Thursday, March 20, 2008

The Fed and the Great Depression

There is a large group of folks who believe that the Depression was caused by Smoot-Hawley, the tariffs which were emplaced to assist US businesses.

Of course, the Smoot-Hawley tariff was not 'the cause' of the Depression--at least by the numbers.

According to the U.S. Statistical Abstract, the effective tariff rate was 13.5% in 1929 and 19.8% in 1933. From 1821 through 1900 the United States averaged 29.7% effective tariff rates and peaked in 1830 at 57.3%, dwarfing the Smoot-Hawley rate

(If anything, the above tells us that higher tariffs are better for the US than the low tariffs of Smoot-Hawley.)

Actually, the Depression was stoked by the Fed--according to Milton Friedman.

The [1929] recession was an ordinary business cycle. We had repeated recessions over hundreds of years, but what converted [this one] into a major depression was bad monetary policy.

The Federal Reserve System had been established to prevent what actually happened. It was set up to avoid a situation in which you would have to close down banks, in which you would have a banking crisis. And yet, under the Federal Reserve System, you had the worst banking crisis in the history of the United States. There's no other example I can think of, of a government measure which produced so clearly the opposite of the results that were intended.

And what happened is that [the Federal Reserve] followed policies which led to a decline in the quantity of money by a third. For every $100 in paper money, in deposits, in cash, in currency, in existence in 1929, by the time you got to 1933 there was only about $65, $66 left. And that extraordinary collapse in the banking system, with about a third of the banks failing from beginning to end, with millions of people having their savings essentially washed out, that decline was utterly unnecessary

Umnnnh......that's why Friedman was called a "monetarist" theoretician in economics. It may be the case that Smoot-Hawley tariffs (which were reciprocated by Canada and Europe) lent to the malaise, and it may not. It SHOULD be hard to argue that the historically-low S-H rates were the "cause" of the Depression, but people make that argument without shame on a regular basis.

The question is "how much cash is right"--clearly, Bernanke is willing to monetize in the current situation.

No doubt we'll learn something this time around, too.

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