delanceyplace.com 12/4/09 - the great depression

In today's encore 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.