Commerce21: Jonathan Catalán - Viewing Profile

The current recession has brought about renewed discussion on the origins of the business cycle, and invariably economists have looked at the Great Depression to provide a historical example. The fact that this recession is one of the deepest since the crash of 1929–32 has also catalyzed a number of comparisons between the two. Without a doubt, having an accurate understanding of how the 1929 recession came into being will be pivotal if there is ever to be any agreement between economists. On the other hand, the 2008 recession has already taken place, and so arguing the origins of the credit crunch has become largely superfluous. There is no doubt that in the long-run the explanation of the business cycle will be extremely important, but in the short-term it may be more valuable to discuss in what fashion an economy can recover from a recession. The Great Depression is also a classic case study for this topic, and disagreement amongst professionals continues in regards to explaining what brought about a recovery during the 1930s and why the recovery took so long. In many ways, the course of action of the Bush and Obama administrations have been very similar to, if not a mirror image of, the course of action taken by Presidents Herbert Hoover and Franklin Roosevelt. There are also key differences.

One of the major disputes revolves around the question of whether or not the Federal Reserve took action to provide liquidity to failing banks. In Free to Chose, Milton Friedman suggests that the decline in money stock between 1929 and 1933 represents the Federal Reserve’s inaction in the face of deflation.[1] Other economic historians have taken a similar stance. For example, in his book on Roosevelt’s New Deal, Burton Folsom writes, “In the early 1930s, the Fed dithered and let the runs on banks continue.”[2] Murray Rothbard suggests something radically different, in America’s Great Depression, offering statistics on the expansion of controlled reserves by part of the Federal Reserve. In fact, as early as the last week of October 1929 the Federal Reserve bolstered bank reserved by nearly $300 million, he claims and lowered the rediscount rate by 1½ percent by November. He goes a long way in explaining why there was a general decrease in the money supply: “…controlled reserves increased by $359 million (with government securities the overriding factor), while uncontrolled reserves fell by $381 million.[3] Regardless if the Federal Reserve did, in fact, attempt to inflate the credit supply as early as late 1929, the fact of the matter that there was a deflation in the money supply between 1929 and 1932 due to a decrease in uncontrolled reserves, which outstripped any attempts to increase the Federal Reserve’s efforts. The difference is that in the case of today’s recession, under Ben Bernanke the money supply has been growing at an accelerating pace.

Economist Jesús Huerta de Soto makes the argument that a recession can be temporarily avoided if the Central Bank creates money at an accelerating, or exponential, rate.[4] The ultimate conclusion to such a policy is still the inevitable reallocation of resources by the market, but only after a continued illusion of wealth—ultimately, such a policy will also lead to hyperinflation. Therefore, unless the Federal Reserve suddenly ends the expansion of credit, there is the chance that the illusion of a recovery will be created.

As already explained, there are key differences between the Federal Reserve’s responses to either financial crisis; there is a minor similarity between the Federal Reserve’s policy between 1933 and 1936 and Ben Bernanke’s current fiscal policy. It is generally accepted that in 1933 the United States economy had bottomed out. At that time, the Federal Reserve continued its inflationary policy by expanding the money supply. However, since the economy had bottomed out uncontrolled reserves were not decreasing at greater rates than controlled reserves, leading to a visible increase in the monetary base. Simultaneously, Roosevelt continued and accelerated Hoover’s public works projects, sparking what was known as the New Deal. Amongst the two, the latter has been at the forefront for explaining either why a recovery occurred at all after 1933, or why the recovery took so long to complete. To a large degree, the former has been all but ignored. However, the latter becomes more relevant when considering that in 1937 the economy suffered another downwards spike, which lasted for two years, largely undoing whatever recovery had taken place between 1933 and 1936 (although, this downturn was not as dramatic as the downturn of 1929–32).

The 1937 downturn, since then called Roosevelt’s Recession, has not been a major topic in any historical overview of the Great Depression. The majority of books which deal with Roosevelt focus on the New Deal between 1933 and 1936, with only a scant look at the events of 1937 and 1938. As it turns out, Roosevelt’s Recession of 1937 may be more relevant to the current financial situation in the United States than the Crash of 1929. This is because we may be headed in the same direction.

Although the 1937 recession is only a minor focal point, that is not to say that economists have not drawn their own conclusions in regards to the causes of this event. Keynesian economists, such as Paul Krugman and Jeff Madrick cite Roosevelt’s objective to balance the budget,[5] while Keynesians and Monetarists alike blame the Federal Reserves sudden tightening of the money supply.[6] Nevertheless, these opinions have drawn two inevitable conclusions: one, the government must (seemingly) perpetually provide public goods by spending more money than collected through tax receipts, and two, the Federal Reserve should not increase interest rates, or at least should better calculate when to finally allow an increase in interest rates. Now, the relationship between the period marked between 1933 and 1936 and the current financial situation in the United States should be clear. Currently, controlled reserves are rising at a rate at which despite any possible decreases in uncontrolled reserves the monetary base is growing exponentially. Furthermore, there is the risk that Obama will actively support the largest deficit spending programs in the fiscal history of the United States government. If the conclusions of the 1937 recession are that bringing these two policies to an end will only lead to another recession, the country currently runs a real risk of complete and utter collapse when the people lose faith in both their government and their currency. Therefore, the recession of 1937 merits a closer look and the pervasive mistakes made by Keynesian and Monetarist economists should be corrected.

Admittedly, of the two schools of thought, the Monetarists are probably closer to the truth. What they fail to realize is the impossibility of calculating when to end credit expansion. In two occasions during the Great Depression a sudden end to credit expansion ended in recession: 1929 and 1937. Furthermore, during other recessions, notably during that of 1921, increases in the reserve ratio requirement as set by the Federal Reserve did not end in a lengthened period of recovery. Instead, the 1921 downturn was one of the worst in the economic history of the nation, but one of the quickest.[7] It becomes obvious that the issue is not related to the sudden increase in interest rates by the Central Bank. And so, while the Monetarists remain half-right, an Austrian approach must be made to this era as to provide an accurate lesson to apply to the current recession, and most importantly to correct the dangerous and false lessons as extracted by the Keynesian and Monetarist schools of thought.

Austrian economists are fighting an uphill battle to end the monopoly on money commanded by the Federal Reserve and ever-growing government fiscal interventionism. Their most powerful case, the 1937 recession, has largely been ignored. Most publications have avoided the topic altogether, focusing instead on the New Deal. The only Austrian explanations are largely as a result of the work of Benjamin Anderson, in Economics and the Public Welfare, and Vedder and Gallaway in Out of Work. A dedicated Austrian explanation of 1937 is in order, as it would severely undermine any pro-centralization arguments provided by rival schools of thought.

As with any historical study of a recession, explaining the downturn of 1937 requires a close examination of the fiscal policies which preceded it. In this case, in order to show what made the crash of 1937 possible and to disprove Keynesian and Monetarist theories, we must put the events of 1933 through 1936 under a microscope.