Gabriel Mathy, American University
The stock market crashed again today and seems headed to a bear market that can only now be compared with the bear market during the Great Depression. While the S&P 500 or another market weighted index is better than an index like the Dow Jones Industrial Average that simply averages the prices of the stocks on the index, the S&P 500 was not available in 1929 while the Dow Jones was. The Dow peaked in October 1929 at 381 and went down to 41 at the trough in July 1932, a decline of almost 90%. This is in dollar terms, so less severe considering the price level and the cost of living fell significantly. But even after inflation resumed, the Dow didn’t reach its old peak in 1929 until 1954. That’s a quarter of a century later. But perhaps this is all too pessimistic, and 1929 is not the right comparison to 2020. So then, let’s think about the initial shocks that set off the recession in 1929 that just kept getting worse through 1933. Here I will largely follow the account of Kindleberger in “The World in Depression, 1929-1939”
The late 1920s were a booming period in the United States, though that wasn’t the case everywhere. In the wake of the First World War, which bankrupted governments and set off waves of inflation and hyperinflation, post-war governments struggled to return to the gold standard. The United Kingdom infamously went back to the prewar exchange rate with gold, leaving the pound severely overvalued and its exports uncompetitive. As prices in pounds had gone up so much, with the old exchange rates imports were much cheaper to buy in gold prices abroad, and so gold flowed out. Gold is money in a gold standard system, so this caused monetary tightness in the UK, leading to general strikes and high unemployment throughout the 1920s. Since prices had gone up everywhere and the norm (Keynes’s “Rules of the Game”) were to return to the gold standard at the old exchange rates, many other countries had similar issues as the UK.
The United States, on the other hand, was booming, though the agricultural sector was troubled. Prices had been high during the war, and many American farmers had taken on debt to expand their operations to take advantage of the high prices. Prices fell once production resumed in areas affected by the war, prices slumped, resulting in farm bankruptcies and many bank failures in rural areas. On the other hand, by the late 1920s, a stock bubble developed, as the roaring economy created a wave of euphoria in stocks. Corporate profitability was rising rapidly, and many thought the party could never end- this was a New Economy after all! Securities market were not regulated like they are today, so short-term margin lending was common for stock purchases, which further fed the bubble. International capital flows, linked through the gold standard, meant the American capital markets hoovered up money from the rest of the world for short term loans for stock speculation on Wall Street. This further worsened monetary conditions. Germany was dependent on American loans to make its reparations payments, and so its economy started weakening in 1928 due to the tight monetary conditions. Agricultural exporting countries in Latin America saw gold outflows at the same time as agricultural prices softened, and they also saw economic weakness before 1929 as well. At the same time, the Fed tightened its monetary policy and raised interest rates in 1928 to try and check the stock bubble. With expected gains on Wall Street in the double digits while the Fed’s discount rate was still in the single digits, this did little to check the boom. The market surged further. As a result of the monetary tightness, the economy began to turn down in the summer of 1929, and industrial production peaked in July. Automobile production fell from 426,000 in July of 1929 to 319,000 in October of 1929. Then the Great Crash came. Stock plunged, and the music stopped on Wall Street. Margin loans were called in, and borrowers had to sell their stock all at once to pay off their loans. This drove the market down more. What had started as a normal recession, perhaps on the mild side, got worse. Agricultural prices worsened, setting off a deflationary wave across the world.
The Fed was not set up to act as a European-style central bank, but instead was structured to stabilize credit conditions and to keep the United States on the gold standard. As interest rates tumbled as the economy collapsed, the leadership at the Fed thought they were fulfilling their mandate. As the economy worsened, banks failed even faster than they had in the 1920s, and by the trough in 1933, over 1/3 of banks had failed. The trough of most indicators occurred within a month or so of the inauguration of a new Democratic Congress and President in 1933. The new Congress was committed to moving off the gold standard, loosening monetary conditions, and raising the price level. It worked, and the economy recovered.
Now let’s compare this to what’s happening now. We’re facing a huge shock to demand, particularly in services, as economic activity is scaled back to address the crisis. Given the huge number of workers involved in the labor-intensive service sector, the speed of job losses could be much more rapid than in normal recessions. Stock market have plunged more than they did in 1929, reflecting expectations for a deeper downturn. On the bright side, the gold standard does not exist anymore to constrain the monetary and fiscal response to the crisis. Countries no longer need to keep interest rates high to attract capital flows and gold from abroad, but the Fed has already brought the interest rate to 0 and has said they will not go negative. The ECB has already gone negative and has signaled no interest in capping interest rates on sovereign debt. A fiscal response will be the only option large enough to offset a shock larger than what we saw in 1929. However, the austerian ideology remains strong, despite the lowest interest rates in the many millennia of recorded human history. The effects are still on display in Greece, its economy devastated by an austerity program that has reduced GDP so much that the debt-to-GDP ratio is higher than it has basically ever been in the millenia of Greek history, near 180%. The only progress that has been made has come from the European Central Bank reducing interest rates below zero, which allowed Greece to issue negative rate debt as well. However, the view that austerity was a success there endures, and this ideology will certainly remain even as the evidence of an insufficient fiscal policy response piles up in the mortuaries and the cemeteries.
Political deadlock in the United States will block any effective fiscal response, as it did in 2008, unless there can be a Democratic wave, as there was in 1933 and 2009. Even FDR disappointed on the fiscal front, campaigning against Hoover’s large deficits. He passed the austerian Economy Act of 1933 in his first 100 days that slashed public sector salaries and veteran’s benefits, and ran the budget outside of the emergency programs like the WPA on a balanced budget basis. The fiscal response was insufficient in the last recession due to moderate and conservative elements in the Obama administration that cut back on the size of the stimulus package.
Given Trump’s completely incompetent response to the coronavirus crisis and a recession whose severity will only become more evident as election day approaches, Trump's electoral prospects seem to dim more and more each day. Biden seems likely to win the democratic nomination. If Biden can win, prospects for a fiscal response on the scale required don’t look good either, even with a Democratic wave election. Biden is much more conservative than Obama and had touted his support for a balanced budget amendment in the past.
Sources:
Automobile Production, Passenger Cars, Factory Production for United States https://fred.stlouisfed.org/series/M0107AUSM543NNBR
Industrial Production Index https://fred.stlouisfed.org/series/INDPRO
Kindleberger, Charles Poor. The world in depression, 1929-1939. Vol. 4. Univ of California Press, 1986.
The stock market crashed again today and seems headed to a bear market that can only now be compared with the bear market during the Great Depression. While the S&P 500 or another market weighted index is better than an index like the Dow Jones Industrial Average that simply averages the prices of the stocks on the index, the S&P 500 was not available in 1929 while the Dow Jones was. The Dow peaked in October 1929 at 381 and went down to 41 at the trough in July 1932, a decline of almost 90%. This is in dollar terms, so less severe considering the price level and the cost of living fell significantly. But even after inflation resumed, the Dow didn’t reach its old peak in 1929 until 1954. That’s a quarter of a century later. But perhaps this is all too pessimistic, and 1929 is not the right comparison to 2020. So then, let’s think about the initial shocks that set off the recession in 1929 that just kept getting worse through 1933. Here I will largely follow the account of Kindleberger in “The World in Depression, 1929-1939”
The late 1920s were a booming period in the United States, though that wasn’t the case everywhere. In the wake of the First World War, which bankrupted governments and set off waves of inflation and hyperinflation, post-war governments struggled to return to the gold standard. The United Kingdom infamously went back to the prewar exchange rate with gold, leaving the pound severely overvalued and its exports uncompetitive. As prices in pounds had gone up so much, with the old exchange rates imports were much cheaper to buy in gold prices abroad, and so gold flowed out. Gold is money in a gold standard system, so this caused monetary tightness in the UK, leading to general strikes and high unemployment throughout the 1920s. Since prices had gone up everywhere and the norm (Keynes’s “Rules of the Game”) were to return to the gold standard at the old exchange rates, many other countries had similar issues as the UK.
The United States, on the other hand, was booming, though the agricultural sector was troubled. Prices had been high during the war, and many American farmers had taken on debt to expand their operations to take advantage of the high prices. Prices fell once production resumed in areas affected by the war, prices slumped, resulting in farm bankruptcies and many bank failures in rural areas. On the other hand, by the late 1920s, a stock bubble developed, as the roaring economy created a wave of euphoria in stocks. Corporate profitability was rising rapidly, and many thought the party could never end- this was a New Economy after all! Securities market were not regulated like they are today, so short-term margin lending was common for stock purchases, which further fed the bubble. International capital flows, linked through the gold standard, meant the American capital markets hoovered up money from the rest of the world for short term loans for stock speculation on Wall Street. This further worsened monetary conditions. Germany was dependent on American loans to make its reparations payments, and so its economy started weakening in 1928 due to the tight monetary conditions. Agricultural exporting countries in Latin America saw gold outflows at the same time as agricultural prices softened, and they also saw economic weakness before 1929 as well. At the same time, the Fed tightened its monetary policy and raised interest rates in 1928 to try and check the stock bubble. With expected gains on Wall Street in the double digits while the Fed’s discount rate was still in the single digits, this did little to check the boom. The market surged further. As a result of the monetary tightness, the economy began to turn down in the summer of 1929, and industrial production peaked in July. Automobile production fell from 426,000 in July of 1929 to 319,000 in October of 1929. Then the Great Crash came. Stock plunged, and the music stopped on Wall Street. Margin loans were called in, and borrowers had to sell their stock all at once to pay off their loans. This drove the market down more. What had started as a normal recession, perhaps on the mild side, got worse. Agricultural prices worsened, setting off a deflationary wave across the world.
The Fed was not set up to act as a European-style central bank, but instead was structured to stabilize credit conditions and to keep the United States on the gold standard. As interest rates tumbled as the economy collapsed, the leadership at the Fed thought they were fulfilling their mandate. As the economy worsened, banks failed even faster than they had in the 1920s, and by the trough in 1933, over 1/3 of banks had failed. The trough of most indicators occurred within a month or so of the inauguration of a new Democratic Congress and President in 1933. The new Congress was committed to moving off the gold standard, loosening monetary conditions, and raising the price level. It worked, and the economy recovered.
Now let’s compare this to what’s happening now. We’re facing a huge shock to demand, particularly in services, as economic activity is scaled back to address the crisis. Given the huge number of workers involved in the labor-intensive service sector, the speed of job losses could be much more rapid than in normal recessions. Stock market have plunged more than they did in 1929, reflecting expectations for a deeper downturn. On the bright side, the gold standard does not exist anymore to constrain the monetary and fiscal response to the crisis. Countries no longer need to keep interest rates high to attract capital flows and gold from abroad, but the Fed has already brought the interest rate to 0 and has said they will not go negative. The ECB has already gone negative and has signaled no interest in capping interest rates on sovereign debt. A fiscal response will be the only option large enough to offset a shock larger than what we saw in 1929. However, the austerian ideology remains strong, despite the lowest interest rates in the many millennia of recorded human history. The effects are still on display in Greece, its economy devastated by an austerity program that has reduced GDP so much that the debt-to-GDP ratio is higher than it has basically ever been in the millenia of Greek history, near 180%. The only progress that has been made has come from the European Central Bank reducing interest rates below zero, which allowed Greece to issue negative rate debt as well. However, the view that austerity was a success there endures, and this ideology will certainly remain even as the evidence of an insufficient fiscal policy response piles up in the mortuaries and the cemeteries.
Political deadlock in the United States will block any effective fiscal response, as it did in 2008, unless there can be a Democratic wave, as there was in 1933 and 2009. Even FDR disappointed on the fiscal front, campaigning against Hoover’s large deficits. He passed the austerian Economy Act of 1933 in his first 100 days that slashed public sector salaries and veteran’s benefits, and ran the budget outside of the emergency programs like the WPA on a balanced budget basis. The fiscal response was insufficient in the last recession due to moderate and conservative elements in the Obama administration that cut back on the size of the stimulus package.
Given Trump’s completely incompetent response to the coronavirus crisis and a recession whose severity will only become more evident as election day approaches, Trump's electoral prospects seem to dim more and more each day. Biden seems likely to win the democratic nomination. If Biden can win, prospects for a fiscal response on the scale required don’t look good either, even with a Democratic wave election. Biden is much more conservative than Obama and had touted his support for a balanced budget amendment in the past.
Sources:
Automobile Production, Passenger Cars, Factory Production for United States https://fred.stlouisfed.org/series/M0107AUSM543NNBR
Industrial Production Index https://fred.stlouisfed.org/series/INDPRO
Kindleberger, Charles Poor. The world in depression, 1929-1939. Vol. 4. Univ of California Press, 1986.