Everything Old is New Again, Part 1934-1937

I have (vainly, I suspect, in both senses of the phrase), tried to start a meme on Twitter, #ifTimGeithnerrantheEmergencyRoom. “The defibrillator would only charge to 30 to prevent scarring; anything more and you’re on your own” probably isn’t winning friends or influencing people, but it does make me feel better.

It also makes me look back at the histories written of the time.  A detailed analysis of Keynes’s discussion of Goldman Sachs’s antics in the late 1920s, which echo their trading in middle 2000s, is left to someone else. (Suffice it to say, one never quite listens to John Denver’s “Take Me Home, Country Roads” the same way again after reading about Blue Ridge and Shenandoah.)

It’s the macro monetary moves that abide, and the lessons of history. Years ago, people failed to notice that money whose multiplier is 1 is not inflationary—most especially when you have one of the so-called “balance sheet recessions” where assets are being carried at a value significantly higher than can be realized even in Edward C. Prescott’s or Thomas M. Hoenig’s most lurid fantasies.  To wit:

Over time, Fed officials became increasingly concerned about substantial increases in bank reserves, especially excess reserves. During 1934 and 1935, gold inflows of some $3 billion contributed to a doubling of member bank total reserves (from $2.76 billion in January 1934 to $5.72 billion in December 1935) and more than a tripling of excess reserves (from $866 million to $2.98 billion; Board of Governors of the Federal Reserve System 1943, 371). The buildup of excess reserves alarmed Fed officials, who feared that these “idle” balances might permit a wave of speculation and inflation.

Using its traditional tools the Fed would have reduced reserves (or slowed their rate of growth) by selling securities and raising the discount rate. But this was not feasible in the mid-1930s. A discount rate increase would have had no effect on reserves since discount-window borrowing already was trivial, even at a discount rate of just 1.5 percent. Similarly, by mid-1935, member bank excess reserves alone equaled the Fed’s total security holdings, leaving the Fed unable to slow significantly the growth of total reserves through open market sales….


And the result, Basel III-like, of ignoring that the accounting Fantasies of Solvency were dwarfing the lending realities:

Alarmed at the sharp increase in excess reserves that had taken place since 1933, and viewing it as potentially inflationary, the Board of Governors increased required reserve ratios in August 1936, and again in March and May 1937. In total, the reserve requirements on time deposits were increased from 3 percent to 6 percent. Requirements on demand deposits were increased from 7, 10, and 13 percent to 14, 20, and 26 percent for country, reserve city, and central reserve city banks, respectively. The increases, according to the Annual Report of the Board of Governors for 1936, were intended to eliminate those excess reserves the board deemed ‘‘superfluous for prospective needs of commerce, industry, and agriculture, and, if permitted to become the basis of a multiple expansion of bank credit, might have resulted in an injurious credit expansion” (14).

If “those who forget the past may be condemned to repeat it,” are those who remember it and still fail to do anything are just condemned to be economists?

All quotes from Charles W. Calmoris and David C. Wheelock, “Was the Great Depression a Watershed for American Monetary Policy,” 1996-1998, as published in Bordo, Goldin, and White eds., The Defining Moment, NBER Press, 1998

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