The Great DEPRESSION: Five Myths

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The Great DEPRESSION: Five Myths
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Wed, 11-05-2008 - 4:44pm
Five Myths About the Great Depression
Herbert Hoover was no proponent of laissez-faire.
By ANDREW B. WILSON


The current financial crisis has revived powerful misconceptions about the Great Depression. Those who misinterpret the past are all too likely to repeat the exact same mistakes that made the Great Depression so deep and devastating.


Here are five interrelated and durable myths about the 1929-39 Depression:


- Herbert Hoover, elected president in 1928, was a doctrinaire, laissez-faire, look-the-other way Republican who clung to the idea that markets were basically self-correcting. The truth is more illuminating. Far from a free-market idealist, Hoover was an ardent believer in government intervention to support incomes and employment. This is critical to understanding the origins of the Great Depression. Franklin Roosevelt didn't reverse course upon moving into the White House in 1933; he went further down the path that Hoover had blazed over the previous four years. That was the path to disaster.


Hoover, a one-time business whiz and a would-be all-purpose social problem-solver in the Lee Iacocca mold, was a bowling ball looking for pins to scatter. He was a government activist fixated on the idea of running the country as an energetic CEO might run a giant corporation. It was Hoover, not Roosevelt, who initiated the practice of piling up big deficits to support huge public-works projects. After declining or holding steady through most of the 1920s, federal spending soared between 1929 and 1932 -- increasing by more than 50%, the biggest increase in federal spending ever recorded during peacetime.


Public projects undertaken by Hoover included the San Francisco Bay Bridge, the Los Angeles Aqueduct, and Hoover Dam. The Republican president won plaudits from the American Federation of Labor for his industrial policy, which included jawboning business leaders to refrain from cutting wages as the economy fell. Referring to counteracting the business cycle and propping up wages, Hoover said: "No president before has ever believed that there was a government responsibility in such cases . . . we had to pioneer a new field." Though he did not coin the phrase, Hoover championed many of the basic ideas -- such as central planning and control of the economy -- that came to be known as the New Deal.


- The stock market crash in October 1929 precipitated the Great Depression. What the crash mainly precipitated was a raft of wrongheaded policies that did major damage to the economy -- beginning with the disastrous retreat into protectionism marked by the passage of the Smoot-Hawley tariff, which passed the House in May 1929 and the Senate in March 1930, and was signed into law by Hoover in June 1930. As prices fell, Smoot-Hawley doubled the effective tariff duties on a wide range of manufactures and agricultural products. It triggered the beggar-thy-neighbor policies of countervailing tariffs that caused the international economy to collapse. Some have argued that the increasing likelihood that the Smoot-Hawley tariff would pass was a major contributing factor to the stock-market collapse in the fall of 1929.


- Where the market had failed, the government stepped in to protect ordinary people. Hoover's disastrous agricultural policies involved the know-it-all Hoover acting as his own agriculture secretary and in fact writing the original Agricultural Marketing Act that evolved into Smoot-Hawley. While exports accounted for 7% of U.S. GDP in 1929, trade accounted for about one-third of U.S. farm income. The loss of export markets caused by Smoot-Hawley devastated the agricultural sector. Following in Hoover's footsteps, FDR concentrated on trying to raise farm income by such tactics as setting quotas on production and paying farmers to remove acreage from production -- even though this meant higher prices for hard-pressed consumers and had the effect of both lowering productivity and driving farmers off their land.


- Greed caused the stock market to overshoot and then crash. The real culprit here -- as in the housing bubble in our own time -- is the one identified by the economic historian Charles Kindleberger in the classic book "Manias, Panics, and Crashes": a speculative fever induced by excessively easy credit and broken by the inevitable return to more realistic valuations.


In the late 1920s, cheap and easy money fueled a tremendous increase in margin trading and a proliferation of "investment trusts" that offered little in the way of dividends or demonstrable earnings per share, but still promised phenomenal capital gains. "Speculation," as Kindleberger neatly defined it, "involves buying for resale rather than use in the case of commodities, and for resale rather than income in the case of financial assets."


The last thing Hoover wanted to do upon coming to office was to rein in the stock market boom by allowing interest rates to rise to a more normal level. The key to prosperity, in his view, lay not in sound money and rising productivity, but in letting the good times roll -- through government action aimed at maintaining high wages and high stock market valuations.


- Enlightened government pulled the nation out of the worst downturn in its history and came to the rescue of capitalism through rigorous regulation and government oversight. To the contrary, the Hoover and Roosevelt administrations -- in disregarding market signals at every turn -- were jointly responsible for turning a panic into the worst depression of modern times. As late as 1938, after almost a decade of governmental "pump priming," almost one out of five workers remained unemployed. What the government gave with one hand, through increased spending, it took away with the other, through increased taxation. But that was not an even trade-off. As the root cause of a great deal of mismanagement and inefficiency, government was responsible for a lost decade of economic growth.


Hoover was destined to fill the role of the left's designated scapegoat. Despite that, the one place where he and FDR truly "triumphed" was in enlisting the support of leading writers and intellectuals for government planning and intervention. This had a lasting effect on the way that generations of people think about the Great Depression. The antienterprise spirit among thought leaders of this time (and later) extended to top business publications. "Do you still believe in Lazy-Fairies?" Business Week asked derisively in 1931. "To plan or not to plan is no longer the question. The real question is who is to do it?"


In his economic policies and his incessant governmental activism, Hoover differed far more sharply with his Republican predecessor than he did with his Democratic successor. Calvin Coolidge, president from 1923 to 1929, made no secret of his disdain for Hoover, who served as his secretary of commerce and won praise from such highly regarded liberals as John Maynard Keynes and Jean Monnet. "That man has offered me unsolicited advice for six years, all of it bad," Coolidge said. He mockingly referred to Hoover as "Wonder Boy."


With the vitality of U.S. and world economies at stake, it is essential that the decisions of the coming months are shaped by the right lessons -- not the myths -- of the Great Depression.


Pages

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Wed, 11-05-2008 - 5:06pm

TIMELINES OF THE GREAT DEPRESSION:

This page features two timelines: the first for general events of the Roaring 20s and the Great Depression, the second for leading economic indicators.

The importance of these timelines cannot be emphasized enough. Seeing the order in which events actually occurred dispels many myths about the Great Depression. One of the greatest of these myths is that government intervention was responsible for its onset. Truly massive intervention began only under the presidency of Franklin Roosevelt in 1933, who was sworn in after the worst had already hit. Although his New Deal did not cure it, all the leading economic indicators improved on his watch.

But don't take my word for it -- here is the raw data:

TIMELINE OF GENERAL EVENTS

1920s (Decade)

  • During World War I, federal spending grows three times larger than tax collections. When the government cuts back spending to balance the budget in 1920, a severe recession results. However, the war economy invested heavily in the manufacturing sector, and the next decade will see an explosion of productivity... although only for certain sectors of the economy.


  • An average of 600 banks fail each year.


  • Agricultural, energy and coal mining sectors are continually depressed. Textiles, shoes, shipbuilding and railroads continually decline.


  • The value of farmland falls 30 to 40 percent between 1920 and 1929.


  • Organized labor declines throughout the decade. The United Mine Workers Union will see its membership fall from 500,000 in 1920 to 75,000 in 1928. The American Federation of Labor would fall from 5.1 million in 1920 to 3.4 million in 1929.


  • "Technological unemployment" enters the nation's vocabulary; as many as 200,000 workers a year are replaced by automatic or semi-automatic machinery.


  • Over the decade, about 1,200 mergers will swallow up more than 6,000 previously independent companies; by 1929, only 200 corporations will control over half of all American industry.


  • By the end of the decade, the bottom 80 percent of all income-earners will be removed from the tax rolls completely. Taxes on the rich will fall throughout the decade.


  • By 1929, the richest 1 percent will own 40 percent of the nation's wealth. The bottom 93 percent will have experienced a 4 percent drop in real disposable per-capita income between 1923 and 1929.


  • The middle class comprises only 15 to 20 percent of all Americans.


  • Individual worker productivity rises an astonishing 43 percent from 1919 to 1929. But the rewards are being funneled to the top: the number of people reporting half-million dollar incomes grows from 156 to 1,489 between 1920 and 1929, a phenomenal rise compared to other decades. But that is still less than 1 percent of all income-earners.
1922

  • The conservative Supreme Court strikes down federal child labor legislation.
1923

  • President Warren Harding dies in office; his administration was easily one of the most corrupt in American history. Calvin Coolidge, who is squeaky clean by comparison, becomes president. Coolidge is no less committed to laissez-faire and a non-interventionist government. He announces to the American people: "The business of America is business."


  • Supreme Court nullifies minimum wage for women in District of Columbia.
1924

  • The Ku Klux Klan reaches the height of its influence in America: by the end of the year it will claim 9 million members. It will decline drastically in 1925, however, after financial and moral scandals rock its leadership.


  • The stock market begins its spectacular rise. Bears little relation to the rest of the economy.
1925

  • The top tax rate is lowered to 25 percent - the lowest top rate in the eight decades since World War I.


  • Supreme Court rules that trade organizations do not violate anti-trust laws as long as some competition survives.
1928

  • The construction boom is over.


  • Farmers' share of the national income has dropped from 15 to 9 percent since 1920.


  • Between May 1928 and September 1929, the average prices of stocks will rise 40 percent. Trading will mushroom from 2-3 million shares per day to over 5 million. The boom is largely artificial.
1929

  • Herbert Hoover becomes President. Hoover is a staunch individualist but not as committed to laissez-faire ideology as Coolidge.


  • More than half of all Americans are living below a minimum subsistence level.


  • Annual per-capita income is $750; for farm people, it is only $273.


  • Backlog of business inventories grows three times larger than the year before. Public consumption markedly down.


  • Freight carloads and manufacturing fall.


  • Automobile sales decline by a third in the nine months before the crash.


  • Construction down $2 billion since 1926.


  • Recession begins in August, two months before the stock market crash. During this two month period, production will decline at an annual rate of 20 percent, wholesale prices at 7.5 percent, and personal income at 5 percent.


  • Stock market crash begins October 24. Investors call October 29 "Black Tuesday." Losses for the month will total $16 billion, an astronomical sum in those days.


  • Congress passes Agricultural Marketing Act to support farmers until they can get back on their feet.
1930

  • By February, the Federal Reserve has cut the prime interest rate from 6 to 4 percent. Expands the money supply with a major purchase of U.S. securities. However, for the next year and a half, the Fed will add very little money to the shrinking economy. (At no time will it actually pull money out of the system.) Treasury Secretary Andrew Mellon announces that the Fed will stand by as the market works itself out: "Liquidate labor, liquidate stocks, liquidate real estate… values will be adjusted, and enterprising people will pick up the wreck from less-competent people." (More)


  • The Smoot-Hawley Tariff passes on June 17. With imports forming only 6 percent of the GNP, the 40 percent tariffs work out to an effective tax of only 2.4 percent per citizen. Even this is compensated for by the fact that American businesses are no longer investing in Europe, but keeping their money stateside. The consensus of modern economists is that the tariff made only a minor contribution to the Great Depression in the U.S., but a major one in Europe. (More)


  • The first bank panic occurs later this year; a public run on banks results in a wave of bankruptcies. Bank failures and deposit losses are responsible for the contracting money supply.


  • Supreme Court rules that the monopoly U.S. Steel does not violate anti-trust laws as long as competition exists, no matter how negligible.


  • Democrats gain in Congressional elections, but still do not have a majority.


  • The GNP falls 9.4 percent from the year before. The unemployment rate climbs from 3.2 to 8.7 percent.
1931

  • No major legislation is passed addressing the Depression.


  • A second banking panic occurs in the spring.


  • The GNP falls another 8.5 percent; unemployment rises to 15.9 percent.
1932

  • This and the next year are the worst years of the Great Depression. For 1932, GNP falls a record 13.4 percent; unemployment rises to 23.6 percent.


  • Industrial stocks have lost 80 percent of their value since 1930.


  • 10,000 banks have failed since 1929, or 40 percent of the 1929 total.


  • About $2 billion in deposits have been lost since 1929.


  • Money supply has contracted 31 percent since 1929.


  • GNP has also fallen 31 percent since 1929.


  • Over 13 million Americans have lost their jobs since 1929.


  • Capital growth investments have dropped from $16.2 billion to 1/3 of one billion since 1929.


  • Farm prices have fallen 53 percent since 1929.


  • International trade has fallen by two-thirds since 1929.


  • The Fed makes its first major expansion of the money supply since February 1930.


  • Congress creates the Reconstruction Finance Corporation. (More)


  • Congress passes the Federal Home Loan Bank Act and the Glass-Steagall Act of 1932. (More)


  • Top tax rate is raised from 25 to 63 percent.


  • Popular opinion considers Hoover's measures too little too late. Franklin Roosevelt easily defeats Hoover in the fall election. Democrats win control of Congress.


  • At his Democratic presidential nomination, Roosevelt says: "I pledge you, I pledge myself, to a new deal for the American people."
1933

  • Roosevelt inaugurated; begins "First 100 Days" of intensive legislative activity. (More)


  • A third banking panic occurs in March. Roosevelt declares a Bank Holiday; closes financial institutions to stop a run on banks.


  • Alarmed by Roosevelt's plan to redistribute wealth from the rich to the poor, a group of millionaire businessmen, led by the Du Pont and J.P. Morgan empires, plans to overthrow Roosevelt with a military coup and install a fascist government. The businessmen try to recruit General Smedley Butler, promising him an army of 500,000, unlimited financial backing and generous media spin control. The plot is foiled when Butler reports it to Congress. (More)


  • Congress authorizes creation of the Agricultural Adjustment Administration, the Civilian Conservation Corps, the Farm Credit Administration, the Federal Deposit Insurance Corporation, the Federal Emergency Relief Administration, the National Recovery Administration, the Public Works Administration and the Tennessee Valley Authority. (More)


  • Congress passes the Emergency Banking Bill, the Glass-Steagall Act of 1933, the Farm Credit Act, the National Industrial Recovery Act and the Truth-in-Securities Act. (More)


  • U.S. goes off the gold standard.


  • Roosevelt does much to redistribute wealth from the rich to the poor, but is obsessed with a balanced budget. He later rejects Keynes' advice to begin heavy deficit spending.


  • The free fall of the GNP is significantly slowed; it dips only 2.1 percent this year. Unemployment rises slightly, to 24.9 percent.
1934

  • Congress authorizes creation of the Federal Communications Commission, the National Mediation Board and the Securities and Exchange Commission. (More)


  • Congress passes the Securities and Exchange Act and the Trade Agreement Act. (More)


  • The economy turns around: GNP rises 7.7 percent, and unemployment falls to 21.7 percent. A long road to recovery begins.


  • Sweden becomes the first nation to recover fully from the Great Depression. It has followed a policy of Keynesian deficit spending. (More)
1935

  • The Supreme Court declares the National Recovery Administration to be unconstitutional.


  • Congress authorizes creation of the Works Progress Administration, the National Labor Relations Board and the Rural Electrification Administration. (More)


  • Congress passes the Banking Act of 1935, the Emergency Relief Appropriation Act, the National Labor Relations Act, and the Social Security Act. (More)


  • Economic recovery continues: the GNP grows another 8.1 percent, and unemployment falls to 20.1 percent.
1936

  • The Supreme Court declares part of the Agricultural Adjustment Act to be unconstitutional.


  • In response, Congress passes the Soil Conservation and Domestic Allotment Act. (More)


  • Top tax rate raised to 79 percent.


  • Economic recovery continues: GNP grows a record 14.1 percent; unemployment falls to 16.9 percent.


  • Germany becomes the second nation to recover fully from the Great Depression, through heavy deficit spending in preparation for war.

dablacksox


Cynic: a blackguard whose faulty vision sees things as they are, not as they ought to be.---Ambrose Bierce, The Devil's Dictionary.

dablacksox


Cynic: a blackguard whose faulty vision sees things as they are, not as they ought to be.---Ambrose Bierce, The Devil's Dictionary.

iVillage Member
Registered: 07-25-2006
Wed, 11-05-2008 - 5:07pm
What???!!! you would besmirch the name of one of the three greatest presidents ever in the entire history of the United States blah blah blah.....


iVillage Member
Registered: 11-11-1999
Wed, 11-05-2008 - 5:18pm
1937

  • The Supreme Court declares the National Labor Relations Board to be unconstitutional.


  • Roosevelt seeks to enlarge and therefore liberalize the Supreme Court. This attempt not only fails, but outrages the public.


  • Economists attribute economic growth so far to heavy government spending that is somewhat deficit. Roosevelt, however, fears an unbalanced budget and cuts spending for 1937. That summer, the nation plunges into another recession. Despite this, the yearly GNP rises 5.0 percent, and unemployment falls to 14.3 percent.
1938

  • Congress passes the Agricultural Adjustment Act of 1938 and the Fair Labor Standards Act. (More)


  • No major New Deal legislation is passed after this date, due to Roosevelt's weakened political power.


  • The year-long recession makes itself felt: the GNP falls 4.5 percent, and unemployment rises to 19.0 percent.


  • Britain becomes the third nation to recover as it begins deficit spending in preparation for war.
1939

  • GNP rises 7.9 percent; unemployment falls to 17.2 percent.


  • The United States will begin emerging from the Depression as it borrows and spends $1 billion to build its armed forces. From 1939 to 1941, when the Japanese attack Pearl Harbor, U.S. manufacturing will have shot up a phenomenal 50 percent!


  • The Depression is ending worldwide as nations prepare for the coming hostilities.


  • World War II starts with Hitler's invasion of Poland.
1945

  • Although the war is the largest tragedy in human history, the United States emerges as the world's only economic superpower. Deficit spending has resulted in a national debt 123 percent the size of the GDP. By contrast, in 1994, the $4.7 trillion national debt will be only 70 percent of the GDP!


  • The top tax rate is 91 percent. It will stay at least 88 percent until 1963, when it is lowered to 70 percent. During this time, America will experience the greatest economic boom it has ever known.
ECONOMIC TIMELINE

The following timeline shows the order of economic events during the Great Depression. Notice the effect that deficit spending had on economic growth:

Receipts: Tax receipts as a percentage of the Gross Domestic Product

Spending: Federal spending as a percentage of the Gross Domestic Product

GNP: Percent change in the Gross National Product

Unemp.: Unemployment rate

Tax Federal GNP Unemp.
Year Receipts Spending Growth Rate
-------------------------------------------------
1929 -- -- -- 3.2% < Hoover era, Great Depression begins
1930 4.2% 3.4% - 9.4% 8.7
1931 3.7 4.3 - 8.5 15.9
1932 2.9 7.0 -13.4 23.6
1933 3.5 8.1 - 2.1 24.9 < FDR, New Deal begins; contraction ends March
1934 4.9 10.8 + 7.7 21.7
1935 5.3 9.3 + 8.1 20.1
1936 5.1 10.6 +14.1 16.9
1937 6.2 8.7 + 5.0 14.3 < recession begins, May
1938 7.7 7.8 - 4.5 19.0 < recession ends, June
1939 7.2 10.4 + 7.9 17.2
1940 6.9 9.9
1941 7.7 12.1
1942 10.3 24.8
1943 13.7 44.8
1944 21.7 45.3
1945 21.3 43.7

As you can see, Roosevelt began relatively modest deficit spending that arrested the slide of the economy and resulted in some astonishing growth numbers. (Roosevelt's average growth of 5.2 percent during the Great Depression is even higher than Reagan's 3.7 percent growth during his so-called "Seven Fat Years!") When 1936 saw a phenomenal record of 14 percent growth, Roosevelt eased back on the deficit spending, overly worried about balancing the budget. But this only caused the economy to slip back into a recession, as the above chart shows.

I have been unable to find reliable economic growth figures from World War II, but as a generalization it is safe to say the economy exploded, experiencing it’s greatest growth in U.S. history. Between 1940 and 1945, the GDP nearly doubled in size, from $832 billion to $1,559 billion in constant 87 dollars. And this occurred as deficit spending soared, to levels Keynes had earlier and unsuccessfully recommended to Roosevelt.

Next Section: Summary
Return to The Great Depression Homepage

Sources:

T.H. Watkins, The Great Depression: America in the 1930s (New York: Little, Brown and Company, 1993)

Kevin Phillips, Boiling Point (New York: HarperCollins, 1993)

Kevin Phillips, The Politics of Rich and Poor (New York: Random House, 1990)

The 1995 Grolier Encyclopedia (Entries: New Deal, Depression of the 30s, Roosevelt, Coolidge.)

The Encyclopedia Brittanica Online (Entries: New Deal, Great Depression.)

Donald Barlett and James Steele, America: What Went Wrong? (Kansas City: Andrews and McMeel, 1992)

Donald Barlett and James Steele, America: Who Really Pays the Taxes? (New York: Simon & Schuster, 1994)

James MacGregor Fox, Roosevelt: The Lion and the Fox (New York: Konecky and Konecky, 1956)

Elaine Schwartz, Econ 101½ (New York: Avon Books, 1995)

Peter Pugh and Chris Garratt, Introducing Keynes (Cambridge, England: Icon Books, Ltd., 1993)

Paul Krugman, Peddling Prosperity (New York: W.W. Norton and Company, 1994)

Online sources:

History lecture notes: http://www.marshall.edu/history/mccarthy/hst331/lecture/greatdep.1

Gary H. Stern (President, Federal Reserve Bank of Minneapolis), "Achieving Economic Stability: Lessons From the Crash of 1929," 1987 Annual Report Essay, http://woodrow.mpls.frb.fed.us/pubs/ar/ar1987.html

Office of Management and Budget, Budget of the United States Government, Fiscal Year 1997, Historical Tables 1.2 and 10.1, http://www.doc.gov/BudgetFY97/histtoc.html

dablacksox


Cynic: a blackguard whose faulty vision sees things as they are, not as they ought to be.---Ambrose Bierce, The Devil's Dictionary.

dablacksox


Cynic: a blackguard whose faulty vision sees things as they are, not as they ought to be.---Ambrose Bierce, The Devil's Dictionary.

iVillage Member
Registered: 04-04-2001
Wed, 11-05-2008 - 6:00pm

So does this mean you approve of the budget deficits and national debt

iVillage Member
Registered: 11-11-1999
Wed, 11-05-2008 - 6:41pm

So does this mean you approve of the budget deficits and national debt

dablacksox


Cynic: a blackguard whose faulty vision sees things as they are, not as they ought to be.---Ambrose Bierce, The Devil's Dictionary.

iVillage Member
Registered: 07-25-2006
Wed, 11-05-2008 - 6:57pm

<>He is aware of what REALLY happened, and not the historical revisionism of the Depression pushed by professional right wing FDR haters.<>


Opinion only.


Are these two UCLA


iVillage Member
Registered: 09-08-2006
Wed, 11-05-2008 - 6:59pm

<<- Herbert Hoover, elected president in 1928, was a doctrinaire, laissez-faire, look-the-other way Republican who clung to the idea that markets were basically self-correcting. The truth is more illuminating. Far from a free-market idealist, Hoover was an ardent believer in government intervention to support incomes and employment. This is critical to understanding the origins of the Great Depression. Franklin Roosevelt didn't reverse course upon moving into the White House in 1933; he went further down the path that Hoover had blazed over the previous four years. That was the path to disaster.>>


The laissez-faire of then was different from today.

 

iVillage Member
Registered: 11-11-1999
Wed, 11-05-2008 - 7:14pm

Are these two UCLA

dablacksox


Cynic: a blackguard whose faulty vision sees things as they are, not as they ought to be.---Ambrose Bierce, The Devil's Dictionary.

iVillage Member
Registered: 11-11-1999
Wed, 11-05-2008 - 7:22pm

http://www.federalreserve.gov/boarddocs/speeches/2004/200403022/default.htm


Remarks by Governor Ben S. Bernanke
At the H. Parker Willis Lecture in Economic Policy, Washington and Lee University, Lexington, Virginia
March 2, 2004


Money, Gold, and the Great Depression


Friedman and Schwartz emphasized at least four major errors by U.S. monetary policymakers. The Fed's first grave mistake, in their view, was the tightening of monetary policy that began in the spring of 1928 and continued until the stock market crash of October 1929 (see Hamilton, 1987, or Bernanke, 2002a, for further discussion). This tightening of monetary policy in 1928 did not seem particularly justified by the macroeconomic environment: The economy was only just emerging from a recession, commodity prices were declining sharply, and there was little hint of inflation. Why then did the Federal Reserve raise interest rates in 1928? The principal reason was the Fed's ongoing concern about speculation on Wall Street. Fed policymakers drew a sharp distinction between "productive" (that is, good) and "speculative" (bad) uses of credit, and they were concerned that bank lending to brokers and investors was fueling a speculative wave in the stock market. When the Fed's attempts to persuade banks not to lend for speculative purposes proved ineffective, Fed officials decided to dissuade lending directly by raising the policy interest rate.


The market crash of October 1929 showed, if anyone doubted it, that a concerted effort by the Fed can bring down stock prices. But the cost of this "victory" was very high. According to Friedman and Schwartz, the Fed's tight-money policies led to the onset of a recession in August 1929, according to the official dating by the National Bureau of Economic Research. The slowdown in economic activity, together with high interest rates, was in all likelihood the most important source of the stock market crash that followed in October. In other words, the market crash, rather than being the cause of the Depression, as popular legend has it, was in fact largely the result of an economic slowdown and the inappropriate monetary policies that preceded it. Of course, the stock market crash only worsened the economic situation, hurting consumer and business confidence and contributing to a still deeper downturn in 1930.


The second monetary policy action identified by Friedman and Schwartz occurred in September and October of 1931. At the time, as I will discuss in more detail later, the United States and the great majority of other nations were on the gold standard, a system in which the value of each currency is expressed in terms of ounces of gold. Under the gold standard, central banks stood ready to maintain the fixed values of their currencies by offering to trade gold for money at the legally determined rate of exchange.


The fact that, under the gold standard, the value of each currency was fixed in terms of gold implied that the rate of exchange between any two currencies within the gold standard system was likewise fixed. As with any system of fixed exchange rates, the gold standard was subject to speculative attack if investors doubted the ability of a country to maintain the value of its currency at the legally specified parity. In September 1931, following a period of financial upheaval in Europe that created concerns about British investments on the Continent, speculators attacked the British pound, presenting pounds to the Bank of England and demanding gold in return. Faced with the heavy demands of speculators for gold and a widespread loss of confidence in the pound, the Bank of England quickly depleted its gold reserves. Unable to continue supporting the pound at its official value, Great Britain was forced to leave the gold standard, allowing the pound to float freely, its value determined by market forces.


With the collapse of the pound, speculators turned their attention to the U.S. dollar, which (given the economic difficulties the United States was experiencing in the fall of 1931) looked to many to be the next currency in line for devaluation. Central banks as well as private investors converted a substantial quantity of dollar assets to gold in September and October of 1931, reducing the Federal Reserve's gold reserves. The speculative attack on the dollar also helped to create a panic in the U.S. banking system. Fearing imminent devaluation of the dollar, many foreign and domestic depositors withdrew their funds from U.S. banks in order to convert them into gold or other assets. The worsening economic situation also made depositors increasingly distrustful of banks as a place to keep their savings. During this period, deposit insurance was virtually nonexistent, so that the failure of a bank might cause depositors to lose all or most of their savings. Thus, depositors who feared that a bank might fail rushed to withdraw their funds. Banking panics, if severe enough, could become self-confirming prophecies. During the 1930s, thousands of U.S. banks experienced runs by depositors and subsequently failed.


Long-established central banking practice required that the Fed respond both to the speculative attack on the dollar and to the domestic banking panics. However, the Fed decided to ignore the plight of the banking system and to focus only on stopping the loss of gold reserves to protect the dollar. To stabilize the dollar, the Fed once again raised interest rates sharply, on the view that currency speculators would be less willing to liquidate dollar assets if they could earn a higher rate of return on them. The Fed's strategy worked, in that the attack on the dollar subsided and the U.S. commitment to the gold standard was successfully defended, at least for the moment. However, once again the Fed had chosen to tighten monetary policy despite the fact that macroeconomic conditions--including an accelerating decline in output, prices, and the money supply--seemed to demand policy ease.


The third policy action highlighted by Friedman and Schwartz occurred in 1932. By the spring of that year, the Depression was well advanced, and Congress began to place considerable pressure on the Federal Reserve to ease monetary policy. The Board was quite reluctant to comply, but in response to the ongoing pressure the Board conducted open-market operations between April and June of 1932 designed to increase the national money supply and thus ease policy. These policy actions reduced interest rates on government bonds and corporate debt and appeared to arrest the decline in prices and economic activity. However, Fed officials remained ambivalent about their policy of monetary expansion. Some viewed the Depression as the necessary purging of financial excesses built up during the 1920s; in this view, slowing the economic collapse by easing monetary policy only delayed the inevitable adjustment. Other officials, noting among other indicators the very low level of nominal interest rates, concluded that monetary policy was in fact already quite easy and that no more should be done. These policymakers did not appear to appreciate that, even though nominal interest rates were very low, the ongoing deflation meant that the real cost of borrowing was very high because any loans would have to be repaid in dollars of much greater value (Meltzer, 2003). Thus monetary policy was not in fact easy at all, despite the very low level of nominal interest rates. In any event, Fed officials convinced themselves that the policy ease advocated by the Congress was not appropriate, and so when the Congress adjourned in July 1932, the Fed reversed the policy. By the latter part of the year, the economy had relapsed dramatically.


The fourth and final policy mistake emphasized by Friedman and Schwartz was the Fed's ongoing neglect of problems in the U.S. banking sector. As I have already described, the banking sector faced enormous pressure during the early 1930s. As depositor fears about the health of banks grew, runs on banks became increasingly common. A series of banking panics spread across the country, often affecting all the banks in a major city or even an entire region of the country. Between December 1930 and March 1933, when President Roosevelt declared a "banking holiday" that shut down the entire U.S. banking system, about half of U.S. banks either closed or merged with other banks. Surviving banks, rather than expanding their deposits and loans to replace those of the banks lost to panics, retrenched sharply.

dablacksox


Cynic: a blackguard whose faulty vision sees things as they are, not as they ought to be.---Ambrose Bierce, The Devil's Dictionary.

dablacksox


Cynic: a blackguard whose faulty vision sees things as they are, not as they ought to be.---Ambrose Bierce, The Devil's Dictionary.

iVillage Member
Registered: 08-13-2008
Wed, 11-05-2008 - 8:00pm

There was no easy way out of the Great Depression - where was the market for goods? The author claims the policy of that time as wrong, that it took money out of the hands of business.


Now I ask, when the government taxes, does it go in a vault, never to be seen again? Does not the author cite government spending? OK, if the government spends, it is one entity in the chain of those who touch the money on its way by, so the lack of economic growth cannot be laid at the feet of government.


When war approached, suddenly there were buyers - other nations, and our own military. Products were needed, and that built a support infrastructure to feed the components of the products. The cycle of market and supplier was now fully engaged again.


Full length fiction: worlds undone

"You have no power over my body..." ~ Anne Hutchinson

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