An Evaluation of Federal Reserve Policy 1924-1930

Claire Helene Young

• Publisher: Taylor & Francis
• Year: 2017
• eBook ISBN: 9781351611626
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Negocios en general

This book, first published in 1992, explores the role of the Federal Reserve System in the Great Depression. Several theories of the causes of the Great Depression are discussed. What the Federal Reserve did, how they defended their actions, and how business writers, businessmen and economists viewed these actions are important. Analysis of these opinions sheds light on how aware of the appropriateness of Federal Reserve policy concerned participants of that time period were.

Chapter 1
Historical Overview The 1920’s and the Great Depression

1 The Prosperity of the 1920's

After the recessionary post World War I setback of 1920-1921, the twenties were characterized by rapid growth in productivity and overall income. The mood of the country was one of unbounded optimism and a feeling that prosperity was permanent. The depression that followed in 1929 shocked Americans and eroded faith in banking, the Federal Reserve System, and the future. So great was the shock that it took several years for the nation, businessmen, and economists to comprehend the gravity of the depression. It is important, therefore, to analyze the prosperity of the 1920's as well as the fundamental weaknesses in order to understand how disaster could strike such an unexpecting population.

During the 1920's a great investment was made in capital goods at the rate of about $17 billion per year. (¹) Technological advances were rapid and productivity per worker underwent substantial increases. World War I had emphasized mass production and specialization benefits, and so post-war industrialists avidly studied the principles of scientific management as promoted by Frederick W. Taylor. Industries were also expanding rapidly (most notably durable consumer and investment goods, and, until 1926, construction). Residential construction increased so rapidly that by 1925, 937,000 units were started as compared to 405,000 units in 1919. However, this number would drop to 509,000 in 1929. (²) The building boom was due to population growth, rising incomes and building interruption during World War I. The automobile industry also grew very rapidly so that by 1929, twenty three million automobiles were registered compared to only eight million in 1920. A total of 4,795,000 automobiles were produced in 1929. (³) Prices for autos had dramatically dropped by 1926 from their 1903 level due to economies of large scale production. Other industries also prospered such as rayon, petroleum, radio, appliances, and chemicals, as well as manufacturing, retail distribution and food processing.

The rate of business consolidations from 1919 to 1929 was starteling. In mining and manufacturing, there were 1268 consolidations. There were 270 consolidations in the iron and steel industries. (⁴) Over 1000 public utilities disappeared in 1926 alone as a result of consolidation. (⁵) By 1929, 49% of corporate wealth, 38% of business wealth and 22% of the nation's entire wealth was held by only 200 non-banking corporations. (⁶)

Furthermore, as a creditor nation after World War I who would not accept manufactured goods from foreign countries, the U. S. maintained a favorable balance of trade by making large foreign loans and investments abroad. From 1922 to 1929 an overflow from the U. S. of capital totalled $3.6 billion. (⁷) This trend continued until 1928 when American investors reduced their foreign loans, and exports of agricultural commodities and raw material substantially decreased. Therefore, until 1928 export trade contributed significantly to economic prosperity. (It was also, as we shall see later, a source contributing to the weakness of the economy.)

Another factor that contributed to the high level of prosperity of the times was the pro-business attitude of the government. (⁸) Because income taxes were reduced in 1924 and 1928, high income groups, business, and industry became the recipients of greater funds to invest. This stimulated rapid capital investment, but also, unfortunately, excessive stock market speculation. Herbert Hoover as Secretary of Commerce from 1921-1928, aided business as much as he could by promoting loans, exports, and protective tariffs. A laissez-faire attitude was taken towards government monitoring of business. In order to allow vast mergers, anti-trust laws were weakly enforced. Social welfare programs that would require higher business taxes or increase the prices of raw materials were vigorously opposed. Even federal public power projects were opposed until the 1930's.

The stock market was also undergoing acceleration as the 1920's were marked by mass speculation. Sensational schemes, narrow margins of 10%-20% (⁹) and other manipulations eventually drove prices of stocks up to unsustainable levels by late 1928. Yet, until that time, price increases were justified by increases in output in some industries.

During the 1921-1929 period, GNP increased 62% and $35 billion was invested in new plants and equipment for industry, agriculture, and commerce. Between 1920-1930, employment increased by 15% with one forth of this increase registered in non-farm sectors. (¹⁰)

In addition to this remarkable prosperity, the period from 1921-1929 is also notable for three other economic characteristics. (¹¹) First, banks were undergoing important changes. Banks were engaging in side businesses such as distributing securities and fiduciary functions. Small town banks dwindled as agriculture became less important and as the automobile brought people to the cities. Second, when the gold standard was abandoned, the inexperienced Federal Reserve System had to develop monetary policy criteria. The result of this was that they attempted to draw upon their powers to promote economic stability. When economic conditions appeared to be favorable, they took credit for it. Third, towards the end of the 1920's a conflict over stock market speculation developed between the Federal Reserve Board and the Federal Reserve Bank of New York. This conflict indirectly contributed to the depressed economy of 1929-1932.

The change in banking and the development of Federal Reserve monetary policy were vital yet immeasurable factors in the boom of the 1920's. They were also integrally involved in the collapse of the system. This will be dealt with more in a later section devoted to the weaknesses of the 1920's.

2 Price Stability

Contrary to the usual expected inflation during a boom as demand accelerates, the prices of the 1920's were remarkably stable. Several explanations have been advanced for the stability. Wholesale and consumer prices were less vulnerable from 1923 through 1929 than in earlier periods.

Milton Friedman and Anna Schwartz mA Monetary History of the United States, 1867-1960 have proposed that the reason prices were stable was that the quantity of money was kept more stable than it otherwise would have been. They give the explanation that the Federal Reserve would not allow gold flows to affect the quantity of money. Therefore, prices were less variable because money was less variable. According to Milton Friedman:

"By 1923, wholesale prices had recovered only a sixth of their 1920-1921 decline. From then until 1929, they fell an average of 1% per year. The cyclical expansion from 1927 to 1929 is one of the very few in our record during which prices were a shade lower at the three months centered on the peak than at the three months centered on the initiation trough. The stock of money too failed to rise, even fell slightly during most of the expansion, a phenomenon not matched in any prior or subsequent cyclical expansion. Far from being an inflationary decade the 20's were the reverse. And the Reserve System far from being an engine of inflation, very likely kept the money stock from rising as much as it would have if gold movements had been allowed to exert their full influence." (¹²)

Price trends from 1920 through 1945 were extremely stable. (¹³) Initially, after World War I prices declined and while stable from 1922 through 1929, there was slight price inflation in 1925 coincident with the peak of the boom in construction.

Albert Niemi, in U. S. Economic History states that from 1815 on prices declined. He proposes this to be due to a decrease in the velocity of circulation, the fact that money may have been held by individuals who could not consume much of what they held, production and technological increases, and some sort of international connection as European price levels were similar. Dr. Niemi wrote, however, that there was no absolute agreement on these factors or on the extent to which they operated on price levels. Louis M. Hacker in The Course of American Growth and Development also states that the stability in wholesale prices, as well as a modest decline in consumer prices, during this period was due to technological and productive advances. (¹⁴)

It is reasonable to assume that as technological advances increased production and further economies of scale were established, prices would fall. Therefore, it seems logical to assume that with increased demand for products and increased supply at a lower cost, prices could be somewhat stable. Additionally, as shall be shown later, the 1920's were characterized by an unequal income distribution such that the most substantial income gains were in the domain of the top 1% of the population. Niemi's argument supports a view that these people had too much to consume with, thereby fueling securities investments instead of purchasing goods. Nevertheless, it must be mentioned that any increase in monetary income increased real wages (due to the stable prices) so that all classes benefitted somewhat from stable prices. This would create a downward pressure on prices as overall demand would be somewhat depressed. Furthermore, the argument of Friedman that the Federal Reserve restricted the variability of prices by restricting the variability of the money supply is important. Additionally, the low prices of farm products kept the cost of living to a manageable level for urban workers. (¹⁵) All of these factors, as well as the unexplained interconnection of European and American price levels, should account in some measure for the curious price stability of the period.

3 The Fundamental Weakness of the 1920's Economy

The reason that the spirit of optimism in the 1920's would eventually be pierced by the Great Depression is that certain fundamental weaknesses existed in the economy of that time period.

John Galbraith in The Great Crash 1929 cites five instabilities operating in the Twenties which will be listed and then discussed in length , in addition to several other weaknesses. (¹⁶) These are as follows:

1. Income was unevenly distributed so that the rich were very rich and so that the economy became dependent upon high levels of luxury consumer spending and/or high investment levels.
2. The corporate structure was weak having opened itself to frauds and swindlers, to holding companies which were over-leveraged, and to investment trusts. Businesses invested more in speculation than in production.
3. The bank structure was unstable as many loans were backed for collateral by goods whose prices subsequently would fall, and many of these loans were broker loans. Banks were weak due to the great number of independent banks, so that if one failed the result would be bank runs.
4. The foreign balance was in a poor state. Private loans were extended to debtor foreign nations by private American creditors. In the majority of cases, their terms were not worked out to protect the creditors. When tariffs prevented increasing exports, massive defaults occurred.
5. The economic intelligence was poor. (Later, a discussion of the weaknesses in Federal Reserve policy will demonstrate this.)

Additional sources of instability were the number of farm bankruptcies due to the weaknesses in the agriculture industry and hurting the holders of farm mortgages, stock market speculation, and the instabilities inherent in the construction industry. (¹⁷)

The following section is an analysis of these factors and how they worked to disrupt economic stability.

4 Agriculture and Construction Industry Weakness

From 1897 until the end of World War II, agriculture boomed. When the war ended the demand for American products declined forcing prices down. Also, as immigration was slowed, consumption demand in the United States fell. Prohibition hurt the grain industry, and so did the fashionable dieting of women. (¹⁸) Therefore, even though production methods improved, demand slid. Furthermore, many marginal farmers could not afford the production capital. Gross farm income was reduced from $26.5 billion in 1920 to $10.5 billion in 1921. (¹⁹) Only modest gains were made from the latter year through 1929. Per capita farm income was $273 in 1929 compared to $750 as a national average. (²⁰) The prices that farmers could receive for their products were substantially less than what they had to pay for the products they needed. Resultant farm bankrupcies and dissavings reduced the capital value of their property, and the share of agriculture in the national income declined.

The residential construction industry after 1925 was also weak. Real estate mortgage bonds furnished most of the money, and when the supply of housing filled post World War I needs (and as immigration fell), demand slackened. An industry that furnished 6% of employment during the boom and that was backed by speculation in bonds was in trouble. (²¹)

Beneath the boom, there were important industries with deep, troubled currents.

5 The Uneven Distribution of Income

Even though the GNP grew at a rate of 6% between 1921 and 1929, gains in income were disproportionately allocated so that the very wealthy received most of the benefits. In point of fact, in 1920 the top 1% of the income bracket earned 13.64% of the total income, in 1925 they received 15.74%, and in 1929 they received 17.15%. In 1920 the top 5% of the income bracket earned 25.76% of the total income...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Table of Contents
• An Evaluation of Federal Reserve Policy 1924-1930
• Introduction
• Chapter 1 Historical Overview The 1920’s and the Great Depression
• Chapter 2 Opinion of the Period Economic Conditions & Federal Reserve Policy
• Chapter 3 Conclusion Policy Evaluation 1924-1930
• Bibliography
• Notes