II. THE BIG PICTURE

The Great Depression was an international catastrophe. The “advanced countries” of the world, sixteen countries in Western Europe and North America, taking 1929 as a base of 100, saw their real national output drop by 17 percent. Prices and trade volumes each fell by about a quarter. At the Depression’s trough in 1932, nearly a third of all workers were unemployed. The real downturn in output in the United States was especially severe—26 percent between 1929 and 1933—although it started from a higher base. While there is still much to be understood about the Depression, it was the product of three different but related forces.⁸

The first was the deflationary momentum created by the major-country^* push for gold-based currencies at prewar parities. The downward price pressure was generated simply because market prices in almost all economies had floated well above the target parities.

The second was the global agricultural glut of the 1930s. As we saw in Part 3, the Hoover administration’s farm programs were overwhelmed by splendid bumper crops at a time of global excess production. But the problems were even worse in most other agrarian countries, which were typically far more dependent on agriculture.

And the third was the collapse in world trade, which was the product of, but additive to, the effects of the first two.

To take them in order: As we have seen, a clear majority of highly experienced economists, finance ministers, investment bankers, and financial academics favored a return of the pound, the mark, and the franc to their traditional relationship with gold. That was not crazy, as it is sometimes made to appear. Throughout history, rulers had destroyed their realms by debasing their money. (The word sincere is derived from the Latin for “without wax,” echoing the times Roman emperors shaved their coins and filled them out with wax.) The admirable Benjamin Strong, with his superior grasp of central banking, was as committed as any to maintaining the gold standard at its traditional parity. Russell Leffingwell of J.P. Morgan had put the reasoning succinctly: if you borrow money, you should pay it back with coin of the same value.

It was particularly easy to reach an anti-reflation consensus, for it was less than a decade since Weimar Germany had provided an object lesson for the ages. The German inflation, in fact, had been started intentionally, with considerable agreement among the political parties. For the first couple of years it was quite successful. Germany’s exports were high, and its unemployment rate was the lowest in Europe. Then some ineffable moment passed, and it was out of control.

Among the wise men of finance, devaluation was only slightly less foolish than an outright repudiation. A sound currency was one that was constant. Economic growth was always desirable, but not at all costs. If public deficits were mounting, and traders getting skittish, you didn’t devalue. Responsible ministers pulled in their horns, reined in the spending, and began to steer under a better star. Strong made his position crystal clear in a much-quoted letter memorializing a meeting with Montagu Norman, his British counterpart:

Mr. Norman’s feelings, which in fact, are shared by me, indicated that the alternative—failure of resumption of gold payment—being a confession by the British Government that it would impossible to resume, would be followed by a long period of unsettled conditions too serious really to contemplate. It would mean violent fluctuations in the exchanges, with probably progressive deterioration of the values of foreign currencies vis-à-vis the dollar; it would provide an incentive to all of those who were advancing novel ideas for nostrums and expedients other than the gold standard to sell their wares; and incentives for governments at times to undertake various kinds of paper money expedients and inflation.⁹

Nineteen-thirty may have been the year of transition to global deflation. Great Britain was struggling to push down its export prices to competitive levels, but with little effect. Heinrich Brüning had taken over as the Reich chancellor to staunch the hemorrhaging of the federal budget and to build back the country’s gold reserves. The French monetary law of 1928 had locked in both the undervalued gold price of the franc and the ban against counting foreign exchange in the monetary base. It took a while before the financial community understood what a powerful deflationary engine that created. The undervaluation of the franc naturally drew foreign exchange to France, which to the French looked like an engine of inflation. So the French began to redeem their foreign exchange holdings for gold, and sterilized the gold. The Bank of France managers, Moreau, Rist, and Quesnay, knew exactly what they were doing. In 1927, after meeting with a senior official of the Bank of England, Moreau wrote in his diary that the English official did not conceal the “distress or anxieties caused to the Bank of England by the brutal revelation of the power of the Bank of France upon the London market.”¹⁰

For its part, the Federal Reserve mostly sat on its hands. To the majority of the governors, the downturn looked like the inevitable result of an out-of-control liquidity binge that had also caused a dangerous stock market bubble. Luminaries like Oliver Sprague preached that the world economies would right themselves once world prices had fallen to the level of “industrial equilibrium.” A respected and long-serving Fed governor, Charles Hamlin, told a group of New England bankers that “the Federal Reserve was designed to break up the vicious circle under which a speculative orgy accompanied every forward step of industry,” and claimed that the present downturn was a sign of the Fed’s success. Passivity reigned.¹¹

The world agricultural crisis was a second major contributor. Charles Kindleberger suggested as much in his 1973 World in Depression, but it did not stimulate much in the way of full-blown research. In a wide-reaching 2001 article, Jakob Madsen argued that the deflationary pressure generated by the mania for gold still did not fully account for the extraordinary drop in world income, and he indicted the Depression-era worldwide agricultural glut as the missing villain of the piece. The United States clearly suffered from a farming price collapse, but it was far worse in the rest of the world. Although the United States was one of the world’s largest agricultural and raw material exporters, those industries were not as important in the American economy as they were in most other industrialized countries. The dominance of Americans in Depression studies may be the reason that the agricultural crisis is not generally highlighted as a primary cause of the downturn.¹²

American farmers did suffer mightily in the Depression. Frederick Mills, a star NBER researcher in the 1930s and 1940s, compiled the changes in farm production and revenues (see Figure 6.1).

Farmers’ terms of trade worsened at the same time. Manufacturers were suffering, too, in 1932, but they had much more control over their production. Measured in February of 1933, Mills calculated that farmers’ pricing power had deteriorated about a third more than the deterioration in the rest of the economy.¹³

Madsen points out that in the sixteen advanced countries in his sample, 31 percent more workers were employed in agriculture than in manufacturing, and they accounted for more than a third of the entire workforce. Removing the United States, the United Kingdom, and Germany from the sample, 54 percent more workers were employed in agriculture than in manufacturing, and agriculture employed 46 percent of the workforce.¹⁴

Worldwide, farmers had much the same wartime experience as those in the United States. Incomes leaped during the war, so farmers responded by expanding aggressively, only to find themselves in a vise when the war ended and European supply chains rebuilt themselves. Giovanni Federico (see Part 2) has made a convincing price-based case that American farmers, after a couple of tough years, stabilized themselves and made reasonable livings in the last half of the twenties. American farmers, however, would have made much greater use of technology, such as Ford tractors, to expand their production and reduce required workers. Few other countries, except possibly Canada, would have made such adjustments. Still, as the Mills data show, American farmers were very hard hit after 1930.¹⁵

The sheer size of the agricultural sector ensures that any large-scale shifts in income or production, especially ones that are sudden, are likely to have profound effects on the rest of the economy. And they did so in the 1930s. Falling farm incomes shifted both income and investment away from the farm sectors. There were radical drops in the value of farmland—American farmland values fell 40 percent from 1928 to 1933, with the greater part of the fall before the stock market crash—suggesting that the industry was following an internal logic of its own. Such steep losses reverberated through bank balance sheets, triggering the doleful consequences of a Fisherian debt deflation—rising real debt loads and real interest costs. Waves of farmer bankruptcies wreaked havoc on rural banks. Most farm commodities were traded internationally, so the glut triggered round after round of cut-throat pricing. The thirties were therefore a heyday of tariffs and quotas, which channeled income away from farmers to governments, or outright subsidies, which reversed the flow. Perversely, many American tariffs were denominated in fixed dollar amounts, so the relative burden of the tariffs increased as prices fell. Finally, since farmers were generally poorer than industrial and services workers, they spent more of their incomes, so by itself, the shift of farm income to other sectors reduced national spending.¹⁶

Madsen included a number of simulations of the GDP and other consequences of the observed developments in his sample countries from 1929 to 1932. Because of the very small number of data points (sixteen countries over four years), the modeling required formidable statistical manipulations. Suffice it to say that the effects he reports are large but are consistent with a commonsense assessment of the vast damage inflicted on what was then the world’s largest industry.

The third global force conducing toward Depression was the collapse in world trade. Between 1929 and 1933, the gold value of world trade shrank by 65 percent, and trade volume fell by a quarter. The decline was driven both by the general fall in national incomes and by an explosion in protectionism. In principle, import substitution by a protectionist country should increase the protectionist’s income. In practice, protectionist moves, especially from a major country, generate offsetting retaliations that result in a standoff in relative trading positions, but at a lower level of output—a lose-lose all around.¹⁷

The United States was a particular offender due to its powerful agricultural lobby. The Fordney-McCumber tariff of 1922 put up quite a high tariff wall, generally a 38.5 percent charge on the value of the dutiable import. Understandably, in the heat of the postwar struggles over reparations and war debt repayment, the tariff drew quite hostile receptions from American trading partners, and over time considerable retaliation.

The Smoot-Hawley tariff, passed in 1930, was a priority of Herbert Hoover in reaction to the agricultural glut. Hoover wanted a modest tariff limited to agricultural products, but lost a bidding war with the Congress that both expanded coverage and raised the levies. Protectionism, coming from the richest and most productive nation in history, again drew much criticism and adverse comment. The average Smoot-Hawley levies were about 20 percent, but were on top of the already high Fordney-McCumber levies.¹⁸

The British, after they had left the gold standard, passed two tariff laws—the Abnormal Importation Act (1931) and the Import Duties Act (1932) that imposed a tariff of just 10 percent levy on most traded goods. Shortly after that, the Treasury pegged the value of the pound at $3.40, a rate that went a long way toward solving the British productivity problems. Another Madsen paper, analyzing the trade patterns of seventeen advanced countries, found that the nominal value of trade fell by more than half between 1928 and 1932. But the profile of trade changed hardly at all. Countries traded with their normal counterparties and traded the same goods, just at lower volumes and lower prices.¹⁹

Although the efficiency losses of the trade collapse seem obvious, it is difficult to place a number on them. The drop in the measured value of trade wasn’t caused primarily by tariffs, since most of it can be accounted for by deflation and the real fall in national incomes. A complicating factor (see Part 3) is that a number of American products had fixed-dollar tariffs instead of a percentage of the import price. In a period of runaway deflation, the burden of fixed dollar tariffs was greatly magnified. Another wild card was introduced by nonmonetary trade barriers, such as the quotas that France imposed on more than a thousand products in 1931 and 1932.

Douglas Irwin and Jakob Madsen have each tried to allocate the impact of protectionism, using quite different methods. Working with an American data base, Irwin found that two-thirds of the decline in trade was due to falling national incomes, with the remaining third split 2:1 between the “debt deflation” effect of fixed-price tariffs and pure protectionism. Madsen, applying statistical models with his 17-country data base computed that falling world incomes accounted for 14 percent of the decline in trade volumes, while discretionary tariffs, deflation-induced tariff increases, and nontariff barriers accounted for further contractions of 8 percent, 5 percent, and 6 percent, respectively, for a volume drop of fully a third.²⁰

Barry Eichengreen and Douglas Irwin have shown a distinct pattern of trade policy management that related to a country’s adherence to the gold standard. Countries that left the gold standard early, like Great Britain and its sterling bloc, imposed far fewer trade restrictions than those that remained on gold. A country that had left the gold standard did not need to impose tariffs, because the pricing could be adjusted in the exchange rates. With no deflationary pressure weighing on their currency, they could reflate and boost their trade and national income, instead of imposing dead-weight trade barriers.²¹