Did Monetary Forces Cause the Great Depression? By Peter Temin. (MIT). WW Norton & Company Inc. NY. 1976. 178 pages, plus appendices, bibliography and index. (Or "what I read on my vacation") NOT ENOUGH MONEY? This book discusses several popular theories of the cause of the Great Depression, starting with the classic "Monetary History of the United States 1867-1960" by Milton Friedman and Anna J. Schwartz. (1963). The Friedman thesis can be summarized as: a fall in the stock of money caused a fall in incomes which resulted in depression. The assumption is that the stock of money is a independent parameter which is determined by the Federal Reserve, and is unrelated to the demand for money. After presenting a series of graph and tables of interest rates and money supply data, the book concludes (on page 126) that "there is no reason to think that the monetary stringency in 1929-30 was more severe than in other inter-war depressions and no evidence that bank failures in 1930 created such stringency. The monetary hypothesis, therefore, gives no reason why the downturn following 1929 differed from other inter-war downturns....(p137)...We conclude, therefore, that the banking panic of 1930 had no deflationary effect on the economy. Instead the data are consistent with the hypothesis that the demand for money was falling more rapidly than the supply during 1930 and the first 3 quarters of 1931." Temin points out that the equations used by Friedman & Schwartz can as well be reversed to claim that the fall in the stock of money was the result of the Depression rather than the cause. And as William Hummel has posted on sci.econ newsgroup, the supply of money cannot be considered as independent of other factors. If people fear the future because they see a depression, they are less likely to want bank loans. FAILURE OF DEMAND? Since the "lack of money" does not pass muster as the cause, Temin falls back on the J. M. Keynes thesis that it was a "failure of demand". People stopped buying goods, and this caused the Depression. But he admits that this thesis is also subject to the same reversal of causality. It can as well be claimed that people spent less because the economy was in a depression. I admit that I have never considered the Keynes thesis to be reasonable. It is in effect the claim that people were poor because they already had everything that they needed (and hence stopped buying): they were poor because they were so rich. I mean, people then had a lot less "stuff" than people have today. So why did they have "too much" while today no one has enough? Is it not obvious that the more people have the more they feel that they need? Temin even points out that a commonly cited "oversupply" of housing in the late 1920’s can’t be considered as the "cause" of the Depression. People who already have a house just spend that money on other things. THE FARMERS DID IT? There was a poor harvest in 1929. Did this trigger a general downturn? Agriculture was a larger sector of the total economy then. But the idea of lower food supplies as a cause of the Depression is hardly consistent with the idea of FDR a few years later. He wanted to REDUCE the food supply as a way to cure the Depression: the "logic" being that a lower supply of food would raise food prices and thus benefit farmers. And richer farmers would lead the overall economy to a recovery. So he actually instituted a program to burn crops and kill livestock as a way to combat the Great Depression!! (Hey, this wasn't MY idea). THE BUBBLE BURST? Another idea that Temin considers only to reject is that the stock market became a "bubble" that "burst" in 1929. The idea is that stocks became vastly over priced in the late 1920’s, and then fell, triggering a reduction in wealth (and thus spending) resulting in the Depression. He presents two arguments against this thesis. First, that the price/earning ratios of stocks remained approximately constant during the years from 1927 to 1932 (!). This was news to me. I too had heard and accepted the idea that the stock market was "over priced" in the late 1920’s. But Temin (in Table 4) presents price and earning data from 4 different measures of the stock market (S&P Composite, S&P Industrial, Crowles Composite and Crowles Industrial) for the years from 1927 to 1932 to show that there was no clear pattern. Some price/earning ratios rose and some fell. Overall, it looks like stocks were probably priced higher relative to corporate earning in 1932 than in 1927. That is, the investors properly anticipated that corporate earning would decline in the future, and were correct to sell their stocks in 1929!. And stock prices in 1929 before the crash properly reflected the high corporate earnings: they were not "overpriced". So (since cause and effect direction is the theme of the book), did the stock market crash cause the Depression? Or was it a result of the Depression? Did corporate earnings fall because the stock market crashed? Or did the stock market crash because investors correctly predicted that corporate earning would fall? To discuss this, Temin (page 43) draws on John B. Kirkwood "The Great Depression: A Structural Analysis" (1972). Kirkwood claims that stock prices fell because expectations about the course of future business changed. "People who had been optimistic before October 1929 suddenly became pessimistic. Stock prices declined as a result, causing investment and income to decline. The Depression occurred because people expected it to occur." Temin comments: "this is hardly an explanation of the Depression without a reason as to why expectations about the future changed in October 1929. We are left completely in the dark as to what this unknown factor might have been". But he indicates that IF there was an explanation as to why expectations of future economic growth changed from optimism to pessimism in the fall of 1929, THEN the crash of the market could explain the Depression. ENTER SMOOT & HAWLEY? The index of the Temin book does not contain either "Smoot" or "Hawley" or "Tariff". And there is no discussion of taxes except in the general terms that they are factors in economic equations. So it is no surprise that that he can’t imagine what could have changed the outlook of investors in October of 1929. But, while the Smoot-Hawley Tariff was not passed until June, 1930, it had been working its way through Congress during 1929. As Jude Wanniski as pointed out, the law had been passed by the House of Representatives by 1929 and President Hoover had indicated that he would sign it. The majority of the Senate had indicated support, so the last chance to kill the bill was in Senate committee. And in October of 1929 it passed a critical Senate committee vote. So could have the prospect of higher tariffs on imported goods and the predictable response of higher foreign tariffs on US exports, have been the "unknown factor" that Temin says could have triggered the Great Depression? And even if the prospect of higher tariffs was only enough to trigger the October 1929 crash, it was later when the tariff actually took effect that the "recession" of 1930 was transformed into the Great Depression . The Smoot-Hawley Tariff plus the Hoover policy of raising taxes to ‘balance the federal budget": the top income tax rate was increased from 25% to 64%. And if these weren’t enough, the Federal Reserve reacted to the crisis by raising the rediscount interest rate, and FDR decided to end the depression by burning the crops and killing the livestock. I mean if there is a recession, what better way to counter it than to raise taxes, raise interest rates, and if that fails, burn the crops? At any rate, causality here cannot be reversed: the Smoot-Hawley Tariff was clearly not passed as a result of the Depression. It was debated in Congress and its passage assured during the period of prosperity before the Great Depression started. ,,,,,,, _______________ooo___(_O O_)___ooo_______________ (_) REPLIES: From: "Dick Eastman" Hi, Jim. I see that the Smoot-Hawley explanation was used by the Democrats to defeat Hoover in 1932. I have found a speech by Hoover in which he answers that charge. It is an interesting answer. It reveals the complexity of the economic environment of the day that our theory-selected model-determined retrospectives have lost. Note that Hoover points out that Roosevelt was governor of New York at the time of the Crash. It also occurs to me that New York Establishment bankers do not like tariffs because they give the government an income that reduces the need to borrow on the Establishment- dominated bond market. Whether you buy that or not, it is not every day you see a speech like this one of Herbert Hoover's on Smoot-Hawley. From the State Papers, Vol. II, p.337 Speech by Herbert Hoover Cleveland, October 15, 1932 Our opponents have been going up and down the land repeating the statement that the sole or major origins of this disruption and this world- wide hurricane came from the United States through the wild flotation of securities and the stock market speculation in New York three years ago, together with the passage of the Smoot-Hawley Tariff Bill, which took place nine months after the storm broke. . . . I propose to discuss this assertion. ... Hoover goes on to deny that the tariff caused the Depression. AND: JMH@badlands.com wrote: >Nice summary. Hi, And I added it to my web age :-) >I don't really know why anyone thinks they can > adequately explain this phenomena as if it were a purely US issue. > Certainly US policies had effects on the experience of the US economy > and, even then, the world economy. The reverse holds also--events and > policies in Europe and elsewhere had direct effects on the US. Aside from tariffs, where trade effects all economies, I don't think anyone has proposed that events in Europe had much impact on the US economy. Except Temin noted that the harvest in Europe was good, and this would reduce the export potential for US farmers (already suffering from low prices). But an additional comment: many people consider the Depression to heve been a consequence of WW I. It has been called 'the last bullet fired in the Great War'. But I doubt that. Just consider the greater destruction that was done during the Second World War. While most of the cities of Europe were undamaged, as were the factories, and WW I was fought mostly in a static 'no-man's land', WW II was fought all over the place and many major cities were destroyed: Berlin, Dresden, Rotterdam, Warsaw, Hiroshima, Tokyo, not to mention London and others, plus many of the factories bombed. Yet WW II was followed by rapid economic recovery, and a decade later (by 1955) we saw the US in what some still consider its period of greatest prosperity, the German "Economic Miracle", Europe back on its feet, and Japan on the road to superpower status. So why wasn't WW II followed by an even greater Depression? masonc@ix.netcom.com Newsgroups: sci.econ, alt.books.reviews, alt.politics.economics References: 1 , 2 mason clark wrote: > There was a surplus of food relative to the demand. Food prices > were very low. Eggs at one cent, I recall. Farms were being > foreclosed. Farmers were rioting -- dumping milk for one thing. Hi, Just to point out that today eggs cost only about half that. One cent in 1935 is inflation corrected to about 12 cents in 1998 money, using the CPI based correction. For details, see: http://www.westegg.com/inflation/infl.cgi This would translate to about $1.44 a dozen today. Today a dozen eggs sell for about 70 to 80 cents a dozen in Madison. They would have had to cut the price to 6 cents a dozen to match today's egg prices. (Just to remind people how good economics conditions in the US are today as compared to the past and to most other countries) Of course farmers are still being foreclosed, and are rioting (at least in France). Wisconsin dairy farmers sure have a hard time, but this is mostly because of the US government's "Eau Claire" pricing system and the laws which keep them from selling in other states. Save Wisconsin family farms and let yourself have the choice of buying Wisconsin cheese--support free trade!! ,,,,,,, _______________ooo___(_O O_)___ooo_______________ (_) jim blair (jeblair@facstaff.wisc.edu) Madison Wisconsin USA. This message was brought to you using biodegradable binary bits, and 100% recycled bandwidth. For a good time call: http://www.geocities.com/capitolhill/4834 Subject: Re: Did Monetary Forces Cause the Great Depression? Date: Sun, 06 Feb 2000 01:55:36 -0500 From: Grinch Organization: Happy Skeptics of America Newsgroups: sci.econ, alt.politics.economics References: 1 , 2 , 3 , 4 , 5 , 6 , 7 , 8 , 9 , 10 , 11 On Wed, 26 Jan 2000 14:05:54 -0800, mason clark wrote: >On Wed, 26 Jan 2000 15:41:46 -0500, "David Lloyd-Jones" wrote: > >>It really was a pretty astonishing read. This was in the days before the >>monetary hypothesis had really gotten any traction. It was still sorta >>sloppily assumed that "panic" or "speculation" constituted explanations. >>John Galbraith reigned, and nobody was tall enough to look him in the eye >>and say "Hunh?" What the Canadian bank folks reported at the time was what >>we today take to be the reality: the Fed squoze the money supply, so demand >>contracted, real cost of borrowing went through the roof, prospective sales >>and hence spot employment dove -- and that was only the rehearsal: they did >>it again in 1932, only big time the second time. >> >> Cheers, >> >> -dlj. >> >>"Dick Eastman" wrote in message >>news:s8ul94lg7q5132@corp.supernews.com... >>> >>> As stocks were liquidated to pay margin lenders. This contracted the >>> money supply, which eventually reduced prices (deflation). >>> >>> But wages would not go down to match the fall in the prices of goods >>> and services. Unemployment resulted. >>> >>> That itself would not have been fatal had the FED pumped money into >>> the system. The FED did the opposite! >>> >>> Thus the deprewssion. IT was all monetary. > > These thoughts fly into the face of facts. > > 1. Maybe the Fed didn't drop the rates fast enough after the > crash, the discount rate went from 6% to 1.5% nominal by 1931. Creating a 10.8% real interest rate on new borrowing. Ouch. Or a 13+% real rate as measured by the prime rate, which is what businesses actually had to pay. Ouch again. From here the Fed *increased* the discount rate two full points (133%) during ongoing 10% deflation. I think it's fair to describe that as being "a little tight" with monetary policy. > 2. They erred again in raising it in 1932-1933 but with what effect > is not clear. Not clear? ;-) The two-point rate hike was in October of 1931. The result was the biggest shock to the monetary system in US history. In the next three months the money supply *collapsed* as M1 fell at over a 25% annual rate and M2 at over a 35% rate. The US has never seen anything like it before, and we hope will never see anything like it again. What could possibly be "not clear" about that? (Unless one imagines this all to be a coincidence. ;-) But I think even a physicist could "forecast backwards" to see cause and effect here.) At the same time, currency holdings and commercial deposits at the Fed surged. People and businesses rushed out of commerce to hold cash. They suddenly realized that with the rate hike, deflation was there to stay, cash was going to *continue* earning 10%, and the real value of debts was going to be ratcheted up until people couldn't pay 'em. So out of commerce, into cash. Like never before or since. > 3. From 1933 to 1943 the rate dropped steadily from 3 to 1/2 % with > no apparent effect. Well, the collapse was over by then. The Depression had two distinct legs: (1) Recession from '29 to '31 leading to the collapse of '32 that followed the Fed's two-point rate hike, which the Fed imposed to defend the dollar's gold-standard parity. Then, after leaving the gold standard, and thus becoming free to drop interest rates, (2) Slow recovery from '33 on. > 4. Note that the deflation was not much: from 80 to 60 (1947=100). Just 25%, not much ;-) Meaning that as of 1933-and-after every business had to pay one dollar worth 1.33 pre-1930 dollars to repay every dollar of pre-1930 borrowing. So every business had 33% added to the debt side of its balance sheet, that's all. Moreover, loans had to be repaid with deflated dollars so every loan outstanding from 1929 or earlier would carry a *real* double-digit interest rate *forever*, on top of the 33% added to real principal. Say you bought a house paying 80% down. Three years later the balance of the mortgage is more than the house's market value and you face paying a real double-digit interest rate on it for the next 27 years. Would you consider that "Not much"? > 5. Fiscal policy is another matter. The Hoover Republicans wanted > nothing more in their benighted lives than a balanced budget. > 6. FDR's political asperations kept him from being effective (but maybe > no one could have overcome the Republican/Economists combine). Poor FDR. With the biggest Democratic majorities in the House and Senate ever, how could he possibly have hoped to overcome those Republican economists? ;-) > 7. FDR's reversion to budget balancing severely aggravated the > depression in 1938. Except for the intrusion of war keynesianism, the > consequences could have been dire indeed. > > 8. Most important to recognize: Expectations--Confidence--Psychology, the > self-protection of both consumers and producers, was the most > important factor in deepening and prolonging the Great Depression. As in: "With 33% added to my debt and owing double-digit real interest rates, I am busted and *expect* the repo man at the door any time now." > 9. Finally, no one here is tall enough or old enough to debate with > J.K.Galbraith -- he was there. > Mason AND: Federal Reserve Board Remarks by Governor Ben S. Bernanke October 15, 2002 Asset-Price "Bubbles" and Monetary Policy http://www.federalreserve.gov/boarddocs/speeches/2002/20021015/default.htm An Historical Example: Federal Reserve Policy in the 1920s The U.S. experience of the 1920s illustrates many of the points I have been making. As you know, the "Roaring Twenties" was a prosperous decade, characterized by extensive innovation in technology and in business practices, rapid growth, American economic dominance, and general high spirits. Stock prices rose accordingly. As early as the mid-1920s, however, various policymakers and commentators expressed concern about the rapidly rising stock market and sought so-called corrective action by the Federal Reserve. The corrective action was not forthcoming, however. According to some authors, this was in large part because of the influence of Benjamin Strong, long-time Governor of the Federal Reserve Bank of New York and America's pre-eminent central banker of that era. Strong resisted attempts to aim monetary policy at the stock market, arguing that raising interest rates sufficiently to slow the market would have highly adverse effects on the rest of the economy. "Some of our critics damn us vigorously and constantly for not tackling stock speculations," Strong wrote about the debate. "I am wondering what will be the consequences of such a policy if it is undertaken and who will assume responsibility for it." However, Strong died from tuberculosis early in 1928, and the Fed passed into the control of a coterie of aggressive bubble-poppers, of whom the most determined was probably Board Governor Adolph Miller. Miller was supported in his objective by another fervent enemy of "speculation"--and Miller's neighbor and close friend--Herbert Hoover, soon to be President. Under Miller's influence the debate within the Federal Reserve System shifted from whether to try to stop stock-market speculation to how best to do it. The Board in Washington favored "direct pressure," which in practice meant threatening New York City banks that made loans to brokers with being cut off from the discount window. Strong's successor at the New York Fed, George Harrison, argued correctly that the availability of alternative sources of credit made this approach ineffectual and pushed for higher interest rates instead. Ultimately, frustrated by the ineffectiveness of direct pressure, the Board in Washington came around to Harrison's view. Hence, in 1928, in a situation in which the inflation rate was actually slightly negative and the economy was only barely emerging from a mild recession, the Fed began to raise interest rates. The New York Fed's discount rate, at 3.5 percent in January 1928, reached 6 percent by August 1929, its highest value since 1921. Rates on term stock-exchange loans peaked in that month at almost 9 percent, and the rate on call loans exceeded 10 percent in early August. For short periods the rates on these loans sometimes spiked above 20 percent. As is well known, U.S. common stock prices peaked in September 1929 and fell sharply in panicky selling in October. The popular view is that the market crash was the harbinger of the Great Depression. In fact, the weight of historical research has shown that this interpretation gets the causality largely backward. The economy was already slowing by the fall of 1929 (the NBER peak, marking the beginning of the Depression cycle, was in August 1929), largely as a result of monetary tightness. Economic indicators, which had been uniformly strong, were becoming more mixed: The Federal Reserve's industrial production index began to decline in July, construction contracts fell sharply in August and September, and automobile sales dipped suddenly at the beginning of October. Conditions abroad were weakening, and both foreign and U.S. interest rates were rising. The famous warning by Roger Babson that led to the "Babson break" in stock prices in September 1929 was based on mounting evidence that an economic slowdown was already in progress, implying that continued strong earnings growth could not be counted on. Thus the stock market decline was more the result of developing economic weakness (and tight money) than the cause of the slowdown--though, obviously, falling stock prices did not help the broader economic situation in late 1929 and 1930. Some additional evidence that the stock market was as much a victim as a cause of the Depression is that, to a degree not fully appreciated today, the stock market boom of the 1920s was surprisingly hard to kill. Indeed, stock prices did not collapse in 1929 but only began to plummet when the depth of the general economic decline became apparent. For example, stock prices in April 1930 were still about the same level as in January 1929; and someone who bought stock in early 1928 and sold in October 1930 would have almost broken even. Only as the bad economic news kept rolling in, in the fall of 1930, did stock prices finally fall below 1928 levels. The correct interpretation of the 1920s, then, is not the popular one--that the stock market got overvalued, crashed, and caused a Great Depression. The true story is that monetary policy tried overzealously to stop the rise in stock prices. But the main effect of the tight monetary policy, as Benjamin Strong had predicted, was to slow the economy--both domestically and, through the workings of the gold standard, abroad. The slowing economy, together with rising interest rates, was in turn a major factor in precipitating the stock market crash. This interpretation of the events of the late 1920s is shared by the most knowledgeable students of the period, including Keynes, Friedman and Schwartz, and other leading scholars of both the Depression era and today. New York Fed Governor Harrison and other participants argued after the fact that the problem with their policy was not that they tried to burst the stock-market bubble but that their efforts were too little and too late. This attempt to defend the Fed's policies of the latter 1920s does not hold up. There is little credible evidence of a bubble in the U.S. stock market before March 1928 (Galbraith, 1954; White, 1990); yet, in part because of the workings of the gold standard, U.S. monetary policy had already turned exceptionally tight by late 1927 (Hamilton, 1987). Tighter policy earlier would have brought the Depression on all the more quickly and sharply (see Eichengreen, 1992, p. 214, for further discussion). The Federal Reserve went on to make a number of serious additional mistakes that deepened and extended the Great Depression of the 1930s. Besides trying to pop the stock market bubble, the Fed made little or no effort to protect the banking system from depositor runs and panics. Most seriously, it permitted a severe deflation in the price level, which drove real interest rates sky-high and greatly increased the pressure on debtors. A small compensation for the enormous tragedy of the Great Depression is that we learned some valuable lessons about central banking. It would be a shame if those lessons were to be forgotten. To which Willaim F. Hummel adds: Bernanke offers no explanation of why the stock market bubble occurred in the first place. As a result he ignores two important facts. When the Fed first saw evidence of the "irrational exuberance", it could have set limits on the _type_ of bank lending, and it could have increased the margin rate on stock purchases. Both were in its power to authorize. The article leaves the impression that raising interest rates was the only tool the Fed had available. The Fed got it wrong again in 1996 when it failed to use its full powers. Asset price bubbles are indeed difficult to end gracefully, as we have "discovered" once again. By the time the 1920s bubble had gotten established, there was probably no way of deflating it gently. The Fed's increasing interest rates was a mistake, but the crash on Wall Street would have happened one way or another. The biggest mistake by the Fed was the failure to support the banking system with the liquidity it needed when asset prices plummeted. At least the Fed got that right in the 1987 when Greenspan flooded the system with liquidity on Black Monday. Bernanke fails to mention Charles Kindleberger whose classic analysis [The World in Depression] is regarded by many economists as the most authoritative explanation of the Great Depression. The Depression was a world-wide event, not just American, and its roots were far wider than the stock market crash.. AND from Grinch: [] Short-short alternate history answer. Benjamin Strong dying in 1928. Strong was the head of the NY Fed and the nation's if not the world's pre-emininent central banker. During the steep Recession of '21 he did exactly the right thing by pumping out a lot of money to prop up demand and give things a boost -- which was a strange and radical notion for that pre-Keynesian era. But Strong fell dead just before the the Recession of '29 hit. A big power struggle then ensued between the NY Fed which knew the market from managing monetary operations, and the Washington DC Fed which was supposed to be setting policy but which had lost power to the NY Fed during Strong's era, and resented it. The Washington Fed won the fight and adopted policy opposite to what the NY Fed was urging -- resulting in the likes of that fatal interest rate hike in '31. Milton Friedman speculated that if Strong hadn't died when he did the Recession of '29 might have passed just like that of '21 without there ever being a Depression. We'll never know, of course -- but it's interesting to consider the possibility that just one guy's living another year and a half could have averted the world-wide Great Depression, and thus the rise of the Nazis, World War II, the Communist seizure of eastern Europe (and maybe much of Asia) and the Cold War... not to mention the New Deal.