The Discovery of "Open-Market Operations" in 1922 Caused a Six-Year Bank Credit Inflation with New Money Pouring into the Stock Market and Real Estate

With the "discovery" of open-market operations around 1922, the Federal Reserve thought it had found a way to smooth out business cycles. In practice, it caused a substantial six-year bank credit inflation by buying securities on the open market and printing the money to pay for them. This money--bank reserves--was pyramided several-fold by means of the fractional reserve banking system. This policy of stabilizing the price level was deliberately engineered by the leader of the Federal Reserve System, Benjamin Strong, to follow the proto-monetarist theory of Yale economist Irving Fisher.

The 1920s are not often seen as an inflationary period because prices did not rise. But the money supply can rise even without prices rising in absolute terms. The 1920s saw such a burst of American technological advancement and cheaper ways of producing things that the natural tendency was for prices to fall (i.e., more goods chasing the same number of dollars). But the inflation caused prices to rise relative to what they would have done. So a "stable" price level was masking the fact that inflation was going on and creating distortions throughout the economy.

Between mid-1922 and April 1928, bank credit expanded by over twice as much as it did to help finance World War I. As with all inflations, this caused speculative excess; in this case, new money poured into the stock market and real estate. The cooling of this speculative fever in 1928 by officials who tightened the money supply because they were finally afraid of the overheated economy led to the Depression, which in turn led to the world's abandonment of the gold standard.

--Ron Paul and Lewis Lehrman, The Case for Gold: A Minority Report of the U.S. Gold Commission (Auburn, AL: Ludwig von Mises Institute, 2007), 123-124.