The Great Depression – Now and Then

The public, these days, is cheering on a government that is repeating the mistakes of 1929 one by one.

It is thus necessary to outline the parallels between 1921-1933 and 2001-2008:

The Inflationary Periods

1921-1929:

  • A sharp recession occurs during 1920 which liquidates the previous inflation from World War 1
  • The 1920s boom is kicked off: The Federal Reserve Bank, established in 1913, inflates the money supply via credit expansion from July 1921 through December 1928 at an average annual rate of 7.7% by printing money to purchase acceptances, commercial paper, government securities, silver certificates, and foreign bonds
  • Motivations of this inflationary policy were mostly:
    • Facilitate speedy recovery of the 1920 recession
    • Support for the government of Great Britain and German states and municipalities via foreign loans
    • Support for export lobbyists in the US by making more US$ available to foreigners
  • The Dow Jones Industrial Average soars from 63.90 in 1921 to 381.17 in October 1929
  • President Coolidge, in office until March of 1929, calls the American prosperity “absolutely sound”, stocks “cheap at current prices”; secretary Treasury Mellon announces “There is an abundant supply of easy money which should take care of any contingencies that might arise.”; both announce a “new era” of permanent prosperity (Ralph W. Robey, “The Capadores of Wall Street”)
  • In October 1929, a liquidation of unsound investments is kicked off by the crash of October 1929

2001-2007:

The Depression

1929 – 1933:

  • In March of 1929 President Herbert Hoover takes office
  • In October 1929, immediately after the crash, the Federal Reserve doubles its holdings of government securities, adding over $150 million in reserves, and discounts about $200 million for member banks, thus postponing necessary liquidations on the stock market and enabling NYC banks to take over brokers’ loans which other non-banks would otherwise have liquidated
  • The money supply expands by nearly 10% in one week
  • The Federal Reserve lowers the rediscount rate from 6% at the time of the crash to 4.5% by mid November
  • Secretary Treasury Mellon periodically assures the public that there is “plenty of credit available”
  • However, toward the end of 1929 all these measures prove futile and the money supply drops back to pre-crash levels
  • During November 1929 Hoover calls in White House conferences with industry leaders, getting them to pledge that wage rates will be maintained and not adjusted as lower prices for goods sold would mandate, thus postponing the necessary correction and prolonging the depression
  • On November 24th 1929 the Dept. of Commerce establishes a definite organization to join with the states in expanding public works programs
  • Hoover grants more subsidies to ship construction through the Federal Shipping Board
  • The Federal Farm Board
    • In June 1929, the Agricultural Marketing Act is passed, establishing the Federal Farm Board (FFB), furnished with $500 million by the Treasury to make all-purpose loans to farm cooperatives at low interest rates and to establish price stabilization corporations with the objective to artificially keep up farm prices
    • On October 26th 1929 the newly established FFB launches a program to lend $150 million to wheat coops and establishes the Farmers’ National Grain Corporation with $10 million capital; as farm prices continue to fall, the Farmers’ National itself begins to buy up wheat to keep up prices; the inevitable fall of prices is thus postponed as farmers are encouraged to keep producing surpluses; in 1930 prices continue to fall as the FFB keeps accumulating wheat surpluses
    • In spring of 1930 Hoover acquires from Congress an added $100 million in order for the FFB to continue lending and buying and establishes the Grain Stabilization Corporation (GSC) to replace Farmers’ National and redouble price stabilization efforts
    • By June 30 1930 the GSC has accumulated over 65 million bushels of wheat held off the market; prices continue to fall
    • On November 15, the GSC is authorized to purchase as much wheat as necessary to stop any further decline in wheat prices and buys up another 200 million bushels until mid 1931; prices continue to fall
    • The FFB finally decides to dump the excess stock abroad and prices fall even more drastically, the entire operation significantly postponed the necessary correction and prolonged the depression
    • By the end of the Hoover administration the FFB has incurred cotton and wheat losses of over $300 million
    • Other programs launched by the FFB that either failed in the same manner or proved impractical from the outset: Cotton Stabilization Corporation, National Wool Marketing Corporation, National Livestock Marketing Association, California Grape Control Board
  • July 3rd 1930: Congress approves the expenditure of a giant $915 million public works program
  • Throughout 1930 the New York Federal Reserve lowers the rediscount rate from 4.5% to 2%; the money supply remains stagnant
  • In mid 1930 the Smoot-Hawley Tariff is signed into law, raising import tariffs to record highs, and spreading protectionism all over the world – consumers and exporters suffer from the ensuing decline of international trade
  • October 1930: Hoover threatens federal regulation of the New York Stock Exchange, unless it bans the practice of short-selling, which would speed up the market correction
  • By December 1930 factory employment has fallen by 16%, manufacturing production by 20%
  • Government expenses rise from 14.3% of Gross Private Product (GPP) in 1929 to 18.2% in 1930
  • May 1931: The crisis spreads to Europe with the run on the Austrian Boden-Kredit Anstalt – the Bank of England, the Austrian government, Rothschild, the Bank of International Settlements, and the New York Fed grant millions of dollars to it
  • In 1931 unemployment in the United States rises to 16%
  • Government expenses rise from 18.2% of GPP in 1930 to 24.3% in 1931
  • The Bacon-Davis act is passed in 1931, requiring a maximum 8 hr work day and payment of at least a prevailing wage on public works projects, thus increasing unemployment
  • By fall of 1931 all agitation to preserve wage rates proves futile and wages begin to fall
  • In fall of 1931 Stock Exchange authorities restrict short selling, prolonging the necessary adjustment of prices
  • In 1931, upon Hoover threatening Federal legislation, the largest US banks establish the National Credit Corporation which quickly moves to bail out failing banks, loaning $153 over a three month period, thus prolonging the misallocation of resources
  • In 1932 sales taxes are imposed on gasoline and other articles, new taxes are levied on bank checks, bond transfers, telephone, telegraph, and radio messages, income taxes are raised from a 1.5% – 5 % range to a 4%-8% range, the corporate income tax is raised from 12% to 13.75%, the gift tax of 33.33% is reinstated
  • Government intrusion increases from 24.3% of GPP in 1931 to 28.9% in 1932
  • In January of 1932 Congress hurriedly establishes the Reconstruction Finance Corporation (RFC), equipped with $500 million of taxpayer money, and empowered to issue further debentures of up to $1.5 billion
  • During the first 5 months of operation the RFC makes $1 billion worth of loans of which about 60% are lent to banks, and 20% to railroads whose securities are held by a lot of savings banks
  • In July 1932 the Emergency Relief and Construction Act increases the RFC’s authorized capital from $2 billion to $3.8 billion
  • Governor Franklin D. Roosevelt of New York establishes the first governmental unemployment relief authority: the Temporary Emergency Relief Administration, equipped with $25 million; other states quickly follow
  • In February 1932 the Glass-Steagall act is passed which greatly broadens the assets that the Federal Reserve Bank can purchase and permits it to use government bonds as collateral for its notes, in addition to commercial paper
  • Throughout 1932, the Federal Reserve increases its reserves by another $660 million to $2.51 billion, an unprecedented increase in history; the money supply keeps falling regardless, because commercial banks begin accumulating excess reserves; excess reserves rise from 2.4% in the first quarter of 1932 to 10.7% in the second
  • In July of 1932 the Federal Home Loan Bank Act establishes 12 district banks, equipped with $125 million of taxpayer money, and the authority to purchase mortgages at as low as 50% of value
  • In the beginning of 1933 many states impose compulsory debt moratoria, debt liquidations are halted
  • In 1933, bank failures rise to 4,000 from 1,453 in 1932
  • In 1933, as a response to increasing bank runs, states impose bank holidays, allowing banks not to redeem deposits
  • In March 1933 Hoover leaves office; as a result of his unprecedented government intervention, by now production has fallen by more than half from 1929, unemployment is at 25%, and GNP has fallen almost in half; the country is in the depths of the Great Depression
  • President Roosevelt continues Hoovers failed New Deal policies of massive government intervention. The US economy remains in a miserable state with above double digit unemployment until 1938 and with a horrible war lasting from then through 1945 during which people are forced to ration consumption and pay up to 90% taxes. The Depression comes to an end after WW2 when malinvestments are liquidated, taxes are but by 1/3 and government spending is cut by 2/3
  • Bottom Line: A recession that was the correction of a boom caused by government intervention in the money and credit market, was prolonged and turned into a decade long depression, again due to government intervention as a result of an unwillingness to let the correction occur clean and quickly.

2007 – 2008:

  • From 2000-2008 the percentage of government intrusion into the private sector increases steadily
  • Throughout 2007 and 2008 the Federal Reserve Bank lowers the federal funds rate from 5.25% in September 2006 to 1% by October 2008
  • Stock and Home Prices keep falling continuously
  • In December 2007 the Federal Reserve Bank introduces the Term Auction Facility (TAF) in order to purchase short term debt from troubled banks who need funds; so far it has injected about $400 billion under this program
  • On January 11, 2008, Bank of America announces that it plans to purchase the troubled bank Countrywide Financial for $4.1 billion in stock
  • In March 2008 the Federal Reserve Bank of New York provides an emergency loan to the troubled bank Bear Stearns; the measure proves useless and the bank is sold to JP Morgan Chase at $10 per share
  • In March 2008 the Federal Reserve announces that it will inject another $200 billion to battle the problems that banks are having with unsound investments
  • On September 7th 2008 the troubled semi-public banks Fannie Mae and Freddie Mac are taken over by the federal government; the banks own or guarantee about half of the U.S.’s $12 trillion mortgage market
  • In September 2008 the SEC imposes a temporary ban on short-selling
  • On September 16 2008, creates an $85 billion credit facility in order to support the troubled insurer AIG at the cost to AIG of the issuance of a stock warrant to the the Federal Reserve Bank for 79.9% of the equity of AIG
  • On October 3rd 2008 the Emergency Economic Stabilization Act of 2008 establishes the Office of Financial Stability, equipped with up to $700 billion in order to buy worthless securities with the objective of stabilizing their prices, home prices continue to fall
  • So far, the combined total of all government actions taken in order to battle the depression have amounted up to $8 trillion – aggravating the crisis significantly
  • From November 07 to November 08 the Federal Reserve Bank more than doubles the amount of assets on its balance sheet by $1.2 trillion to now $2 trillion, but banks build up excess reserves and thus the effect on the money supply is minimal
  • As these lines are written the crisis spreads to the job market. All across the country people are beginning to lose their jobs and production/consumption figures are beginning to slow down significantly; due to the misguided government policy these numbers will, however, turn much worse as the crisis progresses
  • The new government, taking office in January 2009 will enact further measures of government intrusion, including public works programs, raise taxes, and increase the national debt, repeating the mistakes of the Great Depression
  • As things have played out so far 1929 has roughly resembled 2007 and 1930 has resembled 2008; 2009, 2010, and 2011 will most likely resemble 1931, 1932, and 1933

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Abolish the Fed?

I think the easiest, and most convincing proposal toward sound money is the following: Don’t abolish the Fed. Leave it in place. But allow other individuals to compete in the business of money production. Don’t prosecute them for producing their own money. Don’t force individuals to accept paper fiat money via legal tender laws. Leave it up to them to decide which money to accept and which not to accept. Let the consumers decide whose money they prefer. Don’t tax them when a high quality money that they are using becomes more expensive in terms of another, inferior money. Get rid of capital gains taxes on gold and silver.

The crucial problem that is rarely ever discussed is not the money printing by the fed. It is the fact that this money is forced upon the people, and that competing with it is outlawed. Let the Fed suffer the humiliation of going out of business for its inability to compete…

Abolish counterfeiting laws.
Abolish legal tender laws.
Abolish capital gains taxes on gold and silver.

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History of Money

The history of money doesn’t need to be confined to one specific country or time period. It is rather expedient to outline the role money has played and the changes it has gone through in virtually all countries over time. Some events might have occurred earlier or later in one nation or another. However, the general trend to date has been the same. Understanding this trend is of major importance when it comes to understanding money today. This article describes the imaginary story of a country that went from no money at all to a fiat money, paper money. It is conceptually applicable to any country on earth.

The demand for money arose with the appearance of division of labor, when individuals began producing for others rather than for themselves. This was of course a direct outcome of the law of comparative advantage and the corresponding specialization of labor. If individual A transforms land and produces a good that individual B demands, but B has nothing to offer that A demands for consumption, A might still consider receiving a product M in exchange that he can then give to individual C. C happens to demand B’s product for consumption AND offers something that A also demands for consumption. In this case, from A’s point of view M is a medium of exchange, a money.

With division of labor spreading, different goods would be used as money, such as tea, coffee, beans, salt, or cattle. There are numerous accounts of the usage of these goods as money in history. However, there are goods that are better and goods that are worse than others for usage as a medium of exchange. A medium of exchange needs to fulfill criteria such as durability, divisibility, homogeneity, measurability, sufficient but limited availability and broad acceptance. The metals gold and silver emerged as goods that best fulfilled these criteria when used on the market.

Consumers, entrepreneurs, capitalists, landowners, and workers dug up and/or used gold and silver as money in exchange and credit transactions on the market. Decentralized, competing gold mines would channel gold into the market, part of which was used as money. For a fee, some entrepreneurs began offering the service of depositing money in warehouses, also known as deposit banks, so the owners of the money wouldn’t have to carry it with them. They would issue receipts for the money deposited. Soon the receipts themselves, rather than the deposited gold, would be used as money, hence gaining value as media of exchange.

Some of the gold would not be redeemed but rather stay in the warehouses. Thus the entrepreneurs issuing the receipts started offering their own receipts in exchange and credit transactions which were not backed by their own gold. However, they had to be careful not to issue too many uncovered receipts. Because as the price of their additional receipts would drop, their customers would begin redeeming them in exchange for gold again. If there were too many uncovered receipts issued, the warehouse would ultimately lose all its deposits and hence go out of business.

Thus in the long run those deposit banks who managed their deposits most prudently would be the most successful and profitable ones.

But some of the depositors had loaned receipts to the government and hence accumulated public debt. When they faced the threat of going out of business, due to a massive drain upon their gold reserves they sought help with the government.

The government used its police force in order to prevent the deposit banks from having to redeem their customers’ receipts for gold. It declared the receipts of the banks a legal tender, which means that they became a fiat money, a money that people are forced to accept or face government force if they don’t. The operations of different banks were consolidated within one central bank and numerous fractional reserve banks with the exclusive authority to produce fiat money. In addition, the government forcefully confiscated private gold holdings and declared private ownership of gold illegal.

This central bank was no longer under the constraints that the deposit banks used to face. It didn’t depend upon gold deposits and it could inflate the money supply at will. Without voluntary competition within the country, the result was that the quality of the money produced was low. Inflation became a common phenomenon.

Just as seen in the example of the production of cars in the Soviet Union, the more monopolized and centralized the production of a good, the less competition exists, and the less the consumer is given a choice, the lower the quality of the good produced will be from the point of view of those consuming the good.

Roughly, this has been the History of Money and Banking in the United States and the course of events that led to the establishment of the Federal Reserve Bank.

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