The Great Devaluation

12The Money Pit

The Federal Reserve's response to the 1929 collapse has often been criticized by today's central bankers. In a conference honoring Milton Friedman in 2002, future Federal Reserve Chairman Ben Bernanke said, “You're right, we did it. We are very sorry, but thanks to you we won't do it again,” referring to Friedman's claim that it was the mistakes of the central bank that caused the Great Depression.

What the Fed missed most in 1929 was the direction of Benjamin Strong, the Fed's first chairman, who died in 1928, leaving the institution (literally) without strong leadership. Strong had understood the risks coming from the viral growth of the lending business and often lobbied to raise rates to stem the tide of speculators and speculation.

The Federal Reserve system, which was designed to provide the banking industry a lender of last resort, failed miserably in that function. Over 5000 banks would fail by 1933. At the time, the weeding out of weaker banks was considered a necessary function of the system. The House of Morgan, whom the Fed was specifically built to protect, was not a big participant in the Wall Street speculation. In fact, the larger banks, while damaged, were still in decent shape throughout the crisis. The feeling at the Fed was that the smaller institutions were casualties that were to be expected and not to be saved.

For this reason, the collapse was initially tolerable on Wall Street. While the banking cartel lost fortunes, they still maintained ...