The underlying proposition here, advanced generally by present day fed economists, the monetarists (led by Dr. Milton Friedman), and the popular media, is that the depression was caused by failure of the Monetary Authorities (the Fed) to provide sufficient liquidity in the form of money supply.
The first, perhaps most important point made by the author, Frank Shostak is that this is just plain wrong on the record--it's another one of those self serving propositions that when said often enough, is accepted as fact even though a cursory examination of the real data demonstrates that it is a fraud.
Many years ago, when I was in college, the cause of the Great Depression was still a contentious issue--the lead, and best economics professor at the University was an accused card carrying Communist in the 30's because he believed that the depression was the necessary result of internal faults in the free enterprise system.
I took Economic Cycles from a visiting Harvard economics professor who parroted the same lines. However one class session was conducted by an individual who had been on the Fed staff in the 30's. He said the modern monetarist line is nonesense--"What do people think we were doing back then anyway? Did they think we were asleep? Did they think we were not reading the data?"
As a committed believer in the free enterprise system, I spent a lot of time researching to develop my own political economic understanding of what really happened.
This article only refutes the popular legend. The issue however is what in fact is the cause of the economic condition that led to the great depression and is leading to the greater depression today. The answer is clear--the data is readily available; and the analysis is simple.
The depression of the 1930's was caused by the excessive liquidity created by the fed in the 1920's. As the author points out excess liquidity resulting from injection of bank reserves gets into the economy through the debt process. In the 1920's, the principal engine was stock market margin debt--everyone was in the stock market, creating a bubble with margin debt. When it became clear that underlying values (earnings) did not support prices, prices collapsed leaving the debt to be repaid from other sources.
How does debt result in deflation? Debtors of any class, government, business, or individual, have limited liquidity. That is why the debt (borrowed liquidity) was needed in the first place. Debtor liqudity may come from tax revenues, business earnings, or monthly earned income--but it is limited. The portion of available periodic liquidity commited to payments on debt curtails liquidity for other purposes--instead of buying a new car this month, the debtor makes a payment on his new house.
There is no reliable data on what the real limits are--how much of current income can be paid on residential mortgage debt, or credit cards or whatever without creating a deflationary economic environment. Historically, mortgage lenders had rules of thumb however we have now exceeded those limits significantly.
Point is that in the macro economy, you reach a point where aggregate debt service by government, business and individuals consumes so much of periodic liquidity that the entity involved can no longer afford to make additional purchase commitments. Buyers disappear.
In the business environment, pricing power disappears and prices begin to drop; so do profits. Tax revenues drop because they are based on economic activity (income and spending). Jobs disappear; or compensation on continuing employement drops.
Deflation becomes imbedded--because new debt is incurred, not to buy additional assets but instead to make payments on existing debt.
Mortgage debt and the housing market? What has happened is that the users of residential real estate no long have enough current liquidity to pay for the right to use the asset at current market prices which have been inflated by excess available credit to marginally qualified buyers. There are other factors at work in the housing market--property taxes and insurance, both based on the inflated bubble price and taxes raised to support expansionary economy levels of government activity that no longer are required. So we have skipped payments; interest only months; rising default rates and mortgage foreclosures. Monthly payments are made with additional credit card debt. A general decline in market prices is probably not too far ahead.
This is a fair summary of the current economic environment. As Shostak points out, the historical experience is that additional lending has been counterproductive (in the US in the 30's; and in Japan). Reason why is of course set out above.
How do we get out of this mess? Well you have to see how people get additional liquidity other than through the debt process. You have to expect new jobs to be created and employment to go up; compensation has to go up; business income has to go; tax receipts must go up. If anybody sees any positive signs on any of these items, or if anybody can see any reason why any of these things might happen, they should post immediately. I don't.
Worst Stock Market Crashes
The 10 worst stock market crashes in U.S. History.
1932 - 1933 Stock Market Crash
The 10th worst stock market crash in U.S. History.
To find out 10th worst market crash, I had to dig back in the DJIA records all the way back to the 1930s. This crash barely beat out the 1987 stock market crash (loss of 36.1%) - a crash that most of us are more familiar with.
Date Started: 9/7/1932
Date Ended: 2/27/1933
Total Days: 173
Starting DJIA: 79.93
Ending DJIA: 50.16
Total Loss: -37.2%
==================================
1916 - 1917 Stock Market Crash
The 9th worst stock market crash in U.S. History.
If the 1930s sounded like a long time ago, well to find the 9th worst market crash, I had to go back to the WWI era.
It's difficult to break even after a 40% loss. On a $1,000 investment, your portfolio went down to $600. To get back to $1,000, it would have to go up 66.7%!
Date Started: 11/21/1916
Date Ended: 12/19/1917
Total Days: 393 Starting DJIA: 110.15
Ending DJIA: 65.95
Total Loss: -40.1%
====================
1939 to 1942 Stock Market Crash
The 8th worst stock market crash in U.S. History.
Although this stock market crash only took the 8th spot, it is the longest one on our list, lasting nearly 3 years! With WWII and the attack on Pearl Harbor, the markets had a very tough time.
Date Started: 9/12/1939
Date Ended: 4/28/1942
Total Days: 959
Starting DJIA: 155.92
Ending DJIA: 92.92
Total Loss: -40.4%
==============================
1973 - 1974 Stock Market Crash
The 7th worst stock market crash in U.S. History.
Another long market crash - one that many people still remember (think Vietnam and the Watergate scandal). This crash lasted for 694 days before bottoming out.
Date Started: 1/11/1973
Date Ended: 12/06/1974
Total Days: 694
Starting DJIA: 1051.70
Ending DJIA: 577.60
Total Loss: -45.1%
================================
1901 - 1903 Stock Market Crash
The 6th worst stock market crash in U.S. History.
This is the oldest crash to make the list
Date Started: 6/17/1901
Date Ended: 11/9/1903
Total Days: 875
Starting DJIA: 57.33
Ending DJIA: 30.88
Total Loss: -46.1%
==================================
1919 - 1921 Stock Market Crash
The 5th worst stock market crash in U.S. History.
This crash followed a post war boom (Stock prices rose 51%). After the crash bottomed out in August of 1921, this decade saw tremendous growth in the stock market and the economy (often called the roaring twenties).
Date Started: 11/3/1919
Date Ended: 8/24/1921
Total Days: 660
Starting DJIA: 119.62
Ending DJIA: 63.9
Total Loss: -46.6%
========================================
1929 Stock Market Crash
The 4th worst stock market crash in U.S. History.
Although this is the shortest market crash observed, it was a deadly one. Investors saw almost half their money disappear in just two months. This crash kicked off what we now know as the "Great Depression."
Date Started: 9/3/1929
Date Ended: 11/13/1929
Total Days: 71
Starting DJIA: 381.17
Ending DJIA: 198.69
Total Loss: -47.9%
=================================
1906 - 1907 Stock Market Crash
The 3rd worst stock market crash in U.S. History.
This crash was called the "Panic of 1907." The U.S. Treasury department bought 36 million dollars worth of government bonds to offset the decline (and remember, $36 million translates to a much bigger number in today's dollars).
Date Started: 1/19/1906
Date Ended: 11/15/1907
Total Days: 665
Starting DJIA: 75.45
Ending DJIA: 38.83
Total Loss: -48.5%
====================================
1937 - 1938 Stock Market Crash
The 2nd worst stock market crash in U.S. History.
Just when investors thought the market was finally good again, following a recovery of almost half of the great depression losses, the market plunged again due to war scare and Wall street scandals.
Date Started: 3/10/1937
Date Ended: 3/31/1938
Total Days: 386
Starting DJIA: 194.40
Ending DJIA: 98.95
Total Loss: -49.1%
============================
Worst Market Crash Ever (1930 to 1932)
The worst stock market crash ever in U.S. History.
This is the grand daddy of them all. Investors lost 86% of their money over this 813 day beast. This market crash combined with the 1929 crash, makes up the great depression.
If you had $1000 on 9/3/1929 (beginning of the 4th worst crash, it would have gone down to a whopping $108.14 by July 8th, 1932 (end of the worst crash) or an 89.2% loss. To recover from a loss like that, you would have to watch your portfolio go up 825%! The full recovery didn't take place until 1954, 22 years later!
Date Started: 4/17/1930
Date Ended: 7/8/1932
Total Days: 813
Starting DJIA: 294.07
Ending DJIA: 41.22
Total Loss: -86.0%
========================================
http://mutualfunds.about.com/library/weekly/aa102802k.htm
you reach a point where aggregate debt service by government, business and individuals consumes so much of periodic liquidity that the entity involved can no longer afford to make additional purchase commitments. Buyers disappear.
Not only this but the bubble and re-bubble going on by the FED cause dollar devaluation and with more bucks being lent out, lenders will want higher interest rates when they know they will be getting back dollars that buy less because inflation has set in. That $1 hamburger & fries is now $6.75. This added activity leaves the economy no where to turn.
Debtors of any class, government, business, or individual, have limited liquidity. That is why the debt (borrowed liquidity) was needed in the first place. Debtor liqudity may come from tax revenues, business earnings, or monthly earned income--but it is limited. First off, every thing in the universe is limited, however unimaginable those limits might be. Second, government revenues, business earnings, et. al. are indeed limited when speaking in context of the here and now. We borrow-- for a car, a house, whatever-- and the banks lend us money on the carefully considered assumption that we will be worth more tomorrow,or next year, than we are today. Businesses and governments borrow and are loaned money, via stocks and bonds, on basically the same assumption.
There is no reliable data on what the real limits are--how much of current income can be paid on residential mortgage debt, or credit cards or whatever without creating a deflationary economic environment. Speaking in the vast macro-economic sense, yes that is true; but, in reference to individual, business and, yes, even government "debtor liquidity" there are, of course, available,.e.g. Moody's, Morningstar, etc.
Point is that in the macro economy, you reach a point where aggregate debt service by government, business and individuals consumes so much of periodic liquidity that the entity involved can no longer afford to make additional purchase commitments... Again, this is based on the assumption of a static condition: That he who has $5 today, will have $5 tomorrow and $5 next week, maybe less but never than a penny or two more.
In the business environment, pricing power disappears and prices begin to drop; so do profits. True enough, to a point. Prices drop simply because they must in order to the company to maintain it's place in the market- but prices can only drop to a point. When profit derived from these lower, unsubstantiated price cuts (Spacely's Sprockets cut prices not because they found a better,cheaper way to make sprockets but simply because they had to) reach a certain point the company simply stops making the products. Only the federal government can continue to make something, be it goods or services, at a loss.
Deflation becomes imbedded--because new debt is incurred, not to buy additional assets but instead to make payments on existing debt. Which can not be lowered-either by fiat or allowed to drift downward. The cause of this is, in a word: contracts. No matter if it is in re: a union pay agreement, a purchasing order for a business, or a 30 year mortgage.
So we have skipped payments; interest only months; rising default rates and mortgage foreclosures. Monthly payments are made with additional credit card debt. A general decline in market prices is probably not too far ahead. This is because, as the old saying goes, "water seeks its own level". If, for whatever reason, real estate/housing prices are out of wack with reality the Free Market, if allowed to work, will bring them down (or raise them up) to their true level.
This is a fair summary of the current economic environment. As Shostak points out, the historical experience is that additional lending has been counterproductive No doubt, no doubt, but then you come to the sticky question of "additional lending", according to whom? by whose standards? By whose defination?" etc., etc., but that, as they say, is for another day.
How do we get out of this mess? Well you have to see how people get additional liquidity other than through the debt process. You have to expect new jobs to be created and employment to go up; compensation has to go up; business income has to go; tax receipts must go up. If anybody sees any positive signs on any of these items, or if anybody can see any reason why any of these things might happen, they should post immediately. I don't. IMHO, it's call "politics". Elections are not too far off and it is to the benefit of not a few to make sure the kettle stays hot and well stirred
Richard W.