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Pastimes : Book Nook -- Ignore unavailable to you. Want to Upgrade?

To: JF Quinnelly who wrote (48)	3/22/2001 9:00:00 AM
From: Ilaine	Respond to of 443

This is an excerpt from the article in the Bank Credit Analyst I mentioned. I can't log back onto the site right now so I can't give you the URL, I downloaded it as a PDF. The author was comparing 1929 and 1959 at the 30th annual meeting of the Society of Bank Credit Analysts, in 1959. >>Let us now look at action in the other field of control which it is claimed might have helped soften the blow of the 1929 depression, and which would certainly now be used massively if a similar situation arose. I refer of course to overt action by the monetary authorities. There is little doubt that the decision of the Federal Reserve Board to pur- sue an easy money policy in 1927 aided the growth of speculation in the United States. The story is well known. England had returned to the gold standard in 1926 under the leadership of Winston Churchill, the Chancellor of the Exchequer - equivalent position to Secretary of the Treasury in the U.S. In order to encourage an inflow of funds to the U.K. (the pound having been stabilized at the overvalued rate of $4.86) Montagu Norman, the Governor of the Bank of England, convinced the Federal Reserve authori- ties that keeping the rediscount rate low would prevent money flowing from England to the U.S. In actual fact, it probably did the reverse. With a low rediscount rate, a pyramid of easy credit began to build up internally in the U.S. and the rising stock market encour- aged the flow of funds to New York. But it is also entirely questionable whether, had the Federal Reserve followed a tighter rediscount policy, the same thing wouldn't have happened anyway. It is not generally realized how little ammunition the Federal Re- serve really had. The three main instruments of credit policy are the rediscount rate, open market purchases or sales of securities and changing member bank reserve re- quirements. The rediscount rate is simply a negative type of control. You keep putting the rate up until it hurts. But if a bank needs funds, the difference between 5% and 6% is really psychological. If the same bank can get 10% - 20% in the call market, only its puritan instinct will prevent it from borrowing at the Federal Reserve at 5%, or 6% or even 7%. The second area of control is open market activities. To tighten credit, the central bank sells securities which destroys member bank reserves upon which credit can be extended. In the 1920s, however, the Federal Reserve had very few securities to sell. From 1919 through 1929, holdings of U.S. governments tended to fluctuate around $300 million, occasionally running up as high as $600 million (1922) or down as low as $25 million (1924). If we equate these modest figures with the money supply of the time, taking $50 billion as a good round figure representative of the 1925-29 period for deposits and currency, we find that these government securities only amounted to 0.6% of the money supply. Contrast this with 1959 when U.S. governments held by the Federal Reserve total about $25 billion, which represents 10% of the $250 billion of deposits and currency. It can clearly be seen that not much tightening of credit could have been accom- plished in the 1920s by open market operations. There just would not have been enough securities to sell. This left them the other area of control that might have been useful - that of raising reserve requirements. Unfortunately this was out, since it wasn't until 1935 that the Federal Reserve was allowed to revise reserve requirements upward from the fixed minimum and maximum which had hitherto been imposed. Viewed in this perspective, the Board may well be exonerated somewhat from tak- ing all the blame. True, it might have raised its voice in warning more frequently and more often, and it might have raised the rediscount rate earlier. After reducing the rate from 4% to 3½% in August 1927 the Federal Reserve Bank of New York raised the rate to 4%, 4½% and 5% in 1928, and in mid-August 1929 again raised the rate to 6%. But as to being able practically to control the speculation of the late 1920s with the powers at its disposal, all reason suggests that it was completely out of its depth. However, somebody had to be the scapegoat, and apparently economic and monetary historians have to blame it on the Federal Reserve's 1927 easy money policy, failing completely to explain why these very negative easy money actions in 1927 should have produced the greatest boom on record, when very positive easy money actions in the 1930s produced a complete dud.<< By the way, only the Federal Reserve Bank of New York raised the rate to 6% in 1929. The other 11 left it at 5%