As the great American Investor class has grown in the past 20 years, so has the focus on the Federal Reserve and its current chairman Dr. Alan Greenspan. Arguably one of the most powerful men in our country…indeed the world…his words move markets. Precedent for such power comes with the position and dates back to the founding of the Federal Reserve and its first leader, Benjamin Strong.

Ironically, Strong, considered by many at the time to be an easy money advocate, was beginning to take the necessary monetary steps to put a stop to rampant stock market speculation when he died in 1928. Had he lived to continue his work, the Crash of ’29 might have been prevented.

After suffering through the short depression of 1920-21, the American economy took off on a tear. Then Treasury Secretary Andrew Mellon pushed for lower income tax rates and plowed government surpluses into paying off the national debt. Government expenditures fell, but personal income and the gross national product soared in the 1920s. Per capita income rose by a third while inflation was nonexistent.

The boom was fueled by the emerging technology of the time…the automobile. Ancillary industries sprang up…oil, rubber, glass, steel…all financed by booming Wall Street.

Wall Street soared along with the economy. From 1922 to 1929 the Dow Jones® industrial average quadrupled. Worker productivity, thanks to the use of electricity increased 40%, according to author John Gordon in The Great Game.

Credit played an important role in this expansion. Up to then, credit was a privilege reserved for the rich. General Motors®, Macy’s® and other retailers began offering credit to their customers, making the good life available to the middle class. And, it became an easy stretch to expand credit to the stock market by borrowing from a broker to buy securities on margin.

With 90% financing available, the masses flocked to the rising stock market in the quest for easy money that came from buying stocks with low down and selling at rapidly rising prices for a profit. (This practice sounds similar to real estate today in parts of the country.)

Benjamin Strong was named the first governor of the Federal Reserve Bank of New York in 1914 and dominated the Federal Reserve System during its formative years. Strong was an internationalist and saw the central bank playing a substantial international role. Strong advocated monetary policies that assisted our European Allies in rebuilding after World War I.

He wanted U.S. interest rates low to keep European capital from flowing out of Europe and into the U.S. While this may have helped our Allies, it fed the speculation that was going on at home. Low interest rates allowed lenders to earn more lending for margin borrowing…rates got as high as 20% toward the end of the summer of 1929.

Finally Strong had seen enough. He began by raising the discount rate three times in 1928 up to 5% (considered high at the time). He took steps to restrict the money supply. His goal was to avoid a crash on Wall Street while aiding, if possible, the recovery in Europe.

Unfortunately he died of tuberculosis late in 1928, leaving the Fed without a strong leader. As a result no further steps were taken by the Fed to halt the stock market speculation.

The result as the Saturday Evening Post wrote was: