The Fed’s balance sheet, 1914 to 1935
A graphical companion for students of Kindleberger and the dollar
Most Soon Parted readers will need no introduction to Perry Mehrling’s new book Money and Empire: Charles P. Kindleberger and the dollar system. The work is a dual biography, recounting the parallel and interlinked stories of Kindleberger, economist and historian, and of the US dollar, whose emergence as world money defined Kindleberger’s work as economist. Having been Perry’s student, co-author and colleague, I am too close to this book to attempt a critical assessment, though I will note what a relief it is to read an economist who cares about writing, as Mehrling does and as Kindleberger did.
I am progressing through the book in a leisurely way, letting my own questions percolate as I go. Working through Chapter 2, on CPK’s time at Columbia University, I found myself wanting to better understand the changes on the Fed’s balance sheet that had reshaped the Fed between its founding and the Great Depression. Luckily, the needed data has been reconstructed and is readily available.
So, I offer below a graphical companion to Chapter 2 of Perry’s book, with future installments to come. Page numbers in parentheses refer to Money and Empire. I will draw a few points out of Perry’s text here, enough that this post should stand well enough on its own if you don’t have the book yet.
Money and Empire tells the story of the US dollar’s infancy through the work of Henry Parker Willis (pp. 33-40), with whom CPK studied as a graduate student at Columbia in the 1930s. Willis had been central to the institutional discourse that led to the creation of the Federal Reserve.
The graph shows the Fed’s balance sheet during the brief “real bills” period, from the bank’s founding in 1914 until the beginning of war finance in 1917. As usual, I show assets in the top panel, liabilities below. Generally speaking, the Fed’s financial position until 1917 was a large holding of gold, funded mostly by reserve deposits from US banks:
Though gold made up the bulk of the Fed’s asset holding, monetary policy was conducted using a much smaller position in bills. Willis was an advocate of the real bills doctrine, according to which the Fed was to trade in short-term paper meant to be “real” in that it directly financed the production and exchange of commodities on their way to sale. It was good business for a banker, the story went, because the motive force of commerce would keep the goods moving, so ensuring steady cash flow to the banker as the bills were repaid.
The outbreak of World War I (p. 35) brought the real bills doctrine to an end, a shift Willis would hope (in vain) to see eventually reversed. The Fed began to buy bills outright, rather than simply discounting, and to trade in government securities, rather than restraining itself to commercial credit.
The second graph, using the same format and colors as the first, shows a longer period, running all the way until 1935. The pre-WWI period is still included, now compressed horizontally and scaled down vertically to make room for the big expansion of the Fed’s balance sheet during WWI:
The effects of war finance are apparent on the asset side. Government securities, discounted and held outright, came to take up a large share of the Fed’s much expanded asset portfolio. After the war, some of these funds were rolled back into commercial bills, but a decade later the crises of 1933 would again lead the Fed to become a buyer of Treasuries, in another wave of balance sheet expansion.
The more things change
Looking back on the financial consequences of WWI and the Great Depression from the end of 2022, it’s hard not to see the parallels to those of 2008 and 2020. Today’s discussions tend to treat quantitative easing, or the development of new instruments like the Fed’s overnight reverse repo facility, as entirely novel phenomena, without precedent. Kindleberger’s work, and Perry’s, show that such novelty is rather modest, when compared to the repetitions that are apparent to those who bother to look.
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