THE GREAT DUCK DINNER
How Federal-Reserve policies led to the crash of 1929; the expansion of the money supply as a means of helping the economy of England; the resulting wave of speculation in stocks and real estate; evidence that the Federal-Reserve Board had foreknowledge of the crash and even executed the events that were designed to trigger it.
The story is told of a New England farmer with a small pond in his pasture. Each summer, a group of wild ducks would frequent that pond but, try as he would, the farmer could never catch one. No matter how early in the morning he approached, or how carefully he constructed a blind, or what kind of duck call he tried, somehow those crafty birds sensed the danger and managed to be out of range. Of course, when fall arrived, the ducks headed South, and the farmer's craving for a duck dinner only intensified.
Then he got an idea. Early in the spring, he started scattering corn along the edge of the pond. The ducks liked the corn and, since it was always there, they soon gave up dipping and foraging for food of their own. After a while, they became used to the farmer and began to trust him. They could see he was their benefactor and they now walked close to him with no sense of fear. Life was so easy, they forgot how to fly. But that was unimportant, because they were now so fat they couldn't have gotten off the water even if they had tried.
Fall came, and the ducks stayed. Winter came, and the pond froze. The farmer built a shelter to keep them warm. The ducks were happy because they didn't have to fly. And the farmer was especially happy because, each week all winter long, he had a delicious duck dinner.
That is the story of America's Great Depression of the 1930s.
CONSOLIDATION OF POWER
When the Federal Reserve Act was submitted to Congress, many of its most important features were written in vague language. Some details were omitted entirely. That was a tactical move to avoid debate over fine points and to allow flexibility for future interpretation. The goal was to get the bill passed and perfect it later. Since then, the Act has been amended 195 times, expanding the power and scope of the System to the point where, today, it would be almost unrecognizable to the Congressmen and Senators who voted for it.
In 1913, public distaste for concentration of financial power in the hands of a few Wall Street banks helped to fuel the fire for passage of the Federal Reserve Act. To make it appear that the new System would put an end to the New York "money trust," as it was called, the public was told that the Federal Reserve would not represent any one group or one region. Instead, it would have its power diffused over twelve regional Federal Reserve Banks, and none would be able to dominate. As Galbraith pointed out, however, the regional design was "admirable for serving local pride and architectural ambition and for lulling the suspicions of the agrarians."1 But that was not what the planners had in mind for the long haul.
In the beginning, the regional branches took their autonomy seriously, and that led to conflict with members of the national board. The Board of Governors was composed of political appointees representing diverse segments of the economy. They were outclassed by the heads of the regional branches of the System who were bankers with bankers' experience.
RETURN OF THE NEW YORK "MONEY TRUST'
The greatest power struggle arose from the New York Reserve Bank which was headed by Benjamin Strong. Strong had the contacts and the experience. It will be recalled that he was one of the seven who drafted the cartel's structure at Jekyll Island. He had been head of J.P. Morgan's Bankers Trust Company and was closely associated with Edward Mandell House. He had become a personal friend of Montagu Norman, head of the Bank of England, and of Charles Rist, head of the Bank of France. Not least of all, he was head of the
1. Galbraith, p.130
New York branch of the System which represented the nation's largest banks, the "money trust" itself. From the outset, the national board and the regional branches were dominated by the New York branch. Strong ruled as an autocrat, determining Fed policy often without even consulting with the Federal Reserve Board in Washington.
The United States entry into World War I provided the impetus for increasing the power of the Fed. The System became the sole fiscal agent of the Treasury, Federal Reserve Notes were issued, virtually all of the gold reserves of the nation's commercial banks were gathered together into the vaults of the Federal System, and many of the legislative restraints placed into the original Act were abandoned. Voters ask fewer questions when their nation is at war.
The concentration of power into the hands of the very "money trust" the Fed was supposed to defeat, is described by Ferdinand Lundberg, author of America's Sixty Families:
In practice, the Federal Reserve Bank of New York became the fountainhead of the system of twelve regional banks, for New York was the money market of the nation. The other eleven banks were so many expensive mausoleums erected to salve the local pride and quell the Jacksonian fears of the hinterland. Benjamin Strong,... president of the Bankers Trust Company U.P. Morgan] was selected as the first Governor of the New York Reserve Bank. An adept in high finance, Strong for many years manipulated the country's monetary system at the discretion of directors representing the leading New York banks. Under Strong the Reserve System, unsuspected by the nation, was brought into interlocking relations with the Bank of England and the Bank of France. 1
BAILING OUT EUROPE
It will be recalled from Chapters Twelve and Twenty that it was this interlock during World War I that was responsible for the confiscation from American taxpayers of billions of dollars which were given to the central banks of England and France. Much of that money found its way to the associates of J.P. Morgan as interest payments on war bonds and as fees for supplying munitions and other war materials.
Seventy per cent of the cost of World War I was paid by inflation rather than taxes, a process that was orchestrated by the
1. Lundberg, p.
Federal Reserve System. This was considered by the Fed's supporters as its first real test, and it passed with flying colors. American inflation during that period was only slightly less than in England, which had been more deeply committed to war and for a longer period of time. That is not surprising inasmuch as a large portion of Europe's war costs had been transferred to the American taxpayers.
After the war was over, the transfusion of American dollars continued as part of a plan to pull England out of depression. The methods chosen for that transfer were artificially low interest rates and a deliberate inflation of the American money supply. That was calculated to weaken the value of the dollar relative to the English pound and cause gold reserves to move from America to England. Both operations were directed by Benjamin Strong and executed by the Federal Reserve. It was not hyperbole when President Herbert Hoover described Strong as "a mental annex to Europe." 1
Before Alan Greenspan was appointed as Chairman of the Federal Reserve by President Reagan in 1987, he had served on the Board of the J.P. Morgan Company. Before that, however, he had been an outspoken champion of the gold standard and a critic of the System's subservience to the banking cartel. In 1966 he wrote:
When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage. More disastrous, however, was the Federal Reserve's attempt to assist Great Britain who had been losing gold to us.... The "Fed" succeeded: it stopped the gold loss, but it nearly destroyed the economies of the world in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market-triggering a fantastic speculative boom.... As a result, the American economy collapsed?
After his appointment to the Fed , Greenspan became silent on these issues and did nothing to anger the Creature he now served.
AGENTS OF A HIGHER POWER
When reviewing this aspect of the Fed's history, questions arise about the patriotic loyalty of men like Benjamin Strong. How is it possible for a man who enjoys the best that his nation can offer-security, wealth, prestige-to conspire to plunder his fellow citizens in order to assist politicians of other governments to continue plundering theirs?
- Galbraith, p. 180.
- Greenspan, pp. 99-
The first part of the answer was illustrated in earlier sections of this book. International money managers may be citizens of a particular country but, to many of them, that is a meaningless accident of birth. They consider themselves to be citizens of the world first. They speak of affection for all mankind, but their highest loyalty is to themselves and their profession.
That is only half the answer. It must be remembered that the men who pulled the financial levers on this doomsday machine, the governors of the Bank of England and the Federal Reserve, were themselves tied to strings which were pulled by others above them. Their minds were not obsessed with concepts of nationalism or even internationalism. Their loyalties were to men. Professor Quigley reminds us:
It must not be felt that these heads of the world's chief central banks were themselves substantive powers in world finance. They were not. Rather, they were the technicians and agents of the dominant investment bankers of their own countries, who had raised them up and were perfectly capable of throwing them down. The substantive financial powers of the world were in the hands of these investment bankers (also called "international" "merchant" bankers) who remained largely behind the scenes in their own unincorporated private banks. These formed a system of international cooperation and national dominance which was more private, more powerful, and more secret than that of their agents in the central banks.1
So, we are not dealing with the actions of men who perceive themselves as betraying their nation, but technicians who are loyal to the monetary scientists and the political scientists who raised them up. Of the two groups, the financiers are dominant. Politicians come and go, but those who wield the power of money remain to pick their successors.
FARMERS BECOME DUCK DINNER
During the war, prices for agricultural products rose to an all-time high, and so did profits. Farmers had put part of that money into war bonds, but much of it had been placed into savings accounts at banks within the farming communities, which is to say, mostly in the Midwest and South.
1. Quigley, Tragedy, pp. 326-27.
That was unacceptible to the New York banks which saw their share of the nation's deposits begin to decline. A way had to be devised to reclaim that money. The Federal Reserve System, which by then was the captive of the New York banks, was pressed into service to accomplish the deed.
Few of those country banks had chosen to become members of the Federal Reserve System. That added insult to injury, and it also provided an excuse for the Fed to wage economic war against them. The plan was neither complex nor original; it had been used many times before by central bankers. It was (1) extend easy credit to the farmers to lure them into heavy debt, and then (2) create a recession which would decrease their income to the point where they could not make payments. The country banks then would find themselves holding non-performing loans and foreclosed property which they could not sell without tremendous losses. In the end, both the farmers and the banks would be wiped out. The banks were the target. Too bad about the farmers.
Congressman Charles Lindbergh, Sr., father of the man who made the world's first solo transatlantic flight, explained it this way: "Under the Federal Reserve Act, panics are scientifically created; the present panic is the first scientifically created one, worked out as we figure a mathematical problem." 1
The details of how this panic was created were explained in 1939 by Senator Robert Owen, Chairman of the Senate Banking and Currency Committee. Owen, a banker himself, had been a coauthor of the Federal Reserve Act, a role he later regretted. Owen said:
In May 1920 ... the farmers were exceedingly prosperous.... They were paying off their mortgages. They had bought a lot of new land, at the instance of the government-had borrowed money to do it-and then they were bankrupted by a sudden contraction of credit and currency, which took place in 1920....
The Federal Reserve Board met in a meeting which was not disclosed to the public-they met on the 18th of May 1920; it was a secret meeting-and they spent all day; the minutes made 60 printed pages, and it appears in Senate Document 310 of February 10, 1923.... Under action taken by the Reserve Board on May 18, 1920, there resulted a violent contraction of credit.... This contraction of credit and currency had the effect, the next year, of diminishing the national
1. Charles A. Lindbergh, Sr. The Economic Pinch (1923 rpt. Hawthorne, California: Omni Publications, 1968), p.
production $15,000,000,000; it had the effect of throwing millions of people out of employment; it had the effect of reducing the value of lands and ranches $20,000,000,000. 1
The contraction of credit had a disastrous effect on the nation as a whole, not just farmers. But the farmers were more deeply involved, because the recently created Federal Farm Loan Board had lured them with easy credit-like ducks at the pond-into extreme debt ratios. Furthermore, the large-city banks which were members of the System were given support by the Fed during the summer of 1920 to enable them to extend credit to manufacturers and merchants. That allowed many of them to ride out the slump. There was no such support for the farmers or the country banks which, by 1921, were falling like dominoes. History books refer to this event as the Agricultural Depression of 1920-21. A better name would have been Country-Duck Dinner in New York.
BUILDING THE MANDRAKE MECHANISM
In Chapter Ten, we examined the three methods by which the Federal Reserve is able to create or extinguish money. Of the three, the purchase and sale of debt-related securities in the open market is the one that provides the greatest effect on the money supply. The purchase of securities by the Fed (with checks that have no money to back them) creates money; the sale of those securities extinguishes money. Although the Fed is authorized to buy and sell almost any kind of security that exists in the world, it is obligated to show preference for bonds and notes of the federal government. That is the way the monetary scientists discharge the commitment to create money for their partners, the political scientists. Without that service, the partnership would dissolve, and Congress would abolish the Fed.
When the System was created in 1913, it was anticipated that the primary way to manipulate the money supply would be to control the "reserve ratios" and the "discount window." That is banker language for setting the level of mandatory bank reserves (as a percentage of deposits) and also setting the interest rate on loans made by the Fed to the banks themselves. The reserve ratio under the old National Bank Act had been 25%. Under the Federal Reserve Act of 1913, it was reduced to 18% for the large banks, a drop of 28%. In 1917, just four years later, the reserve requirements for Central Reserve-City Banks were further dropped from 18% to 13% (with slightly lesser reductions for smaller banks). That was an additional 28% cut. 1
It quickly became apparent that setting reserve ratios was an inefficient tool. The latitude of control was too small, and the amount of public attention too great. The second method, influencing the interest rate on commercial loans, was more useful. Here is how that works:
Under a fractional-reserve banking system, a bank can create new money merely by issuing a loan. The amount it creates is limited by the reserve ratio or "fraction" it is required to maintain to cover its cash-flow needs. If the reserve ratio is 10%, then each $10 it lends includes $9 that never existed before. A commercial bank, therefore, can create a sizable amount of money merely by making loans. But, once the bank is "loaned up," that is to say, once it has already lent $9 for every $1 it holds in reserve, it must stop and wait for some of the old loans to be paid back before it can issue new ones. The only way to expand that process is to make the reserves larger. That can be accomplished in one of four ways: (1) attract more deposits, (2) use some of the bank's profits, (3) sell additional stock to investors, or (4) borrow money from the Fed.
WHEN BANKS BORROW FROM THE FED
The fourth option is the most popular and is called going to the "discount window." When banks go to the Fed's discount window to obtain a loan, they are expected to put up collateral. This can be almost any debt contract held by the bank, including government bonds, but it commonly consists of commercial loans. The Fed then grants credit to the bank in an amount equal to those contracts. In essence, this allows the bank to convert its old loans into new "reserves." Every dollar of those new reserves then can be used as the basis for lending nine more dollars in checkbook money!
The process does not stop there. Once the new loans are made, they, too, can be used as collateral at the Fed for still more reserves. The music goes 'round and 'round, with each new level of debt
1. In 1980, statutory limits on reserve ratios were eliminated altogether. The Federal Reserve Board now has the option to lower the ratio to zero, which means the power to create unlimited quantities of money. It is the ultimate dream of central bankers.
becoming "reserves" for yet a higher level of loans, until it finally plays itself out at about twenty-eight times. 1 That process is commonly called "discounting commercial paper." It was one of the means by which the Fed was able to flood the nation with new money prior to the Great Dam Rupture of 1929.
But, there is a problem with that method, at least as far as the Fed is concerned. Even though interest rates at the discount window can be made so low that most bankers will line up like ducks looking for free corn, some of them-particularly those "hicks" in the country banks-have been known to resist the temptation. There is no way to force the banks to participate. Furthermore, the banks themselves are dependent upon the whims of their customers who, for reasons known only to themselves, may not want to borrow as much as the bank wants to lend. If the customers stop borrowing, then the banks have no new loans to convert into further reserves.
That left the third mechanism as the preferred option: the purchase and sale of bonds and other debt obligations in the open market. With the discount window, banks have to be enticed to borrow money which later must be repaid, and sometimes they are reluctant to do that. But with the open market, all the Fed has to do is write a fiat check to pay for the securities. When that check is cashed, the new money it created moves directly into the economy without any concurrence required from the recalcitrant banks.
But, there was a problem with this method also. Before World War I, there were few government bonds available on the open market. Even after the war, the supply was limited. Which means the vast inflation that preceded the Crash of 1929 was not caused by deficit spending. In each year from 1920 through 1930 there was a surplus of government revenue over expenses. Surprising as it m1 be, on the eve of the depression, America was getting out of debt. As a consequence, there were few government bonds for the Fed to buy. Without government bonds, the open-market engine was constantly running out of gas.
The solution to all these problems was to create a new market tailor-made to the Fed's needs, a kind of half-way house between
- See Robert T. Patterson, The Great Boom and Panic; 1921-1929 (Chicago: Henry Regnery Company, 1965), p.
the discount window and the open market. It was called the "acceptance window," and it was through that imagery that the System purchased a unique type of debt-related security called banker's acceptances.
Banker's acceptances are contracts promising payment for commercial goods scheduled for later delivery. They usually involve international trade where delays of three to six months are common. They are a means by which a seller in one country can ship goods to an unknown buyer in another country with confidence that he will be paid upon delivery. That is accomplished through guarantees made by the banks of both buyer and seller. First, the buyer's bank issues a letter of credit guaranteeing payment for the goods, even if the buyer should default. When the seller's bank receives this, one of its officers writes the word "accepted" on the contract and pays the seller the amount of the sale. The accepting bank, therefore, advances the money to the seller in expectation of receiving future payment from the buyer's bank. For this service, both banks charge a fee expressed as a percentage of the contract. Thus, the buyer pays a little more than the amount of the sales contract, and the seller receives a little less.
Historically, these contracts have been safe, because the banks are careful to guarantee payment only for financially sound firms. But, in times of economic panic, even sound firms may be unable to honor their contracts. It was underwriting that kind of business that nearly bankrupted George Peabody and J.P. Morgan in London during the panic of 1857, and would have done so had they not been bailed out by the Bank of England.
Acceptances, like commercial loan contracts, are negotiable instruments that can be traded in the securities market. The accepting banks have a choice of holding them until maturity or selling them. If they hold them, their profit will be realized when the underlying contract is eventually paid off and it will be equal to the amount of its "discount," which is banker language for its fee. Acceptances are said to be "rediscounted" when they are sold by the original discounter, the underwriter. The advantage of doing that is that they do not have to wait three to six months for their profit. They can acquire immediate capital which can be invested to earn
The sale price of an acceptance is always less than the value of the underlying contracts; otherwise no one would buy them. The difference represents the potential profit to the buyer. It is expressed as a percentage and is called the "rate" of discount-or, in this case, rediscount. But the rate given by the seller must be lower than what he expects to earn with the money he receives, otherwise he will be better off not selling.
Although bankers' acceptances were commonly traded in Europe, they were not popular in the United States. Before the Federal Reserve Act was passed, national banks had been prohibited from purchasing them. A market, therefore, had to be created. The Fed accomplished this by setting the discount rate on acceptances so low that underwriters would have been foolish not to take advantage of it. At a very low discount, they could acquire short-term funds which then could be invested at a higher rate of return. Thus, acceptances quickly became plentiful on the open market in the United States.
But who would want to buy them at a low return? No one, of course. So, to create that market, not only did the Federal Reserve set the discount rate artificially low, it also pledged to buy all of the acceptances that were offered. The Fed, therefore, became the principal buyer of these securities. Banks also came into the market as buyers, but only because they knew that, at any time they wanted to sell, the Fed was pledged to buy.
Since the money was being created out of nothing, the cost did not really matter, nor did the low profit potential. The Fed's goal was not to make a profit on investment. It was to increase the nation's money supply.
WARBURG AND FRIENDS MAKE A LITTLE PROFIT
The man who benefited most from this artificially created market was none other than Paul Warburg, a partner with Kuhn, Loeb and Co. Warburg was in attendance at the Jekyll Island meeting at which the Federal Reserve System was conceived. He was considered by all to have been the master theoretician who led the others in their deliberations. He was one of the most influential voices in the public debates that followed. He had been appointed as one of the first members of the Federal Reserve Board and later became its Vice Governor until outbreak of war, at which time he resigned because of publicity regarding his connections German banking. He was a director of American I.G. Chemical Corp. and Agfa Ansco, Inc., firms that were controlled by I.G. Farben, the infamous German cartel that, only a few years later, would sponsor the rise to power of Adolph Hitler. 1 He was also a director of the CFR (Council on Foreign Relations). It should not be surprising, therefore, to learn that he was able to position himself at the center of the huge cash flow resulting from the Fed's purchase of acceptances.
Warburg was the founder and Chairman of the International Acceptance Bank of New York, the world's largest acceptance bank. He was also a director of several smaller "competitors," including the prestigious Westinghouse Acceptance Bank. He was founder and Chairman of the American Acceptance Council. Warburg was the acceptance market in America. But he was not without friends who also swam in the river of money. Men who controlled America's largest financial institutions became directors or officers of the various acceptance banks. The list of companies that became part of the interlocking directorate included Kuhn, Loeb and Co.; New York Trust Co.; Bank of Manhattan Trust Co.; American Trust Co.; New York Title and Mortgage Co.; Chase National Bank; Metropolitan Life Insurance Co.; American Express Co.; the Carnegie Corp.; Guaranty Trust Co.; Mutual Life Insurance Co.; the Equitable Life Assurance Society of New York; and the First National Banks of Boston, St. Louis, and Los Angeles, to name just a few. The world of acceptance banking was the private domain of the financial elite of Wall Street.
Behind the American image, however, was a full partnership with investors from Europe. Total capital of the IAB's American shareholders was $276 million compared with $271 million from foreign investors. A significant portion of that was divided between the Warburgs in Germany and the Rothschilds in England.2,
Just how large and free-flowing was that river of acceptance money? In 1929, it was 1.7 trillion-dollars wide. Throughout the 1920s, it was over half of all the new money created by the Federal Reserve-greater than all the other purchases on the open market
- For a detailed account of this episode, see Part Two of the author's book, World without Cancer: The Story of Vitamin B17 (Westlake Village, California: American Media, 1974).
- Larry Schweikart, ed. The Encyclopedia of American History and Biography (New York: Facts on File, 1990), p.
plus all the loans to all the banks standing in line at the discount window.1
The monetary scientists who created the Federal Reserve, and their close business associates, were well-rewarded for their efforts. Profit-taking by insiders, however, is not the issue. Far more important is the fact that the consequence of this self-serving mechanism was the massive expansion of the money supply that made the Great Depression inevitable. And that is the topic which impelled us to look at acceptances in the first place.
CONGRESS SUSPICIOUS BUT AFRAID TO TINKER
By 1920, suspicions and resentment were growing in the halls of Congress. Politicians were not getting their share. It is possible that many of them failed to realize that, as partners in the scheme, they were entitled to a share. Nevertheless, they were dazzled by banker language and accounting tricks and were afraid to tinker with the System lest they accidentally push the wrong button.
Watching with amusement from London was Fabian Socialist John Maynard Keynes. Speaking of the Federal Reserve's manipulation of the value of the dollar, he wrote:
That is the way by which a rich country is able to combine new wisdom with old prejudice. It can enjoy the latest scientific improvements, devised in the economic laboratory of Harvard, whilst leaving Congress to believe that no rash departure will be permitted.... But there is in all such fictions a certain instability.... The suspicions of Congressmen may be aroused. One cannot be quite certain that some Senator might not read and understand this book.2
There was not much danger of that! By then, American politicians had acquired a taste for the heady wine of war funding and stopped asking questions. World War I had created enormous demands for money, and the Fed provided it. By the end of the war, Congressional hostility to the Federal Reserve became history.
PAYING FOR WORLD WAR I
Much of the war debt was absorbed by the public which responded to patriotic instincts and purchased war bonds. The Treasury launched a massive publicity campaign for "Liberty Loans" to reinforce that sentiment.
- Ibid., p. 448; also Murray N. Rothbard, America's Great Depression (Kansas City: Sheed and Ward, 1963), p.117.
2. Keynes, A Tract on Monetary Reform, pp. 198-99.
These small denomination bonds did not expand the money supply and did not cause inflation, because the money came from savings. It already existed. However, many people who thought it was their patriotic duty to support the war effort went to their banks and borrowed money so they could buy bonds. The bank created most of that money out of nothing, drawing upon credits and bookkeeping entries from the Federal Reserve, so those purchases did inflate the money supply. The same result could have been obtained more simply and less expensively by getting the money directly from the Fed, but the government encouraged the trend anyway, because of its psychological value in generating popular support for the war. When people make sacrifices for an endeavor, it reinforces their belief that it must be worthy.
Although the war was financed partly by taxes and partly by Liberty Bonds purchased by the public, a significant portion was covered by the sale of Treasury bonds to the Federal Reserve in the open market. Benjamin Strong's biographer, Lester Chandler, explains:
The Federal Reserve System became an integral part of the war financing machinery. The System's overriding objective, both as a creator of money and as fiscal agent, was to insure that the Treasury would be supplied with all the money it needed, and on terms fixed by Congress and the Treasury.... A grateful nation now hailed it as a major contributor to the winning of the war, an efficient fiscal agent for the Treasury, a great source of currency and reserve funds, and a permanent and indispensable part of the banking system. 1
THE EMERGENCE OF GOVERNMENT DEBT
The war years were largely a period of testing new strategies and consolidating power. Ironically, it was not until after the war-when there was no longer a justification for deficit spending-that government debt became plentiful. Up until World War
I, annual federal expenses had been running about $750 million. By the end of the war, it was running $18 and-a-half billion, an increase of 2,466%. Approximately 70% of the cost of war had been financed by debt. Murray Rothbard reminds us that, on the eve of depression in 1928, ten years after the end of war, the banking system held more government bonds than during the war itself. That means
- Chandler, pp. 101-102.
2. Depression, p. 125.
the government did not pay off those bonds when they came due. Instead, it rolled them over by offering new bonds to replace the old. Why? Was it because Congress needed more money? No. The bonds had become the basis for money in circulation and, if they had been redeemed, the money supply would have decreased. A decrease in the money supply is viewed by politicians and central bankers as a threat to economic stability. Thus, the government found itself unable to get out of debt even when it had the money to do so, a dilemma that continues to this day.
There is an apparent contradiction here. In his book, The Great Boom and Panic, Robert Patterson says that, on the eve of depression, America was getting out of debt. 1 Yet, Rothbard tells us there were more government bonds held by the banking system than during the war! The only way both statements can be true is if there were, in fact, more bonds outstanding during the war but they were held by the public, not by the banking system. That would make it possible for there to be fewer total bonds in 1928 and yet the System could still hold more of them than previously. That would be the expected result of the Fed's growing role in the open market. As the publicly-held bonds matured, the Treasury rolled them over, and the Fed picked them up. Bonds purchased by the public do not increase the money supply whereas those purchased by banks do. Therefore, conditions in 1928 would have been far more inflationary than during the war-even though the government was getting out of debt.
Before 1922, the Federal Reserve bought Treasury bonds primarily for three purposes: (1) for income to operate the system, (2) to pay for the newly issued Federal Reserve Notes which were replacing silver certificates, and (3) to push down interest rates. The motive for manipulating interest rates was to encourage borrowing from abroad in the United States (where rates were low). 2 It also encouraged investment from the United States into Europe (where rates were higher). By making it possible to borrow American dollars at one rate and invest them elsewhere at a higher rate, the Fed was deliberately moving money out of the United States, with gold reserves following behind.
- Page 223.
- Chandler, p. 211; also Rothbard, Depression, p.
As President Kennedy had said in his 1963 address at the IMF, the outflow of American gold "did not come about by chance." 1
THE "DISCOVERY" OF THE OPEN MARKET
It is commonly asserted by writers on this topic that the power of the open-market mechanism to manipulate the money supply was "discovered" by the Fed in the early 1920s and that it came as a total surprise. Martin Mayer, for example, in his book, The Bankers, writes:
Now, through an accident as startling as those which produced the discovery of X-Rays or penicillin, the central bank learned that "open market operations" could have a significant effect on the behavior of the banics.2
This makes the story interesting, but it is difficult to believe that Benjamin Strong, Paul Warburg, Montagu Norman, and the other monetary scientists who were pulling the levers at that time were taken by surprise. These men could not possibly have been ignorant of the effect of creating money out of nothing and pouring it into the economy. The open market was merely a different funnel. If there was any element of surprise, it likely was only in the ease with which the mechanism could be activated. It is not important whether that part of the story is fact or fiction, except that it perpetuates the "accidental" view of history, the myth that no one is responsible for political or economic chaos: Things just happen. There was no master plan. No one is to blame. Everything is under control. Relax, pay your taxes, and go back to sleep!
In any event, by the end of the war, Congress had awakened to the fact that it could use the Federal Reserve System to obtain revenue without taxes. From that point forward, deficit spending became institutionalized. A gradually increasing issuance of Treasury bonds was encouraging to the Fed because it provided still one more source of debt to convert into money, a source that eventually would become far more reliable than either bank loans or banker's acceptances. Best of all, now that Congress was becoming dependent on the free corn, there was little chance it would find its wings and fly away. The more dependent it became, the more secure the System itself became.
In 1921, the twelve regional Reserve banks were separately buying and selling in the open market. But motives varied. Some merely needed income to cover their operating overhead, while others-notably the New York branch under Benjamin Strong- were more interested in sending American gold to England. Strong began immediately to gather control of all open-market operations into the hands of his own bank. In June of 1922, the "Open-Market Committee" was formed to coordinate activities among the regional Governors. In April of the next year, however, the national board in Washington replaced the Governor's group with one of its own creation, the "Open-Market Investments Committee." Benjamin Strong was its chairman. The powers of that group were enhanced ten years later by legislation which made it mandatory for the regional branches to follow the Open-Market Committee's directives, but that was a mere formality, for the die had been cast much earlier. From 1923 forward, the Fed's open-market operations have been carried out by the New York Federal Reserve Bank. The money trust has always been in control.
DROWNING IN CREDIT
Actions have consequences, and one of the consequences of purchasing Treasury bonds and other debt-related securities in the open market is that the money created to purchase them eventually ends up in the commercial banks where it is used for the expansion of bank credit. "Credit" is another of those weasely words that have different meanings to different people. In banker language, the expansion of credit means the banks have "excess reserves" (bookkeeping entries) which can be multiplied by nine and earn interest for them-if only someone would be kind enough to borrow. It is money waiting to be created. The message is: "Come on to the bank, folks. Don't be bashful. We've got plenty of money to lend. You have credit you didn't even know you had."
In the 1920s, the greater share of bank credit was bestowed upon business firms, wealthy investors, and other high rollers, but the little man was not ignored. In 1910, consumer credit accounted for only 10% of the nation's retail sales. By 1929, credit transactions were responsible for half of the $60 billion retail market. In his book, Money and Man, Elgin Groseclose says: "By 1929 the United States was overwhelmed by a flood of credit. It hadcovered the land. It was pouring into every nook and cranny of the national economy"
The impact of expanding credit was compounded by artificially low interest rates-the other side of the same coin-which were intended to help the governments of Europe. But they also stimulated borrowing here at home. Since borrowing is what causes money to be created under fractional-reserve banking, the money supply in America began to expand. From 1921 through June of 1929, the quantity of dollars increased by 61.8%, substantially more than the increase in national product. During that same time, the amount of currency in circulation remained virtually unchanged. That means the expansion was comprised entirely of money substitutes, such as bonds and loan contracts.
BOOMS AND BUSTS MADE WORSE
The forces of the free market are amazingly flexible. Like the black market, they manage to exert themselves in unexpected ways in spite of political decree. That had been the case throughout most of American history. Prior to the creation of the Federal Reserve, banking had been coddled and hobbled by government. Banks were chartered by government, protected by government, and regulated by government. They had been forced to serve the political agendas of those in power. Consequently, the landscape was strewn with the tombstones of dead banks which had taken to their graves the life savings of their hapless depositors. But these were mostly regional tragedies that were offset by growth and prosperity in other areas. Even within the communities most severely affected, recovery was swift.
Now that the cartel had firm control over the nation's money supply, the pattern began to change. The corrective forces of the free market were more firmly straight-jacketed than ever. All banks in the entire country were in lock step with each other. What happened in one region is what happened in all regions. Banks were not allowed to die, so there could be no adjustments after their demise. Their illness was sustained and carried like a deadly virus to the others.
The expansion of the money supply in the 1920s clearly shows that effect. It was not a steady advance but a series of convulsions.
1. Groseclose, America's Money Machine, p.154
Each cycle was at a higher level than the previous one. That is because the busts that followed the booms were not allowed to play themselves out. The monetary scientists now had so many mechanisms at their command they were able to initiate new expansions to cancel out the downward adjustments. It was like prescribing increasing doses of narcotics to postpone the awareness of an advancing disease. It increased the prestige of the doctor, but it did not bode well for the patient.
THE ROLLER COASTER
Between 1920 and 1929, there were three distinct business cycles with several minor ones within them. For the average American, it was confusing and destructive. For the investor, it was a roller-coaster ride to oblivion:
UP! The Fed had inflated the money supply to pay for World War I. The resulting boom caused prices to rise.
DOWN! In 1920, the Fed raised interest rates to cool off the inflation. That caused a recession, and prices tumbled. Farmers were hit the hardest, and hundreds of country banks were closed.
UP! In 1921, the Fed lowered interest rates to stop the recession and to help the governments of Europe. Inflation and expanding debt resulted.
DOWN! In 1923, the Fed tightened credit to put the brakes on inflation.
UP! But that was offset by its simultaneous policy of lowering the rate at the discount window, thus encouraging banks to borrow new reserves to expand the money supply.
UP! In 1924, the Fed suddenly created $500 million dollars in new money. Within one year, the commercial banks parlayed that into more than $4 billion, an expansion of eight-to-one. The boom that followed took on the character of speculation rather than investment. Prices in the stock market rose drastically.
DOWN! In 1926, the Florida land boom collapsed, and the economy began to contract once again.
UP! In 1927, Montagu Norman of the Bank of England visited the United States to consult with Benjamin Strong. Shortly after his visit, the Fed pumped new money into the system, and the boom
DOWN! In the spring of 1928, the Fed contracted credit to halt the boom.
UP! But the banks shifted their reserves into time deposits (where customers agree to wait before withdrawing their money). Since time deposits require a smaller reserve ratio than demand deposits, the banks were able to issue more loans than before. That offset the Fed's contraction of credit.
UP! By that time, the British government had consumed its previous subsidy which was used to maintain its welfare state. In the spring of 1928, the pound sterling was again sagging on the international market, and gold began to flow back into the United States. Once again, the fledgling Creature came to the aid of the Bank of England, its ailing parent. The Fed bought a huge volume of banker's acceptances to depress interest rates and halt the flow of gold. The money supply suddenly increased by almost $2 billion.
DOWN! In August, the Fed reversed its expansionist policy by selling Treasury bonds in the open market and raising interest rates. The money supply began to contract.
It was the final bubble.
SIXTH REASON TO ABOLISH THE FED
One of the myths about the Federal Reserve is that it is needed to stabilize the economy. Yet, it has achieved just the opposite. Destabilization is dramatically clear in the years prior to the Crash, but the same cause-and-effect continues to this day. As long as men are given the power to tinker with the money supply, they will strive to circumvent the natural laws of supply and demand. No matter how high their intentions or pure their motives, they will cause disruptions in the natural flow. When these disruptions are perceived, they will try to compensate by causing opposite disruptions. But, long before they act, there will already be new forces at work which they cannot, in all their wisdom, perceive until they are already manifest. It is the height of egotistical folly for "experts" to think they can outsmart or do better than the combined, interactive decisions of hundreds of millions of people all acting in response to their own best judgment. Thus, the Fed is doomed to failure by its nature and its mission. That is the sixth reason it should be abolished: It destabilizes the economy.
Easy credit was not the only problem in this period. Equally important was the effect that had on the behavior patterns of the populace. Responding to herd instinct and a belief in the possibility of something-for-nothing, men were driven to the most bizarre form of investment speculation.
This was not the first time such hysteria had seized a population. One of the most graphic examples occurred in Holland between the years 1634 and 1636. It came to pass that a new, rare flower, called the tulip, was discovered in the gardens of some of the more wealthy inhabitants of Constantinople, now known as Istanbul. When the root bulbs of these exotic blossoms were brought into Holland, they rapidly became a status symbol among the wealthy-much as race horses or rare breeds of dogs are today in our own society-and those with surplus funds found that an investment in tulips brought them significant social recognition.
The price of tulip bulbs climbed steadily until they became, not merely symbols of status, but speculative investments as well. At one point, prices doubled every few days, and speculators were seen everywhere amassing great fortunes with no input of either labor or service. Many otherwise prudent people found themselves infected by the hysteria. They borrowed against their homes and invested their life savings to get in on the anticipated windfall. This pushed up prices even further and tended to create the fulfillment of its own prophecy. Contracts for the future delivery of tulip bulbs-a form of today's commodity market-became a dominant feature of Holland's stock market.
Tulip bulbs eventually became more precious than gemstones. As new varieties were developed, the market became more complex, requiring experts to certify their origin and their grade. Prices soared, and the herd went insane. One bulb of the species called Admiral Liefken was valued at 4,400 florins; a Semper Augustus, worth 5,500 florins, was purchased for a new carriage, two gray horses, and a complete set of harnesses. It was recorded that, at one sale, a single Viceroy brought two lasts of wheat, four lasts of rye, four fat oxen, eight fat swine, twelve fat sheep, two hogsheads of wine, four casks of butter, one-thousand pounds of cheese, a bed and mattress, a suit of clothes, and a silver drinking
Then, one day without warning, reality returned from her two-year vacation. By that time, everyone knew deep in their hearts that the spiralling prices bore no honest relationship to the value of the tulips and that, sooner or later, someone was going to get hurt. But they continued to speculate for fear of being too quick in their timing and losing out on profits yet to come. Everyone was confident they would sell out precisely at the top of the market. In any herd, however, there are always a few who will take the lead and, by 1636, all it took was one or two prominent merchants to sell out their stock. Overnight, there were no buyers whatsoever, at any price. The tulip market vanished, and speculators by the thousands saw their dreams of easy wealth-and, in many cases, their life savings also-disappear with it. Tulipomania, as it was called at the time, had come to an end.1
Or did it? As we have seen, the Federal Reserve can create large amounts of money simply by going into the open market and buying debt contracts. But, once it is in the mainstream of the economy, commercial banks can multiply that money by up to a factor of nine, and that is where the real inflationary action is. To protect that privilege is one of the reasons the banks formed this cartel in the first place. Nevertheless, the public still has the final say. If no one wants to borrow their money, the game is over.
That possibility is more theoretical than real. Although men may be hesitant to go into debt for legitimate business ventures in times of economic uncertainty, they can be lured by easy credit to take a long shot. Dreams of instant wealth are powerful motivaters. Gaming casinos, poker parlors, race tracks, lottery windows, and other forms of tulipomania are convincing evidence that the lust for gambling is embedded in genetic code. The public has always been interested in free corn.
TULIPS IN THE STOCK MARKET
During the final phase of America's credit expansion of the 1920s, the rise in prices on the stock market was entirely speculative. Buyers did not care if their stocks were overpriced compared to the dividends they paid. Commonly traded issues were selling for 20 to 50 times their earnings; some traded at 100. Speculators acquired stock merely to hold for a while and then sell at a profit. It
1. See Charles Mackay, LL.D., Extraordinary Popular Delusions and the Madness of Crowds (1841 rpt. New York: L.C. Page & Company, 1932), pp. 89-97.
was the "Greater-Fool" strategy. No matter how high the price is today, there will be a greater fool tomorrow who will buy at an even higher price. For a while, that strategy seemed to work.
To make the game even more exciting, it was common for investors to purchase their stocks on margin. That means the buyer puts up a small amount of money as a deposit (the margin) and borrows the rest from his stockbroker-who gets it from the bank, which gets it from the Fed. In the 1920s, the margin for small investors was as low as 10%. Although the average stock yielded a modest 3% annual dividend, speculators were willing to pay over 12% interest on their loans, meaning their stock had to appreciate about 9% per year just to break even.
These margin accounts are sometimes referred to as "call loans" because the broker has the right to "call them in" on very short notice, often as short as twenty-four hours. If the broker calls the loan, the investor must produce the money immediately. If he cannot, the broker will obtain the money by selling the stock. In theory, the sale of the stock will be sufficient to cover the loan. But, in practice, about the only time brokers call their loans is when the market is tumbling. Under those conditions, the stock cannot be sold except at a loss: a total loss of the investor's margin; and a variable loss to the broker, depending on the severity of the price fall. To obtain even more leverage, investors sometimes use the stocks they already own as collateral for a margin loan on new stocks. Therefore, if they cannot cover a margin call on their new stocks, they will lose their old stocks as well.
In any event, such silly concerns were not in vogue in the 1920s. From August of 1921 to September of 1929, the Dow-Jones industrial stock-price average went from 63.9 to 381.17, a rise of 597%. Credit was abundant, loans were cheap, profits were big.
BANKS BECOME SPECULATORS
The commercial banks were the middlemen in this giddy game. By the end of the decade, they were functioning more like speculators than banks. Instead of serving as dependable clearing houses for money, they also had become players in the market. Loans to commercial enterprises for the production of goods and services-which normally are the backbone of sound banking practice-were losing ground to loans for speculating in the stock market and in urban real estate. Between 1921 and 1929, while
commercial loans remained constant, total bank loans increased from $24,121 million to $35,711 million. Loans on securities and real estate rose nearly $8 billion. Thus, about 70% of the increase during this period was in speculative investments. And that money was created by the banks.
New York banks and trust companies had over $7 billion on loan to brokers at the New York Stock Exchange for use in margin accounts. Before the war, there were 250 securities dealers. By 1929, the number had grown to 6,500.
The banks not only generated the money for speculation, they became speculators themselves by purchasing large blocks of high-yield bonds, many of which were of dubious quality. Those were the kinds of securities that are difficult to liquidate in a declining market. Borrowing money on short term and investing on long term, the banks were maneuvering themselves into a precarious position.
Did the Federal Reserve cause the speculation in the stock market? Of course not. Speculators did that. The Fed undoubtedly had other objects in mind, but that did not cancel its responsibility. It was acutely aware of the psychological effect of easy credit and had consciously used that knowledge to manipulate public behavior on numerous occasions. Behavioral psychology is a necessary tool of the trade. So it could claim neither ignorance nor innocence. In the unfolding of this tragedy, it was about as innocent as a spider whose web "accidentally" caught the fly.
THE FINAL BUBBLE
In the Spring of 1928, the Federal Reserve expressed concern over speculation in the stock market and raised interest rates to curb the expansion of credit. The growth in the money supply began to slow down, and so did the rise in stock prices. It is conceivable that the soaring economy could have been brought in for a "soft landing"-except that there were other agendas to be considered. Professor Quigley had said that the central bankers were not substantive powers unto themselves but were as marionettes whose strings were pulled by others. Just as the speculation spree appeared to be coming under control, those strings were yanked, and the Federal Reserve flip-flopped once again.
The strings originated in London. Even after seven years of subsidy by the Federal Reserve, the British economy was sagging from the weight of its socialist system, and gold was moving back into the United States. The Fed, in spite of its own public condemnation of excessive speculation, reversed itself at the brink of success and purchased over $300 million of banker's acceptances in the last half of 1928, which caused an increase in the money supply of almost $2 billion. Professor Rothbard says:
Europe, as we have noted, had found the benefits from the 1927 inflation dissipated, and European opinion now clamored against any tighter money in the U.S. The easing in late 1928 prevented gold inflows into the U.S. from getting very large. Great Britain was again losing gold, and sterling was weak once more. The United States bowed once again to its overriding wish to see Europe avoid the inevitable consequences of its own inflationary policies. 1
Prior to the Fed's reversal of policy, stock prices had actually declined by five per cent. Now, they went through the roof, rising twenty per cent from July to December. The boom had returned in spades.
Then, in February of 1929, a curious event occurred. Montagu Norman travelled to the United States once again to confer privately with the officers of the Federal Reserve. He also met with Andrew Mellon, Secretary of the Treasury. There is no detailed public record of what transpired at these closed meetings, but we can be certain of three things: it was important; it concerned the economies of America and Great Britain; and it was thought best not to tell the public what was going on. It is not unreasonable to surmise that the central bankers had come to the conclusion that the bubble-not only in America, but in Europe-was probably going to rupture very soon. Rather than fight it, as they had in the past, it was time to stand back and let it happen, clear out the speculators, and return the markets to reality. As Galbraith put it: "How much better, as seen from the Federal Reserve, to let nature take its course and thus allow nature to take the blame." 2
Mellon was even more emphatic. Herbert Hoover described Mellon's views as follows:
Mr. Mellon had only one formula: "liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate." He insisted that, when the people get an inflation brainstorm, the only way to get it out of their blood is to let it collapse.
- Rothbard, Depression, p. 147.
- Galbraith, p. 181.
He held that even a panic was not altogether a bad thing. He said: "It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people."1
If this had been the mindset between Mellon and Norman and the Federal Reserve Board, the purpose of their meetings would
have been to make sure that, when the implosion happened, the central banks could coordinate their policies. Rather than be overwhelmed by it, they should direct it as best they can and turn itultimately to their advantage. Perhaps we shall never know if that
scenario is accurate, but the events that followed strongly support such a view.
ADVANCE WARNING FOR MEMBERS ONLY
Immediately after the meetings, the monetary scientists began to issue warnings to their colleagues in the financial fraternity to get
out of the market. On February 6, the Federal Reserve issued an advisory to its member banks to liquidate their holdings in thestock market. The following month, Paul Warburg gave the same advice in the annual report to the stockholders of his International Acceptance Bank. He explained the reason for that advice:
If the orgies of unrestrained speculation are permitted to spread, the ultimate collapse is certain not only to affect the speculators themselves, but to bring about a general depression involving the entire country.2
Paul Warburg was a partner with Kuhn, Loeb & Co. which maintained a list of preferred customers. These were fellow bankers, wealthy industrialists, prominent politicians, and high officials in foreign governments. A similar list was maintained at J.P. Morgan Co. It was customary to give these men advance notice on important stock issues and an opportunity to purchase them at two
to fifteen points below their price to the public. That was one of the
means by which investment bankers maintained influence over the
- Quoted by Burton Hersh, The Mellon Family: A Fortune in History (New York: William Morrow and Co., 1978), p. 290.
- This advice was reprinted in the Commercial and Financial Chronicle, March 9, 1929, p. 1444.
affairs of the world. The men on these lists were notified of the coming crash.
John D. Rockefeller, J.P. Morgan, Joseph P. Kennedy, Bernard Baruch, Henry Morganthau, Douglas Dillon-the biographies of all the Wall Street giants at that time boast that these men were "wise" enough to get out of the stock market just before the Crash. And it is true. Virtually all of the inner club was rescued. There is no record of any member of the interlocking directorate between the Federal Reserve, the major New York banks, and their prime customers having been caught by surprise. Wisdom, apparently, was greatly affected by whose list one was on.
A MESSAGE OF COMFORT TO THE PUBLIC
While the crew was abandoning ship, the passengers were told it was a lovely cruise. President Coolidge and Treasury Secretary Mellon had been vociferous in their public utterances that the economy was in better shape than ever. From his socialist perch in London, John Maynard Keynes exclaimed that the management of the dollar by the Federal Reserve Board was a "triumph" of man over money. And, from the plush offices of his New York Federal Reserve Bank, Benjamin Strong boasted:
The very existence of the Federal Reserve System is a safeguard against anything like a calamity growing out of money rates.... In former days the psychology was different, because the facts of the banking situation were different. Mob panic, and consequently mob disaster, is less likely to arise.1
The public was comforted, and the balloon continued to expand. It was now time to sharpen the pin. On April 19, the Fed held an emergency meeting under cloak of great secrecy. The following day, the New York Times reported as follows:
RESERVE COUNCIL CONFERS IN HASTE
Atmosphere of Mystery is Thrown
about Its Meeting in Washington
An atmosphere of deep mystery was thrown about the proceedings both by the board and the council. No advance announcement had been made that an extraordinary session of the council was contemplated, and the fact that the members were in the city became known only when newspaper correspondents happened
1. Quoted by Greider, p. 298.
to see some of them entering the Treasury Department building. Even after that, evasive replies were given.... While the joint meeting was in progress at the Treasury Department, every effort was made to guard the proceedings, and a group of newspaper correspondents were asked to leave the corridor. 1
Let us return briefly to Montagu Norman. His biographer tells us that, after he became head of the Bank of England, his custom was to journey to the United States several times each year, although his arrival was seldom noted by the press. He travelled in disguise, wearing a long, black cloak and a large, broad-brimmed hat, and he used the pseudonym of Professor Skiru-ter.2 It was on one of those unpublicized trips that he ran into a young Australian by the name of W.C. Wentworth. Sixty years later, Wentworth wrote a letter to The Australian, a newspaper in Sydney, and told of his encounter:
In 1929 I was a member of the Oxford and Cambridge athletic team, visiting America to run against American Universities. Late in July we split up to return, and I, together with some other members, boarded a smallish passenger vessel in New York (There were, of course, no aeroplanes in those days.)
A fellow passenger was "Mr. Skinner," and a member of our team recognized him. He was Montagu Norman, returning to London, after a secret visit to the US Central Bank, travelling incognito.
When we told him we knew who he was, he asked us not to blow his cover, because if the details of his movement were made public, it could have serious financial consequences. Naturally, we agreed, and on the days following, as we crossed the Atlantic, he talked to us very frankly.
He said, "In the next few months there is going to be a shake-out. But don't worry-it won't last for long."3
On August 9, just a few weeks after that ship-board encounter, the Federal Reserve Board reversed its easy-credit policy and raised the discount rate to six per cent. A few days later, the Bank of England raised its rate also. Bank reserves in both countries began to shrink and, along with them, so did the money supply. Simultaneously
- "Reserve Council Confers in Haste," New York Times, April 20, 1929, p. 89.
- Hargrave, p. 1.
- "Letters to the editor," The Australian (GPO Box 4162, Sydney, NSW. 2001), February 7, 1989.
the System began to sell securities in the open market, a maneuver that also contracts the money supply. Call rates on margin loans had jumped to fifteen, then twenty per cent. The pin had been inserted.
THE DUCK DINNER BEGINS
The securities market reached its high point on September 19. Then, it began to slide. The public was not yet aware that the end had arrived. The roller coaster had dipped before. Surely it would shoot upward again. For five more weeks, the public bought heavily on the way down. More than a million shares were traded during that period. Then, on Thursday, October 24, like a giant school of fish suddenly turning direction in response to an unseen signal, thousands of investors stampeded to sell. The ticker tape was hopelessly overloaded. Prices tumbled. Thirteen million shares exchanged hands. Everyone said the bottom had dropped out of the market. They were wrong. Five days later, it did.
On Tuesday, October 29, the exchanges were crushed by an avalanche of selling. At times there were no buyers at all. By the end of the trading session, over sixteen million shares had been dumped, in most cases at any price that was offered. Within a single day, millions of investors were wiped out. Within a few weeks of further decline, $3 billion of wealth had disappeared. Within twelve months, $40 billion had vanished. People who had counted their paper profits and thought they were rich suddenly found themselves to be very poor.
The other side of the coin is that, for every seller, there was a buyer. The insiders who had moved their investments into cash and gold were the buyers. It must be remembered that falling stock prices didn't necessarily mean that there was anything wrong with the stocks. Those representing solid companies were still paying dividends and were good investments-at a realistic price. In the panic, prices had tumbled far below their natural levels. Those who had the cash picked them up for a small fraction of their true worth. Giant holding companies were formed for that task, such as Marine Midland Corporation, the Lehman Corporation, and the Equity Corporation. J.P. Morgan set up the food trust called Standard Brands. Like the shark swallowing the mackerel, the big speculators devoured the
There is no evidence that the Crash was planned for the purpose of profit taking. There was considerable motivation for the monetary scientists to avert it, and they might have done so had not their higher-priority agendas gotten in the way. Yet, once they realized the inevitability of a collapse in the market, they were not bashful about using their privileged position to take full advantage of it. In that sense, FDR's son-in-law, Curtis Dan, was right when he wrote: "It was the calculated 'shearing' of the public by the World Money Powers."1
NATURAL LAW NO. 5
Here is another of those "natural laws" of economics that needs to be added to our list:
LESSON: It is human nature for man to place personal priorities ahead of all others. Even the best of men cannot long resist the temptation to benefit at the expense of their neighbors if the occasion is placed squarely before them. This is especially true when the means by which they benefit is obscure and not likely to be perceived as such. There may be exceptional men from time to time who can resist that temptation, but their numbers are small. The general rule will prevail in the long run.
A managed economy presents men with precisely that kind of opportunity. The power to create and extinguish the nation's money supply provides unlimited potential for personal gain. Throughout history the granting of that power has been justified as being necessary to protect the public, but the results have always been the opposite. It has been used against the public and for the personal gain of those who control. Therefore,
LAW: When men are entrusted with the power to control the money supply, they will eventually use that power to confiscate the wealth of their neighbors.
There is no better illustration of that law than the Crash of 1929 and the lingering depression that followed.
1. Curtis B. Da11, FDR: My Exploited Father-In-Law (Tulsa, Oklahoma: Christian Crusade Publications, 1967), p. 49.
FROM CRASH TO DEPRESSION
The lingering depression is an important part of the story. The speculators had been ruined, but what they lost was money acquired without effort. There were some unfortunate souls who also lost their life savings, but only because they gambled those savings on call loans. Those who bought stock with money they actually possessed did not have to sell, and they did quite well in the long run. For the most part, something-for-nothing had merely been converted back into nothing. The price of stocks had plummeted, but the companies behind them were still producing products, still employing people, and still paying dividends. No one lost his job just because the market fell. The tulips were gone, but the wheat crop remained.
So, where was the problem? In truth, there was none-at least not yet. The crash, as devastating as it was to the speculators, had little effect on the average American. Unemployment didn't become rampant until the depression years which came later and were caused by continued government restraint of the free market. The drop of prices in the stock market was really a long-overdue and healthy adjustment to the economy. The stage was now set for recovery and sound economic growth, as always had happened in the past.
It did not happen this time. The monetary and political scientists who had created the problem now were in full charge of the rescue. They saw the crash as a golden opportunity to justify even more controls than before. Herbert Hoover launched a multitude of government programs to bolster wage rates, prevent prices from dropping, prop up failing firms, stimulate construction, guarantee home loans, protect the depositors, rescue the banks, subsidize the farmers, and provide public works. FDR was swept into office by promising even more of the same under the slogan of a New Deal. And the Federal Reserve launched a series of "banking reforms," all of which were measures to further extend its power over the money supply.
In 1931, fresh money was pumped into the economy to restart the cycle, but this time the rocket would not lift off. The dead weight of new bureaucracies and government regulations and subsidies and taxes and welfare benefits and deficit spending and tinkering with prices had kept it on the launching
Eventually, the productive foundation of the country also began to crumble under the weight. Taxes and regulatory agencies forced companies out of business. Those that remained had to curtail production. Unemployment began to spread. By every economic measure, the economy was no better or worse in 1939 than it was in 1930 when the rescue began. It wasn't until the outbreak of World War II, and the tooling up for war production that followed, that the depression was finally brought to an end.
It was a dubious save. In almost every way, it was a repeat of the drama played out with World War I, even to the names of two of its most important players. FDR and Churchill worked together behind the scenes to bring America into the conflict-Churchill wanting American assistance in a war England was losing and could not afford, FDR wanting a jolt to the economy for political reasons, and the financiers, gathered behind J.P. Morgan, wanting the profits of war. But that is another chapter, and this book is long enough.
What happened after World War II was the focus of the first six chapters. That brings us to the end of the historical record. It's time, now, to reset the coordinates on our time machine and return to the present.
Congress had been assured that the Federal Reserve Act would decentralize banking power away from Wall Street. However, within a few years of its inception, the System was controlled by the New York Reserve Bank under the leadership of Benjamin Strong whose name was synonymous with the Wall Street money trust.
During the nine years before the crash of 1929, the Federal Reserve was responsible for a massive expansion of the money supply. A primary motive for that policy was to assist the government of Great Britain to pay for its socialist programs which, by then, had drained its treasury. By devaluing the dollar and depressing interest rates in America, investors would move their money to England where rates and values were higher. That strategy succeeded in helping Great Britain for a while, but it set in motion the forces that made the stock-market crash inevitable.
The money supply expanded throughout this period, but the trend was interspersed with short spasms of contraction which
were the result of attempts to halt the expansions. Each resolve to use restraint was broken by the higher political agenda of helping the governments of Europe. In the long view, the result of plentiful money and easy credit was a wave of speculation in the stock market and urban real estate that intensified with each passing month.
There is circumstantial evidence that the Bank of England and the Federal Reserve had concluded, at a secret meeting in February of 1929, that a collapse in the market was inevitable and that the best action was to let nature take its course. Immediately after that meeting, the financiers sent advisory warnings to lists of preferred customers-wealthy industrialists, prominent politicians, and high officials in foreign governments-to get out of the stock market. Meanwhile, the American people were being assured that the economy was in sound condition.
On August 9, the Federal Reserve applied the pin to the bubble. It increased the bank-loan rate and began to sell securities in the open market. Both actions have the effect of reducing the money supply. Rates on brokers' loans jumped to 20%. On October 29, the stock market collapsed. Thousands of investors were wiped out in a single day. The insiders who were forewarned had converted their stocks into cash while prices were still high. They now became the buyers. Some of the greatest fortunes in America were made in that fashion.