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Why The Friedman/Bernanke Thesis About The Great Depression Was Dead Wrong

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Submitted by David Stockman via Contra Corner blog,

In explaining to the FT’s Martin Wolf why he bailed out the Wall Street gamblers at Goldman Sachs and Morgan Stanley while crushing millions of ordinary American savers and retirees, Bernanke typically repaired to his go to argument. It had nothing to do with the mild excesses of inventories and labor that had built up in the main street economy owing to the Greenspan housing and credit boom, as explained in Part 1.

That’s because Bernanke was not aiming to ameliorate the mild economic liquidation that ensued after the Lehman event; and which, as previously demonstrated, would have runs its course and self-corrected without any help from the Fed in any event.

No, Ben S. Bernanke will be someday remembered as the world’s most destructive battleship admiral. Not only was he fighting the last war, but his whole multi-trillion money printing campaign after September 15, 2008 was aimed at avoiding an historical Fed mistake that had never even happened!

As Bernanke explained it:

I should have done more (to mitigate anti-Fed sentiments). But I was very much engaged in trying to put out the fire. So I don’t know what to say. It was kind of predictable. The Federal Reserved failed in the 1930s. I think we did much better than in the 1930s.

The claim that the Fed resorted to “extraordinary policies” of ZIRP and QE because it was fighting a recurrence of Great Depression 2.0 is completely, profoundly, unequivocally and destructively wrong.

It is the giant fig leaf that obscures what really happened during and after the crisis. Namely, that the main street economy recovered on its own, and that the flood of money generated by Bernanke never left the canyons of Wall Street, thereby causing the destruction of honest price discovery in the financial markets once and for all.

So doing, the Fed and other central banks have turned financial markets into dangerous, unstable casinos. In the name of precluding the contra-factual——that is, Great Depression 2.0—-they have generated the mother of all financial bubbles.

There is no other possible outcome than another thundering crash after upwards of 90 months of free money subsidy to the carry trade gamblers and upwards of $19 trillion of rank monetization of the public debt and other existing assets by the Fed and its central bank fellow travelers.

At the end of the day, however, the monetary mayhem that was unloosed in September 2008 is the responsibility of two professors of economics who got the causes of the 1930-1933 collapse of the US economy completely wrong. In the excerpts below from the Great Deformation, I refute the two great myths that still pop out of journalists’ keyboards whenever the events of September 2008 are touched upon.

To wit, first, the Fed did not cause the banking crisis of 1930-1933 by failing to undertake a massive bond-buying campaign; and secondly, the banking system was rotten to the core with bad loans and insolvency after the artificial boom of World War I and the follow-on bubbles of the Roaring Twenties. It could not have been fixed with a 1930s version of QE or any other massive intrusion of the central bank.

WHEN PROFESSOR FRIEDMAN OPENED PANDORA’S BOX: OPEN MARKET OPERATIONS

 

At the end of the day, Friedman jettisoned the gold standard for a remarkably statist reason. Just as Keynes had been, he was afflicted with the economist’s ambition to prescribe the route to higher national income and prosperity and the intervention tools and recipes that would deliver it. The only difference was that Keynes was originally and primarily a fiscalist, whereas Friedman had seized upon open market operations by the central bank as the route to optimum aggregate demand and national income.

 

There were massive and multiple ironies in that stance. It put the central bank in the proactive and morally sanctioned business of buying the government’s debt in the conduct of its open market operations. Friedman said, of course, that the FOMC should buy bonds and bills at a rate no greater than 3 percent per annum, but that limit was a thin reed.

 

Indeed, it cannot be gainsaid that it was Professor Friedman, the scourge of Big Government, who showed the way for Republican central bankers (e.g. Greenspan and Bernanke) to foster that very thing. Under their auspices, the Fed was soon gorging on the Treasury’s debt emissions, thereby alleviating the inconven- ience of funding more government with more taxes.

 

Friedman also said democracy would thrive better under a regime of free markets, and he was entirely correct. Yet his preferred tool of prosperity promotion, Fed management of the money supply, was far more antidemocratic than Keynes’ methods. Fiscal policy action was at last subject to the deliberations of the legislature and, in come vague sense, electoral review by the citizenry.

 

By contrast, the twelve-member FOMC is about as close to an unelected politburo as is obtainable under American governance. When in the fullness of time, the FOMC lined up squarely on the side of debtors, real estate owners, and leveraged speculators——-and against savers, wage earners, and equity financed businessmen——-the latter had no recourse from its baleful policy actions.

 

The greatest untoward consequence of the closet statism implicit in Friedman’s monetary theories, however, is that it put him squarely in opposition to the vision of the Fed’s founders. As has been seen, Carter Glass and Professor Willis assigned to the Federal Reserve System the humble mission of passively liquefying the good collateral of commercial banks when they presented it.

 

Consequently, the difference between a “banker’s bank” running a discount window service and a central bank engaged in continuous open market operations was fundamental and monumental, not merely a question of technique. By facilitating a better alignment of liquidity between the asset and liability side of the balance sheets of fractional reserve deposit banks, the original “reserve banks” of the 1913 act would, arguably, improve banking efficiency, stability, and utilization of systemwide reserves.

 

Yet any impact of these discount window operations on the systemwide banking aggregates of money and credit, especially if the borrowing rate were properly set at a penalty spread above the free market interest rate, would have been purely incidental and derivative, not an object of policy. Obviously, such a discount window–based system could have no pretensions at all as to managing the macroeconomic aggregates such as produc- tion, spending, and employment.

 

In short, under the original discount window model, national employment, production prices, and GDP were a bottoms-up outcome on the free market, not an artifact of state policy. By contrast, open market operations inherently lead to national economic planning and targeting of GDP and other macroeconomic aggregates. The truth is, there is no other reason to control M1 than to steer demand, production, and employment from Washington.

 

Why did the libertarian professor, who was so hostile to all of the projects and works of government, wish to empower what even he could have recognized as an incipient monetary politburo with such vast powers to plan and manage the national economy, even if by means of the remote and seemingly unobtrusive steering gear of M1?

 

There is but one answer: Friedman thoroughly misunderstood the Great Depression and concluded erroneously that undue regard for the gold standard rules by the Fed during 1929–1933 had resulted in its failure to conduct aggressive open market purchases of government debt, and hence to prevent the deep slide of M1 during the forty-five months after the crash.

 

Yet the historical evidence is unambiguous; there was no liquidity shortage and no failure by the Fed to do its job as a banker’s bank.

 

Indeed, the six thousand member banks of the Federal Reserve System did not make heavy use of the discount window during this period and none who presented good collateral were denied access to borrowed reserves. Conse- quently, commercial banks were not constrained at all in their ability to make loans or generate demand deposits (M1).

But from the lofty perch of his library at the University of Chicago three decades later, Professor Friedman determined that the banking system should have been flooded with new reserves, anyway. And this post facto academician’s edict went straight to the heart of the open market operations issue.

 

The discount window was the mechanism by which real world bankers voluntarily drew new reserves into the system in order to accommodate an expansion of loans and deposits. By contrast, open market bond purchases were the mechanism by which the incipient central planners at the Fed forced reserves into the banking system, whether sought by member banks or not.

 

Friedman thus sided with the central planners, contending that the market of the day was wrong and that thousands of banks that already had excess reserves should have been doused with more and still more reserves, until they started lending and creating deposits in accordance with the dictates of the monetarist gospel. Needless to say, the historic data show this proposition to be essentially farcical, and that the real-world ex- ercise in exactly this kind of bank reserve flooding maneuver conducted by the Bernanke Fed forty years later has been a total failure—a monumental case of “pushing on a string.”

 

FRIEDMAN’S ERRONEOUS CRITIQUE OF THE DEPRESSION-ERA FED OPENED THE DOOR TO MONETARY CENTRAL PLANNING

 

The historical truth is that the Fed’s core mission of that era, to rediscount bank loan paper, had been carried out consistently, effectively, and fully by the twelve Federal Reserve banks during the crucial forty-five months between the October 1929 stock market crash and FDR’s inauguration in March 1933.

 

And the documented lack of member bank demand for discount window borrowings was not because the Fed had charged a punishingly high interest rate. In fact, the Fed’s discount rate had been progressively lowered from 6 percent before the crash to 2.5 percent by early 1933.

 

More crucially, the “excess reserves” in the banking system grew dramatically during this forty-five-month period, implying just the opposite of monetary stringency. Prior to the stock market crash in September 1929, excess reserves in the banking system stood at $35 million, but then rose to $100 million by January 1931 and ultimately to $525 million by January 1933.

 

In short, the tenfold expansion of excess (i.e., idle) reserves in the banking system was dramatic proof that the banking system had not been parched for liquidity but was actually awash in it. The only mission the Fed failed to perform is one that Professor Friedman assigned to it thirty years after the fact; that is, to maintain an arbitrary level of M1 by forcing reserves into the banking system by means of open market purchases of Uncle Sam’s debt.

 

As it happened, the money supply (M1) did drop by about 23 percent during the same forty-five-month period in which excess reserves soared tenfold. As a technical matter, this meant that the money multiplier had crashed. As has been seen, however, the big drop in checking account deposits (the bulk of M1) did not represent a squeeze on money. It was merely the arithmetic result of the nearly 50 percent shrinkage of the commercial loan book during that period.

 

As previously detailed, this extensive liquidation of bad debt was an unavoidable and healthy correction of the previous debt bubble. Bank loans outstanding, in fact, had grown at manic rates during the previous fifteen years, nearly tripling from $14 billion in 1914 to $42 billion by 1929. As in most credit- fueled booms, the vast expansion of lending during the Great War and the Roaring Twenties left banks stuffed with bad loans that could no longer be rolled over when the music stopped in October 1929.

 

Consequently, during the aftermath of the crash upward of $20 billion of bank loans were liquidated, including billions of write-offs due to business failures and foreclosures. As previously explained, nearly half of the loan contraction was attributable to the $9 billion of stock market margin loans which were called in when the stock market bubble collapsed in 1929.

 

Likewise, loan balances for working capital borrowings also fell sharply in the face of falling production. Again, this was the passive consequence of the bursting industrial and export sector bubble, not something caused by the Fed’s failure to supply sufficient bank reserves. In short, the liquidation of bank loans was almost exclusively the result of bubbles being punctured in the real economy, not stinginess at the central bank.

 

In fact, there has never been any wide-scale evidence that bank loans outstanding declined during 1930–1933 on account of banks calling performing loans or denying credit to solvent potential borrowers. Yet unless those things happened, there is simply no case that monetary stringency caused the Great Depression.

 

Friedman and his followers, including Bernanke, came up with an academic canard to explain away these obvious facts. Since the wholesale price level had fallen sharply during the forty-five months after the crash, they claimed that “real” interest rates were inordinately high after adjusting for deflation.

 

Yet this is academic pettifoggery. Real-world businessmen confronted with plummeting order books would have eschewed new borrowing for the obvious reason that they had no need for funds, not because they deemed the “deflation-adjusted” interest rate too high.

 

At the end of the day, Friedman’s monetary treatise offers no evidence whatsoever and simply asserts false causation; namely, that the passive decline of the money supply was the active cause of the drop in output and spending. The true causation went the other way: the nation’s stock of money fell sharply during the post-crash period because bank loans are the mother’s milk of bank deposits. So, as bloated, insolvent loan books were cut down to sustainable size, the stock of deposit money (M1) fell on a parallel basis.

 

Given this credit collapse and the associated crash of the money multiplier, there was only one way for the Fed to even attempt to reflate the money supply. It would have been required to purchase and monetize nearly every single dime of the $16 billion of US Treasury debt then outstanding.

 

Today’s incorrigible money printers undoubtedly would say, “No problem.” Yet there is no doubt whatsoever that, given the universal antipathy to monetary inflation at the time, such a move would have triggered sheer panic and bedlam in what remained of the financial markets. Needless to say, Friedman never explained how the Fed was supposed to reignite the drooping money multiplier or, failing that, explain to the financial markets why it was buying up all of the public debt.

 

Beyond that, Friedman could not prove at the time of his writing A Monetary History of the United States in 1965 that the creation out of thin air of a huge new quantity of bank reserves would have caused the banking system to convert such reserves into an upwelling of new loans and deposits. Indeed, Friedman did not attempt to prove that proposition, either. According to the quantity theory of money, it was an a priori truth.

 

In actual fact, by the bottom of the depression in 1932, interest rates proved the opposite. Rates on T-bills and commercial paper were one-half percent and 1 percent, respectively, meaning that there was virtually no unsatisfied loan demand from credit-worthy borrowers.

 

The dwindling business at the discount windows of the twelve Federal Reserve banks further proved the point. In September 1929 member banks borrowed nearly $1 billion at the discount windows, but by January 1933 this declined to only $280 million. In sum, banks were not lending because they were short of reserves; they weren’t lending because they were short of solvent borrowers and real credit demand.

 

In any event, Friedman’s entire theory of the Great Depression was thoroughly demolished by Ben S. Bernanke, his most famous disciple, in a real-world experiment after September 2008. The Bernanke Fed undertook massive open market operations in response to the financial crisis, purchasing and monetizing more than $2 trillion of treasury and agency debt.

 

As is by now transparently evident, the result was a monumental wheel-spinning exercise. The fact that there is now $2.7 trillion of “excess re- serves” parked at the Fed (compared to a mere $40 billion before the crisis) meant that nearly all of the new bank reserves resulting from the Fed’s bond-buying sprees have been stillborn.

 

By staying on deposit at the central bank, they have fueled no growth at all of Main Street bank loans or money supply. There is no reason whatsoever, therefore, to believe that the outcome would have been any different in 1930–1932.

By contrast, the real cause of the Great Depression was the massive and unsustainable expansion of credit and bank lending during the Great War of 1914-1918, and the financial boom of 1924-1929.

*  *  *

Ironically, both of these credit bubbles were financed by the newly created Federal Reserve, as outlined in the additional sections from The Great Deformation. Indeed, even the famous banking crisis of 1933 was not what it is cracked-up to be. As explained below, both the recession and the banking crisis were over by the summer of 1932; a Hoover Recovery had actually begun.

Indeed, the banking holiday declared by FDR upon his inauguration was the result of a 10-day run on the banks that had been caused by his actions during February 1933. In short, Bernanke has spent the last 7-years claiming he stopped a bank run like that of the 1930s, when, in fact, the actual pre-Roosevelt bank run had nothing whatsoever to do with policy actions by the Federal Reserve:

THE GREAT WAR AND THE ROARING TWENTIES: CRADLE OF THE GREAT DEPRESSION

FDR’s mortal blow to international monetary stability and world trade is the pattern through which the New Deal was shaped. Once Roosevelt went for domestic autarky, the New Deal was destined to be a one-armed bandit. It capriciously pushed, pulled, and reshuffled the supply side of the domestic economy, but it could not regenerate the external markets upon which the post-1914 American prosperity had vitally depended.

Herbert Hoover had been correct: the US depression was rooted in the collapse of global trade, not in some flaw of capitalism or any of the other uniquely domestic afflictions on which the New Deal programs were predicated. Indeed, the American economy had been thoroughly internationalized after August 1914 and had grown by leaps and bounds as a great export machine and prodigious banker to the world.

While it lasted, the export boom of 1914–1929 generated strong gains in growth had averaged nearly 4 percent annually, a rate that has never again been matched over a comparable length of time.

The trouble was that this prosperity was neither organic nor sustainable. In addition to the debt-financed demand for American exports, stock market winnings and the explosion of consumer debt generated exuberant but unsustainable household purchases of big-ticket durables at home. So when the stock market finally broke, this financially fueled chain of economic expansion snapped and violently unwound.

The first victim was the foreign bond market, which was the subprime canary in the coal mine of its day. Within a few months of the crash, new issuance had dropped 95 percent from its peak 1928 levels, causing foreign demand for US exports to collapse. Worse still, the price of the nearly $10 billion of foreign bonds outstanding also soon plunged to less than ten cents on the dollar, meaning that the collapse was of the same magnitude and speed as the subprime mortgage collapse of 2008.

Foreign debtors had been borrowing to pay interest. When the Wall Street music stopped in October 1929, the house of cards underlying the American export bonanza collapsed. By 1933, US exports had dropped by nearly 70 percent.

The Wall Street meltdown also generated ripples of domestic contraction which compounded the export swoon. Stock market lottery winners, for example, had been buying new automobiles hand over fist. But after sales of autos and trucks peaked at 5.3 million units in 1929, they then dropped like a stone to only 1.4 million vehicles in 1932. Needless to say, this 75 percent shrinkage of auto sales cascaded through the auto supply chain, including metal working, steel, glass, rubber, and machine tools—with devastating impact.

The collapse of these “growth” industries also caused a withering cutback in business investment. Plant and equipment spending tumbled by nearly 80 percent between 1929 and 1933, while nearly half of all the production inventories extant in 1929 were liquidated over the next three years. This unprecedented liquidation of working inventories—from $38 billion to $22 billion—amounted to nearly a 20 percent hit to GDP before the cycle reached bottom.

Overall, nominal GDP had been $103 billion in 1929 but by 1933 had shrunk to only $56 billion. Yet the overwhelming portion of this unprecedented contraction was in exports, inventories, fixed plant and equipment, and consumer durables. These components declined by $33 billion during the four years after 1929 and accounted for fully 70 percent of the decline in nominal GDP.

The underlying story in these data refutes the postwar Keynesian narrative about the Great Depression. What happened during 1929–1932 was not a mysterious loss of domestic “demand” that was somehow recoverable through enlightened macroeconomic stimulus policies. Instead, what occurred was an inevitable shrinkage in the unsustainable levels of output that had been reached by exports, durables, and a once-in-a-life-time capital investment boom, not unlike the massive China investment cycle of 1994–2015.

It was not the depression bottom level of GDP during 1932–1933 that was avoidably too low; it was the debt and speculation bloated GDP peak of 1929 that had been unsustainably too high. Accordingly, the problem could not be solved by macroeconomic pump-priming at home. The Great Depression was therefore never a candidate for the Keynesian cure which was inherently inward looking and nationalistic.

The frenetic activity of the first hundred days of the New Deal, of course, is the stuff of historians’ legends. Yet when viewed in the context of this implosion of the nation’s vastly inflated export/auto/capital goods sector, it’s evident that the real cure for depression did not lie in the dozens of acronym-ridden programs springing up in Washington.

Contrary to the long-standing Keynesian narrative, therefore, the New Deal contributed virtually nothing to the mild recovery which did materialize during the six-year run-up to war in 1939. In fact, the modest seesaw expansion which unfolded during that period had been already set in motion during the summer of 1932, well before FDR’s election.

 

THE HOOVER RECOVERY INTERRUPTED

The New Deal hagiographers never mention that 50 percent of the huge collapse of industrial production, that is, the heart of the Great Depression, had already been recovered under Hoover by September 1932. The catalyst for the Hoover recovery was not Washington-based policy machinations but the natural bottoming of the severe cycle of fixed-asset and inventory liquidation after 1929.

By mid-1932, the liquidation had finally run its course because inventories were virtually gone, and capital goods and durables production could hardly go lower. Accordingly, nearly every statistic of economic activity turned upward in July 1932. From then until the end of September, the Federal Reserve Board index of industrial production rose by 21 percent, while rail freight loadings jumped by 20 percent and construction contract awards rose by 30 percent.

Likewise, the American Federation of Labor’s published count of industrial unemployment dropped by nearly three-quarters of a million persons between July 1 and October 1. Retail sales and electrical power output also rose smartly in the months after July, and some core industry which had been nearly prostrate began to spring back to life.

Cotton textile mill manufacturing, for example, surged from 56 percent of capacity in July to 97 percent in October, and mill consumption of wool nearly tripled during the same period. Likewise, the giant US Steel Corporation, which then stood at the center of the nation’s industrial economy, recorded its first increase in sixteen months in its order backlog.

Related indicators also confirmed a broad and vigorous recovery. Wholesale prices rose by nearly 20 percent from their early 1932 bottom, marking the first sustained uptick since September 1929. The stock market quickly grasped the picture and rebounded from its depression low on the Dow Jones Index of 41 on July 7, 1932, to 80 in early September, before fears of a Roosevelt victory set it back.

The most important sign of economic rebound, however, was in the be- leaguered banking sector. After having experienced nearly three hundred bank closings per month for much of the post-1929 period, bank failures dropped sharply to only seventy to eighty closings a month after June.

Indeed, for the period of July through October 1932, deposits held by banks which were reopened during that interval exceeded those of newly failed banks, a complete break with the month-after-month deposit losses that had occurred until then. In a similar vein, the United States experienced five straight months of gold inflows after July, indicating that the panicked gold flight that had commenced after the British default of Sep- tember 1931 had decisively reversed.

As one careful journalistic reconstruction of events published during this period noted, “With the defeat of all threatening inflationary legislation in June . . . [and] the complete restoration of foreign confidence in the American gold position—the breath of recovery began to be felt over the land.”

No less an authority on the national mood than Walter Lippmann, then at the peak of his game and influence, later summarized, “There is very good statistical evidence . . . that as a purely economic phenomena the world depression reached its low point in mid-summer 1932 and that in all the leading countries a very slow but nevertheless real recovery began.”

By election time, however, the rebound had cooled. Subsequently, all the indicators of economic and financial activity weakened sharply during the long interregnum between Election Day and the March 4, 1933, inauguration.

As outlined below, there is powerful evidence that this setback can be attributed to a “Roosevelt panic” in the gold and banking markets that was avoidable and the result of FDR’s numerous errors and provocations during the presidential interregnum. The fact is, every other major industrial country in the world also began to recover in July 1932, but none had a relapse back into depression during the winter of 1932–1933.

 

THE BANKING CRISIS THAT FDR MADE

The Hoover recovery has largely been omitted from the history books, fostering the impression that the American economy had continuously plunged after October 1929 until it reached a desperate bottom on exactly March 4, 1933. That rendition of events was far from accurate, but it did mightily burnish the Roosevelt miracle legend; namely, that FDR decisively reopened the frozen banking system, restarted the wheels of commerce, and restored a heartbeat to capitalism through the swarm of acronyms which flew out of New Deal Washington during the Hundred Days.

But the received version of the March 1933 banking crisis is an invention of Arthur Schlesinger Jr. and other postwar commentators who postulated FDR’s “bank holiday” as the dividing line between Hooverian darkness and the Roosevelt miracles. By contrast, the most savvy and erudite financial observers at the time saw it far differently, and for a very good reason: on the Friday evening before Roosevelt’s inauguration most of the US banking system was still solvent, including the great money center banks of New York: the Chase National Bank, First National City Bank, the Morgan Bank, and many more.

Indeed, the latter had to be practically coerced into agreeing to the New York State banking holiday signed into effect by Governor Lehman at 4:30 a.m. in the wee hours before FDR’s inauguration. As it happened, the governor was a scion of the banking house bearing his name, but the circumstances of 1933 were the opposite of those which accompanied its demise in 2008.

Back then there had been no bank runs in the canyons of Wall Street because the great banks had largely observed time-tested standards; that is, they had been fully and adequately collateralized on their stock loans and were sitting on cash reserves up to 20 percent of deposits. The stock market crash of 1929–1930 had been brutal, of course, but in those purportedly be- nighted times officialdom had the good sense to allow Mr. Market to make his appointed rounds.

Accordingly, stock market punters by the thousands had been felled quickly and cleanly when upward of $9 billion of margin loans were called after Black Thursday. Indeed, the banks and brokerages liquidated in a matter of months the massive margin loan bubble—$1 trillion in today’s economy—that had built up under the stock averages in the final years of the mania.

The fact that none of the great New York money center banks closed their doors during the four years between the crash and FDR’s inauguration points to the real story; namely, that the bank insolvency problem had been in the provinces and countryside, not the nation’s money center.

In fact, the run of bank failures was largely contained within the borders of the oversized 1914–1929 agricultural and industrial export economy. As the latter collapsed, overloaned banks in industrial boom towns like Chicago, Detroit, Toledo, Youngstown, Cleveland, and Pittsburgh had taken heavy hits.

In the case of the agricultural hinterlands, the Great Depression had started to roll in a decade before the crash, owing to the unique farm country boom and bust which had accompanied the Great War. The unprecedented total industrial-state warfare of 1914–1918 had drastically disrupted European agricultural production and markets, inducing an explosion of export demand, high prices, and soaring output in the American farm belt. There soon followed an orgy of speculation in land and real estate that ex- ceeded in relative terms even the sand-state housing boom of 2002–2007.

Once the agricultural lands of Europe came back into production, how- ever, the great American granary lost much of its artificial war-loan export market, causing farm prices to abruptly plunge in 1920–1921 and then to continue sinking for the next decade. Not surprisingly, thousands of one-horse banks dotting the countryside had been caught up in the wartime frenzy and then suffered massive, unrelenting losses during the long post- war deflation of the farm bubble.

Overall, about 12,000 banks failed during 1920–1933, but 10,000 of these were tiny rural banks located in places of less than 2,500 population. Their failure rate of more than 1,000 per year throughout the 1920s makes for eye-catching historical statistics, but they were largely irrelevant to the nation’s overall GDP.

Losses at failed US banks during the entire twelve-year period through 1932, in fact, accumulated to only 2–3 percent of deposits. This extended wave of failures was an indictment of the short-sighted anti-branch banking laws that rural legislators had forced upon the states, as well as a reminder that wartime inflation and disruption had cast a long shadow on the future.

The crucial point, however, is that these thousands of failed banks were insolvent and should have been closed. They were not evidence of some fundamental breakdown of the banking system, or failure of the Fed to supply adequate liquidity, or a systemic crisis of capitalism.

Even after the 1929 crash, when the failure rate accelerated to about 2,400 in the twelve months ending in mid-1932, the periodic spurts of bank closures were not national in scope. Instead, they struck with distinct regional incidence in the agricultural and industrial interior. And almost without exception, these regional bank failure breakouts were centered on cities or banking chains which had indulged heavily in speculative real estate lending and other unsound practices.

That was certainly the case with the first significant outbreak of bank runs in November 1930 when the Caldwell banking chain collapsed. A speculative pyramid of holding companies which controlled more than a hundred banks in Tennessee, Arkansas, and North Carolina, it failed when real estate values fell sharply in the upper Cotton Belt. While there was some spillover on local banks, the runs did not spread beyond the region and quickly burned out because deposits were moved to sounder banks, not to mattresses.

The most powerful evidence of the noncontagious nature of the pre–February 1933 bank failures occurred shortly thereafter with the famous collapse of the Bank of the United States in December 1930. An upstart New York City bank, the Bank of the United States, grew by leaps and bounds in the late 1920s through serial mergers, aggressive real estate lending, and pyramiding of holding company capital.

The bank had been a stock market rocket ship, rising from $5 per share in 1925 to a peak of $230 before the crash. But its promoter, one Bernard Marcus, who had been the Sandy Weill of his day, had been more adept at making deals than making sound loans, and thereby soon rendered his hastily assembled banking empire insolvent. Yet there was virtually zero spillover to other New York banks when state banking supervisors shut- tered what was then the city’s third-largest institution with around seventy branches and deposits on the order of $30 billion on today’s scale.

The same pattern occurred the following June in Chicago. There had been a giant real estate bubble in the Chicago suburbs during the 1920s, but owing to Illinois’s particularly restrictive anti-branch-banking law the Great Loop banks had been sidelined, leaving the suburban real estate lending spree to poorly capitalized newbies.

Chicago had been an epicenter of the 1914–1929 agricultural/industrial/export boom, so when the party ended abruptly after the stock market crash, the region’s economy was hit harder than any other industrial center outside of Detroit. Real estate prices experienced a particularly devastating collapse in the newly developed suburban communities, triggering a wave of defaults in loan portfolios which were heavily laden with commercial and residential mortgages.

Yet with one exception a year later, the Great Loop banks remained solvent and experienced no lines at their teller windows. By contrast, the “runs” on the suburban banks were both swift and warranted because they were deeply insolvent.

In short, the Chicago case further illuminates the fact that the wave of bank failures during 1930–1932 was not the result of irrational public sentiment and “contagion,” or a fundamental breakdown of bank liquidity, but instead was evidence of a discriminating, rational flight of depositors from unsound banks and markets.

Even when surges of bank failures extended eastward, such as in the Philadelphia runs of October 1931, there was far more rationality to the pattern than the conventional narrative acknowledges. In this case, the overwhelming share of failures was concentrated among newly formed “trust banks” which had been chartered under state law with far less stringent requirements for capital and cash reserves than was the case with national banks.

Again, the late 1931 wave of bank failures in Philadelphia quickly burned out after deposits had moved from the lightly regulated trust banks, which had been on the leading edge of real estate lending and securities speculation, to the far better capitalized national banks. Indeed, the fundamental solvency of the US banking system was dramatically evidenced during this same period when the Fed raised the discount rate in mid-October.

This Fed action is habitually and roundly criticized by contemporary advocates of central bank money printing, but it was actually the proper move under then-extant gold standard rules. Specifically, the initial impact of the British default on September 1931 had been a run on US gold out of fear that the United States would be the next to default. So a discount rate hike was necessary to stop the outflow and, in fact, the rate of gold losses fell sharply in the months ahead and eventually reversed to an inflow by mid-1932.

More importantly, there was no acceleration of bank failures after the discount rate hike, and within weeks the failure rate slackened dramatically while discount borrowings actually increased. This was proof positive that banks were failing not because they were illiquid or could not get emergency funding from the Fed but because they were, alas, bankrupt.

Indeed, Herbert Hoover’s unfortunate banking cure at the time—the emergency enactment of the Reconstruction Finance Corporation (RFC) in January 1932—was designed to alleviate insolvency, not provide emer- gency funding or replace hoarded deposits. Accordingly, the RFC went on to become a paragon of crony capitalism, rescuing dozens of busted railroads and recapitalizing several thousand insolvent banks.

Yet the outcome was perverse: the stock and bondholders of bailed-out institutions were rescued, competitors were harmed, and the nation’s economy was left to slog it out with far too much railroad capacity and way too many banks that were deeply insolvent.

*  *  *

The Banking Crisis Was Over Before FDR Got Started

…..The trigger for the pre-election panic, in fact, did not occur until the morning of February 14, when the governor of Michigan capriciously declared a one-week bank holiday owing to a funding crisis at Detroit’s second-largest banking chain. The Guardian Trust Group consisted of about forty banks controlled by Edsel Ford and included Goldman Sachs among its principle stockholders.

It was another of the late-1920s banking pyramids that had been organized with a modest $5 million of capital in 1927 and had grown to a $230 million holding company two years later, through a spree of mergers and stock swaps. These maneuvers elevated the stock price from $20 per share to $350 at the 1929 peak.

Unfortunately, the bank’s principle assets consisted of loans to insiders to buy the bank’s own stock and loans to both real estate developers and homeowners in the red-hot Detroit auto belt. Propelled by a population explosion from 300,000 to 1.6 million in the previous three decades, the volcanic price gains in the Detroit real estate market eclipsed the current era’s Sunbelt booms by orders of magnitude.

Consequently, when auto production dropped by 75 percent and triggered mass layoffs, and the Guardian Group’s stock price plummeted by 95 percent, the bank’s loan book became hopelessly impaired. However, what might have been embarrassing investment liquidation for Edsel Ford and his cronies became a national headline when the Guardian Group crisis turned into a brawl between Henry Ford and his despised erstwhile partner and then Michigan Democratic senator, James Couzens.

Senator Couzens was the Tyler Winklevoss (he and his twin brother were involved in the origins of Facebook) of his day and believed that he had been bilked out of his share of Ford Motor Company by Henry Ford. He could not abide a move afoot to have the RFC ride to the rescue of Edsel Ford’s mess, so he mustered his considerable weight as US senator and put the kibosh on the deal.

President Hoover unhelpfully got himself in the thick of the brawl. However, he did quickly recognize that the Detroit headlines were becoming a catalyst for a financial panic that was already brewing due to a complete breakdown of transition cooperation and FDR’s studied silence on his prospective financial policies.

Indeed, the increasing flow of hints and leaks from FDR’s radical brain trusters—such as Columbia professor Rexford Tugwell and secretary of agriculture designate Henry Wallace—that the incoming president would depreciate the dollar and pursue other inflationary schemes had already begun to trigger a run on gold and currency.

Therefore, on February 18 Hoover penned an eloquent private letter to FDR outlining the peril from these developments and the urgent need for a reassuring statement from the President-elect outlining his policies with respect to gold, currency, banking and the budget…..

By Monday morning February 27, Tugwell’s leak spread far and wide in the financial markets. The panic was on.

As Professors Nadler and Bogen noted in their classic 1933 history of the banking crisis, the “gold room” of the New York Federal Reserve Bank soon became a center of pandemonium: “As the panic week [February 27 to March 3] progressed, long lines formed to exchange ever larger amounts of gold there, until finally the metal was being carried away in large boxes and suitcases loaded on trucks.”

During the next five days approximately $800 million, or 20 percent, of the US gold stock was withdrawn by citizens, earmarked by foreign central banks, or implicitly purchased by speculators who took out a massive short position on the dollar. The lessons of the British default of September 1931 were still fresh, and as the smart money took aggressive actions to defend itself, the knock-on effect was almost instantly felt.

As Wall Street historian Barrie A. Wigmore noted in his magisterial history of the Great Depression, owing to the gold hemorrhage “the lender of last resort [i.e., the Fed] for the banking system was in doubt. Frightened depositors lined up for cash, the only working substitute for bank deposits.”

Wigmore’s point is dispositive. What financially literate citizens knew at the time, and was never grasped by postwar Keynesians, is that Federal Reserve currency notes were then required by statute to be backed by a 40 percent gold cover. The public therefore realized that only a few more days of the panicked gold drain could cause a sharp constriction of both the hand-to-hand currency supply and the banking system overall.

Accordingly, the daily currency figures provide ringing evidence of FDR’s culpability for the crisis. By February 23, the daily increase in currency out- standing had risen from the $8 million early February level to about $40 million, and then in the crisis week soared to nearly $200 million on Monday and hit $450 million on Friday, March 3, the day before the inauguration.

All told, the great bank teller window run and currency-hoarding crisis caused currency outstanding to rise from $5.6 billion to a peak of $7.5 billion. Yet $1.5 billion, or nearly 80 percent, of this gain occurred during the last ten days before FDR took office; that is, in the interval between the day Carter Glass said no and the morning FDR took the oath.

Barrie Wigmore’s work consists of seven hundred pages of massive documentation and only occasional viewpoints and judgments. But on the question of culpability for the banking crisis he left no doubt: “Roosevelt exacerbated the crisis. If he had handled the ‘lame duck’ period differently, there would have been no Bank Holiday . . . the banking system was un- usually liquid prior to the bank crisis, and [the] recovery from it was unusually rapid . . . [proving] that the peculiar circumstances of Roosevelt’s transition were the cause of the crisis.”

Four days after FDR officially closed the nation’s 17,000 banking institutions, the Senate approved, after seventy-five minutes of debate and no written copy of the bill, the Emergency Banking Act, which empowered the secretary of the treasury “to re-open such banks as have already been as- certained to be in sound condition.”

But there was no New Deal magic in the bill at all. It had been drafted by Hoover holdovers and was a content-free enabling act which required no change whatsoever in bank procedures in order to obtain a license to “re- open,” and included no standards for review or approval by the Treasury Department.

In fact, the legislation was the first of many FDR ruses. Once Hoover had been implicitly saddled with the blame for what appeared to be a frozen banking system and prostrate economy on March 4, FDR simply moved along to another topic, having had no intention of closing or reforming any banks.

Accordingly, with such dispatch as would have made Internet-era number crunchers envious, the White House began opening banks the next Monday (March 13th), and by Wednesday 90 percent of the deposit basis among national banks had been reopened.

Within the following ten days nearly all of the $2 billion in hoarded currency had flowed back into the banking system, and the Fed’s gold reserves soon reached pre-crisis levels. By early April, fully 13,000 banks with $31 billion of deposits were open and more than 2,000 more quickly followed after they had been given RFC capital injections.

By contrast, at year-end 1933 only a thousand mostly tiny rural banks with aggregate deposits of less than $1 billion had been closed, thus demonstrating that at the time of FDR’s banking crisis only 3 percent of the nation’s bank deposits were still in insolvent institutions. In effect, the severe business cycle liquidation of the Great Depression was over even before Roosevelt was elected, and within weeks of his self-instigated banking crisis the US economy had resumed its natural rebound.

By June 1933, economic activity levels attained in the previous September had been regained and a slow upward climb ensued, led by the steady replenishment of fixed assets and working capital. To be sure, recovery was greatly attenuated by the shutdown of international trade, but in a process that was drawn and halting, nominal GDP eventually reached the $90 billion level by 1939. After seven years of New Deal medication, the nation’s money income was still straining to reach its 1929 level.

 

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Wed, 10/28/2015 - 17:55 | 6723615 Raymond_K._Hessel
Raymond_K._Hessel's picture

'It is difficult to get a man to understand something, when his salary depends on his not understanding it.'

- Upton Sinclair

The Fed exists to prevent markets, and to transfer wealth from productive labor to banks.

and that's all it's for.

Wed, 10/28/2015 - 18:11 | 6723671 Mr.Sono
Mr.Sono's picture

If history has any guidance, "which Dr. Shalom thinks other wise" is that after recession comes depression. And that's if, you don't let free markets due its due diligence.

Wed, 10/28/2015 - 18:19 | 6723710 Pinto Currency
Pinto Currency's picture

 

 

Bernanke's thesis was never about the 1930s. 

It was about presenting a plan to bail-out the banks. 

That is how he got the job as Chairman - and he knew it.

Wed, 10/28/2015 - 18:29 | 6723756 Mr Poopra
Mr Poopra's picture

That quiver in his lower lip whenever he was questioned by Ron Paul absolutely delighted me.

Imagine that we treat the Fed as a legitimate institution right now.  We dress up in suits and interview guys like Bernanke cordially, when really we should have his fucking head in vice.

Wed, 10/28/2015 - 18:11 | 6723673 ZerOhead
ZerOhead's picture

Yep.

The author also misses the point that banking is a completely fraudulent undertaking that creates money out of thin air and eventually destroys and then dispossess the host nation where it has taken hold. Always has and always will.

Franklin and Jefferson were right.

http://www.theguardian.com/commentisfree/2014/mar/18/truth-money-iou-ban...

Wed, 10/28/2015 - 19:22 | 6723973 Starkman
Starkman's picture

No, banking doesn't do what you said it does; corrupt banking and corrupt baking rules do that. Otherwise, the idea of a bank that holds your money and even offers to pay a bit of interest on it is an exceptable business. That kind of banking just can't be found, unfortunately.

Thu, 10/29/2015 - 09:37 | 6725754 mtl4
mtl4's picture

X2

 

The problem isn't fractional banking and it's not the gold standard either, the real problem is the banks are now traders which means that they no longer have to rely on business relationships (via loans) to create profits.  The banks have now bought the law makers too so at this point the system will basically need to completely melt down in order to get reform because both bankers and politicians will not give up their power willingly. 

Wed, 10/28/2015 - 18:04 | 6723641 jump_mutha_fukah
jump_mutha_fukah's picture

FUCK YOU Bernanke. We know you are listening and an avid reader....you worthless fuck...SC isn't too far of a drive when SHTF.

Wed, 10/28/2015 - 18:04 | 6723644 Seer
Seer's picture

Cows.  Barn doors...

Bernanke is doing just fine.

Wed, 10/28/2015 - 18:07 | 6723658 Duc888
Duc888's picture

"The fed" and it's member banks are in business to skim off of those who are productive on this planet. It was never and is currently not a symbiotic relationship. There is no purpose for "The Fed" since our government can legally coin (print) it's own money.
The "Fed" exists solely for the purpose of gorging on the host (people / governments) of the planet. The Fed is a parasite.

Wed, 10/28/2015 - 18:46 | 6723835 newnormaleconomics
newnormaleconomics's picture

It's "its member banks". If you're going to waste a keystroke, do it correctly. 

If you don't know the difference between a possessive pronoun and a contraction, look it up. Not knowing makes you look like someone who doesn't know that he doesn't know, which is the worst kind of ignorance; it detracts from your otherwise good point. 

 

Wed, 10/28/2015 - 19:20 | 6723962 Starkman
Starkman's picture

Really? A grammatical mistake, and you're all over his case? What, you're the grammar police now? Your comment contributed so greatly to the don't-make-grammar-mistakes-ever cause?

Wow!

Thu, 10/29/2015 - 06:48 | 6725238 amadeus39
amadeus39's picture

Obviously it distracts you, you nitpicking naboob.

 

Wed, 10/28/2015 - 18:17 | 6723693 buzzsaw99
buzzsaw99's picture

had they guaranteed bank deposits in 1929 it would have mitigated the pain. now they guarantee everything and the maggots are only too happy to take advantage of the situation. there is no way out now. they will buy it all someday. even they don't know it yet but they will.

Wed, 10/28/2015 - 18:21 | 6723721 I AM SULLY
I AM SULLY's picture

Why can't we load Bernanke, in a shoddy USSR (1960's) Soviet rocket, but a broken one - and just launch that ass into space, but not really, he will just explode after lift-off? Why can't we raise some funds to do this? HELL! WE COULD RAISE FUNDS THIS WAY! I'd pay to see Bernanke loaded onto a rocket that is guaranteed (and I mean guaranteed) to explode!

https://www.youtube.com/watch?v=iKS-pcyNERQ

Wed, 10/28/2015 - 18:25 | 6723736 taopraxis
taopraxis's picture

Long article...too long. The Fed's policy actions and the stated theories used to justify them do not merit serious economic debate because what is underway is a fraud designed to prop up insolvent banks and governments via a pyramid scheme.

The nightmare of the past seven years reminds me of a couple of previous occasions in my life where I happened upon people discussing the incoherent and outrageous speech/actions of a pathological liar, i.e., sociopath. People tried to reason their way to a conciliation between words and actions that refused to cooperate. They debated the subject's motives endlessly. They seemed fascinated. The idea that the individual was simply a liar never seemed to dawn upon them...

Wed, 10/28/2015 - 18:50 | 6723857 Seer
Seer's picture

As Derrick Jensen says, folks try to shoot the premise past you so that you don't notice.  Once people have no real premise to examine then pretty much anything can fly.

The fundametally bad premise, the one that NO ONE talks about (not even the "smart" people here) is that EVERYTHING is based on perpetual growth on a finite planet.  These sociopaths are able to roam freely because no one questions the insanity of the premises (mostly that "growth is good").

Wed, 10/28/2015 - 19:18 | 6723933 Exalt
Exalt's picture

We can only hope we grow ourselves off this planet before we are forced to confront that deepest darkest reality.

People think space travel is a pipe dream and maybe it is, but we had better find out if we can sail the infinite sea soon.

If that doesn't happen, well... we will just be another evolutionary dead end. A tragic one for sure, but hopefully a bright one too.

Wed, 10/28/2015 - 21:01 | 6724323 Seer
Seer's picture

We've got a "behavioral" problem.  Taking off in a space ship won't correct that. (rinse, repeat)

On one side there's the religious folks believing that they'll be pulled off the planet and up to <heaven/wherever>.  On the other hand it's the technology folks believing that we'll escape by rocket ship.  For some reason folks aren't able to ask what's so bad about this planet?  I really wish that those two (huge) groups of people got their wish and were able to leave this planet, myself and others would then, perhaps, have some real peace.

Realistically, all I push is for people to understand this growth thing.  I don't hold out much hope that we'll change behavior or wise up, but I believe that the odds are likely better than those "solutions" being pushed by the two predominant-"thinking" groups.

Thu, 10/29/2015 - 02:26 | 6725016 StychoKiller
StychoKiller's picture

You do know that the Sun ain't gonna last forever, correct?

Thu, 10/29/2015 - 06:53 | 6725248 amadeus39
amadeus39's picture

Forever is a very long time. A little less than that will suit our species just fine.

 

Wed, 10/28/2015 - 19:03 | 6723899 Exalt
Exalt's picture

Love your little anecdotes taopraxis keep them coming!

Wed, 10/28/2015 - 18:36 | 6723781 MASTER OF UNIVERSE
MASTER OF UNIVERSE's picture

Friedman & Bernanke are both retarded Jews.

 

End of story, class dismissed.

Wed, 10/28/2015 - 18:41 | 6723810 newnormaleconomics
newnormaleconomics's picture

https://research.stlouisfed.org/fred2/graph/fredgraph.png?g=2l9K

https://research.stlouisfed.org/fred2/graph/fredgraph.png?g=2l9X

For any of the resident bitchez who are among the minority who presume to believe that the Fed will raise rates, au contraire. 

Corporate risk spreads are recessionary and at the levels of the onset of recessions and bear markets in 2008 and 2001. 

More QEternity and NIRP is our future. 

But what about "breaking the buck"? 

Where to hide? 

Wed, 10/28/2015 - 19:02 | 6723890 Seer
Seer's picture

BUT!  Can we really say that "rates" haven't been raised?  To the average person it appears that the "cost" of getting their hands on more money is only becoming more difficult (credit contraction).

I think that concentrating on "rates" is exactly what they want you to do as we all miss the sleight of hand activity that's happening.

When it's all being manipulated then any normal sense of terminologies can no longer really be taken as being viable to describe or convey what is going on: OK, "theft" is still applicable, and might be the ONLY word/term that still is!

Wed, 10/28/2015 - 19:01 | 6723822 Exalt
Exalt's picture

This was an awesome article. Really well informed and educational, if a little long. I thoroughly enjoyed reading it though.

I always liked Milton Friedman but found myself completely at odds with his position on monetary policy and money.

This article presents a very clear and sober view of how he went wrong and how history was distorted...

Wed, 10/28/2015 - 18:44 | 6723824 ali-ali-al-qomfri
ali-ali-al-qomfri's picture

The courage to Act, like you know what you are doing.

Wed, 10/28/2015 - 19:05 | 6723905 Exalt
Exalt's picture

Well said.

Wed, 10/28/2015 - 21:06 | 6724336 Seer
Seer's picture

Well, they really are little more than actors, right?  It's all a big show they're putting on.  Our bust for thinking that it's reality...

Wed, 10/28/2015 - 18:49 | 6723853 RaceToTheBottom
RaceToTheBottom's picture

The solution is always more WS hangings

Wed, 10/28/2015 - 18:51 | 6723862 lordbyroniv
lordbyroniv's picture

Ricardo, Says, Friedman, Keynes...stockman,..etc...etc...

All these intellectuals are missing what is really going on.

And espousing flowery rhetoric to cover it all up.

Its ALL 'Will to Power' shit that is going on.

Nothing more.  Nothing less.

There is no other way to explain the day to day betrayals that are obvious on their face,...day after day.

No, no,..this is not about finding the flaw in reasoning and execution.

Everything IS going according to plan.

Perfectly in fact.

There are no mistakes.

None.

 

 

Wed, 10/28/2015 - 18:57 | 6723884 adr
adr's picture

If they would have just burned down Wall Street and outlawed public stock trading after 1929, everything would have been fine.

Wed, 10/28/2015 - 19:03 | 6723900 I Write Code
I Write Code's picture

TL;DR.  I was liking it, but then as usual Stockman started wandering off into the weeds.  I don't have a position (or deep knowledge) of What Really Caused The Depression, but contra Stockman I gather there is *some* truth to the idea that there was a liquidity shortage engineered erroneously by TPTB.  Stockman says, "Nobody who presented good collateral" was turned down, but that's the problem nobody could present good collateral.  OTOH, there's also nothing wrong with running an economy on cash, so maybe I agree that it wasn't the Fed's actions that caused or extended the Depression.

But I'm also not certain that Bernanke ever *really* cared about liquidity or lending, no matter how many times he mouths the words.  What he cared about was bank capital.  Due to the collapse of the leveraged market system in 2008, banks were in technical violation of every capital rule in the book for the next five years - and the Federal government started running a trillion dollar deficit thanks to Bush's wars and Obama's patronage.  The Fed funded banks, wars, and welfare.  Thanks, Fed.

Bernanke NEVER HAD A CRISIS to deal with.  Paulson took care of the crisis in 2008 with TARP funds, which were largely repaid.  The Fed facilitated that, and maybe that was a good thing, but it was basically over by the end of 2009.  The next FOUR TRILLION dollars printed, and still earning interest for the Fed, Bernanke's Bonanza, has no real purpose.  OK one, it helped hide the collapse of the real estate bubble and the huge backlog of foreclosures, still not completely rectified.  Bernanke thought he was buying some inflation with that $4t, he *wanted* that inflation to monetize the real estate mess, but that inflation never came.  For better or worse.  No matter how much courage Bernanke thinks he showed.

But he's been a coward, a liar, and a crook since about 2010.

Wed, 10/28/2015 - 19:30 | 6723999 AMPALANCE
AMPALANCE's picture

Pre internet Theory suggested that a newly enacted charity/nonprofit laws where changed and the deadline to remain under the old rules pulled 1/3 of the currencey out of the economy in 1927 IIRC. Hence the terms old money and new money. Liquidity contraction was under way before the peak would be reached in 1929.

Wed, 10/28/2015 - 19:51 | 6724084 I Write Code
I Write Code's picture

Interesting.  News to me.  Makes a kind of sense.  But bubbles happen and they always pop, it's always something.

Wed, 10/28/2015 - 19:17 | 6723949 Starkman
Starkman's picture

Disregard

Wed, 10/28/2015 - 19:53 | 6724007 Give up. Realit...
Give up. Reality is not scientific nor even mathematical.'s picture

Here's a synopsis by quotes, with a comment after each quote.

"By contrast, the twelve-member FOMC is about as close to an unelected politburo as is obtainable under American governance. When in the fullness of time, the FOMC lined up squarely on the side of debtors, real estate owners, and leveraged speculators——-and against savers, wage earners, and equity financed businessmen——-the latter had no recourse from its baleful policy actions."

This is our current situation the author is describing.  Years of ZIRP are strangling the economy.  Interest income is the engine of consumption.  This extended funneling of the value inherent to the depositor's dollar by shunting interest income to the TBTF banks with ZIRP free money is causing a genocide in the U.S.  It is not bankers jumping out of windows.  It is every day Amercans committing suicide today.

"At the end of the day, Friedman’s monetary treatise offers no evidence whatsoever and simply asserts false causation; namely, that the passive decline of the money supply was the active cause of the drop in output and spending. The true causation went the other way: the nation’s stock of money fell sharply during the post-crash period because bank loans are the mother’s milk of bank deposits. So, as bloated, insolvent loan books were cut down to sustainable size, the stock of deposit money (M1) fell on a parallel basis."

The Bernanke solution was to provide trillions to the insolvent TBTF banks, trillions in ZIRP money, which have not been loaned, but were converted into Treasuries, which have been parked at the FED.

"The dwindling business at the discount windows of the twelve Federal Reserve banks further proved the point. In September 1929 member banks borrowed nearly $1 billion at the discount windows, but by January 1933 this declined to only $280 million. In sum, banks were not lending because they were short of reserves; they weren’t lending because they were short of solvent borrowers and real credit demand."

There's no multiplier effect from money parked at the FED, then or now.

 "Herbert Hoover had been correct: the US depression was rooted in the collapse of global trade, not in some flaw of capitalism or any of the other uniquely domestic afflictions on which the New Deal programs were predicated. Indeed, the American economy had been thoroughly internationalized after August 1914 and had grown by leaps and bounds as a great export machine and prodigious banker to the world."

We have a collapse of global trade today that is accelerating because local and national economies are not recovering.  Local and national economies must nominally recover before the global economy will revive.  The FED stares dumbfounded at commodity and global trade numbers, while ignoring Main Street, which must recover before global trade will revive.

"In short, the Chicago case further illuminates the fact that the wave of bank failures during 1930–1932 was not the result of irrational public sentiment and “contagion,” or a fundamental breakdown of bank liquidity, but instead was evidence of a discriminating, rational flight of depositors from unsound banks and markets."

All our TBTF banks are unsound today.  They have borrowed trillions at the FED window and rehypothicated those trillions with the Treasuries they bought, which are simply parked at the FED.  The trillions in rehypothicated paper money (Treasuries) can never be paid back, because the Federal Government will be forced to roll over the debt.  So our TBTF banks are still insolvent, impossibly indebted to the FED.  That debt will be permanent.

"By June 1933, economic activity levels attained in the previous September had been regained and a slow upward climb ensued, led by the steady replenishment of fixed assets and working capital. To be sure, recovery was greatly attenuated by the shutdown of international trade, but in a process that was drawn and halting, nominal GDP eventually reached the $90 billion level by 1939. After seven years of New Deal medication, the nation’s money income was still straining to reach its 1929 level."

Hoover stressed rebuilding the local and national economies, not the global trade that had collapsed.  And this worked.

"The crucial point, however, is that these thousands of failed banks were insolvent and should have been closed. They were not evidence of some fundamental breakdown of the banking system, or failure of the Fed to supply adequate liquidity, or a systemic crisis of capitalism."

This is the way an economy is supposed to work.  Some of the TBTF banks need to go out of business.  They are insolvent and dependent upon FED interest rate schemes that are causing genocide in the US.  The FED is focused on the gloabl economy, ignoring the tragic genocidal consequences playing out in our local economies.

The value of bank deposits should reset to free market rates, and not be set by the FED for the benefit of insolvent banks that are strangling any possible American economic recovery.  Some, if not all of the TBTF banks, are just so much unnecessary chaff in the economy.  The contraction is that severe after years of ZIRP.  We cannot continue to support all these TBTF banks through FED maneuvers that ignore the plight of so many Americans.


Wed, 10/28/2015 - 20:18 | 6724176 MASTER OF UNIVERSE
MASTER OF UNIVERSE's picture

The FED is simply hanging on to the last remnants of dear life that it can hang onto before the earthquakes of rot in the system start to shift tectonic plates in the shadow banking sector, and on main street, as well as EM. I get your logic for renewal, but ask yourself if you really think that any sort of renewal is heading towards American banks, or the banking sector, anytime soon? The trend puts America in the shitter for a minimum of forever based on what it would take to reverse damage done since 2008. Trillions upon trillions have been pumped into the Ponzi and it cannot be pumped back up. Ergo, the entire system is crashing progressively each quarter. The FED knows they are effin' fucked, and so do we.

 

End the FED Totalitarianism.

Wed, 10/28/2015 - 19:46 | 6724056 Wilcox1
Wilcox1's picture

It is pretty much the ultimate example of moral hazzard: You give any unaccountable government worker who has no business experience access to the taxpayer and that unaccountable government worker will very soon think that money is free.

Wed, 10/28/2015 - 20:12 | 6724153 blindman
blindman's picture

b.b., should he awaken, may become the smedly
butler of the financial wars of the 21st century.
.
probably not.
.
VerbeWarp
"Madness is rare in individuals, but in groups, parties, nations, and ages it is the rule." ~ Friedrich Nietzsche
http://verbewarp.blogspot.com.au/2015/10/its-not-economy-stupid-its-econ...
.
i would offer that madness is just fucking ubiquitous,
but, that from a blind seeing madman.
.
28 OCTOBER 2015

John Ralston Saul and Chris Hedges On NeoLiberalism, Ideology, and Dead Infants
.
"'Modern capitalism is masterful at producing services people don't need and in large part probably don't want. It is brilliant at convincing people that they do need and want them. But it has difficulty turning itself to the production of those services which people really do need.

Not only that, it often spends an enormous amount of time and effort convincing people that those services are either unrealistic, marginal or counterproductive.'

John Ralston Saul" jca
.
it seems power is just a fiction
which people share under the umbrella
of fear of impotence, a gender thing?
.
http://jessescrossroadscafe.blogspot.com/2015/10/john-ralston-saul-and-c...

Wed, 10/28/2015 - 20:25 | 6724198 hannah
hannah's picture

the whole premise of this article is wrong. bernanke has never done what he says he is doing. it is all a front. all he can do is print or not print money. period. his goal is to print as much money to give to the .1% as possible til the wheels fall off. reading his shit is worthless. look at what he did not what he said,.....

Wed, 10/28/2015 - 20:47 | 6724270 jmeyer
jmeyer's picture

There actually IS a big problem that Yellen, Bernanke, and Greenspan have had to deal with and that is the problem of the degree to which banks have driven their speculation, especially in DERIVATIVES. Nominal total derivative valuations are around $1000 TRILLION. If only 10 % is at very serious risk then there is a monster financial problem if the boat capsizes. This is a world wide financial neutron bomb that must be " pretended and extended " as far as possible to prevent detonation. Even the Rothschilds are worried.

 

Wed, 10/28/2015 - 21:39 | 6724477 Don Pancho
Don Pancho's picture

Paul Eberhart is sure glad the honor-hero brernanke had the courage to act and save america.

Wed, 10/28/2015 - 22:10 | 6724565 Turin Turambar
Turin Turambar's picture

Not going to waste my time reading this overly long article. Want to know the truth about the Great Depression? One word:

ROTHBARD!

Friedman is the most overrated so-called "free-market" economist ever. Yeah, he's great if all you need is a pithy quote, but for some serious free-market Econ, run from the Chicago school and in the direction of Austrians like Mises and Rothbard.

Thu, 10/29/2015 - 10:28 | 6725962 MEFOBILLS
MEFOBILLS's picture

Stockman seems to be perpetually confused.

After the FED creation around 1912 America almost immediately got into WW1.  The bankers wanted this war.  At end of WW1 allies were on a debt hook to U.S. Treasury, and had transferred most of their Gold to U.S.  For example, American doughboys sent to France were partially paid by France, as if doughboys were mercenaries.

These countries could not export to gain dollars to then pay America, so instead they sent their Gold for Guns/doughboys.

After WW1, Euro-Peons, especially banker buddies in England and America made a secret deal to keep interest rates low, so Gold could be repatriated back to Europe.  This is a matter of congressional record.

Interest rates low in the U.S. artificially stimulated credit creation out of private sector.  People took out loans to then gamble in stock market.  Extra bank credit formation also leads to low exchange rate price for gold, and export dollar acquistion by England and France.  This means they could buy back their gold.

Keeping rates artifically low in the U.S. was purposeful banker collusion and led directly to stock market bubble.  This in turn built up private debts.

Note that private debt formation is also behind the recent housing bubble.  

Everytime there is a bubble it pushes sector prices.   In this case it pushed the stock market.  Stock market goes up, people take out more loans, stock market goes up and so on in positive feedback.  But, since it is loaned credit money pushing prices, and not real economic activity, then eventually the bubble will collapse.

Upon collapse stocks become undervalued, yet banker debt instruments stay on the books.  Debt instruments still demand to be paid, and they drain their credit back into ledger to then make said credit disappear.

In this way, private bank credit money disappears, and causes deflation.  On beginning of hypothecation cycle, credit formation causes inflation and stock market price pushing, and then later it caused deflation to depression.

To get out of banker induced depression, it took exogenous money from treasury to then pay off private debts.  

This exogenous money came from Reconstruction finance corporation and later from WW2 line item spending.

These extra external dollars (exogneous means outside of banking system) then funneled into paying labor, and labor then paid off their private debts built up during bubble years of the 20's.

So, absolutely, FED and private bankers caused the great depression.  After stock market crashed, Bankers also called in loans, further accelerating the destruction of credit money used normally for transactions.  In this environment also, bankers stopped making loans, further draining money supply.

Stockman, you lose more and more credibility with every utterance.  You are confused and your narratives do not pass muster.

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