After World War I, it looked as if things could get back to normal. With the Second Liberty Loan issue and the Victory Loan issue successfully floated and funded by the Federal Reserve, the government could start collecting taxes to repay the loans, and the Federal Reserve could get back to its main purpose. That was to provide liquidity as the lender of last resort to the private sector by rediscounting bills from member commercial banks, and engaging in limited open market operations involving businesses and non-member banks, and retiring the government bonds backing the National Bank Notes and the Treasury Notes of 1890.
Swift action by the Federal Reserve is considered responsible for staving off a potential financial panic in the early 1920s when it announced it was ready to expand rediscounting of private sector bills to ensure an adequate money supply to meet the needs of commerce. What must astonish today's politicians faced with the ineffectiveness of endless rounds of "stimulus" and "quantitative easing" is that the Federal Reserve didn't actually have to increase rediscounts in order to restore confidence and avoid a financial panic. The simple announcement that the Federal Reserve stood ready to provide adequate private sector liquidity was sufficient to restore confidence in the system.
Today's politicians, however, being trained in the dogmas of Keynesian economics, don't understand the significance of the difference between the Federal Reserve's assurance in the early 1920s that it stood ready to provide adequate asset-backed currency to the private sector, and today's flooding the channels of commerce with massive amounts of currency backed only by government debt. The former is precisely what the Federal Reserve was designed to do, while the latter is what the institution has been corrupted into doing. For this we can put the blame squarely where it belongs: on the economics of John Maynard Keynes.
The financing of the First World War with government debt seemed to confirm the tenets of the Currency School, although the hyperinflation that subsequently hit Germany and Austria-Hungary still cannot be explained within that framework. It should therefore come as no surprise that Keynes, who viewed government debt as the only legitimate backing for the currency, was able to leverage his expertise at telling the politicians precisely what they want to hear into a position as the most influential economist of the 20th and 21st century, establishing his reputation in 1919 with the publication of The Economic Consequences of the Peace (1919).
This did not happen immediately, however. During the decade following the war, the Federal Reserve served as lender of last resort to the private sector, and worked to reduce outstanding government debt from the war. It also achieved its objective of replacing the National Bank Notes and the Treasury Notes of 1890 with Federal Reserve Bank Notes. The program was terminated in the late 1930s, by which time all remaining National Bank Notes and Treasury Notes of 1890 remaining in circulation were to be construed as Federal Reserve Bank Notes.
Unfortunately, given the remaining outstanding debt from World War I, the debt-backed Federal Reserve Bank Notes could not be replaced with asset-backed Federal Reserve Notes at the same rate. At the same time, while the Federal Reserve was reducing non-productive government debt and backing up the asset-backed lending of the commercial banking system, the commercial banking system was also creating massive amounts of money for speculation that was channeled into the stock market, creating the "bubble" of the 1920s.