Samuel Toro
POS 1001
Professor Harris

The Fed Throughout history, many great nations have risen and fallen. Their policies, laws, and culture dictate whether a nation will fall or flourish. From a consumer culture to a more conservative culture, it plans out the style and ideals of the population as a whole. Mass media also shapes how the population views the world around them; they can make an individual in favor or against a certain issue using techniques to speak to the consumer at a subconscious level. Monetary policy by far is a significant factor in the survival and well being of any nation. It can destroy or exalt any nation through policies that effect how the economy and money interact. Ranging from the Reserve Bank of New Zealand, the Bank of Japan, and the Swiss National Bank to the European Central Bank and the Federal Reserve, these banks were deployed to attend the dire need of keeping monetary value stable; at what ever cost. Though for the best interest, centralized banks have helped and hurt their respective economies in many different ways. “During the nineteenth century and the beginning of the twentieth century, financial panics plagued the nation, leading to bank failures and business bankruptcies that severely disrupted the economy. The failure of the nation's banking system to effectively provide funding to troubled depository institutions contributed significantly to the economy's vulnerability to financial panics” (Fox 1). I will be proving, as a liberal, how failed monetary policies of the Federal Reserve were the ongoing cause of the Great Depression.
The onset of the Great Depression can be traced back to August 1929. In the fall of 1930, 15 months had passed since the beginning of the contraction; the economy finally began to appear poised for recovery. The last three contractions has lasted an average of 15 months. However, in November 1930, a failure in monetary policy among commercial banks resulted in the longest and deepest contraction of the twentieth century. As perfectly stated by Gary Richardson: “When the crises began, over 8,000 commercial banks belonged to the Federal Reserve System, but nearly 16,000 did not. Those non-member banks operated in an environment similar to that which existed before the Federal Reserve was established in 1914. That environment harbored the causes of banking crises.” One factor in the financial crisis was the practice of counting checks in the process of collection as part of banks’ cash reserves. Richardson goes to say, “These 'floating' checks were counted in the reserves of two banks, the one in which the check was deposited and the one on which the check was drawn, and in many cases, additional banks, through which the check flowed through while clearing. In reality, however, the cash resided in only one bank. Bankers at the time referred to the reserves comprised of float as fictitious reserves. The quantity of fictitious reserves rose throughout the 1920s and peaked just before the financial crisis in 1930. Estimates vary, but in the fall of 1930, fictitious reserves probably accounted for more than half and possibly up to four-fifths of all reserves in non-member banks. This meant that the banking system as a whole had a limited amount of cash reserves available for emergencies.” This led to widespread uncertainty of the validity of checks.
Moreover, the inability of banks to mobilize reserves in times of crisis had a profound impact on the beginnings of the great depression. “Non-member banks kept a portion of their reserves as cash in their vaults and the bulk of their reserves as deposits in correspondent banks in designated cities. Many, but not all, of the ultimate correspondents belonged to the Federal Reserve System. This reserve pyramid limited country banks' access to reserves during times of crisis. When a bank needed cash, because its customers were panicking and withdrawing funds en masse, the bank had to turn to its correspondent, which might be faced with requests from many banks simultaneously, or might be beset by depositor runs itself. The correspondent bank also might not have the funds on hand because its reserves consisted of checks in the mail, rather than cash in its vault. If so, the correspondent would, in turn, have to request reserves from another correspondent bank. That bank, in turn, might not have reserves available or might not respond to the request” (Richardson). The involvement of the Federal Reserve on non-member banks remained an open question. These flaws had been apparent to the founders of the Federal Reserve however. The National Monetary Commission described the problems with the structure of the Federal Reserve implying that the Federal Reserve could only solve problems that involved member banks.
These flaws in the financial system were the roots to the initial banking crisis of the Great Depression. “This crisis began with the collapse of Caldwell and Company. Caldwell was a rapidly expanding conglomerate and the largest financial holding company in the South. It provided its clients with an array of services--including banking, brokerage, and insurance--through an expanding chain and a series of overlapping directorates controlled by its parent corporation headquartered in Nashville, Tennessee. The parent got into trouble when its leaders invested too heavily in securities markets and lost substantial sums when stock prices declined. In order to cover their own losses, the leaders drained cash from the corporations that they controlled” (Richardson). He goes on to explain, “On November 7, one of Caldwell's principal subsidiaries, the Bank of Tennessee closed its doors. On November 12 and 17, Caldwell affiliates in Knoxville, TN, and Louisville, KY, also failed. The failures of these institutions triggered a correspondent cascade that forced scores of commercial banks to suspend operations. In communities where these banks closed, depositors panicked and withdrew funds from other banks. Panic spread from town to town. Within a few weeks, hundreds of banks suspended operations.” This resulted in citizens making a run for their money and the panic spread from town to town. After the panic began to subdue in early December, another blow was dealt to the already bloody economy. On December 11, the Bank of United States, the fourth largest bank in New York City, closed its doors. The bank had been on the verge of merging with another institution. The New York Fed attempted to aid in the search for a merge partner. In a failed attempt by the Fed, negotiations broke down, and depositors rushed to withdraw their money causing fear among the public and making newspaper headlines throughout the U.S. The Fed’s reaction to the crisis varied by district. In the sixth district, the Atlanta Fed accelerated discount lending to member banks, encouraged member banks to extend loans to their non-member respondents, and rushed funds to cities and towns beset by banking panics. This policy caused issues in Mississippi due to the northern half of the state being part of a different district, district 8. The banking crisis was fueled almost entirely by panic and the wake of Caldwell’s collapse. Moreover, the eight district, headquartered in St. Louis, didn’t react to the crisis in a decisive and constructive manner. “The leaders of the Federal Reserve Bank of St. Louis had a narrower view of their responsibilities and refused to rediscount loans for the purpose of accommodating non-member banks. During the crisis, the St. Louis Fed limited discount lending and refused to assist non-member institutions” (Richardson). This caused the banking system to remain faltered and also caused a decline in loans and an unemployment rise. The inability for the Federal Reserve to act accordingly in all districts, resulted in uncertainty between banks; member or non-member.

Furthermore, the indecisiveness of the Federal Reserve during the early years of the depression has attributed to the cause of the whole crisis. The inability of the Fed to act accordingly can be traced back to “the shift of power within the system [from the Federal Reserve Bank of New York to the Federal Reserve Board] and the lack of understanding and experience of the individuals to whom power shifted” (Friedman and Schwartz 411). The actions undertaken by the Federal Reserve during the recessions of the 1920s and relative inaction of the early 1930s are explained by well-reasoned contemporary concerns over the reestablishment and maintenance of the international gold standard according to Wicker. Due to the collapse of the gold standard in much of Europe during the first war, the Federal Reserve was influenced in not making the same mistake. Additionally, through a close examination of the relationship between interwar attitudes regarding consumption, saving and consumer credit and Federal Reserve policy during the early years of the Great Depression. According to Paul J. Kubik, dramatic changes occurred in household spending and credit patterns during the interwar years. The development of an array of new consumer durable items and the creation of innovative credit devices and selling techniques, most prominently, installment financing; influenced the public to buy products freely. The rapid expansion of installment credit during the 1920s had “loaded the masses with debts and obligations,” fueling an excessive expansion of consumption spending, and thereby contributed to the severity of the interwar economic boom and collapse (Chapman 307). Personal papers of a number of important Federal Reserve officials concluded that the attitudes of these individuals paralleled those of their contemporaries; this helps explain why the central bank officials expressed the view that a period of debt and asset liquidation was crucial to ensuring the long-term health of the U.S. economy during the first two years of the Great Depression, according to Kubik.

The change in consumption practices paralleled with an unprecedented increase in material abundance gave rise to a sustained, wide-ranging debate. The Real Gross National Product per capita increased from an average of $531 during the period 1869-78 to $1,011 by 1900 and to $1,671 by 1929 [U.S. Department of Commerce 1975]; raising purchasing power. By the second half of the 1920s, Americans were focused almost exclusively on the extension of credit to the household. With this in place, consumer debt rose exponentially during the 1920s, unlike the previous two decades with relatively stable debt. Consequently, consumer debt rose from 4.64 percent in 1919 to 9.34 percent in 1929, along with installment selling reaching its peak during 1925-27. Knowingly, officials of the Federal Reserve were well aware of the ongoing debate regarding household spending and installment credit. While a number of central bank officials participated in finding a solution, most followed the debate from the sidelines. George W. Norris, governor of the Philadelphia Federal Reserve Bank during 1920-1936, shared his thoughts on installment credit noting that there was “little question that the easy terms upon which goods so sold may be purchased encourage the purchase of unnecessary goods or of unnecessarily expensive goods” (Norris 210). This message was widely ignored. “ Condemnation of installment credit by Federal Reserve officials and their counterparts in business, government, labor, and finance, while widespread, was hardly universal” (Kubik 834). Other officials including Eugene R. Black, governor of the Federal Reserve Bank of Atlanta during the 1930s, went on to falsely claim that it was the extravagant spending habits if the American people, fueled by installment selling, that had caused the collapse in business; rejecting the real cause of the rise in debt and therefore, the collapse of our banking system. Maybe if Fed officials would have simply followed the guideline established during the recessions of 1923-24 and 1926-27, the collapse of the 1930s could have been avoided. In conclusion, many policies can make or break a nation. Monetary policy is one of great importance in the survival of a nation. During the 1920s and 30s, the Federal Reserve’s monetary policy caused a rise in debt and consequently a downturn causing one of the deepest and longest recessions of the twentieth century, the Great Depression.

Works Cited
Richardson, Gary. "Banking crises and the Federal Reserve as a lender of last resort during the Great Depression." NBER Reporter 2013.3 (2013). Business Insights: Global. Web. 7 May 2015.

M. Carlson, K. Mitchener, and G. Richardson, "Arresting Banking Panics: Fed Liquidity Provision and the Forgotten Panic of 1929," NBER Working Paper No. 16460, October 2010, published in Journal of Political Economy 119 (2011), 888-924.

K. Mitchener and G. Richardson, "Shadowy Banks and Financial Contagion during the Great Depression: A Retrospective on Friedman and Schwartz." American Economic Review, 103(May 2013): 73-78.

G. Richardson, "Correspondent Clearing and the Banking Panics of the Great Depression," NBER Working Paper No. 12716, December 2006. Published as "The Check is in the Mail: Correspondent Clearing and Clearing and the Collapse of the Banking System, 1930 to 1933." Journal of Economic History, 67(3) 2007: 643-71.

G. Richardson, "Bank Distress during the Great Contraction, 1929 to 1933, New Data from the Archives of the Board of Governors," NBER Working Paper No. 12590, October 2006. I

G. Richardson and P. Van Horn, "Intensified Regulatory Scrutiny and Bank Distress in New York City during the Great Depression," NBER Working Paper No. 14120, June 2008, published in Journal of Economic History 69 (2009).

Lien, Kathy. "Get To Know The Major Central Banks." Investopedia. N.p., 12 Mar. 2006. Web. 07 May 2015.

Fox, Lynn S., ed. The Federal Reserve System: Purposes and Functions. 9th ed. N.p.: n.p., n.d. Publications Committee, June 2005. Web. 07 May 2015.

Kubiak, Paul J. "Federal Reserve Policy during the Great Depression: The Impact of Interwar Attitudes regarding Consumption and Consumer Credit." Federal Reserve Policy during the Great Depression: The Impact of Interwar Attitudes regarding Consumption and Consumer Credit 30.3 (1996): 829-42. FLVC SFX Services. Web. 07 May 2015.