Free To Choose: a personal Statement

save the Bank
of
United States but only after some
of
their heads had
been knocked together.
I asked them if their decision to drop the plan was still final. They
told me it was. Then I warned them that they were making the most
colossal mistake in the banking history
of
New York.
2
The closing of the Bank of United States was tragic for its
owners and depositors. Two of the owners were tried, convicted,
and served prison sentences for what everybody agreed were tech-
nical infractions of the law. The depositors had even that part of
their funds that they finally recovered tied up for years. For the
country as a whole the effects were more far-reaching. Depositors
all over the country, frightened about the safety of their deposits,
added to the sporadic runs that had started earlier. Banks failed
by the droves—352 banks in the month of December 1930 alone.
Had the Federal Reserve System never been established, and
had a similar series of runs started, there is little doubt that the
same measures would have been taken as in 1907—a restriction
of payments. That would have been more drastic than what actu-
ally occurred in the final months of 1930. However, by prevent-
ing the draining of reserves from good banks, restriction would
almost certainly have prevented the subsequent series of bank
failures in 1931, 1932, and 1933, just as restriction in 1907
quickly ended bank failures then. Indeed, the Bank of United
States itself might have been able to reopen, as the Knickerbocker
Trust Company had in 1908. The panic over, confidence restored,
economic recovery would very likely have begun in early 1931,
just as it had in early 1908.
The existence of the Reserve System prevented this drastic
therapeutic measure: directly, by reducing the concern of the
stronger banks, who, mistakenly as it turned out, were confident
that borrowing from the System offered them a reliable escape
mechanism in case of difficulty; indirectly, by lulling the com-
munity as a whole, and the banking system in particular, into the
belief that such drastic measures were no longer necessary now
that the System was there to take care of such matters.

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The Anatomy of Crisis
83
The System could have provided a far better solution by en-
gaging in large-scale open market purchases of government bonds.
That would have provided banks with additional cash to meet
the demands of their depositors. That would have ended—or at
least sharply reduced—the stream of bank failures and have pre-
vented the public's attempted conversion of deposits into cur-
rency from reducing the quantity of money. Unfortunately, the
Fed's actions were hesitant and small. In the main, it stood idly
by and let the crisis take its course—a pattern of behavior that
was to be repeated again and again during the next two years.
It was repeated in the spring of 1931, when a second banking
crisis developed. An even more perverse policy was followed in
September 1931, when Britain abandoned the gold standard. The
Fed reacted—after two years of severe depression—by
raising
the rate of interest (the discount rate) that it charged banks for
loans more sharply than ever before in its history. It took this
action to avert a drain on its gold reserves by foreign holders of
dollars that it feared would be set off by Britain's abandonment
of the gold standard. The effect domestically, however, was
highly deflationary—putting further pressure on both commercial
banks and business enterprises. The Fed could, by open market
purchases of government securities, have offset this sharp mone-
tary blow that it gave to a struggling economy, but it did not do so.
In 1932, under strong pressure from Congress, the Fed finally
undertook large-scale open market purchases. The favorable ef-
fects were just starting to be felt when Congress adjourned—and
the Fed promptly terminated its program.
The final episode in this sorry tale was the banking panic of
1933, once again initiated by a series of bank failures. It was in-
tensified by the interregnum between Herbert Hoover and Frank-
lin D. Roosevelt, who was elected on November 8, 1932, but not
inaugurated until March 4, 1933. Herbert Hoover was unwilling
to take drastic measures without the cooperation of the President-
elect, and FDR was unwilling to assume any responsibility until
he was inaugurated.
As panic spread in the New York financial community, the
System itself panicked. The head of the New York Federal Re-
serve Bank tried unsuccessfully to persuade President Hoover to
declare a national banking holiday on Hoover's last day in office.

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84
FREE TO CHOOSE: A Personal Statement
He then joined with the New York Clearing House banks and
the State Superintendent of Banks to persuade Governor Lehman
of New York to declare a state banking holiday effective on
March 4, 1933, the day of FDR's inauguration. The Federal
Reserve Bank closed along with the commercial banks. Similar
actions were taken by other governors. A nationwide holiday was
finally proclaimed by President Roosevelt on March 6.
The central banking system, set up primarily to render un-
necessary the restriction of payments by commercial banks, itself
joined the commercial banks in a more widespread, complete,
and economically disturbing restriction of payments than had ever
been experienced in the history of the country. One can certainly
sympathize with Hoover's comment in his memoirs: "I concluded
it [the Reserve Board] was indeed a weak reed for a nation to
lean on in time of trouble."
At the peak of business in mid-1929, nearly 25,000 commercial
banks were in operation in the United States. By early 1933 the
number had shrunk to 18,000. When the banking holiday was
ended by President Roosevelt ten days after it began, fewer than
12,000 banks were permitted to open, and only 3,000 additional
banks were later permitted to do so. All in all, therefore, roughly
10,000 out of 25,000 banks disappeared during those four years
—through failure, merger, or liquidation.
The total stock of money showed an equally drastic decline.
For every $3 of deposits and currency in the hands of the public
in 1929, less than $2 remained in 1933—a monetary collapse
without precedent.
FACTS AND INTERPRETATION
These facts are not in question today—though it should be
stressed that they were not known or available to most con-
temporary observers, including John Maynard Keynes. But they
are susceptible of different interpretations. Was the monetary
collapse a cause of the economic collapse or a result? Could the
System have prevented the monetary collapse? Or did it happen
in spite of the best efforts of the Fed—as many observers at the
ti me concluded? Did the depression start in the United States

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