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The Great Depression revisited – some key facts

2008 financial crisis | The Great Depression revisited – some key facts Anthony Harrington

As a counterweight to the view of the Great Depression expressed by the Chairman of the Federal Reserve, Ben Bernanke, I recently embarked on a reading of Murray Rothbard’s “America’s Great Depression”, Rothbard being a pupil of Ludwig von Mises, the key figure along with Friedrich Hayek, of the Austrian school.

The point of the exercise was to try to get a little more clarity on whether Bernanke, with his stimulus programme of QEI and QEII, as his detractors proclaim, is overseeing the destruction of the US economy and the US dollar, or whether his Keynesian prescription for the US – keep throwing dollars at the economy until it perks up – is the right one, as Bernanke supporters like the Nobel prize winning economist and New York Times columnist Paul Krugman assert.

The current edition of Rothbard’s work (available as an ebook ) has an excellent Introduction written by Paul Johnson. This provides a quick resume, for those of us for whom the key facts of the Great Depression are at best foggy, of the astonishing parallels with the crash of 2008. 

As Johnson points out, the US economy had grown rapidly since the last downturn in 1920 and a correction was more than due (the parallel with 2008 was the bull market that flourished after the dot.com crash). This growth from 1920 had been fed by bank credit. In particular, easy credit had stoked the American love affair with stock market investments.

“In 1929 1,548,707 customers had accounts with America’s 29 stock exchanges. In a population of 120 million, nearly 30 million families had an active association with the market, and a million investors could be called speculators. Moreover, of these nearly two-thirds, or 600,000, were trading on margin; that is, on funds they either did not possess or could not easily produce.”

Replace “stock exchanges” and “stocks” with “banks” and “home purchases” and you have an interesting parallel with the credit fuelled boom in US subprime mortgages. The leverage which financial innovation brought in 2006 and 2007 and which magnified the subprime sage has its complement in what Johnson calls “the mushrooming of investment trusts” in 1929. Demand for shares bid up their value magnificently. Radio Corporation of America, which had never paid a dividend, went from 85 to 410.

“By 1929 some stocks were selling at 50 times earnings. A market boom based entirely on capital gains is merely a form of pyramid selling. By the end of 1928 the new investment trusts were coming onto the market at the rate of one a day and virtually all were archetype inverted pyramids … (securing) phenomenal stock exchange growth on the basis of a very small plinth of real growth.”

The US economy had stopped growing by July 1929, and when shrewder fund managers got back to their desks after their September holidays, they started pruning their portfolios fairly rigorously – in some instances while enthusiastically urging clients to continue to buy the very stocks they themselves were dumping (parallel: the continued sale of residential mortgage backed securities in 2007 by investment firms long after any competent person in their position, knowing what they knew, would have realised that these securities were toxic rubbish). The party came to an end on October 24th 1929, when shares fell off a cliff and speculators were sold out as they failed to respond to margin calls. By Black Tuesday, October 29th everything was being sold, good stocks and bad, as investors fought to stay liquid. However, as Rothbard points out, catastrophic as this was for the investors involved, it was the predictable corrective end to a stock bubble and should have worked its way out the system fairly quickly. By November 13th the index had more than halved, from 452 to 224. Bad as this was though, it was not much worse than December of the preceding year, when the market crashed to 245 and the bounce back might have been expected to be as rapid. As Johnson puts it in his introduction:

"Business and stock exchange downturns serve essential economic purposes. They have to be sharp, but they need not be long because they are self-adjusting. All they require on the part of the government, the business community, and the public is patience. The 1920 recession had adjusted itself within a year. There was no reason why the 1929 recession should have taken longer, for the American economy was fundamentally sound. If the recession had been allowed to adjust itself, as it would have done by the end of 1930 on any earlier analogy, confidence would have returned and the world slump need never have occurred."

However, the recession did not adjust itself and instead turned into what Johnson calls “an engine of doom” plunging the globe into depression:

"Why so deep? Why so long? We do not really know to this day... For half a century, the conventional, orthodox explanation, provided by John Maynard Keynes and his followers, was that capitalism was incapable of saving itself, and that government did too little to rescue an intellectually bankrupt market system from the consequences of its own folly. This analysis seemed less and less convincing as the years went by, especially as Keynesianism itself became discredited. In the meantime, Rothbard had produced, in 1963, his own explanation, which turned the conventional one on its head. The severity of the Wall Street crash, he argued, was not due to the unrestrained license of a freebooting capitalist system, but to government insistence on keeping a boom going artificially by pumping in inflationary credit. The slide in stocks continued, and the real economy went into freefall, not because government interfered too little, but because it interfered too much. Rothbard was the first to make the point, in this context, that the spirit of the times in the 1920s, and still more so in the 1930s, was for government to plan, to meddle, to order, and to exhort.”

It is a fascinating account, and Rothbard’s analysis is a must read. Of course, the operational reins this time round are very firmly in the hands of the Fed, not the theorists, and we are all going to be witness to the success or failure of the current experiment. Here’s hoping we don’t have to live with the consequences for decades to come.

Further reading on the 2008 financial crisis:




Tags: Austrian School of Economics , Ben Bernanke , Federal Reserve , Great Depression , intervention , John Maynard Keynes , Keynesian , Murray Rothbard
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