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The Great Depression, the gold standard and FDR



April 26, 2008 – Comments (8)

This is the second part, this time on the Great Depression. Sorry for the length but I just kept on writing, it is a fascinating theme. I hope this piece is interesting and worth your time.

You can read the first part on the roaring 1920s and the stock market crash 1929 here. Again, first some text and then a few videoclips (BTW, if you click on the clips and it says "video not available anymore", just reload the page. It is some kind of bug by youtube were videos become unavailable after the page is open for an hour or so)

The Great Depression (GD) was a period were economies worldwide contracted over several years. Prices for goods dropped massively and brought entire industries to a virtual halt. Crop prices dropped 50%. Massive unemployment resulted.

The USA was one of the hardest hit, as from 1929-1933 their economy contracted 30% and unemployment rose to 25% by 1933 from 4%. In Australia unemployment reached 30%. In Canada industrial production fell to 60% of their 1929 level, unemployment reached 27%. In the UK exports fell by 50% and unemployment reached 20%. In Germany the crisis brought down the Weimar Republic and brought Adolf Hitler to power.

After the huge stock bull market during the 1920s, the Fed started to raise rates early in 1929 to reduce speculation. As we know this resulted in the crash in october 1929, when massively overleveraged speculators had to liquidate their positions. Back then credit was very lose. Some of those speculators were millionaires who were leveraged 10:1, which means they might have had $10 millions worth in stocks with only $1 million of their own money. Or $100 m in stocks with $10 m. While the market crashed they received a margin call from their broker, and so they were forced to throw all their stocks into the crashing market. Needless to say they went broke.

So, huge fortunes were destroyed in the crash of 1929. However this was NOT the cause for the Great Depression. Because the stock market recovered and gained almost 50% until April 1930. However the economy started to cool down and it was thought that a normal recession was ahead.

Today we live in a system of flexible currency rates. This helps the central banks of each country to concentrate on their own economy, which is very actual in the US today, as the Fed is trying to solve the banking crisis and help the economy. As we know the dollar dropped massively while other currencies like the Euro, the Canadian Loonie or the Australian dollar gained.

Back then however it was thought that currencies had to be stable and that flexible currencies were bad for international trade. Also, it was thought that every currency had to have a certain value measured in gold. Everybody (individuals, banks, companies etc.) had the right to exchange their paper money for gold. This is called the gold standard. It was thought to give trust in a currency.

The gold standard forced the central banks (CB) to accumulate massive gold reserves. The standard worldwide was that 40% of currency in circulation should be backed by gold. If this limit was broken the CBs had to take appropriate measures which meant they usually had to raise rates. Because since gold doesn't generate any income, it would calm down investors as they would receive higher income.

So as the US economy cooled down it brought some politicians to introduce the Smooth-Hawley act in June 1930, which would raise tariffs on imported goods. This made other countries to introduce tariffs on US imports themselves in retaliation.

So as the world economy cooled down banks worldwide started to fail. When the giant Austrian bank Creditanstalt (the Rothschild bank), on which 60% of the Austrian economy was dependent, collapsed in 1931, it caused many panicked investors and depositors to redeem their money and exchange it for gold.

Germany later said they would stop paying for war reparations to France and the UK which caused even more panic. Depositors and banks worldwide started to exchange their paper money into gold at the central banks. When the British central bank had almost no gold reserves left, they started to raise rates to keep the confidence of depositors. However they weren't successful and finally the UK in September 1931 decided to drop the gold standard and let the currency float freely. The British Pound dropped and it was thought that inflation would hit the country hard. But this was not the case, on the contrary the economy recovered.

When the British Pound collapsed frightened depositors in the USA started to redeem their money too and exchange it for gold, as accounts were not insured back then. So the Fed was forced to raise rates rates from 1.5% to 3.5%, this during a recession. Since the USA had more gold reserves than the Bank of England, they were finally able to convince people to keep their money in the banks (but only after a while...).

Many more banks in the US collapsed, more than 2200 by the end of 1931. But the Fed did not intervene to help them, it was thought that "the market will do its thing". So loans were called in or not renewed. Lending standards were raised. The money supply contracted by 30%. This caused many businesses to cut down massively or even go bankrupt, and so they let their employees go which resulted in a huge unemployment rate. As there was no social security those unemployed went to live in tents and huts in shantytowns or "Hoovervilles", as they were also called. The same what you can see in third world countries today.

Finally in April 1932 the Fed started to buy securities from the banks to give them liquidity and stabilize the banking system. In July 1932 the stock market finally bottomed out after losing 89%. On November 8 Franklin D. Roosevelt (FDR) defeated Herbert Hoover and became the 32nd President of the USA. The economy bottomed out in March 1933.

FDR announced the New Deal and introduced several programs to revive the economy. He first declared a bank holiday in March 1933 to reorganize the banks. On April 19 the USA went off the gold standard. People were told to exchange all their for paper money, except their jewelry and gold teeth for the then official price of $20.67 (Foreign banks however were still allowed to exchange dollars for gold.) In June the Glass-Steagall act was introduced which separated the banks into investment banks and commercial banks. The FDIC was created which insured all bank deposits up to $5000 (back then, today it's $100'000). Minimum wages were introduced and minimum prices, to curb brutal competition.

The prohibition, which created huge profits for gangsters that smuggled alcohol from foreign countries, eg Canada, was abolished. Al Capone controlled almost all clubs serving alcohol. Many people continued to drink during the prohibition in clubs controlled by organized crime. They immediately lost all their income, once the prohibition was abolished. Also, since it was illegal, there was no control and regulation and so quality was often terrible, resulting in health problems. Home breweries flourished.

In January 1934 FDR raised the price of gold to $35, thus devaluing the US dollar. Other programs were introduced. The unemployment rate dropped from 25% to 9% by 1937. In 1935 social security was introduced, which back then also included unemployment insurance.

In November 1936 FDR was reelected as President of the USA. In May 1937 the US economy fell into another recession lasting through most of 1938. The unemployment rate rose to 19%. Other programs were introduced. Over time federal spending rose to 10% of Gross National Product, up from 3% in 1929.

So the economy started to improve again, but only World War 2, which resulted in massive government spending and raised the national debt from 40% of GDP to 128% of GDP, finally ended the Great Depression. The war spending also resulted in personal savings by ordinary people.

Chart from, with some further interesting infos.

OK, let's go to the videoclips.

First clip covers the abolishment of the gold standard, one of the main causes of the Great Depression. (4 min)

Second clip covers the inauguration of FDR, the New Deal; the announcement of a bank holiday; the so called "fireside chat"; the end of the gold standard (5:30)

Third clip is the second part of the previous clip and covers the programs during the New Deal (4 min)

rise and fall of the NRA (National Recovery Act) a program by FDR that included codes of conduct for marketing, pricing and labour standards, eg minimum wages, unions. (4:45)

Here another interestin clip that covers the Great Depression (4 min)

I hope this piece wasn't too long and you had as much fun to read it as I had to research it. Again, here is the first part on the roaring 1920s and the stock market crash 1929. 

8 Comments – Post Your Own

#1) On April 26, 2008 at 3:38 PM, camistocks (67.03) wrote:

Charlie Chaplin was a comedian and pioneered silent movies. His most famous character is the "Tramp".

One of his most famous movies is "Modern Times" from 1936 which pictures the times of the Great Depression in a funny way. The entire movie is posted on youtube! You can start on the following link and click on the next parts on the right. Have fun!

First part:

And finally here is a clip from the movie the Great Dictator from 1940, where Chaplin portrays Adolf Hitler alias Adenoid Hynkel. As we know Hitler came to power because of the demise of the Weimar Republic, which was caused by the Great Depression. This was a so called early warning movie, but it was ignored. It shows how Dictators try to manipulate and control the masses.

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#2) On April 27, 2008 at 1:50 PM, saunafool (< 20) wrote:

Great stuff. Thank you.

And so, the conclusion is that the great depression was caused by the implosion of overly leveraged speculators into a gold standard market that was inflexible in dealing with the implosion. Yes?

Now, I think we are in a similar situation on the front end--a downturn caused by the implosion of overly leveraged speculators, this time in the housing market. The Fed will likely prevent a huge deflationary depression by pumping liquidity into the system. this going to lead to something else? My guess is the biggest risk is an out of control inflationary spiral. I thinik the risk is worse because the measures of inflation are so distorted by political considerations--can't show the CPI at 6% because we'll have to raise Social Security payments.

Having looked at the Great Depression, do you have any ideas of what might happen today? Speculate with me, even though it's probably futile.

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#3) On April 28, 2008 at 9:05 AM, camistocks (67.03) wrote:

Sauna, yes, apparently overleveraged speculators and the gold standard were a reason for the Great Depression. (Think of overleveraged hedge funds today) Another very important reason was that the Fed did just stand by and let the market "do its thing", meaning collapse, fueled by short sellers. They did not help the banking system.

Today the Fed and the government are here to help the economy and the banking system. They won't let the market "do its thing" (meaning that short sellers would have a free lunch. Some of them are really angry, that they can not make more money by shorting investment banks.)

Or as to quote Bernanke during a speech honoring Milton Friedman in 2002:

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.

Bernanke has studied the causes of deflation for all his life (Great Depression, Japan deflation), so I guess he should know how to help the economy. 

There will certainly be deleveraging in the next 1-2 years, as the banks tighten loan standards, but it will be a gradual process which over time will erase those that aren't able to cope with their payments. I guess most of the overleveraged homeowners have already lost their house, now the remaining homeowners will have to prove that they are worth it. Same for businesses, whose business model relied on very low rates and lose lending standards. They will be wiped out. 

Regarding hyperinflation: there is a measure for inflation which is not affected by the government propaganda. It's the long term rates, because they are set by the market. Currently 10 year treasuries only yield 3.8%. That is not a sign that the market is afraid of inflation, otherwise rates would be higher. Back in the high inflation 1970s yields were between 6 and finally 15% for the 10 year treasury. 

But as you say, who knows what the future will really bring... :-)

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#4) On April 28, 2008 at 12:12 PM, camistocks (67.03) wrote:

Here the chart, there's no inflation fear ahead for the economy... (although we might have price increases in some sectors, like food or gasoline)


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#5) On May 01, 2008 at 4:49 PM, madcowmonkey (< 20) wrote:

Did he say "Herapin is garbage?"

 Nice addition to the GD . Why the treasuries not higher? It doesn't make sense. How are they keeping up? I am still listening to Chaplin:) The other videos were rough. The farming pictures, wow. I never realized how bad the dust storms were. That had to be Oklahoma (armpit of america). Thanks for the information. 

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#6) On May 04, 2008 at 2:20 PM, madcowmonkey (< 20) wrote:

if this was around during the gd, we would have pulled through immediately or at least there would be less suicides.



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#7) On May 06, 2008 at 12:41 AM, camistocks (67.03) wrote:

madcow, Chaplin/Hynkel did say a lot of things, just the beginning: "der Wienerschnitzel mit der Lagerbeer und der Sauerkraut...", Well... :-)

BTW apparently they sent Hitler a copy of the movie, and according to an eyewitness, he did watch it! No comments on his reaction however... 

Hey what's that, you're watching Stefan Raab...? (although he is pretty much OT here... )

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#8) On May 06, 2008 at 1:07 PM, madcowmonkey (< 20) wrote:

Raab is fun to watch and I check on the new videos for youtube. I get a kick out of his sense of humor and how he plays the artists that he invites on his show. 

I am sure hitler was laughing and throwing stuff at the same time. Leaders tend to not take criticism/mockery so well, especially a leader looking for world domination.

 I think that what your article depicts is that a few misplaced/misguided steps and bad things can start to domino . Fortunately, there is a knowledge of history in this case, but that doesn't make it a guarantee that bad things will not happen. If the homeowners that are left can pay their mortgages, then a rebuild will be in place. If not, then we will have a bigger crisis. Regardless, our banks are hurting right now, but my opinion is that they were the ones that put us in this spot.

The masses can only react to what is in the media these days and I feel the media is manipulating and misinforming the public. Not very often do you see the public making the first move, it is always followed by the medias coverage/thoughts first. This is a different era than the GD and it will be interesting to see it play out.

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