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August 31, 2003

The Fed's Depression Policies

By Gregory Bresiger

Also in this article

A History of the Federal Reserve. Volume 1: 1913-1951.

by Allan H. Meltzer

With a Foreword by Allan Greenspan

(University of Chicago Press, 799 pages).

Reviewed by Gregory Bresiger

Many traders I know have frequently told me of their suspicions of the Fed.

Here is a well researched book that will confirm many of these fears.

The complaints of these traders are almost limitless and could fill up the biggest issue of Traders Magazine: It is a politically motivated central bank that raises and lowers rates not in the best long-term interests of our economy, but to advance the agenda of the reigning administration. The Fed's leaders

often misread the economy's signals and get it wrong. They raise rates too fast and choke a recovery. They drop rates too fast and end up causing disastrous rates of inflation, wiping out large parts of interest sensitive industries. (Remember the era of stagflation back in the 1970s. If you were a builder then, you certainly do!)

Fed critical traders are not alone. In fact, this book will remind you that those who question the wisdom of the Fed are part of a long tradition in American history. Thomas Jefferson, an opponent of our first national bank, is reputed to have said that a national bank is a greater threat than a standing army.

Here, in this interesting book about the history of the first few generations of the Fed, is a work with countless illustrations of that Jeffersonian fear of political banks underwritten by governments. To read this book is like reading a kind of Pentagon Papers of American monetary history: It is a litany of failed policies and mistaken notions along with frequent calls for the Fed to obtain greater and greater powers despite its sorry record.

Possibly, the biggest chapter in this sad sack record is the Fed's wrongheaded policies leading up to and after the Great Crash. The Fed, Allan Meltzer tells us, consistently misread the signals just before the crash, then contracted the money supply after the crash. This turned what might have been a short recession into the greatest depression in the nation's history. The parallels to today's economy are striking.

The author of "A History of the Federal Reserve"- unlike, say John Kenneth Galbriath or some other socialist writers - doesn't blame "speculators" for the crash and the resulting depression. The fault lies with the Fed, the author rightfully tells us, which, meeting months after the crash, made some bad decisions.

"If the governors of the Federal Reserve had used the stock of money instead of interest rates as an indicator of monetary policy, they would not have concluded that monetary policy was easy," he writes of the Fed a few months after the crash. "Additional open market purchases at this time would have contributed to the expansion. Instead, the further contraction of money contributed to the decline in output and to the bank failures that came with increased frequency after this meeting." (page 298).