AGD - Chapter IV: The Inflationary Factors

Having presented the theoretical part, Rothbard now digs into the analysis of the AGD, starting with Part II of the Book, The Inflationary Boom (1921 – 1929). It is clearly demonstrated, that inflation is not as easy a process, as just “printing” money. Instead he lists all the inflationary effects the US government and the FED created in that period of time.

Some general remarks on how difficult it is to do empirical analysis on any economic data open the chapter. Even if you can determine the price development within a certain period, the question what if … (there would have been different politics) … remains open. Focusing too much on what you can measure will not get you ahead in the view of Rothbard.

The Definition of MoneySupply: Next pages focus on what is considered money, and Rothbard includes de facto not only gold, paper (Federal Reserve Notes), but also demand deposits, time deposits, savings deposits and he goes even further and includes shares in savings-and-loan associations and life insurance surrender liabilities.

Inflation on the Money Supply , 1921 – 1929: Total money supply raised from USD 45.3 bn in July 1930 to 73 USD bn in June 1929, with the entire expansion taking place in money substitutes. (The numbers do not look dramatic given where we stand today.) The CAGR was around 7,7 %, the inflation 63 % over the time period. Total dollar claims vs. gold reserves raised from a factor of 17 to 24.

Generating the Inflation, I: Reserve Requirements: Reserve Requirements did not change in the 1920s, and it is also demonstrated, that there was no inflationary effect from a shift between different types of banks, or different regions. Time deposits (with lower reserve requirements of only 3 percent) did increase vs. demand deposits (with reserve requirements between 7 and 13 percent, depending on the location of the bank).

Generating the Inflation, II: Total Reserves: Reserves did rise in the 1920s by 47.5 % (from 1.6 to 2.36 USD bn) and thus provide the major lever for the 62 % increase in money supply (from 45.3 to 73.3 USD bn). So 760 USD mn of reserve increase could lift the money supply by 28 bn USD. (Worried about the world of today???) So, what increased the total reserves?

1) Monetary Gold Stock (uncontrolled – 100% effect): Deposition or withdrawal of gold

2) Federal Reserve Assets Purchased (controlled – 100%): most prominent operation is buying of US Gov. Securities by the FED

3) Bills Discounted by the FED (controlled)

4) Other Federal Reserve Credit (controlled) : checks not collected by the FED (zero interest credit) – not of importance

5)  Money in Circulation outside the Banks (uncontrolled) 

6) Treasury Currency Outstanding (controlled)

7)  Treasury Cash Holdings (controlled)

8) Treasury Deposits at the FED (controlled)
9) Non-member Bank Deposits at the FED (uncontrolled)
10) Unexpended Capital Funds of the FED (controlled)

In the whole period, while uncontrolled items (items the government, FED could not steer) did decline, controlled items did increase. Rothbard then shows the development over 10 sub-segments of the 1920s.

Bills discounted: FED started to keep the rediscount rate below market value. So banks could borrow from the FED, lending out at a higher rate to the public. (Sure you have never heard of that in the 2010s …) Politicians and bureaucrats cited the FED to be an institution that should ensure that the ‘enlarged credit resources demanded by the needs of business and agricultural enterprises will come into existence almost automatically’.

Bills bought-acceptances: Rothbard demonstrates that the FED created and subsidized an artificial acceptance market, and bought whatever was offered to it at an artificially cheap rate. The effect of this action is considered much worse than the discount policy or the stock market loans. Paul M. Warburg seems to have profited most from this policy, being an advisor to the FED and chairman of the board of the International Acceptance Bank of New York himself. Interesting are the change in regulations: from “no purchasing of acceptances allowed for national banks” to “a limit of 50 % of a banks capital and surplus” to 100 %, 150 % …

US Government Securities: FED tripled its stock of government securities during Nov. 1921 and June 1922. This was also the time, when the Open-Market Committee of the Reserve banks was founded. In addition, the government started to use short-term debt on a large scale. Those floating bills had to be refunded on and on. Member banks of the FRS (Federal Reserve System) were encouraged to hold such bonds.