Delanceyplace.com 12/17/08--The Great Depression

In today's excerpt-the calamity of the Great Depression dwarfs the calamity of 2008, in large part because the Fed turned the crisis of 1929 into the Great Depression by acting to contract the money supply, helping cause U.S. output to decline by a third and unemployment to rise to 33%:

"In perhaps the most important work of American economic history ever published, Milton Friedman and Anna Schwartz argued that it was the Federal Reserve System that bore the responsibility for turning the crisis of 1929 into a Great Depression. They did not blame the Fed for the bubble itself [and] ... the New York Fed responded effectively to the October 1929 panic by conducting large-scale (and unauthorized) market operations (buying bonds from the financial sector) to inject liquidity into the market. However, after Strong's death from tuberculosis in October 1928, the Federal Reserve Board in Washington came to dominate monetary policy, with disastrous results.

"First, too little was done to counteract the credit contraction caused by banking failures. This problem had already surfaced several months before the stock market crash, when commercial banks with deposits of more than $80 million suspended payments. However, it reached critical mass in November and December 1930, when 608 banks failed, with deposits totaling $550 million, among them the Bank of United States, which accounted for more than a third of the total deposits lost. The failure of merger talks that might have saved the Bank was a critical moment in the history of the Depression.

"Secondly, ... the Fed made matters worse by reducing the amount of credit outstanding (December 1930-April 1931). This forced more and more banks to sell assets in a frantic dash for liquidity, driving down bond prices and worsening the general position. The next wave of bank failures, between February and August 1931, saw commercial bank deposits fall by $2.7 billion, 9 per cent of the total. Thirdly, ... the Fed raised its discount rate in two steps to 3.5 per cent, ... driving yet more US banks over the edge: the period August 1931 to January 1932 saw 1,860 banks fail with deposits of $1.45 billion. ...

"In the United States, output collapsed by a third. Unemployment reached a quarter of the civilian labour force, closer to a third if a modern definition is used. World trade shrank by two-thirds as countries sought vainly to hide behind tariff barriers and import quotas. ...

"The Fed's inability to avert a total of around 10,000 bank failures was crucial not just because of the shock to consumers whose deposits were lost or to shareholders whose equity was lost, but because of the broader effect on the money supply and the volume of credit [which saw] a decline in bank deposits of $5.6 billion and a decline in bank loans of $19.6 billion, equivalent to 19 per cent of 1929 GDP."

Niall Ferguson, The Ascent of Money, Penguin, Copyright 2008 by Niall Ferguson, pp. 158, 161-163