Causes of The Great Depression: Difference between revisions
| Line 77: | Line 77: | ||
There are many similarities leading up to the Crash of '29 and '00. The differences can start to be seen after the crash of '00, when correct policies were implimented. | There are many similarities leading up to the Crash of '29 and '00. The differences can start to be seen after the crash of '00, when correct policies were implimented. | ||
In the "Roaring 20's" and "go-go 80's" there was huge flows of investment capital to the U.S. There would have been more if in the 20's banks did not fail at a rate of 2 per day and in the 80's the banking system did not go under. In | In the "Roaring 20's" and "go-go 80's" there was huge flows of investment capital to the U.S. The huge leaps in technology spurred massive investment, whether it was the new farm equipment or mass communication devices like the radio and the internet. There would have been more investment if in the 20's banks did not fail at a rate of 2 per day and in the 80's the banking system did not go under. In the late 20's and in the 90's corporations would use their money to invest in the market and support their stock price. The problem here is that this money should have been used to support their day to day business or invest in capital. As bubbles go, these unjustified high prices were merely a facade over the declining physical economy. The physical economy was not getting the investment it deserved because money was re-designated for the stock market instead. | ||
Just before both crashes there was a three month rally with soaring prices but many would continue to play the "greater fool" game until they became that fool. In the "greater fool theory" speculators would buy stocks that they knew were overpriced because they guessed that someone else would be willing to buy it for an even more absurd price. At some point the buying stops and people begin to panic and sell which leads others to domino in the same fashion. | Just before both crashes there was a three month rally with soaring prices but many would continue to play the "greater fool" game until they became that fool. In the "greater fool theory" speculators would buy stocks that they knew were overpriced because they guessed that someone else would be willing to buy it for an even more absurd price. At some point the buying stops and people begin to panic and sell which leads others to domino in the same fashion. | ||
Revision as of 04:39, 30 November 2006
Undeniable Facts
From 1929 to 1933, real output fell by about 30%.
From 1929 to 1933, unemployment rose from about 3% to about 25%.
From 1929 to 1933, the dollar deflated on average 10% per year.
From 1929 to 1933, the money supply fell by about 30%.
To put this in perspective we can look at another deflationary episode in American history.
From 1973 to 1975, real output fell by about 3.4%.
From 1973 to 1975, unemployment rose from around 4% to 9%.
Historical Overview
Keynesian vs. Monetarists
Black Thursday - The Great Crash
Banks
In June in 1929 there were 25,300 banks in the U.S. Out of these thouands were mismanaged partly due to a lack of effective regluation. In the six years leading up to 1929, the crash and subsequent depression, on average two banks failed every day. For the six year period ending in 1932, they failed at three or more each day.
The loss of deposits, an estimated 25%, was nothing in comparison to the loss of confidence in the banks of 100%.
Tariffs
1922 1924 Hawley-Smoot
The Gold Standard
In our analysis of the Gold Standard in the U.S. and the World, we will be focusing on 1870's to the beginning of the First World War and from the end of the First World War up until 1936 when some of the last major countries went off.
Before the First World War, the gold standard was a successful means of stabilizing the currency. This is due to, on part, the Bank of England, which since 1694 had let the international system. The Bank of England did this by provided management and incuding cooperation. This made for a stable system because the Bank of England could easily adjust for imbalances in the system.
After the First World War was over the countries that managed to get back on to the gold standard found it very unstable. This was not the gold standard they remembered, the credibility was weakened by the destroyed economies, the financial problems such as large government debt, hyperinflation, and now there was no international leader like there had been for hundreds of years. Speculators attacked currencies like the British Pound by demanding gold for their pounds which lead the the bank collapsing in 1931.
Going back off the gold standard was not so bad. Once off the gold standard, central banks would be able to pursue expansionary policies and combat deflation. If the currency is not dirctly linked to the supply of gold, policy makers are free to increase the money supply. In hindsight we now see that those who got off the gold standard early such as Britain and Scandinavia, recovered sooner. Those who got off later such as France and Belgium, recovered later.
The Dustbowl
First, a background on agriculture. Before and during the First World War, millions upon millions of acres farmland were bought and cultivated to feed the evergrowing demand. America was still very agriculturally based and Europe was at war and demanded agricultural products. Since Europe was more focused on industry compared to the U.S., American farmers could still make a profit at the inflated prices for land and high interest loans.
Later in the 20's, this large surplus of farmland, now no longer needed to support Europe, had trouble staying economically viable. Along with this, the large technological improvements greatly increased the manhour productivity on farms lowering the acreage demand. The shift in style of clothing away from wool and cotton further exacerbated the low demand problem. Unlike the factories, The farmer at the time had no means of price control. This means that the farmer had to sell at the lowest price at auctions but had to buy at the high retail prices. It was at this time the country was making a shift towards industry partly due to the increased demand from war-torn Europe and partly due to the lack of demand for more farms. Along with this, the U.S. government dropped their subsidies on agriculture goods and placed them on industrial goods instead. The Tariffs did not help out the situation either.
When there are high interest rates on loans like during the 1920's and 1930's, only those who have a high risk but high profit expectation will take the loans. This concept born out of the bad monetary policy had disasterous effects both on agriculture and industry. In terms of agriculture, the American farmer who was converting the primarily midwestern grazing land into cash-crop farms was betting that the trade barriers would fall and the government subsidy would remain on agricultural products. Their high risk high potential profit possibility blew up into dust when the cycles of nature and government policies went against them.
What the farmers did was they would remove the protective grass in order to plant crops like wheat thus creating an enormous potential for erosion. In the midwest there have been periodic dry spells every twenty years or so and this occured at a time when there was less grass and trees to protect the ground from wind erosion and from the dirt being lifted off the ground. The productivity dropped drastically as farm ownership dropped by more than 30% during the 30's and productivity per acre dropped more than 10 fold due to the havoc the dust caused to plants.
As an aside, I think it's interesting that despite drastic changed in technology and factory-like farms necessary to be economically competitive, changes in the way of life and the mindset of most Americans, politicians still love the quintessential farmer. The small American farmer who is always struggling to make ends meet is still considered the true American.
Environmental and Economic Collapse in the 1930s
The Four Major Monetary Policy Errors According to Bernanke
1. The tighening of the money supply in 1928 helped lead to the crash. This tightening of the money supply took the form of increased interest rates. The logic was that this would help those who needed the credit for productive purposes, and would disuade those who were using the credit for speculation. The Fed at the time had an onging concern with the speculation.
It worked. The Crash of 1929 will show us that the efforts the Fed did in fact pay off. They managed to bring down prices and slow down speculation. The flaw in their "pyrrhic victory" was that they accomplished their goal at extreme cost.
2. Next, The Gold Standard came under fire.
When many speculators doubted the ability of certain countries, namely Britain, to maintain their currency value relative to gold, they acted. The speculators who expected Britain to be forced off the gold standard and exchanged their pounds for gold forced the pound off of the gold standard. Here, like the panicky crash of '29, we have a "self fulfilling prophecy."
3. In 1932 the Fed eased the interest rates on government bonds and corporate debt because they were under fire from Congress. This brought about an uproar who argued that the depression was necessary to get rid of the financial excess of the 20's. The claimed that the relative disparity between the rich and poor had grown too large. When the Fed eased many fired back claiming that there was already easy money, clearly seen in the Treasury Bonds and the almost zero nominal interest rate. Later in 1932, the Fed reversed their policy.
4. The bank problems of the time received no help from the Fed and were left to their own devices. During the "bank holidays" from 1930 to 1933, half of the U.S. banks had closed their doors or merged. Not only was there a problem with having less banks but the banks that survived did not seek to expand their deposits or increase their loans to replace those lost when other banks had closed. Furthermore, people did not trust banks and hoarded cash, taking currency out of circulation. The dollar bills in the shoebox buried in the lawn can't be circulated. This exacerbated the already dismal and decreasing money supply.
The Liquidationists of the time applauded these circumstances because they felt that this was weeding out the weak banks. It was harsh, yes, but necessary for the banking system to be strong in the long run.
Crash of 1929 vs 2000. Learning From Our Mistakes
There are many similarities leading up to the Crash of '29 and '00. The differences can start to be seen after the crash of '00, when correct policies were implimented.
In the "Roaring 20's" and "go-go 80's" there was huge flows of investment capital to the U.S. The huge leaps in technology spurred massive investment, whether it was the new farm equipment or mass communication devices like the radio and the internet. There would have been more investment if in the 20's banks did not fail at a rate of 2 per day and in the 80's the banking system did not go under. In the late 20's and in the 90's corporations would use their money to invest in the market and support their stock price. The problem here is that this money should have been used to support their day to day business or invest in capital. As bubbles go, these unjustified high prices were merely a facade over the declining physical economy. The physical economy was not getting the investment it deserved because money was re-designated for the stock market instead.
Just before both crashes there was a three month rally with soaring prices but many would continue to play the "greater fool" game until they became that fool. In the "greater fool theory" speculators would buy stocks that they knew were overpriced because they guessed that someone else would be willing to buy it for an even more absurd price. At some point the buying stops and people begin to panic and sell which leads others to domino in the same fashion.
After both of the crashes we can start to see some very different actions. The Fed of '29 reduced liquidity, tightened monetary policy, and ignored the Banks cry for help. The Fed of '00 essentially put up a "wall of money" creating easy money, they supported the banks, and enacted expansionary fiscal policy by lowering taxes. To add to the Tariffs In 1930 we also had the Hawley-Smoot Tariff Act which worsened the already highly tariffed foreign trade relations and the productivity of the American firms. After the crash of '29 we had the "natural disaster" of the dust bowl, and after the crash of '00 we had 9/11.
The wall of money and increase in the money supply was not a Fed handout post 2000 crash. This wall of money was actually just a promise to provide liquidity, the Fed only gave confidence, which gave optimism and the expected fall was not as hard as that of 1929 when the pompous economic leaders of the time were thought to be out of touch and disengaged. For example, the Treasury Secretary Andrew Mellon said in 1929, "I see nothing in the present situation that is either menacing or warrants pessimism."
