The Coming of the Great Depression

Michael Bordo was parachuted at the last minute into the Council on Foreign Relations New Deal Conference last Monday to make it less hopelessly biased–less of an event that, as one senior Bush I economic policy advisor and rock-ribbed Republican quipped, was the Council on Foreign Relations’ attempt “to outbid Heritage as the most biased and least educational thinktank:” He did a good job in talking about infrastructure spending during the Great Depression, and why you would never have expected it to curematters: there just wasn’t enough of it:>The 1920s: Bubble, Growth, or Gold? – Council on Foreign Relations: BORDO: Okay, my comments are going to in some respect echo what Dick Sylla said and what the others said.  There are sort of — there are two principal stories on what cause the Great Depression. One is the failure of the Federal Reserve.  And the second is the gold standard.  And I’ll just mention each of those two views briefly….>[W]hen the stock-market boom started, about 1926, the Fed became increasingly concerned about this on real bills doctrine lines. In a sense, they thought that the asset price inflation was really going to be inflationary and that policy should be used to  tighten it, to stop that.  And so they tightened progressively starting in ’28. This led to a recession, which started in the summer of ’29.  And then the Crash followed the recession.  Okay, and the Crash itself, as everyone and the others have all said, was not the cause of the Great Depression.>In fact, the Fed initially — the New York Fed initially followed very good policies in October and November of ’29.  And they flooded the money markets, the New York money markets, to prevent a liquidity crisis. But then they stopped, in late ’29.  And they stopped because there was pressure coming from the board on real bills line, which had said, look, if we keep expanding, we’re going to refuel the stock market boom.  And so they checked the tight policy, from that point onwards.  And we know that ’30 was a disaster.  It was a disaster because there was a series of banking panics which started in October ’31 — October of ’30, and the last one was in ’33. And these four panics, okay, were disasters because they did two things:  A, they drastically reduced the money supply, and this reduced spending in prices and output.  And secondly, they destroyed the credit — they destroyed what Bernanke called “credit intermediation.”  And this again had a very negative effect.  Okay?  >And the Fed did not — the reason the Fed did this — and there’s two stories, there’s Friedman and Schwartz, and Bernanke and Meltzer. But you know, one is the real bills story that I told you.  Another is the Fed itself, okay, had some serious structural problems.  There was a sort of continuing conflict between the reserve banks — and specifically, New York — and the board in Washington.  So there was a paralysis and the Fed couldn’t act to deal with the deflation and depression that was taking place.  Okay. And it didn’t end until Roosevelt came in and the banking panic — and imposed the banking holiday in March 1933, which ended up closing one-sixth of the nation’s banks, and so in a sense clearing away the serious problem of bank insolvency.  And also, the last thing that happened, thank God, is that — and it started getting us out of the Depression — was the Treasury followed expansionary gold purchasing policies, not the Federal Reserve.  That in a sense led to a recovery that started in ’33.  >Okay.  I have a minute, and I want to just mention — I’ll mention the gold.  So the gold standard comes in in a number of ways. The one way in specific is that all the countries in the world are tied together with gold.  When the U.S. goes down, the shock is transmitted to the rest of the world.  Okay, and so we transmit — the Depression starts in the United States; it’s transmitted to the rest of the world. Also, the rest of the world, the small countries and even fairly large countries, have a problem, in that because they had not — they do not credibly adhere to the gold standard, okay, to the gold- exchange standard and the problems of the gold-exchange standard that  Benn Steil talked about, okay, that they could not follow expansionary policies to get us out of the Depression; that when they did, there would be speculative attacks on their currencies.  >And so they were anchored by what’s called golden fetters.    >And the only country that could have gotten us out was the United States, because the U.S. had extremely large gold reserves.  And if they had followed expansionary policies starting in 1930, which they could have done, they had the technology to do so, that could have re- flated the world and prevented the Depression from turning great.  

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