Based on information and analyses provided by the Mises Institute and Murray Rothbard.1
The Expansion of Demand and Time Deposits
During Woodrow Wilson’s presidency (1913-1921) demand deposits2 grew exponentially (by 96.9% from 1914-1920), time deposits3 also skyrocketed in popularity (by 126.1% from 1914-1920).
After the short 1920-1921 economic recession that President Warren G. Harding’s administration (1921-1923) effectively dealt with by cutting the Federal budget and lowering taxes, the economy began booming and led into what would be later remembered as the “Roaring Twenties”. In part of this boom caused by Harding’s administration, from 1921-1929 demand deposits increased by 36.5% and time deposits expanded by 75.9%. From 1914-1929 the total number of demand deposits increased by 133.4% and time deposits increased by 202%.
However, this new and incredible surge in the economy was full of hot air. The Roaring Twenties were in reality, largely in part being funded by the massive amount of debt being used to expand time deposits. The greatest expansion of this debt was to be found in Central Reserve centers such as New York and Chicago, where the Fed’s open market operations4 were all conducted, as opposed to Reserve Cities and Country Banks. During this period, time deposits would be treated like demand deposits in case of bank runs, which would go on to create problems towards the start of the Great Depression.
The Golden Deal
With the passage of the Federal Reserve Act in 1913,5 President Wilson appointed Benjamin Strong Jr. to be the Governor of the Federal Reserve Bank of New York. Strong would use this position to dominant the Federal Reserve System with his proximity to financial institutions and behind-closed-door-deals. Strong would begin to make Fed policy without the consultation or even against the consultation of the Federal Reserve Board of Washington D.C. Strong ran this powerful position from 1914-1928.
Strong was a massive proponent of inflationary policies that would be used to fund the Great War on the behest of President Wilson, which also connected to the agenda of the House of Morgan.6 Another motivation was to prop up the Bank of England and put them in the debt of the United States government after the Great War. The Bank of England decided to return to the gold standard7 in the 1920s but they faced a major problem, they had an overvalued currency. To prevent the loss of gold to the states in 1924, Montagu Norman, the Governor of the Bank of England secretly convinced Strong that inflating their gold would benefit both parties involved. The expansion would cease after the death of Strong in 1928, but the effects it caused would culminate into the Great Depression.
In 1928, Strong confessed:
“Very few people indeed realized that we were now paying the penalty for the decision which was reached early in 1924 to help the rest of the world back to a sound financial and monetary basis.”8
The decision Strong is referring to is the decision to prop up the fake value of Britain’s gold standard, which would cause the world to trade in an inflated gold backed currency, and caused the United States to suffer from the brunt of that deal.
The inflation was also motivated to help farmers export more produce to foreign markets by using foreign lending. However at the same time the United States turned to a strong protectionist policy when the Fordney-McCumber Tariff Act was passed in 1922.9 Foreign lending exploded at this time but foreign countries were simultaneously being hampered by the new protectionist policies of the Harding administration, so during this time, they were encouraged to borrow United States dollars.
The government did not have the authority to interfere with loans during times of peace, however, they proceeded to do so illegally. In 1921, the Harding administration began to confer with several prominent bankers, at the instigation of Secretary of Commerce, Herbert Hoover, to be informed in advance of foreign loans, so that the United States government could “advise” the bankers on how the government would handle these loans if they were the ones making the agreements. To Hoover, even bad loans stimulated exports and provided a cheaper alternative to employment relief. Later Hoover would demand that all foreign loans were to be “inspected” by the Department of Commerce under the guise of “national interests”.
Demand deposits/Checkbook money: are funds held in demand accounts in commercial banks. These account balances are usually considered money and form the greater part of the narrowly defined money supply of a country. Simply put, these are deposits in the bank that can be withdrawn on demand, without any prior notice.
Time Deposit/Term Deposit: (also known as a certificate of deposit in the United States) is a deposit in a financial institution with a specific maturity date or a period to maturity, commonly referred to as its "term". A time deposit is generally not negotiable; it is not transferable by the depositor, so that depositors need to deal with the financial institution when they need to prematurely cash out of the deposit.
Open Market Operation (OMO): is an activity by a central bank to give (or take) liquidity in its currency to (or from) a bank or a group of banks. The central bank can either buy or sell government bonds (or other financial assets) in the open market (this is where the name was historically derived from) or, in what is now mostly the preferred solution, enter into a repo or secured lending transaction with a commercial bank: the central bank gives the money as a deposit for a defined period and synchronously takes an eligible asset as collateral.
Federal Reserve Act of 1913: An Act to provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes
Nickname for the banking institution, J.P. Morgan & Company.
Gold Standard: a monetary system in which the standard economic unit of account is based on a fixed quantity of gold.
Murray N. Rothbard, "The Mystery of Banking", Chapter 16: Central banking in the United States IV: The Federal Reserve System, p. 235-246, 1983.
Fordney–McCumber Tariff of 1922: was a law that raised American tariffs on many imported goods to protect factories and farms. The US Congress displayed a pro-business attitude in passing the tariff and in promoting foreign trade by providing huge loans to Europe. That, in turn, bought more US goods. However, five years after the passage of the tariff, American trading partners had raised their own tariffs by a significant degree. France raised its tariffs on automobiles from 45% to 100%, Spain raised its tariffs on American goods by 40%, and Germany and Italy raised their tariffs on wheat. According to the American Farm Bureau, farmers lost more than $300 million annually as a result of the tariff.
Hey! Let’s cool it with the antisemitism.
Warren G. Harding is a truly underrated president. His winning formula of fiscal conservatism—tax cuts, less government spending, and cordial relations abroad—all contributed to the booming energy of the Roaring Twenties.