Clearinghouse Certificates during the Great Depression: A Non-example of “Unaccounted Money”
Abstract: This article examines the non-issue of bank clearinghouse certificates during the Great Depression of the 1930s. Instead of a market failure, this non-issue is found to have been the result of an intervention. At the time, the issue of clearinghouse certificates to temporarily meet the need of the economy for a medium of exchange following a financial panic was a well-established practice. To make a long story short: in 1933, plans were underway by bankers to resort to this expedient. Merchants and the public at large were anxious to get their hands on the money substitute. But federal authorities said no. Instead of a short-term fix, following which the economy would return to its former ways, federal authorities had other plans. This paper examines both the specifics of the issue of emergency money during the Great Depression and the general principles involved in such issues.
JEL Classification: B53, E14, E51, N12
Clifford F. Thies ([email protected]) is Eldon R. Lindsey Chair of Free Enterprise Professor of Economics and Finance at Shenandoah University. He thanks two anonymous referees for their constructive criticism and absolves them of any fault for remaining errors and shortcomings.
According to Paul Krugman (1999, 8–11), a contributing cause to a depression is hoarding. Because of hoarding, the government should issue massive amounts of money to prevent recessions from turning into depressions. But, why must the government do this? Why can’t the private sector issue money during an emergency? At one level, the answer is easy: the government has monopolized money and prohibits the private sector from issuing money during an emergency. At another level, the answer is complicated.
Relying on numismatic sources, Richard Timberlake (1981, 860) demonstrated that the private sector repeatedly issued massive amounts of money during the hard times of the early to mid-nineteenth century. While there appears to have been some number of issues throughout the period, private, non-bank issues of money mostly appeared during certain times (1814–17, 1837–40, 1857–58, and 1862–64). Timberlake describes this money as “unaccounted.” Subsequent research has documented other instances of unaccounted money including Michigan when the state was nearly without banks (Baily, Hossain and Pecquet 2018), and New Orleans when it was occupied by northern troops during the Civil War (Pecquet and Thies 2010). During the National Bank Era, clearinghouse associations took the lead in issuing money during financial crises (Dwyer and Gilbert 1989, Gorton 1985). So why was there no clearinghouse money during the Great Depression of the 1930s?
In 1999, when Krugman wrote The Return of Depression Economics, it was received strangely. It was a thin book, written in large type, short on economics and long on story-telling. Supposedly, it was about Japan’s “lost decade,” when—according to Krugman—they had not increased their national debt enough. Yet, Japan’s national debt had grown to 200 percent of GDP. Krugman updated the book, The Return of Depression Economics and the Crisis of 2008 (2008). In the update, his concern was that the U.S., with a budget deficit of 12 percent of GDP, was not adding to its national debt fast enough.
To illustrate the problem of hoarding, Krugman used the example of the Capitol Hill Baby-Sitting Co-op of Washington, D.C., of the 1970s. As Krugman describes this co-op, it consisted of lawyers and other such well-heeled persons who decided that, instead of hiring baby-sitters, they would take turns baby-sitting each others’ children. The co-op required that its members only obtain baby-sitting services from each other, and use chits distributed by the co-op for the service. But, the members of the co-op hoarded the chits they had (in order to have them available when they really needed baby-sitting services), rather than use them freely in order to go out. And, since few people were purchasing baby-sitting services, nobody could be sure of acquiring chits through the offer of baby-sitting services, which only served to reinforce the urge to hoard chits.
After trying various New Deal-type “solutions” to the hoarding problem, such as requiring members to go out at least twice a month, the Co-op happened upon the idea of distributing more chits. The additional chits allayed members’ concerns that had led to the hoarding problem, and the market in baby-sitting services picked up.
What does Krugman’s story of the hoarding of baby-sitting chits have to do with depressions? During depressions, people lose confidence in their ability to earn money by offering their labor and other productive services. They therefore seek to build up cash reserves, i.e., to “hoard money.” But, the Keynesian story goes, the hoarding of money lowers the demand for labor and other productive services, resulting in a further loss of confidence, and intensifying the urge to hoard.
Other examples of hoarding come readily to mind. During the coronavirus panic of 2020, there was a run on toilet paper. Because people were not confident in future supplies of the item, they rushed to buy it, and emptied the shelves. Voila! stores ran out of toilet paper, just as panicked shoppers feared. But the shortage was only temporary, and the supply chain quickly restored retail inventories.
Throughout most of the world, replacement kidneys are in short supply as most people “hoard” their extra kidney not being confident of being able to obtain a replacement kidney if the need should arise. But not in Iran, where the authorities allow an internal market in kidneys. In that country, replacement kidneys are in good supply (Fry-Revere 2014).
In 1834, in conjunction with the failure of one bank (the Bank of Maryland) and rumors about others, there was a run on the banks of Baltimore. People lined up at banks to demand their specie (Niles’ Reporter, March 29, 1834). But, as the day wore on, those in line saw others leaving their banks with their bags and wheelbarrows heavy with coins, and—their fears allayed—people began leaving the line. Later in the day, some who had earlier gotten their specie were returning their coins to their banks. Accordingly, there was no general suspension.
Each of these examples indicates that a government intervention is not always needed to solve a hoarding problem (interpreting allowing a market in Iran as reduced involvement by government). Even the example cited by Krugman was resolved by the Baby-Sitting Co-op without a government intervention.
There is more to what is called the “hoarding” of money than the impact of income uncertainty on what the Keynesians call aggregate demand.1 Historically, times of hoarding were times of bank suspensions and of runs on the bank, and sometimes they were also times of uncertainty regarding the gold standard and runs on the dollar.2
The impact of hoarding can be particularly severe with a fractional reserve banking system. In a fractional reserve banking system, every dollar removed from banks forces a multiple reduction of the money supply. Furthermore, a “run on the bank” might result in banks being forced into suspension, immobilizing the funds still in them. The run of the bank can force a suspension even if the bank has positive net worth and reserves sufficient to meet the run because maintaining a certain amount of reserves is required by law or regulation.
In the past, when banks suspended, a great deal of the money people had in their banks became illiquid, meaning that it was unavailable as a medium of exchange. The combination of reduced consumer confidence, job insecurity, a reduced money supply, money tied up in banks in suspension, concerns for additional bank failures, and speculation on gold caused people to cut back on their spending either for lack of income or in order to build-up a cash reserve, and deprived the economy of a portion of its medium of exchange.
To be sure, hoarding might not have been a primary cause of a recession. Hoarding might have only broken out when the public became concerned for the soundness of money and/or of the banking system, and thus may have been a secondary cause making a recession worse. In the monetary history of the United States, money generally disappeared only after banks were forced into suspension.
The great champion of the gold standard Ludwig von Mises recognized the usefulness of money substitutes to deal with bank panics. “[I]t has repeatedly happened in times of crisis that confidence has been destroyed,” he said (Mises 1953, 371). This loss of confidence in bank deposits would result in “a collapse of a part of the national business organization” if allowed to run its course. In England, the Bank of England emitted additional bank notes; and, in the United States, which had no central bank, clearing house certificates were emitted (372). Even though such actions seemed to violate the “rules of the game” of the gold standard, Bordo and Kydland (1996, 85) say these actions may have supported the commitment to the gold standard in the long run.
F.A. Hayek (1967, 109), in an often-misunderstood passage, described the phenomenon as a “secondary depression.” Walter Bagehot’s dictum, that central bankers should lend freely on good collateral to solvent banks at high interest rates during panics, would seem to obviate the effects of hoarding; b
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