Free To Choose: a personal Statement

The Anatomy of Crisis
85
and spread abroad? Or did forces emanating from abroad con-
vert what might have been a fairly mild recession in the United
States into a severe one?
Cause or Ef
f
ect
The System itself expressed no doubt about its role. So great is
the capacity for self-justification that the Federal Reserve Board
could say in its Annual Report for 1933, "The ability of the Fed-
eral Reserve Banks to meet enormous demands for currency
during the crisis demonstrated the effectiveness of the country's
currency system under the Federal Reserve Act. . . . It is diffi-
cult to say what the course of the depression would have been
had the Federal Reserve System not pursued a policy of liberal
open market purchases."
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The monetary collapse was both a cause and an effect of the
economic collapse. It originated in large measure from Federal
Reserve policy, and it unquestionably made the economic collapse
far worse than it would otherwise have been. However, the eco-
nomic collapse, once it started, made the monetary collapse worse.
Banks loans that might have been "good" loans in a milder reces-
sion became "bad" loans in the severe economic collapse. Defaults
on loans weakened the lending banks, which added to the tempta-
tion for depositors to start a run on them. Business failures, de-
clining output, growing unemployment—all fostered uncertainty
and fear. The desire to convert assets into their most liquid form,
money, and into the safest kind of money, currency, became wide-
spread. "Feedback" is a pervasive feature of an economic system.
The evidence by now is all but conclusive that the System not
only had a legislative mandate to prevent the monetary collapse,
but could have done so if it had used wisely the powers that had
been granted to it in the Federal Reserve Act. Defenders of the
System have offered a series of excuses. None has withstood care-
ful examination. None is a valid justification for the failure of the
System to perform the task for which its founders had established
it. The System not only had the power to prevent the monetary
collapse, it also knew how to use that power. In 1929, 1930,
1931, the New York Federal Reserve Bank repeatedly urged the

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86
FREE TO CHOOSE: A Personal Statement
System to engage in large-scale open market purchases, the key
action the System should have taken but did not. New York was
overruled not because its proposals were demonstrated to be mis-
directed or not feasible but because of the struggle for power
within the System, which made both other Federal Reserve Banks
and the Board in Washington unwilling to accept New York's
leadership. The alternative proved to be confused and indecisive
leadership by the Board. Knowledgeable voices outside the Sys-
tem also called for the correct action. An Illinois congressman,
A. J. Sabath, said on the floor of the House, "I insist it is within
the power of the Federal Reserve Board to relieve the financial
and commercial distress." Some academic critics—including Karl
Bopp, who later became the head of the Federal Reserve Bank
of Philadelphia—expressed similar views. At the Federal Reserve
meeting at which the 1932 open market purchases were ap-
proved, under direct pressure from the Congress, Ogden L. Mills,
then Secretary of the Treasury and an ex officio member of the
Board, stated, in explaining his vote for the action, "For a great
central banking system to stand by with a 70% gold reserve with-
out taking active steps in such a situation was almost incon-
ceivable and almost unforgivable." Yet that was precisely how
the System had behaved for the two prior years and was to resume
behaving as soon as Congress adjourned a few months later, as
well as during the climactic final banking crisis of March 1933.
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