The many comments, on this post, regarding capitalism’s role in causing the Great Depression prompt me to reprise this June 2006 post on the work of the economic historian Robert Higgs.
June 14, 2006
Challenging a Depressing Myth
Don Boudreaux
At last, a book that I’ve long awaited has been published: Robert Higgs’s Depression, War, and Cold War (Oxford University Press, 2006).
As compelling, informative, and important as are his chapters on the
military-industrial-congressional complex, my favorite chapter is the
first: "Regime Uncertainty: Why the Great Depression Lasted So Long and
Why Prosperity Resumed After the War." (Here’s an earlier version.)
Higgs’s thesis in this chapter, which is backed by data (including
interesting data on bond yields from the mid-1920s through the
mid-1950s), is that the Great Depression was prolonged and deepened by
the "regime uncertainty" created by FDR and the New Deal. As it turns
out, Uncle Sam never engaged in wholesale nationalizations and other
whacky central-planning schemes — but no one in the 1930s knew what
the future held. For investors back then to believe that any
investments they made in the U.S. might be confiscated or regulated to
smithereens was not unreasonable, given the rhetoric of the time and
the shift in policy brought by FDR and his "brain trust."
This "regime uncertainty" stifled investment, keeping the economy stagnant.
Higgs’s analysis complements — but adds significantly to — many of
the prevailing insights about the Great Depression. For example,
speaking about theories — such as that of Friedman and Schwartz –
that focus on the contractionary monetary policy of the era, Higgs says
I
do not claim [that these theories] are wrong, only that, even if they
are correct as far as they go, they are insufficient. If property
rights are seriously up for grabs, no amount of pumping money into a
depressed economy can bring about genuine complete economic recovery
[p. xi].
And as for the Great Depression being cured
by America’s entry into WWII, Higgs masterfully casts grave doubt on
that popular claim.
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{ 32 comments }
For investors back then to believe that any investments they made in the U.S. might be confiscated or regulated to smithereens was not unreasonable, given the rhetoric of the time and the shift in policy brought by FDR and his "brain trust."
I find the rhetoric of the Clinton campaign to be similar, and would expect investors to have the same hesitation — except, of course, those investors who will profit by regulation.
I have slowly pulled all investments I have in any regulated industries over the past twenty years, and I find non-regulated business opportunities are becoming a lot harder to find. Offshore looks better every year, but they're getting their hooks deeper into those earnings as well.
…and we can ask Jim Taggart how well it works to be an investor who profits by regulation.
Also along these 'did capitalism cause the great depression' comments, and in line with things mentioned from Higgs' book, the EconTalk podcast with Amity Schlaes (sp?) was informative and helpful.
Hey Sheetwise -
Maybe you could back off on your dose of Clinton-hate pills and show me the rhetoric? Maybe you could also show Wall Street, cuz' they're backing Hillary big time. (http://dealbook.blogs.nytimes.com/2007/10/18/hillary-clintons-wall-street-comeback/)
Another thing to consider. In something I read once, someone pointed out that the problem in the Middle East wasn't instability, it was stability — the same actors in the 60's and 70's were still in charge in the 90s. The reason we had so many troubles in the Great Depression is precisely because we had the same clown in charge the whole time. Why hasn't anyone noticed that correlation?Or that, under FDR, after the unemployment rate dropped down to about 8%, it leapt back up to 20-25%? People praise him for getting us out of the Great Depression, but as far as I can tell, he kept us in it.
holymoly… tinyurl that link, wouldja?
Troy Camplin –
I don't usually follow blind links, do you? Unless you have very high security against scripts, or some kind of add-in that shows tinyurl's true target, then clicking on tinyurl links is pretty much like Russian Roulette for your system.
oops sorry — post should have been addressed to shawn, not Troy Camplin.
…your other option is to include the 'preview' link, which provides, as shown herein, a preview of where it goes.
http://tinyurl.com/35amzv (the original link, without preview)
http://preview.tinyurl.com/35amzv (the preview link)
though, with up-to-date firefox and other protections, I'm not worried about links, especially given from here at the cafe from a poster. Out in the random internet, yes, worrisome.
shawn —
thanks for the tip! was not aware of the preview option.
Upon Exxon's last profits statement Hillary Clinton announced "I want to take those profits and use them for [some government boondoggle or other.]"
That won't create uncertainty as the New Dealers did, it creates certainty of a very bad sort should the American people decide they really don't want a prosperous country.
Holymoly,
The money will go to the expected winner because its purpose is to buy influence. This says a lot about our political system, but not what you think it says about Hillary. It doesn't mean that the investors are not afraid of what her election will mean, just that they hope to buy a seat at the table.
Holymoly –
I don't know you're refering to when you say "Clinton-hate pills" — the topic, it seems to me, is the Great Depression, FDR, the New Deal, and their relationship to investor confidence.
Aside from Hillary's stated desire to nationalize the oil industry — she certainly spends a lot of time quoting FDR and, if you can believe her, channeling Eleanore.
Since one of FDR's greatest admirers wants to be president — this might be a good time to learn from history, as well as learn the history.
holymoly wrote, "Maybe you could back off on your dose of Clinton-hate pills and show me the rhetoric? Maybe you could also show Wall Street, cuz' they're backing Hillary big time."
Please try to connect all the dots.
More money is going to Democrats because they are in power. The more power they have the higher the price they can command for it.
For example, earlier this year, after the Democrats had taken control of Congress, the Democrats launched an aggressive assault upon private equity firms and hedge funds threatening to substantially raise their taxes. To passify their aggressors such firms donated large sums of cash to Democratic campaigns. Two or three weeks ago, Harry Reid announced he was temporarily calling off the attack.
The media spun this as though private equity firms and hedge funds had bought their way out of more taxes. What really happened was extortion.
marcus…I keep thinking of munger on the 'rent seeking' econtalk:
"man, this is a nice restaurant you've got here…sure would be a shame if anything were to happen to it."
A similar question along the same line is "why in 1800s, during the gold standard era, were harsh recessions and depressions commonplace"? I s'pose the standard answer is that of 'moral hangover'. If people foolishly invest and the investment goes belly up then they go broke and a lesson learnt. Nowadays some people can get their losses their subsidized so they can do it all over again.
But then "why didn't the 1987 stock market crash not trigger a great depression"? Were the losses subtlely subsidized across taxpayers? Or did only those who lost this time not take down everyone else with them. Even if the 1987 was secretly subsidized then is it still a better option then a great depression?
Then a final question "if the Great Depression kept going on and on because of regulations why does modern society prosper even though we have more regulations than were around 70+ years ago"?
Gil wrote, "But then "why didn't the 1987 stock market crash not trigger a great depression"? Were the losses subtlely subsidized across taxpayers? Or did only those who lost this time not take down everyone else with them. Even if the 1987 was secretly subsidized then is it still a better option then a great depression?"
Consider the monetary expansion caused by the fractional reserve system of banks. Here's a link to help understand it:
http://en.wikipedia.org/wiki/Fractional-reserve_banking
Now consider the monetary contraction that results from bank failures. When banks fail all that expansion they caused through fractional reserve lending goes away.
By 1933, 25% of the money supply disappeared because of the monetary contraction caused by bank failures. This caused high demand for money which drove the value of the dollar up which caused severe deflation.
The Federal Reserve didn't let that happen in 1987. Their monetary policy was entirely different. Informed, in part, by the work of Milton Friedman.
It doesn't have anything to do with regulations or subsidies.
"Then a final question "if the Great Depression kept going on and on because of regulations why does modern society prosper even though we have more regulations than were around 70+ years ago"?"
One of the reasons, but not the only reason, the depression kept going on and on is because FDR and Congress kept misunderstanding the cause of deflation.
In 1933 while people were standing in soup lines, FDR actually ordered farmers to grow less food. Why? Because he thought the deflation was caused by too much supply and not enough demand for food! He said so in one of his fire side radio addresses. Here's a link:
http://www.mhric.org/fdr/chat3.html
Here's what he said, "First, the Farm Act: It is based on the fact that the purchasing power of nearly half our population depends on adequate prices for farm products. We have been producing more of some crops than we consume or can sell in a depressed world market. The cure is not to produce so much."
He was wrong. His policies only exacerbated the problem.
Also, we have relatively less burdensome government then we did have in the 70's. In the 70's the economy was a horrible mess suffering from stagflation. Milton Friedman predicted this would happen. It is why he won the Nobel prize.
The deregulation that followed in the 80's is why we have had the booming economy we have had for the last 25 years.
Are there any mainstream defenders of the fractional reserve system? I don't totally buy into the Austrian theory of the business cycle, mostly because I think in a fractional reserve system, the externalities caused by bank failure might be worse than the malinvestment caused by artificially low interest rates. Its been shown how fractional reserve banks have incentives to make bad loans when interest rates are held low, and we know how destructive monetary contraction can be.
I'm curious if the fractional reserve system has any real defenders other than the grim realization that it and the laws propping it up aren't going anywhere any time soon.
Are there any mainstream defenders of the fractional reserve system?
Of course there are. Monetary contraction from bank failures may be the downside but the monetary expansion makes capital available for businesses to expand. At least, that's the argument.
My post wasn't meant to argue for or against fractional reserve lending, only to point out the role that monetary policies played in explaining the differences between the 30's and 1987.
Back to Gil, "why does modern society prosper even though we have more regulations than were around 70+ years ago"
Beyond the role of monetary policy was the role protectionism played. We are MUCH less protectionist today than we were in the 30's.
In 1930, Hoover signed into law the Smoot-Hawley Tariff Act. Here's a link:
http://en.wikipedia.org/wiki/Smoot-Hawley_Tariff_Act
This act, along with the resulting retaliations of other countries, brought world trade to a near stand still.
The 30's really were a comedy of errors by the government.
In contrast, in 1987 we were opening our borders to trade rather than closing them.
But I fear that the protectionists are back. Everyday now we hear protectionist arguments from politicians.
The government cannot, through force, cause the generation of wealth but it sure can put a stop to it. And it can put a stop to it again.
Marcus,
Your example of the hedge funds and private equity firms beging targeted for extortion by democrats is spot on.
It fits the example set by the Clintons in the individual framework as well. Who can forget the way the Clinton adminstration used the courts to go after Bill Gates and Microsoft, for predatory trade practices and monopoly; but for in truth the fact that he sat out there in Washington State and hadn't been slathering money all over the politicians in Washington D.C.. It was a miracle how fast that whole thing disappeared when Microsoft money began to flow to D.C..
Bill Gates learned what government is all about. He also learned that some politicians are stupid enough to kill a golden goose if they aren't getting the eggs. Rather than fight and see Microsoft torn apart and ultimately destroyed, Gates paid up.
Bill Gates learned what government is all about.
A legal protection racket. If you don't give us some money, we'll take it all.
From 1929 to 1933 real nonresidential fixed investment fell 70%. From 1933 to 1937 it rose 160%. So the big plunge was before FDR was elected and the massive rebound was when FDR was supposedly threatening to nationalize private wealth. during the period that business confidence was supposedly being destroyed by FDR the stock market rose 2.5 fold. If business confidence was so bad, why did the best measure of business confidence, the stock market, rose so strongly?
If you make real nonresidential fixed investment a function of corporate profits, capacity utilization and the stock market the behavior of real business spending in the 1930s is explained by these three factors just as well as these three factors explain real business investment growth since WW II.
It looks to me he has cherry picked data to demonstrate his priors.
Can you tell me if he tested his model of what happened in the 1930s to see if it also worked to explain the growth in capital spending after WW II? My model does.
By the way, even though we have great theories that say business fixed investment is influenced strongly by interest rates when you look at the actual data and try to model it you consistently get the wrong sign on rates. So what sign did he get between interest rates and capital spending in the 1930s? That is why I use the stock market rather than rates to represent the cost of capital in my model — it give you the correct sign.
Spencer -
So, the 1929 investment of $1.00 became the 1933 investment of $.30 — and by 1937 became the investment of $.48 (your analysis assumes, I believe, different baselines).
Was that the "massive rebound", or am I reading incorrectly?
BTW– Does "nonresidential fixed investment" include government expenditures?
Nonresidential fixed investment is what is commonly called business investment, it does not include government or housing.
The argument is that FDR scared businessmen into not investing. My argument is that if you look at the dominant factors explaining investment — profits, capacity utilization defined as the GDP gap, and the stock market and this includes the cost of capital since the market PE is the inverse of the cost of capital — that investment is exactly what these variables said it should have been. Given this the argument that FDR scared businessmen into not investing is not supported by the fundamental facts.
What is so hard to understand about that?
I am not arguing that investment was not weaker than in other recoveries. I am arguing that given the low level of profits and massive excess capacity in place when FDR took office – the GDP gap was 55% –that investment should have been weaker than in other recoveries but not weaker than it actually was. Given these factors and the point that FDR had to fight tight Fed policy throughout the recovery the fact that there was any investment at all is sort of amazing.
Remember in late 1936-early 1937 the Fed was so worried that the strong economy was creating inflationary pressures that they raised reserve requirement and induced the 1937-38 recessions to offset the inflationary pressures created by the success of The New Deal in getting the economy moving again.
Nonresidential fixed investment is what is commonly called business investment, it does not include government or housing.
The argument is that FDR scared businessmen into not investing. My argument is that if you look at the dominant factors explaining investment — profits, capacity utilization defined as the GDP gap, and the stock market and this includes the cost of capital since the market PE is the inverse of the cost of capital — that investment is exactly what these variables said it should have been. Given this the argument that FDR scared businessmen into not investing is not supported by the fundamental facts.
What is so hard to understand about that?
I am not arguing that investment was not weaker than in other recoveries. I am arguing that given the low level of profits and massive excess capacity in place when FDR took office – the GDP gap was 55% –that investment should have been weaker than in other recoveries but not weaker than it actually was. Given these factors and the point that FDR had to fight tight Fed policy throughout the recovery the fact that there was any investment at all is sort of amazing.
Remember in late 1936-early 1937 the Fed was so worried that the strong economy was creating inflationary pressures that they raised reserve requirement and induced the 1937-38 recessions to offset the inflationary pressures created by the success of The New Deal in getting the economy moving again.
Correlation is not causation.
To turn the correlation you present us into a causation by FDR's policies you need to connect it in a way that is more than merely coincindental. What about FDR's policies would lead to more investment?
How much of your numbers can be explained by the fact that the monetary contraction stopped in 1933 and the money supply began expanding.
In other words, from 1930 to 1933, the money sitting in your pocket grew more valuable over that period of time. In 1933, inflation kicked back in and the money sitting in your pocket grew less valuable over time.
This fact alone has got to affect investment patterns.
"Given these factors and the point that FDR had to fight tight Fed policy throughout the recovery the fact that there was any investment at all is sort of amazing."
So why do you assume FDR had anything to do with the recovery at all?
Well the fact that the 1929-33 economic downdraft ended as soon as FDR took office and declared a bank holiday that effectively stopped the hemorrhaging of the banking system and the contraction of the money supply was a major reason. Another point there is a virtual complete agreement among almost all main stream students of the depression that FDR taking the US off the gold system and devaluing gold was a major factor ending the depression. Bernanake did a major study of this that showed that in almost every country the major economic downturn of 1929-33 ended just after each country deserted the gold system and that was true of the US as well. But the US was the last major industrial country to desert the gold system. This played a major role in creating inflation expectations so that real interest rates came down and it was no longer more profitable to hide your cash in the mattress then to invest it. In other words the end of the Keynesian liquidity crises that played such a major role in creating the recession in the first play and also played a similar role in Japan over the last couple of decades. Third, after 1933 the only reason the money supply started growing again was the Treasury operations to monetize the debt that Hoover and the Fed had opposed and the Fed continued to oppose.
If you are going to make major pronouncements on how FDR made things worse you should try to actually study what actually happened so as soon as you say something you do not betray your ignorance.
Don quotes Higgens on how bond yields rose after 1933. But he is using nominal bond yields and if you look at real bond yields they moved in almost the exact opposite direction. In the period where he shows nominal yields to be flat the economy was experiencing nearly 10% deflation so real bond yields were very high. But after 1933 even though nominal yields rose, real yields fell sharply to only two or three percent. This is why I accused him of cherry picking data. Almost every main stream student of the great depression — including Milton Friedman — emphasized that high real yields was a major factor behind the depression. Yet Higgens makes a point of using a rise in nominal yields and ignoring the sharp fall in real yields that occurred after 1933. Moreover, this happened because policy moves by FDR ended the contraction in the money supply and nearly double digit deflation of the early 1930s. The rise in nominal yields after 1933 was a healthy development that reflected the fact that the economy was starting to grow again. This is just the opposite of what Don or Higgens would have you believe.
I just looked at Higgs interest rate spreads again.
He is doing some interesting math.
He is saying the spread between short rates and long rates increased sharply and expresses it by showing the longer rates as a multiple of short rates.
But during the 1930s bond yields fell almost constantly.For example Moodys AAA corporate yield peaked at 5.3% in December, 1931 and fell to a low of 2.92% in June,1939.
But when you do the math like Higgs did
you get the results he did from falling rates. For example:
short…..long…..ratio
3…….5…….1.6
2…….4…….2
1…….3…….3
If both long rates and short rates fall by
100 points from 3% to 2% and from 5% to 4%
the ratio — or what Higgs was calculating — rises from 1.6 to 2. If both fall to 1% and 3% the ratio rises to 3, or almost double what it was before they both fell 200 basis points.
So what it looks like Higgs is doing is taking good news, falling corporate bond yields and presenting it is such a manner that it appears to be bad news.He is drawing exactly the opposite conclusion I would from the data.
I know nothing about the man. But if I were a referee for the material in this article
I would sure want a complete explanation of why he is not doing something that at first glance appears to be a fundamentally dishonest analysis designed to lead the reader to the wrong conclusion.
Don, do you have an explanation of why I am interpreting this analysis incorrectly?
Thanks for the posts (unnecessary insults notwithstanding). They are informative and give more context to your first post.
Thanks for the posts (unnecessary insults notwithstanding). They are informative and give more context to your first post.
For a different view of capital spending in the depression go to:
http://angrybear.blogspot.com/
wow ilike the threads its my first time my question what did capitalism contribute in the 1920s
wow ilike the threads its my first time my question what did capitalism contribute in the 1920s