BOOK REVIEW

1931
by
Eric H. Allen

FUTURECASTS online magazine
www.futurecasts.com
Vol. 12, No. 11, 11/1/10

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The Crash of 1931:

 

 

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  A useful emphasis on the events of 1931 is provided by Eric H. Allen in "1931: The Year of the Great Worldwide Financial Crash." Allen provides a plethora of charts and tables highlighting the pertinent facts. The material on 1931 is presented in a commendably concise format with about half the book summarizing the economic developments from WW-I through 1930 and 1932 through the New Deal years to provide context.
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By any measure, the rapid decline of prices resulted in a substantial increase in the money supply in real - inflation adjusted - terms in the first six months after the '29 Crash, yet the considerable rebound in economic and securities markets through April 10, 1930, nevertheless aborted.

 

The full impact of the trade war had been postponed by the flow of cheap credits from Wall Street to debtor nations, but that could not be maintained indefinitely and was contracting substantially in the year before the Crash of '29.

  It was "the year that made the Great Depression Great," Allen emphasizes. Like MIlton Friedman, Allen emphasizes the role of the fractional reserve banking system in the boom and bust business cycle. See, Friedman & Schwartz, "A Monetary History of U.S. (1867-1960)," Part II, "Roaring Twenties Boom - Great Depression Bust (1921-1933)." However, Allen asserts that broader measures of the money supply than those emphasized by Friedman contradict Friedman's assertion of monetary contraction prior to the '29 Crash. By any measure, the rapid decline of prices resulted in a substantial increase in the money supply in real - inflation adjusted - terms in the first six months after the '29 Crash, yet the considerable rebound in economic and securities markets through April 10, 1930, nevertheless aborted. (It was a fundamentally flawed revival, with major economic elements not participating. See, Great Depression, Rebound from Crash of '29,)
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  Allen asserts that Hoover administration stimulus efforts and efforts to cushion labor market impacts were actually counterproductive. They slowed down essential economic adjustment processes. However, he does not contend that the economy could have avoided the Crash of 1931 in the absence of those measures. The fundamental causes of the Great Depression, involving the costs and commercial dislocations of WW-I and the Treaty of Versailles, the huge war debts and reparations obligations, and the trade war initiated and intensified by U.S. tariff legislation and other policies, were determinedly ignored by U.S. political leaders throughout the 1930s. (Keynesian and monetarist economists still determinedly ignore or attempt to minimize the impacts of these factors.) The full impact of the trade war had been postponed by the flow of cheap credits from Wall Street to debtor nations, but that could not be maintained indefinitely and was contracting substantially in the year before the Crash of '29.
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Fiscal year 1931-1932 federal spending surged 30%. It was up 46% in real - inflation adjusted - terms due to the sharp decline in prices. While state and local government spending stayed level, this meant an 11% increase in real terms.

  In 1931, the usual spring business season pickup was very disappointing. Business was seasonal in those days before air conditioning and mechanized snow removal. Business surged each spring and fall. However, in 1931, the stock market actually peaked in late February and was in steady decline by spring.
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  The federal government Farm Board price support program ended that spring, but the damage had already been done. The artificially high prices left vast surplus agricultural inventories that devastated agricultural markets. Prices quickly collapsed, as did an increasing number of rural banks. However, federal government stimulus efforts were massively intensified. Allen points out that fiscal year 1931-1932 federal spending surged 30%. It was up 46% in real - inflation adjusted - terms due to the sharp decline in prices. While state and local government spending stayed level, this meant an 11% increase in real terms.

  Keynesians assert that this deficit spending was just not enough. It never is! Even the trillions of dollars in deficit spending and monetary expansion during the Credit Crunch recession was "not enough" to achieve Keynesian and monetarist objectives. It never will be!

Austrian social expenditures pushed Austrian municipal and federal government budgets and deficits sharply higher during the 1920s, accompanied by economic deterioration and sharp increases in unemployment. 

  Abroad, financial crises struck first in Austria. Allen shows how Austrian social expenditures pushed Austrian municipal and federal government budgets and deficits sharply higher during the 1920s, accompanied by economic deterioration and sharp increases in unemployment. This came on top of the vast destruction of wealth during WW-I.

  "Austria's high consumption levels were essentially subsidized by funds that would otherwise have been used to maintain and replace capital.  A combination of taxes, trade union actions, inflation, and protective tariffs all served to inhibit maintenance of existing capital or investment in new capital. Since productive capacity was not maintained, it fell steadily over an 18-year period. An analysis of corporations listed on the Viennese stock exchange in 1930 by the [Austrian Institute for Business Cycle Research] indicates that the collective value of corporate capital remaining in post-war Austria declined by a staggering 79% from 1913 to 1930. By October 1931, the decline reached 87%."

  The Kreditanstalt, Austria's largest private bank,  required help that May. In the nature of European banking, it owned 80% of Austria's industry. Allen provides interesting details of the struggle to keep the bank afloat, and the contagious nature of the struggle which extended to other banks and then to the Austrian currency. That May was also a month of accelerating decline in the U.S. stock market.
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  The Bank of England provided substantial support to Austria in June so the Austrian government could guarantee Kreditanstalt debt. The Austrian National Bank discount rate was increased from 5% to 7% to stem the flight of capital out of Austria. The situation was temporarily stabilized, but there was a shakeup in the Austrian government as a result of the crisis.
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  Suspicion shifted to Germany, however. There was a run on German banks and on German gold reserves, forcing a sharp increase in German interest rates. A $100 million credit was arranged from the Bank of England, the U.S. Federal Reserve System, the Bank of France and the Bank for International Settlements. In the U.S., the rate of bank failure surged higher, with 19 small banks suspended in Chicago in two days.
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There was widespread expectation that the moratorium would be extended beyond a single year.

  The Hoover Moratorium initiative momentarily lifted the gloom. Hoover proposed a one-year suspension of principal and interest payments on intergovernmental debts owed to the U.S. It was conditioned on similar suspensions among all the debtor nations to include also the WW-I reparations payments. Allen sets forth the massive sums involved. The U.S. still adamantly insisted that all debts owed to the U.S. ultimately be paid. Nevertheless, there was widespread expectation that the moratorium would be extended beyond a single year.
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  However, capital flight from Germany continued unabated. German gold reserves fell alarmingly. Two major German banks failed on July 13. Once again there were government guarantees for bank deposits, bank discount rates were increased sharply, and substantial international loans to Germany were arranged. The German stock market closed, and German banks restricted withdrawals to 10% of deposits.
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  The crisis quickly spread through Central Europe, affecting Hungary, Latvia, Poland. German marks were rejected in many European countries after Germany placed restrictions on mark/gold exchanges. A 15% discount rate finally stabilized the situation.
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England's international accounts were also in  the red, and there just wasn't enough gold to do the job. Financial contagion thus spread to the pound.

  English gold was now propping up the German and Austrian currencies as well as the pound. However, England's international accounts were also in  the red, and there just wasn't enough gold to do the job. Financial contagion thus spread to the pound.
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  In the beginning of August, the Bank of France and the U.S. Federal Reserve provided a $250 million credit to the Bank of England. However, capital flight from England continued, draining both the credit and gold. Another $400 million had to be provided by the end of August. In about three weeks, it was gone.
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Worldwide financial panic:

 

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  When England abandoned the gold standard on September 20, 1931, financial panic spread worldwide. The pound, after all, was still the world's primary reserve currency and medium of international exchange. 233 years of currency stability - during which there had just been a few primarily wartime lapses - had ended.
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The U.S. stock market dropped 30.7%, the largest percentage loss for any month in its history. Unlike during the 1929 Crash, this Crash included the bond markets.

  Now, even the U.S. suffered a substantial run on its gold reserves. Bank failures in the U.S. soared, now impacting banks in major cities as well as the small rural banks. Allen provides details.
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  The U.S. stock market dropped 30.7%, the largest percentage loss for any month in its history. Unlike during the 1929 Crash, this Crash included the bond markets. The decline in the domestic bond market was 10% for the month. The entire capital structure was crumbling, from top to bottom.
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  Monetarists assert that U.S. and French sterilization of gold inflows - their refusal to play by gold standard rules and allow gold inflows to expand their money supply - was a predominant cause of the failure of the pound. (Today, China and many other dollar surplus nations are accused of doing the same thing with the dollar.) Allen questions that assertion and views international trade barriers and welfare costs as more important factors. By this time, Britain was a welfare state and actually made little effort to defend the pound. Its discount rate was not increased above 4% until after the devaluation, when strenuous efforts were in fact made to stabilize the pound at its lower valuation.

  "It is debatable how much of a factor that the 1925 decision to restore the pound at pre-war gold parity played in the 1931 devaluation. Had the pound been formally devalued in 1925 when gold payments were resumed, it certainly would have been easier to defend the pound in 1931. However, the international trade barriers and growing statism of the 1920s and 1930s would still have collapsed economic growth and the value of outstanding debt. These factors were eroding the value of most currencies around the world -- including the U.S. dollar -- relative to gold."

Commerce contracted sharply as interest rates rose sharply and volatile fluctuations increased currency risks.

  The pound lost about 30% of its value by the end of 1931, but much of that loss was probably due simply to the suspension of its gold reserve backing. It was no longer a reliable store of value. Japan, Denmark and Austria quickly abandoned the gold standard, followed by Sweden, Norway and Egypt. Commerce contracted sharply as interest rates rose sharply and volatile fluctuations increased currency risks.
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The Great Depression:

  The ultimate plunge into the Great Depression depths had begun. The full impact of the trade barriers could no longer be postponed by cheap credit.
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"True recovery required, preferably, a lowering of the international trade walls. Failing that, recovery was incumbent on a liquidation of export-driven capital, which was now of diminished value."

  To stem capital flight and restore essential monetary stability, central bank discount rates in the U.S. and many other nations had to be pushed sharply higher. The collapse of credit in effect imposed monetary austerity.

  "Unfortunately, officials still looked for a return to cheap credit in a misguided effort at recovery. True recovery required, preferably, a lowering of the international trade walls. Failing that, recovery was incumbent on a liquidation of export-driven capital, which was now of diminished value."

High levels of unemployment did not save Great Britain from price inflation. Harsh austerity measures limited the price inflation impact of pound devaluation, but it was still 10% by the end of the year. 

  The rate of bank failures in the U.S. rose precipitously and remained high through the first two months of 1932. Cash in circulation also rose sharply as the availability of banking services declined along with faith in banks. The stock market was hitting new Great Depression lows by the end of the year, reflecting the sharp contraction of business.
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  High levels of unemployment did not save Great Britain from price inflation. Harsh austerity measures limited the price inflation impact of pound devaluation, but it was still 10% by the end of the year. Since prices continued to tumble sharply in dollar and gold terms, the pound was suffering a considerably sharper loss of purchasing power than indicated by the nominal price inflation. Austerity was effective, reducing imports and increasing exports, so Great Britain was soon able to make major payments on its $650 million emergency credits and bring price inflation to a halt.

  As always, it was austerity rather than currency devaluation that did the heavy lifting in reversing trade and payments deficits.

Eight years of New Deal spending and industrial policy type efforts had resulted in "as much unemployment as when we started - - - and an enormous debt to boot."

  The Hoover Moratorium was approved by Congress on December 22, 1931, but was accompanied by rejection of any possibility of revision or cancellation of war debts. Allen provides a brief summary of the final plunge into the 1933 bank holiday period and the failure of New Deal inflationist and industrial policy type efforts through the middle of 1939. He is harshly critical of the New Deal policies that left the economy with still about 19% unemployment as late as 1938. Treasury Secretary Henry Morganthau, Jr., lamented in 1939 that eight years of New Deal spending and industrial policy type efforts had resulted in "as much unemployment as when we started - - - and an enormous debt to boot."

  This is the inevitable result of Keynesian type policies - as we saw during the Keynesian inflationary morass of the 1970s and are seeing yet again during and after the Credit Crunch. Keynesian efforts to stabilize the economy always results in increasing instability, a volatile business cycle with serious recessions and disappointing recoveries - and no effort to pay down stimulus debts in between recessions. Stimulus debts thus just keep piling up one recession after another until they reach unsustainable levels.

The impact of market constraints:

  The continuing flow of major economic policy blunders after the '29 Crash repeatedly thwarted any hope of recovery, Allen points out.
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"Had true market forces been allowed to operate following the crash of '29, there is no doubt that the subsequent economic correction would have been sharper and initially deeper. However, it also would have had a chance to stabilize much sooner."

  The inherent instability of fractional reserve banking magnified the collapse, while government policies blocked the essential market adjustment processes.

"The trade walls erected prior to 1929 were sufficient to force a sharp economic adjustment. However, it is questionable whether the depression would have become 'Great' without the long list of economic blunders that followed the crash of 1929: Federal Farm Board price supports [from 1929  to 1931];  the [1930] Smoot-Hawley tariff; [Hoover administration] coercion to avoid wage cuts; significant increases in [Hoover administration] government spending; and a mammoth tax hike [in 1932]."

  The U.S. economy has incredible resiliency with market mechanisms that powerfully assure recovery from business cycle contractions. Only government policies of incredible stupidity can block economic recovery and cause either chronic depression or chronic inflation. Keynesian and monetarist assertions to the contrary is proof of their colossal ignorance of basic economics.

  The trade war and heavy debt burdens were international along with the widespread increase in statist policies that inevitably suppressed commerce.

  "Had true market forces been allowed to operate following the crash of '29, there is no doubt that the subsequent economic correction would have been sharper and initially deeper. However, it also would have had a chance to stabilize much sooner."

With globalization, there can be no repeat of the Great Depression, but entitlement programs and a tripling of the basic money supply make it almost impossible to avoid serious inflation problems.

  The differences and worrisome similarities between the government policy responses to the Great Depression and the current Credit Crunch recession are summarized by Allen.
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  Globalization and a peaceful commercially united Europe provide assurance that there can be no repeat of the Great Depression, but massive entitlement programs lacking any real cost constraints and a rapid tripling of the basic money supply by the Federal Reserve make it almost impossible to avoid serious inflation problems (such as those of the 1970s). Ultimately, failure to restrain monetary inflation could destroy the status of the dollar as the world's primary reserve currency and the huge benefits enjoyed by the U.S. as a result of that status.

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