“Friedman Friday” (Part 16) (“Free to Choose” episode 3 – Anatomy of a Crisis. part 2 of 7)


George Eccles: Well, then we called all our employees together. And we told them to be at the bank at their place at 8:00 a.m. and just act as if nothing was happening, just have a smile on their face, if they could, and me too. And we have four savings windows and we said, never leave the window. Lunch hour, anything else, we must have every window open all day. But, the important things was we knew you would have a big line so there was no use trying to hurry, because the line was going to continue. So we said, now, when you get a withdraw slip and the passbook, go back and check the signature. Even though you know your friend John Jones, just to delay time, just to mark time and then when you pay the money out, we are not going to pay in $100 bills. We are going to pay in $5, $10 and $20. And count it twice and hand it out with a smile.
Friedman: The banks survived the morning. But they didn’t have enough cash left so in the afternoon they called for more from the Federal Reserve Bank.
George Eccles: So the Federal Reserve sent up the armored car, two big sacks full of currency were brought in by the guard crowded through the crowd and the assistant manager, Morgan Kraft, came in also. So Mariner and my brother grabbed Mr. Kraft and he says, now, get up on this marble counter and tell these people that you brought up a lot of money and there is more where that came from! And he did. And then Mariner got up and said now you’ve heard that story, were not going to close. We’re going to stay open as long as any of you people want your money. So don’t worry about it at all. Well, of course, you had one other bank in the city and we called him and told him he couldn’t close either. He said well I can’t I haven’t got any money to stay open. So we made him a temporary loan. Because if we had another bank close while this run was going on the psychology of the public would be such that they’d, we’d never break the run in our bank. Everybody would come until they got all of their money out. (END)
The bank survived the first day’s run. It was time to change psychology. The second day was to be very different.
George Eccles: So that evening we called our employees all together because we knew that the next day that people had been working during the day and would have heard about this and the next morning we’d have them with us. So we figured now we can’t let a crowd build up in the lobby. So we told our tellers, I say now, you pay out this money just as fast as you can. So when anybody comes in the front door they don’t see a line. You pay out in $100 bills and don’t let any line ever develop at your window. Well it never did. So along about noon time people were just coming and going in a normal fashion and the run was over.
Friedman: It was all a question of reassuring the public that they could get their money. The Federal Reserve System was there to insure that this happened by supplying cash to the banks.
Why didn’t this system prevent The Great Depression after 1929? Because from 1929 to 1930 after the stock market crashed, the Federal Reserve system allowed the quantity of money to decline slowly thereby throttling the monetary structure. By December 1930, the quantity of money had fallen by 3% which may not seem much, but a growing economy needs additional money in order to prevent deflation and problems. Given this throttling of the monetary system, what happened after that was more or less inevitable. If the Bank of United States had not happened to fail, some other bank would have been the victim. It would have failed and would’ve set off the runs. Once the runs started, the Federal Reserve could have prevented them from having the disastrous consequences they did by stepping in and providing the banking system in general through creating new money with the cash it needed to meet the demands of the depositors. After all, once depositors start trying to take their money out of the banks, there is a strong tendency for the quantity of money to fall. Each dollar of cash which is withdrawn from a bank had been backing several dollars of deposits. If the Federal Reserve had stepped in, bought government securities on a large scale, provided the cash, the depositors would have found that they could’ve got their money and they would have stopped asking for it.
Ironically, the people at the New York Reserve Bank knew that this was the right policy. No one had advocated it more forcefully than Benjamin Strong, the first head of the bank. Tragically for America, he died two years before the real crisis.
With the death of Benjamin Strong, a truly remarkable man who not only ran the New York bank but was also the key figure in the entire Federal Reserve system. A struggle for power broke out between New York, the other banks and the Board in Washington. New York lost, the other banks and even more, the Board in Washington, won. That was a little noticed event but it was the first step in that massive move of power to Washington that has dominated our lives ever since. Then and now, this building housed the U.S. Treasury Department. But at that time, the Federal Reserve Board also had its modest offices somewhere in the same building. The shift of power was sealed a few years later when the Board got its own magnificent temple a few blocks away from here on Constitution Avenue. Despite excellent advice from New York, the system refused to buy government bonds, something which would have provided cash to the commercial banks with which they could have met more easily the insisted demands of their depositors. Instead, believe it or not, the system stood idly by while banks crashed on all sides. As the head of one of the banks put it, the reserve system had to keep its powder dry for a real emergency.
But if this wasn’t an emergency, what was? As bank after bank closed a chain reaction was in process destroying money as it went. It’s a process that even today a few bankers understand.
If you ask an individual banker whether he creates money, he’ll look at you as if you are mad. Of course not, he’ll say. I don’t create money, all I do is I accept deposits from high customers, I put a little of that deposit in the vault as a reserve and I lend the rest out. I don’t create money. From the point of view of the economist, the situation is very different. As I explained earlier, most of the deposits on the books of banks were put there by an accountant’s pen. But that simple fact is concealed from the individual banker, because is doesn’t happen here, inside the bank, it happens as a result of the transactions between banks.
As the men who ran the Federal Reserve knew very well, it happens when money loaned by one bank is deposited into another bank, to be loaned out yet again. In the depression the process was working in reverse. The banks were destroying money. Nonetheless, the Federal Reserve let it happen.
The end result was that by the time the whole sorry episode was over, by 1933 the quantity of money in the United States had gone down by a third. The slow throttling had turned into strangulation. For every $3 of currency in deposits the people had in 1929, only $2 were left. For every three banks that were open in 1929, in 1933 only two were left.
The terrible depression that followed was a direct result of bungling by the Federal Reserve System. Their monetary policy starts with any hope of economic recovery.
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