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Page 49
of the commercial banking system, the books of the "lender of last resort" show a decline in the amount of credit it made available to its member banks.
In September 1931, Britain went off the gold standard. This act was preceded and followed by gold withdrawals from the United States. Although gold had been flowing into the United States in the prior two years, and the U.S. gold stock and the Federal Reserve gold reserve ratio were at an all time high, the Reserve System reacted vigorously and promptly to the external drain as it had not to the previous internal drain. It did so in a manner that was certain to intensify the internal financial difficulties. After more than two years of severe economic contraction, the System raised the discount ratethe rate of interest at which it stood ready to lend to member banksmore sharply than it has within so brief a period in its whole history before or since. The measure arrested the gold drain. It was also accompanied by a spectacular increase in bank failures and runs on banks. In the six months from August 1931 through January 1932, roughly one out of ten banks in existence suspended operations and total deposits in commercial banks fell by 15 per cent.
A temporary reversal of policy in 1932 involving the purchase of $ 1 billion of government bonds slowed down the rate of decline. Had this measure been taken in 1931, it would almost surely have been sufficient to prevent the debacle just described. By 1932, it was too late to be more than a palliative and, when the System relapsed into passivity, the temporary improvement was followed by a renewed collapse terminating in the Banking Holiday of 1933when every bank in the United States was officially closed for over a week. A system established in large part to prevent a temporary suspension of convertibility of deposits into currencya measure that had formerly prevented banks from failingfirst let nearly a third of the banks of the country go out of existence and then welcomed a suspension of convertibility that was incomparably more sweeping and severe than any earlier suspension. Yet so great is the capacity for self-justification that the Federal Reserve Board could write in its annual report for 1933, "The ability of the Federal Reserve Banks to meet enormous demands for currency during the crisis demonstrated the effectiveness of the country's currency

 
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