Great Depression

Charles Kindleberger Defined

Charles Kindleberger was an economist in the twentieth century.He was highly active , especially in macroeconomic-related fields, and was involved in economics in some form or another for more than sixty years. Throughout the course of this activity, Kindleberger had extensive experience and contirubtion to both practical and theoretical economics.

On the practical side,He held several high ranking positions in government and international bodies. To name a few, Kindleberger served on the board of governors for the Federal Reserve System from 1940-1942. He was also the department of state’s head of economic security policy, and helped to create the Marshall Plan in the post World War II era.

As a professor, Kindleberger taught at MIT primarily, and earned the title of Ford International Professor of Economics at MIT, and also taught at Middlebury and several other colleges throughout the later years of his life. He continued to remain active in the field of economics, lecturing, and occasionally teaching until his death in 2003.

Kindleberger's legacy

Over the course of his life, Kindleberger wrote several books. One book, in particular, is seen as his greatest contribution: in 1973, Kindleberger's first edition of The World in Depression 1929-1939 was released, to be followed by a second, expanded edition of the book in 1986. This book is considered to have revolutionized the general economic scope on the great depression, and to have created an entirely unique, and now fairly popular, approach to the great depression.

It is the views that Kindelberger expressed in The World in Depression 1929-1939 that is the focus of this website.

Kindleberger's Story- Economic History

Kindlberger is categorized as a modern historical economist. Historical Economics studies how economics have behaved within history, often focusing on how economic phenomena developed within world history. Historical economics has been called “a cross-breeding between economics and history”. However, its current form is often regarded as a sub field of economics, not history. In short, Historical Economics analyses the historical development which lead to specific national and world economic statuses, both past and present.

Kindleberger, like most modern historical economists, as well as most economists in general uses a combination of economic theory and statistical and quantitative data to analyze historical events. This is referred to as Cliometrics. He uses this systematic approach in analyzing the Great Depression in The World in Depression.

Historical economics often uses history as real-life data to support and test economic theory. It also has applications in present day, as past phenomena are used to analyze the present and predict the future.

Historical economics, or economic history, is often reported in a narrative style with econometrics and economic theory as its backbone. Explanations in this disipline are often characteristic of narration: events, causes, and effects thereof of historic economic phenomena are told as "story" from an economical perspective. Thus, Kindleberger's "story" is his economic anlaysis of the geopolitical political and economic factors which caused the great depression.

In the hands of Kindleberger, as a historical economist, analysis of the great depression was a relatively wide based web. What this means is that his historical economic view has a relatively large scope; he looks at a large number of factors, from an international view.

For example, Kindleberger actively disagreed with some of his counterparts of the time, specifically monetarists Milton Friedman and Anna Schwartz. In 1963 these two economists published a book titled a Monetary History of the United States. Within this publication, the two blame the great depression largely on the Federal reserve. They basically blame the Federal Reserve's failure to implement effective monetary policy as the cause for the Great Depression. Kindleberger believed this view was too narrow. As a historical economist, he believed that a worldwide phenomenon such as the depression could not have been caused by so narrow a cause as the federal reserve. Kindleberger's story is one of a "detailed big picture", which looks at the multiple causes of the great depression acorss several spectrums.

What led to the Great Depression

There are many theories and disputes over how the great depression started. The Friedmans believe that the depression was no accident and that the Great Crash is unimportant to later events. They believe that the depression was caused by the United States Monetary policy. Samuelson believes that the Great Crash was one of several factors that reflected the great depression and made it stronger. Kindleberg believes it was caused by “a complex systematic set of causes, international in scope and partly monetary or at least financial.

In 1919 to 1920 there was a world wide economic boom, especially in Britain in the United States, this led to a rise in the price of capital assets. War debts had piled up from WWI. Germany had reparations to pay to the French. Reparations, along with the war debts “complicated and corrupted” the international economy from the 1920s through June 15, 1933. The United States refused to accept reparations from Germany and instead wanted to be repaid for loans, advances, and supplies giving to the Allies. By February 9, 1922, the United States made settlements with 13 countries. Britain suggested to ship $100 million in gold to the U.S. for payment. Keynes did not want to lift the gold embargo believeing it would not result in deflation for Britain but inflation. Many thought that if the U.S. prices didn’t go up then they couldn’t squeeze British prices down another ten percent. During and after the war, foreign countries were barrowing form New York and Washington. The U.S. didn’t fallow any type of supply model. Between 1924-1929 the U.S. loaned $6.4 billion abroad. In 1927 the U.S. went into a recession. In July of that year another Boom had started. (see "The Boom" for details)

Monetary Policy

Charles Kindleberger argued that only mistakes in monetary policies brought about by the US monetary authorities was not the only reason that a recession turned in the Great Depression. He argues that the depression was brought about by a complex systematix set of causes which was only partly related to monetary policies. Even to this date, economists cannot agree on a single set of problems that was the root of the Great Depression. Economists usually argue between two unicasual theories those being Keynsianism and monetarism. The debate is whether the failure of the money supply to grow led to a decline in spending or an independent, autonomous decline in spending actually lead to a decrease of the money supply.

According to Kindleberger, there should be different explanations depending on the time frame during the depression. He suggests that there should be different explanations for 1929-30 and others for the more ordinary recession from 1931-33 Keynesian. If this is done then monetarists get a different impression since the real money values actually rose between 1929-30. The 1929 Great Depression was not the only one to have happened in world history but it was by far the most deep and widespread. So by looking at the Depressions from the 19th century we can see that like after the First World War, there was a similar short, sharp deflation after the Napoleonic war. This was followed by a period of monetary adjustments which lead to the restoration of the value of the currency. This was followed by a great deal of foreign lending which was followed by the crash of the stock market and the depression.

But, Milton Freedman argued that it was completely monetary in nature and that the factors that brought about the depression were all in the national economy and had nothing to do with the international economy or the delay in the implementation of Glass-Steagall Act of 1932 which allowed the Federal Reserve System to substitute government securities instead of gold for the liabilities of the central bank because of a shortage of monetary gold.

Economic historians such as Youngson and some others thought that the depression was brought about by the fall in the gold standard after the First World War, and that the plunge of the gold standard was brought about by the monetary policies of America and France. Also the Franc was undervalued and the British pound was overvalued. This coupled with the unwillingness of the United States to carry out large scale monetary policies might have been a big mistake that subsequently lead to the fall in the gold standard. Eventually the Franc stabilized, which was good for the French, but not so much for the other countries.

Recovery from the First World War

From 1921-29 there was a boom taking place in the US economy fueled by the production of cars and its complementary and supplementary goods and other products such as motion pictures, etc. Murray Rothbard was a result of the relaxed monetary policies used by the Federal Reserve System. Since there is supposed to be inflation in the long run because the boom would mean more money for the people to spend, hence more demand. So production would increase and this would ultimately lead to a rise in the cost of production because of the tight labor market thus leading to inflation. Kindleberger cites that whatever goes up must come down and quotes “It is agreed that to prevent the depression, the only effective method was to prevent a boom.” “A condition of recovery is the gold standard to preserve interlocal equilibrium and to avoid the development of booms.” “A satisfactory theory of the boom explains the depression. In the crisis what has been sown during the boom has to be reaped.”

The Boom

In July 1927, after the Long Island conference, the Federal Reserve System reduced the interest rate to 3.5% to help the British gain capital and thus halt the loss of gold. But, this was also done with domestic considerations in mind and it helped stimulate the rise in the stock market in the spring of 1928. This however was not the cause of the crash of the stock market later. Schwartz and Friedman believed that what lead to the crash was that Federal Reserve System later directed policy partly both to the stock market and the level of business. They believe that the Federal Reserve System should have ignored the boom in the stock market or just carried out either one of its objectives since the two objectives of the monetary policy lead to conflict between them. Although this was not the sole factor responsible for the crash, it did have some significance.

The US foreign lending plummeted in June 1928 since people were diverted into the stock market as it was booming and heading for a climax, albeit a nervous one. The Federal Reserve System, using monetary policy tried to tighten credit and slow down the diversion of money from business and households into the stock market. These factors helped tighten the credit conditions in the industrial and commercial sector.

The Agricultural Depression

Agricultural goods were the main source of export for the United States and cotton was the most important of them all. When in 1929 an attack of bool weevil in the southeastern United States ravaged the cotton fields, it decreased production and increased price. This lead the bank failure in the Atlanta Federal Reserve district in the same year just prior to the stock market crash. However this was thought to be a local phenomenon. But, Benjamin Strong of the Federal Reserve System of New York pointed out that this was something to be worried about since cotton was the most important source of export and was hence very important as the main problem plaguing the United States was its depreciating foreign exchange.

The 1929 Stock Market Crash

In response to what caused the 1929 stock market crash Kindleberger quotes “The stock market crash in 1929 was a momentous event, but it did not produce the Great Depression and it was not a major factor in the Depression’s severity. A sharp but not unprecedented contradiction was converted into a catastrophe by bad monetary policy… Whatever happens in a stock market, it cannot lead to a great depression unless it produces or is accompanied by a monetary collapse.” Friedman argued that what was necessary during the depression was to maintain a constant money supply over the time period. But Kindleberger disagrees with this and points out that there was no decrease in money supply between October and December of that year, during which time there was a depression going on and in fact was deepening. As soon as the crash happened other countries jumped into the international monetary scene to resolve the issue. England, Netherlands, Norway, Austria, Belgium, Denmark, Germany, Hungary and Sweden lowered their discount rates anywhere between one and three times by the end of the year.

Gold Bloc

The gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold. In the 1920's, the United States there was increased uncertainty in the market which created a higher demand for gold. The U.S. raised interest rates to try and increase the value of the dollar. This created a deflationary gap. The Federal Reserve confused the situation and treated it as if they were in an inflationary gap which led to more reduced prices and decreased aggregate demand. Many countries followed policies of larger economies and aided in created a worldwide depression. In 1933 there was a depreciation of sterling in Belgium, France and the Netherlands, and from it they all suffered exchange losses. Before this time France was the leader of the Gold bloc which was an independent monetary force at the time. France had large gold reserves, buoyant trade and budgetary surpluses that made it impervious to the trouble that affected Germany, Britain and the United States. This began to change because as the world broke up into sterling, dollar, blocked-currency (non convertible currency), and gold blocs, it proved impossible a task of deflating to maintain trade balance and gold reserves.

Deflation at this point seemed the only option as a cure for disequilibrium. Recent history would not permit depreciation and pride forbade exchange control in many countries, except Italy. Exchange controls are typically used by countries with weaker economies. These controls allow countries a greater degree of economic stability by limiting the amount of exchange rate volatility due to currency inflows/outflows. Deflation seemed the only remedy. There was also stress on French exports because of the francs overvaluation of about 26 percent. There were high yearly declines in exports from 1930 to 1935. Also the price disadvantage was severe and it proved impossible to reduce costs and prices to make up for the appreciation of the currency. Whole sale prices feel from 462 in 1931 to 347 in 1935. The governments tried to balance by cutting expenditure and especially by reducing payment pensioners and veterans. Also they reduced the wages of government employees. Obviously, these changes were strongly opposed. Veterans and pensioners were not as affected by the depression as strongly because their wages were determined by the amounts they received and not the declining prices.

Disposable income also dropped from 331 billion francs in 1930 to 221 billion in 1935 for real GDP. These events also caused a reversal of normal movement as people began to move back out to the countryside instead of to the cities. This was especially prevalent in the United States. The Minister of finance was sometimes able to propose expenditure cuts and new taxes, but even the few that were passed most of the governments failed anyways.

Fiscal Policy

“Fiscal policy is a type of stabilization policy that involves the use of changes in taxation, government transfers, or government purchases of goods and services.” The 3 types of fiscal policies used are:

Government expenditures

Taxes

Transfers

Fiscal policies can be of 2 types:

Expansionary fiscal policy

Contractionary fiscal policy

During the Great Depression, expansionary fiscal policy was used to help pull the economy out of the depression.

More information about fiscal policies during the Great Depression can be found on the following link. http://www.investopedia.com/articles/04/051904.asp

The World in Depression

At the time of the Great depression, positive fiscal policy was almost non-existent since the world was at a balanced peace time budget, as opposed to the time of the First World War. Positive fiscal policy was not followed by any country at that time. The only fiscal policy that existed was in the shape of taxes changed.

The Beginnings of Recovery

In 1934-35 after the Great Depression, under President Roosevelt, limited amounts of fiscal policies were being used to expand employment. However the democratic administration at that time did stick to balanced budgets.

The 1937 Recession

It is believed that the depression, to some extent, was brought about by a sudden change in fiscal policy in 1937. On April 14 1938, after the market collapse, the President agreed with the US Treasury and a program was worked out that would use positive fiscal policy as a process of stabilizing the economy. It was announced to the Congress the evening of the same day that it was finalized. The money and backing component of this recovery program involved a reduction of reserve requirements by about $750 million and the discontinuance of the Treasury’s inactive gold account which had about $1.183 billion left in it. After being rejected for seven years of depression, by Hoover and Roosevelt, the Keynesian doctrine of spending for stability was accepted and put into motion. This meant increasing government spending to pull the economy out of the depression. So spending was increased by more than $2 billion and about $1 billion in loans were also loaned out to other spending bodies. Previously, before adopting the new budgetary policies deficits were viewed as a shortfall on the part of the administration to reduce taxes or expenditures, but the new budget involved the acceptance of deficits. As a result of the new changes, the economy slowly began to recover from the recession even though the recovery was uneven, as opposed to a smooth gradual increase. The recovery was accompanied by a slight but consistent fall in prices. The recession that happened after the Great Depression actually had a couple of benefits. It provided the intellectual basis for the stabilizing the economy. Then the recovery from the recession after deploying the new budget demonstrated the effectiveness of the Keynesian ideas.

Thesis summation

Kindleberger’s “story”, or overall thesis as an economic historian is that the United States failure to realize itself as the economic hegemon in the post World War I era was the primary cause of the great depression.

Kindleberger’s argues that prior to World War I, Britain was the leader of the global economy, and functioned as such as an economic stabilizer. However, at the end of World War I Britain gave a lot of attention, specifically, economic efforts, toward rebuilding Germany. As a result, it no longer was able to effectively lead the world economy.

The United States, on the other hand, had the ability to take over as world economic leader, but did not do so.

According to Kindleberger, the absence of an effective world power stabilizer, caused by the United States continued isolationism and hesitancy during this period leading up to 1929, is what ultimately led the to the Great Depression’s severity and unusual length,.

HEGEMONIC STABILITY

Within his thesis, Kindleberger also asserts that world economic stability needs “a single stabilizer”. That is, a hegemonic economic leader who behaves as an effective stabilizer will yield the greatest equilibrium in the world economy.

This theory has a widespread popularity among both political and economic experts. Kindleberger is considered to have been the lead advocate for the theory of economic hegemonic stability, and one of two leading advocates overall.

Kindleberger’s economic evaluation and analysis in World in Depression is a basis for the development of this theory. By arguing that the United States failure to accept the responsibility of economic hegemeon from Britain caused the great depression, thus attributing the eventual worldwide depression to the absence of a predominant national body, Kindleberger conveys that a hegemonic economic scenario is the best environment for a healthy economy worldwide.

The FIVE PILLARS

Kindleberger’s “narration” outlines five pillars of hegemonic stability. Kindleberger conveys both British attempts/successes and American failures to uphold these pillars, and how they eventually led to the depression.

1). A relatively open market for distress goods needs to be maintained

Free trade must have flexibility when it came to foreign productive capacity fluctuations; it needs to be able to adapt.

Free trade must be kept during periods of stress and downturn. Kindleberger argued that holding fast in a policy of free trade leads to a greater stability level

Where the US failed-: The United States, when the depression hit, instated imposed the Hawley-Smoot Tariff. This raised tariffs to record high levels, and effectively created a huge isolationist barrier to free trade with other nations. These nations in turn produced retaliatory tariffs, thus reducing exports and imports.In short, the US cut and ran, in a short sighted self preservation effort, which eventually worsened the overall status of the both the global economy and of the US as a constituent of that economy. Without any exportation or importation flow, economies were left to struggle on their own. The Hawley Smoot Tariff effectively divided the world into individual economies and forced them to deal with the depression’s various degrees of severity on their own.

Remember Y= C + I + G + X - M

2). Stability in long term lending-

follow the “demand model”

when there is a depression domestically, and a foreign boom, invest abroad,

when there is a domestic boom and a depression abroad, invest domestically

Where the US failed- The United States followed a “supply model” instead during the depression. In a supply model, investment depends solely on domestic success, in short domestic savings. So when the depression hit, even when there was investments which would clearly yield higher returns abroad, the United States chose instead to invest in a higher risk, lower return strategy by concentrating its funds solely on domestic issues. Thus worsening the depression for itself, as well as its neighbors.

I= NS + KI

3) policing a relatively stable system of exchange rates

the hegemon needs to effectively monitor a system of exchange rates between currencies.

Kindleberger states that with flexible exchange rates in a world of deflation (such as the 1930's), depreciation does not affect domestic prices, but decreases prices in countries where exchange rates have appreciated. In a world of inflation, the opposite occurs, as depreciation will cause domestic prices to rise. Thus, Kindleberger argued for a stricter regulation of the exchange rate.

How Britain succeeded in this role: Exchange rates were stable in the 19th century, due to the gold standard. The price of gold was fixed and managed by the Bank of England. After the inflations of WWI, exchange rates were altered. Then came the depression, which led countries to stop borrowing and decrease their export prices and values in an attempt to depreciate their currencies. The idea was that by depreciating their currencies, foreign investment would make purchases in the market. However, this competition also caused massive inflation, which further increased the severity of the depression.

How the US failed: the US failed in this role simply by neglecting to recognize the need to stabilize the exchange rate. Instead of regulating the exchange rate, the United states retreated inside its own borders economically, and in the absence of an economic leader practices were put into place which caused a mass inflation.

4) ensuring the coordination of macroeconomic policies;

It is important to have a singular coordinator of nation’s macroeconomic policies.

Kindelberger believed that monetary policy and fiscal policy should both be monitored closely

Britain’s Example in Pre-World War I times, monetary policy was dictated to the world in large part by England. The Bank of England created techniques for management of London money and capital markets. Fiscal policy existed only to shape taxes. Its purpose was not to hold stability and national income, but for resource allocation and income distribution.

How the US exacerbated the depression: After World War I, the gold standard broke down, as the US and France accumulated a large amount of gold, with no reciprocal outflux of the gold back into the market. Thus sterilizing the gold standard. The United States, instead of regulating monetary policy, condensed its concerns on the matter to domestic usage. As did the rest of the world. Thus, there was little communication and virtually zero policy coordination.

5) acting as a lender of last resort by discounting or otherwise providing liquidity in financial crisis.

Lender of Last resort is the idea that a hegemonic nation should behave a financial intermediary that will lend money to foreign banks, governments, and other institutions when they are experiencing difficulty, even when a loan is high risk or the financial institution which needs one is near collapse.

The strongest country must assume these responsibilities, and may have to forgo short run capitalist gains to provide long run stability, both in the hegemonic nation and the international community.

How Britain succeeded: Domestically, the British paid close attention to the status of their banks. The Bank of England rescued the William Deacons Bank in January of 1929. Similarly in Italy, a plethora of banks were saved secretly in 1930.

Internationally, Britain tried to maintain the position as lender of last resort in the post world war I period. The Dawes and Young plans, which dealt with German war reparations, were actually largely developed by British economists. These plans dealt with reparations, debt consolidation, and generally trying to balance the German budget and stabilize currency. By 1929, it was clear that Great Britain could not stay at the helm any longer and could no longer last as an automatic stabilizer.

How the United States failed In the face of British incapability to continue to serve as the lender of last resort, and the increasing potential of the United States to assume that role, the U.S. declined to help, and effectively eliminated the lender of last resort. Thus, there was no security net, which contributed to bank runs, panics, etc.

PROOF AFTER THE DEPRESSION

the recovery after the depression in the post World War II era seems to legitimize the theory of a hegemonic authority acting as a stabilizer to macroeconomies.

The United States ascended to become a stabilizer, and porceeded to follow policies in agreement with the five pillars.

For example,the Marshall Plan can be seen as a policy reinforcing last resort lending. More than 13 billion dollars donated by the United States from 1947 to 1951 helped to rebuild the economy of European nations.

The Marshall Plan also stimulated free trade by its indirectly easing tarrifs between nations.

"Food shortages and inflation discouraged maximum efforts by a demoralized work force. Shortages of coal, steel, and other basic resources further restrained production; and the severe winter of 1946-47, the worst in modern memory, nearly wiped out earlier economic gains. In 1947, Western Europe’s agricultural production averaged only 83 percent of its prewar volume, industrial production only 88 percent, and exports a bare 59 percent."

usinfo.state.gov

"Thanks to the Marshall Plan, the economy of the democratic part of Europe was saved. The success was a striking demonstration ofthe advantages of cooperation between theUnited States and Europe, as well as among the countries of Europe themselves."— paul-henri spaak

prime minister, belgium, 1947-1949

Initiatives such as this, helped bolster every national economy that participated in the program beyond pre-war levels.

Works Cited

Kindleberger, Charles. The World in Depression: 1929-1939. University of California Press, 1986 [Revised and Enlarged Edition]

"The Marshall Plan: Rebuilding Europe". US international information programs. May 2007.

http://usinfo.state.gov/products/pubs/marshallplan/

European Historical Economics Society Online

http://eh.net/EHES/

"Hegemonic Stability Theory and Economic Analysis: Reflections on Financial Instability and the Need for an International Lender of Last Resort". University of California, Berkeley. 1996

http://repositories.cdlib.org/cgi/viewcontent.cgi?article=1034&context=iber/cider