Thomas Tooke

Archive for April, 2012|Monthly archive page

A brief viewpoint from Kemmerer on the 1797 to 1821 Bank of England restriction

In Uncategorized on April 30, 2012 at 11:54 pm

Kemmerer writes in 1920:


“Although the Bank of England suspended specie payment February 27th, 1797, and did not resume redeeming its notes in coin until May 1st, 1821; and although the notes were at a discount in terms of gold and silver during the greater part of this twenty-four-year period — a discount reaching a maximum of about 41% for the year 1814 — the greatest increase in wholesale prices for the period of suspension (using 1797 as the base year) was 49%. This price advance is equivalent to only about two-fifths of the price advance that has taken place in the United States since 1913. Stated in another way, the purchasing power of the United States dollar declined about 62% from 1913 to February, 1920, while that of the irredeemable bank note of the Bank of England declined but 33% during the entire period of the Napoleonic Wars.


Reading the comparative decline in the pound during the bank restriction versus the first world war and subsequently the second world war and the Vietnam War effect on the USD, it seems that the world is progressing (in the quantity of debasement).


Inflation in 1913-1920. The obvious mistake of blending all prices together.

In Commodities, Inflationary Period of 1913-1920 on April 30, 2012 at 11:43 pm

Kemmerer seems to be writing as of 2012 not 1920. This is why I abundantly cite his books back from those days. In this post and the next few posts, we examine the result of the reduction in reserves, Gold embargo, re-hypothecation of War bonds by the Fed, liberal 0 reserve requirements for Government bonds, propaganda to elicit the public into buying war bonds that we have described before. Here is the result on commodities prices. Here is what Kemmerer writes:


Of course even without inflation the prices of those commodities for which the war made most urgent demands, such as munitions, ship building materials, and the like, would have advanced greatly, but these advances would have been compensated for by declines in the prices of other goods. If an individual with a given income spends more for articles A, B, and C, he will, of necessity, spend less for articles A, B, and C, he will, of necessity, spend less for articles D, E and/or F, unless he draws on his capital, in which case someone will have less to spend on these or other articles. A shifting of the country´s economic demand from one kind of goods, say the goods of peace, for another kind, say the goods of war, will force up the prices of the former. If more of the circulating media is used in exchanging the war goods less will be available for exchanging the peace goods, and the demand for them will fall off with a consequent reduction in their prices. The rise in the prices of the one group, however, would be compensated for by the fall in the prices of the other and little or no change in the general price level would result. When, however, this shift of the economic demand from peace commodities to war commodities is accompanied by a large inflation of the media of exchange, no such compensating effect is necessary. There may be an upward movement of practically all prices although of course the price of those commodities upon which the war demand is concentrated will advance most.


A few important points here.

First commodities price rise = inflation in the mind of the author, it is quite a different situation that today´s massaged numbers.

Second, evidently a rise in prices of a set of essential needs with inelastic demand, say food and energy will decrease the income available for other consumption. So there will not be a lot of pricing power from the sellers of 3-D TV while demand for food is quite inelastic if not growing if the population grows.

The conclusion would be that statistical agencies know about this phenomenon perfectly well, and evidently the omission is not “devoid of sense” since it is not an omission in the first place, as it is excluded purposely.

Finally, from an investment point of view, one should select the commodities whose demand increase in period of stress or stay constant. To that respect agricultural commodities have the most inelastic demand features and benefit a lot in period of massive monetary expansions.

Here is below indexes of commodities price computed by different agencies.

Kemmerer continues:


Taking the index numbers of United States Bureau of Labor Statistics as the most comprehensive and most scientifically prepared of the index numbers covering the entire period 1913 to 1919 inclusive, we may way that the wholesale price level increased from 1913 to April, 1920, 165%; in other words, if one calls the dollar of 1913 a 100% dollar in its purchasing power over commodities at the wholesale, the dollar of today is approximately a 38 % dollar.


Patriotism well rewarded!

Decrease in Gold backing of the currency and deposits in 1920 in different countries.

In Gold vs monetary base on April 29, 2012 at 4:12 pm

Kemmerer writes


The proportion of gold in our total circulation has likewise materially declined. On July 1, 1914, our stock of monetary gold (namely, gold coin, plus gold bullion in the treasury) was equivalent to 55.3 per cent of our total monetary circulation (as computed by the Treasury Department); and on June 1st, 1920, it was equivalent to 43.6 per cent. On June 30th, 1914, the stock of monetary gold was equivalent to 29.7 per cent of our national banks deposits bank deposits (exclusive of bankers´balances), and on December 31st, 1919 (the date of the last Comptroller´s call for which figures are available), the stock of monetary gold, less than held by the federal reserve notes, was equivalent to only 14.1 per cent of the national bank deposits.


There is no manipulation of the Gold price! At least not before September 7th 1917. Or before 1873? Patrotism used again as the excuse.

In Inflationary Period of 1913-1920, Uncategorized, Unreserved Banking on April 29, 2012 at 3:19 pm

In the middle of 1830s, Gold was free to leave the Bank of England, and the bullion free to be exported. When over-expansion of paper money would occur, the result would prompt the speculators to lean against the tide by changing their Gold early in the process for Bullion and ship it overseas. This would lead to a contraction and at some point it would become interesting to bring bullion again in the UK.  However on September 7th, 1917 the United States government decided to monopolize money further (after the Fed layered the banking system with war bonds –treasuries–),  and declared an embargo on Gold shipments.

As Kemmerer writes:


The heavy drain of gold which such a condition of affairs would normally have brought about was prevented by the gold embargo, which was in effect from September 7th, 1917, to June 10th, 1919, by the government´s giving wide publicity to the doctrine that hte use of gold coin or gold certificates in circulation was an unpatriotic act, that all gold should be impounded in the federal reserve banks where it would serve the country with maximum efficiency, and by the further fact that most of the leading countries of the world were inflating their currency and bank credit at even more rapid rates than we were.

The result was an expansion of bank loans and, in consequence, of deposit currency such as this country and probably no other country ever saw before in an equal space of time. In the following table the expansion of bank deposits is shown. The figures cover individual and government deposits in commercial banks and government deposits in federal reserve banks.


Here we have within a period of six years an increase in our national bank deposits of approximately 118 per cent, or over seven billion dollars, and an increase of state bank and trust company deposits of over 121 per cent, or over six billion dollars. The two together represent and increase of over 120 per cent of our deposits in commercial banks since 1913, or an increase of over 13 billion dollars. Probably 80 to 85 per cent of the country´s business is concluded through the instrumentality of bank checks. It is through checks that deposits circulate and that the bank´s depositor gives expression to his demand for goods. The war period has been one in which deposits have circulated at a more rapid rate than usual and the doubling of deposits has therefore probably resulted in an even greater increase in the country´s deposit currency circulation.

This tremendous increase in bank deposits has resulted in a great decline in the average percentage of actual cash reserves held against deposits — namely the ratio of deposits (as above computer) to actual cash held by national banks, state banks, trust companies, and federal reserve banks (exclusive of reserves held against federal reserve notes). This average percentage for the country as a whole has varied as follows since 1913:

The hidden high interests to the government. War as a distorting mechanism to boost demand for capital.

In Inflationary Period of 1913-1920, Unreserved Banking on April 29, 2012 at 2:39 pm

Kemmerer makes an interesting argument that indeed high interests have to be paid one way or the other even if the nominal interest rates are low.


The Fundamental economic law which makes the interest rate the resultant of the interaction of the forces of demand and supply in the capital market was forcing up the real interest rate under the influences of a world wide destruction of capital and an unprecedented demand. “Present goods were at a large and ever-increasing premium over future goods.

The government, it is true, paid lower rates of interest on its bonds, but it was compelled to pay higher prices for the war supplies it bought, and was therefore compelled to float more bonds. It paid lower interest rates by reason of this policy, but it paid an dwill pay more interest.


Here I will interest some remarks. It sounds like the destruction of capital and manufacturing capacity, and probably the restriction of the flow of goods (which also a feature of the Napoleonic wars as noted by Tooke, has the real impact of forcing the demand for capital up. True the soldiers dead by millions reduce demand undeniably, but overall the destruction of capital is larger than the destruction of population.


Because of the observation that the more money and deposit credit an individual has the more goods he can buy, the inference was popularly drawn that the more money and deposit credit the government could get, the more war goods and services it could buy. The forces above described favored loan and deposit expansion. Such expansion was profitable to the banks and profitable to businessmen, while to the banker, the business man, and the ordinary citizen, the acts which were resulting in this expansion appeared to be acts of patriotic duty.

The unique purpose of low interest rates: Fund the government debts, concept of risk free upside down, usurpation of interest rates mechanism

In Inflationary Period of 1913-1920, Unreserved Banking on April 27, 2012 at 2:31 am

As Kemmerer further explains in 1920, the main purpose of low interest rates was to fund the government and it was dearly paid by the citizens of the United States through steep inflation.


In their laudable desire to keep interest rates low on bank loans to essential war industries, and more importantly, to make possible the floatation of large government war loans at excessively low rates of interest, the federal reserve authorities adopted a policy of low discount rates for the federal reserve banks and of preferential rates and great liberality for advances made on the security of government war obligations. Throughout the entire period of our belligerency the loan and discount rates of the federal reserve banks were below the market rates, and “the market was in the federal reserve banks.” Funds received by banks for the government through the sale of liberty bonds and short-time certificates were usually left for a time on deposit with these receiving banks at the low rate of 2 per cent interest and without reserve requirement. This policy greatly expanded deposit credit. When the deposits were called by the government the funds for meeting the calls could readily be obtained by the bank´s borrowing from its federal reserve bank either by the rediscount of war paper, or by a direct loan collateraled by government security; and the rates charged for these loans were usually enough lower than the rates paid to the banks by the customer for his advance used in buying the bonds to yield the bank at least a small net profit. The result was the piling up of many billions of dollars of liberty bonds and certificates of indebtedness in the commercial banks of the country and the federal banks, particularly the latter, in the form of collateral for loans.  Federal reserve banks loans so collateraled provided member banks with a continuously increasing supply of legal reserves for further loan and deposit expansion; and the expansion of federal reserve loans, with resulting increase in federal reserve deposits and issues of federal reserve notes was continually reducing the percentage of reserves held by federal banks. We bough our low interest rates on government paper at the price of very high prices for commodities. We kept interest rates down by a policy that kept pushing the price level up.


I will add a few personal comments here. This paragraph is important because a lot falsehood commonly held as “truth” are revealed here.

First on the issue of central bank as an independent entity. It appears that without re-discount from a federal system there would have been no demand for war bonds (treasuries), hence the conclusion is that the Federal Reserve was there to facilitate the low borrowing costs of the government.

Second the idea that the Fed must set interest rates is heavily fought by this author in 1920 as we will see later. He actually complains that “the market is in the Federal Reserve banks” instead of being in the real market.

The great fallacy of risk free rate on government bonds has the following origin. In order to maximize the flooding of government bonds in the banking system, the reserve requirements are 0. The legal requirement has nothing to do with the risk.  It is an upside down concept ignoring the agenda of the government.

The Federal System by treating government bonds very liberally without regards to the good bills doctrine but purely by political imperative, results in expansion of credit based on the re-hypothecation of government bonds with artificially low rates.


A convenient way to flood the banking system with government securities.

In Inflationary Period of 1913-1920, Unreserved Banking on April 27, 2012 at 1:55 am

As Kemmerer wrote, patriotism was quite convenient:


Much of this potential loan and deposit expansion appeared in the early years of the war, when the demands of European belligerents for our products assumed tremendous proportions and offered high profits to American producers of materials, so high as to call for a large expansion in the production of these materials. Labor was shifted from “non-essential industries” to “essential industries,” and while many of the former lagged, the latter were greatly stimulated. Here then was a great demand for increasing bank credit at just the time that the establishment of the federal reserve system, the reduced cash reserve requirements of commercial banks, and the heavy imports of Gold from Europe were making a larger loan and deposit expansion possible. The new federal reserve law and the  heavy gold imports created a potential supply of new circulating bank credit, the war stimulated the demand. It was the banker´s financial interest to expand credit, and to the interest of many groups of business men to seek these newly available funds.

As a matter of patriotic duty bankers were expected to expand their loans and deposits. Long before the United State entered the war, the sympathy to the Allies in this country became so pronounced and the conviction that they were fighting our battles became so strong, that production for the Allies and the granting of loans to finance such production were felt to be patriotic acts. After the United States entered the war, the extension of bank credit to the maximum limit consistent with safety to “essential industries,” and to the buyers of libery bonds was looked upon as the paramount duty of banks. “.


My comment here about how the Treasuries (war bonds) were initially inserted into the banking system with the incentive to let people borrow short term at low rates to buy liberty bonds and make a “spread”. Before that, without the generous  discount, it would be very difficult for the bank to have incentives to load up on government war bonds. This is how the Treasuries invade the banking system.

More from Kemmerer´s writings…


The demands of patriotism were looked upon as requiring the public to avail themselves to the limit of the liberal loan facilities made available by the banks. Nearly everywhere the belief prevailed that with the loans thus available, war industries should expand their production and the public should buy bonds to the maximum. “Borrow and buy”was a widely used slogan in the first three liberty loan campaigns, and was strongly, although more quietly, urged upon the public, in the fourth liberty loan and the victory loan campaigns.


The mechanics through which the Fed encouraged Malinvestment in 1913

In Unreserved Banking on April 27, 2012 at 12:53 am

In  a previous post we have discussed the level of unreserved banking which the Federal Reserve System brought about. Today I want to show how exactly the Malinvestment was encouraged by the Federal Reserve System.

As Kemmener discussed in 1920.

Take the case of a bank in a central reserve city which had been normally carrying a cash reserve in the neighborhood of say 25 per cent, because that was the minimum per-centage required by law, or because experience had shown that a reserve about that size was best suited to its particular type of business, or both of these reasons. Such a bank we will assume after the establishment of the federal reserve system, of which it became a member, found that the legal reserve requirement against demand deposits was cut to 13 per cent and that the greater liquidity of its assets brought about, through the facilities for rediscount and collateral loans offered by the federal loans offered by the federal reserve system would apparently make it safe for it to reduce its reserve to 17 per cent (namely, 13 per cent legal reserve in the form of a deposit with its federal reserve bank and 4 per cent cash in vault).

What would be such a bank´s probably course of action under these circumstance? The answer is obvious. It would reduce its normal reserve percentage from 25 to 17 because by so doing it would increase its profits without materially weakening its financial position or impairing its efficiency. The most likely method of doing this and the method that would probably be used, if possible, would be for the bank to extend its loan and deposit accounts. To do this it might well reduce its discount rates, extend the credit limits of its best customers, and possibly extend credit to others whom it had previously refused out of what might appear to it now to have been an excess of caution (emphasis added). In this way the loan account would be expanded, deposits would be increased, and the reserve percentage (legal plus till money) would be reduced from 25 per cent to the new norm of 17 per cent, the bank thereby probably realizing for its stockholders substantially increased profits.


So the leverage in the economy is actually not regulated by the Fed, but promoted by its existence, note the impact on lending to clients which were before denied credit for lack of credit quality.


If this reduced reserve requirement were limited to one bank, the possibility of deposit expansion thereby created would be small because the enlarged deposits resulting from the increased loans would tend to give the bank an unfavorable clearing house balance, and to draw quickly away thereby a part of its reserve money. Under the conditions, however existing during the war period this opportunity and this motive for reserve reduction, or in other words for loan and deposit expansion, were open to all of the national banks in the country and to large numbers of state banks and trust companies. It was but natural therefore that they should all endeavor to expand, in order to take advantage of the opportunity to increase their profits. The last few years have been highly profitable years for commercial banks.


The Fed encouraging un-reserved banking from the Start (1913-1919 account).

In Unreserved Banking on April 26, 2012 at 2:01 am

Kemmerer writes the following in his books in 1920:

State banks and trust companies entering the federal reserve system have generally experienced substantial reductions in legal requirements so far as actual cash reserves are concerned.  The reduction of legal reserve requirements was a statutory recognition of the fact that smaller cash reserves are needed under a banking system possessing a group of central banks of issue and rediscount than are needed under a highly decentralized system of banks like our American banking system prior to the federal reserve act. It was perfectly proper that with the establishment of the federal reserve system the legal reserve requirements of the banks should be reduced. Whether the reduction was too great or not, only experience will tell. […]

Well I let the readers make their own opinion about that. Kemmerer continues.


In the writer´s judgment the reduction was excessive, and it was a mistake to discontinue all-cash-in-vault legal reserve requirements of member banks. The important fact however, to note is, that the reduction of reserve is taking place at just the time when the country was being flooded with gold from the belligerent countries of Europe created the possibility of a tremendous loan and deposit expansion. This potential expansion was quickly turned into an actual expansion under the pressure of four important forces.

In fact from August 1st, 1914 to April 1917 (practically the period of the war prior to our entrance as a belligerent), our net importations of gold amounted to $1,109 millions and this enormous increase in our supply we maintained throughout the remainder of the war. We have most of it to this day, although there have been substantial losses since the armistice.

There four forces  were:

(1) the natural desire of bankers and business men for profit

(2) the patriotic impulses of bankers and business men to render the nation the best possible service in its time of emergency

(3) the desire of the Government to finance itself with the minimum disturbance to legitimate busines

(4) the desire of the Government to float its securities in large volume at the minimum possible rate of interest.

Reserve requirements reduction during 1913-1919. The Federal un-reserved system.

In Unreserved Banking on April 25, 2012 at 3:02 am

As Kemmener writes in March 1920:


The period of 1913 to 1919 was a period in which the country´s legal reserve requirements for bank deposits were enormously reduced. In 1913 national banks in central reserve cities, namely, New York, Chicago and St Louis, were required to keep on hand cash reserves equivalent to 25 per cent of their deposits, both demand deposits and time deposits. National banks in the 47 reserve cities were also required to maintain reserves of 25% per cent, but one-half of this could be maintain as an ordinary deposit with a national bank in a central reserve city. Other national banks, so called “country banks” were required to maintain against deposits reserves of 15 per cent of which three-fifths could be held as an ordinary deposit with a national bank in a reserve city or a central reserve city. For all banks the 5 per cent cash redemption bank notes was counted as part of the legal reserves against deposits.

At the present time (1920) all legal reserves of national banks consist of deposits with federal reserve banks consist of deposits with federal reserve banks against which deposits the federal reserve banks are required to maintain only 35 per cent lawful money reserve. Time deposits, namely deposits after notice of 30 days, which constitute about one-fourth of the total individual deposits of national banks, since 1913 have been treated separately as regards legal reserves and in all national banks are now subject to a reserve requirement of only 3 per cent. The 5 per cent bank note redemption fund can not longer be counted as legal reserve against deposits. Against demand deposits the present legal reserve requirement is 13 per cent for banks in central reserve cities, 10 per cent in reserve cities, and 7 per cent for banks in other cities.

An idea of the extent of the reductions in legal reserves of national banks since 1913 can be obtained by assuming three national banks, each having $1,200,000 demand deposits, $300,000 of times deposits, and $100,000 of national bank notes outstanding, one bank being in central reserve city, on in a reserve city, and one in a “country bank” city, and asking ourselves what ultimate legal cash reserves would have been held against theses deposits in 1913 and 1920 respectively. The answer is given in the following table.