From the Economist:
A refresher on the 1930s
With investors reeling and recession on the march, thoughts turn to the Great
Depression. Could it happen again? Maybe, if governments try hard
FROM a distance of more than 60 years, it should be possible to view the 1930s
objectively. What went wrong, how things were handled and how they should have
been-all this ought to be understood by now, you might think. If it were, lessons
could be drawn to guide policymaking in difficult times such as these. Unfortunately, it
isn't.
The century's greatest economic minds have examined the subject without producing
anything like a consensus. Still, enough is known to refute the folk-memory
version-namely, that the Depression started with the Wall Street crash of October
1929; that the slump persisted because policymakers just sat there; and that it took
Roosevelt's New Deal, heralding the modern era of enlightened activism, to put things
right. Briefly, the Depression did not start with the stockmarket crash; American
policymakers were not passive, they were incompetently active; and on balance the
New Deal, far from ending the slump, most likely prolonged it.
At around the beginning of 1928 the Federal Reserve, worried about financial
speculation and inflated stock prices, began raising interest rates. Industrial production
turned down in the spring of 1929, and overall growth turned negative in the summer.
A recession had started. In the two months before the Wall Street crash, industrial
production fell at an annual rate of 20%. When the crash came, however, it was
savage: stunning drops on October 24th, 28th and 29th, then a rally, then another fall.
By mid-November the market had declined by a half.
Coming on top of a recession that had already begun, the crash set the scene for a
severe contraction-but not for the decade-long slump that ensued. The key question
about the Depression is why a bad downturn just kept getting worse, year after year,
not just in the United States but around the globe.
In 1929 most of the world was on the gold standard. Allowed to work, this system
should have helped stabilise the American economy. As demand there slowed, its
imports fell, its balance of payments moved further into surplus and-under the
ordinary "rules of the game"-gold should have flowed into the country, expanding the
money supply and buoying the economy. But this mechanism was deliberately shut
down by the Fed, which was still worried about the effect of easier credit on
speculation. The inflow of gold was "sterilised" by the sale of government debt, and
money grew tighter.
Double jeopardy
Abroad, meanwhile, outflows of gold had their customary effect of reducing the money
supply and curbing demand. Governments everywhere then tried to reduce imports
through tariffs, with America kicking things off with the Smoot-Hawley act of 1930.
The effort was futile: the monetary pressure wasn't eased, and collapsing trade only
added to the plight of industry. The Fed's policy, together with Smoot-Hawley, had
turned the gold standard into a global-recession machine.
There was worse to come. In 1930 American banks began failing. The Fed let them,
again not out of neglect but as a deliberate act. Its policy was to insist on collateral
before it would help out, but the kind it wanted (commercial bills) the banks didn't
have. Before the Fed was created in 1913, the banks had had their own
clearing-house arrangements for helping each other resist runs; now, with those
arrangements all but defunct, the banks looked to the Fed to do the job, and nothing
happened. As the crisis of confidence spread, more banks failed, and then more. By
1933 more than 11,000 of America's 25,000 banks had failed. As people rushed to
turn bank deposits into cash, the money supply collapsed.
So much for monetary policy. Fiscal policy was little better. Hoover notoriously raised
taxes in 1932, to help balance the budget and "restore confidence". But history has
been unfair to Hoover, who tried to get the Fed to do more for the banks, and too
generous to Roosevelt. His New Deal delivered no substantial fiscal
stimulus-Roosevelt, like Hoover, believed in balancing the budget. On the good side,
it brought in bank-deposit insurance (a wise move, though not without problems). On
the other hand, it piled taxes on business and sought to prevent "excessive
competition". To stop prices falling, controls were brought in, alongside other new and
avowedly anti-business regulations.
In 1935 the economy was recovering-by now America was off the gold standard
and the money supply was expanding again-but unemployment stayed up, partly
because of the New Deal. In 1937-38 the economy moved into recession again. In
1939 the jobless rate was still 17%. It was the war, not the New Deal, that restored
full employment in America.
A study of the 1930s offers rather little comfort in 1998. It shows how much damage
bad policy can do, and how fragile economies can be. The policies of those years now
seem grossly mistaken, but that was not obvious at the time, and every age has its own
flawed orthodoxies. Indeed some rationales for bad policy in the 1930s have echoes in
today's debates-the need for fiscal austerity to "restore confidence", the "moral
hazard" argument against extending assistance to countries in financial distress, and so
on. But the best cure of all for complacency is to reflect on the fact that banks, the crux
of what went wrong in the 1930s, are still causing mayhem 60 years on, and regulators
haven't yet worked out what to do with them. |
