The World in Depression, 1929-1939 by Charles P. Kindleberger
World War I had two major features: 1) it created a global coordinating event for aggregate supply, and 2) it showed that state capacity to act judiciously was limited while its ability to marshall resources was not.
When the War To End All Wars ended, war-time production capacity switched back to peace-time products. Goaded by the war-caused high prices, farmers produced as much as possible.
In the United States, farmers took advantage of the new Federal Farm Loan Act of 1916 to borrow funds for expansion, and farmed marginal lands. This over-farming created two problems: 1) the marginal lands lost their topsoil and created the Dust Bowl, and 2) this "subprime for farms" bankrupted farmers as they all expanded production, which drove prices down and made it harder to repay the loans.
From 1925 to 1929, a process of what might by analogy be called structural deflation occurred in the world primary-product economy. Instead of excess demand, there was excess supply. A few countries tried to meet the situation by absorbing the excess supply in stockpiles. Without an adjustment in production, this only stored up trouble. Other countries, one by one, found it necessary to evade the consequences of the excess supply by keeping it out of the domestic market, or selling the crop for what it could bring, perhaps cushioning the consequences at home by depreciation, which forced prices down abroad. The excess supply imposed a kind of structural deflation on the system.
Governments had outgrown their environs while unaware that a) the global environ had deteriorated, and b) their `remedial' actions were not helping.1 This tyranny of being the wrong size meant that solutions that worked or at least were not materially harmful when the actions were smaller now became destructive (dosis sola facit venenum).
The explanation of this book is that the 1929 depression was so wide, so deep and so long because the international economic system was rendered unstable by British inability and United States unwillingness to assume responsibility for stabilizing it in three particulars: (a) maintaining a relatively open market for distress goods; (b) providing counter-cyclical long-term lending; and (c) discounting in crisis.
The shocks to the system from the overproduction of certain primary products such as wheat; from the 1927 reduction of interest rates in the United States (if it was one); from the halt of lending to Germany in 1928; or from the stock-market crash of 1929 were not so great. Shocks of similar magnitude had been handled in the stock-market break in the spring of 1920 and the 1927 recession in the United States. The world economic system was unstable unless some country stabilized it, as Britain had done in the nineteenth century and up to 1913. In 1929, the British couldnt and the United States wouldnt. When every country turned to protect its national private interest, the world public interest went down the drain, and with it the private interests of all.
This `conspiracy of dunces' seems unavoidable. The world is continually complex, and there will always be some first army to march across a bridge in lock step and cause it to collapse.
By far, the most curious note was the following:
For the first time on any substantial scale, the economic system developed an asymmetry: with expansion from full employment, one encountered price and wage increases in the manufacturing sector; with contraction, stubborn resistance of prices and wages and unemployment. The British example was the sharpest. But in Germany, too, it was noted that a new phenomenon - unemployment - showed up after the war.
The previous Great Depression (1873 - 1896) had many firms fail with an accompanying increase in unemployment. Perhaps he means structural reasons, ie. not just bankruptcies? The false lesson of the 1920-21 recession (keep wages high) seems to have been the US culprit, but other countries? Perhaps this was a continental problem with unionization? Yet another conspiracy of dunces?
The October 1929 crash of the stock market strikes no chords in my memory. With the rest of the world, I was aware of it, but to a sophomore in college it meant little. The familys few stocks were owned outright rather than on margin. Despite the decline of business, and with the help of an uncle in shipping, I got a job the next summer working on a freighter delivering heavy equip ment from Copenhagen to Leningrad and bringing back wood- pulp from Kotka, Raumo and Kemi in Finland. I dont think this was ordinary dumping, but I dont know. It was not the kind of exchange-dumping which occurred after 1932 and is discussed in Chapter 8. It was memorable mainly for the fact that one could drink beer and spirits against ones pay after the ship reached Copenhagen. (My wages as a deck-boy were $20 a month.) The trip cultivated an interest in international trade and a taste for Tuborg beer which have lasted all my life.
By February 1933 I had arranged to study graduate economics at Columbia University the following autumn. As an introduction, I took an evening course in money and banking from Ralph W. Robey, the financial editor of the New York Evening Post. In the early weeks of February and March 1933, he regaled the class with day-to-day accounts of the collapse of the American banking system which made economics as exciting as The Perils of Pauline.
Another form o fhistorical accident might be the pure fortui tousness of regularly recurring cycles of three different periodicities reaching their depression phases simultaneously. The depression of a Kongratieff long cycle covering as much as fifty years arrived simultaneously with the depressions of a Juglar intermediate nine-year cycle and of a short-range Kitchin cycle in inventories. Vastly oversimplified, this is the Schumpeter view.
Often no one in authority had any positive idea of what to do, and responded to disaster in the policy clichs of balancing budgets, restoring the gold standard and reducing tariffs. Hobsbawm puts it too strongly perhaps: Never did a ship founder with a captain and a crew more ignorant of the reasons for its misfortune or more impotent to do anything about it.8
This is a typical non-zero sum game, in which any player under taking to adopt a long-range solution by itself will find other countries taking advantage of it. Agreement that all should adopt a long-range strategy may be conceptually satisfactory, but is likely to involve different degrees of sacrifice from different players at a given moment in time. Britain wants to stabilize currencies at $3*40 to the pound, while the United States lacks interest in the subject until the rate is nearer $4*86. Or postulate a network of reparations, war debts and commercial loans in which Germany owes reparations to Britain and France and commercial debts to the United States; Britain owes to the United States about what it receives from Germany, and is owed in war debts from France; France is to receive the lions share of reparations, well in excess of its war debts to Britain and the United States. In this circum stance, Germany is more ready to cancel reparations than to default on commercial debts, since it owns some assets abroad and is interested in maintaining its credit. Britain is willing to cancel reparations, but only if war debts are excused. France insists on receiving reparations, wants war debts cancelled, and is relatively indifferent to commercial loans. The United States can see no connection between war debts and reparations, is prepared in extremis to accept a moratorium on reparations and war debts, but seeks to safeguard the sanctity of commercial debts and wants to revive war-debt payments after the years moratorium is over. No equitable solution is possible. Inevitably the system runs down to wipe the slate clean of reparations, debts and service on commercial lending. In exactly the same way, the attempt of a system of countries with interlocking multilateral trade to achieve export surpluses tends to wipe out all trade as successive trading partners cut imports from the next country.
In these circumstances, the international economic and monetary system needs leadership, a country which is prepared, consciously or unconsciously, under some system of rules that it has internal ized, to set standards of conduct for other countries; and to seek to get others to follow them, to take on an undue share of the burdens of the system, and in particular to take on its support in adversity by accepting its redundant commodities, maintaining a flow of investment capital and discounting its paper. Britain performed this role in the century to 1913; the United States in the period after the Second World War to, say, the Interest Equalization Tax in 1963. It is the theme of this book that part of the reason for the length, and most of the explanation for the depth of the world depression, was the inability of the British to continue their role of underwriter to the system and the reluc tance of the United States to take it on until 1936.
The year 1925 generally marks the transition from postwar recovery to the brief and limited boom which preceded the depres sion. This was the year of the stabilization of sterling and of the other currencies which followed it back to the gold standard. (In the United States, it also marked the peak of the boom in a number of important respects: the collapse of Florida land speculation, the peak for postwar housing starts, and the highest price of wheat.)
By 1925 or 1926, however, Europe stopped looking back to 1914 and began to contemplate the future more confidently. The state of recovery achieved contained certain seeds of trouble, initial conditions from which the world depression of 1929 emerged. These con cerned especially an increased reluctance by labour to accept wage decreases after about 1921, making for an irreversibility of wage and price increases;1 reparations and war debts which, however much they appeared to have been settled by the Dawes 1
Plan and the interallied debt settlements, were to prove destabiliz ing; the system of exchange rates, with the pound overvalued and the franc undervalued, resulting in the substantial accumula tion of French claims on Britain; and the entry into world lending of the United States, substituting in part for Britain, with much enthusiasm, no experience, and little in the way of guiding prin ciples.
Viewed from the 1970s, the attempt by the Allies to exact repara tions from Germany make little sense. The notion that Germany could be saddled at the same time with the costs of the war and reconstruction made even less. At the time, however, there was ample precedent for taking this course. Germany had collected 5,000 million marks in reparations in 1871, without involving France in any great difficulty.8 Britain had led the victors at Waterloo in exacting 700 million francs from France after 1815. Now it was the turn of the French. Having paid twice, they were ready to receive.
Occupation of the Ruhr did not help. German employers and workers sabotaged output and distribution in a massive exhibition of passive resistance or non-violent warfare. There was even violence: on 31 March 1924, Easter Saturday, a French squad of soldiers searching Krupps was threatened by a crowd of workers, and, firing into them, killed thirteen, including five teenagers, and wounded fifty-two. The funeral was a highly emotional one. Throughout the occupation, the strain was said to be harder on French troops than on the German populace.* 1 1 12 The German government paid subventions to industry and discounted securities for banks to maintain payrolls. The inflation well under way in 1922 gave way to hyperinflation. By June, the mark was 100,000 to the dollar; by November 4,000 million. Grigg thought that the occupation of the Ruhr was the most effective and direct cause of Hitler, and but for this there would have been no Second World War. Most observers blame the inflation and the conse quent pauperization of the middle class rather than the occupation of the Ruhr itself.14 Whether one inevitably involved the other is perhaps an open question. But hyperinflation had one delayed result in making it difficult, after 1930, to fight deflation in the midst of depression. By demonstrating the devastation that could be caused by inflation, it furnished those who believed in putting the economy through the purifying fires of deflation with an inexhaustible supply of ammunition against programmes of even moderate monetary or fiscal expansion.
It is hard to discern that the French had ambitions of their own beyond resisting British domination, and British gobbling up of all the central-bank allies. Moreover, British designs for the system - the gold-exchange standard, stabilization of exchange rates, restora tion of the financial importance (hegemony) of London - could be said to be guided by national considerations rather than or as well as by those of the international monetary system. Norman believed in the dependence of the United Kingdom on the restora tion of the world economy, as well as the obverse. For the leader, it is often difficult to distinguish the public from the private good.
One of the most interesting passages in Moreaus memoirs records a report of a visit by Quesnay to London where he saw not only Norman but also Niemeyer, Salter, Strakosch and Kindersley. As reported by Moreau, Quesnay observed that the grand British design was not only to stabilize currencies, even without the support of the Bank of France, but to link up central banks into a cooperative network which could, independent of politi cal considerations, and even of governments, regulate the questions essential for prosperity, viz. monetary security, distribution of credit and movement of prices. Moreau characterizes these views as surely doctrinaire, no doubt somewhat utopian, even perhaps Machiavellian, but possible! See Souvenirs d'un gouverneur de la Banque de France, pp. 136-7.
Germany had originally accumulated sterling as the counterpart of the British share of the Dawes loan. Schacht and Norman worked together closely in the issuance of the loan and in getting the Golddiskonto bank established, and Schacht had every interest in assisting in the stabilization of the pound at par, to the limited extent the Reichsbank then counted, since a rise in the pound increased the value of the banks reserve holdings. When, towards the end of 1926, there was an excessive inflow of foreign capital into Germany, however, he faced a dilemma. He was unwilling to see the inflow of capital continue, but equally reluctant to repel it by lowering domestic interest rates, which would have contri buted to domestic expansion. Accordingly, he chose to convert sterling to gold to tighten interest rates abroad. This would keep the capital in London. The Bank of England was as unwilling to raise the interest rate as the Reichsbank was unwilling to lower it. British unemploy ment was widespread; still tighter money would have produced resistance from the Treasury and political unrest. Accordingly, the Bank of England allowed the gold to leave without responding in the traditional manner. German power over the London market was not substantial. But the episode suggested that the period of effective functioning of the gold standard was coming to an end.
On this showing, there was a swing of something in the order of $2,000 millions in lending by the United States between the eighteen months from 1 January 1927 to 30 June 1928, and from 1 July 1928 to 30 September 1929, $1,275 million in new foreign securities, minus $100 million in direct investment, plus, perhaps, $700 million in outstanding securities. This was a sub stantial amount. What was it that hit United States foreign lending in June 1928? The short answer is the stock market. Investors were diverted into stocks; financial intermediaries, who were not permitted to buy stocks, loaned funds on the call market. Interest rates rose sharply beginning in the spring of 1928 as the Federal Reserve System sold off the additions to its open-market port folio of the summer of 1927, and more, and raised the rediscount rate three times. Turnover rose on the New York Stock Exchange. Call-money loans went from $4,400 million at the end of 1927 to $5,275 million at mid 1928 and $6,400 million at the end of the year. Banks withdrew to an extent from the market, but non banks took their place and more. Railroads and industrial com panies as well as financial houses turned from real investment to call loans which were safe, liquid (it was thought) and high- yielding.
Up to the business cycle of 1857, or perhaps 1866, the harvest was the measure of business conditions. A bumper crop lowered the price of bread, and hence industrial wages, and simultaneously provided an outlet for industrial produce by enlarging farm in come. Crop failure, on the other hand, led to depression. Differ ences existed from situation to situation, depending upon parti cular conditions in land tenure and whether the economy was open for foreign trade.
Outside Western Europe, however, agriculture was of importance. Farming accounted for a quarter of total employment in the United States in 1929, and farm exports for 28 per cent of farm income. Regions of recent settlement, including the Domin- ions, Argentina and Uruguay, had higher percentages on both scores. Almost two fifths of world trade was in agricultural products, and another fifth in mineral raw materials. The failure of the price system in farm products, moreover, is readily explained. In part, it resulted from the restoration of production in Europe under circumstances where production elsewhere had expanded to fill wartime gaps. In part it was the usual failure of the price system in products with a long period of gestation between new investment, in response to price in creases, and ultimate output, as in tree crops.
Once overproduction gets under way, government policy in producing areas enters the picture. As prices slip, exports may be subsidized, or stockpiles accumulated, or, in a few cases, exports (and occasionally production) restricted. For agricultural produc tion as a whole, Timoshenko suggests that stocks are a better index of oversupply than prices, because of government attempts to maintain price by purchases.5 An index of world agricultural prices and stocks based on 1923-5 as 100, shows prices declining gradually from the end of 1925 to a level of about 70 from July to October 1929, while stockpiles increased by about 75 per cent. Thereafter, as finance for holding stocks became scarce, the pace of price declines increased, in December 1932 falling to 24-4 per cent of the base year, while stocks rose another 50 or so per cent to 260.6 The annual price declines for 1930, 1931 and 1932 were 40,28 and 12 per cent respectively.
The capacity to finance wheat in storage was not an unmixed blessing. It lead to the temptation to speculate, which was not always rewarded. In the autumn of 1928, Canada already had a large amount of wheat in storage, but with a record crop and a world shortage of hard wheat, which usually commanded a premium over the ordinary wheats of other major exporters, it decided to hold back exports. This was expensive for the economy and for the balance of payments. It was necessary to dump some securities in the New York market and to withdraw funds from the call-money market. In January 1929, the gold drain led to an informal embargo on gold exports, but short-term capital in flows prevented the Canadian dollar from depreciating. Also in January, the prospect of damage to winter wheat from storms in the Soviet Union and the United States led to more holding back of exports. But European buyers went on strike against the high premiums of hard over other wheats and switched sources of supply. Black Tuesday on the Winnipeg Wheat Exchange in early May drove the price down. Lower prices failed to repair the decline in exports. Compounding their mistake and relying on mediocre 1928-9 crops in Argentina and Australia, the Wheat Pool and private grade interests continued restraint in selling the 1929 wheat crop. This policy proved disastrous, leading to loss of wheat exports, weakness in the Canadian dollar, tight money and widespread losses. The shortage of hard wheat ! produced a spread of 42 per cent in July 1929, compared to a normal one of 10 cents on a bushel of wheat priced at $1-25. When Canada was forced to sell for lack of storage space towards the end of the year, however, the spread returned to normal in a matter of months
The pattern in sugar was broadly similar to that in wheat, though applying to a different set of countries. Rapid expansion after the war, especially in Cuba and Java, was followed by a comeback in European production. To the expected recovery of Continental Europe were added new policies in Britain: imperial preference for cane beginning in 1919 and subsidy to domestic beet-sugar producers after 1 October 1924. So rapid was the European recovery, that by the mid 1920s Czechoslovakia was unable to find markets for her traditional exports.13 Hardest hit in the depression was Java. During the 1920s, it had benefited from the development by Dutch agronomists of new seeds which increased production. But it lacked a sheltered market. Protection cut off its market in India, where a white-sugar process, which did not use bone char and was therefore not offensive to Hindu sensitivities, was put into production in 1930. This forced Javanese exports down from three million tons in 192! 8-9 to one sixth of that amount three years later. The fall in prices produced trouble everywhere. Riots broke out in Cuba as early as 1928, not waiting for the actual depression, which was to stimulate fifty revolutions in Latin America.14
Falling farm prices, the halt to foreign loans and protective tariffs all interacted. To begin with, farm debt was serious. Total farm mortgages in the United States had risen from $3,300 million in 1910 to $6,700 million in 1920 and $9,400 million in 1925. In some states as much as 85 per cent of farms were mortgaged. In Canada, in 1931, more than one third of wholly owned farms had mortgages averaging 40 per cent of their value. In Germany, landowners had paid off their debt in the inflation, but had contrac ted new ones, with the largest farms mortgaged for half their value.
The rise in agricultural stocks and the slippage of prices after 1925 make it clear, however, that there were structural factors at work. The abundance of credit up to the middle of 1928 helped to paper over the structural cracks while excluding the monetary explanation to that stage. The world might have evaded the consequences of raw-material overproduction had it escaped monetary deflation. Surpluses and deflation provided the fateful mixture. -- Federal Farm Loan Act of 1916 , cf subprime loans , two systems one distributed and one centralized with the centralized coordination overloading the distributed , central coordinating event was ww1.
The foreign capitalists and United States out-of-town banks and corporations who withdrew call money from the New York mar ket caused large losses to individual investors. These cut their spending. Firms which had counted on ready access to the New York stock and bond markets joined in the race for liquidity, and cut their spending. Production fell sharply, and inventories were run off. The liquidity panic extended to mortgages, which were normally financed at that time in the United States on unamortized three-year obligations, so that a third came due annually. House owners seldom had the cash to pay them off. Where a mortgage holder wanted the money and a house-owner had difficulty in getting a new loan elsewhere - which was the frequent case - foreclosure was undertaken.
During the 1920s, a small minority opposition had campaigned against the restoration of the yen to par, holding out for a lower rate. Led by Tanzan Ishibashi and Kemekicki Takahashi, a distinguished journalist, it had fed on the views of Gustav Cassel, and later of Keynes, whose Tract on Monetary Reform was trans lated into Japanese in 1924, and Treatise on Money in 1932. These works did not anticipate the theory of public spending, but im pressed Ishibashi and Takahashi with their advocacy of a managed currency.
The lack of leadership in providing discount facilities, anti- cyclical lending or an open market for goods rendered the system unstable. So did the heritage of war, and especially the combina tion of reparations, war debts, overvaluation of the pound and undervaluation of the French franc. One should perhaps add the German inflation of 1923, which made that country paranoid in its subsequent attachment to deflation. The structural dislocations of war in excess production of wheat, sugar and wool, plus ships, cotton textiles and coal, were of less consequence and could have been cared for fairly readily by the price system if macroeconomic stability could have been preserved. The financial distortions made such stability difficult if not impossible to sustain. A far-seeing leadership on the part of the United States might have been willing to waive war debts, but it would have been difficult to persuade the American voter of the merit of the course, especially when Britain! and France were receiving reparations. Britain was willing to forego reparations, to the extent that war debts were written off - an attitude of limited self-denial - but the suggestion that the French could write off reparations, after having paid them in 1871 and 1819, and after four years of cruel war, is to ask too much from history.