From New Deal Banking Reform to World War II Inflation

This selection from the authors' A Monetary History of the United States, 1867-1960 (Princeton) describes the changes that were made in the banking structure and in the monetary standard following the great contraction of 1929 to 1933, the establishment of monetary policies after the New Deal period, and the development of inflation during World War II.

Originally published in 1980.

The Princeton Legacy Library uses the latest print-on-demand technology to again make available previously out-of-print books from the distinguished backlist of Princeton University Press. These editions preserve the original texts of these important books while presenting them in durable paperback and hardcover editions. The goal of the Princeton Legacy Library is to vastly increase access to the rich scholarly heritage found in the thousands of books published by Princeton University Press since its founding in 1905.

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From New Deal Banking Reform to World War II Inflation

This selection from the authors' A Monetary History of the United States, 1867-1960 (Princeton) describes the changes that were made in the banking structure and in the monetary standard following the great contraction of 1929 to 1933, the establishment of monetary policies after the New Deal period, and the development of inflation during World War II.

Originally published in 1980.

The Princeton Legacy Library uses the latest print-on-demand technology to again make available previously out-of-print books from the distinguished backlist of Princeton University Press. These editions preserve the original texts of these important books while presenting them in durable paperback and hardcover editions. The goal of the Princeton Legacy Library is to vastly increase access to the rich scholarly heritage found in the thousands of books published by Princeton University Press since its founding in 1905.

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From New Deal Banking Reform to World War II Inflation

From New Deal Banking Reform to World War II Inflation

From New Deal Banking Reform to World War II Inflation

From New Deal Banking Reform to World War II Inflation

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This selection from the authors' A Monetary History of the United States, 1867-1960 (Princeton) describes the changes that were made in the banking structure and in the monetary standard following the great contraction of 1929 to 1933, the establishment of monetary policies after the New Deal period, and the development of inflation during World War II.

Originally published in 1980.

The Princeton Legacy Library uses the latest print-on-demand technology to again make available previously out-of-print books from the distinguished backlist of Princeton University Press. These editions preserve the original texts of these important books while presenting them in durable paperback and hardcover editions. The goal of the Princeton Legacy Library is to vastly increase access to the rich scholarly heritage found in the thousands of books published by Princeton University Press since its founding in 1905.


Product Details

ISBN-13: 9780691615646
Publisher: Princeton University Press
Publication date: 07/14/2014
Series: Princeton Legacy Library , #67
Pages: 184
Product dimensions: 9.00(w) x 6.00(h) x 0.60(d)

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From New Deal Banking Reform to World War II Inflation


By Milton Friedman, Anna Jacobson Schwartz

PRINCETON UNIVERSITY PRESS

Copyright © 1980 National Bureau of Economic Research
All rights reserved.
ISBN: 978-0-691-00363-4



CHAPTER 1

New Deal Changes in the Banking Structure and Monetary Standard

The New Deal period offers a striking contrast in monetary and banking matters. On the one hand, monetary policy was accorded little importance in affecting the course of economic affairs and the policy actually followed was hesitant and almost entirely passive. On the other hand, the foundations of the American financial structure and the character of the monetary standard were profoundly modified. Both developments were direct outgrowths of the dramatic experiences of the preceding years. The apparent failure of monetary policy to stem the depression led to the relegation of money to a minor role in affecting the course of economic events. At the same time, the collapse of the banking system produced a demand for remedial legislation that led to the enactment of federal deposit insurance, to changes in the powers of the Federal Reserve System, and to closer regulation of banks and other financial institutions. The depressed state of the economy, the large preceding fall in prices and, despite those conditions, the poor competitive position of our exports thanks to the depreciation of the pound and other currencies, all combined with the New Deal atmosphere to foster experimentation with the monetary standard. The experiments involved temporary departure from gold, a period of flexible and depreciating exchange rates, silver purchases, subsequent nominal return to gold at a higher price for gold, and drastic changes in the terms and conditions under which gold could be held and obtained by private parties.

This chapter describes the changes that were made in the banking structure (section 1) and in the monetary standard (section 2). The next chapter discusses the monetary policies followed during the New Deal period.


1. Changes in the Banking Structure

Three kinds of legislative measures were enacted after the 1933 banking panic: emergency measures designed to reopen closed banks and to strengthen banks permitted to open; measures that effected a more lasting alteration in the commercial banking structure — the most important being federal deposit insurance — and, more generally, in the financial structure; measures that altered the structure and powers of the Federal Reserve System. In addition, the banking system was affected in important ways by the reaction of the banks themselves, independently of legislation, to their experiences during the prior contraction.


EMERGENCY MEASURES

We have already had occasion to refer to the Emergency Banking Act of March 9, 1933. Title I of the act approved and confirmed the action taken by President Roosevelt in proclaiming a nationwide bank holiday from March 6 to March 9, inclusive, under the wartime measure of October 6, 1917, which conferred broad powers over banking and currency upon the President of the United States. Title I, further, amended the wartime measure to empower the President in time of national emergency to regulate or prohibit the payment of deposits by all banking institutions. During the period of emergency proclaimed by the President, member banks were forbidden to transact any banking business unless authorized by the Secretary of the Treasury with the approval of the President.

Title II of the act provided for the reopening and operation on a restricted basis of certain national banks with impaired assets, which under existing laws would have' been placed in receivership and liquidated. Conservators were to be appointed for those banks by the Comptroller of the Currency. The Comptroller could direct the conservators to make available for immediate withdrawal amounts of existing deposits he deemed it safe to release; and the conservators, subject to his approval, could receive new deposits, available for immediate withdrawal without restriction and segregated from other liabilities of the bank. The conservators were also to be charged with the duty of preparing plans of reorganization, subject to the Comptroller's approval, which could be put into effect with the consent of 75 per cent of a bank's depositors and other creditors or of two-thirds of the stockholders.

Title III provided for issues of nonassessable preferred stock by national banks to be sold to the general public, or the Reconstruction Finance Corporation (RFC), which might also buy similar issues from state banks.

Title IV provided for emergency issues of Federal Reserve Bank notes up to the face value of direct obligations of the United States deposited as security, or up to 90 per cent of the estimated value of eligible paper and bankers' acceptances acquired under the provisions of the Emergency Banking Act. After the emergency recognized by the Presidential proclamation of March 6, 1933, had terminated, Federal Reserve Bank notes could be issued only on the security of direct obligations of the United States. Over $200 million of Federal Reserve Bank notes were issued in 1933. Thereafter until the war, they were retired as fast as returned from circulation. The liability for those notes was assumed by the Treasury in March 1935.

Under Title IV, Federal Reserve Banks were also authorized, until March 3, 1934, to make advances in exceptional and exigent circumstances to member banks on their own notes on the security of any acceptable assets. That provision superseded the one regarding advances to member banks in the Glass-Steagall Act (see Chapter 7, footnote 26). The provision was extended by Presidential proclamation until March 3, 1935, when it expired. The provision adopted in the Banking Act of 1935 omitted the requirement that advances be made only in exceptional and exigent circumstances and to member banks whose other means of obtaining accommodation from Federal Reserve Banks were exhausted (see below, pp. 447–448).


Opening of Banks

Under the authority of the Emergency Banking. Act, President Roosevelt issued a proclamation on March 9 continuing the banking holiday, and an executive order on March 10 empowering the Secretary of the Treasury to issue licenses to member banks to reopen. Every member bank was directed to make application for a license to the Federal Reserve Bank of its district, which would serve as an agent of the Secretary in granting licenses. The executive order also empowered state banking authorities to reopen their sound banks that were not members of the Federal Reserve System. Another executive order dated March 18 granted state banking authorities permission to appoint conservators for unlicensed state member banks when consistent with state law.

In a statement to the press on March 11 and a radio address on March 12, the President announced the program for reopening licensed banks on March 13, 14, and 15. Member banks licensed by the Secretary of the Treasury as well as nonmember banks licensed by state banking authorities "opened for normal business on an unrestricted basis, except so far as affected by legal contracts between the banks and depositors with respect to withdrawals or notice of withdrawals" on March 13, in the twelve Federal Reserve Bank cities; on March 14, in some 250 cities having active, recognized clearing house associations; and on March 15, elsewhere.


Effect on Number and Deposits of Banks

At the turn of the year, two months before the banking holiday, there had been nearly 17,800 commercial banks in operation, by the definition of banks then in use (Table 13). When the banking holiday was terminated, only 17,300 remained to be recorded in the statistics, and fewer than 12,000 of those were licensed to open and do business. The more than 5,000 unlicensed banks were left in a state of limbo, to be either reopened later — the fate of some 3,000 — or to be closed for good and either liquidated or consolidated with other banks — the fate of over 2,000 (Table 14). The changes in deposits were only slightly less drastic. From December 1932 to March 15, 1933, deposits in banks open for business fell by one-sixth. Seventy per cent of the decline was accounted for by the deposits on the books of banks not licensed to open, yet not finally disposed of (Table 13, lines 3–7, col. 2).

The banks licensed to open operated generally without restrictions, though in some cases legal contracts were in effect limiting withdrawals by depositors to a specified fraction of the amounts due them. Many of the unlicensed banks, in their turn, were open for a limited range of business, with conservators authorized to receive new deposits subject to the order of the depositor and segregated from other funds. The line between licensed and unlicensed banks was therefore less sharp in practice than in the records.


Fate of Unlicensed Banks

Table 14 shows what happened to the unlicensed banks over the next several years. By the end of June 1933 over 2,300 of the banks, holding nearly half the total restricted deposits, had been disposed of — nearly 2,000 banks were licensed to reopen, 388 closed. However, the closed banks had decidedly the larger volume of deposits, and this was to remain true for the rest of the period as well, so that the three-fifths of the banks ultimately reopened held only three-eighths of the deposits.

The RFC played a major role in the restoration of the banking system as it had in the futile attempts to shore it up before the banking holiday. It invested a total of over $1 billion in bank capital — one-third of the total capital of all banks in the United States in 1933 — and purchased capital issues of 6,139 banks, or almost one-half the number of banks. In addition, it made loans to open banks for distribution to depositors of $187 million and to closed banks of over $900 million, on the security of the best assets of those institutions. The loans, made after the banking panic, were in addition to loans of $951 million to open banks and of $80 million to closed banks made before the banking panic. In aggregate, 5,816 open banks and 2,773 closed banks obtained RFC loans totaling more than $2 billion. RFC and other federal authorities doubtless also played a role in fostering bank mergers, particularly purchase by larger banks of smaller banks with doubtful portfolios, that served further to reduce the number of individual banks and, hopefully, to strengthen their solvency.


Effects on Money Stock Measures

The banking holiday and its aftermath make our recorded figures on the money stock even less reliable than for other times as indicators of some consistent economic magnitude meriting the label money. Before the banking holiday, many banks had imposed restrictions on the use of deposits in an attempt to avoid suspension. Those deposits are counted in full in the recorded money stock. On the other hand, after the holiday, both restricted and unrestricted deposits in unlicensed banks are excluded completely from the recorded money stock. The shift in treatment, which can hardly correspond to a shift in economic significance, is the major factor behind the sharp decline in the recorded figures in March 1933. Consistent accounting would require exclusion of restricted deposits throughout or their inclusion throughout. Criteria of economic significance would call for including in the money stock a fraction of restricted deposits, the fraction fluctuating over time. Any one of these courses would eliminate the discontinuous drop in our series in March 1933 and yield a milder decline before March and a milder rise thereafter.

Unfortunately, there is no adequate statistical basis for estimating restricted deposits before March 1933; hence they cannot easily be excluded. Table 15 and Chart 34 therefore bridge the discontinuity at that month by including restricted deposits throughout to derive an alternative estimate of the stock of money similar in construction before and after the holiday. This alternative estimate is compared with the estimate in our basic tables.

Neither of these two estimates is economically ideal. The alternative estimate may be viewed as setting an upper limit to the "ideal" estimate of the money stock, and our money stock figures in Table A-1 as setting a lower limit. We have noted that the figures in Table A-1 are not continuous from February to March 1933, since the figures for February include restricted deposits and the figures for March exclude them. That is why a dotted line is used on Chart 34 in connecting the values for February and March. The alternative estimate at the end of March, however, is also not strictly continuous with the end-of-February figure, so a dotted line again is used in connecting the two figures. At the end of March, depositors in unlicensed banks, for which neither a conservator nor a receiver had been appointed, had reason to regard deposits in such banks as less akin to cash then they had been before the banking holiday, even though restricted then. The attempt to achieve continuity with February by including all deposits in unlicensed banks in March figures accordingly overstates the money stock even on the concept implicit in the estimates for the end of February. And that concept itself overstates the money stock by treating $1 of restricted deposits as strictly on a par with $1 of unrestricted deposits.

Another defect in our figures traceable to the bank holiday is their exclusion of perhaps as much as $1 billion of currency substitutes introduced in communities bereft of banking facilities before, during, and immediately after the panic. To the extent currency substitutes were used because restricted deposits were unavailable to depositors, the error of their exclusion from Table A-I before the panic is offset by the error of the inclusion of restricted deposits. To the extent they were so used after the panic, currency substitutes should be added to Table A-1, since unlicensed bank deposits are not included in that table, but not to the alternative estimates in Table 15 or Chart 34, since these include unlicensed bank deposits. To the extent currency substitutes came into use to replace deposits in failed banks and the reduction of deposits in open banks, i.e., to enable the public to raise the ratio of currency to deposits, both Table A-1 and Table 15 should include them. There seems no way now, however, of estimating the changing amounts of these currency substitutes in 1932 and 1933.

Finally, we note two minor defects in the series in Table A-1: the figures exclude unrestricted deposits in unlicensed banks; the figures for commercial bank deposits are probably too low for February 1933 and too high for March 1933.

None of the several experiments we have made to take these various defects into account has been sufficiently illuminating to add much to the simple statement that an "ideal" estimate would be somewhere between the two curves in Chart 34. Almost any such intermediate curve which is plausible, in the sense that it is consistent with our qualitative knowledge of other defects and also divides the space between the two limits in proportions that do not vary erratically from month to month, implies that economic recovery in the half-year after the panic owed nothing to monetary expansion; the apparent rise in the stock of money is simply a statistical fiction. The emergency revival of the banking system contributed to recovery by restoring confidence in the monetary and economic system and thereby inducing the public to reduce money balances relative to income (to raise velocity) rather than by producing a growth in the stock of money.


REFORM MEASURES AFFECTING THE BANKING STRUCTURE

Federal Insurance of Bank Deposits

Federal insurance of bank deposits was the most important structural change in the banking system to result from the 1933 panic, and, indeed in our view, the structural change most conducive to monetary stability since state bank note issues were taxed out of existence immediately after the Civil War. Individual states had experimented with systems of deposit insurance and numerous proposals for federal deposit insurance had been introduced into the U.S. Congress over many years. A bill providing for deposit insurance was passed by the House of Representatives in 1932 under the sponsorship of Representative Henry B Steagall, chairman of the House Banking and Currency Committee, but killed in the Senate because of intense opposition by Senator Carter Glass, an influential member of the Senate Banking and Currency Committee. Glass favored merely a liquidating corporation to advance to depositors in failed banks the estimated amount of their ultimate recovery. In 1933, Steagall and Glass agreed to combine the two proposals and incorporate them in the Banking Act of 1933. The resulting section of the act provided for a permanent deposit insurance plan with very extensive coverage to become effective July 1, 1934.


(Continues...)

Excerpted from From New Deal Banking Reform to World War II Inflation by Milton Friedman, Anna Jacobson Schwartz. Copyright © 1980 National Bureau of Economic Research. Excerpted by permission of PRINCETON UNIVERSITY PRESS.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

Table of Contents

  • FrontMatter, pg. i
  • Contents, pg. vi
  • Chapter 1. New Deal Changes in the Banking Structure and Monetary Standard, pg. 1
  • Chapter 2. Cyclical Changes, 1933–41, pg. 76
  • Chapter 3. World War II Inflation, September 1939-August 1948, pg. 129



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