An Explanation of the Nineteen Twenty-Nine Depression

An Explanation of the Nineteen Twenty-Nine Depression

We return to the original questions: What produced the world depression of Nineteen Twenty-Nine and why was it so widespread, so deep, so long? Was it caused by real or monetary factors? Did it originate in the United States, in Europe, in the primary-producing countries of the periphery, in the relations among them? Was the fatal weakness the nature of the international capitalist system or the way it was operated, that is, the policies pursued by governments? Were such policies, to the extent they were important, the consequence of ignorance, short-sightedness, or ill will? Were the depth and length of the depression a reflection of the strength of the shock to a relatively stable system, or were they a measure of the system's instability in the presence of a blow or series of blows of normal force (however measured)? Or-to bring the issue back among Paul Samuelson, Milton and Rose Friedman, and me-was the depression a fortuitous event, the consequence of deliberate and misguided monetary policy on the part of the U.S. Federal Reserve Board, or were its origins complex and international, involving both financial and real factors? Inevitably in drawing the threads together there will be a considerable amount of confirmation of preconceptions. I am open to the accusation of having selected statistics, facts, and incidents from the history of the decade which support a position chosen a priori. But I would claim that I have not knowingly suppressed

AN EXPLANATION OF THE NINETEEN TWENTY-NINE DEPRESSION

any facts that do not fit the explanation that follows, nor ignored other explanations, such as U.S. monetary policy (Friedman), misuse of the gold standard (Robbins), mistaken deflation (Keynes), secular stagnation (Hansen), structural disequilibrium (Svennilson), and the like. The chapter is entitled "An Explanation," not "The Explanation."

The explanation of this book is that the Nineteen Twenty-Nine depression was so wide, so deep, and so long because the international economic system was rendered unstable by British inability and U.S. unwillingness to assume responsibility for stabilizing it by discharging five functions:

(One) maintaining a relatively open market for distress goods;

(Two) providing countercyclical, or at least stable, long-term lending;

(Three) policing a relatively stable system of exchange rates;

(Four) ensuring the coordination of macroeconomic policies;

(Five) acting as a lender of last resort by discounting or otherwise providing liquidity in financial crisis.

These functions, I believe, must be organized and carried out by a single country that assumes responsibility for the system. If this is done, and especially if the country serves as a lender of last resort in financial crisis, the economic system is ordinarily capable, in my opinion though not in that of others, of making adjustments to fairly serious dislocations by means of the market mechanism. There will be times when the structural dislocation is so far-reaching that more thoroughgoing measures are called for, such as the Marshall Plan and the British loan after the Second World War. D. E. Moggridge believes that the dislocation was so deep-seated in Nineteen Twenty-Nine through Nineteen Thirty-One that no rescue loans from France and the United States to Austria, Germany, and England would have served to halt the spiraling collapse of currencies. The question is whether the shocks to the system-overproduction in primary products, French insistence on collecting reparations from Germany, U.S. demands for payment of war debts, overvaluation of the pound and undervaluation of the French franc, the halting of foreign lending by New York, the stock market crash, and the like-were so great that they would overwhelm any set of defenses; or whether, in the absence of some country willing and able to act as a stabilizer, any random shock to the system above some minimum level could set the unstable system off toward depression.

My contention is that the difficulty lay in considerable latent instability in the system and the absence of a stabilizer. Before the First World War, Britain stabilized the world by the discharge of the functions listed, more or less, and with the enormous help of gold standard mythology, which internalized both stable exchange rates and coordinated macroeconomic policies. There were occasions when Britain was either not involved or stood aside, as in Eighteen Seventy-Three when Central Europe and the United States shared a long depression. In Eighteen Ninety, after five years of accelerated foreign lending, the London capital market suddenly stopped. The system was saved, after depression lasting from Eighteen Ninety to Eighteen Ninety-Five, by a deus ex machina in the form of a substantial flow of gold from the Rand mines of the Transvaal, discovered in Eighteen Eighty-Six. In Nineteen Twenty-Nine, Nineteen Thirty, and Nineteen Thirty-One Britain could not act as a stabilizer, and the United States would not. When

Two. See his "Policy in the Crises of Nineteen Twenty and Nineteen Twenty-Nine." Haberler agrees with the position taken here, that the aftermaths of the First and Second World Wars called for different therapies because of differences in the extent of physical, economic, and political devastation and dislocation. See his "Die Weltwirtschaft und das internationale Währungssystem in der Zeit zwischen den beiden Weltkriegen," pages two hundred eighty-eight to two hundred eighty-nine. It may be remarked, however, that some years ago Haberler sided with those such as Roy Harrod, Friederich Lutz, Jacob Viner, and Senator Joseph Ball who opposed the notion of "dollar shortage," and in some instances the Marshall Plan, maintaining that stability and growth could be reestablished in Europe right after the war if countries would "halt the inflation and adjust the exchange rate." See the discussion in my Dollar Shortage, Nineteen Fifty, pages two to six.

For a largely political view that the two postwar eras are of the same piece, together with dissents, see Charles S. Maier, "The Two Postwar Eras and the Conditions for Stability in Twentieth-Century Europe," Nineteen Eighty-One, with comments by Stephen A. Schuker and me, and a reply by Maier.

Three. See my Manias, Panics, and Crashes, page two hundred eleven.

Four. See my "International Propagation of Financial Crises."

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.