The Mystery of Banking

de facto
demand deposits.
The Federal Reserve staff itself admitted that, during the
1920s, 
there developed a tendency to induce depositors to transfer
their funds from checking accounts to savings accounts.
Banks frequently not only allowed such a transfer but
encouraged it in order to take advantage of lower reserves
and to obtain a large basis for credit expansion. . . . In many
cases, particularly in large centers, the aspect of savings was
impaired by allowing depositors to draw a limited number
of checks against time deposits.
4
Time deposits expanded more rapidly than demand deposits
from the outset of the Federal Reserve System. From June 1914
to January 1920, when demand deposits were growing from $9.7
billion to $19.1 billion, or 96.9 percent, time deposits at commer-
cial banks rose from $4.6 billion to $10.4 billion, or 126.1 per-
cent. Then, in the great boom of the 1920s, starting after the reces-
sion of 1920–21, total demand deposits rose from $16.7 billion in
July 1921 to $22.8 billion eight years later, in July 1929, an
Central Banking in the United States IV
239
4
Quoted in M. Friedman and A. Schwartz, 
A Monetary History of the
United States 1867–1960
(Princeton N.J.: National Bureau of Economic
Research, 1963), pp. 276–77. Also ibid., p. 277n. See also Phillips, et al.,
Banking and the Business Cycle
, pp. 29, 95–101.
Chapter Sixteen.qxp 8/4/2008 11:38 AM Page 239

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The Mystery of Banking
increase of 36.5 percent. On the other hand, time deposits in
commercial banks expanded from $11.2 billion to $19.7 billion
in the same period, a far greater rise of 75.9 percent. The great
boom of the 1920s was largely fueled by credit expansion going
into time deposits. 
Furthermore, Phillips, McManus, and Nelson point out that
by far the greatest expansion of time deposits came in Central
Reserve Cities (New York and Chicago), where the Fed’s open
market operations were all conducted. Central Reserve City time
deposits rose by 232 percent from December 1921 to December
1929; whereas Reserve City time deposits rose by 132 percent and
Country Banks time deposits by 77 percent in the same period.
Moreover, most of the rise in time deposits occurred in the three
years 1922, 1925, and 1927—precisely the three big years of
open market purchases by the Federal Reserve, and hence of cre-
ation of new bank reserves by the Fed. Significantly, these facts
show that time deposits in the 1920s were not genuine savings,
but merely a convenient means by which the commercial banks
expanded on top of new reserves generated by open market oper-
ations of the Fed. 
Phillips, McManus, and Nelson describe the process as fol-
lows: 
Chronologically and causally, the order of developments
was as follows: Federal Reserve open-market purchases
resulted in expansion of member bank reserve balances; this
served to instigate increased purchases of investments by the
member banks; and the credit generated thereby took the
form largely of time deposits. The Reserve Banks pumped
credit into the money market, inducing increased reserve to
purchase investments . . . which created more deposits in
the banking system, and the increased deposits, being
unneeded by business men and corporations as demand
deposits for current transactions, were shifted to time
deposits which could draw interest.
5
5
Phillips, et al., 
Banking and the Business Cycle
, p. 99. On time deposits
in the 1920s, see also Murray N. Rothbard,