An Economic Analysis of the Great Depression: Lessons for Today

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An Economic Analysis of the Great Depression
Lessons for Today

• Council for Economic Education
• March 21, 2009
• Mark C. Schug, Ph.D.
• University of Wisconsin-Milwaukee

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Whatdunnit? The Great Depression Mystery

• Focus Understanding
• Economics in U.S. History
• Lesson 30

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Whatdunnit?

• In the 1920s, jobs were plentiful and the economy
  was growing and the standard of living was
  rising.
• Between 1920 and 1929 homeownership doubled.
• Most home-owning families enjoyed amenities such
  as electric lights and flush toilets.
• 60 of all households had cars, up from 26.
• More teenagers were attending high school.

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Whatdunnit?

• By 1933
• One fourth of the labor forces was unemployed.
• Families were losing their homes and many were
  going hungry.
• Adolescents who should be in school were riding
  around the country in freight cars, looking for
  jobs.

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Whatdunit?

• What happened?
• The United states possessed the same productive
  resources in the 1930s as it had in the 1920s.
• Great factories and productive machinery were
  still present.
• Workers had the same skills and were willing to
  work just as hard.
• How could life have become so miserable for so
  many in such a short period of time?

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1920s

• Prosperity of the 1920s was based largely on
  purchases of homes and cars.
• Toward the end of the decade sales began to
  decline.

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End of the 1920s

• Machinery workers stand.
• Car sales people stand.
• Auto workers stand.
• Steel workers stand.
• Construction workers stand.
• Furniture sellers stand.
• Furniture workers stand.
• Clothing sellers stand.
• Restaurant workers stand.
• Grocery workers stand.

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1929

• Normally, people start buying again as
  automobiles wear out and incomes improve.

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Expansion Begins Again

• Machinery workers sit.
• Car sales people sit.
• Auto workers sit.
• Steel workers sit.
• Construction workers sit.
• Furniture sellers sit.
• Furniture workers sit.
• Clothing sellers sit.
• Restaurant and grocery workers sit.
• Grocery workers sit.

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What Are the Alleged Causes of the Great
Depression?

• The Stock Market Crash of October 29, 1929.
• Excessive borrowing to purchase stocks and
  consumer goods.
• Overproduction of goods and services
• High tariffs which prevented imports and hurt
  exports.
• Low farm prices and low wages, leading to an
  uneven distribution of income.

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Why did a mild recession in 1929 become the Great
Depression of the 1930s? A Hint

• Its mainly about money, banks, and the Federal
  Reserve System

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How is Money Created?

• Banks are not just businesses.

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Hint Banks Create Money100 Reserves
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Hint Banks Create MoneyBank 1 10 Reserves
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Hint Banks Create MoneyBank 2 10 Reserves
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The Fed

• The Federal Reserve System was created in 1913.
• The Fed has 4 parts
• Board of Governors (Washington D.C.)
• Federal Open Market Committee (FOMC)
• Reserve Banks (12 members)
• Member Banks

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Conducting Monetary Policy

• Inflation Enemy Number 1
• The Federal Reserve System has 3 tools to
  control inflation
• 1. Sets reserve requirements for banks.
• Raise reserve requirement reduce money supply
• Lower reserve requirement increase money supply

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Conducting Monetary Policy

• 2. Manages the Federal Open Market Committee
  (FOMC).
• The FOMC sets a target rate for the Federal Funds
  rate. This is the rate for loans made from bank
  to bank.
• This is almost always what the media is referring
  to when it says the Federal Reserve "changing
  interest rates".
• To increase the money supply, the Fed instructs
  the Open Market Desk at the New York Fed to buy
  bonds to try and hit the target rate.
• To decrease the money supply, the Fed instructs
  the Open Market Desk at the New York Fed to sell
  bonds.

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Conducting Monetary Policy

• 3. Sets the discount rate for members who borrow
  money from the Fed.
• Banks can borrow funds to keep up their required
  reserves is by taking a loan from the Fed Reserve
  at the discount window.
• The discount rate is usually higher than the
  federal funds rate.
• Raise discount rate reduce money supply
• Lower discount rate increase money supply

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Visual 30.2 Number of U.S. Banks Closing
Temporarily or Permanently, 1920-1933
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Visual 30.3 Money in Circulation
Currency plus bank deposits, in billions of
dollars.
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Why Did the Fed Fail to Act?

• The Board of Governors believed that many banks
  were unsound.
• They wished to protect the value of the dollar by
  keeping interest rates high.
• They wished to protect the nation against
  inflation which they thought was the main problem.

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We Did It.
In 2002, at Milton Friedmans 90th birthday Ben
Bernanke, then Federal Reserve Board Governor,
said I would like to say to Milton and Anna
Regarding the Great Depression, you were right,
we did it. Were very sorry. But thanks to you,
we wont do it again.
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The Crash of 08
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After 24 Consecutive Quarters of Growth
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The Cliff

• And then we went off the cliff.

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House Price Change
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Default Rate
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Foreclosure Rate
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Doubling of Household Debt as a Share of Income
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Consumption
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Causes of the Crash of 08?

• The likely suspects
• The erosion of government regulations of
  conventional lending standards.
• The Feds manipulation of interest rates during
  2002-2006.

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Causes of the Crash of 08?

• An SEC Rule change adopted in April 2004 led to
  highly leveraged lending practices by investment
  banks and their quick demise when default rates
  increased.
• Doubling of the Debt/Income Ratio of Households
  since the mid-1980s.

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Is It 1929 All Over Again?

• Primary causes of the Great Depression were
• Poor monetary policy
• Reduced money supply
• High interest rates
• Failure of Fed to act
• Poor fiscal Policy
• Tax increase to balance the budget
• Increasing protectionism
• Smoot-Hawley tariff

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Banks Are Not Lending

• Today, the problem is not liquidity per se.
• Many banks are holding Mortgage Backed Securities
  (MBS) and other bad paper.
• Who do you trust?

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So far

• Actions taken so far have been mainly aimed at
  increasing liquidity and spending rather than
  getting rid of bad assets.

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What are the Characteristics of Money?

• Medium of exchange
• Standard of value
• Store of value

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What is Money?

• M1
• Currency
• Checking accounts (63)
• M2 add in
• Savings accounts
• CDs
• Money market accounts

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Jobs of the Fed

• Services to Banks
• Check clearing
• Loans to member banks
• Services to Government
• Federal checkbook
• Federal deposits
• Supervise members banks

• Conduct monetary policy
• Managing the nations money supply.

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Auction

• Distribute 10 dollars in envelops to the class.
  Ask them to count the money but do not stress
  the amount they have.
• Auction off one or two items (T-shirts?),
  recording the prices. Figure the average price.
• Distribute 20 dollars to the class.
• Auction off one or two more items, recording the
  prices. Figure the average price.
• Explain the price change according to the amount
  of money in circulation.

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Activity 30.3 What Would You Have Done?

• 1. The world financial system that emerged after
  World War I was based upon the gold standard. The
  United States and Great Britain guaranteed that
  they would exchange their currencies for gold at
  a fixed rate (20.67) for an ounce of gold.
• Other major countries agreed to exchange their
  currencies for gold, dollars or pounds.
• In 1927, several countries, most notably Germany
  and Austria, experienced serious bank runs. To
  stabilize their currencies, they exchanged their
  dollars and pounds for gold. The United States
  experienced a serious loss of gold
• To encourage foreign investors to buy American
  investments, the Federal Reserve Banks raised
  interest rates.
• If you were an American business owner planning
  to build a new factory or buy new equipment, what
  would you have done after interest rates were
  increased?

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Activity 30.3 What Would You Have Done?

• 2. The Federal Reserve lowered interest rates
  after a time, but in 1930 and 1931, when the
  American economy had already taken a downturn,
  more bank runs occurred in many countries, and
  again gold flowed out of the United States.
• To keep gold in the United States, the Federal
  Reserve Banks again raised interest rates.
• What was the result?

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Activity 30.3 What Would You Have Done?

• 3. Now imagine that you are an American citizen
  with a bank account.
• You read the newspapers. You see that banks are
  collapsing in other countries and that the rate
  of bank failures in the United States has risen.
• What might you do?

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Activity 30.3 What Would You Have Done?

• 4. In 1932 Congress creates the Reconstruction
  Finance Corporation (RFC), which lends money to
  businesses that are in trouble, including banks.
• The law requires that the names of banks
  receiving loans from the RFC must be published.
• You read in the newspaper that the bank in which
  your money is deposited is receiving help from
  the RFC.
• What are you likely to do?

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Overview

• Overview of Focus Understanding Economics in
  U.S. History
• Demonstration of Lesson 30 Causes of the Great
  Depression
• Implications for today

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Todays Stock Market Report

• Paper stocks were stationary.
• Fluorescent tubing dimmed in light trading.
• Knives were up sharply.
• Elevators rose, while escalators continued their
  slow decline.
• Mining equipment hit rock bottom.
• Diapers remain unchanged.

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Todays Stock Market Report

• Coca Cola fizzled.
• Caterpillar stock inched up a bit.
• Balloon prices were inflated.
• Scott Tissue touched a new bottom.
• And batteries exploded in an attempt to recharge
  the market...

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Table of Contents

• Unit 1 Three World Meet
• Unit 2 Colonization and Settlement
• Unit 3 Revolution and the New Nation
• Unit 4 Expansion and Reform
• Unit 5 Civil War and Reconstruction

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Table of Contents

• Unit 6 The Development of the Industrial United
  States
• Unit 7 The Emergence of Modern America
• Unit 8 The Great Depression and World War II
• Unit 9 Postwar United States
• Unit 10 Contemporary United States

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Federal Reserve Banks

• New York
• Boston
• Philadelphia
• Richmond
• Atlanta
• Cleveland

• Minneapolis
• Chicago
• St. Louis
• Kansas City
• Dallas
• San Francisco

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Job Number One for the FED

• Conduct monetary policy
• Managing the nations money supply.