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The US recession and the myth of 1937
Gerard Jackson
The current situation has many people referring back to the Great Depression, particularly the 1937 downturn. As usual they are drawing the wrong conclusions. The lesson that so many have failed to grasp is that the Great Depression is a tragic testimony as to what can happen to a country when governments defy economic laws.
Let us begin with Roosevelt's 1935 Wagner Act. This had been passed in reaction to the Supreme Court's decision to declare the economically destructive National Recovery Act unconstitutional. However, constitutional lawyers advised business that the Wagner Act was also unconstitutional. In view of this advice most big businesses ignored the Act and used free market prices to increase output and employment. As a result unemployment fell from 9.1 million in 1935 to 6.4 million in 1937, iron and steel production rose to more than 100 per cent the 1933-34 level and car production more than doubled the 1933 level.
Production trends were similar for other products. Even so, it was still a weak recovery and aggregate wages as a per centage of national income exceeded 70 per cent while profits were only about 15 per cent. This meant an overall 10 per cent increase in labour costs would be enough to slash profits by about 50 per cent. Clearly, any wage-push would quickly derail the recovery.
In 1937 tragedy struck. The Supreme Court in a series of 5 to 4 decisions reversed its reasoning in the NRA case and upheld the Wagner Act as constitutional. The Act meant that business was now forced by law to 'negotiate' with politically privileged unions. Market wage rates would no longer be tolerated. The court's decision was immediately followed by an immense outbreak in union activity (some of it quite violent) resulting in a rapid rise in labour costs. The result was as predictable as it was tragic — unemployment leapt from 6.4 million in 1937 to 9.8 million in 1938. (This is a fact that lefty historians and economists like Christine Romer, Krugman and Stiglitz ignore.)
Naturally, alternative explanations for the tragedy were sought. The most popular one — and it still is — was based on reserve requirements. Between 1936 and 1937 the Fed reduced reserves from $3 billion to about $927 million. This, it was argued, cut the supply of funds to business and precipitated the crash. However, this view overlooks the fact that the Fed was eliminating excess reserves. In short, idle reserves. If they were otherwise, their elimination would have affected interest rates to the extent that business would have been restricted (probably severely) in its use of cash and credit.
The monetary figures support this argument. In 1929 money supply stood at $46.42 billion. By 1933 it had dropped to $32.2 after which it continued to increase, reaching $45.68 billion in 1937. A marginal decrease brought it down to $45.51 billion in 1938, it then rapidly expanded rising to $55.2 billion in 19402. Instead of a monetary we do find is that:
• interest rates remained absurdly low, e.g., the rate on commercial paper did not rise above 1 per cent;
• there was a dramatic rise in commercial loans from $2 billion to $6.966 billion — and that was just the federal reserve system;
• the reduction of excess reserves was accompanied by a great and welcome increase in the issue of new securities.
In the beginning of 1935 issues of new securities were more than 85 per cent down on the 1923 level; by the second quarter of 1937 they had reached 50 per cent of the 1923 level. It was union activity that destroyed this healthy job-creating trend. Clearly, the ‘reserve requirement theory’ does not hold a drop of water.
This only leaves the deficit and gold sterilisation explanations to be dealt with. The was argument that the virtual disappearance of the government’s deficit caused the crash doesn't hold up. Total federal expenditure for the whole of 1937 and the first four months of 1938 was $10,058,000,000 while revenue equalled $8,229,000,000. Even the cash income and outgo approach cannot rescue this explanation.
The nail needs to be rammed home on the so-called link between deficits and unemployment. In 1932 the deficit was $2.7 billion and unemployment was 23.6 per cent; in 1937 it was $2.8 billion and unemployment stood at 14.3 per cent. Unemployment averaged 18.6 per cent during the depression while deficits averaged 3.6 per cent of GNP. Though unemployment and deficits varied throughout this period, 'deficit theorists' should have realised that their proposition was not being supported by the economic facts.
The gold sterilisation approach fares no better than the other two. The argument that sterilisation cut the money supply and thus caused the economy to contract should be too silly for words. Sterilisation only prevented incoming gold from adding to excess reserves. As we have seen, these reserves were successfully reduced without affecting business activity. (From a gold standard-free trade point of view, however, the gold inflow should not have been sterilised.)
It was Roosevelt's anti-recovery industrial codes combined with destructive union activity that finally sent the American economy into a vicious tailspin. While leftists write of unions fighting to maintain wages they omit the salient fact that in 1938 real wages were 29 per cent higher than the 1929 rate. More importantly, productivity-adjusted wage rates exceeded the 1929 rate by 14 per cent. (See Richard K. Vedder and Lowell E. Gallaway's Out of Work, New York University Press, 1997, p. 103). The grey area in the chart below shows the difference between hourly wage rates and productivity.(Also see Minimum wages and capital accumulation: lefty economists fail again)
[The] NRA was not a revival measure. It was an anti-revival measure. . . Through the whole of the NRA period industrial production did not rise as high as it had been in July 1933, before the NRA came in. Following disappearance of NRA, after the Supreme Court decision in May 1935, there cam the first real recovery. We passed the July 1933 peak in the autumn of 1935, and then, with rapidly growing volume of production and with decreasing unemployment, had approximately two years of growing business activity. . . (Benjamin M. Anderson, Economics and the Public Welfare: A Financial and Economic History of the United States 1914-1946, LibertyPress, 1979, pp. 333-34).
Unfortunately Roosevelt finally got his way and in doing so aborted the recovery. Frederick C. Mills wrote:
During the ten months that followed the end of [Roosevelt's] code operations employment rose 7 per cent, and average hourly earnings remained constant. Over the entire period of recovery we have a pronounced advance in total wages paid, a considerable rise in man hours worked and a notable increase in hourly rates of pay. (Frederick C. Mills, Prices in Recession and Recovery, The National Bureau of Economic Research, Inc., New York, 1936, p. 325).
However, America was not alone in its economic folly. Under the 'Blum New Deal' France also followed the same route with the same tragic consequences. That, however, is a story for another day.
I know some readers will be wondering about the role taxation played in prolonging the recession. This is not as straightforward as it seems and leads us to the fallacy of 'excess savings'. It was argued that the depression was caused by a unprecedented level of corporate surpluses. Surpluses in 1928 were $2,400 million (after which they fell) against $4,908 million for 1916. It was these surpluses that allowed a great many firms to weather the financial crisis of 1920-213. The current monetary disorder is a graphic example of what can happen to firms when they have insufficient funds to withstand a financial crisis. (This subject requires a separate article in itself).
Having accepted the fallacy of excess savings Roosevelt implemented in 1936 a undistributed profits tax. He and his advisors believed that this tax would have the effect of stimulating demand. What it actually did was dissipate capital. It needs to be made clear that if wage rates had been allowed to clear the tax would not have prevented the hiring of labour. What it would have done is reduce the intensity of demand for labour in the long term by reducing the 'rate' of capital accumulation.
However, it must be borne in mind that Roosevelt's anti-recovery taxes and regulations had set in motion a severe process of capital consumption. In 1925 44 per cent of metal working machinery was more than 10 years old; by 1930 the figure had risen to 48 per cent; in 1935 it was 65 per cent, rising to 70 per cent in 1940. Only the advent of WW II reversed the process.
The myth that Roosevelt in anyway promoted economic recovery is just that — a myth. His ignorance and constant meddling gave the US its longest and deepest depression in its history. Unfortunately Obama and his advisors have so far given every indication of being equally as ignorant as Roosevelt and every bit as inclined to meddle with the economy.
1. Larry Beinhart is one such economic illiterate. On the basis of a clumsy correlation he made the absurd claim that tax cuts cause the boom-bust cycle. How's this for a correlation: every boom in American was preceded by rapid monetary expansion. Unless, for example, Beinhart thinks the boom that preceded the 1819 depression was caused by tax cuts. I guess the same goes for 1830s boom that was followed by the 1837 crash which was then followed by a brief boom that ended in the 1839 crash. Then of course there were the booms and busts that plagued the British economy in the first half of the nineteenth century.
No doubt he would also argue that medieval booms and busts were also caused by tax cuts. His ridiculous treatment of taxation and economic growth serves only to further underline his economic idiocy. In short, Beinhart is an economic ignoramus, a man thoroughly unschooled in the fields economic history and the history of economic thought.
2. Richard G. Anderson, Some Tables of Historical U.S. Currency and Monetary
Aggregates Data, Federal Reserve Bank of St. Louis, research paper, April 2003.
3. Unfortunately this fallacy is still alive and well. John Stone, former head of the Australian Treasury stated that "Keynes was right for the 1930s," that "savings exceeded investment" and that Japan's present problem is that it is saving too much.
Gerard Jackson is Brookesnews' economics editor
BrookesNews.Com
Monday 1 March 2010
Benjamin M. Anderson was scathing about the destructive consequences of the National Recovery Act:
United States
Percent of average (ratio scale)
F. A. Harper, Why Wages Rise, The Foundation For Economic Education, Irvingto-on-Hudson, New York, 1957, p.16
(See How the Laffer curve really works