Roots of Hope Thorns of Reality, part 1

By the late 19th century the federal government began dabbling with regulating the U.S. economy with the railroads and anti-trust laws.  By 1913 the Federal Reserve (Fed) was created during President Wilson’s administration.  The Fed did little during the 1920s bull market but galloped in like calvary during the Great Depression.  What follows is an economic synopsis of that time, connecting the dots to today’s economy:


      The Great Depression was the worst economic calamity in history.
      It began in late October 1929.  By 1932:
                  -The stock market had lost 89% of its value
                  -25-33% of the workforce was jobless, 40% in some states
                  -Worldwide trade dropped by 67% due to tariffs, 
                  -Only the planned Russian economy was unaffected
                   -First hyper-regulated depression=longest, most severe one


A devastating aspect of the Great Depression was the collapse of so many, primarily American, banks.  In 1913 the Fed was created by President Wilson to halt the boom/bust cycles of the industrializing economy.  One of its functions was to adjust the money supply in emergencies.


Contrary to common belief after the 1929 crash President Hoover used a heavy federal hand to try and control the crisis, such as raising the sales tax to the highest rate ever to balance the budget. By 1933 President Franklin Roosevelt (FDR) continued Hoover’s policies.  FDR increased the income tax rate on wealthy from 59% to 75%, further constricting investment capital.  FDR used record-breaking deficit spending for public works projects, modeled on  English economist J.M. Keynes’s belief that government spending could correct an economic downturn, instead of trusting the market to correct itself.


Unemployment stayed in the double digits all during the 1930s.  Not until the U.S. entered World War II, when the government redirected it’s war against wealth creation to the war against the Germans and Japanese, did the economy rebound.

Milton Friedman & Anna Schwartz’s ground breaking analysis


Before the 1929 crash, and more so afterwards, the Fed constricted the money supply.  The Fed feared the 1920s bull market was due to irrational exuberance instead of genuine expansion of the most invention-rich period in history--cars, airplanes, phones, electrification, radio, a new, consumption economy. Unemployment in the 1920s was at its lowest rate ever, 1.2%.


However, many Fed board members suspected bank loans were being used on the stock market instead of business investment for job creation, hence their pre-crash, misguided tightening of the money supply.  After the crash the Fed’s tight money supply was a fatal blow to banks, for people were trying to withdraw life savings only to find no money, exacerbating consumer anxiety, accelerating more bank failures.


Further complicating the picture, the Smoot Hawley Tariff bill was working it’s way through Congress before the crash.  It proposed raising tariffs to near record levels, an economic downer in the best of times. The bill passed in 1930, spurring an international backlash of tariffs, further crippling the free exchange of goods and jobs.  Also, whether or not the U.S. would stay on the gold standard became an issue that’s too involved for this discussion. It certainly didn’t help matters though. 


In 1957 Milton Friedman and Anna Schwartz published A Monetary History of the United States, contributing to Friedman receiving a Nobel Prize in Economics, 1976.  The book’s most startling conclusion was the Federal Reserve’s ‘inept or inflexible monetary policy in the wake of October 1929 turned a correction into a depression.’  Friedman/Schwartz conclude the Fed should have drastically increased the money supply from 1929 onwards, rather than contracting it.  A startling conclusion for it countered most established academic thought that FDR’s policies were essential to the U.S. surviving the Depression


             Results of the Fed’s lethal contraction of the money supply (-33%
             from 1929-1932):
            -$1.2 billion moved from banks (and investment in jobs) to mattresses
            -$15.6 billion decline in bank deposit
            -$19.6 billion decline in bank loans=19% of Gross Domestic Product


The reason no one talks about the similarly dramatic stock market crash of 1921 is because we came out of it naturally, within a year. The same elastic rebound occurred in the October 1987 crash, which also rebounded within a year. 


Next:  The Democratization of home ownership,  Roots of Hope, Thorns of Reality.
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Sources:
The Housing Boom and Bust by Thomas Sowell, 2009
The Ascent of Money by Niall Ferguson, 2008
A Patriot’s History of the United States by Larry Schweikart, 2004