The Roaring Twenties was the decade of conspicuous consumption. Urbanites experienced levels of material prosperity which was unprecedented while American farmers struggled for survival. While the two developments may at first seem unrelated, both derive from a common source: inflationary central banking policies. Beginning with a financial injection in 1922, two more in 1924, 1927, the Federal Reserve attempted to stabilize the dollar at prewar par with the British pound. The injections came in the form of security purchases on the open market. Consequently, the availability of credit increased. The Federal Reserve was already in the habit of increasing liquidity during harvest season, so most of the new loans were given to the growing business sector either directly, or indirectly through loans to speculators. While the farming sector’s income decreased due to the postwar depression of 1920-21, it faced increased operating costs – eg., for workers and resources – due to the credit fueled competition of business and industry. In short, urban areas prospered while rural areas suffered. By the end of the decade, however, both sectors were impacted by defaults and the credit contraction as the chimera of easy money gave way to the reality of limited resources. Thus, the Federal Reserve’s irresponsible inflationary policy simultaneously drove conspicuous consumption and rural poverty, creating an unsustainable economic climate whose collapse was inevitable.
Since the Civil War the banking in the United States became more and more centralized. During the Gilded Era, business interests pushed for the establishment of a central bank akin to those found in Europe. The preceding century had witnessed political tumult over the issue as the early United States established a charter for a central bank which was then revoked under Andrew Jackson as his fait accompli. The consolidation of political and economic power during and after the Civil War allowed a revival of the issue. The powerful banker Jay Cooke, in collaboration with Secretary of Treasury Salmon P. Chase and Senator John Sherman helped establish the National Banking Act.[1] It allowed successful private banks, by the blessing of government charters, to act together as a central banking cartel. Smaller were allowed to deposit 60% of their required reserves in demand deposit accounts at reserve city banks. In a similar manner, the reserve city banks were then allowed to deposit 50% of their required reserves at New York City banks.[2] The system allowed for a massive expansion of money substitutes, eg., unbacked bank notes. In the short term, beneficiaries of such a system are those who receive the new currency first: banks and debtors who receive the new loans.[3] While these groups saw national banking as an improvement over Jacksonian era “free banking,” it lacked the precision of a true central banking system.
A more centralized system took form in 1900 with the passage of the Gold Standard Act, and in 1913with the establishment of the Federal Reserve. The Gold Standard Act moved the U.S. away from a bimetal standard where the value of gold in terms of silver was legally established at a fixed ratio. Before the passage of the act, Americans exchanged dollars for either gold or silver. After, dollars were only exchangeable for gold. Consequently, gold currency was centralized as it flowed into banks. F. W. Taussig of Harvard University explained that in lieu of silver currency, “paper is desired for convenience of use by persons having gold on their hands.”[4] This also had the side effect of increasing the power of the U.S. Treasury which increased the circulation of dollars as gold flowed into its vaults. It was then empowered to intervene into the economy. Beginning in 1903 the Secretary of Treasury, Leslie Shaw, began to use excess reserve to expand the money supply by making purchases on the open market. The Treasury’s attempt to act as a central bank failed miserably as its funds were limited. It was unable to act as a lender of last resort and it could not significantly influence the decisions of U.S. banks. This weakness was made clear with the panic of 1907 and the stage was set for the establishment of the Federal Reserve.[5]
After an intense propaganda campaign which purported that the panic of 1907 occurred mainly because of a lack of liquidity, influential bankers and politicians met at Jekyll Island to lay the foundation for the Federal Reserve Act of 1913. Attendees included Senator Aldrich and powerful business interests “Henry P. Davidson, Morgan Partner; Paul Warburg, Kuhn Loeb partner; Frank A. Vanderlip, vice-president of Rockefeller’s National City Bank of New York; Charles D. Norton, president of Morgan’s First National Bank of New York; and Professor A. Piatt Andrew, head of the NMC… [and] Assistant Secretary of the Treasury under Taft.”[6] Each of the attendees were, as bankers and politicians, in a position to benefit, at the expense of others holders of dollars, from the future Federal Reserve’s ability to expand the money supply and act as lender of last resort. The act which resulted formed a central bank whose mandate was:
To furnish and elastic currency, to afford means of rediscounting commercial paper, to establish a more elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes. [7]
In other words, it was given the means to increase the volume of currency and to cartelize the nation’s banks. The Federal Reserve soon employed these powers.
The Federal Reserve began operation in 1914 just as World War I began, however it did not engage in major economic intervention until 1917 when the U.S. joined the war. At that time, the Federal Reserve benefited from new reserve policies that lowered reserve requirements for member banks, reserve city banks, and country banks, forced member banks to hold their gold on deposits at the Federal Reserve, and allowed the Federal Reserve to issue notes against commercial paper as long as gold holdings amounted to 40% of its reserves.[8] The Federal Reserve’s new policies, along with inflationary policies of European governments and central banks, helped fuel the war efforts and increase demand for food stuffs. Farm profits rose, but operating costs rose as well. The Federal Reserve continued its policy of loose credit for more than a year after the armistice of November 11, 1918. The problem grew worse. A boom psychology had set in and was fostered by artificially low interest rates after the war. Federal Reserve Board member A. C. Miller wrote in hindsight:
Dealers, both wholesale and retail, were bidding against one another for such supplies as there were, and manufacturers were bidding against one another for raw materials and labor. The rapid rise of prices induced buying for speculation, and speculation in its turn accelerated the rise of prices. Inflation was becoming cumulative and systemic in its effects, and pervading the whole body economic.[9]
The cause of the imbalance was an artificially low discount rate which persisted after wartime price controls were lifted. Postwar malinvestment could have been minimized “if the federal reserve system [sic] had functioned as effectively in 1919 in regulating credit as it did in 1920 in retarding and eventually arresting expansion.”[10] Austere measures arrived tardily in 1920, and with them, the beginning of hardship for farmers.
In 1920 the Federal Reserve finally raised the discount rate on commercial paper from 4.75% to 6%. The speculative bubble in agriculture quickly deflated as both crop and land values lost nearly 50% of their value as measured from their peak.[12] The depression of 1920-21 impacted farmers more than any other group in the country. Operating costs rose dramatically between 1916 and 1920, and they remained high even after the Federal Reserve raised the discount rate. While crop prices had begun falling after 1919 due largely to increased production, farmer demand for a limited supply of production goods – eg., tractors and other farming equipment – did not decrease. Economic readjustment proved painful for farmers. Their plight worsened throughout the 1920s due to Federal Reserve policy that favored American business and finance over American farmers.
The Federal Reserve began to engage in major open market operations in 1922. In other words they increased the money supply by purchasing assets, usually government securities, on the open market. Between July 1921 and December 1922 it purchased $510 million in bills and securities.[13] These open market purchases by the Federal Reserve lowered interest rates as they satiated demand for money. Capital thus flowed into areas of the economy which otherwise would have remained unfunded. The purchases of 1922 were in part an experiment, but the expectations of Federal Reserve officials were clear; lower interest rates were to help “facilitate business improvement.”[14] Pleased with its results, the Federal Reserve followed up with two more major open market purchases: one in 1924 and another in 1927. The Federal Reserve’s loose credit policy helped the business sector recover, but that recovery outpaced and even inhibited recovery in the farming sector.
Much of the increased funds from the first two open market purchases flowed into time deposit accounts. Reserve requirements for time deposits were only 3% and therefore held a greater potential to increase the total volume of currency than money placed in demand deposit accounts.[16] Consequently, bank loans increased as both time and demand deposit holdings increased. At first businesses and consumers took out many of these loans, but after 1925 speculators in real estate, stocks, and securities. Much of the excess capital then made its way to the business sector through increased investment and consumption.
Though not the cause of imbalance, the expansion of credit installment plans to consumers was indicative of the growing economic imbalance and set the precedent for business growth throughout the 1920s. Though many debate the influence of installment credit in the buildup to the crash of 1929, increased consumer dependency on these plans is clear. Between 1920 and 1929, aggregate consumer debt more than doubled in nominal terms. The story is more precarious for specific industries. The number of refrigerators produced increased by 4500% in the same time period, due largely to consumer credit.[18] Though not fully responsible for imbalance, installment credit definitely encouraged a psychology of overconsumption to which businesses reacted with expansion.
In addition to consumer credit, profits from speculation in property also resulted in business gains. Just like loans to consumers, real estate mortgages showed a large increase during the 1920s. Between 1918 and 1927, banks holdings of mortgages securities increased from $460 million to $3 billion.[20] As money flowed into the real estate market, land values increased and speculators earned profits. This phenomenon did not remain isolated from the rest of the economy. Benjamin Anderson, economist for Chase National Bank between 1920 and 1939 observed, “A very considerable part of the supposed income of the people which was sustaining our retail and other markets was coming from …capital gains on stocks, bonds, and real estate.”[21] Business growth and speculative profits gave the impression that many companies were more valuable than they actually were and the foundation was laid for the stock boom of the late twenties.
The greatest part of the boom in stocks occurred with the Federal Reserve’s third major open market purchase in mid-1927. By this time, the market for time deposits was satiated, and real estate was less attractive than it had been during the decade. The new money flowed into the stock market and the resultant strong gains worried the Federal Reserve. In 1928 the Federal Reserve attempted to tighten credit, but the situation was beyond its control. As interest rates rose, member banks simply withdrew their deposits from the Federal Reserve and provided more loans at high rates of interest to market speculators.[23] Five years of easy credit, exacerbated by the money multiplication inherent in fractional-reserve made impossible a successful reversal in the short time period required by the Federal Reserve. Between 1927 and 1929, the major stock indices nearly doubled. Historian John Kenneth Galbraith argues that the speculative boom in stocks and Federal Reserve policy were not directly related, but the investment statistics
throughout the decade make his claim dubious at best. [25] Loose credit spawned conspicuous consumption and speculative booms in both real estate and stocks which brought substantial short term gains to those involved. For many, however, loose credit from the Federal Reserve brought only burden.
Farmers faced increasing economic hardship throughout the 1920s. Mortgage foreclosure swelled after the depression of 1920-21 and a large number of bank failures followed. During 1928 nearly 1.8% of American farms were foreclosed upon and between 1921-1928, nearly 4700 banks, most of them rural banks, had fallen into bankruptcy. [26] The situation did not improve for farmers who persisted to the end of the decade:
[By 1929] outstanding debt had fallen by a total of 2.4 billion current dollars while, according to Raymond Goldsmith, foreclosures had wiped out 2.8 billion of debt. Thus farmers who had managed to stay in business were heavily indebted. [27]
Farmers never truly recovered from the postwar fall in crop prices and property values. Their financial problems from the beginning of the decade were instead exacerbated by the Federal Reserve’s monetary policy.
While business and industry experienced a boom dependent on easy credit, the price of agricultural goods remained stagnant and high operating costs forced farmers to operate at a loss.
Business and industry in the cities acted as a strong pull force for rural workers – so strong that over 3,000,000 rural workers moved to the city during the 1920s. [29] Farmer wages were depressed while wages in industrial jobs offered workers higher wages. Professor Gene Smiley notes that farm wages “fell after the recovery from the 1920-1921 depression” while “real average weekly earnings for unskilled males rose 8.7 percent between 1923 and 1929."[30] The farmers were unable to compete with business and industrial sectors backed by the Federal Reserve inflationary monetary policy. Their losses grew as industrial production reached record highs – production increased from 67 in 1921 to 111 in 1928 (1923-25=100). The Federal Reserve had neglected the farmers in favor of business men, industrialists, and financiers.
Historians and other academics must confront the reality that the Federal Reserve was not – and still is not – a benevolent or disinterested force. From its founding, powerful individuals held heavy sway over members of the Federal Reserve Board. Economist and historian, Murray Rothbard, revealed the ties between big business, government, and the Federal Reserve:
The Federal Reserve, in its first two decades, contained two loci of power: the main one was the head, then called the governor, of the Federal Reserve Bank of New York; of lesser importance was the Federal Reserve Board in Washington. The governor of the New York Fed…was Benjamin Strong, who had spent his entire working life in the Morgan ambit.[32]
Other affiliates of the House of Morgan included U.S. financial advisor and supporter of fascism Thomas W. Lamont, friend to Calvin Coolidge and later U.S. ambassador Dwight Morrow, and Secretary of Treasury under Wilson, William Gibbs McAdoo. Additionally, Rockefeller associates held a majority on the Federal Reserve Board.[33]
Though Morgan and Rockefeller interests were often opposed, individuals in both parties sought to foster the growth of business and personal gain. Morgan control over the Federal Reserve in its early years was used to aid such interests:
The Morgans played a substantial role in bringing the United States into the war on Britain’s side, and, as head of the Fed, Benjamin Strong obligingly doubled the money supply to finance America’s role in the war effort. After the end of the war, Strong’s monetary policy was deliberately guided by the prime objective…to restore “England” – which really meant the Morgans’ English associates and allies – to her old position of financial dominance by helping her establish a phony gold standard.[34]
This tie with England was one major factor in the Federal Reserve’s final inflationary push in 1927. Governor Strong and Governor Norman , in an attempt to reverse the gold outflow from England, initiated the final round of open market purchases.[35] The self-interest of Federal Reserve members impeded any policies that may have supported general economic stability. Instead, policies that reflected that self-interest produced massive misallocation of resources, conspicuous consumption, and rural poverty.
Government institutions are no better than the individuals that comprise them. The same is true for the quasi-governmental Federal Reserve. Unopposed due to widespread political and economic ignorance, its members, guided by narrowly tailored self-interest, steered the U.S. economy into the Great Depression. The unintended consequences of their actions destroyed the livelihood of many individuals – first of farmers, then those of all classes. If any future academic work regarding the Great Depression is to benefit society, it must transcend the assumption of benevolent government and account for policies influenced by the self-interest of officials involved. Only then can they properly identify and eventually eradicate the injustice inherent in their political and economic institutions.
Bibliography
Anderson, Benjamin M. Economics and the Public Welfare. Indianapolis, IN: Liberty Press, [1949] 1979.
Eckler, A. Ross. “Recent Expansion of Bank Credit.” Review of Economics and Statistics 11, no 1 (February 1929): 46.
Federico, Giovanni. "Not Guilty? Agriculture in the 1920s and the Great Depression."
Journal of Economic History 65, no. 4 (December 2005): 949-976.
Galbraith, John Kenneth. The Great Crash: 1929. New York: Houghton Mifflin Company, [1954] 1997.
Hacker, Louis M. Major Documents in American Economic History, Volume II. New York: D. Van Nostrand Company, Inc, 1963.
Harris, S.E.. Twenty Years of Federal Reserve Policy. Cambridge, MA: Harvard University Press, 1933.
Hüllsmann, Jörg G.. The Ethics of Money Production. Auburn, AL: Ludwig von Mises Institute, 2008.
Miller, A. C. “Federal Reserve Policy.” The American Economic Review 11, no 2 (June 1921): 177-206.
Olney, Martha L. “Avoiding Default: The Role of Consumer Credit in the Consumption Collapse of 1930.” The Quarterly Journal of Economics 114, no 1 (February 1999): 319-335.
Persons, Charles E. “Credit Expansion, 1920 to 1929, and its Lessons.” The Quarterly Journal of Economics 45, no 1 (November 1930): 94-130.
Rothbard, Murray. America’s Great Depression. Auburn, AL: Ludwig von Mises Institute, [1963] 2000.
------ A History of Money and Banking in the United. Auburn, AL: Ludwig von Mises Institute, [2002] 2005.
------ The Case Against the Fed. Auburn, AL: Ludwig von Mises Institute, [1994] 2007
Smiley, Gene. "The U.S. Economy in the 1920s." Economic History Services (accessed November 30, 2010), http://eh.net/encyclopedia/article/Smiley.1920s.final.
Taussig, F. W. “The Currency Act of 1900.” The Quarterly Journal of Economics 14, no 3 (May 1900): 394-415.
[1] Murray Rothbard, “A History of Money and Banking Before the Twentieth Century,” in A History of Money and Banking in the United States: The Colonial Era to World War II (Auburn, AL: Ludwig von Mises Institute, [2002] 2005), 132-135.
[2] Ibid., 136-138.
[3] “Invariably it [inflation] produces three characteristic consequences: (1) it benefits the perperators at the expense of all other money users; (2) it allows the accumulation of debt beyond the level debts could reach on the free market; and (3) it reduces PPM [the purchasing power of money] below the level it would have reached on the free market.” Jörg G Hüllsmann, The Ethics of Money Production (Auburn, AL: Ludwig von Mises Institute, 2008), 175.
[4] F. W. Taussig, “The Currency Act of 1900,” The Quarterly Journal of Economics 14, no 3 (May 1900): 402.
[5] Murray Rothbard, “The Origins of the Federal Reserve,” in A History of Money and Banking in the United States, 202-208.
[6] Murray Rothbard, The Case Against the Fed (Ludwig von Mises Institute, [1994] 2007, 116.
[7] The Federal Reserve Act of December 23, 1913 in Major Documents in American Economic History, Volume II, ed. Louis M. Hacker (New York: D. Van Nostrand Company, Inc, 1963), 31.
[8] Benjamin M. Anderson, Economics and the Public Welfare (Indianapolis, IN: Liberty Press, [1949] 1979), 57.
[9] A. C. Miller, “Federal Reserve Policy,” The American Economic Review 11 no 2 (June 1921): 187.
[10] Ibid., 188.
[11] “Farm Issue Moves Toward a Climax,” New York Times, 2 Jan 1927 p. 140
[12] “Wallace Calls to Aid the Farmer,” 13 Mar 1921, p. 10; Commodities graph of WWI era. Giovanni Federico, “Not Guilty? Agriculture in the 1920s and the Great Depression,” Journal of Economic History 65, no 4 (December 2005): 957.
[13] See Rothbard’s chart. Murray Rothbard, America’s Great Depression (Auburn, AL: Ludwig von Mises Institute, [1963] 2008), 109.
[14] Benjamin Strong quoted in Murray Rothbard, “The Gold Exchange Standard in the Interwar Years,” in A History of Money and Banking in the United States, 375.
[15] Murray Rothbard, America’s Great Depression, 92.
[16] Ibid., 99.
[17] A. Ross Eckler, “Recent Expansion of Bank Credit,” Review of Economics and Statistics 11, no 1 (February 1929): 46.
[18] 75% of the money used to purchase these goods came from consumer credit. Charles E Persons, “Credit Expansion, 1920 to 1929, and its Lessons,” The Quarterly Journal of Economics 45, no 1 (November 1930): 112.
[19] Only 1919 to 1929 shown for simplicity. Martha L. Olney, “Avoiding Default: The Role of Consumer Credit in the Consumption Collapse of 1930,” The Quarterly Journal of Economics 114, no 1 (February 1999): 321.
[20] Benjamin M. Anderson, Economics and the Public Welfare, 182.
[21] Ibid., 186-187.
[22] Figure 25: Standard and Poor’s Common Stock Price Index, 1920 to 1930. Gene Smiley, “The U.S. Economy,” Economic History Services (Accessed November 30, 2010) http://eh.net/encyclopedia/article/Smiley.1920s.final
[23] According to Harris, the Federal Reserve’s move failed because it could not stick to its decision. The Reserve did not want to tighten the money supply and cause a recession in business. Harris, S.E., Twenty Years of Federal Reserve Policy, Harvard Economic Studies, vol. XLI (Cambridge, MA: Harvard University Press, 1933), 526.
[24] Anderson, Economics and the Public Welfare, 202.
[25] John Kenneth Galbraith, The Great Crash: 1929 (New York: Houghton Mifflin Company, [1954] 1997), 10-11.
[26]Wilson administration saw 578 bank failures while Coolidge’s administration witnessed over 4700 bank failures. “Calls Coolidge Novelist” New York Times 18 Oct 1928, p. 13.
[27] Federico, “Not Guilty? Agriculture in the 1920s and the Great Depression,” 966.
[28] Figure 8: Farm Foreclosure Rate, 1920 to 1930. Gene Smiley, “The U.S. Economy.”
[29] “The Farmer’s Revolt,” New York Times 30Sep 1925, p. 140.
[30] Gene Smiley, “The U.S. Economy.”
[31] Agricultural prices never recovered above 1917 values. Federico, “Not Guilty? Agriculture in the 1920s and the Great Depression,” 954.
[32] Murray Rothbard, “The Federal Reserve and Financial Elites,” A History of Money and Banking in the United States, 264.
[33] “But the Morgans not only had by far the most powerful Federal Reserve banker, Benjamin Strong, in their corner, they also had the Republican administrations of the 1920s. Although there were various groups around President Warren G. Harding, as an Ohio Republican he was closest to the Rockefellers, and his secretary of state, Charles Evans Hughes, was a mentor of John D. Rockefeller, Jr.’s, New York Bible class, a leading Standard Oil attorney, and a trustee of the Rockefeller Foundation. Harding’s sudden death in August 1923, however, unexpectedly elevated Vice President Calvin Coolidge to the presidency. Coolidge has been misleadingly described as a colorless small-town Massachusetts attorney. Actually, the new president was a member of a prominent Boston financial family, who were board members of leading Boston banks. One, T. Jefferson Coolidge, became prominent in the Morgan-affiliated United Fruit Company of Boston.” Ibid., 264-265.
[34] Ibid., 270.
[35] Anderson, Economics and the Public Welfare, 189-190.
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