bank note issues amounted to only $186,000,000, while deposit liabilities had risen to $2,606,800,000. Against these total deposit liabilities the gold stock stood at a relationship of 26.7 per cent.

Bank notes thereafter ceased to be any considerable proportion of total bank credit. The increase in the public debt incident to the depression of 1893-1896, and the Spanish-American War, rendered it profitable to increase the note issue, but the great expansion occurred in the form of deposits. These amounted to $4,753,000,000 in 1900, $10,772,000,000 in 1910, $30,560,000,000 in 1920 and $42,996,000,000 in 1930. Bank notes in this last named year amounted to only $698,000,000. In the forty years 1890 to 1930, the population of the country doubled, the value of farm property increased three and a half times, pig iron production four and a half times, exports five * Gold is taken rather than cash holdings because in a gold standard country, all the instruments of money (government notes, bank notes, and deposits) are, in final analysis, demands upon gold. In an individual bank, of course, a variety of items may be regarded as prime reserves against deposits—government currency, bank notes (of other banks) and deposits with other banks.

210 MONEY AND MAN times, coal production five times, and freight traffic five and a half times, but commercial bank deposits increased over seventeen and a half times. Thus, while the gold stock had increased proportionally with the increase of industrial production, the expansion in bank credit had far outstripped both and had thus been at the expense of a thinning gold reserve. The monetary gold stock available to support and redeem this tremendous amount of bank liabilities that was being created, which had been 25.3 per cent of total note and deposit liabilities of banks in 1865, and 23.9 per cent in 1880, steadily dropped under the pressure of the public upon the banking interest for more and more credit, standing in 1900 at 20.4 per cent, in 1910 at 14.2 per cent and in 1930 at 10.4 per cent. Such had been the diminution of reserves that by the decade 1920-1930, banking was being conducted "on a shoestring."

«•§ §•> The case has here been stated in terms of total note and deposit liabilities to total gold stock. It may be stated another way, in terms of the cash holdings of the banks to their deposit liabilities. In 1890, national and state commercial banks and trust companies held vault cash of only $434,325,000 to meet deposit liabilities of $2,420,800,000, or a reserve of slightly less than 18 per cent. The reserve percentage would be even less if deposits in savings banks were included, since savings deposits are usually paid out on demand, and their reserves are in still smaller ratio to their liabilities. The actual ratio of all bank cash to all bank deposit liabilities was 12 per cent. In 1900 the ratio of vault cash to deposit liabilities of commercial banks had dropped to 14.8 per cent, and in 1910 to 12.7 per cent—vault cash in those years being respectively $706,302,000 and $1,366,164,000.

From 1890 on, the banking system as a whole, and individual banks in particular, were pushing against reserve requirements. The system was rapidly reaching a stage in which any shock to banking confidence would set the whole structure toppling.

THE INFLATIONARY AGE 211 In 1893 the country was precipitated into a depression which was generally regarded prior to 1929 as the most severe which the country had ever experienced. It was a depression that was world wide. A variety of causes is assigned, but its genesis is dated from the collapse of Baring Brothers in London, which occurred as the result of an overextension of credit in South America and a resulting Argentine default. To preserve the liquidity of English banking, the Bank of England was forced to obtain a gold loan from the Bank of France, and English banking houses began to withdraw their American credits. In addition to these influences, there had been a febrile expansion of American business, with excessive purchases from abroad, financed by foreign credits, and a consequent decline in the American trade balance. The attempt to increase the currency via the bimetallic route—the silver purchases—had only resulted in a drain on gold and uneasiness over the soundness of the money system, and this uneasiness was intensified by the proposed demonetization of silver in India in 1893—which meant a further drop in the value of this metal. The national banks of the East, warned by the European crisis, began to scan their loans and to strengthen their gold holdings—at the expense, naturally, of their correspondent banks. All these forces came to a head in 1893. On May 9, the Chemical National Bank of Chicago closed its doors, and two days later, the Columbia National Bank of the same city. The infection spread rapidly, and by July the country was in the grip of a financial paralysis.

Banking institutions, national, state and private, were daily suspending, depositors were withdrawing their cash from the banks, and industrial enterprises were coming to a halt. Twentyfive national banks suspended in June—a number never before exceeded in an entire year—seventy-eight suspended in July, and thirty-eight in August. The collapse of private and state banks was even more alarming. An average of about seventy suspensions a year—a figure disturbing enough when the influence of banking on general business is considered—swelled to 415 during the first eight months of 1893. Though the New York banks had succeeded in increasing their reserves to 30 per cent of net deposits in June, it was hopeless to attempt to maintain a 212 MONEY AND MAN sound core surrounded by such rotten fruit. By August 5, their reserves were below the legal minimum, and the only alternative was to suspend specie payments.

President Cleveland had hastened, on June 30, to summon Congress into extraordinary session to repeal the silver purchase acts, but this did little to stay the progress of the panic. Banks all over the country were refusing to make payments in cash, offering instead certified or clearing-house checks. This was no more than exchanging one form of bank obligation for another. Currency went to a premium, and many factories were obliged to shut down for lack of money to pay their employees. All varieties of devices were introduced as substitute money. Certificates and clearing-house checks were issued in scores of communities, the 10 per cent tax on state bank note issues was disregarded and state and private bank notes reappeared. Certificates and certified checks were issued by single banks where clearing houses did not exist; they were issued by railway companies and manufacturers when arrangements could not be made with banks. In a few cases they were issued with the guarantee of the local authorities. Thus, the whole fabric of money disintegrated under the strain of a vast weight of credit obligations payable on demand in money.

Conant, commenting upon the crisis of 1893, points out that the overissue of bank notes played little part in bringing on the debacle, and blames the extension of banking on deposits instead of on the capital and surplus of the banks. Bank capital, he recalls, had increased 70 per cent from 1870 to 1892, and the number of banks had more than doubled, but individual deposits had been multiplied three and a half times and had risen from one-third of total liabilities to more than one-half.1 The crisis of 1893 was met by the repeal of the silver purchase acts, which restored confidence in the official monetary system; by the use of government credit to buy gold from abroad, which fortified the foreign exchanges and diminished the strain on the banks from this direction; by a curtailment of foreign purchases, which redressed the foreign trade balances and assisted in strengthening monetary reserves of the country; and finally by the extinction of a large volume of inflated bank and investment THE INFLATIONARY AGE 213 credit by means of defaults, bankruptcies and foreclosures. Thus relieved, the banking system, in which no reform had been made, went again on its crisis-bestrewn way.

In 1907, the country again experienced a sharp money panic, fortunately of shorter duration, and again the familiar substitutes for money developed in 1893 were called into use. In twothirds of the cities of more than 25,000 population the banks suspended cash payments to one degree or another, and in at least half the larger cities resort was made to clearing-house loan certificates, clearing-house checks, cashiers' checks payable only through the clearing house, or other substitutes for legal money. The necessity for banking reform finally became apparent, but such was the blindness of the age that the bank suspensions were taken as evidence of a need for laxer, rather than stricter, reserve requirements, and agitation centered upon a demand for a "more flexible currency." This thinly veiled cry for cheaper money was met in 1913 by the passage of the Federal Reserve Act. ///. The Federal Reserve System THE common explanation for the institution of the Federal Reserve System is that the concentration of the banking reserves of the country into one institution permitted a greater mobility to these reserves; that is, by pooling the cash, it was possible to use it, like a central fire station, to put out incipient runs on banks and to meet seasonal demands for cash in certain localities. In the optimistic language of one of its chief sponsors, J. Laurence Laughlin, written in 1914, "The rigidity of credit-banking in the past, the destructive snatching of reserves, are displaced by a system which allows good commercial paper to be converted into lawful reserves In time of panic—if any such arrives— there will be no reason for a run on cash reserves, or, if there is a semblance of it, there will be a quick and ready way by which reserves can be replenished. There can be no serious run on the cash by the public, because the member bank can furnish at will 214 MONEY AND MAN reserve notes by making request for them at the Reserve Bank."1 Following the panic of 1907 Congress had appointed a National Monetary Commission to study the whole question of improvements in the banking system, and so assiduously did it perform this task that twenty-four volumes were required to report its findings. Yet it is remarkable that one may find in these volumes exhaustive treatment of the banking and credit systems of the principal countries of the world, but no treatment of the essentials of a monetary system, such as a definition of the standard, the nature of coinage, and the integrity of the reserve.

The one thing demanded by the public and reflected in the ensuing legislation was a mechanism for making money and credit more plentiful. It was the "flexible currency" provisions of the Federal Reserve Act which obtained the enthusiastic endorsement of the commercial and banking community—the promise of cheaper and more plentiful money, and the prospect that credit-debt expansion on a vaster scale than had ever been dreamed of might now proceed. To the bankers, the Federal Reserve Act meant the employment of a larger proportion of total assets in the market, hence with greater profit on bank capital; to the commercial community, it meant easier credit, with money more freely available, if not at lower rates, at least for more speculative ventures. A realistic appreciation of these factors, written at the time, is that of the noted journalist, C. W. Barron: "The 'motif underlying the Federal Reserve Act is not that which is nominated in the bond. 'An elastic currency' could have been had by an enactment of twenty lines. The 'means of rediscounting commercial paper' are already at hand and such discounts exist to the extent of at least 100 millions in the national banking system. It is not 'to establish a more effective supervision of banking in the United States,' for that could be accomplished by increasing the appropriation and enlarging the salaries of the examiners, so that men with larger experience and breadth of vision would perform more effective supervision.

"The purpose of the act most largely in its inception was 'for other purposes,' and these 'purposes' can never be wisely or effectively carried out; if persisted in they spell disaster to the THE INFLATIONARY AGE 215 country. The hidden purpose or 'motif which inaugurated this legislation, however in effect it may work out under wise administration, is to cheapen money. "The whole primary discussion of this bank act was to make money easier, to cheapen it to the farmer and producer and manufacturer and merchant. Senators and representatives both proclaimed within and without Washington that what they were seeking was a financial system that would give us an average rate approaching that of the Bank of France, where interest over a series of years averages between 3 and 4 per cent. They frankly said they hoped for something under the 4 per cent rate."2 To understand how the Federal Reserve System gave a greater leverage to the inflation mechanism of deposit banking, it is necessary to outline the relative provisions of the act. The act created twelve Federal Reserve Banks, each serving a separate geographical region of the country, and made them depositories for the cash reserves of the national banking system.

At the time of the creation of the System, much emphasis was placed on the note issue functions of the Reserve Banks (the banks being permitted, in effect, to issue legal tender notes against a combined security of gold and certain types of commercial instruments of debt, provided the gold proportion of the reserve constituted at least 40 per cent of the total) .3 Because of the growth of check-money and the expansion of deposit credit, however, the real leverage in the money system occurred in the banking reserve requirements of the System. The opportunity offered for bank credit inflation will be understood by setting forth the various reserve requirements, and the manner in which they were manipulated: (1) The Federal Reserve System lowered the reserve requirements against deposits. The national banking system had classified banks according to the size of the city in which they were located, as Central Reserve City Banks, Reserve City Banks, and Country Banks. For Central Reserve City Banks a reserve of 25 per cent of total net deposits was required to be 216 MONEY AND MAN held in cash in the bank's own vaults; for Reserve City Banks a reserve of 25 per cent of total net deposits, of which one-half might be held on deposit with designated correspondent banks; and for Country Banks, a reserve of 15 per cent of total net deposits, of which three-fifths might be held on deposit with designated correspondent banks.

The Federal Reserve Act classified deposits into two categories, demand and time, with separate reserve requirements for each category. For demand deposits the act reduced the reserve requirements to 18 per cent for Central Reserve City Banks, of which six-eighteenths (6 per cent of total net demand deposits) were to be held in the bank's own vault, seven-eighteenths to be held on deposit with the Federal Reserve Bank for its district, and five-eighteenths optional, either in the bank's own vault or on deposit with the Federal Reserve Bank. Reserve City Banks were required to maintain against demand deposits a reserve of 15 per cent, of which five-fifteenths (5 per cent of total net demand deposits) should be held in vault, six-fifteenths on deposit with the Federal Reserve Bank, and four-fifteenths optional. Country Banks were required to maintain reserves of 12 per cent against demand deposits, of which four-twelfths (4 per cent of total net demand deposits) should be held in vault, five-twelfths on deposit with the Federal Reserve Bank, and three-twelfths optional. For time deposits the reserve was only 5 per cent for all classes of banks.

(2) In 1917, as an aid in floating government war loans, the reserve requirements were further relaxed, the proportionate reserves being reduced to 13 per cent, 10 per cent and 7 per cent, according to the classification of the bank, with 3 per cent for time deposits for all classes. The amendment provided that all reserve cash should be held on deposit with the Federal Reserve Banks. Although, under this amendment, till or vault cash could no longer be counted in as reserves, the amount of till cash required to meet daily withdrawals was small, so that the result was an actual reduction in reserve requirements. The effect of the amendment was to cause the banks to maintain smaller and smaller amounts of vault cash, in order to THE INFLATIONARY AGE 217 expand their operations to the maximum, and to rely on the nearby Reserve Bank for accommodation to meet sudden cash withdrawals. For instance, between June, 1917, before the new reserve requirements went into effect, and June 30, 1930, net demand plus time deposits of member banks of the Federal Reserve System increased from $12,000,000,000 to $32,000,000,000, but holdings of vault cash at the time time decreased from about $800,000,000 to less than $500,000,000. By making progressive economies in their use of vault cash at a time of rapid increase in their deposit liabilities, member banks were able to reduce their vault cash to less than 3 per cent of their net demand plus time deposits by 1919, to less than 2 per cent by 1924, and to less than 1.5 per cent by 1930. In New York City, for instance, member bank holdings of vault cash in June, 1930, averaged only threefourths of 1 per cent of their net demand plus time deposits and less than 1 per cent of their net demand deposits alone. The practical effect of the 1917 amendment was, it was found, to reduce reserves against net demand deposits from 18 per cent to 14 per cent for Central Reserve City Banks, and from 15 per cent to 12 per cent for Reserve City Banks, with no change for Country Banks.4 (3) During the decade ending 1930, at a time when the banking power of the country was being strengthened inordinately by large accretions of gold from abroad, the banking system further diluted its reserves by a process of wholesale reclassification of demand deposits into time deposits in order to take advantage of the lower reserve requirements. A special investigation conducted in May, 1931, by the Federal Reserve System, revealed the fact that out of $13,000,000,000 of time deposits held by member banks at that time, $3,000,000,000 consisted of individual accounts with balances in excess of $25,000. Even though accounts of this size may consist of inactive deposits with a low turnover, the Committee on Member Bank Reserves concluded that they were not the typical small savings accounts for the accommodation of which the low reserve against time deposits was primarily instituted. In 1914, when national banks were required to maintain the same reserve against all of their deposits, they held only about $1,200,000,218 MONEY AND MAN 000 in time deposits. Following the lowering of the reserve requirements against these deposits, time deposits increased steadily and amounted to about $8,700,000,000 at national banks alone in 1930. During the same period, time deposits of non-national commercial banks, including both state member and non-member banks, increased from about $2,800,000,000 to $10,200,000,000 and savings deposits of mutual and stock savings banks from $4,800,000,000 to $10,500,000,000. The increase in time or savings deposits for national banks was over 600 per cent, for non-national commercial banks over 250 per cent, and for savings banks 120 per cent.

"With only a 3 per cent reserve required against time deposits," the committee found, "there is an inducement for member banks to persuade or permit commercial customers to classify a large part of their working accounts as time deposits and then to permit a very rapid turnover on that small part of these accounts that remain in the demand-deposit classification." As a result of these various provisions and subterfuges, the committee reported, between 1914 and 1931, the period covered by its survey, total net deposits of member banks increased from $7,500,000,000 to $32,000,000,000 or more than 300 per cent in less than two decades. Some of this increase reflected the accession of state banks to membership in the Federal Reserve System, but the greater part reflected the expansion of member bank credit. While war financing and the huge inflow of gold which followed the war constituted the immediate driving force back of much of this expansion, it was facilitated by a progressive reduction in effective member bank requirements for reserves. Thus member banks actually held (in 1931) about $2,900,000,000 of reserves against $32,000,000,000 of net deposits. These reserves were both the legal reserves which they held with the Federal Reserve Banks and cash which they held in their vaults. If the vault cash requirements of national banks prior to 1914 had been retained in the Federal Reserve Act, member banks would have been required to hold about $4,400,000,000 instead of $2,900,000,000. This means that, THE INFLATIONARY AGE 219 in the aggregate, total reserve requirements were about 34 per cent less in proportion to their deposits than they were before the Federal Reserve Act was passed. "It is clear, consequently,"

said the committee, "that the largest expansion of member bank credit since 1914 has been facilitated by a progressive diminution in reserve requirements as well as by large imports of gold." (4) As the reserves held by member banks against their deposit liabilities are concentrated in the Federal Reserve Banks, so these reserves in turn constitute deposits with the Federal Reserve Banks. Against these deposits, which are the prime reserves of the commercial banks, the Federal Reserve Banks were required to hold, as a minimum, gold to the extent of only 35 per cent.5 In other words, just as commercial banks could expand their liabilities on the basis of small amounts of cash, so the Federal Reserve Banks could expand their liabilities upon small amounts of gold. This was achieved by permitting member banks to strengthen their reserves with the Federal Reserve Banks by borrowing upon the security of government bonds and by discounting their commercial paper. If a bank wished to expand its operations, and did not have the cash for the minimum reserve requirements it could, in effect, create a fictitious reserve by borrowing the credit of the Federal Reserve Bank. The only limit was the legal restriction upon the Federal Reserve Bank against permitting its gold reserve to drop below the 35 per cent minimum ratio to its deposit liabilities. Thus, if the average reserves held by the commercial banks against their deposits were taken as 10 per cent, and the gold reserves held by the System against these reserves at 35 per cent, the actual gold held against the commercial deposits of the System could be reduced to as low as 3.5 per cent.

(5) A final mechanism by which deposits were inflated is that of "open market operations" by the Federal Reserve Banks themselves. Theoretically designed to enable the central banks to regulate the volume of bank credit, and hence to check, as 220 MONEY AND MAN well as encourage, expansion, it has proved more effective as a spur than as a restraint to expansion. Under the Federal Reserve Act, a Federal Reserve Bank is authorized to invest not only in rediscounts and advances to member banks, but in a defined category of commercial obligations.6 These items may be purchased and sold "in the open market, at home or abroad, either from or to domestic or foreign banks, firms, corporations, or individuals."7 Such dealings in the money market directly with the public are called "open market operations." A purchase of investments on the open market is paid for by the Federal Reserve Bank either in Federal Reserve notes or by check drawn on itself, depending on whether the bank wishes to increase the actual quantity of money in circulation, or the banking power of the System. If paid in notes, the money passes directly into circulation; if paid by check, the recipient of the check deposits it with his commercial bank, which in turn presents it to the Federal Reserve Bank for credit. This credit thus becomes a deposit to the account of the member bank, and as such deposits constitute banking reserves for the member bank, the lending power of the member bank is thereby multiplied.

Conversely, of course, the effect of selling portfolio holdings by the Federal Reserve Banks is to reduce reserve credit outstanding, and to restrict the lending operations of member banks. In 1924, with the object of creating money conditions in the international markets favorable to the efforts of Great Britain and a number of lesser European countries to return to the gold standard, the Federal Reserve System embarked on its famous "easy credit" policy, by reducing the rate at which it lent to member banks (the rediscount rate) and by forcing Reserve Bank credit into the banking system by heavy open market operations. As a result, between the end of 1923 and the end of 1927, $548,000,000 of Federal Reserve credit had been forced into the banking system by purchases of bills and securities. This amount must be multiplied many times to appreciate its effect on the credit power of the banking system.

During the early years of this policy, the effect of this leverage was nullified to some extent by the more cautious policy of the commercial banks themselves, which took occasion to reduce THE INFLATIONARY AGE 221 their own borrowings at the Reserve Banks from $857,000,000 to $314,000,000 during the year 1924. They soon got the idea, however, and encouraged by the reduction of the rediscount rate from 4.5 per cent to 3 per cent (in New York), they began again to borrow to increase their reserves, and their own lending power. By the end of 1927 they were again in debt by the amount of $609,000,000. When the central bank authorities became alarmed in 1928 over the results of their easy credit policy, and attempted to halt the further expansion of credit, it was too late. As rapidly as the Reserve Banks drew credit out of the banking system by the process of selling bills and securities, it was siphoned back in by the banks increasing their own borrowing. By the end of July, 1929, the Reserve Banks had reduced the volume of their open market purchases to $222,000,000, but meantime member banks had increased their borrowings to $1,076,000,000, and when the Reserve authorities began to shake their fingers in warning the head of the largest American bank replied by thumbing his nose and announcing that his institution would continue to support the security markets, and had twenty-five million dollars to lend.

The actual degree to which the gold reserves of the Federal Reserve System were thinned out behind the deposit liabilities at any one time cannot be precisely stated as the gold holdings of the System supported both deposit and note liabilities. On December 31, 1928, when the speculative frenzy was approaching a climax, the gold holdings of the System amounted to only $2,584,232,000 against note liabilities of $1,838,194,000 and total net deposit liabilities of member banks of $33,397,000,000. As the Federal Reserve Act required, as a minimum metallic reserve against notes issued, gold in amount equivalent to 40 per cent of note liabilities, or $735,277,000 at this date, the remaining gold holdings represented a reserve of only slightly over 5.5 per cent of the total commercial deposit liabilities of the System. Actually, of the gold held by the Reserve Banks, $1,307,437,000 had been deposited as security against 222 MONEY AND MAN notes issued, so that the remaining gold held by the Federal Reserve Banks ($1,276,795,000) constituted a reserve of only 3.9 per cent against the total deposits of member banks.

Not all the gold reserves of the country were concentrated in the Federal Reserve Banks, nor, on the other hand, did the Federal Reserve System comprise the total banking power of the country. The greater number of banks were outside the System. In the same year the total demand and time deposit liabilities of all commercial banks and trust companies (but not private banks and savings banks) amounted to a total of $42,900,000,000, and the total monetary gold of the country amounted to $4,109,000,000, or a reserve of 9.6 per cent. IV. The Gushing Rock IT will prove useful to analyze the operations of the Federal Reserve System, not only for an understanding of the Great Crash of 1933, but as a guide to understanding the monetary bankruptcy of the country, made visible in August, 1971, by the suspension of all gold redemption by the United States Treasury. An extraordinary change in the direction of credit had been going on in the preceding decade. Between June 30, 1921, and June 30, 1929, total loans and investments of member banks increased from $24,121,000,000 to $35,711,000,000. Ordinary commercial loans, which traditionally should form the major portion of the assets of deposit banks, fell from one-half to one-third the total. It is a remarkable fact that these loans were actually less in the boom year of 1929 than in the depression year of 1921 in spite of a rise of nearly 80 per cent in industrial production. These loans stood at $12,844,000,000 on June 30, 1921, and at $12,804,000,000, on June 30, 1929.

Meanwhile, during these eight years, the more speculative and less liquid loans on securities and urban real estate together rose nearly eight billion dollars, representing almost threefourths of the total increase in loans and investments during the period. Diversion of credit into these markets had the two-fold THE INFLATIONARY AGE 223 consequence of financing a prolonged and colossal speculation and of loading the banks with the kinds of assets which are particularly difficult to liquidate under conditions of declining prices. From 1922 to 1929, the ratio of loans on securities to total loans and investments of reporting member banks advanced from 25 per cent to somewhat more than 43 per cent; while from 1924 to 1929, the prices of industrial common stocks more than tripled, their index numbers, according to the compilations of the Standard Statistics Company, rising from 65.6 to 216.1 in September, 1929. On September 30, 1929, New York banks and trust companies alone had over seven billion dollars loaned to New York Stock Exchange brokers to finance security speculation.

Not only was bank credit poured freely into the security markets with the result of inflating security prices, but vast amounts of bank credit were used indirectly, through the investment banking system, in the flotation of new issues. During the five years ending 1924, the average annual volume of new capital issues, exclusive of refunding issues and United States Government issues, was $4,280,000,000. During the next five years the average annual volume mounted to $7,730,000,000, and in 1929 over ten billion dollars of new capital was subscribed. The total amount of new money made available to corporations, states and municipal bodies, and to foreign governments and corporations, either by way of shares or loans, was in excess of thirty-eight billion dollars in these five years. In floating these issues the credit facilities of the commercial banks were called into active play. The commercial banker's aid appears at three stages: (a) In periods of a rising or active capital market, corporations desiring to expand their plant or operations frequently obtain shortterm loans from commercial banks against the security of inventory, receivables or other liquid assets, expecting to refund the loans by a capital issue. The bank generally understands the purpose of the shortterm borrowing.

(b) The investment banker who provides the necessary longterm capital to the corporation does so by the purchase of the shares or bonds to be issued. As the investment banker is ordi224 MONEY AND MAN narily possessed of relatively small capital, he calls upon the aid of his correspondent commercial bank. In assuming a commitment, the investment banker relies upon a quick sale of the securities to relieve him of his responsibility. There is, however, a short interval of time in which he must finance his commitment, and in doing so, the credit of the commercial bank is used. The bank advances, usually against the deposit of other securities held by the investment banker, the sum necessary to purchase the issue of stocks, and is repaid upon their sale. (c) The investment banker relieves himself of his obligation by selling the securities to investors, using for this purpose a corps of salesmen and a group of smaller dealers in securities. In a rising market investors buy avidly, frequently beyond their means, and apply to their commercial banker for aid. They purchase the shares or bonds by means of a loan from their banker secured by the deposit of the purchased securities. If the investor buys through a broker "on margin" the broker, in turn, carries the securities through the aid of a bank loan. Thus the vicious circle.

Not only did the commercial banks assist the process of security speculation by financing the investment banker and the pseudo-investor, but they purchased large blocks of bonds outright. The prospects of high yields and large profits from the turnover of investments filled the portfolios of banks with many high coupon bonds of foreign governments and corporations and with second, third and fourth grade bonds of American companies and municipalities. Between 1921 and 1929, member banks' holdings of securities, aside from United States Government securities, increased from $3,507,000,000 to $5,921,000,000. The result was to convert many a bank from the status of a commercial credit institution to that of an investment company. The unsoundness of this process became apparent later when banks had to liquidate these holdings on a falling market. It was a policy of borrowing at short term (using deposits which are payable on demand) and lending at long term (for bond holdings despite the fact that they are marketTHE INFLATIONARY AGE 225 able, are loans at long term) which the banks would never have tolerated on the part of their commercial customers.

A second outlet for the excessive credit created by the banking system was in financing an urban real estate boom. During the decade 1920-1930, people were moving in a constant stream into the cities; the population of the sixty-three metropolitan zones (cities of 100,000 or more plus adjacent counties) rose from 46,491,000 to 59,118,000, or from 44 per cent of total population to 48 per cent. Seventy-four per cent of the increase in total population during the decade occurred in the metropolitan areas. A huge building boom followed, the Federal Reserve Board index of building contracts awarded, 1923-1925 taken as 100, rising from 63 in 1920 to 122 in 1925, and 135 in 1928. This boom occurred chiefly in skyscraper offices and expensive apartment house developments, whose notes were more readily marketable, rather than in the modest single family accommodations. The result was that when the era had passed the slums still existed, like rats' nests around the whitened skeletons of downtown mastodons.

Until 1927, national banks were limited in their real estate loans to amounts no greater than 25 per cent of their paid-in capital and unimpaired surplus or one-third of their time deposits; nor could they make loans on improved real estate for more than one year. In 1927, in response to demand for liberalization of these requirements, the MacFadden Act was passed permitting the making of real estate loans to 25 per cent of paid-in capital and unimpaired surplus or one-half of time deposits. In addition, banks could now extend loans to a maximum of five years. By 1929, member bank loans against real estate, other than farm land, amounted to $2,760,000,000, against $875,000,000 in 1921, but the growth of bank credit on real estate is not fully indicated by these figures. There is reason to believe that a considerable and increasing proportion of the "commercial" loans made by banks in this period were directly or indirectly loans on 226 MONEY AND MAN real estate. The tremendous urban and suburban developments, begun and completed in this decade, and the continued rise in the assessed valuation of real property, coupled with the large real estate holdings of banks convinced the President's Research Committee on Social Trends "of the magnitude of speculative enterprise in real estate and of the important role which banking credit played in its unfolding."1 Two other important groups of borrowers appeared at the sylvan pool of credit during this decade, ready to draw off purchasing power as rapidly as it was replenished from the copious springs of the banking system. From the end of World War I down to the end of 1929, over nine billion dollars was lent abroad, the movement reaching its peak in the four years 19251928, when nearly $4,80,000,000 in foreign government and corporation issues were floated in the New York market. This money was provided, through investment banking channels, by private investors, but the movement was stimulated greatly by the assistance of the commercial banks. While much of this money was invested more wisely than is generally thought, it is true that sums were provided for all sorts of unwise purposes, from financing reparations payments (in Germany) to building battleships (in Chile) and removing a mountain (in Rio de Janeiro). By 1931, a nominal amount of $2,383,000,000 invested in South America had suffered a market depreciation of over 80 per cent; $1,793,000,000 European government loans had declined 43 per cent2; and by March, 1934, approximately $2,930,000,000 foreign loans were in default.3 At home, consumers had discovered the ease of going into debt for automobiles, radios, furniture and groceries, but after the enactment of the Federal Reserve System, the use of credit grew at an astounding rate. In 1910, of total retail sales of twenty billion dollars, approximately 10 per cent are estimated to have been made on credit. By 1929, half the sixty billion dollars of retail sales in that year were credit transactions, and of the thirty billion dollars worth of goods sold on credit in that year, some seven billion dollars were sold on instalments.4 Sales made on THE INFLATIONARY AGE 227 open account were financed by the store itself, generally by resources supplied by the commercial banks; sales made on instalments were financed through instalment finance companies which in turn discounted a large part of their paper at the banks.

Thus, so effective had been the smiting of the rock that by 1929 the United States was overwhelmed by a flood of credit. It had covered the land. It was pouring into every nook and cranny of the national economy. Flimsy structures of business— the speculative and trading element—it carried away on the crest of the wave, while those of a more substantial and conservative sort it either submerged or destroyed by undermining their foundations. V. Disintegration Abroad ABROAD, as in America, money systems were being dissolved by the new inflation. In England, where the use of the bank check had undergone a similar, though perhaps not so extensive, expansion as here, the inflation occurred in the field of deposit credit. In Europe, where the bank check was more restricted, government money was watered by an infiltration of commercial and government credit through the note issue device. Less developed countries, South American particularly, were taught by American "money doctors" the use of commercial credit as a means of note issue expansion, and "Federal Reserve" systems, in imitation of the American, were grafted, in all their complexity, upon their rude and unprepared economy. Frequently, loans were floated in the American market to hasten the process.

Everywhere, from the turn of the century on, banking and credit became the fetish of statesmen, the manna of an errant civilization wandering in the desert of monetary illusion. In England, the hegemony of credit gradually became centered in the Bank of England. Although it had never enjoyed the preferred legal status conferred upon the Federal Reserve 228 MONEY AND MAN Banks, it had become in fact the "bankers' bank" of England, and the final reserve for the banking power of the country, with more actual authority and influence than the Federal Reserve Banks ever achieved. Below it were the great jointstock banks, eighteen in number, organized upon the basis of head offices and branches, which dominated the avenues of commercial credit. Of these eighteen, five controlled between 80 and 85 per cent of the deposit credit of the country.* The jointstock banks carried their banking reserves as deposits with the Bank of England.

Up to the outbreak of World War I, the Bank of England note was almost the exclusive paper currency in circulation, and, as we have noted, it could be increased only by the deposit of equivalent amounts of gold. In July, 1914, Bank of England note and deposit liabilities amounted to £97,900,000 against which the gold reserve amounted to £38,600,000, a ratio slightly less than 40 per cent. Notes issued amounted to £29,700,000.1 On the outbreak of war, a run occurred on the bank, and by August 5 the gold reserve had dropped to £26,000,000. Again convertibility was suspended. The British government, like the other participants in the war, like the Federal Government during the Civil War, was reluctant to finance military expenditures by taxation—a method which would have brought the war home to the masses too quickly—and currency inflation was adopted. Instead of outright fiat money, however, which would have shaken confidence, the specious device was adopted of a quasiindependent authority, the Currency Redemption Fund, which issued notes secured by non-interest bearing government securities and a meager amount of gold. By the end of the war, there were £323,400,000 currency notes in issue as against £70,200,000 notes of the Bank of England. The gold behind the currency notes was never more than 10 per cent of the amount issued.2 At the same time the note and deposit liabilities of the Bank of England rose to £311,400,000 against gold reserves of £80,000,000, a ratio of less than 26 per cent.

* The "Big Five" (Midland Bank, Lloyds Bank, Barclays Bank, Westminster Bank, and National Provincial Bank).

THE INFLATIONARY AGE 229 Resumption of gold payments was undertaken in 1925, but the credit structure had become too inflated for the most heroic efforts to sustain, and in September, 1931, England went off the free gold standard. As W. A. Shaw pointed out in prophetic words a year before that event occurred, the banking system of England was working "to the full limit of its capacity." "For," he said, "the condition of British industry is so perilous, and has now been such for so long a time, that the banks are loaded up with worthless industrial securities, both paper and plant."3 The inability of England to support the gold standard, after resumption of gold payments in 1925, may be enlightened by an examination of the banking position in that year. Total demand liabilities of the Big Five jointstock banks amounted to £1,513,935,000, supported by reserves of cash or balances with the Bank of England of only £198,824,000, a ratio of only 13.1 per cent. To support this amount of bank credit, the total gold stock of England at the same date was only £146,325,000, of which £142,764,000 was held by the Bank of England. This was a reserve of only 9.7 per cent gold against the commercial banking liabilities of the country on the books of the Big Five.

British banking is frequently held up for admiration because no internal runs have occurred on the banks, but this overlooks a vital point. A run did occur. Runs on banks, like plagues, are of uncertain origin. In the case of England in 1931, the run started from abroad—slow at first but panicky later, when the Bank of France began to call its London deposits. London, as the international banker, should have been prepared for an attack from this quarter, but when it appeared, it was found to be one of the foolish virgins. The trouble, of course, was that England had attempted to return to the pre-war parity of the pound, a gold unit of value upon which a vast, unmanageable structure of credit had been erected. The sterling value of this mass of debt should have been written down by a currency devaluation—a course which the English, very properly, regarded with horror—or it should have been reduced by an internal deflation. Neither was done.

230 MONEY AND MAN In Europe, the methods of war finance adopted brought universal inflation. We need not recount its familiar history in Russia, in Germany, where the mark reached finally onetrillionth of its pre-war value, in France and elsewhere, for it is but the story of the Roman emperors and the medieval princes which we have already told. What is of more concern at the moment is the method taken to restore the gold standard. This was the deceptive "gold exchange standard"—one of the Class A exhibits of the delusion of credit, and the sophistry of the phrase "economy in the use of gold." The gold exchange standard emerged as one of the recommendations of a European conference held in Genoa, Italy, in 1922. It was presented as a device to "economize gold." Under the gold exchange standard, in lieu of gold, central banks may count as reserves against notes or deposits current deposits in banks in countries on a free gold standard, or foreign exchange payable in gold currencies. Nominally, this achieved economy in the use of gold, since a given amount of credit could be supported by a smaller base of gold. Actually it meant a further pyramiding of credit. Let us see how it worked in the period 1925-1929, taking for illustration the system used in Austria.

An Austrian corporation has issued a longterm loan in New York, the net proceeds of which are $1,000,000. The corporation, which needs schillings, has sold the proceeds of the loan to a Viennese bank. The latter in turn has sold the credit with the banks in New York to the Austrian national bank. As the New York bank deposit is nominally convertible into gold, the process has increased the "metallic" reserve of the latter, and enabled it to increase its notes in circulation or demand deposits by about $3,000,000 or about 21,000,000 schillings, assuming a reserve ratio of 33.33 per cent (the legal requirement was actually lower). As these notes or deposits were in turn reserves for the commercial banks, commercial credit of three or four times this amount could be created. The loan to the Austrian corporation of $1,000,000 resulted in an equal increase in deposits on the books of the New York bank with which the proceeds of the loan were deposited.

Against this deposit the New York bank had to maintain a reTHE INFLATIONARY AGE 23 1 serve with the Federal Reserve Bank of 13 per cent, or $130,000. The latter in turn was required to maintain a reserve of 35 per cent against its deposits, or $45,500. Thus, under the gold exchange standard system, against an actual gold reserve of less than $50,000 in the Federal Reserve Bank of New York, a central bank operating on the gold exchange standard was able to increase its notes in circulation or demand deposits by about $3,000,000, upon which, in turn, the commercial banks could build a deposit credit structure of $10,000,000 to $12,000,000.4 Here, then, was inflation with a vengeance, all the more vicious because the mechanism was so complex that the ordinary man did not comprehend it, and consequently accepted it blindly. If money is intrinsic, and deposits are to be really representative of actual money left with bankers, then it is legerdemain and duplicity of the rankest sort continually to reduce the amount of money available to meet calls from depositors. If, however, money is purely conventional, then there is no need whatsoever of gold reserves, and it is fraud practiced upon the public to lead it to believe that money is intrinsic and supported by gold.

VI. Reaping the Whirlwind THE events beginning in 1929 and culminating in the bank closures and economic debacle of 1933 revealed, for all to see, the consequences that can befall a country that allows itself to fall under captivation by the money mechanism: a collapse of enterprise; corrosive unemployment; want in the midst of plenty; and spread of idleness, misery, and despair—all leading to political innovation, acceptance of the totalitarian state, national paranoia, military venture, madness, and the holocaust of another world war. During the interval between the two world wars, the course of inflation, temporarily halted, resumed through the use of bank credit, and in frantic efforts to support this expansive growth, a world scramble for gold reserves began.

232 MONEY AND MAN Despite an extraordinary activity in gold mining, particularly in South Africa, that doubled annual production in two decades, from 20 million ounces annually to nearly 40 million annually in 1939, a gold famine prevailed. The trouble was that no amount of gold would have sufficed, for as rapidly as it was added to the stores of the central banks, new bank credit was created. By the beginning of 1929, four countries—the United States, France, the United Kingdom, and Germany—had increased their gold holdings by 2.4 times over pre-war, and held 59 per cent of world gold reserves as against 49 per cent at the end of 1913. In 1929, the ratio of cash to total bank deposits in these countries stood as follows: United Kingdom, 11.3 per cent; France, 7.4 per cent; United States, 7.3 per cent; Germany 3.1 per cent.1 Thus, while lesser countries were trying to lay hold of gold by the deceptive device of borrowing it, or multiplying its effectiveness by the gold exchange standard, the greater, by the manipulation of discount rates and the application of tariff barriers, were effectively retaining, and adding to, their existing supplies.

When American investors began to grow wary of the tremendous amounts of foreign borrowing in New York, and the bond market suddenly broke in May, 1928, one stimulus to artificial gold movements was removed, and in the lesser countries the pinch of gold shortage began to grow acute. In England, in August of the following year, a group of speculative enterprises built up by a promoter by the name of Clarence Hatry suddenly collapsed when Mr. Hatry was caught in defalcations and sent to prison. Investors began to sell to realize cash, and American securities held in England began to be offered on the New York Stock Exchange. In New York, speculation had gone so far that it took only a pin prick to rupture the bubble, and in October a crash occurred which rocked the world. On October 24, no fewer than 12,894,650 shares were sold on the New York Stock Exchange amid scenes of wild panic. Values of prime stocks broke in half, and men, broken in spirit, committed suicide in the streets. Over a billion shares changed hands during that fateful year—a record not approached in the following thirty THE INFLATIONARY AGE 233 years. Leading banking houses formed an emergency pool to stem the tide, but in vain. On October 29, the market sank in a new collapse, with 16,410,030 shares being sold, a gigantic figure for that period. At the end of the first year of the crash, an aggregate deflation of $40,000,000,000 in the value of New York Stock Exchange securities had resulted.

But the stock exchange collapse was but the splendid conflagration that marked the close of an era. A gnawing flame had for years been creeping through the withered dry grass of banking. Its toll is to be read in the record of bank failures during the dazzling decade of the twenties. Bank failures reached 900 a year compared with 85 a year the preceding decade. When it is realized that each bank represents a community of depositors, whose business and homes and personal security are often entirely dependent upon the safety of their funds, and that the effect of the bank failures represented, in effect, the destruction of the economic life of 5,642 separate communities, the bitter blight of suspensions can be more clearly visualized. It was a situation which not the strongest nation could long endure. The stock exchange collapse revealed to the world the whole flimsy character of the financial situation, and as the eyes of men widened in distrust and suspicion, the debacle spread. In the United States, banks began to suspend in increasing number— 1,352 in 1930 and 2,294 in 1931—trade dried up, and commercial failures increased. Huge industrial combinations began to disintegrate. Ivar Kreuger, whose Swedish Match Company had been banker to governments, committed suicide as his paper towers fell to pieces. Samuel Insull, czar of a utility empire, fled from his domain as the law cried vengeance.

Abroad, the gold standard was everywhere falling. In the spring of 1931, the principal commercial bank of Austria—the Credit-Anstalt—failed. This involved Germany, and in July President Hoover proposed his famous moratorium on reparations payments. This was extended to private payments, under 234 MONEY AND MAN the "stand-still" agreements. But England was now involved, because of its inability to withdraw its German credits, and when a run on British gold began from abroad, it was too weak to survive. The suspension of gold payments by the Bank of England in September, 1931, was a world catastrophe, and by July, 1933, of the major countries of the world only Belgium, Switzerland, France, The Netherlands, Italy, and Poland could be classified as on the gold standard. * Efforts made in this country to deal with the situation that had developed were futile for the simple fact that the only remedy applied was the same old nostrum—more credit. The Federal Reserve Banks, in the hope of breathing a new life into the exhausted spirit of credit, had by May, 1931, reduced the discount rate to 1.5 per cent (in New York) and were flooding the market with reserve credit by open market purchases. During the early years of the depression, the problem was still one of banking—technical insolvency due to a drop in the value of investments and actual insolvency due to an inability to liquidate loans and investments. The government currency was still unquestioned. To aid the banks, the banking and currency laws were relaxed by a series of measures.! Early in 1932 (January 22) a huge lending corporation, the Reconstruction Finance Corporation, was created with a credit power of $2,000,000,000 supplied by the United States Treasury, to bolster the credit structure of the country by loans to embarrassed banks, insurance and other financial companies, to railroads, to states and * Albania, Lithuania, Danzig, and the Dutch East Indies were also on the gold standard.

t (a) Banks were permitted to value investments at prices above the market value; (b) the privilege of issuing national bank notes against government securities was expanded (Act of July 27, 1932); (c) loans by banks to veterans against adjusted service certificates were made eligible for rediscount with Federal Reserve Banks (Act of July 21, 1932). This was a violation of Federal Reserve theory, which held that Federal Reserve credit should be created only to finance short term commercial transactions.