Currency: The Federal Reserve System

Currency

Currency: Revolutionary War and Confederation

Currency: The New Republic

Currency: Civil War Developments

Currency: New Deal and After

The United States continued to be plagued by bank panics. The Panic of 1907 led to renewed effort for currency and banking reform, culminating in the Federal Reserve Act of 1913. The act created a new type of paper money—Federal Reserve notes. These were supposed to be an “elastic” currency, capable of expansion during a panic when the banks were being pressed to redeem deposits in currency. Banks that chose to become members of the Federal Reserve system would maintain reserve deposits with their regional Federal Reserve bank. They could always draw currency from their reserve deposits, borrowing from the Federal Reserve if they needed more. 

The new system seemed to work well. When the economy entered a brief but severe depression in 1920 following the end of the inflationary pressures arising from World War I, there was no banking panic. By 1920, Federal Reserve notes constituted about three-fifths of outstanding coin and currency. 

As the United States slid into depression in 1929, the most severe bank panic in American history occurred. Numerous bank failures had taken place during the 1920’s but they were generally of small banks in rural areas. In 1930 failure struck numerous urban banks as well. The Federal Reserve was well designed to aid banks that were solvent but lacked cash. However, the bank failures that spread after 1930 generally involved insolvent banks—those whose assets were less than their liabilities, often because they had made speculative investments in stocks and real estate. Spreading bank failures led to massive withdrawals of currency from the banks, forcing them to sell investments and refuse to renew loans. Deflationary pressure was worsened by U.S. adherence to the international gold standard. Britain’s departure from the gold standard in 1931 set off a large effort to buy U.S. Treasury gold, a process that reduced bank reserves and the money supply. To protect the nation’s gold reserve, the Federal Reserve imposed credit restraints that worsened the economic downswing and accelerated bank failures.