The mistakes of 1937 was monetary contraction, and an attempt by FDR to force wages up
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October 1937
The 1937 October crash (which like the 1929 and 2008 crashes actually lasted from September to November) was just as interesting as 1929, and even more complex. First we need to consider a few basic facts:
1. In 1937 the U.S. was back in the international gold standard. It wasn’t much of a standard (with only a few countries), and Americans could no longer own gold (officially—but they hoarded it in London banks.) Nevertheless, our monetary policy was now at the mercy of shocks to the international gold market. Put simply, an orgy of gold dishoarding caused the US WPI to soar about 10% between mid-1936 and mid-1937, despite the depressed economy. Then between mid-1937 and mid-1938 it fell back my an equal amount. By itself, this would have caused a very strong period of growth in late 1936 and early 1937, and a mild recession thereafter. But that is not exactly what happened. The very strong growth in industrial production in 1936 leveled off in the spring of 1937, despite the expansionary monetary policy.
2. The second factor was the third of FDR’s five wage shocks, and the one least directly connected to government policy. Toward the end of 1936 and throughout much of 1937 union membership soared. The 1935 Wagner Act had made it much easier to organize unions, and FDR’s overwhelming victory in 1936 assured union organizers that Washington would support them in their battles. The resulting wage shock looks a lot like the WPI price bubble, except shifted a half year into the future. Wages started rising later, peaked later, and fell later than the WPI. In addition they fell by much less that prices. This is why output didn’t grow even faster in early 1937, and it’s also the factor that turned what would have been just a mild recession from the pullback if commodity prices, into a deep depression–comparable to 1920-21.
The real wage rate (nominal wages divided by the WPI) tracks monthly industrial production very closely throughout the 1930s, and 1936-38 is no exception. (Actually you have to invert the real wage series—as wages were countercyclical.) The economy boomed when real wages fell (due to the WPI rising faster than nominal wages, and fell when nominal wages rose much faster than prices. Some growth occurred when real wages were flat. So 1936-38 fits my overall model of the Depression. Then it all comes down to explaining wages and the WPI. The main exogenous factors influencing wages were the five New Deal wage shocks discussed in an earlier post. The WPI can be explained with a model of the international gold market when the price of gold is fixed (1929-33, 1934-40) or by changes in the price of gold itself in 1933-34—as in my Warren post.
Working with this model, I found that there were three factors pushing up prices in 1936-37. Central bank dishoarding of gold increased in late 1936, as countries such as France abandoned the gold standard. Another factor was increasing Russian gold sales, along with the (incorrect) expectation that much more was coming from Russia. And this also led to private dishoarding, motivated by both the collapse of the gold standard in Europe (no longer a need to hoard gold in expectation of future devaluation), and fears that the huge gold flows to the US would prove so inflationary that FDR would be forced to revalue the dollar upward. This is what the Paul Einzig quotation in my “worse than economists expected. . . ” post was referring to.
For very complex reasons this process started to reverse in mid-1937. As rising wages slowed the US economy, revaluation fears disappeared. The Russian gold sales that were expected never fully materialized. Gradually, gold dishoarding gave way to gold hoarding, as people saw that the U.S. was again sliding back into depression and investors worried that FDR might seek another monetary “shot in the arm,” just as in 1933. By the fall, devaluation fears grew rapidly and gold hoarding increased sharply. Gold inflows to the U.S. virtually ceased. Under the burden of high wages and sharply falling prices the U.S. slid into a deep depression, and stock and commodity prices fell sharply.
I find several interesting parallels between 1937 and 2008. Both years started with rapidly rising commodity prices all over the world, and ended with prices falling just as rapidly. One difference was that the 1936-37 boom was purely monetary, as the economy was still somewhat depressed. In contrast, the 2007-08 boom was driven by strong growth in developing countries.
An even more interesting parallel is the sharp reversal of expectations of medium term growth and inflation. In the first half of 1937 it was very obvious that both the financial markets and the press expected inflation to continue due to the expected swelling of the US gold stock. By the end of 1937 expectations had changed radically, and there was a perception (which turned out correct) that we were headed for a prolonged period of deflation. The WPI did decline almost continuously from mid-1937 to mid-1940...
themoneyillusion.com
The US recession and the myth of 1937
Gerard Jackson
BrookesNews.Com
Monday 1 March 2010
The current situation has many people referring back to the Great Depression, particularly the 1937 downturn. As usual they are drawing the wrong conclusions. The lesson that so many have failed to grasp is that the Great Depression is a tragic testimony as to what can happen to a country when governments defy economic laws.
Let us begin with Roosevelt's 1935 Wagner Act. This had been passed in reaction to the Supreme Court's decision to declare the economically destructive National Recovery Act unconstitutional. However, constitutional lawyers advised business that the Wagner Act was also unconstitutional. In view of this advice most big businesses ignored the Act and used free market prices to increase output and employment. As a result unemployment fell from 9.1 million in 1935 to 6.4 million in 1937, iron and steel production rose to more than 100 per cent the 1933-34 level and car production more than doubled the 1933 level.
Production trends were similar for other products. Even so, it was still a weak recovery and aggregate wages as a per centage of national income exceeded 70 per cent while profits were only about 15 per cent. This meant an overall 10 per cent increase in labour costs would be enough to slash profits by about 50 per cent. Clearly, any wage-push would quickly derail the recovery.
In 1937 tragedy struck. The Supreme Court in a series of 5 to 4 decisions reversed its reasoning in the NRA case and upheld the Wagner Act as constitutional. The Act meant that business was now forced by law to 'negotiate' with politically privileged unions. Market wage rates would no longer be tolerated. The court's decision was immediately followed by an immense outbreak in union activity (some of it quite violent) resulting in a rapid rise in labour costs. The result was as predictable as it was tragic — unemployment leapt from 6.4 million in 1937 to 9.8 million in 1938. (This is a fact that lefty historians and economists like Christine Romer, Krugman and Stiglitz ignore.)...
brookesnews.com
Phase IV: The Wagner Act
By Lawrence W. Reed | Jan. 1, 1998
The stage was set for the 1937-38 collapse with the passage of the National Labor Relations Act in 1935 — better known as the "Wagner Act" and organized labor's "Magna Carta." To quote Sennholz again:
This law revolutionized American labor relations. It took labor disputes out of the courts of law and brought them under a newly created Federal agency, the National Labor Relations Board, which became prosecutor, judge, and jury, all in one. Labor union sympathizers on the Board further perverted this law, which already afforded legal immunities and privileges to labor unions. The U.S. thereby abandoned a great achievement of Western civilization, equality under the law.
The Wagner Act, or National Labor Relations Act, was passed in reaction to the Supreme Court's voidance of NRA and its labor codes. It aimed at crushing all employer resistance to labor unions. Anything an employer might do in self-defense became an "unfair labor practice" punishable by the Board. The law not only obliged employers to deal and bargain with the unions designated as the employees' representative; later Board decisions also made it unlawful to resist the demands of labor union leaders. [34]
Armed with these sweeping new powers, labor unions went on a militant organizing frenzy. Threats, boycotts, strikes, seizures of plants and widespread violence pushed productivity down sharply and unemployment up dramatically. Membership in the nation's labor unions soared: By 1941, there were two and a half times as many Americans in unions as had been the case in 1935. Historian William E. Leuchtenburg, himself no friend of free enterprise, observed, "Property-minded citizens were scared by the seizure of factories, incensed when strikers interfered with the mails, vexed by the intimidation of nonunionists, and alarmed by flying squadrons of workers who marched, or threatened to march, from city to city." [35]
mackinac.org
Worth 1000 words. 
This is the graph that should have been posted with the “Payback” post last week. I’d like to thank Rob Fightmaster, who helped me get this and several other graphs into a form that could be posted. (If you can’t see it well, there is a bigger version at the very bottom.)
Update: I forget to mention that Steve Silver helped me to produce this graph in the early 1990s.
The bottom time series shows the Great Depression. More specifically, it shows the log of industrial production, monthly, detrended, from the beginning of 1929 to the end of 1939. And the Depression still wasn’t over. The two low points are July 1932 and March 1933 (the month FDR took office.) Then you see the 4 month spike in industrial production that I often discuss in my blog. That peaks in July 1933.
On the top is the real wage series; the nominal manufacturing wage deflated by WPI. Also logs, with the variation multiplied three times. Most importantly, the real wage series is INVERTED, to make it easier to see the negative correlation between W/P and IP at high frequencies, which is very much obscured using annual data. Just looking at 1933 makes it easy to see why. Real wages fell very sharply during that period of explosive growth between March and July 1933, and hit bottom in July. Then real wages soared and output plunged.
I don’t want to oversell this graph; I think other factors like Smoot-Hawley and the huge rise in MTRs during 1932 also help explain the extreme fall in output during 1932. Since I don’t plan to post my chapters covering 1933-40, perhaps I should say a word about the events that shaped the very uneven course of the recovery:
1. As you can see IP fell sharply after the July 1933 peak, in response to FDR’s surprise decision to raise all wages by 20%. Not surprisingly, there was a huge stock market crash as the story leaked out over three days (indeed the 3rd biggest three day crash ever.) By late October FDR was getting nervous. Time for another shot in the arm from more dollar depreciation. He brought in George Warren, who I discuss in this post. As far as I know every single economic historian, liberal and conservative, think Warren’s policy failed. Actually it succeeded. The dollar fell sharply between October 1933 and February 1934. Industrial production began rising and peaked in the spring of 1934.
2. Then FDR decided to raise wages again (I know, don’t they ever learn?) And again he killed off a promising recovery.
3. In May 1935 IP was still lower than July 1933. The Supreme Court then declared the NIRA unconstitutional. (The NIRA was the law that allowed FDR to raise wages.) The economy took off on a two year boom. It was helped by fast rising prices between mid-1936 and mid-1937. The prices rose because once the international gold standard fell apart in 1936, hoarders who had feared devaluation now dis-hoarded on the reality of devaluation. Output should have risen rapidly right up through the summer of 1937.
4. Actually, output hit a wall in early 1937. The Wagner Act was a response to the Supreme Court’s NIRA decision. It made it much easier to form unions. The union movement was emboldened by FDR’s big win in late 1936, which unions had helped to achieve, and union drives rapidly increased membership in late 1936 and 1937. The resulting wage shock slowed the economy sharply in 1937, despite high prices.
5. As the economy slowed, people began to no longer fear inflation, but rather deflation. Gold hoarding increased strongly in late 1937 in response to renewed fears of dollar devaluation, causing prices to fall. This created an identical situation to 1920-21 and 1929-30, as prices fell rapidly. Since wages are slow to adjust (particularly with the stronger unions) real wages rose and IP fell sharply.
6. Eventually wages did adjust, and in the spring of 1938 output began rising. Then in late November 1938, FDR instituted the first minimum wage law (25 cents an hour) and the recovery immediately stalled. In the spring of 1939, the economy again began recovering. But in November 1939 he raised the minimum wage to 30 cents an hour, and the recovery stalled for the 5th and last time.
7. Unfortunately my graph gives out at the end of 1939. In early 1940 the economy was weak, but it took off like a rocket after the German invasion of France, which is when the “phony war” turned into a real war. I don’t study this time period, but there were two factors contributing to recovery. Fiscal stimulus; and (perhaps) higher inflation expectations, both of which would reduce currency hoarding.
themoneyillusion.com
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