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History Incognito:
The untold origins of the Roaring Twenties, the Crash, and the
Great Depression
By Sean P. Breen
Monday, April 10, 2006
Submitted in Partial Fulfillment of the Requirements for the Degree of Bachelor of
Arts in the Department of History, Middlebury College
History Incognito –
The untold origins of the Roaring Twenties, the Crash and
the Great Depression
This paper offers an answer to three important unanswered questions regarding
the economic history of the 1920’s boom, the Crash of 1929 and the subsequent Great
Depression. This paper supports its answers by creating new historical databases and
subjecting the historical data to rigorous modern statistical analysis.
The three questions are: what caused the boom of the 1920’s, what caused the
Crash of 1929 and what caused the ensuing Great Depression of 1930’s? The answer,
which is detailed in the following pages, is that the antecedent cause for all three
questions was the transformation of the United States into the world’s creditor as a result
of World War One. This War and the reversal of the Unite States from a debtor nation to
become the world’s only remaining banker, created a fragile world economy that
demanded continued U.S. lending to support a level of international commerce that
could allow repayment of War debts. The Mellon Treasury was masterful in managing
the economic dislocation of the War Years and returning the U.S. economy to growth
through a progressive and scientific reform of the U.S. tax structure and U.S. debt
markets. This was the ‘cause’ of the 1920’s boom. The restructuring of lower peacetime
tax rates and the lowering of tariffs promoted expanding trade with Europe that was
essential if the European nations were to recover from the War and perform on the War
debts owed to the U.S. Enabled by the Mellon treasury, the U.S. loaned money to
Europe to buy U.S. products so that they could earn enough from the commerce to
continue to perform on War debt and reparations that were in turn owed to the U.S.
These policies were successful until the late 1920’s when declining agricultural prices,
driven down by technological productive innovation, raised political temperament for
agricultural tariffs. The politics of the agricultural tariff movement blossomed into a
general tariff movement as all sectors of the economy sought to share in the political
largesse. Unfortunately, the resulting Smoot-Hawley tariff destroyed the precarious
basis under which the fragile international financial structure functioned. This was the
‘cause’ that resulted in the Crash of 1929. As international tariffs reduced international
commerce the international financial system collapsed and the U.S. stock marked
crashed. In reaction to the economic collapse U.S. policy retreated from the paradigm of
low taxes and open markets to high taxes and closed markets which prevented recovery
and so, ‘caused’ the Great Depression.
Sean P. Breen is a B.A. candidate in History at Middlebury College, in Middlebury
Vermont. He gratefully acknowledges assistance of the College Library, History and
Economic Faculty, which provided advice as well as strict deadlines contributing to the
completion of this paper in April, 2006. He would like to further extend a special thanks
to his advisors Travis Jacobs and Robert Prasch as well as Ed Breen, his father, and
other members of the thesis committee for their support and encouragement. Finally,
Sean is grateful to the late Jude Wanniski who laid the seeds that grew into this paper.
Previous contributions by Milton Friedman, Anna Schwartz, Barry Eichengreen, Irving
Fisher, Alan Meltzer, Robert Archibald, David Feldman, Eugene White, Claudia Goldin,
Michal Bordo, Kevin Carey, Irwin Douglas, John Kenneth Galbraith, David Kennedy,
Charles Kindleberger, Murray Rothbard, Peter Temin, and Jude Wanniski among many
others were invaluable in composing this paper.
Contents:
INTRODUCTION ··························································································· 1
CHAPTER ONE: ··························································································· 9
TAX POLICY: W ORLD W AR ONE TO 1929 ···························································· 9
CHAPTER TWO: ························································································ 28
MONETARY POLICY, W ORLD W AR ONE AND CHANGES IN THE PRICE LEVEL ················ 28
CHAPTER 3:······························································································ 53
INTERNATIONAL FINANCE – W ORLD W AR ONE AND THE INTERNATIONAL DEBTS IN THE
1920S ···································································································· 53
CHAPTER 4:······························································································ 68
FEDERAL RESERVE POLICY AFTER 1921 AND THE ERA OF PRICE STABILITY················ 68
CHAPTER 5:······························································································ 84
THE COOLIDGE BULL MARKET ······································································· 84
CONCLUSION ·························································································· 148
APPENDIX A: ··························································································· 152
APPENDIX B: ··························································································· 154
APPENDIX C: ··························································································· 160
APPENDIX D: ··························································································· 166
BIBLIOGRAPHY ························································································ 167
DATA SOURCES: ······················································································· 167
PRIMARY SOURCES (ORDER OF YEAR PUBLISHED): ············································· 167
SECONDARY SOURCES (ALPHABETICAL ORDER): ················································ 173
Introduction
It is not possible to know for sure what direction economic and social history
would have taken if the First World War never occurred. Nonetheless, it is rational to
expect that the international economy would have developed in much of the same way
as it had during the fifty years that preceded the conflict. Within this construct, World
War I can be understood as a large exogenous shock. It was a shock that so upset the
underlying equilibrium of international development and growth, that the result was a
breakdown of the integrated international framework which characterized much of the
nineteenth century. Within this construct, the roots of the 1929 downturn in economic
activity and the collapse of the international economy can be traced directly to the
economic impact of the war. Conversely, if this construct is false, the initial shock of the
war and the resulting disturbance in economic development can be seen as only
temporary.
Such that after a short adjustment period, economies reverted to their
previous trends without marked effects. In such case, the War had less of an impact on
the 1929 downturn and the subsequent depression.
Though the literature concerning the interwar period economy is vast, much of it
is of mediocre quality and some subjects still await serious analysis. Moreover, despite
the Great Depression’s reputation as the “holy grail” of economics, little consensus has
been reached over its fundamental origins. The same is true for the “Roaring Twenties”
and the period’s infamous ending with the “Great Crash” in October, 1929. The purpose
of this thesis is to create a picture of the American economy on the eve of Depression.
In doing so, an argument is formed both to explain the booming stock market throughout
the decade, and the source that precipitated its eventual collapse.
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In order to
understand fully the Crash and its relation to the ensuing Great Depression, a thorough
analysis of the previous decade is required.
An examination of the fiscal policy of the Harding administration, particularly the
fight in Congress over the proper tax system for a peace-time economy, and the actions
of the still emergent and amorphous Federal Reserve System is required to illuminate
the superstructures which supported the economy of the 1920s. More importantly, the
understanding of how these two factors compliment or fight each other is essential to
understanding the events of the decade, including the Crash.
The goal of this thesis is to help the reader understand both the precarious
position of the international financial system and the United States’ emergent role within
that system, as well as the forces within America that were pulling and pushing the
economy in different directions. Ultimately, considerable evidence is found supporting a
connection between the Mellon tax reform and a growing economy. Next, a microoriented look at the stock market build-up, with particular attention to intangible capital,
demonstrated that the stock market, even at its peak in 1929, was performing rationally
and in line with fundamental valuations.
Finally, theories surrounding the stock market collapse are examined and a new
explanation is presented. The Smoot-Hawley Tariff, which passed congress in June,
1930, played a considerable role in changing investor expectations and consequently in
changing market valuations. This connection has been made before, notably by Jude
Wanniski, but a major addition is added here through econometric analysis which
dismisses criticism of the theory as simply “coincidental.”
What this paper strives to produce, is a coherent picture of the 1920s economy
and America’s role within the world financial system. Too many studies of the inter-war
period, and particularly those addressing the Great Crash in 1929, fall into a Weberian
“iron cage,” becoming lost in the details while ignoring the bigger picture. The economy
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is a fluid machine.
It is continually changing and reacting to future events.
As
contemporary Joseph Schumpeter made famous: “Capitalism…is by nature a form or
method of economic change and not only never is, but never can be, stationary.” 1 This
thesis attempts to allow for this “dynamic” nature of the economy by examining a longer
period and by identifying the key drivers of change. In doing so, main themes arise both
in the tremendous growth experienced during the bulk of the 1920s and the dramatic
disintegration that occurred during 1929 and 1930.
Unlike authors who begin their
analysis in October, 1929, no assumptions about the economy are made here. Instead,
an historical picture is painted that makes nearly every existing explanation of the Great
Crash inadequate. The full history reveals a series of fiscal decisions that interacted
with a fragile monetary structure left as a result of World War One. For most of the
period, these fiscal decisions were positive, as tax reform began to “restore normalcy” in
the American economy and opened capital markets for increased investment and
growth. Beginning with the election of Herbert Hoover, however, in 1929, the political
platform changed.
The direction of policy began to focus more on isolation and
protection rather than integration and open markets. This policy shift is exemplified by
the Smoot-Hawley debate in Congress that began in 1928 and continued through June
1930, when the bill was finally signed into law. Ample evidence has been gathered and
presented here to conclude that this shift in policy was a substantial cause of the decline
in market valuation that has become known as the “Crash of ’29.” The forces at work,
however, were no different than those that fueled the “Roaring Twenties,” or those that
accelerated the market downturn into the Great Depression of the 1930s. Certainly
monetary instability during the period played a significant part in these events, but the
initiation of both the period of growth, and the period of depression came from fiscal
1
Joseph Schumpeter, Capitalism, Socialism and Democracy (London: Allen & Udwin Publishing, 1943)
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activities. There is no prior literature that examines the period as I propose to do herein.
This thesis is presented in six chapters.
Chapter One provides an in depth overview of American fiscal policy from before
World War One through to the end of 1929. This detailed examination of the tax reform
orchestrated by the Mellon Treasury has yet to be included in the modern literature
about the Depression and the Crash. Most authors view the 1920s as separate from the
1930s, with the Crash as a defining event that separates the two epochs. Instead,
readers should consider that this was one unified period during which a change occurred
in the way monetary and fiscal forces worked in steering the economy. The purpose in
this chapter is to establish a case to explain the root cause for the booming economy
and stock market. This explanation will later be supported by an extensive examination
of the stock market boom itself in Chapter Five.
Chapter Two concerns the complex period in American monetary history that
began with the establishment of the Federal Reserve System and continued through
World War I until 1922, when the American economy experienced severe price volatility.
The fledgling Fed, created in 1914, never had a chance to establish its institutional
independence before the onset of World War I.
As a consequence, the Treasury
remained in control of America’s finances as the government attempted to fund the war.
Wholesale prices more than doubled by 1920 before a sudden and sharp recession
corresponded with a dramatic drop in prices. Nevertheless, in 1922, once prices again
stabilized, the PPI remained forty percent (40%) above its 1914 level. The existing
literature does not satisfactorily identify the drivers behind these price movements. The
traditional explanation blames the Federal Reserve’s conduct of monetary policy. In
particular, Monetarists attribute the post war inflation to the “artificially” low interest rates
induced by the Treasury to finance war debts immediately after the war. When the Fed
regained control over the discount rate in late 1919 and enacted a “tight” monetary
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policy, prices fell. An alternate theory promoted primarily by Jude Wanniski, argues that
no “monetary” inflation occurred. Instead, the volatility of prices should be attributed to
changes in demand, as the economy moved from wartime to peacetime. When all the
data is examined, however, neither of these arguments seems wholly accurate. Instead,
it appears as if factors of both loose money, particularly during the 1919-1920 period,
and a drastic change in demand, both played a role in the resulting price volatility. As a
result of the drop in prices, the burden of international war debts were greatly increased
in real terms.
These first two chapters should be considered in tandem. Monetary and fiscal
policies act as the two main levers on the economy.
Higher tax rates will, ceteris
paribus, decrease dollar demand, creating excess liquidity as too many existing dollars
begin to chase too few goods and services. Conversely, lower tax rates will stimulate
dollar demand and, unless more money is injected into the system, cause a shortage of
liquidity, as too few dollars chase too many goods and services. The former situation
instills inflationary pressures on the economy, while the later introduces deflationary
pressures. Similarly, lower discount rates encourage economic activity by reducing the
cost of financing, resulting in increased dollar liquidity. Higher discount rates, ceteris
paribus, have the opposite effect.
During the period immediately following the war,
income tax rates were higher than ever before.
At the same time, the Treasury
dominated the Federal Reserve and held the discount rate down. Thereafter, beginning
in late 1919, the Fed gained more independent control over monetary policy and began
to raise the discount rate. However, during the same time, the Revenue Bill of 1918
remained in effect and war-demand for production began to decrease. The net effect
was ambiguous, as money supply decreased (high discount rate) while money demand
also decreased (high taxes and higher cost of financing). Inflation remained rampant,
indicating that demand destruction took place more rapidly than supply depletion which
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produced a net increase in liquidity. By mid-1920, however the Fed had raised the
discount rate to seven percent (7%), restricting dollar supply so much as to induce a
recession. This in turn resulted in too few dollars chasing too many goods and services.
Deflation set in and the economy fell into a sharp but brief recession until the Revenue
Bill of 1921, cut taxes, and boosted dollar demand. This indeed contributed to the
deflationary pressures on the economy, but did so by stimulating economic activity,
stopping the recession originally responsible for the falling prices.
Chapter Three discusses the precarious position of the international financial
system as a result of World War One. This chapter is essential for understanding the
real impact of the Smoot-Hawley Tariff on the world financial system in 1929 and 1930,
and the role of the tariff law in creating the drop in market prices. Beside the creation of
high income taxes, the most significant economic result of the War was a reshuffling of
the international financial order.
The United States, historically a debtor nation
throughout its existence, became the world’s creditor. The Treaty of Versailles ultimately
made Germany responsible for paying off the World’s debts to America. In addition,
credit risk was not limited to governments but was securitized and sold excessively to
the American people, who began to discover and invest in capital markets for the first
time. Bond issuances from all over the world found markets in America. The table was
set for an international disaster if the debt payments failed to be met. Moreover, what
becomes increasingly clear is that the continued flow of these debt payments were
reliant on two factors: first, the extension of further credit, usually from the private sector
in the form of foreign direct investment (FDI), from the United States, or second, a
balancing trade surplus between the U.S. and foreign countries to match their credit
account deficit. Unfortunately, both these dependant factors were removed in 1928/29
due, in the first case, to American’s increasing interest in investing domestically brought
about by higher rates of return and lower risk, and in the second case, to the erection of
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tariff barriers beginning with the Smoot-Hawley Tariff. The result was a collapse of the
world financial system.
Chapter Four provides an overview of monetary policy after 1922 through 1929
and the Crash. The goal here is to present an explanation of the relative price stability of
much of the 1920s and to dispute arguments that insist that the growing economy was
only a façade built on an inflationary boom. This chapter is also important in that it
deflects the argument that the Fed “burst” the stock market “bubble” by hiking interest
rates.
Chapter Five offers a micro analysis of the stock market just before the crash in
1929. In addition to a fundamental valuation of all United States businesses, the chapter
also analyses previous explanations for the stock market boom. None of the existing
literature presents a coherent argument for the flourishing market. All previous authors
cite business cycle facts and reiterate the effects of the boom, but there is a general
failure to find the origin. Of course, understanding the origin of a boom is of particular
interest in discerning its validity. In this chapter evidence is presented linking the Mellon
tax reforms along with the deregulation of business in the 1920s and the booming stock
market.
The result is to show on the one hand, a valid foundation for the thriving
markets, and also to demonstrate on the other, that the capital markets themselves were
not overvalued (but were if anything undervalued) on the eve of the notorious stock
market crash in October, 1929.
Finally, Chapter Six concludes by addressing the Crash itself and the existing
theories that surround it. As with the boom, the quantity of literature is astounding, but
no explanation of the origin of the Crash can be found. The most common theories rely
almost completely on the formation of an “irrational bubble” which does not take into
consideration the factors discussed in Chapter Five. With this in mind, a new and often
overlooked explanation is examined: the uncertainty created by the debate around the
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Smoot-Hawley tariff.
This theory is not new, but was expressed repeatedly by
contemporary economists and bankers.
Nevertheless, it only finds its way into the
modern literature in The Way the World Works by Jude Wanniski. This chapter adds to
Wanniski’s study by including regression analysis to identify and quantify the importance
of tariff news to stock market valuation. In addition, this chapter builds on Wanniski’s
research by including analysis of stock market volatility. An entire new data base was
created for this empirical testing.
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Chapter One:
Tax Policy: World War One to 1929
At the end of World War I, taxes were high. The demand for revenue created by
America’s entry into the First World War elevated the rate of the three-year-old income
tax into otherwise impossible heights.2 The 16th Amendment, ratified in 1913, stated,
“The Congress shall have the power to lay and collect taxes on incomes, from whatever
source derived, without apportionment among the several States, and without regard to
any census or enumeration.”3 Congress then agreed to a one percent (1%) levy on net
personal income greater than $3,000 and a graduated surtax beginning at one percent
(1%) on income over $20,000, increasing to six percent (6%) on additional income over
$500,000 to create a top marginal rate of seven percent (7%). The corporate tax of one
percent (1%) was repealed.
Congress then modified these initial ranges with The
Revenue Act of 1916, which raised personal income rates to two percent (2%) at the
entry level then progressively increased rates up to fifteen percent (15%) for the highest
income bracket. The fifteen percent (15%) rate, however, applied only to income over
2
Technically, the income tax was not a new idea. Historically, its existence emerged under President
Lincoln when he created the Commissioner of Internal Revenue to raise money to pay for the Civil War. It
levied incomes between $600 - $10,000 at three percent (3%) and all incomes over $10,000 at 5%. The
income tax, however, was never enforced due to public dismay. In the later half of the 19 th century ninety
percent (90%) of all government revenues came from consumption taxes on liquor, beer, wine and tobacco.
In 1872 the income tax was repealed. In 1894, the Wilson Tariff Act revived the income tax with the creation
of the income tax division within the IRS. A year later, in 1895 the Supreme Court ruled the income tax
unconstitutional. President Taft recommended to Congress in 1909 that a constitutional amendment be
created empowering the government to tax incomes without allocating the burden along states according to
level of population. Congress also levied a net tax on corporate income over $5,000. In 1913, Taft’s
recommendation became the 16th Amendment when Wyoming ratified the proposal.
3 U.S. Constitution, 16th Amendment. See:
http://www.senate.gov/civics/constitution_item/constitution.htm#amdt_16_(1913). Visited on: 12.04.05
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$2 million.4 Nevertheless, b1917, the need to raise revenue quickly for the war became
imperative and a fundamental shift in tax policy occurred.
The War Revenue Act of 1917, signed into law on October 3rd shortly after
declaring war, further increased the rates while simultaneously slashing exemptions.
Treasury Secretary William McAdoo presented Congress with specific estimates of the
costs of entering the World War One. In his budget, McAdoo initially estimated $3.5
billion in direct costs for the U.S. and $3.0 billion in loans to the Allies. According to his
plan, fifty percent (50%) of these costs would be raised through income taxation while
the rest would be raised through bond offerings. The resulting Bill, after a strong push
by Senator Robert LaFollete for more steeply progressive taxes on the wealthy,
exceeded any prior action of the federal government both in amount of revenue raised
and redistribution of wealth. It was truly revolutionary. The Act marks distinctly the shift
in American tax structure away from consumption levies (customs and excise taxes)
toward production levies (income taxes). Specifically, the Bill drastically cut exemptions
from $3,000 for single taxpayers and $4,000 for joint returns, to $1,000 and $2,000
respectively.
All incomes above these levels were taxed at two percent (2%) and
surtaxes were added progressively, beginning with an additional two percent (2%)
(creating a marginal rate of 4%) on income over $3,000 ($4,000 for married couples)
until reaching a maximum of fifty percent (50%) (creating a marginal rate of 52%) on
incomes over $1 million. Corporate taxes were doubled from two percent (2%) to four
percent (4%) on income over $3,000 ($6,000 for partnerships). An additional graduated
corporate excise profits tax was also added, beginning at eight percent (8%) and
increasing to sixty percent (60%).5
Personal and professional service profits were
limited to an eight percent (8%) tax on income over $3,000. Finally, the inheritance tax
4
$2 million in 1916 is equivalent to approximately $36.5 million in 2005.
Profits were measured by return on investment (ROI) from 1911 – 1913 generally seven-to-nine percent
(7-9%)
5
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was increased beginning at 0.5% on estates over $50,000 and peaking at 10% on
estates over $10 million.6 The result of this significant tax increase and structural shift in
the tax scheme increased revenue from $0.8 billion in 1917 to $3.7 billion in 1918, a 463
percent (463%) increase. The income taxes and excise profits taxes accounted for
nearly ninety-percent (90%) of this increase.7
Nevertheless, as the War raged on President Wilson found himself again asking
Congress for additional revenue in the spring of 1918. The war was proving to be much
more expensive than McAdoo originally projected. On May 27th, Wilson presented his
argument to both Houses:
We are not only in the midst of the war, we are at the very peak and crisis of it.
Hundreds of our men, carrying our hearts with them and our fortunes, are in the
field, and our ships are crowded faster and faster to the ports of France and
England with regiment after regiment…to join them until the enemy shall be
beaten and brought to reckoning with mankind…If this is to be accomplished
gentlemen, money must sustain it to the utmost. Our financial program must no
more be left in doubt or suffered to lag more than our ordnance program or our
ship program or our munitions program…These are not programs, indeed, but
mere plans upon paper, unless there is to be an unquestionable supply of
money.8
The following bill proposed by Secretary McAdoo in September of 1918 passed the
House unanimously, but met trouble in the Senate. Wilson argued that the American
people will “bear any burden and undergo any sacrifice” to win the war. “We need not
be afraid to tax them, if we lay taxes justly,” he continued in his speech to Congress,
“The noble use for which [American] wealth has been piled up [will bring Americans] to
see the dawn of a day of righteousness and justice and peace.”9
With the Armistice on November 11, 1918, however, and the end of the Great
War, circumstances changed dramatically. Wilson’s use of the War as justification for
the new Revenue Bill needed to be reconciled, and McAdoo presented a new set of
6
John F. Witte, The Politics and Development of the Federal Income Tax, (Madison Wisconsin: 1985) pgs.
67-87. Also see: Historical Highlights of the IRS, Internal Revenue Service, US Treasury Department. See:
http://www.irs.gov/irs/article/0,,id=101101,00.html. Visited on Dec. 3rd, 2005.
7 Charles Gilbert, American Financing of World War I¸ (Westport Connecticut: 1970)
8 Taken from: Steven Weisman, The Great Tax Wars, (New York: 2002) p.331
9 See Weisman, 332.
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recommendations.
Insurgent Republican’s, led by Senator LaFollette of Wisconsin,
pushed for more extreme rates on profits and the wealthy, calling for marginal rates of
ninety percent (90%) on the top bracket.10
While the extremism of LaFollette was
defeated 55 to 6 in the Senate, the Revenue Bill of 1918 received approval in February,
1919, and drastically increased marginal rates yet again.
The bottom tax bracket
doubled, from two percent (2%) to four percent (4%) on income up to $4,000.
Thereafter, the normal tax rate was twelve percent (12%) for the calendar year 1918 and
eight percent (8%) in following years. A surtax was then added to income in excess of
$5,000 on a progressive scale to a maximum of sixty-five percent (65%) up from the
1917 maximum of fifty percent (50%). The resulting top marginal rate was, therefore,
increased from the 1917 level of fifty-two percent (52%) to seventy-seven percent (77%)
for the calendar year 1918 and seventy-three (73%) for subsequent years. Moreover,
the top threshold was lowered from $2 million to $1 million, effectively further increasing
the top tax rate for those on the margin. With the Revenue Act of 1918, the United
States established the highest tax rates of any country in the world. Economist Edwin
Seligman announced: “This is the high water mark thus far reached in the history of
taxation. Never before, in the annals of civilization, has an attempt been made to take
as much as two thirds of a man’s income by taxation.”11
Although the Revenue Bill of 1917 had more drastic changes, the Revenue Bill of
1918 raised not only surtaxes on the wealthy, but significantly increased the “normal”
taxes and, consequently, affected a larger number of taxpayers.
Also, and more
importantly, the Revenue Bill of 1918 came after the Great World War. Because of the
10
The LaFollete insurgency also formed an opposition group later in 1929 against the protective SmootHawley tariff and had also supported an income tax increase under the Theodore Roosevelt Administration.
They continually supported increasingly progressive income taxation. They represented a rural middlewestern constituency that paid little or no income tax because of high personal exemptions, but were not
particularly poor.
11 See Sidney Ratner, American Taxation: Its History as a Social Force in Democracy, (New York: 1942) pg.
376 and see Edwin Seligman, “Comparative Tax Burden,” Political Science Quarterly, Vol. 39, No. 1,
(March, 1924) pg. 125 – 129;
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war the public largely accepted the 1917 bill. As the Wall Street Journal reported on
January 17, 1918: “We must win the war. All our useful activities must be subordinate to
this supreme object. To win the war men, money and munitions are required. Money –
a lot of it – must be raised by taxation.”12
Conversely, the 1918 Bill created a different consensus in American society, as
illustrated by the New York Times in an article dated February 8, 1919:
Manufacturers Say Pending Bill Will Bankrupt Industry
Stephen C. Mason, President of the National Association of Manufacturers,
issued a vigorous protest yesterday against the pending Revenue Bill. In Mr.
Mason’s opinion: “the adoption and enforcement of the pending Revenue
measure will intensify and make more general the present condition of industrial
stagnation. It will contribute”, he said, “toward the longer duration of the existing
period of business uncertainty and unemployment and most seriously hamper
desired rapidity in our readjustment [in peacetime] and expansion of our
industries [for rebuilding].
...in order to penalize the comparatively few ‘big business’ concerns, the framers
of the bill are willing to jeopardize the existence and continued operation of those
comparatively small manufacturing institutions which are likely to be made
bankrupt and permanently put out of business under its enforcement.
Wage earners of the country have just as vital an interest in the far reaching
effects [of the Revenue Bill]…because…it will result in serious impairment and
immediate reduction of the ability of employers throughout the country to pay
wages in accord with present standards of living.”13
With the end of fighting, Americans were no longer willing to pay such high tax rates.
Consequently, the populace, especially the small business world, was outraged by the
Revenue Bill of 1918, when they had been equally supportive of the high rates in the
1917 bill.
Clearly World War One shocked government finances, transformed the tax-code,
and moved America exponentially closer to its modern position in the world.
The
legitimacy of the income tax, while confirmed by the ratification of the 16 th Amendment in
1913, was transformed into America’s major revenue producing agent. During the War,
Wall Street Journal, “Income Tax Procedure 1918,” pg. 6 January 17, 1918. Taken from an excerpt of
Robert Montgomery’s Income Tax Procedure 1918. Montgomery was the former president of the American
Association of Public Accountants.
13 New York Times, “May Pass Bill by Monday Night,” pg. 6 February 8, 1919.
12
-13-
the severity of the new income tax system was overlooked, but with the armistice the
circumstances were completely changed. As America shifted from war to peace, the
American people demanded an adjustment of the wartime tax scheme to one
appropriate for peacetime. When this transition failed to happen, the consequences
were immediate: a sweeping reversal of Democratic majorities in the Presidential and
Congressional elections of 1920 and 1918 occurred.14
The Harding campaign
understood this popular sentiment and captured the demand for change with its slogan
of a “return to normalcy.”
Harding won in a landslide, capturing sixty (60%) of the
popular vote and seventy-six percent (76%) of the Electoral College.15 As a result, the
new Republican administration had a popular mandate to dismantle a tax scheme that
was considered abusive, by most in society.
Immediately following the armistice, McAdoo left the Wilson Cabinet and Wilson
appointed Carter Glass as Treasury Secretary.
Glass continued very much in the
fashion of McAdoo. He issued $5 billion in Victory Bonds to help liquidate the expenses
of World War I. In doing so he ignored his under secretary, Russel C. Leffingwell’s
recommendation for tax reform, instead arguing to a receptive Congress that high tax
rates were necessary to pay off war debt. While McAdoo and Glass were steadfast in
their calls for heavy and steeply progressive tax structures, Glass’ understudy,
Leffingwell, began contemplating a permanent peacetime income tax system.16
Leffingwell began correspondence with a number of leading economists to discuss the
issue, including T.S. Adams, Irving Fisher, Frank Taussig, and Edwin Seligman.
14
There clearly were many issues that played into this political reversal, but it is the view of the author that
the tax reform play a dominate role. While only one news article is given here as evidence of popular outcry
against the tax bill, the authors opinion is based off of hundreds of articles from numerous news sources of
the period.
15 http://www.archives.gov/ “Electoral College Box Scores 1789 – 1996. Visited on 12.04.05
16 The reader should acknowledge that Glass, nor his immediate predecessor David Houston, were
completely blind to the need to reduce taxes. Secretary Glass told Congress: “The utmost brackets of the
surtax have already passed the point of productivity,” and Secretary Houston argued: “It seems idle to
speculate in the abstract as to whether or not a progressive income tax schedule rising to rates in excess of
70 percent is justifiable. We are confronted with a condition not a theory. The fact is that such rates cannot
be successfully collected.”
-14-
Moreover, Glass pressured the Federal Reserve System to keep discount rates low to
ensure that the newly floated bonds traded near par value.17 In consequence, America
faced one of the sharpest depressions in history from 1920 through 1921. Money was
loose at the precise time that war production declined and post war taxation suffocated
growth. This left excess liquidity in the system and caused the price level to inflate.
Wholesale prices rose nearly forty-three percent (42.8%) between the end of the war in
1918 and 1920.18
After the election of Harding in 1920, Leffingwell left the Treasury to become a
partner at J.P. Morgan and Company, but he was replaced by his protégé, S. Parker
Gilbert, who became undersecretary to Harding’s Treasury Secretary, Andrew Mellon.
Gilbert and Leffingwell formed a group of tax reform supporters who touted “scientific”
taxation as a way to raise revenue fairly while limiting interference in the economy to a
minimum. The term “scientific” intended to emphasis that the reform proposals were
based on economic theory rather than political ideology.
President Harding, in his
inaugural address, explained that America “can reduce abnormal expenditures, and
[America] will. [America] can strike at war taxation, and [America] must.”19 Harding
expanded on this statement a month later when he addressed a Special Session of
Congress on April 12, 1921:
The most substantial relief from the tax burden must come for the present from
the readjustment of internal taxes, and the revision or repeal of those taxes which
have become unproductive and are so artificial and burdensome as to defeat
their own purpose. A prompt and thoroughgoing revision of the internal tax laws,
made with due regard to the protection of the revenues, is, in my judgment, a
requisite to the revival of business activity in this country. 20
17
See Chapter Three for a full description of this process and its consequences.
Wholesale Price Index, Bureau of Labor Statistics. Adapted from Figure 1 in Mundell: A Reconsideration
of the Twentieth Century, (Dec. 1999).
19
Warren
Harding,
Inaugural
Address,
March
4th,
1921.
Taken
from
http://www.bartleby.com/124/pres46.html. Visited on 12.04.05
20 Harding, A Return to Normalcy, April 12 1921. See Congressional Record, 67 Cong., 1 Sess., pp. 169173.
18
-15-
Harding clearly understood the relationship between business activity and taxation.
Beginning with the Revenue Bill of 1921, the Harding administration delivered a
complete dismantling of the war time tax system and pulled the American economy from
the depths of the worse recession since the 1890s into a decade of prosperity. The
“Mellon Plan,” after the Treasury Secretary, adopted a tax reform scheme consistent
with the recommendations of Leffingwell and Gilbert. The “Mellon Plan” orchestrated by
Gilbert and publicized by Mellon, had the support of leading economists with the
common goal to design a nonpartisan permanent peacetime industrial capitalist
economy.
In a letter to Gilbert on November 1, 1920, Leffingwell observed “one very
unpleasant consequence of these heavy taxes is the constant pressure for exemption
from them.”
21
He related his experience at J.P. Morgan, working with clients who
supported a movement to exempt railway and public utilities from taxes because of
difficulty and cost to obtain the necessary capital due to competition with tax-free
municipal bonds. Leffingwell, however, dismissed the notion of exemption from taxes as
a proper policy, noting that it would be “fundamentally wrong, since, first, the
Government needed the revenue, and second, it was anti-social.”22 Instead, Leffingwell
encouraged a reduction in surtaxes. In March of 1921, Gilbert wrote to Secretary Mellon
explaining the need to reform:
The high surtax rates are not producing revenue. The rates are so high that
large taxpayers are under constant pressure to reduce their taxable income.
Among other things, the higher surtaxes are driving capital out of productive
enterprise into tax exempt public securities which are largely unproductive. The
investment capital required by industry and trade is being absorbed by
unproductive public works.23
21
National Archives and Records Administration (NARA), Record Group 56, Correspondence of the
Secretary of the Treasury, 1917-1932, Individual Files: Leffingwell. Even while Leffingwell had left the
Treasury for J.P, Morgan, he remained in close contact with his former colleagues and frequently offered
advice to Gilbert and Mellon.
22 NARA, Individual Files: Leffingwell.
23 NARA, Record Group 56, Tax-General
-16-
Gilbert identified the phenomenon that under the current tax structure, tax-exempt
securities, such as state and municipal bonds, offered higher after-tax return on
investment than did taxable corporate securities.24
Contemporary economist T.S.
Adams confirmed this observation, arguing, “Such a possibility is enough to destroy the
long run potency of a sixty-five percent (65%) surtax.”25 On April 30, 1921 Mellon wrote
to Representative Joseph W. Fordney, chairman of the Ways and Means Committee,
recommending surtax reductions.
President Harding called a Special Session of
Congress to consider tax reform. Economist T.S. Adams created the original draft for
the 1921 tax reform through correspondence with Gilbert and the House Ways and
Means Committee brought the bill to Congress. As presented to Congress, the bill
reduced the top marginal rate to thirty-three percent (33%), from seventy-three (73%) by
slashing the surtax rate from a maximum of sixty-five (65%) to a maximum of twenty-five
(25%). Base income tax rates remained the same. While the draft passed the House
easily, insurgent Senate leader LaFollette and Senator Kenyon of Iowa, a Republican
leader of the farm bloc, forged a bipartisan coalition with the Democrats to block the
reform. Secretary Mellon testified to the Senate Finance Committee explaining the case
against high surtaxes. Mellon argued that since the inception of wartime taxation in
1916, the number of tax returns with annual incomes over $300,000 declined fifty
percent (50%). Moreover, total reported income of these returns decreased more than
fifty percent (50%) while total reported income during the period showed an increase of
nearly three hundred percent (300%). Obviously tax-evasion was rampant.
He
continued:
It is interesting to note that substantially as much revenue was realized from
incomes over $300,000 under a 13% maximum in 1916 as was realized from the
24
For the sake of clarity, consider the extreme instance of an individual subject to the top marginal taxes of
73% in 1921. In order to match the return on investment of a municipal bond yielding 5% annually in the
corporate market the investor would need to receive taxable returns of greater than 18% annually.
25 T.S. Adams, “Fundamental Problems of Federal Income Taxation,” The Quarterly Journal of Economics,
Vol. 35, No. 4, (Aug. 1921) pg. 531-32
-17-
same class of taxpayers under a 65% rate in 1921. The high surtax rates are
war taxes; and, as the war is over, such taxation should cease. 26
Mellon explicitly understood the distinction between war economy and peace economy
and the amount of taxation each could support. During Congressional debate, Senator
Reed Smoot of Utah argued that the immediate reduction of surtaxes to a thirty-two
percent (32%) maximum for the fiscal year 1922 was “a mathematical calculation. The
reason is because thirty-two percent (32%) is the difference between the income from a
tax-exempt security and one that is taxable on the basis of today’s money markets.”27
The key here is to understand the “scientific” language behind the Mellon Plan. Despite
this bid, Mellon could not overcome the popular appeal to the notion, espoused by
Senator La Follette, that surtaxes could only be reduced at increased expense to
ordinary people. For example, Senator Kitchin, the ranking Democratic member of the
House Ways and Means Committee rebuffed the surtax reductions:
…even if millionaires and multimillionaires were putting their surplus income into
state, county, and municipal bonds, are not the people of the states and counties
and municipalities thereby benefited by getting a higher price for such bonds, and
do not the proceeds from these state and municipal bonds go more directly for
the benefit of the people than the taxes of the federal government?28
In the end, The Revenue Bill of 1921 lowered the maximum surtax to fifty percent (50%),
leaving a top marginal rate of fifty-eight percent (58%).
In addition, the maximum
threshold was lowered to $200,000 from the 1918 level of incomes over $1 million.29
At first glance, the resulting Bill can appear to be more of a tax increase than a
tax decrease because, while the top surtax rate was reduced from sixty-five percent
(65%) to fifty percent (50%) the top threshold was lowered from $1 million to $200,000.
This is misleading, however. Surtaxes in both the 1918 and 1921 Bills increased at a
rate of one-percent (1%) for every additional $2,000 in income up to $90,000. The
26
Andrew Mellon, Taxation: The Peoples Business, (New York: 1924). pg. 130-131.
Roy Blakey, “The Revenue Act of 1921” American Historical Review, Vol. 12. No. 1 (Mar. 1922) 81.
28 Blakey, “The Revenue Act of 1921” 80-83.
29 Congressional Record. The Revenue Act of 1921, Washington: 1923 (Seventy-Sixth Congress, Session I,
Chpt. 136, 1921).
27
-18-
graduation then became more progressive. In 1918, incomes between $200,000 and
$300,000 were subject to a sixty percent (60%) surtax, those between $300,000 and
$500,000 a surtax of sixty-three percent (63%), $500,000 and $1 million sixty-four
percent (64%), and incomes over $1 million were subject to a top surtax rate of sixty-five
percent (65%)
Under the new Bill, the top surtax was levied at fifty-percent (50%) on
incomes over $200,000 significantly reducing the $200,000 bracket by ten percent (10%)
and those brackets above it by larger amounts. More importantly, in 1918, the first
surtax of (1%) kicked in at incomes between $5,000 and $6,000, but in 1921 the bottom
threshold was raised to $6,000 and the minimum surtax rate of one-percent (1%) was
stretched through to incomes of up to $10,000. The effect of this was to lower all
surtaxes in all brackets up to $90,000 by two-percent (2%). Incomes between $90,000
and $100,000 were reduced by one-percent (1%) each, and those between $100,000
and $200,000 by four percent (4%) and seven percent (7%) respectively.
The Bill,
therefore, while not to a great degree and no where close to the level called for the by
Mellon Plan, did marginally reduced tax rates.30
The Bill received moderate coverage in the press as senators made it explicit
that the tax reform would not end here. For example, on November 23rd, 1921, The New
York Times Reported:
TO PASS TAX BILL TODAY AND ADJOURN;
Senate Agrees to Take the Final Vote by 5 o'Clock This Afternoon.
TEMPORARY, SAYS PENROSE
He Asserts Measure Does Not Place Tax System on Stable or Scientific
Basis.
BUT DOES LESSEN BURDENS
House Prepares for Adjournment by Passing Deficiency Bill Carrying
$104,000,000. Reductions Made in Taxes.
Notice the “scientific” reference in the language of the Senators. Similarly, on
December 8th The Times printed:
MELLON CALLS FOR MORE CUTS IN TAXES;
30
Congressional Record, The Revenue Act of 1921.
-19-
Tells Congress High Surtax Maximum Burdens the Masses and Reduces
Revenues.
WANTS LOWER ESTATE LEVY
Suggests Small Tax on Specific Articles or Classes of Articles or
Transactions.
STILL OPPOSES BONUS LAW
Secretary's Annual Report Points to Economies Made and Need of
Continuing Reductions. Tax Revision Still Needed. Tax-Exempt
Securities. Destruction of Incentive. Burden Falls on the People. Free
Business Essential Sees Remedy in Lower Rates. Opposes Soldiers'
Bonus Law.
As promised, following the 1921 Bill, the Treasury continued to push for a twentyfive percent (25%) maximum surtax and a top marginal rate of thirty-three percent
(33%). Gilbert began a rigorous consultancy with T.S. Adams and Price Waterhouse
accountants George O. May and Joseph Sterret that was focused on revising the
Revenue Act of 1921. On February 17, 1923 Gilbert urged Mellon to submit another bill
to revise the surtax rates. “If the revision is not made by the present Congress, there is
almost no possibility, with a more radical Congress and the Presidential election less
than a year off…”31
Gilbert understood that LaFollette’s insurgent coalition was
increasing its power to resist tax reduction due to their success in the 1922
Congressional elections.
Throughout 1923, a tax revision committee fashioned a
complete revision of the 1921 Bill.
The underlying message remained the same,
however: reduce surtax rates.
The new tax revision received support from economist T.S. Adams, whose
career had been dedicated to the development of the progressive income tax structure.
Nevertheless, he viewed the current level of surtaxes as unsustainable. Adams argued
along lines similar to those posed by Gilbert and Mellon:
The key to tax revision – and at once the simplest and most difficult tax problem
before Congress – is the proper fixation of the upper surtax rates. It is charged
that those rates are excessive, that they practically force wealthier taxpayers to
avoid or evade the tax, that their yield is shrinking rapidly, and the current of free
investment funds has been diverted away from railroad and industrial bonds to
31
NARA, Tax – General.
-20-
tax-free securities, with consequent recession of private enterprise and a
corresponding fillip to municipal and state enterprise. 32
Adams wrote the House Ways and Means Chairman, Congressman William Green, to
argue that because of tax avoidance opportunities at both the individual and corporate
level, income tax-rate reduction was needed to save the progressive nature of the tax
structure and to continue economic recovery. The popular press closely covered the
tax bill’s progress. The New Times on November 12, 1923 headlined: “INCOME TAX
CUTS URGED BY MELLON. CALLS SURTAX A FAILURE.” The same day The Wall
Street Journal ran with “MELLON WANTS LOWER INCOME TAXES.” Business and
professional circles also supported the plan enthusiastically. On November 13, The New
York Times announced: “GLAD FOR SMALL INVESTORS: PHILADELPHIA BANKERS
SAY MELLON PLAN WILL PUT CAPITAL IN INDUSTRY,” and in a separate article:
“MELLON PLAN BOON TO INDUSTRY, FINANCERS ASSERT; TAX REDUCTIONS
THE GREATEST AID TO PROSPERITY CONGRESS COULD GIVE.
WOULD
STIMULATE BUSINESS.” On Nov. 14 The Times reported: “PRESIDENT MITCHELL
OF NATIONAL CITY AND OTHERS HIGHLY PRAISE SECRETARY’S ABILITY. SEE
BIG BOOM IN BUSINESS.” On November 22, The Times expressed the Presidents
endorsement: “COOLIDGE WILL SEND LETTER PAVING WAY FOR MELLON PLAN.”
On every one of these days the market went up.
Private and academic circles also rallied around the cause.
The Citizens’
National Committee, a nonpartisan organization formed in January of 1924 to educate
the public on “the basic facts and economic laws governing industrial activities,” became
a large promoter. The Committee consisted of leading economists Edwin Seligman,
Frank Taussig, Irving Fisher, and Roy G. Blakey, along with Saturday Evening Post
financial writer Albert W. Atwood; statistician and financial analyst Roger W. Babson,
32
Adams, pg. 529.
-21-
investment banker Otto Kahn, former Harvard University President Charles W. Elliot,
and the Committee was chaired by lawyer and war hero, General John F. O’Ryan. The
committee thoroughly endorsed the Mellon Plan as “scientific taxation.”
Such
endorsements were not limited to the academic and financial realms either. On January
1, 1924, The Times reported: “MELLON TAX APPEAL ON MENUES.” Later, O’Ryan
announced a National Tax Reduction Week beginning April 7, 1924 with planned media
events to involve the entire country. The New York Times reported that 327 movie
theaters flashed special messages about the Mellon plan across their screens
throughout the week. This tax reform was a popular revolution that came from all facets
and demographics of society.
Finally, Mellon laid out the basic idea in his book,
Taxation: The Peoples Business, which can be recognized as a clear articulation of what
is today referred to as the “Laffer Curve”: 33
33
The Laffer Curve is named after Arthur Laffer, who in the winter of 1974 drew a curve for an aid to
President Gerald Ford to show that there are always two tax rates that yield the same revenues. A tax rate
of 100 percent (100%) yields zero revenue because all production ceases in the money economy. Similarly,
a tax rate of zero percent (0%) yields no revenue because people keep 100 percent of what they produce.
The two rates are differentiated in that the former minimizes production and the later maximizes it. There is
only one tax rate for every economy that will maximize both production and revenue at once. Here the tax
system is said to be in “equilibrium.” Tax rates above this “equilibrium rate” will yield less production in the
economy and less revenue for government. Tax rates below the “equilibrium rate” will yield more production
in the economy and less revenue for government. The fact that revenue increased as the Mellon tax cuts
were implemented demonstrates that the US economy following the end of World War One was constrained
by tax rates that were above the “equilibrium rate.” The Mellon tax reform brought America “down” the
Laffer curve toward equilibrium. This concept is illustrated in the graph below:
-22-
It seems difficult for some to understand that high rates of taxation do not
necessarily mean large revenue to government, and that more revenue may
often be obtained by lower rates. There was an old saying that a railroad freight
rate should be “what the traffic will bear”; that is, the highest rate at which the
largest quantity of freight would move. The same rule applies to all private
business. If a price is fixed too high, sales drip off and with them profits; if a price
is fixed too low, sales may increase, but profits decline. 34
Taxation is the business of government. Mellon simply tried to maximize its “profits” in
the form of revenue.
Nevertheless, despite overwhelming transparency and public
support, the Mellon plan again faced resistance in Congress, especially in the Senate.
As Gilbert feared, the insurgent Republican-Democratic alliance moved to block the bill,
resulting again, in a mixed victory for Mellon’s tax reform.
On June 2, President
Coolidge, who had become President upon Harding’s death, singed the Revenue Bill of
1924 but announced:35
As I have said, the bill does not represent a sound permanent tax policy and in its
passage has been subject to unfortunate influence which ought not to control
fiscal questions…A correction of its defects may be left to the next Congress. I
trust a bill less political and more truly economic may be passed at that time. 36
The 1924 Bill reduced top surtax rates to forty percent (40%), and cut the top base
income tax rate to six percent (6%), leaving a top marginal rate of forty-six percent (46%)
down from fifty-eight percent (58%) under the 1921 bill.
More importantly though,
bracket thresholds were raised. The top marginal rate threshold was raised to $500,000
from $200,000. In the lowest bracket, income tax rates were reduced from four percent
(4%) to two percent (2%) and a new income tax bracket with a rate of six percent (6%)
was created for incomes that exceeded $4000 but were less than $8000. While its
proponents considered this bill a step in the right direction, the Mellon plan was still far
from its 1920 goals.
As economist Roy Blakey wrote: “The Federal Revenue act
34
Mellon, pg 16.
Calvin Coolidge became President on August 3, 1923 following the death of President Harding.
36 U.S. Treasury Department. 1925, Annual Report of the Secretary of the Treasury on the State of the
Finances for the Fiscal Year ended June 30, 1924, Washington, C.C., GPO
35
-23-
approved June 2nd, 1924, is not a revolutionary measure; on the contrary, it is very
similar in general character to the Revenue act of 1921.”37
Coolidge, led by Mellon and Gilbert, seized the “loss” on tax reform as a
campaign issue and described the Republican Party platform on June 11, 1924, only
nine days after signing the Revenue Bill, as a commitment to “progressive tax reductions
through tax reform…to place our tax system on a sound, peacetime basis.”
The
“scientific” language stressed as early as 1920 by Leffingwell and Gilbert and the need
for a “peacetime” tax system remained evident. These were not partisan issues. The
reaction was overwhelming. The 1924 election reaffirmed Republican control of the
White House and created strong Republican majorities in both the House and the
Senate.
President Coolidge received 2.5 million more votes than the Democratic
challenger John Davis, or the Independent candidate, Insurgent Republican, LaFollette.
Republicans received a sixty seat majority in the House and a seventeen seat majority in
the Senate. More importantly, the election ended the progressive and insurgent
Republicans’ challenge to the Republican Platform and, particularly, the Mellon Tax
Plan.38
By 1925, public enthusiasm for the Mellon Plan supported the possibility of
greater surtax reduction than proposed in 1921.
country to promote the Mellon Plan.
“Tax clubs” sprang up across the
Tax reform suddenly became a grassroots
movement. In addition, a federal surplus, which began to build in 1920, reached almost
to the billion-dollar level in 1924. Slowly, tax cuts had pulled rates down from prohibitory
levels to produce a booming economy able to pay off the war debts. The United States
economy was moving “down” the Laffer Curve.
Roy Blakey, “The Revenue Act of 1924,” American Economic Review, Vol. 14, No. 3 (Sep. 1924) pg. 475.
The author acknowledges that many other issues besides tax reform contributed to Coolidge’s and the
Republican’s success in 1924, but taxes certainly played, an important, and in the eyes of the author, a
central role.
37
38
-24-
During March, 1925, Congress authorized a Special Session to facilitate the
revenue bill in the new Congress. The final success of the Mellon Plan was a forgone
conclusion by the time the Ways and Means Committee began hearings in October,
1925.39 The Revenue Bill of 1926 passed nearly unanimously in the House by a vote of
355 to 28, and in the Senate the very next day by a vote of 61 to 10. It was the signed
into law by President Coolidge on February 26, 1926 – a date that corresponds exactly
with, and so marks the beginning, of the Coolidge Bull Market. Over the weekend, the
Dow Jones Railroad Index jumped from 107 to 120, over a twelve percent increase
(12.15%). The maximum surtax rate was reduced to twenty percent (20%) on incomes
over $100,000 from the 1924 maximum of 40% on incomes in excess of $500,000.
Base income tax rates were reduced from the two percent-four percent-six percent (2%4%-6%) progressive schedule of 1924 to a one-and-one-half percent-three percent-five
percent (1½%-3%-5%) schedule.
The new maximum marginal rate, therefore, was
twenty-five percent (25%), lower than what Mellon originally called for.40
Again, one could question the validity of this tax reduction as the top threshold
dropped considerably from $500,000 to $100,000. For this reason, some further detail is
necessary.
In addition to the reduction in income rates, the bottom threshold for
surtaxes, which began at one-percent (1%), was raised from $6,000 to $10,000.
Roy Blakey, “The Revenue Acct of 1926”, American Economic Review, Vol. 16, No. 3 (Sept. 1926), pg.
407 – 408.
40 Congressional Record. The Revenue Act of 1926, Washington: 1926 (Seventy-ninth Congress, Session I,
Chpt. 26, 27).
It is interesting that the 1926 Bill settled on a top rate of 25% on incomes over $100,000. One of the effects
of the Laffer Curve is that under complicated progressive systems, such as those that exist today, it is
difficult to actually collect more than twenty-two percent (22%) of GDP no matter what the tax rate is. Most
flat tax schemes, such as those proposed by Hall & Robbins of Stanford or Steven Forbes, fall in around
twenty percent (20%) if they keep mortgage deductions and fall off into the teens if they do not. Using a CPI
Calculator provided by the Federal Reserve Bank of Minneapolis, $100,000 in 1926 is approximately $1.1
million today. This implies real rate of less than 25% on a generally flat tax basis for the majority of tax
players, probably close to the rates proposed today by flat tax advocates in the United States and Europe
trying to maximize revenue through a scientific taxation scheme of their own.
39
-25-
Moreover, as was the case in 1924, the new tax code reduced rates in every bracket
despite lowering thresholds on the top end.41
The last Revenue act of the decade came in 1928.
The bill reduced the
corporate tax rate from thirteen-and-one-half percent (13½%) to twelve percent (12%)
but left personal rates unchanged.42
A 1929 resolution in response to the market
crashes in October lowered corporate rates one percent (1%) to eleven percent (11%)
and stopped the market decline.43 More importantly, prior to the crash, the Republican
Party reversed its political position with regard to tax reform. Influenced by a perceived
imbalanced of wealth distribution between city and farm, the Republican nominee
Herbert Hoover ran on a platform of tariff protection:
The Republican Party believes that the home market, built up under the
protective policy, belongs to the American farmer, and it pledges its support of
legislation which will give this market to him to the full extent of his ability to
supply it…It is inconceivable that American labor will ever consent to the abolition
of protection, which would bring the American standard of living down to the level
of that in Europe, or that the American farmer could survive if the enormous
consuming power of the people in this country were curtailed and its market at
home, if not destroyed, at least seriously impaired. 44
A tariff tax by its nature is a tax on international commercial transactions in the same
way that income tax, surtax and excise tax are levies against domestic transactions.
Hoover campaigned on, what can be effectively, if indirectly, understood as an antiMellon Plan platform.
With the election of Herbert Hoover, the United States new fiscal policy took hold
of the American Economy. Throughout the 1920s tax reform allowed the economy to
grow rapidly. Between 1922 and 1929, real gross domestic product (GDP) grew at an
annual rate of four-point-seven percent (4.7%) and unemployment dropped from six41
Congressional Record, The Revenue Act of 1926.
Congressional Record. The Revenue Act of 1928, Washington: 1928 (Seventieth Congress, Session I,
Chpt. 842).
43 On November 13, 1929, the day the resolution was announced by Mellon, the market stopped its decline
at 198, as measured by the DJIA, and rallied the next day to 217 and then to 228 on November 15, gaining
over fifteen percent (15.15%) in the two days. The DJIA finished the year at 239.
44 Jude Wanniski, The Way The World Works, (New York: 1978) p. 127; also see Arthur Schlesinger, History
of presidential elections, (New York: 1971), 3: 2624-40.
42
-26-
point-seven percent (6.7%) to three-point-two percent (3.2%).45 Nor was this growth
simply fixed on the high earners.
Total income grew as more people became
prosperous in the growing economy.
Between 1922 and 1928, the average income
reported on tax returns of those earning more than $100,000 increase fifteen percent
(15%), but the number of taxpayers within this bracket quadrupled. At the same time,
the number of taxpayers earning less that $10,000 fell. In the middle, the number of
taxpayers with incomes between $10,000 and $100,000 increase by eighty-four percent
(84%). It is clear that by establishing a scientific peacetime tax system, the Mellon tax
reform revived the economy by restoring the incentives to work, save, and invest, and by
discouraging tax shelters. To understand fully the economy and the success of the
1920s, however, a thorough analysis of the monetary forces at work is needed.46
45
46
U.S. Bureau of the Census, Series F1-5 and D85-86, pp. 135, 244
For a graphical description of the tax policy of the 1920s, see Appendix C.
-27-
Chapter Two:
Monetary Policy, World War One and Changes in the Price Level
Congress created the Federal Reserve in December, 1913, in direct response to
the multiple bank failures during the depression of 1907 but also in light of the tight
markets of the fall and in an effort to manage the gold standard. The establishment of a
central bank represented a compromise between opposing factions in the early twentieth
century. Opponents saw a central bank as open to political manipulation by the federal
government and vested interests of Wall Street. As a result, the system differed from
the older central banks in Europe. The United States established twelve regional banks,
each acting as a central bank in its own right, and a Federal Reserve Board, presiding in
Washington oversaw the system. The compromise between no central bank and a
single central bank was two fold: first it protected the system from being manipulated
due to over concentration and, second, it allowed the “central banks system” to meet the
varying credit needs of different parts of the country. The Federal Reserve primarily
sought to prevent financial panics, bank failures and speculation by adding elasticity to
the money supply and by acting as lender of last resort, to maintain the gold standard,
and to provide legitimate credit needs to both agriculture and business. Nevertheless,
despite all attempts to make the Reserves system apolitical, the outbreak of World War I
immediately put the system at the behest of the Treasury.47
From May 14, 1917, to April 21, 1919, the Treasury floated four Liberty Loans
and one Victory Loan to finance World War I and European recovery. All issues were at
A number of books address the history of the Fed’s formation in detail. Allan Meltzer’s A History of the
Federal Reserve, (Chicago: University of Chicago Press, 2003) , Benjamin H. Beckhart, Federal Reserve
System, (United States of America: American Institute of Banking, 1972), also see Thomas Humphrey’s
article “Monetary Policy Frameworks and Indicators for Federal Reserve in the 1920s,” Economic Quarterly,
Federal Reserve Bank of Richmond, Vol. 87, No. 1, 2001.
47
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par in denominations as low as $50.48
Banks encouraged borrowing to buy these
government obligations which could be purchased through installments over a four
month period. In total, the bond issuances attracted over 66 million subscribers. As of
October 31, 1919, after all five loans had been floated successfully; total federal debt
amounted to $26.2 billion, including prewar bonds. This sum is well above McAdoo’s
original budget estimates of just over $6 billion with half to be financed through taxation.
The four Liberty Loans and one Victory Loan alone raised over $20 billion. In an effort to
keep costs down for the government, low interest payment became a priority for the
Secretary McAdoo, who stated in 1918:
The higher the rate on Government bonds, the greater the cost to the American
people of carrying on the war and the greater will be the depreciation in all other
forms of investment securities. We cannot regard without concern declines in the
general value of fixed investments.49
The first Liberty Loan issuance sold at par with a coupon of 3.5 percent (3.5%) and
encouraged investment by offering exemptions from income taxes.
In the following
issuances the coupon, which can be thought of as the cost of financing for the
government, slowly rose as some tax-exemptions were eliminated. The third bond sold
at par with a yield of 4.25 percent (4.25%), but the forth again required substantial tax
exemptions to be sold at par. The final Victory Loan offered a choice between taxexempt 3.75 percent (3.75%) and taxable 4.75 percent (4.75%) coupon payments.
Despite the advantages of the loans, they soon began to trade at a discount. When
bonds trade at a discount to par, their yields increase, rising the interest payment due by
the government to bond holders.
In an effort to halt this rising cost of capital, the
Treasury created the War Finance Corporation to begin buying back bonds to support
the price and keep yields low.
48
Beckhart, p. 158
Annual Report of the Secretary of the Treasury on the State of the Finances for the Fiscal Year Ended
June 30, 1917 (Washington, D.C.: Government Printing Office, 1918) p. 4
49
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The huge national deficit caused the Treasury to pressure the Fed toward
accommodative monetary policy. If the Fed tried to increase interest rates by raising the
discount rate, it would adversely affect the bond markets, causing yields to increase and
making it more expensive for the Treasury to pay off the government debt. Maintenance
of interest rates at artificially low levels had the effect of increasing liquidity in the
economy and caused the commercial banking system to finance much of the deficit.
The commercial banking system’s total share of war interest-bearing debt was $7 billion
or thirty percent (30%).50
Only World War II surpassed this proportion when the
commercial banking system supported forty percent (40%) of the deficit. The extension
of commercial credit to finance the war deficit was combined with a decrease in the
reserve requirement for Federal Reserve notes and deposit liabilities of member banks
and an embargo on gold exports to keep the price of gold from falling. The Federal
Reserve encouraged this increase in credit through loans to member banks. Discounted
bills totaled $1.8 billion by the end of 1917. Discount rates were continually adjusted in
relation to coupon rates on Liberty bonds to create preferential rates for loans against
war paper. This spread between the rate at which member banks could borrow from the
Fed and the rate at which they could purchase government war debt became known as
the “gentlemen’s agreement” and encouraged member banks to borrow in order to buy
war bonds. This “gentlemen’s agreement” effectively gave the Treasury control over the
Fed’s discount rate. The surge in member-bank borrowing from the Federal Reserve
caused short term rates to increase faster than long term rates and the yield curve
inverted. Most importantly, however, World War I destroyed the years of planning to
50
Sixth Annual Report of the Federal Reserve Board (Washington, D.C.: Government Printing Office, 1920),
p. 115-117.
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keep the Federal Reserve system free from government influence and, following the
armistice in 1918, the Fed became increasingly controlled by the Treasury.51
Perhaps the most visible change in the American economy as a result of the war
was a sharp increase in prices. Between 1913 and 1917, wholesale prices rose an
astounding sixty-eight percent (68.3%).52 By 1918, wholesale prices were even higher
at eighty-eighty percent (88%) above their 1913 levels.
following the armistice in November, 1918.
Nor did prices stop rising
Wholesale prices rose almost another
twenty-two percent (21.85%) before peaking in 1920 at 121.67 percent (121.67%) above
their pre-war levels. Consumer prices followed a similar pattern, as producers pushed
rising costs onto consumers. Before the United States entered the War in 1917, retail
prices had increased just over twenty-nine percent (29.29%) during the previous four
years. By the armistice, retail prices were fifty percent (50%) greater than before the war
and by 1920 consumer prices reached a level twice as high (102%).
Moreover,
consumer prices rose much more rapidly than producer prices following the armistice,
some thirty-two percent (32.45%) as compared with the still high twenty-two percent
(21.85%) rise in producer prices. In part this is due to the fact that producer prices “lead”
consumer prices. Producer prices rose much more quickly during the war as rising
demand for raw materials drove up costs. After the armistice, these costs were pushed
onto the consumer. The end result is one that corresponds well with the data. Producer
prices spike first, followed by rapid rises in consumer prices. Even more importantly,
however, the following year, 1921, both consumer and producer prices collapsed,
dropping on a year-over-year basis ten-and-a-half percent (-10.5%) and nearly thirtyseven percent (-36.84%) respectively. The movement in consumer and producer price
indexes (retail and wholesale prices) is detailed table below:
51
52
Beckhart, p. 178-182
Computed by the U.S. Bureau of Labor Statistics (Index converted to 1913 base)
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Table 5
Year CPI (1913 = 100) % Change YoY % change PPI (1913 = 100) % change YoY % change
1913
100
100.0
1914
101.01
1.01%
1.01%
98.3
-1.67%
-1.67%
1915
102.02
2.02%
1.00%
100.0
0.00%
1.69%
1916
110.10
10.10%
7.92%
122.5
22.50%
22.50%
1917
129.29
29.29%
17.43%
168.3
68.33%
37.41%
1918
152.53
52.53%
17.97%
188.3
88.33%
11.88%
1919
174.75
74.75%
14.57%
199.2
99.17%
5.75%
1920
202.02
102.02%
15.61%
221.7
121.67%
11.30%
1921
180.81
80.81%
-10.50%
140.0
40.00%
-36.84%
1922
169.70
69.70%
-6.15%
139.2
39.17%
-0.60%
1923
172.73
72.73%
1.79%
144.2
44.17%
3.59%
1924
172.73
72.73%
0.00%
140.8
40.83%
-2.31%
1925
176.77
76.77%
2.34%
148.3
48.33%
5.33%
1926
178.79
78.79%
1.14%
143.3
43.33%
-3.37%
1927
175.76
75.76%
-1.69%
137.5
37.50%
-4.07%
1928
172.73
72.73%
-1.72%
139.2
39.17%
1.21%
1929
172.73
72.73%
0.00%
136.7
36.67%
-1.80%
1930
168.69
68.69%
-2.34%
124.2
24.17%
-9.15%
1931
153.54
53.54%
-8.98%
105.0
5.00%
-15.44%
1932
138.38
38.38%
-9.87%
93.3
-6.67%
-11.11%
1933
131.31
31.31%
-5.11%
95.0
-5.00%
1.79%
1934
135.35
35.35%
3.08%
107.5
7.50%
13.16%
1935
138.38
38.38%
2.24%
115.0
15.00%
6.98%
*Source: Bureau of Labor Statistics (www.bls.gov)
In the span of a single year, 1920-1921, wholesale prices to producers
decreased from 121.67 percent (121.67%) above their pre-war 1913 level to forty
percent (40.00%) above their prewar level, over an eighty-one percent (81.67%) decline
in wholesale prices with respect to their 1913 levels and nearly a forty percent (40%)
year-over-year deflation. The forces at work here are essential toward understanding
the following decade and the precarious position of international debts.
The traditional story, told by Milton Friedman and Anna Schwartz in their
magnum opus The Monetary History of the United States, is that the Fed’s
accommodative interest rate policy caused rapid borrowing by member banks, excess
liquidity of the dollar and, consequently, a monetary inflation caused by a surge in the
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supply of money.53
This argument relies on changes in total money supply in
comparison to changes in GDP. The classic monetarist framework argues the Money
Supply multiplied by Money Velocity equals the Price Level times GDP growth
(MV=PY).54
Friedman assumes velocity is constant and consequently argued that
increases in the money supply immediately fed through to a rising price level.55 With this
methodology, the low interest rates that encouraged member bank borrowing to finance
the war debt increased the money supply and caused a monetary inflation.
sentence, Friedman blames the Fed.
In a
Much of this argument is based around the
formation of an “elastic currency” with the development of the Fed. Prior to the formation
of the Federal Reserve there existed four types of paper money:
1.
Gold certificates - secured dollar for dollar by gold and held in the
Treasury and could only be increased/decreased with changes in the
volume of gold held in the Treasury.
2.
Silver certificates, secured dollar for dollar by coined silver and the
amount was limited by law.
3.
United States notes or “greenbacks” issued during the Civil War
originally secured by nothing other than the promise of the government
to pay but by 1914 about fifty percent (50%) were covered by gold.
The total in circulation was limited by law to no more than $346 million.
53
See Milton Friedman and Anna Schwartz, A Monetary History of the United States, (Princeton: Princeton
University Press, 1963).
54 Where M=Money Supply; V=Money Velocity; P=Price Level; Y=GDP growth. See Humphrey, 2001 for a
full description.
55 It is in this assumption that money velocity, which can easily be understood as money demand, remains
constant that Friedman and his monetarist followers falter. The tax changes documented in Chapter On that
created so much public outcry after the armistice certainly impacted the countries demand for money. As
small businesses, the group most outraged by the Revenue Bill of 1918, were driven into bankruptcy,
business transactions decreased and consequently the need for money declined. This fact, however, still
supports the idea of a monetary inflation. With money supply rising (P increasing) and velocity decreasing
(V decreasing) the inflationary effect would have been expounded. Similarly, the 1921 tax reform increased
the demand for money (V increased) which helps explain the sudden decline in prices. Of course this
analysis does not account for changes in international demand as Europe, which increasingly needed
dollars, began rebuilding their countries following the war. These international considerations and the
impact on velocity is covered later in the Chapter. The basic effect, however, is to increase the demand for
dollars (V increased), hurting the Monetarists argument.
-33-
4.
National bank notes issued by national banks and secured by
government bonds. The total amount in circulation was also limited,
only by the number of government bonds carrying a circulation
privilege.56
In 1914, before the war and the establishment of the Federal Reserve, the total paper
money in circulation was $2.56 billion, with gold certificates making up the largest
portion, about forty percent (40%) of the total supply.57
National bank notes were
second, near their maximum level, at twenty-eight percent (28%). It should be noted
that all paper was interchangeable, dollar for dollar, whether backed by metallic means
or government obligation. Moreover, the total circulation comprised of these for species
was fixed so that the supply of money could not be increased or decreased to respond to
seasonal demand changes or periods of emergency, such as war. The introduction of
the Federal Reserve Act and the creation of a fifth specie of paper money, the Federal
Reserve Note, provided a currency for emergencies and added flexibility into the
previously static system. The Federal Reserve Note is directly related to trade activity
and its issuance is intended to allow the supply of money to meet changes in short term
demand. By 1920 the total supply of paper money in circulation had risen to 4.84 billion,
nearly double the 1914 amount.58 Federal Reserve Notes, which by then made up
approximately seventy-three percent (73%) of all circulating paper, accounted for the
largest portion of this increase. Federal Reserve Notes were unique in that they could
be secured against short-term promissory notes or banker’s acceptances generated by
industrial, commercial, and agricultural transactions. This meant that, as W. Randolph
56
W. Randolph Burgess, The Reserve Banks and the Money Market, (New York: Harper & Brothers
Publishers, 1927), pg. 41-64: Chapter IV: “Changes in Currency.”
57 Burgess, p. 42
58 Burgess, p. 42.
-34-
Burgess, deputy governor under Governor Benjamin Strong at the New York Fed,
explained in 1927:
…paper used as security represents agricultural products or other goods in the
process of production, or in movement from producer to retailer, in process of
export or import, or on the shelves of retailer of wholesaler awaiting sale….The
acceptance of this kind of paper as collateral was essential in the war, and at
present it offers the most convenient form for short-term member bank borrowing
and usually represents business needs for funds as truly as paper having the
form of a business obligation.59
This new form of currency created money supply “elasticity” in that it enabled currency
expansion to meet “any conceivable emergency.” Even in 1920, when the amount of
currency in circulation reached its maximum, the Reserve Banks could have issued
another $800 million in Federal Reserve Notes before the percentage gold reserve
minimum legally set for the system would have been met.60
Another way to examine total money supply, the process used by Friedman and
Schwartz, is through total deposits plus circulating currency (M1). The total deposit
increase from before the war through 1920 moved in line with the data already
presented. Deposits increased ninety-three percent (93%) from 1914 to 1920. During
the two years after the armistice, between 1918 and 1920, deposits increased
approximately twenty-seven percent (26.54%). This increase, in turn, was driven by a
sharp increase in total outstanding loans of approximately thirty-six percent (36.42%).
The increase in loans was made possible by the preferential treatment that the Federal
Reserve gave to commercial banks in its effort to assist the Treasury in reducing the
floating government debt.61
Contemporary economists of the period, as well as by
researchers such as Friedman, Schwartz, and Meltzer of the modern period, argued that
by keeping discount rates below market rates commercial banks had economic incentive
to borrow from the Fed and lend out through the commercial paper markets, thereby
59
Burgess, p. 44
Burgess p. 45
61 This treatment, dealt with earlier in the Chapter, became known as the “gentlemen’s agreement.”
60
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increasing the money supply and driving up prices.
This relationship between the
discount rate and the yield on commercial paper is demonstrated by the graph below:
9
8
7
6
5
4
3
2
1
0
Discount Rate
Oct-22
Jul-22
Apr-22
Jan-22
Jul-21
Oct-21
Apr-21
Jan-21
Oct-20
Jul-20
Apr-20
Jan-20
Oct-19
Jul-19
Apr-19
Weighted Avg. Open Market
Rates
Jan-19
% Yield
Interest Rates (1919-1922)
L/T Gov. Bond Rates
Commercial Paper Rates
Date
The discount rate was
raised above the rate on
war bonds and long-term
treasuries. This was the
end of “preferential rates”
by the Federal Reserve,
supporting the Treasury.
Another notable point. The weighted average of all open market rates crossed below
the discount rate. The Federal Reserve then began to cut the discount rate. Under
the ideology of the Fed at this time, the rate movements needed to be initiated by the
market. The debate over this policy is extensively covered by Alan Meltzer in A
history of the Federal Reserve (2002). The policy has been blamed with causing the
Fed to keep rates too high for too long and by extension the sharp recession of 19201921.
The increase in the discount rate in November, 1919, pushed rates above the open
market rate, as measured by commercial paper, and marked the beginning of Federal
Reserve independence from the Treasury:
The disappearance of the Treasury from the long-term loan market and the rapid
reduction of its requirements for short-term accommodation foreshadows the
approach of the time when financial operations of the Government will cease to
be the important factor in shaping the Reserve Bank policies which they have
been, and the Federal Reserve Bank rates once more will be fixed solely “with a
view of aiding commerce and business.” 62
Prior to this point, the Fed was unable to increase the interest rate because of Treasury
opposition despite the strong preference of Governor Benjamin Strong and the Bank of
New York.63 There is considerable evidence of the dominating influence by the Treasury
over Federal Reserve Policy. The minutes from the September 4, 1919, meeting of the
Federal Reserve Board in Washington D.C. read:
62
Federal Reserve Bulletin (Oct. 1919) p. 910.
For a more detailed account of the debate between Benjamin Strong of the New York Federal Reserve
Bank, Secretary McAdoo at the Treasury, and the Federal Reserve Board of Governors in Washington D.C.,
see Alan Meltzer’s The History of the Federal Reserve, part 1.
63
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The Governor made a statement reviewing the conditions under which the
Federal Reserve System has been operating since the entrance of the United
States into the world war, which conditions had made it impossible for the system
to function independently of the Treasury, particularly with respect to the
determination of the discount rate…64
Moreover, Fed Board Chairman W.P.G Harding expanded on his statements before the
Joint Commission of Agriculture in 1921 following the collapse in prices65:
…if the Board had adopted that policy [of raising the discount
rate] a year
before it did, would there have been less
disturbance than we now have?
Governor Harding: That is quite probable, Senator.
Senator Lenroot: Now, why was it not done?
Governor Harding: For reasons relating to Government finance. 66
Senator Lenroot:
The Fed found itself not only handcuffed because of the Treasury’s desire to cheaply
restructure the war debt, but also it understood that this handicap hurt the economy
through increased volatility in the price level. In order to be sustainable, this argument
relies on a clear connection between money supply and the discount rate, as well as a
clear relationship between the money supply and inflation.
64
Federal Reserve Board Minutes from meeting on Sept. 4 1919. Available at:
http://fraser.stlouisfed.org/docs/MeltzerPDFs/min090419.pdf, visited on 1-March 2006
65 This collapse will be analyzed in the remainder of the chapter.
66 Benjamin Beckhart, The Discount Policy of the Federal Reserve System, (New York: Henry Hold and
Company, 1924) p. 465
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CPI
PPI
Discount Rate
250
8
7
6
5
4
3
2
1
0
1913 = 100
200
150
100
November 1919
the Fed begins
to increase
interest rates.
Sep-22
Jan-22
May-22
Sep-21
Jan-21
May-21
Sep-20
Jan-20
Sources: Bloomberg, Bureau of Labor
Statistics (BLS), National Bureau of
Economic Research (NBER)
May-20
Sep-19
Jan-19
May-19
Sep-18
Jan-18
May-18
Sep-17
May-17
Jan-17
Sep-16
May-16
Jan-16
Sep-15
May-15
Jan-15
Sep-14
Jan-14
0
May-14
50
Discount Rate (%)
CPI and PPI Changes
May 1921, Fed
Begins to cut
the discount
Rate
June 1920,
Discount Rate
Reaches its
peak of 7%
This relationship is reflected in the graph above. Wholesale prices began to
appreciate in October of 1915. At the time, the war had begun and Federal Reserve
Notes had just been introduced into the system. The rate of price increase quickened in
mid-1916 before leveling off in 1917, but continued to rise again in 1918 through mid1920.
This is consistent with supports the argument that the price increases were
caused by an increase in the supply of Federal Reserve Notes. The Federal Reserve
System conducted an accommodative “easy” money policy at the insistence of the
Treasury. Once the Federal Reserve regained its independency in November, 1919, it
began to hike rates and prices began to decline precipitously. The decline in prices did
not, however, response to the rate hikes at first.
Nevertheless, in line with the
monetarists’ argument, the decline in prices occurred with a higher interest rate,
reflecting a sharp decline in the money supply. The data and the graphical analysis both
support this argument. Total bank deposits decreased from $41.84 billion in 1920 to
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$38.93 billion in 1921, or nearly seven percent (6.93%).
Outstanding loans decreased
from $31.19 billion to $29.24 billion, a similar decline of about six percent (6.26%).67
The Fed has often been blamed for keeping rates too high for too long. As the
graph shows, the Fed kept the discount rate at seven percent (7%) for nearly a year
while prices began to decline almost immediately. The Report of the Joint Commission
of Agriculture Inquiry stated:
Notwithstanding the apprehensions of the Federal Reserve Board and Federal
reserve banks regarding the possible results in a change in policy [as regards
discount rates], the commission is of the opinion that a more liberal policy could
have been adopted in the latter part of 1920 and the early part of 1921 and that
the adoption of such a policy would have served to arrest in part the tide of
deflation and to reduce the hardships and losses incident thereto. 68
Gustav Cassel, the famous Swedish economist of the period, held similar beliefs. He
argued that the maintenance of the discount rate at seven percent (7%) for caused an
“aimless increase in the internal value of the dollar.”69 He argued that if rates had been
reduced sooner, the depression that began with the price declines in 1920-1921 could
have been abated. Instead, the rapid price decline put the country into a severe but brief
recession with unemployment jumping from just above seven percent (7.2%) in 1920 to
over twenty-three percent (23.1%) in 1921 and GDP plunging to negative 4.24 percent
(-4.24%).
Even with the implementation of a pro-growth tax reform by the Mellon
Treasury and the discount rate cuts beginning in June of 1921, which together spurred a
business expansion and caused a jump in GDP growth to seven percent (7.01%) in
1922 and over thirteen percent (13.46%) in 1923, unemployment remained high at
eighteen percent (18%) in 1922, before dropping again to its 1920 level of about seven
percent (7.2%) in 1923.70 American GDP growth can be seen in the table below:
67
All Bank Statistics, United States, 1896-1955, (Board of Governors of the Federal Reserve System, April
1959) p. 34
68 Cited in Beckhart, p. 400.
69 Gustav Cassel, Money and Foreign Exchange After 1914, (London: Constable and Co, 1922) p 236
70 Douglas, Paul H., and Director, Aaron, The Problem of Unemployment (Macmillan Company, New York,
1931), p. 28.
-39-
Year
1919
1920
1921
1922
1923
1924
1925
1926
1927
1928
1929
Average
Total
growth
(since 1919)
GDP
$70,271
71,383
68,355
73,150
82,994
85,222
87,359
93,438
94,161
95,715
101,444
Gross Domestic Product (Millions of 1929 Dollars)
YoY % Change
GDP
YoY % Change
Year
Year
1.58%
-4.24%
7.01%
13.46%
2.68%
2.51%
6.96%
0.77%
1.65%
5.99%
3.84%
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
Average
44.36%
Total
growth
(since 1929
91,513
84,300
70,682
68,337
74,609
85,806
95,798
103,917
96,670
103,736
1940
1941
1942
1943
1944
GDP
YoY % Change
112,961
126,237
122,571
121,918
126,633
8.17%
10.52%
-2.99%
-0.54%
3.72%
-10.85%
-8.56%
-19.27%
-3.43%
8.41%
13.05%
10.43%
7.81%
-7.50%
6.81%
-0.31%
Average
3.78%
2.26%
Total
growth
(since 1929
24.83%
Yet this “monetarist” explanation of the price level rise and fall is not the only
theory purporting to describe the transition to the post war economy. Jude Wanniski in
The Way the World Works, has emphasized that the United States never left the gold
standard and the value of the dollar, therefore, remained legally fixed at $20.67/ounce.71
Consequently, Wanniski argued that it is difficult to see how the value of the dollar
declined in a monetary inflation. Instead, he asserted that increased war demand drove
up the value of goods and services in what can be thought of as a war-demand driven
inflation. It was not that the dollar became less valuable while goods and services
remained steady, but that certain goods and services became more valuable, while the
dollar remained steady, fixed at $20.67/oz of gold. This is a subtle argument, but an
important one. Following the armistice this war demand collapsed and prices weakened.
This war-demand-explanation is also supported by the fact that both the consumer price
index and producer price index were rudimentary at the time and heavily weighted
71
This rate actually did deviate slightly from this rate as monetary policies changed. Data pulled from
Bloomberg indicates that from 1920-32 the dollar-gold price did move between $20.58/oz to $21.32/oz. In
addition, just before the devaluation to $35/oz, gold was trading at $26.33/oz., well above its legal parity.
Moreover, it should be noted that from the period 1917 – 1919, the U.S. enacted a “gold embargo” that
suspended outflows of gold. While not technically a departure from the gold-standard, it did protect the
existing gold-dollar parity, while also allowing the money supply to expand.
-40-
toward basic commodity prices, those most susceptible to major swings in supply and
demand. In fact, regular publication of the national CPI did not occur until 1921 after the
price declines.
The United States Bureau of Labor Statistics conducted surveys of
family expenditures in 92 industrials centers from 1917 to 1919. The various weights
used to construct the CPI reflected the relative importance of goods and services
purchased by consumers. The CPI was made up of the following components: Food,
clothing, rent, fuels, house furnishings, and miscellaneous other goods with food getting
the heaviest weighting. More importantly, all CPI data prior to 1921 was based on
estimated city averages back to 1913 using food prices only. This is important because
food prices are traditionally some of the most volatility and hence will tend to
overestimate measurements of aggregate price movements for the earlier period.72
One way to test Wanniski’s theory is to examine relative price changes for select
goods. In a monetary inflation, the price of all goods and services should appreciate
proportionally, or at least roughly proportionally, as the value of the dollar decreases.
Conversely, if the price rise is driven by changes in demand, individual prices should
move separately. A closer look at price changes reveals some surprising support for
Wanniski’s argument. The following table is useful:
72
Bureau of Labor Statistics, Handbook of Methods, chapter 17, found at:
http://stats.bls.gov/opub/hom/homch17_d.htm#17a – visited on 2-March 2006
-41-
Changes in post-war commodity prices in 1919
Commodity
Change since 1913
Farm Products
116%
Foods
94%
Cloths and Clothing
110%
Fuel and Lighting
78%
Metals and Metal Products
70%
Building Materials
73%
Chemicals and Drugs
69%
House Furnishings
65%
Farming Commodity Index
121%
Industrial Commodity Index
85%
Wholesale Index
99%
Retail Index
75%
This table reflects that prices did not move uniformly as is expected under a monetary
inflation. In the aggregate, the wholesale price indexed measured prices at ninety-nine
percent (99%) higher than in 1913 while retail prices were seventy five percent (74.75%)
higher. Moreover, there is a marked difference between the increase in the industrial
commodities index (PPI for industry inputs only) and the farming commodity index.
Industrial commodities in 1919 were about seventy-seven percent (77.31%) higher than
before the war while farming commodities were an astounding 107.78 percent
(107.78%) higher. Nor did prices rise uniformly between 1919 and 1920, the year of
greatest inflation that, according to the Monetarist explanation, was caused by Fedinduced artificially low interest rates.
The greatest price increase was in building
materials, which was 193 percent (193%) higher than before the war.
This fact is
important because in the four years 1914-1918, building materials appreciated only
seventy-three percent (73%). The dramatic rise in the 1919-1920 year, however, is not
surprising as the sudden need to rebuild postwar Europe drove demand for building
materials.
Prices sky rocketed.
Wanniski’s explanation does not seem out of line
considering the disparate increases of the different product sectors.
Similarly, the price declines in 1921 were not uniform or regular but varied
significantly between industries.
-42-
Changes in post-war commodity prices in 1922
Commodity
Change since 1913
Farm Products
22%
Foods
31%
Cloths and Clothing
76%
Fuel and Lighting
95%
Metals and Metal Products
12%
Building Materials
57%
Chemicals and Drugs
24%
House Furnishings
78%
Farming Commodity Index
31%
Industrial Commodity Index
46%
Wholesale Index
39%
Retail Index
69%
Farm prices, which had aggregated the highest before the war, were depressed the
most and remained only twenty two percent above their pre-war level. Moreover, this
decline in farm prices continued throughout the decade as economies of scale and new
technologies enabled more production in the farming sector. Notably, fuel and lighting
actually increased from seventy-eight percent (78%) above pre-war levels in 1919 to
ninety five percent (95%) in 1922. A similar situation arose in house furnishing prices.
These price rises are not in line with a sudden and terrific monetary deflation. In fact,
except for the producers of metal products and chemicals and drugs, the decline in
prices occurred most acutely in the agriculture industry undergoing tremendous
changes.
As the Federal Reserve Bulletin explained, farm price volatility is not
surprising:
The reason for this situation is not hard to find. Foodstuffs are peculiarly subject
to the vicissitudes of the market. A relatively slight surplus will result in a
disproportionately sharp drop in prices. On the contrary, scarcity in relation to
demand will bring about a sharp rise. It was natural, therefore, that during the
war prices of foodstuffs should advance out of relation to many other
prices…Following the war the great increase in foreign demand for American
products, coupled with active domestic buying, gave an enormous impetus to the
rise in agricultural prices.73
By 1920 agricultural exports began to subside.
73
Federal Reserve Bulletin, (Federal Reserve Board of Governors: Washington D.C., 1922), pp. 262-263
-43-
Finally, a closer look at aggregate price level change provides further evidence to
the war-demand-inflation hypothesis.
As the table below demonstrates, price level
change began to decline substantially in 1917 and then stabilized between June, 1918,
and November, 1919, at a range between two and three percent inflation on a year-overyear basis (2-3% YoY).
CP YoYI
PPI YoY
Discount Rate
12 per. Mov. Avg. (PPI YoY)
12 per. Mov. Avg. (CP YoYI)
CPI and PPI Changes
60.00%
8
7
40.00%
5
Jul-22
Jan-22
Jul-21
Jan-21
Jul-20
Jan-20
Jul-19
Jan-19
Jul-18
Jan-18
Jul-17
Jan-17
Jul-16
Jan-16
Jul-15
Jan-15
-20.00%
4
Jul-14
0.00%
Jan-14
% Change
20.00%
3
Discount Rate (%)
6
2
-40.00%
1
June 1920, both
Retail and
Wholesale
Prices begin to
fall dramatically.
-60.00%
Sources: Bloomberg, Bureau of Labor
Statistics (BLS), National Bureau of
Economic Research (NBER)
August 17th, 1917
The Wholesale
Price inflation
began to subside
dramatically.
November 1919
the Fed begins
to increase
interest rates.
0
June 1921, Retail
and Wholesale
Prices both
bottom
In November 1919, when the Fed first began to tighten money supply by
increasing the discount rate from 4.5 percent (4.5%) to 4.75 percent (4.75%), the
inflation rate actually began to climb significantly. This is counter-intuitive under the
Monetarist framework. The annual rate of inflation, as measured by the wholesale index
(PPI), rose from 2.5 percent (2.5%) in November, 1919, to a staggering 24.5% in April,
-44-
1920. During the same period, the discount rate went from 4.5 percent (4.5%) to six
percent (6%). This rise in the rate of inflation is interesting because prices had been
relatively stable for the previous year during which the Fed kept the discount rate low at
the insistence of the Treasury. According to the monetarist argument, prices should
have continued their increase as excess liquidity added to the system. Instead, inflation
only increased again when the Fed began to raise the discount rate, which in their
framework should extract liquidity. Not until the final rate hike of one full percentage
point from six percent (6%) to seven percent (7%) in May, 1920, did prices being to
decrease.74 This rate hike, on top of the post war slow down, also drove the national
economy into depression, consequently causing prices to plummet as demand was
destroyed.
Viewing the period as a whole, it appears obvious that the rate of inflation
was initially driven up by increased demand from Europe created by the war. This war
demand peaked in 1917, just after the United States declared war against Germany, and
then began a continual decline until January 1922.
It is important to note that the
economy was healthy in 1919, with inflation running at approximately 2.5 (2.5%)
annually, unemployment at 6.9 percent (6.9%), and GDP growing at an annual rate of
10.8 percent (10.8%) or 8.3 percent (8.3%) in real terms.75 Prices were admittedly
higher than their 1913 levels, but their rate of increase had slowed substantially. The
economy as a whole in 1919 was stable until the Fed began to hike rates.
Measures of industrial production cycles also corroborate a war-demandinflation-hypothesis. Industrial production peaked in 1917 and then steadily declined
In light of this data, an argument can be made that the Fed’s rate hikes were actually inflationary in the
short term as transactions were pushed forward as businesses tried to get “ahead” of future rate hikes.
Eventually, however, the rate hikes drove the economy into recession, destroying demand and in this way
causing prices to decline. In this case the Fed’s inflation fighting policy was very inefficient indeed. It can be
equated to “running a treadmill backward,” as it does indeed stem inflation, but only by wrecking the
economy.
75 GDP data from Miron, Jeffrey A. and Christina D. Romer. "A New Monthly Index of Industrial Production,
1884-1940." Journal of Economic History Vol. 50, no. 2 (1990): 321-37; inflation rate from data gathered by
BLS, unemployment information taken from SOURCE: Douglas, Paul H., and Director, Aaron, The Problem
of Unemployment (Macmillan Company, New York, 1931), p. 28.
74
-45-
thereafter, a pattern consistent with the increase in prices and eventual stabilization as
discussed above.
Industrial production measures are generally used to describe
economic health and to indicate changes in aggregate demand. Industrial production
declined some thirty-one (31%) between 1918 and 1920. This decline reflected the shift
from a war economy to a peace economy. The rise and decline in prices can therefore
be explained by changes in world demand. The largest annual increase in industrial
production was a thirty-two percent (32%) surge in 1917, which marked the height of the
war and the precise peak of the annual rate of inflation. What is more, a thirty-two
percent (32%) year-over-year increase is huge and could certainly cause a large spike in
prices.
Just as important, industrial production slowed by over twenty-one percent
(21.2%) in 1920, which undoubtedly contributed to the decline in prices. See graph and
table below:
Industrial production (1916 =100)
160
140
1916=100
120
100
80
60
40
20
0
1916
1917
1918
1919
1920
Year Industrial production (1916 =100)
% YoY
1916
100
1917
132
1918
139
1919
137
1920
108
Source: Miron and Romer (1990, table 2).
32.00%
5.30%
-1.44%
-21.17%
-46-
In addition, by looking at unemployment data and the annual change in GDP, it
becomes clear that the American economy began a significant slow down after 1919.
The graphs below are helpful:
YoY % GDP growth
20.00%
10.00%
0.00%
-10.00%
1919
1920
1921
1922
1923
1924
1925
1926
1927
1928
1929
-20.00%
-30.00%
-40.00%
GDP
CPI
PPI
Average CPI/PPI change
Unemployment Rate
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
1919
1920
1921
1922
1923
1924
1925
1926
1928
1929
Sources: Bloomberg, Bureau of Labor Statistics (BLS), National Bureau of Economic
Research (NBER) Douglas, Paul H., and Director, Aaron, The Problem of
Unemployment (Macmillan Company, New York, 1931), p. 28.
According to GDP data, growth began to decline as early as 1919, well before
the prices began to decrease. Once growth turned negative in early 1921, however,
both unemployment and prices began to react negatively.
Unemployment rose
dramatically as prices fell and the nation proceeded into a horrible recession. More
importantly, however, the official beginning of this recession is January 1920, well before
-47-
the decline in prices which began six months later in June of 1920. These statistics
support the argument that declining demand instigated the collapse of prices and that at
least part of change in money supply was due to the resulting decrease in the demand
for dollars.
Despite all this data, which seems to support both the Monetarist theory of
inflation and the war-demand-inflation hypothesis, it is, nonetheless, difficult to gauge
what drove aggregate price movements. Was money supply out of control as Friedman
and Schwartz claim or was the increase in the money supply only the natural adjustment
to the increased level of business and higher demand created by the war? In economist
jargon, was money supply really endogenous?
Did the dollar’s value fluctuate
dramatically relative to steady commodities prices causing prices to change or did the
dollar remain fixed, as the legal gold parity of $20.67/oz. of gold implies, while other
goods became more or less expensive relative to the dollar according to their own
supply and demand issues that caused prices to change?
This controversy is illuminated by considering the accepted definition of inflation
and deflation. Since the 1920s economists have defined inflation and deflation through
reference to price indexes of one sort or another.
Under this definition, inflation is
defined as a rise in prices, while a deflation is defined as a decline in prices. In general,
these same price level definitions have been used thus far in this analysis. However, the
classical definition of inflation is a decline in the value of currency and that of deflation is
a rise in the value of currency. In 1817, David Ricardo addressed this very issue:
It has been my endeavor carefully to distinguish between a low value of money and a high
value of corn, or any other commodity with which money may be compared. These have
been generally considered as meaning the same thing; but it is evident that when corn
rises from five to ten shillings a bushel, it may be owing either to a fall in the value of
money or a rise in the value of corn…The effects resulting from a high price of corn when
produced by a rise in the value of corn, and when caused by a fall in the value of money,
are totally different.76
76
David Ricardo, Principles of Political Economy and Taxation, (New York: Prometheus Books, 1996) p. 101
-48-
The real question of importance, therefore, is: Did the value of gold decline or the value
of goods and services rise?77
Clearly, the answer is both. The surge in demand created by the war certainly
played a hand in causing prices to rise. At the same time, the suspension of the goldstandard throughout most of Europe caused instability in the world monetary system.
The huge increase in the supply of money and the manipulation of the discount rate by
the Treasury through controlling the Federal Reserve also had an impact on prices. In
fact, it appears that the money supply increased in 1920 as world demand began to
decline. The two forces were likely working in tandem to create the volatility in prices
that defined the maladjustment of the post-war period. This confusion between money
supply and real economic demand can be inferred through the decline in industrial
production, matched by the increasing money supply. The relationship is shown below:
160
$40.00
140
$35.00
120
$30.00
100
$25.00
80
$20.00
60
$15.00
40
$10.00
20
$5.00
0
$0.00
1916
1917
1918
Industrial production (1916 =100)
1919
Billions of $
1916=100
Industrial Prodcution
1920
Stock of money, M2 (billions of dollars)
To estimate the importance of money supply in explaining the changing prices of
the period, regression analysis can be used.78
77
It appears that, ceteris paribus, the
The dollar was pegged to gold, so a change in the value of the dollar was only possible if the value of gold
changed.
-49-
growth in deposits during the twenty two years 1914 – 1935 can explain just over fifty
percent (50.4%) of the movement of wholesale prices and about fifty-five (55.4%) of the
movement in retail prices. These results are significant to a high degree (1% confidence
level) and have been corrected for normal time series problems.79
It should be
acknowledged that changes in money supply are not exogenous from changes in
demand, however. The entire idea behind the creation of the Federal Reserve System
was to make the dollar supply more elastic to adjust to changes in the demand for
money. World War I was a large shock to the world economy and it drastically changed
the demand for and flow of goods and services. Some of the increase in money supply
was in response to the changed world economy and wartime demand. Nonetheless, it is
useful to see what the money supply alone implied for prices. The table below shows
the annual year-over-year change in the CPI predicted by changes in the money supply.
78
See Appendix D for the data output.
Durbin Watson test for autoregressive problems turned up negative. In addition, it was found that total
growth in deposits and price level are co-integrated, meaning they move together over time. This result was
found using the dickey-fuller test for cointegration.
79
-50-
Date
1914
1915
1916
1917
1918
1919
1920
1921
1922
1923
1924
1925
1926
1927
1928
1929
1930
1931
1932
1933
1934
1935
CPIYoY
1.01%
1.00%
7.92%
17.43%
17.97%
14.57%
15.61%
-10.50%
-6.15%
1.79%
0.00%
2.34%
1.14%
-1.69%
-1.72%
0.00%
-2.34%
-8.98%
-9.87%
-5.11%
3.08%
2.24%
Actual vs. Predicted Price Level Changes
CPIhat
+/DepositsYoY PPIYoY PPIhat
2.46%
-1.45%
5.56%
-1.67% 2.72%
1.27%
-0.27%
3.87%
1.69% 0.78%
11.78%
-3.86%
18.81%
22.50% 17.89%
9.38%
8.05%
15.40%
37.41% 13.98%
3.58%
14.39%
7.15%
11.88% 4.53%
9.02%
5.55%
14.88%
5.75% 13.39%
5.68%
9.92%
10.14%
11.30% 7.96%
-6.33%
-4.17%
-6.93%
-36.84% -11.60%
2.69%
-8.84%
5.89%
-0.60% 3.09%
3.92%
-2.14%
7.64%
3.59% 5.09%
4.23%
-4.23%
8.08%
-2.31% 5.60%
4.91%
-2.57%
9.05%
5.33% 6.71%
1.39%
-0.25%
4.04%
-3.37% 0.98%
1.50%
-3.20%
4.20%
-4.07% 1.15%
0.33%
-2.06%
2.54%
1.21% -0.75%
-1.29%
1.29%
0.23%
-1.80% -3.40%
1.08%
-3.42%
3.60%
-9.15% 0.46%
-5.04%
-3.94%
-5.10%
-15.44% -9.49%
-15.84%
5.97%
-20.45%
-11.11% -27.08%
-7.45%
2.34%
-8.53%
1.79% -13.42%
6.59%
-3.51%
11.43%
13.16% 9.44%
5.85%
-3.61%
10.38%
6.98% 8.23%
+/-4.38%
0.92%
4.61%
23.44%
7.35%
-7.64%
3.34%
-25.25%
-3.68%
-1.50%
-7.91%
-1.38%
-4.35%
-5.22%
1.96%
1.60%
-9.61%
-5.94%
15.97%
15.20%
3.72%
-1.25%
With the understanding that changes in the money supply will reflect some of the
changes in business activity noted above, we can still examine the impact on prices of
money supply alone. In reference to the above table, it becomes clear that retail prices
should have risen at a much lower rate during World War I, and through 1920.
Moreover, the decline in prices in 1921-1922 appears overstated. The 6.5 percent (6.5%) retail price decline in 1922 should actually have been a 2.7 percent (2.7%) rise in
prices according to changes in bank deposits. There is a similar result on the wholesale
side of the equation. Prices increased during, and immediately after the war, at a much
faster pace than is predicted by money supply growth alone. In addition, the rapid and
dramatic decline in prices is not effectively explained by tighter money policy. The highs
and lows of annual price changes cannot be explained by changes in the money supply
alone. Clearly other forces, such as declining world demand for American goods and
services in the early 1920s (perhaps driven by Germany’s reparation problems) played
-51-
an important role in influencing retail prices both up and down to extreme levels. 80
Without regard for the multi variable causes of the price decline, the fact that wholesale
prices decreased by thirty-seven percent (-37.22%) and retail prices by sixteen percent
(16%) in two years, dramatically worsened the already problematic indebtedness of
Europe. Suddenly, the complicated allied debts needed to be paid back in dollars worth
much more than they were worth when they were borrowed. The world economy stood
at a precarious position.
80
The German reparations will be examined in detail in Chapter Three.
-52-
Chapter 3:
International Finance – World War One and the International Debts in
the 1920s
The First World War completely changed the structure of the international world
order. It created a decisive transition from the old guard order of the post Napoleonic
era to the modern era of American dominance. From a political point of view, the war
ended civilization’s experiment with Monarchy as a form of National government
organization. Facades of the old regime still remained in Britain, Italy, and Japan, but in
reality the world’s long experience with monarchial forms of government had ended.
The three major European empires were in ruins: the Hohenzollern’s in Germany, the
Romanov’s in Russia, and the Habsburg’s in Austria-Hungry. Similarly in the MiddleEast, the Ottoman Empire had fallen.
England too began losing its dominance to
America.
The most important economic fact born out of the Great War, however, and that
which is focused on for the purposes of this paper, was the scale of international war
debts. Prior to the War, the United States was a debtor nation, borrowing foreign money
throughout its history. This debtor position was balanced by European’s large holdings
of American assets: stocks, bonds and real estate. World War I caused European
nations to begin to liquidate their American assets by selling off their American bonds,
property holdings, and stock investments in order to raise revenue for the war. Before
the war, American bankers borrowed heavily and became indebted to British bankers to
the extent of approximately $500 million. 81 As war became increasingly inevitable, the
81
Benjamin Haggot Beckhart, Federal Reserve System, (United States of America: American Institute of
Banking, 1972), p. 135 “Funds were customarily borrowed in the spring to pay for the seasonal rise in
imports and were repaid in the fall thanks to the seasonal outflow of cotton and wheat. This practice
enabled American banks to sell sterling at its seasonal high and buy it at its seasonal low. It had the
important secondary consequence of reducing seasonal fluctuations in sterling exchange.”
-53-
Bank of England on July 27th 1914, ceased to accept time bills of exchange. While this
policy protected the Bank of England from potential losses on bills contracted with
parties in hostile nations, it also meant American bankers could not replenish their
deposits by buying sterling bills as was the normal practice. As a consequence, the
British Pound became scarce, relative to demand, and its price rose from $4.8820 on
July 25th to 4.9200 and then to 5.5000 by August 1. The New York Times reported “The
price of foreign exchange, the practical suspension of business on the London Stock
Exchange, and the settlement day were named as being responsible for the inability to
do business with England.”82
Quickly gold began to flow to the United States as sterling crossed above the
“gold-export point.” Under normal circumstances gold flows would balance the system,
by driving the dollar and sterling toward equilibrium, but as was reported on the front
page of The New York Times: “KAISER CALLS RUSSIA TO HALT WITHIN 24 HOURS;
IF SHE REFUSES GERMANY, TOO, WILL MOBILIZE; ENGLAND AND FRANCE
READY, BUT HOPE FOR PEACE; AUSTRIANS DRIVE SERBIANS BACK FROM
BELGRADE,” the world was on the eve of a confrontation of enormous scale.
83
It
seemed as if all of Europe began to dump its holdings of American Securities in
preparation for war. On July 31, after approximately 1.3 million shares were sold on July
30 in a collapse not seen on the Exchange since the bank failures and panic of 1907, the
New York Stock Exchange was closed.84 The decision came after a meeting at J.P.
Morgan and Company that included Benjamin Strong Jr., then Vice President of Bankers
Trust who would go on to become governor of the Federal Reserve Bank of New York
following the war. The exchange did not reopen on an unrestricted basis until April 1,
82
The New York Times, July 25, 1914
The New York Times, June 30 1914. This confrontation was certainly not assumed in the contemporary
mindset, but clearly circumstances were anything but “normal.”
84 “Bankers Here Confer on War” New York Times, July 31 st 1914, p. 1
83
-54-
1915,85 eight months later. By November, the premium on sterling had disappeared and
the pound was pegged to the dollar through J.P. Morgan & Co. at $4.76, based on the
new British gold-exchange point, where it remained until March 21, 1919, when the peg
was removed.
As the war got underway, the United States became the primary supplier of both
money and goods to the rest of the world. There was a dramatic, immediate and rapid
expansion of demand for foodstuffs, chemicals, explosives, and industrial products,
which led to an equally rapid increase in American production along with general prices.
Between 1913 and 1917, production, as measured by economist Wesley Clair Mitchell,
rose fourteen percent (14%). Exports rose 260 percent (260%) from $2.4 billion to $6.2
billion. Imports rose nearly 100 percent (100%) from $1.8 billion to $3.0 billion. Over the
three years ending June 1917, shipments of wheat increased by 680 percent (680%),
wheat flour by 200 percent (200%), meat by 240 percent (240%), sugar by an
astounding 3,380 percent (3380%) and zinc by 3,700 percent (3700%).86 The calendar
year 1915 marked the first time in history that exports outpaced imports in excess of
one-billion dollars.
By 1916, exports exceeded imports by more than three-billion
dollars. The rising importance of net-exports is illustrated in the table below:
Year
1913
1914
1915
1916
Table: Net Exports (in $ millions)
Exports
Imports
2.5
1.8
2.1
1.8
3.6
1.8
5.5
2.4
Net
0.7
0.3
1.8
3.1
Source: Lewis, C. America's Stake in International Investments, Brookings Institution,
Washington D.C., 1938
“New York Stock Exchange Special Closings, 1885 – present” available at
http://www.nyse.com/pdfs/closings.pdf or via www.nyse.com. Visited on March-25, 2006. The exchange
was re-opened for bond trading with special price restrictions as early at November 28th 1914. A limited
number of stocks were re-opened to trading, again under price restrictions, on December 12th and then all
stocks were opened with price restrictions on December 15 th.
86 74 Cong. 2 sess., Munitions Industry, Hearings on S. res 206 before Senate Special Committee
Investigating the Munitions Industry (1937), Part 26, p. 7934. The increases for individual commodities
reflect both price increases and increased volume of exports.
85
-55-
This surging foreign and domestic demand for goods caused the fourteen percent (14%)
up-tick in production as the war progressed, but once production reached capacity,
prices were adjusted aggressively upward as has been discussed in Chapter 2.
At first the world paid for this surge of goods from the United States by canceling
the some $400 million in debts of American banks and businesses.87
As the War
escalated, however, Europeans sold bonds to Americans in order to finance the rising
costs. The Allies began to export gold, float loans and either sell holdings of American
assets or collateralize those assets for additional loans. During the first months of war
the State Department was reluctant to lend to the European belligerents. U.S. Secretary
State, William Jennings Bryan, stated in a letter to J.P. Morgan & Co., “in the judgment
of this government loans by American banks to any foreign nation which is at war are
inconsistent with the true spirit of neutrality.”88 Yet banks soon found a way to appease
the government and continue to extend loans to Allies. In October, 1914, National City
Bank extended a five-million dollar loan to Russia and a ten-million dollar loan to France
by accounting for the loans as credits extended in connection with legitimate trade. In
early 1915, J.P. Morgan & Co. made similar open “credit” issuances for the British and
French governments. By June, 1915, following Secretary Bryan’s resignation from the
State Department, the distinction between credits and loans was abandoned by the
American government and in October a $500 million “loan” was offered to the American
public by J.P. Morgan on behalf of the British and French governments. By April 5,
1917, as the US Congress was declaring war on Germany, the outstanding debt to
European belligerents from private American banks and businesses totaled $2.6715
“Yearbook of the United States Department of Agriculture,” 1915 (Washington D.C., Government Printing
Office, 1916) p. 10.
88 Munitions, Hearings, Part 30 pp. 9644-45; can also be found at
http://www.lib.byu.edu/~rdh/wwi/1915/usloans.html , visited on 26th-Feb.-2006 At the time, Byran was
heartily against entering the war and was battling with Wilson, who wanted to join the allies.
87
-56-
billion.89 Approximately eight-four percent (84%) of these foreign dollar loans were for
national governments, with the rest for provincial and municipal government as well as
corporations.
Regardless of the issuer, however, the purpose of the loans was
consistent: to finance the expanding purchase of American goods. The distribution of
these credits can be seen below:
Table: Credit Extension before entrance into WWI
(in $ millions)
Long Term
Borrowers
Short Term (<5years)
(>5years)
France and Great Britian
$2,101.6
N/A
Russia and Italy
$75.0
N/A
Canada and Australia
$135.1
$269.6
Subtotal
$2,311.7
$269.6
Germany
$7.5
N/A
European neutrals
$7.0
$5.0
South America
$27.5
$28.3
Other Latin Americas
$6.7
-$3.5
Other Countries
$7.8
$3.9
Total
$2,368.2
$303.3
Source: Lewis, C. America's Stake in International Investments,
The United States gained over $1 billion in gold at $20.67/oz, giving America
approximately a third of the world’s reserves.90
Benjamin Strong, now head of the New York Federal Reserve Bank, summarized
the transition of financial power from London to New York in a speech given at the
London Clearing Banks dinner on March 10, 1916:
This War might entail tremendous sacrifices upon the English people, including
the bankers, and if it involved the surrender of some of the world’s banking to
New York, at least we believed that it would be surrendered upon fair terms, on
fair competition, and that some of us felt that if this great sacrifice had to be
made, England, which had established the standard of commercial honor and
integrity throughout the world, would rather relinquish this great trust into the
hands of those who spoke their own language and who believed in the same
institutions, and had, I hoped, the same high ideals of honor and integrity. 91
89
Lewis, C. America's Stake in International Investments, Brookings Institution, Washington D.C., 1938.
Equivalent to approximately $45.287 billion in 2005.
90 “Banking and Monetary Statistics 1914-1970” Section 14: Gold, (Board of Governors of the Federal
Reserve System, April 1959)
91 Benjamin Strong, Diary, March, 10th, 1916, reporting speech at London Clearing Banks dinner, File
1000.2, Benjamin Strong Papers, Federal Reserve Bank of New York.
-57-
The war reversed the financial world order with New York, not London, at its center.
This fact was enforced when Congress declared war against Germany in April, 1917,
and the American government began to lend directly to the Allied nations. The United
States became, for the first time in its history, a net creditor rather than a net debtor
nation. Treasury Secretary McAdoo authorized the first “Liberty Loan Act” on April 24,
1917, allowing the Treasury to purchase foreign governmental obligations for countries
at war with Germany.
The following day, McAdoo wrote a check to the British
government for $200 million. By the end of the year, $3.7 billion had been issued to the
Allies.
The Liberty Loan Act limited the maximum amount of credit that could be
extended to foreign governments to $10 billion.
By the end of 1922, after the last
government check was paid out on May 29 under a credit established much earlier, total
outstanding US government credit to the “rest of the world” was $9.387 billion. 92 Of this
$9.387 billion in outstanding debt, $4.137 billion was extended to Britain, $2.933 billion
to France, and $1.648 billion to Italy. The total extent of the war debts was astounding.
Germany was easily the largest debtor with eleven creditors, while the U.S. was the
largest creditor with sixteen debtors. Britain and France had seventeen and ten debtors
apiece, while even the small net debtors, such as Czechoslovakia, Hungary, and
Bulgaria, were each under obligation to nine or ten creditors.93 When reconstruction
loans are included France’s combined public debt to the United States reached $3.5
billion. Total public credit extended by the United States at the end of the war, including
war reconstruction loans, was at least $12 billion. 94 The entire world was interconnected
by this complex network of obligations and much of the risk had been sold to the
American people through the capital markets.
92
Combined Annual Reports of the World War Foreign Debt Commission, Fiscal Year 1922-26, Washington,
Government print. office., 1927. Equivalent to $97.166 billion in 2005 dollars.
93 H.G. Moulton and L. Pasvolsky, War Debts and World Prosperity (Washington D.C., The Brookings
Institute: 1932) p. 5
94 Lewis, p. 368, 375; Derek H. Aldcroft, From Versailles to Wall Street, (Los Angeles: 1977) p. 78 – 80
-58-
In addition, debt came from the private sector to help recapitalize Europe, further
involving American businesses.
Agricultural output was far below pre-war levels in
Europe and capital equipment and transportation systems had been run down or
destroyed. The continent in particular was in desperate need of food, raw materials and
manufactured goods, but had no foreign exchange with which to purchase them. On
January 12, 1920, The New York Times reported:
URGES PRIVATE LOANS TO HUNGRY EUROPE: ECONOMIC
ASSOCIATION COMMITTEE SAYS CHAOS MUST BE AVERTED, EVEN FOR
SELFISH REASONS.
“Without food and raw materials,” says the committee’s report, “Europe may fall
into chaos which may react upon us, industrially and perhaps politically. Europe
must have our goods and to get them she needs our credit.”
“But for purely selfish reasons we must lend. In order to balance our
international debts and credits, the courses before are to curtail exports, increase
imports or to lend.”95
Members of the committee referred to in the article included Thomas W. Lamont of J.P.
Morgan & Co., David Friday of the University of Michigan, A. Barton Hepburn of the
Chase National Bank, F.W. Taussig of the Tariff Commission and of Harvard University,
and Elisha M. Friedman of the War Finance Corporation.96
Between 1919 and 1920, continental Europe imported $17.5 billion worth of
goods, while only exporting $5 billion. The majority of the financing came from loans for
reconstruction, of which at least eighty percent (80%) came from the United States. For
example, starting in 1919, Baldwin Locomotive Works sold $11.6 million worth of
engines to Belgium. Baldwin Locomotive and American Locomotive companies sold
engines to Poland, Rumania, Argentina, Mexico, China, and Columbia. By the end of
1922, Baldwin, American, and Standard Steel held over thirty million dollars worth of
foreign treasury notes. American Engineers and construction companies in the U.S.
also received large contracts from overseas, often doing work on credit because
95
96
The New York Times, January 12th, 1920, pg. 2
As an aside, A. Barton Hepburn graduated from Middlebury College in 1911.
-59-
Europeans did not have the dollars to pay.
For example, in 1920 the American
International Corporation Stone & Webster group, along with Ulen Contracting Co,
received $2.253 million in Bolivian government notes for the construction of sanitation
works in La Paz and Cochabamba.
These bonds were then publicly sold to the
American public in 1921. While not directly related to reconstruction in Europe, these
investments in South America and elsewhere reflect the increasingly international scope
of American financing. The world debt structure became increasingly entangled among
many different nations, but always included the United States government and, more
importantly, its people and businesses as its center. The same group also received a
seven billion dollar deal to build a railway 128 miles long paid for with eight percent (8%)
Bolivian government bonds. In China the Federal Telegraph Company was contracted
to build radio stations in 1921 and were paid with eight-percent (8%) Chinese
government securities worth $6.5 million.97 Besides dollar loans, three other forms of
foreign assets were acquired by Americans following the war. Quotas on treasury bills,
issued in dollars by the British and French governments were absorbed by New York
companies. Huge blocks of foreign currency loans and shares of foreign corporations
were brought to America for sale between 1920 and 1924. Unsold portions of loans
from Britain, Argentina, Australia, Brazil, Colombia, Dutch East Indies, Japan, Palestine,
Peru, and Rumania all found markets in the United States. Purchase of foreign stock by
Americans totaled no less than $67 million. Short term credits were also extended to
foreign governments and companies by American banks and businesses. Outstanding
credit amounted to between $600 million and $1 billion by the close of 1924.98
Before the war, in 1914, American investors held less than $1 billion in foreign
securities. By December 1924, private American holdings amounted to approximately
97
98
These numbers indicate fair value not market value.
Lewis, p. 360 - 375
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$4.6 billion, roughly 5.4 billion when including short-term credits. When combined with
the aggregate government holdings of foreign obligations of $11.9 billion, the real picture
of America’s risk exposure to the “rest of the world” becomes apparent. In only ten
years, the United State government and its citizens had acquired at least $17.3 billion
worth of foreign securities, an amount fifteen times as great as that accumulated during
the preceding 130 years.
America’s position in the world financial network was
extraordinary. In affect, America was funding the purchases of its own goods abroad by
extending new credit lines so that the rest of the world could then meet the interest and
principle payments due from the previous American loans extended during the war. The
importance of a sound repayment system for inter-allied war debts was increasingly
essential to avoid world wide economic disaster.
On top of this, Britain, which was the single largest debtor to the United States
with a total $4.7 billion debt to the United States, was due an additional $11.1 billion from
the rest of Europe.99 It is important to realize that much of this Allied debt, especially in
the case of England, was in the form of worthless Tsarist bonds. The size and scope of
the Russian debt is unaccounted for, although in the case of Britain, it was carried for a
number of years on the official books as an unfunded obligation of more than one-billion
pounds sterling or $4.86 billion at an exchange rate of $4.86/pound. This number,
however, is likely understated.
Beginning with the budget of 1918-19, the British
Chancellors of the Exchequer followed the practice of counting debts due from Allies at
one-half of their face values.100 In consequence, defaulted Russian debt may have been
in the order of $9 billion for Britain alone. According to a letter from British Secretary of
State for Foreign Affairs, Arthur J. Balfour, to the French ambassador in London,
Derek H. Aldcroft, From Versailles to Wall Street, (Los Angeles: 1977) p. 78 – 80; Jude Wanniski, The
Way The World Works, (New York: 1978) pg. 117
100 F.W. Hirst and J.E. Allen, British War Budgets, 1926, p. 204-205. Also see Moulton, War Debts and
World Prosperity, p. 110.
99
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Britain’s total loans to her Allies were more than double her borrowings from the United
States.
This horribly entwined nature of the debts was disastrous with Britain and
France owing the majority of debt to the United States and with the “rest of the world”
owing just as much or more to Britain and France. In effect America’s exposure to credit
risk was leveraged like never before.
Total inter-Allied war debts amounted to
approximately $26.5 billion, owed almost exclusively to the United States and Britain,
with France as the largest net debtor.101
To make matters worse, the Allies forced Germany to agree to approximately
$33 billion in reparations through the Treaty of Versailles.102 Article 231 of the Treaty of
Versailles, the “war guilt clause,” held Germany solely responsible for the “loss and
damages” suffered by the allied forces, including calculations for veterans’ pensions. In
essence, the Allies sought to have the Germans pay off their debts.
From their
perspective, Germany had remained mostly unharmed from the war, which was fought
almost entirely on French soil.
The sum of $33 billion was estimated to be seven
percent (7%) of prewar German GNP, not an obnoxious amount.103 Even those who
disagreed encouraged a quick ratification of the Treaty. Benjamin Strong, for example,
reasoned that the continuation of a technical state of war would cultivate persistent
uncertainty about European conditions among American businessmen and financiers.104
Such uncertainty would discourage private American investment, which Strong saw as
the only possible road to long term reconstruction.
As was established above, the
American people did play a significant role in rebuilding Europe. The unreasonableness
of the German reparations was thought of as a temporary and acceptable “imperfection.”
101
Aldercroft, p. 79
In 1921, the Reparations Comission announced the sum of German reparations, totaling $132 billion gold
marks plus a variable payment equal to twenty-six percent (26%) of Germany’s exports.
103 Wanniski, p. 128
104 Benjamin Strong, for his part, opposed the Carthaginian peace, but supported instead a more moderate
reparations agreement and a cancellation of the Allied debts.
102
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Some of Germany’s negotiating economists also advised a quick acceptance of the
Treaty. Carl Melchior of M.M Warburg & Co argued,
We can get through the first two or three years with the aid of foreign loans. By the end
of that time foreign nations will have realized that these large payments can only be
made by huge German exports and these exports will ruin the trade in England and
America so that creditors themselves will come to us to request modification.105
Regardless of Germany’s ability to pay, the principal beneficiaries of these
reparations were Britain and France.
The United States did not claim a share.
Indirectly, however, America assumed most of the risk because of the extensive
indebtedness of Britain and France to the United States. Moreover, officially the United
States denied any connection between the reparations and the war debts. While it might
have simplified the process if America accepted payment directly from Germany, the
United States refused to entertain such an idea.106 As a result, both Britain and France
began payment of war debts on schedules lasting until 1984 and 1987 respectively. All
the strings of the international monetary system were attached and entwined. A house
of cards was slowly being built with American at the top with the longest way to fall.
Initially Germany did meet its obligations, but its ability to do so rapidly
deteriorated by the end of 1921. Germany had made an initial payment of $250 million
financed simply by printing reichsmarks and using them to buy foreign currency. This
was a pure monetary inflation.
The market was flooded with money without any
increase in the underlying economy. The excess liquidity in the absence of any real
growth created a sharp rise in prices.
The obligation to make cash payments led the
government to begin selling large blocks of paper marks to foreigners, exporting almost
entirely Germany’s foreign exchange and gold reserves depleting the base for its
currency.
The German government simply printed money to pay off its debts, and
Viscount Edgar Vincent D’Abernon, An Ambassador of Peace, (London: 1929) Vol. 1, p. 194, Readers
should also acknowledge the importance place on trade, particularly the ability to export for debtor nations,
in paying off debts. This would come to be the source of anxiety about the American Smoot-Hawley tariff bill
in 1929.
106 Fearon, p. 82
105
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created the hyper-inflation of 1922-23. Total reichmark supply came to four-quintillion
(RM 4,000,000,000,000,000,000) before stabilizing at one-trillion paper marks to one
gold mark.
All internal debt was inflated away, but the international reparations
remained the same, as they were denominated in gold reichmarks.107
By January, 1923, the Reparations Commission realized that Germany was in
default.
The Allies hand was forced and a new reparations scheme needed to be
established.
A Reparations Commission created two committees of “non-political”
experts to examine possible solutions.
The committee in charge of creating a new
payment schedule was headed by Chicago banker Charles C. Dawes. In April, 1924,
the Dawes committee presented the “Dawes Plan” to the Commission, which accepted it
and put it into action in September 1924. It reduced annual payments to one-billion
marks for the first year, rising to 2.5 billion marks per year over a period of four years. In
addition, the Reichsbank, Germany’s central bank, was reorganized under the
supervision of an “Agent General for Reparations.” This Agent was S. Parker Gilbert,
who was then undersecretary to Andrew Mellon in the US Treasury and the real
mastermind of the “scientific taxation” put into place throughout the 1920s in America.108
Finally, as a part of the plan, American banks underwrote an international loan of 800
million gold marks that was floated to help Germany readjust from hyperinflation and
rejoin the now U.S.-led gold standard. The plan restored confidence in the German
system and large amounts of capital began to flood the German market through foreign
direct investment (FDI), enabling reparation payments to run smoothly. With German
payments made in full between 1924 and 1925, Britain and France paid their debts to
the United States. The fragile system wavered but the Dawes plan kept it standing for
the time being. This “repayment,” however, was essentially financed, first by the
107
108
Wanniski, 129
See Chapter One for a full account of the Mellon tax reform and Gilbert’s role therein.
-64-
American banks through the Dawes loan, and then by the American people when the
loan was securitized and sold through the capital markets. The necessity of restoring
Germany’s payments can be perceived in the words of Charles Evans Hughes,
Secretary of State, who told Poincaré regarding the Dawes Plan: “Here is the American
policy. If you turn this down, America is through.” Hughes went on to stress that the
Coolidge administration backed the plan so devoutly because the United States was
“vitally interested [in] economic recovery abroad.”109 The reasons for this “interest” are
obvious. A European economic failure would collapse the world financial system and
America would tumble from its position atop the delicate system.110
With the execution of the Dawes plan and the restoration of the German
currency,
Americans became
increasingly optimistic about foreign investment
opportunities on a whole. The higher yielding issuance of foreign obligations gained
favor on Wall Street. Loans for “productive purposes,” for highways, railways, public
utilizes, sanitation works, apartment houses, school, churches, etc., all flooded the
American market between 1925 and 1929. According to testimony before the Senate
Committee on Finance, there were twenty-nine representatives of American banks
bidding for loans to Columbia’s national government alone. Thirty-six were recorded
competing for a city of Budapest loan and fourteen for a loan issued by Belgrade.111 It
was not only banks that were investing abroad with increasing optimism.
The big
American construction companies began to finance public works abroad. Ulen and Co.
financed and built public works throughout Greece in Athens and Piraeus. They also
built stockyards, tramways, gas and waterworks systems in Warsaw, Poland as well as
instigated projects in Turkey, Chile, and Colombia. Warren Bros. began building roads
109
Houghton Diary, August 20, 1924, file 176-27, Houghton Papers.
Fearon, p. 82; Aldcroft, p. 84-86; Wanniski pg. 129; Frank Costigliola, Awkward Dominion, (London:
Cornell University Press, 1984) p. 114-116
111 72 Cong. I session, Sale of Foreign Bonds or Securities in the United States, (1932), Hearings on S. res.
19 before Senate Committee on Finance, p. 1324.
110
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in Argentina, Chile, Colombia, Cuba, and Guatemala.
A loan was extended to the
Uruguayan city of Montevideo to extend a seacoast boulevard, develop beach front and
widen streets. Loans such as these created a huge market for American goods and
services abroad and drove both U.S. and foreign economic growth.
Road building
contracts created demand for steam shovels and grading machinery as well as for
cement and asphalt. Sanitation, gas and waterworks systems created demand for metal
piping and plumbing. Railway development called for steel production, engines and
cars. Foreign employment of American engineers increased. Lending helped spur on
other parts of the economy too, although less directly.
Commodities of all kinds
boomed. This economic boom, however, was created by importing international risk and
selling it to the American people through the financial markets.
The public readily understood this aggressive foreign investment and perceived
its risks. Thomas W. Lamont of J.P. Morgan & Co. advised against “indiscriminate
lending and borrowing,” Which he perceived amongst his peers and competitors. On
October 13, 1927, Agent General for Reparations, Gilbert, issued a public warning
against further loans to Germany. Nevertheless, Americans continued to invest abroad,
particularly in Germany where investment in excess of repayments amounted to $379.2
million in 1927-1929.112 In total, Americans floated $5.1 billion of foreign dollar loans in
the United States by 1929. The yearly breakdown of net American foreign investment is
shown below, followed by a breakdown by country. In the 1920s, Germany, the nation
at the very heart of the international debt structure, became the largest international
borrower of American credit by a factor of more than two. This was the only way, bar a
large increase in German exports, that Germany could continue to pay its reparations to
England and France who in turn could then repay the United States.113
112
113
Lewis, p. 380
Lewis, p. 393
-66-
Table 3
Foreign Investment
(in $millions)
Year
1925
$712.5
1926
$686.0
1927
$1,010.7
1928
$677.2
1929
-$101.0
1930
$537.0
1931
-$176.4
1932
-$284.3
1933
-$308.1
1934
-$539.2
1935
-$230.9
Source: Lewis, p. 393
Table 4
Country
Germany
Canada
Italy
Australia
Chile
Argentina
Brazil
Colombia
Japan
Poland
-67-
Table 4
Foreign Investment
(in $millions)
$842.5
$370.8
$297.7
$217.6
$184.2
$180.2
$178.0
$150.8
$148.2
$102.1
Chapter 4:
Federal Reserve Policy after 1921 and the Era of Price Stability
Price levels stabilized following the dramatic inflationary, then deflationary,
movements during and immediately following the war.114 By 1922, both wholesale and
retail prices had found a new level, and the Fed had lowed the discount rate back to 4.5
percent (4.5%), precisely where it was before the rate hikes began in November 1919.
The following two graphs help illustrate the price level for this period. The first shows
prices relative to their pre-war, 1913, level through the end of 1929.
The second
demonstrates the annual rate at which prices changed following their post-war
adjustment.
114
These movements are covered in detail in Chapter Two.
-68-
CPI
PPI
Discount Rate
250
8
7
6
5
4
3
2
1
0
1913 = 100
200
150
100
50
Sources: Bloomberg, Bureau of Labor
Statistics (BLS), National Bureau of
Economic Research (NBER)
January 1920,
official
beginning of
economic
contraction
July 1924,
official end
of economic
contraction
July 1921,
official end
of economic
contraction
May 1923
official
beginning of
economic
contraction
Jan-29
Jan-28
Jan-27
Jan-26
Jan-25
Jan-24
Jan-23
Jan-22
Jan-21
Jan-20
Jan-19
Jan-18
Jan-17
Jan-16
Jan-15
Jan-14
0
Discount Rate (%)
CPI and PPI Changes
November
1927, official
end of
economic
contraction
August 1929,
official
beginning of
October 1926
economic
official
contraction
beginning of
(Great
economic
Depression)
contraction
CPI YoYI
PPI YoY
Discount Rate
12 per. Mov. Avg. (PPI YoY)
12 per. Mov. Avg. (CPI YoYI)
CPI and PPI Changes
60.00%
8.00%
7.00%
40.00%
5.00%
Jul-22
Jan-22
Jul-21
Jan-21
Jul-20
Jan-20
Jul-19
Jan-19
Jul-18
Jan-18
Jul-17
Jan-17
Jul-16
Jan-16
Jul-15
Jan-15
-20.00%
4.00%
Jul-14
0.00%
Jan-14
% Change
20.00%
3.00%
2.00%
-40.00%
1.00%
-60.00%
0.00%
Sources: Bloomberg, Bureau of Labor
Statistics (BLS), National Bureau of
Economic Research (NBER)
-69-
Discount Rate (%)
6.00%
These graphs illustrate a number of important points. First, the second graph
indicates that prices were relatively stable after the price declines during 1921-1922.
Wholesale prices oscillated between +/- 5 percent (5%) while retail prices were more
stable. On the whole, prices trended down slightly, with wholesale prices 5.2 percent
(5.2%) lower in 1929 than in 1923. Second, both graphs show that the Fed was relatively
active in moving the discount rate in response to economic activity. The Fed cut rates
after the beginning of a recession and raised them during the periods of strong growth.
Various factions within the Federal Reserve coarsely debated Federal Reserve
policy throughout the 1920s.
The resulting strategy was the result of a monetary
learning process, while two separate theories struggled for dominance.
With the
collapse of the international gold standard in World War I, two divergent views emerged
within the Fed concerning the appropriate role of monetary policy.
New York Fed
Governor, Benjamin Strong, who increasingly became the “face of the Fed” in the 1920s,
argued for price stability and the use of open market operations. Until Strong’s death in
1928, open market operations offset gold inflows and stabilized the level of bank
reserves. An opposing view, taken by the Federal Reserve Board under the influence of
Adolph C. Miller and economist W.W. Stewart, supported the “real-bills” doctrine which
advocated discount rate changes rather than open market operations. This doctrine
argued that changes in the discount rate should be determined on a discretionary basis.
This “soft” rule for monetary policy held that credit should be extended or withheld based
on the extent of “unsound” credit within the banking system. That is, so long as money
was being extended into “real” business activity as opposed to “speculative” activity, the
discount rate need not to be changed.115
Under the guidance of economist Irving Fisher of Yale University, an active group
of private individuals, including economist John Commons, began to form “Stable Money
115
Fearon 76-85; Alan Meltzer, The History of the Federal Reserve, Vol. 1 (London: 2003) Chapt. 4
-70-
Associations” in order to lobby for price level stability.116 Fisher was one of the first
economists of what is now called the “monetarist” school. During the same time, in
Congress, a number of politicians representing agricultural states began to focus on
price level stability as well. During this period American farmers suffered from lower
and lower prices. In 1926, the advocates of stable money, led by Representative James
Strong of Kansas, introduced a bill that required the Federal Reserve to make price
stability its principal goal.
Hearings were held during 1926-27 and in 1928.
John
Commons and Irving Fisher argued in support of the “Strong Bill,” as it came to be
called, pointing to Governor’s Strong success in stabilizing the price level by stabilizing
bank reserves after 1922.117 The bill sought to establish the price level policy of the New
York Federal Reserve under Benjamin Strong throughout the entire system.
Governor’s Strong’s policy of open market operations and price stability was
formed through a process of trial and error. The impact of open market operations on
the money supply was discovered accidentally following the 1921 recession. Prior to
1922 Federal Reserve banks executed open market operations in an uncoordinated
manner through the independent action of individual Federal Reserve officials, who
regarded the Reserve System banks more as a source of revenue than as a monetary
tool for regulating reserves and controlling the money supply. The sharp decline in
member-bank barrowing from 2.8 billion immediately after the war to $1 billion in 1922
occurred as a result of the sharp recession of 1921.118 Higher interest rates during the
recession attracted an inflow of gold stock as foreigners liquidated their borrowings,
increasing gold reserves by $800 million.
The simultaneous slowdown in business
Fisher, Irving, “Discussion by Professor Irving Fisher.” The Annals of The American Academy of Political
and Social Science, (January 1934), pp. 150-151
117 Readers should realize the “Strong” bill was named such because of Rep. James Strong who proposed
the bill, not Fed Governor Benjamin Strong who supported it.
118 Beckhart, 1972
116
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activity caused a rapid decline in circulating money totaling approximately $1.1 billion. 119
As borrowing decreased and the economy slipped further into recession, the discount
rate was allowed to come down from its high of seven percent (7%) in May 1921. It
continued to be cut throughout the remainder of 1921 until the rate reached four percent
(4%) in July 1922.120 The combination of a decline in borrowing and rates began to
erode the earnings of the Reserve banks. Net earnings in 1922 were 61% lower than in
1921.121
The banks that suffered the worse were those in metropolitan areas,
particularly the New York City and Chicago Reserve banks.
Strong described the
situation during the Strong Bill hearings before Congress in 1926:
…in the latter part of 1921 and early 1922, the member banks had liquidated so
large a portion of their discounts [borrowings] at the reserve banks that there was
some concern felt by some of the Federal reserve banks as to their earnings…I
think I should state very frankly to the committee that many directors, of many of
the reserve banks, strongly held the feeling that a part of their duty was to earn
enough to pay expenses…122
In response to these circumstances, Strong initiated a policy at the New York
Fed began of purchasing government obligations. Other reserve banks acted similarly,
but all purchases were done individually and according to each bank’s own initiative.
Significantly, a need for income, not business activity, motivated these purchases. 123
The Treasury complained about these actions because of the effect on interest rates,
which made it difficult for the Treasury to determine the appropriate coupon for the
issuance of new debt. During the period, Federal Reserve holdings increased 85.1
119
Banking and Monetary Statistics (Washington, D.C.: Board of Governors of the Federal Reserve System,
November 1943), p. 369; and Federal Reserve Bulletin, 1923 – cited liquidation of foreign borrowings as
cause of gold stock increase.
120 NBER, SERIES: 13009, can be found at:
http://www.nber.org/databases/macrohistory/contents/chapter13.html?tools=printit visited in 4th March 2006.
121 Ninth Annual Report of the Federal Reserve Board Covering Operations for the Year 1922 (Washington,
D.C.: Government Printing office, 1923) pp. 18-25
122 Stabilization, pt. 1. Formal title of hearings before the Committee on Banking and Currency, House of
Representatives, 69th Cong. 1st Sess., Washington, D/C: Government Printing Office, March, and April 1926,
pg. 309
123 Operation of the National and Federal Reserve Banking System, Hearings before a Subcommittee of
the Committee on Banking and Currency. U.S. Senate, 71st Cong., 3rd sess. Pursuant to S. Res. 71
Appendix, Part 6. Federal Reserve Questionnaires (Washington D.C.: Government Printing Office, 1931)
pp. 799 – 811.
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percent (85.1%), with the majority of the increase coming in short term Treasury
Securities.124 Strong again commented in 1926:
So that in that period [1921] the reserve banks, being autonomous and having
the power to invest money, were making considerable investments in the market,
buying bills and buying Government securities. It was found that in that actual
execution of the orders, and in the effect upon the price of Government securities
in the market, there seemed to be some cause for complaint in the Treasury. 125
In response, Strong formed a committee (OMIC) of regional Fed governors to coordinate
purchases of government bonds. He explained:
…So, in May of 1922, at a meeting of the governors of the reserve banks, it was
decided to get some sort of supervision of the way this was done, so as to satisfy
the Treasury and equally so as to have more orderly procedure. A small
committee was appointed to deal with the matter…126
Carl Snyder, a statistician and economist under Governor Strong at the Federal Reserve
Bank of New York from 1920 to 1935, attributed Strong’s monetary policy to Strong’s
experience in 1921 and 1922. Snyder argued that Strong believed that it was the open
market purchases of government obligations in 1921, albeit done arbitrarily at the time
and for reasons of financing only, that actually brought the economy out of recession:
Towards the end of 1921 several Reserve Banks found themselves facing a
deficit…So to acquire some earning assets, they began considerable purchases
of government securities. Within six months the fall in prices had stopped,
business began to recover and confidence returned. A…result which did not
escape the attention of careful observers, and most noticeable of Governor
Strong.127
Synder goes on to attribute Strong’s reaction to the economic slowdown in 1924
to his experience in 1921. Synder stated “in 1924, not as a means of meeting expenses
but as a deliberate policy” Governor Strong advocated a lowering of the discount rate
and heavy buying of government securities.128 The OMIC used short term market rates
and discount window borrowing activity to estimate whether money supply met money
U.S. Monetary Policy and Financial Markets, chapter 2: “The Federal Reserve and U.S. Monetary Policy:
a short history,” Federal Reserve Bank of New York, p. 22. Total holdings of treasury securities increased
form $234.1 million to $433.4 million..
125 Stabilization, pt. 1, pg. 309
126 Stabilization, pt. 1, pg. 309.
127 Carl Synder, Capitalism the Creator. (New York: the Macmillan Co, 1940) pg. 226
128 Snyder, p. 277.
124
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demand.
The large open market purchase beginning in December, 1923, and
continuing through September, 1924, represented the first joint investment strategy of all
the Federal Reserve Banks directed solely towards influencing economic conditions.
The result, when paired with the news of tax reform in the 1924 budget, was only a
shallow recession, as the economy quickly recovered. These actions can be seen in the
first graph at the beginning of this chapter,. Note that the discount rate was lowered in a
series of rate cuts from 4.5 percent (4.5%) in April, 1924, to three percent (3%) in
August. Total Federal Reserve holdings increased 304.3 percent (304.3%), the vast
majority of which came through the purchasing of treasury securities.129 The economy
began to recover in July, 1924. The connection between open market operations and
the discount rate for the remainder of the decade is outlined in the table below. The Fed
continued to purchase securities during economic slowdowns, accompanied by cuts in
the discount rate, and the Fed continued its practice to sell securities during economic
expansions.
129
U.S. Monetary Policy and Financial Markets, p. 22, source: Federal Reserve Bank of New York.
Holdings of treasury securities increased from $133.6 million to $540.2 million.
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Open-Market Operations, 1922-1929
Operation: Operations: NewYork Federal
Purchases (in Sales (in
Reserve Discount
Period
$mlns)
$mlns)
Rate
Jan. 1922 - May 1922
$365
1-Jan-1922 4.50%
22-Jun-1922 4.00%
June 1922-July 1923
$494
23-Feb-23 4.50%
1-May-24 4.00%
Dec. 1923 - Sept. 1924
$469
12-Jun-24 3.50%
8-Aug-24 3.00%
27-Feb-25 3.50%
Nov. 1924 - March 1925
$212
8-Jan-26 4.00%
23-Apr-26 3.50%
April-1926
$63
13-Aug-26 4.00%
August 1926 - Sept. 1926
$37
5-Aug-27 3.50%
May 1927 - Nov. 1927
$288
3-Feb-28 4.00%
Jan. 1928 - Aug. 1928
$497
18-May-28 4.50%
13-Jul-28 5.00%
Aug. 1928 - Dec. 1928
$358
Jan. 1929 - July 1929
$480
July 1929 - Oct. 1929
$269
9-Aug-29 6.00%
Source: The timing of policy operation except those for 1928 and 1929 are
taken from Operations of the National and Federal Rerserve Banking
Systems. Subcommittee on Banking and Currency. U.S. Senate. 71st
Cong. 3d Sess. 1931 (Washington, D.C.: Government Printing Office) p.
803. The data given are monthly average of daily data, except for April 1926
which are end of the month data.
It should also be noted, that during all these periods of recovery (1921, 1924,
1927),
dramatic reform of the tax system was being signed into law by Congress.
These tax reforms increased the demand for money. The Fed, in turn, responded to the
demand by purchasing government securities and lowering of the discount rate to
increase the money supply in order to avoid changes in the price level. Money demand
is often forgotten in the historical account of this economic period, despite the fact that
the Federal Reserve System was established to respond to these very changes in dollar
demand. Certainly both the tax reforms (Chapter 1) and the actions of the Fed worked
in tandem to help resurrect the economy which began to pick up substantially after the
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Productio
1921 recession. The economy boomed beginning as early as 1924 and continued to
expand until the beginning of the Great Depression in June 1930.130
The official beginning of the 1923-24 contraction occurred in May, 1923. Shortly
thereafter, Governor Strong began to notice the slow down as he observed mounting
“pressure for loan liquidation,” by which he meant that businesses were going
bankrupt.131 Strong aimed to create “a somewhat lower level of interest rates in this
country at a time when prices were falling generally.” He believed that this policy would
promote the flow of funds to foreign markets and further the resumption of gold
payments to Britain. Part of this crisis can be attributed to the Fordney-McCumber Tariff
which was signed into law on September 19, 1922, to replace the Emergency Tariff Act
of 1921. The tariff raised rates to approximately where they were prior to the rate
reductions that were achieved in the 1913 Underwood Tariff. While this increase was
not as onerous as what was to come at the end of the twenties, the increase in tariff
rates did make it more difficult for Europeans to meet their reparation and debt
repayment obligations. For this reason the tariff increase marked a step in the wrong
direction. Strong observed this fact, noting that the increased tariff barriers made it
difficult for the European nations to conduct the necessary trade to pay off their debts.
With the barrier to trade established, the only way to avoid recession in the US and to
sustain the repayments of the European Allies was through lowering domestic interest
rates and encouraging an outflow of American capital abroad. In effect, the United
States had to lend more money overseas so the rest of the world could continue to buy
The “Great Crash” of the stock market in October 1929 is often cited as the beginning of the Great
Depression. Marking the beginning of the depression to October 1929, however, is problematic. The
economy was still growing strongly in late 1929 despite a mild slow down in industrial production and other
indicators of economic health. The stock market also rallied off its lows of 198 in November when the
Treasury announced a one percent (1%) corporate income tax cut. By year end the market was in the low
200s and rallied all the way up to 298 before declining again in June. After June, 1930 both the economy
and the market continued to spiral down. The, albeit brief, recovery following the crash makes this later date
a more proper end for the “booming twenties.”
131 Stabilization, pt. 1, 1926, p.336)
130
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American goods and services, receiving American dollars to pay off debts while at the
same time keeping the American economy afloat.
As a result of the open market
purchase and the subsequent lowering of the discount rate the pressure for loan
liquidation was relaxed, a market was created for the flotation of foreign and domestic
security issuances, sterling rose in the exchange markets and business recovered. The
increasingly fragile international financial web was sustained for the time being.
The year 1927 is often pointed to as one of the most crucial to understanding the
proceeding “bubble” in the stock market and the crash in late 1929. GDP growth slowed
from nearly seven percent (6.9%) on an annual basis in 1926 to less than one percent
(0.77%) in the fiscal year 1927. The official beginning of the slow down is October 1926.
As in 1924, the Fed moved to purchase securities and lower rates to assist business
recovery. Federal Reserve security holdings increased almost seventy-eight percent
(77.9%) from $695.8 million to $868.9 million.132 In addition, as Bankers’ Acceptances
actually declined during the period, the increase in Fed holdings came completely from
purchases of government securities, which amounted to a total of $288 million from May
through November, 1927 (see earlier chart). It has been argued by Allan Meltzer in The
History of the Federal Reserve and Benjamin Beckhart in The Federal Reserve System
that the open market operations between May 11th and November 16th created a rapid
increase in money supply and a reduction in the gold stock.133 This had the effect, it is
argued, of reducing both short-term and long-term interest rates and resulted in
increased speculative lending through security loans and investments by memberbanks. In particular, they point to the growing importance of time deposits and the
corresponding credit expansion into more long-term lending, which increased the
velocity of money in the economy The result was a growing irrational bubble in the stock
132
U.S. Monetary Policy and Financial Markets, p. 22, source: Federal Reserve Bank of New York
See chapter three in Metlzer’s A History of the Federal Reserve (Chicago: University of Chicago Press,
2002, pg. 65-135.
133
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market, which, according to this argument, “burst” when the Fed reversed policy and
raised the interest rate, stemming the speculative lending.
Friedman and Schwartz
similarly have argued that the Fed was in a precarious position. On the one hand,
setting lower rates to help faltering businesses, and on the other trying to discourage
speculation on the stock market. In other words, they argue that while the stock market
was inflating, the economy was not, stating: “Federal Reserve policy was not restrictive
enough to halt the bull market yet too restructure to foster vigorous business
expansion.”134
While this view of the stock market and the economy may or may not have been
the case, as will be addressed in Chapter Five, these commentators also point to
international factors as the primary motive behind the rate cuts. Instead of trying to help
businesses recover in the United States, Strong pressured the Fed to lower discount
rates to help his friends at the European central banks. Under this view, discount rates
were made “artificially” low in 1927.
In particular, appeals came from the Bank of
England, which was attempting to reestablish the gold standard at the pre-war parity,
and the Bank of France, which was attempting to rejoin the gold standard in 1927. By
lowering rates and expanding the money supply in the United States, sterling
strengthened as gold flowed out of the United States and into France and England.
Moreover, Governor Strong robustly supported the reestablishment of the international
gold standard, stating in 1926:
I really have a feeling in my own mind that the prosperity of our country is so
wrapped up in general world prosperity that…the best that we can do for our
people is to try in a any way that we can to maintain these markets on which our
prosperity so largely depends…I earnestly believe that the greatest service that
the Federal reserve system is capable of performing to-day in this matter is to
hasten…monetary reform in the countries that have suffered from the war. 135
134
135
Friedman and Schwartz, Chpt.9: “The Great Contraction.”
Stabilization, pt. 1, 1926, p. 518
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This quotation also illustrates the point made in Chapter Three about U.S. credit risk.
American prosperity increasingly relied on European economic success and the ability to
pay off debts. The importance of these international factors is also clearly documented
in the papers during this period. The front page of The New York Times reports on
March 4 1927:
BANK OF ENGLAND HEAD SEES REICHBANK CHIEF; BERLIN DENIES
VISIT CONCERNS THE STABILIZATION OF THE FRENCH CURRENCY.
Then on the front page of the June 15, 1927 edition:
OLD WORLD BANKERS TO SEE STRONG HERE; NORMAN, SCHLACHT
AND RIST OF BANK OF FRANCE COMING FOR CONFERENCE.
PROBABLY EARLY IN JULY PROBLEMS OF STABILIZATION OF FOREIGN
FINANCIAL AFFAIRS TO BE DISCUSSED.
Then again on page one of June 29, 1927:
OLD-WORLD BANKERS BEGIN PARLEYS HERE: GOVERNORS OF BANK
OF ENGLAND AND REICHSCBANK ARRIVE AND JOIN FRENCH OFFICIAL.
TAKEN TO FEDERAL RESERVE. CONVERSATIONS WITH STRONG TO
INCLUDE MONEY RATES AND GOLD SHIPMENTS. STRICT SECRECY
OVER ALL. QUARTER OF VISITORS NOT REVEALED – NORMAN AND
SCHACHT CLOSE COMPANIONS ON VOYAGE.
Meetings took place from July 1 through July 8 when France pledged to formally rejoin
the gold standard the following month.136
statements made by the Federal Reserve banks in replies to a questionnaire
transmitted by the United States Senate in early 1931 indicate the 1927 open market
purchases were driven by seven factors:
First, to assist European countries in the
purchase of American agricultural products; second, to strengthen the foreign
exchanges; third, to preserve the gold standard in Europe; fourth, to facilitate flotation of
foreign bonds in the American market; fifth, to stimulate a business recovery; sixth, to
initiate discount rate reductions; and finally, to check the decline in commodity prices.
Clearly international factors played the dominant role.
Moreover, the same
questionnaire provides the observed consequences: foreign exchange rates improved;
136
See The New York Times, pg. 1 July 8th 1927
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floatation of foreign bonds were encouraged; gold export movement was induced; the
gold standard was maintained abroad; domestic production improved; interest rates
declined; wholesale prices stabilized; and finally, the banks noted a “stimulation of
speculative activity.”137
The following activity of the Federal Reserve also draws attention to Friedman
and Schwartz’s argument. Both in 1928 and 1929 open-market holdings were reduced
in the first half of the year and then increased in the second. From January 1928
through August the Fed sold $497 million worth of open market securities. Then from
August through December, the Reserve banks bought back $358 million of securities on
the open market. With the turn of the New Year, the Fed began to liquidate its holdings
again, selling $480 million worth of securities from January 1929 through July. Then, as
if like clockwork; the Fed bought back $269 million in securities beginning in July ending
in October when the market “crashed.” This chaotic, even schizophrenic, credit policy at
the Fed is what led Friedman and Schwartz to their somewhat contorted conclusions
about stock market inflation in light of economic deflation.138
It also indicates the
conflicting views that existed within the Fed about the appropriate policy action.
The view that open market operations should be used as a countercyclical tool to
control monetary conditions gained favor as the 1920s progressed, but debate for procyclical policies based on the demand for credit for commercial activity, such as the real
bills doctrine, continued.
In addition, even those that argued that open market
operations and discount rate changes should be used to moderate business cycles in a
counter-cyclical fashion feared such policy might impart an inflationary bias to the Fed.
On the one side was Governor Strong in New York, working with Montagu Norman of
the Bank of England and Charles Rist of the Bank of France to reestablish the worldwide
137
Hearings before the Subcommittee of the Committee on Banking and Currency, United States, Seventyfirst Congress, Third Session, Pursuant to S. Res 71, Part VI, pp. 795-96.
138 Friedman and Schwartz, Chpt.9: “The Great Contraction.”
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gold standard and promoting open market operations within the US to keep prices
stable. On the other was Adolph Miller of the Fed Board of Governors who promoted the
“real bills doctrine.” In the 1928 Strong Bill hearings, Miller criticized the validity of the
assumption that credit changes could impact business activity rather than vice versa:
One of those assumptions is that changes in the level of prices are caused by
changes in the volume of credit and currency; the other is that changes in volume
of credit and currency are caused by the Federal reserve policy. Neither of those
assumptions is true of the facts or the realities. They are both in some degree
figments-figments of scholastic invention-that have never found any very
substantial foundation in economic reality, and less to-day in the United States
than in other times.
…undertaking to regulate the flow of Federal Reserve credit by the price index is
a good deal like trying to regulate the weather by the barometer. The barometer
does not make the weather; it indicates what is in process.
The total money in circulation is determined by the community. The Federal
Reserve System has no appreciable control over that and no disposition to
interfere with it.139
Under the real bills doctrine the changes in monetary policy needed to be initiated by the
public, with the Fed acting indirectly through changes in the discount rate. Open market
operations required direct action by the Fed, and so undesirable under this doctrine.
Instead, reserve control through the discount window put the initiative in the hands of
public businesses. Miller saw the open market purchases in 1927 as excessive and
misguided, arguing that the increased credit made possible through the purchases was
beyond the needs of trade and so put to speculative purposes.140 Instead, in 1928 Miller
urged for the discount rate to become the primary policy variable for the Fed.
Consequently, the discount rate was raised from 3.5 percent (3.5%) to four percent (4%)
in January 1928, following Governor Strong’s open market purchases. Beginning in
May, the Fed hiked the discount rate a quarter point per month, moving it to five percent
(5%) by August 1928 where it remained until August, 1929. In August, as the market
continued to boom, the Federal Reserve raised the discount rate three-quarters of a
139
Stabilization, pt. 2 1928, pp. 1009, 348, 180
pt. 2, 1928, pp. 172 – 174. Miller argued: “…the low money rates that resulted form the
Federal Reserve policy, in light of subsequent developments, appear to have been particularly effective in
stimulating the absorption of credit in stock speculation.
140 Stabilization,
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point to 5.75 percent (5.75%) and then another quarter point to 6 percent (6%) in
September, one month before the notorious Crash. This “push and shove” between
Governor Strong at the New York Fed and Adolph Miller at the Board of Governors in
Washington helps explain the oscillating policy between open market purchases and
sales.141
Throughout the 1920s, Governor Strong had dominated the Board, but by late
1927 the power struggle with the Board was heating up again. At the same time the
reserve system was debating policy, it was struggling to meet its multiple goals
simultaneously – stabilizing European currencies, curbing the use of speculative credit,
and stimulating business to offset the declines of 1924 and 1927. These competitive
and often inconsistent agendas combined with confusion over policy and the power
struggle within the Fed contributed to an unsound and hesitant environment.
The Strong Bill hearings in the spring of 1928 marked the last public appearance
for Governor Benjamin Strong. The Board of Governors disapproved of the bill and, as
Irving Fisher wrote in 1934, “Governor Strong felt bound by their action.”142 In the fall of
1928, amongst the open market purchases, Governor Strong died and the Strong bill
failed to pass through Congress. This greatly shifted the balance of power toward the
Board and the consequences of Strong’s death have been a matter of speculation ever
since. As Irving Fisher wrote in 1935, “I myself believe very strongly that this depression
was almost wholly preventable and that it would have been prevented if Governor Strong
had lived.”143
This same argument was later made by Friedman and Schwartz. 144
Regardless of this counterfactual proposition, just prior to the stock market crash of
October 1929 and the following Great Depression, the face of the Federal Reserve died
For a full account of the dynamics between Strong and Miller See Allan Meltzer’s The History of the
Federal Reserve (2002).
142 Fisher, (1934) p. 171
143 Irving Fisher, Stable Money: A History of the Movement (New York: Adelphi Company, 1934) p. 517.
144 See Freidman and Schwartz, pages 255-264 and chapt.9: “The Great Contraction”
141
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and this tipped the scale of power toward the Board of Governors. This power shift
occurred at a time when the Fed struggled with a rapidly rising stock market, an
economy emerging from the contraction of 1927 and a newly functional worldwide gold
standard. The resulting policy was hardly coherent.
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Chapter 5:
The Coolidge Bull Market
By 1926, the American economy was booming. Beginning in 1924, as Mellon
and Coolidge unveiled another round of tax reforms and the Fed succeeded in
maintaining a fairly consistent price level, business began to expand rapidly.
More
importantly, it was becoming increasingly clear in 1926 that Mellon would realize his aim
of a twenty-five percent (25%) top marginal tax rate (Chapter 1) and the great Coolidge
bull market began.145 The physical output of industry in 1926 exceeded that in any other
previous year.146
This terrific production was paired with low unemployment and a
declining price level, something so exceptional it has yet to be reproduced since.
Monthly, seasonally adjusted industrial production levels are illustrated in the below
graph:
145
It should be noted that there are many other factors that contributed to the Coolidge bull market besides
fiscal policy. It is the opinion of this author, however, that the tax reform allowed for other factors to take
shape.
146 Manufacturing production reached 108 with 1923-1925 equaling 100. Index was compiled from original
data from Federal Reserve Board Bulletin, August 1940
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Industrial Production
10
8
6
4
2
Jan-35
Jan-34
Jan-33
Jan-32
Jan-31
Jan-30
Jan-29
Jan-28
Jan-27
Jan-26
Jan-25
Jan-24
Jan-23
Jan-22
Jan-21
Jan-20
Jan-19
0
Date
Source: Bureau of Economic Analysis;
(www.bea.gov)
Beginning of irrational “bubble” in the stock
market for many historians in an attempt to
explain the “Crash” in October. The fact
remains, however, that Industrial Production
began to grow at an unprecedented pace at this
precise moment. The stock market growth was
based on fundamental market activity.
From 1920 through 1924 the New York Times index of industrial share prices
hardly from 90 to 106, but by December 1924 it reached 134. At the end of 1925 it had
climbed to 181 where is paused throughout 1926 before tracking upward to 245 in 1927.
The New York Times industrials average peaked on September 19th 1929 at 469, over
quadruple its level at the open of 1924. The Dow Jones Industrial Average (DJIA)
preformed similarly. Opening the century at 68, the DJIA traded between 50 and 100
points through the first fifth of the century. From 1920 to the beginning of 1924 the DJIA
actually declined from 108 to 96, or a drop of nearly twelve percent (12%). Over the
period, the market traded as low as 63.9 on August 25, 1921 as market prices collapsed
with the sharp recession and decline in the general price level covered in Chapter Two,
before rebounding in 1922 and 1923. By year end 1925 the DJIA stood at 151, an
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increase of over fifty percent (50%) in two years. It too paused at this plateau in 1926
ending the year at 157 before rallying to 200 by the end of 1927. The DJIA peaked on
September 3, 1929 at 381.17, nearly four times their 1924 level. The below graph
details the yearly changes in the DJIA from 1922 through 1929:
Sources: Bloomberg
Beginning of the
stock boom,
May – 14th 1924
with DJIA at
88.77
Market Peak –
September 3rd
1929 with DJIA
at 381.17
As the graph shows, growth throughout the twenties, especially after 1924, was steady
and significant. After declining slightly in 1923, the market as measured by the DJIA
appreciated over twenty-five percent in 1924 (26.16%) and 1925 (25.37%). It paused in
1926, moving up only four points (4.05%) from 151 to 157 and then surged forward in
1927 and 1928 moving 27.67 percent (27.67%) and 49.48 percent (49.48%)
respectively. The bull market continued through the first three quarters of 1929 before
the legendary crash brought valuations down, causing the market to lose one-third of its
worth in the period of week.
Controversy still abounds over what caused the stock market boom, whether a
bubble emerged in 1928-29 and what precisely caused of the stock market to crash.
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Despite the vast literature on this topic, no clear explanation has emerged let along a
consensus among economists or historians. The most famous account of the crash,
John Kenneth Galbraith’s The Great Crash 1929, does not attempt to explain the stock
market boom at all. Galbraith simply supposed a bubble emerged in the market during
the rapid economic growth of the 1920s, but he makes no reference to what may have
caused the rapid growth in the underlying economy. He then emphasized the irrational
“mania” of the public, arguing “the vested interest of euphoria [led] men and women,
individuals and institutions to believe that all will be better, that they are meant to be
richer and to dismiss as intellectually deficient what is in conflict with that conviction.” 147
The fuel behind this “euphoria,” according to Galbraith, was excess speculative liquidity
evident through brokers’ loans.
In The World in Depression, 1929-1939, Charles
Kindleberger is equally vague about what caused of the boom. In writing about the
American market, Kindleberger only proclaims, “…the boom was built around the
automobile, not only the manufacture of vehicles, but tires and other components, roads,
gasoline stations, oil refineries…”148 Kindleberger offers no explanation, however, as to
what might have caused the automobile boom. Nor does he offer more explanation for
what caused the crash. Like Galbraith, Kindleberger focuses on the precarious position
of the irrational investor, believing a bubble existed and that this bubble inevitably had to
“pop.149”
There remain a number of important questions to be answered concerning not
only the crash in 1929, but the boom before it. There seems a tendency to blame the
depression of the 1930s on the happiness and exuberance of the 1920s. The 1920s
have been continually characterized as an extravagant self-indulgent period of
147
John Kenneth Galbriath, The Great Crash, (Cambridge MA: The Riverside Press, 1954) pp. xii-xiii
Charles P. Kindleberger, The World in Depression: 1929-1939, (London: University of California Press,
1973) p. 44
149 See Galbriath’s The Great Crash, 1929 and Kindleberger’s The World in Depression, 1929-1939, esp.
chapters 1-3.
148
-87-
unchecked excesses which led to the crash of 1929 and the following depression. In
order to test this conventional understanding, considerable attention will be given both to
the causes behind the aggregate boom in the economy and to the stock market itself to
determine if prices were justified before the crash.
Popular criticisms of the 1920s have resounded ever since the Crash of 1929
and the onset of depression.
One argument is that wages remained low in the
“prosperous decade” despite the large gains in productivity. Irving Bernstein, in The
Lean Years: A History of the American Worker, 1920 – 1933, and Frank Stricker, in
Affluence for whom? – Another Look at Prosperity and the Working Classes in the
1920s,” present the 1920s as a period of sluggish or even declining wages for the
American worker. This was simply not the case, however. Wage rates did decline
significantly, but the entirety of the wage decline came in the 1920 – 1921 depression
when consumer prices fell 10.5 percent
percent (-36.8%).
(-10.5%) and producer prices fell by 36.8
During the same period, unskilled manufacturing wages fell by
twenty-two percent (22%) and skilled manufacturing wages by twenty percent (20%).150
While this decline is substantial, it should not be used to manipulate the rest of the
decade. From 1922 through 1929, both unskilled and skilled manufacturing wages had
substantial increases of twenty percent (20%).151 Moreover, using data estimated by
Keynesian economist Lawrence Klein in his book titled The Keynesian Revolution
published in 1947, wage growth looks even more impressive. Klein’s data for all private
wage bills indicates a drop of only 11.5 percent
(-11.5%) in the 1920-1921 period and
Paul David and Peter Solar, “A Bicentenary Contribution to Research the History of the Cost of Living in
America,” In Economic History, pg. 1-80 in Vol. 2, (Greenwich: JAI Press) Table B1, pg. 59.
151 Historical Statistics of the United States, Colonial Times to 1970, 2 vols (Washington DC, 1975) series
D839-44)
150
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then substantial growth of forty-one percent (41%) from 1922 through 1929. The wage
level of 1929 would not be reached again for another decade.152
Another popular argument blaming the Twenties for the economic pain of the
Thirties is that of excess profits. Using the incorrect assumption of falling wages, the
argument concludes a “shift to profits” must have occurred. This “shift,” it is argued,
moved most of the income growth to high income groups with lower “propensities to
save.” The result was supposed to be more savings than could profitably be applied to
real business activity. This helps the “bubble” theorist such as Galbraith and others who
argue surplus savings flowed directly into the stock market speculation as a form of easy
money.
In particular, supporters of this argument point to wealthy individuals and
corporations who would offer idle savings to brokerage firms to lend out on margin.153
Again, however, the data does not support this argument. Before tax corporate profits
average 8.2 percent (8.2%) in 1920 through 1929 as compared with 9.7 percent (9.7%)
in the pervious decade of 14.1 percent (14.1%) in the 1940s.154 More importantly, the
share of GDP going to employee compensation averaged over sixty percent (60%) in the
1920s as compared with fifty-fifty five percent (55%) in the first fifth of the century.155
Others point to the “farmer depression” of the 1920s. Proponents of this theory
highlight “sharply lower prices” for farmers, while arguing that goods in general were
rising in price. Again facts are to the contrary. Putting aside the 1920-21 price decline,
farm commodities actually increased in price on an annual basis five out of the eight
years 1922 to 1929 and were nearly twenty percent (18.4%) higher in 1929 than in 1921.
152
Lawrence Klein, The Keynesian Revolution, (New York: MacMillan Company: 1947). This is the Klein
Model I data set, available from http://pages.stern.nyu.edu/~wgreene/Text/tables/tablelist5.htm visited on
February 15th, 2006.
153 Irving Fisher, The Stock Market Crash and After, (New York: The Macmillan Company, 1930) pp.. 44-48.
154 After tax corporate profits, 1929 and later: www.bea.doc.gov/dn1.htm, NIPA Table 1.14; for period before
1929 see Ellen McGrattan and Edward Prescott, “The Stock Market Crash of 1929: Irving Fisher was right!”
NBER Working Paper 8622, December 2001 and Reynolds, (1979).
155 Reynolds, 1979 While economic circumstances were notably different during the separate decades and
consequently a direct comparison is impossible, the data still does not support any upward “shift” in profits.
Whether an argument can be made for shifts in the opposite direction is less clear.
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The CPI, on the other hand, was actually 4.5 percent (4.5%) lower in 1929 than in 1921
and only rose on an annual basis in three of the eight years. Moreover, net income of
farm operators on a per capita (per farm) basis rose 4.6 percent (4.6%) in 1928 and 2.3
percent (2.3%) in 1929. Finally, the “parity cost” of farm costs to prices rose in every
year of the bull market and at ninety-two (92) in 1929, was higher than in any year
before 1954.156 Agricultural prices did decline when the decade is measured as a whole,
but this is a manipulation of the data. As with wages, agricultural prices grew when the
1920-1921 depression is accounted for.
Two monetarist schools also disagree over the period. Murray Rothbard argues
in America’s Great Depression that the boom was only a product of inflation. Rothbard
has a broad definition of “money” and estimated the money supply increased by 68.1
percent (68.1%).157 Rothbard counters the fact that the CPI declined by 4.5 percent (4.5%) and the PPI by 11.3 percent (-11.3%) by arguing prices should have declined
more because of the increases in productivity.158 This is a tough argument to make.
Conversely, Friedman and Schwartz on have a much more limited view of “money” and
go to lengths to separate the stock market activity from business expansion, arguing:
“Far from being an inflationary decade, the twenties were the reverse.”159 They point out
that “The cyclical expansion from 1927 to 1929 is one of the very few…during which
prices were…lower at the three months centered on the peak than on the three months
…on the initial trough.”
Moreover, they point out “The stock of money…fell slightly
during most of the expansion – a phenomenon not matched in any prior or subsequent
cyclical expansion.” As a result, Friedman and Schwartz conclude that “Federal Reserve
policy was not restrictive enough to halt the bull market, yet too restrictive to foster
156
Bureau of Labor Statistics, Handbook of Methods, chapter 17, found at:
http://stats.bls.gov/opub/hom/homch17_d.htm#17a – visited on 2-March 2006 and Reynolds (1979)
157 Rothbard used a measurement similar to M2, which includes time-deposits.
158 Murray Rothbard, America’s Great Depression, esp. part 2, entitled “The inflationary Boom, 1921-29.”
Similar arguments are presented by conservative historian Paul Johnson in Modern Times, chpt. 7.
159 Friedman and Schwartz use M1 which includes on demand deposits.
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vigorous business expansion.”160 Taking the opposite extreme from Rothbard, they
believe the Federal Reserve policy actually restrained the economy and argue for the
lack of a boom.161
Nevertheless, it is difficult to deny that the period 1922 through 1929 was an episode of
exceptional economic growth and not a period of inflation. GDP expanded from 68.4
billion in 1921 to 101.4 billion in 1929 and averaged an annual growth rate of 5.13
percent (5.13%) over the entire period. At the same time, prices declined meaning real
growth was even greater. Industrial Production (seasonally adjusted) increased from 4.4
in 1921 to 8.5 in 1929, a jump of over ninety-one percent (91.3%). Life expectancy at
birth rose by 5.6 years. There were more applications for patents in 1929 than in any
other year until 1965.162 Productivity also expanded rapidly. Output per man hour of
U.S. production increased 66.5 percent (66.5%) from 44.6 to 74.3.163 It does not seem
as if any of the “theories” arguing that the 1920s exuberance laid the foundation for the
1930s depression hold any merit. The 1920s was a period of extreme creativity and
economic revolutions.
Whole new industries, such as the manufacture of radios,
developed. Production of autos, crude oil, and electricity nearly doubled from 19201929. Consequently, it is clear that despite a plethora of criticisms, the 1920s was built
around genuine economic growth and prosperity. One question remains, however: what
about the stock market?
In August of 1929, just a month before the market began its perpetual decline,
Charles Dice, Ohio State University economist, argued that the current stock market was
justified by economic fundamentals. On October 22, 1929, The New York Times printed
160
Friedman and Schwartz, pp. 298-99
See Rothbard’s America’s Great Depression and Friedman and Schwartz’s A Monetary History of the
United States, 1867-1860.
162 Alan Reynolds, “What do we know about the Great Crash?” National Review, Nov. 9th 1979, pg. 1416 –
1421.
163 Federal Reserve Board - available at: http://www.federalreserve.gov/releases/G17/ visited on March 7,
2006
161
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the headline: “FISHER SAYS PRICES OF STOCKS ARE LOW – QUOTATIONS HAVE
NOT CAUGHT UP WITH REAL VALUES AS YET”164 The article covers Fisher’s speech
to the New York Credit Men’s Association, where Fisher commented on the short-term
market sell off from Friday October 18th through Monday October 21st when the DJIA
dropped from a close of 341.86 on Thursday to 320.91 on Monday, a lost of over 9.5
percent (-9.5%). Fisher argued the two day break in the market was a “readjustment” to
“trade” and that any predictions of overvaluation were unfounded, arguing:
Let us take the month of August, 1929, when the price level of stocks had reached its
record top of 200. The price level was 145 in August of the preceding year. Yet, August,
1929, common stocks, as computed by the Standard Statistics Company, were selling at
thirteen-times the total earnings, as compared with fourteen times the total earnings in
August of the preceding year…In other words, while the index of prices of representative
stocks has risen very rapidly during the past year, it has risen more slowly than the rate
of total earnings.165
Fisher clearly believed the market was based on a sound economic reality. The next
day the market plunged 6.3 percent (6.3%) from 326.51 to 305.85 and the Great Crash
had begun.
Even following the crash, in December 1929, Fisher continued to argued that “the
market went up principally because of sound, justified expectations of earnings, and only
partly because of unreasoning and unintelligent mania for buying.” In his book The
Stock Market Crash and After, published in 1930, Irving Fisher exclaims that in hindsight
it is easy to see a picture of the market as portending or predicting the disaster that
came: “In the rapidly mounting aggregate of margin accounts the unsoundness of the
situation is revealed.” He points to the Federal Reserve Board’s warning of an inflated
stock market beginning in March 1929 and the resulting “shutting off of stock market
credit that at once precipitated a near panic.”
The panic Fisher cites was avoided
through the efforts of Charles Mitchell, Chairman of the National City Bank of New York,
who made $100,000,000 available to the market at high rates. Fisher notes that “From
164
165
The New York Times, “Fisher Says Stocks are Low” October 22, 1929 pg. 24.
The New York Times, “Fisher Says Stocks are Low” October 22, 1929 pg. 24.
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[this picture] many have hastily concluded that the new plateau of stock prices was
wholly unwarranted and merely the result of insane speculation.”166
There is, however, as Fisher stressed, another side of the story. To begin with,
Mitchell’s actions in March, 1929, which were so criticized by Senator Carter Glass and
others following the crash, were not unwarranted. William C. Durant, founder of General
Motor’s Corp., was outraged by the Federal Reserve actions in the beginning of 1929.
Durant polled 500 industrialists across twenty cities concerning the Fed’s policy. In
response Durant received 463 replies from companies, with only twelve supporting the
Federal Reserve. Durant called the Fed’s actions a “battle” against the businesses of
the country. Calling the board an “autocratic group” Durant argued that the Federal
Reserves’ decision to hike the discount rate twenty basis points on March 27, 1929
created a situation where “a Stock Exchange panic was in the making.” Durant called
Mitchell’s actions in response a “patriotic offer,” And demanded a lowering of the
discount rate to three percent (3%).
Durant also supported Mitchell’s calls for the
abolishment of the capital gains tax to free up investors capital.167 The capital gains tax
enticed investors to circumvent selling stock in efforts to avoid a taxable event. Instead,
investors borrowed to buy new stocks through margin accounts. As will be shown, this
leverage played a considerable part in the October Crash. The liquidation that would
result in abolishing the capital gains tax, Mitchell argued, would wipe out any “artificiality”
in stock prices, free up capital for investors by decreasing the demand for broker loans
and allow the Fed to focus on supporting business interests.168
166
Irving Fisher, The Stock Market Crash and After, (New York: The Macmillan Company, 1930) pp. xx-xxi.
The New York Times, “W.C. Durant Demand Reserve Board Keep Hands Off Business,” April 15 th, 1929.
p. 1.
168 The New York Times, “Wall Street Differs On Mitchell Plan: Proposal to Abolish Tax on Profits From
Stock Sales Widely Discussed,” April 20th, 1929. p. 9.
167
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Moreover, as Fisher points out, every stock price represents a discounted value
of the future dividends and earnings of that stock. For the rise in the stock market to be
rational, therefore, it could only occur for four reasons:
(1) Because the earnings are continually plowed-back into business instead of being
declared in dividends, this plowing-back resulting in an accumulation at
compound interest, so to speak;
(2) Because the expected earnings will increase on account of technical progress
within industry;
(3) Because less risk is believed to attached to those earnings than formally;
(4) Because the “basis” by which the discount is made has been lowered.169
Fisher demonstrated that all four of these forces were at work and, fundamentally, the
market was justified.
Rather than simply take Fisher’s word for this fact, however, as he has been
continually criticized for his proclamations both before and after the crash in light of the
events of late 1929. A detailed analysis of the actual market is necessary as Fisher’s
analysis has been discredited, if not ignored, when the market went from a high of
381.17 in September 1929 to 41.22 on July 8th 1932, its lowest value of the twentieth
century..
The Undervalued Stock Market: A Fundamental Analysis
Strong growth in company profits drove the market in the late 1920s. Both Dice
and Fisher pointed to growing earnings and dividends provided by new technologies,
better management techniques, and mergers that consolidated industries and gained
economies of scale and scope for corporations. This rising in corporate earnings and
169
Fisher, 1930, p. xxii
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earnings potential as resulting in the stock market boom. In a speech on October 22,
1922 the day prior to the first big sell off that marked the beginning of the crash, Fisher
explained:
During the past six years there have been pronounced changes in the tempo of
production and trade, due to the vast increment of scientific research and
application of inventions. Virtually every line of manufacturing witnessed daily
technical development that results in a greater total of products, at reduced
costs, greater profits, and lower prices to consumers. These gains are
continuing into the future.170
More recently, Gerald Sirkin (1975) used average price-to-earnings (P/E) multiples
during the boom to argue stocks were, if anything, undervalued. During the period 192529, the average P/E ratio was 20.4, as measured by Sirkin. Based off a historical normal
P/E for the DJIA of 15, earnings would need to grow at nine percent (9%) for another 10
years to justify the 20.4 P/E of the boom period. Average growth during the 1925-29
period was in fact slightly higher than nine percent (9%), making the market valuation
appear justified. Sirkin also argued that the market valuation for the period, compared
with post-World War Two yields and stock returns, implied growth rates for dividends
that were quite conservative and in fact below post-World War II growth rates. That is,
investors rewarded growth less in the 1925-1929 period than they did after World War
Two.171
A different approach to using dividend data to judge the valuation of companies
prior to the crash in 1929 is to use data on productive capital stocks and tax rates to
estimate the fundamental value of all U.S. public companies.
In fact, a model that
values the assets of a company is advantageous to one that uses expected discounted
dividends, as Sirkin’s did, because it does not rely on assumptions of investor
expectations.
Ellen McGrattan and Edward Prescott conservatively estimate the
fundamental value of all corporations before the crash as twenty times (20X) after tax
The New York Times, “Fisher Says Stocks are Low” October 22, 1929 pg. 24.
Gerald, Sirkin, “The Stock Market of 1929, Revisited: A Note” Business History Review, Summer 1975,
Vol. 44, pp. 381-386.
170
171
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corporate earnings, which for 1929 is 1.8 times (1.8X) GDP.172 Actual market value was
between 1.57 times (1.57X) and 1.24 times (1.24X) GDP, indicating Fisher was right.
No bubble existed and, if anything, the market was undervalued on the eve of the crash.
McGrattan and Prescott assume real interest rates were high (above 5%) and market
participants were extremely risk adverse to generate these ratio.
If a more reasonable real interest rate is assumed and the level of risk aversion
lowered, fundamental values for U.S. corporations is actually estimated to be higher than
twenty times (20X) earnings.173 The real rate of interest is based on open market rates
and the expected rate of inflation. On a gold standard, as the U.S. was on in 1929,
expectations of inflation should be near zero.
Romer (1989) estimates an annual
inflation rate of slightly below zero at -0.29 percent (-0.29%) for the period 1925-1929.174
Therefore, only slight adjustments need to be made to open market rates to determine
the real rate of interest. The Fed discount rate during this period ranged between 3.5
percent (3.5%) in early 1927 to six percent (6%) late in 1929, but for the majority of the
period was between four percent (4%) and five percent (5%). Short-term U.S. treasury
securities ranged between 3.5 percent (3.5%) and just below five percent (5%), while
Long-term U.S. treasuries remained below four percent (4%) for the entire period.
Commercial paper rates ranged mostly between four percent and 4.5 percent (4%-4.5%)
until the Fed increased discount rates significantly. Commercial paper reaching five
percent (5%) in the middle of 1928, 5.5 percent (5.5%) by 1929 and just over six percent
See Ellen McGrattan and Edward Prescott “The Stock Market Crash of 1929: Irving Fisher was Right!”
Working Paper 8622, National Bureau of Economic Research (NBER), December 2001
173 McGattan and Prescott use the following valuation model, which assumes a stable tax policy:
V=(1-tpers)(K’t + (1-tcorp)K’i)
Where K’t is the end of period resource cost of tangible capital, K’I is the end of period resource cost of
intangible capital, tpers is the personal income tax rate including stock dividends, and tcorp is the tax rate on
corporate profits. Other models used to measures bubbles use discounted value of expected future stock
dividends to value companies. This model is preferred because it makes no assumptions about market
participants’ expectations.
174 Christina Romer “The prewar Business Cycle reconsidered: New estimates of Gross National Product,
1869 – 1908.” Journal of Political Economy, Vol. 97, p. 1-37. Also see Romer, “The Great Crash and the
Onset of the Great Depression,” NBER Working Paper, June 1988.
172
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(6%) at the peak of the market just prior to the crash in October. These high rates,
however, were only temporary, lasting less than a few months. Corporate bonds yields
are perhaps the most relevant for measuring assets in the corporate sector. According
to the Federal Reserve’s Banking and Monetary Statistics, the basic nominal yield on
corporate bonds with maturities of two years is around five percent (5%) for 1929.
Corporate bonds with longer maturities have coupons closer to 4.4 percent (4.4%). Only
in the very short term are yields as high as 5.6 percent (5.6%).175
Taking all this into account, 5.75 percent (5.75%) is a conservative upper bound
for real interest rates. Using this real rate of interest, total value of all corporations is
around 1.78 times GDP or 20 times corporate earnings. A more realistic real rate of
interest of five percent (5%) yields a total value of 2.75 times GDP, indicating that even
at its peak, the market was fundamentally undervalued in 1929.
The actual 1929 market value can be estimated using a number of methods.
Irving Fisher estimated the August 1929 price-to-earnings ratio to be 13.176 McGrattan
and Prescott took three different approaches. The first used estimates based off a
detailed study of 135 industrial corporations provided by Laurence Sloan and Associates
(1936) at the Standard Statistics Company.
McGrattan and Prescott viewed this
estimate as the most representative for the total market. The second method used the
S&P Composite index made up of fifty industrial companies, twenty railroads, and twenty
utilities. Finally, an estimate is made using the total market capitalization of all 846
175
Short-term, Long-term, and Corporate interest rates from Federal Reserve Board of Governors, Flow of
Funds Accounts of the United States (Washington D.C.: Federal Reserve Board, 1943), Table 115: Federal
Reserve Bank Discount Rates on Eligible Paper; Table 120: Short-term Open Market Rates in New York
City; Table 122: yields on short term U.S. government securities; Table 125 Bond Yields; Intermediate-term
U.S. Bonds yields from Ibbotson Associates Stocks, Bonds, and Inflation 2000 Yearbook (Chicago: Ibbotson
Associates, Inc., 2000), Table A-13
176 The New York Times, “Fisher Says Stocks are Low” October 22, 1929 pg. 24.
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companies on the New York Stock Exchange (NYSE). These estimates and others are
outlined in the table below:177
Estimates of Market Value of All U.S. Corporations on August 30, 1929 Based On Information for Subsets
of Corporations
Market
Company
Value ($
Estimated Total
Data Source**
Coverage
billions) Price/Earnings Market Value/GDP
Sloan & Associates 1936
CRSP & Moody's Industrial Manual
CRSP & Moody's Industrial Manual
Irving Fisher 1930
NYSE & Flow of Funds Accounts
Jovanovic and Rousseau 2001
135 Industirals
40 S&P Industrials
90 S&P Composit
45 Industrials
846 listed on NYSE
All Corporations
30.80
26.20
43.30
89.70
130.6*
17.5
18.4
19.0
14.1
14.1
1.54
1.62
1.57
1.24
1.24
1.25*
*End of year estimate was divided by 0.7 because prices fell 30 percent (30%) between August
1.67 and December
**CRSP = Center for Research on Security Prices and NYSE = New York Stock Exchange
Source: Prescott and McGrattan (2001)
As the table shows, all the estimates are below nineteen times (19X) after tax corporate
earnings, or 1.67 times GDP. With no evidence of high real rates of interest, given the
market rates of 1929, a conservative fair value for all U.S. companies is at least twenty
times (20X) after tax earnings, or 1.8 times (1.8X) GDP. Because this “fair value” for
U.S. companies is greater than the existing market value in just before the Crash the
market was undervalued. This result uses the highest estimate for the actual market
valuation of U.S. companies in August, 1929, while also using the lowest fundamental
valuation. In other words, it is the most conservative analysis possible and there still
exists no evidence in support of a bubble.
As McGattan and Prescott write: “A
fundamental valuation any lower is not justified by observation on profits, capital stock,
tax rates, growth rates, and interest rates.”178 As a result, this data supports Fisher’s
argument that stocks were in fact undervalued in August 1929 and that no bubble
Market Value of All Listed Companies – Survey of Current Business Annual Supplement, various issues
starting 1932 (U.S. Commerce 1929 – 2000), Flow of Funds Accounts of the Unites States (Federal Reserve
Board 1945-2000), Javanovic and Rousseau (2001), www.econ.nyu.edu/user/jovanovi - visited on 3/8/2006.
178 McGrattan and Prescott, (2001)
177
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existed. The table below shows different fundamental valuations using different real
rates of interest.179
Estimates of Intangible Capital and the Fundamental Value of U.S. Corporations in
August 1929 for Various Real Interest Rates
Estimates of
Market
Market
Real Interest Rate (%) Fundamental Value/GNP Overvaluation (%)* Overvaluation (%)***
5.00
5.25
5.50
5.75
6.00
6.25
6.50
6.75
6.93
2.75
2.33
2.01
1.78
1.59
1.43
1.32
1.21
1.14
-39.27
-28.33
-16.92
-6.18
5.03
16.78
26.52
38.02
46.49
*Assumes a market value of 1.67 times GNP
-44.00%
-33.91%
-23.38%
-13.48%
-3.14%
7.69%
16.67%
27.27%
35.09%
1.67
1.54
**Highlighted region is conservative estimate for real rates. Real rates were likely closer to 5 percent for the period 19251929
***Assumes a market value of 1.54 times GNP
Source: Prescott and McGrattan (2001)
Most of the work done regarding the stock market of 1920s incorrectly assumes
that markets can be overvalued but not undervalued.
Authors have consciously or
subconsciously believed that asset prices were either overvalued relative to
fundamentals or justified vis-à-vis fundamentals in 1929. Nevertheless, as McGrattan
and Prescott demonstrate the use of modern theory and historical data support Fisher’s
original claims that the market was undervalued even at their peak. Fisher’s claims have
been washed aside by Galbraith and the slew of “bubble” theorists including Eugene
White (1990, 1993) because they viewed the crash as clear and indisputable evidence
179
Data used in calculation, such as after-tax profits, GNP for 1929 and later, domestic tangible corporate
capital – all available at www.bea.gov (NIPA Table 1.14, 1.9, 7, 9) – visited on 03/09/2006
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that Fisher was wrong. These authors have presented no evidence that the market was
overvalued, but have simply started with the presumption that a bubble existed and
pointed to circumstantial evidence to make their points.
Conversely, another recent article by Tim Nicholas (2004) also finds that
companies were undervalued prior to the crash in 1929.180 Nicholas’ work is important
because it brings concrete validity to McGrattan and Prescott theoretical valuations. In
their valuation, McGrattan and Prescott estimate intangible capital indirectly, using
equilibrium relations from a growth model.181 Their efforts are notable because they
represent the first attempt to systematically estimate intangible capital during the 1920s
bull market, and effective because they use conservative estimates indicating that
unless intangible capital were zero, stocks were undervalued in August of 1929.
Nicholas adds further support to this argument by introducing a robust measure of
intangible capital based on patenting activity of firms during the 1920s. In particular he
uses citations to patents in the current data set of patents granted between 1976 and
2002 to reduce the “signal to noise” ratio that is often associated with using patents as
measures of innovation. Patents citations during the late 1920s were particularly high
compared to other historical periods. Nicholas demonstrates that in light of the rapid
Tim Nicholas, “Stock Market Swings and the Value of innovation, 1908-1929,” (April, 2004),. LSE
Working Paper.
181 Intangible Capital is needed in McGrattan and Prescott’s valuation model, but because it is not recorded
by the BEA, it is more difficult to compute. McGrattan and Prescott construct a lower bound for Intangible
Capital (K’i – in their model) through the following method:
A relation between after-tax NIPA profits and corporate capital stocks can be used to infer Intangible Capital
(K’i):
∏ = iKt + (I – g)(1-tcorp)Ki
Where ∏ is after-tax NIPA profits, i is the real interest rate, and g is the growth rate of real output.
McGrattan and Prescott assume that (1) the after-tax rate of return for tangible capital is equal to the rate of
return for intangible capital and all other types of capital. This makes sense if firms are operating in the best
interest of their owners. (2) that tax policy is unchanging so that steady state analysis is appropriate. This
assumption too is supported by the corporate tax environment of the late 1920s. Average taxes on profits
and dividends from 1925 – 1929 was 12.45 percent (12.45%). The maximum annual rate was reached in
1927 at 12.95 percent (12.95%) and the lowest annual rate was for the fiscal year 1929 at 11.75 percent
(11.75%).
McGrattan and Prescott use Romer (1989) estimates of real GNP growth as a estimate for the growth rate of
3.63 percent (3.64%). The difficulty comes in measuring the real interest rate (i), which was covered earlier.
Higher levels of real interest imply low values for intangible capital and vice versa.
180
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innovation of the 1920s, as measured by patent citations, the booming stock market
valuations were justified. Moreover, he illustrated that investors were aware of the value
of intangibles during the boom. Nicholas finds cited patents have a substantial amount
of explanatory power in market value regressions, indicating that investors placed a
premium on firms that invested heavily in innovation. What is more, while most studies
of the stock market boom have concentrated on short time intervals, such as Rappoport
and White who focus on the period from 1928 through October 1929, Nicholas’ uses
over twenty years of data prior to the Crash to track firm-level innovation over several
major movements of financial markets. His results are robust for the entirety of the
period as well as for shorter sub-periods.
Nicholas makes clear that intangible capital growth during the 1920s was
significant, that investors realized such growth and that investors integrated this
innovation into their market pricing decisions. Between 1920 and 1929 the United States
Patent and Trademark Office (USPTO) granted the 121 firms included in Nicholas’ study
19,948 patents, of which 4,215 were subsequently cited in patent grants during the
1976-2002 period. These patent citations represent inter-generational flow of knowledge
and so indicate that the 1920s was a major period of technological progress. Evidence
is also provided by the companies themselves.
For example, J.I. Case Threshing
Machine Company, the Wisconsin agricultural machinery manufacturer, reported $1.4
million worth of patents between 1922 and 1928, explicitly indicating the value of patents
and intangible capital.
American Bosch Magneto Corporations, which manufactured
devices for internal combustion engines, valued its patents at between $584,176 and
$633,356 from 1924 through 1926, a amount equivalent to one-third (33%) of its total
assets.182
182
Nor does evidence of innovation in the 1920s need to be limited to patent
See Moody’s Manual of Industrials for company balance sheets
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citations as Nicholas does in order to test the theory empirically.
From a purely
historical prospective the 1920s represented a period of rapid technological change.183
The 1920s was a period of “Schumpeterian competition,” where new
technologies brought about competition that “strikes not only at the margins of the profits
and outputs of existing firms, but at their foundation and very lives.”184
Waves of
“creative destruction” drove the 1920s economy, which saw the electrification of
America, the popularization of movies, the mass production of the radio, the first
transatlantic flight, and the Model T. The first rocket was invented in early 1926 and the
first color movies began in early 1928.
Beginning in the great merger wave between 1897 through 1904, firms began to
build up separate research and development laboratories. For example, when General
Electric and Westinghouse in 1896 agreed to pool their patents they were criticized for
creating a virtual duopoly. Heavy investment, however, in research and development
made GE and Westinghouse the leaders of productivity-enhancing electrification for the
next few decades.
In effect, innovation became increasingly firm oriented rather
focusing primarily around than individual inventor-entrepreneur.185
This became
especially evident in the 1926-1929 period, which saw a sharp rise in the number of firm
patents in comparison to total patents. Firm patents were driven by early investments in
research and development (R&D) departments earlier in the century. R&D departments
increased nearly eighty percent (80%) from 1918 through 1929 with the most rapid rate
of growth occurring in the later part of the decade. Over the same period, total patents
Tim Nicholas, “Why Schumpeter was Right: Innovation, Market Power, and Creative Destruction in 1920s
America” The Journal of Economic History, Vol. 63, No. 4 (December 2003) p. 1023 – 1058) Also see
Claudia Goldin, “The Human Capital Century and American Leadership: Fruits of the Past.” Journal of
Economic History, (June 2001) Vol. 61, pp. 263-291 and Paul David, “The Dynamo and the Computer: An
Historical Perspective on the Modern Productivity Paradox” American Economic Review Papers and
Proceedings, (May 1990) Vol. 80, pp. 355-361
184 Joseph Schumpeter, Capitalism, Socialism and Democracy (New York: Harper Brothers Publishing,
1950) p. 84
185 See Naomi Lamoreaux, The Great Merger Movement in American Business 1895-1904 (Cambridge:
Cambridge University Press, 1988).
183
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increased approximately only twenty percent (20%), indicating the growth of firm driven
innovation of the Schumpeterian type. Over the same period186 During the 1920s,
prices for electrical capital goods declined substantially, driven by the innovation of GE
and others, encouraging the electrification of the mass production economy. By 1920 at
least fifty-three percent (53%) of mechanical power was provided for by electricity, rising
to nearly eighty percent (78%) by 1930.187 In consequence, productivity picked up and
with it the demand for skilled, literate, and educated labor. Larger generating unit and
higher voltage transmission lines came online, reducing the cost of electric power at the
same time the expanding economy and growing population was providing an ever larger
market for the new technology. In turn, utility companies made up one of the strongest
industries during the boom.
Both operating public utilities and public utility holding
companies performed well during the bull market.
approximately $5.1 billion.
By 1929, utilities were worth
Galbraith and others pointed to this sector as one of
especially egregious speculation, but this ignores the tremendous growth through
innovation and the rising importance to the economy of the new technologies these utility
companies provided.
Consolidated Gas Co. was the most widely held stock by
investment trusts.188
Innovation existed in other sectors as well. As White (1990) pointed out, General
Motors became attractive to investors because it upgraded faster than Ford to the
changing technological environment. In addition, the chemical industry, which is heavily
oriented toward innovation, went through major expansion in the 1920s. Industry profits
were $157 million in 1929 on sales of $4 billion.189
None of the leading chemical
companies held any debt and the overall industry averaged a 17.8 percent (17.8%)
Nicholas (2004), p. 11, also see David Mowery, “The Boundaries of the U.S. Firm in Research and
Development,” in Coordination and Information: Historical Perspectives on the Organization of Enterprise,
ed. Naomi Lamoreaux and Daniel Raff, (Chicago: University of Chicago Press, 1995) p. 147 - 182
187 David (1990)
188 Wigmore, p. 38 – Investment Trusts in the 1920s were the equivalent of Mutual Funds today.
189 Wigmore, p. 54.
186
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return on equity.
E.I. Du Pont de Nemours and Co. led the sector, with business
primarily in explosives, plastics, paints, rayon, cellophane, dyes, and ethyl alcohol.
Beginning in 1917, Du Pont also held about 10 million shares of General Motors
(22.9%).
Average return on equity for Du Pont during the boom was 22.2 percent
(22.2%). In contrast to the Du Pont behemoth, Commercial Solvents, a small firm with a
$13 million market cap, was highly innovative and produced mostly butyl alcohol and
other solvents through the “Weizmann Process,” which it developed and held exclusive
rights to. Commercial Solvents averaged an annual return on equity of 31.9 percent
(31.9%) from 1925 through 1929. The market rewarded Commercial Solvents Co. much
more than that of Du Pont or Commercial Solvents’ equally sized competitors such as
Monsanto Chemical or Dow Chemical Co., which generated ROE averages of about
13.3 percent (13.3%) and 17.5 percent (17.5%) respectively.190
Moreover, Nicholas’ showed empirically in a separate paper that the threat of
creative destruction loomed continually in the product markets of the 1920s and financial
markets handsomely rewarded innovators with large payoffs.191 Nicholas illustrated that
both competition and market power, treated as separate aspects of market structure,
functioned concurrently. This dichotomy is the foundation of Schumpeterian innovation
through creative destruction.
Access to capital through the financial markets likely
mediated the positive correlation between market power and innovation during the
1920s. This fact further points to Schumpeter’s observation, writing in the 1930s, that
financial institutions and the ability to raise capital are essential catalysts to creative
destruction and growth. Following the successful issuances of the Liberty and Victory
Bonds during World War One, the public became more responsive to different types of
190
191
Wigmore, p. 54
See Nicholas (2003)
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securities issued by corporations.192 Companies increasingly used the capital markets in
the 1920s as a source of financing rather than the commercial paper market.
Perhaps as a result of the threats of creative destruction, the 1920s and
especially the stock market boom from 1925-1929 was associated with a period of
intense mergers and acquisitions. The 1920s began relatively tough on anti-trust policy,
with both President Wilson and President Harding pursuing traditional enforcement, of
the sort established under Theodore Roosevelt, against cartels, mergers and vertical
restraints.
The Federal Trade Commission (FTC) filed 121 restraint of trade cases in 1919,
as compared with only sixty-four in 1918 and twenty in 1917 before the armistice.193
Nine merger cases were also filed against public companies.
Moreover, Harding’s
attorney general, Harry Daugherty, gained trust busting authority in a series of rulings
giving the Antitrust Division more strength against trade associations. Daugherty began
to treat many trade associations as cartels. After Harding’s death in 1923, however,
Daugherty was indicted in the Teapot Dome Scandal.194 Coolidge replaced Daugherty
with Harlan Stone, who worked closely with Herbert Hoover, then Secretary of
Commerce, to create safe havens for trade associations.195
192
William Peach, The Security Affiliates of National Banks, John Hopkins, 1942
Richard Posner, “A Statistical Study of Antitrust Enforcement,” Journal of Law and Economics, Vol. 14,
(October 1970) p. 365-419
194 The Tea Pot Dome Scandal was over oil reserves in Wyoming restricted for the use of the Navy. In
1922, the reserves were under jurisdiction of Edwin Denby, Secretary of the Navy. Senator Albert Fall was
publicly opposed to the restrictions on the oil reserves and, in mid-1922 was able to gain control over the oil
fields. Fall then illegally leased the rights to the oil to Harry Sinclair of Mammoth Oil. On April 14, 1922 the
Wall Street Journal broke the story. On April 15th, Senator La Follette headed the Senate Committee on
Public lanes to investigate the matter. The investigation led to a series of civil and criminal charges
throughout the 1920s. In 1927 the Supreme Court found the oil leases to have been illegal and the reserves
were delivered back to the navy.
195 George Bittlingmayer, “The Stock Market and Early Antitrust Enforcement” Journal of Law and Finance,
(1993) Vol. 36, p. 1-32
193
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In 1925, when Coolidge selected William Donovan as antitrust chief and William
Humphrey as FTC commissioner, anti-trust enforcement changed drastically.196
Donovan focused on price-fixing, but allowed advance clearance of mergers.
Humphrey’s appointment to the FTC created a majority of pro-business Republicans in
control of the FTC. Humphrey publicly pledged a more open merger market, advocating
informal settlements over formal court cases.
He described the new policy as
“cooperation and stipulation,” which gives “opportunity for an industry to do away with
any fraudulent or unfair practice” and “to regulate itself, to clear its own house…to
achieve decency instead of having the government thrust decency upon it.”197 For the
period 1919 through 1925 the average number of restraint of trade cases brought by the
FTC was 46 per year, the average number of complaints was 146, and the combined
number of annual merger cases brought by the FTC and DOJ was 5. Conversely, the
averages for the period 1926 through 1929 are significantly lower. The average number
of restraint of trade ceases declined seventy nine percent (-79%) to 9.75, the number of
complaints decreased fifty-four percent (-54%) to sixty-five, and the number of average
annual merger cases declined by thirty-five percent (-35%) to 3.2.198 Below are graphs
displaying the annual number of antitrust cases brought by the FTC and DOJ during the
1920s199:
196
Following his stint as Antitrust chief, William Donovan successfully defended Appalachian Coal in
APPALACHIAN COAL vs. UNITED STATES where the “per se” law against price fixing was overturned.
The “cartel” was allowed to continue in operation. See http://www.justia.us/us/288/344/case.html for details,
visited on 03/09/2006
197 Taken from Fisher, (1930) p. 111
198 FTC Restrain of Trade Cases from Posner (1970) pp. 366 and 369); FTC Complaints Issued from FTC
Annual Report (1935) p. 82-83; DOJ Merger Cases compiled from Commerce Clearing House, The Federal
Antitrust Laws (1952); FTC Merger Cases compiled from Commerce Clearing House.
199 Ibid.
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Measures of Antitrust Enforcement, 1919-1929
Number of Cases
250
200
150
100
50
0
1919
1920
1921
1922
1923
1924
1925
1926
1927
1928
1929
Year
FTC Restraint of Trade Cases
FTC Restraint of Trade Complaints
FTC and DOJ Merger Cases, 1919-1929
Number of Cases
10
8
6
4
2
0
1919
1920
1921
1922
1923
1924
1925
1926
1927
1928
1929
Year
This decline in antitrust enforcement fueled a merger boom during the 1922-1929
period. As Irving Fisher wrote: “One who reads the headlines sees that there is a ‘Race
for Mergers in Steel’; ‘Large Mergers on Way in Utilities’; that there are mergers
moves…of various kinds in nation-wide links, expected for economical reasons…”200
Moreover, Fisher, who dedicated an entire chapter in his book The Stock Market Crash
and After to the ‘Age of Mergers,’ claims that “the continued increase in the number of
mergers and consolidations in the trade association field is presaged by the steady
200
Fisher, (1930) p. 101
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growth of combinations in trade and industry.”201 Clearly mergers had much to do with
the increase in the stock price during the 1920s. Moreover, Fisher compliments the
merger movement calling the mergers “generally…inevitable” because of the ability to
lower production costs. He goes on to note a change in public opinion:
Only a short time ago there was great prejudice against big business of every
kind, particularly when it was obtained by combination. But suddenly the pent-up
pressure toward larger business unites, in spite of public prejudice and
opposition of politicians, has broken free in a wonderful period of expansion. 202
Fisher goes on to identify an important point concerning merger activity. As the market
is continually pricing the future value of corporations, mergers and anticipated mergers
will discount future growth into the current stock price. In the short run, this can lead to
abnormal price-to-earning ratios and other standard tools of valuation.
In sum, the
merger boom played a vital role in the stock market boom and in the economy. As
Fisher argued, “The big examples of mass production today, as instanced by Henry
Ford, General Motors, Westinghouse and General Electric, the great railways…the big
banks and so on, have reduced costs to the consumer by reducing costs in general.”
The effect of mergers was cost reduction, which led to lower corporate costs, lower
consumer cost, great profits and larger market shares. The stock market responded
accordingly.203
Finally, the stimulus of all these market forces was the movement “down the
Laffer Curve” through the extensive tax reform orchestrated by Secretary of Treasury
Andrew Mellon covered in Chapter One.
From 1920 through 1930, the Mellon tax
reforms managed to cut the national debt to $16.9 billion from $24.3 billion and stimulate
business, inciting a booming economy and a bull market. The accumulation of intangible
capital and the large merger boom help explain the rise in stock market prices.
Nevertheless, these explanations are also only products of the general economic
201
Fisher (1930). p. 102
Fisher (1930) p. 105
203 See Fisher (1930) p,. 101-118 for a full discussion.
202
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success of the period in the United States. This economic success was founded on a
sound fiscal platform put into place throughout the decade.
John Maynard Keynes, presiding in Cambridge, England, had trouble explaining
the “booming 1920s” in America. From his theoretical framework, tax cuts could only
“stimulate” the economy if tax relief was concentrated in the lower tiers of the income
distribution, where the “propensity to spend” was higher than in the upper echelons. 204
As Jude Wanniski points out in The Way The World Works, part of Keynes trouble was
that fact that his vantage point was England, and the British economy did not boom in
the 1920s. It should be noted that amongst other mistakes, notably returning to the gold
standard at the overvalued pre-war parity, Britain also left the highly progressive income
taxes in place from the war.
The tax reform outlined in Chapter One clearly impacted business activity and
stimulated the bull market of 1924 through 1929. The sampling of The New York Times
headlines in the following paragraphs makes this fact explicitly clear.
Amongst secretary Mellon’s second battle with congress for tax reform that
eventually resulted in cutting the top marginal income tax rate from fifty-eight percent
(58%) to forty-six percent (46%), The New York Times reported on a speech by the
Chairman of United States Steel Company entitled: “PROSPERITY AND TAX
REFORM.” In the speech given to the League for Political Education, Chairman Gary
argued for a clear connection between the quest for tax reduction and a revival of trade.
The New York Times reported that as “Chairman of the largest steel corporation in the
world [he] was qualified by his position to indicate the influence of the one consideration
on the other.” The Times further pointed out that the Chairman needed to include such
204
This idea became even stronger in the early 1930s when Richard Kahn presented the consumption
multiplier relation. Nevertheless, the views are evident in Keynes’ original writings. See: John Maynard
Keynes, The general theory of employment, interest and money, (New York: Harcourt, Brace and Howe,
1936)
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considerations in his own business calculations. Chairman Gary placed the blame for a
slowing economy in 1923-1924 “unhesitatingly” on the existing Federal tax code, which
were:
“so heavy as to drive the wealthy investor out of the ordinary industrial
investments, where the high surtax would practically cut his 5 or 6 per cent return down
to 3, and into the 4 per cent tax-free bonds of States or municipalities.”205 Similarly, The
Times reported on March 19, 1924: “SEES MUCH GOOD IN TAX PUBLICITY; C.F.
Noyes Believes That It Will Bring About Revision of "Iniquitous" System. SAYS
EVASION IS RIFE.”206
Wall Street also responded to the tax cuts, explicitly connecting Mellon’s tax
reform and the initiation of the bull market. In November of 1924, The New York Times
reported:
NATION-WIDE BUYING TAXES WALL STREET AND PRICES SOAR;
Heaviest Trading on New York Stock Exchange
of Any Saturday Since 1906.
1,388,105 SHARES IN 2 HOURS
Country's Response to Coolidge and Baldwin Victories and
Setback to Radicalism.
EXCITEMENT ON EXCHANGES
Ralls Lead In Seething Market –
Business Outlook and Tax Cut Prospect Help.
NATION-WIDE BUYING TAXES WALL STREET
The article described the inflow of new investors from all across the country following
Coolidge’s re-election and the enactment of the new Budget of 1924. Brokers reported
business increasing some 300 percent (300%) following the election on November 3. In
citing the causes of the “Bull Market” The Times reports:
Wall Street sums up the development which have brought about this bull
market as follows: The re-election of President Coolidge, the veering away
from radicalism in the United States and in Great Britain, the assurance that
the railroads will be free from adverse legislation…the knowledge that drastic
tax readjustment will be the next step of Administration at Washington… 207
205 The New York Times, December 2nd, 1923 – p. E6 “Prosperity and Tax Reform”
The New York Times, March 19th, 1924 “FINANCIAL MARKETS” pg. 27.
The New York Times Nov 9, 1924. “NATION WIDE BUYING TAXES WALL STREET AND PRICES
SOAR” p. 1
206
207
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There was a similar reaction in the Markets following the tax reform in 1926 and 1928.
On October 20, 1925, while Mellon was battling for his third tax cut that would bring top
marginal rates down twenty five percent (25%), The New York Times reported:
TOPICS IN WALL STREET.
A Day of Wildly Confused Stock Market Movements; Trading Large.
The financial district, when if found time yesterday afternoon to talk of anything but stocks, was
greatly encouraged by the outline by Secretary Mellon of his policies on taxation. It was generally
believe in Wall Street that the tax reform will be bound to be adopted in the next session of
Congress, with resultant stimulus to business. Great prosperity to corporations all along the line
was predicted as a result of the reduction in Federal imposts, and the bankers also expressed the
hope that the various States would emulate the Federal Government in its program of economy
and tax reductions.208
On December 9, 1927, The Times ran with:
TAX CUT REVISED; PUT AT $232,735,000;
Committee Reports Bill to House
With Figures Verified by Treasury Experts.
CORPORATE RELIEF LARGER
Cut Will Run to $176,000,000 and Apply on Income Received in 1927.
The reduction in the corporation tax from 13 ½ to 11 ½ percent, the bill
provides, shall become operative on March 15th, 1928 on income of 1927. All
other cuts in taxes become effective thirty days after the approval of the
measure by the president.209
Evidence is clear and abundant.210 The fiscal reforms driven by secretary Mellon
under the Harding and Coolidge presidencies created an environment in which the
American economy could thrive. At the same time, the Federal Reserve was able to
establish a relatively stable price level following the depression in 1921-1922. Europe
was demanding huge amounts of American goods and the United States economy
began to respond. Business innovation was high and productivity increased throughout
the decade. As taxes continued to come down the “Laffer curve,” revenue continued to
The New York Times Oct 20, 1925. “TOPICS IN WALL STREET” p. 31
Special to The New York Times.., “TAX CUT REVISED” Dec 9, 1927. p. 3
210 This is only a sampling of the articles in The New York Times alone. Interested readers could find many
more similar articles both in The New York Times as well as the other major newspapers and journals of the
period.
208
209
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increase for government and the “booming” twenties were fully underway. 211 In addition,
in response to an attractive fiscal and legal environment, businesses began to expand
and a major merger boom began to drive the economy beginning in 1925/26.
Productivity continued to increase as mergers created economies of scale and scope
and allowed corporations to reach new markets. Moreover, there is ample evidence that
even immediately prior to the stock market crash in 1929, the market was fairly priced
according to company fundamentals. Described as such, the causes and the scope of
the boom are not so surprising. In fact, the lack of previous explanations surrounding
the boom, both in the economy and the stock market, in much of the traditional literature
is startling.
The only other country to bring tax rates down in the 1920s was Italy, which also
enjoyed a booming economy following the war. In the years following the war, Italy
found itself in severe economic retrenchment. In 1922, Benito Mussolini took control
over the Italian government. Under Mussolini, Alberto de Stefani, the Italian Minister of
Finance, reformed the fiscal structure, slashing both tariffs and the progressive income
tax policies established during the War.
France took similar action when Henri Poincare took office in August, 1926.
Following the war, France imposed a steeply progressive income tax called “l'impôt des
poires,” literally, “the tax of pears.” Wanniski describes this tax as a “suckers tax” that
was effectively only paid by those who could not escape it. As the decade progressed,
the government became more adept at enforcing tax codes and the French economy
began to contract amongst high inflation, which pushed more people into the higher tax
brackets.
Total government revenues were only slightly higher for the period 1920
through 1925 than in they were in 1913, when there no income tax existed.
The
financial crisis ended in 1926 when the Poincare cabinet rose to power and announced a
211
See appendix C for a graphical representation of the impact of the tax-reform.
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new tax reform on August 3, 1926. The top income tax rate was slashed from sixty
percent (60%) to thirty percent (30%). The inheritance tax and estate tax rates were
also reduced and made less progressive. The tax on securities, the capital gains tax,
was decreased by nearly forty percent (40%); the “carnet de coupons” was also
abolished.212 Following the tax reform, the franc stabilized and actually strengthened
against the dollar as the economy recovered. By 1927, the tax cuts had generated an
increase in revenues of nearly twenty-three percent (22.9%) from 5.4 billion to 7 billion
prewar francs. After Poincare took office in July, 1926 through the end of the year, the
franc rapidly strengthened on the foreign-exchange market from two cents to four cents
on the dollar, a 100 percent (100%) gain.213
Commenting on this stabilization and
strengthening of the franc, The New York Times printed: “the advance of the franc…has
now got a further favorable influence from the French Senate’s passage of all the taxreform bills.”214
The connection between tax reform, namely tax reduction during the 1920s from
excessively high progressive world income taxes, and economic success was not only
economically valid, but also readily understood by the public during this period. It is only
the historians and economists since that have failed to recognize, or acknowledge, the
connection.
What remains to be seen, however, is what changed so drastically in
October 1929 to cause a sudden and remarkable fall in market valuation? Moreover,
were these the same forces that propelled the nation, and the world, into the most
severe and chronic depression in modern history?
The “carnet de coupons” was established to check tax evasion on income tax due from sale of securities.
Robert Murray Haig, The Public Finances of Post-War France (New York: Columbia University Press,
1929) p. 163. Information for this entire paragraph can be attributed to this source.
214 The New York Times, December 2nd, 1923 pg. E6 “Prosperity and Tax Reform”
212
213
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Chapter Six:
The Stock Market Crash and the Smoot-Hawley Tariff – Evidence of a Catalyst
Gain through freeing imports from taxation does not depend on other countries doing the
same. For other countries to tax our exports to them is an injury to us and an obstacle to
trade. For us to tax their exports to us is not a correction of that injury; it is just a separate
additional obstacle of trade….If one country has good harbors while all the rest have bad
ones, it will not realize the advantages of good harbors so fully as if all the rest had good
ones also. But it will realize some advantages; it will be better off than if it, too, sank rocks
all round its coasts.215
After rising four-fold from January 1924 to September 1929, the DJIA dropped a
third of its value in the third week of October 1929, crashing from 306 to 230 from
October 23 through October 29. In the years following the “Crash” the marked lost
ninety percent (90%) of its peak September 1929 value of 381 in an irregular decline to
41 on July 8, 1932, marking its lowest point for the DJIA in the twentieth century. In
returning to the original question – what caused the stock market crash and subsequent
depression of 1929, where the causes one and the same, and why was the depression
so severe, wide in scope, and lengthy? – It is helpful to give an overview of the existing
theories.
With regard to the crash, Galbraith, Kindleberger, Friedman and Schwartz, and
others, focus on the inevitability of collapse in prices rather than attempt to explain the
causes for the rapid decline in stock market valuation during that infamous week of
October 1929.
The traditional story is that bubbles pop because they must.
This
absence of any trigger for Galbraith’s “speculative mania” or for the subsequent “crash”
215Sir
William Beveridge, Tariffs: The Case Examined, (London: Longmans, Green & Co, 1932) pgs. 109-
110.
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leave students of the 1920s and 1930s with much to be desired.216 Eugene White
addressed some of these issues in a number of articles in the early 1990s, but fails
himself to come to conclusive results.217 Inevitably, he defaults back to the “bubble”
explanation. While not attempting himself to estimate the fundamental value of stocks
before the crash, White posits that the necessary conditions for a bubble were already
present.
Citing work by Oliver Blanchard and Mark Watson (1982), White argues
fundamentals were becoming difficult to access in the late boom environment,
mentioning major changes in industry as evidence of this opaqueness.218
White’s second point concerns investors themselves. He argues the “overall
sophistication of investors was weakened” as more people entered the market. White
points to women as an identifiable new group that brokers began to cater toward.219 Yet
this too is unsatisfactory. To attribute the crash to “stupid investors” does not give the
market of the 1920s the respect it deserves. Nor is it easy to believe such as story
considering the sophistication of investment bankers of the time. For example, during
the first days of the Crash, bankers assembled at J.P. Morgan & Company’s office at the
corner of Wall and Broad streets across from the NYSE. The “Bankers’ Pool,” as the
group became known, consisted of Thomas Lamont CEO of J.P. Morgan & Co., his
These authors often rely on the argument that expectation are “herd” events and that they need not have
clear “turning points.” Whether this is a valid point or not will be left for another discussion, but even
irrationality must have a source. A herd of animals may stampede irrationally, but there is always one
animal that notices a threat and starts to run, enticing the others. It is in this animal that the irrational panic
begins. It is in what this animal understood as a threat that can be attributed as the origin of the stampede.
There is always a source and the stock market is no different. Moreover, it is the opinion of this author that
ample evidence has been presented that stock prices were valued rationally and so something must have
turned investors’ expectations.
217 See White, “The Stock Market Boom and Crash of 1929 Revisited” The Journal of Economic
Perspectives, Vo. 4, No. 2 (Spring 1990) 67-83 and “Was There a Bubble?” The Journal of Economic
History, Vol. 53, no. 3 (September 1993).
218 See Oliver Blanchard and Mark Watson’s “Bubbles, Rational Expectations, and Financial Markets,” In
Paul Watchel’s Crises in the Economic Financial Structure. (Lexington: D.C. Heath and Co, 1982) pp. 295316. In particular White references the shift in dominance toward the modern General Motors Corp. and
away from the proprietary Ford Motor Co as specific evidence for the increasing importance of technology.
It should be noted that General Motors was increasing its dividend throughout the period, a clear and
transparent bull signal for investors. White also cites RCA, Radio Manufacturers of America, as further
evidence. RCA did not pay a dividend, but sales were growing 50 percent (50%) a year throughout the
decade and there was a plethora of information concerning the extent and use of radio’s in America.
219 Evidence surrounding the role of women in the stock market can be found in Frances McMullen “Women
and the Ticker Tape – A Year after the Crash,” The Women’s Journal, 1987, No. 60, pp. 1-40.
216
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partner and heir, George Whitney, along with head of Chase National Bank, Albert
Wiggin, Chairman of the Guaranty Trust Co, William Potter, president of Bankers Trust,
Seward Prosser, and Charles Mitchell president of National City Bank. The group
immediately devoted $125 million or the equivalent of $1.54 billion in 2006 toward
supporting stocks, giving orders to Richard Whitney and Warren Nash, President and
Treasurer of the NYSE, to execute. The idea was to place large buy orders well above
market prices to halt the sell off and restore stability to the market. For example, by
noon on “Black Thursday,” October 24, 1929, a bid for 25,000 shares at $205 (over $5
million) was placed by Whitney for U.S. Steel using the bankers’ capital, while the stock
was trading at $195. Similar bid were placed in other blue chips stocks. This was a
tactic used by J.P. Morgan himself to help stabilize the markets during the 1907 panics.
It is difficult to believe that such experienced and developed investors with such huge
amounts of capital were overwhelmed by White’s new group of “unsophisticated”
investors.220
In another article, White and Rappoport present more evidence to support the
Galbraith “bubble” theory, citing widening spreads between interest rates on broker
loans (call and time loans collateralized by stocks and bonds) and other money market
rates (banker acceptances’ and commercial paper). They argue this spreading gap
indicated that “lenders…thought stock prices might collapse during the term of a loan
and jeopardize the collateral.”221 Moreover, White and Rappoport contend that these
“high premia in the brokers’ loan market therefore contain information about lenders’
220
Barrie A. Wigmore The Crash and Its Aftermath, (London: Greenwood Press, 1985). During the 1907
bank crisis, J.P. Morgan organized a team of bankers and trust managers to redirect money between banks
and secure international credit lines to halt the run on the banks and give the system liquidity. Moreover, the
group eagerly created markets to keep the exchange open by buying the plunging stocks of healthy
corporations. Stability in the market was created and panic subsided with only minimal macroeconomic
effects.
221 White and Rappaport (1993) p. 570
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perceptions of a bubble in the stock market.””222 Yet, as Tung Liu, Gary Santoni and
Courtenay Stone (1995) showed, similar or in fact larger credit spreads formed between
broker’s loans and other market rates in the late 1919 and 1920 period, when stocks
were actually declining.223
Moreover, econometric tests provide no evidence of
parameter instability or structural breaks in credit spreads during the 1928-1929 boom.
Finally, these “interest rate premia” cited by White and Rappoport as evidence of a
“bubble,” disappeared in the weeks prior to the crash. This disappearance should not
occur if White and Rappaport are correct. Instead, it appears that the run up in broker
loan rates was due to a credit squeeze caused by the Federal Reserve, which used
moral suasion and other techniques to discourage such loans.
As the supply was
restricted, simple supply of brokers’ loans and demand economics explain the higher
rates on call and time loans in comparison to banker acceptances’ and commercial
paper.224
Finally, unable to find a cause for the crash even after assuming the existence of
a bubble, White simply argued that traders’ revised their future expectations of cash flow
as evidence emerged of economic slow down. Specifically, White pointed to a drop in
Industrial Producing in July 1929. The evidence of oncoming recession combined with
rising interest rates, White argued, caused a modification in valuations and a collapse of
the “bubble.” Putting aside the fact that White first attributed the booming stock market
to “irrational exuberance,” but then proceeded to attribute the collapse to a rational
readjustment of expectations to economic conditions, White left a number of
fundamental questions unanswered. For example, why this collapse came in the last
week of October when the slowdown began in July, and why the market rallied through
222
White and Rappaport (1993) p. 550.
Tung Liu, Gary Santoni, Courtenay Stone “In Search of Stock Market Bubbles: A Comment on Rappoport
and White,” The Journal of Economic History, Vol. 55, No. 3 (Sept. 1995) p. 647 - 654
224 See Liu, Santoni, and Stone (1995) p. 647-654 for a full description of this argument.
223
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the first half of 1930 to a high of 297, nearly where the DJIA stood before the crash,
White does not address. Nor does he address the fact that, according to information
provided by the Federal Reserve index, industrial production actually increased by 1.38
percent (1.38%) on a seasonally adjusted basis (2% not adjusted) in July and only
began to fall in August. Moreover, this fall was of a mere one percent (1%) on a monthover-month basis, hardly enough to cause a severe revision in expectations. Even more
important, this industrial production data only became available to traders during the
week following the crash in October, when the figures were published.225 White’s theory
is simply not supported by the data.
Even if investors somehow reacted off non-
published information, the decline in output was gradual and the timing does not support
a link to the crash. As a result, it is not plausible that such a rapid and vast revaluation
of the market occurred as a result of a typical cyclical slow down in the economy,
especially considering the slowdown was not even visible to contemporaries at the time
of the Crash. There is little evidence to support White’s argument for a revision in
expectations due to a foreseen recession as the driving factor in the crash.
Galbraith sums up his explanation for the Crash in a single paragraph:
It was simply that a roaring boom was in progress in the stock market and, like
all booms, it had to end. On the first of January of 1929, as a simple matter of
probability, it was most likely that the boom would end before the year was out,
with a diminishing change that it would end in any given year thereafter. When
prices stopped rising – when the supply of people who were buying for an
increase was exhausted – then the ownership on margin would become
meaningless and everyone would want to sell. The market wouldn’t level out; it
would fall precipitately.226
This account is more of a non-explanation that anything else. As with Galbraith above,
Kindleberger also believed that what goes up must come down. To him, however, the
225
See Federal Reserve Board Index for Industrial Production - available at:
http://www.federalreserve.gov/releases/G17/ visited on March 8th, 2006. Alternatively, an argument could be
made, but was not by White, that investors anticipated November’s much larger decline in output of five
percent (5%) on a seasonally adjusted basis and nine percent (9%) not adjusted. This would be more inline
with statistical evidence demonstrating that stock prices lead output. Nevertheless, the decline in output
was likely a result or, not a cause of, the crash.
226 Galbriath (1955) pg. 29
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crash was not a “superficial phenomenon” or a “trigger.” Kindleberger argued the crash
was endogenous to the Great Depression, by viewing it as part of the deflationary
mechanism. Yet Kindleberger failed to offer a reason for the “deflationary mechanism”
itself.
Instead he fell back on Friedman and Schwartz’s argument, which credits a
liquidity squeeze caused by the Fed’s decision to hike the discount rate from five percent
(5%) to six percent (6%) in August 1929 as causing the crash and eventually created the
subsequent liquidity panic and bank runs of the 1930s. This theory, however, is not
wholly believable. Even if money was tight immediately prior to the crash, the Fed had
taken similar action in 1926, 1924, and 1921. The only other time the Fed’s actions can
be said to have caused a collapse was 1921, when commodity prices plunged sixty
percent (60%) in only a few months. Assets prices also fell sharply, dropping from a
high of 119 in late November 1919 to a low of sixty-six in December, 1920, a decline of
over forty-four percent (44.2%). Why did this collapse not lead to similar bank failures
and depression? Moreover, the rise in the discount rate did not have a significant impact
in the loan market. Broker loans peaked on a weekly basis for the week of October 9,
1929 at $3.94 billion and only fell to $3.82 billion on October 23, the first day of the
crash.
Previous declines of larger scale did not lead to any catastrophic sell offs,
indicating the “squeeze” by the Fed was not the cause of the crash. Moreover, by
looking at the period of the boom before the crash and the period after, brokers’ loans
appear to reacted to the markets, but not to drive them.227
Others historians and economists point to similar financial factors such as a
sharp increase in the supply of new stocks, the Hatrey empire financial collapse in
England, or the October 11, 1929, decision of the Massachusetts Department of Public
Utilities to deny a stock split. These theories, however, are equally lacking in power,
circumstances or timing.
227 Liu, Santoni, Stone (1994) p. 654 & White, (1990) pg. 80.
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Fred I. Kent, of Bankers Trust put forward the argument that the issuance of new
securities overwhelmed the market.
Stock issuances were increasing continually
throughout the Coolidge bull market. In addition, the new flow of issuances while large
in nominal terms was miniscule in comparison with the aggregate stock of equities. At
the end of August 1929 the NYSE had a market capitalization of $89.7 billion. A dilution
because of new stock issuances might have had an impact in the decline, but could not
have been the cause the sudden break in prices.
The Hatrey collapse in London was mentioned by Galbraith as an important
shock to the market both in London and in New York. Yet the timing was wrong. The
Hatrey collapse occurred on September 20, 1929. Moreover, in order to show causality,
prices in London should fall before prices in New York. As White (1990) demonstrated,
this was not the case. The London market only lost 2.8 percent (2.8%) by October 18th,
before the New York Crash, and most of the sell off was in the Anglo-American
securities of railway stocks. The decline in both markets following the crash was simply
London reacting to the collapse in New York, not the other way around.228
Finally, the notion that the crash was triggered by a refusal to allow a Boston
Edison stock split on October 11 fails to stand up under scrutiny. The timing was again
wrong. The crash did not occur for nearly another two weeks. This fact alone cannot
refute the theory entirely, but the market also gave no indication of anticipating the
crash, as would be expected under this presumption. The day of the announcement by
the Massachusetts Department of Public Utilities, the market failed to react. The DJIA
lost 0.05 percent (-0.05%) on Friday October 11 and only half a percent (0.5%) on the
following Monday. The absence of a market reaction that might portend the later violent
sell off greatly discredits the theory. The Boston Edison regulatory decision must be
considered irrelevant to the crash.
228
White, 1990, p. 79.
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This lack of a satisfactory explanation surrounding the crash is troubling. Bull
markets do not crash for no reason. Even speculative “bubbles,” which has been shown
to be unlikely in 1929, need to be “popped.” In the conventional literature, however, no
convincing theory adequately tells the story. The most lasting legacy of fear from the
Great Crash has been the failure to explain it. One more theory does remain, however.
Jude Wanniski in The Way The World Works presented a new theory surrounding the
crash; one that accepts the booming market as legitimate and looks to explain the
severe reduction in future valuations in real terms. Specifically, Wanniski points to the
Smoot-Hawley Tariff of 1930 as the “trigger” for the stock market crash.
Consider the following course of events:
(1) The New York Times ran with eight articles on December 5, 1928 documenting the
lobbying of different groups for higher duties in the new tariff and the growing resentment
of Europe to such discussions. Five more articles ran the following day, December 6.
On December 7, The Times reported that the House Ways and Means Committee had
scheduled hearings of fourteen subcommittees to take up tariff testimony in the New
Year and the hearings would cover all commodities, not just agriculture. The market
reacted immediately dropping from 290 to 279 on Thursday December 6 then to 271 on
Friday and to 263 on Monday, December 10. In the three day period, the DJIA lost
nearly ten percent (-9.2%) of its value, its largest four day sell-off since before the war!
(2) News then died down around the tariff and Coolidge actually spoke out against the
idea arguing tariff revision would be of little benefit to American farmers. The DJIA
traded up to 300 by December 31, 1928 and continued upward in 1929 until March 23,
when it stood at 310. On Sunday, march 24, page two of The New York Times read:
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WATSON PREDICTS TARIFF DIFFICULTIES
AFTER CONFERENCE WITH HOOVER, SENATE LEADER
SAYS INDUSTRIES SEEK WIDE REVISION
HE WILL ASK CEMENT RISE
OTHER LEGISLATORS WILL BACK OWN INDUSTRIES
LONGWORTH SUPPORTS PRESIDENT ON LIMIT
The article clearly stated that Congress will not tolerate a limited tariff revision, but will
fight for a complete overhaul of the existing tariff to push rates up across the board. The
DJIA dropped to 297, a decline of 4.1 percent (-4.1%) making it the worse day on Wall
Street since October 10, 1927 when the market dropped from 197 to 189 or 4.3 percent
(4.3%). The New York Times reported that “only twice in the history of the Exchange
have there been broader breaks.”229
The following day, Tuesday March 26th, The Times printed:
GIVE HOOVER TARIFF DATA
DAVENPORT AND TREADWAY TELL HIM OF
TEXTILE INDUSTRY’S NEEDS
In the article, it was clear that a substantial hike in textile tariff schedules was being
pushed with little resistance in the Ways and Means Committee. This was further bad
news for the already volatile market. The market crashed on record trading volume.
8,246,740 shares changed hands, approximately 19 percent (19%) higher than any
trading day over the history of the exchange. The New York Times reported “The day’s
trading reflected forced liquidation of the most drastic sort, and the inability or
disinclination of traders…to further carry stocks whose quotations were rapidly melting
away.”230
The “crash” was adverted by a group of institutional buyers including a
number of prominent banks that stood in to stem the panic. The DJIA finished at 296,
only one point off the day before but the trading was much more volatile with the low for
the day at 281. Before bankers aided the market with concentrated support, the market
The New York Times, March 25th 1929, “STOCKS PRICES BREAK HEAVILY AS MONEY SOARS TO
14 PER CENT” p. 1
230 The New York Times, March 27th, 1929, “FINANCIAL MARKETS” p. 40
229
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sold off twenty-three percent (23%) of its value in two days, a decline nearly equivalent
to that of the “Great Crash” that would come in October.
(3) The market then recovered, advancing to 300 where it remained through May.
President Hoover called the first Special Extra Session of Congress since 1922 to
discuss the tariff bill. He stressed revision in farm duties only. The New York Times
headlined the story on front page on April 17th 1929:
HOOVER FOR FARM BOARD AS EXPERIMENT
AND 'LIMITED' REVISION OF THE TARIFF;
SHARP DIVISIONS RISE IN BOTH PARTIES
In response, the market traded up two percent (2%) to 309. Meanwhile, opposition to
the tariff began to form in the Senate. A coalition of thirty-nine Democrats and fifteen
“progressive” Republicans joined forces against the “Old Guard” Republicans led by
chairman of the Senate Finance Committee and champion of the tariff bill, Senator Reed
Smoot of Utah. It appeared as if the coalition would win and the tariff would be rebuked
entirely in the Senate or, if passed, limited to agricultural products. The DJIA moved to
347 by the end of July and then to 380 by August 30. The DJIA reached 381 on
September 3, 1929, a level it would not attained again for another quarter of a century
on November 23, 1954.
4) On September 4, Congress came back to Washington from the summer recess and
the redrafted bill was presented to the Senate. The decline from 381 on September 3
began immediately, but was orderly and consistent. By Friday October 11, the DJIA was
at 352. Loans over the past two weeks had declined by $120 million as foreigners pulled
money out of America putting stress on margin accounts.231 This foreign selling was to
be expected in a world concerned over the tariff bill. The Fed had tightened rates in
231
Friedman and Schwartz, p. 307-308
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August, so the current squeeze could not be attributed directly to its one percentage rate
hike to six percent (6%).
5) On October 21, the Senate rejected 64 to 10 a movement by Senator Thomas of
Oklahoma to limit the bill to increases in agriculture only. The market reacted violently.
The New York Times reported “wild and erratic movements” as traders complained of
“absence in Europe of a leading broker whose optimism” could serve to stem the slide.
6)
During the debate on October 21, Senator LaFollette of Wisconsin argued the
progressive Republican bloc had voted against limiting the tariff reform to agricultural
duties with hopes of reducing rates on industrial products.
On October 22, the
progressive bloc, along with the Democrats, forced a cut in the chemical rates in a test
vote, 45 to 33. The market moved up sharply, gaining six points or almost two percent
(2%) to 326.
7) Late in the afternoon on October 23, The Commercial and Financial Chronicle noted:
“A weakening of the Democratic-Progressive Coalition,” as the sixteen members of the
anti-tariff coalition switched sides and voted to double the tariff on calcium carbide from
Canada. Stocks buckled in the last hour of trading. The DJIA dropped to 305, losing
over six percent (6.3%). The “Great Crash” began.
8) The following day, October 24 or Black Thursday, The New York Times covered both
stories on the front page:
COALITION BREAKS
OVER CARBIDE RATE
PRICES IN STOCK CRASH
HEAVY LIQUIDATION
TOTAL DROP OF BILLIONS
CRASH IN FINAL HOUR
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The crash that began in the final hour of trading on Wednesday, once the news of the
senate vote hit the markets, continued on Thursday. As Galbraith described, “The panic
did not last all day. It was a phenomenon of the morning hours.”232 The DJIA reached
as low as 272.32 or 11 percent (11%) off their opening of 305. The New York Times
called it “The widest break in the history of the stock market since the war…” 233 The
DJIA closed at 299, down only two percent (2%). In almost identical fashion to the
earlier March crash, Bankers had pooled together to place large orders to support
stocks, including a 25,000-share bid for US Steel at ten dollars ($10) over the market
price. Volume was enormous as 12,894,650 shares exchanged hands, more the four
million more than the previous record set during the March panics.
9) By the afternoon on Black Thursday, the anti-tariff coalition had reassembled and
pushed through further cuts in chemical rates and put crude chicle on the free list. 234
The DJIA gained almost two points to 301 as The New York Times reported “STOCKS
GAIN AS MARKET IS STEADIED.”235
10) On Monday, October 28, a delegation of senators appealed to Hoover for help in
pushing through the tariff bill. The front page of The New York Times read:
LEADERS INSIST
BILL WILL PASS
SMOOT AND BORAH
CONTRADICT REED
WHO TOLD PHILADELPHIANS
BILL WAS DEAD
Suddenly both the anti-tariff coalition and the old guard Republicans promised the bill
would pass. The DJIA dropped a record thirty-eight points or eleven percent (11%),
232
Galbraith, pg. 104
The New York Times, October 25th 1929, “TOPICS IN WALL STREET” pg. 43.
234 Chicle is a type of tree.
235 The New York Times, October 26th 1929, “STOCKS GAIN AS MARKET IS STEADIED” pg. 1
233
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closing a shade over 260 for a total loss of more than $14 billion in what The New York
Times called a “Nation-Wide Stampede to Unload,” as an “unexpected torrent of
liquidation again rock[ed] market.”
What is more, The Times reported “Selling by
Europeans and “Mob Psychology” as big factors in the break. The Commercial and
Financial Chronicle headlined news about broker loans reporting: “Recall of Foreign
Money Grown Heavier – All Europe Withdrawing Capital.” Again, this mad selling by
Europeans was consistent with the tariff hypothesis.
11) The following day, Black Tuesday, the selling continued and the press proceeded to
print assurance that the tariff would pass. The DJIA dropped another thirty points to
230. Volume reached another new high, smashing the previous mark with 16,410,030
shares trading hands.
12) On Wednesday, October 30 the front page of The New York Times reported, “THE
COALITION FIGHTING MOVE TO KILL TARIFF.” The DJIA rallied twenty-eight points
or over twelve percent (12.3%) to 258.
13) The Market moved erratically downward, but at a much calmer pace until the DJIA
reached 198 on November 14. On this day, The Chronicle reported that a demoralized
Senator Smoot, “virtually surrendered the tariff bill to the Coalition of Progressives and
Democrats,” and President Hoover announced a one percent (1%) tax cut on person
and corporate income rates. The DJIA finished the day at 217, up almost ten percent
(10%).
14)
In the following days, the Senate postponed action on the bill until the spring
session. Talk of a filibuster covered the press. It looked like a stalemate. The market
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traded continually upward reaching 241 on November 20, and then 254 where it roughly
remained, closing the year at 248. By February 18, 1930, the DJIA reached 270 and by
April 17 had reached 294, only eleven points or 3.4 percent (3.4%) from its pre-crash
level of 305. The DJIA would did not reach 294 again until 1954.
15) Also on April 17, the Tariff Conference Committee finished consideration of the
rates agreed on by the House and Senate in March and reported to Congress. The
Market began a continued downward march. Both the House and the Senate approved
the Tariff in March, while debate lingered regarding if Hoover would veto. A tariff defeat
was looking increasingly unlikely. From April 17, to the beginning of May, the DJIA
steadily declined until settling around 265 where it continued to trade within a small
range.
16) June opened and the DJIA was at 275. A plethora of economists and businessmen
warned Congress and the President not to pass the bill. 1,028 economists petitioned
against the bill. On June 3rd Dr. Theodore Grayson, Dean of the Wharton School of
Finance, was quoted in The New York Times as saying “the present method of making
tariffs is ‘suicidal as well as ridiculous.’”236 On June 10 the general sales manager for
General Motors gave a speech against the tariff stating:
America has become a creditor nation for the first time, and it is elemental in
economic history that a creditor nation, particularly one which happens also to
be one of the world’s greatest producing nations, must, if it hopes to preserve
its prosperity, do more than buy foreign services and send its tourists abroad –
it must buy foreign goods…237
Over the period, stocks declined over eight percent (8.2%), dropping to 249 the day after
the General Motor’s speech.
236
237
The New York Times, June 3rd, 1930, “CALLS TARIFF WALL SUICIDE FOR TRADE” pg. 6
The New York Times, June 10th, 1930 “URGE TARIFF CUT TO AID WORLD AMITY” pg. 2
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17) On June 12, the market awaited Senator Reed’s decision on the tariff. At the time,
the Senate was split 50-50 with Reed’s decision understood as the deciding factor. The
New York Times reports:
TOPICS IN WALL STREET
Because of the impression that Senator Reed’s attitude might easily be
the deciding factor in the fight over the tariff legislation, Wall Street
waited yesterday with intense interest for his speech in the Senate. It
was about 2:30 o’clock when the financial news ticker flashed the word
that the Pennsylvania Senator would vote for the Smoot-Hawley Tariff.
Brokerage houses in their afternoon circulars devoted much space to
the tariff bill’s prospects…The average price of fifty representative
stocks showed a net decline of 89 cents on the day. The erratic price
swings reflected the shifting moods of the [traders].238
STOCKS BREAK AND RALLY THROUGHOUT DAY
TRADERS LAY DECLINES TO REED TARIFF STAND
… For the last half our of trading the downward trend of prices was
slow but steady. Of reasons given for the decline the most popular
one with traders was that Senators Reed’s statement that he intended
to vote for the tariff bill as it now stands spread abroad a feeling that
the new measure would be passed.”239
18) In the afternoon on June 13, the Senate finally adopted the conference agreements
and the tariff bill was virtually assured. The DJIA finished up two points to 249, but
turnover was almost non-existent with only 2,221,900 shares traded, less than half the
average daily volume. The market was literally waiting to hear what the Senate would
do and news only broke after the market closed. The New York Times covers trader’s
sentiment:
TOPICS IN WALL STREET
Trading on the Stock Exchange was sharply curtailed yesterday, but prices
were higher as professional selling subsided. The total turnover was only
2,221,900 shares and the shrinkage was ascribed to the waiting attitude
assumed by the market community on the eve of the vote in the Senate on the
tariff bill. News of that body’s approval of the conference report was not
received until shortly after the close of the market….With the bear party
The New York Times, June 13th, 1930, “TOPICS IN WALL STREET.” Pg. 40
The New York Times, June 13th, 1930, “STOCKS BREAK AND RALLY THROUGHOUT DAY: TRADERS
LAY DECLINE TO REED TARIFF STAND.”
238
239
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temporarily inactive, the market was able to make considerable headway on
the up side.
The following day all the market reacted to the previous day’s news from the Senate.
The House also passed the bill. The New York Times Reports:
STOCKS PRICES SAG ON PASSAGE OF TARIFF
VIEWED AS WALL STREET’S DISAPPROVAL OF BILL
The market pointed downward soon after the opening and remained heavy
until the close, final quotations disclosing net losses of from 2 to 7 points in
many of the active issues. Among the stocks which led the decline were
United States Steel, Standard of New Jersey, Westinghouse Electric,
Worthington Pump, American Water Works, Baltimore & Ohio Calumet and
Arizona, Anaconda Copper, J.I. Case, United States Freight, Consolidated
Gas, Eastman Kodak, International Telephone and Telegraph and Radio
Corporations.
Brokerage houses in their week-end circulars devoted much space to the tariff
legislation, most of them expressing the view that its effect had been
discounted, so far as the stock market was concerned.
It is important to note that all stocks broke and that the “normal” market ,movers
continued despite trader’s actions being explicitly driven by the tariff. This aggregate
market move has been a source of criticism of opponents to the tariff hypothesis who
believe news on the tariff should only impact businesses controlled by the export and
import market. Nonetheless, the precarious position of the international financial system
left all U.S. businesses and citizens directly at risk and consequently impacted by the
bill’s passage. In addition the stock market, the grain market and other commodities
collapsed in Chicago, with wheat at an eight year low of 99 cents. Dissatisfaction with
the tariff bill was explicitly stated in The New York Times in multiple articles as the
primary cause of the general market sell off. Also, market gossip noted the long held
short position of many bear investors, indicating they had been playing this position on
the tariff for some time, perhaps since the debate picked up the previous March, 1929.
The DJIA closed the short two hour Saturday session down five points or just over two
percent (-2%) to 244.
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19) Uncertainty still surrounded whether Hoover would sign the bill. Then, on Sunday,
the front page of The New York Times read: “HOOVER SAYS HE WILL SIGN TARIFF
BILL,” arresting any ambiguity. On Monday the market absorbed the news. The New
York Times made the connection clear:
DEMOCRATS TURN TARIFF FIRE ON HOOVER
AS SENATE SENDS BILL TO WHITE HOUSE;
BREAK IN STOCK AND COMMODITY PRICES
Selling Swamps Exchange
Leading Issues Tumble as
Wall Street Assails the New Tariff
Cotton and Wheat Down
Former Touches the Lowest in
Three Years With Grain Sagging in Chicago
Many Margin Wiped Out
Much Liquidation Due to Brokers Calling
In Vain for Further Deposit
In what The Times called the “markets formal reaction to the tariff” over eight million
shares changed hands, or four times that on Friday when the street waited in
anticipation of the Senate decision. Active issues declined seven to nineteen points and
included many of the strongest names, with Industrials and Railways declining roughly
equal amounts. Commodity prices also broke, with Wheat dropping 3½ cents to 95½
cents, or twelve cents below its level of a weak earlier, a decline of eleven percent (11%). The DJIA broke fourteen points or six percent (-6%) to close the day at 230,
precisely where it stood at the close of Black Tuesday, the last day of the “Great Crash”
of the previous October. The accuracy and continuity in pricing the tariff is astounding.
20) The next day, the markets in London, Paris and Germany all sold off with AngloAmerican and international shares leading the decline. The Times reported:
MARKETS IN LONDON, PARIS AND BERLIN
FRENCH STOCKS DELINE; MANY BREAK SHARPLY, WHILE TRADING IS
DULL –
SELLING MOVEMENT HALTED ON GERMAN BOERSE.
A liquidation continued all day as a result of increasing nervousness over
European as well as American markets. Virtually no buying was anywhere in
evidence until the afternoon.
PRICES DECLINE IN PARIS
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There was considerable talk in financial circles of the passage of the new
American tariff bill, which some quarters is credited with causing the Wall
Street recession. Little optimism is expressed here as regards the prospects
for the immediate future.
BERLIN RECOVERS AFTER LOSSES
The Wall Street break in prices had a depressing influence on today’s session of the Boerse.
In light of this congruence, this story in quite attractive.
News on the tariff
correlate nearly perfectly with activity on the stock market. More importantly, the stock
market behavior, in its timing, volume, volatility, and price level is consistent. Every
major market event corresponds to the tariff. The largest three day break since World
War One corresponded with news that the tariff would be extended to all industries in
December 1928. The beginning of the battle for industrial rate increases in Congress,
lacking a coherent anti-tariff bloc at the time, corresponded with the near panic in March,
1929. The apparent certainty behind the passage of the tariff in late October matched
perfectly with the famous stock market crash. Finally, the passage of the bill in June
brought prices down dramatically and to the exact same level as in late October, 1929.
The same can be said for market rises.
Every dramatic rise in the stock market
corresponds to a move by the anti-tariff coalition to block the tariff all together or to hold
rate increases to agricultural products only.
Similarly, market volume jumped
considerably, often to new highs, whenever there was prominent news concerning the
tariff. Lack of news during the key periods of the debate are also related to abnormally
low volume on the major exchanges.
The tariff theory explaining the crash rests upon the notion that the stock market
measures the future value of corporations. The market, in this sense, is an instrument
for measuring the capital stock of a country. It absorbs information and translates this
information into a valuation of the shares on the market. As Wanniski explained, “The
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market is the most accurately programmed computer on the planet, the closest
expression of the mind of the electorate itself. It places a value on each company within
it, based on its calculation of that company’s future income stream.”240
The most
important day-to-day information absorbed by the market is political. Only political news,
according to Wanniski, can explain a vast, universal, change in market valuation. Only a
political shock, in other wards, can instantly affect the entire market and dramatically
alter the market’s expected future income streams. In this instance, mounting evidence
supports the case for the Smoot-Hawley tariff as just such a shock.
Wanniski’s assumptions are based on a plethora of financial literature.
The
“discounted-cash-flow” valuation system used by nearly every analyst and commentator
on Wall Street as well as within every major corporation in the world is based off this
very idea. In the world of finance, what is important is the future, not the past or present.
Moreover, the importance of political news is also well documented.
George
Bittlingmayer demonstrated the overriding importance of political news on the market in
Output, Stock Volatility, and Political Uncertainty in a Natural Experiment: Germany
1880-1940.241
Bittlingmayer illustrated that political uncertainty created increased
volatility in the stock market and reduced output in the economy. Moreover, he finds that
despite increases in market volatility commonly being associated with output declines,
political events are actually more clearly the source of such volatility as well as often the
source of such contractions in output. Bittlingmayer’s findings are also supported by and
support the theory of irreversible choice under uncertainty. Ben Bernanke (1983) argued
that irreversibility of investment decisions implies that firms must make timing decisions
240
Wanniski, 1978, p. 124
George Bittingmayer, “Output, Stock Volatility, and Political Uncertainty in a Natural Experiment:
Germany, 1880-1940” Journal of Finance, Vol. LIII, No. 6, December 1998, p. 2243.
241
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based off the trade on between the greater potential upside from early investment
decisions against the security gained from waiting for more information.242
Using the investment framework outlined by Bernanke and others, Robert
Archibald and David Feldman (1998) demonstrated that the political uncertainty
surrounding the Smoot-Hawley tariff played an important role in shaping investment
decisions.243 These results further support Wanniski’s theory and help show how the
tariff pushed the economy into depression by stemming output. Archibald and Feldman
find that uncertainty surrounding the Smoot-Hawley tariff did in fact slow investment
spending by businesses. Uncertainty took the form of both the domestic passage of the
bill by Congress and then the possibility of a counter-reaction by the rest of the world. In
particular they find that during 1929 investment was significantly negatively effected by
the uncertainly surround the bill. Archibald and Feldman summed up their findings by
arguing: “our results suggest that Smoot-Hawley played an important role in the
recession that later became the Great Depression.”
Yet, in general, the tariff theory has not received serious attention from the
academic world. Eugene White dismissed the idea rather quickly. He argued the tariff
could only be a key factor in the crash if the major export industries were particularly
depressed during the crash.
These industries, he argued, should have reacted
differently than the aggregate market because they were the most directly impacted by
the decreased foreign demand caused by the tariff and foreign tariff retaliation. The
opposite would have been true, according to White, for nontradeables and importcompeting industries who may have actually benefited from the tariff.
White then
Ben Bernanke, “Irreversibility, uncertainty, and cyclical investment” Quarterly Journal of Economics, No.
85, 1983, pg. 85-106. Robert Pindyck (1991), in “Irreversibility, uncertainty, and investment” likened the
concept to a financial call option. Since Pindyck, MIT professor Steward Myers has coined a similar
valuation model “real options” which uses Black-Scholes like inputs for financial options pricing to value
companies.
243 Robert Archibald & David Feldman, “Investment during the Great Depression: Uncertainty and the Role
of the Smoot-Hawley Tariff,” Southern Economic Journal, Vol. 64, No. 4 (Apr. 1998) p. 857 – 879.
242
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identified industries as “exporters,” “importer-competing” or “nondurables” and found that
the stocks of all groups declined approximately the same percentage at the time when
the tariff was assured. He then concluded that “thus no evidence [exists] to support the
view that the Smoot-Hawley tariff significantly contributed to the crash.”244
Barry
Eichengreen also questioned the theory by citing the fact that exports only represented
four-to-five percent (4-5%) of GDP at the time and therefore could not possibly have
caused such a large drop in market valuation.245 Others economist and historians there
was little record of trader gossip linking the tariff with the crash.
All these criticisms, however, are unfounded. To begin with the last criticism first,
traders and commentators did link the crash with the tariff. This is especially evident
during the market decline in 1930 where the New York Times continually cited traders
who attributed the violent market sell offs to the tariff. Less has been written about the
Crash of 1929, but it can hardly be said that there was no gossip. In the ten days
between October 21, 1929 and October 31, The New York Times alone published 171
stories concerning the tariff bill. This plethora of news, averaging seventeen articles a
day with multiple headlines frequently covering the front page, hardly could have
escaped traders’ radar.
In addition, Irving Fisher, the prominent financial economist of
the day, made the connection in his book The Stock Market Crash and after. Similarly,
immediately after the October crash, Fred I. Kent, President of Banker’s Trust, outright
accused the uncertainty around the tariff bill as the primary causing of the crash. Nor
was Kent alone when he argued: “As soon as dealers in securities who were constantly
on watch for indications as to business changes, realized this feeling of uneasiness [on
account of the tariff bill] was spreading throughout industry, they began selling stocks.”246
244
White, (1990), pg. 79.
Barry Eichengreen, “The Origins and Nature of the Great Slump Revisited,” The Economic History
Review, (May, 1992). Vol. 45, No. 2
245
246
Fisher (1930), p. 48
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Kent made similar remarks on November 11, in a speech before 400 bankers. The
connection between the tariff bill and stock market activity was well established by
contemporaries of the period. The same can be seen in The Commercial and Financial
Chronicle, the leading investment journal of the day, which extensively covered the news
of the tariff. In 1922, no such news coverage was given to the Fordney-McCumber tariff.
Clearly the financial community was aware and active with regard to the tariff and
criticisms based on a “lack of trader gossip” are unfounded.
The other main sources of criticism can be treated together. The blindness and
vastness of the market reaction can only be understood in light of the uniqueness of the
post war economy. World War One was a tremendous shock to the world financial
system and completely changed both the monetary and fiscal environments by derailing
the Gold Standard and introducing the income tax. Even more importantly, it placed the
world on unstable financial footing in the form of huge international war debts. These
debts are what made the world economy, as well as the American stock market, so
susceptible to collapse. The fiscal activity focused on in this theory simply put pressure
on the economy to support (tax reform) or break (tariff bill) this precarious international
financial situation.
Throughout the 1920s, Secretary of Treasury Mellon and Presidents Harding and
Coolidge embarked on a vast reformation of the American domestic tax system. As
Chapter One and Chapter Five made clear, the stock market responded positively to this
tax reform. The bull market corresponded almost perfectly to the systematic reduction in
tax rates from seventy-three percent (73%) during the war, to fifty-three percent (53%) in
1921, to forty-six percent (46%) in 1924 when the market began its rise, and then to
twenty-five percent (25%) in 1926 when the market truly began its steep upward climb.
In addition, the corporate tax cut in 1928, with new rates effective on 1927 earnings, also
corresponded beautifully with the booming bull market of the 1927-29 period.
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In late 1928, however, the country changed course dramatically. The election of
President Hoover in November 1928 brought a new type of taxation into the economy –
a tax on international transactions. Hoover ran on a protectionist platform, stating:
The Republican Party believes that the home market, built up under the
protective policy, belongs to the American farmer, and it pledges its support of
legislation which will give this market to him to the full extent of his ability to
supply it….It is inconceivable that American labor will ever consent to the
abolition of protection, which would bring the American standard of living down to
the level of that in Europe, or that the American farmer could survive if the
enormous consuming power of the people in his country were curtailed and its
market at home, if not destroyed, at least seriously impaired. 247
A tariff on agricultural goods, however, was not the major concern. Farmers
were in dire straights in much of the country simply because mass production and
technological innovation had created greater economies of scale and allowed farmers to
bring more to market. This increase in supply was paired with a decrease in demand
from Europe with the revival of European production after the War. The threat, however,
came in the form of a protective tariff which spread rate increases to other industries,
halting international trade and creating problems in the international banking system.
Besides the enormous war debts of $11.9 billion, some of which had been paid off, the
rest of the world borrowed an additional $12.5 to 14.5 billion from private American
sources between 1919 and 1929, according to estimates by the Department of
Commerce.248 In order for Europe to pay off these debts, it needed to trade with the
United States. The rest of the world ran a “trade deficit” with America, buying more
goods and services from the United States than it sold. At the same time, the America
ran a “capital-accounts deficit” with the rest of the world, as is illustrated in its huge
creditor position. The only way for the United States citizens, who were particularly
247
Wanniski, p. 127
Special to The New York Times. May 5, 1930 “1,028 Economists Ask Hoover To Veto Pending Tariff
Bill:Professors in 179 Colleges and Other Leaders Assail Rise in Rates as Harmful to Country and Sure to
Bring Reprisals. Economists of All Sections Oppose Tariff Bill” This article cites information from the
Department of Commerce.
248
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exposed, to continue to get paid back was through continued world trade. Either the rest
of the world needed to sell their goods and services on the American market to take in
dollars for which they could pay off debts, or America needed to continue to extend
credit in dollars to the rest of the world to allow them to meet their debt payments.
Investment abroad by Americans had already begun to decline in 1928/29 period. This
slow down in FDI corresponded with a slowdown in the world economy beginning in
1928. Then, in 1929, the government threatened to choke off the possibility of trade and
the only chance for investors to get paid back began to disappear.
More importantly, this concept was well understood at the time.
The World
Economic Conference of 1927 held in Geneva stressed the importance of free
international trade to support the continuance of debt payments and the maintenance of
peace.
The Conference was called under the general theme of consolidating the
economic recovery to ensure its continuance: “the whole work of the Conference was
dominated by…resolutions on international trade…inspired by the ideal of the rational
distribution of work between nations.”249 International trade was deemed essential in
maintaining world peace and avoiding another war of international scale.
The
Conference made the case as follows:
We are concerned not only with the prosperity but with the peace of the world. It
is our unanimous conviction that the maintenance of world peace depends
largely upon the principles on which the economic policies of nations are formed
and executed, that the Governments and people of all countries should
constantly take counsel together as to this aspect of the economic problem; and
that we should look forward to the establishment of a recognized body of
principles designed to eliminate the economic difficulties which cause friction and
misunderstanding. Economic conflicts and divergence of economic interest are
perhaps the most serious and most permanent of all dangers which are likely to
threaten peace of the world….No task is more urgent or more vital than that
of securing agreement on certain principles of policy which are necessary
in the interests of future peace. (Bond mine) 250
249
J.P. Day, An Introduction to World Economic History Since the Great War, (London: Macmillan and Co,
1939) pg. 75.
250 Taken from Day, p. 76
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The Conference went on to conclude that “for these reasons…the time has come to put
a stop to the growth of Customs tariffs.”251
In addition, The New York Times ran a series of articles following the election of
Hoover regarding the impact of a new tariff. On November 1, 1928, The Times printed:
“TARIFFS AND DEBTS,” in which it stated:
It is much to be hoped that an adjustment of all these tariff disputes may be
reached. Neither country could face a tariff war with equanimity. The United
States would suffer more from it than would France. This is not simply because
she buys from us more than she sells, but because the whole question of the
French war debt to our Treasury is involved in the question of French exports.
Already the French press is complaining that America, while demanding full
payment of the French debt, is more and more shutting her doors against French
goods…252
Another article published on July 7, 1929, titled: EUROPE LOOKS HARD AT OUR
TARIFF WALL,” stressed the fear felt by the rest of the world concerning the enactment
of a new, higher tariff wall by the United States. The article quoted a German writer
confused by the American actions. He called it a “curious irony” that simultaneously with
the Young plan for payment of reparations and debts, America began considering an
increase in tariff rates, which would handicap the rest of the world in making debt
payments. “One can not continue to sell where one does not buy…and a creditor should
not reduce his debtor’s capacity to pay.” The French understood the same argument. A
Parisian business man quoted in the article explained: “In agreeing to pay our debt in
America we ought at least to be assured that our export trade, necessary to pay the
debt, will receive fair treatment.”253
World economists spoke out against the tariff as well. The month before the
Smoot-Hawley bill was signed into law, 1,028 economists, including Irving Fisher of
251
Taken from Day, p. 78
The New York Times, Nov 1, 1928. “TARIFFS AND DEBTS” p. 28
253 Harold Callender,The New York Times, Jul 7, 1929. “EUROPE LOOKS HARD AT OUR TARIFF WALL;
Nations Across the Sea Weigh Means to Meet the New Threat of Competition Involved in Higher Schedules-The Various Objections Put Forth by Manufacturers and Commercial Organizations Some of European
Complaints. The Most Unhealthy Aspect. Causes of Europe's Fears. British Anxieties. Bitter French
Protests. European Rapprochement. "Invisible Payments." America's Prohibitions. “p. 110
252
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Yale, Frank Taussig of Harvard, Frank Fetter of Princeton, Wesley Mitchell of Columbia,
and J. Laurence Laughlin of the University of Chicago among many others, petitioned
Hoover in protest of the bill. The New York Times front page ran the story:
1,028 Economists Ask Hoover To Veto Pending Tariff Bill:
Professors in 179 Colleges and Other Leaders Assail Rise in Rates as Harmful to
Country and Sure to Bring Reprisals. Economists of All Sections Oppose Tariff
Bill
The text of the [economists] statement is: …Many of our citizens have invested
their money in foreign enterprises. The Department of Commerce has estimated
that such investments, entirely aside from the war debts, amounted to between
$12,555,000,000 and $14,555,000,000 on Jan. 1, 1929. These investors, too,
would suffer if restrictive duties were to be increased, since such actions would
make it still more difficult for their foreign debtors to pay them the interest due
them.
…The higher duties proposed in our pending legislation…invite other nations to
compete with us in raising further barriers to trade. A tariff war does not furnish
good soil for the growth of world peace.
It is clear that not only did the entire world understand that a tariff war would bring down
the international banking system at the expense of American creditors, but also that
such actions would threaten world peace. Both, in retrospect, seem to be eerily
prophetic statements.
Following the passage of the tariff in June, country after country took retaliatory
actions, enacting their own tariffs. The much feared tariff war had come to fruition. This
tariff war brought a complete slow down in world trade and the stock market continued to
sink. While obviously detrimental to the import and export industries, the tariff bill’s real
horror was the realization that Americans would never be paid back what they were
owed by the rest of the world. With at least $12.5 billion in privately invested funds
extended abroad, the tariff greatly increasing the chance of default. This sudden change
in credit risk caused a vast re-valuation on Wall Street. Of course other factors
contributed, but as the international financial system collapsed, output declined and the
world sank into depression.
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Finally, the size and speed of the market sell offs cannot be wholly attributed to
the Tariff. The capital gains tax helped to make the crash a panic. As the stock market
rose, seemingly continuously, from 1926 through 1929, investors were hesitant to close
their positions for fear of creating a taxable event. Throughout the period investors
criticized the Capital gains tax. President Mitchell of National City Bank and President
Kent of Bankers Trust were two of the loudest voices against the tax. Mitchell wrote in
January 1929, “If one could check up on the people leaning on borrowed money for the
carrying of securities, it would be found that there are an overwhelming number of
holder, who, because of this tax, do not sell.”254 Others too called for an abolition of the
capital gains tax. Irving Fisher wrote in 1930, “the capital gains tax operated to prevent
outright selling and buying of stocks…[and] stimulated holders to enlarge their margin
accounts because their own funds were locked up in held securities.”255 For years
investors held unrealized gains, refusing to take profits through liquidation, but instead
bought new stock on margin using borrowed money. As the capital gains tax kept
decreasing throughout the decade as Mellon slashed income taxes from seventy-three
percent (73%) to twenty-five percent (25%) investors had further reason to hold their
stocks. The expectation of future tax reductions made selling increasingly irrational for
the contemporary investor. The resultant rapid build up of margin accounts in 1929 put
the market in a bad technical position, and made it vulnerable to a crash when news of
the tariff hit the wires. The capital gains tax was not the trigger, but effectively
leveraged the market and so helped the readjustment due to the tariff be increasingly
severe and uncontrollable. Panic set in as more and more margin calls forced more
and more selling on the market. As Irving Fisher wrote: “…revenue from the sale of
capital assets including stocks, bonds and real estate, amounted to less than 10 percent
254
255
Fisher, 1930, p. 39
Fisher, 1930, p. 38.
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(10%) of total…incomes. In any event the government would have had little to lose and
much to save,” by abolishing the capital gains tax.256
Econometric Support: A Regression Analysis
It is important to examine the period 1928-1930 as a whole.
The crash of
October 1929 should not be separated from the earlier panics in March 1929 or later
panics in June 1930. Nor should the “crash” be analyzed separately and without context
of the bull market that preceded it. Obviously it is impossible to say with certainty what
caused the stock market to move up or down on any certain day, but the evidence
surrounding a correlation between the market of 1929 and the Smoot Hawley tariff is
compelling. The historical importance and degree of this connection has already been
outlined in this thesis and by Jude Wanniski and Alan Reynolds before.257 In order to
better understand the connection, however, some econometric analysis is useful.
Econometric tools helps illustrate and quantify the significance of the Smoot Hawley tariff
in a way hitherto unexamined. From January 1, 1928 through July 31, 1930, the words
“Smoot” and “Tariff” appear together in 464 articles.
These articles were used for
econometric analysis. In addition, however, articles appeared in 240 of the 647 trading
days of the period under examination. Because Senator Smoot was the champion of the
Bill in the Senate, articles that include his name were generally the largest and most
important articles surrounding the bill on a given day. That said, news of the tariff
dominated the period. In fact, 7,799 articles were written in The New York Times alone
from January 1, 1928, through July 31, 1930.258 During the period of the crash, from
256
Fisher, 1930, pg. 40.
See Wanniski (1978) and Reynolds (1979).
258 A compilation of this full data set would be a great addition to this preliminary study. Due to time and
energy limits, however, the small data set of 464 articles was used. This data set is available from the
author upon request. As a point of comparison, the North American Free Trade Agreement (NAFTA) and
257
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October 20, through Oct, 31, 126 articles appeared. In the ten days March 20 through
March 30, during the first market panics of 1929, sixty-two (62) articles appeared in The
New York Times.
Similarly, during the panics of June 1930, which traders directly
attributed to news on the tariff, The New York Times printed 169 stories from June 9
through 18. Over each these periods, articles covered the front page, headlining next to
reports about the market panics of the day before. This saturation of tariff news is
important and impossible to miss.
In order to gauge the importance of this news to traders, the news stories can be
broken into three groups: “good” stories that indicate the bill will be killed or limited to
agricultural industries only, “bad” stories that indicate the bill will be passed and include
rate hikes in all industries, and “ambiguous” stories that are not clearly positive or
negative.259 When done, a number of supporting facts become evident. First of all,
news about the tariff had important effects on daily market returns.260
“Bad” news regarding the tariff is related to large market sell offs, especially
during the period of the October crash. At the same time, the inverse is true regarding
“good” news about the tariff. This is a substantial finding. Average market returns on
days with “good” tariff news is 1.15 percent (1.15%) or over 205 percent (205.6%) above
that of the average daily return for all trading days in the study. Similarly, average
returns for days with “bad” tariff news is negative 1.53 percent (-1.53%) or a decline of
over 507 percent
(-507.35%) of the average daily return. The results become
even more dramatic during the periods immediately surrounding the crash in October
the World Trade Organization (WTO) debates in the 1990s received substantially less press. From 1991
through 1994, NAFTA received only 722 articles in The New York Times, while WTO received 677. For all
of the 1990s, there is only 2,306 articles regarding NAFTA and 1,132 articles concerning the WTO. Even
combined, and over a period of ten years, the WTO and NAFTA debates received substantially less press
than the Smoot-Hawley’s 7,799 articles in less than three years.
259 The reader should be aware that the following information uses only those stories in which the words
“tariff” and “smoot” appeared. A data base including this breakdown and the news story headlines is
available from the author upon request.
260 For the purpose of this paper, market returns are estimated using the daily return of the Dow Jones
Industrial Average.
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1929 and July 1930.
This fact, that “good” tariff news is clearly and substantially
associated with positive market returns and “bad” tariff news with negative returns, add
explicit empirical support to the historical correlation observed and documented
surrounding the stock market crash and the tariff.
The below table highlights the
profound impact news about the tariff had on market returns.
Returns Summary
January 1928 through July 1930
Tariff News
Bad Tariff News
Good Tariff News
Period Average:
August 1929 through December 1929
Tariff News
Bad Tariff News
Good Tariff News
January 1930 through January 1930
Tariff News
Bad Tariff News
Good Tariff News
Average Return Impact % Increase
-0.13% -0.51% -134.49%
-1.53% -1.91% -507.35%
1.15% 0.77%
205.60%
0.38%
-0.20%
-2.58%
1.95%
-0.57%
-2.95%
1.58%
-151.99%
-784.03%
419.08%
-0.13%
-1.44%
0.85%
-0.51%
-1.82%
0.48%
-135.82%
-482.94%
126.57%
In addition, regression analysis indicates that news about the tariff is statistically
important to daily market returns. This examination allows a degree of causation to be
attributed to the tariff, disputing the criticism that the connection between tariff news and
market conditions being completely coincidental. For the entire period under analysis
“bad” tariff news brought a 1.7 percent (-1.7%) decrease in market valuation, while
“good” news brings a one percent (1%) increase in market value.261 Moreover, nearly
fifteen percent (15%) of market returns can be explained by tariff news alone. These
findings become more robust when specific periods are examined individually. News on
the tariff becomes even more explanatory. For the period of the October crash, news on
261
These results were found using the DJIA.
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the tariff can explain twenty-three percent (23%) of market returns and for the period of
the July 1930 crash, the tariff can explain twenty-seven percent (27%).262
During the period of the Crash, from August, 1929 through December, 1929,
“bad” news caused a drop in market valuation by 2.3 percent (-2.3%), while good news
caused an increase of 2.2 percent (2.2%). Similar results are found for the period of the
June, 1930 crash. During this time frame, from January 1, 1930 through July 31,, 1930,
“bad” tariff news alone can explain nearly a quarter of daily market returns, causing a
drop in the DJIA of 1.7 percent (-1.7%) to 1.9 percent (-1.9%) on average. These are
large moves in daily market valuation. For the entire period, average daily returns are
less than a tenth of a percent (0.06%). Tariff news clearly contributed significantly to
changes in daily market returns, adding support to the argument that the tariff
substantially helped trigger the market panics of March, 1929, October, 1929 and July,
1930.263
The second important observation arising from the data is the impact on short
term volatility.264 The table below summarizes these findings:
Tariff News
Bad Tariff News
Good Tariff News
No Tariff News
Period Average
Volatility Summary
Average Volatility
28.28%
32.79%
28.01%
19.99%
23.26%
With Respct to
Good News Impact
Bad New Impact
Tariff News Impact
No Tariff News
+ 8.02%
+ 12.80%
+ 8.29%
262
% Increase
+ 41.50%
+ 64.06%
+ 40.14%
The results are robust even when corrected for problems of autocorrelation and heteroskedasticity.
Using the ARCH function in stata to correct for these potential problems, the results remain the same with a
WaldChi-Squared statistic of 224.97 indicating the regression is highly significant.
263 See Appendix A for results.
264 Short term, ten-day historical volatility was used in this analysis.
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As can be seen in the table, “bad” news about the tariff significantly increased market
volatility. Specifically, “bad” tariff news caused a more than sixty-four percent (64.04%)
increase in volatility. Furthermore, even if the subjectivity of separating articles into
“good” and “bad” groups is removed, aggregate tariff news alone brings over a forty
percent (40.14%) volatility premium. A more volatile market is generally considered a
more bearish market. In many ways, volatility is equated with risk. Therefore, this
finding indicates that news about the tariff, directly or indirectly, made traders more
nervous about the inherent risk of stocks. Market valuations became more uncertain as
the tariff appeared more likely to pass.
Regression analysis again demonstrates that the results even more compelling.
The analysis indicates that while “good” news is not statistically important to stock
volatility, “bad” news is very significant.265 The finding makes sense and is consistent
with the existing literature because trading reactions to negative tariff news was
exaggerated by other factors, such as margin calls, which increased selling and caused
volatility to spike even further. Furthermore, when removing any subjectivity from the
examination, the impact of any “tariff news” signifies that the tariff was an important
cause of market volatility.
As was the case with daily returns, more insight can be gained by examining the
impact of the tariff on market volatility for specific time periods. While news surrounding
the tariff can only explain approximately eight percent (8%) of market volatility for the
entire period January 1, 1928 through July 31, 1930, the explanatory power increases
substantially around the period of the October, 1929 crash and the July, 1930 crash.
For the period surrounding the “Great Crash” tariff news can explain fifty-six percent
(56%) of changes in short term volatility. “Bad” news again is found to be significant
while good news is not. On average, a day with “bad” tariff news saw a 13.4 percent
265
See Appendix B for data output.
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(13.4%) jump in volatility for this period.
Also the results are the same when the
subjectivity of the analysis is eliminated by analyzing the impact of “tariff news” in
general without grouping the news further into good and bad categories. On average,
days with any tariff news of any kind saw volatility fourteen percentage points (14%)
higher than on days without tariff news. The results for the period surrounding the crash
in June 1930 are even more robust. For this period, tariff news can explain nearly
seventy percent (69.3%) of the variation in market volatility.
By objectively demonstrating the connection between tariff news and the
increase in market volatility surrounding the 1929-1930 stock market, these findings
contribute to existing literature.
A gap in the current literature exists in the largely
unexplained decline in consumer spending during the period. In 1990, Christina Romer
illustrated that stock market variability can explain the decline in aggregate demand, as
uncertainty halted consumer expenditure. Romer writes that “the negative effects of
stock market variability is more than strong enough to account for the entire decline in
real consumer spending on durables that occurred in late 1929 and 1930.”266 Romer,
however, did not attempt to hypothesis what caused the increase in market volatility in
the first place. The large significance of tariff news in explaining volatility during this
same period substantially adds to Romer’s findings by identifying exactly what triggered
market volatility. The tariff bill, therefore, indirectly precipitated the decline in consumer
spending. In such, a new path is uncovered over which the Smoot Hawley tariff was
transmitted to the aggregate economy.
From this investigation, both historical and econometric, it is clear that the
Smoot-Hawley tariff played a substantial part in the stock market collapse of the 19281930 period. In the modern literature, the stock market boom and crash of the 1920s
remains largely unexplained.
266
Most authors have not even attempted to explain the
Romer, “The Great Crash and the Onset of the Great Depression,” NBER Working Paper, June 1988.
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boom, but instead have focused, unsuccessfully, on proving the existence of a “bubble.”
Nor have authors succeeded in explaining what triggered the “bursting” of the bubble
with any plausibility. The most shocking aspect of the modern literature is really the lack
of any explanation.
Instead authors merely assert that the stock market collapsed
simply because it rose. By understanding the impact of fiscal activity on the market a
new interpretation of the Crash and the depression is possible. Instead of the failure of
markets, the failure becomes that of government. It is only in light of this entire process
of the post-war period that the micro events surrounding the “Great” Crash of 1929 can
be understood. An analysis of the stock market cannot be done in a vacuum. The
forces at work in the 1920s boom did not change in October 1929 or in the post crash
period of 1930 through the ensuing years of depression. Only by viewing the period,
including the crash, in this larger context can the causes be understood. The enormous
economic shock of World War One transformed the international economic and political
relationships that existed previously.
The international debt and banking structure
completely reversed and in many ways was left in shambles with the United States and
Germany as opposing pressure points. The world was left with excessively high tax
rates following the war. As the United States reduced rates throughout the 1920s, the
economy and then the stock market reacted brilliantly. The change in policy in late 1928
with the introduction of protectionist policies caused a period of uncertainty and
eventually disaster. The passage of the tariff corresponded perfectly with the panics on
Wall Street and helps explain the decline in consumer expenditure stimulated by
excessively volatile capital markets. The basis of this thesis was originally presented by
Jude Wanniski in The Way the World Works, but has remained largely ignored by the
modern literature. The addition of econometric analysis in support of the tariff theory
adds new validity, and hopefully new attention, to the explanation.
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Conclusion
The date, October, 1929 is undoubtedly an historical landmark. Like September
11, 2001 and December, 1941, October, 1929 has remained fixed in the minds of most
Americans. The date and the Crash that took place that day have become part of our
modern culture. However, to most scholars and certainly most Americans, the crash of
1929 is also a great mystery. Now, more than seventy years later, Americans still worry
during every bull market, whether the tragedy is about to be repeated. Like the World
Trade Center attacks on September 11, 2001 or the dropping of the first atomic bomb in
1945, historians and economists alike have used the stock market crash as a symbol for
the end of one era and the beginning of another.
This is understandable.
At the
beginning of the year, economic activity was still thriving. By the end of 1929, however,
the stock market had collapsed and the world was lurching into an increasingly serious
recession. As a result of this thinking, however, scholars have struggled to come up with
convincing answers to what caused the crash and what, if any, role it played in bringing
on the following depression. As David Kennedy observed, “The disagreeable truth…is
that the most responsible students of the events of 1929 have been unable to
demonstrate an appreciable cause-and-effect linkage between the Great Crash and the
Depression.”267
By approaching the problem from a wider historical prospective, this thesis
presents a new integrated explanation for these unanswered questions. The events that
drove the economic boom and the large stock market appreciation in the 1920s also
drove the events in 1929 and 1930 that sent the economy and the stock market spiraling
267
David M. Kennedy, Freedom from Fear: The American People in Depression and War, 1929-1945, (New
York, 1999) p. 39
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downward. History, like the economy, cannot be judged by examining instantaneous
and static moments. Only be accounting for the fluidity of history can an understanding
be reached.
World War One brought such an enormous shock to the international financial
system that it left the world in a precarious position. Even while economic conditions
were good, as they were for almost the entirety of the 1920s, America was continually at
risk of collapse had the European reconstruction failed at any time. The huge creditor
position of the United States vested U.S. interest entirely with that of the world economy.
Isolation was financially impossible after World War One.
As demonstrated in the
preceding chapters, those economies (with particular attention to the United States) that
brought tax rates down toward peacetime equilibrium saw tremendous economic growth
and prosperity along with rising tax revenues. These measures propped up the fragile
international financial system. At the same time, the Fed struggled to find a functional
monetary policy as Europe scrambled to rejoin the now-US led Gold Standard. Barriers
to trade were lowered and the American economy became increasingly open as the tax
wedge was eliminated. The economy boomed and the stock market flourished.
However,, a reverse policy of protection, including increasingly high barriers to
trade, began, in late 1928, to move the economy toward a more closed posture. The
vehicle of this policy reversal was the debate over the Smoot-Hawley tariff, which
passed Congress in June 1930 and was signed into law the same month. These actions
put the opposite pressure on the world financial system, breaking down world trade and
bursting the credit imbalance that existed as a result of World War One. The stock
market and the economy collapsed as international finances were forced into default.
While it cannot be covered properly in the scope of this thesis, the same forces
continued to work as America fell into the worst and most prolonged depression of its
short history. By the beginning of 1931, the economy seemed to have reached a point
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of economic equilibrium, having discounted the higher international wedge created by
the tariff bill. This equilibrium, however, was lower than that of the pre-tariff period and
the slowdown in economic activity had created a budget deficit for Hoover of more than
$1 billion in only eighteen months.268 Hoover and Ogden Mills, who had replaced Mellon
as Secretary of Treasury, proposed an increase in income-tax rates to close the deficit.
The top marginal personal income tax was pushed up from the twenty-five percent
(25%) rate established by Mellon in 1926 to sixty-three percent (63%).
Just as
importantly, the lowest bracket saw a rate increase of four-hundred percent (400%),
increasing from a rate of one percent (1%) to a rate of four percent (4%). Corporate
rates were also raised in the bill. To make matters worse, the bill, which passed the
Senate and was signed by Hoover in June, 1932, was made retroactive to January 1,
1932.269
Having already widened the international wedge with the tariff bill, Hoover now
put the domestic wedge back to its 1921 position, effectively undoing the “scientific
taxation” orchestrated by the Mellon plan that Harding and Coolidge had worked to put
into place. As a result, money flowed out of the stock market as business activity was
further depressed. The bill passed on June 6, 1932 and the market dropped eight
percent (-8%) in two days of trading. After only a month, the market lost over sixteen
percent (-16.4%) of its value, reaching its lowest point of the twentieth century on July 8,
1932 of 41.22.
Franklin Roosevelt then ran on a platform that “condemned” the Smoot-Hawley
tariff and pledged “reciprocal tariff agreements with other nations, and called for an
international economic conference designed to restore international trade and facilitate
268
269
Wanniski, pg. 152
Wanniski, pg. 152.
-150-
exchange.”270 Before his inauguration, in February, 1933, Roosevelt named Cordell Hull
as Secretary of State. Hull was a former Senator from Tennessee who had devoted
much of his attention in the preceding years to repealing the tariff bill. He attributed
America’s economic problems to international causes. On April 9, 1933, The New York
Times printed: “ROOSEVELT SCRAPS POLICY OF ECONOMIC NATIONALISM TO
ASSIST WORLD PARLEY.” The article described how Hull attributed the “World Slump
to 12 years of isolation.” The new administration had invited eleven nations to consider
a revival of trade through agreements to lower tariffs. In response the stock market
surged nearly seventy percent (70%) from 59 on April 8, 1933 to finish the year at 100.
Increasingly, however, President Roosevelt turned away from the international platform
he campaigned on. Instead, he began to focus on internal remedies, such as national
planning and the infamous New Deal. Consequently, the economy would continue to
flounder for much of the remaining decade and would not truly come out of economic
stagnation until after World War Two.
“The Democratic Party Platform of 1932,” taken from The American Presidency Project at UC Santa
Barbara website. Available at: http://www.presidency.ucsb.edu/showplatforms.php?platindex=D1932;
visited on April 9, 2006.
270
-151-
APPENDIX A:
Results for entire period: January 1st, 1928 through July 31st, 1930:
. regress returns TariffNews Goodnews BadNews
Source |
SS
df
MS
-------------+-----------------------------Model | .032925694
3 .010975231
Residual | .192734893
640 .000301148
-------------+-----------------------------Total | .225660588
643
.00035095
Number of obs
F( 3,
640)
Prob > F
R-squared
Adj R-squared
Root MSE
=
=
=
=
=
=
644
36.44
0.0000
0.1459
0.1419
.01735
-----------------------------------------------------------------------------returns |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------TariffNews |
.0004909
.0022747
0.22
0.829
-.0039758
.0049576
Goodnews |
.0096464
.0028463
3.39
0.001
.0040573
.0152356
BadNews | -.0171963
.0027883
-6.17
0.000
-.0226716
-.0117209
_cons |
.0013685
.0008634
1.59
0.113
-.0003269
.0030639
------------------------------------------------------------------------------
Results for August 1st, 1929 through December 31st, 1929:
. regress returns goodnews3 badnews3
Source |
SS
df
MS
-------------+-----------------------------Model | .028728597
2 .014364299
Residual | .097841648
99 .000988299
-------------+-----------------------------Total | .126570245
101 .001253171
Number of obs
F( 2,
99)
Prob > F
R-squared
Adj R-squared
Root MSE
=
=
=
=
=
=
102
14.53
0.0000
0.2270
0.2114
.03144
-----------------------------------------------------------------------------returns |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------goodnews3 |
.0223085
.0075353
2.96
0.004
.0073567
.0372602
badnews3 | -.0229887
.0075353
-3.05
0.003
-.0379404
-.008037
_cons | -.0027652
.0046352
-0.60
0.552
-.0119624
.006432
------------------------------------------------------------------------------
-152-
Results for January 1st, 1929 through July 31st, 1930.
. regress returns goodnews4 badnews4
Source |
SS
df
MS
-------------+-----------------------------Model | .010746427
2 .005373214
Residual | .029722279
143 .000207848
-------------+-----------------------------Total | .040468707
145 .000279095
Number of obs
F( 2,
143)
Prob > F
R-squared
Adj R-squared
Root MSE
=
=
=
=
=
=
146
25.85
0.0000
0.2655
0.2553
.01442
-----------------------------------------------------------------------------returns |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------goodnews4 |
.0062286
.0029162
2.14
0.034
.0004642
.0119931
badnews4 | -.0167194
.0029162
-5.73
0.000
-.0224839
-.010955
_cons |
.0023017
.0016991
1.35
0.178
-.0010568
.0056602
------------------------------------------------------------------------------
-153-
APPENDIX B:
Results for entire period: January 1st 1928 through July 31st, 1930:
. regress Vol10day TariffNews Goodnews BadNews djia
Source |
SS
df
MS
-------------+-----------------------------Model | 1.77822576
4
.44455644
Residual | 20.1651203
640
.031508
-------------+-----------------------------Total |
21.943346
644 .034073519
Number of obs
F( 4,
640)
Prob > F
R-squared
Adj R-squared
Root MSE
=
=
=
=
=
=
645
14.11
0.0000
0.0810
0.0753
.1775
-----------------------------------------------------------------------------Vol10day |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------TariffNews |
.0637542
.0239878
2.66
0.008
.0166499
.1108586
Goodnews |
.0339946
.029117
1.17
0.243
-.0231819
.0911711
BadNews |
.0763634
.0286006
2.67
0.008
.0202012
.1325257
djia | -.0004857
.0001496
-3.25
0.001
-.0007794
-.0001919
_cons |
.3237481
.0391644
8.27
0.000
.2468418
.4006543
------------------------------------------------------------------------------
. arch Vol10day TariffNews Goodnews BadNews djia
Time-series regression
Sample:
1 to 645
Log likelihood =
Number of obs
Wald chi2(4)
Prob > chi2
202.3426
=
=
=
645
59.91
0.0000
-----------------------------------------------------------------------------|
OPG
Vol10day |
Coef.
Std. Err.
z
P>|z|
[95% Conf. Interval]
-------------+---------------------------------------------------------------Vol10day
|
TariffNews |
.0637542
.021933
2.91
0.004
.0207662
.1067422
Goodnews |
.0339946
.0223984
1.52
0.129
-.0099054
.0778946
BadNews |
.0763634
.0212212
3.60
0.000
.0347706
.1179562
djia | -.0004857
.0002236
-2.17
0.030
-.0009239
-.0000474
_cons |
.3237481
.0580788
5.57
0.000
.2099157
.4375804
-------------+---------------------------------------------------------------SIGMA2
|
_cons |
.0312638
.0011712
26.69
0.000
.0289682
.0335593
------------------------------------------------------------------------------
-154-
Results for entire period: August 1st 1929 through December 31st, 1929:
. regress Vol10day tariffnews3 djia
Source |
SS
df
MS
-------------+-----------------------------Model | 6.47520992
2 3.23760496
Residual | 5.08688122
99 .051382639
-------------+-----------------------------Total | 11.5620911
101
.11447615
Number of obs
F( 2,
99)
Prob > F
R-squared
Adj R-squared
Root MSE
=
=
=
=
=
=
102
63.01
0.0000
0.5600
0.5511
.22668
-----------------------------------------------------------------------------Vol10day |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------tariffnews3 |
.1396821
.0534341
2.61
0.010
.0336571
.245707
djia | -.0044602
.0003974
-11.22
0.000
-.0052487
-.0036718
_cons |
1.72372
.1226986
14.05
0.000
1.48026
1.967181
------------------------------------------------------------------------------
. regress Vol10day goodnews3 badnews3 djia
Source |
SS
df
MS
-------------+-----------------------------Model |
6.44807
3 2.14935667
Residual | 5.11402114
98 .052183889
-------------+-----------------------------Total | 11.5620911
101
.11447615
Number of obs
F( 3,
98)
Prob > F
R-squared
Adj R-squared
Root MSE
=
=
=
=
=
=
102
41.19
0.0000
0.5577
0.5442
.22844
-----------------------------------------------------------------------------Vol10day |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------goodnews3 |
.0812368
.0549909
1.48
0.143
-.0278907
.1903644
badnews3 |
.1338718
.0552912
2.42
0.017
.0241482
.2435954
djia | -.0043791
.0003952
-11.08
0.000
-.0051634
-.0035947
_cons |
1.745059
.1232366
14.16
0.000
1.5005
1.989618
------------------------------------------------------------------------------
-155-
. arch Vol10day tariffnews3 djia
Time-series regression
Sample:
397 to 498
Log likelihood =
Number of obs
Wald chi2(2)
Prob > chi2
8.181972
=
=
=
102
71.77
0.0000
-----------------------------------------------------------------------------|
OPG
Vol10day |
Coef.
Std. Err.
z
P>|z|
[95% Conf. Interval]
-------------+---------------------------------------------------------------Vol10day
|
tariffnews3 |
.1396821
.0515102
2.71
0.007
.0387238
.2406403
djia | -.0044602
.0005486
-8.13
0.000
-.0055355
-.003385
_cons |
1.72372
.1459529
11.81
0.000
1.437658
2.009783
-------------+---------------------------------------------------------------SIGMA2
|
_cons |
.0498714
.0069165
7.21
0.000
.0363153
.0634275
-----------------------------------------------------------------------------. arch Vol10day goodnews3 badnews3 djia
Time-series regression
Sample:
397 to 498
Log likelihood =
Number of obs
Wald chi2(3)
Prob > chi2
7.910597
=
=
=
102
64.34
0.0000
-----------------------------------------------------------------------------|
OPG
Vol10day |
Coef.
Std. Err.
z
P>|z|
[95% Conf. Interval]
-------------+---------------------------------------------------------------Vol10day
|
goodnews3 |
.0812368
.053501
1.52
0.129
-.0236232
.1860969
badnews3 |
.1338718
.0586034
2.28
0.022
.0190113
.2487324
djia | -.0043791
.0005505
-7.95
0.000
-.0054581
-.0033001
_cons |
1.745059
.1428938
12.21
0.000
1.464992
2.025125
-------------+---------------------------------------------------------------SIGMA2
|
_cons |
.0501375
.0076128
6.59
0.000
.0352167
.0650582
------------------------------------------------------------------------------
-156-
Results for entire period: January 1st 1930 through July 31st, 1930:
-157-
. regress Vol10day tariffnews4 djia
Source |
SS
df
MS
-------------+-----------------------------Model | 1.64996706
2 .824983532
Residual | .767537088
143 .005367392
-------------+-----------------------------Total | 2.41750415
145 .016672442
Number of obs
F( 2,
143)
Prob > F
R-squared
Adj R-squared
Root MSE
=
=
=
=
=
=
146
153.70
0.0000
0.6825
0.6781
.07326
-----------------------------------------------------------------------------Vol10day |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------tariffnews4 |
.0250012
.0126968
1.97
0.051
-.0000964
.0500988
djia |
-.005036
.0002874
-17.52
0.000
-.0056042
-.0044678
_cons |
1.526885
.075025
20.35
0.000
1.378584
1.675187
-----------------------------------------------------------------------------. regress Vol10day goodnews4 badnews4 djia
Source |
SS
df
MS
-------------+-----------------------------Model | 1.67527471
3 .558424904
Residual | .742229439
142 .005226968
-------------+-----------------------------Total | 2.41750415
145 .016672442
Number of obs
F( 3,
142)
Prob > F
R-squared
Adj R-squared
Root MSE
=
=
=
=
=
=
146
106.84
0.0000
0.6930
0.6865
.0723
-----------------------------------------------------------------------------Vol10day |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------goodnews4 |
.0414431
.0150386
2.76
0.007
.0117147
.0711715
badnews4 |
.0274246
.0148512
1.85
0.067
-.0019335
.0567827
djia | -.0051037
.0003011
-16.95
0.000
-.0056989
-.0045085
_cons |
1.543173
.0787266
19.60
0.000
1.387545
1.6988
------------------------------------------------------------------------------
-158-
. arch Vol10day tariffnews4 djia
Time-series regression
Sample:
500 to 645
Log likelihood =
Number of obs
Wald chi2(2)
Prob > chi2
175.9518
=
=
=
146
283.83
0.0000
-----------------------------------------------------------------------------|
OPG
Vol10day |
Coef.
Std. Err.
z
P>|z|
[95% Conf. Interval]
-------------+---------------------------------------------------------------Vol10day
|
tariffnews4 |
.0250012
.0126138
1.98
0.047
.0002786
.0497239
djia |
-.005036
.0002989
-16.85
0.000
-.0056219
-.0044501
_cons |
1.526885
.0740144
20.63
0.000
1.38182
1.671951
-------------+---------------------------------------------------------------SIGMA2
|
_cons |
.0052571
.0005833
9.01
0.000
.0041138
.0064004
-----------------------------------------------------------------------------. arch Vol10day goodnews4 badnews4 djia
Time-series regression
Sample:
500 to 645
Log likelihood =
Number of obs
Wald chi2(3)
Prob > chi2
178.3993
=
=
=
146
311.52
0.0000
-----------------------------------------------------------------------------|
OPG
Vol10day |
Coef.
Std. Err.
z
P>|z|
[95% Conf. Interval]
-------------+---------------------------------------------------------------Vol10day
|
goodnews4 |
.0414431
.0148735
2.79
0.005
.0122915
.0705947
badnews4 |
.0274246
.0145081
1.89
0.059
-.0010107
.0558599
djia | -.0051037
.0003003
-17.00
0.000
-.0056923
-.0045151
_cons |
1.543173
.0746989
20.66
0.000
1.396766
1.68958
-------------+---------------------------------------------------------------SIGMA2
|
_cons |
.0050838
.0005691
8.93
0.000
.0039683
.0061992
------------------------------------------------------------------------------
-159-
APPENDIX C:
A Look at the Mellon Tax Reform
5-Years
Before
primary
Tax Cut
4-Years
After
primary
Tax Cut
Before and After: Federal Government Receipts
(in $ billions)
Inflatoin
Fiscal
YoY %
Adjusted YoY %
Year
Revenue Change
Revenue Change
1920
$6.6
6.6
1921*
$5.6
-15.2%
6.2
-6.1%
1922
$4.0
-28.6%
4.8
-22.6%
1923
$3.9
-2.5%
4.5
-6.3%
1924*
$3.9
0.0%
4.5
0.0%
Average
-11.6%
-8.7%
1925
$3.6
-7.7%
4.2
-6.7%
1926**
$3.8
5.6%
4.3
2.4%
1927
$4.0
5.3%
4.6
7.0%
1928
$3.9
-2.5%
4.5
-2.2%
Average
0.2%
0.1%
*Small tax cuts did occur in these years
** Major tax cut and completion of Mellon tax plan outlined in 1920-1921
Source: Fiscal year U.S. Budge Data
Federal Revenue Growth
2.0%
0.0%
-2.0%
Before
After
-4.0%
-6.0%
-8.0%
-10.0%
-12.0%
-14.0%
-160-
Real GDP Growth
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
Before
After
Unemployment Rate
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
Before
After
-161-
-162-
Precentage Share of Total Income
Taxes Paid by Income Class: 1920,
1925, and 1920
Income Class
Under $5,000
$5,000 - $10,000
$10,000 - $25,000
$25,000 - $100,000
Over $100,000
1920
15.4%
9.1%
16.0%
29.6%
29.9%
Source: Internal Revenue Service
-163-
1925
1.9%
2.6%
10.1%
36.6%
48.8%
1929
0.4%
0.9%
5.2%
27.4%
62.2%
-164-
IMPACT OF SMOOT-HAWLEY TARIFF:
Source: U.S. Bureau of the Census, Historical Statistics of the United States, Colonial
Times to 1970, Washington, D.C.: USGPO, 1975, Series 212.
-165-
APPENDIX D:
Regression of year-over-year changes in the CPI index and the PPI index with
respect to year-over-year changes in the total amount of demand deposits:
. regress CPIYoY DepositsYoY
Source |
SS
df
MS
-------------+----------------------------Model | .081074053
1 .081074053
Residual | .065279702
20 .003263985
-------------+----------------------------Total | .146353755
21 .006969226
Number of obs =
22
F( 1,
20) =
24.84
Prob > F
= 0.0001
R-squared
= 0.5540
Adj R-squared = 0.5317
Root MSE
= .05713
-----------------------------------------------------------------------------CPIYoY |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+--------------------------------------------------------------DepositsYoY |
.7035407
.1411635
4.98
0.000
.4090788
.9980025
_cons | -.0145222
.0138238
-1.05
0.306
-.0433581
.0143137
-----------------------------------------------------------------------------. regerss PPIYoY DepositsYoY
unrecognized command: regerss
r(199);
. regress PPIYoY DepositsYoY
Source |
SS
df
MS
-------------+----------------------------Model | .214775694
1 .214775694
Residual |
.21135013
20 .010567506
-------------+----------------------------Total | .426125824
21 .020291706
Number of obs =
22
F( 1,
20) =
20.32
Prob > F
= 0.0002
R-squared
= 0.5040
Adj R-squared = 0.4792
Root MSE
=
.1028
-----------------------------------------------------------------------------PPIYoY |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+--------------------------------------------------------------DepositsYoY |
1.145093
.2540005
4.51
0.000
.6152575
1.674929
_cons | -.0365532
.0248736
-1.47
0.157
-.0884386
.0153323
------------------------------------------------------------------------------
-166-
Bibliography
Data Sources:
U.S. Bureau of the Census. Series F1-5 and D85-86.
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Data, National Bureau of Economic Research (NBER).
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Can found at: http://stats.bls.gov/opub/hom/homch17_d.htm#17a
Important in understanding the construction of the CPI in the 1920s.
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Primary documents -- personal correspondence of Benjamin Strong.
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the Fiscal Year Ended June 30, 1917. Washington, D.C, Government Printing Office.
Montgomery, R. (1918). "Income Tax Procedure 1918."
-167-
Source was used through the Wall Street Journal. Montgomery was the former
president of the American Association of Public Accountants. His analysis of the
Revenue Bill of 1918 was useful in that he offered a contemporary criticism.
(1920). "Individual Files: Leffingwell." National Archives and Records Administration
(NARA): Correspondence of the Secretary of the Treasury 1917-1932 Record Group 56.
Even while Leffingwell had left the Treasury for J.P, Morgan, he remained in
close contact with his former colleagues and frequently offered advice to Gilbert
and Mellon. This source was invaluable to understanding Leffingwell's continued
relationship with the Treasury and position in designing the "Mellon" tax plan.
(1920). Sixth Annual Report of the Federal Reserve Board. Washington, D.C,
Government Printing Office.
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Brace and Howe.
Keynes was fundamental opposed to the Treaty of Versailles. This essay laid
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Taussig, F. W. (1920). Free Trade, the Tariff and Reciprocity. New York, Macmillan
Company.
Head of the Harvard Economic Department and a leading international
economist himself during much of the period, Taussig laid out the fundamental
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that can manipulate bills and create uneconomical results.
(1921). "The Revenue Act of 1921." Congressional Record: Seventy-Sixth Congress
Session I(Chpt. 136).
The actual Revenue Bill of 1921. Very useful in determining how drastic it
changed tax rates on the margin.
Taussig, F. W. (1921). Selected Readings in International Trade and Tariff Problems.
Boston, Ginn and Company.
Cassel, G. (1922). Money and Foreign Exchange After 1914. London, Constable and
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Governors, F. R. B. o. (1922). Federal Reserve Bulletin. Washington D.C., Federal
Reserve Board of Governors.
Keynes, J. M. (1922). A revision of the Treaty, being a sequel to The economic
consequences of the peace,. New York, Harcourt, Brace and Howe.
(1923). Ninth Annual Report of the Federal Reserve Board Covering Operations for the
Year 1922. Washington D.C., Federal Reserve Board.
-168-
Moulton, H. M., Constantine (1923). Germany's Capacity to Pay. New York, McGraw-Hill
Book Company Inc.
A contemporary study of the German reparations problem
Seligman, E. (March, 1924). "Comparative Tax Burden." Political Science Quarterly Vol.
39(No. 1): 125 - 129.
A terrific primary source written by one of the authors/correspondents to Gilbert
and Mellon in the Treasury. Seligman effectively helped Gilbert and Mellon
orchestrate the tax reform throughout the 1920s. This article details the
comparative tax burdens post war countries. It examines the United States,
France, Germany, and England in detail.
Beckhart, B. (1924). The Discount Policy of the Federal Reserve System. New York,
Henry Hold and Company.
An important primary source documenting the Fed policy in the immediate post
war period. Beckharts analysis helped me in understanding the complex makeup of different monetary tools (such as the introduction of the Federal Reserve
Note). Beckhart also documented a plethora of Congressional debates
surrounding Fed policy, offering some incite as to how Congress was viewing the
Fed's policy and what the reaction was by the nation following the price declines
in 1920-21.
Mellon, A. (1924). Taxation: The Peoples Business. New York, Macmillan.
A important source. Secretary Mellon's own argument surrounding the much
needed tax reform that would eventually become known as the "Mellon Plan."
The book was used to popularize the plan in the 1924 campaign to adopt the tax
reform. Very quotable, but also full of facts. Let's the reader "into" the Treasury's
mindset during the 1920 tax debates.
(1925). "Annual Report of the Secretary of the Treasury on the State of the Finances for
the Fiscal Year ended June 30, 1924." U.S. Treasury Department.
Moulton, H. L., Cleona (1925). The French Debt Problem. New York, The Macmillan
Company.
(1926). "The Revenue Act of 1926." Congressional Record: Seventy-ninth Congress
Session I(Chpt. 26-27).
Allen, F. W. H. J. E. (1926). British War Budgets. Oxford, Oxford University Press.
Hoover, H. (1926). The Future of Our Foreign Trade. Washington D.C, GPO.
Burgess, W. R. (1927). The Reserve Banks and the Money Market. New York, Harper &
Brothers Publishers.
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Another invaluable primary source for understanding the monetary policy of the
1920s. Burgess was particularly important because he worked directly under
Benjamin Strong at the New York Fed. Strong was undoubtedly the most
important figure in monetary policy throughout the period until his death in 1928.
Burgess's first hand account of Fed policy is, therefore, an important source for
discussing monetary policy in the 1920s.
Burgess, W. R. (1927). The Reserve Bank and the Money Market. New York, Harper &
Brothers Publishing.
Valuable primary source for understanding monetary policy in the 1920s.
Burgess worked closely with Benjamin Strong at the New York Fed. Strong
actually wrote the introduction to this book.
Glass, C. (1927). An Adventure in Constructive Finance. New York, Doubleday, Page
and Company.
A valuable examination of monetary policy by a former Secretary of Treasury
and Senator Carter Glass.
Taussig, F. W. (1927). International Trade. New York, Macmillan Company.
Another important study by the leading international economist of his day.
Taussig makes clear that international trade is of up most importance to the
stability of the system after World War One.
(1928). "The Revenue Act of 1928." Congressional Record: Seventieth Congress
Session I(Chpt. 842).
(1928-1932). Numerous Articles - See Footnotes. The New York Times. New York.
Invaluable resource of information.
(1928-1932). Numerous Articles. The Wall Street Journal. New York.
(1929). Hearings before the Subcommittee of the Committee on Banking and Currency.
Subcommittee of the Committee on Banking and Currency. Washington D.C.,
Government Printing Office.
D'Abernon, V. E. V. (1929). An Ambassador of Peace. London, Hodder and Stoughton.
Haig, R. M. (1929). The Public Finances of Post-War France. New York, Columbia
University Press.
(1929-1930). Numerous Articles. The Commercial and Financial Chronicle. New York.
A valuable resource as this was the prominent news source for Wall Street
traders.
Fisher, I. (1930). The Stock Market Crash and After. New York, The Macmillan
Company.
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A useful primary source from the dominant name in economics during the 1920s.
Fisher offers an extensive analysis of the primary causes and implications of the
Stock Market Crash in October 1929. He builds the case that prices were mostly
based on fundamental economic activity and so should not depreciate much
more. He has been discredited by historians ever since, but his points are still
important to understand.
Keynes, J. M. (1930). A treatise on money. New York, Harcourt, Brace and Howe.
Written just after or during the Crash in America and published in 1930. A
precursor to "The General Theory of Employment" and essential to truly
understanding Keynes' theory and his theoretical development.
Douglas, P. H. D., Aaron (1931). The Problem of Unemployment. New York, Macmillan
Company.
Important source analyzing the source/extent of unemployment, especially
between sectors/classes in the 1920s. Was particularly useful in examining the
agricultural/farming sector and understanding the criticism of the Twenties as
being a decade of "excess" that inevitably led to the opposite reaction in the
Great Depression.
Nations, S. o. t. L. o. (1931). The Course and Phases of the World Economic
Depression. Geneva, League of Nations and World Peace Foundation.
(1932). Sale of Foreign Bonds or Securities in the United States. Senate Committee on
Finance. Washington D.C., United States Congress.
Beckhart, B. (1932). The New York Money Market. New York, Columbia University
Press.
Beveridge, S. W. (1932). Tariffs: The Case Examined. London, Longmans, Green & Co.
Moulton, H. (1932). War Debts and World Prosperity. Washington D.C., The Brookings
Institute.
Important source directly connecting international economic trouble and the war
debts.
Pasvolsky, H. G. M. L. (1932). War Debts and World Prosperity. Washington D.C., The
Brookings Institute.
A valuable resource in understanding the credit risks of the United States and
their profound impact on the world economy in the early 1930s.
Commerce, U. S. D. o. (1933). Economic Analysis of Foreign Trade of the United States
in Relation to the Tariff. Washington D.C, U.S. Department of Commerce, GPO.
Fisher, I. (1934). Stable Money: A History of the Movement. New York, Adelphi
Company.
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Jones, J. (1934). Tariff Retaliation: Repercussions of the Hawley-Smoot Bill.
Philadelphia, University of Pennsylvania Press.
The best case of the view that there was extensive foreign retaliation against
Smoot-Hawley. Some have criticized Jones' argument as generally overstated
but it offers a glimpse into the contemporary mind set of Americans.
Schattschneider, E. E. (1935). Politics, Pressures and the Tariff. New York, PrenticeHall.
Offered a classic account of the political process that resulted in the SmootHawley tariff. Much of this information could be gained through an examination
of the news sources, as is provided in this thesis. Nonetheless,
Schattschneider's analysis is valuable.
Joint Committee, C. E. I. C. o. C. (1936). International Economic Reconstruction. Paris,
Carnegie Endowment & International Chamber of Congress.
Keynes, J. M. (1936). The general theory of employment, interest and money. New York,
Harcourt, Brace and Howe.
Keynes' most famous work, in which he laid out his fundamental theory and
attempted to refute says law and the classical economics of this period.
Lewis, C. (1936). The Recovery Problem in the United States. Washington D.C., The
Brookings Institution.
Invaluable source in understanding the international financial structure of the
world following the First World War. Helps outline the interconnectivity of the
economy in this period and is full of useful statistical data.
(1937). Munitions Industry. Senate Special Committee Investigating the Munitions
Industry. Washington D.C.: Part 26, p. 7934.
Important in finding/understanding export and import statistics used in thesis.
Lewis, C. (1938). America's Stake in International Investments. Washington D.C.,
Brookings Institution.
Essential in understanding the precarious position of the international finances
following the war. A primary source full of detailed information and data
summaries.
Day, J. P. (1939). "An Introduction to World Economic History Since the Great War."
London Macmillan and Co.
Useful in understanding economic reasoning behind need to open up trade in
late 1920s. Covered major economic conferences around the world as well as
the Depression in detail.
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Synder, C. (1940). Capitalism the Creator. New York, the Macmillan Co.
Valuable in understanding the development of Open Market Operations at the
Federal Reserve Bank of New York under Benjamin Strong in the 1920s.
Secondary Sources (alphabetical order):
(2001). Survey of Current Business Annual Supplement. Washington D.C., U.S.
Commerce 1929 - 2000.
(2005). Historical Highlights of the IRS, Internal Revenue Service, US Treasury
Department.
(Feb. 1930). "Review of the Year 1929." The Review of Economic Statistics Vol. 12(No.
1): 1-14.
A useful source, full of important statistical data. Also gives incite into the
contemporary outlook for the coming years.
(January 17, 1918). Income Tax Procedure 1918. Wall Street Journal. New York: 6.
(March and April 1926). Stabilization. Committee on Banking and Currency. Washington
D.C., Government Printing Office.
(Sept. 4 1919). Federal Reserve Board Minutes. Federal Reserve Board Meeting,
Washington D.C.
Available at: http://fraser.stlouisfed.org/docs/MeltzerPDFs/min090419.pdf
Adams, T. S. (Aug. 1921). "Fundamental Problems of Federal Income Taxation." The
Quarterly Journal of Economics Vol. 35(No. 4): pg. 531-32.
An invaluable source. T.S. Adam's was the most important tax economist of the
1920s period. He actively participated with the Treasury through the post war
period and can be thought of as a primary architect of the "Mellon" tax reform.
This source presents the argument for why the tax system needed to be
reformed following World War I.
Aldcroft, D. (1978). The European Economy, 1914-1970. New York, St Martin's Press.
Aldcroft, D. (1997). Studies in the Interwar European Economy. Aldershot, England,
Ashgate.
Aldcroft, D. H. (1977). From Versailles to Wall Street. Los Angeles, University of
California Press.
A valuable source in connecting the War Debts created by the Treaty of
Versailles (among other things) and the stock market crash and depression in
1929 and after.
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Anderson, K. L. F. (April 1934). World Economic Survey 1931-1932. Geneva, League of
Nations.
Anderson, K. L. F. (Oct. 1935). World Economic Survey 1934-35. Geneva, League of
Nations.
Archibald, R. B. F., David H., (April 1998). "Investment during the Great Depression:
Uncertainty and the Role of the Smoot-Hawley Tariff." Southern Economic Journal Vol.
64(No. 4).
A very important article in which the authors make the case that uncertainty
surrounding the Smoot-Hawley bill caused a depression in investment in 1929.
Archibald and Feldman use econometric techniques and modern day investment
theory to demonstrate their results.
Associates, I. (2000). Stocks, Bonds, and Inflation 2000 Yearbook. Chicago, Ibbotson
Associates, Inc.
Balderston, T. (2004). "Reflections on the Great Depression." International Journal of
Social Economics 31(7/8): 732-733.
The book Reflections on the Great Depression, by Randall E Parker, is reviewed.
Beckhart, B. H. (1972). Federal Reserve System. United States of America, American
Institute of Banking.
Essential to understanding the Federal Reserve System in the 1920s. Not as
detailed as Meltzer's history of the Fed, but more sweeping and easier to see the
"big picture." Particularly useful in comparing different period due to the way the
book is organized. It also covers the international perspective of the world debt
system following World War One.
Bernanke, B. (1983). "Irreversibility, uncertainty, and cyclical investment." Quarterly
Journal of Economics(No. 85).
Bernanke, B. S. (2004). Essays on the Great Depression. Princeton, NJ, Princeton
University Press.
A compilation of all Bernanke's essay's on the Great Depression. An invaluable
source, although extremely economic in nature.
Bittingmayer, G. (Dec. 1998). "Output, Stock Volatility, and Political Uncertainty in a
Natural Experiment: Germany, 1880-1940." Journal of Finance Vol. 53.
Bittlingmayer, G. (1993). "The Stock Market and Early Antitrust Enforcement." Journal of
Law and Finance Vol. 36.
Bittlingmayer, G. (Jan. 2002). "The 1920's Boom, The Great Crash and After." Working
Paper - University of Kansas.
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Blakey, R. (Mar. 1922). "The Revenue Act of 1921." American Historical Review Vol.
12(No. 1).
This is a published document covering the precise tax rate changes by bracket.
It includes the entire progressive surtax structure. Important in analyzing the true
impact of the Revenue Bill of 1921
Blakey, R. (Sep. 1924). "The Revenue Act of 1924." American Economic Review Vol.
14(No. 3): pg. 475.
Blakey, R. (Sep. 1926). "The Revenue Act of 1926." American Economic Review Vol.
16(No. 3): pg. 407 - 408.
Board, F. R. (1945-2000). Flow of Funds Accounts of the Unites States. Washington
D.C., Federal Reserve Board.
Bordo, M. G., Claudia & White, Eugene (1998). The Defining Moment: The Great
Depression and The American Economy in the Twentieth Century. Chicago, University
of Chicago Press.
Brownlee, W. E. (1996). Federal Taxation in America: A short history. Cambridge,
England, Cambridge University Press.
An important source in documenting and understanding the progression of
taxation from consumer levies (sales and tariff taxes) to production taxes (income
and profit taxes). A good overview. Not too in-depth, but this is a virtue in many
ways. Very useful.
Brunner, K., Ed. (1981). The Great Depression Revisited. Boston, Martinus Nijhoff
Publishing.
A compilation of essays surveying different understandings of the Great
Depression and illustrating the lack of consensus regarding the origins and
causes of the decline.
Callahan, C. M. M., Judith A. & O'Brien, Anthony Patrick (Sept. 1994). "Who Voted for
Smoot-Hawley." The Journal of Economic History Vol. 54(No. 3).
Again, this sources helped outline the progression of the Smoot-Hawley Tariff in
Congress and the process of voting that took place. Less directly important for
my thesis, but an interesting approach to the political side of the debate.
Calomiris, C. W. and J. R. Mason (2003). "Fundamentals, Panics, and Bank Distress
During the Depression." American Economic Review 93(5): 1615-1647.
We assemble bank-level and other data for Fed member banks to model
determinants of bank failure. Fundamentals explain bank failure risk well. The
first two Friedman-Schwartz crises are not associated with positive unexplained
residual failure risk, or increased importance of bank illiquidity for forecasting
failure. The third Friedman-Schwartz crisis is more ambiguous, but increased
residual failure risk is small in the aggregate. The final crisis (early 1933) saw a
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large unexplained increase in bank failure risk. Local contagion and illiquidity
may have played a role in pre-1933 bank failures, even though those effects
were not large in their aggregate impact. [PUBLICATION ABSTRACT]
Carey, K. (Sept. 1999). "Investigating a Debt Channel for the Smoot-Hawley Tariffs:
Evidence from the Sovereign Bond Market." The Journal of Economic History Vol.
59(No. 3).
Cary examined the change in price of certain sovereign bonds over several
weeks in 1930 that corresponded with the progress in the Smoot-Hawley Tariff.
He argued that If market was anticipating increased defaults due to the Tariffs, it
will be visible in the cross-country patterns of bond prices. Cary shows there is a
significant correlation, but that the overall effect is relatively small.
Carlstrom, C. T. and T. S. Fuerst (2001). "Perils of price deflations: An analysis of the
Great Depression." Federal Reserve Bank of Cleveland. Economic Commentary: 1-3.
In the last 2 decades, central banks within the industrialized world have been
successful at lowering inflation rates. Now that inflation rates are near zero,
periodic deflations are much more plausible. Some think that a policy of price
stability requires that the monetary authority walk a tight rope between the
danger of letting inflation reignite and the threat of allowing possible deflation.
Some of the potential perils of price deflations are reviewed. How price deflation
contributed to the worst economic calamity of the twentieth century - the Great
Depression - is examined. Economic theory suggests that deflations potentially
pose 3 main dangers: 1. Because nominal interest rates cannot fall below zero
percent, deflations can increase real interest rates. 2. If employers are unable to
reduce nominal wages, price deflations will increase the real wage, which tends
to discourage employment growth. 3. Price deflations can lead to large
redistributions of wealth from borrowers to lenders.
Costigliola, F. (1984). Awkward Dominion. London, Cornell University Press.
Crucini, M. J., & Kahn, James (1996). "Tariffs and Aggregate Economic Activity: Lessons
from the Great Depression." Journal of Monetary Economics Vol. 38(No. 3).
Crucini and Kahn combined stochastic growth and a computable general
equilibrium model to argue that the macroeconomic impact of the Smoot-Hawley
Tariff has been universally understated. They find that Tariffs could have
increased US output by 2% between 1929-1932. View's tariffs as taxes on
intermediate inputs, distorting labor supply and capital accumulation. This article
does not take the collapse of the international financial structure as an
endogenous event, related to the tariff war, as I have proposed in this thesis.
David, P. (May 1990). "The Dynamo and the Computer: An Historical Perspective on the
Modern Productivity Paradox." American Economic Review Papers and Proceedings
Vol. 80.
Dornbusch, R. F., Stanley (1986). The Open Economy: Implications of Monetary and
Fiscal Policy. American Business Cycle: Continuity and Change. Chicago, University of
Chicago Press. Vol. 25.
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Dornbusch and Fischer discuss the potential macroeconomic impact of the
Smoot-Hawley Tariff.
Douglas, I. K., Randall S. (1996). "Log-Rolling and Economic Interests in the Passage of
the Smoot-Hawley Tariff." Carnegie-Rochester Series on Public Policy Vol. 4.
Eichengreen, B. (1989). "The Political Economy of the Smoot-Hawley Tariff." Research
in Economic History Vol. 12.
Eichengreen's understanding of the Smoot-Hawley bill, which he dismissed as
being a primary cause of the Depression.
Eichengreen, B. (2004). "Viewpoint: Understanding the Great Depression." Canadian
Journal of Economics 37(1): 1-25.
If there is a feature of modern scholarship on the Great Depression that
distinguishes it from its antecedents, it is the tendency of recent contributions to
frame that event as a global phenomenon (see e.g. Eichengreen, 1992; Johnson
1998; Bernake, 2000; and James 2001). Whether this new research has
produced a scholarly consensus is another matter. In this paper, it is asked
whether it is possible to arrive at such a consensus by synthesizing the old and
the new literatures. It is suggested that the opposition between the 'old' and 'new;
(or 'US-centric' and 'global') views of the Great Depression may ultimately prove
artificial.
Eichengreen, B. (May, 1992). "The Origins and Nature of the Great Slump Revisited."
The Economic History Review Vol. 45(No. 2).
A good overview of the existing theories - especially focusing on Fearson's article
"The origins and nature of the Great Slump, 1929-1932." Eichengreen argues
that while Fearson demonstrated the lack of consensus over the central issues of
the Great Depression, today (written in 1992) a consensus has emerged.
Eichengreen takes us through a number of competing arguments (structural
changes of post war production, labor market operational changes, and others)
and then focus' on the failure of the international monetary system as today's
consensus.
Eichengreen, B. T., Peter (2000). "The Gold Standard and the Depression."
Contemporary European History Vol. 9(No. 2): 183-207.
Evans, P. and I. T. E. W. Hasan (2004). "Monetary Explanations of the Great
Depression: A Selective Survey of Empirical Evidence." Economic Review - Federal
Reserve Bank of Atlanta 89(3): 1-23.
Seventy years after the Great Depression, economists still debate the causes of
this economic catastrophe. Two leading explanations are distinguished by
whether or not the Federal Reserve's monetary policies are perceived as being
chiefly responsible for propagating and magnifying the initial contraction into a
depression. This article surveys recent modeling efforts and empirical work that
examine aggregate explanations for the Great Depression from both the
extensive literature using vector auto regression techniques and the more recent
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literature using dynamic stochastic general equilibrium modeling. Neither of these
approaches has yielded a consensus about the causes of the depression. Data
alone are insufficient to distinguish the precise role of monetary policy during that
period. The modeling strategies impose restrictions that help isolate the
meaningful economic interactions in the data. In each literature, the ways in
which the respective models identify monetary policy can differ substantially, and
these differences are why monetary policy shocks may or may not explain much
of the output contraction. Also, these modeling approaches vary in their ability to
capture important institutional features of the banking and financial system.
Fackler, J. S. and R. E. Parker (2005). "Was Debt Deflation Operative During the Great
Depression?" Economic Inquiry 43(1): 67-78.
This study demonstrates three facts consistent with the debt deflation/credit view
explanation of the Great Depression. First, private medium- and long-term
nominal debt during the 1920s exhibited a combination of a high initial value
relative to income and a rapid growth rate that is unparalleled in a consistent data
set covering more than half a century. Second, the debt issued during the 1920s
occurred in a stable price regime. Third, near the onset of the Depression, the
price process switched to one of deflation. Taken together, the evidence
suggests that debt deflation was operative during the Depression. For the debt
deflation/credit view to explain part of the path of output during the Depression,
large unanticipated rises in real debt should be observed. This can occur due to
rises in nominal long-term outstanding debt and/or due to unanticipated deflation.
The argument is that each occurred at the onset of the Depression, with rapid
rises in nominal debt during a period of price stability followed by a switch to a
deflationary price process.
Fainsod, M. (1941). Government and the American Economy. New York, W.W. Norton &
Company, Inc.
Fearon, P. (1987). War Prosperity and Depression: The US Economy 1917-1945.
Kansas, University Press of Kansas.
Peter Fearon surveyed the depression of the 1930s first in The origins and
nature of the Great Slump, 1929-1932, and then in more detail in War, Prosperity
& Depression: The U.S. Economy 1917-1945. In this survey, Fearon revived
literature that treated the depression as a consequence of the instabilities of the
development of the previous decades. Half of his account is devoted to World
War I and the 1920s. He focused on the structural changes of the interwar
economy away from staple trades (iron and steel, coal, textiles, shipbuilding) and
toward the 'new industries' (chemicals, electrical, engineering, motor vehicles.)
Fearon noted the inability of Britain to adapt to these structural changes in
contrast to the flexibility of the United States as the driving force for economic
success during the decade in the face of Britain's relative underperformance.
Federico, G. (2005). "Not Guilty? Agriculture in the 1920s and the Great Depression."
Journal of Economic History 65(4): 949-976.
Agricultural distress in the 1920s is routinely quoted among the causes of the
Great Depression. This article challenges the conventional wisdom. World
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agriculture was not plagued by overproduction and falling terms of trade. The
indebtedness of American farmers, a legacy of the boom years 1918-1921, did
jeopardize the rural banks, but the relation between their crises, the banking
panic of 1930, and the Great Depression is tenuous at best. [PUBLICATION
ABSTRACT]
Ferderer, J. P., & Zalewski, David A., (Dec. 1994). "Uncertainty as a Propagating Force
in the Great Depression." The Journal of Economic History Vol. 54(No. 4).
Ferderer, J. P. Z., David A (Sept. 1999). "To Raise the Golden Anchor? Financial Crises
and Uncertainty during the Great Depression." The Journal of Economic History Vol.
59(No. 3).
Field, A. J. (2003). "The most technologically progressive decade of the century."
American Economic Review 93(4): 1399-1413.
The years 1929-1941 were in the aggregate, the most technologically
progressive of any comparable period in US economic history. This hypothesis
entails two primary claims: 1. that during this period businesses and government
contractors implemented or adopted on a more widespread basis a wide range of
new technologies and practices, resulting in the highest rate of measured
peacetime peak-to-peak multifactor productivity growth in the century, and 2. that
the Depression years produced advances that replenished and expanded the
larder of unexploited or only partially exploited techniques, thus providing the
basis for much of the labor and multifactor productivity improvement of the 1950's
and 1960's. The 1929-1948 period is critical in understanding the long-term
trajectory of technological change in the US, both because of its direct effect on
growth during the period and because of its lagged effect on multifactor
productivity advance in the 1950s which when coupled with renewed capital
deepening, produced a golden age of labor productivity growth and living
standard improvement.
Fisher, I. (Jan. 1934). "Discussion by Professor Irving Fisher." The Annals of The
American Academy of Political and Social Science.
Friedman, M. S., Ann (1965.). The Monetary History of the United States, 1967-1960.
Princeton, Princeton University Press.
The entire book is valuable for its wealth of statistical information, but of most
interest was the Chapter on the Depression entitled "The Great Contraction."
Friedman and Schwartz argued that while the stock market boomed throughout
the 1920s, the economy did not. They asserted that the "Federal Reserve policy
was not restrictive enough to halt the bull market, yet too restrictive to foster
vigorous business expansion." I find this argument troubling as GNP grew from
$69.9 billion to $103.1 billion during the period and the CPI Index dropped from
53.6 - 51.3, making the growth in national output even faster (54%) in real terms.
Galbraith, J. K. (1955). The Great Crash, 1929. Boston, Houghton Mifflin.
In many ways, this book is still the "bible" for students of the 1929 stock market
Crash. Galbraith founded, or at least popularly publicized the bubble theory for
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the stock market and for the Crash of 1929. He made no attempt, however, to
explain the causes of the stock market boom or the trigger for the Crash.
Gerald, S. (Summer 1975). "The Stock Market of 1929, Revisited: A Note." Business
History Review Vol. 44.
Gilbert, C. (1970). American Financing of World War I. Westport Connecticut,
Greenwood Publishing.
Goldin, C. (June 2001). "The Human Capital Century and American Leadership: Fruits of
the Past." Journal of Economic History Vol. 61.
Gordon, R. J. and M. Friedman (1974). Milton Friedman's monetary framework : a
debate with his critics. Chicago, University of Chicago Press.
Harding, W. (April 12 1921). "A Return to Normalcy." Congressional Record 67 Cong(1
Sess.): pp. 169-173.
Harding, W. (March 4, 1921). "Inaugural Address."
See: http://www.bartleby.com/124/pres46.html
Hetzel, R. (1985). "The Rules verse Discretion Debate over Monetary Policy in the
1920s." Federal Reserve Bank of Richmond.
Hetzel, R. (Winter 2002). "German Monetary History in the First Half of the Century."
Economic Quarterly - Federal Reserve Bank of Richmond.
Higgs, R. (1987). Crisis and Leviathan: Critical Episodes in the Growth of American
Government. Oxford, Oxford University Press.
Himmelberg, R. F., Ed. (1968). The Great Depression and American Capitalism. Boston,
D.C. Heath and Company.
Hoover, H. (1952). The Memoirs of Herbert Hoover: The Cabinet and the Presidency,
1920 - 1933. New York, Macmillan Company.
Lays out the Republican Party platforms for the era and gives a first hand (but
probably not completely truthful) account of the Hoover administration. Chapter
41, on the tariff bill, is particularly useful.
Humphrey, T. M. (2001). "Monetary policy frameworks and indicators for the Federal
Reserve in the 1920s." Economic Quarterly - Federal Reserve Bank of Richmond 87(1):
65-92.
The 1920s saw the Fed reject a state-of-the-art quantity theory framework for a
flawed real bills one. The quantity theory framework featured the money stock,
price level, and real interest rates as policy guides. By contrast, the real bills
framework featured nominal interest rates, volume of discount window borrowing,
and type of commercial paper eligible for discount. When the start of the Great
Depression put these rival sets of indicators to the test, the quantity theory set
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correctly signaled that monetary policy was sharply contractionary, while the real
bills set incorrectly signaled that money and credit conditions were sufficiently
easy and needed no correction. This experience shows that policy guides
originating in a theoretically flawed framework can lead the policymaker astray.
Irwin, D. A. (May, 1998). "The Smoot-Hawley Tariff: A Quantitative Assessment." The
Review of Economics and Statistics Vol. 80(No. 2).
Irwin finds that the Smoot-Hawley tariff both negatively and significantly disrupted
the macroeconomy of the early Depression. Irwin is refuting Eichengreen's
analysis, which found the tariff actually helped the US economy during the
Depression (especially the later years of the Depression). Irwin finds that up to
40% of the decline in imports can be accounted for by the Smoot-Hawley Tariff.
Kennedy, D. M. (1999). Freedom From Fear: the American People in Depression and
War, 1929 - 1945. New York, Oxford University Press.
A good overview of the period that addressed the political, economic, and social
impacts of the Crash and the Depression.
Kindleberger, C. P. (1973). The World in Depression, 1929 - 1939. London, Allen Lane.
Argued primary effects of Tariffs was to redirect aggregate demand from foreign
trade to home products, so that while losses occur due to decreased trade, gains
also occur due to increased aggregate demand. He was somewhat ambiguous
on the net impact. I am not sure I entirely accept this claim.
Also argues that foreign trade was such a small percentage of US aggregate
demand that any impact is ill-founded.
Nevertheless, Kindleberger offers a good overview of the depression and
focuses on the impact of the entire world economy and the interconnectivity of
countries due to the war debts.
Klein, L. (1947). The Keynesian Revolution. New York, MacMillan Company.
Klein, M. (2001). Rainbow's End. Oxford, Oxford University Press.
Lamoreaux, N. (1988). The Great Merger Movement in American Business 1895-1904.
Cambridge, Cambridge University Press.
Leffingwell, R. (Jun. 1931). "Causes of the Depression." Proceedings of the Academy of
Political Science Vol. 14(No. 3).
Leffingwell was a partner at J.P. Morgan and Company as well as one of the
architects of the Mellon Tax reform. His short article noted the Tariff as a
contributing cause to the Depression.
Lewis, N. (July 2001). "The Role of Money and Gold in the Great Contraction of the
1930s." Polyconomics, Inc.
A new argument surrounding the importance of the Gold Standard. Lewis
argued against Eichengreen and others that the failure of the Gold Standard was
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in the revaluations in the early and mid-1930s that upset existing the international
monetary framework.
Lewis, W. A. (1950). Economic Survey 1919-1939. Philadelphia, The Blakiston
Company.
McDonald, J. O. B., Anthondy Patrick & Callahan, Colleen (1997). "Trade Wars:
Canada's Reaction to the Smoot-Hawley Tariff." Journal of Economic History Vol. 57(No.
4).
McMullen, F. (1987). "Women and the Ticker Tape - A Year after the Crash." The
Women's Journal(No. 60).
Melling, A. B. P., Ed. (2004). America in the 1920. Mountfield TN, Helm Information.
Meltzer, A. (1976). "Monetary and Other Explanations of the Start of the Great
Depression." Journal of Monetary Economics Vol. 2.
Meltzer emphasized the importance of Smoot-Hawley in explaining the Great
Depression. Much of this monetary points are extended upon in his book "The
History of the Federal Reserve."
Meltzer, A. (2003). A History of the Federal Reserve. Chicago, University of Chicago
Press.
A very important work and one that covers the Federal Reserve System's actions
in extreme detail. Meltzer covers day-to-day debate over monetary policy
between different Federal Reserve Banks as well as between Governor Strong at
the New York Bank and Adolph Miller at the Board of Governors. Meltzer's book
is perhaps a too critical of the Fed in causing the recession of 1921 and in not
stopping the deflation and bank runs during the Depression. Metlzer's work
offers a complete documentary of the Feds actions throughout the period, and a
detailed account of the personalities at work. In particular, Meltzer focuses on
Benjamin Strong of the New York Fed and is sympathetic of Milton Friedman and
Anna Schwartz's claim that had Strong lived through 1928, the Great Depression
could have been avoided.
Meltzer, A. H. (2001). "Money and monetary policy: An essay in honor of Darryl Francis."
Review - Federal Reserve Bank of St. Louis 83(4): 23-31.
The 1960s and 1970s were the Keynesian decades in US economic policy.
Keynesian policy views were mainstream views in the academic profession. The
primary role of fiscal policy in economic stabilization was a distinguishing
characteristic of Keynesian policy. At the height of the controversy in the late
1960s and early 1970s, Darryl Francis was the principal, and usually the only,
spokesman who challenged this orthodoxy at meetings of the Federal Open
Market Committee. Federal Reserve history suggests that neglect of money
growth is a major mistake. The Federal Reserve would have avoided mistakes
such as the Great Depression and the Great Inflation if it had used money growth
as an indicator of the thrust of monetary policy.
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Mintz, I. (1959). Trade Balances during Business Cycles: U.S. and Britain since 1880.
New York, National Bureau of Economic Research (NBER).
Mintz, I. (1961). American Exports During the Business Cycle, 1879-1958. New York,
Natoinal Bureau of Economic Research (NBER).
Miron, J. A. R., Christina D. (1990). "A New Monthly Index of Industrial Production, 18841940." Journal of Economic History Vol. 50(no. 2): 321-37.
Useful for its estimations of GDP and other macro variables in the 1920s.
Mises, L. v. (1949). Human Action. New York, Regnery.
A full economic theory in itself. "Human Action" was useful in understanding the
difference between a monetary inflation/deflation and demand/supply driven
inflation/deflation. He also has a full theory around incentives which include
taxation.
Mowery, D. (1995). The Boundaries of the U.S. Firm in Research and Development.
Coordination and Information: Historical Perspectives on the Organization of Enterprise.
N. L. a. D. Raff. Chicago, University of Chicago Press.
Mundell, R. (Dec. 1999). "A Reconsideration of the Twentieth Century." The Nobel
Foundation, Stockholm, Sweden.
This article is a revised version of the lecture Robert A. Mundell delivered in
Stockholm, Sweden, December 10, 1999, when he received the Bank of Sweden
Prize in Economic Sciences in Memory of Alfred Nobel.
The underlying theme of the speech was the role of the United States in what
has been aptly called the "American century." Mundell brought out the role of the
monetary factor as a determinant of political events. Specifically, he argued that
many of the political changes in the century have been caused by littleunderstood perturbations in the international monetary system, while these in
turn have been a consequence of the rise of the United States and mistakes of
its financial arm, the Federal Reserve System. In particular, the first section
"Mismanagement of the Gold Standard" was most useful
Murnane, M. S. (2004). "Selling Scientific Taxation: The Treasury Department's
Campaign for Tax Reform in the 1920s." American Bar Foundation.
Valuable in understanding the debate and forces that brought the Mellon Plan to
fruition.
Nicholas, T. (2004). "Stock Market Swings and the Value of Innovation." LSE Working
Paper.
This article investigated whether the run-up in stock market valuation during the
1920s was related to the accumulation of intangible capital by firms. Valuable in
testing the results of Prescott and McGattan who found that stocks were
undervalued in late 1929, before the crash.
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Nicholas, T. (Dec. 2003). "Why Schumpeter was Right: Innovation, Market Power, and
Creative Destruction in 1920s America." The Journal of Economic History Vol. 63(No. 4).
Pastor, R. (1980). Congress and the Politics of United States Foreign Economic Policy,
1929 - 1976. Berkeley Calif, University of California Press.
Takes the view that party politics was of supreme importance in passage of the
tariff.
Peach, W. (1942). The Security Affiliates of National Banks. John Hopkins, John
Hopkins University.
Pierce, P., Ed. (1982). The Dow Jones Averages 1885-1980. Homewood, Illinois, Dow
Jones-Irwin.
Pindyck, R. (1991). "Irreversibility, uncertainty, and investment." Journal of Economic
Literature.
Posner, R. (October 1970). "A Statistical Study of Antitrust Enforcement." Journal of Law
and Economics Vol. 14.
Prescott, E. M. E. (Dec. 2001). "The Stock Market Crash of 1929: Irving Fisher was
right!"" NBER Working Paper 8622.
An important article that demonstrated the stock market was in fact undervalued
on the eve of the Crash, just as Fisher had broadcasted.
Rappaport, E. W. P. (1993). "Was the Crash Expected?" The American Economic
Review Vol. 84(No. 1).
Ratner, S. (1942). American Taxation: Its History as a Social Force in Democracy. New
York.
Reynolds, A. (Nov. 9th 1979). "What do we know about the Great Crash?" National
Review.
Although trained at the Chicago Monetarist School under Milton Friedman,
Reynolds argued in line with Wanniski that the Smoot-Hawley bill played a
dominant role in the October 1929 Stock Market Crash. Used "The Commercial
and Financial Chronicle" to test the theory.
Ricardo, D. (1996). Principles of Political Economy and Taxation. New York, Prometheus
Books.
Roberts, P. (Spring 2000). "Benjamin Strong, the Federal Reserve, and Limits to
Interwar American Nationalism." Economic Quarterly - Federal Reserve Bank of
Richmond.
Romer, C. (1969). "The prewar Business Cycle reconsidered: New estimates of Gross
National Product, 1869 - 1908." Journal of Political Economy Vol. 97.
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Romer, C. (June 1988). "The Great Crash and the Onset of the Great Depression."
NBER Working Paper.
Rothbard, M. (1975). America's Great Depression. Kansas City, Sheed and Ward, Inc.
Rothbard, M. (2002). A History of Money and Banking in the United States: The Colonial
Era to World War II. Auburn Alabama, Ludwig von Mises Institute.
Rothbard, M. G., Garet (1980). "The Great Depression and New Deal Monetary Policy."
San Francisco Cato Institute.
Santoni, G. (Nov. 1987). "The Great Bull Markets 1924-1929 and 1982-1987:
Speculative Bubbles or Economic Fundamentals." Federal Reserve Bank of St. Louis
Review Vol. 69.
Schlesinger, A. (1971). History of presidential elections. New York.
Schumpeter, J. (1950). Capitalism, Socialism and Democracy. New York, Harper
Brothers Publishing.
Schwartz, A. J. (2001). "Essays on the Great Depression." Cato Journal 20(3): 493-495.
Essays on the Great Depression, by Ben S. Bernanke, is reviewed.
Schwartz, M. F. a. A. (1963). A Monetary History of the United States. Princeton,
Princeton University Press.
Perhaps the most famous book on the period. Milton Friedman and Anna
Schwartz offer a tremendous amount of data focusing primarily on the money
stock and monetary policy of the United States in explaining changes in price
level and even the Depression. This is the definitive "monetarist" explanation
for the period. Much of what Friedman and Schwartz have said has been since
discredited. My own analysis of their theory also found many flows.
Nevertheless, it remains the starting point for any anlysis of the economy
during the 1920s/1930s and is especially important for understanding monetary
factors. Even if its conclusions can be criticized, the work is invaluable for its
data collection, all of which is provided in extensive appendixes.
Siegler, M. V. (2005). "International growth and volatility in historical perspective."
Applied Economics Letters 12(2): 67-71.
This paper studies the relationship between the volatility and growth of real GDP
using a newly constructed panel data set from twelve countries over the 1870 to
1929 period. In addition, many other variables are examined that are related to
economic growth. The goal has been to uncover robust empirical regularities on
this issue for the period prior to the Great Depression - a period which has been
relatively neglected in previous empirical work. The main finding is that there is a
robust negative partial correlation between volatility and growth, after controlling
for other factors. This result is consistent with recent empirical evidence on the
post-World War II period. [PUBLICATION ABSTRACT]
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Siegler, M. V. and K. A. Van Gaasbeck (2005). "From the Great Depression to the Great
Inflation: Path Dependence and monetary policy." Journal of Economics & Business
57(5): 375-387.
There is substantial narrative evidence that the shadow of the Great Depression
may have influenced the conduct of U.S. monetary policy during the 1970s. In
this paper, we estimate central bank reaction functions for the United States and
12 other countries over the 1970s to examine the relationship between the
magnitude of the Great Depression and the response of central banks to output
gaps and inflation during the Great Inflation. The main finding is that countries
which suffered the most during the 1930s had monetary policy reaction functions
that responded substantially more aggressively to output gaps during the 1970s.
[PUBLICATION ABSTRACT]
Silverman, D. (1982). Reconstructing Europe after the Great War. Cambridge, Harvard
University Press.
Stevens, M. (1989). Sudden Death. New York, Penguin Books.
System, B. o. G. o. t. F. R. (1959). All Bank Statistics, United States, 1896-1955.
Washington D.C., Federal Reserve Board of Governors.
Essential data source for many of the graphs/regressional studies in the thesis.
Thompson, N. (2004). "The End of Globalization, Lessons from the Great Depression."
Labor History 45(4): 554-555.
The End of Globalization, Lessons from the Great Depression by Harold James
is reviewed.
Tung Liu, G. S., & Courtenay Stone (Sept. 1995). "In Search of Stock Market Bubbles: A
Comment on Rappoport and White." The Journal of Economic History Vol. 55(No. 3).
Wanniski, J. (1978). The Way The World Works. New York, Basic Books.
The work that inspired this Thesis. Wanniski was the first to propose the
importance of the tariff in the modern literature as the central cause behind the
crash and the main factor (along with poor tax policy) in pushing the United
States into depression. He thoroughly documents the tariff through the news
during the period of the October stock market crash. In addition, Wanniski
argues that Secretary Mellon's tax plan helped bring the economy out of
recession in 1921 and laid the foundation from which the "booming twenties"
where able to grow. His book also outlines his understanding for the functioning
of the political and economic dynamics within the world. He would call himself
(and his theory) a "supply-side" political economic theorist.
Wanniski, J. (2005). Re: Gold Fetters. B. Eichengreen, non-published Wanniski
archives.
Valuable private correspondence between Jude Wanniski and Barry Eichengreen
concerning the Crash of 1929, the Depression and the organs of both. Not
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published information but available from Polyconomics (www.polyconomics.com)
upon request.
Wanniski, J. (2005). Origins of the Great Depression. B. Bernanke, non-published
Wanniski archives.
Important, non-published and private correspondence between Jude Wanniski
and Ben Bernanke discussing the origins and sources of the Crash of 1929 and
the Great Depression. Also useful because it compares situations to modem day
phenomenon. This is on the eve of Bernanke becoming Fed Chairman in 2006.
Wanniski, J. (2005). Re: Eichengreen Response. B. Bernanke, non-published; Wanniski
Archives.
Correspondence between Wanniski and Bernanke regarding Eichengreen's
thoughts on the origins of the Depression.
Wanniski, J. (January 8th, 2005). "The Crash of 1929." Supply Side University - Memo
on the Margin.
Wanniski, J. (June 17th, 2005). "75th Anniversary of Smoot-Hawley Tariff Act." Supply
Side University - Memo on the Margin.
Watson's, O. B. M. (1982). Bubbles, Rational Expectations, and Financial Markets.
Crises in the Economic Financial Structure. P. Watchel. Lexington: D.C, Heath and Co.
Weidenbaum, M. L. (1990). Business, Government and the Public. Englewood Cliffs, NJ,
Prentice Hall.
Weisman, S. (2002). The Great Tax Wars: Lincoln to Wilson, The Fierce Battles Over
Money and Power that Transformed the Nation. New York, Simon & Schuster.
An invaluable book for the first chapter. Extensively covers the tax debates in
the United States since the Civil War. Weisman is somewhat sympathetic to the
Mellon tax reform of the inter-war years. Like Witte's "The Politics and
Development of the Federal Income Tax" it was lacking in specific detail
regarding the bills most important to my thesis. For this detailed information I
used the actual bills themselves.
West, R. C. (1977). Baning Reform and the Federal Reserve 1863-1923. Ithaca, Cornell
University Press.
Wheelock, D. C. (Jun. 1989). "The Strategy and Consistency of Federal Reserve
Monetary Policy, 1919-1933." The Journal of Economic History Vol. 49(No. 2).
White, E. (1990). When the Ticker Ran Late: The Stock Market Boom and Crash in
1929. Crises and Panics: The Lessons of History. Homewood, Dow Jones Company.
White, E. (Sept. 1993). "Was There a Bubble?" The Journal of Economic History Vol.
53(No. 3).
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White, E. (Spring 1990). "The Stock Market Boom and Crash of 1929 Revisited." The
Journal of Economic Perspectives Vo. 4(No. 2).
Important article that attempts to demonstrate a bubble existed in 1929. Major
contribution to research.
Wigmore, B. A. (1985). The Crash and Its Aftermath. London, Greenwood Press.
Valuable in understanding the different sectors in the stock market on the eve of
the Crash as well as how they reacted both during and after the crash. Wigmore
detailed the individual stocks admirably. A valuable resource.
Wilkins, M. (2004). The History of Foreign Investment in the United States, 1914-1945.
Cambridge, Harvard University Press.
Wilson, J. J., Charles (Apr. 1987). "A Comparison of Annual Common Stock Returns:
1871-1925 with 1926-85." The Journal of Business Vol. 60(No. 2).
Witte, J. F. (1985). The Politics and Development of the Federal Income Tax. Madison,
Wisconsin, University of Wisconsin Press.
An overview of the development of the Federal Income Tax beginning with the
Civil War. The first section covers tax theory while the later sections delve into
the history. A useful work to get a sense of the political reaction/debate over
different Revenue Bills but not completely inclusive regarding the specifics of all
tax changes. The work is important because it promotes a method for studying
public policy that integrates political theory, political practice, and policy analysis
(definitively for tax policy).
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