A Distant Mirror: Credit contraction, monetary policy

and commodity prices during the Great Depression
John Kemp
Reuters
30 January 2009

MANUFACTURING OUTPUT AND CONSUMER PRICES 1920-1953
INDEX JAN 1920 = 100

400

350

300

250

200

150

100

50

0
1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 1942 1944 1946 1948 1950 1952

Manufacturing Output

Consumer Prices

CONSUMER AND WHOLESALE PRICES 1920-1953
INDEX JAN 1920 = 100

200

175

150

125

100

75

50

25

0
1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 1942 1944 1946 1948 1950 1952

Consumer Prices

Producer Prices

BORROWING BOOM IN 1920s …. FOLLOWED BY DE-LEVERAGING IN 1930s
U.S.$ bn
350

300

250

200

150

100

50

0
1920

1922

1924

1926

1928

1930

1932

1934

Private sector net debt

1936

1938

1940

1942

of which, Corporate net debt

1944

1946

1948

1950

1952

BEFORE THE CRASH, ROARING TWENTIES SAW HUGE RISE IN DEBT, EQUITY ISSUANCE
U.S.$ mn
10,000
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
1920

1922

1924

1926

1928

1930

1932

1934

1936

1938

1940

1942

Net issue of new securities (minus retirements)

1944

1946

1948

1950

1952

RECORD MARGIN LOANS TO FUND EQUITY PURCHASES, DOUBLING 1926-1928,
ONE MANIFESTATION OF RAPID FINANCIAL INNOVATION AND INCREASED RISK APPETITE

U.S.$ mn
7,000

6,000

5,000

4,000

3,000

2,000

1,000

0
1920

1922

1924

1926

1928

1930

1932

1934

1936

1938

1940

1942

Brokers' loans to fund purchase of equities (1920-1938)

1944

1946

1948

1950

1952

ONCE DOWNTURN UNDERWAY, BANKS RESPOND BY SHRINKING BALANCE SHEETS
BANK ASSETS FALL 30 PERCENT 1930-1934

U.S.$ mn
250,000

200,000

150,000

100,000

50,000

0
1920

1922

1924

1926

1928 1930

1932

1934

1936

1938

1940

1942

Commercial bank assets in the United States

1944 1946

1948

1950

1952

CONTRACTION HITS REGULAR COMMERCIAL LOANS HARDEST,
BANKS SHIFT BALANCE SHEETS TO CASH AND MARKETABLE ASSETS

U.S.$ mn
250,000

200,000

150,000

100,000

50,000

0
1920

1922

1924

1926

1928 1930

1932

1934

Cash

1936

1938

Investments

1940

Loans

1942

1944 1946

1948

1950

1952

VOLUME OF BANK LOANS SHRINKS 50 PERCENT BETWEEN 1929 AND 1933
U.S.$ mn
90,000

80,000

70,000

60,000

50,000

40,000

30,000

20,000

10,000

0
1920

1922

1924

1926

1928

1930

1932

1934

1936

1938

1940

1942

1944

1946

Outstanding loans and advances by commercial banks in the United States

1948

1950

1952

RESTRICTIVE CREDIT POLICY AND SLUMPING ECONOMY TRIGGER UNPRECEDENTED
WAVE OF BANK FAILURES
Number, U.S.$ mn
4,500

4,000

3,500

3,000

2,500

2,000

1,500

1,000

500

0
1920

1922

1924

1926

1928

1930

1932

1934

Number of banks suspended

1936

1938

1940

1942

1944

1946

Volume of deposits in suspended institutions

1948

1950

1952

DURING 1933, MORE THAN 8 PERCENT OF ALL BANK DEPOSITS ARE "SUSPENDED"
(ie FROZEN)

Per cent
10
9
8
7
6
5
4
3
2
1
0
1920

1922

1924

1926

1928

1930

1932

1934

1936

1938

1940

1942

Deposit suspensions as percentage of total bank deposits

1944

1946

1948

1950

1952

COLLAPSING CONFIDENCE IN THE BANKING SYSTEM DRIVES STRONG PREFERENCE
FOR CASH RATHER THAN BANK DEPOSITS
U.S.$ bn
60

50

40

30

20

10

0
1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940
Currency held by public

Bank deposits

DEMAND FOR LIQUIDITY BECOMES EXTREME,
DEPOSITS SHRINK EVEN AS CASH DEMAND RISES
12

10

8

6

4

2

0
1920

1922

1924

1926

1928

1930

1932

1934

1936

1938

1940

1942

Ratio of bank deposits to currency in circulation

1944

1946

1948

1950

1952

MONEY SUPPLY CONTRACTS 20-25 PER CENT,
INTENSIFYING DOWNWARD PRESSURE ON BUSINESS ACTIVITY AND PRICES

US$ bn
180

160

140

120

100

80

60

40

20

0
1920

1922

1924

1926

1928

1930

1932

1934

M1 (Currency + demand deposits)

1936

1938

1940

1942

1944

1946

1948

M2 (Currency + demand deposits + time deposits)

1950

1952

INTENSE DEMAND FOR SAFE, LIQUID INSTRUMENTS DRIVES SHORT-TERM TREASURY
BILL RATES CLOSE TO ZERO

Per cent
8

7

6

5

4

3

2

1

0
1920

1922

1924

1926

1928

1930

1932

1934

Yield on 3mth Treasury bills

1936

1938

1940

1942

1944

1946

Commercial paper rates for 4-6 mth paper

1948

1950

1952

Per cent yield

PRONOUNCED UPWARD SLOPE IN YIELD CURVE, DEMAND FOR SAFETY AT FRONT-END,
FEARS ABOUT DEFAULT & INFLATION KEEP BACK END UP

8

7

6

5

4

3

2

1

0
1920

1922

1924

1926

1928

1930

1932

1Yr Aaa Corp Bonds

1934

1936

1938

5Yr Aaa Corp Bonds

1940

1942

1944

1946

10Yr Corp Aaa Bonds

1948

1950

1952

SHARP EASING IN NEARBY RATES
ONLY GRADUALLY REFLECTED IN BACK END

Per cent
8

7

6

5

4

3

2

1

0
1920

1922

1924

1926

1928

1930

1932

1934

1936

Commercial paper rates for 4-6 mth paper

1938

1940

1942

1944

1946

Yield on 10Yr Aaa-rated corp bonds

1948

1950

1952

FED STANDS BY AS MONEY SUPPLY AND BANK CREDIT COLLAPSE,
NO REAL INCREASE IN FED'S BALANCE SHEET BEFORE 1934-1935

U.S.$ mn
60,000

50,000

40,000

30,000

20,000

10,000

0
1920

1922

1924

1926

1928

1930

1932

1934

1936

1938

1940

1942

1944

Consolidated Balance Sheet of the Federal Reserve Banks

1946

1948

1950

1952

FED LENDING TO THE BANKING SYSTEM REMAINS STUBBORNLY UNCHANGED 1929-33,
CENTRAL BANK REFUSES TO BOOST MONEY SUPPLY THROUGH QUANTITATIVE EASING

U.S.$ mn
30,000

25,000

20,000

15,000

10,000

5,000

0
1920

1922

1924

1926

1928

1930

1932

1934

1936

1938

Federal Reserve Credit

1940

1942

1944

1946

1948

1950

1952

LIQUIDITY PILES UP IN FEDERAL RESERVE
U.S.$ mn

COMMERCIAL BANKS INCREASE EXCESS RESERVE BALANCES RATHER THAN RAISE LENDING

25,000

20,000

15,000

10,000

5,000

0
1920

1922

1924

1926

1928

1930

1932

1934

1936

1938

1940

1942

1944

Commercial bank reserves with the Federal Reserve System

1946

1948

1950

1952

CYCLICAL RECOVERY AND INTEREST RATES 1920-1953
LHS MANUFACTURING INDEX JAN 1920 = 100, RHS INTEREST RATES PER CENT

400

16

350

14

300

12

250

10

200

8

150

6

100

4

50

2

0
1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 1942 1944 1946 1948 1950 1952
Manufacturing Output
FRBNY Discount Rate (RHS)
FRBNY advances to banks (RHS)
FRBNY other loans secured on US government obligations (RHS)

0

FED GIVES ABANDONS CONVENTIONAL POLICY AFTER 1934,
SWITCH FROM DISCOUNT RATE (COST OF MONEY) TO RESERVE REQ'MENT (QTY OF CREDIT)

20.00

30.00

18.00

28.00

16.00

26.00

14.00

24.00

12.00

22.00

10.00

20.00

8.00

18.00

6.00

16.00

4.00

14.00

2.00

12.00

0.00
1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 1942 1944 1946 1948 1950 1952

10.00

FRBNY Discount Rate
FRBNY advances to banks
FRBNY other loans secured on US government obligations
Reserve Requirements (RHS)

SHARE PRICES 1920-1953
DOW JONES INDUSTRIAL AVERAGE JAN 1920 = 100

400

16

350

14

300

12

250

10

200

8

150

6

100

4

50

2

0
1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 1942 1944 1946 1948 1950 1952

Manufacturing Output

Dow Jones Industrial Average

FRBNY Discount Rate (RHS)

0

NO SUSTAINABLE RECOVERY IN FARM PRICES UNTIL SECOND WORLD WAR,

Index Jan 1920
= 100

BUT FARM PRICES HAD BEEN TRENDING LOWER SINCE END OF FIRST WAR

250
225
200
175
150
125
100
75
50
25
0
1920

1922

1924

1926

1928

1930

1932

1934

1936

Winter wheat

1938

1940

Cotton

1942

1944

1946

1948

1950

1952

Index Jan 1920
= 100

ENERGY PRICES FALL, BUT RECOVERY UNDERWAY FROM 1934 AND PREVIOUS PRICE
LEVEL MOSTLY REGAINED BY 1938

250
225
200
175
150
125
100
75
50
25
0
1920

1922

1924

1926

1928

1930

1932
Coke

1934

1936
Gasoline

1938

1940

Crude oil

1942

1944

1946

1948

1950

1952

SHARP GAINS IN METAL PRICES DURING 1936-1937 (STEEL RISES 25 PER CENT IN 1937)
Index Jan 1920
= 100

FED RAISES RESERVE REQUIREMENTS AMID FEAR EXCESS LIQUIDITY IS DRIVING INFLATION

250
225
200
175
150
125
100
75
50
25
0
1920

1922

1924

1926

1928

1930

1932

Steel (billet)

1934

1936
Copper

1938

1940

Lead

1942
Zinc

1944

1946

1948

1950

1952

TIGHTENING OF RESERVE REQUIREMENTS IN 1937-1938 DRAINS $3 BILLION OF EXCESS
RESERVES FROM SYSTEM, CONTRACTS CREDIT, AND TRIGGERS SECOND DOWNTURN
400

50

350

45

300

40

250

35

200

30

150

25

100

20

50

15

0
1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 1942 1944 1946 1948 1950 1952

Manufacturing Output (LHS)

Reserve Requirement (RHS)

10

Data is taken from the Census Bureau’s Statistical History of the United States (various
editions)
Except:
Manufacturing output (Federal Reserve System)
Consumer and wholesale prices (Bureau of Labor Statistics)
Dow Jones Industrial Average (Dow Jones and Co)

Sign up to vote on this title
UsefulNot useful