The Great Depression

1
The Great Depression

• What?
• When?
• Who?
• Why?
• Can it happen again?

2
The Great Depression what?

• A severe and unprecedented worldwide decline in
  economic activity
• Unemployment reached 25
• About 9,000 bank failures
• Stock market lost nearly 90 of its value from
  1929 to 1933
• General pessimism and uncertainty

3
The Great Depression when?

• Unprecedented duration about 1930 to 1940
• Economic activity not revived until World War II
• Unemployment cured by military conscription and
  enlistment
• Prosperity did not return until late 1940s

4
The Great Depression who?

• Herbert Hoover, Republican, was president from
  1929 to 1933
• His reputation as a laissez faire president is
  entirely wrong
• Programs initiated during his administration can
  be thought of as the start of the New Deal
• Franklin Roosevelt was president from 1933 to
  1945
• Ran as an economic conservative in 1933,
  promising to balance the budget
• Initiated vast increased in Federal government
  power

5
The Stock Market

• The DJI had climbed from about 64 to 381 during
  the 1920s
• A crash in October 1929 sent the average below
  230 in a matter of days. Much forced selling due
  to margin calls.
• A recovery in the spring of 1930 to about 280
  leading many to believe the worst was over
• Steep decline to a low of 44 in 1932.
• Strong gains followed by another decline in 1937
• 1929 high not exceeded until after 1950

6
Bank failures

• About 9,000 banks failed during the course of the
  Great Depression
• Many of these banks were not insolvent, but
  merely illiquid
• Example Bank of United States
• Failed in Dec, 1930 with 200 million in deposit
  liabilities
• Served primarily low-income Jewish immigrants
• Likely could have been rescued by a merger
• Ultimately paid out over 80 of its liabilities
  despite having to sell some assets at fire sale
  prices

7
Decline in money stock

• The M2 money stock declined from 45 billion to
  33 billion, perhaps in response to loan
  liquidations
• Prices could have adapted to the new lower money
  stock but wages in particular were not allowed to
  fall
• The Fed may have lacked reliable and timely
  statistics
• The Fed was focused on interest rates which are
  more readily apparent

8
Why did the stock market crash?

• The Fed had inflated the money supply
  substantially during the 1920s in part to
  support Britains ill-advised move to restore the
  pounds link to gold at its pre-war level
• Much of this money had found its way into the
  stock market
• Speculative fever had spread widely. Some were
  buying on as little as 10 margin
• Even some economists thought stocks could only go
  up

9
The Smoot-Hawley Tariff of 1930

• Raised tariffs on 20,000 items to record high
  levels
• 1,000 economists signed a statement of opposition
• Proposed by republicans to placate farmers who
  had already been suffering
• President Hoover called the bill vicious,
  extortionate, obnoxious. But he signed it.
• Predicable results
• Drastic fall in international trade
• Retaliatory tariffs, depression exported to Europe

10
The Smoot-Hawley Tariff of 1930 -- why?

• Farmers had suffered their own depression during
  the late 1920s. Republicans promised them
  restrictions on agricultural imports
• Immediate effects of a tariff are likely to be
  beneficial to domestic industries
• Predictable retaliation should have been seen
• Consumers generally were the victims, but they
  had no effective voice in Congress

11
Unemployment

• The official figure reached 25 in 1933
• Bad as this was, this figure does not include
  underemployment
• Qualified people working at menial jobs
• People given make-work government jobs
• Wages should adjust downward to balance supply
  and demand in labor markets
• Hoover tried to keep wages high, partly by
  jawboning.

12
Tax increase of 1932

• 1931 Federal deficit had reached the staggering
  sum of 2 billion dollars (about three days of
  interest on todays national debt)?
• One of the largest increases in tax rates in
  peacetime history. New or increased taxes
• Excise taxes revived or increased on gasoline,
  tires, automobiles, electricity, malt,
  toiletries, furs, jewelry, etc.
• New taxes on bank checks, stock and bond
  transfers, telephone, telegraph messages

13
Federal income, estate and gift tax increases

• Normal rate was 1.5 to 4, raised to 4 to 8
• Reduction in personal exemptions
• Earned credit repealed
• Taxes on top income brackets raised from 25 to
  63
• Corporate income tax rate raised from 12 to
  13.75
• Exemption for small corporations eliminated
• Estate tax doubled exemption floor halved
• Gift tax reinstated, top rate 33

14
Postage rate increases

• First class rate raised from 2 to 3 cents even
  though first class postage was already profitable
• Second class (magazines etc) raised 33
• Parcel post increased 25 (no UPS or FedEx
  competition)?

15
Result of tax rate increases

• In spite of drastically higher tax rates, federal
  tax revenue actually were actually lower in 1932
  than in 1931
• Lower tax receipts were due to the deepening
  depression which had been worsened by tax
  increases

16
Reconstruction Finance Corp.

• Government agency given 500 million capital and
  authorized to issue 1,500 million bonds
• Made loans to failing institutions
• Mostly to banks and railroads
• Many loans to politically connected firms
• Loans kept secret till Congress forced disclosure
• Excuse disclosure would erode confidence in the
  receiving institution
• Counter they deserved to lose confidence
• Compare todays stress tests or CAMELS ratings

17
Fed actions in 1932

• Huge monetary inflation, 1 billion in one year
• Yet bank deposits declined. Why?
• Excess reserves! Banks reluctant to lend because
  of
• Fear of making bad loans
• Fear of spooking depositors
• Does this sound familiar?

18
Two interpretations of the Feds Depression
policies

• Friedman the Fed irresponsibly let the money
  stock drop by 33
• Rothbard the Fed tried to re-inflate but the
  public, the commercial banks, and foreign holders
  of dollars wisely resisted. Deflation was
  necessary to correct prior monetary excesses.

19
Bank failures

• Approximately 9,000 banks failed during the
  course of the Great Depression an astounding
  number
• Some of these banks were merely illiquid, not
  necessarily insolvent. Example Bank of United
  States
• The number of bank failures in Canada during this
  time was exactly zero.
• Canada has always had nationwide banking
• No Canadian central bank at that time

20
Roosevelts New Deal

• National Industrial Recovery Act
• Attempt to cartelize all industry
• Tailor jailed for charging 35 cents instead of 40
• Parades took on a fascist tone
• Ruled unconstitutional by Supreme Court
• Unilateral abrogation of the gold standard
• Agricultural adjustment act
• Ruled unconstitional
• Works Progress Administration -- relief
• Federal Deposit Insurance
• Federal Crop Insurance
• Federal Housing Administration

21
Roosevelts New Deal

• Social Security
• Securities Exchange Commission
• Tennessee Valley Authority
• Farm Security Administration
• Rural Electrification Administration
• Court-packing scheme
• Seen as a bid for dictatorial power
• Defeated by Congress

22
Regime uncertainty

• An aspect of the Great Depression often
  overlooked because it is difficult to quantify
• Business people must try to predict the future.
  This is very hard to do when the rules are
  changing constantly.
• Roosevelts explicit policy was to try something
  and if it didnt work, try something else.

23
Regime Uncertainty

• Was full-blown dictatorship coming?
• Would business firms see their property
  confiscated?
• Roosevelts language and some of his initiatives
  suggested it might be
• It was happening in Germany and Italy
• This was not the sort of atmosphere that would
  instill business confidence

24
Roosevelts conservative shift

• Toward the end of the 1930s it looked like war
  was coming
• Roosevelt needed the cooperation of businesses
  for war production
• He brought conservative business people into his
  administration and kicked out some of the radical
  New Dealers

25
The war ended the Depression, or did it?

• Conventional wisdom says that the war
• Unemployment was eliminated.
• Good news people had paying jobs
• Bad news the job meant getting shot at
• GNP went up, but ...
• Most of the increase was due to government
  purchases
• Many consumer goods were unavailable
• Passenger cars were not produced
• Gasoline, tires, and sugar were rationed

26
What really ended the Great Depression

• Roosevelt died in 1945. This did a lot to remove
  regime uncertainty
• Truman was no friend of business, but neither was
  he a radical New Dealer
• Republicans gained control of both houses in 1946
  and proceeded to dismantle or tone down some of
  the New Deal measures.
• A period of prosperity began that lasted until
  about 1970

27
The panic of 1837-43 versus the Great Depression,
1929-33
28
Summing up the Great Depression

• Usual interpretation
• Due to inherent flaws in free markets a market
  failure.
• The New Deal rescued the country from the
  Depression while avoiding totalitarianism
• Revised interpretation
• Due to inherent flaws in government
  interventions a government failure
• The New Deal did not rescue the country from the
  Depression nor did World War II. Post-war
  lessening of New Deal programs was the major
  cause of renewed prosperity.