[dustinbauerhowell]

The Economist ran an article last week on the history of financial crises in the United States and one passage in particular struck me as incredible. When discussing the crash of 1907 (which served as the impetus for the creation of the Federal Reserve), the article readily admits that the crisis was stemmed by “illegal” private-sector money creation:

“With legal tender so scarce, alternatives quickly sprang up. In close to half of America’s large towns and cities, cash substitutes started to circulate. These included cheques and small-denomination IOU’s written by banks. The total value of this private-sector emergency cash–all of it illegal–was around $500m, far bigger than the Morgan bail-out. It did the trick, and by 1909 the American economy was growing again.”

It seems, in addition to the crash of 1920 (which, it should be noted, was omitted from the article), to be another much-needed vindication of free banking and currency competition. It just seems a bit ironic that the crash that spawned the federal reserve was set right again by the private sector. Does anyone have any particular insight as to the validity of this perspective?

[woods]

I talk a little bit about it in Meltdown. It was a case of the banks not having money available for deposit, but holding it instead in the form of income-earning securities. If they were to sell off a large number of these to raise cash for depositors, it would crash the value of the rest of the bank’s portfolio. The mainstream response to this is to say the banks need to be supported in cases like this, when to me the obvious response is that they shouldn’t do it in the first place.

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